EX-13 6 a2189817zex-13.htm EXHIBIT 13

 

Report of Financials

 

INTERNATIONAL BUSINESS MACHINES CORPORATION and Subsidiary Companies

 

MANAGEMENT DISCUSSION

 

 

Road Map

 

18

Forward-Looking and Cautionary Statements

 

18

Management Discussion Snapshot

 

19

Description of Business

 

20

Year in Review

 

25

Prior Year in Review

 

39

Discontinued Operations

 

44

Other Information

 

44

Looking Forward

 

44

Liquidity and Capital Resources

 

45

Critical Accounting Estimates

 

48

Currency Rate Fluctuations

 

51

Market Risk

 

51

Financing Risks

 

52

Employees and Related Workforce

 

52

Global Financing

 

53

 

 

 

REPORT OF MANAGEMENT

 

58

 

 

 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

59

 

 

 

CONSOLIDATED FINANCIAL STATEMENTS

 

 

Earnings

 

60

Financial Position

 

61

Cash Flows

 

62

Stockholders’ Equity

 

63

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

 

A

Significant Accounting Policies

 

66

B

Accounting Changes

 

76

C

Acquisitions/Divestitures

 

78

D

Fair Value

 

84

E

Financial Instruments (Excluding Derivatives)

 

85

F

Inventories

 

86

G

Financing Receivables

 

86

H

Plant, Rental Machines and Other Property

 

86

I

Investments and Sundry Assets

 

87

J

Intangible Assets Including Goodwill

 

87

K

Borrowings

 

88

L

Derivatives and Hedging Transactions

 

90

M

Other Liabilities

 

94

N

Stockholders’ Equity Activity

 

95

O

Contingencies and Commitments

 

97

P

Taxes

 

99

Q

Research, Development and Engineering

 

101

R

Earnings Per Share of Common Stock

 

102

S

Rental Expense and Lease Commitments

 

103

T

Stock-Based Compensation

 

103

U

Retirement-Related Benefits

 

106

V

Segment Information

 

116

W

Subsequent Event

 

119

 

 

 

 

FIVE-YEAR COMPARISON OF SELECTED FINANCIAL DATA

 

120

 

 

 

SELECTED QUARTERLY DATA

 

121

 

 

 

PERFORMANCE GRAPHS

 

122

 

 

 

BOARD OF DIRECTORS AND SENIOR LEADERSHIP

 

124

 

 

 

STOCKHOLDER INFORMATION

 

125

 

17



 

Management Discussion

 

INTERNATIONAL BUSINESS MACHINES CORPORATION and Subsidiary Companies

 

Road Map

 

The financial section of the International Business Machines Corporation (IBM or the company) 2008 Annual Report consists of this Management Discussion, the Consolidated Financial Statements and the Notes to the Consolidated Financial Statements. This Road Map is designed to provide the reader with some perspective regarding the information contained in the financial section.

 

ORGANIZATION OF INFORMATION

 

·                  The Management Discussion is designed to provide readers with a narrative on the company’s financial results and certain factors that may affect future prospects from the perspective of the company’s management. The “Management Discussion Snapshot” on pages 19 and 20 presents an overview of the key performance drivers in 2008.

 

·                  Beginning with the “Year in Review” on page 25, the Management Discussion contains the results of operations for each segment of the business, a discussion of the company’s financial position and cash flows, in addition to other key information and data. It is useful to read the Management Discussion in conjunction with note V, “Segment Information,” on pages 116 to 119.

 

·                  Global Financing is a reportable segment that is measured as if it were a standalone entity. A separate “Global Financing” section is included beginning on page 53. The information presented in this section is consistent with this separate company view.

 

·                  The Consolidated Financial Statements are presented on pages 60 through 65. These statements provide an overview of the company’s income and cash flow performance and its financial position.

 

·                  The notes follow the Consolidated Financial Statements. Among other items, the notes contain the company’s accounting policies (pages 66 to 76), acquisitions and divestitures (pages 78 through 83), detailed information on specific items within the financial statements, certain contingencies and commitments (pages 97 to 99), and retirement-related benefits information (pages 106 to 116).

 

·                  The reference to “adjusted for currency” in the Management Discussion is made so that certain financial results can be viewed without the impacts of fluctuating foreign currency exchange rates and therefore facilitates a comparative view of business performance. See “Currency Rate Fluctuations” on page 51 for additional information.

 

·                  Within the financial tables in this Annual Report, certain columns and rows may not add due to the use of rounded numbers for disclosure purposes. Percentages reported in the financial tables throughout this Annual Report are calculated from the underlying whole-dollar numbers.

 

DISCONTINUED OPERATIONS

 

On December 31, 2002, the company sold its hard disk drive (HDD) business to Hitachi, Ltd. (Hitachi). The HDD business was accounted for as a discontinued operation under generally accepted accounting principles (GAAP) and therefore, the HDD results of operations and cash flows have been removed from the company’s results of continuing operations and cash flows for all periods presented in this document except 2008, in which there was no activity. See page 44 for additional information.

 

Forward-Looking and Cautionary Statements

 

Certain statements contained in this Annual Report may constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements involve a number of risks, uncertainties and other factors that could cause actual results to be materially different, as discussed more fully elsewhere in this Annual Report and in the company’s filings with the Securities and Exchange Commission (SEC), including the company’s 2008 Form 10-K filed on February 24, 2009.

 

Management Discussion

18

ROAD MAP

18

FORWARD-LOOKING AND CAUTIONARY STATEMENTS

18

MANAGEMENT DISCUSSION SNAPSHOT

19

DESCRIPTION OF BUSINESS

20

YEAR IN REVIEW

25

PRIOR YEAR IN REVIEW

39

DISCONTINUED OPERATIONS

44

OTHER INFORMATION

44

GLOBAL FINANCING

53

Report Of Management

58

Report Of Independent Registered Public Accounting Firm

59

Consolidated Statements

60

Notes

66

 

18



 

Management Discussion Snapshot

(AND SHARES IN MILLIONS EXCEPT PER SHARE AMOUNTS)
For the year ended December 31:

 

2008

 

2007

 

Yr.-to-Yr.
Percent/
Margin
Change

 

Revenue

 

$

103,630

 

$

98,786

 

4.9

%*

Gross profit margin

 

44.1

%

42.2

%

1.8

pts.

Total expense and other income

 

$

28,945

 

$

27,240

 

6.3

%

Total expense and other income-to-revenue ratio

 

27.9

%

27.6

%

0.4

pts.

Income from continuing operations before income taxes

 

$

16,715

 

$

14,489

 

15.4

%

Provision for income taxes

 

4,381

 

4,071

 

7.6

%

Income from continuing operations

 

$

12,334

 

$

10,418

 

18.4

%

Net income

 

$

12,334

 

$

10,418

 

18.4

%

Net income margin

 

11.9

%

10.5

%

1.4

pts.

Earnings per share of common stock:

 

 

 

 

 

 

 

Assuming dilution:

 

 

 

 

 

 

 

Continuing operations

 

$

8.93

 

$

7.18

 

24.4

%

Discontinued operations

 

 

(0.00

)

NM

 

Total

 

$

8.93

 

$

7.18

 

24.4

%

Weighted-average shares outstanding:

 

 

 

 

 

 

 

Assuming dilution

 

1,381.8

 

1,450.6

 

(4.7

)%

Assets**

 

$

109,524

 

$

120,431

 

(9.1

)%

Liabilities**

 

$

96,058

 

$

91,962

 

4.5

%

Equity**

 

$

13,465

 

$

28,470

 

(52.7

)%


*    2.3 percent adjusted for currency.

** At December 31.

NM—Not meaningful

 

CONTINUING OPERATIONS

 

In 2008, the company performed extremely well in a difficult economic environment, delivering record levels of revenue, pre-tax profit, earnings per share and cash flow from operations. The financial performance reflected the continuing strength of the company’s global model and the results of the ongoing transformation of the business. The key elements of the company’s transformation include:

 

·                  A continuing shift to higher value businesses;

 

·                  Investing for growth in the emerging markets;

 

·                  Global integration;

 

·                  Investing in innovation; and

 

·                  Ongoing productivity resulting in higher profit margins.

 

Overall, the company capitalized on the opportunities in the global economies, generating approximately 65 percent of its revenue outside the United States (U.S), in delivering full year growth of 4.9 percent (2 percent adjusted for currency). Revenue increased in all geographies, both on an as reported basis and adjusted for currency — the revenue performance, adjusted for currency, was stable throughout the year as the company focused on solutions that meet clients’ needs. Revenue from the company’s growth markets organization increased 9.8 percent (10 percent adjusted for currency). In these markets, where the growth is driven by the infrastructure build-out, the company invested aggressively to capture these opportunities. For the full year and in the fourth quarter, growth in these markets, adjusted for currency, was 8 points greater than the major markets.

 

Gross profit margins improved, reflecting the shift to higher value businesses, pricing for value and the continued focus on productivity and cost management. Pre-tax income from continuing operations grew 15.4 percent and net income from continuing operations increased 18.4 percent reflecting an improvement in the company’s tax rate. Diluted earnings per share improved 24.4 percent reflecting the strong growth in net income and the benefits of the common stock repurchase program. In 2008, the company repurchased approximately 90 million shares of its common stock.

 

The increase in 2008 revenue was primarily due to:

 

·                  Continued strong performance from Global Technology Services and Global Business Services with growth in all business lines and geographic units;

 

·                  Continued strong demand in the Software business, driven by Key Branded Middleware products, with strong contributions from strategic acquisitions; and

 

·                  Continued strength in the growth markets.

 

The increase in income from continuing operations before income taxes in 2008 was primarily due to the revenue growth and gross profit margin improvements in the Global Services and Software segments.

 

The consolidated gross profit margin increased 1.8 points versus 2007 to 44.1 percent. Gross margin performance by segment and the impact to the consolidated gross margin was as follows:

 

 

 

Gross
Margin

 

Yr.-to-Yr.
Change

 

Consolidated
Impact

 

Global Technology Services

 

32.6

%

2.7

pts.

0.8

pts.

Global Business Services

 

26.7

%

3.2

pts.

0.5

pts.

Software

 

85.4

%

0.2

pts.

0.5

pts.

Systems & Technology

 

38.1

%

(1.7

)pts.

(0.2

)pts.

Global Financing

 

51.3

%

4.6

pts.

0.1

pts.

 

19



 

Total expense and other income increased 6.3 percent in 2008 versus 2007. The year-to-year drivers were approximately:

 

·                  Operational expense, -1 point

 

·                  Acquisitions, +5 points

 

·                  Currency, +2 points

 

The effective tax rate for 2008 was 26.2 percent, compared with 28.1 percent in 2007. The decrease in the tax rate was primarily due to increased utilization of tax credits.

 

At December 31, 2008, the company’s balance sheet and liquidity positions remained strong. Cash on hand was $12,741 million. Total debt decreased $1,349 million year to year, and the company generated $18,812 million in operating cash flow in 2008. The company has consistently generated strong cash flow from operations and also continues to have access to additional sources of liquidity through the capital markets and its global credit facility.

 

Key drivers in the company’s balance sheet and total cash flows are highlighted below.

 

Total assets decreased $10,907 million ($5,854 million adjusted for currency) primarily due to decreases in cash and cash equivalents ($2,250 million), prepaid pension assets ($15,816 million), short-term marketable securities ($989 million) and total financing receivables ($1,233 million). These decreases were partially offset by increases in long-term deferred taxes ($5,757 million), goodwill ($3,941 million) and intangible assets ($771 million).

 

Total liabilities increased $4,097 million ($5,275 million adjusted for currency) driven primarily by increases in retirement and non-pension postretirement benefit obligations ($5,871 million) and total deferred income ($547 million), partially offset by decreases in total debt ($1,349 million) and accounts payable ($1,041 million).

 

Stockholders’ equity of $13,465 million decreased $15,004 million versus 2007. Net income of $12,334 million was offset by the effects of pension remeasurements and other retirement-related items ($14,856 million), common/treasury stock activity ($6,322 million), dividends ($2,585 million) and equity translation adjustments ($3,552 million).

 

The company generated $18,812 million in cash flow provided by operating activities, an increase of $2,718 million, compared to 2007, primarily driven by increased net income ($1,916 million). Net cash used in investing activities of $9,285 million was $4,611 million higher than 2007, primarily due to increased spending for acquisitions ($5,304 million). Net cash used in financing activities of $11,834 million increased $7,095 million primarily due to debt transactions ($14,556 million), partially offset by lower common stock repurchases ($8,249 million) in 2008 versus 2007.

 

Total Global Services signings increased 2 percent to $57,182 million ($49,738 million adjusted for currency, flat versus 2007). Short-term signings were $26,831 million, an increase of 8 percent year to year (5 percent adjusted for currency), while long-term signings were $30,351 million, a decrease of 3 percent (5 percent adjusted for currency). The estimated Global Services backlog, adjusted for currency, was $117 billion at December 31, 2008, down $2 billion versus the December 31, 2007 balance.

 

For additional information and details, see the “Year in Review” section on pages 25 to 39.

 

Description of Business

 

Please refer to IBM’s Annual Report on Form 10-K filed with the SEC on February 24, 2009 for a more detailed version of this Description of Business, especially Item 1A. entitled “Risk Factors.”

 

The company creates business value for clients and solves business problems through integrated solutions that leverage information technology and deep knowledge of business processes. IBM solutions typically create value by reducing a client’s operational costs or by enabling new capabilities that generate revenue. These solutions draw from an industry leading portfolio of consulting, delivery and implementation services, enterprise software, systems and financing.

