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    2015 IBM Annual Report


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    Dear IBM Investor: IBM is unique. It is the only company in our industry that has reinvented itself through multiple technology eras and economic cycles. We do so for one reason: to create differentiating value for our clients and for you, our owners. We are doing so again, in an IT industry that is fundamentally reordering at an unprecedented pace. In important ways, our industry is unrecognizable from what it looked like just a few years ago. So is your company. Today, IBM is much more than a “hardware, software, services” company. IBM is now emerging as a cognitive solutions and cloud platform company.


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    2 A Letter from the Chairman Virginia M. Rometty Chairman, President and Chief Executive Officer


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    2015 IBM Annual Report 3 In this year’s report, I will share my Then last year, we launched integrated perspective on what this means to you and units to make it easier and quicker to put to our clients around the world. I will discuss together solutions drawn from our expanding our results from 2015 and what we expect digital portfolio, further accelerating growth to achieve this year and beyond. Although more and enhancing client experience. We shifted must be done and the work of transformation more than $5 billion of investment to add fuel is never complete, I believe we have reached to our strategic imperatives, and in 2015 these a turning point in our journey. businesses delivered solid growth, contributing 35 percent of IBM’s total revenue, up signifi- The Progress of Our Transformation cantly from 22 percent two years ago. Two years ago, we laid out our strategic plan Now, in 2016, we have reached a new to transform IBM, in order to ensure that we meet stage in our transformation. As important the changing needs of our clients and capture as “becoming digital” is to our clients, it the highest-value opportunities for our investors. has become clear that it is not the destination. As part of this, we divested commoditizing Rather, digital business is converging with businesses that provided diminishing value a new kind of digital intelligence—what you will to our clients and contributed revenue but little recognize as Watson. We call this Cognitive or no profit. We restructured other businesses, Business. In October we launched a global of which hardware was the largest—businesses conversation about this new era of business vital to our future but in need of reinvention. and technology. At the same time, we dramatically accelerated Cognitive Business simultaneously speaks the growth of our strategic imperatives— to clients about the coming era and explains Data and Analytics, Cloud, Mobile, Social and the IBM that is now emerging. Let me describe Security—to help our clients become “digital.” it in greater depth.


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    4 A Letter from the Chairman Our Solutions Are Cognitive Data is the world’s Cognitive includes—but is broader than— new natural resource, and it is transforming artificial intelligence, machine learning and natural all industries and professions. IBM has been language processing. And its embodiment building and acquiring the capabilities is Watson. necessary to lead in data and analytics, Watson has come a long way since it won deepening our industry expertise and growing on the American quiz show Jeopardy! in 2011. partnerships and ecosystems. Today, our data Back then, it did one thing: natural language Q&A, and analytics business is the industry leader, powered by five technologies. Today, Q&A is generating revenue of $18 billion in 2015. just one of more than 30 Watson capabilities— This is a strong and growing business— all of which have been turned into digital services, but its potential is actually much greater. or application programming interfaces (APIs), That potential lies in the 80 percent of the delivered via the cloud. This means that we can world’s data that is unstructured: everything literally build cognition into everything digital. we encode in language—from textbooks With Watson, every digital application, product and formulas to literature and conversation— and process can understand, reason and learn. plus all digital video, audio and images. This You can see why cognitive is becoming the unstructured data has been essentially heart of our solutions businesses. What started invisible to computers. They can capture, store as one Watson unit is now a growing family: and process it, but they cannot understand the core Watson team, which continues to build what it means. new capabilities and nurture its expanding But with cognitive technology, we can now ecosystem; and individual Watson businesses, probe this “dark data.” Cognitive systems aimed at particular industries or professional can ingest it all, and they can understand its domains, such as IBM Watson Health and meaning, through sensing and interaction. They IBM Watson Internet of Things. Each business can reason about it, generating hypotheses, brings together Watson capabilities with industry arguments and recommendations. And unlike expertise, vast data sets and an ecosystem any computing system we have known, they of partners and clients, and each is powered are not programmed. Rather, they learn—from by the IBM Cloud. training by experts and from their own experience. In fact, they never stop learning.


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    2015 IBM Annual Report 5 In IBM Watson Health, for example, our partners include Medtronic, Memorial Sloan Kettering Cancer Center, the New York Genome Center and CVS Health. We have enhanced our capabilities in healthcare with expertise and data sets acquired through population health management leader Phytel, health data analytics provider Explorys and medical images firm Merge Healthcare. In February 2016 we announced our intention to acquire Truven Health Analytics, a leading provider of cloud- based healthcare data, analytics and insights. And Watson is being trained by the world’s leading practitioners and researchers in multiple fields of life sciences, medicine and healthcare. Because these IBM Watson units will be fed by an enormous new volume and variety of data, we have moved aggressively to expand our clients’ access to it, through partnerships with companies such as Twitter and Box and our acquisition of assets from The Weather Company. IBM Watson today is a rapidly expanding business, with clients in 36 countries, including leaders and start-ups in healthcare, financial services, retail, energy, automotive, government and more. And we continue to grow Watson’s capabilities—for example, giving it the capacity to “see” and expanding its natural language range beyond English—so far including Japanese, Spanish, Brazilian Portuguese and Arabic. “We can literally build cognition into everything digital. With Watson, every digital application, product and process can understand, reason and learn.”


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    6 A Letter from the Chairman Our Platform Is Cloud In a world being rewritten in code, coders are the new builders, and cloud is the platform on which they are building. All of our IBM Watson units, along with the rest of our growing portfolio of cognitive solutions, are being built on a cloud platform. The word “platform” is important. Much more than simply a faster and cheaper way to access IT, a cloud platform is a new model of innovation, manufacturing and distribution. Cloud platforms provide an open environment for collaboration and rapid scaling. They expose growing libraries of APIs from which partners and third parties across a broad ecosystem can create new, innovative solutions. And cloud offers access to multiple data sets and relevant expertise—not only about technology, but also from business and societal domains. The IBM Cloud is designed for this new era. It is the overall platform on which we, our clients and our ecosystem partners are building a rapidly expanding array of solutions. It encompasses multiple technology and data platforms: • IBM Bluemix, our platform-as-a-service for developers, was created by IBMers using Agile and Design Thinking approaches. It has grown rapidly, ending the year onboard- ing 15,000 developers a week. And with more “Hybrid is the fastest- growing segment of the cloud market, and IBM is the global leader in hybrid cloud for the enterprise.”


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    2015 IBM Annual Report 7 than 120 services, IBM Bluemix is the largest • For our industry-leading IBM Security deployment of Cloud Foundry, an open source business, the IBM QRadar Security cloud application development platform. Intelligence Platform offers collaboration, an app exchange and pertinent APIs. Our • IBM SoftLayer is the core of our infrastructure- Security business also launched IBM X-Force as-a-service platform, which now consists Exchange, a cloud platform for more than of 46 cloud data centers in every major market 2,000 members across 16 industries to share in the world. This business grew by double threat data, with one of the world’s fullest digits in 2015. catalogs of threat information, from more than • The Weather Company is not just a source 20 billion security events monitored daily. of enormously valuable weather data. It is • In January 2016 we announced IBM Cloud a platform, and it forms the heart of our new Video Services, enhancing our substantial IBM Watson Internet of Things solutions unit. organic video capabilities with the acquisi- Today the platform can analyze data from tions of Aspera, Cleversafe, Clearleap 3 billion weather forecast reference points, and, most recently, streaming video service including satellites, weather stations, air- Ustream. Like weather, video is one of the planes, consumer apps and more. It handles richest and fastest-growing data sources— 26 billion inquiries to its cloud-based expected to comprise 80 percent of Internet services each day in the United States alone, traffic by 2019. The market for cloud-based making it the country’s fourth most popular video services, analytics and software app. Going forward, we will apply this is estimated to be more than $100 billion by powerful platform to collect, integrate and 2019, and we are now positioned for strong analyze data from multiple sources, such as growth there. telematics in cars, sensors in buildings, readings from wearable devices and data • Finally, Watson itself is a cloud platform, from smartphones, social media, supply supporting a growing ecosystem. More chains and the environment. than 80,000 developers are using Watson APIs, and more than 500 start-ups and businesses in the Watson ecosystem are building applications and solutions powered by Watson.


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    8 A Letter from the Chairman Importantly, the future of cloud is hybrid, will be the heart of hybrid. IBM WebSphere, spanning public cloud, private cloud and the for example, unlocks all data and applications for integration software, systems and services the cloud. It enables clients’ existing apps to needed to bring these environments together access the cloud and new “born on the cloud” securely and seamlessly. As enterprises move applications to access existing assets. to the cloud, hybrid is not a transition phase; A final reason we will remain the global it is the destination. leader in enterprise cloud is that cloud’s future Indeed, it is the fastest-growing segment depends on infrastructure innovation. This is of the cloud market, and IBM is the global leader why the full spectrum of IBM Systems remains in hybrid cloud for the enterprise. In this, our critical in this new era. We continue to design, incumbency is a significant advantage—from develop and deliver leading-edge servers, processing and protecting nearly three-fourths storage and software built for a hybrid cloud of the world’s transactions on the IBM main- world. For instance, our mainframe, reinvented frame to designing and running core banking for mobile transactions, serves as an advanced systems, supply chains, reservation and retail analytics accelerator and security-rich enterprise systems, and more. cloud server. And our Power platform is being For example, we are bringing our large base used to deliver cognitive workloads through the of clients in IBM Global Technology Services rapidly growing OpenPOWER ecosystem and (GTS) to the cloud. Last year, of our more than a vibrant Linux community. 70 services deals greater than $100 million, Cognitive and cloud—many in our industry seven out of 10 featured hybrid cloud. see these as two separate phenomena. We see We have also brought all of IBM’s relevant them differently: as two sides of the same coin, middleware into IBM Cloud. Our middleware two dimensions of a single model. Cognitive is the world’s leading IT integration platform, is the only way to ingest and extract value from with one analyst firm naming us the middleware the new natural resource of data in all its forms, leader for the past 14 years. And middleware so that it can be turned into competitive advantage and societal value. And cloud is the platform on which these solutions are designed, built, tested and deployed in the world.


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    2015 IBM Annual Report 9 2015 Performance The impact of our transformation is clear in our 2015 results. Our strategic imperatives—Analytics, Cloud, Mobile, Social and Security—grew by 26 percent and generated $29 billion last year. As I mention- ed, that represented 35 percent of IBM’s total revenue at year end. Adjusted for the impact of currency and divestitures (as are all revenue results reported in this letter), Analytics revenue grew 16 percent for the year, to $18 billion. Mobile more than tripled for the second straight year. Security grew 12 percent. And Social was up 21 percent. Not only did total Cloud revenue increase by more than 50 percent, to $10 billion, making ours the largest cloud business in the world, but our cloud-delivered as-a-service revenue continued to grow, reaching $4.5 billion in 2015, with a year-end annual run rate of IBM’s strategic imperatives grew by 26 percent and $5.3 billion. generated $29 billion last year. That represented Even as we fueled these high-growth 35 percent of IBM’s total revenue. businesses, we continued to bring innovation Revenue Growth Yr /Yr to the businesses our clients have long valued and relied on. Analytics 16% IBM Global Technology Services, which Cloud 57% is increasingly injecting automation and cognition into our services delivery, grew both Mobile 250% Security 12% Social 21% Revenue growth rate is at constant currency and excludes divested businesses. Overlap in strategic imperatives primarily reflects solutions delivered via Cloud. Investment IBM prioritizes investments in research and development, capital and acquisitions, and those investments are increasingly directed toward strategic imperatives. 2015 Total Investment: $13 billion Strategic Imperatives 54%


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    10 A Letter from the Chairman revenue and signings, finishing with a growing The progress of our transformation—in backlog. We have also grown in the parts particular our growth in hardware and GTS— of IBM Global Business Services (GBS) where shows what IBMers can do to reinvent we have transitioned to our high-growth our core businesses. In 2016, we will focus on: strategic imperatives, with nearly half of our • Our software businesses, where we will GBS revenue now coming from those busi- accelerate our shift to cognitive solution- nesses. In December we announced that our based opportunities and help our partnership with Apple had delivered more clients make the transition to as-a-service than 100 IBM MobileFirst for iOS applications, models delivered via hybrid cloud. helping to transform the way work gets done across 14 industries and 65 professions. • GBS, where we will use cognitive to differen- Our Systems Hardware business had tiate and drive our consulting business; a strong year. Since the launch of the z13 modernize GBS’s core business with digital in the first quarter of 2015, we have delivered value propositions; and grow margin through mainframe growth of 35 percent, with strong continued focus on high-value markets and double-digit gains every quarter. Power revenue improved productivity. grew 4 percent in 2015 and has grown for • Storage, where we will accelerate our four straight quarters on the strength of shift to object storage and strengthen OpenPOWER and Linux on Power. The strong our leadership in flash. performance of our Systems Hardware business over the past two years—swinging Our model is based on strong generation from a year-to-year decline in profit of $1.7 billion of free cash flow, which we maintained with in 2013 to reporting profit growth of nearly $13.1 billion in 2015. We use our cash to invest in $600 million last year—is largely the result of the future and to return value to you, our owners. the significant business restructuring we In 2015 we invested more than 6 percent of have implemented. our revenue in R&D and about $4 billion in capital For the full year, we generated revenue expenditures. We announced 15 acquisitions. of $81.7 billion, down 1 percent. We achieved And for the 23rd consecutive year, IBM led operating earnings per share of $14.92 and delivered operating net income of $14.7 billion.


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    2015 IBM Annual Report 11 in U.S. patents earned, once again breaking the 7,000 threshold. Even more important than the total number is the transformation those patents represent. Consider that when our streak began more than two decades ago, 27 percent of our patents were in hardware. Last year, not only did we earn seven times as many total patents, but 31 percent of them were in cloud, analytics and cognitive. We also returned $9.5 billion to you in 2015, including dividends of nearly $5 billion and $4.6 billion in gross share repurchases. This marks the 20th consecutive year of an increased dividend, and IBM’s 100th straight year of providing one. The Emerging IBM Because IBM uniquely transforms both tech- nology and business, our own reinventions in response to changing eras have been far- reaching. This is evident again today. As you have seen, we have transformed our portfolio— shedding businesses that provided little differ- entiating value to our clients, shifting our R&D and making dozens of acquisitions to fuel our growth businesses. At the same time, we have also injected new thinking and talent into IBM’s culture—such as training 60,000 IBMers in Agile methods and increasing our team “As important as ‘becoming digital’ is to our clients, it has become clear that it is not the destination. Rather, digital business is converging with a new kind of digital intelligence. We call this Cognitive Business.”


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    12 A Letter from the Chairman of professional designers to more than 1,000, For IBM, 2015 was a pivotal year in our journey embedded with clients and in 23 design studios to this new era, providing strong confirmation around the world. Both client satisfaction and of the strategic direction of our transformation. employee engagement are on the rise. We know who we are. We know why our clients Our experience over multiple eras of techno- seek to work with us. We know why you choose logical change has also taught us the importance to invest with us. of understanding its implications for the global We also know why brilliant experts, economy, for society and for how all of us work professionals and innovators seek to become and live. Today, some have expressed concerns and remain IBMers. Together, we understand about the impact of intelligent systems on that we are at a turning point in IBM history jobs and the future of work. These are legitimate and in the history of technology. We are questions, which must be addressed in a committed to doing what every prior generation thoughtful manner across business, government of IBMers has done—transforming ourselves and civil society. to lead in a new era of business and technology, At IBM, our experience with cognitive systems in order to remain essential to our clients and —undertaking the deep science, learning what to the world. cognitive systems actually do and working every My colleagues and I are excited and day to apply these capabilities in the world—has confident about the cognitive future, and we taught us that cognitive technology does not are working hard with our clients, partners replace, but rather enhances, human capabilities. and peers to build it. I am proud of the IBM team Instead of “artificial” intelligence, the real-world for bringing us here, and I am grateful to you, work of cognitive business is intelligence our shareholders, for your steadfast support. augmentation. And its benefits for the human condition will be extraordinary. In the end, the most important challenges we face are not about technology, but about values. Whether the question is civil liberties and national security; or privacy and conven- Virginia M. Rometty ience; or some professions rising while others Chairman, President and Chief Executive Officer decline, our path to this enormously hopeful future will depend on the creation of mutual value, transparency and, above all, trust. This letter includes selected references to certain non-GAAP financial measures about the company’s fi nancial results related to z Systems revenue and Power that are made to facilitate a comparative view of the company’s ongoing operational revenue adjusted for currency, operating earnings per share and operating net performance. For information about the company’s financial results related to income on a continuing operations basis and free cash flow, which are non-GAAP strategic imperatives, Analytics revenue, Security revenue, Social revenue, Mobile measures, see the company’s 2015 Annual Report, which is Exhibit 13 to the revenue and IBM revenue adjusted for the impact of currency and divestitures, which Form 10-K submitted to the SEC on February 23, 2016. For reconciliation and other are non-GAAP measures, see Non-GAAP Supplementary Materials and related information concerning these items, refer to pages 33, 41 and 62 of the company’s information in the Form 8-K submitted to the SEC on January 19, 2016. For information 2015 Annual Report.


