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    Dear IBM Investor: Over the past decade, hundreds of thousands of IBMers have transformed your company. Today, IBM has laid the foundation for a new era of technology and business. 2019 Annual Report


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    Dear IBM Investor: Over the past decade, hundreds of thousands of IBMers have transformed your company. Today, IBM has laid the foundation for a new era of technology and business. It’s easy to forget that we are still in the early stages of a long cycle of technological revolution. The driving forces of this change are well understood: the phenomenon of data, the value of cloud and the scaling of artificial intelligence. As a result, we are experiencing a great wave of corporate transformations, as the most essential organizations in the world—transportation providers, hospital networks, financial services, telecommunications networks, government agencies and more—become digital. But the most challenging and complex work of these digital transformations still lies ahead. We call this work “Chapter 2,” in which our clients modernize and move their mission-critical workloads to the cloud, and infuse AI deep into the decision-making workflows of their business. At the end of this journey is something we have termed the Cognitive Enterprise: an agile organization that is fueled by data, guided by AI insight and built for change on a hybrid cloud. The IBM company itself has been transformed to enable our clients’ digital reinvention. In my last letter to you as CEO, I will share our 2019 financial results, detail the many changes we have made to build a strong foundation for growth and prepare your company for the future, and share our plans for transitioning to new leadership in 2020.


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    2 Virginia M. Rometty Chairman, President and Chief Executive Officer


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    A Letter from the Chairman 3 2019: Enabling sustainable growth 2. Portfolio: Built for the future In 2019, IBM delivered a second consecutive year of revenue The shifts in capital allocation were designed to build a growth excluding the impact of currency and divestitures. portfolio that is stronger and more aligned with the fastest We ended the year on a strong note, with accelerating growing segments of the market. Since 2012, we also revenue growth and our strongest year-to-year increase divested businesses with annual revenues of more than in gross profit margins in over a decade. $10 billion ($2 billion in 2019 alone) that do not strengthen For the full year, the company achieved $77.1 billion our hand in Chapter 2. We did this while keeping annualized in revenue, operating gross profit margins of 48 percent revenue growth approximately flat, excluding the impact and operating earnings per share of $12.81. We had strong of divestitures and currency. Today, we have reinvented cash generation with net cash from operating activities of 50 percent of our portfolio, including: $14.8 billion and free cash flow of $11.9 billion. We returned $7.1 billion in capital to our shareholders, including – Cloud: In 2013, cloud represented only 4 percent dividends of $5.7 billion. This was the 24th consecutive year of IBM’s revenue. Today, cloud is 27 percent— of raising our dividend, and the 104th consecutive year a $21.2 billion business—and growing rapidly. In the of providing one. past year, we’ve substantially enhanced our public These results are the product of bold moves to cloud offerings, including dramatic improvements transform your company from top to bottom, strengthening in ease of use, 99.999% availability and the strongest our integrated value proposition and positioning us for security posture in the industry. That’s why clients sustainable growth. with the most demanding regulatory and resiliency requirements, like BNP Paribas, are moving their most The new foundation of integrated value critical workloads to the IBM Cloud. The problems we solve for clients are complex equations that cannot be satisfied with technology alone. They require – Data and AI: Our investments in data and AI have a partner that can also offer deep industry expertise cemented our position of enterprise market leadership. and a relationship of trust. For the third straight year, IDC has named IBM the IBM is the only company that combines the portfolio, global leader in AI. We secured more than 1,800 people and sense of purpose necessary to meet today’s AI patents in 2019 alone. Our Data Science Elite team enterprise demands. Over the last decade, we have forged the is accelerating client journeys to AI. And there are foundations of our end-to-end, integrated value proposition more than 30,000 Watson client engagements across through a series of transformative actions. 20 different industries, helping clients like Yara build a digital farming platform, Woodside Energy optimize 1. Capital: A bold shift to drive innovation its operations and Vodafone Idea transform its core Transformation requires investment. And since 2012, IT infrastructure. we have devoted significant capital to developing new capabilities. In all, we invested more than $120 billion – Security: IBM helps secure 95 percent of the Fortune to transform our strategy, our portfolio and our workforce. Global 500 and manages more than 70 billion events At the same time, we returned $97 billion to shareholders. every day. In 2019, we introduced Cloud Pak for Security, We invested nearly $30 billion in capital expenditures, a powerful new security solution designed to solve building our cloud and cognitive offerings and bolstering a critical pain point in the industry: connecting and our security and services capabilities. orchestrating disparate security tools. We have also invested $45 billion in research and development, forging the futures of cloud, AI, blockchain – Blockchain: IBM is the global leader in enterprise and quantum computing. IBM inventors received 9,262 blockchain solutions, with hundreds of client U.S. patents in 2019, the most ever awarded to a U.S. engagements infusing new levels of trust and company. It was our 27th straight year of patent leadership. transparency into the global supply chain. We have We have bolstered our portfolio with 65 companies, more than 2,000 blockchain experts. And we are including Red Hat, the largest acquisition in the history working with more than 20 large consortium networks of IBM. In Red Hat, we acquired a powerful growth engine, that are reshaping entire industries, like IBM Food Trust and a company synonymous with the cloud, open source for reliable food supply and TradeLens for shipping. and interoperability. Its singular architecture allows clients to build an application once and run it anywhere. And it enables the seamless integration of multiple clouds, from any vendor, addressing a $1.2 trillion hybrid cloud market opportunity.


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    4 Moments from IBM’s transformation As our company has led IBM Cloud IBM Q Red Hat clients on their digital IBM Cloud has grown to be a more A fundamentally different way One of the largest technology than $21 billion business offering of computing, quantum has the acquisitions in history combined journeys, IBM has also enterprises public, private and potential to transform business and the power and flexibility of transformed itself— hybrid cloud solutions. In 2019, solve some of the world’s biggest Red Hat’s open hybrid cloud through acquisitions, IBM introduced the world’s first problems. IBM has led in quantum technologies with the scale financial services-ready public research and development and and depth of IBM’s innovation breakthrough technologies cloud, secure and purpose-built now offers a fleet of 15 advanced and industry expertise. and social innovations. for the industry. quantum computers. IBM Watson IBM Security IBM Garage Strategic Divestitures IBM Watson helped AI emerge IBM Security was built for industry- A comprehensive approach Over eight years, IBM has sold from a long “winter” and is now leading compliance, threat to innovation and transformation, businesses with more than deployed in customer service, monitoring and container security. the IBM Garage process brings $10 billion in revenue, including healthcare, supply chain, weather In 2019, Cloud Pak for Security designers and developers together semiconductor manufacturing forecasts, energy exploration was introduced to orchestrate tools with clients and stakeholders. The and x86 servers, in order to and other fields—totaling more across the entire security stack. process helps create and scale new allocate capital to innovation. than 30,000 client engagements. ideas and achieve business value. 1. Purpose 2. Ownership 3. Transparency P-TECH IBM Blockchain Principles for Trust & Transparency Business Roundtable Pathways in Technology Early IBM Food Trust, TradeLens and For more than a century, IBM In 2019, IBM signed the College High Schools (P-TECH) other initiatives are streamlining has earned the trust of clients Business Roundtable Statement is a new education model supply chain processes and and society. In 2018, we codified on the Purpose of a Corporation. co-developed by IBM working bringing trust and transparency the core principles that guide The Business Roundtable is together with educators, to transactions. everything we do, from handling a group that brings together the policymakers and elected officials. client data to the responsible CEOs of nearly 200 American deployment of new technologies. companies.


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    A Letter from the Chairman 5 – IBM Services: From digital strategy to infrastructure 4. Speed: Changing the way we work services, IBM Services exemplifies the end-to-end Today, enterprise client expectations are dictated by their capability of our company. Over the last 10 years, consumer technology experiences. In order to match the we have built the world’s largest digital agency, with speed of development found in consumer markets, we 57 studios and 17,000 IBM iX digital consultants. needed to fundamentally change the way IBM worked. And we have scaled our global delivery network, with This process began with the creation of IBM Design services professionals that have breadth of experience Thinking, an enterprise-grade variant of the well-known and industry expertise in areas like financial services, human-centered design process. We then adopted agile telecommunications and supply chain, around the world. development practices, to create the working conditions for small, diverse teams to solve problems and introduce – IBM Systems: The recently launched IBM z15 is new solutions quickly. our most secure and capable mainframe ever, with IBM has hired more than 20,000 designers. We have encryption that can be applied across hybrid cloud more than 100,000 employees working in agile methodology. environments, cloud-native development capabilities And we have converted more than 10 million square feet and an industry-first approach to instant recovery. of offices into agile workspaces. This led to a significant change in the way our clients – Quantum: In 2019, IBM introduced a 53-qubit quantum experience IBM today: the IBM Garage. These are dedicated, computer, the largest universal quantum computing physical spaces in which clients work side by side with system available for commercial use. More than IBMers to co-create solutions, applying IBM Design Thinking 100 global clients and 200,000 registered users have and agile methods. They can happen anywhere in the world, run over 160 billion experiments on the IBM Quantum in dedicated IBM spaces or client offices. Computation Center’s fleet of 15 quantum systems In 2019, we conducted approximately 600 engagements through the cloud, including Daimler AG, JPMorgan in which we helped clients adopt these same practices. Chase and Anthem. The end result has been record Net Promoter Scores from clients across all IBM businesses. 3. IBMers: Talent, skills and culture AI and other advanced technologies are changing the very 5. Good tech: A model of responsible stewardship nature of work. To keep up with the rate and pace of these for the digital age changes, IBM has revitalized the skills of our workforce. Of all the work we have done to transform IBM, I am most In the last five years, the percentage of IBMers with skills proud of the way in which we are defining responsible of the future increased to 90 percent. stewardship in the digital age. At the heart of our workforce transformation is the At IBM, we have always taken the long view. That means constant acquisition of relevant skills. To support this work, grounding strategy and business decisions in core values we built a platform that allows IBMers to plainly see the skills that endure through decades of political, technological they have, and the skills they need. And we developed an and societal change. They are: AI-based, personalized learning system to help them acquire those skills. More than 26 million learning hours were logged – Dedication to every client’s success. in 2019 alone. – Innovation that matters, for our company As important, IBM is committed to fostering a culture and for the world. in which all IBMers feel they can bring their best selves to – Trust and personal responsibility in all relationships. work. Diversity and inclusion are essential to our business. They fuel innovation and drive employee satisfaction. Leading with values is not wide-eyed altruism. It is clear- And in 2019, we achieved record diversity across all eyed business strategy. Values attract the best employees. representation groups and best-in-class inclusion scores. They sustain our client relationships. And they have guided We were again widely recognized as one of the best places our efforts to lead the industry in modeling what “good tech” to work for mothers, veterans, LGBTQ employees and more. looks like. IBM understands that diversity is a fact, but inclusion is a choice. We have made our choice. And that is just one reason why our employee engagement score is at an all-time high, improving 17 points since 2014.


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    6 For example, our Principles for Trust and Transparency New leadership for a new era have become the global ethical standard of digital I am enormously proud of the work we have done to transform responsibility, inspiring similar doctrine in businesses IBM for this moment. And with the foundation for growth now and governments around the world: in place, it is the right time for a new leader to continue this critically important journey for IBM and our clients. – The purpose of new technology is to augment As such, I have elected to retire at the end of 2020 after mankind, not replace it. nearly 40 years with the company. Effective April 6, 2020, – Data and the insights it yields belong only Arvind Krishna, our Senior Vice President for Cloud and to the owner of that data. Cognitive, will become the next Chief Executive Officer of IBM – AI should be open, transparent and explainable. and a member of the Board. Jim Whitehurst, CEO of Red Hat, will become President of IBM. At IBM, we consider the full impact of our technology on Arvind is a brilliant business leader and technologist society. And we readily accept our leadership role in making who has played a significant role in developing our key the digital era an inclusive era. technologies including artificial intelligence, cloud, quantum As such, we have pioneered programs that ensure computing and blockchain. And Jim is a seasoned leader who the many—not just a few—benefit from the digital economy. built Red Hat into the world’s leading provider of open source To that end, we substantially expanded our 21st-century enterprise IT software solutions and services. Together, apprenticeship program and P-TECH six-year high school this dream team of technological acumen and business education model in 2019. Enrollment in the apprentice savvy will build on IBM’s new foundations. program grew twice as fast as expected. And P-TECH doubled As we make this transition, I want you to know that my the number of participating schools to 220, in 24 countries, belief in IBM and IBMers has never been stronger. It has been with a pipeline of 150,000 students. the privilege of my life to lead this great company during this Our Call for Code and Code and Response programs time of significant transformation. And, most importantly, continue to scale, tapping the talents of developers to address I would like to thank our employees for their tireless some of society’s most intractable challenges. In 2019, dedication, our clients for their trust and partnership, 180,000 developers from 165 countries created more than and our investors for their continued belief in our company 5,000 applications focused on disaster relief. and its strategy. In 2019, IBM published its 29th annual IBM and the At IBM, we believe in the fundamental promise of Environment Report, and advanced our environmental technology: that when we apply science to real-world leadership as a founding member of the Climate Leadership problems, we can create a tomorrow that is better than today; Council, where we have supported a carbon tax that will a tomorrow that is more sustainable, more profitable and reduce carbon emissions globally through market-based more equitable. incentives. At the same time, we remain on track to achieve a And I believe that IBM is essential to fulfilling 40 percent reduction of carbon dioxide emissions associated that promise. with our own energy consumption by 2025. In addition, IBM developed a breakthrough method of recycling polyethylene terephthalate (PET), a widely used plastic with a high carbon footprint that is difficult to recycle. IBM’s new method will make it possible for more types of PET plastic to become 100 percent recyclable, helping to reduce the 8 million tons Virginia M. Rometty of plastics that enter our oceans each year. Chairman, President and Chief Executive Officer In an effort to provide additional and useful information regarding the company’s financial results and other financial information, as determined by generally accepted accounting principles (GAAP), these materials contain non-GAAP financial measures on a continuing operations basis, including operating earnings per share, operating gross profit margin, free cash flow, and revenue adjusted for divested businesses and constant currency. The rationale for management’s use of this non-GAAP information is included on pages 26, 27 and 58 of the company’s 2019 Annual Report, which is Exhibit 13 to the Form 10-K submitted with the SEC on February 25, 2020. For reconciliation of these non-GAAP financial measures to GAAP and other information, please refer to pages 39, 46, 59 and 139 of the company’s 2019 Annual Report.


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    7 What does it + Innovative Technology We help build agile organizations, take to lead fueled by data, guided by AI insight and built for change in any cloud IBM’s clients environment. Add blockchain and the coming era of quantum in their next computing, and we’ll continue leading our clients’ journeys chapter of digital to the Cognitive Enterprise. transformation? + Industry Expertise The problems we solve and the opportunities we discover for clients cannot be achieved through technology alone. Providing counsel and insights, based on deep industry knowledge and experience, IBM is the only company with the portfolio and the people to meet today’s enterprise demands. + Trust and Security We build trust, privacy and security into even our most cutting-edge technologies. Just as crucial is the trust we build into our business relationships. Continually considering the full impact of our technology on society, we are committed to responsible stewardship for the digital age.


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    8 Hybrid cloud is a potential $1.2 trillion market, with IBM already in the lead. Innovative As businesses construct and connect multiple clouds, IBM offers customers Technology the ability to build applications once and run them anywhere. Whether for public cloud, private cloud or on-premises systems, IBM’s hybrid approach enables clients to unleash any cloud’s full potential. Our acquisition of Red Hat has been a game changer. Red Hat OpenShift is the platform of choice for hybrid cloud. $21.2 billion cloud revenue in 2019 2,000+ clients using Red Hat and IBM’s hybrid cloud platform


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    Innovative Technology 9 Banks are accelerating their transformations Banks were pioneers in building consumer-facing apps, but deeper digital reinvention in the finance industry has been slower, limited by concerns that include data security and privacy. Today, many institutions are working with IBM to reinvent their infrastructure—and create new technology models for finance, such as the world’s first financial services-ready cloud. When the global bank BNP Paribas began accelerating its digitization strategy, its goal was to deliver superior services to its customers and corporate clients while ensuring the security and confidentiality of their data. The bank discovered that it could not digitize quickly enough with its existing private cloud. It turned to IBM to co-create a public cloud that would be robust, reliable and secure enough to support its banking applications and its extensive compliance and security requirements. The BNP Paribas dedicated public cloud will combine the security of a private cloud with the speed, scalability and cost savings of a public cloud. The bank will also benefit from IBM Watson AI and other services—enabling it to tap into new technologies, innovate more quickly and, ultimately, deliver a better customer experience. Consumers expect convenience and security from their banks. The challenge: how to increase convenience without giving up on security. State Bank of India, the country’s largest bank, partnered with IBM Services to create a secure mobile platform, YONO (You Only Need One), that is transforming how more than 18 million people in India bank, invest, shop, order food and more.