 

STRATEGY

 

In IBM’s view, today’s networked economy has created a global business landscape and a mandate for business change. It also opens the opportunity to upgrade the efficiency and effectiveness of the global infrastructure through embedded information technology — what IBM calls a “smarter planet.” Smart airports, smart highways, smart supply chains are all possible. IBM is working with clients and governments around the world to explore these opportunities and implement new ideas.

 

Integrated global economies have opened markets of new opportunity and new sources of skills. The Internet has enabled communication and collaboration across the world and brought with it a new computing model premised on continuous global connection. In that landscape, companies can distribute work and technology anywhere in the world. IBM continues to adjust its footprint toward emerging geographies, tapping their higher growth, providing the technology infrastructure they need and taking advantage of the talent pools they provide to better service the company’s clients.

 

Management Discussion

18

ROAD MAP

18

FORWARD-LOOKING AND CAUTIONARY STATEMENTS

18

MANAGEMENT DISCUSSION SNAPSHOT

19

DESCRIPTION OF BUSINESS

20

YEAR IN REVIEW

25

PRIOR YEAR IN REVIEW

39

DISCONTINUED OPERATIONS

44

OTHER INFORMATION

44

GLOBAL FINANCING

53

Report Of Management

58

Report Of Independent Registered Public Accounting Firm

59

Consolidated Statements

60

Notes

66

 

20



 

At the same time, the current economic crisis increases the pressure on both businesses and governments around the world to adapt. The needs for additional transparency, security and efficiencies are clear.

 

Given these opportunities and economic challenges, IBM is working with its clients to develop new business designs and technical architectures that allow their businesses the flexibility required to compete in this new landscape. IBM’s strategy addresses this new era and delivers value to its clients through three strategic priorities:

 

Focus on Open Technologies and High-Value Solutions

 

A new computing model has emerged, replacing the PC-based, client/server approach. This new model is networked, modular, open and represents a fundamental shift in the technology requirements of the company’s clients. IBM is well positioned to provide its enterprise clients the open technologies and high-value solutions they will need to compete.

 

·                  IBM is leveraging its leadership position in the convergence of software and services, in service oriented architecture (SOA), in virtualization, in business intelligence and analytics, in open and modular information technology (IT) — continuing its shift from commoditizing segments to higher value segments with better profit opportunity.

 

·                  The company continues to be a leading force in open source solutions to enable its clients to achieve higher levels of interoperability, cost efficiency and quality.

 

Deliver Integration and Innovation to Clients

 

Changes in the market have caused IBM’s clients to seek flexibility and innovation in everything from technical architecture to their business model. In response, IBM is focused on delivering integration and innovation to its clients — offering them technologies and services that support real value creation.

 

·                  IBM has a long heritage of transforming the business operations of large enterprises and has earned the trust to be their innovation partner and global integrator.

 

·                  The company has an extensive set of global assets and capabilities it is applying to improve services profitability, both for its clients and for itself.

 

Become the Premier Globally Integrated Enterprise

 

As global networks and technology capabilities change business economics, legacy business designs can quickly become noncompetitive. IBM believes a globally integrated enterprise, designed for this new landscape, can compete effectively and will benefit from the opportunities offered.

 

·                  To reshape its business for the global economy, IBM has replaced vertical hierarchies with horizontally integrated teams.

 

·                  Across the business, the company has made significant investments in emerging markets, taking core processes and functions that were once managed regionally and shifting them to a globally integrated model.

 

Looking forward, IBM is confident it understands the economic shift of globalization, the evolution of the new computing model and the powerful role of innovation in this new landscape. Its unique capabilities are well adapted to help the company’s clients innovate and compete effectively in this new environment.

 

BUSINESS MODEL

 

The company’s business model is built to support two principal goals: helping clients succeed in delivering business value by becoming more innovative, efficient and competitive through the use of business insight and IT solutions; and, providing long-term value to shareholders. The business model has been developed over time through strategic investments in capabilities and technologies that have the best long-term growth and profitability prospects based on the value they deliver to clients.

 

The company’s global capabilities include services, software, hardware, fundamental research and related financing. The broad mix of businesses and capabilities are combined to provide business insight and solutions for the company’s clients.

 

The business model is flexible, adapting to the continuously changing market and economic environment. The company has divested commoditizing businesses like personal computers and hard disk drives, and strengthened its position through strategic investments and acquisitions in higher value segments like business intelligence and analytics, virtualization and green solutions. In addition, the company has transformed itself into a globally integrated enterprise which has improved overall productivity and is driving investment and participation in the world’s fastest growing markets. As a result, the company is a higher performing enterprise today than it was several years ago.

 

The business model, supported by the company’s long-term financial model, has enabled the company to deliver consistently strong earnings, cash flows and returns on invested capital in changing economic environments.

 

21



 

BUSINESS SEGMENTS AND CAPABILITIES

 

The company’s major operations are comprised of: a Global Technology Services segment; a Global Business Services segment; a Software segment; a Systems and Technology segment; and a Global Financing segment.

 

Global Services is a critical component of the company’s strategy of providing IT infrastructure and business insight and solutions to clients. While solutions often include industry-leading IBM software and hardware, other suppliers’ products are also used if a client solution requires it. Within Global Services there are two reportable segments: Global Technology Services and Global Business Services.

 

Global Technology Services (GTS) primarily provides IT infrastructure services and business process services, delivering business value through the company’s global scale, standardization and automation.

 

GTS CAPABILITIES

 

Strategic Outsourcing Services. Comprehensive IT services integrated with business insight working with clients to reduce costs and improve productivity through the outsourcing of processes and operations.

 

Integrated Technology Services. Services offerings that help clients access, manage and support their technology infrastructures, through a combination of skilled resources, software and IBM’s knowledge of business processes. The portfolio includes Service Product Lines which complement hardware from Systems and Technology and software offerings from the Software business.

 

Business Transformation Outsourcing. A range of offerings from standardized processing platforms and Business Process Outsourcing through transformational offerings that deliver improved business results to clients through the strategic change and/or operation of the client’s business processes, applications and infrastructure.

 

Maintenance. A number of support services from product maintenance through solution support to maintain and improve the availability of clients’ IT infrastructure.

 

Global Business Services (GBS) primarily provides professional services and application outsourcing services, delivering business value and innovation to clients through solutions which leverage industry- and business-process expertise.

 

GBS CAPABILITIES

 

Consulting and Systems Integration. Delivery of value to clients through consulting services for client-relationship management, financial management, human-capital management, business strategy and change, and supply-chain management.

 

Application Management Services. Application development, management, maintenance and support services for packaged software, as well as custom and legacy applications. Value is delivered through the company’s global resource capabilities, industry knowledge and the standardization and automation of application development.

 

Software consists primarily of middleware and operating systems software. Middleware software enables clients to integrate systems, processes and applications across a standard software platform. IBM middleware is designed to open standards which allows the efficient integration of disparate client applications that may have been built internally, or provided by packaged software vendors or system integrators. Operating systems are the software engines that run computers. Approximately two-thirds of external software segment revenue is annuity-based, coming from recurring license charges and ongoing subscription and support from one-time charge (OTC) arrangements. The remaining one-third of external revenue relates to OTC arrangements, in which the client pays one up-front payment for a perpetual license. Typically, arrangements for the sale of OTC software include one year of maintenance. The client can also purchase ongoing maintenance after the first year, which includes product upgrades and technical support.

 

SOFTWARE CAPABILITIES

 

WebSphere Software. Management of a wide variety of business processes using open standards to interconnect applications, data and operating systems. Provides the foundation for Web-enabled applications and is a key product set in deploying a SOA.

 

Information Management Software. Advanced database, content management, information integration and business intelligence software that helps companies integrate, manage and gain value from their business information.

 

Tivoli Software. Software for infrastructure management, including security and storage management that will help organizations better manage their IT infrastructure to more effectively deliver IT services.

 

Lotus Software. Collaboration, messaging and social networking software that enables businesses to communicate, collaborate and increase productivity.

 

Management Discussion

18

ROAD MAP

18

FORWARD-LOOKING AND CAUTIONARY STATEMENTS

18

MANAGEMENT DISCUSSION SNAPSHOT

19

DESCRIPTION OF BUSINESS

20

YEAR IN REVIEW

25

PRIOR YEAR IN REVIEW

39

DISCONTINUED OPERATIONS

44

OTHER INFORMATION

44

GLOBAL FINANCING

53

Report Of Management

58

Report Of Independent Registered Public Accounting Firm

59

Consolidated Statements

60

Notes

66

 

22



 

Rational Software. Software tools that help clients manage their software development processes and capabilities. With the acquisition of Telelogic in 2008, Rational software supports software development for both IT solutions and embedded system solutions.

 

Operating Systems. Software that manages the fundamental processes that make computers run.

 

Systems and Technology provides clients with business solutions requiring advanced computing power and storage capabilities. Approximately 55 percent of Systems and Technology’s server and storage sales transactions are through the company’s business partners; approximately 45 percent are direct to end-user clients. In addition, Systems and Technology provides leading semiconductor technology and products, packaging solutions and engineering technology services to clients and for IBM’s own advanced technology needs.

 

SYSTEMS AND TECHNOLOGY CAPABILITIES

 

Servers. IBM systems, which are typically connected to a network and provide the required infrastructure for business. These systems use both IBM and non-IBM operating systems, and all IBM servers can also run Linux, a key open source operating system. (System z, legacy System i, converged System p and System x).

 

Storage. Information infrastructure products and solutions, which address critical client requirements for information retention and archiving, availability and virtualization, and security and compliance. The portfolio consists of a broad range of disk and tape storage systems and software.

 

Microelectronics. Semiconductor design and manufacturing primarily for use in IBM systems and for sale to external clients (OEM).

 

Retail Store Solutions. Point-of-sale retail systems (network connected cash registers) as well as solutions which connect them to other store systems.

 

Global Financing is described on pages 53 through 57.

 

GLOBAL FINANCING CAPABILITIES

 

Client Financing. Lease and loan financing to end users and internal clients for terms generally between two and seven years.

 

Commercial Financing. Short-term inventory and accounts receivable financing to dealers and remarketers of IT products.

 

Remarketing. The sale and lease of used equipment (primarily sourced from the conclusion of lease transactions) to new or existing clients.

 

IBM WORLDWIDE ORGANIZATIONS

 

The following worldwide organizations play key roles in IBM’s delivery of value to its clients:

 

·                  Sales and Distribution

 

·                  Research, Development and Intellectual Property

 

·                  Integrated Supply Chain

 

·                  Integrated Technology Delivery

 

·                  Business Process Delivery

 

Sales and Distribution

 

IBM has a significant global presence, operating in over 170 countries, with an increasingly broad-based geographic distribution of revenue. The company’s Sales and Distribution organization manages a strong global footprint, with dedicated country based operating units focused on delivering client value. Within these units, client relationship professionals work with integrated teams of consultants, product specialists and delivery fulfillment teams to improve clients’ business performance. These teams deliver value by understanding the clients’ business and needs, and then bring together capabilities from across IBM and an extensive network of Business Partners to develop and implement solutions.

 

By combining global expertise with local experience, IBM’s geographic structure enables dedicated management focus for local clients, speed in addressing new market opportunities and timely investments in emerging opportunities. The geographic units align industry-skilled resources to serve clients’ agendas. IBM extends capabilities to mid-market client segments by leveraging industry skills with marketing, ibm.com and local Business Partner resources.

 

In 2008, the company implemented a new growth markets organization to increase its focus on the emerging markets of Brazil, Russia, India and China and the additional opportunities around the world that have market growth rates greater than the global average — countries within Southeast Asia, Eastern Europe, the Middle East and Latin America. The company’s major markets include the United States, Canada, the U.K., France, Germany, Italy, Japan, Denmark, Sweden, Switzerland, Austria, Belgium, Finland, Greece, Ireland, the Netherlands, Portugal, Cyprus, Norway, Israel, Spain, the Bahamas and the Caribbean region.

 

The majority of IBM’s revenue, excluding the company’s original equipment manufacturer (OEM) technology business, occurs in industries that are broadly grouped into six sectors:

 

·      Financial Services: Banking, Financial Markets, Insurance

 

·      Public: Education, Government, Healthcare, Life Sciences

 

·      Industrial: Aerospace and Defense, Automotive, Chemical and Petroleum, Electronics

 

23



 

·      Distribution: Consumer Products, Retail, Travel and Transportation

 

·      Communications: Telecommunications, Media and Entertainment, Energy and Utilities

 

·      Small and Medium Business: Mainly companies with less than 1,000 employees

 

Research, Development and Intellectual Property

 

IBM’s research and development (R&D) operations differentiate the company from its competitors. IBM annually spends approximately $6 billion for R&D, focusing its investments on high-growth, high-value opportunities. As a result of innovations in these and other areas, IBM was once again awarded more U.S. patents in 2008 than any other company, the first company to achieve over 4,000 patents in a year. The company will continue to actively seek intellectual property protection for its innovations, while increasing emphasis on other initiatives designed to leverage its intellectual property leadership and promote innovation.

 

In addition to producing world-class hardware and software products, IBM innovations are also a major differentiator in providing solutions for the company’s clients through its services businesses. The company’s investments in R&D also result in intellectual property (IP) income of approximately $1 billion annually. Some of IBM’s technological breakthroughs are used exclusively in IBM products, while others are licensed and may be used in either/both IBM products and/or the products of the licensee. While the company’s various proprietary intellectual property rights are important to its success, IBM believes its business as a whole is not materially dependent on any particular patent or license, or any particular group of patents or licenses. IBM owns or is licensed under a number of patents, which vary in duration, relating to its products. Licenses under patents owned by IBM have been and are being granted to others under reasonable terms and conditions.