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    2015 IBM Annual Report 13 What does it take to change the world and transform a company?


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    14


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    Explore 150+ stories of IBM Today. ibm.com/2015ar


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    16 Financial Highlights International Business Machines Corporation and Subsidiary Companies ($ in millions except per share amounts) For the year ended December 31: 2015 2014 Revenue $ 81,741 $ 92,793 Net income $ 13,190 $ 12,022 Income from continuing operations $ 13,364 $ 15,751 Operating (non-GAAP) earnings* $ 14,659 $ 16,702 Earnings per share of common stock (continuing operations) Assuming dilution $ 13.60 $ 15.59 Basic $ 13.66 $ 15.68 Diluted operating (non-GAAP)* $ 14.92 $ 16.53 Net cash provided by operating activities $ 17,008 $ 16,868 Capital expenditures, net 3,780 3,779 Share repurchases 4,609 13,679 Cash dividends paid on common stock 4,897 4,265 Per share of common stock 5.00 4.25 At December 31: 2015 2014** Cash, cash equivalents and marketable securities $ 8,195 $ 8,476 Total assets 110,495 117,271 Working capital 8,235 7,797 Total debt 39,890 40,722 Total equity 14,424 12,014 Common shares outstanding (in millions) 966 991 Market capitalization $133,507 $158,920 Stock price per common share $ 137.62 $ 160.44 * See pages 41 and 42 for a reconciliation of net income to operating earnings. ** Reclassified to reflect adoption of FASB guidance on deferred taxes and debt issuance costs in consolidated financial statements.


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    Report of Financials 17 International Business Machines Corporation and Subsidiary Companies MANAGEMENT DISCUSSION NOTES TO CONSOLIDATED Overview 18 FINANCIAL STATEMENTS Forward-Looking and Cautionary Statements 19 A Significant Accounting Policies 82 Management Discussion Snapshot 19 B Accounting Changes 92 Description of Business 22 C Acquisitions/Divestitures 93 Year in Review 29 D Financial Instruments 99 Prior Year in Review 49 E Inventories 106 Other Information 60 F Financing Receivables 106 Looking Forward 60 G Property, Plant and Equipment 109 Liquidity and Capital Resources 61 H Investments and Sundry Assets 110 Critical Accounting Estimates 64 I Intangible Assets Including Goodwill 110 Currency Rate Fluctuations 67 J Borrowings 111 Market Risk 68 K Other Liabilities 114 Financing Risks 68 L Equity Activity 114 Cybersecurity 68 M Contingencies and Commitments 118 Employees and Related Workforce 69 N Taxes 120 Global Financing 69 O Research, Development and Engineering 123 P Earnings Per Share of Common Stock 123 Report of Management 74 Q Rental Expense and Lease Commitments 124 R Stock-Based Compensation 124 Report of Independent Registered S Retirement-Related Benefits 127 Public Accounting Firm 75 T Segment Information 141 U Subsequent Events 146 CONSOLIDATED FINANCIAL STATEMENTS Earnings 76 Five-Year Comparison of Selected Financial Data 147 Comprehensive Income 77 Financial Position 78 Selected Quarterly Data 148 Cash Flows 79 Changes in Equity 80 Performance Graph 149 Board of Directors and Senior Leadership 150 Stockholder Information 151


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    18 Management Discussion International Business Machines Corporation and Subsidiary Companies OVERVIEW held for sale at December 31, 2014. The operating results of The financial section of the International Business Machines Cor- the Microelectronics business are reported as discontinued poration (IBM or the company) 2015 Annual Report includes the operations. The transaction closed on July 1, 2015. In addition, Management Discussion, the Consolidated Financial Statements in 2015, the company renamed its Systems & Technology and the Notes to Consolidated Financial Statements. This Over- segment to Systems Hardware and its System z brand to view is designed to provide the reader with some perspective z Systems. Also, in 2015, the company’s business process regarding the information contained in the financial section. outsourcing business, Global Process Services, which was previously managed within Global Technology Services, Organization of Information was integrated into Global Business Services, creating an • The Management Discussion is designed to provide readers end-to-end business transformation capability for clients and with an overview of the business and a narrative on the to better leverage the company’s industry knowledge. Prior company’s financial results and certain factors that may affect periods have been reclassified to conform to this presenta- its future prospects from the perspective of the company’s tion in the Management Discussion, the Consolidated management. The “Management Discussion Snapshot,” Financial Statements and the Notes, where applicable, to beginning on page 19, presents an overview of the key per- allow for a meaningful comparison of continuing operations. formance drivers in 2015. • The references to “adjusted for currency” or “at constant • Beginning with the “Year in Review” on page 29, the currency” in the Management Discussion do not include Management Discussion contains the results of operations operational impacts that could result from fluctuations in for each reportable segment of the business and a discus- foreign currency rates. Certain financial results are adjusted sion of the company’s financial position and cash flows. based on a simple mathematical model that translates current Other key sections within the Management Discussion period results in local currency using the comparable prior include: “Looking Forward” on page 60, and “Liquidity and year period’s currency conversion rate. This approach is used Capital Resources” on page 61. for countries where the functional currency is the local country • Global Financing is a reportable segment that is measured currency. This information is provided so that certain financial as a stand-alone entity. A separate “Global Financing” section results can be viewed without the impact of fluctuations in is included in the Management Discussion beginning on foreign currency rates, thereby facilitating period-to-period page 69. comparisons of business performance. See “Currency Rate • The Consolidated Financial Statements are presented on Fluctuations” on page 67 for additional information. pages 76 through 81. These statements provide an overview • Within the financial statements and tables in this Annual of the company’s income and cash flow performance and Report, certain columns and rows may not add due to its financial position. the use of rounded numbers for disclosure purposes. • The Notes follow the Consolidated Financial Statements. Percentages reported are calculated from the underlying Among other items, the Notes contain the company’s whole-dollar numbers. accounting policies (pages 82 to 92), acquisitions and divestitures (pages 93 to 99), detailed information Operating (non-GAAP) Earnings on specific items within the financial statements, certain In an effort to provide better transparency into the operational contingencies and commitments (pages 118 to 120) and results of the business, the company separates business results retirement-related plans information (pages 127 to 141). into operating and non-operating categories. Operating earnings • The Consolidated Financial Statements and the Notes have from continuing operations is a non-GAAP measure that excludes been prepared in accordance with accounting principles the effects of certain acquisition-related charges, retirement-re- generally accepted in the United States (GAAP). lated costs, discontinued operations and their related tax impacts. • In October 2014, the company announced a definitive agree- For acquisitions, operating earnings exclude the amortization of ment to divest its Microelectronics business. The assets and purchased intangible assets and acquisition-related charges liabilities of the Microelectronics business were reported as such as in-process research and development, transaction costs, applicable restructuring and related expenses and tax charges related to acquisition integration. For retirement-related costs, the


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    Management Discussion 19 International Business Machines Corporation and Subsidiary Companies company characterizes certain items as operating and others as MANAGEMENT DISCUSSION SNAPSHOT non-operating. The company includes defined benefit plan and ($ and shares in millions except per share amounts) nonpension postretirement benefit plan service cost, amortization Yr.-to-Yr. of prior service cost and the cost of defined contribution plans Percent/ Margin in operating earnings. Non-operating retirement-related cost For the year ended December 31: 2015 2014 Change includes defined benefit plan and nonpension postretirement Revenue $ 81,741 $ 92,793 (11.9)%* benefit plan interest cost, expected return on plan assets, amor- Gross profit margin 49.8% 50.0% (0.2) pts. tized actuarial gains/losses, the impacts of any plan curtailments/ Total expense and other (income) $ 24,740 $ 26,421 (6.4)% settlements and multi-employer plan costs, pension insolvency Total expense and other costs and other costs. Non-operating retirement-related costs are (income)-to-revenue ratio 30.3% 28.5% 1.8 pts. primarily related to changes in pension plan assets and liabilities Income from continuing which are tied to financial market performance and the company operations before income taxes $ 15,945 $ 19,986 (20.2)% considers these costs to be outside the operational performance Provision for income taxes from of the business. continuing operations $ 2,581 $ 4,234 (39.1)% Overall, the company believes that providing investors with a Income from continuing view of operating earnings as described above provides increased operations $ 13,364 $ 15,751 (15.2)% transparency and clarity into both the operational results of the Income from continuing business and the performance of the company’s pension plans; operations margin 16.3% 17.0% (0.6) pts. improves visibility to management decisions and their impacts on Loss from discontinued operational performance; enables better comparison to peer com- operations, net of tax $ (174) $ (3,729) (95.3)% panies; and allows the company to provide a long-term strategic Net income $ 13,190 $ 12,022 9.7% view of the business going forward. The company’s reportable Earnings per share from segment financial results reflect operating earnings from continu- continuing operations: ing operations, consistent with the company’s management and Assuming dilution $ 13.60 $ 15.59 (12.8)% measurement system. Consolidated earnings per share— assuming dilution $ 13.42 $ 11.90 12.8% FORWARD-LOOKING AND Weighted-average shares CAUTIONARY STATEMENTS outstanding Certain statements contained in this Annual Report may consti- Assuming dilution 982.7 1,010.0 (2.7)% tute forward-looking statements within the meaning of the Private Assets** $110,495 $117,271+ (5.8)% Secur ities Litigation Reform Act of 1995. Any forward-looking Liabilities** $ 96,071 $105,257+ (8.7)% statement in this Annual Report speaks only as of the date on which it is made; the company assumes no obligation to update Equity** $ 14,424 $ 12,014 20.1% or revise any such statements. Forward-looking statements are * (4.1) percent adjusted for currency; (1.2) percent adjusted for divestitures and based on the company’s current assumptions regarding future currency. ** At December 31. business and financial performance; these statements, by their + Reclassified to reflect adoption of the FASB guidance on deferred taxes and debt nature, address matters that are uncertain to different degrees. issuance costs in consolidated financial statements. Refer to note B, “Accounting Forward-looking statements involve a number of risks, uncer- Changes,” for additional information. tainties and other factors that could cause actual results to be materially different, as discussed more fully elsewhere in this Annual Report and in the company’s filings with the Securities and Exchange Commission (SEC), including the company’s 2015 Form 10-K filed on February 23, 2016.


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    20 Management Discussion International Business Machines Corporation and Subsidiary Companies The following table provides the company’s (non-GAAP) operating System x divestiture, with double-digit growth in each quarter. In earnings for 2015 and 2014. total, the strategic imperatives generated $28.9 billion in revenue in 2015, which represents approximately 35 percent of the com- ($ in millions except per share amounts) pany’s total revenue, an increase of 13 points from 2013. Yr.-to-Yr. Cloud revenue increased 43 percent as reported in 2015 and Percent For the year ended December 31: 2015 2014 Change 57 percent adjusted for currency and the System x divestiture. Net income as reported $13,190 $12,022 9.7% In 2015, Cloud revenue was $10.2 billion making the company the largest cloud provider. The company has been building off Loss from discontinued operations, net of tax (174) (3,729) (95.3) its extensive relationships in enterprise IT and incumbency in the data center to help clients implement hybrid cloud environments. Income from continuing operations $13,364 $15,751 (15.2)% In addition: Non-operating adjustments (net of tax) • As-a-Service revenue increased 50 percent (61 percent Acquisition-related charges 562 670 (16.1) adjusted for currency) year to year to $4.5 billion and the Non-operating retirement-related company exited 2015 with an annual run rate of $5.3 billion. costs/(income) 734 280 161.8 • 2015 Cloud revenue included $5.6 billion of revenue from Operating (non-GAAP) earnings* $14,659 $16,702 (12.2)% foundational offerings—where the company provides Diluted operating (non-GAAP) software, hardware and services for clients to build their earnings per share $ 14.92 $ 16.53 (9.7)% own clouds. * See pages 41 and 42 for a more detailed reconciliation of net income to operating • Clients are using cloud not just to reduce costs, but also to earnings. gain agility and to enable innovation. The company has been leading clients in making the move to cloud through In 2015, the company delivered $81.7 billion in revenue, $13.4 billion consuming as-a-Service, or through their own clouds or the in income from continuing operations and $14.7 billion in operat- implementation of a hybrid environment. ing (non-GAAP) earnings resulting in diluted earnings per share • The company made seven cloud acquisitions in 2015 includ- from continuing operations of $13.60 as reported and $14.92 on an ing; Cleversafe, for object storage, Gravitant, for cloud operating (non-GAAP) basis. The results of continuing operations brokerage services and Clearleap, for cloud video services. exclude a net loss from discontinued operations of $174 million The company also invested nearly $1 billion in 2015 to expand in 2015 and $3,729 million in 2014 related to the divestiture of the its global cloud data center footprint to 46. The company Microelectronics business. On a consolidated basis, net income possesses an ecosystem of developers globally and its Blue- in 2015 was $13.2 billion, with diluted earnings per share of $13.42. mix Platform-as-a-Service has already expanded to over a The company generated $17.0 billion in cash from operations and million users, adding 15 thousand developers a week. $13.1 billion in free cash flow in 2015 driving shareholder returns of $9.5 billion in gross common stock repurchases and dividends. Business analytics revenue of $17.9 billion in 2015 increased 7 per- Total consolidated revenue in 2015 decreased 11.9 percent as cent as reported and 16 percent year to year adjusted for currency reported and 1 percent year to year adjusted for currency and making the company the largest analytics provider. The company the divestitures of the System x and customer care businesses has also been moving into new areas including Watson Health and reflecting a modest improvement in year-to-year performance Watson Internet of Things (IoT). compared to the year ago period on an adjusted basis. Currency • In Watson Health, the company is integrating its own organic had an 8 point, or $7.2 billion impact on reported revenue in 2015. Revenue was impacted by 3 points in 2015 from the divested capabilities with content acquired through Merge Healthcare, businesses. Combined, the impact of currency and divested busi- Phytel and Explorys. Healthcare represents a new revenue nesses reduced the reported revenue growth by 11 points. and profit opportunity as the company changes the face of In 2014, the company declared its strategic imperatives around healthcare through its cognitive platform to provide value to big data and analytics, cloud, mobile, social and security, areas providers, payers and partners. • In the IoT market, The Weather Company acquisition will where clients were looking to the company to help move them to the future. The company has made significant progress in shifting not only provide the company tremendously valuable its business toward these strategic imperatives and is continuing data, but also a high-volume, cloud-based, insight-driven to invest in capabilities which are not yet reflected in its revenue platform to integrate with Watson to address significant stream. In 2015, strategic imperatives revenue grew 17 percent year new opportunities. to year as reported and 26 percent adjusted for currency and the