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    10 Airlines are building new travel experiences Airlines must deliver superior passenger experiences with every flight. To do that, they are rethinking and reinventing their technology core—and how their employees work. Carriers are shifting mission-critical workloads to IBM Cloud and hybrid cloud environments, taking advantage of the open, scalable architecture and microservices to improve their processes, accommodate growth and offer new digital services such as automatic rebooking. And airlines are using AI to offer personalized pricing and other new services. The IBM Travel Platform offers a range of customized mobile applications that empower airline employees, allowing them to offer higher levels of service, manage boarding more efficiently, deploy maintenance resources, and more. Aloft, The Weather Company’s Total Turbulence can predict turbulence ahead of time, so plane routes can be optimized. Across the industry, these shifts are allowing carriers to find new ways to improve the journey.


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    Innovative Technology 11 Telcos are innovating more nimbly Success in any market requires rapid, agile innovation. In Europe, Vodafone Business partnered with IBM to combine Vodafone’s leadership in Edge, 5G and IoT with IBM’s public and hybrid cloud, industry expertise and professional services. The partnership is enabling companies like National Express to deliver digital solutions faster, utilizing a multicloud approach and capitalizing on AI, blockchain and other advanced technologies. In India, Vodafone Idea, a Vodafone Group joint venture, signed an IT outsourcing partnership with IBM to deliver enhanced customer experience to millions of connected customers and yield synergies by consolidating two large pre-merger IT environments. The partnership uses IBM’s hybrid cloud, analytics and security capabilities to accelerate Vodafone Idea’s progression to an open, agile and secure IT environment. IBM, with Red Hat, is also helping Vodafone Idea build an open universal hybrid cloud, able to serve all aspects of core network and IT from a common cloud. This will enable continued improvements in customer service, a step change reduction in cost, and the rapid deployment of Edge-based offerings to enterprise clients.


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    12 Artificial intelligence is transforming how businesses operate, how people do their jobs and how customers engage. Across industries, IBM clients are rapidly moving from pilots to enterprise-wide AI adoption. With IBM Watson, the pieces are now in place to scale AI with trust and transparency. And with IBM’s allegiance to open source technology, these AI solutions perform with seamless interoperability, whatever the software platform or cloud environment. Infrastructure can maintain its own safety The world’s civil infrastructure is aging. Catastrophic failures of bridges and roads are a growing threat. A recent study determined that in the U.S. alone, 47,052 bridges were structurally deficient. Sund & Bælt, which owns and operates some of the #1 largest infrastructure in the world—including the Great Belt Bridge in Denmark—has partnered with IBM to create Maximo for Civil Infrastructure, a solution that uses machine market leader intelligence to monitor the effects of stress, use and age in enterprise AI on bridges and tunnels—and to announce when intervention is required. It will measure the impacts of cracks, rust, corrosion 30,000+ and other potential stressors by integrating and analyzing data from The Weather Company, maintenance records IBM Watson client and sensors that are placed on structures, worn by workers and flown by drones. Using predictive and prescriptive engagements maintenance strategies, the system can flag the most serious issues. As a result, maintenance crews will be able to work with maximum efficiency and effectiveness. 1,800+ AI patents in 2019


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    Innovative Technology 13 Energy production Advertisers are getting is embedded with AI closer to their audiences Gaining real value from AI requires moving from In advertising, insights allow brands to better understand experiments to scale—embedding AI into processes and engage with their audiences. As the volume of data throughout an organization. accelerates, so do the challenges of aggregating and Woodside Energy takes a forward-looking, technology- interpreting it. based approach to energy. The Australian natural gas Wunderman Thompson Data, the data and analytics company has deployed IBM Watson since 2016 and now arm of global creative and technology agency Wunderman estimates that around 80 percent of Woodside employees Thompson, had data dispersed across many clouds. have used Watson in their work. The company knew that if it could pull together and mine Now, Woodside and IBM are collaborating to explore this data, it could build new and expanded customized quantum computing and to deploy and scale AI further campaigns for its clients. It partnered with IBM to create an into operations. New applications could help Woodside unprecedented machine learning practice using IBM Watson save a significant portion of annual maintenance costs to discover new customer insights and deliver increased and optimize workflows, part of Woodside’s vision ROI for brands. The use of Watson also helped Wunderman for an “intelligent plant.” Thompson Data amplify its capabilities by being able to leverage the company’s entire portfolio of data assets. To make it happen, it brought in IBM’s Data Science Elite team—all experts in helping companies push AI and machine learning models into production—to accelerate and modernize the building of their machine learning practice. This allowed Wunderman Thompson Data to build a proof of concept with IBM; the collaboration resulted in a new machine learning pipeline—in the time span of just several weeks.


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    14 Quantum computing is an entirely new paradigm. Based on the principles of quantum physics, quantum computing has the potential to crack previously unsolvable problems in chemistry, materials science, finance and any other field that has hit the limits of classical computing—and could lead to breakthroughs in areas such as weather forecasting and drug discovery. For decades, IBM has led the research and development of quantum information science and quantum machines. And IBM was the first to give the world the chance to experience it by putting a quantum computer on the cloud in 2016. Now, quantum computing is moving out of the lab and into the hands of users and commercial clients worldwide. 100+ organizations in the IBM Q Network 160 billion executions on IBM’s quantum fleet


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    Innovative Technology 15 Quantum is being applied to our toughest problems More than 100 companies and institutions have joined the IBM Q Network to explore practical applications of quantum computing. They are using IBM’s fleet of 15 of the most advanced quantum computers commercially available. Daimler AG and IBM are exploring ways the automotive and transportation industry can leverage quantum computing. Daimler’s research currently focuses on the development of novel quantum algorithms for chemistry and materials science to support its long-term goal of designing new batteries. New materials may lead to the development of higher performance, longer lasting and less expensive vehicle batteries. JPMorgan Chase and IBM are researching methodologies for financial modeling and risk management. The joint research has led to the creation of a methodology to price financial derivative contracts, known as options, as well as portfolios of options, which may have future potential to substantially accelerate and enhance business operations. This collaboration recently led to the first experiment modeling a European call option on a real quantum computer.


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    16 Our industry expertise is a key advantage as we help clients Industry respond to their customers’ evolving needs and stay nimble in the face Expertise of continuous technological change. “Mission-critical” means more than technology. To fundamentally change the way businesses work and innovate, they need expert guidance. From manufacturing to financial services, to retail and more—our experts possess deep knowledge developed through decades of work with the world’s most complex systems. ~90% of credit card transactions run on IBM systems 83% of the world’s largest telcos are IBM clients


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    Industry Expertise 17 Supply chains are getting more transparent The worldwide container logistics ecosystem carries 90 percent of the goods we use daily, but only recently moved beyond paper-based processes. Technology that can cut costs, ensure transparency and eliminate inefficiencies has become a necessity. Enter blockchain, which is the basis for TradeLens, the global container logistics digitization platform developed jointly by A.P. Moller-Maersk and IBM. In 2019, the major ocean carriers CMA CGM, MSC Mediterranean Shipping Company, Hapag-Lloyd and Ocean Network Express joined TradeLens. Today, TradeLens is on pace to trace 12 million documents annually, accounting for data on more than 60 percent of the world’s ocean container cargo. The digital ship—secure, transparent and open-standards-based— has come in. Insurers can deliver world-class customer experience Consumers’ expectations of how they interact with companies are continually rising—regardless of the industry or technology platforms involved. To meet its customers’ evolving needs, State Farm, the largest property and casualty insurer in the U.S., wanted to accelerate its development of new digital services. To do that, it needed to adopt a DevOps model in order to unlock cloud- native development across its core systems—something often thought impossible in the industry. For State Farm, this meant transforming most of its mission-critical workloads, run on the IBM Z platform, to a new way of working. The first step for State Farm in implementing modern DevOps practices on its z/OS systems was using industry- standard tools—a mix of open source, homegrown and proprietary—drawing from its experience in cloud development. Moving to continuous development and integration cycles accelerated delivery of new functionality—and opened up its enterprise servers to a new generation of developers.


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    18 Whether gusty winds that send a delivery drone off-track or a tornado that flattens a town, disruptive weather patterns are affecting the lives of individuals, businesses and institutions around the world. IBM GRAF, the Global High-Resolution Atmospheric Forecasting system, from The Weather Company, an IBM Business, can now offer the whole world forecasts with 3-kilometer resolution. GRAF is democratizing weather data, promising to improve farming and other industries as well as our everyday lives. An IBM supercomputer called Dyeus assimilates 108 gigabytes worth of atmospheric observations every second and performs about 12 trillion computations per day on that data. The result: much finer-grained predictions of the atmosphere and forecasts updated Weather data is up to a dozen times more frequently than conventional global modeling systems, from one of the world’s most becoming democratized trusted sources for weather data. Somalia Uganda Kenya Tanzania


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    Industry Expertise 19 Yara, a global crop nutrition company based in Norway, is on a mission to responsibly feed and protect the planet by advancing more productive and sustainable agriculture to create a world without hunger. The company is combining its 115 years of agronomic expertise with IBM technology and agriculture industry experience to bring more knowledge to farmers by building the world’s leading digital farming platform. By merging Yara’s crop knowledge and modeling capabilities with insights from IBM Watson Studio, IBM PAIRS technology, The Weather Company and other services, the platform will be able to provide hyperlocal weather forecasts in addition to offering real-time recommendations, tailored to the specific needs of individual fields and crops. Agriculture is being One example: Yara’s FarmWeather app, installed by more than 800,000 small farmers in Asia and Africa, is one enriched by data of the fastest-growing digital farming tools.


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    20 Trust is becoming the most important competitive differentiator of our Trust and time. We know our obligations don’t begin and end with the technology Security itself. That’s why many of IBM’s investments have been made in building trust, privacy and security into our technology. For more than a century, IBM has earned the confidence of businesses and society by acting as a steward of our clients’ data and insights, and by responsibly ushering powerful new technologies into the world. That includes ensuring that our clients’ data is theirs and theirs alone, while helping them secure it from mishap or malfeasance. Our values also guide us to work with purpose and to act as responsible stewards of technology. 70 billion security events managed each day 180,000 developers participated in Call for Code


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    Trust and Security 21 Cities are growing more secure Ransomware struck more than 170 U.S. cities in 2019, costing millions, disrupting critical services and threatening public safety. And it is often targeted at smaller companies and organizations that don’t have the tools to combat it. In Los Angeles, IBM Security and the LA Cyber Lab are helping businesses fight back. Together, they are building the Threat Intelligence Sharing Platform to provide the city’s businesses, utilities and local governments with threat data. This helps them detect and identify ransomware and other dangers. Making enterprise-grade threat intelligence available to these organizations lets them understand and respond to threats with speed and tactics previously available only to large firms. The platform is giving them a fighting chance against ransomware and other cybercrime. AI can now explain itself In every industry, key workflows and decisions are benefiting from AI and machine learning. But a potential drawback is the “black box problem”— the difficulty in understanding why AI has made a decision or recommendation. IBM holds as a core principle that new technology such as AI must always be transparent and explainable. Now that AI is being used in consequential use cases, ensuring “explainability” is essential. To empower users to understand their AI models, IBM Research released the AI Explainability 360 toolkit. This comprehensive, open source toolkit uses state-of- the-art algorithms and methods to provide insights into a machine’s decision-making process through a single interface. By adding interpretability and explainability in AI systems, we can help advance the theory and practice of responsible and trustworthy AI.


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    22 We are working with purpose and responsibility IBM pursues the highest standards of responsibility in all we do. Our stewardship is focused on three areas: Data responsibility. We have an obligation to responsibly handle the data we collect, manage or process. Through this commitment, IBM earns the trust of the world’s largest enterprises as a steward of their most valuable data. Jobs and skills. IBM has invested in building and preparing a workforce for the 21st century, through apprenticeship programs, returnships for women reentering the workforce, veterans programs and skills-building sessions for more than 3.2 million students worldwide. Diversity and inclusion. Consciously building inclusive teams and encouraging diversity of ideas helps us make the greatest impact for our clients, our colleagues and the world. Developers are tackling natural disasters As the Founding Partner of Call for Code, a worldwide developer competition, IBM is rallying the developer community to envision innovative solutions to the world’s most pressing problems. The effort is supported by IBM Code and Response, a multiyear initiative dedicated to building and deploying open source technologies to tackle these challenges. In Barcelona, a nurse, a firefighter and three developers teamed up to win the 2019 Call for Code Global Challenge with Prometeo, a solution that uses IBM’s Cloud IoT platform to help monitor the safety of firefighters in real time as they battle blazes. The team received a $200,000 prize as well as support from IBM and the Linux Foundation. Next up: deployments in Spain. In 2020, the Call for Code challenge will focus on climate change, inviting developers to create applications that can help smooth the path to sustainability.


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    Trust and Security 23 150,000 students are learning new collar skills It began as a challenge almost a decade ago: How could IBM, with educators and business and community leaders, reinvent high school education and help address the global STEM skills shortage? Since that time, the P-TECH education model has grown from one school in Brooklyn, New York, into a global network of 220 schools and 650 companies. More than 150,000 students are in the pipeline in two dozen countries. The model integrates high school, college and career readiness training with curricula mapped to industry needs. Academically rigorous and economically transformative, P-TECH schools prepare young women and men, many from underserved communities, for 21st-century careers. Students benefit from one-on-one mentoring and paid internships with partners such as IBM, graduate debt-free with a high school diploma and a community college degree, and are first in line for new collar jobs with partner companies. In 2020, IBM is launching Open P-TECH to equip young people and educators with foundational knowledge and professional skills in emerging technologies like cybersecurity, AI and more, all for free.


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    24 Financial Highlights International Business Machines Corporation and Subsidiary Companies ($ in millions except per share amounts) For the year ended December 31: 2019 2018 Revenue $ 77,147 $ 79,591 Net Income $ 9,431* $ 8,728* Income from continuing operations $ 9,435* $ 8,723* Operating (non-GAAP) earnings** $ 11,436 $ 12,657 Earnings per share of common stock—continuing operations Assuming dilution $ 10.57* $ 9.51* Basic $ 10.63* $ 9.56* Diluted operating (non-GAAP)** $ 12.81 $ 13.81 Net cash provided by operating activities $ 14,770 $ 15,247 Capital expenditures, net $ 2,370 $ 3,716 Share repurchases $ 1,361 $ 4,443 Cash dividends paid on common stock $ 5,707 $ 5,666 Per share of common stock $ 6.43 $ 6.21 At December 31: 2019 2018 Cash, cash equivalents, restricted cash and marketable securities $ 9,009 $ 12,222 Total assets $152,186 $123,382 Working capital $ 718 $ 10,918 Total debt $ 62,899 $ 45,812 Total equity $ 20,985 $ 16,929 Common shares outstanding (in millions) 887 892 Stock price per common share $ 134.04 $ 113.67 * Includes charges of $0.1 billion in 2019 and $2.0 billion in 2018 associated with U.S. tax reform. ** See page 46 for a reconciliation of net income to operating earnings.