 

Integrated Supply Chain

 

Consistent with the company’s work with clients to transform their supply chains for greater efficiency and responsiveness to global market conditions, the company continues to derive business value from its own globally integrated supply chain, which provides a strategic advantage for the company to create value for clients. IBM leverages its supply-chain expertise for clients through its supply-chain business transformation outsourcing service to optimize and help operate clients’ end-to-end supply-chain processes, from procurement to logistics.

 

IBM spends approximately $38 billion annually through its supply chain, procuring materials and services globally. The supply, manufacturing and logistics and customer fulfillment operations are integrated in one operating unit that has optimized inventories over time, improved response to marketplace opportunities and external risks and converted fixed costs to variable costs. Simplifying and streamlining internal processes has improved operations, sales force productivity and processes, and these actions have improved client satisfaction.

 

Integrated Technology Delivery

 

Integrated Technology Delivery (ITD) combines all of the worldwide service delivery capabilities for Strategic Outsourcing with strong local and regional management teams supported by a set of global competencies. ITD leverages the company’s global scale and advanced technology to deliver standardized solutions that are automated, repeatable and globally integrated. Clients gain cost advantages, access to industry-leading skills and IBM’s scale and overall flexibility. ITD manages the world’s largest privately-owned IT infrastructure with employees in over 40 countries supporting over 450 data centers.

 

Business Process Delivery

 

Business Process Delivery (BPD) provides highly efficient, world-class delivery capabilities in IBM’s business process delivery operations, which include Business Transformation Outsourcing, Business Process Outsourcing and Business Process Services. BPD has employees and delivery centers in over 40 countries worldwide.

 

Management Discussion

18

ROAD MAP

18

FORWARD-LOOKING AND CAUTIONARY STATEMENTS

18

MANAGEMENT DISCUSSION SNAPSHOT

19

DESCRIPTION OF BUSINESS

20

YEAR IN REVIEW

25

PRIOR YEAR IN REVIEW

39

DISCONTINUED OPERATIONS

44

OTHER INFORMATION

44

GLOBAL FINANCING

53

Report Of Management

58

Report Of Independent Registered Public Accounting Firm

59

Consolidated Statements

60

Notes

66

 

24



 

Year in Review

 

RESULTS OF CONTINUING OPERATIONS

 

Segment Details

 

The following is an analysis of the 2008 versus 2007 reportable segment results. The analysis of 2007 versus 2006 reportable segment results is on pages 39 to 42.

 

The following table presents each reportable segment’s external revenue and gross margin results.

 

(IN MILLIONS)

For the year ended December 31:

 

2008

 

2007

 

Yr.-to-Yr.
Percent/
Margin
Change

 

Yr.-to-Yr.
Percent Change
Adjusted
for Currency

 

Revenue:

 

 

 

 

 

 

 

 

 

Global Technology Services

 

$39,264

 

$36,103

 

8.8

%

5.8

%

Gross margin

 

32.6

%

29.9

%

2.7

pts.

 

 

Global Business Services

 

19,628

 

18,041

 

8.8

%

5.1

%

Gross margin

 

26.7

%

23.5

%

3.2

pts.

 

 

Software

 

22,089

 

19,982

 

10.5

%

8.2

%

Gross margin

 

85.4

%

85.2

%

0.2

pts.

 

 

Systems and Technology

 

19,287

 

21,317

 

(9.5

)%

(10.8

)%

Gross margin

 

38.1

%

39.7

%

(1.7

)pts.

 

 

Global Financing

 

2,559

 

2,502

 

2.3

%

0.3

%

Gross margin

 

51.3

%

46.7

%

4.6

pts.

 

 

Other

 

803

 

842

 

(4.6

)%

(5.9

)%

Gross margin

 

13.4

%

4.4

%

9.1

pts.

 

 

TOTAL REVENUE

 

$103,630

 

$98,786

 

4.9

%

2.3

%

Gross profit

 

$45,661

 

$41,729

 

9.4

%

 

 

Gross margin

 

44.1

%

42.2

%

1.8

pts.

 

 

 

The following table presents each reportable segment’s external revenue as a percentage of total segment revenue and each reportable segment’s pre-tax income as a percentage of total segment pre-tax income.

 

 

 

Revenue

 

Pre-tax Income*

 

For the year ended December 31:

 

2008

 

2007

 

2008

 

2007

 

Global Technology Services

 

38.2

%

36.9

%

26.3

%

23.5

%

Global Business Services

 

19.1

 

18.4

 

15.3

 

13.6

 

Total Global Services

 

57.3

 

55.3

 

41.6

 

37.1

 

Software

 

21.5

 

20.4

 

40.4

 

39.6

 

Systems and Technology

 

18.8

 

21.8

 

8.8

 

14.2

 

Global Financing

 

2.5

 

2.6

 

9.2

 

9.1

 

TOTAL

 

100.0

%

100.0

%

100.0

%

100.0

%


*   Segment pre-tax income includes transactions between segments that are intended to reflect an arm’s-length transfer price.

 

25



 

In 2008, Global Services and Software increased as a percentage of total segment revenue and total segment pre-tax income. Global Services increased its revenue and profit contribution by 2.0 points and 4.5 points, respectively, while the Software business increased by 1.1 points and 0.8 points, respectively. These improvements reflect the company’s portfolio actions and targeted investment strategies — both aimed at market segments that present the best long-term opportunities.

 

Global Services

 

The Global Services segments, Global Technology Services (GTS) and Global Business Services (GBS), had combined revenue of $58,891 million, an increase of 8.8 percent (6 percent adjusted for currency) in 2008 when compared to 2007. Revenue performance was broad based across the segments, lines of business and geographic units, driven primarily by a strong annuity base and growth in short-term signings.

 

In 2008, total Global Services signings increased 2 percent year to year to $57,182 million ($49,738 million adjusted for currency, flat year to year). Short-term signings were $26,831 million, an increase of 8 percent (5 percent adjusted for currency) versus 2007. Short-term signings increased in both the growth markets and the major markets. Long-term signings were $30,351 million, a decrease of 3 percent (5 percent adjusted for currency) compared to 2007. Long-term signings declined in both the major and growth markets. The total Global Services backlog decreased $2 billion from the prior year to an estimated $117 billion at December 31, 2008.

 

The Global Services segments leveraged very strong margin performance and delivered combined pre-tax profit of $7,288 million in 2008, an improvement of 29.6 percent versus 2007. The services business contributed approximately 42 percent of the company’s segment pre-tax profit in 2008. Through its transformation initiatives, the Global Services business has focused on higher value offerings with a more flexible labor model that can adapt to changing market environments.

 

(IN MILLIONS)

For the year ended December 31:

 

2008

 

2007

 

Yr.-to-Yr.
Change

 

GLOBAL SERVICES REVENUE:

 

$

58,891

 

$

54,144

 

8.8

%

Global Technology Services

 

$

39,264

 

$

36,103

 

8.8

%

Strategic Outsourcing

 

20,183

 

18,701

 

7.9

 

Integrated Technology Services

 

9,283

 

8,438

 

10.0

 

Business Transformation Outsourcing

 

2,550

 

2,294

 

11.2

 

Maintenance

 

7,250

 

6,670

 

8.7

 

Global Business Services

 

$

19,628

 

$

18,041

 

8.8

%

 

Global Technology Services revenue increased 8.8 percent (6 percent adjusted for currency) in 2008 versus 2007 with strong performance across all lines of business. Total signings in GTS increased 1 percent (flat adjusted for currency) led by short-term signings growth of 5 percent (4 percent adjusted for currency). Long-term signings decreased 1 percent (2 percent adjusted for currency).

 

Strategic Outsourcing (SO) revenue was up 7.9 percent (5 percent adjusted for currency) with growth in all geographies, driven by prior year’s signings and continued growth in the base accounts. SO signings in 2008 increased 3 percent (1 percent adjusted for currency) when compared to 2007. Signings were very strong in the fourth quarter (up 20 percent), as clients focused on the value of the SO offerings in the current environment. The initiatives around standardization, global integration and improved efficiency are driving improvements in quality and customer satisfaction which are reflected in the signings performance and in improved profitability.

 

Information Technology Services (ITS) revenue increased 10.0 percent (7 percent adjusted for currency) in 2008 versus 2007 led by growth in key infrastructure offerings such as Green Data Center and Converged Communications. ITS infrastructure offerings deliver high-value, standardized, asset-based services that leverage the company’s services, hardware and software capabilities, providing clients end-to-end solutions and processes that transform their businesses. ITS signings increased 5 percent (4 percent adjusted for currency) in 2008.

 

Business Transformation Outsourcing (BTO) revenue increased 11.2 percent (12 percent adjusted for currency) with growth in all geographies, led by Asia Pacific. The Daksh business, which is focused on business process outsourcing, delivered strong growth. BTO signings decreased 18 percent (14 percent adjusted for currency) in 2008 compared to 2007.

 

Maintenance revenue increased 8.7 percent (5 percent adjusted for currency) with growth in availability services on both IBM and non-IBM IT equipment.

 

Global Business Services revenue increased 8.8 percent (5 percent adjusted for currency) in 2008, with balanced growth across all three geographies. Revenue performance was led by growth in Application Management Services (12.5 percent) and Core Consulting (6.1 percent). Total signings in GBS increased 2 percent (decreased 1 percent adjusted for currency), led by a 10 percent (6 percent adjusted for currency) growth in short-term signings. Short-term signings growth was driven by offerings that enable clients to reduce cost and conserve capital. In the second half of the year, signings for transformational and compliance offerings also increased. Long-term signings decreased 14 percent (16 percent adjusted for currency) year over year.

 

Management Discussion

18

ROAD MAP

18

FORWARD-LOOKING AND CAUTIONARY STATEMENTS

18

MANAGEMENT DISCUSSION SNAPSHOT

19

DESCRIPTION OF BUSINESS

20

YEAR IN REVIEW

25

PRIOR YEAR IN REVIEW

39

DISCONTINUED OPERATIONS

44

OTHER INFORMATION

44

GLOBAL FINANCING

53

Report Of Management

58

Report Of Independent Registered Public Accounting Firm

59

Consolidated Statements

60

Notes

66

 

26


 

($ IN MILLIONS)

For the year ended December 31:

 

2008

 

2007

 

Yr.-to-Yr.
Change

 

GLOBAL SERVICES GROSS PROFIT:

 

 

 

 

 

 

 

Global Technology Services:

 

 

 

 

 

 

 

Gross profit

 

$

12,802

 

$

10,800

 

18.5

%

Gross profit margin

 

32.6

%

29.9

%

2.7

pts.

Global Business Services:

 

 

 

 

 

 

 

Gross profit

 

$

5,238

 

$

4,240

 

23.5

%

Gross profit margin

 

26.7

%

23.5

%

3.2

pts.

 

GTS gross profit increased 18.5 percent compared to 2007, with gross profit margin improving 2.7 points. All lines of business delivered gross margin expansion year over year driven by a combination of a mix to higher value offerings and an improved cost structure. Segment pre-tax profit increased 29.5 percent to $4,607 million with a pre-tax margin of 11.3 percent, an increase of 1.9 points versus 2007. GTS has delivered six consecutive quarters of double-digit pre-tax profit growth. The margin improvement was driven primarily by a delivery structure that maximizes utilization and flexibility, a mix to higher value offerings, lower retirement-related costs and improved productivity.

 

GBS gross profit increased 23.5 percent to $5,238 million in 2008 when compared to 2007, and the gross profit margin improved 3.2 points. Segment pre-tax profit increased 29.9 percent to $2,681 million with a pre-tax margin of 13.0 percent, an improvement of 2.2 points year over year. This was the third straight year of profit growth greater than 20 percent in GBS and demonstrates the results of a strong operating discipline and the benefits of a globally integrated operating model. The margin expansion was driven by improved utilization, cost and expense management, stable pricing and lower retirement-related costs.

 

Global Services Signings

 

The tables below present Global Services signings as reported and adjusted for currency. Signings at actual currency rates provide investors a better view of how these signings will convert to services revenue and provide better comparability to other companies in the industry who report signings using actual rates.