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    Management Discussion 21 International Business Machines Corporation and Subsidiary Companies In the area of engagement, revenue increased 64 percent as The reduction in expense was driven primarily by currency reported and 77 percent adjusted for currency. Security revenue impacts, a lower level of workforce rebalancing charges and the increased 5 percent as reported (12 percent adjusted for cur- impact of the divested System x business. These benefits were rency), mobile revenue more than tripled year to year and social partially offset by the impact of lower divestiture gains ($1.6 billion) revenue increased 14 percent as reported (21 percent adjusted year to year. The reduction in operating (non-GAAP) expense was for currency). driven primarily by the same factors. The company is continuing From a segment perspective, Global Services revenue to shift resources and spending within its operational expense declined 10.5 percent as reported and 1 percent adjusted for base—driving productivity and efficiency in some areas while currency (9 points) and divestitures. Global Technology Services increasing investment in support of the strategic imperatives. In (GTS) declined 9.7 percent as reported, but increased 1 percent 2015, the company shifted over $5 billion of spending across cost, year to year adjusted for currency (10 points) and the System x expense and capital expenditures, to the strategic imperatives. divestiture with strong growth in the strategic imperatives on Pre-tax income from continuing operations of $15.9 billion in an adjusted basis. Global Business Services (GBS) revenue 2015 decreased 20.2 percent year to year and the pre-tax margin decreased 12.0 percent as reported and 4 percent adjusted for was 19.5 percent, a decrease of 2.0 points. The continuing oper- currency (8 points). GBS revenue continues to be impacted by ations effective tax rate for 2015 was 16.2 percent, a decrease the shift away from traditional large enterprise application imple- of 5.0 points versus 2014. The tax rate in 2015 reflected benefits mentations. Software revenue declined 9.8 percent as reported from the settlement of the U.S. tax audit and geographic mix of and 4 percent adjusted for currency with growth in annuity-based pre-tax profits, partially offset by less utilization of foreign tax cred- revenue, including Software-as-a-Service (SaaS), more than its. Income from continuing operations of $13.4 billion decreased offset by declines in transactional revenue reflecting the flexi- 15.2 percent and the net income margin was 16.3 percent, a bility the company has provided to its largest enterprise clients. decrease of 0.6 points versus 2014. Losses from discontin- Systems Hardware revenue decreased 24.2 percent as reported, ued operations, net of tax, were $174 million in 2015 compared but increased 8 percent adjusted for the System x divestiture to $3,729 million in 2014. Net income of $13.2 billion increased (28 points) and currency (4 points), reflecting a successful main- 9.7 percent year to year. Operating (non-GAAP) pre-tax income frame cycle in 2015 and the repositioning of Power Systems to from continuing operations decreased 16.3 percent year to year address a broader opportunity. and the operating (non-GAAP) pre-tax margin from continu- From a geographic perspective, revenue in the major markets ing operations decreased 1.1 points to 21.6 percent. Operating declined 9.9 percent as reported and 1 percent adjusted for cur- (non-GAAP) income from continuing operations of $14.7 billion rency (8 points) and divestitures (2 points) with growth in Germany, decreased 12.2 percent including an impact of 7 points from the Japan and the UK on an adjusted basis. Growth markets revenue 2014 gains from the System x and customer care divestitures. The decreased 18.4 percent as reported and 3 percent adjusted for operating (non-GAAP) income margin from continuing operations currency (9 points) and divestitures (6 points). On an adjusted of 17.9 percent decreased 0.1 points. The operating (non-GAAP) basis, declines in Asia Pacific were partially offset by growth in effective tax rate from continuing operations in 2015 was 17.2 per- Latin America and Middle East and Africa. cent versus 21.0 percent in 2014. The 2015 profit and margin The consolidated gross profit margin of 49.8 percent performance reflect portfolio actions taken as the company shifts decreased 0.2 points year to year. The operating (non-GAAP) to higher value, as well as investments being made to add capa- gross margin of 50.8 percent increased 0.2 points compared to bilities to drive the transformation. the prior year primarily driven by the shift to higher value through Diluted earnings per share from continuing operations of $13.60 portfolio actions and the relative strength of z Systems, partially in 2015 decreased 12.8 percent year to year. In 2015, the company offset by margin declines in Global Services and Software. repurchased 30.3 million shares of its common stock at a cost of Total expense and other (income) decreased 6.4 percent in $4.7 billion. Operating (non-GAAP) diluted earnings per share of 2015 compared to the prior year. Total operating (non-GAAP) $14.92 decreased 9.7 percent versus 2014 including an impact expense and other (income) decreased 7.8 percent compared to of 7 points from the 2014 gains from the System x and customer 2014. The key year-to-year drivers were: care divestitures. Diluted earnings per share from discontinued operations was ($0.18) in 2015 compared to ($3.69) in 2014. Total Operating Consolidated (non-GAAP) • Currency* (9) points (9) points • System x divestiture (2) points (2) points • Divestiture gains 6 points 6 points • Workforce rebalancing (3) points (3) points * Reflects impacts of translation and hedging programs.


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    22 Management Discussion International Business Machines Corporation and Subsidiary Companies At December 31, 2015, the company continued to have the DESCRIPTION OF BUSINESS financial flexibility to support the business over the long term. Cash Please refer to IBM’s Annual Report on Form 10-K filed with and marketable securities at year end was $8.2 billion, a decrease the SEC on February 23, 2016 for a more detailed version of $0.3 billion from December 31, 2014. Key drivers in the balance of this Description of Business, especially Item 1A. entitled sheet and total cash flows were: “Risk Factors.” Total assets decreased $6.8 billion ($0.3 billion adjusted for currency) from December 31, 2014 driven by: The company creates value for clients through integrated solu- tions and products that leverage: data, information technology, • Decreases in total receivables ($4.4 billion), deferred taxes deep expertise in industries and business processes, and a ($1.9 billion) and prepaid expenses and sundry assets broad ecosystem of partners and alliances. IBM solutions typi- ($1.1 billion); partially offset by cally create value by enabling new capabilities for clients that • Increased goodwill ($1.5 billion). transform their businesses and help them engage with their cus- tomers and employees in new ways. These solutions draw from Total liabilities decreased $9.2 billion ($4.7 billion adjusted for cur- an industry-leading portfolio of consulting and IT implementation rency) from December 31, 2014 driven by: services, cloud and cognitive offerings, and enterprise systems and software; all bolstered by one of the world’s leading research • Decreases in other liabilities ($2.3 billion), taxes ($2.2 billion), organizations. retirement-related liabilities ($1.8 billion), deferred income ($0.8 billion), total debt ($0.8 billion) and accounts payable Strategy ($0.8 billion). IBM has transformed throughout its 100+ year history, and in its Total equity of $14.4 billion increased $2.4 billion from Decem- current transformation, IBM is leading a reordering of the tech- ber 31, 2014 as a result of: nology industry. In 2014, the company’s strategic imperatives were declared • Higher retained earnings ($8.3 billion) and higher common around the three main forces behind “digital”: big data and ana- stock ($0.6 billion); partially offset by lytics, cloud and engagement. Since 2010, IBM has invested • Increased treasury stock ($4.8 billion) and increased approximately $30 billion in these areas, built out the IBM Cloud accumulated other comprehensive losses ($1.7 billion). on a global scale, established the Watson Group, announced 50 acquisitions and entered into major partnerships, including the The company generated $17.0 billion in cash flow provided by landmark alliance with Apple to bring mobile to the enterprise. operating activities, an increase of $0.1 billion when compared to As IBM’s clients transform, “digital” itself is not the destina- 2014, driven primarily by lower income tax payments, offset by tion, but a foundation to create a truly Cognitive Enterprise. This is net income performance. Net cash used in investing activities of resulting in new types of interactions between people, organiza- $8.2 billion was $5.2 billion higher than 2014, primarily driven by a tions and machines. decrease in cash provided from divestitures ($2.8 billion) and an Through these developments, IBM is emerging as more than increase in net cash used for acquisitions ($2.7 billion). Net cash a hardware, software and services company; IBM is transforming used in financing activities of $9.2 billion decreased $6.3 billion into a cognitive solutions and cloud platform company. Key tenets compared to the prior year, driven primarily by a decrease in cash of the company’s highly differentiated strategy include: used for gross common stock repurchases ($9.1 billion), partially offset by lower net debt issuances ($1.8 billion) and higher dividend Cognitive Solutions: Cognitive, advanced analytics and key data payments ($0.6 billion). are being integrated into all leading solutions. The 2015 results are a reflection of the continuing transition in Cloud Platform: New solutions will be built on the IBM Cloud and the company’s business as it addresses the significant shifts in the the company’s offerings will be cloud-enabled. The company is industry, as well as some of the cyclical challenges of the global continuing to build the premier cloud stack, developer environment business environment. This transformation is taking place over and most secure hybrid cloud platform in the industry. the longer term. In 2015, the company strengthened its existing Industry Focus: Because industry context is so important to the portfolio while investing aggressively in new opportunities such value of IBM’s solutions, these solutions will be built for the needs as Watson Health, Watson Internet of Things and IBM Cloud. In of individual industries and professions. January 2016, the company disclosed that it is expecting GAAP earnings of at least $12.45 and operating (non-GAAP) earnings of at least $13.50 per diluted share for 2016.


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    Management Discussion 23 International Business Machines Corporation and Subsidiary Companies Cognitive Solutions Cloud Platform Since 2011 when IBM’s Watson was introduced, IBM has been Cloud is at the heart of the “digital” revolution. No enterprise is developing a new generation of cognitive systems that can see untouched by this revolution and the shifts are occurring rapidly. and analyze the massive amounts of data that have previously Enterprises are benefiting from cloud by using it to transform been invisible to computers and enterprises. Cognitive systems their information technology (IT) and business processes into dig- have the capability to inject a kind of thinking ability into every ital services. Cloud brings two compelling sources of value: digitalized object, process and service. IBM is on the forefront of deploying these systems and assisting clients to become truly • Innovation: In addition to cloud enabling the sharing of Cognitive Enterprises. infrastructure, the real promise of cloud is innovation. By Cognitive systems are not programmed; like humans, they forcing greater levels of standards throughout the technol- learn from experts, from every interaction, and from big data. They ogy value chain, new products and services, and even are enabled to learn by using advanced algorithms to sense, pre- entire business models, can be created in weeks rather dict and infer. Ultimately they can augment human intelligence, than months or years. allowing individuals to make more informed decisions. • Hybrid: Data, cloud and engagement are powerful forces For the past five years, IBM has continued to invest in Watson, changing the landscape of technology and businesses. including dedicating $100 million to venture investments to support Enterprises need to bring this new world of technology start-ups building cognitive apps through the Watson Developer together with their existing systems in order to capture their Zone on Bluemix. IBM is also making Watson more widely available full value. Hybrid cloud brings together the back-end systems through the Watson Ecosystem, which has grown to more than infrastructure with the new strategic imperative “digital” 500 partners. technologies. Unless the new and traditional IT worlds Paired with Watson is the company’s core big data and ana- are brought together, they will be isolated within the lytics business. IBM has invested over $15 billion in these areas enterprise. IBM servers and storage can handle mobile since 2010, including over $7 billion on more than 20 acquisitions. transactions, compose and expose APIs and integrate Nearly half of IBM Research’s spending is focused on analytics across hybrid clouds to unlock new value from data. and cognitive. Making applications work across on-premise, public and private IBM’s leading-edge cognitive technology is only the starting cloud environments is what hybrid cloud is all about. This requires point. The company is developing entirely new solutions busi- a deep understanding of both traditional and new IT models, nesses around that cognitive capability. In 2015, the Watson something that IBM is unique in bringing to its clients: Health unit was formed, which is IBM’s first business unit designed around a single industry. Watson Health will create cognitive • In traditional IT, for example, the z Systems mainframe is solutions that can better help doctors diagnose and anticipate used by all of the top 25 global banks and almost three- disease; it will recommend treatments that are tailored to individ- quarters of the top 25 U.S. retailers. In addition, 70 percent uals; and it will assist researchers to predict and prevent the next of the top 25 Fortune 500 companies rely on IBM to manage generation of diseases. their critical IT infrastructures. Another set of cognitive solutions IBM is building is the Internet • In the new world of IT, the IBM Cloud has become the stan- of Things (IoT). It is estimated that there are more than 9 billion dard for enterprise-grade cloud—bringing performance connected devices operating in the world today, generating and the integration across all IT. The company continues to 2.5 quintillion bytes of new data daily. Watson IoT will bring the build cloud into Global Technology Services’ (GTS) large power of cognitive to the challenge of extracting and analyzing base of outsourcing relationships. data embedded in intelligent devices in real time. In addition, • Each of these areas of IT requires uncompromising security. the recent closure of The Weather Company acquisition essen- IBM Security brings to clients advanced technologies in fraud tially expands the company’s IoT platform; with one that collects, and threat protection, identity and access management, integrates and analyzes data from three billion weather forecast application and data security, mobile and cloud security. reference points, including satellites, weather stations, airplanes, IBM’s systems are among the most secure in the world with consumer apps and more for IBM and our clients. advanced encryption, threat monitoring and tracking and Through Cognitive, IBM is ushering in a new era for the industry behavioral analytics. Further, high-end security consulting and for clients. brings the expertise of 6,000 dedicated security specialists. Built on big data analytics, IBM manages over 20 billion security events per day on 2.5 million desktops for 12,000 clients through its Security Operations Centers.


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    24 Management Discussion International Business Machines Corporation and Subsidiary Companies IBM’s Cloud platform includes: Industry Focus IBM’s solutions and platforms are most relevant in the context of • IBM Cloud’s Infrastructure-as-a-Service, which offers bare each client’s industry. General-purpose tools have their place, but metal, private cloud and virtual server instances, enabling it the company can unlock much greater value in building solutions to cover many different workloads with unprecedented per- for the specific needs of an industry. In this context, Industries formance. IBM’s platform also has tremendous geographic are the focus. reach—with 46 cloud centers around the globe. Watson Health is an example of how the company is defining • Bluemix is IBM’s Platform-as-a-Service, built on the open solutions around industry needs. In addition to Watson Health, in standards foundation of Cloud Foundry and powered by IBM 2015, 20 new industry-specific analytics solutions were launched Cloud’s infrastructure. Bluemix offers cloud-based services, with pre-built predictive analytics capabilities. These include solu- APIs and leading third-party services to developers in an tions that allow clients to mine customer data for hidden insights integrated platform. With $1 billion of investment, Bluemix for action, spot fraud or risk and predict vulnerabilities to preempt is now the largest Cloud Foundry development, has a signifi- before they occur. These solutions, which are tailored specifically cant number of services and is onboarding thousands of for retail, banking, telecommunications, insurance and others, will developers per week. make it easier and faster for organizations to uncover and act on • IBM Cloud Marketplace brings together the company’s critical business insights. In addition, IBM has announced over extensive portfolio of cloud capabilities, providing a self- 100 apps through its alliance with Apple that bring value in the service, digital experience for developers, IT and business context of individual industries. leaders. IBM has a significant number of Software-as-a-Ser- Complementing the power of the company’s technology solu- vice offerings and visitors to the Marketplace have access tions is the industry expertise of IBM’s Global Business Services to an extensive and growing portfolio of cloud capabilities consulting business. It is the combination of IBM’s technology and from IBM and qualified third-party vendors. services, which enable clients to achieve their business outcomes. • In 2015, IBM acquired: Blue Box Group, Inc. (private cloud), Compose (database-as-a-service), StrongLoop, Inc. (devel- Summary oper technology), Cleversafe, Inc. (object-based storage), Each successive transformation of IBM has brought something Gravitant, Inc. (cloud brokerage) and Clearleap, Inc. (cloud- new and innovative to the world. More than 50 years ago, IBM based video). brought forward a revolutionary transactional computer called the • The Weather Company acquisition in January 2016, whose mainframe. In the decades that followed, IBM commercialized the dynamic cloud data platform powers the fourth most-used personal computer, created an industry around IT services and a daily mobile app in the United States and handles 26 billion software market around middleware. Each of these innovations is inquiries to its cloud-based services each day. This high- with the world today; they were built to last. volume cloud platform processes, analyzes and distributes The company’s next chapter is ushering in an entirely new era enormous data sets at scale in real time. It adds an important of human-organization-computer interaction—embodied in Cog- dimension to the company’s cloud platform. nitive Solutions and the Cloud Platform. • IBM has entered into strategic partnerships all focused on bringing innovative data and analytics solutions to the Business Model market. The IBM Cloud is the most powerful platform for The company’s business model is built to support two principal enterprise-grade environments, bringing clients unparalleled goals: helping enterprise clients to become more innovative, effi- levels of security, performance and scalability. cient and competitive through the application of business insight and IT solutions; and providing long-term value to shareholders. The business model has been developed over time through strate- gic investments in capabilities and technologies that have superior long-term growth and profitability prospects based on the value they deliver to clients. The company’s global capabilities include services, software, systems, fundamental research and related financing. The broad mix of businesses and capabilities are combined to provide inte- grated solutions and platforms to the company’s clients.