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    Report of Financials 25 International Business Machines Corporation and Subsidiary Companies MANAGEMENT DISCUSSION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Overview 26 Basis & Policies Forward-Looking and Cautionary Statements 27 A Significant Accounting Policies 74 Management Discussion Snapshot 27 B Accounting Changes 86 Description of Business 29 Performance & Operations Year in Review 34 C Revenue Recognition 88 Prior Year in Review 53 D Segments 89 Other Information 56 E Acquisitions & Divestitures 93 Looking Forward 56 F Research, Development & Engineering 96 Liquidity and Capital Resources 57 G Taxes 97 Critical Accounting Estimates 60 H Earnings Per Share 99 Currency Rate Fluctuations 63 Balance Sheet & Liquidity Market Risk 63 I Financial Assets & Liabilities 100 Cybersecurity 64 J Inventory 101 Employees and Related Workforce 64 K Financing Receivables 101 L Property, Plant & Equipment 105 Report of Management 65 M Leases 105 Report of Independent Registered N Intangible Assets Including Goodwill 109 Public Accounting Firm 66 O Investments & Sundry Assets 110 P Borrowings 110 CONSOLIDATED FINANCIAL STATEMENTS Q Other Liabilities 113 Income Statement 68 R Commitments & Contingencies 114 Comprehensive Income 69 S Equity Activity 116 Balance Sheet 70 Risk Management, Compensation/Benefits & Other Cash Flows 71 T Derivative Financial Instruments 120 Equity 72 U Stock-Based Compensation 123 V Retirement-Related Benefits 125 W Subsequent Events 138 Five-Year Comparison of Selected Financial Data 139 Selected Quarterly Data 140 Performance Graphs 141 Stockholder Information 142 Board of Directors and Senior Leadership 143


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    26 Management Discussion International Business Machines Corporation and Subsidiary Companies OVERVIEW it is done so that certain financial results can be viewed The financial section of the International Business Machines without the impact of fluctuations in foreign currency Corporation (IBM or the company) 2019 Annual Report includes exchange rates, thereby facilitating period-to-period the Management Discussion, the Consolidated Financial Statements comparisons of business performance. Financial results and the Notes to Consolidated Financial Statements. This Overview adjusted for currency are calculated by translating current is designed to provide the reader with some perspective regarding period activity in local currency using the comparable the information contained in the financial section. prior-year period’s currency conversion rate. This approach is used for countries where the functional currency is the Organization of Information local currency. Generally, when the dollar either strengthens • The Management Discussion is designed to provide readers or weakens against other currencies, the growth at constant with an overview of the business and a narrative on our currency rates or adjusting for currency will be higher or lower financial results and certain factors that may affect our than growth reported at actual exchange rates. See “Currency future prospects from the perspective of management. Rate Fluctuations” for additional information. The “Management Discussion Snapshot” presents an • To provide better transparency on the recurring performance overview of the key performance drivers in 2019. of the ongoing business, the company provides revenue • Beginning with the “Year in Review,” the Management growth rates excluding divested businesses and at constant Discussion contains the results of operations for each currency. These divested businesses are included in the reportable segment of the business and a discussion of company’s Other segment. our financial position and cash flows. Other key sections • Within the financial statements and tables in this Annual within the Management Discussion include: “Looking Report, certain columns and rows may not add due to the Forward” and “Liquidity and Capital Resources,” which use of rounded numbers for disclosure purposes. includes a description of management’s definition and Percentages reported are calculated from the underlying use of free cash flow. whole-dollar numbers. • The Consolidated Financial Statements provide an overview of income and cash flow performance and financial position. Operating (non-GAAP) Earnings In an effort to provide better transparency into the operational • The Notes follow the Consolidated Financial Statements. results of the business, supplementally, management separates Among other items, the Notes contain our accounting business results into operating and non-operating categories. policies, revenue information, acquisitions and divestitures, Operating earnings from continuing operations is a non-GAAP certain commitments and contingencies and retirement- measure that excludes the effects of certain acquisition-related related plans information. charges, intangible asset amortization, expense resulting from basis • On July 9, 2019, IBM acquired 100 percent of the differences on equity method investments, retirement-related costs outstanding shares of Red Hat, Inc. (Red Hat). Red Hat is and discontinued operations and their related tax impacts. Due to reported within the Cloud & Cognitive Software segment, in the unique, non-recurring nature of the enactment of the U.S. Tax Cloud & Data Platforms. The consolidated financial results Cuts and Jobs Act (U.S. tax reform), management characterizes the at and as of the year ended December 31, 2019 reflect the one-time provisional charge recorded in the fourth quarter of 2017 impacts of the acquisition on IBM; including: recognition of and adjustments to that charge as non-operating. Adjustments, goodwill, intangible assets and related amortization and among others, include true-ups, accounting elections, any changes deferred tax liabilities, along with other purchase accounting to regulations, laws and audit adjustments that affect the recorded adjustments including a deferred revenue fair value one-time charge. For acquisitions, operating (non-GAAP) earnings adjustment. The Consolidated Income Statement for the exclude the amortization of purchased intangible assets and year ended December 31, 2019 includes impacts from these acquisition-related charges such as in-process research and purchase accounting adjustments, higher interest expense, development, transaction costs, applicable retention, restructuring transaction-related costs and other acquisition-related and related expenses, tax charges related to acquisition integration activities. Refer to note E, “Acquisitions & Divestitures” for and pre-closing charges, such as financing costs. These charges are additional information. excluded as they may be inconsistent in amount and timing from period to period and are significantly impacted by the size, type • Effective the first quarter of 2019, we made a number of and frequency of the company’s acquisitions. All other spending for changes to our organizational structure and management acquired companies is included in both earnings from continuing system. As a result of these changes, we revised our operations and in operating (non-GAAP) earnings. Throughout the reportable segments. There was no change to the Management Discussion, the impact of acquisitions over the prior Consolidated Financial Statements. Refer to note D, 12-month period may be a driver of higher expense year to year. For “Segments” for additional information on our reportable retirement-related costs, management characterizes certain items segments. The periods presented in this Annual Report are as operating and others as non-operating, consistent with GAAP. reported on a comparable basis. We provided recast We include defined benefit plan and nonpension postretirement historical segment information reflecting these changes benefit plan service costs, multi-employer plan costs and in a Form 8-K dated April 4, 2019. the cost of defined contribution plans in operating earnings. • The references to “adjusted for currency” or “at constant Non-operating retirement-related costs include defined benefit currency” in the Management Discussion do not include plan and nonpension postretirement benefit plan amortization operational impacts that could result from fluctuations in of prior service costs, interest cost, expected return on plan foreign currency rates. When we refer to growth rates at assets, amortized actuarial gains/losses, the impacts of any constant currency or adjust such growth rates for currency,


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    Management Discussion 27 International Business Machines Corporation and Subsidiary Companies plan curtailments/settlements and pension insolvency costs and FORWARD-LOOKING AND CAUTIONARY STATEMENTS other costs. Non-operating retirement-related costs are primarily Certain statements contained in this Annual Report may constitute related to changes in pension plan assets and liabilities which are forward-looking statements within the meaning of the Private tied to financial market performance, and the company considers Securities Litigation Reform Act of 1995. Any forward-looking these costs to be outside of the operational performance of statement in this Annual Report speaks only as of the date on the business. which it is made; IBM assumes no obligation to update or revise any such statements except as required by law. Forward-looking Overall, management believes that supplementally providing statements are based on IBM’s current assumptions regarding investors with a view of operating earnings as described above future business and financial performance; these statements, provides increased transparency and clarity into both the by their nature, address matters that are uncertain to different operational results of the business and the performance of the degrees. Forward-looking statements involve a number of risks, company’s pension plans; improves visibility to management uncertainties and other factors that could cause actual results to decisions and their impacts on operational performance; enables be materially different, as discussed more fully elsewhere in this better comparison to peer companies; and allows the company Annual Report and in the company’s filings with the Securities and to provide a long-term strategic view of the business going Exchange Commission (SEC), including IBM’s 2019 Form 10-K forward. Our reportable segment financial results reflect pre-tax filed on February 25, 2020. operating earnings from continuing operations, consistent with our management and measurement system. In addition, these non-GAAP measures provide a perspective consistent with areas of interest we routinely receive from investors and analysts. MANAGEMENT DISCUSSION SNAPSHOT ($ and shares in millions except per share amounts) Yr.-to-Yr. Percent/Margin For the year ended December 31: 2019 2018 Change** Revenue $ 77,147 $ 79,591 (3.1)%* Gross profit margin 47.3% 46.4% 0.9 pts. Total expense and other (income) $ 26,322 $ 25,594 2.8% Income from continuing operations before income taxes $ 10,166 $ 11,342 (10.4)% Provision for income taxes from continuing operations $ 731 $ 2,619+ (72.1)% Income from continuing operations $ 9,435 $ 8,723+ 8.2% Income from continuing operations margin 12.2% 11.0% 1.3 pts. Net income $ 9,431 $ 8,728+ 8.1% Earnings per share from continuing operations—assuming dilution $ 10.57 $ 9.51+ 11.1% Weighted-average shares outstanding—assuming dilution 892.8 916.3 (2.6)% Assets++ $152,186 $123,382 23.3% Liabilities++ $131,202 $106,452 23.2% Equity++ $ 20,985 $ 16,929 24.0% * (1.0) percent adjusted for currency; 0.2 percent excluding divested businesses and adjusted for currency. ** 2019 results were impacted by Red Hat purchase accounting and acquisition-related activity. + Includes charges of $2.0 billion or $2.23 of diluted earnings per share in 2018 associated with U.S. tax reform. ++At December 31 The following table provides the company’s operating (non-GAAP) earnings for 2019 and 2018. See page 46 for additional information. ($ in millions except per share amounts) Yr.-to-Yr. For the year ended December 31: 2019 2018 Percent Change* Net income as reported $ 9,431 $ 8,728** 8.1% Income/(loss) from discontinued operations, net of tax (4) 5 NM Income from continuing operations $ 9,435 $ 8,723** 8.2% Non-operating adjustments (net of tax) Acquisition-related charges 1,343 649 107.0 Non-operating retirement-related costs/(income) 512 1,248 (58.9) U.S. tax reform charge 146 2,037 (92.8) Operating (non-GAAP) earnings $11,436 $12,657 (9.6)% Diluted operating (non-GAAP) earnings per share $ 12.81 $ 13.81 (7.2)% * 2019 results were impacted by Red Hat purchase accounting and acquisition-related activity. ** Includes charges of $2.0 billion in 2018 associated with U.S. tax reform. NM—Not meaningful


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    28 Management Discussion International Business Machines Corporation and Subsidiary Companies In 2019, we reported $77.1 billion in revenue, $9.4 billion in From a geographic perspective, Americas revenue declined income from continuing operations and operating (non-GAAP) 1.9 percent year to year as reported (1 percent adjusted for earnings of $11.4 billion, resulting in diluted earnings per share currency), but grew 1 percent excluding divested businesses from continuing operations of $10.57 as reported and $12.81 on and adjusted for currency. Europe/Middle East/Africa (EMEA) an operating (non-GAAP) basis. We also generated $14.8 billion in decreased 4.1 percent (flat adjusted for currency), but grew 1 cash from operations, $11.9 billion in free cash flow and delivered percent excluding divested businesses and adjusted for currency. shareholder returns of $7.1 billion in dividends and gross common Asia Pacific declined 4.0 percent year to year as reported stock repurchases. These results reflect solid performance in key (3 percent adjusted for currency) and 2 percent excluding high-value areas as we continued to strengthen our foundation divested businesses and adjusted for currency. for the next chapter of our clients’ digital reinventions. During 2019, we completed the acquisition of Red Hat and have started The consolidated gross margin of 47.3 percent increased 0.9 to benefit from the synergies of IBM and Red Hat together. We points year to year, and the operating (non-GAAP) gross margin continued to bring new innovations to the market, launching the of 48.0 percent increased 1.1 points versus the prior year. The new z15, delivering new high-end storage and modernizing and improved margins in 2019 reflect the actions we have taken to containerizing our software portfolio. We have expanded our focus on higher value and portfolio optimization while also driving services offerings and skills for the cloud journey and the reach productivity and operational efficiency. of our Watson/AI offerings. We also divested select businesses as we continue to prioritize our investments and optimize our Total expense and other (income) increased 2.8 percent in 2019 portfolio for this next chapter in cloud. compared to the prior year. The year-to-year performance was driven by higher spending including investment to deliver new Total consolidated revenue decreased 3.1 percent as reported innovations, Red Hat operational spending and interest expense and 1 percent adjusted for currency compared to the prior year. from debt issuances to fund the acquisition (8 points), amortization Excluding divested businesses, revenue increased 0.2 percent of acquired intangible assets and other non-operating activity adjusted for currency. Cloud & Cognitive Software increased related to the Red Hat acquisition (3 points) and a decrease in 4.5 percent as reported and 6 percent adjusted for currency, intellectual property (IP) income (1 point), partially offset by lower with strong results from the contribution of Red Hat beginning non-operating retirement-related costs (4 points), gains from in the third quarter. Cloud & Data Platforms, which includes divestitures (3 points) and the impact of currency (3 points). Total Red Hat, grew 10.4 percent as reported (12 percent adjusted operating (non-GAAP) expense and other (income) increased 4.1 for currency), Cognitive Applications increased 2.3 percent as percent year to year, driven primarily by the same factors excluding reported (4 percent adjusted for currency), while Transaction the non-operating retirement-related costs and the amortization Processing Platforms declined 0.5 percent as reported but grew of acquired intangible assets and other non-operating activity 1 percent adjusted for currency. Global Business Services (GBS) related to the Red Hat acquisition. grew 0.2 percent as reported and 2 percent adjusted for currency led by Consulting which grew 3.7 percent (6 percent adjusted Pre-tax income from continuing operations of $10.2 billion for currency) with year-to-year improvement in each quarter of decreased 10.4 percent and the pre-tax margin was 13.2 2019. Global Technology Services (GTS) decreased 6.1 percent percent, a decrease of 1.1 points versus 2018. The second as reported and 4 percent adjusted for currency with declines half of 2019 was impacted by the deferred revenue purchase in Infrastructure & Cloud Services and Technology Support accounting adjustment and Red Hat acquisition-related activity. Services. Performance in Infrastructure & Cloud Services was The continuing operations effective tax rate for 2019 was 7.2 impacted by lower in-period revenue from client business percent, a decrease of 15.9 points compared to 2018. The volumes, while the decline in Technology Support Services was year-to-year change was primarily driven by a charge of $2.0 primarily due to transitions in the hardware product cycle. As billion in 2018 for U.S. tax reform. Net income from continuing we continued to take actions to accelerate the shift to the higher operations of $9.4 billion increased 8.2 percent and the net value segments of the market opportunity, there was solid growth income from continuing operations margin was 12.2 percent, in the cloud offerings within GTS. Systems decreased 5.3 percent up 1.3 points year to year primarily due to the 2018 $2.0 billion year to year as reported and 4 percent adjusted for currency. IBM charge for U.S. tax reform. Operating (non-GAAP) pre-tax income Z decreased 1.1 percent (flat adjusted for currency) reflecting from continuing operations of $12.5 billion decreased 9.0 percent product cycle dynamics. There was a year-to-year decline year to year and the operating (non-GAAP) pre-tax margin from through the first three quarters of the year at the end of the continuing operations decreased 1.1 points to 16.2 percent. z14 product cycle, but strong growth in the fourth quarter after The operating (non-GAAP) tax rate for 2019 was 8.5 percent, an shipment of the new z15 mainframe began in the last week of increase of 0.7 points compared to 2018. Operating (non-GAAP) September. Storage Systems declined 8.9 percent as reported income from continuing operations of $11.4 billion decreased (8 percent adjusted for currency) with improved year-to-year 9.6 percent and the operating (non-GAAP) income margin from performance in the second half of the year and growth in the continuing operations of 14.8 percent was down 1.1 points fourth quarter led by high-end products. Power Systems declined year to year driven primarily by the Red Hat deferred revenue 13.5 percent (12 percent adjusted for currency) compared with purchase accounting adjustment and acquisition-related activity. strong performance in the prior year. Across the segments, total IBM cloud revenue of $21.2 billion in 2019 grew 11 percent as Diluted earnings per share from continuing operations of $10.57 reported and 13 percent adjusted for currency and represented in 2019 increased 11.1 percent and operating (non-GAAP) diluted 27 percent of our total 2019 revenue. earnings per share of $12.81 decreased 7.2 percent versus 2018. In 2019, we repurchased 10.0 million shares of common stock at a cost of $1.3 billion before the share repurchase program was suspended at the time of the Red Hat closing.