 

At Actual Currency Rates

 

($ IN MILLIONS)

For the year ended December 31:

 

2008

 

2007

 

Yr.-to-Yr.
Change

 

GLOBAL TECHNOLOGY SERVICES SIGNINGS:

 

 

 

 

 

 

 

Long term

 

$

24,446

 

$

24,576

 

(0.5

)%

Short term

 

10,247

 

9,776

 

4.8

 

TOTAL

 

$

34,693

 

$

34,352

 

1.0

%

GLOBAL BUSINESS SERVICES SIGNINGS:

 

 

 

 

 

 

 

Long term

 

$

5,905

 

$

6,847

 

(13.8

)%

Short term

 

16,584

 

15,094

 

9.9

 

TOTAL

 

$

22,488

 

$

21,941

 

2.5

%

 

Adjusted for Currency

 

($ IN MILLIONS)

For the year ended December 31:

 

2008

 

2007

 

Yr.-to-Yr.
Change

 

GLOBAL TECHNOLOGY SERVICES SIGNINGS:

 

 

 

 

 

 

 

Long term

 

$

21,220

 

$

21,550

 

(1.5

)%

Short term

 

8,920

 

8,604

 

3.7

 

TOTAL

 

$

30,141

 

$

30,154

 

0.0

%

GLOBAL BUSINESS SERVICES SIGNINGS:

 

 

 

 

 

 

 

Long term

 

$

5,333

 

$

6,330

 

(15.8

)%

Short term

 

14,264

 

13,411

 

6.4

 

TOTAL

 

$

19,597

 

$

19,741

 

(0.7

)%

 

Global Services signings are management’s initial estimate of the revenue value of a client’s commitment under a Global Services contract. Signings are used by management to assess period performance of Global Services management. There are no third-party standards or requirements governing the calculation of signings. The calculation used by management includes an approximation of currency and involves estimates and judgments to gauge the extent of a client’s commitment, including the type and duration of the agreement, and the presence of termination charges or wind-down costs. For example, for long-term contracts that require significant up-front investment by the company, the portions of these contracts that constitute a signing are those periods in which there is a significant economic impact on the client if the commitment is not achieved, usually through a termination charge or the client incurring significant wind-down costs as a result of the termination. For short-term contracts that do not require significant upfront investments, a signing is usually equal to the full contract revenue value. Long-term contracts represent SO and BTO contracts as well as GBS contracts with the U.S. Federal government and its agencies and Application Management Services (AMS) for custom and legacy applications. Short-term contracts represent the remaining GBS offerings of Consulting and Systems Integration, AMS for packaged applications and ITS contracts.

 

Signings include SO, BTO, ITS and GBS contracts. Contract extensions and increases in scope are treated as signings only to the extent of the incremental new revenue value. Maintenance is not included in signings as maintenance contracts tend to be more steady state, where revenues equal renewals.

 

Backlog includes SO, BTO, ITS, GBS and Maintenance. Backlog is intended to be a statement of overall work under contract and therefore does include Maintenance. Backlog estimates are subject to change and are affected by several factors, including terminations, changes in the scope of contracts, periodic revalidations, adjustments for revenue not materialized and currency assumptions used to approximate constant currency.

 

27



 

Contract portfolios purchased in an acquisition are treated as positive backlog adjustments provided those contracts meet the company’s requirements for initial signings. A new signing will be recognized if a new services agreement is signed incidental or coincidental to an acquisition or divestiture.

 

SOFTWARE

 

($ IN MILLIONS)

For the year ended December 31:

 

2008

 

2007

 

Yr.-to-Yr.
Change

 

SOFTWARE REVENUE:

 

$

22,089

 

$

19,982

 

10.5

%

Middleware

 

$

17,305

 

$

15,505

 

11.6

%

Key Branded Middleware

 

12,383

 

10,827

 

14.4

 

WebSphere Family

 

 

 

 

 

6.2

 

Information Management

 

 

 

 

 

24.5

 

Lotus

 

 

 

 

 

10.4

 

Tivoli

 

 

 

 

 

2.9

 

Rational

 

 

 

 

 

13.2

 

Other middleware

 

4,922

 

4,678

 

5.2

 

Operating systems

 

2,337

 

2,319

 

0.8

 

Product Lifecycle Management

 

960

 

1,051

 

(8.6

)

Other

 

1,488

 

1,107

 

34.4

 

 

Software segment revenue of $22,089 million increased 10.5 percent (8 percent adjusted for currency) in 2008 led by growth in the Key Branded Middleware products and strong contributions from the annuity base and acquisitions. Clients continue to embed the company’s software in the fabric of their IT infrastructures.

 

Key Branded Middleware revenue increased 14.4 percent (12 percent adjusted for currency) and represented 56 percent of total Software segment revenue, an increase of 2 points from 2007. When adjusted for currency, growth in 2008 was led by Information Management, Rational and Lotus. Strategic acquisitions, including Cognos and Telelogic, have extended the segment’s middleware capabilities.

 

WebSphere Family revenue increased 6.2 percent (5 percent adjusted for currency) in 2008 and was led by growth in WebSphere Application Servers and WebSphere Business Integration software. In December 2008, the company completed the acquisition of ILOG, whose products help customers improve business decisions with optimization, visualization and business rules software. The WebSphere products provide the foundation for Web-enabled applications and are a key product set in deploying a client’s SOA. Information Management revenue increased 24.5 percent (22 percent adjusted for currency) in 2008 versus the prior year, reflecting contribution from Cognos and strong demand for the distributed relational database products. Cognos’ performance management solution helps customers improve decision-making across the enterprise to optimize business performance.

 

Lotus revenue increased 10.4 percent (8 percent adjusted for currency) in 2008 led by growth in Lotus Notes products as customers continue to invest to improve their workforce efficiency. Lotus software is well established as a tool for providing improved workplace collaboration and productivity.

 

Tivoli revenue increased 2.9 percent (2 percent adjusted for currency) in 2008 when compared to 2007. Revenue performance was led by growth in Tivoli Security and Storage Management products. Tivoli software provides the advanced capabilities required to run large mission-critical environments. This includes security and storage software which helps customers improve utilization and reduce costs.

 

Rational revenue increased 13.2 percent (12 percent adjusted for currency) in 2008 driven primarily by Telelogic contributions. Telelogic’s suite of system programming tools complements Rational’s IT tool set, providing a common framework for software and systems delivery across a client’s enterprise.

 

Revenue from Other middleware products increased 5.2 percent (3 percent adjusted for currency) in 2008 versus the prior year. This software product set includes more mature products which provide a more stable flow of revenue.

 

Other software segment revenue increased 34.4 percent (31 percent adjusted for currency) versus 2007 reflecting continued growth in software-related services.

 

($ IN MILLIONS)

For the year ended December 31:

 

2008

 

2007

 

Yr.-to-Yr.
Change

 

SOFTWARE GROSS PROFIT:

 

 

 

 

 

 

 

Gross profit

 

$

18,859

 

$

17,015

 

10.8

%

Gross profit margin

 

85.4

%

85.2

%

0.2

pts.

 

Software segment gross profit increased 10.8 percent to $18,859 million in 2008, driven primarily by the strong revenue growth. The large annuity base of this business continues to provide a predictable and growing profit stream. Gross profit margin was 85.4 percent in 2008, an increase of 0.2 points versus 2007. The company has been investing significantly in the software business with good results. The Software segment contributed $7,075 million of pre-tax profit in 2008, an increase of 17.9 percent versus 2007 while successfully integrating Cognos and Telelogic. Software contributed approximately 40 percent of the company’s segment pre-tax profit in 2008. The segment pre-tax profit margin increased 1.7 points to 28.5 percent. The pre-tax income and margin improvements have been driven primarily by revenue growth and increasing operational efficiencies.

 

Management Discussion

 

18

ROAD MAP

 

18

FORWARD-LOOKING AND CAUTIONARY STATEMENTS

 

18

MANAGEMENT DISCUSSION SNAPSHOT

 

19

DESCRIPTION OF BUSINESS

 

20

YEAR IN REVIEW

 

25

PRIOR YEAR IN REVIEW

 

39

DISCONTINUED OPERATIONS

 

44

OTHER INFORMATION

 

44

GLOBAL FINANCING

 

53

Report Of Management

 

58

Report Of Independent Registered Public Accounting Firm

 

59

Consolidated Statements

 

60

Notes

 

66

 

28



 

SYSTEMS AND TECHNOLOGY

 

($ IN MILLIONS)

For the year ended December 31:

 

2008

 

2007

 

Yr.-to-Yr.

Change

 

SYSTEMS AND TECHNOLOGY REVENUE:

 

$

19,287

 

$

21,317

 

(9.5

)%

System z

 

 

 

 

 

12.5

%

Legacy System i

 

 

 

 

 

(66.1

)

Converged System p

 

 

 

 

 

11.2

 

System x

 

 

 

 

 

(16.9

)

System Storage

 

 

 

 

 

(3.4

)

Retail Store Solutions

 

 

 

 

 

(15.0

)

Total Systems

 

 

 

 

 

(4.9

)

Microelectronics OEM

 

 

 

 

 

(25.1

)

Printing Systems

 

 

 

 

 

NM

 


NM—Not meaningful

 

Systems and Technology segment revenue decreased 9.5 percent (down 11 percent adjusted for currency) in 2008 versus 2007. In June 2007, the company divested its printing business. Systems and Technology revenue, excluding the divested printing business, decreased 7.8 percent (9 percent adjusted for currency) in 2008 versus 2007. Total Systems revenue decreased 4.9 percent (6 percent adjusted for currency) in 2008 versus 2007.

 

In the current economic environment, clients are focused on reducing the cost of running their IT infrastructure. Virtualization, which provides the capability to run multiple workloads on a single server, is a key enabler of efficiency. System z is the leading platform for virtualization as it is able to support thousands of images and operate fully utilized. The company’s POWER architecture supports hundreds of partitions, often driving utilization rates of over 60 percent. Both of these platforms leverage the entire system, from the company’s custom semiconductors through the software stack, to achieve these high levels of efficiency and lower cost of ownership. The distributed computing model, which utilizes many small servers, cannot offer the same level of efficiency and value.

 

System z revenue increased 12.5 percent (11 percent adjusted for currency) in 2008 versus 2007. System z revenue growth was particularly strong in the Americas (up 19 percent), as well as in the Financial Services and Industrial sectors globally. Clients in emerging markets also leveraged this platform’s stability and efficiency during 2008. MIPS (millions of instructions per second) shipments increased 25 percent in 2008 versus 2007, posting double-digit growth in each quarter, reflecting strength in both traditional and specialty workloads. Specialty MIPS increased 68 percent in 2008, as clients exploit the capabilities of System z to bring new Linux and Java applications to this highly efficient and cost effective platform.

 

Converged System p revenue increased 11.2 percent (11 percent adjusted for currency) in 2008 versus 2007, reflecting solid demand for the energy efficiencies and multi-operating system capabilities of POWER6 technology. Clients are concluding that POWER6 technology is the right solution for a multitude of workloads. The revenue growth was primarily driven by midrange servers which increased 32 percent and high-end servers which increased 3 percent in 2008 versus 2007.

 

Legacy System i revenue decreased 66.1 percent (67 percent adjusted for currency) in 2008 versus 2007, as the company continues to transition the System i customer base to the converged POWER platform within System p.

 

System x revenue decreased 16.9 percent (19 percent adjusted for currency) in 2008 versus 2007. System x server revenue declined 15 percent and blades revenue decreased 3 percent, in 2008 versus 2007, respectively. The decline in server revenue reflects a significant slowdown in the x86 market, especially in the second half of 2008, as clients are virtualizing and consolidating workloads onto more efficient platforms such as POWER and mainframe.

 

System Storage revenue decreased 3.4 percent (5 percent adjusted for currency) in 2008 versus 2007. Total disk revenue was essentially flat in 2008 versus 2007. Enterprise Disk revenue increased 2 percent primarily due to increased demand for the DS8000 product, while midrange disk revenue declined 15 percent. Tape revenue declined 10 percent in 2008 primarily due to reduced demand and clients deciding to purchase additional media to expand the utilization of their existing devices.

 

Microelectronics OEM revenue decreased 25.1 percent (25 percent adjusted for currency) in 2008 versus 2007. The primary mission of this business is to provide leadership technology for the systems business, as demonstrated during 2008 in the new System z10 mainframe and POWER6 systems.

 

Retail Stores Solutions revenue decreased 15.0 percent (16 percent adjusted for currency) in 2008 versus 2007, reflecting weakness in the retail sector and a compare to a strong 2007, when a new programmable point-of-sale solution was being delivered to large clients.

 

($ IN MILLIONS)
For the year ended December 31:

 

2008

 

2007

 

Yr.-to-Yr.
Change

 

SYSTEMS AND TECHNOLOGY GROSS PROFIT:

 

 

 

 

 

 

 

Gross profit

 

$

7,341

 

$

8,468

 

(13.3

)%

Gross profit margin

 

38.1

%

39.7

%

(1.7

)pts.

 

29



 

Overall, gross margin decreased by 1.7 points versus the prior year. This decrease was primarily driven by margin declines in System z, System x and Microelectronics OEM which impacted the overall margin by 1.6 points, 1.3 points and 1.2 points, respectively. Partially offsetting these margin declines was a revenue mix benefit of 2.7 points due to the increased revenue in System z and Converged System p.

 

Systems and Technology segment pre-tax margin declined 2.0 points to 7.7 percent in 2008 reflecting the lower revenue and gross profit margin in 2008 versus 2007.

 

GLOBAL FINANCING

 

See pages 53 and 54 for an analysis of Global Financing’s segment results.

 

GEOGRAPHIC REVENUE

 

In addition to the revenue presentation by reportable segment, the company also measures revenue performance on a geographic basis. The following geographic, regional and country-specific revenue performance discussion excludes OEM revenue, which is presented separately.

 

($ IN MILLIONS)
For the year ended December 31:

 

2008

 

2007

 

Yr.-to-Yr.
Change

 

TOTAL REVENUE:

 

$

103,630

 

$

98,786

 

4.9

%

Geographies:

 

$

100,939

 

$

95,320

 

5.9

%

Americas

 

42,807

 

41,122

 

4.1

 

Europe/Middle East/Africa

 

37,020

 

34,699

 

6.7

 

Asia Pacific

 

21,111

 

19,501

 

8.3

 

OEM

 

$

2,691

 

$

3,465

 

(22.4

)%

 

Geographic revenue increased 5.9 percent (3 percent adjusted for currency) to $100,939 million in 2008 when compared to 2007. Revenue increased in all geographies in 2008, and adjusted for currency, revenue growth was strongest in the Americas followed by Europe and Asia Pacific. Revenue from the company’s growth markets organization increased 9.8 percent (10 percent adjusted for currency) while growth in the more established major markets was 5.1 percent (2 percent adjusted for currency).