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    Management Discussion 25 International Business Machines Corporation and Subsidiary Companies The business model is dynamic, adapting to the continuously Integrated Technology Services: delivers a portfolio of project- changing industry and economic environment, including the based and managed services that enable clients to transform and company’s transformation into cloud and -as-a-Service delivery optimize their IT environments by driving efficiency, flexibility and models. The company continues to strengthen its position through productivity. The portfolio is built around a key set of solutions strategic organic investments and acquisitions in higher-value addressing systems, mobility, resiliency, networking, cloud and areas while divesting certain businesses. In addition, the company security. This portfolio includes key assets and intellectual prop- is transforming into a more agile enterprise helping to drive pro- erty and incorporates best practices and proven methodologies ductivity, which supports investments for participation in markets that ensure high quality delivery, security and compliance. with significant long-term opportunity. This business model, supported by the company’s financial Cloud: delivers a comprehensive set of hybrid cloud services model, has enabled the company to deliver strong earnings, cash including assisting clients with building their own private clouds, flows and returns to shareholders over the long term. building customized dedicated managed clouds, allowing cli- ents to leverage standardized cloud infrastructure services from Business Segments and Capabilities the SoftLayer and Cloud Managed Services offerings; and cre- The company’s major operations consists of five business seg- ating environments linking their private and public workloads ments: Global Technology Services and Global Business Services, together. This portfolio of cloud offerings spans across the GTS which the company collectively calls Global Services, Software, business lines. Systems Hardware and Global Financing. Technology Support Services (Maintenance Services): delivers In late February 2016, the company plans to meet with investors a complete line of support services from product maintenance to discuss changes in the business, which will result in a change in through solution support to maintain and improve the availability the company’s reportable segments beginning in the first quarter of clients’ IT infrastructures. of 2016. Global Business Services (GBS) has the mission to deliver pre- Global Services: is a critical component of the company’s strategy dictable business outcomes to the company’s clients across: of providing IT infrastructure and business insight and solutions Consulting and Systems Integration, Application Management Ser- to clients. These solutions include industry-leading IBM software vices and Process Services. These professional services deliver and systems, as well as other suppliers’ products if a solution business value and innovation to clients through solutions which requires it. Approximately 60 percent of external Global Services leverage industry and business process expertise. The role of GBS segment revenue is annuity based, coming primarily from out- is to drive initiatives that integrate IBM content and solutions and sourcing and maintenance arrangements. The Global Services drive the progress of the company’s strategic imperatives. As cli- backlog provides a solid revenue base entering each year. Within ents transform themselves in response to market trends like big Global Services, there are two reportable segments: Global Tech- data, social and mobile computing, GBS helps clients use these nology Services and Global Business Services. technologies to reinvent relationships with their customers and Global Technology Services (GTS) provides IT infrastructure realize new standards of efficacy and efficiency in the internal pro- services, creating business value for clients through integrated cesses, data and applications that they use to run their businesses. services, incorporating unique intellectual property within its global In 2015, GBS announced the industry’s first practice dedicated to delivery model. By leveraging insights and experience drawn cognitive business, Cognitive Business Solutions. from IBM’s global scale, skills and technology, with applied inno- vation from IBM Research, clients gain access to leading-edge, GBS Capabilities high-quality services with improved productivity, flexibility, cost Consulting and Systems Integration: delivers client value with and outcomes. solutions in Strategy and Transformation, Application Innovation Services, Enterprise Applications and Smarter Analytics. Consult- GTS Capabilities ing is also focused on bringing to market client solutions that drive Strategic Outsourcing: delivers comprehensive IT outsourcing smarter commerce, cloud, mobile and social business. services focused on clients’ enterprise IT infrastructure environ- Application Management Services: delivers application manage- ments to enable digital transformation and consistently deliver ment, maintenance and support services for packaged software, improved quality, flexibility, risk management and financial value. as well as custom and legacy applications. Value is delivered The company integrates long-standing expertise in service man- through advanced capabilities in areas such as application test- agement and technology with the ability to exploit the power of ing and modernization, cloud application services, the company’s new technologies from IBM systems and software, such as cloud highly differentiated globally integrated capability model, industry computing, analytics, cognitive computing and virtualization, knowledge and the standardization and automation of applica- to deliver high performance, innovation and improved ability to tion management. achieve business objectives.


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    26 Management Discussion International Business Machines Corporation and Subsidiary Companies Global Process Services: (included within Application Management Tivoli: helps clients optimize the value they get from their infrastruc- Services) delivers a range of offerings consisting of standardized tures and technology assets through greater visibility, control and through transformational solutions including processing plat- automation across their end-to-end business operations. These forms and business process outsourcing. These services deliver asset management solutions foster integrated service delivery improved business results to clients through the strategic change for cloud and datacenter management, enterprise endpoint and and/or operation of the client’s business processes, applications mobile device management, asset and facilities management, and and infrastructure. storage management. Tivoli includes security systems software that provides clients with a single security intelligence platform Software consists primarily of middleware and operating systems that enables them to better secure all aspects of their enterprise software. Middleware serves as a software layer that connects and prevent security breaches. operating systems to applications across a standard software plat- form. The IBM Middleware portfolio allows seamless integration of Workforce Solutions: enables businesses to connect people and unrelated systems, processes, and applications all while providing processes for more effective communication and increased pro- market leading functionality, in both on-premise and hybrid cloud ductivity through collaboration, messaging and social networking environments. Operating systems are the software engines that software. By remaining at the forefront of collaboration tools, IBM’s run computers. Approximately 70 percent of external Software social business offerings help organizations reap real benefits segment revenue is annuity based, coming from recurring license associated with social networking, as well as create a more effi- charges, software sold “as-a-Service” and ongoing post-contract cient and effective workforce. support. The remaining revenue relates to one-time charge (OTC) arrangements in which clients pay one, up-front payment for a Rational: supports software development for both IT and com- perpetual license. Typically, the sale of OTC software includes one plex embedded system solutions, with a portfolio of products and year of post-contract support. Clients can also purchase ongoing solutions supporting DevOps and Smarter Product Development, post-contract support after the first year, which includes unspec- transforming the way lines of business, development and opera- ified product upgrades and technical support. tions work together to deliver innovation via software. In January 2015, the company made several changes designed Software Capabilities to more effectively align its key capabilities and resources to its WebSphere: delivers capabilities that enable organizations to run strategic imperatives. These changes have enabled the com- high-performance business applications. With these applications, pany to respond more quickly to critical client agendas and drive clients can integrate and manage business processes across their higher value. Across Software, the company is transitioning its organizations with the flexibility and agility they need to respond portfolio to capture growth and continue to drive innovation. The to changing conditions. Built on services-oriented architecture focus is centered around analytics, security, and commerce, uti- (SOA), and open standards support for cloud, mobile and social lizing its software assets to improve speed and agility in bringing interactions, the WebSphere platform enables enterprises to integrated solutions to its clients and to help clients become cog- extend their reach and optimize interactions with their key con- nitive enterprises. stituents. Smarter Commerce software helps companies better manage and improve each step of their value chain and capitalize Watson: the first commercially available cognitive computing on opportunities for profitable growth, efficiency and increased platform that has the ability to interact in natural language, pro- customer loyalty. cessing vast amounts of big data, and learning from its interactions with people and computers. As an advisor, Watson is able to sift Information Management: enables clients to integrate, manage through and understand large amounts of data delivering insights and analyze enormous amounts of data from a large variety of with unprecedented speeds and accuracy. sources in order to gain competitive advantage and improve their business outcomes. With this approach, clients can extract real value out of their data and use it to make better business decisions. IBM’s middleware and integrated solutions include advanced database management, information integration, data governance, enterprise content management, data warehousing, business ana- lytics and intelligence, predictive analytics and big data analytics.


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    Management Discussion 27 International Business Machines Corporation and Subsidiary Companies Watson Health: a business unit focused on the health industry, Technology: In 2014, the company announced a definitive agree- built upon the foundation of the work done with Watson and the ment to divest its Microelectronics business and manufacturing momentum of Cloud. This team of consultants, medical prac- operations. This transaction closed in 2015. titioners, clinicians, developers and researchers work with an extensive ecosystem of partners and clients to advance the quality Global Financing facilitates IBM clients’ acquisition of information and effectiveness of individual health with advanced data ana- technology systems, software and services by providing financ- lytics and insights. ing solutions in the areas where the company has the expertise. The financing arrangements are predominantly for products or Watson Internet of Things (IoT): in today’s world, physical devices services that are critical to the end users’ business operations. of all types are now instrumented with compute capabilities that These financing contracts are entered into after a comprehensive allow for direct sensing and communication of data. IBM’s focus is credit evaluation and are secured by legal contracts. As a captive enabling companies to use that data to improve operations, drive financier, Global Financing has the benefit of both deep knowledge new business and work directly with clients. of its client base and a clear insight into the products and services financed. These factors allow the business to effectively manage Systems Hardware provides clients with innovative infrastructure two of the major risks, credit and residual value, associated with technologies to help meet the new requirements of hybrid cloud financing while generating strong returns on equity. Global Financ- and cognitive workloads—from deploying advanced analytics, ing also maintains a long-term partnership with the companies’ to moving to digital service delivery with the cloud, and securing clients through various stages of IT asset life cycle—from initial mobile transaction processing. Approximately half of Systems purchase and technology upgrades to asset disposition decisions. Hardware’s server and storage sales transactions are through the company’s business partners; with the balance direct to end- Global Financing Capabilities user clients. IBM Systems also designs and procures advanced Client Financing: lease, installment payment plan and loan financ- semiconductor devices for use in the company’s systems. ing to end users and internal clients for terms up to seven years. Assets financed are primarily IT products and services where Systems Hardware Capabilities the company has expertise. Internal financing is predominantly Servers: a range of high-performing systems designed to address in support of Global Services’ long-term client service contracts. capacity, security, speed and compute power needs for busi- Global Financing also factors a selected portion of the company’s nesses, organizations and technical computing applications. The accounts receivable, primarily for cash management purposes. All portfolio includes z Systems, a trusted enterprise platform for internal financing arrangements are at arm’s-length rates and are integrating data, transactions and insight, and Power Systems, a based upon market conditions. system designed from the ground up for big data, optimized for scale-out cloud and Linux, and delivering open innovation with Commercial Financing: short-term inventory and accounts receiv- OpenPOWER. The company is also a founding member of the able financing to suppliers, distributors and remarketers of IBM OpenPOWER foundation, a group of industry-leading companies and OEM products. working together to develop high-performance compute solutions based on the IBM POWER architecture. Remanufacturing and Remarketing: assets include used equip- ment returned from lease transactions, or used surplus equipment Storage: data storage products and solutions that allow clients acquired internally or externally. These assets may be refurbished to retain and manage rapidly growing, complex volumes of digital or upgraded and sold or leased to new or existing clients both information. These solutions address critical client requirements externally or internally. Externally remarketed equipment revenue for information retention and archiving, security, compliance represents sales or leases to clients and resellers. Internally remar- and storage optimization including data deduplication, availabil- keted equipment revenue primarily represents used equipment ity and virtualization. The portfolio consists of a broad range of that is sold internally to Systems Hardware and Global Services. software-defined storage solutions, flash storage, disk and tape Systems Hardware may also sell the equipment that it purchases storage solutions. from Global Financing to external clients.


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    28 Management Discussion International Business Machines Corporation and Subsidiary Companies IBM Worldwide Organizations to IBM’s portfolio every year and helps clients address their most The following worldwide organizations play key roles in IBM’s deliv- difficult challenges. IBM Research also explores the boundaries ery of value to its clients: of science and technology—from nanotechnology and future systems, to big data analytics, secure clouds and advancing the • Sales and Distribution world’s first cognitive computing platform, IBM Watson. • Research, Development and Intellectual Property In 2015, IBM was awarded more U.S. patents than any other • Integrated Supply Chain company for the 23rd consecutive year. IBM’s 7,355 patents awarded in 2015 position the company to compete and lead in Sales and Distribution the emerging opportunities represented by big data and analyt- IBM has a significant global presence, operating in more than ics, security, social and mobile technologies. These inventions will 175 countries, with an increasingly broad-based geographic advance IBM’s cloud platform and the new era of computing in distribution of revenue. The company’s Sales and Distribution which machines will learn, reason and interact with people in more organization manages the IBM global footprint, with dedicated natural ways. country-based operating units focused on delivering unique value The company continues to actively seek intellectual property and a superior client experience. Within these units, client rela- (IP) protection for its innovations, while increasing emphasis on tionship professionals work with integrated teams of consultants, other initiatives designed to leverage its IP leadership. Some of product specialists and delivery fulfillment teams to enable clients’ IBM’s technological breakthroughs are used exclusively in IBM business growth and innovation. These teams deliver value by products, while others are licensed and may be used in IBM prod- understanding the clients’ business and needs, and then bringing ucts and/or the products of the licensee. While the company’s together capabilities from across IBM and an extensive network various proprietary IP rights are important to its success, IBM of Business Partners to develop and implement client solutions. believes its business as a whole is not materially dependent on By combining global expertise and digital sales capabilities any particular patent or license, or any particular group of patents with local experience, IBM’s geographic structure enables client or licenses. IBM owns or is licensed under a number of patents, relationships through dedicated management focus for local cli- which vary in duration, relating to its products. ents, speed in addressing new market opportunities and timely investments in emerging opportunities. The geographic units align Integrated Supply Chain industry solution, product and services expertise to serve clients’ IBM has an extensive integrated supply chain, procuring mate- agendas. IBM also extends the reach of its capabilities to com- rials and services globally. In 2015, the company also managed mercial clients by leveraging industry skills with digital marketing, approximately $24 billion in procurement spending for its clients digital sales and local Business Partner resources. through the Global Process Services organization. The supply, The company continues to invest to capture the long-term manufacturing and logistics operations are seamlessly integrated opportunity in key growth markets around the world—India, China and have optimized inventories over time. Simplifying and stream- and countries within Southeast Asia, Eastern Europe, the Middle lining internal processes has improved sales force productivity and East, Africa and Latin America. The company’s major markets operational effectiveness and efficiency. Supply chain resiliency include the G7 countries of Canada, France, Germany, Italy, Japan, enables IBM to reduce its risk during marketplace changes. the United States (U.S.) and the United Kingdom (UK) plus Austria, The company continues to derive business value from its own the Bahamas, Belgium, the Caribbean region, Cyprus, Denmark, globally integrated supply chain providing a strategic advantage Finland, Greece, Iceland, Ireland, Israel, Malta, the Netherlands, for the company to create value for clients. IBM leverages its supply Norway, Portugal, Spain, Sweden and Switzerland. chain expertise for clients through its supply chain business trans- formation outsourcing service to optimize and help operate clients’ Research, Development and Intellectual Property end-to-end supply chain processes, from procurement to logistics. IBM’s research and development (R&D) operations differentiate Utilizing analytics, mobile, cloud and social—with numerous proj- the company from its competitors. IBM annually invests approxi- ects, has allowed the integrated supply chain to drive positive mately 6 percent of total revenue for R&D, focusing on high-growth, business outcomes for the company and its clients. high-value opportunities. IBM Research works with clients and the company’s business units through global labs on near-term and midterm innovations. It contributes many new technologies


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    Management Discussion 29 International Business Machines Corporation and Subsidiary Companies YEAR IN REVIEW Results of Continuing Operations Segment Details The following is an analysis of the 2015 versus 2014 reportable segment results. The table below presents each reportable segment’s external revenue and gross margin results. Segment pre-tax income includes transactions between segments that are intended to reflect an arm’s-length transfer price and excludes certain unallocated corporate items. ($ in millions) Yr.-to-Yr. Yr.-to-Yr. Percent/ Percent Change Margin Adjusted for For the year ended December 31: 2015 2014** Change Currency Revenue Global Technology Services $32,017 $35,442 (9.7)% 0.5%* Gross margin 37.4% 39.0% (1.5) pts. Global Business Services 17,166 19,512 (12.0)% (4.1)%* Gross margin 28.2% 30.4% (2.2) pts. Software 22,932 25,434 (9.8)% (3.5)% Gross margin 87.3% 88.6% (1.3) pts. Systems Hardware 7,581 9,996 (24.2)% 7.6%* Gross margin 46.6% 39.5% 7.2 pts. Global Financing 1,840 2,034 (9.5)% 1.5% Gross margin 45.6% 49.4% (3.7) pts. Other 206 374 (45.0)% (39.1)% Gross margin (253.0)% (215.0)% (38.0) pts. Total consolidated revenue $81,741 $92,793 (11.9)% (1.2)%* Total consolidated gross profit $40,684 $46,407 (12.3)% Total consolidated gross margin 49.8% 50.0% (0.2) pts. Non-operating adjustments Amortization of acquired intangible assets 373 416 (10.5)% Retirement-related costs/(income) 469 173 170.7% Operating (non-GAAP) gross profit $41,526 $46,996 (11.6)% Operating (non-GAAP) gross margin 50.8% 50.6% 0.2 pts. * Adjusted for divestitures and currency. ** Reclassified to conform with 2015 presentation. Global Services In 2015, the Global Services segments, GTS and GBS, delivered million decreased 10.3 percent and 2 percent adjusted for cur- combined revenue of $49,182 million, a decrease of 10.5 percent as rency. The estimated Global Services backlog at December 31, reported and 1 percent adjusted for currency (9 points) and dives- 2015 of $121 billion increased 1 percent year to year, adjusted titures. Total outsourcing revenue of $21,889 million decreased for currency. Combined pre-tax income for the year decreased 10.7 percent as reported and 1 percent adjusted for currency 18.2 percent and the pre-tax margin decreased 1.4 points to (10 points) and divestitures. Total transactional revenue of $21,161 15.1 percent.