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    Management Discussion 29 International Business Machines Corporation and Subsidiary Companies At December 31, 2019, we continued to have the financial flexibility Financing activities were a net source of cash of $9.0 billion in to support the business. Cash, restricted cash and marketable 2019 compared to a net use of cash of $10.5 billion in 2018. The securities at year end were $9.0 billion, a decrease of $3.2 billion year-to-year increase in cash flow of $19.5 billion was driven by from December 31, 2018 as we had built up our cash position in an increase in net cash sourced from debt transactions ($16.6 advance of the closing of the Red Hat acquisition. Goodwill and billion) primarily driven by net issuances to fund the Red Hat intangible assets increased $34.1 billion and total debt increased acquisition and a decrease in cash used for gross common stock $17.1 billion since December 31, 2018, primarily due to the Red repurchases ($3.1 billion). Hat acquisition. With strong cash flow from operating activities and free cash flow, and disciplined financial management, we In January 2020, the company disclosed that it is expecting significantly deleveraged in the second half of 2019. GAAP earnings per share from continuing operations of at least $10.57 and operating (non-GAAP) earnings of at least $13.35 per Total assets increased $28.8 billion (increased $29.0 billion diluted share for 2020. The company expects free cash flow to be adjusted for currency) from December 31, 2018 primarily driven by: approximately $12.5 billion in 2020. Refer to the Looking Forward section for additional information on the company’s expectations. • Increases in goodwill of $22.0 billion and net intangible assets of $12.1 billion primarily associated with the acquisition of Red Hat; and DESCRIPTION OF BUSINESS Please refer to IBM’s Annual Report on Form 10-K filed with the • An increase in operating right-of-use assets of $5.0 billion SEC on February 25, 2020, for Item 1A. entitled “Risk Factors.” resulting from the adoption of the new leasing standard on January 1, 2019; partially offset by We create value for clients by providing integrated solutions • A decrease in financing receivables of $8.6 billion and products that leverage: data, information technology, deep primarily due to the wind down of OEM IT commercial expertise in industries and business processes, with trust and financing operations. security and a broad ecosystem of partners and alliances. IBM solutions typically create value by enabling new capabilities for Total liabilities increased $24.7 billion (increased $25.0 billion clients that transform their businesses and help them engage adjusted for currency) from December 31, 2018 driven by: with their customers and employees in new ways. These solutions draw from an industry-leading portfolio of consulting and IT • An increase in total debt of $17.1 billion primarily driven by implementation services, cloud, digital and cognitive offerings, new issuances to finance the Red Hat acquisition; and and enterprise systems and software which are all bolstered by • An increase in operating lease liabilities of $5.3 billion one of the world’s leading research organizations. resulting from the adoption of the new leasing standard. IBM Strategy Total equity of $21.0 billion increased $4.1 billion from December IBM’s strategy begins with our clients. IBM is distinguished as 31, 2018 as a result of: being first and foremost an Enterprise company, serving the world’s leaders in their industries. • Increases from net income of $9.4 billion and retirement related plans of $1.4 billion; partially offset by Serving enterprises requires a distinct set of skills as our clients • Decreases from dividends of $5.7 billion and gross share entrust us with building, integrating and running the world’s repurchases of $1.3 billion. mission-critical systems. These are systems that cannot fail, systems that require the highest levels of privacy and security. Cash provided by operating activities was $14.8 billion in 2019, a They are built with our software and on our systems, designed decrease of $0.5 billion compared to 2018, driven primarily by an and managed by IBM services. For example, we manage increase in cash income tax payments ($0.3 billion), an increase approximately ninety percent of the credit card transactions in interest payments on debt ($0.3 billion) driven by incremental and half of the world’s wireless connections. We do this with an debt used to fund the acquisition of Red Hat, and performance- unparalleled commitment to our clients’ data security. related declines within net income, including lower operating cash flows due to businesses divested in 2019; partially offset by an We are unique in bringing innovative technology and industry increase in cash provided by financing receivables ($0.8 billion). expertise on a foundation of trust and security as an integrated proposition to our clients. This integrated proposition allows us Net cash used in investing activities of $26.9 billion was $22.0 to deliver business impact that matters to our clients, impact that billion higher than the prior year, primarily driven by an increase requires bringing together technologies such as hybrid cloud, data in net cash used for acquisitions ($32.5 billion) driven by the and AI insight with workflow and advanced industry skills. This acquisition of Red Hat. This was partially offset by an increase integrated proposition helps our clients transform themselves in cash provided by net non-operating finance receivables from traditional businesses to what we call Cognitive Enterprises. ($7.2 billion) primarily driven by the wind down of the OEM IT commercial financing operations, a decrease in cash used for net capital expenditures ($1.3 billion) and an increase in cash provided by divestitures ($1.1 billion).


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    30 Management Discussion International Business Machines Corporation and Subsidiary Companies Furthermore, as technology becomes more central for business, Our public cloud is built on a foundation of open source software as well as in our personal lives, trust matters more than ever. and enterprise grade infrastructure. It is the most open and For decades we have followed core principles grounded secure public cloud, and it is built for the enterprise with Cloud in commitments to trust and transparency that guide our Paks—enterprise-ready, containerized software solutions for responsible development and deployment of new technologies. applications, automation, data, integration and multi-cloud These values ground our business decisions, inspire our management. employees, and sustain our client relationships. We have not only followed guidelines around the responsible handling of data and To accelerate our clients’ success, we acquired Red Hat in 2019, the stewardship of new technology, but created them, published further strengthening our leadership in hybrid cloud. Red Hat is them and invited others to adopt similar commitments. Our focus the world’s leader in open source technology, including Enterprise is not just on our direct client work, but extends to society at Linux, the operating system of the cloud, as well as containers large, as we have been very active in areas such as education, and OpenShift, technology platforms that create seamless sustainability and security. This is reinforced through a culture integration between traditional and cloud environments. As the of inclusion and diversity. All of IBM treats this “responsible leader in open source, Red Hat brings capability that enables stewardship” as core to our mission. applications to be “written once and run anywhere”, in turn helping companies avoid lock-in to a single cloud provider, A New Chapter in Technology thereby taking advantage of the entire industry’s innovation. 2019 ushered in Chapter 2 of our clients’ digital journeys in which These technologies are central to the next era of computing. the two predominant technology forces of our day—hybrid cloud and data/AI—are moving from “start-up” to “production at scale”. Our systems and services play a large role in these hybrid These two forces work together to help companies become what cloud offerings as well. We have introduced new versions of our we call Cognitive Enterprises—companies that are powered by systems that work securely and seamlessly in the hybrid cloud, innovation, agility and data-driven intelligent decision making. bringing mission-critical workloads into our clients’ digital journeys. Through our services, we play a large role in helping We describe below how IBM is leading the way in Chapter 2. our clients map out their digital journeys, and then helping them build, manage and run the technology and the workflows. Hybrid Cloud Chapter 1 marked the early stages of cloud with the rise of public This integrated value proposition of innovative technology and cloud. This stage was focused on new end-user applications, industry expertise built on trust and security, and now together including applications that have allowed consumers to check with Red Hat, is helping our clients realize the full potential and their bank balances, access social media, make online purchases competitive advantage of the hybrid cloud. and receive online support. While movement to public cloud has been strong, only twenty percent of workloads have been Data and AI addressed in Chapter 1. Clients are merely at the beginning of a A new era of business reinvention is emerging as leading multi-stage journey. companies are moving from merely improving their processes to creating truly “intelligent workflows,” processes that are not Chapter 2 is about clients modernizing the remaining eighty only efficient at what they do, but intrinsically smart: capable of percent of workloads, moving mission-critical workloads to finding, connecting and analyzing data to uncover deep insights the cloud and infusing AI deep into the decision-making of that can inform intelligent decisions. Data and AI, in concert with their businesses. These mission-critical workloads include hybrid cloud, are making intelligent workflows possible. core financial transaction systems, customer databases and Enterprise Resource Planning systems. Some of these workloads We have been a pioneer of technologies and services that help will gravitate to the public cloud in Chapter 2, while others will clients collect, organize, and analyze their vast data stores and move to a private cloud or remain in traditional IT environments then operationalize AI across their business. Our long-running for security, compliance and/or performance reasons. innovation in automation, data science, and natural language processing is helping clients manage their data as a strategic Wherever clients’ workloads reside, these environments resource and deploy AI for greater insight and more accurate, must work together seamlessly to communicate, share data trusted predictions. and share capacity. With enterprises having accumulated as many as fifteen public clouds, each with its own means of Our data offerings help clients organize, collect, analyze and management, harmonizing these different clouds has become embed their data into their workflow. IBM software spans areas a necessity. Bringing these multiple public clouds, private cloud ranging from data management and discovery to reporting, and traditional IT together is what we call hybrid cloud. Hybrid governance, compliance and risk management. Our systems cloud defines the mission for Chapter 2 in IT. process our clients’ data with unparalleled speed, accuracy and security and our services help clients capture and embed the We are a leader in hybrid cloud, and our mission in Chapter 2 is value of their data into their business. to bring our expertise and experience in building and managing mission-critical systems to lead our enterprise clients along this multi-stage journey.


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    Management Discussion 31 International Business Machines Corporation and Subsidiary Companies Our IBM Watson AI system has been named by industry analysts This business model, supported by our financial model, has as the worldwide market leader in AI for three consecutive enabled IBM to deliver strong earnings, cash flows and returns years. Watson is not only a leading AI technology, but a leader to shareholders over the long term. in enterprise deployments in production and at scale. In addition to extracting deep insight from data, IBM Watson allows clients Business Segments and Capabilities to trace the origins of the data that their AI models use, explain Our major operations consist of five business segments: Cloud & what is behind their recommendations and ensure that bias Cognitive Software, Global Business Services, Global Technology has not crept into results. Furthermore, IBM Watson is the only Services, Systems and Global Financing. system that is built for the hybrid cloud, able to work on numerous public and private clouds. These innovations are making AI more Cloud & Cognitive Software brings together IBM’s software consumable by everyday users, not just data scientists. platforms and solutions, enabling us to deliver integrated and secure cloud, data and AI solutions to our clients. It includes Creating intelligent workflows relies on our integrated proposition all software, except operating system software reported in the of technology, services and industry expertise, built on a Systems segment. foundation of trust and security. The way in which we bring these together is through an interactive process with our clients that we Cloud & Cognitive Software comprises three business areas— call the IBM Garage, a process of deep collaboration, co-creation Cognitive Applications, Cloud & Data Platforms, and Transaction and innovation. Processing Platforms. * * * * * Cloud & Cognitive Software Capabilities We are in an era when our clients are embedding technology into Cognitive Applications: includes software that address vertical and their businesses in ways they have never done before. Technology domain-specific solutions, increasingly infused with AI, enabled is no longer merely a “tool”, it is at the center of their businesses, by IBM’s Watson technology. Application areas such as health, the source of their competitive advantage and the force behind financial services, Internet of Things (IoT) solutions, weather, and their emerging business models. security software and services are among the offerings. In Chapter 2, IBM is bringing hybrid cloud and data/AI together Cloud & Data Platforms: includes the company’s distributed to help our clients reinvent themselves as Cognitive Enterprises. middleware and data platform software, including Red Hat, which The most challenging and complex work still lies ahead. With our enables the operation of clients’ hybrid multi-cloud environments, strong commitment to responsible stewardship and our integrated whether on-premise or in public and private clouds. It also value proposition, this makes us unique in helping our clients on includes product areas such as Cloud Paks, WebSphere their transformative digital journeys. distributed, analytics platform software such as DB2 distributed, information integration, and enterprise content management, as Business Model well as IoT, Blockchain and AI/Watson platforms. Our business model is built to provide long-term value to stakeholders. We bring together innovative technology, industry As clients increasingly move more of their mission-critical expertise and a commitment to trust and transparency to help workloads to the cloud, their multi-cloud environments will enterprise clients move from one era to the next. We provide be based on a foundation of Linux, with Kubernetes open- integrated solutions and platforms, leveraging global capabilities source software to deploy, manage and scale container-based that include services, software, systems, related financings and applications. Red Hat, which provides the leading Linux operating fundamental research. The business model has been developed system—Red Hat Enterprise Linux—and the leading hybrid over time through strategic investments in capabilities and cloud platform—Red Hat OpenShift—is at the center of this technologies that have long-term growth and profitability transformational shift among clients. prospects based on the value they deliver to clients. Transaction Processing Platforms: the software that supports The business model is dynamic, adapting to the continuously client mission critical on-premise workloads in industries such as changing industry and economic environment, including our shift banking, airlines and retail. This includes transaction processing to cloud delivery models. We continue to strengthen our position software such as Customer Information Control System and through strategic organic investments and acquisitions in higher- storage software, as well as the analytics and integration value areas, broadening our industry expertise and integrating AI software running on IBM operating systems (e.g., DB2 and into more of what we offer. In addition, we are transforming into WebSphere running on z/OS). a more agile enterprise to drive innovation and speed, as well as helping to drive productivity, which supports investments for Global Business Services provides clients with consulting, participation in markets with significant long-term opportunity. business process and application management services. We also regularly evaluate our portfolio and investments, These professional services deliver value and innovation to proactively bringing products to end of life, engaging in IP clients through solutions which leverage industry, technology partnerships and executing divestitures to optimize our portfolio. and business strategy and process expertise. GBS is the digital reinvention partner for IBM clients, combining industry knowledge, functional expertise, and applications with the power


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    32 Management Discussion International Business Machines Corporation and Subsidiary Companies of business design and cognitive and cloud technologies. The in building and running contemporary, software-defined IT full portfolio of GBS services is backed by its globally integrated environments. These offerings integrate long-standing expertise delivery network and integration with technologies, solutions in service management and emerging technologies, drawn from and services across IBM including IBM Research and Global across IBM’s businesses and ecosystem partners. The portfolio Technology Services. is built leveraging platforms, such as the IBM Services Platform with Watson, which augment human intelligence with cognitive GBS assists clients on their journeys to becoming Cognitive technologies and address complex, hybrid cloud environments. Enterprises, helping them build business platform strategies IBM’s services capabilities integrate IBM Cloud, cognitive and experiences, transform processes to intelligent workflows computing and multi-cloud management to provide clients with using AI and other exponential technologies, and build hybrid, high-performance, end-to-end innovation and an improved ability open cloud infrastructures. to achieve business objectives. GBS Capabilities Technology Support Services: delivers comprehensive support Consulting: provides business consulting services focused on services to maintain and improve the availability of clients’ IT bringing to market solutions that help clients shape their digital infrastructures. These offerings include maintenance for IBM blueprints and customer experiences, define their cognitive products and other technology platforms, as well as open-source operating models, unlock the potential in all data to improve and cross-vendor software and solution support, drawing on decision-making, set their next-generation talent strategies and innovative technologies and leveraging IBM Services Platform create new technology architectures in a cloud-centric world. with Watson capabilities. Application Management: delivers system integration, application Systems provides clients with innovative infrastructure platforms management, maintenance and support services for packaged to help meet the new requirements of hybrid multi-cloud and software, as well as custom and traditional applications. Value enterprise AI workloads. IBM Systems also designs advanced is delivered through advanced capabilities in areas such as semiconductor and systems technology in collaboration with IBM security and privacy, application testing and modernization, Research, primarily for use in our systems. cloud application migration and automation. Systems Capabilities Global Process Services (GPS): delivers finance, procurement, Systems Hardware: includes IBM’s servers and Storage Systems. talent and engagement, and industry-specific business process outsourcing services. These services deliver improved business Servers: a range of high-performance systems designed to results to clients through a consult-to-operate model which address computing capacity, security and performance needs includes the strategic change and/or operation of the client’s of businesses, hyperscale cloud service providers and scientific processes, applications and infrastructure. GBS is redefining computing organizations. The portfolio includes IBM Z and process services for both growth and efficiency through the LinuxONE, trusted enterprise platforms for integrating data, application of the power of cognitive technologies like Watson, transactions and insight; and Power Systems, a system designed as well as the IoT, blockchain and deep analytics. from the ground up for big data and enterprise AI, optimized for hybrid cloud and Linux. Global Technology Services provides compre hensive IT infrastructure and platform services that create business value Storage Systems: data storage products and solutions that for clients. Clients gain access to leading-edge, high-quality allow clients to retain and manage rapidly growing, complex services, and realize greater flexibility and economic value. volumes of digital information and to fuel data-centric cognitive This is enabled through insights drawn from IBM’s decades applications. These solutions address critical client requirements of experience across thousands of engagements, the skills of for information retention and archiving, security, compliance and practitioners, advanced technologies, applied innovation from storage optimization, including data deduplication, availability IBM Research and global scale. and virtualization. The portfolio consists of a broad range of flash storage, disk and tape storage solutions. GTS Capabilities Infrastructure & Cloud Services: delivers a portfolio of project, Operating Systems Sof tware: IBM Z operating system managed, outsourcing and cloud-delivered services focused on environments include z/OS, a security-rich, high-performance clients’ enterprise IT infrastructure environments to enable digital enterprise operating system, as well as Linux. Power Systems transformation with improved quality, flexibility and economic offers a choice of AIX, IBM i or Linux operating systems. These value. The portfolio contains the IBM Cloud and a comprehensive operating systems leverage POWER architecture to deliver set of hybrid cloud services and solutions that include resiliency, secure, reliable and high performing enterprise-class workloads network and security capabilities to assist enterprise clients across a breadth of server offerings.


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    Management Discussion 33 International Business Machines Corporation and Subsidiary Companies Global Financing encompasses two primary businesses: Global Markets financing, primarily conducted through IBM Credit LLC (IBM IBM operates in more than 175 countries with a broad distribution Credit), and remanufacturing and remarketing. IBM Credit is a of revenue. To manage this global footprint, Global Markets leads wholly owned subsidiary of IBM that accesses the capital markets our dedicated country-based IBM operations in order to serve directly. IBM Credit, through its financing solutions, facilitates IBM clients, develop markets, and ultimately, ensure IBM is led clients’ acquisition of information technology systems, software through a client lens. and services in the areas where we have expertise. The financing arrangements are predominantly for products or services that are These integrated teams serve our clients locally, complemented critical to the end users’ business operations. Global Financing by digital capabilities, global talent and resources, and an conducts a comprehensive credit evaluation of its clients prior extensive partner ecosystem. These country teams have client to extending financing. As a captive financier, Global Financing relationship managers at their center, who integrate teams of has the benefit of both deep knowledge of its client base and IBM consultants, solution specialists, delivery professionals a clear insight into the products and services financed. These and business partners on behalf of clients. Their mission is to factors allow the business to effectively manage two of the provide insights and innovation and co-create with clients to major risks associated with financing, credit and residual value, help them address their most pressing business challenges and while generating strong returns on equity. Global Financing also opportunities. maintains a long-term partnership with IBM’s clients through various stages of the IT asset life cycle—from initial purchase In this way, we serve as a trusted partner to clients, establishing and technology upgrades to asset disposition decisions. and maintaining relationships that deliver long-term value based on industry expertise, innovative technologies and an ability to Global Financing Capabilities deliver mission critical capabilities to an enterprise at scale. Client Financing: lease, installment payment plan and loan financing to end users and internal clients for terms up to seven Research, Development and Intellectual Property years. Assets financed are primarily new and used IT hardware, Our research and development (R&D) operations differentiate software and services where we have expertise. Internal us from our competitors. In 2019, we invested approximately financing is predominantly in support of Global Technology 8 percent of total revenue for R&D, focusing on high-growth, Services’ long-term client service contracts. All internal financing high-value opportunities. IBM Research works with clients and arrangements are at arm’s-length rates and are based upon our business units through global labs on near- and mid-term market conditions. innovations. It delivers many new technologies to our portfolio every year and helps clients address their most difficult challenges. Commercial Financing: short-term working capital financing IBM Research scientists are conducting pioneering work in to suppliers, distributors and resellers of IBM. Beginning in the artificial intelligence, quantum computing, security, cloud, systems second quarter of 2019 and continuing throughout the year, we and more—applying these technologies across industries including wound down the portion of our commercial financing operations financial services, healthcare, manufacturing and automotive. which provides short-term working capital solutions for Original Equipment Manufacturer (OEM) IT suppliers, distributors In 2019, for the 27th consecutive year, IBM was awarded more and resellers. This wind down is consistent with IBM’s capital U.S. patents than any other company. IBM’s 9,262 patents allocation strategy and high-value focus. Commercial Financing awarded in 2019 represent a diverse range of inventions in also includes internal activity where Global Financing factors a strategic growth areas for the company, including more than selected portion of IBM’s accounts receivable primarily for cash 4,500 patents related to work in artificial intelligence, cloud, management purposes, at arm’s-length rates. This program was cybersecurity and quantum computing. suspended in the second quarter of 2019. We actively continue to seek IP protection for our innovations, Remanufacturing and Remarketing: assets include used while increasing emphasis on other initiatives designed equipment returned from lease transactions, or used and surplus to leverage our IP leadership. Some of our technological equipment acquired internally or externally. These assets may breakthroughs are used exclusively in IBM products, while be refurbished or upgraded, and sold or leased to new or existing others are licensed and may be used in IBM products and/or clients both externally and internally. Externally remarketed the products of the licensee. As part of our business model, equipment revenue represents sales or leases to clients and we license certain of our IP assets, which constitute high-value resellers. Internally remarketed equipment revenue primarily technology, but may be applicable in more mature markets. The represents used equipment that is sold internally to Global licensee drives the future development of the IP and ultimately Technology Services. Systems may also sell the equipment that expands the customer base. This generates IP income for IBM it purchases from Global Financing to external clients. both upon licensing, and with any ongoing royalty arrangements between it and the licensee. While our various proprietary IP IBM Worldwide Organizations rights are important to our success, we believe our business as The following worldwide organizations play key roles in IBM’s a whole is not materially dependent on any particular patent or delivery of value to its clients: license, or any particular group of patents or licenses. IBM owns or is licensed under a number of patents, which vary in duration, • Global Markets relating to its products. • Research, Development and Intellectual Property


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    34 Management Discussion International Business Machines Corporation and Subsidiary Companies YEAR IN REVIEW Results of Continuing Operations Segment Details The following is an analysis of the 2019 versus 2018 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: 2019 2018 Change Currency Revenue Cloud & Cognitive Software $23,200 $22,209* 4.5%** 6.2% Gross margin 76.7% 77.6%* (0.9)pts.** Global Business Services 16,634 16,595* 0.2% 2.4% Gross margin 27.7% 26.8%* 0.9 pts. Global Technology Services 27,361 29,146* (6.1)% (3.7)% Gross margin 34.8% 34.4%* 0.3 pts. Systems 7,604 8,034 (5.3)% (4.1)% Gross margin 53.1% 49.8% 3.2 pts. Global Financing 1,400 1,590 (11.9)% (10.0)% Gross margin 35.6% 29.1% 6.4 pts. Other 948 2,018* (53.0)% (51.7)% Gross margin 4.7% 37.8%* (33.1) pts. Total consolidated revenue $77,147 $79,591 (3.1)%+ (1.0)% Total consolidated gross profit $36,488 $36,936 (1.2)%** Total consolidated gross margin 47.3% 46.4% 0.9 pts. Non-operating adjustments Amortization of acquired intangible assets 534 372 43.8% Acquisition-related charges 13 — NM Operating (non-GAAP) gross profit $37,035 $37,307 (0.7)%** Operating (non-GAAP) gross margin 48.0% 46.9% 1.1 pts. * Recast to reflect segment changes. ** 2019 results were impacted by Red Hat purchase accounting and acquisition-related activity. + 0.2 percent excluding divested businesses and adjusted for currency. NM—Not meaningful Cloud & Cognitive Software ($ in millions) Yr.-to-Yr. Yr.-to-Yr. Percent Change Percent Adjusted for For the year ended December 31: 2019 2018* Change ** Currency** Cloud & Cognitive Software external revenue $23,200 $22,209 4.5% 6.2% Cognitive Applications $ 5,765 $ 5,633 2.3% 3.9% Cloud & Data Platforms 9,499 8,603 10.4 12.3 Transaction Processing Platforms 7,936 7,974 (0.5) 1.4 * Recast to reflect segment changes. ** 2019 results were impacted by Red Hat purchase accounting. Cloud & Cognitive Software revenue of $23,200 million increased and IBM are driving synergies with strong adoption of Cloud Paks 4.5 percent as reported (6 percent adjusted for currency) in 2019 since their introduction, expansion of our combined client base compared to the prior year. There was strong growth in Cloud and more than 2,000 clients using our hybrid cloud platform. & Data Platforms, as reported and at constant currency, driven Cognitive Applications also grew as reported and at constant primarily by the acquisition of Red Hat in the third quarter of 2019. currency. Transaction Processing Platforms declined year to year Red Hat had continued strong performance since the acquisition, as reported, but grew 1 percent adjusted for currency driven by in Red Hat Enterprise Linux (RHEL), application development and strong fourth-quarter performance. emerging technologies, led by OpenShift and Ansible. Red Hat


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    Management Discussion 35 International Business Machines Corporation and Subsidiary Companies Cognitive Applications revenue of $5,765 million grew 2.3 percent ($ in millions) as reported (4 percent adjusted for currency) compared to the Yr.-to-Yr. Percent/ prior year, driven by double-digit growth as reported and adjusted Margin for currency in Security, and growth in industry verticals such as For the year ended December 31: 2019 2018* Change** IoT. The Security performance included continued strong results Cloud & Cognitive Software in threat management software and services offerings. Within External gross profit $17,790 $17,224 3.3% IoT, we had good revenue performance across the portfolio as External gross profit we continued to invest in new offerings and industry-specific margin 76.7% 77.6% (0.9)pts. solutions. Pre-tax income $ 7,952 $ 8,882 (10.5)% Cloud & Data Platforms revenue of $9,499 million increased 10.4 Pre-tax margin 30.6% 35.0% (4.4)pts. percent as reported (12 percent adjusted for currency) compared * Recast to reflect segment changes. to the prior year. Performance was driven by the addition of RHEL ** 2019 results were impacted by Red Hat purchase accounting and and OpenShift and the continued execution of the combined Red acquisition-related activity. Hat and IBM hybrid strategy. The Cloud & Cognitive Software gross profit margin decreased Transaction Processing Platforms revenue of $7,936 million 0.9 points to 76.7 percent in 2019 compared to the prior year. decreased 0.5 percent as reported, but grew 1 percent adjusted The gross profit margin decline was driven by the purchase price for currency in 2019, compared to the prior year. Revenue accounting impacts from the Red Hat acquisition. performance reflects the ongoing investment in IBM platforms, and the timing of larger transactions that are tied to client Pre-tax income of $7,952 million decreased 10.5 percent business volumes and buying cycles. compared to the prior year with a pre-tax margin decline of 4.4 points to 30.6 percent which reflects the acquisition of Red Hat, Within Cloud & Cognitive Software, cloud revenue of $4.2 ongoing investments in key strategic areas and lower income billion grew 40 percent as reported and 42 percent adjusted for from IP partnership agreements. currency year to year, reflecting the acquisition of Red Hat and client adoption of our hybrid cloud offerings. Global Business Services ($ in millions) Yr.-to-Yr. Yr.-to-Yr. Percent Change Percent Adjusted for For the year ended December 31: 2019 2018 Change Currency Global Business Services external revenue $16,634 $16,595* 0.2% 2.4% Consulting $ 7,993 $ 7,705 3.7% 5.6% Application Management 7,646 7,852 (2.6) (0.3) Global Process Services 995 1,037* (4.1) (1.3) * Recast to reflect segment changes. GBS revenue of $16,634 million increased 0.2 percent as reported Application Management revenue of $7,646 million decreased and 2 percent adjusted for currency in 2019 compared to the 2.6 percent as reported, but was flat adjusted for currency. We prior year. The strong growth in Consulting reflected GBS’ ability had growth in offerings that help clients develop and manage to bring together our industry specific expertise and innovative cloud applications and modernize and automate their application technology portfolio to help clients with their digital reinventions. portfolio, offset by continued decline in the more traditional Our performance reflects continued investment in offerings and application management engagements. With the acquisition capabilities to help advise clients and move their applications to of Red Hat, we continued to integrate OpenShift as clients’ hybrid multi-cloud environments. In the second half, we saw an preferred cloud-native application development platform. acceleration in new Red Hat engagements. Global Process Services revenue of $995 million decreased Consulting revenue of $7,993 million increased 3.7 percent 4.1 percent as reported (1 percent adjusted for currency) as as reported and 6 percent adjusted for currency compared to demand has been shifting away from traditional Business Process the prior year. This strong performance was driven primarily by Outsourcing (BPO) offerings to new business platforms around growth in offerings that enable each phase of our clients’ digital intelligent workflows. journey. These offerings include cognitive technology and data platform services, application modernization and next-generation Within GBS, cloud revenue of $5.2 billion grew 10 percent as enterprise applications and offerings that use AI to help clients reported and 13 percent adjusted for currency, reflecting the unlock new opportunities and realize productivity improvements. growth in cloud consulting engagements and cloud application development.


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    36 Management Discussion International Business Machines Corporation and Subsidiary Companies ($ in millions) The GBS profit margin increased 0.9 points to 27.7 percent and Yr.-to-Yr. pre-tax income of $1,666 million increased 2.2 percent year to Percent/ year. The pre-tax margin of 9.9 percent increased slightly year Margin For the year ended December 31: 2019 2018* Change to year. The year-to-year improvements in margins and pre-tax Global Business Services income were driven by the continued mix shift to higher-value offerings, the yield from delivery productivity improvements and External gross profit $4,606 $4,448 3.5% a currency benefit from leveraging the global delivery resource External gross profit model. We continued to invest in our services offerings and skills margin 27.7% 26.8% 0.9 pts. necessary to assist our clients on their cloud journey. Pre-tax income $1,666 $1,629 2.2% Pre-tax margin 9.9% 9.6% 0.2 pts. * Recast to reflect segment changes. Global Technology Services ($ in millions) Yr.-to-Yr. Yr.-to-Yr. Percent Change Percent Adjusted for For the year ended December 31: 2019 2018 Change Currency Global Technology Services external revenue $27,361 $29,146* (6.1)% (3.7)% Infrastructure & Cloud Services $20,736 $22,185* (6.5)% (4.1)% Technology Support Services 6,625 6,961 (4.8) (2.2) * Recast to reflect segment changes. GTS revenue of $27,361 million decreased 6.1 percent as Technology Support Services (TSS) revenue of $6,625 million reported (4 percent adjusted for currency) in 2019 compared to decreased 4.8 percent as reported (2 percent adjusted for the prior year. We had continued growth in cloud services that currency) in 2019, partially driven by dynamics in the hardware help clients move and manage workloads. However, performance product cycles. reflected lower client business volumes in more traditional labor-based managed services. We continue to take actions to Within GTS, cloud revenue of $8.6 billion grew 8 percent as accelerate the shift to higher-value segments of the market and reported and 10 percent adjusted for currency. are introducing new managed services offerings for public and private cloud, in areas like cybersecurity, data management and ($ in millions) hybrid orchestration. We are investing in joint services offerings Yr.-to-Yr. integrating GTS and GBS, and deploying joint go-to-market Percent/ Margin capabilities, as clients demand solutions that merge applications For the year ended December 31: 2019 2018* Change and infrastructure. Although lower business volumes impacted Global Technology Services full-year revenue and profit in 2019, we ended the year with External total gross profit $9,515 $10,035 (5.2)% growth in cloud signings and a solid pipeline of future deals that External total gross will deliver productivity to our clients. profit margin 34.8% 34.4% 0.3 pts. Pre-tax income $1,645 $ 1,781 (7.6)% Infrastructure & Cloud Services revenue of $20,736 million decreased 6.5 percent as reported (4 percent adjusted for Pre-tax margin 5.8% 5.9% (0.2)pts. currency) compared to the prior year. Revenue was impacted by * Recast to reflect segment changes. our customers’ own business volumes which were lower year to year in certain offerings. Clients are modernizing their core The GTS gross profit margin increased 0.3 points year to year infrastructures to hybrid multi-cloud infrastructures. GTS is to 34.8 percent, due to the benefits of workforce actions and continuing to invest in cloud capabilities, introduce new managed the continued scale out of our public cloud. We continued to services offerings and build out its cloud data center footprint take structural actions to improve our cost competitiveness to capture this opportunity. Growth in cloud signings reflects and are accelerating the use of AI and automation in delivery our re-alignment of GTS offerings to help our clients on their operations, including leveraging Red Hat’s Ansible platform. journey to cloud, infusing offerings with IP and leveraging Red Pre-tax income of $1,645 million decreased 7.6 percent, driven Hat’s capabilities. primarily by the decline in revenue and gross profit, and a higher level of workforce rebalancing charges in the current year. Pre-tax margin of 5.8 percent was essentially flat year to year, with the 2019 pre-tax margin reflecting benefits from structural and workforce actions.


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    Management Discussion 37 International Business Machines Corporation and Subsidiary Companies Services Backlog and Signings ($ in billions) Yr.-to-Yr. Yr.-to-Yr. Percent Change Percent Adjusted for At December 31: 2019 2018 Change Currency Total backlog $112.4 $116.1 (3.1)% (2.7)% The estimated total services backlog at December 31, 2019 was calculation of signings. The calculation used by management $112 billion, a decrease of 3.1 percent as reported (3 percent involves estimates and judgments to gauge the extent of a client’s adjusted for currency). commitment, including the type and duration of the agreement, and the presence of termination charges or wind-down costs. Total services backlog includes Infrastructure & Cloud Services, Security Services, Consulting, Global Process Services, Signings include Infrastructure & Cloud Services, Security Application Management and TSS. Total backlog is intended to Services, Consulting, Global Process Services and Application be a statement of overall work under contract which is either Management contracts. Contract extensions and increases in noncancellable, or which historically has very low likelihood scope are treated as signings only to the extent of the incremental of termination, given the criticality of certain services to the new value. TSS is generally not included in signings as the company’s clients. Total backlog does not include as-a-Service maintenance contracts tend to be more steady state, where arrangements that allow for termination under contractual revenues equal renewals. Certain longer-term TSS contracts commitment terms. Backlog estimates are subject to change and that have characteristics similar to outsourcing contracts are are affected by several factors, including terminations, changes included in signings. in the scope of contracts, periodic revalidations, adjustments for revenue not materialized and adjustments for currency. Contract portfolios purchased in an acquisition are treated as positive backlog adjustments provided those contracts meet the Services signings are management’s initial estimate of the company’s requirements for initial signings. A new signing will be value of a client’s commitment under a services contract. There recognized if a new services agreement is signed incidental or are no third-party standards or requirements governing the coincidental to an acquisition or divestiture. ($ in millions) Yr.-to-Yr. Yr.-to-Yr. Percent Change Percent Adjusted for For the year ended December 31: 2019 2018 Change Currency Total signings $40,741 $44,700 (8.9)% (6.9)% Systems ($ in millions) Yr.-to-Yr. Yr.-to-Yr. Percent Change Percent Adjusted for For the year ended December 31: 2019 2018 Change Currency Systems external revenue $7,604 $8,034 (5.3)% (4.1)% Systems Hardware $5,918 $6,363 (7.0)% (5.9)% IBM Z (1.1) (0.3) Power Systems (13.5) (12.1) Storage Systems (8.9) (7.6) Operating Systems Software 1,686 1,671 0.9 2.6 Systems revenue of $7,604 million decreased 5.3 percent year Within Systems Hardware, IBM Z revenue decreased 1.1 percent to year as reported (4 percent adjusted for currency). Systems as reported but was essentially flat adjusted for currency, Hardware revenue of $5,918 million declined 7.0 percent as reflecting the mainframe product cycles. Revenue declined reported (6 percent adjusted for currency), driven primarily by through the first three quarters due to the end of the z14 product declines in Power Systems and Storage Systems. Operating cycle, but there was strong growth in the fourth quarter driven Systems Software revenue of $1,686 million grew 0.9 percent by z15 shipments. The z15’s strong performance demonstrates as reported (3 percent adjusted for currency) compared to the client demand for technology that offers improved data privacy prior year. and resiliency in the hybrid cloud environment. The z15


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    38 Management Discussion International Business Machines Corporation and Subsidiary Companies mainframe’s capabilities extend the platform’s differentiation Pre-tax income of $701 million declined 22.4 percent and pre-tax with encryption everywhere, cloud-native development and margin of 8.4 percent decreased 1.8 points year to year driven instant recovery. In October, we announced OpenShift for IBM Z, by the declines in Power Systems and Storage Systems revenue bringing together the industry’s most comprehensive enterprise and the continued investment in innovation across the Systems container and Kubernetes platform with the enterprise server portfolio, mitigated by the benefit from the new hardware platforms of IBM Z and LinuxONE. IBM Z continues to deliver a launches in the second-half 2019. high-value, secure and scalable platform for our clients. Global Financing Power Systems revenue decreased 13.5 percent as reported Global Financing is a reportable segment that is measured as (12 percent adjusted for currency) year to year, due to the strong a stand-alone entity. Global Financing facilitates IBM clients’ performance during the second half of 2018 driven by Linux and the acquisition of information technology systems, software and introduction of the POWER9-based architecture in our mid-range services by providing financing solutions in the areas where and high-end products. the company has expertise, while generating strong returns on equity. Global Financing also optimizes the recovery of residual Storage Systems revenue decreased 8.9 percent as reported values by selling assets sourced from end of lease, leasing used (8 percent adjusted for currency) year to year, with improvements equipment to new clients, or extending lease arrangements in year-to-year performance in the fourth quarter of 2019, driven with current clients. Sales of equipment include equipment primarily by the launch of the next generation high-end storage returned at the end of a lease, surplus internal equipment system DS8900 in November. and used equipment purchased externally. Residual value is a risk unique to the financing business and management of this Within Systems, cloud revenue of $2.9 billion declined 4 percent risk is dependent upon the ability to accurately project future as reported and 3 percent adjusted for currency. equipment values at lease inception. Global Financing has insight into product plans and cycles for both the IBM and OEM ($ in millions) IT products under lease. Based upon this product information, Yr.-to-Yr. Global Financing continually monitors projections of future Percent/ Margin equipment values and compares them with the residual values For the year ended December 31: 2019 2018 Change reflected in the portfolio. Systems External Systems Results of Operations Hardware gross profit $2,622 $2,590 1.2% ($ in millions) External Systems Yr.-to-Yr. Hardware gross Percent For the year ended December 31: 2019 2018 Change profit margin 44.3% 40.7% 3.6 pts. External Operating External revenue $1,400 $1,590 (11.9)% Systems Software Internal revenue 1,232 1,610 (23.5) gross profit $1,412 $1,412 0.0% Total revenue $2,632 $3,200 (17.8)% External Operating Pre-tax income $1,055 $1,361 (22.5)% Systems Software gross profit margin 83.8% 84.5% (0.7)pts. External total In 2019, Global Financing delivered external revenue of $1,400 gross profit $4,034 $4,002 0.8% million and total revenue of $2,632 million, with a decrease in External total gross gross margin of 2.7 points to 58.8 percent. Total pre-tax income profit margin 53.1% 49.8% 3.2 pts. of $1,055 million decreased 22.5 percent compared to 2018 and Pre-tax income $ 701 $ 904 (22.4)% return on equity decreased 5.0 points to 25.8 percent. Pre-tax margin 8.4% 10.2% (1.8)pts. Global Financing total revenue decreased 17.8 percent compared to the prior year. This was due to a decrease in internal revenue of 23.5 percent, driven by decreases in internal used equipment The Systems gross profit margin increased 3.2 points to 53.1 sales (down 27.4 percent to $862 million) and internal financing percent in 2019 compared to the prior year. The increase was (down 12.6 percent to $370 million). External revenue declined driven by actions taken in 2018 to better position the cost 11.9 percent due to decreases in external financing (down 8.5 structure over the longer term, a mix to IBM Z hardware and percent to $1,120 million) and external used equipment sales operating systems and margin improvement in Storage Systems. (down 23.4 percent to $281 million).


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    Management Discussion 39 International Business Machines Corporation and Subsidiary Companies The decrease in internal financing revenue was due to lower Global Financing pre-tax income decreased 22.5 percent year to average asset balances, partially offset by higher asset yields. year primarily driven by a decrease in gross profit ($422 million), The decrease in external financing revenue reflects the wind partially offset by a decrease in total expense ($115 million), down of the OEM IT commercial financing operations. which was mainly driven by a decline in IBM shared expenses in line with the segment’s performance, a lower provision for credit Sales of used equipment represented 43.4 percent and 48.5 losses and a gain from the sale of certain commercial financing percent of Global Financing’s revenue for the years ended capabilities in the first quarter of 2019. December 31, 2019 and 2018, respectively. The decrease in 2019 was due to a lower volume of internal used equipment The decrease in return on equity from 2018 to 2019 was primarily sales. The gross profit margin on used sales was 52.2 percent and due to lower net income. Refer to page 45 for the details of the 54.2 percent for the years ended December 31, 2019 and 2018, after-tax income and return on equity calculations. respectively. The decrease in the gross profit margin was driven by lower margins on internal used equipment sales. Geographic Revenue In addition to the revenue presentation by reportable segment, we also measure revenue performance on a geographic basis. ($ in millions) Yr.-to-Yr. Percent Change Yr.-to-Yr. Excluding Divested Yr.-to-Yr. Percent Change Businesses And Percent Adjusted for Adjusted for For the year ended December 31: 2019 2018 Change Currency Currency Total revenue $77,147 $79,591 (3.1)% (1.0)% 0.2% Americas $36,274 $36,994 (1.9)% (1.1)% 0.8% Europe/Middle East/Africa 24,443 25,491 (4.1) 0.4 1.3 Asia Pacific 16,430 17,106 (4.0) (3.0) (2.5) Total revenue of $77,147 million in 2019 decreased 3.1 percent Total Expense and Other (Income) year to year as reported (1 percent adjusted for currency), ($ in millions) but increased 0.2 percent excluding divested businesses and Yr.-to-Yr. adjusted for currency. Percent/ Margin For the year ended December 31: 2019 2018 Change* Americas revenue decreased 1.9 percent as reported (1 percent adjusted for currency), but grew 1 percent excluding divested Total consolidated expense and other (income) $26,322 $25,594 2.8% businesses and adjusted for currency. Within North America, the U.S. decreased 2.4 percent and Canada increased 4.0 percent Non-operating adjustments as reported (6 percent adjusted for currency). Latin America Amortization of acquired declined as reported but grew adjusted for currency. Within Latin intangible assets (764) (437) 74.8 America, Brazil declined 4.8 percent as reported, but was flat Acquisition-related charges (409) (16) NM adjusted for currency. Non-operating retirement- related (costs)/income (615) (1,572) (60.9) EMEA revenue decreased 4.1 percent as reported, but was Operating (non-GAAP) essentially flat adjusted for currency and increased 1 percent expense and excluding divested businesses and adjusted for currency. As other (income) $24,533 $23,569 4.1% reported, the U.K., France and Italy decreased 2.9 percent, Total consolidated 4.1 percent and 1.3 percent, respectively, but grew 1 percent, expense-to-revenue ratio 34.1% 32.2% 2.0 pts. 1 percent and 4 percent, respectively, adjusted for currency. Operating (non-GAAP) Germany decreased 7.9 percent as reported and 3 percent expense-to-revenue ratio 31.8% 29.6% 2.2 pts. adjusted for currency. The Middle East and Africa region decreased * 2019 results were impacted by Red Hat purchase accounting and 3.5 percent as reported and 2 percent adjusted for currency. acquisition-related activity. NM—Not meaningful Asia Pacific revenue decreased 4.0 percent as reported (3 percent adjusted for currency) and 2 percent excluding The following Red Hat-related expenses were included in divested businesses and adjusted for currency. Japan increased 2019 total consolidated expense and other (income), with no 2.3 percent as reported and 1 percent adjusted for currency. corresponding expense in the prior-year: Red Hat operational Australia decreased 17.3 percent as reported and 11 percent spending, interest expense from debt issuances to fund the adjusted for currency. China decreased 13.4 percent as reported acquisition and other acquisition-related activity, including: and 11 percent adjusted for currency and India decreased amortization of acquired intangible assets, retention and legal 8.1 percent as reported and 5 percent adjusted for currency. and advisory fees associated with the transaction.


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    40 Management Discussion International Business Machines Corporation and Subsidiary Companies Total expense and other (income) increased 2.8 percent in Bad debt expense increased $22 million in 2019 compared 2019 versus the prior year primarily driven by higher spending to 2018. The receivables provision coverage was 1.7 percent including Red Hat operational spending and investments in at December 31, 2019, an increase of 10 basis points from software and systems innovation, higher interest expense, December 31, 2018. non-operating acquisition-related activity associated with the Red Hat transaction and lower IP income, partially offset by Research, Development and Engineering Expense lower non-operating retirement-related costs, divesture-related ($ in millions) activity (gains on divestitures and lower spending) and the effects Yr.-to-Yr. of currency. Total operating (non-GAAP) expense and other Percent (income) increased 4.1 percent year to year, driven primarily by For the year ended December 31: 2019 2018 Change the factors above excluding the higher non-operating acquisition Total consolidated related activity and lower non-operating retirement-related costs research, development described above. and engineering $5,989 $5,379 11.3% Non-operating adjustment For additional information regarding total expense and other Acquisition-related charges (53) — NM (income) for both expense presentations, see the following Operating (non-GAAP) analyses by category. research, development and engineering $5,936 $5,379 10.4% Selling, General and Administrative Expense NM—Not meaningful ($ in millions) Yr.-to-Yr. Research, development and engineering (RD&E) expense was Percent 7.8 percent of revenue in 2019 and 6.8 percent of revenue in 2018. For the year ended December 31: 2019 2018 Change Selling, general and RD&E expense increased 11.3 percent in 2019 versus 2018 administrative expense primarily driven by: Selling, general and administrative—other $17,099 $16,438 4.0% • Higher spending (11 points) including investment in the z15 Advertising and promotional and Red Hat spending in the second half of 2019 (8 points); expense 1,647 1,466 12.3 and Workforce rebalancing • Higher acquisition-related charges associated with the charges 555 598 (7.2) Red Hat transaction (1 point); partially offset by Amortization of acquired intangible assets 762 435 74.9 • The effects of currency (1 point). Stock-based compensation 453 361 25.2 Operating (non-GAAP) expense increased 10.4 percent year Bad debt expense 89 67 32.5 to year primarily driven by the same factors excluding the Total consolidated acquisition-related charges associated with the Red Hat selling, general and administrative expense $20,604 $19,366 6.4% transaction. Non-operating adjustments Intellectual Property and Custom Development Income Amortization of acquired intangible assets (762) (435) 74.9 ($ in millions) Acquisition-related charges (282) (15) NM Yr.-to-Yr. Percent Operating (non-GAAP) For the year ended December 31: 2019 2018 Change selling, general and Licensing of intellectual administrative expense $19,560 $18,915 3.4% property including NM—Not meaningful royalty-based fees $367 $ 723 (49.2)% Custom development income 246 275 (10.5) Total selling, general and administrative (SG&A) expense Sales/other transfers of increased 6.4 percent in 2019 versus 2018, driven primarily by intellectual property 34 28 22.6 the following factors: Total $648 $1,026 (36.9)% • Higher spending (5 points) driven by Red Hat spending (5 points); and Licensing of intellectual property including royalty-based • Higher acquisition-related charges and amortization of fees decreased 49.2 percent in 2019 compared to 2018. This acquired intangible assets associated with the Red Hat was primarily due to a decline in new partnership agreements acquisition (3 points); partially offset by compared to the prior year. The timing and amount of licensing, sales or other transfers of IP may vary significantly from period • The effects of currency (2 points). to period depending upon the timing of licensing agreements, economic conditions, industry consolidation and the timing of Operating (non-GAAP) expense increased 3.4 percent year new patents and know-how development. to year primarily driven by the same factors excluding the acquisition-related charges and amortization of acquired intangible assets associated with the Red Hat transaction.


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    Management Discussion 41 International Business Machines Corporation and Subsidiary Companies Other (Income) and Expense Interest expense increased $621 million compared to 2018. Interest expense is presented in cost of financing in the ($ in millions) Consolidated Income Statement only if the related external Yr.-to-Yr. Percent borrowings are to support the Global Financing external business. For the year ended December 31: 2019 2018 Change Overall interest expense (excluding capitalized interest) in 2019 Other (income) and expense was $1,952 million, an increase of $473 million year to year, Foreign currency transaction driven by a higher average debt balance and higher interest rates losses/(gains) $ (279) $ (427) (34.6)% as we issued debt to finance the Red Hat acquisition. (Gains)/losses on derivative instruments 15 434 (96.6) Operating (non-GAAP) interest expense increased $393 million Interest income (349) (264) 32.2 compared to the prior-year period. It excludes the Red Hat pre-closing debt financing costs. Net (gains)/losses from securities and investment assets (32) (101) (67.9) Stock-Based Compensation Retirement-related Pre-tax stock-based compensation cost of $679 million increased costs/(income) 615 1,572 (60.9) $169 million compared to 2018. This was primarily due to increases related to the issuances and conversions of stock-based Other (937) (63) NM compensation for Red Hat ($150 million) and issuance of restricted Total consolidated other stock units ($27 million). Stock-based compensation cost, and the (income) and expense $ (968) $ 1,152 NM year-to-year change, was reflected in the following categories: Non-operating adjustments Cost: $100 million, up $18 million; SG&A expense: $453 million, Amortization of acquired up $91 million; and RD&E expense: $126 million, up $60 million. intangible assets (2) (2) 50.0% Acquisition-related Retirement-Related Plans charges 154 0 NM The following table provides the total pre-tax cost for all Non-operating retirement- retirement-related plans. Total operating costs/(income) are related costs/(income) (615) (1,572) (60.9)% included in the Consolidated Income Statement within the Operating (non-GAAP) other caption (e.g., Cost, SG&A, RD&E) relating to the job function of (income) and expense $(1,431) $ (422) 239.4% the plan participants. NM—Not meaningful ($ in millions) Total consolidated other (income) and expense was income of Yr.-to-Yr. Percent $968 million in 2019 compared to expense of $1,152 million in For the year ended December 31: 2019 2018 Change 2018. The year-to-year change was primarily driven by: Retirement-related • Lower non-operating retirement-related costs ($957 million). plans—cost Refer to “Retirement-Related Plans” for additional information. Service cost $ 385 $ 431 (10.7)% Multi-employer plans 32 38 (16.9) • Higher gains from divestitures ($833 million) reflected in Cost of defined Other; and contribution plans 1,040 1,024 1.5 • Higher net exchange gains (including derivative instruments) Total operating costs/ ($272 million). The company’s hedging programs help (income) $ 1,457 $ 1,494 (2.5)% mitigate currency impacts in the Consolidated Income Interest cost $ 2,929 $ 2,726 7.4% Statement. Expected return on plan assets (4,192) (4,049) 3.5 Operating (non-GAAP) other (income) and expense was $1,431 Recognized actuarial million of income in 2019 and increased $1,010 million compared losses 1,819 2,941 (38.2) to the prior-year period. The year-to-year change was primarily Amortization of prior driven by the same factors excluding lower non-operating service costs/(credits) (9) (73) (87.6) retirement-related costs. Curtailments/settlements 41 11 262.2 Interest Expense Other costs 28 16 76.2 Total non-operating ($ in millions) costs/(income) $ 615 $ 1,572 (60.9)% Yr.-to-Yr. Percent Total retirement-related For the year ended December 31: 2019 2018 Change plans—cost $ 2,072 $ 3,066 (32.4)% Interest expense $1,344 $723 85.9% Non-operating adjustment Total pre-tax retirement-related plan cost decreased by $994 Acquisition-related charges (228) — NM million compared to 2018, primarily driven by a decrease in Operating (non-GAAP) recognized actuarial losses ($1,123 million), primarily due to the interest expense $1,116 $723 54.4% change in the amortization period in the U.S. Qualified Personal Pension Plan and higher expected return on plan assets ($143 NM—Not meaningful million), partially offset by higher interest costs ($203 million).


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    42 Management Discussion International Business Machines Corporation and Subsidiary Companies As discussed in the “Operating (non-GAAP) Earnings” section, Actual shares outstanding at December 31, 2019 and 2018 we characterize certain retirement-related costs as operating were 887.1 million and 892.5 million, respectively. The year- and others as non-operating. Utilizing this characterization, to-year decrease was primarily the result of the common stock operating retirement-related costs in 2019 were $1,457 million, repurchase program. The average number of common shares a decrease of $37 million compared to 2018. Non-operating costs outstanding assuming dilution was 23.5 million shares lower in of $615 million in 2019 decreased $957 million year to year, driven 2019 versus 2018. primarily by the same factors as above. Financial Position Income Taxes Dynamics The continuing operations effective tax rate for 2019 was 7.2 At December 31, 2019, we continued to have the financial percent, a decrease of 15.9 points versus the prior year. The flexibility to support the business over the long term. Cash, decrease in the effective tax rate was primarily driven by the restricted cash and marketable securities at year end were following factors: $9,009 million. We continued to manage the investment portfolio to meet our capital preservation and liquidity objectives. • A lower charge year to year of 16.5 points from the impacts of U.S. tax reform; Total assets increased $28,805 million since December 31, • A charge in 2018 from intercompany payments of 3.4 points; 2018. This was primarily due to an increase in goodwill and partially offset by net intangible assets of $34,104 million, driven by the Red Hat acquisition and an increase of $4,996 million in right-of-use • A lower benefit year to year from audit settlements of assets recorded as a result of the adoption of the new leasing 4.4 points. standard in 2019. This was partially offset by a decline in net receivables of $7,312 million since year-end 2018 levels, The operating (non-GAAP) tax rate was 8.5 percent in 2019, an primarily due to the wind down of OEM IT commercial financing increase of 0.7 points versus 2018, principally driven by the same operations which we announced in February 2019. factors described above, excluding the impacts of U.S. tax reform. Total debt of $62,899 million increased $17,087 million from For more information, see note G, “Taxes.” prior year-end levels primarily to fund the Red Hat acquisition. The commercial paper balance at December 31, 2019 was $304 Earnings Per Share million, a decrease of $2,691 million from the prior year end. Basic earnings per share is computed on the basis of the Within total debt, $24,727 million is in support of the Global weighted-average number of shares of common stock outstanding Financing business which is leveraged at a 9 to 1 ratio. During during the period. Diluted earnings per share is computed on the 2019, we completed bond issuances totaling $25,712 million, with basis of the weighted-average number of shares of common stock terms ranging from 2 to 30 years, and interest rates ranging from outstanding plus the effect of dilutive potential common shares 0.375 to 4.25 percent depending on maturity. We have reduced outstanding during the period using the treasury stock method. total debt $10,140 million since the end of the second quarter Dilutive potential common shares include outstanding stock of 2019. We have consistently generated strong cash flow from options and stock awards. operations and continue to have access to additional sources of liquidity through the capital markets and our credit facilities. Yr.-to-Yr. Percent For the year ended December 31: 2019 2018 Change Consistent with accounting standards, the company remeasured Earnings per share of the funded status of our retirement and postretirement plans at common stock from December 31. At December 31, 2019, the overall net underfunded continuing operations position was $11,090 million, an improvement of $2,043 million Assuming dilution $10.57 $ 9.51* 11.1% from December 31, 2018 driven by higher returns on assets Basic $10.63 $ 9.56* 11.2% partially offset by lower discount rates and interest costs. At year end, our qualified defined benefit plans were well funded and the Diluted operating required contributions related to these plans and multi-employer (non-GAAP) $12.81 $13.81 (7.2)% plans are expected to be approximately $300 million in both 2020 Weighted-average shares and 2021. In 2019, the return on the U.S. Personal Pension Plan outstanding (in millions) assets was 14.9 percent and the plan was 107 percent funded Assuming dilution 892.8 916.3 (2.6)% at December 31, 2019. Overall, global asset returns were 13.6 Basic 887.2 912.0 (2.7)% percent and the qualified defined benefit plans worldwide were * Includes a charge of $2.0 billion or $2.23 of basic and diluted earnings 102 percent funded at December 31, 2019. per share in 2018 associated with U.S. tax reform. During 2019, we generated $14,770 million in cash from operations, a decrease of $477 million compared to 2018. Our free cash flow for 2019 was $11,909 million, an increase of $33 million versus the prior year. See pages 58 and 59 for additional information on free cash flow. We returned $7,068 million to shareholders in 2019, with $5,707 million in dividends and $1,361 million in gross share repurchases. In 2019, we


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    Management Discussion 43 International Business Machines Corporation and Subsidiary Companies repurchased 10.0 million shares and had $2.0 billion remaining Working capital decreased $10,200 million from the year-end in share repurchase authorization at year end. We suspended 2018 position. The key changes are described below: our share repurchase program at the time of the Red Hat closing to focus on debt repayment. Our cash generation permits us Current assets decreased $10,726 million ($10,477 million to invest and deploy capital to areas with the most attractive adjusted for currency) due to: long-term opportunities. • A decline in receivables of $6,769 million ($6,695 million adjusted for currency) driven by a decline in financing Global Financing Financial Position Key Metrics receivables of $8,197 million primarily due to the wind down ($ in millions) of OEM IT commercial financing operations; partially offset At December 31: 2019 2018 by an increase in other receivables of $989 million primarily Cash and cash equivalents $ 1,697 $ 1,833 related to divestitures; and Net investment in sales-type • A decrease of $3,213 million ($3,052 million adjusted for and direct financing leases (1) 6,224 6,924 currency) in cash and cash equivalents, restricted cash, and Equipment under operating leases— marketable securities primarily due to retirement of debt. external clients (2) 238 444 Client loans 12,884 12,802 Current liabilities decreased $526 million ($449 million adjusted Total client financing assets 19,346 20,170 for currency) as a result of: Commercial financing receivables 3,820 11,838 • A decrease in accounts payable of $1,662 million primarily Intercompany financing receivables (3) (4) 3,870 4,873 due to the wind down of OEM IT commercial financing Total assets $29,568 $41,320 operations; and Debt 24,727 31,227 • A decrease in short-term debt of $1,410 million due to Total equity $ 2,749 $ 3,470 maturities of $12,649 million and a decrease in commercial (1) Includes deferred initial direct costs which are eliminated in paper of $2,691 million; partially offset by reclassifications IBM’s consolidated results. of $7,592 million from long-term debt to reflect upcoming (2) Includes intercompany mark-up, priced on an arm’s-length basis, on maturities and issuances of $6,334 million; offset by products purchased from the company’s product divisions which is eliminated in IBM’s consolidated results. • An increase in operating lease liabilities of $1,380 million (3) Entire amount eliminated for purposes of IBM’s consolidated results as a result of the adoption of the new leasing standard on and therefore does not appear in the Consolidated Balance Sheet. January 1, 2019; and (4) These assets, along with all other financing assets in this table, are leveraged at the value in the table using Global Financing debt. • An increase in deferred income of $861 million ($890 million adjusted for currency). At December 31, 2019, substantially all financing assets were IT-related assets, and approximately 62 percent of the total Receivables and Allowances external portfolio was with investment-grade clients with no Roll Forward of Total IBM Receivables Allowance direct exposure to consumers, an increase of 7 points year to for Credit Losses year. This investment-grade percentage is based on the credit ($ in millions) ratings of the companies in the portfolio. January 1, December 31, 2019 Additions* Write-offs** Other+ 2019 We have a long-standing practice of taking mitigation actions, $639 $89 $(178) $4 $554 in certain circumstances, to transfer credit risk to third parties, * Additions for Allowance for Credit Losses are charged to expense. including credit insurance, financial guarantees, nonrecourse ** Refer to note A, “Significant Accounting Policies,” for additional borrowings, transfers of receivables recorded as true sales in information regarding Allowance for Credit Loss write-offs. accordance with accounting guidance or sales of equipment + Primarily represents translation adjustments. under operating lease. Adjusting for the mitigation actions, the investment-grade content would increase to 67 percent, a The total IBM receivables provision coverage was 1.7 percent decrease of 3 points year to year. at December 31, 2019, an increase of 10 basis points compared to December 31, 2018. The increase was primarily driven by the IBM Working Capital overall decline in gross financing receivables. The majority of the ($ in millions) write-offs during the year related to receivables which had been At December 31: 2019 2018 previously reserved. Current assets $38,420 $49,146 Current liabilities 37,701 38,227 Working capital $ 718 $10,918 Current ratio 1.02:1 1.29:1


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    44 Management Discussion International Business Machines Corporation and Subsidiary Companies Global Financing Receivables and Allowances • An increase in prepaid pension assets of $2,199 million The following table presents external Global Financing receivables ($2,152 million adjusted for currency) driven by excluding residual values, the allowance for credit losses and higher returns on plan assets and plan remeasurements; immaterial miscellaneous receivables: partially offset by • A decrease in net property, plant and equipment of ($ in millions) $782 million ($785 million adjusted for currency). At December 31: 2019 2018 Recorded investment(1) $22,446 $31,182 Long-term debt increased $18,497 million ($18,550 million Specific allowance for credit losses 177 220 adjusted for currency) primarily driven by: Unallocated allowance for credit losses 45 72 • Issuances of $26,081 million; partially offset by Total allowance for credit losses 221 292 Net financing receivables $22,224 $30,890 • Reclassifications to short-term debt of $7,592 million to reflect upcoming maturities. Allowance for credit losses coverage 1.0% 0.9% (1) Includes deferred initial direct costs which are eliminated in Noncurrent liabilities (excluding debt) increased $6,778 million IBM’s consolidated results. ($6,911 million adjusted for currency) primarily driven by: The percentage of Global Financing receivables reserved was • An increase in long-term operating lease liabilities of 1.0 percent at December 31, 2019, compared to 0.9 percent $3,879 million ($3,893 million adjusted for currency) as a at December 31, 2018. The decline in the allowance for credit result of the adoption of the new leasing standard on losses was driven by write-offs of $64 million, primarily of January 1, 2019; and receivables previously reserved, and net releases of $7 million as • An increase in other liabilities of $2,352 million a result of lower average asset balances in client and commercial ($2,320 million adjusted for currency), primarily driven by financing. See note K, “Financing Receivables,” for additional increases in deferred tax liabilities of $1,534 million and information. income tax reserves of $923 million. Roll Forward of Global Financing Receivables Allowance Debt for Credit Losses (included in Total IBM) Our funding requirements are continually monitored and we ($ in millions) execute our strategies to manage the overall asset and liability January 1, Additions/ December 31, profile. Additionally, we maintain sufficient flexibility to access 2019 (Releases)* Write-offs** Other+ 2019 global funding sources as needed. $292 $(7) $(64) $0 $221 ($ in millions) * Additions for Allowance for Credit Losses are charged to expense. At December 31: 2019 2018 ** Refer to note A, “Significant Accounting Policies,” for additional information regarding Allowance for Credit Loss write-offs. Total company debt $62,899 $45,812 + Primarily represents translation adjustments. Total Global Financing segment debt $24,727 $31,227 Debt to support external clients 21,487 27,536 Global Financing’s bad debt expense was a release of $7 million Debt to support internal clients 3,239 3,690 in 2019, compared to an addition of $14 million in 2018, due to Non-Global Financing debt 38,173 14,585 lower specific reserves and a higher unallocated reserve release in 2019. Total debt of $62,899 million increased $17,087 million from Noncurrent Assets and Liabilities December 31, 2018, driven by issuances of $32,415 million; ($ in millions) partially offset by debt maturities of $12,673 million and a At December 31: 2019 2018 decrease in commercial paper of $2,691 million. Noncurrent assets $113,767 $74,236 Non-Global Financing debt of $38,173 million increased $23,587 Long-term debt $ 54,102 $35,605 million from prior year-end levels primarily driven by issuances Noncurrent liabilities (excluding debt) $ 39,398 $32,621 to fund the Red Hat acquisition. The increase in noncurrent assets of $39,531 million ($39,470 Global Financing debt of $24,727 million decreased $6,500 million adjusted for currency) was driven by: million from December 31, 2018, primarily due to the wind down of OEM IT commercial financing operations. • A net increase in goodwill and net intangible assets of $34,104 million ($34,058 million adjusted for currency) due Global Financing provides financing predominantly for IBM’s to the acquisition of Red Hat; and external client assets, as well as for assets under contract • An increase in operating right-of-use assets of $4,996 by other IBM units. These assets, primarily for GTS, generate million ($5,010 million adjusted for currency) as a long-term, stable revenue streams similar to the Global Financing result of the adoption of the new leasing standard on asset portfolio. Based on their attributes, these GTS assets are January 1, 2019; and leveraged with the balance of the Global Financing asset base.


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    Management Discussion 45 International Business Machines Corporation and Subsidiary Companies The debt used to fund Global Financing assets is composed Net cash provided by operating activities decreased $477 million of intercompany loans and external debt. Total debt changes in 2019 driven by the following key factors: generally correspond with the level of client and commercial • An increase in cash income tax payments of $346 million; financing receivables, the level of cash and cash equivalents, the change in intercompany and external payables and the • An increase in interest payments on debt of approximately change in intercompany investment from IBM. The terms of $300 million, driven by incremental debt used to fund the the intercompany loans are set by the company to substantially acquisition of Red Hat; and match the term, currency and interest rate variability underlying • Performance-related declines within net income, the financing receivable and are based on arm’s-length pricing. including lower operating cash flows due to businesses The Global Financing debt-to-equity ratio remained at 9 to 1 at divested in 2019; partially offset by December 31, 2019. • An increase of $836 million in cash provided by As previously stated, we measure Global Financing as a financing receivables. stand-alone entity, and accordingly, interest expense relating to debt supporting Global Financing’s external client and Net cash used in investing activities increased $22,023 million internal business is included in the “Global Financing Results driven by: of Operations” and in note D, “Segments.” In the Consolidated • An increase in net cash used for acquisitions of $32,491 Income Statement, the external debt-related interest expense million, primarily driven by the acquisition of Red Hat; supporting Global Financing’s internal financing to IBM is offset by reclassified from cost of financing to interest expense. • An increase of $7,223 million in cash provided by net Equity non-operating finance receivables primarily driven by the Total equity increased by $4,055 million from December 31, wind down of OEM IT commercial financing operations; 2018 as a result of net income of $9,431 million, a decline in • A decrease in cash used for net capital expenditures of accumulated other comprehensive losses of $893 million $1,346 million; and primarily due to retirement-related benefits plans, and an increase in common stock of $745 million; partially offset by • An increase in cash provided by divestitures of decreases from dividends of $5,707 million, and an increase in $1,076 million. treasury stock of $1,342 million mainly due to share repurchases. Financing activities were a net source of cash of $9,042 million in Cash Flow 2019 compared to a net use of cash of $10,469 million in 2018. Our cash flows from operating, investing and financing activities, The year-to-year increase in cash flow of $19,512 million was as reflected in the Consolidated Statement of Cash Flows on page driven by: 71 are summarized in the table below. These amounts include • An increase in net cash sourced from debt transactions of the cash flows associated with the Global Financing business. $16,584 million primarily driven by net issuances to fund the Red Hat acquisition; and ($ in millions) For the year ended December 31: 2019 2018 • A decrease in cash used for gross common share Net cash provided by/(used in) repurchases of $3,082 million. continuing operations Operating activities $ 14,770 $ 15,247 Global Financing Return on Equity Calculation Investing activities (26,936) (4,913) ($ in millions) Financing activities 9,042 (10,469) At December 31: 2019 2018 Effect of exchange rate changes Numerator on cash, cash equivalents and Global Financing after-tax income (1) * $ 765 $1,065 restricted cash (167) (495) Denominator Net change in cash, cash equivalents Average Global Financing equity (2) ** $2,968 $3,460 and restricted cash $ (3,290) $ (630) Global Financing return on equity (1)/(2) 25.8% 30.8% * Calculated based upon an estimated tax rate principally based on Global Financing’s geographic mix of earnings as IBM’s provision for income taxes is determined on a consolidated basis. ** Average of the ending equity for Global Financing for the last five quarters.


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    46 Management Discussion International Business Machines Corporation and Subsidiary Companies GAAP Reconciliation The tables below provide a reconciliation of the company’s income statement results as reported under GAAP to its operating earnings presentation which is a non-GAAP measure. The company’s calculation of operating (non-GAAP) earnings, as presented, may differ from similarly titled measures reported by other companies. Please refer to the “Operating (non-GAAP) Earnings” section for management’s rationale for presenting operating earnings information. ($ in millions except per share amounts) Acquisition- Retirement- U.S. Tax Related Related Reform Operating For the year ended December 31, 2019: GAAP Adjustments Adjustments Charges (non-GAAP) Gross profit $36,488 $ 547 $ — $ — $37,035 Gross profit margin 47.3% 0.7 pts. — pts. — pts. 48.0% SG&A $20,604 $(1,044) $ — $ — $19,560 RD&E 5,989 (53) — — 5,936 Other (income) and expense (968) 152 (615) — (1,431) Interest expense 1,344 (228) — — 1,116 Total expense and other (income) 26,322 (1,173) (615) — 24,533 Pre-tax income from continuing operations 10,166 1,721 615 — 12,503 Pre-tax margin from continuing operations 13.2% 2.2 pts. 0.8 pts. — pts. 16.2% Provision for income taxes* $ 731 $ 378 $ 103 $(146) $ 1,067 Effective tax rate 7.2% 2.0 pts. 0.5pts. (1.2)pts. 8.5% Income from continuing operations $ 9,435 $ 1,343 $ 512 $ 146 $11,436 Income margin from continuing operations 12.2% 1.7 pts. 0.7 pts. 0.2 pts. 14.8% Diluted earnings per share from continuing operations $ 10.57 $ 1.50 $0.58 $0.16 $ 12.81 * 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. ($ in millions except per share amounts) Acquisition- Retirement- U.S. Tax Related Related Reform Operating For the year ended December 31, 2018 : GAAP Adjustments Adjustments Charges (non-GAAP) Gross profit $36,936 $ 372 $ — $ — $37,307 Gross profit margin 46.4% 0.5 pts. — pts. — pts. 46.9% SG&A $19,366 $(451) $ — $ — $18,915 RD&E 5,379 — — — 5,379 Other (income) and expense 1,152 (2) (1,572) — (422) Interest expense 723 — — — 723 Total expense and other (income) 25,594 (453) (1,572) — 23,569 Pre-tax income from continuing operations 11,342 824 1,572 — 13,739 Pre-tax margin from continuing operations 14.3% 1.0 pts. 2.0 pts. — pts. 17.3% Provision for income taxes* $ 2,619 $ 176 $ 324 $(2,037) $ 1,082 Effective tax rate 23.1% (0.1) pts. (0.3) pts. (14.8) pts. 7.9% Income from continuing operations $ 8,723 $ 649 $ 1,248 $ 2,037 $12,657 Income margin from continuing operations 11.0% 0.8 pts. 1.6 pts. 2.6 pts. 15.9% Diluted earnings per share from continuing operations $ 9.51 $0.71 $ 1.36 $ 2.23 $ 13.81 * 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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    Management Discussion 47 International Business Machines Corporation and Subsidiary Companies Consolidated Fourth-Quarter Results ($ and shares in millions except per share amounts) Yr.-to-Yr. Percent/ Margin For the fourth quarter: 2019 2018 Change* Revenue $21,777 $21,760 0.1%** Gross profit margin 51.0% 49.1% 1.9 pts. Total expense and other (income) $ 7,107 $ 6,253 13.7% Income from continuing operations before income taxes $ 3,993 $ 4,434 (10.0)% Provision for income taxes from continuing operations $ 324 $ 2,481+ (87.0)% Income from continuing operations $ 3,669 $ 1,954+ 87.8% Income from continuing operations margin 16.8% 9.0% 7.9 pts. Net income $ 3,670 $ 1,951+ 88.1% Earnings per share from continuing operations—assuming dilution $ 4.11 $ 2.15+ 91.2% Weighted-average shares outstanding—assuming dilution 893.7 905.2 (1.3)% * 2019 results were impacted by Red Hat purchase accounting and acquisition-related activity. ** 0.7 percent adjusted for currency; 2.8 percent excluding divested businesses and adjusted for currency. + Includes a charge of $1.9 billion or $2.15 of diluted earnings per share in 2018 associated with U.S. tax reform. The following table provides operating (non-GAAP) earnings for the fourth quarter of 2019 and 2018. See page 52 for additional information. ($ in millions except per share amounts) Yr.-to-Yr. Percent For the fourth quarter: 2019 2018 Change* Net income/(loss) as reported $3,670 $1,951** 88.1% Loss from discontinued operations, net of tax 0 (2) NM Income/(loss) from continuing operations $3,669 $1,954** 87.8% Non-operating adjustments (net of tax) Acquisition-related charges 376 171 119.7 Non-operating retirement-related costs/(income) 175 348 (49.8) U.S. tax reform charge (14) 1,944 NM Operating (non-GAAP) earnings $4,206 $4,417 (4.8)% Diluted operating (non-GAAP) earnings per share $ 4.71 $ 4.87 (3.3)% * 2019 results were impacted by Red Hat purchase accounting and acquisition-related activity. ** Includes a charge of $1.9 billion in 2018 associated with U.S. tax reform. NM—Not meaningful


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    48 Management Discussion International Business Machines Corporation and Subsidiary Companies Snapshot In the fourth quarter of 2019, we reported $21.8 billion in The consolidated gross margin of 51.0 percent increased 1.9 revenue, $3.7 billion in income from continuing operations points year to year reflecting contribution from our high-value and operating (non-GAAP) earnings of $4.2 billion, resulting in software and systems, partially offset by impacts related to diluted earnings per share from continuing operations of $4.11 Red Hat (deferred revenue adjustment and amortization of as reported and $4.71 on an operating (non-GAAP) basis. We intangibles). The operating (non-GAAP) gross margin of 51.8 also generated $3.5 billion in cash from operations, $6.0 billion percent increased 2.3 points versus the prior year, primarily in free cash flow and delivered shareholder returns of $1.4 billion driven by the same factors, excluding the amortization of in dividends. We had solid transactional performance across our intangibles. high-value software and systems. In addition, benefits from the synergies of IBM and Red Hat drove growth in our services to Total expense and other (income) increased 13.7 percent in the migrate, build and manage hybrid cloud environments. Overall, fourth quarter of 2019 versus the prior year primarily driven by performance resulted in revenue growth, margin expansion and higher spending including Red Hat operational spending, higher strong free cash flow generation in the quarter. interest expense from debt issuances to fund the acquisition, continued investment in innovation and go-to-market capabilities, Total consolidated revenue increased 0.1 percent as reported higher acquisition-related charges and higher amortization of and 1 percent adjusted for currency compared to the prior year. acquired intangibles. These increases were partially offset by Excluding divested businesses, revenue was up 2.2 percent divestiture-related gains and lower non-operating retirement- as reported and 3 percent adjusted for currency. Cloud & related costs. Total operating (non-GAAP) expense and other Cognitive Software increased 8.7 percent as reported and 9 (income) increased 14.7 percent year to year, driven primarily percent adjusted for currency with growth across all three by the higher spending and investment, partially offset by the lines of business. Cloud & Data Platforms, which includes Red divestiture-related gains described above. Hat, grew 19.0 percent (20 percent adjusted for currency), Cognitive Applications grew 0.6 percent (1 percent adjusted for Pre-tax income from continuing operations of $4.0 billion, currency) and Transaction Processing Platforms increased 2.9 decreased 10.0 percent and the pre-tax margin was 18.3 percent (4 percent adjusted for currency). GBS decreased 0.6 percent, a decrease of 2.0 points versus the prior-year period percent as reported and was flat adjusted for currency. There reflecting the purchase accounting deferred revenue adjustment was continued growth in Consulting which grew 3.5 percent (4 for Red Hat (lower revenue without an equivalent adjustment to percent adjusted for currency) driven by services that enable each cost and expense) and acquisition-related activity. The continuing phase of our clients’ digital journeys. GTS decreased 4.8 percent operations effective tax rate for the fourth quarter of 2019 was as reported and 4 percent adjusted for currency, with declines 8.1 percent and net income from continuing operations was in Infrastructure & Cloud Services and Technology Support $3.7 billion. This is compared with net income from continuing Services. While there was continued year-to-year growth in our operations of $2.0 billion in the fourth quarter of 2018, which cloud offerings within GTS, there were declines in client-based included a $1.9 billion charge for tax reform. Our net income volumes, in some of the more traditional labor-based managed margin from continuing operations was 16.8 percent, an increase services. Systems increased 16.0 percent as reported and 16 of 7.9 points year to year. percent adjusted for currency with growth in IBM Z and Storage Systems, partially offset by a decline in Power Systems. IBM Z had Operating (non-GA AP) pre-tax income from continuing strong growth of 62.3 percent (63 percent adjusted for currency) operations of $4.7 billion decreased 6.6 percent year to year in the first full quarter of z15 shipments. Storage Systems and the operating (non-GAAP) pre-tax margin from continuing increased 2.8 percent (3 percent adjusted for currency) year to operations decreased 1.5 points to 21.6 percent. The operating year led by growth in the high end, while Power Systems declined (non-GAAP) effective tax rate from continuing operations in the 23.7 percent (23 percent adjusted for currency) compared with fourth quarter of 2019 was 10.5 percent versus 12.2 percent strong performance in the prior year. Across the segments, total in the prior year. Operating (non-GAAP) income from continuing IBM cloud revenue of $6.8 billion in the fourth quarter of 2019 operations of $4.2 billion decreased 4.8 percent with an grew 21 percent as reported and adjusted for currency. operating (non-GAAP) income margin from continuing operations of 19.3 percent, down 1.0 points year to year. From a geographic perspective, Americas revenue increased 2.3 percent year to year as reported (3 percent adjusted for currency) Diluted earnings per share from continuing operations of $4.11 and 6 percent excluding divested businesses and adjusted for in the fourth quarter of 2019 increased 91.2 percent, primarily currency. EMEA increased 0.1 percent (2 percent adjusted for due to the prior-year tax reform charge. Operating (non-GAAP) currency) and 4 percent excluding divested businesses and diluted earnings per share of $4.71 decreased 3.3 percent versus adjusted for currency. Asia Pacific declined 5.2 percent year to the fourth quarter of 2018. year as reported (7 percent adjusted for currency) and 6 percent excluding divested businesses and adjusted for currency.


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    Management Discussion 49 International Business Machines Corporation and Subsidiary Companies Segment Details The following is an analysis of the fourth quarter of 2019 versus the fourth quarter of 2018 reportable segment external revenue and gross margin results. Segment pre-tax income includes transactions between the 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 fourth quarter: 2019 2018 Change Currency Revenue Cloud & Cognitive Software $ 7,238 $ 6,661* 8.7% 9.4% Gross margin 79.2% 79.4%* (0.2)pts.** Global Business Services 4,243 4,269* (0.6)% (0.3)% Gross margin 27.5% 27.8%* (0.3) pts. Global Technology Services 6,949 7,299* (4.8)% (4.0)% Gross margin 35.2% 34.9%* 0.2 pts. Systems 3,042 2,621 16.0% 16.5% Gross margin 56.0% 50.8% 5.2 pts. Global Financing 301 402 (25.3)% (24.9)% Gross margin 35.6% 29.1% 6.5 pts. Other 4 507* (99.2)% (99.1)% Gross margin NM 42.0%* NM Total consolidated revenue $21,777 $21,760 0.1%+ 0.7% Total consolidated gross profit $11,100 $10,687 3.9%** Total consolidated gross margin 51.0% 49.1% 1.9 pts. Non-operating adjustments Amortization of acquired intangible assets 189 89 112.2% Operating (non-GAAP) gross profit $11,289 $10,776 4.8%** Operating (non-GAAP) gross margin 51.8% 49.5% 2.3 pts. * Recast to reflect segment changes. ** 2019 results were impacted by Red Hat purchase accounting and acquisition-related activity. + 2.8 percent excluding divested businesses and adjusted for currency. NM—Not meaningful Cloud & Cognitive Software Cloud & Cognitive Software revenue of $7,238 million grew Cloud & Data Platforms revenue of $3,101 million increased 8.7 percent as reported and 9 percent adjusted for currency in 19.0 percent as reported and 20 percent adjusted for currency the fourth quarter of 2019 compared to the prior year. We had compared to the prior year reflecting the acquisition of Red Hat growth as reported and adjusted for currency in all three lines in 2019. Demand for our cloud capabilities continued to ramp of business: Cognitive Applications, Cloud & Data Platforms and we began to realize synergies across IBM and Red Hat. We and Transaction Processing Platforms. Growth in Cloud & Data had strong performance in the quarter in Red Hat’s RHEL and Platforms and total cloud revenue in the segment reflected the OpenShift, and broad-based traction across the suite of Cloud acquisition of Red Hat and clients’ continued adoption of our Paks that addresses workloads across automation, data and hybrid cloud solutions. integration. Clients are realizing the benefits of hybrid cloud with our containerized middleware and data platform software In the fourth quarter, Cognitive Applications revenue of $1,619 portfolio, including faster deployment and improved automation. million increased 0.6 percent as reported and 1 percent adjusted for currency, reflecting the strength of our AI-led software Transaction Processing Platforms revenue of $2,517 million solutions including Security and IoT. We continue to drive new increased 2.9 percent as reported (4 percent adjusted for innovations in these areas, and in November 2019, we launched currency) reflecting the value we provided clients by managing Cloud Pak for Security which allows clients to leverage their their critical workloads, and providing for predictability in IT spend. investments in cybersecurity by integrating their security tools with existing data sources to more quickly resolve security Within Cloud & Cognitive Software, total cloud revenue of $1.6 incidents. In IoT, we extended our Maximo suite of offerings billion grew 78 percent as reported and adjusted for currency, with the announcement of Maximo Asset Monitor, an AI-powered which reflects the acquisition of Red Hat. monitoring solution designed to help clients better maintain and improve performance of their high-value physical assets.

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