 

Americas revenue increased 4.1 percent (4 percent adjusted for currency) in 2008. Revenue increased in all regions with the U.S. up 2.9 percent, Canada 5.6 percent (6 percent adjusted for currency) and Latin America 13.9 percent (11 percent adjusted for currency).

 

Europe/Middle East/Africa (EMEA) revenue increased 6.7 percent (3 percent adjusted for currency) in 2008 when compared to 2007. The majority of major market countries performed well led by Spain which grew 12.0 percent (5 percent adjusted for currency), Germany increased 10.8 percent (4 percent adjusted for currency) and France increased 9.0 percent (2 percent adjusted for currency). Italy increased 5.8 percent (decreased 1 percent adjusted for currency) while the U.K. decreased 4.9 percent (increased 4 percent adjusted for currency).

 

Asia Pacific revenue increased 8.3 percent (2 percent adjusted for currency) year over year. Revenue increased in the India, South Korea, ASEAN, Australia/New Zealand and China regions with combined growth of 8.1 percent (9 percent adjusted for currency). Japan revenue, which represented 49 percent of the Asia Pacific revenue base, increased 8.5 percent as reported, but decreased 5 percent adjusted for currency in 2008 when compared to 2007.

 

Across the geographies, aggregate revenue from the countries comprising the company’s growth markets organization increased 9.8 percent (10 percent adjusted for currency) in 2008 and represented approximately 18 percent of the company’s total geographic revenue. The company has continued to invest to capture new infrastructure spending in the growth markets. Adjusted for currency, growth in these markets was 8 points higher than in the major markets. The BRIC countries, a subset of the growth markets, together grew 17.6 percent (15 percent adjusted for currency), with growth in India of 25.8 percent (33 percent adjusted for currency), Brazil 18.3 percent (13 percent adjusted for currency), China 14.7 percent (8 percent adjusted for currency) and Russia 11.0 percent (11 percent adjusted for currency).

 

OEM revenue decreased 22.4 percent (23 percent adjusted for currency) in 2008 when compared to 2007, driven by reduced demand in the Microelectronics OEM business.

 

TOTAL EXPENSE AND OTHER INCOME

 

($ IN MILLIONS)

For the year ended December 31:

 

2008

 

2007

 

Yr.-to-Yr.

Change

 

Total expense and other income

 

$

28,945

 

$

27,240

 

6.3

%

Expense to Revenue

 

27.9

%

27.6

%

0.4

pts.

 

The key drivers year to year in total expense and other income were approximately:

 

·      Operational expense, -1 point

 

·      Acquisitions, +5 points

 

·      Currency, +2 points

 

In 2008, the company continued to focus on productivity improvements in its more established markets and increased its investments in the growth markets. Within selling, general and administrative expense (SG&A), total sales and marketing expense increased 4 percent year to year (2 percent adjusted for currency). Sales and marketing expense in the growth markets increased 13 percent (13 percent

 

Management Discussion

18

 

ROAD MAP

18

 

FORWARD-LOOKING AND CAUTIONARY STATEMENTS

18

 

MANAGEMENT DISCUSSION SNAPSHOT

19

 

DESCRIPTION OF BUSINESS

20

 

YEAR IN REVIEW

25

 

PRIOR YEAR IN REVIEW

39

 

DISCONTINUED OPERATIONS

44

 

OTHER INFORMATION

44

 

GLOBAL FINANCING

53

 

Report Of Management

58

 

Report Of Independent Registered Public Accounting Firm

59

 

Consolidated Statements

60

 

Notes

66

 

 

30


 

adjusted for currency), as compared to major markets where sales and marketing expense increased 3 percent (1 percent adjusted for currency) year to year. On a consolidated basis, general and administrative expenses, which are indirect expenses incurred in the business, increased 2 percent (flat at constant currency) year to year.

 

Selling, General and Administrative

 

($ IN MILLIONS)

For the year ended December 31:

 

2008

 

2007

 

Yr.-to-Yr.
Change

 

Selling, general and administrative — base

 

$

20,006

 

$

19,078

 

4.9

%

Advertising and promotional expense

 

1,259

 

1,242

 

1.4

 

Workforce reductions — ongoing

 

706

 

318

 

121.8

 

Amortization expense — acquired intangibles

 

306

 

234

 

30.5

 

Retirement-related expense

 

319

 

607

 

(47.3

)

Stock-based compensation

 

484

 

480

 

0.8

 

Bad debt expense

 

306

 

100

 

205.1

 

TOTAL

 

$

23,386

 

$

22,060

 

6.0

%

 

Total SG&A expense increased 6.0 percent (4 percent adjusted for currency) in 2008 versus 2007. The increase in SG&A was primarily due to acquisition related spending, predominantly for Cognos and Telelogic, which accounted for 5 points of the increase, while the effects of currency accounted for 2 points. Workforce reductions—ongoing expense increased $387 million primarily due to charges recorded in the fourth quarter reflecting workforce actions in Japan ($120 million) and other ongoing skills rebalancing that is a regular element of the company’s business model. In addition, bad debt expense increased $206 million primarily driven by additional specific accounts receivable reserves reflecting the current economic environment in many industries. The company’s accounts receivable provision coverage at year end is 2.0 percent, an increase of 50 basis points from year-end 2007. These increases were partially offset by lower retirement-related expense of $287 million.

 

Other (Income) and Expense

 

($ IN MILLIONS)
For the year ended December 31: 

 

2008

 

2007

 

Yr.-to-Yr.
Change

 

Foreign currency transaction losses*

 

$

330

 

$

45

 

NM

 

(Gains)/losses on derivative instruments*

 

(27

)

194

 

(114.1

)%

Interest income

 

(343

)

(565

)

(39.3

)

Net gains from securities and investment assets

 

(52

)

(68

)

(22.6

)

Net realized gains from certain real estate activities

 

(26

)

(18

)

45.0

 

Other

 

(179

)

(214

)

(16.5

)

TOTAL

 

$

(298

)

$

(626

)

(52.4

)%


* Reclassified to conform with 2008 presentation.

NM—Not meaningful

 

Other (income) and expense was income of $298 million and $626 million in 2008 and 2007, respectively. The decrease in income was primarily driven by higher foreign currency transaction losses ($285 million) and lower interest income reflecting lower cash balances and the current interest rate environment ($222 million). These decreases were partially offset by a gain on derivative instruments which primarily hedge foreign currency risks ($221 million). Included within the foreign currency hedging activity, the company hedges its major cross-border cash flows to mitigate the effect of currency volatility in its global cash planning, which also reduces volatility in the year-over-year results. The impact of these hedging programs is primarily reflected in other (income) and expense, as well as cost of goods sold. The impact of losses from these cash flow hedges reflected in other (income) and expense was $186 million, a decrease of $24 million year to year.

 

Research, Development and Engineering

 

($ IN MILLIONS)

For the year ended December 31:

 

2008

 

2007

 

Yr.-to-Yr.
Change

 

Research, development and engineering

 

 

 

 

 

 

 

TOTAL

 

$

6,337

 

$

6,153

 

3.0

%

 

The increase in research, development and engineering (RD&E) expense was primarily driven by acquisitions and investments to maintain technology leadership across the company’s offerings. Software spending increased $262 million, partially offset by lower spending in Systems and Technology ($54 million) and other unit spending ($74 million), while stock-based compensation expense decreased $9 million versus 2007.

 

Intellectual Property and Custom Development Income

 

($ IN MILLIONS)
For the year ended December 31:

 

2008

 

2007

 

Yr.-to-Yr.
Change

 

Sales and other transfers of intellectual property

 

$

138

 

$

138

 

(00.0

)%

Licensing/royalty-based fees

 

514

 

368

 

39.7

 

Custom development income

 

501

 

452

 

10.9

 

TOTAL

 

$

1,153

 

$

958

 

20.4

%

 

The timing and amount of sales and other transfers of IP may vary significantly from period to period depending upon timing of divestitures, industry consolidation, economic conditions and the timing of new patents and know-how development. While IP income increased 20.4 percent in 2008, there were no significant individual IP transactions in 2008 or 2007. The improvement year to year was primarily driven by the Systems and Technology business.

 

31



 

Interest Expense

 

($ IN MILLIONS)
For the year ended December 31:

 

2008

 

2007

 

Yr.-to-Yr.
Change

 

Interest expense

 

 

 

 

 

 

 

TOTAL

 

$

673

 

$

611

 

10.3

%

 

The increase in interest expense was primarily due to the increase in debt in 2007 associated with the financing of the accelerated share repurchase agreements, partially offset by lower interest rates in 2008. See note N, “Stockholders’ Equity,” on pages 95 and 96 for additional information regarding the accelerated share repurchase. Interest expense is presented in cost of financing in the Consolidated Statement of Earnings if the related external borrowings are to support the Global Financing external business. See page 56 for additional information regarding Global Financing debt and interest expense. Overall interest expense for 2008 was $1,477 million, an increase of $46 million versus 2007.

 

STOCK-BASED COMPENSATION

 

Total pre-tax stock-based compensation cost of $659 million decreased $54 million compared to 2007. The decrease was principally the result of a reduction in the level of stock option grants ($203 million), offset by an increase related to restricted and performance-based share units ($149 million). The year-to-year change was reflected in the following categories: reductions in cost ($50 million) and RD&E expense ($9 million), and increases in SG&A expense ($4 million) and other (income) and expense ($1 million).

 

See note T, “Stock-Based Compensation,” on pages 103 to 106 for additional information on the company’s stock-based incentive awards.

 

RETIREMENT-RELATED BENEFITS

 

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

 

($ IN MILLIONS)
For the year ended December 31:

 

2008

 

2007

 

Yr.-to-Yr.
Change

 

Defined benefit and contribution pension plans cost

 

$

1,053

 

$

2,198

 

(52.1

)%

Nonpension postretirement plans costs

 

363

 

399

 

(9.0

)

TOTAL

 

$

1,416

 

$

2,597

 

(45.5

)%

 

Overall, retirement-related plan costs decreased $1,181 million versus 2007 primarily as a result of pension plan redesign efforts and a lower level of recognized actuarial losses.

 

Effective January 1, 2008, benefit accruals ceased in the IBM Personal Pension Plan, a U.S. defined benefit plan. This decrease was partially offset by an increase in defined contribution plans, primarily in the U.S. See note U, “Retirement-Related Benefits,” on pages 106 to 116 for additional information on these plan changes and all the factors driving the year-to-year change in total cost.

 

Retirement-related plan costs decreased approximately $771 million in cost, $287 million in SG&A expense, $117 million in RD&E expense and $5 million in other (income) and expense year to year.

 

ACQUIRED INTANGIBLE ASSET AMORTIZATION

 

The company has been investing in targeted acquisitions to increase its capabilities in higher value businesses. The following table presents the total acquired intangible asset amortization included in the Consolidated Statement of Earnings. See note J, “Intangible Assets Including Goodwill,” on pages 87 and 88 for additional information.

 

($ IN MILLIONS)

For the year ended December 31:

 

2008

 

2007*

 

Yr.-to-Yr.
Change

 

Cost:

 

 

 

 

 

 

 

Software (Sales)

 

$

173

 

$

91

 

89.2

%

Global Technology Services (Services)

 

32

 

41

 

(21.0

)

Global Business Services (Services)

 

0

 

1

 

(67.0

)

Systems and Technology (Sales)

 

8

 

0

 

NM

 

Selling, general and administrative expense

 

306

 

234

 

30.5

 

TOTAL

 

$

520

 

$

367

 

41.5

%


*  Reclassified to conform with 2008 presentation disclosing the two services segments separately.

NM—Not meaningful

 

INCOME TAXES

 

The effective tax rate for 2008 was 26.2 percent, compared with 28.1 percent in 2007. The 1.9 point decrease was primarily driven by the 2008 net increase in the utilization of foreign and state tax credits (2.9 points), the benefit associated with the second quarter 2008 agreement reached with the U.S. Internal Revenue Service (IRS) regarding claims for certain tax incentives (1.7 points) and the benefit related to certain issues associated with newly published U.S. tax regulations (1.2 points). These benefits were partially offset by several

 

Management Discussion

 

18

ROAD MAP

 

18

FORWARD-LOOKING AND CAUTIONARY STATEMENTS

 

18

MANAGEMENT DISCUSSION SNAPSHOT

 

19

DESCRIPTION OF BUSINESS

 

20

YEAR IN REVIEW

 

25

PRIOR YEAR IN REVIEW

 

39

DISCONTINUED OPERATIONS

 

44

OTHER INFORMATION

 

44

GLOBAL FINANCING

 

53

Report Of Management

 

58

Report Of Independent Registered Public Accounting Firm

 

59

Consolidated Statements

 

60

Notes

 

66

 

32



 

items including the net impact related to the completion of the U.S. federal income tax examination for the years 2004 and 2005 including the associated income tax reserve redeterminations (0.5 points), the second quarter 2008 tax cost associated with the intercompany transfer of certain intellectual property (2.8 points) and lower capital loss utilization in 2008 (0.7 points). The remaining items were individually insignificant.

 

EARNINGS PER SHARE

 

Basic earnings per share is computed on the basis of the weighted-average number of shares of common stock outstanding during the period. Diluted earnings per share is computed on the basis of the weighted-average number of shares of common stock plus the effect of dilutive potential common shares outstanding during the period using the treasury stock method. Dilutive potential common shares include outstanding stock options, share awards, convertible notes and shares which may be required to settle accelerated share repurchase (ASR) agreements.