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    30 Management Discussion International Business Machines Corporation and Subsidiary Companies ($ in millions) Yr.-to-Yr. Yr.-to-Yr. Percent Change Percent Adjusted for For the year ended December 31: 2015 2014** Change Currency Global Services external revenue $49,182 $54,954 (10.5)% (1.1)%* Global Technology Services $32,017 $35,442 (9.7)% 0.5%* Outsourcing 16,992 19,082 (11.0) (0.5) Integrated Technology Services 8,893 9,506 (6.4) 2.5 Maintenance 6,132 6,853 (10.5) 1.2* Global Business Services $17,166 $19,512 (12.0)% (4.1)%* Outsourcing 4,898 5,438 (9.9) (2.0)* Consulting and Systems Integration 12,268 14,075 (12.8) (4.9) * Adjusted for divestitures and currency. ** Reclassified to conform with 2015 presentation. Global Technology Services revenue of $32,017 million decreased cloud stack is an open platform that enables this innovation. Cli- 9.7 percent as reported in 2015 compared to the prior year, but ents can choose from public, private and dedicated environments increased 1 percent adjusted for currency (10 points) and the based on their needs, such as workload, performance, data sov- System x divestiture, as the company helps clients transition to a ereignty and regulatory requirements. Entire industries and value hybrid cloud services platform bringing cloud, mobility and secu- chains are being disrupted, and clients are looking to the company rity to infrastructure services. Within GTS, outsourcing revenue for competitive advantage. of $16,992 million decreased 11.0 percent as reported and 1 per- Global Business Services revenue of $17,166 million decreased cent adjusted for currency as the company continues to reinvent 12.0 percent as reported and 4 percent adjusted for currency its portfolio, providing the most modern IT services that connect (8 points) compared to the prior year. Within GBS, outsourcing clients to the cloud-based mobile world. Integrated Technology revenue of $4,898 million decreased 9.9 percent as reported and Services (ITS) revenue of $8,893 million decreased 6.4 percent 2 percent adjusted for currency (8 points). Consulting and Systems as reported, but grew 3 percent adjusted for currency compared Integration (C&SI) revenue of $12,268 million declined 12.8 percent to the prior year with strong performance in SoftLayer through- as reported and 5 percent adjusted for currency. out the year. Maintenance revenue of $6,132 million decreased As the company continued to transform the GBS business 10.5 percent as reported, but grew 1 percent adjusted for currency during the year, revenue from the strategic imperative practices (9 points) and the System x divestiture (3 points). This business grew at strong rates. However, overall revenue performance con- continues to contribute significant revenue by delivering a wide tinues to be impacted by the company’s shift away from traditional range of support services to maintain and improve clients’ IT infra- enterprise application implementations. Clients are moving away structure. Throughout 2015, there was continued strong demand from ERP engagements to initiatives that focus on digitizing their for Multi-Vendor Support services where clients can leverage the business with analytics, cloud and mobile technologies. As part of company’s global distribution and inventory capabilities. the company’s partnership with Apple, it has now delivered over Within GTS, the strategic imperatives, including hybrid cloud 100 MobileFirst for iOS applications. This unique partnership services, grew strong double digits at constant currency for the full brings together the simplicity of design and ease of use of the year, including strong demand for SoftLayer. The company con- Apple mobile device with IBM’s ability to build applications that tinues to increase its cloud capacity with 46 cloud data centers scale securely and efficiently to the enterprise, helping to transform opened around the world as of December 31, 2015. This Infrastruc- the way work gets done across 14 industries and 65 professions. ture-as-a-Service cloud platform provides clients with a range of These applications allow clients to securely access their most cloud services, including virtual and bare metal servers along with critical data and processes, so that they can redesign workflows a dedicated dark fiber network infrastructure. As clients evaluate and drive productivity. Since the partnership with Apple was their technology roadmap, they look for agility and innovation and announced in 2014, the company has generated over $1 billion in to gain insight into data from all sources. The company’s hybrid signings from the program.


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    Management Discussion 31 International Business Machines Corporation and Subsidiary Companies ($ in millions) The GBS gross profit margin decreased 2.2 points to 28.2 per- Yr.-to-Yr. cent in 2015 compared to the prior year. Pre-tax income decreased Percent/ Margin 22.7 percent to $2,634 million and pre-tax margin declined For the year ended December 31: 2015 2014* Change 2.1 points to 14.9 percent compared to the prior year. This year-to- Global Services year profit decline reflects the market shifts in the GBS business. Global Technology Services In parts of the portfolio where the market is declining, there is External gross profit $11,981 $13,808 (13.2)% price and profit pressure and action is being taken to optimize the External gross profit margin 37.4% 39.0% (1.5) pts. cost structure in these areas. The company continues to shift and add significant resources to the high-growth analytics, cloud and Pre-tax income $ 5,002 $ 5,931 (15.7)% mobility practices, which impacts productivity and margin in the Pre-tax margin 15.2% 16.3% (1.1) pts. near term. Global Business Services External gross profit $ 4,837 $ 5,923 (18.3)% Global Services Backlog External gross profit margin 28.2% 30.4% (2.2) pts. The estimated Global Services backlog at December 31, 2015 was Pre-tax income $ 2,634 $ 3,408 (22.7)% $121 billion, a decrease of 6.0 percent as reported, but an increase of 1 percent adjusted for currency, compared to the December 31, Pre-tax margin 14.9% 17.0% (2.1) pts. 2014 balance. The estimated transactional backlog at Decem- * Reclassified to conform with 2015 presentation. ber 31, 2015 decreased 6.5 percent as reported, but was flat year to year adjusted for currency. The estimated outsourcing backlog The GTS gross profit margin decreased 1.5 points to 37.4 per- decreased 5.4 percent as reported, but grew 2 percent adjusted cent in 2015 compared to prior year. Pre-tax income decreased for currency compared to the prior year. 15.7 percent to $5,002 million. The GTS pre-tax margin declined Clients are looking to transform their most critical systems into 1.1 points to 15.2 percent compared to the prior year, primarily due hybrid cloud environments, and the complexity of these partner- to investments being made in this business. The company con- ships in many cases results in larger engagements. For the full year tinues to invest to deliver the most contemporary offerings that of 2015, over 70 services deals greater than $100 million were are built with cloud, analytics, mobile, security and cognitive tech- signed, which was 40 percent more than in 2014. About 70 percent nologies enabling it to transform clients’ enterprises. In addition, of those transactions feature hybrid cloud content, which reflects currency had a large year-to-year impact on profit given the strong both the value IBM’s clients see in hybrid and the reality that not dollar currency environment. all their workloads are optimized for the cloud. ($ in billions) Yr.-to-Yr. Yr.-to-Yr. Percent Change Percent Adjusted for At December 31: 2015 2014 Change Currency Backlog Total backlog $120.7 $128.4 (6.0)% 0.8% Outsourcing backlog 76.4 80.8 (5.4) 1.7 Total Global Services backlog includes GTS Outsourcing, ITS, Global Services signings are management’s initial estimate GBS Outsourcing, Consulting and Systems Integration and Main- of the value of a client’s commitment under a Global Services tenance. Outsourcing backlog includes GTS Outsourcing and GBS contract. There are no third-party standards or requirements Outsourcing. Transactional backlog includes ITS and Consulting governing the calculation of signings. The calculation used by and Systems Integration. Total backlog is intended to be a state- management involves estimates and judgments to gauge the ment of overall work under contract and therefore does include extent of a client’s commitment, including the type and duration of Maintenance. Backlog estimates are subject to change and are the agreement, and the presence of termination charges or wind- affected by several factors, including terminations, changes in the down costs. scope of contracts, periodic revalidations, adjustments for revenue not materialized and adjustments for currency.


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    32 Management Discussion International Business Machines Corporation and Subsidiary Companies Signings include GTS Outsourcing, ITS, GBS Outsourcing and Contract portfolios purchased in an acquisition are treated as Consulting and Systems Integration contracts. Contract exten- positive backlog adjustments provided those contracts meet the sions and increases in scope are treated as signings only to the company’s requirements for initial signings. A new signing will be extent of the incremental new value. Maintenance is not included recognized if a new services agreement is signed incidental or in signings as maintenance contracts tend to be more steady state, coincidental to an acquisition or divestiture. where revenues equal renewals. ($ in millions) Yr.-to-Yr. Yr.-to-Yr. Percent Change Percent Adjusted for For the year ended December 31: 2015 2014 Change Currency Total signings $48,243 $51,569 (6.5)% 2.8% Outsourcing signings $25,196 $26,517 (5.0)% 4.9% Transactional signings 23,046 25,052 (8.0) 0.5 Software ($ in millions) Yr.-to-Yr. Yr.-to-Yr. Percent Change Percent Adjusted for For the year ended December 31: 2015 2014 Change Currency Software external revenue $22,932 $25,434 (9.8)% (3.5)% Middleware $19,473 $21,474 (9.3)% (3.0)% Key branded middleware 15,778 17,098 (7.7) (1.5) WebSphere (5.3) 0.2 Information Management (8.0) (1.6) Workforce Solutions (8.1) (0.6) Tivoli (6.3) 0.1 Rational (20.3) (15.1) Other middleware 3,695 4,376 (15.6) (8.7) Operating systems 1,815 2,119 (14.3) (8.1) Other 1,644 1,841 (10.7) (4.9) Software revenue of $22,932 million decreased 9.8 percent as middleware, WebSphere decreased 5.3 percent (flat adjusted reported and 4 percent adjusted for currency in 2015 compared for currency), Information Management decreased 8.0 percent to the prior year. Year-to-year software revenue performance (2 percent adjusted for currency), Workforce Solutions decreased reflected a decrease in middleware with declines in transactional 8.1 percent (1 percent adjusted for currency), Tivoli decreased revenue and a continuing headwind from operating systems. 6.3 percent (flat adjusted for currency), and Rational decreased Key branded middleware revenue of $15,778 million, which 20.3 percent (15 percent adjusted for currency). Other middleware accounted for approximately 69 percent of total software revenue decreased 15.6 percent as reported and 9 percent adjusted for in 2015, decreased 7.7 percent as reported and 2 percent adjusted currency. Operating systems decreased 14.3 percent as reported for currency compared to the prior year. Within key branded and 8 percent adjusted for currency.


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    Management Discussion 33 International Business Machines Corporation and Subsidiary Companies On an annual basis, approximately 70 percent of the company’s Software gross profit margin decreased 1.3 points to 87.3 percent. software business is annuity-like, including Software-as-a-Service Software pre-tax income of $9,066 million decreased 15.3 percent, and subscription and support. Renewal rates are steady, the SaaS with a pre-tax margin of 34.6 percent, a decrease of 2.4 points. business is growing, and overall annuity revenue grew for the full Profit performance for the year reflected the overall revenue trajec- year. Transactional revenue declined year to year as large clients tory, a higher level of investments in areas such as Watson, Watson with multi-year contracts continued to utilize the flexibility the com- Health, Watson IoT and Bluemix, and an impact from currency. pany has provided in deployment of their software. Outside the The company continues to transform and invest in the Software company’s top 250 clients, software revenue increased low single business. Middleware serves the purpose of integrating different digits adjusted for currency on a year-to-year basis. environments, such as on premise and cloud. Key capabilities have now been delivered on SoftLayer or as part of the Bluemix ($ in millions) platform to enable hybrid environments. The company’s middle- Yr.-to-Yr. ware remains the number one integration platform in the world and Percent/ Margin now integrates across cloud environments. This allows clients’ For the year ended December 31: 2015 2014 Change existing applications to access the cloud, and new “born to the Software cloud” applications to access clients’ existing assets. External gross profit $20,013 $22,533 (11.2)% The company is also adding substantial new capabilities to its External gross profit margin 87.3% 88.6% (1.3) pts. software and solutions portfolio, including The Weather Company acquisition, which closed in January 2016. This acquisition will Pre-tax income $ 9,066 $10,699 (15.3)% bring with it a high-volume platform that can ingest sensor data Pre-tax margin 34.6% 37.0% (2.4) pts. at scale. The power of this platform is its ability to use Watson cognitive capabilities to gather new insights by connecting data at scale from multiple industry domains. Systems Hardware ($ in millions) Yr.-to-Yr. Yr.-to-Yr. Percent Change Percent Adjusted for For the year ended December 31: 2015 2014 Change Currency Systems Hardware external revenue $7,581 $9,996 (24.2)% 7.6%* z Systems 28.1% 34.7% Power Systems (0.4) 4.5 Storage (11.9) (7.0) * Adjusted for the System x divestiture and currency. Systems Hardware revenue of $7,581 million decreased 24.2 per- broader opportunity. The company continued to deliver innova- cent as reported, but grew 8 percent year to year adjusted for tion to its systems to enable them to run the most contemporary the divestiture of the System x business (28 points) and currency workloads. Approximately half of the Systems Hardware revenue (4 points) driven by z Systems and Power Systems. Systems in 2015 was for solutions that address analytics workloads, or Hardware had a successful mainframe product cycle in 2015 hybrid and private clouds. and Power Systems grew as it was repositioned to address a


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    34 Management Discussion International Business Machines Corporation and Subsidiary Companies z Systems revenue increased 28.1 percent as reported and ($ in millions) 35 percent adjusted for currency compared to the prior year, with Yr.-to-Yr. Percent/ strong double-digit growth adjusted for currency in each quar- Margin For the year ended December 31: 2015 2014 Change ter since the launch of the z13 system in the first quarter of 2015. MIPS (millions of instructions per second) shipments increased Systems Hardware 33 percent in 2015. The z13 system was contemporized for the External gross profit $3,535 $3,945 (10.4)% workloads around mobile, hybrid cloud and analytics. These External gross profit margin 46.6% 39.5% 7.2 pts. innovations continue to resonate with existing customers and the Pre-tax income $ 604 $ 34 NM company continues to add new customers to the platform. In 2015, Pre-tax margin 7.5% 0.3% 7.2 pts. the z Systems business added 50 new clients across 25 countries. Power Systems revenue decreased 0.4 percent as reported, NM—Not meaningful but grew 4 percent adjusted for currency in 2015 compared to the prior year, the first year of revenue growth since 2011. The Power Systems Hardware gross profit margin of 46.6 percent increased Systems performance reflects the progress being made to trans- 7.2 points versus the prior year. The increase was due to mix form the platform to align around data and cloud opportunities, (11.8 points) driven by strong growth in z Systems and the divesti- while embracing an open ecosystem. The company continues to ture of the lower margin System x business. This improvement was address the high value opportunity in the UNIX market. Simultane- offset by lower margins (4.6 points) in z Systems and Power Sys- ously, the company has introduced a low-end Linux-based Power tems compared to the prior year. Pre-tax income was $604 million system to capture the growing Linux market. The OpenPOWER ini- in 2015, an increase of $570 million compared to 2014. Pre-tax tiative continues to progress as the company integrates innovation margin increased 7.2 points year to year to 7.5 percent. Systems from the broader ecosystem with its own products and licenses IP Hardware results reflect a successful transformation and reposi- to support third-party Power-based offerings. tioning of the business including a solid mainframe product cycle Storage revenue decreased 11.9 percent as reported and 7 per- and successful Power Systems transformation. cent adjusted for currency in 2015 driven by continued weakness in traditional disk and tape. Value in the storage market continues to Global Financing shift to software and offering requirements that are driving demand See pages 69 through 73 for an analysis of Global Financing’s for flash and object-based storage. The company is well positioned segment results. in these new areas with its FlashSystems offerings and the recent acquisition of Cleversafe, Inc. Geographic Revenue In addition to the revenue presentation by reportable segment, the company also measures revenue performance on a geographic basis. The following geographic, regional and country-specific revenue performance excludes OEM revenue. ($ in millions) Yr.-to-Yr. Yr.-to-Yr. Percent Change Percent Adjusted for For the year ended December 31: 2015 2014 Change Currency* Total revenue $81,741 $92,793 (11.9)% (1.2)% Geographies $81,430 $92,326 (11.8)% (1.1)% Americas 38,486 41,410 (7.1) (1.8) Europe/Middle East/Africa 26,073 30,700 (15.1) 0.3 Asia Pacific 16,871 20,216 (16.5) (1.7) Major markets (9.9)% (0.5)% Growth markets (18.4)% (3.1)% BRIC countries (27.1)% (10.1)% * Adjusted for divestitures and currency.


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    Management Discussion 35 International Business Machines Corporation and Subsidiary Companies Total geographic revenue of $81,430 million in 2015 decreased Asia Pacific revenue of $16,871 million decreased 16.5 percent 11.8 percent as reported and 1 percent adjusted for currency as reported and 2 percent adjusted for currency (9 points) and the (8 points) and the divestitures of the System x and customer care divested businesses (6 points) compared to the prior year. Japan businesses (3 points) compared to 2014. Major market coun- decreased 9.9 percent as reported, but had growth of 5 percent tries decreased 9.9 percent as reported and 1 percent adjusted adjusted for currency (13 points) and the divested businesses for currency (8 points) and the divested businesses (2 points). (2 points). On an adjusted basis, the Japan growth was more than Within the major markets, performance varied in 2015. While the offset by a decline in other markets. China decreased 34.4 percent U.S. was down compared to the prior year, revenue in Germany, as reported and 21 percent adjusted for the divested businesses Japan and the UK grew year to year on an adjusted basis. Over- (12 points) and currency (1 point). India decreased 3.8 percent as all, growth market countries decreased 18.4 percent as reported reported, but had growth of 8 percent adjusted for the divested and 3 percent adjusted for currency (9 points) and the divested businesses (7 points) and currency (5 points). businesses (6 points). From a regional perspective, on an adjusted basis, growth in Latin America and the Middle East and Africa Total Expense and Other (Income) region was more than offset by declines in the Asia Pacific growth ($ in millions) market countries. Yr.-to-Yr. Percent/ Americas revenue of $38,486 million decreased 7.1 percent Margin as reported and 2 percent adjusted for currency (3 points) and For the year ended December 31: 2015 2014 Change divestitures (2 points) compared to 2014 with a decline in North Total consolidated expense America and growth in Latin America on an adjusted basis. The and other (income) $24,740 $26,421 (6.4)% U.S. decreased 4.4 percent as reported and 3 percent adjusted for Non-operating adjustments divestitures. Canada was down 17.2 percent as reported and 2 per- Amortization of acquired cent adjusted for currency (13 points) and divestitures (2 points). intangible assets (304) (374) (18.8) In Latin America, Brazil decreased 26.0 percent as reported and Acquisition-related charges (26) (12) 112.6 2 percent adjusted for currency (22 points) and the divested Non-operating retirement-related businesses (2 points), while Mexico had growth of 0.5 percent (costs)/income (581) (180) 222.4 as reported and 14 percent adjusted for currency (9 points) and Operating (non-GAAP) divestitures (4 points). expense and other (income) $23,830 $25,855 (7.8)% Europe/Middle East/Africa (EMEA) revenue of $26,073 million Total consolidated in 2015 decreased 15.1 percent as reported, but was flat year to expense-to-revenue ratio 30.3% 28.5% 1.8 pts. year adjusted for currency (13 points) and the divested businesses Operating (non-GAAP) (3 points). On an adjusted basis, there was growth in Germany expense-to-revenue ratio 29.2% 27.9% 1.3 pts. and the UK. Germany decreased 13.2 percent as reported, but grew 7 percent adjusted for currency (17 points) and the divested The key drivers of the year-to-year change in total expense and businesses (3 points). The UK decreased 6.3 percent year to year other (income) were approximately: as reported, but grew 3 percent adjusted for currency (7 points) Total Operating and the divested businesses (2 points). The Middle East and Africa Consolidated (non-GAAP) region decreased 4.8 percent as reported, but grew 5 percent • Currency* (9) points (9) points adjusted for the divested businesses (6 points) and currency • System x divestiture (2) points (2) points (4 points). Russia decreased 32.2 percent as reported and 24 per- • Divestiture gains 6 points 6 points cent adjusted for the divestitures. • Workforce rebalancing (3) points (3) points * Reflects impacts of translation and hedging programs. For additional information regarding total expense and other (income) for both expense presentations, see the following anal- yses by category.


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    36 Management Discussion International Business Machines Corporation and Subsidiary Companies Selling, General and Administrative Research, Development and Engineering ($ in millions) ($ in millions) Yr.-to-Yr. Yr.-to-Yr. Percent Percent For the year ended December 31: 2015 2014 Change For the year ended December 31: 2015 2014 Change Selling, general and Total consolidated research, administrative expense development and engineering $5,247 $5,437 (3.5)% Selling, general and Non-operating adjustment administrative—other $16,643 $18,532 (10.2)% Non-operating retirement-related Advertising and promotional (costs)/income (48) 77 NM expense 1,290 1,307 (1.3) Operating (non-GAAP) research, Workforce rebalancing charges 587 1,472 (60.1) development and engineering $5,200 $5,514 (5.7)% Retirement-related costs 1,052 811 29.7 NM—Not meaningful Amortization of acquired intangible assets 304 374 (18.8) Research, development and engineering (RD&E) expense was Stock-based compensation 322 350 (8.0) 6.4 percent of revenue in 2015 and 5.9 percent of revenue in 2014. Bad debt expense 231 334 (30.8) RD&E expense decreased 3.5 percent in 2015 versus 2014 Total consolidated selling, primarily driven by: general and administrative expense $20,430 $23,180 (11.9)% • The effects of currency (5 points); and Non-operating adjustments • The impact of the divested System x business (4 points); Amortization of acquired partially offset by intangible assets (304) (374) (18.8) • Increased base spending (4 points); and Acquisition-related charges (21) (11) 81.1 • Higher expense due to acquisitions (1 point). Non-operating retirement-related (costs)/income (533) (257) 107.3 Operating (non-GAAP) RD&E expense decreased 5.7 percent in 2015 compared to the prior year, driven primarily by the same Operating (non-GAAP) selling, general and factors. administrative expense $19,573 $22,537 (13.2)% Intellectual Property and Custom Development Income Total selling, general and administrative (SG&A) expense d e- ($ in millions) creased 11.9 percent in 2015 versus 2014, driven primarily by the Yr.-to-Yr. Percent following factors: For the year ended December 31: 2015 2014 Change Sales and other transfers • The effects of currency (7 points); and of intellectual property $303 $283 7.1% • Lower workforce rebalancing charges (3 points); and Licensing/royalty-based fees 117 129 (9.8) • The impact of the divested System x business (1 point). Custom development income 262 330 (20.5) Operating (non-GAAP) expense decreased 13.2 percent year to Total $682 $742 (8.1)% year driven primarily by the same factors. Bad debt expense decreased $103 million in 2015 compared The timing and amount of Sales and other transfers of IP may vary to 2014. The receivables provision coverage was 2.6 percent at significantly from period to period depending upon the timing of December 31, 2015, an increase of 40 basis points from Decem- divestitures, economic conditions, industry consolidation and the ber 31, 2014. timing of new patents and know-how development. There were no material individual IP transactions in 2015 or 2014.


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    Management Discussion 37 International Business Machines Corporation and Subsidiary Companies Other (Income) and Expense The decrease in interest expense in 2015 versus 2014 was primar- ($ in millions) ily driven by lower average debt levels, partially offset by higher Yr.-to-Yr. average interest rates. Interest expense is presented in cost of Percent For the year ended December 31: 2015 2014 Change financing in the Consolidated Statement of Earnings only if the related external borrowings are to support the Global Financing Other (income) and expense external business. Overall interest expense (excluding capital- Foreign currency transaction ized interest) in 2015 was $1,009 million, a decrease of $16 million losses/(gains) $ 414 $ (599) NM year to year. (Gains)/losses on derivative instruments (853) 654 NM Stock-Based Compensation Interest income (72) (90) (19.8)% Pre-tax stock-based compensation cost of $468 million decreased Net (gains)/losses from securities $44 million compared to 2014. This was due primarily to decreases and investment assets 47 (26) NM related to performance share units ($32 million), the conversion Other (260) (1,878) (86.1)% of stock-based awards previously issued by acquired entities Total consolidated other ($6 million) and restricted stock units ($6 million). Stock-based (income) and expense $(724) $(1,938) (62.6)% compensation cost, and the year-to-year change, was reflected Non-operating adjustment in the following categories: Cost: $100 million, down $21 million; Acquisition-related charges (5) (1) NM SG&A expense: $322 million, down $28 million; RD&E expense: Operating (non-GAAP) $51 million, down $3 million and Other (income) and expense: other (income) and expense $(729) $(1,939) (62.4)% ($6 million), down $8 million. The amount of stock-based com- NM—Not meaningful pensation cost included in the loss from discontinued operations, net of tax, was immaterial in 2015 and 2014. The decrease in income of $1,214 million year over year was pri- marily driven by: Retirement-Related Plans The following table provides the total pre-tax cost for all retire- • Lower gains on divestitures ($1,623 million) primarily associ- ment-related plans. These amounts are included in the Consoli- ated with the divestitures of the System x and customer care dated Statement of Earnings within the caption (e.g., Cost, SG&A, businesses in 2014; and RD&E) relating to the job function of the plan participants. • Higher foreign currency transaction losses ($1,013 million); partially offset by ($ in millions) Yr.-to-Yr. • Increased gains on derivative instruments ($1,507 million). Percent For the year ended December 31: 2015 2014 Change Interest Expense Retirement-related plans—cost ($ in millions) Service cost $ 484 $ 482 0.5% Yr.-to-Yr. Amortization of prior service Percent For the year ended December 31: 2015 2014 Change costs/(credits) (100) (114) (12.0) Interest expense Cost of defined contribution plans 1,138 1,253 (9.2) Total $468 $484 (3.2)% Total operating costs/(income) $ 1,522 $ 1,621 (6.1)% Interest cost 3,316 3,994 (17.0) Expected return on plan assets (5,879) (6,351) (7.4) Recognized actuarial losses 3,283 2,467 33.1 Curtailments/settlements 36 25 41.2 Multi-employer plan/other costs 293 218 34.8 Total non-operating costs/ (income) $ 1,050 $ 353 197.2% Total retirement-related plans—cost $ 2,572 $ 1,974 30.3%


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    38 Management Discussion International Business Machines Corporation and Subsidiary Companies In 2015, total pre-tax retirement-related plan cost increased by Earnings Per Share $598 million compared to 2014, primarily driven by an increase in Basic earnings per share is computed on the basis of the weight- recognized actuarial losses ($816 million), lower expected return ed-average number of shares of common stock outstanding on plan assets ($472 million) and higher pension obligations related during the period. Diluted earnings per share is computed on the to litigation in Spain ($85 million), partially offset by lower inter- basis of the weighted-average number of shares of common stock est cost ($678 million) and lower defined contribution plans cost outstanding plus the effect of dilutive potential common shares ($115 million). outstanding during the period using the treasury stock method. As discussed in the “Operating (non-GAAP) Earnings” section Dilutive potential common shares include outstanding stock on pages 18 and 19, the company characterizes certain retire- options and stock awards. ment-related costs as operating and others as non-operating. Utilizing this characterization, operating retirement-related costs Yr.-to-Yr. in 2015 were $1,522 million, a decrease of $99 million compared Percent For the year ended December 31: 2015 2014 Change to 2014, primarily driven by lower defined contribution plans cost ($115 million). Non-operating costs of $1,050 million increased Earnings per share of common stock from continuing operations $696 million in 2015 compared to the prior year, driven primarily Assuming dilution $13.60 $15.59 (12.8)% by an increase in recognized actuarial losses ($816 million), lower expected return on plan assets ($472 million), higher pension obli- Basic $13.66 $15.68 (12.9)% gations related to litigation in Spain ($85 million), partially offset by Diluted operating (non-GAAP) $14.92 $16.53 (9.7)% lower interest cost ($678 million). Weighted-average shares outstanding (in millions) Income Taxes Assuming dilution 982.7 1,010.0 (2.7)% The continuing operations effective tax rate for 2015 was 16.2 per- Basic 978.7 1,004.3 (2.5)% cent, a decrease of 5.0 points versus the prior year, driven by the following factors: Actual shares outstanding at December 31, 2015 and 2014 were • The benefit resulting from the completion of the U.S. 2011–2012 965.7 million and 990.5 million, respectively. The average number tax audit, including the associated reserve redeterminations of common shares outstanding assuming dilution was 27.3 million (3.9 points); and shares lower in 2015 versus 2014. The decrease was primarily the • A benefit due to the geographic mix of pre-tax income in result of the common stock repurchase program. 2015 (3.5 points); and • A benefit due to the 2014 tax charge related to the divestiture Results of Discontinued Operations of the System x business (0.9 points); partially offset by The loss from discontinued operations, net of tax, was $0.2 billion • A reduced benefit year to year in the utilization of foreign tax in 2015 and $3.7 billion in 2014. The loss from discontinued opera- credits (2.5 points); and tions in 2014 included a nonrecurring pre-tax charge of $4.7 billion, • The year-to-year increase in tax charges related to or $3.4 billion, net of tax, which included an impairment to reflect intercompany payments made by foreign subsidiaries and the fair value less estimated costs to sell the Microelectronics the intercompany licensing of certain IP (0.8 points). business and other estimated costs related to the transaction, including cash consideration. The discontinued operations effec- The continuing operations operating (non-GAAP) effective tax rate tive tax rate in 2015 was 40.3 percent compared to 30.2 percent was 17.2 percent, a decrease of 3.8 points versus 2014 principally in 2014. driven by the same factors described above.


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    Management Discussion 39 International Business Machines Corporation and Subsidiary Companies Financial Position Dynamics At December 31, 2015, the company continued to have the financial The assets and debt associated with the Global Financing flexibility to support the business over the long term. Cash and business are a significant part of the company’s financial posi- marketable securities at year end were $8,195 million. During the tion. The financial position amounts appearing on page 78 are the year, the company continued to manage the investment portfolio consolidated amounts including Global Financing. The amounts to meet its capital preservation and liquidity objectives. appearing in the separate Global Financing section, beginning on Total debt of $39,890 million decreased $832 million from prior page 69, are supplementary data presented to facilitate an under- year-end levels. The commercial paper balance at December 31, standing of the Global Financing business. 2015, was $600 million, a decrease of $50 million from the prior year end. Within total debt, $27,205 million is in support of the Working Capital Global Financing business which is leveraged at a 7.3 to 1 ratio. ($ in millions) The company continues to have substantial flexibility in the debt At December 31: 2015 2014 markets. During 2015, the company completed bond issuances Current assets $42,504 $47,377* totaling $3,368 million, with terms ranging from 3 to 7 years, and Current liabilities 34,269 39,581* ** interest rates ranging from 0.53 to 2.88 percent depending on Working capital $ 8,235 $ 7,797* ** maturity. The company has consistently generated strong cash flow from operations and continues to have access to additional Current ratio 1.24:1 1.20:1* ** sources of liquidity through the capital markets and its $10 billion * Reclassified to reflect adoption of the FASB guidance on deferred taxes in global credit facility, with 100 percent of the facility available on a consolidated financial statements. Refer to note B, “Accounting Changes,” for additional information. same day basis. ** Reclassified to reflect adoption of the FASB guidance on debt issuance costs in Consistent with accounting standards, the company remea- consolidated financial statements. Refer to note B, “Accounting Changes,” for additional information. sures the funded status of its retirement and postretirement plans at December 31. At December 31, 2015, the overall net under- funded position was $15,513 million, a decrease of $1,419 million Working capital increased $439 million from the year-end 2014 from December 31, 2014 driven by an increase in discount rates. position. The key changes are described below: At year end, the company’s qualified defined benefit plans were Current assets decreased $4,873 million ($2,074 million well funded and the cash requirements related to these plans adjusted for currency), as a result of: remain stable going forward at approximately $500 million per • A decline of $3,277 million ($1,316 million adjusted for currency) year through 2020. In 2015, the return on the U.S. Personal Pension in receivables driven by the receipt of tax refunds; and Plan assets was negative 1.0 percent and the plan was 101 percent • A decrease of $762 million ($470 million adjusted for currency) funded at December 31. Overall, global asset returns were negative in prepaid expenses and other current assets due to 0.2 percent and the qualified defined benefit plans worldwide decreases in counterparty collateral postings and derivative were 97 percent funded at December 31, 2015. assets, partially offset by an increase in prepaid income During 2015, the company generated $17,008 million in cash taxes; and from operations, an increase of $139 million compared to 2014. • A decline of $553 million ($480 million adjusted for currency) in In addition, the company generated $13,075 million in free cash inventories primarily driven by the Microelectronics divestiture. flow, an increase of $703 million versus the prior year. See pages 62 to 63 for additional information on free cash flow. The company Current liabilities decreased $5,311 million ($3,418 million adjusted returned $9,507 million to shareholders in 2015, with $4,897 mil- for currency), as a result of: lion in dividends and $4,609 million in gross share repurchases. In 2015, the company repurchased 30.3 million shares and had • A decrease in taxes of $2,237 million ($1,995 million adjusted $5.6 billion remaining in share repurchase authorization at year for currency) primarily driven by income tax payments, settle- end. The company’s cash generation permits the company to ment of the U.S. tax audit and a tax benefit associated with invest and deploy capital to areas with the most attractive long- the Microelectronics divestiture; and term opportunities.