 

For the year ended December 31:

 

2008

 

2007

 

Yr.-to-Yr.
Change

 

Earnings per share of common stock:

 

 

 

 

 

 

 

Assuming dilution:

 

 

 

 

 

 

 

Continuing operations

 

$

8.93

 

$

7.18

 

24.4

%

Discontinued operations

 

 

(0.00

)

NM

 

Total

 

$

8.93

 

$

7.18

 

24.4

%

Basic:

 

 

 

 

 

 

 

Continuing operations

 

$

9.07

 

$

7.32

 

23.9

%

Discontinued operations

 

 

(0.00

)

NM

 

Total

 

$

9.07

 

$

7.32

 

23.9

%

Weighted-average shares outstanding (in millions):

 

 

 

 

 

 

 

Assuming dilution

 

1,381.8

 

1,450.6

 

(4.7

)%

Basic

 

1,359.8

 

1,423.0

 

(4.4

)%


NM—Not meaningful

 

Actual shares outstanding at December 31, 2008 and December 31, 2007 were 1,339.1 million and 1,385.2 million, respectively. The average number of common shares outstanding assuming dilution was 68.8 million shares lower in 2008 versus 2007. The decrease was primarily the result of the company’s common stock repurchase program. See note N, “Stockholders’ Equity Activity,” on pages 95 and 96 for additional information regarding common stock activities. Also see note R, “Earnings Per Share of Common Stock,” on page 102.

 

Financial Position

 

DYNAMICS

 

At December 31, 2008, the company’s balance sheet and liquidity position remain strong. Cash on hand at year-end was $12,741 million. Total debt of $33,926 million decreased $1,349 million from prior year-end levels. The commercial paper balance at December 31 was $468 million, down $5,363 million from December 31, 2007. In 2008, the company generated $18,812 million in cash from operations, an increase of $2,718 million compared to 2007. The company has consistently generated strong cash flow from operations and continues to have access to additional sources of liquidity through the capital markets and its $10 billion global credit facility.

 

Consistent with retirement and postretirement plan accounting standards, the company remeasures the funded status of its plans at December 31. The funded status is measured as the difference between the fair value of the plan assets and the benefit obligation and is recognized in the Consolidated Statement of Financial Position. At December 31, 2008, primarily as a result of the returns on plan assets, coupled with changes in certain plan assumptions and plan contributions, the overall net funded position decreased $21,793 million from December 31, 2007 to a net under-funded position of $18,485 million. This change is primarily reflected in prepaid pension assets and retirement and nonpension postretirement benefit obligations which decreased $15,816 million and increased $5,871 million respectively from year-end 2007 levels. Due to the extreme volatility in the equity markets in 2008, the return on IBM Personal Pension Plan assets declined 15 percent, compared to a 14 percent increase in 2007. The company’s asset return in the non-U.S. plans declined approximately 21 percent. Within the company’s defined benefit plans, the net funded status declined in 2008 due to the volatility in the financial markets. At December 31, 2008 the company’s qualified defined benefit plans worldwide were 93 percent funded, with the U.S. qualified Personal Pension Plan 97 percent funded.

 

In addition, stockholders’ equity decreased $15,004 million, net of tax, primarily as a result of changes from pension remeasurements and current year activity within accumulated gains and (losses) not affecting retained earnings. This is a non-cash impact to equity and does not affect the company’s access to capital markets or its ability to meet its obligations.

 

The assets and debt associated with the Global Financing business are a significant part of the company’s financial position. The financial position amounts appearing on pages 34 to 36 are the consolidated amounts including Global Financing. The amounts appearing in the separate Global Financing section on pages 53 through 57 are supplementary data presented to facilitate an understanding of the Global Financing business.

 

33



 

WORKING CAPITAL

 

($ IN MILLIONS)

At December 31:

 

2008

 

2007

 

Current assets

 

$

49,004

 

$

53,177

 

Current liabilities

 

42,435

 

44,310

 

WORKING CAPITAL

 

$

6,568

 

$

8,867

 

Current ratio

 

1.15

 

1.20

 

 

Working capital decreased $2,299 million compared to the prior year primarily as a result of a net decrease in current assets. The key drivers are described below:

 

Current assets decreased $4,174 million due to:

 

·        A decrease of $3,239 million in cash and cash equivalents and marketable securities (see Cash Flow analysis below and on page 35);

 

·        A decrease of $1,235 million in short-term receivables driven by currency impacts of $1,202 million;

 

Partially offset by:

 

·        An increase of $409 million in prepaid expenses and other current assets primarily resulting from:

 

— an increase of $353 million in prepaid taxes;

 

— an increase of $238 million in derivative assets primarily due to changes in foreign currency rates for certain economic hedges; and

 

— approximately $189 million negative currency impact.

 

Current liabilities decreased $1,875 million as a result of:

 

·        A decrease of $1,041 million (including $260 million of negative impact due to currency) in accounts payable primarily due to lower purchasing volumes;

 

·        A decrease of $999 million in short-term debt primarily driven by the reduction in commercial paper balances; and

 

·        A decrease of $930 million (including $222 million negative currency impact) in taxes payable;

 

Partially offset by:

 

·        An increase of $679 million in other accrued liabilities primarily due to:

 

— an increase of $502 million in derivative liabilities as a result of changes in foreign currency rates;

 

— an increase of $329 million in workforce reduction accruals; and

 

— approximately $172 million negative currency impact.

 

·        An increase of $436 million (net of a $288 million negative currency impact) in deferred income mainly driven by Software ($285 million) and Global Services ($139 million).

 

CASH FLOW

 

The company’s cash flow from operating, investing and financing activities, as reflected in the Consolidated Statement of Cash Flows on page 62, is summarized in the following table. These amounts include the cash flows associated with the Global Financing business.

 

($ IN MILLIONS)
For the year ended December 31:

 

2008

 

2007

 

Net cash provided by/(used in) continuing operations:

 

 

 

 

 

Operating activities

 

$

18,812

 

$

16,094

 

Investing activities

 

(9,285

)

(4,675

)

Financing activities

 

(11,834

)

(4,740

)

Effect of exchange rate changes on cash and cash equivalents

 

58

 

294

 

Net cash used in discontinued operations—operating activities

 

 

(5

)

NET CHANGE IN CASH AND CASH EQUIVALENTS

 

$

(2,250

)

$

6,969

 

 

Net cash from operating activities for 2008 increased $2,718 million as compared to 2007 driven by the following key factors:

 

·        An increase in net income of $1,916 million;

 

·        Decreases in accounts receivable drove an increase in cash of $1,682 million, driven by Global Financing receivables ($1,280 million) and non-Global Financing receivables ($402 million) primarily resulting from reduced fourth-quarter 2008 revenue and improved collections; and

 

·        A decrease year to year in retirement-related plan funding of $426 million.

 

Partially offset by:

 

·   Accounts payable drove a use of cash of $718 million; and

 

·   A decrease in cash of $284 million driven by growth in inventory.

 

Net cash used in investing activities increased $4,611 million on a year-to-year basis driven by:

 

·        An increase of $5,304 million utilized for acquisitions (see note C, “Acquisitions/Divestitures,” on pages 78 through 83 for additional information); and

 

·   A decrease of $239 million received from divestitures;

 

Management Discussion

 

18

ROAD MAP

 

18

FORWARD-LOOKING AND CAUTIONARY STATEMENTS

 

18

MANAGEMENT DISCUSSION SNAPSHOT

 

19

DESCRIPTION OF BUSINESS

 

20

YEAR IN REVIEW

 

25

PRIOR YEAR IN REVIEW

 

39

DISCONTINUED OPERATIONS

 

44

OTHER INFORMATION

 

44

GLOBAL FINANCING

 

53

Report Of Management

 

58

Report Of Independent Registered Public Accounting Firm

 

59

Consolidated Statements

 

60

Notes

 

66

 

34


 

Partially offset by:

 

·                  The net impact of the purchases and sales of marketable securities and other investments resulted in an increase in cash of $642 million; and

 

·                  A decrease in net capital spending of $431 million resulting from:

– a decrease of $272 million primarily driven by lower spending by Global Technology Services and Systems and Technology; and

 – a decrease of $159 million in capitalized software development expenditures.

 

Net cash used in financing activities increased $7,095 million compared to 2007 as a result of:

 

·                  An increase of $14,556 million in cash used to retire debt, net of cash proceeds, primarily driven by higher proceeds in 2007 due to the issuance of debt for the ASR and a decline in commercial paper in 2008;

 

·                  Higher dividend payments of $438 million; and

 

·                  A decrease of $350 million in cash received due to lower other common stock transactions primarily due to stock option exercises;

 

Partially offset by:

 

·                  Lower common stock repurchases of $8,249 million.

 

Within total debt, on a net basis, the company utilized $2,444 million in net cash to retire debt versus $12,112 million in net cash proceeds in 2007. The net cash used to retire debt in 2008 was comprised of: $10,248 million in cash payments to settle debt and net payments of $6,025 million in short-term borrowings, partially offset by $13,829 million of new debt issuances. See note K, “Borrowings,” on pages 88 to 90 for a listing of the company’s debt securities.

 

NONCURRENT ASSETS AND LIABILITIES

 

($ IN MILLIONS)

 

 

 

 

 

At December 31:

 

2008

 

2007

 

Noncurrent assets

 

$

60,520

 

$

67,254

 

Long-term debt

 

$

22,689

 

$

23,039

 

Noncurrent liabilities (excluding debt)

 

$

30,934

 

$

24,612

 

 

The decrease in noncurrent assets of $6,733 million compared to the prior year-end balance was primarily driven by:

 

·                  A decrease of $15,816 million in prepaid pension assets primarily resulting from pension remeasurements;

 

·                  A decrease of $777 million in plant, rental machines and other property mainly due to currency impact ($576 million) and lower capital spending primarily in Global Technology Services; and

 

·                  A decrease of $420 million in long-term financing receivables mainly due to currency impact;

 

Partially offset by:

 

·                  An increase in deferred tax assets of $5,757 million primarily due to pension remeasurements; and

 

·                  An increase in goodwill of $3,941 million (net of a $1,529 million negative currency impact) and an increase of $771 million (net of a $160 million negative currency impact) in intangible assets-net primarily driven by the Cognos and Telelogic acquisitions.

 

Long-term debt decreased $350 million primarily due to reclasses to short-term debt as certain instruments approached maturity; offset by new debt issuances.

 

Other noncurrent liabilities, excluding debt, increased $6,322 million primarily driven by:

 

·                  An increase of $5,871 million in retirement and nonpension postretirement benefit obligations primarily driven by pension remeasurement; and

 

·                  An increase in noncurrent tax reserves of $1,450 million related to unrecognized tax benefits;

 

Partially offset by:

 

·                  A decrease of $794 million in noncurrent deferred tax liabilities primarily due to pension remeasurement; and

 

·                  A decrease of $154 million in restructuring liabilities mainly driven by the reclass to current liabilities.

 

DEBT

 

The company’s funding requirements are continually monitored and strategies are executed to manage the overall asset and liability profile.

 

($ IN MILLIONS)

 

 

 

 

 

At December 31:

 

2008

 

2007

 

Total company debt

 

$

33,926

 

$

35,274

 

Total Global Financing segment debt:

 

$

24,360

 

$

24,532

 

Debt to support external clients

 

20,892

 

21,072

 

Debt to support internal clients

 

3,468

 

3,460

 

 

35



 

The Global Financing business provides funding predominantly for the company’s external client assets as well as for assets under contract by other IBM units. These assets, primarily for Global Services, generate long-term, stable revenue streams similar to the Global Financing asset portfolio. Based on their nature, these Global Services assets are leveraged with the balance of the Global Financing asset base. The debt analysis on page 35 is further detailed in the Global Financing section on page 57.

 

Total debt decreased $1,177 million in 2008 versus 2007, primarily due to reductions in commercial paper. The debt-to-capital ratio at December 31, 2008 was 49.0 percent, an increase of 19.0 points from December 31, 2007, primarily due to the reduction in equity driven by the pension remeasurements.

 

EQUITY

 

($ IN MILLIONS)

 

 

 

 

 

 

 

At December 31:

 

 

 

2008

 

2007

 

Stockholders’ equity

 

 

 

 

 

 

 

TOTAL

 

 

 

$

13,465

 

$

28,470

 

 

The company’s consolidated stockholders’ equity decreased $15,004 million in 2008 as a result of several key factors:

 

·                  A decrease of $18,431 million in accumulated gains and (losses) not affecting retained earnings resulted from non-cash equity impacts, primarily from pension remeasurement and other retirement-related activities ($14,856 million), and a decrease in foreign currency translation adjustments ($3,552 million); and

 

·                  A decrease related to net stock transactions of $6,286 million, driven by common stock repurchases;

 

Partially offset by:

 

·                  An increase of $9,713 million in retained earnings primarily driven by net income of $12,334 million, partially offset by dividends ($2,585 million).

 

CONSOLIDATED FOURTH-QUARTER RESULTS

 

 

 

 

 

 

 

Yr.-to-Yr.
Percent/

 

($ AND SHARES IN MILLIONS EXCEPT PER SHARE AMOUNTS)

 

 

 

 

 

Margin

 

For the fourth quarter:

 

2008

 

2007

 

Change

 

Revenue

 

$

27,006

 

$

28,866

 

(6.4

)%*

Gross profit margin

 

47.9

%

44.9

%

3.0

pts.

Total expense and other income

 

$

7,127

 

$

7,481

 

(4.7

)%

Total expense and other income-to-revenue ratio

 

26.4

%

25.9

%

0.5

pts.

Income from continuing operations before income taxes

 

$

5,808

 

$

5,489

 

5.8

%

Provision for income taxes

 

1,382

 

1,537

 

(10.1

)%

Income from continuing operations

 

4,427

 

3,951

 

12.0

%

Income from discontinued operations

 

 

1

 

NM

 

Net income

 

$

4,427

 

$

3,952

 

12.0

%

Net income margin

 

16.4

%

13.7

%

2.7

pts.

Earnings per share of common stock:

 

 

 

 

 

 

 

Assuming dilution:

 

 

 

 

 

 

 

Continuing operations

 

$

3.28

 

$

2.80

 

17.1

%

Discontinued operations

 

 

0.00

 

NM

 

Total

 

$

3.28

 

$

2.80

 

17.1

%

Weighted-average shares outstanding:

 

 

 

 

 

 

 

Assuming dilution

 

1,347.9

 

1,412.9

 

(4.6

)%


* (1.0) percent adjusted for currency.

NM – Not meaningful

 

Continuing Operations

 

In the fourth quarter, in an increasingly challenging economic environment, the company delivered solid financial results. Total revenue decreased 6.4 percent as reported, 1.0 percent adjusted for currency, versus the fourth quarter of 2007. Gross margin improved 3.0 points driven by margin expansion in Global Services and Software. This improvement in gross margin coupled with focused expense management drove an improvement year to year in pre-tax income of 5.8 percent. A lower tax rate versus the prior year, primarily driven by the utilization of tax credits, resulted in a 12.0 percent increase in net income. Diluted earning per share of $3.28 increased 17.1 percent year to year.

 

Management Discussion

 

18

ROAD MAP

 

18

FORWARD-LOOKING AND CAUTIONARY STATEMENTS

 

18

MANAGEMENT DISCUSSION SNAPSHOT

 

19

DESCRIPTION OF BUSINESS

 

20

YEAR IN REVIEW

 

25

PRIOR YEAR IN REVIEW

 

39

DISCONTINUED OPERATIONS

 

44

OTHER INFORMATION

 

44

GLOBAL FINANCING

 

53

Report Of Management

 

58

Report Of Independent Registered Public Accounting Firm

 

59

Consolidated Statements

 

60

Notes

 

66

 

36



 

Fourth quarter revenue performance was impacted by currency and the changing economic environment, but the modest decline of 1.0 percent adjusted for currency reflects the company’s broad business capabilities and contribution from the annuity content of the business model. Adjusted for currency, revenue performance was led by growth in the Software and Global Services segments offset by a decline in Systems and Technology.

 

The Global Services segments combined had $14,333 million of revenue in the fourth quarter, a decrease of 4.0 percent (increase of 2 percent adjusted for currency) and delivered pre-tax profit of $2,177 million, an increase of 32.1 percent year to year. The services business performed exceptionally well in the current economic environment through disciplined execution on resource optimization and improved operating efficiencies, while at the same time delivering services with a high level of quality and customer satisfaction. Total signings for Global Services in the fourth quarter were $17,207 million, a decrease of 5 percent (increase of 2 percent adjusted for currency) versus the fourth quarter of 2007. Signings in the quarter included 24 deals larger than $100 million. Long-term signings of $9,900 million decreased 3 percent (increased 3 percent adjusted for currency) with a 20 percent growth in Strategic Outsourcing signings. Short-term signings decreased 7 percent (1 percent adjusted for currency) to $7,307 million, compared to a very strong fourth quarter of 2007.

 

GTS revenue of $9,623 million decreased 3.7 percent (increased 3 percent adjusted for currency) versus the fourth quarter of 2007. GTS signings of $11,045 million decreased 2 percent (increased 4 percent adjusted for currency) with long-term signings increasing 4 percent (9 percent adjusted for currency) to $8,221 million, offset by a 15 percent decrease (7 percent adjusted for currency) in short-term signings. SO revenue decreased 3.2 percent (increased 3 percent adjusted for currency). SO signings increased 20 percent (23 percent adjusted for currency) led by strong signings in the U.S. and Europe as clients turn to outsourcing’s value proposition as an effective way to attain their financial objectives in this economic climate. ITS revenue increased 0.2 percent (6 percent adjusted for currency). ITS signings decreased 15 percent (7 percent adjusted for currency), although signings in the key infrastructure offerings continued to be good. BTO revenue decreased 19.0 percent (11 percent adjusted for currency) and signings decreased 53 percent (44 percent adjusted for currency). GTS gross profit increased 11.8 percent in the quarter and the gross margin improved 4.8 points with margin expansion in all lines of business. The GTS segment fourth-quarter pre-tax profit was up 35.5 percent and the margin improved 4.1 points to 14.4 percent from fourth-quarter 2007. This was the sixth consecutive quarter of double-digit pre-tax profit growth in GTS. The margin improvement was driven primarily by a delivery structure that maximizes utilization and flexibility, a mix to higher value offerings, lower total managed labor costs and a global skills mix that efficiently moves resources to opportunities.

 

GBS revenue of $4,709 million decreased 4.5 percent (flat adjusted for currency) compared to fourth-quarter 2007. In the current economy, offerings that deliver cost savings continued to drive the majority of business, although demand for transformational and compliance offerings also increased. GBS signings of $6,162 million, decreased 9 percent (3 percent adjusted for currency), driven by a 25 percent decline (16 percent adjusted for currency) in long-term signings. Short-term signings of $4,483 million decreased 1 percent (increased 4 percent adjusted for currency) in the quarter. Cost savings offerings accounted for the majority of the new signings. GBS gross profit increased 18.5 percent in the quarter with the gross margin improving 5.6 points. The GBS segment pre-tax profit increased 26.0 percent in the quarter and the margin expanded 3.6 points to 14.9 percent. The margin performance reflects a strong operating discipline and the benefits of a globally integrated operating model. Despite slower revenue growth, utilization improved year to year resulting from resource optimization throughout the globally integrated capacity model as well as effective balancing of domestic, global and subcontracted resources. GBS also benefited from continued deal selectivity, stable pricing, lower managed labor costs and ongoing operational efficiencies.

 

Software segment revenue of $6,420 million, increased 2.6 percent (9 percent adjusted for currency), driven by solid sales execution and growth in mission critical production software. Customers continue to utilize infrastructure software in their production environments to optimize their data centers. Many large customers signed multi-year deals in the fourth quarter demonstrating continued commitment to the company’s technology. Revenue growth was led by Americas with an increase of 13 percent, adjusted for currency. Revenue from Key Branded Middleware increased 6.2 percent (13 percent adjusted for currency) and represented 61 percent of total software revenue. Revenue from the WebSphere Family of products declined 0.9 percent (increased 5 percent adjusted for currency) in the quarter. Information Management revenue increased 17.9 percent (25 percent adjusted for currency) driven by contribution from Cognos as well as organic growth. Revenue from Distributed Relational Database products increased over 30 percent, adjusted for currency. Lotus revenue decreased 0.5 percent (increased 6 percent adjusted for currency) capitalizing on the strong performance of collaboration software. Tivoli software revenue decreased 3.8 percent (increased 4 percent adjusted for currency). Rational revenue decreased 1.3 percent (increased 5 percent adjusted for currency) compared to a strong fourth-quarter 2007 with revenue performance led by Telelogic.

 

Software gross profit increased 3.3 percent with margin improvement of 0.6 points. The Software segment delivered pre-tax profit of $2,789 million, an increase of 14.6 percent. The pre-tax margin of 39.1 percent increased 4.2 points compared to fourth-quarter 2007. The large annuity base in the software business continues to provide a predictable and growing stream of profit and cash.

 

37



 

Systems and Technology segment revenue was $5,425 million, a decrease of 20.2 percent (16 percent adjusted for currency), reflecting growth in high-end servers offset by a decline in x86 and storage products. System z revenue decreased 5.9 percent (increased 1 percent adjusted for currency). Adjusted for currency, revenue performance was led by double-digit growth in the Americas and strong growth in the Financial Services and Industrial sectors globally. System z continues to perform well due to its ability to consolidate multiple workloads onto a single, virtualized platform. System z MIPS shipments increased 12 percent year to year. This was the fourth consecutive quarter of double-digit MIPS growth. Converged System p revenue grew 8.0 percent (14 percent adjusted for currency), driven by strong growth in both high-end and midrange servers. This was the tenth consecutive quarter of revenue growth for Converged System p. System x revenue decreased 33.0 percent (29 percent adjusted for currency) reflecting a significant slowdown in the industry-standard x86 market as customers are virtualizing and consolidating workloads onto more efficient platforms such as POWER and mainframe. System x server revenue declined 32 percent (28 percent adjusted for currency) with blades down 27 percent (23 percent adjusted for currency). Legacy System i revenue decreased 91.6 percent (91 percent adjusted for currency) as the company continues to transition the System i customer base to the converged POWER platform within System p. Systems Storage revenue decreased 19.9 percent (16 percent adjusted for currency) driven by revenue declines in total disk and total tape products. Retail Store Solutions revenue decreased 27.8 percent (22 percent adjusted for currency) and Microelectronics OEM revenue declined 34.3 percent.

 

Systems and Technology gross margin of 39.9 percent, declined 5.8 points versus the fourth quarter of 2007 driven by margin declines in all system brands and Microelectronics OEM; partially offsetting these margin declines was a revenue mix benefit due to a shift in revenue toward System z and converged System p. Systems and Technology segment pre-tax profit decreased 47.1 percent to $722 million. Pre-tax margin declined 6.7 points to 12.7 percent compared to the fourth quarter of 2007.

 

Global Financing revenue of $660 million decreased 1.3 percent (increased 5 percent adjusted for currency). Increased financing revenue was more than offset by a decline in sales of used equipment.

 

Geographic revenue decreased 5.6 percent (flat adjusted for currency) with mixed performance by geography. Adjusted for currency, Americas had the strongest performance with Europe and Asia both declining year to year. Globally, revenue in the major markets decreased 5.3 percent (1 percent adjusted for currency) while revenue from the company’s growth markets organization decreased 7.1 percent (increased 6 percent adjusted for currency). Americas revenue was $11,454 million, a decrease of 1.9 percent (increase of 2 percent adjusted for currency). Adjusted for currency, Latin America was up 12 percent, Canada was up 6 percent and the U.S. was flat. EMEA revenue decreased 12.2 percent (1 percent adjusted for currency) to $9,468 million. Revenue performance in the major countries was mixed when adjusted for currency, with Germany up 7 percent, the U.K. up 4 percent, France grew 2 percent while Italy declined 8 percent. Asia Pacific revenue decreased 0.7 percent (1 percent adjusted for currency) to $5,469 million, with growth in the India, Australia/ New Zealand, and South Korea regions, being more than offset by declining revenue in Japan. The company has been investing heavily in the emerging markets to capture opportunities to build out public and private infrastructures. Additionally, these markets benefited in the quarter from customer demand for cost saving offerings during the current economic environment. Revenue from these markets represented 18 percent of the company’s geographic revenue in the quarter and increased 6 percent, adjusted for currency. The BRIC countries, a subset of the growth markets, together grew 1.6 percent (13 percent adjusted for currency) led by double-digit growth in Brazil and India, adjusted for currency. Russia revenue was significantly impacted by credit limitations and declined 22 percent in the fourth quarter.

 

Revenue from the company’s industry sales units decreased 5.7 percent (flat adjusted for currency) in the fourth quarter of 2008. Public sector revenue decreased 0.8 percent (increased 5 percent adjusted for currency) with strength in government and with education returning to growth, when adjusted for currency. In the growth markets, clients are investing in education as a way to develop national skill sets. Industrial sector revenue decreased 8.0 percent (5 percent adjusted for currency) as concerns with the credit markets and margin pressures continued. Financial Services sector revenue declined 5.8 percent (1 percent adjusted for currency) and was in line with the company’s overall performance for the fifth consecutive quarter. The U.S. financial services sector revenue was up 4 percent and improved significantly from the third quarter. Growth was driven by banking and financial markets reflecting strong performance in software, System z and POWER products. Partially offsetting the U.S. growth was weakness in Japan and Europe as the economic climate worsened. Revenue from small and medium business clients declined 8.6 percent (3 percent adjusted for currency) although services signings in this customer set increased 10 percent versus the fourth quarter of 2007.

 

Management Discussion

 

18

ROAD MAP

 

18

FORWARD-LOOKING AND CAUTIONARY STATEMENTS

 

18

MANAGEMENT DISCUSSION SNAPSHOT

 

19

DESCRIPTION OF BUSINESS

 

20

YEAR IN REVIEW

 

25

PRIOR YEAR IN REVIEW

 

39

DISCONTINUED OPERATIONS

 

44

OTHER INFORMATION

 

44

GLOBAL FINANCING

 

53

Report Of Management

 

58

Report Of Independent Registered Public Accounting Firm

 

59

Consolidated Statements

 

60

Notes

 

66

 

38



 

Total expense and other income decreased 4.7 percent compared to the fourth quarter of 2007. The decrease was driven by approximately 8 points due to the effects of currency, partially offset by 6 points due to the impact of acquisitions with the remainder attributed to lower operational expenses. The company continues to focus on structural changes that reduce spending and improve productivity. Within selling, general and administrative expense, workforce reduction charges increased approximately $380 million in the fourth quarter, reflecting workforce actions in Japan and other ongoing skills rebalancing. Other (income) and expense was $97 million of income, a decrease of 1.5 percent compared to fourth-quarter 2007. Interest income was down approximately $120 million reflecting the current interest rate environment. While the effects of foreign currency transaction losses also negatively impacted other (income) and expense in the fourth quarter, they were partially offset by a benefit from the impact of the company’s hedging programs, which was a gain in the fourth quarter of 2008 compared to a loss in the prior year.