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    40 Management Discussion International Business Machines Corporation and Subsidiary Companies • A decrease in other accrued expenses and liabilities of $1,641 Net cash used in financing activities decreased $6,286 million as million ($1,281 million adjusted for currency) driven by net compared to the prior year driven by the following factors: activity associated with the Microelectronics divestiture and workforce rebalancing payments; and • A decrease of $9,070 million of cash used for gross share • A decrease in deferred income of $856 million ($226 million repurchases; partially offset by adjusted for currency); and a decline of $837 million ($568 • A decrease in net cash sourced from debt transactions of million adjusted for currency) in accounts payable reflecting $1,764 million driven by a lower level of issuances in the current the wind down of the divested System x business payables year; and and decreases in counterparty collateral postings; partially • An increase in dividend payments of $632 million. offset by • An increase in short-term debt of $731 million ($872 million Noncurrent Assets and Liabilities adjusted for currency). ($ in millions) At December 31: 2015 2014 Cash Flow Noncurrent assets $67,991 $69,894* ** The company’s cash flows from operating, investing and financ- Long-term debt $33,428 $34,991** ing activities, as reflected in the Consolidated Statement of Cash Noncurrent liabilities (excluding debt) $28,374 $30,686* Flows on page 79 are summarized in the table below. These amounts include the cash flows associated with the Global Financ- * Reclassified to reflect adoption of the FASB guidance on deferred taxes in consolidated financial statements. Refer to note B, “Accounting Changes,” for ing business. additional information. ** Reclassified to reflect adoption of the FASB guidance on debt issuance costs in consolidated financial statements. Refer to note B, “Accounting Changes,” for ($ in millions) additional information. For the year ended December 31: 2015 2014 Net cash provided by/(used in) The decrease in noncurrent assets of $1,903 million (an increase continuing operations of $1,735 million adjusted for currency) was driven by: Operating activities $17,008 $ 16,868 Investing activities (8,159) (3,001) • A decrease of $1,853 million ($1,417 million adjusted for Financing activities (9,166) (15,452) currency) in deferred taxes driven by the utilization of the tax Effect of exchange rate changes on benefit associated with the Microelectronics divestiture; and cash and cash equivalents (473) (655) • A decrease of $1,096 million ($186 million adjusted for cur- Net change in cash and cash equivalents $ (790) $ (2,240) rency) in long-term financing receivables; partially offset by • An increase in goodwill of $1,466 million ($2,561 adjusted for currency) resulting from acquisitions during the year. Net cash provided by operating activities increased by $139 million in 2015 driven by the following key factors: Long-term debt decreased $1,563 million ($862 million adjusted for currency) driven by: • A decline in cash income tax payments ($3,092 million); and • An improvement in sales cycle working capital of $1,192 million; • Reclassification of $5,549 million to short-term debt to reflect partially offset by upcoming maturities; partially offset by • Performance-related declines within net income; and • Debt issuances of $4,647 million. • An increase in performance-related compensation payments of $470 million. Other noncurrent liabilities, excluding debt, decreased $2,312 million ($387 million adjusted for currency) primarily driven by: Net cash used in investing activities increased $5,158 million driven by: • A decrease in retirement and nonpension postretirement liabilities of $1,757 million driven by a currency impact of • A decrease in cash provided by divestitures of $2,758 $1,295 million; and million; and • A decline of $635 million ($207 million adjusted for currency) • An increase in cash used related to acquisitions of in other liabilities associated with a reclass to short-term $2,693 million. payables of a portion of the consideration payment associ- ated with the Microelectronics divestiture.


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    Management Discussion 41 International Business Machines Corporation and Subsidiary Companies Debt The company’s funding requirements are continually monitored and equity as management believes this is more representative and strategies are executed to manage the overall asset and liabil- of the company’s core business operations. This ratio can vary ity profile. Additionally, the company maintains sufficient flexibility from period to period as the company manages its global cash to access global funding sources as needed. and debt positions. “Core” debt-to-capitalization ratio (excluding Global Financing debt and equity) was 54.3 percent at Decem- ($ in millions) ber 31, 2015 compared to 59.2 percent at December 31, 2014. At December 31: 2015 2014 Consolidated debt-to-capitalization ratio at December 31, 2015 Total company debt $39,890 $40,722* was 73.4 percent versus 77.2 percent at December 31, 2014. Total Global Financing segment debt $27,205 $29,103 Equity Debt to support external clients 23,934 25,531 Total equity increased by $2,410 million from December 31, 2014 Debt to support internal clients 3,271 3,572 as a result of an increase in retained earnings of $8,332 million and Non-Global Financing debt 12,684 11,619* common stock of $596 million offset by an increase in treasury * Reclassified to reflect adoption of the FASB guidance on debt issuance costs in stock of $4,803 million mainly due to gross common stock repur- consolidated financial statements. Refer to note B, “Accounting Changes,” for chases and an increase in other comprehensive losses of $1,731 additional information. million primarily due to foreign currency translation adjustments. Global Financing provides financing predominantly for the com- GAAP Reconciliation pany’s external client assets, as well as for assets under contract The tables below provide a reconciliation of the company’s income by other IBM units. These assets, primarily for Global Services, statement results as reported under GAAP to its operating earn- generate long-term, stable revenue streams similar to the Global ings presentation which is a non-GAAP measure. The company’s Financing asset portfolio. Based on their attributes, these Global calculation of operating (non-GAAP) earnings, as presented, may Services assets are leveraged with the balance of the Global differ from similarly titled measures reported by other companies. Financing asset base. The debt analysis above is further detailed Please refer to the “Operating (non-GAAP) Earnings” section on in the Global Financing section on pages 72 and 73. pages 18 and 19 for the company’s rationale for presenting oper- Given the significant leverage, the company presents a ating earnings information. debt-to-capitalization ratio which excludes Global Financing debt ($ in millions except per share amount) Acquisition- Retirement- Related Related Operating For the year ended December 31, 2015: GAAP Adjustments Adjustments (non-GAAP) Gross profit $40,684 $ 373 $ 469 $41,526 Gross profit margin 49.8% 0.5 pts. 0.6 pts. 50.8% SG&A $20,430 $(324) $ (533) $19,573 RD&E 5,247 — (48) 5,200 Other (income) and expense (724) (5) — (729) Total expense and other (income) 24,740 (330) (581) 23,830 Pre-tax income from continuing operations 15,945 703 1,050 17,697 Pre-tax margin from continuing operations 19.5% 0.9 pts. 1.3 pts. 21.6% Provision for income taxes* $ 2,581 $ 141 $ 316 $ 3,037 Effective tax rate 16.2% 0.2 pts. 0.9 pts. 17.2% Income from continuing operations $13,364 $ 562 $ 734 $14,659 Income margin from continuing operations 16.3% 0.7 pts. 0.9 pts. 17.9% Diluted earnings per share from continuing operations $ 13.60 $0.57 $ 0.75 $ 14.92 * The tax impact on operating (non-GAAP) pre-tax income is calculated under the same accounting principles applied to the GAAP pre-tax income which employs an annual effective tax rate method to the results.


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    42 Management Discussion International Business Machines Corporation and Subsidiary Companies ($ in millions except per share amount) Acquisition- Retirement- Related Related Operating For the year ended December 31, 2014: GAAP Adjustments Adjustments (non-GAAP) Gross profit $46,407 $ 416 $ 173 $46,996 Gross profit margin 50.0% 0.4 pts. 0.2 pts. 50.6% SG&A $23,180 $(385) $(257) $22,537 RD&E 5,437 — 77 5,514 Other (income) and expense (1,938) (1) — (1,939) Total expense and other (income) 26,421 (386) (180) 25,855 Pre-tax income from continuing operations 19,986 803 353 21,142 Pre-tax margin from continuing operations 21.5% 0.9 pts. 0.4 pts. 22.8% Provision for income taxes* $ 4,234 $ 133 $ 73 $ 4,440 Effective tax rate 21.2% (0.2) pts. 0.0 pts. 21.0% Income from continuing operations $15,751 $ 670 $ 280 $16,702 Income margin from continuing operations 17.0% 0.7 pts. 0.3 pts. 18.0% Diluted earnings per share from continuing operations $ 15.59 $0.66 $0.28 $ 16.53 * The tax impact on operating (non-GAAP) pre-tax income is calculated under the same accounting principles applied to the GAAP pre-tax income which employs an annual effective tax rate method to the results. Consolidated Fourth-Quarter Results The following table provides the company’s operating (non-GAAP) ($ and shares in millions except per share amounts) earnings for the fourth quarter of 2015 and 2014. Yr.-to-Yr. Percent/ ($ in millions except per share amounts) Margin For the fourth quarter: 2015 2014 Change Yr.-to-Yr. Percent Revenue $22,059 $24,113 (8.5)%* For the fourth quarter: 2015 2014 Change Gross profit margin 51.7% 53.3% (1.6) pts. Net income as reported $4,463 $5,484 (18.6)% Total expense and other (income) $ 6,308 $ 5,767 9.4% Income/(loss) from discontinued operations, net of tax 3 (31) NM Total expense and other (income)-to-revenue ratio 28.6% 23.9% 4.7 pts. Income from continuing operations 4,460 5,515 (19.1) Income from continuing operations Non-operating adjustments before income taxes $ 5,098 $ 7,094 (28.1)% (net of tax) Provision for income taxes from Acquisition-related charges 110 186 (41.0) continuing operations $ 638 $ 1,580 (59.6)% Non-operating retirement-related Income from continuing operations $ 4,460 $ 5,515 (19.1)% costs/(income) 137 84 63.8 Income from continuing Operating (non-GAAP) earnings* $4,707 $5,785 (18.6)% operations margin 20.2% 22.9% (2.7) pts. Diluted operating (non-GAAP) Income/(loss) from discontinued earnings per share $ 4.84 $ 5.81 (16.7)% operations, net of tax $ 3 $ (31) NM * See page 48 for a more detailed reconciliation of net income to operating earnings. Net income $ 4,463 $ 5,484 (18.6)% NM—Not meaningful Earnings per share from continuing operations: Assuming dilution $ 4.59 $ 5.54 (17.1)% Consolidated earnings per share— assuming dilution $ 4.59 $ 5.51 (16.7)% Weighted-average shares outstanding Assuming dilution 972.8 995.4 (2.3)% * (2.3) percent adjusted for currency. NM—Not meaningful


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    Management Discussion 43 International Business Machines Corporation and Subsidiary Companies Snapshot In the fourth quarter of 2015, the company reported $22.1 billion From a geographic perspective, revenue in the major markets in revenue and delivered $4.5 billion in income from continuing declined 6.9 percent and 2 percent adjusted for currency. While operations with diluted earnings per share from continuing oper- the U.S. was down, revenue in Europe and Japan grew on an ations of $4.59 as reported and $4.84 on an operating (non-GAAP) adjusted basis. Growth markets revenue decreased 13.6 percent basis. The results of continuing operations exclude net income and 4 percent adjusted for currency with growth in Latin America from discontinued operations of $3 million related to the divesti- and the Middle East and Africa region more than offset by declines ture of the company’s Microelectronics business. The company in Asia Pacific. generated $5.3 billion in cash from operations and $6.1 billion in The consolidated gross profit margin decreased 1.6 points free cash flow in the fourth quarter and continued a high level of versus the fourth quarter of 2014 to 51.7 percent. The operating investment, including $2.5 billion in acquisitions and driving share- (non-GAAP) gross margin of 52.7 percent decreased 1.2 points holder returns of $2.0 billion in gross common stock repurchases with year-to-year declines across all business segments. and dividends. Total expense and other (income) increased 9.4 percent in the Performance in the fourth quarter continued to reflect the fourth quarter of 2015 compared to the prior year. Total operating transitions in the business as the company addressed both the (non-GAAP) expense and other (income) increased 9.2 percent significant shifts in the industry as well as some of the cyclical year to year. The key drivers of the year-to-year change in total challenges of the global business environment. expense and other (income) were approximately: In the fourth quarter, total consolidated revenue decreased Total Operating 8.5 percent as reported and 2 percent adjusted for currency, with Consolidated (non-GAAP) a year-to-year impact of $1.5 billion due to currency. Revenue in the • Currency* (8) points (8) points strategic imperatives grew 10 percent as reported and 16 percent • Divestiture gains 23 points 24 points adjusted for currency. • Workforce rebalancing (10) points (10) points Within the company’s segments, total Global Services reve- * Reflects impacts of translation and hedging programs. nue declined 8.1 percent as reported and 1 percent adjusted for currency. Global Technology Services revenue decreased 7.1 per- The year-to-year increase in expense was driven by prior year cent as reported but grew 1 percent adjusted for currency as the items. A gain of $1.4 billion associated with the System x dives- company continues to help clients transition to a hybrid cloud titure was recorded in the fourth quarter of 2014 and a charge services platform bringing more mobility and security to infra- of $86 million for the impairment of equity securities received as structure services. Global Business Services revenue decreased consideration was recorded in the fourth quarter of 2015. These 9.9 percent (4 percent adjusted for currency). GBS has continued items were partially offset by lower workforce rebalancing charges to add resources and transition to the strategic areas while shift- of $0.6 billion and the impact of currency in the fourth quarter of ing away from some of the more traditional areas of the business. 2015 compared to the prior-year period. Software revenue decreased 10.7 percent (6 percent adjusted for Pre-tax income from continuing operations of $5,098 million currency). Software annuity content grew but transactional per- decreased 28.1 percent year to year and the pre-tax margin was formance continued to be impacted by the flexibility the company 23.1 percent, a decrease of 6.3 points versus the fourth quarter has provided in Enterprise License Agreements with clients. Sys- of 2014. The prior period gain from the System x divestiture rep- tems Hardware revenue decreased 1.4 percent but grew 3 percent resented effectively all of the year-to-year decline in the pre-tax adjusted for currency driven by z Systems and Power Systems. margin, but the margin performance also reflected higher levels of investment, mix of contracts and resource shifts in the ser- vices business. The continuing operations effective tax rate for


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    44 Management Discussion International Business Machines Corporation and Subsidiary Companies the fourth quarter was 12.5 percent, down 9.7 points year to year. Diluted earnings per share from continuing operations of While the underlying effective tax rate was approximately 20 per- $4.59 decreased 17.1 percent year to year. Operating (non-GAAP) cent, the fourth quarter 2015 rate reflected the benefit from the diluted earnings per share of $4.84 decreased $0.97 or 16.7 per- recent U.S. tax legislation and settlement of the company’s U.S. cent versus the fourth quarter of 2014. There was no impact to tax audit. Income from continuing operations of $4,460 million diluted earnings per share from discontinued operations in the decreased 19.1 percent year to year. Net income of $4,463 million fourth quarter of 2015. In the fourth quarter of 2015, the company decreased $1,021 million year to year. Operating (non-GAAP) pre- repurchased 6.0 million shares of its common stock. tax income from continuing operations of $5,516 million decreased 25.4 percent with a year-to-year impact from currency of approx- Results of Continuing Operations imately $300 million. The operating (non-GAAP) pre-tax margin Segment Details was 25.0 percent, a decrease of 5.7 points year to year. Operat- The following is an analysis of the fourth quarter of 2015 versus ing (non-GAAP) income from continuing operations decreased the fourth quarter of 2014 reportable segment external revenue 18.6 percent and the operating (non-GAAP) income margin of and gross margin results. Segment pre-tax income includes 21.3 percent decreased 2.7 points compared to the prior year. The transactions between the segments that are intended to reflect operating (non-GAAP) effective tax rate from continuing operations an arms-length transfer price and excludes certain unallocated was 14.7 percent versus 21.8 percent in the fourth quarter of 2014 corporate items. reflecting the same current year factors described above. ($ in millions) Yr.-to-Yr. Yr.-to-Yr. Percent/ Percent Change Margin Adjusted for For the fourth quarter: 2015 2014* Change Currency Revenue Global Technology Services $ 8,126 $ 8,746 (7.1)% 0.9% Gross margin 37.7% 39.1% (1.5) pts. Global Business Services 4,297 4,771 (9.9)% (4.2)% Gross margin 28.2% 31.5% (3.3) pts. Software 6,767 7,578 (10.7)% (5.8)% Gross margin 88.0% 90.0% (2.0) pts. Systems Hardware 2,372 2,406 (1.4)% 2.7% Gross margin 48.0% 49.6% (1.6) pts. Global Financing 454 532 (14.6)% (5.8)% Gross margin 39.9% 48.7% (8.8) pts. Other 43 82 (47.1)% (42.2)% Gross margin (312.7)% (401.7)% (89.0) pts. Total consolidated revenue $22,059 $24,113 (8.5)% (2.3)% Total consolidated gross profit $11,407 $12,862 (11.3)% Total consolidated gross margin 51.7% 53.3% (1.6) pts. Non-operating adjustments Amortization of acquired intangible assets 105 101 3.2% Retirement-related costs/(income) 119 33 262.8% Operating (non-GAAP) gross profit $11,630 $12,996 (10.5)% Operating (non-GAAP) gross margin 52.7% 53.9% (1.2) pts. * Reclassified to conform with 2015 presentation.


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    Management Discussion 45 International Business Machines Corporation and Subsidiary Companies Global Services In the fourth quarter of 2015, the Global Services segments, Global Business Services revenue of $4,297 million decreased GTS and GBS, delivered combined revenue of $12,422 million, a 9.9 percent as reported and 4 percent adjusted for currency in the decrease of 8.1 percent as reported and 1 percent adjusted for cur- fourth quarter of 2015 compared to the prior year. GBS outsourc- rency. Combined pre-tax income in the fourth quarter decreased ing revenue of $1,223 million decreased 9.7 percent as reported 0.1 percent year to year and the pre-tax margin increased 1.3 points and 4 percent adjusted for currency. C&SI revenue of $3,074 mil- to 17.2 percent. lion declined 10.0 percent as reported and 4 percent adjusted for Global Technology Services revenue of $8,126 million de- currency. creased 7.1 percent as reported, but grew 1 percent adjusted Revenue continued to be impacted by the company’s shift for currency. This was the third consecutive quarter of revenue away from traditional enterprise application implementations as growth, adjusted for currency and divestitures. Outsourcing rev- clients move from these engagements to initiatives that focus on enue of $4,262 million decreased 9.1 percent as reported and digitizing their business with analytics, cloud and mobile tech- 1 percent adjusted for currency. ITS revenue of $2,360 million nologies. Revenue from the strategic imperatives within the GBS decreased 2.6 percent as reported but grew 5 percent adjusted segment increased double digits adjusted for currency in the for currency. Maintenance revenue of $1,505 million decreased fourth quarter compared to the prior year. 8.0 percent as reported but was flat adjusted for currency. The GBS gross profit margin decreased 3.3 points to 28.2 per- Within GTS, strategic imperatives including hybrid cloud ser- cent in the fourth quarter compared to the prior year. Pre-tax vices grew strong double digits in the fourth quarter adjusted for income decreased 8.6 percent to $708 million and pre-tax margin currency. This included strong demand for SoftLayer which again was up 0.2 points to 16.0 percent. Current year benefit from lower grew double digits on an adjusted basis. The company continues workforce rebalancing charges was offset by the impact of price to expand its cloud capabilities through acquisitions including pressure in declining areas of the business and continued invest- Gravitant, Inc. and Clearleap, Inc. announced in the fourth quarter ment in analytics, cloud and mobility practices. In addition, the of 2015. company is investing to scale a new cognitive consulting practice The GTS gross profit margin decreased 1.5 points to 37.7 per- that is focused on helping clients unlock the transformative value cent in the fourth quarter of 2015 compared to prior year. This of cognitive business. decline was driven by investments in cloud data centers and the Within Global Services, the company has continued momen- acceleration of new contracts, which generally have lower up-front tum in services offerings that modernize clients’ IT systems and margins. In the fourth quarter, pre-tax income increased 4.5 per- move their operations into the cloud-based mobile world. cent to $1,486 million and pre-tax margin was up 1.9 points to 17.8 percent. The margin increase was driven by lower workforce Software rebalancing charges and savings from actions taken throughout In the fourth quarter of 2015, Software revenue of $6,767 million the year to drive efficiency in the delivery model. These savings decreased 10.7 percent as reported and 6 percent adjusted for were offset by higher investment as the company continues to currency compared to the prior year period. Annuity content grew invest to contemporize clients IT systems, transforming them year to year, but transactional content declined. Key branded mid- into digital enterprises. The company is scaling its cloud foot- dleware revenue of $4,858 million, which accounted for 72 percent print with 46 cloud centers opened around the world. Currency of total software revenue in the fourth quarter, decreased 10.4 per- also continued to impact margin in the fourth quarter and was cent as reported and 6 percent adjusted for currency with declines the largest impact on year-to-year profit growth given the strong across all brands. Within key branded middleware, WebSphere dollar environment. decreased 9.2 percent (5 percent adjusted for currency), Infor- mation Management decreased 10.2 percent (5 percent adjusted for currency), Tivoli decreased 5.8 percent (1 percent adjusted for currency), Workforce Solutions decreased 9.9 percent (4 percent


  • Page 48

    46 Management Discussion International Business Machines Corporation and Subsidiary Companies adjusted for currency) and Rational decreased 31.6 percent The Systems Hardware gross profit margin of 48.0 percent (28 percent adjusted for currency). Other middleware decreased decreased 1.6 points in the fourth quarter of 2015 compared to 14.0 percent as reported and 9 percent adjusted for currency. the prior year. The decrease was due to margin (4.3 points) driven Operating systems decreased 12.2 percent as reported and by z Systems, partially offset by a more favorable product mix. 7 percent adjusted for currency. Systems Hardware pre-tax income of $349 million in the fourth While the transactional performance in the quarter was quarter decreased 10.1 percent year to year with a pre-tax margin consistent with the third quarter of the year; the fourth quarter of 13.9 percent, down 1.5 points year to year. has a higher transactional mix. This had a larger impact on total software performance resulting in a deceleration in the software Global Financing performance in the fourth quarter. Many large clients with multi- Global Financing Revenue of $454 million was down 14.6 per- year contracts continue to utilize the flexibility on deployment of cent as reported and 6 percent adjusted for currency due to their software as they build out their environments with the com- decreases in financing revenue and used equipment sales reve- pany’s broad portfolio. Outside the company’s top 250 clients, nue. The Global Financing fourth quarter pre-tax income increased software revenue increased low single digits adjusted for currency 28.3 percent to $674 million and the pre-tax margin increased in the quarter. 8.5 points to 55.4 percent. The increase in pre-tax income was The Software gross profit margin decreased 2.0 points to driven by an increase in gross profit ($97 million) and decreases in 88.0 percent in the fourth quarter of 2015 compared to the prior financing receivable provisions ($41 million) and SG&A expenses year. Software pre-tax income of $2,959 million in the fourth quar- ($11 million). ter decreased 21.4 percent, with a pre-tax margin of 39.4 percent, a decrease of 5.3 points. Profit performance in Software con- Geographic Revenue tinues to reflect the overall revenue trajectory, a higher level of Total geographic revenue of $21,988 million decreased 8.3 per- investments in areas like Watson, Watson Health, Watson IoT and cent as reported and 2 percent adjusted for currency in the fourth Bluemix, and an impact from currency translation. quarter of 2015 compared to the prior year. Major market countries decreased 6.9 percent as reported and 2 percent adjusted for Systems Hardware currency. Adjusted for currency, Europe returned to growth, led by In the fourth quarter of 2015, Systems Hardware revenue of $2,372 continued growth in Germany, France and the UK. In Asia Pacific, million decreased 1.4 percent as reported but grew 3 percent Japan continued to grow year to year, adjusted for currency. U.S. adjusted for currency compared to the prior year period. This revenue was down in the fourth quarter compared to the prior was the fourth consecutive quarter of growth in both z Systems year. Overall, growth market countries decreased 13.6 percent as and Power Systems, adjusted for currency. z Systems revenue reported and 4 percent adjusted for currency, relatively consistent increased 15.6 percent as reported and 21 percent adjusted for with the previous two quarters. From a regional perspective, on an currency. MIPS shipments increased 28 percent year to year. Since adjusted basis, growth in Latin America and the Middle East and the launch of z13 in the first quarter of 2015, there has been strong Africa region was more than offset by declines in the Asia Pacific double-digit revenue growth on an adjusted basis in every quar- growth market countries. ter of the year. Power Systems revenue increased 3.8 percent as Americas revenue of $10,251 million decreased 7.6 percent as reported and 8 percent adjusted for currency in the fourth quar- reported and 4 percent adjusted for currency compared to the ter compared to the prior year. This was the strongest quarterly fourth quarter of 2014 with a decline in North America and growth performance during 2015. In Power, the company continues to in Latin America on an adjusted basis. The U.S. decreased 5.5 per- serve a high-value market while adding capabilities and finding cent year to year. Although there was strong growth in the U.S. in new economic models to grow over time. However, in the fourth Systems Hardware, it was offset by weak services and transac- quarter the strong growth in servers was mitigated by a year-to- tional software performance. Canada was down 14.6 percent as year decline in Storage. Storage revenue decreased 11.2 percent reported and was flat adjusted for currency. In Latin America, on as reported and 7 percent adjusted for currency and continued to an adjusted basis, there was growth across a number of the larger be impacted by weakness in traditional disk and tape. countries including Brazil, Mexico, Argentina, and Colombia.


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    Management Discussion 47 International Business Machines Corporation and Subsidiary Companies EMEA fourth quarter revenue of $7,320 million decreased Total expense and other (income) increased 9.4 percent in the 8.5 percent as reported, but grew 1 percent adjusted for cur- fourth quarter with an expense-to-revenue ratio of 28.6 percent rency on a year-to-year basis. Germany decreased 0.3 percent compared to 23.9 percent in the fourth quarter of 2014. Total as reported, but had growth of 13 percent adjusted for currency. operating (non-GAAP) expense and other (income) increased The UK decreased 1.4 percent year to year as reported, but grew 9.2 percent in the fourth quarter. The increase in total operating 3 percent adjusted for currency. France declined 10.6 percent as expense and other (income) was primarily driven by divestiture reported, but grew 2 percent adjusted for currency. The Middle gains in the prior-year period (24 points), partially offset by lower East and Africa region grew 2.6 percent as reported and 8 percent workforce rebalancing charges in the current year (10 points) and adjusted for currency. However, there was a decline in the central the impact of currency in the fourth quarter of 2015 compared and eastern European region. with the prior year (8 points). There were several large items that Asia Pacific fourth quarter revenue of $4,417 million decreased impacted the growth rate this quarter. In the fourth quarter of 9.8 percent as reported and 3 percent adjusted for currency com- 2014, other (income) and expense included the pre-tax gain from pared to the prior year. Japan decreased 2.6 percent as reported, the System x divestiture of $1.4 billion; while selling, general and but had growth of 3 percent adjusted for currency, led by services. administrative expense included a workforce rebalancing charge On an adjusted basis, this was the 13th consecutive quarter of of $577 million with essentially none in the current year period. revenue growth in Japan. Australia decreased 5.2 percent year The fourth quarter of 2015 included a charge of $86 million for the to year, but returned to strong growth of 11 percent in the fourth impairment of the equity securities received as consideration in the quarter adjusted for currency. India also had strong growth com- System x divestiture. Outside these larger items, the fourth-quarter pared to the prior year. However, this growth was more than offset expense dynamics were consistent with the rest of the year as the by declines in China and other countries in the region. company accelerates shifts within the operational expense base driving productivity and efficiency in some areas, while increasing Total Expense and Other (Income) investment in support of the strategic imperatives. ($ in millions) Yr.-to-Yr. Results of Discontinued Operations Percent/ Margin Income from discontinued operations, net of tax, was $3 million For the fourth quarter: 2015 2014 Change in the fourth quarter of 2015 compared with a loss of $31 million Total consolidated expense in 2014. and other (income) $6,308 $5,767 9.4% Non-operating adjustments Cash Flow Amortization of acquired The company generated $5,278 million in cash flow provided by intangible assets (80) (93) (13.7) operating activities, a decrease of $781 million compared to the Acquisition-related charges (15) (2) 646.7 fourth quarter of 2014 driven by operational performance within net income, partially offset by declines in income tax payments. Non-operating retirement-related (costs)/income (100) (74) 33.8 Net cash used in investing activities of $5,445 million increased Operating (non-GAAP) $4,209 million compared to the prior year, primarily due to acqui- expense and other (income) $6,114 $5,598 9.2% sitions in the fourth quarter of the current year and cash received Total consolidated for the System x divestiture in the prior year period. Net cash used expense-to-revenue ratio 28.6% 23.9% 4.7 pts. in financing activities of $1,348 million decreased $4,351 million Operating (non-GAAP) compared to the prior year, primarily due to a decline in net cash expense-to-revenue ratio 27.7% 23.2% 4.5 pts. payments to settle debt, partially offset by an increase in cash used for gross common stock repurchases.


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    48 Management Discussion International Business Machines Corporation and Subsidiary Companies GAAP Reconciliation The tables below provide a reconciliation of the company’s income differ from similarly titled measures reported by other companies. statement results as reported under GAAP to its operating earn- Please refer to the “Operating (non-GAAP) Earnings” section on ings presentation which is a non-GAAP measure. The company’s pages 18 and 19 for the company’s rationale for presenting oper- calculation of operating (non-GAAP) earnings, as presented, may ating earnings information. ($ in millions except per share amount) Acquisition- Retirement- Related Related Operating For the fourth quarter 2015: GAAP Adjustments Adjustments (non-GAAP) Gross profit $11,407 $ 105 $ 119 $11,630 Gross profit margin 51.7% 0.5 pts. 0.5 pts. 52.7% SG&A $ 5,157 $ (95) $ (88) $ 4,975 RD&E 1,362 — (12) 1,350 Other (income) and expense (146) 0 — (146) Total expense and other (income) 6,308 (95) (100) 6,114 Pre-tax income from continuing operations $ 5,098 $ 199 $ 218 $ 5,516 Pre-tax margin from continuing operations 23.1% 0.9 pts. 1.0 pts. 25.0% Provision for income taxes* $ 638 $ 89 $ 82 $ 809 Effective tax rate 12.5% 1.2 pts. 1.0 pts. 14.7% Income from continuing operations $ 4,460 $ 110 $ 137 $ 4,707 Income margin from continuing operations 20.2% 0.5 pts. 0.6 pts. 21.3% Diluted earnings per share from continuing operations $ 4.59 $0.11 $0.14 $ 4.84 * The tax impact on operating (non-GAAP) pre-tax income from continuing operations is calculated under the same accounting principles applied to the GAAP pre-tax income which employs an annual effective tax rate method to the results. ($ in millions except per share amount) Acquisition- Retirement- Related Related Operating For the fourth quarter 2014: GAAP Adjustments Adjustments (non-GAAP) Gross profit $12,862 $ 101 $ 33 $12,996 Gross profit margin 53.3% 0.4 pts. 0.1 pts. 53.9% SG&A $ 6,034 $ (94) $ (95) $ 5,845 RD&E 1,320 — 21 1,341 Other (income) and expense (1,506) (1) — (1,506) Total expense and other (income) 5,767 (95) (74) 5,598 Pre-tax income from continuing operations 7,094 196 107 7,398 Pre-tax margin from continuing operations 29.4% 0.8 pts. 0.4 pts. 30.7% Provision for income taxes* $ 1,580 $ 10 $ 24 $ 1,613 Effective tax rate 22.3% (0.5) pts. 0.0 pts. 21.8% Income from continuing operations $ 5,515 $ 186 $ 84 $ 5,785 Income margin from continuing operations 22.9% 0.8 pts. 0.3 pts. 24.0% Diluted earnings per share from continuing operations $ 5.54 $0.19 $0.08 $ 5.81 * The tax impact on operating (non-GAAP) pre-tax income from continuing operations is calculated under the same accounting principles applied to the GAAP pre-tax income which employs an annual effective tax rate method to the results.

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