 

The company’s effective tax rate in the fourth-quarter 2008 was 23.8 percent compared with 28.0 percent in the fourth quarter of 2007. The 4.2 point decrease in the fourth-quarter 2008 tax rate was primarily attributable to the net effect of several items in the quarter. In 2008, the fourth-quarter tax rate was favorably impacted by the net increase in the utilization of foreign and state tax credits as well as the retroactive reinstatement of the U.S. research tax credit in the fourth quarter of 2008. These benefits were partially offset by the net tax cost related to the completion of the U.S. federal income tax examination for the years 2004 and 2005 including the associated income tax reserve redeterminations.

 

Share repurchases totaled $604 million in the fourth quarter. The weighted-average number of diluted common shares outstanding in the fourth quarter of 2008 was 1,347.9 million compared with 1,412.9 million in the fourth quarter of 2007.

 

The company ended the quarter with $12,741 million of cash and cash equivalents and generated $6,621 million in cash flow provided by operating activities driven primarily by net income. Net cash from investing activities was a use of cash of $880 million in fourth quarter of 2008 versus a source of cash of $1,098 million in the fourth quarter of 2007, resulting primarily from the disposition of higher levels of short-term marketable securities in 2007.

 

Prior Year in Review

 

The Prior Year in Review section provides a summary of the company’s financial performance in 2007 as compared to 2006. For a detailed discussion of 2007 performance, see the company’s 2007 Annual Report.

 

 

 

 

 

 

 

Yr.-to-Yr.

 

 

 

 

 

 

 

Percent/

 

($ AND SHARES IN MILLIONS EXCEPT PER SHARE AMOUNTS)

 

 

 

 

 

Margin

 

For the year ended December 31:

 

2007

 

2006

 

Change

 

Revenue

 

$

98,786

 

$

91,424

 

8.1

%*

Gross profit margin

 

42.2

%

41.9

%

0.4

pts.

Total expense and other income

 

$

27,240

 

$

24,978

 

9.1

%

Total expense and other income-to-revenue ratio

 

27.6

%

27.3

%

0.3

pts.

Income from continuing operations before income taxes

 

$

14,489

 

$

13,317

 

8.8

%

Provision for income taxes

 

4,071

 

3,901

 

4.4

%

Income from continuing operations

 

10,418

 

9,416

 

10.6

%

Income/(loss) from discontinued operations

 

 

76

 

NM

 

Net income

 

$

10,418

 

$

9,492

 

9.7

%

Net income margin

 

10.5

%

10.4

%

0.2

pts.

Earnings per share of common stock:

 

 

 

 

 

 

 

Assuming dilution:

 

 

 

 

 

 

 

Continuing operations

 

$

7.18

 

$

6.06

 

18.5

%

Discontinued operations

 

(0.00

)

0.05

 

NM

 

Total

 

$

7.18

 

$

6.11

 

17.5

%

Weighted-average shares outstanding:

 

 

 

 

 

 

 

Assuming dilution

 

1,450.6

 

1,553.5

 

(6.6

)%

Assets**

 

$

120,431

 

$

103,234

 

16.7

%

Liabilities**

 

$

91,962

 

$

74,728

 

23.1

%

Equity**

 

$

28,470

 

$

28,506

 

(0.1

)%


* 4.2 percent adjusted for currency.

** At December 31.

NM - Not meaningful

 

CONTINUING OPERATIONS

 

The company’s performance in 2007 reflected the strength of its global model. Revenue increased in all geographies, with strong growth in emerging markets worldwide. The company capitalized on the opportunities in the global economies, generating 63 percent of its revenue outside the United States, in delivering full-year growth of 8.1 percent (4 percent adjusted for currency).

 

Gross profit margins improved reflecting a shift to higher value offerings, continued benefits from productivity initiatives and the transformation to a globally integrated enterprise. Pre-tax income from continuing operations grew 8.8 percent and net income from continuing operations increased 10.6 percent versus 2006. Diluted earnings per share improved 18.5 percent, reflecting the strong growth in net income and the benefits of the common stock repurchase program. In 2007, the company repurchased approximately $18.8 billion of its common stock, including a $12.5 billion accelerated share repurchase in the second quarter.

 

39



 

The increase in 2007 revenue was primarily due to:

 

·                     Strong performance from Global Technology Services and Global Business Services with growth in all business lines;

 

·                     Continued strong demand in the Software business, driven by Key Branded Middleware products, with strong contributions from strategic acquisitions; and

 

·                     Continued growth in emerging countries (Brazil, Russia, India and China: up 26 percent) and solid performance in all geographies, led by Asia Pacific.

 

The increase in income from continuing operations before income taxes in 2007 was primarily due to the revenue growth and gross profit margin improvements in the Global Services and Systems and Technology segments.

 

The following is an analysis of the 2007 versus 2006 reportable segment results for Global Services, Systems and Technology and Software. The Global Financing segment analysis is included in the Global Financing section on pages 53 through 57.

 

Global Services

 

($ IN MILLIONS)

 

 

 

 

 

Yr.-to-Yr.

 

For the year ended December 31:

 

2007

 

2006

 

Change

 

GLOBAL SERVICES REVENUE:

 

$

54,144

 

$

48,291

 

12.1

%

Global Technology Services:

 

$

36,103

 

$

32,322

 

11.7

%

Strategic Outsourcing

 

18,701

 

17,044

 

9.7

 

Integrated Technology Services

 

8,438

 

7,448

 

13.3

 

Maintenance

 

6,670

 

5,986

 

11.4

 

Business Transformation Outsourcing

 

2,294

 

1,845

 

24.4

 

Global Business Services

 

$

18,041

 

$

15,969

 

13.0

%

 

The Global Services segments, GTS and GBS had combined revenue of $54,144 million, an increase of 12.1 percent (8 percent adjusted for currency) in 2007 when compared to 2006. Global Services signings at actual rates were $56.3 billion in 2007 as compared to $53.4 billion in 2006. The Global Services backlog was estimated to be $118 billion at December 31, 2007, versus $116 billion at December 31, 2006. The Global Services segments delivered combined pre-tax profit of $5,622 million, an increase of 12.6 percent.

 

GTS revenue increased 11.7 percent (7 percent adjusted for currency) in 2007 versus 2006. The strong performance reflected the extensive transformation which occurred in this business over the past few years. This transformation included revamping the entire ITS portfolio, continued improvement in SO delivery and a disciplined approach to driving new business in existing accounts. Total signings in GTS increased 7 percent (2 percent adjusted for currency). SO revenue was up 9.7 percent (5 percent adjusted for currency) with growth in all geographies, led by EMEA and Asia Pacific. Revenue growth benefited from prior-year signings, sales of new business in existing accounts, lower base contract erosion and good yield from 2007 signings. ITS revenue increased 13.3 percent (9 percent adjusted for currency). Revenue growth was driven primarily by increased signings and reflected the strength of the ITS portfolio worldwide. The revamped ITS portfolio includes ten Service Product Lines which complement hardware offerings from Systems and Technology and software offerings from the Software business. The acquisition of Internet Security Systems (ISS), in the fourth quarter of 2006, also contributed to the revenue growth. BTO revenue increased 24.4 percent (20 percent adjusted for currency), with double-digit growth in all geographies. Maintenance revenue increased 11.4 percent (7 percent adjusted for currency) driven primarily by increased availability services on non-IBM IT equipment. Services provided to InfoPrint Solutions, following the divestiture of the printer business in the second quarter of 2007, contributed 4 points of growth.

 

GBS revenue increased 13.0 percent (9 percent adjusted for currency) with balanced growth across all three geographies. Revenue performance was led by double-digit growth in application management services offerings and growth in all consulting service lines. Total signings in GBS increased 3 percent (1 percent adjusted for currency), led by growth in shorter term signings.

 

($ IN MILLIONS)

 

 

 

 

 

Yr.-to-Yr.

 

For the year ended December 31:

 

2007

 

2006

 

Change

 

GLOBAL SERVICES GROSS PROFIT:

 

 

 

 

 

 

 

Global Technology Services:

 

 

 

 

 

 

 

Gross profit

 

$

10,800

 

$

9,623

 

12.2

%

Gross profit margin

 

29.9

%

29.8

%

0.1

pts.

Global Business Services:

 

 

 

 

 

 

 

Gross profit

 

$

4,240

 

$

3,694

 

14.8

%

Gross profit margin

 

23.5

%

23.1

%

0.4

pts.

 

Management Discussion

18

 

ROAD MAP

18

 

FORWARD-LOOKING AND CAUTIONARY STATEMENTS

18

 

MANAGEMENT DISCUSSION SNAPSHOT

19

 

DESCRIPTION OF BUSINESS

20

 

YEAR IN REVIEW

25

 

PRIOR YEAR IN REVIEW

39

 

DISCONTINUED OPERATIONS

44

 

OTHER INFORMATION

44

 

GLOBAL FINANCING

53

 

Report Of Management

58

 

Report Of Independent Registered Public Accounting Firm

59

 

Consolidated Statements

60

 

Notes

66

 

 

40


 

GTS gross profit increased 12.2 percent with gross profit margin improving 0.1 points, driven primarily by margin expansion in SO, due to an improved cost structure, and ITS, which benefited from a mix to higher value offerings. Segment pre-tax profit increased 8.2 percent to $3,557 million with a pre-tax margin of 9.4 percent, a decline of 0.2 points. Increased investments in sales and delivery, acquisitions and workforce reduction charges were essentially offset by productivity improvements and effective expense management.

 

GBS gross profit increased 14.8 percent to $4,240 million and the gross profit margin improved 0.4 points. Segment pre-tax profit increased 21.0 percent to $2,064 million with a pre-tax margin of 10.7 percent, an improvement of 0.9 points. The margin expansion was driven primarily by revenue growth, ongoing productivity and utilization initiatives and expense management.

 

Software

 

($ IN MILLIONS)

 

 

 

 

 

Yr.-to-Yr.

 

For the year ended December 31:

 

2007

 

2006*

 

Change

 

SOFTWARE REVENUE:

 

$

19,982

 

$

18,161

 

10.0

%

Middleware:

 

$

15,505

 

$

13,891

 

11.6

%

Key Branded Middleware

 

10,827

 

9,373

 

15.5

 

WebSphere Family

 

 

 

 

 

19.1

 

Information Management

 

 

 

 

 

14.7

 

Lotus

 

 

 

 

 

8.7

 

Tivoli

 

 

 

 

 

18.0

 

Rational

 

 

 

 

 

13.7

 

Other middleware

 

4,678

 

4,518

 

3.5

 

Operating systems

 

2,319

 

2,273

 

2.0

 

Product Lifecycle Management

 

1,051

 

1,123

 

(6.4

)

Other

 

1,107

 

874

 

26.7

 


* Reclassified to conform with 2007 presentation.

 

Software segment revenue of $19,982 million increased 10.0 percent (6 percent adjusted for currency) in 2007 reflecting strong demand for the Key Branded Middleware products. Revenue performance was led by double-digit growth in the Financial Services, Public and Small and Medium Business sectors.

 

Key Branded Middleware revenue was $10,827 million, up 15.5 percent (11 percent adjusted for currency) and increased 3 points to 54 percent of total software segment revenue.

 

WebSphere Family revenue increased 19.1 percent (14 percent adjusted for currency) and was led by double-digit growth in WebSphere Application Servers and WebSphere Business Integration software. The strong revenue performance reflected the industry’s adoption of SOA. Information Management revenue increased 14.7 percent (10 percent adjusted for currency) in 2007 versus the prior year. The acquisition of FileNet, in the fourth quarter of 2006, contributed strong revenue growth throughout the year. Lotus revenue increased 8.7 percent (4 percent adjusted for currency) in 2007 driven by the Notes/Domino family of products. Lotus Connections, released in the second quarter of 2007, was rapidly adopted by customers. The latest version of Lotus Notes, Lotus Notes 8.0, was delivered in the third quarter of 2007. Revenue from Tivoli software increased 18.0 percent (13 percent adjusted for currency) with double-digit growth in each segment of the portfolio: Systems Management, Security and Storage. The acquisitions of MRO, in the fourth quarter of 2006, and Vallent and Consul, in the first quarter of 2007, also contributed to the brand’s revenue growth. Rational revenue increased 13.7 percent (9 percent adjusted for currency) in 2007 which reflected strong customer acceptance of its integrated product set.

 

Revenue from Other middleware products increased 3.5 percent (flat adjusted for currency) in 2007 versus the prior year. This software product set includes mature products which provide a more stable flow of revenue.

 

Operating systems revenue increased 2.0 percent (decreased 2 percent adjusted for currency) in 2007 versus 2006. Product Lifecycle Management (PLM) revenue decreased 6.4 percent (11 percent adjusted for currency) driven by declines in the Small and Medium Business sector. Other software segment revenue increased 26.7 percent (22 percent adjusted for currency) reflecting growth in software-related services, such as consulting and education.

 

($ IN MILLIONS)

 

 

 

 

 

Yr.-to-Yr.

 

For the year ended December 31:

 

2007

 

2006

 

Change

 

SOFTWARE GROSS PROFIT: