EX-13 3 a2206744zex-13.htm EX-13

Exhibit 13

 

Report of Financials

International Business Machines Corporation and Subsidiary Companies

 

Management Discussion

 

 

 

Overview

18

Forward-Looking and Cautionary Statements

18

Management Discussion Snapshot

19

Description of Business

20

Year in Review

26

Prior Year in Review

44

Other Information

55

Looking Forward

55

Liquidity and Capital Resources

56

Critical Accounting Estimates

58

Currency Rate Fluctuations

61

Market Risk

61

Financing Risks

62

Employees and Related Workforce

63

Global Financing

63

 

 

Report of Management

68

 

 

Report of Independent Registered Public Accounting Firm

69

 

 

Consolidated Financial Statements

 

 

 

Earnings

70

Comprehensive Income

71

Financial Position

72

Cash Flows

73

Changes in Equity

74

 

 

Notes to Consolidated Financial Statements

 

 

 

 

A

Significant Accounting Policies

76

B

Accounting Changes

86

C

Acquisitions/Divestitures

89

D

Financial Instruments

93

E

Inventories

100

F

Financing Receivables

101

G

Property, Plant and Equipment

104

H

Investments and Sundry Assets

104

I

Intangible Assets Including Goodwill

105

J

Borrowings

106

K

Other Liabilities

108

L

Equity Activity

110

M

Contingencies and Commitments

112

N

Taxes

115

O

Research, Development and Engineering

117

P

Earnings Per Share of Common Stock

117

Q

Rental Expense and Lease Commitments

118

R

Stock-Based Compensation

118

S

Retirement-Related Benefits

121

T

Segment Information

135

U

Subsequent Events

139

 

 

 

Five-Year Comparison of Selected Financial Data

140

 

 

Selected Quarterly Data

141

 

 

Performance Graphs

142

 

 

Board of Directors and Senior Leadership

144

 

 

Stockholder Information

145

 

17


 

Management Discussion

International Business Machines Corporation and Subsidiary Companies

 

Overview

 

The financial section of the International Business Machines Corporation (IBM or the company) 2011 Annual Report includes the Management Discussion, the Consolidated Financial Statements and the Notes to the Consolidated Financial Statements. This Overview 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 an overview of the business and a narrative on the company’s financial results and certain factors that may affect its 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 2011.

 

·                  Beginning with the “Year in Review” on page 26, the Management Discussion contains the results of operations for each reportable segment of the business and a discussion of the company’s financial position and cash flows. Other key sections within the Management Discussion include: “Looking Forward” on page 55, and “Liquidity and Capital Resources” on pages 56 to 58. It is useful to read the Management Discussion in conjunction with note T, “Segment Information,” on pages 135 to 139.

 

·                  Global Financing is a reportable segment that is measured as a stand-alone entity. A separate “Global Financing” section is included beginning on page 63.

 

·                  The Consolidated Financial Statements are presented on pages 70 through 75. 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 76 to 86), acquisitions and divestitures (pages 89 to 93), detailed information on specific items within the financial statements, certain contingencies and commitments (pages 112 to 115) and retirement-related benefits information (pages 121 to 135).

 

·                  The Consolidated Financial Statements and the Notes have been prepared in accordance with accounting principles generally accepted in the United States (GAAP).

 

·                  The references to “adjusted for currency” or “at constant currency” in the Management Discussion do not include operational impacts that could result from fluctuations in foreign currency rates. Certain financial results are adjusted based on a simple mathematical model that translates current period results in local currency using the comparable prior year period’s currency conversion rate. This approach is used for countries where the functional currency is the local country currency. This information is provided so that certain financial results can be viewed without the impact of fluctuations in foreign currency rates, thereby facilitating period-to-period comparisons of business performance. See “Currency Rate Fluctuations” on page 61 for additional information.

 

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

 

Operating (non-GAAP) Earnings

 

In an effort to provide better transparency into the operational results of the business, the company separated business results into operating and non-operating categories beginning January 1, 2011. Operating earnings is a non-GAAP measure that excludes the effects of certain acquisition-related charges and retirement-related costs, and their related tax impacts. For acquisitions, operating earnings exclude the amortization of purchased intangible assets and acquisition-related charges such as in-process research and development, transaction costs, applicable restructuring and related expenses and tax charges related to acquisition integration. For retirement-related costs, the company has characterized certain items as operating and others as non-operating. The company includes defined benefit plan and nonpension postretirement benefit plan service cost, amortization of prior service cost and the cost of defined contribution plans in operating earnings. Non-operating retirement-related cost includes defined benefit plan and nonpension postretirement benefit plan interest cost, expected return on plan assets, amortized actuarial gains/losses, the impacts of any plan curtailments/settlements and multi-employer plan costs, pension insolvency costs and other costs. Non-operating costs are primarily related to changes in pension plan assets and liabilities which are tied to financial market performance and the company considers these costs to be outside the operational performance of the business.

 

Overall, the company believes that providing investors with a view of operating earnings as described above provides increased transparency and clarity into both the operational results of the business and the performance of the company’s pension plans; improves visibility to management decisions and their impacts on operational performance; enables better comparison to peer companies; and allows the company to provide a long-term strategic view of the business going forward. For its 2015 earnings per share Road Map, the company is utilizing an operating view to establish its objectives and track its progress. Effective January 1, 2011, the company’s segment financial results and performance reflect operating earnings, consistent with the company’s management and measurement system. The 2010 and 2009 financial results in this Annual Report have been reclassified to conform with the 2011 presentation of business results into operating and non-operating categories.

 

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. Any forward-looking statement in this Annual Report speaks only as of the date on which it is made; the company assumes no obligation to update or revise any such

 

18


 

statements. Forward-looking statements are based on the company’s current assumptions regarding future business and financial performance; these statements by their nature address matters that are uncertain to different degrees. Forward-looking 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 2011 Form 10-K filed on February 28, 2012.

 

Management Discussion Snapshot

 

($ and shares in millions except per share amounts)

 

For the year ended December 31:

 

2011

 

2010

 

Yr.-to-Yr.
Percent/
Margin
Change

 

Revenue

 

$

106,916

 

$

99,870

 

7.1

%*

Gross profit margin

 

46.9

%

46.1

%

0.8

pts.

Total expense and other income

 

$

29,135

 

$

26,291

 

10.8

%

Total expense and other income-to-revenue ratio

 

27.3

%

26.3

%

0.9

pts.

Income before income taxes

 

$

21,003

 

$

19,723

 

6.5

%

Provision for income taxes

 

5,148

 

4,890

 

5.3

%

Net income

 

$

15,855

 

$

14,833

 

6.9

%

Net income margin

 

14.8

%

14.9

%

0.0

pts.

Earnings per share of common stock

 

 

 

 

 

 

 

Assuming dilution

 

$

13.06

 

$

11.52

 

13.4

%

Weighted-average shares outstanding

 

 

 

 

 

 

 

Assuming dilution

 

1,213.8

 

1,287.4

 

(5.7

)%

Assets**

 

$

116,433

 

$

113,452

 

2.6

%

Liabilities**

 

$

96,197

 

$

90,279

 

6.6

%

Equity**

 

$

20,236

 

$

23,172

 

(12.7

)%

 

*      3.4 percent adjusted for currency.

**   At December 31.

 

The following table provides the company’s operating (non-GAAP) earnings for 2011 and 2010.

 

($ in millions except per share amounts)

 

For the year ended December 31:

 

2011

 

2010

 

Yr.-to-Yr.
Percent
Change

 

Net income as reported

 

$

15,855

 

$

14,833

 

6.9

%

Non-operating adjustments (net of tax)

 

 

 

 

 

 

 

Acquisition-related charges

 

495

 

443

 

12.0

 

Non-operating retirement-related costs/(income)

 

(32

)

(253

)

(87.3

)

Operating (non-GAAP) earnings*

 

$

16,318

 

$

15,023

 

8.6

%

Diluted operating (non-GAAP) earnings per share

 

$

13.44

 

$

11.67

 

15.2

%

 

* See page 38 for a more detailed reconciliation of net income to operating earnings.

 

In 2011, the company delivered strong financial results highlighted by solid revenue performance, continued margin expansion, strong profit and cash generation and effective use of cash. In its centennial year, the company achieved record levels of revenue, profit, free cash flow and earnings per share (EPS). The financial performance is the result of the transformation of the company which began years ago. This transformation has been focused on shifting the business to higher value areas of the market, improving productivity and investing in opportunities to drive future growth. These changes have contributed to nine consecutive years of double-digit earnings per share growth. More importantly, this transformation has strengthened the business and put the company on track to achieve its 2015 Road Map objective of at least $20 of operating (non-GAAP) earnings per share.

 

The focus on key growth initiatives and investments in innovation are enabling the company to expand into new markets and capitalize on trends like business analytics and cloud computing. The growth markets strategy to expand into new markets, build out IT infrastructures and lead in specific industries is driving strong performance and market share gains. Growth markets revenue increased 16.0 percent (11 percent adjusted for currency) in 2011 contributing approximately two-thirds of the total constant currency revenue growth for the year and represented 22 percent of total geographic revenue. The company’s business analytics solutions helps clients leverage massive amounts of data and content to gain business insight and optimize results. Business analytics revenue increased 16 percent compared to 2010. The Smarter Planet offerings generated close to 50 percent growth year to year, with Smarter Commerce demonstrating strong market momentum. In cloud computing, the company is helping its clients improve the economics of information technology. In 2011, the company continued to expand its offerings and cloud revenue for the year was more than three times the prior year results. With strong contribution from these growth initiatives, the company delivered revenue growth of 7.1 percent (3 percent adjusted for currency) compared to 2010.

 

Segment performance was led by Software which increased revenue 10.9 percent (8 percent adjusted for currency) driven by key branded middleware which increased 15.6 percent (13 percent adjusted for currency) and continued to extend its lead in the middleware market. In the Global Services business, Global Technology Services increased 7.0 percent (3 percent adjusted for currency) and Global Business Services grew revenue 5.8 percent (1 percent adjusted for currency) driven by strong performance in the growth markets where both segments grew revenue 11 percent at constant currency. Systems and Technology delivered revenue growth of 5.6 percent (3 percent adjusted for currency) driven by strong performance in Power Systems which increased 12.0 percent (9 percent adjusted for currency) and the growth markets which increased 14.9 percent (12 percent adjusted for currency).

 

The consolidated gross profit margin increased 0.8 points versus 2010 to 46.9 percent. This was the eighth consecutive year of improvement in the gross profit margin. The operating (non-GAAP) gross margin of 47.2 percent increased 1.1 points compared to the prior year. The increase in gross margin in 2011 was driven by margin improvements in Software, Systems and Technology and Global Services, and an improved revenue mix driven by Software.

 

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Total expense and other income increased 10.8 percent in 2011 versus the prior year. Total operating (non-GAAP) expense and other income increased 10.2 percent compared to the prior year. The year-to-year drivers for both categories were approximately:

 

·

Currency*

4 points

·

Acquisitions**

3 points

·

Base expense

3 points

 

* Reflects impacts of translation and hedging programs.

** Includes acquisitions completed in prior 12-month period.

 

Pre-tax income grew 6.5 percent and the pre-tax margin was 19.6 percent, a decrease of 0.1 points versus 2010. Net income increased 6.9 percent and the net income margin was 14.8 percent, flat versus 2010. The effective tax rate for 2011 was 24.5 percent, compared with 24.8 percent in the prior year. Operating (non-GAAP) pre-tax income grew 8.7 percent and the operating (non-GAAP) pre-tax margin was 20.2 percent, an increase of 0.3 points versus the prior year. Operating (non-GAAP) earnings increased 8.6 percent and the operating (non-GAAP) earnings margin of 15.3 percent increased 0.2 points versus the prior year. The operating (non-GAAP) effective tax rate was 24.5 percent versus 24.4 percent in 2010.

 

Diluted earnings per share improved 13.4 percent reflecting the growth in net income and the benefits of the common stock repurchase program. In 2011, the company repurchased approximately 89 million shares of its common stock. Diluted earnings per share of $13.06 increased $1.54 from the prior year. Operating (non-GAAP) diluted earnings per share of $13.44 increased $1.77 versus 2010 driven by the following factors:

 

·

Revenue increase at actual rates

 

$

0.82

 

 

·

Margin expansion

 

$

0.18

 

 

·

Common stock repurchases

 

$

0.77

 

 

 

At December 31, 2011, the company’s balance sheet and liquidity positions remain strong and are well positioned to support the company’s objectives. Cash and cash equivalents at year end was $11,922 million. Key drivers in the balance sheet and total cash flows are highlighted below.

 

Total assets increased $2,981 million ($4,636 million adjusted for currency) from December 31, 2010 driven by:

 

·                  Increases in total receivables ($1,564 million), cash and cash equivalents ($1,262 million), goodwill ($1,077 million) and prepaid expenses and other assets ($1,022 million), partially offset by

·                  Decreases in marketable securities ($990 million) and investments and sundry assets ($883 million).

 

Total liabilities increased $5,918 million ($6,324 million adjusted for currency) from December 31, 2010 driven by:

 

·                  Increases in total debt ($2,695 million), retirement and nonpension postretirement benefit obligations ($2,396 million), accounts payable ($713 million) and deferred income ($798 million), partially offset by

·                  Decreases in taxes ($903 million).

 

Total equity of $20,236 million decreased $2,937 million from December 31, 2010 as a result of:

 

·                  Increased treasury stock ($14,803 million) driven by share repurchases, pension adjustments ($2,448 million) and currency translation adjustments ($711 million), partially offset by

·                  Higher retained earnings ($12,326 million) and common stock ($2,711 million).

 

The company generated $19,846 million in cash flow from operations, an increase of $298 million compared to 2010, primarily driven by the increase in net income. Net cash used in investing activities of $4,396 million was $4,111 million lower than 2010, driven by less cash used for acquisitions ($4,111 million). Net cash used in financing activities of $13,696 million was $1,267 million higher, compared to 2010, primarily due to lower cash from common stock transactions ($991 million) and increased dividend payments ($296 million).

 

As a result of the strong cash performance, the company continued to invest in capital and acquisitions and delivered significant returns to its shareholders with over $18 billion in share repurchase and dividends in 2011.

 

The estimated Global Services backlog was $141 billion at December 31, 2011, down $2 billion (flat adjusted for currency) versus the prior year-end balance, and up $4 billion ($5 billion adjusted for currency), from September 30, 2011.

 

In January 2012, the company disclosed that it is expecting GAAP earnings of at least $14.16 and operating (non-GAAP) earnings of at least $14.85 per diluted share for the full year 2012.

 

For additional information and details, see the “Year in Review” section on pages 26 through 43.

 

Description of Business

 

Please refer to IBM’s Annual Report on Form 10-K filed with the SEC on February 28, 2012 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.

 

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Strategy

 

Despite the volatility of the information technology (IT) industry over the past decade, IBM has consistently delivered excellent performance, with a steady track record of sustained earnings per share growth. The company has shifted its business mix, exiting certain segments while increasing its presence in higher-value areas such as services, software and integrated solutions. As part of this shift, the company has acquired over 120 companies since 2000, complementing and scaling its portfolio of products and offerings.

 

IBM’s clear strategy has enabled steady results in core business areas, while expanding its offerings and addressable markets. The key tenets of this strategy are:

 

·                  Deliver value to enterprise clients through integrated business and IT innovation;

·                  Shift the business mix to higher-value areas; and

·                  Become the premier globally integrated enterprise

 

These priorities reflect a broad shift in client spending toward integrated solutions, as companies seek higher levels of business value from their IT investments. IBM has been able to deliver this enhanced client value thanks to its industry expertise, understanding of clients’ businesses and the breadth and depth of the company’s capabilities.

 

Consistent with this strategy IBM is leveraging its capabilities to build and expand strong positions in targeted growth areas. IBM’s growth initiatives include Smarter Planet, Growth Markets, Business Analytics and Optimization and Cloud Computing. Each initiative represents a significant growth opportunity with attractive profit margins for IBM.

 

Smarter Planet

 

Smarter Planet is IBM’s vision of a technology-enabled world that is more instrumented, interconnected, and intelligent than ever before, enabling people and organizations to tackle significant business and societal challenges. At the heart of this vision is the opportunity for meaningful innovation—exploring and extending the boundaries of businesses, industries and communities. It’s about helping the company’s clients become better at what they do for their clients. IBM’s strategy is to accelerate progress towards a “smarter planet” by equipping its clients with the advanced, integrated capabilities that they will need to thrive in this exciting new world that is unfolding before us—capabilities such as business analytics, business process management, social business and cloud computing.

 

Over the past year, IBM has steadily deepened its commitment to understanding and delivering on the promise of a smarter planet for its line of business and IT clients across a broad range of industries. An industry-based approach is central to the strategy, since every industry confronts a distinct set of challenges and opportunities in today’s constantly transforming world. Whether “smarter” means helping a hospital group to deliver improved health-care, a local government to ease traffic congestion, or a retail chain to execute a successful cross-channel campaign, IBM is aggressively developing and investing in a portfolio of industry solutions that will help these clients achieve their goals.

 

Two recently announced initiatives that are already driving significant value illustrate IBM’s deep commitment to building a smarter planet: Smarter Commerce and Smarter Cities. IBM’s Smarter Commerce model integrates and transforms how companies manage and adapt their buy, market, sell and service processes, placing the customer squarely at the center of their business. IBM’s Smarter Cities initiative enables local governments to make smarter decisions, anticipate issues and coordinate resources more effectively, and deliver citizen-centric services that underpin sustainable economic growth.

 

Growth Markets

 

The company has benefited from its investments over the past several years in growth markets. The focus now is on geographic expansion of IBM’s presence; on selected industries of the highest impact and opportunity; on countries’ build-out of infrastructure aligned with their national agendas; and on creating markets and new business models to serve the different requirements that exist in these emerging countries. The company’s efforts in developing new growth markets within the African continent is a good example of this focus. Many of these initiatives are leading edge, both in technologies and business models and are delivering both increased revenue and margin expansion.

 

In order to support this growth, IBM is continuing to invest significantly in these markets to expand capacity, to develop talent and to deepen its research and development (R&D) capabilities on the ground. At the same time, IBM continues to leverage talent across growth markets under its globally integrated enterprise model to the benefit of both its clients and the company globally.

 

Business Analytics and Optimization

 

Business Analytics and Optimization is core to achieving a Smarter Planet, helping leaders of this new information-centric and insight-driven world make better and faster business decisions. As the proliferation of “big data” continues from both structured and unstructured sources, IBM is helping organizations leverage analytics in new ways to address market uncertainty, complexity and volatility. These capabilities allow decision makers to identify patterns and gain deeper insights in a way that is unimaginable by other means. These insights give organizations the ability to anticipate and shape better outcomes so they can grow, retain and satisfy customers. They can now dynamically plan, forecast and align resources and manage risk, reduce fraud and ensure compliance. They can also leverage analytics to increase operational efficiency and agility.

 

IBM’s approach is to ensure customers have complete end-to-end solutions across industries and functional focus areas like sales, finance and risk. These solutions are designed to help organizations: develop an information and analytics strategy that flows from the business strategy; establish a strong information foundation; make analytics skills and capabilities pervasive; and create a culture that takes action on analytics. IBM continues to invest in its analytics capabilities to deliver real world solutions that its clients can put to work today. These ongoing investments in both organic development and new acquisitions are complemented by IBM’s focus on game-changing innovations like Watson, which is ushering in a new generation of probabilistic analytics that can dramatically improve

 

21

 

decision making through natural language processing, hypotheses generation and evidence-based learning. It is another unique example of just how far organizations can go with IBM analytics.

 

Cloud Computing

 

Cloud is a new model for consuming and delivering business and IT services. It can deliver significant economies of scale, enable higher qualities of service and even serve as a transformative platform for business innovation. From a business perspective, the promise of cloud computing lies in the ability to shape influential communities, launch product innovations and explore new business models with minimal time, cost and effort. From an IT perspective, the power of the model comes from harnessing vast stores of underutilized technology with highly efficient virtualization and management, consumer-style user interfaces and ubiquitous broadband.

 

IBM has already helped thousands of its clients adopt and leverage cloud computing through its broad portfolio of IBM SmartCloud products, solutions and services. Today, IBM delivers many line-of-business solutions via cloud-based hosting models, enabling rapid adoption and exploration of new capabilities that can drive significant business value for its clients and their customers. For developers and IT organizations seeking to leverage cloud computing, IBM can help build out private, on-premise cloud-based environments, provide security and integration services across private and hybrid cloud models, and/or offer its own cloud-based infrastructure and services, including advanced analytics, collaboration, and IT infrastructure such as virtual servers, storage and tools for testing software. Across IBM’s entire SmartCloud portfolio, the company offers expert consulting, breakthrough technologies and a portfolio of cloud-based services squarely focused on the requirements of the enterprise.

 

Business Model

 

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

 

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

 

The business model is resilient, adapting to the continuously changing market and economic environment. The company continues to divest certain businesses and strengthen its position through strategic organic investments and acquisitions in higher-value segments like business analytics, smarter planet and cloud computing. In addition, the company has transformed itself into a globally integrated enterprise which has improved overall productivity and is driving investment and expanding participation in the world’s fastest growing markets.

 

This business model, supported by the company’s financial model, has enabled the company to deliver strong earnings, cash flows and returns to shareholders over the long term.

 

Business Segments and Capabilities

 

The company’s major operations consists of five business segments: Global Technology Services, Global Business Services, Software, Systems and Technology and Global Financing.

 

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 systems, other suppliers’ products are also used if a client solution requires it. Approximately 60 percent of external Global Services segment revenue is annuity based, coming primarily from outsourcing and maintenance arrangements. The Global Services backlog provides a solid revenue base entering each year. 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 global scale, standardization and automation.

 

GTS Capabilities

 

Strategic Outsourcing Services: comprehensive IT outsourcing services dedicated to transforming clients’ existing infrastructures to consistently deliver improved quality, flexibility, risk management and financial value. The company integrates long-standing expertise in service management and technology with the ability to exploit the power of new technologies from IBM systems and software, such as cloud computing, analytics and virtualization, to deliver high performance, innovation and improved ability to achieve business objectives.

 

Global Process Services: a range of standardized through transformational offerings including processing platforms and business process outsourcing. These services deliver improved business results to clients through the strategic change and/or operation of the client’s business processes, applications and infrastructure.

 

Integrated Technology Services: project-based portfolio of services that enable clients to optimize their IT environments by driving efficiency, flexibility and productivity, while reducing costs. The standardized portfolio is built around key assets and patented software, and incorporates best practices and proven methodologies that ensure predictive quality of delivery, security and compliance.

 

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Maintenance: a complete line of support services from product maintenance through solution support to maintain and improve the availability of clients’ IT infrastructures.

 

GTS Services Delivery: responsible for the worldwide delivery of IBM’s technology- and process-based services. Operating within a globally integrated delivery model enables regional client-facing teams to utilize a global network of competencies and centers, providing industry-leading, standardized, integrated tools and processes. By leveraging insights and experience drawn from IBM’s global scale, skills and technology, with applied innovation from IBM Research, clients gain access to leading-edge, high-quality services with improved productivity, flexibility, cost and outcomes.

 

Global Business Services (GBS) primarily provides professional services and application management services, delivering business value and innovation to clients through solutions which leverage industry and business-process expertise while integrating the industry-leading portfolio of IBM and strategic partners, to define the upper end of client-valued services.

 

GBS Capabilities

 

Consulting and Systems Integration: delivery of value to clients through consulting services for Strategy and Transformation; Application Innovation Services; Enterprise Applications and Business Analytics and Optimization.

 

Application Management Services: application development, management, maintenance and support services for packaged software, as well as custom and legacy applications. Value is delivered through advanced capabilities in areas such as applications testing and modernization, cloud application security, the company’s highly differentiated globally integrated capability model, 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 to improve their business results, solve critical problems and gain competitive advantage within their industries. IBM middleware is designed on open standards, making it easier to integrate disparate business applications, developed by different methods and implemented at different times. 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. The remaining one-third relates to one-time charge (OTC) arrangements in which clients pay one, up-front payment for a perpetual license. Typically, the sale of OTC software includes one year of subscription and support. Clients can also purchase ongoing subscription and support after the first year, which includes unspecified product upgrades and technical support.

 

Software Capabilities

 

WebSphere Software: delivers capabilities that enable clients to integrate and manage business processes across their organizations with the flexibility and agility they need to respond to changing conditions quickly. With a services-oriented architecture (SOA), businesses can more easily link together their fragmented data and business processes to extract value from their existing technology. Smarter Commerce software enables seamless interaction between companies, their customers and suppliers throughout the business cycle, resulting in better customer experience, higher sales, lower inventories, better service levels and improved response times.

 

Information Management Software: enables clients to integrate, manage and use their information to gain business value and improve their outcomes. Solutions include advanced database management, enterprise content management, information integration, data warehousing, performance management business analytics and intelligence, as well as the emerging area of big data analytics.

 

Tivoli Software: helps clients manage their technology and business assets by providing visibility, control and automation across their organizations. With solutions for identity management, data security, storage management, cloud computing, enterprise mobility and the ability to provide automation and provisioning of the datacenter, Tivoli helps build the infrastructure needed to make the world’s systems—from transportation to water, energy and telecommunications—
run smarter.

 

Lotus Software: enables businesses to connect people and processes for more effective communication and increased productivity through collaboration, messaging and social networking software. By remaining at the forefront of collaboration tools, Lotus helps organizations reap the benefits of social networking and social business.

 

Rational Software: supports software development for both IT as well as complex and embedded system solutions with a suite of Collaborative Lifecycle Management products. Jazz, Rational’s technology platform, transforms the way people work together to build software, making software delivery more integrated and collaborative, while optimizing for successful business outcomes.

 

Security Systems Software: provides clients with a single security intelligence platform that aligns with their business objectives and enables them to more intelligently secure their enterprises by applying deep analytics to better identify and prevent vulnerabilities within traditional, cyber, cloud and mobile security.

 

Operating Systems: software that manages the fundamental processes that make computers run.

 

23


 

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

 

Systems and Technology Capabilities

 

Systems: a range of general purpose and integrated systems designed and optimized for specific business, public and scientific computing needs. These systems—System z, Power Systems and System x—are typically the core technology in data centers that provide required infrastructure for business and institutions. Also, these systems form the foundation for IBM’s integrated offerings, such as IBM Smart Analytics, IBM Netezza, IBM SmartCloud Entry and IBM BladeCenter for Cloud. IBM servers use both IBM and non-IBM microprocessor technology and operating systems. All IBM servers run Linux, a key open-source operating system.

 

Storage: data storage products and solutions that allow clients to retain and manage rapidly growing, complex volumes of digital information. These solutions address critical client requirements for information retention and archiving, security, compliance and storage optimization including data deduplication, availability and virtualization. The portfolio consists of a broad range of disk and tape storage systems and software, including the ultra-scalable disk storage system XIV.

 

Retail Store Solutions: provider of market leadership solutions that include hardware, software and services for the retail industry, including point-of-sale and self-service systems and peripherals. Solutions leverage industry standards and interfaces enabling efficient rollouts and superior integration.

 

Microelectronics: semiconductor design and manufacturing primarily for use in IBM systems and storage products as well as delivering semiconductors and related services to external clients.

 

Global Financing facilitates clients’ acquisition of IBM systems, software and services. Global Financing invests in financing assets, leverages with debt and manages the associated risks with the objective of generating consistently strong returns on equity. The primary focus on the company’s offerings and clients mitigates many of the risks normally associated with a financing company. Global Financing has the benefit of both a deep knowledge of its client base and a clear insight into the products and services that are being financed. This combination allows Global Financing to effectively manage two of the major risks (credit and residual value) that are normally associated with financing.

 

Global Financing Capabilities

 

Client Financing: lease and loan financing to end users and internal clients for terms generally between one and seven years. Internal financing is predominantly in support of Global Services’ long-term client service contracts. Global Financing also factors a selected portion of the company’s accounts receivable, primarily for cash management purposes. All internal financing arrangements are at arm’s-length rates and are based upon market conditions.

 

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

 

Remanufacturing and Remarketing: as equipment is returned at the conclusion of a lease transaction, these assets are refurbished and sold or leased to new or existing clients both externally and internally. Externally remarketed equipment revenue represents sales or leases to clients and resellers. Internally remarketed equipment revenue primarily represents used equipment that is sold or leased internally to Systems and Technology and Global Services. Systems and Technology may also sell the equipment that it purchases from Global Financing to external clients.

 

24


 

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

·                  Enterprise Transformation

·                  Integrated Supply Chain

 

Sales and Distribution

 

IBM has a significant global presence, operating in more than 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’ businesses 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.

 

Through its growth markets organization, the company continues to increase its focus on the emerging markets 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 G7 countries of Canada, France, Germany, Italy, Japan, the United States (U.S.) and the United Kingdom (U.K.) plus Austria, the Bahamas, Belgium, the Caribbean region, Cyprus, Denmark, Finland, Greece, Iceland, Ireland, Israel, Malta, the Netherlands, Norway, Portugal, Spain, Sweden and Switzerland.

 

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

·                  Distribution: Consumer Products, Retail, Travel and Transportation

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

·                  General Business: Mainly companies with fewer than 1,000 employees

 

Research, Development and Intellectual Property

 

IBM’s R&D operations differentiate the company from its competitors. IBM annually invests approximately $6 billion for R&D, focusing on high-growth, high-value opportunities.

 

IBM Research works with clients and IBM business units on near-term and mid-term innovations and solutions and, in many cases, qualifies new technologies to be transferred to IBM development organizations. It also explores the boundaries of science and technology—from nanotechnology, to systems, to analytics, to cloud, to IBM Watson, a computer system that applied advanced analytics to defeat the all-time champions on the television quiz show, Jeopardy!

 

In addition to producing world-class systems, software and technology products, IBM innovations also are a major differentiator in providing solutions for the company’s clients through its services businesses. IBM Research has the world’s largest mathematics department of any public company. This unit is actively involved with many of the company’s business analytics client engagements.

 

In 2011, the company once again was awarded more U.S. patents than any other company, the 19th consecutive year IBM has been the patent leader. IBM’s 6,180 patents in 2011 were the most U.S. patents ever awarded to one company in a single year; more than 70 percent of the patents IBM was issued in 2011 were for software and services.

 

The company continues to actively seek intellectual property protection for its innovations, while increasing emphasis on other initiatives designed to leverage its intellectual property leadership. 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 many of the patents owned by IBM have been and are being granted to others under reasonable terms and conditions.

 

Enterprise Transformation

 

A key element of the company’s strategy has been focused on becoming the premier globally integrated enterprise. The company has implemented a consistent set of processes and standards worldwide to reduce inefficiencies and improve collaboration. With its processes fully integrated, the company implemented a new operating model with work shared in global resource centers of excellence located where it made the most business sense. Since 2005, global integration has enabled the company to deliver over $6 billion in productivity and improve service quality, speed and risk management. The company has shifted resources toward building client relationships and employees skills, while positioning the company for new market opportunities. During this transformation, IBM pioneered this new operating model, changing from a classic “multinational,” with smaller versions of the parent

 

25


 

company replicated in countries around the world, to a global model with one set of processes, shared services and broadly distributed decision making.

 

The company has now embarked on the next generation of its transformation in which new capabilities and technologies like business analytics and cloud computing will drive performance. The proven principles of the globally integrated enterprise will be applied to all of the company’s spending to continue to drive additional productivity benefits in shared services, integrated operations and end-to-end process transformation.

 

Integrated Supply Chain

 

IBM spends approximately $35 billion annually through its supply chain, procuring materials and services globally. In addition, in 2011, the company managed approximately $20 billion in procurement spending for its clients through the Global Process Services organization. The supply, manufacturing and logistics and customer fulfillment operations are integrated in one operating unit that has optimized inventories over time. Simplifying and streamlining internal processes has improved sales force productivity and operational effectiveness and efficiency. Continuous improvements to supply chain resiliency against market-place changes and risks have been particularly valuable in maintaining continuity during natural disasters and other disruptive events that are occurring with increased frequency.

 

The company’s continuing efforts to derive business value from its own globally integrated supply chain 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.

 

Year in Review

 

Segment Details

 

The following is an analysis of the 2011 versus 2010 reportable segment results. The table below presents each reportable segment’s external revenue and gross margin results.

 

($ in millions)

 

For the year ended December 31:

 

2011

 

2010*

 

Yr.-to-Yr.
Percent/
Margin
Change

 

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

 

Revenue

 

 

 

 

 

 

 

 

 

Global Technology Services

 

$

40,879

 

$

38,201

 

7.0

%

2.7

%

Gross margin

 

35.0

%

34.5

%

0.5

pts.

 

 

Global Business Services

 

19,284

 

18,223

 

5.8

%

1.5

%

Gross margin

 

28.8

%

28.0

%

0.7

pts.

 

 

Software

 

24,944

 

22,485

 

10.9

%

8.0

%

Gross margin

 

88.5

%

87.9

%

0.5

pts.

 

 

Systems and Technology

 

18,985

 

17,973

 

5.6

%

3.2

%

Gross margin

 

39.8

%

38.1

%

1.6

pts.

 

 

Global Financing

 

2,102

 

2,238

 

(6.1

)%

(9.1

)%

Gross margin

 

49.8

%

51.3

%

(1.5)

pts.

 

 

Other

 

722

 

750

 

(3.8

)%

(6.3

)%

Gross margin

 

(54.5

)%

(8.6

)%

(45.9)

pts.

 

 

Total consolidated revenue

 

$

106,916

 

$

99,870

 

7.1

%

3.4

%

 

 

 

 

 

 

 

 

 

 

Total consolidated gross profit

 

$

50,138

 

$

46,014

 

9.0

%

 

 

Total consolidated gross margin

 

46.9

%

46.1

%

0.8

pts.

 

 

Non-operating adjustments

 

 

 

 

 

 

 

 

 

Amortization of acquired intangibles assets

 

340

 

260

 

30.8

%

 

 

Acquisition-related charges

 

1

 

0

 

NM

 

 

 

Retirement-related costs/(income)

 

2

 

(204

)

NM

 

 

 

Operating (non-GAAP) gross profit

 

$

50,481

 

$

46,070

 

9.6

%

 

 

Operating (non-GAAP) gross margin

 

47.2

%

46.1

%

1.1

pts.

 

 

 

* Reclassified to conform with 2011 presentation.

NM—Not meaningful

 

26

 

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

 

 

 

Revenue

 

Pre-tax Income*+

 

For the year ended December 31:

 

2011

 

2010

 

2011

 

2010

 

Global Technology Services

 

38.5

%

38.5

%

27.4

%

26.3

%

Global Business Services

 

18.2

 

18.4

 

13.1

 

12.2

 

Total Global Services

 

56.7

 

56.9

 

40.6

 

38.4

 

Software

 

23.5

 

22.7

 

43.5

 

45.2

 

Systems and Technology

 

17.9

 

18.1

 

7.1

 

7.0

 

Global Financing

 

2.0

 

2.3

 

8.8

 

9.4

 

Total

 

100.0

%

100.0

%

100.0

%

100.0

%

 

*  Segment pre-tax income includes transactions between segments that are intended to reflect an arm’s-length transfer price and excludes certain unallocated corporate items; see note T, “Segment Information,” on pages 135 to 139 for additional information.

+  Reclassified to conform with 2011 presentation.

 

The Product Lifecycle Management (PLM) transaction gain recorded in the first quarter of 2010 impacted the year-to-year results of the company’s reportable segments for 2011 compared to 2010. In addition, workforce rebalancing charges were incurred in every segment in the first quarter of both years. The PLM transaction gain ($591 million) was recorded in Software in the first quarter of 2010. In the segment analysis below and in the Global Financing analysis on pages 63 and 64, each segment’s pre-tax income and pre-tax margin for 2011 and 2010 is presented on an as-reported basis and on a basis normalized for these actions in both years to provide a better perspective of the underlying operational performance of the segments.

 

Global Services

 

The Global Services segments, Global Technology Services (GTS) and Global Business Services (GBS), delivered $60,163 million of revenue in 2011, an increase of 6.6 percent (2 percent adjusted for currency) compared to 2010. Services revenue performance, adjusted for currency, was consistent over the course of the year driven by stability in the backlog. Performance in 2011 was led by strength in the growth markets with total services revenue up 16.9 percent (11 percent adjusted for currency) and gross margin 2 points higher than in the major markets. The services segments also had good performance in the other key growth initiatives: cloud, business analytics and Smarter Planet. Total outsourcing revenue of $28,301 million, which includes GTS Outsourcing and GBS Application Management Services Outsourcing, increased 7.8 percent (3 percent adjusted for currency) and total transactional revenue of $24,348 million, which includes Consulting and Systems Integration within GBS and Integrated Technology Services within GTS, increased 6.2 percent (2 percent adjusted for currency) year to year.

 

($ in millions)

 

For the year ended December 31:

 

2011

 

2010*

 

Yr.-to-Yr.
Percent
Change

 

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

 

Global Services external revenue

 

$

60,163

 

$

56,424

 

6.6

%

2.3

%

Global Technology Services

 

$

40,879

 

$

38,201

 

7.0

%

2.7

%

Outsourcing

 

23,911

 

22,241

 

7.5

 

3.0

 

Integrated Technology Services

 

9,453

 

8,714

 

8.5

 

4.1

 

Maintenance

 

7,515

 

7,250

 

3.6

 

(0.2

)

Global Business Services

 

$

19,284

 

$

18,223

 

5.8

%

1.5

%

Outsourcing

 

4,390

 

4,007

 

9.5

 

4.8

 

Consulting and Systems Integration

 

14,895

 

14,216

 

4.8

 

0.5

 

 

* Reclassified to conform with 2011 presentation of Outsourcing and Consulting and Systems Integration revenue within GBS.

 

27


 

Global Technology Services revenue of $40,879 million increased 7.0 percent (3 percent adjusted for currency) in 2011 versus 2010. Revenue performance was led by the growth markets which were up 16.8 percent (11 percent adjusted for currency). GTS Outsourcing revenue increased 7.5 percent (3 percent adjusted for currency) in 2011 and gained share. Outsourcing performance in 2011 was driven by strength in the growth markets with revenue up 11 percent, adjusted for currency, as the outsourcing offerings are continuing to help clients build out their IT infrastructures. Integrated Technology Services (ITS) revenue increased 8.5 percent (4 percent adjusted for currency) in 2011 versus 2010, also led by the growth markets which increased 13 percent, adjusted for currency. Revenue growth year over year, adjusted for currency, in both GTS Outsourcing and ITS was relatively consistent over the course of the year.

 

Global Business Services revenue of $19,284 million increased 5.8 percent (1 percent adjusted for currency) in 2011 led by strength in the growth markets with revenue up 17.4 percent (11 percent adjusted for currency). Application Outsourcing revenue increased 9.5 percent (5 percent adjusted for currency) in 2011 year to year. Consulting and Systems Integration (C&SI), which includes Consulting, Application Management Services systems integration and the U.S. Federal business, grew revenue in 2011 4.8 percent (1 percent adjusted for currency). Both GBS lines of business had strong year-to-year performance in the growth markets with double-digit constant currency revenue growth. GBS was impacted in 2011 by revenue declines in Japan and in the Public Sector; excluding Japan and the Public Sector, total GBS revenue increased 11.9 percent in 2011 (8 percent adjusted for currency).

 

($ in millions)

 

For the year ended December 31:

 

2011

 

2010*

 

Yr.-to-Yr.
Percent/
Margin
Change

 

Global Services

 

 

 

 

 

 

 

Global Technology Services

 

 

 

 

 

 

 

External gross profit

 

$

14,320

 

$

13,194

 

8.5

%

External gross profit margin

 

35.0

%

34.5

%

0.5

pts.

Pre-tax income

 

$

6,284

 

$

5,499

 

14.3

%

Pre-tax margin

 

14.9

%

13.9

%

1.0

pts.

Pre-tax income—normalized**

 

$

6,399

 

$

5,771

 

10.9

%

Pre-tax margin—normalized

 

15.2

%

14.6

%

0.6

pts.

Global Business Services

 

 

 

 

 

 

 

External gross profit

 

$

5,545

 

$

5,106

 

8.6

%

External gross profit margin

 

28.8

%

28.0

%

0.7

pts.

Pre-tax income

 

$

3,006

 

$

2,546

 

18.1

%

Pre-tax margin

 

15.0

%

13.4

%

1.6

pts.

Pre-tax income—normalized+

 

$

3,052

 

$

2,674

 

14.1

%

Pre-tax margin—normalized

 

15.2

%

14.1

%

1.1

pts.

 

*    Reclassified to conform with 2011 presentation.

**  Excludes $116 million and $273 million of workforce rebalancing charges in the first quarter of 2011 and 2010, respectively.

+    Excludes $45 million and $128 million of workforce rebalancing charges in the first quarter of 2011 and 2010, respectively.

 

GTS gross profit increased 8.5 percent in 2011 and gross margin improved 0.5 points year to year. Margin expansion was driven by improved gross profit performance in all lines of business. Pre-tax income increased to $6,284 million in 2011 with a pre-tax margin of 14.9 percent. On a normalized basis, segment pre-tax income in 2011 increased 10.9 percent and margin expanded 0.6 points to 15.2 percent.

 

GBS gross profit increased 8.6 percent in 2011 and gross margin improved 0.7 points to 28.8 percent, led primarily by margin improvement in Application Management Services Outsourcing. GBS segment pre-tax income improved 18.1 percent to $3,006 million with a pre-tax margin of 15.0 percent. On a normalized basis, segment pre-tax income in 2011 increased 14.1 percent with a pre-tax margin of 15.2 percent, an increase of 1.1 points year to year.

 

Total Global Services segment pre-tax income was $9,290 million in 2011, an increase of $1,246 million or 15.5 percent year to year. The combined pre-tax margin in 2011 improved 1.2 points versus 2010. On a normalized basis, total Global Services pre-tax income in 2011 increased 11.9 percent with a pre-tax margin of 15.2 percent, up 0.8 points year to year. In 2011, the company established two Global Services integration hubs which will drive the business to a new level of global consistency, integration and standardization in the development and delivery of solutions to clients. Both Global Services segments had strong profit and margin performance in 2011 as they continue to mix to higher value offerings and markets, and continue to focus on productivity and cost management.

 

Global Services Backlog

 

The estimated Global Services backlog at December 31, 2011 was $141 billion, a decrease of $1.7 billion (flat adjusted for currency) compared to the December 31, 2010 balance, and an increase of $3.8 billion ($4.7 billion adjusted for currency) compared to the September 30, 2011 balance. There are three primary drivers of total services revenue: backlog, new sales into the existing contract base and new client signings. A very high percentage of annual services revenue, approximately 70 percent, comes from the run out of the opening backlog. The December 31, 2011 backlog position provides a very solid base of revenue for total Services to begin 2012. In 2012, the company expects approximately 3 percent revenue growth from the backlog, at consistent foreign exchange currency rates. The estimated outsourcing backlog at December 31, 2011 was $93 billion, a decrease of $4.0 billion ($2.8 billion adjusted for currency) from December 31, 2010 balance, and an increase of $2.2 billion ($2.8 billion adjusted for currency) from the September 30, 2011 level.

 

28


 

($ in billions)

 

At December 31:

 

2011

 

2010

 

Yr.-to-Yr.
Change

 

Yr.-to-Yr.
Change
Adjusted for
Currency

 

Backlog

 

 

 

 

 

 

 

 

 

Total backlog

 

$

140.6

 

$

142.4

 

$

(1.7

)

$

0.0

 

Outsourcing backlog

 

92.5

 

96.5

 

(4.0

)

(2.8

)

 

Total Global Services backlog includes GTS Outsourcing, ITS, GBS Outsourcing, Consulting and Systems Integration and Maintenance. Outsourcing backlog includes GTS Outsourcing and GBS Outsourcing. Total 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 adjustments for currency.

 

Global Services signings are management’s initial estimate of the value of a client’s commitment under a Global Services contract. There are no third-party standards or requirements governing the calculation of signings. The calculation used by management 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.

 

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

 

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.

 

($ in millions)

 

For the year ended December 31:

 

2011

 

2010*

 

Yr.-to-Yr.
Percent
Change

 

Yr.-to-Yr.
Change
Adjusted for
Currency

 

Total signings

 

$

57,435

 

$

57,696

 

(0.5

)%

(4.0

)%

Outsourcing signings

 

$

29,251

 

$

31,268

 

(6.5

)%

(9.7

)%

Transactional signings

 

28,184

 

26,428

 

6.6

 

2.6

 

 

* Reclassified to conform with 2011 presentation.

 

Software

 

($ in millions)

 

For the year ended December 31:

 

2011

 

2010*

 

Yr.-to-Yr.
Percent
Change

 

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

 

Software external revenue

 

$

24,944

 

$

22,485

 

10.9

%

8.0

%

Middleware

 

$

20,650

 

$

18,445

 

12.0

%

9.0

%

Key Branded Middleware

 

16,051

 

13,879

 

15.6

 

12.7

 

Web Sphere Family

 

 

 

 

 

40.5

 

37.4

 

Information Management

 

 

 

 

 

12.5

 

9.6

 

Lotus

 

 

 

 

 

3.8

 

0.2

 

Tivoli

 

 

 

 

 

10.2

 

7.4

 

Rational

 

 

 

 

 

4.9

 

1.8

 

Other middleware

 

4,600

 

4,565

 

0.8

 

(1.9

)

Operating systems

 

2,479

 

2,282

 

8.6

 

5.6

 

Other

 

1,814

 

1,758

 

3.2

 

0.4

 

 

* Reclassified to conform with 2011 presentation.

 

29


 

Software revenue of $24,944 million increased 10.9 percent (8 percent adjusted for currency) in 2011 compared to 2010. Adjusting for the divested PLM operations, revenue grew at 11.8 percent (9 percent adjusted for currency) in 2011. Revenue growth was driven by key branded middleware, reflecting continued strong demand for the company’s offerings and solid growth in key focus areas such as Smarter Commerce and business analytics. Overall, the Software business had another very good year in 2011, delivering nearly $10 billion in segment pre-tax income, an increase of $500 million from 2010. The company continues to invest in additional capabilities for the Software business through both organic investments and strategic acquisitions, including the completion of five acquisitions in 2011, plus acquisitions announced in the fourth quarter of 2011 that closed in the first quarter of 2012.

 

Key branded middleware revenue increased 15.6 percent (13 percent adjusted for currency) and again gained market share in 2011, as the Software business extended its lead in the middleware market. Software revenue continued to mix to the faster growing branded middleware which accounted for 64 percent of total software revenue in 2011, an increase of 3 points from 2010. Performance in 2011 was led by strong double-digit growth in WebSphere. The Software business continued to have solid performance in its growth initiatives, with business analytics revenue up double digits in 2011 year to year.

 

WebSphere revenue increased 40.5 percent (37 percent adjusted for currency) in 2011 with strong performance throughout the year and gained share. WebSphere’s five product areas all had revenue growth of 18 percent or higher in 2011, led by the Smarter Commerce offerings, which more than tripled year to year. This performance contributed to the company’s overall growth in the retail industry in each of the last two years. The 2010 acquisitions of Sterling Commerce, Coremetrics and Unica Corporation all contributed to the WebSphere year-to-year performance.

 

Information Management revenue increased 12.5 percent (10 percent adjusted for currency) and gained share in 2011 compared to 2010. Distributed Database revenue increased 33 percent in 2011, led by strong performance from the Netezza offerings. Since acquiring Netezza in November 2010, the Software business has expanded its customer base by over 40 percent. The company’s business analytics software offerings, most of which are part of Information Management, continue to outpace the market with double-digit revenue growth, year to year in 2011.

 

Lotus revenue increased 3.8 percent (flat adjusted for currency) in 2011 compared to 2010, with growth driven by the Social Business offerings.

 

Tivoli revenue increased 10.2 percent (7 percent adjusted for currency) in 2011 when compared to 2010 and gained share. Revenue growth was led by Storage software with growth of 25 percent (22 percent adjusted for currency). Security solutions software also delivered growth in 2011, with revenue up 9 percent (6 percent adjusted for currency).

 

Rational revenue increased 4.9 percent (2 percent adjusted for currency) in 2011 versus 2010 and gained share. Revenue growth was driven by Telelogic, which increased 11 percent (7 percent adjusted for currency) year to year.

 

Operating systems revenue increased 8.6 percent (6 percent adjusted for currency) in 2011 compared to 2010, driven primarily by growth in Power Systems.

 

Other software revenue increased 3.2 percent (flat adjusted for currency) with growth in software-related services partially offset by the divestiture of the PLM operations in the first quarter of 2010.

 

($ in millions)

 

For the year ended December 31:

 

2011

 

2010*

 

Yr.-to-Yr.
Percent/
Margin
Change

 

Software

 

 

 

 

 

 

 

External gross profit

 

$

22,065

 

$

19,774

 

11.6

%

External gross profit margin

 

88.5

%

87.9

%

0.5

pts.

Pre-tax income

 

$

9,970

 

$

9,466

 

5.3

%

Pre-tax margin

 

35.3

%

37.2

%

(1.9

)pts.

Pre-tax income—normalized**

 

$

10,009

 

$

8,972

 

11.6

%

Pre-tax margin—normalized

 

35.5

%

35.3

%

0.2

pts.

 

*   Reclassified to conform with 2011 presentation.

** Excludes $39 million and $98 million of workforce rebalancing charges in the first quarter of 2011 and 2010, respectively, and $(591) million related to the PLM gain in the first quarter of 2010.

 

Software gross profit increased 11.6 percent to $22,065 million in 2011 driven primarily by the growth in revenue. Gross profit margin improved 0.5 points versus 2010. Software delivered segment pre-tax income of $9,970 million in 2011, an increase of 5.3 percent versus 2010. On a normalized basis, segment pre-tax income increased 11.6 percent and segment pre-tax margin improved 0.2 points to 35.5 percent in 2011. The Software segment delivered strong margin and profit growth in 2011 and contributed to the company’s continued margin expansion and profit performance.

 

30


 

Systems and Technology

 

($ in millions)

 

For the year ended December 31:

 

2011

 

2010

 

Yr.-to-Yr.
Percent
Change

 

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

 

Systems and Technology external revenue

 

$

18,985

 

$

17,973

 

5.6

%

3.2

%

System z

 

 

 

 

 

0.3

%

(2.1

)%

Power Systems

 

 

 

 

 

12.0

 

9.5

 

System x

 

 

 

 

 

5.7

 

2.4

 

Storage

 

 

 

 

 

5.8

 

3.1

 

Retail Store Solutions

 

 

 

 

 

11.6

 

9.4

 

Total Systems

 

 

 

 

 

6.5

 

3.8

 

Microelectronics OEM

 

 

 

 

 

0.2

 

0.1

 

 

Systems and Technology revenue increased 5.6 percent (3 percent adjusted for currency) in 2011 versus 2010. Performance in 2011 was driven by the growth markets which increased 14.9 percent (12 percent adjusted for currency). The major markets increased 2.7 percent, but were essentially flat at constant currency versus the prior year period.

 

System z revenue increased 0.3 percent (down 2 percent adjusted for currency) in 2011 versus 2010. MIPS (millions of instructions per second) shipments increased 16 percent in 2011 versus 2010. The revenue performance and lower MIPS growth was a result of the strong prior-year performance and was consistent with prior mainframe product cycles, as the company successfully launched its zEnterprise 196 server in the third quarter of 2010. Since the z196 server began shipping, the company has added over 115 new System z clients, with more than 33 percent in the growth markets.

 

Power Systems revenue increased 12.0 percent (9 percent adjusted for currency) in 2011 versus 2010 with performance driven by strong growth in high-end systems. High-end systems revenue increased 31 percent (28 percent adjusted for currency) in 2011 compared to 2010. The company extended its market leadership in 2011, having posted 15 consecutive quarters of year-to-year share gains. In addition, this was the second consecutive year that the company had over 1,000 competitive displacements, which this year generated over $1 billion of business; approximately 50 percent of this business was from Hewlett Packard, with most of the balance from Oracle/Sun.

 

System x revenue increased 5.7 percent (2 percent adjusted for currency) in 2011 compared to 2010. High-end System x revenue increased 35 percent (31 percent adjusted for currency) in 2011 versus the prior year. System x revenue increased 22 percent (18 percent adjusted for currency) in the growth markets and closed the year with its ninth consecutive quarter with a double-digit increase in the growth markets.

 

Storage revenue increased 5.8 percent (3 percent adjusted for currency) in 2011 versus 2010. Total disk revenue increased 7 percent (4 percent adjusted for currency) in 2011 versus 2010, driven by growth in enterprise disk products. Tape revenue increased 3 percent (flat adjusted for currency) in 2011 versus 2010. When combined with storage software, total storage revenue increased 10 percent in 2011 compared to the prior year.

 

Retail Stores Solutions revenue increased 11.6 percent (9 percent adjusted for currency) in 2011 versus the prior year. The brand gained share in 2011 and contributed to the company’s overall improved performance in the retail industry.

 

Microelectronics OEM revenue increased 0.2 percent (flat adjusted for currency) in 2011 versus 2010, as the company shifted its production to meet internal demand.

 

($ in millions)

 

For the year ended December 31:

 

2011

 

2010*

 

Yr.-to-Yr.
Percent/
Margin
Change

 

Systems and Technology

 

 

 

 

 

 

 

External gross profit

 

$

7,555

 

$

6,856

 

10.2

%

External gross profit margin

 

39.8

%

38.1

%

1.6

pts.

Pre-tax income

 

$

1,633

 

$

1,456

 

12.2

%

Pre-tax margin

 

8.2

%

7.8

%

0.5

pts.

Pre-tax income—normalized**

 

$

1,652

 

$

1,513

 

9.2

%

Pre-tax margin—normalized

 

8.3

%

8.1

%

0.3

pts.

 

*    Reclassified to conform with 2011 presentation.

**  Excludes $19 million and $57 million of workforce rebalancing charges in the first quarter of 2011 and 2010, respectively.

 

The increase in external gross profit for 2011 versus 2010 was due to higher revenue and an improved overall gross profit margin.

 

Overall gross margin increased 1.6 points in 2011 versus the prior year. The increase was primarily driven by margin improvements in Power Systems (1.2 points), System z (0.4 points) and System x (0.6 points), partially offset by lower margins in Microelectronics (0.6 points) and Storage (0.2 points).

 

Systems and Technology’s pre-tax income increased $177 million (12.2 percent) to $1,633 million in 2011 and on a normalized basis increased $139 million to $1,652 million in 2011, when compared to the prior year. Pre-tax margin increased 0.5 points, and on a normalized basis 0.3 points, versus the prior year.

 

Global Financing

 

See pages 63 through 67 for an analysis of Global Financing’s segment results.

 

31

 

Geographic Revenue

 

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

 

($ in millions)

 

For the year ended December 31:

 

2011

 

2010

 

Yr.-to-Yr.
Percent
Change

 

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

 

Total revenue

 

$

106,916

 

$

99,870

 

7.1

%

3.4

%

Geographies

 

$

104,170

 

$

97,060

 

7.3

%

3.6

%

Americas

 

44,944

 

42,044

 

6.9

 

6.2

 

Europe/Middle East/Africa

 

33,952

 

31,866

 

6.5

 

1.6

 

Asia Pacific

 

25,273

 

23,150

 

9.2

 

1.7

 

Major markets

 

 

 

 

 

5.1

%

1.6

%

Growth markets

 

 

 

 

 

16.0

%

11.4

%

BRIC countries

 

 

 

 

 

18.6

%

16.1

%

 

Total geographic revenue increased 7.3 percent (4 percent adjusted for currency) to $104,170 million in 2011, led by strong performance in the growth markets.

 

The growth markets increased 16.0 percent (11 percent adjusted for currency) in 2011 and gained 4 points of market share. The growth markets strategy to expand into new markets, build out IT infrastructures and lead in specific industries is driving the strong performance and share gains. Revenue growth outpaced growth in the major markets by 10 points in 2011 on a constant currency basis. In the BRIC countries (Brazil, Russia, India and China), revenue increased 18.6 percent (16 percent adjusted for currency) in 2011, with double-digit growth in each country. Overall in 2011, the company had double-digit constant currency revenue growth in nearly 40 growth market countries. These countries contributed nearly two-thirds of the company’s 2011 constant currency revenue growth and represented 22 percent of total geographic revenue in 2011. To further drive market expansion, the company opened 92 new branches and added over 1,500 new sales resources in 2011.

 

Americas revenue increased 6.9 percent (6 percent adjusted for currency) in 2011. Within the major market countries, the U.S. increased 4.2 percent and Canada increased 14.3 percent (10 percent adjusted for currency). Revenue in the Latin America growth markets increased 16.9 percent (14 percent adjusted for currency) with growth in Brazil of 13.0 percent (9 percent adjusted for currency).

 

Europe/Middle East/Africa (EMEA) revenue increased 6.5 percent (2 percent adjusted for currency) in 2011 compared to 2010. In the major market countries, revenue growth was led by the U. K. up 9.4 percent (5 percent adjusted for currency), Spain up 11.2 percent (6 percent adjusted for currency), Germany up 5.8 percent (1 percent adjusted for currency) and France up 4.4 percent (flat adjusted for currency). Revenue in Italy decreased 0.6 percent (5 percent adjusted for currency). The EMEA growth markets increased 11.6 percent (10 percent adjusted for currency) in 2011, led by growth in Russia of 49.8 percent (49 percent adjusted for currency).

 

Asia Pacific revenue increased 9.2 percent (2 percent adjusted for currency) year over year. The Asia Pacific growth markets increased 16.8 percent (11 percent adjusted for currency), led by growth in China of 21.6 percent (18 percent adjusted for currency) and India of 10.9 percent (13 percent adjusted for currency). Japan revenue increased 2.0 percent (decreased 7 percent adjusted for currency).

 

OEM revenue of $2,746 million in 2011 decreased 2.3 percent (3 percent adjusted for currency) compared to 2010, driven by the Microelectronics OEM business.

 

Total Expense and Other Income

 

($ in millions)

 

For the year ended December 31:

 

2011

 

2010

 

Yr.-to-Yr.
Percent/
Margin
Change

 

Total consolidated expense and other (income)

 

$

29,135

 

$

26,291

 

10.8

%

Non-operating adjustments

 

 

 

 

 

 

 

Amortization of acquired intangible assets

 

(289

)

(253

)

14.4

 

Acquisition-related charges

 

(45

)

(46

)

(1.8

)

Non-operating retirement-related (costs)/income

 

74

 

210

 

(64.6

)

Total operating (non-GAAP) expense and other (income)

 

$

28,875

 

$

26,202

 

10.2

%

Total consolidated expense-to-revenue ratio

 

27.3

%

26.3

%

0.9

pts.

Operating (non-GAAP) expense-to-revenue ratio

 

27.0

%

26.2

%

0.8

pts.

 

32


 

Total expense and other (income) increased 10.8 percent in 2011 versus 2010. Total operating (non-GAAP) expense and other (income) increased 10.2 percent versus the prior year. The key drivers of the year-to-year change in total expense and other (income) for both expense presentations were approximately:

 

·

Currency*

4 points

·

Acquisitions**

3 points

·

Base expense

3 points

 

*

Reflects impacts of translation and hedging programs.

**

Includes acquisitions completed in prior 12-month period.

 

In the execution of its strategy, the company continues to invest in its growth initiatives, innovation and strategic acquisitions. The company also has had an ongoing focus on increasing efficiency and productivity across the business.

 

For additional information regarding total expense and other income, see the following analyses by category.

 

Selling, General and Administrative

 

($ in millions)

 

For the year ended December 31:

 

2011

 

2010

 

Yr.-to-Yr.
Percent
Change

 

Selling, general and administrative expense

 

 

 

 

 

 

 

Selling, general and administrative—other

 

$

20,287

 

$

18,585

 

9.2

%

Advertising and promotional expense

 

1,373

 

1,337

 

2.7

 

Workforce rebalancing charges

 

440

 

641

 

(31.3

)

Retirement-related costs

 

603

 

494

 

22.1

 

Amortization of acquired intangibles assets

 

289

 

253

 

14.4

 

Stock-based compensation

 

514

 

488

 

5.4

 

Bad debt expense

 

88

 

40

 

116.6

 

Total consolidated selling, general and administrative expense

 

$

23,594

 

$

21,837

 

8.0

%

Non-operating adjustments

 

 

 

 

 

 

 

Amortization of acquired intangible assets

 

(289

)

(253

)

14.4

 

Acquisition-related charges

 

(20

)

(41

)

(52.3

)

Non-operating retirement-related (costs)/income

 

(13

)

84

 

NM

 

Operating (non-GAAP) selling, general and administrative expense

 

$

23,272

 

$

21,628

 

7.6

%

 

NM—Not meaningful

 

Total Selling, general and administrative (SG&A) expense increased 8.0 percent (5 percent adjusted for currency) in 2011 versus 2010. Overall the increase was driven by currency impacts (3 points), acquisition-related spending (3 points) and base expense (2 points). Operating (non-GAAP) SG&A expense increased 7.6 percent (5 percent adjusted for currency) primarily driven by the same factors. Workforce rebalancing charges decreased $201 million due primarily to actions taken in the first quarter of 2010 ($558 million). Bad debt expense increased $47 million in 2011 primarily due to higher receivable balances and the current economic environment in Europe. The accounts receivable provision coverage was 1.5 percent at December 31, 2011, a decrease of 30 basis points from year-end 2010.

 

Other (Income) and Expense

 

($ in millions)

 

For the year ended December 31:

 

2011

 

2010

 

Yr.-to-Yr.
Percent
Change

 

Other (income) and expense

 

 

 

 

 

 

 

Foreign currency transaction losses/(gains)

 

$

513

 

$

303

 

69.2

%

(Gains)/losses on derivative instruments

 

(113

)

(239

)

(52.9

)

Interest income

 

(136

)

(92

)

48.4

 

Net (gains)/losses from securities and investment assets

 

(227

)

31

 

NM

 

Other

 

(58

)

(790

)

(92.7

)

Total consolidated other (income) and expense

 

$

(20

)

$

(787

)

(97.4

)%

Non-operating adjustment

 

 

 

 

 

 

 

Acquisition-related charges

 

(25

)

(4

)

NM

 

Operating (non-GAAP) other (income) and expense

 

$

(45

)

$

(791

)

(94.3

)%

 

NM—Not meaningful

 

Other (income) and expense was income of $20 million and $787 million for 2011 and 2010, respectively. The decrease in income in 2011 was primarily driven by the net gain ($591 million) from the PLM transaction recorded in the first quarter of 2010 and a net gain associated with the disposition of a joint venture in the third quarter of 2010 ($57 million) reflected in Other in the table above. In addition, foreign currency rate volatility drove higher foreign currency transaction losses ($210 million) and lower gains on derivative instruments ($126 million). These decreases in income were partially offset by higher net gains from securities and investment asset sales ($258 million), primarily in the first quarter of 2011.

 

33


 

Research, Development and Engineering

 

($ in millions)

 

For the year ended December 31:

 

2011

 

2010

 

Yr.-to-Yr.
Percent
Change

 

Total consolidated research, development and engineering

 

$

6,258

 

$

6,026

 

3.8

%

Non-operating adjustment

 

 

 

 

 

 

 

Non-operating retirement-related (costs)/income

 

88

 

126

 

(30.4

)

Operating (non-GAAP) research, development and engineering

 

$

6,345

 

$

6,152

 

3.1

%

 

The company continues to invest in research and development, focusing its investments on high-value, high-growth opportunities and to extend its technology leadership. Total research, development and engineering (RD&E) expense increased 3.8 percent in 2011 versus 2010, primarily driven by acquisitions (up 4 points) and currency impacts (up 2 points), partially offset by base expense (down 2 points). Operating (non-GAAP) RD&E expense increased 3.1 percent in 2011 compared to the prior year primarily driven by the same factors. RD&E investments represented 5.9 percent of revenue in 2011, compared to 6.0 percent in 2010.

 

Intellectual Property and Custom Development Income

 

($ in millions)

 

For the year ended December 31:

 

2011

 

2010

 

Yr.-to-Yr.
Percent
Change

 

Sales and other transfers of intellectual property

 

$

309

 

$

203

 

52.3

%

Licensing/royalty-based fees

 

211

 

312

 

(32.5

)

Custom development income

 

588

 

638

 

(8.0

)

Total

 

$

1,108

 

$

1,154

 

(4.0

)%

 

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. There were no significant individual IP transactions in 2011 or 2010.

 

Interest Expense

 

($ in millions)

 

For the year ended December 31:

 

2011

 

2010

 

Yr.-to-Yr.
Percent
Change

 

Interest expense

 

 

 

 

 

 

 

Total

 

$

411

 

$

368

 

11.6

%

 

The increase in interest expense in 2011 versus 2010 was primarily driven by higher average debt levels, partially offset by lower average interest rates. Interest expense is presented in cost of financing in the Consolidated Statement of Earnings only if the related external borrowings are to support the Global Financing external business. See pages 66 and 67 for additional information regarding Global Financing debt and interest expense. Overall interest expense (excluding capitalized interest) for 2011 was $964 million, an increase of $41 million year to year.

 

Stock-Based Compensation

 

Total pre-tax stock-based compensation cost of $697 million increased $68 million compared to 2010. The increase was primarily the result of an increase related to the company’s assumption of stock-based awards previously issued by acquired entities ($22 million) and increases related to restricted stock units and performance share units ($48 million), partially offset by a reduction related to stock options ($2 million). Cost, and the year-to-year change, was reflected in the following categories: Cost: $120 million, up $27 million; SG&A expense: $514 million, up $26 million; and RD&E expense: $62 million, up $14 million.

 

See note R, “Stock-Based Compensation,” on pages 118 to 121 for additional information on stock-based incentive awards.

 

Retirement-Related Plans

 

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:

 

2011

 

2010

 

Yr.-to-Yr.
Percent
Change

 

Retirement-related plans—cost

 

 

 

 

 

 

 

Service cost

 

$

549

 

$

550

 

(0.2

)%

Amortization of prior service cost/(credits)

 

(157

)

(183

)

(14.6

)

Cost of defined contribution plans

 

1,513

 

1,430

 

5.8

 

Total operating costs

 

$

1,905

 

$

1,796

 

6.0

%

Interest cost

 

4,601

 

4,763

 

(3.4

)

Expected return on plan assets

 

(6,574

)

(6,488

)

1.3

 

Recognized actuarial losses

 

1,788

 

1,194

 

49.7

 

Plan amendments/curtailments/ settlements

 

1

 

27

 

(98.0

)

Multi-employer plan/other costs

 

112

 

89

 

26.0

 

Total non-operating costs/(income)

 

$

(72

)

$

(414

)

(82.5

)%

Total retirement-related plans—cost

 

$

1,832

 

$

1,382

 

32.6

%

 

In 2011, total retirement-related plans cost increased by $450 million compared to 2010, primarily driven by an increase in recognized actuarial losses of $594 million and increased cost associated with defined contribution plans ($83 million), partially offset by lower interest cost of $162 million and an increased expected return on plan assets of $87 million.

 

34


 

As discussed in the “Operating (non-GAAP) Earnings” section on page 18, the company characterizes certain retirement-related costs as operating and others as non-operating. Utilizing this characterization, operating retirement-related costs in 2011 were $1,905 million, an increase of $108 million compared to 2010, primarily driven by the $83 million increase in defined contribution plan costs. Non-operating costs of $(72) million increased $342 million in 2011 compared to the prior year driven primarily by the increase in recognized actuarial losses ($594 million), partially offset by lower interest cost ($162 million) and the increase in expected return on plan assets ($87 million).

 

Income Taxes

 

The effective tax rate for 2011 was 24.5 percent compared with 24.8 percent in 2010. The operating (non-GAAP) tax rate for 2011 was 24.5 percent compared with 24.4 percent in 2010. The 0.3 point decrease in the as-reported effective tax rate was primarily driven by a more favorable geographic mix of pre-tax earnings (0.6 points), the lack of prior year impacts related to certain intercompany payments made by foreign subsidiaries (6.6 points) and a reduced impact associated with the intercompany licensing of certain intellectual property and acquisition integration costs (2.2 points). These benefits were offset by a decrease in the utilization of foreign tax credits (3.7 points) and a decrease in the benefits associated with the settlements of the U.S. federal income tax audit (5.5 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 outstanding 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 and stock awards.

 

For the year ended December 31:

 

2011

 

2010

 

Yr.-to-Yr.
Percent
Change

 

Earnings per share of common stock

 

 

 

 

 

 

 

Assuming dilution

 

$

13.06

 

$

11.52

 

13.4

%

Basic

 

$

13.25

 

$

11.69

 

13.3

%

Diluted operating (non-GAAP)

 

$

13.44

 

$

11.67

 

15.2

%

Weighted-average shares outstanding (in millions)

 

 

 

 

 

 

 

Assuming dilution

 

1,213.8

 

1,287.4

 

(5.7

)%

Basic

 

1,197.0

 

1,268.8

 

(5.7

)%

 

Actual shares outstanding at December 31, 2011 and 2010 were 1,163.2 million and 1,228.0 million, respectively. The average number of common shares outstanding assuming dilution was 73.6 million shares lower in 2011 versus 2010. The decrease was primarily the result of the common stock repurchase program. See note L, “Equity Activity,” on page 110 for additional information regarding common stock activities. Also see note P, “Earnings Per Share of Common Stock,” on page 117.

 

Financial Position

 

Dynamics

 

At December 31, 2011, the company’s balance sheet and liquidity positions remain strong and are well positioned to support the company’s long-term objectives. Cash and cash equivalents at year end was $11,922 million, an increase of $271 million from the prior year-end position. During the year, the company continued to manage its investment portfolio to meet its capital preservation and liquidity objectives, which resulted in a shift to higher rated institutions. At year end, a significant portion of the investment portfolio was invested in U.S. sovereign instruments with no holdings of European sovereign debt securities.

 

Total debt of $31,320 million increased $2,695 million from the prior year-end level. The commercial paper balance at December 31, 2011 was $2,300 million, an increase of $1,156 million from the prior year. Within total debt, $23,332 is in support of the Global Financing business which is leveraged at a 7.2 to 1 ratio. The company continues to have substantial flexibility in the market. During 2011, the company completed bond issuances totaling $4,850 million, with terms ranging from three to ten years and priced from 0.875 to 2.90 percent depending on the maturity. In addition, the company renewed its $10 billion global credit facility for five years, with 100 percent of the facility available on a same day basis.

 

Consistent with accounting standards the company remeasures the funded status of its retirement and postretirement plans at December 31. At December 31, 2011, the overall net underfunded position was $16,389 million, an increase of $2,654 million from December 31, 2010 as the increase in the benefit obligation due to the reduction in discount rates more than offset the returns on plan assets. At year end, the company’s qualified defined benefit plans were well funded and its cash requirements related to these plans remain stable going-forward. In 2011, the return on the U.S. Personal Pension Plan assets was 8.4 percent and the plan was 98 percent funded. Overall, global asset returns were 6.1 percent and the company’s qualified defined benefit plans worldwide were 96 percent funded.

 

The company’s qualified defined benefit plans do hold European sovereign debt securities in their trust funds. See note S, “Retirement-Related Benefits,” on page 129 for additional information.

 

During 2011, the company generated $19,846 million in cash from operations, an increase of $298 million compared to 2010. In addition, the company generated $16,604 million in free cash flow in 2011, an increase of $305 million over the prior year. See pages 56 and 57 for additional information on free cash flow. The company returned $18,519 million to shareholders in 2011, with $15,046 million in share repurchases and $3,473 million in dividends. In 2011, the company repurchased approximately 89 million shares and had $8.7 billion remaining in share repurchase authorization at year end. The company has consistently generated strong cash from operations and strong free cash flow and this permits the company to invest and deploy capital to areas with the most attractive long-term opportunities.

 

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 page 72 are the consolidated amounts including Global Financing. The amounts

 

35


 

appearing in the separate Global Financing section, beginning on page 63, are supplementary data presented to facilitate an understanding of the Global Financing business.

 

Working Capital

 

($ in millions)

 

At December 31:

 

2011

 

2010

 

Current assets

 

$

50,928

 

$

48,116

 

Current liabilities

 

42,123

 

40,562

 

Working capital

 

$

8,805

 

$

7,554

 

Current ratio

 

1.21:1

 

1.19:1

 

 

Working capital increased $1,251 million from the year-end 2010 position. The key changes are described below:

 

Current assets increased $2,812 million ($3,734 million adjusted for currency), due to:

 

·                  An increase of $1,337 million ($1,594 million adjusted for currency) in short-term receivables due to:

·                  Higher volumes of financing receivables of $644 million ($789 million adjusted for currency) driven by customer loans and inventory financing; and

·                  Higher software sales volumes of approximately $300 million, and

·                  Reclasses of approximately $300 million of long-term other receivables to reflect maturity dates.

·                  An increase of $1,022 million ($1,181 million adjusted for currency) in prepaid expenses and other current assets primarily due to:

·                  An increase of $387 million in collateral received related to derivatives valuations; and

·                  An increase of $326 million in income taxes primarily driven by tax payments in the U.S.; and

·                  An increase of $310 million in various prepaid expenses; and

·                  An increase of $1,262 million ($1,755 million adjusted for currency) in cash and cash equivalents (see the following cash flow analysis); partially offset by

·                  A decline of $990 million in marketable securities due to sales of securities during 2011.

 

Current liabilities increased $1,561 million ($1,779 million adjusted for currency) as a result of:

 

·                  An increase in short-term debt of $1,685 million primarily driven by:

·                  New debt issuances of $6,123 million including commercial paper; and

·                  Reclasses of $4,325 million from long-term to short-term debt to reflect maturity dates; partially offset by

·                  Payments of $8,910 million.

·                  An increase in accounts payable of $713 million ($766 million adjusted for currency) reflecting higher year-end activity as well as the increase in collateral related to derivatives; and

·                  An increase in deferred income of $617 million ($638 million adjusted for currency) driven by the software business, including acquisitions; partially offset by

·                  A decrease of $903 million in taxes payable primarily due to tax payments in the U.S. during 2011; and

·                  A decrease in other accrued expenses and liabilities of $621 million ($473 million adjusted for currency) primarily due to derivatives valuations.

 

Cash Flow

 

The company’s cash flow from operating, investing and financing activities, as reflected in the Consolidated Statement of Cash Flows on page 73, is summarized in the table below. These amounts include the cash flows associated with the Global Financing business.

 

($ in millions)

 

For the year ended December 31:

 

2011

 

2010

 

Net cash provided by/(used in)

 

 

 

 

 

Operating activities

 

$

19,846

 

$

19,549

 

Investing activities

 

(4,396

)

(8,507

)

Financing activities

 

(13,696

)

(12,429

)

Effect of exchange rate changes on cash and cash equivalents

 

(493

)

(135

)

Net change in cash and cash equivalents

 

$

1,262

 

$

(1,522

)

 

Net cash from operating activities increased by $298 million in 2011 as compared to 2010 driven by the following key factors:

 

·                  Improved net income of $1,022 million; and

·                  A decrease in net gains on asset sales of $459 million, driven by the PLM transaction gain in 2010; partially offset by

·                  A decrease in cash provided by operating assets and liabilities of $1,152 million due to:

·                  Higher net tax payments of approximately $900 million during 2011 compared to 2010; and

·                  A decrease in cash provided by receivables of $790 million as a result of higher volumes in 2011; partially offset by

·                  A decrease in cash used related to retirement-related plans of $196 million, primarily driven by lower non-U.S. employer funding in 2011; and

·                  A decrease in cash used for workforce rebalancing activities of $278 million during 2011 compared to 2010.

 

Net cash used in investing activities decreased $4,111 million due to a decrease in cash used for acquisitions.

 

Net cash used in financing activities increased $1,267 million as a result of:

 

·                  A net decrease of $991 million in cash from common stock transactions; and

·                  An increase in dividends paid of $296 million in 2011 compared to 2010; partially offset by

·                  A decrease in common stock repurchases of $329 million in 2011 compared to 2010.

 

36

 

Noncurrent Assets and Liabilities

 

($ in millions)

 

At December 31:

 

2011

 

2010

 

Noncurrent assets

 

$

65,505

 

$

65,335

 

Long-term debt

 

$

22,857

 

$

21,846

 

Noncurrent liabilities (excluding debt)

 

$

31,217

 

$

27,871

 

 

The increase in noncurrent assets of $169 million ($902 million adjusted for currency) was driven by:

 

·                  An increase of $1,077 million in goodwill ($1,282 million adjusted for currency) driven by acquisitions during 2011; and

·                  An increase of $282 million in deferred taxes ($256 million adjusted for currency) primarily driven by retirement related activity; partially offset by

·                  An increase of $227 million ($330 million adjusted for currency) in long-term financing receivables driven by increased volumes; and

·                  A decrease of $883 million ($753 million adjusted for currency) in investments and sundry assets driven by net asset sales of $395 million during 2011 as well as a reclass to short-term other receivables of approximately $300 million to reflect maturity dates; and

·                  A decrease of $225 million ($66 million adjusted for currency) in prepaid pension assets resulting from pension remeasurements; and

·                  A decrease of $214 million in property, plant and equipment (net) primarily due to currency.

 

Long-term debt increased by $1,011 million due to new debt issuances of $5,194 million, partially offset by reclasses of $4,325 million to short-term debt as certain instruments approach maturity.

 

Other noncurrent liabilities, excluding debt, increased $3,346 million ($3,544 million adjusted for currency) primarily driven by:

 

·                  An increase in retirement and nonpension benefit obligations of $2,396 million ($2,488 million adjusted for currency) primarily driven by remeasurements in the U.S., the United Kingdom and Japan; and

·                  An increase of $770 million ($834 million adjusted for currency) in other noncurrent liabilities primarily due to an increase in tax related liabilities.

 

Debt

 

The company’s funding requirements are continually monitored and strategies are executed to manage the overall asset and liability profile. Additionally, the company maintains sufficient flexibility to access global funding sources as needed.

 

($ in millions)

 

At December 31:

 

2011

 

2010

 

Total company debt

 

$

31,320

 

$

28,624

 

Total Global Financing segment debt

 

$

23,332

 

$

22,823

 

Debt to support external clients

 

20,051

 

19,583

 

Debt to support internal clients

 

3,281

 

3,240

 

 

Global Financing provides financing 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 attributes, these Global Services assets are leveraged with the balance of the Global Financing asset base. The debt analysis above is further detailed in the Global Financing section on pages 66 and 67.

 

Given the significant leverage, the company presents a debt-to-capitalization ratio which excludes Global Financing debt and equity as management believes this is more representative of the company’s core business operations. This ratio can vary from period to period as the company manages its global cash and debt positions.

 

“Core” debt-to-capitalization ratio (excluding Global Financing debt and equity) was 32.0 percent at December 31, 2011 compared to 22.6 percent at December 31, 2010. The increase was primarily driven by an increase in non-Global Financing debt of $2,186 million and by a decrease in non-Global Financing equity of $2,929 million from December 31, 2010 balances.

 

Consolidated debt-to-capitalization ratio at December 31, 2011 was 60.7 percent versus 55.3 percent at December 31, 2010.

 

Equity

 

Total equity decreased by $2,937 million as a result of an increase in treasury stock of $14,803 million, driven by common stock repurchases in 2011; a higher pension adjustment of $2,448 million reflecting the impact of pension remeasurements as well as increased foreign currency translation adjustments of $711 million; partially offset by an increase in retained earnings of $12,326 million, and an increase of $2,711 million in common stock primarily driven by stock option exercises and stock based compensation.

 

37


 

GAAP Reconciliation

 

The tables below provide a reconciliation of the company’s income statement results as reported under GAAP to its operating earnings presentation which is a non-GAAP measure. The company’s calculation of operating earnings, as presented, may differ from similarly titled measures reported by other companies. Please refer to the “Operating (non-GAAP) Earnings” section on page 18 for the company’s rationale for presenting operating earnings information.

 

($ in millions except per share amounts)

 

For the year ended December 31, 2011:

 

GAAP

 

Acquisition-
related
Adjustments

 

Retirement-
related
Adjustments

 

Operating
(non-GAAP)

 

Gross profit

 

$

50,138

 

$

341

 

$

2

 

$

50,481

 

Gross profit margin

 

46.9

%

0.3

pts.

0.0

pts.

47.2

 

SG&A

 

$

23,594

 

$

(309

)

$

(13

)

$

23,272

 

RD&E

 

6,258

 

0

 

88

 

6,345

 

Other (income) and expense

 

(20

)

(25

)

0

 

(45

)

Total expense and other (income)

 

29,135

 

(334

)

74

 

28,875

 

Pre-tax income

 

21,003

 

675

 

(72

)

21,605

 

Pre-tax income margin

 

19.6

%

0.6

pts.

(0.1

)pts.

20.2

%

Provision for income taxes*

 

$

5,148

 

$

179

 

$

(40

)

$

5,287

 

Effective tax rate

 

24.5

%

0.1

pts.

(0.1

)pts.

24.5

%

Net income

 

$

15,855

 

$

495

 

$

(32

)

$

16,318

 

Net income margin

 

14.8

%

0.5

pts.

(0.0

)pts.

15.3

%

Diluted earnings per share

 

$

13.06

 

$

0.41

 

$

(0.03

)

$

13.44

 

 

*                 The tax impact on operating (non-GAAP) pre-tax income is calculated under the same accounting principles applied to the GAAP pre-tax income which employs an annual effective tax rate method to the results.

 

($ in millions except per share amounts)

 

For the year ended December 31, 2010:

 

GAAP

 

Acquisition-
related
Adjustments

 

Retirement-
related
Adjustments

 

Operating
(non-GAAP)

 

Gross profit

 

$

46,014

 

$

260

 

$

(204

)

$

46,070

 

Gross profit margin

 

46.1

%

0.3

pts.

(0.2

)pts.

46.1

%

SG&A

 

$

21,837

 

$

(294

)

$

84

 

$

21,628

 

RD&E

 

6,026

 

0

 

126

 

6,152

 

Other (income) and expense

 

(787

)

(4

)

0

 

(791

)

Total expense and other (income)

 

26,291

 

(298

)

210

 

26,202

 

Pre-tax income

 

19,723

 

558

 

(414

)

19,867

 

Pre-tax income margin

 

19.7

%

0.6

pts.

(0.4

)pts.

19.9

%

Provision for income taxes*

 

$

4,890

 

$

116

 

$

(162

)

$

4,844

 

Effective tax rate

 

24.8

%

(0.1)

pts.

(0.3

)pts.

24.4

%

Net income

 

$

14,833

 

$

443

 

$

(253

)

$

15,023

 

Net income margin

 

14.9

%

0.4

pts.

(0.3

)pts.

15.0

%

Diluted earnings per share

 

$

11.52

 

$

0.34

 

$

(0.20

)

$

11.67

 

 

*                 The tax impact on operating (non-GAAP) pre-tax income is calculated under the same accounting principles applied to the GAAP pre-tax income which employs an annual effective tax rate method to the results.

 

38


 

Consolidated Fourth-Quarter Results

 

($ and shares in millions except per share amounts)

 

For the fourth quarter:

 

2011

 

2010

 

Yr.-to-Yr.
Percent/
Margin
Change

 

Revenue

 

$

29,486

 

$

29,019

 

1.6

%*

Gross profit margin

 

49.9

%

49.0

%

0.9

pts.

Total expense and other income

 

$

7,448

 

$

7,271

 

2.4

%

Total expense and other income-to-revenue ratio

 

25.3

%

25.1

%

0.2

pts.

Income before income taxes

 

$

7,274

 

$

6,956

 

4.6

%

Provision for income taxes

 

1,784

 

1,698

 

5.1

%

Net income

 

$

5,490

 

$

5,257

 

4.4

%

Net income margin

 

18.6

%

18.1

%

0.5

pts.

Earnings per share of common stock

 

 

 

 

 

 

 

Assuming dilution

 

$

4.62

 

$

4.18

 

10.5

%

Weighted-average shares outstanding

 

 

 

 

 

 

 

Assuming dilution

 

1,188.7

 

1,258.4

 

(5.5

)%

 

* 1.4 percent adjusted for currency.

 

The following table provides the company’s operating (non-GAAP) earnings for the fourth quarter of 2011 and 2010.

 

($ in millions except per share amounts)

 

For the fourth quarter:

 

2011

 

2010

 

Yr.-to-Yr.
Percent
Change

 

Net income as reported

 

$

5,490

 

$

5,257

 

4.4

%

Non-operating adjustments (net of tax)

 

 

 

 

 

 

 

Acquisition-related charges

 

119

 

170

 

(30.0

)

Non-operating retirement-related costs/(income)

 

(12

)

(74

)

(84.0

)

Operating (non-GAAP) earnings*

 

$

5,597

 

$

5,354

 

4.5

%

Diluted operating (non-GAAP) earnings per share

 

$

4.71

 

$

4.25

 

10.8

%

 

* See page 43 for a more detailed reconciliation of net income to operating earnings.

 

Snapshot

 

In the fourth quarter of 2011, the company grew revenue, expanded gross, pre-tax and net income margins and delivered earnings per share of $4.62, up 10.5 percent as reported, and $4.71, up 10.8 percent on an operating (non-GAAP) basis. The company generated $7.1 billion in cash from operations in the quarter enabling shareholder returns of $4.5 billion in common stock repurchases and dividends in the period.

 

The company’s performance in the fourth quarter was driven by several factors. The Software segment continued its momentum with performance reflecting both strong demand for its offerings and solid sales execution. Software revenue increased 8.7 percent (9 percent adjusted for currency) driven by strong growth in the focus areas of Smarter Commerce, business analytics and storage solutions. Software pre-tax income increased 12.5 percent. Global Services delivered strong margin and profit growth, with pre-tax income up 16.9 percent. Total Global Services revenue growth was again led by the growth markets which were up 11.4 percent (13 percent adjusted for currency). Within Systems and Technology, Power Systems delivered revenue growth of 6.3 percent (6 percent adjusted for currency) while continuing to drive competitive displacements and extend its share gains in Unix. In the fourth quarter, each of the company’s 16 brands gained or held share, with the exception of System z, which had the largest revenue growth in the last decade in the fourth quarter of 2010. The company estimates that System z lost share in the fourth quarter, primarily to Power Systems.

 

The company’s ongoing focus on productivity together with the relative strength of the Software business drove strong margin performance in the fourth quarter of 2011. The consolidated gross profit margin increased 0.9 points versus the fourth quarter of 2010 to 49.9 percent. The operating (non-GAAP) gross margin increased 1.1 points to 50.2 percent. The improvement was driven by margin expansion in both services segments, and an improved segment mix due to the Software revenue performance.

 

Total expense and other income increased 2.4 percent in the fourth quarter compared to the prior year. Total operating (non-GAAP) expense and other income increased 2.1 percent compared to the fourth quarter of 2010. The year-to-year drivers for both categories were approximately:

 

· Acquisitions*     1 point

· Base expense    1 point

 

* Includes acquisitions completed in prior 12-month period.

 

Pre-tax income grew 4.6 percent and the pre-tax margin was 24.7 percent, an increase of 0.7 points versus the fourth quarter of 2010. Net income increased 4.4 percent and the net income margin of 18.6 percent improved 0.5 points year to year. The effective tax rate for the fourth quarter was 24.5 percent, compared with 24.4 percent in the prior year. Operating (non-GAAP) pre-tax income grew 5.6 percent and the operating (non-GAAP) pre-tax margin was 25.1 percent, an increase of 0.9 points versus the prior year. Operating (non-GAAP) earnings increased 4.5 percent and the operating (non-GAAP) earnings margin of 19.0 percent increased 0.5 points versus the prior year. The operating (non-GAAP) effective tax rate was 24.4 percent versus 23.7 percent in the fourth quarter of 2010.

 

Diluted earnings per share improved 10.5 percent reflecting the growth in net income and the benefits of the common stock repurchase program. In the fourth quarter, the company repurchased 19 million shares of its common stock. Diluted earnings per share of $4.62 increased $0.44 from the prior year. Operating (non-GAAP) diluted earnings per share of $4.71 increased $0.46 versus the fourth quarter of 2010 driven by the following factors:

 

· Revenue increase at actual rates

 

$0.07

· Margin expansion

 

$0.13

· Common stock repurchases

 

$0.26

 

Gross margin expansion drove $0.19 of operating (non-GAAP) earnings per share growth, partially offset by a $0.02 per share impact from expense and a $0.04 per share impact from the higher tax rate. Overall, margin expansion contributed $0.13 of improvement.

 

39


 

Segment Details

 

The following is an analysis of the fourth quarter of 2011 versus the fourth quarter of 2010 reportable segment external revenue and gross margin results. Segment pre-tax income includes transactions between the segments that are intended to reflect an arm’s-length transfer price and excludes certain unallocated corporate items.

 

($ in millions)

 

For the fourth quarter:

 

2011

 

2010*

 

Yr.-to-Yr.
Percent/
Margin
Change

 

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

 

Revenue

 

 

 

 

 

 

 

 

 

Global Technology Services

 

$

10,452

 

$

10,165

 

2.8

%

2.6

%

Gross margin

 

36.6

%

34.5

%

2.1

pts.

 

 

Global Business Services

 

4,877

 

4,758

 

2.5

%

1.7

%

Gross margin

 

29.3

%

28.0

%

1.3

pts.

 

 

Software

 

7,648

 

7,039

 

8.7

%

8.7

%

Gross margin

 

89.8

%

89.6

%

0.2

pts.

 

 

Systems and Technology

 

5,803

 

6,277

 

(7.6

)%

(7.7

)%

Gross margin

 

40.5

%

43.6

%

(3.1

)pts.

 

 

Global Financing

 

548

 

628

 

(12.9

)%

(12.6

)%

Gross margin

 

49.7

%

51.8

%

(2.1

)pts.

 

 

Other

 

159

 

151

 

4.7

%

4.7

%

Gross margin

 

(11.0

)%

10.3

%

(21.3

)pts.

 

 

Total consolidated revenue

 

$

29,486

 

$

29,019

 

1.6

%

1.4

%

 

 

 

 

 

 

 

 

 

 

Total consolidated gross profit

 

$

14,722

 

$

14,227

 

3.5

%

 

 

Total consolidated gross margin

 

49.9

%

49.0

%

0.9

pts.

 

 

Non-operating adjustments

 

 

 

 

 

 

 

 

 

Amortization of acquired intangible assets

 

81

 

82

 

(1.2

)%

 

 

Acquisition-related charges

 

0

 

0

 

0.0

%

 

 

Retirement-related costs/(income)

 

(10

)

(60

)

(82.9

)%

 

 

Operating (non-GAAP) gross profit

 

$

14,793

 

$

14,249

 

3.8

%

 

 

Operating (non-GAAP) gross margin

 

50.2

%

49.1

%

1.1

pts.

 

 

 

* Reclassified to conform with 2011 presentation.

 

Global Services

 

The Global Services segments, Global Technology Services (GTS) and Global Business Services (GBS) delivered $15,329 million of revenue in the fourth quarter, an increase of 2.7 percent (2 percent adjusted for currency) year to year. Overall revenue growth in the quarter was driven by the growth markets with revenue up 11.4 percent (13 percent adjusted for currency) with double-digit constant currency revenue growth in the outsourcing, transactional and maintenance businesses. Total outsourcing revenue of $7,210 million increased 3.6 percent (3 percent adjusted for currency) and total transactional revenue of $6,246 million increased 2.9 percent (2 percent adjusted for currency) year over year. Total Global Services segment pre-tax income was $2,771 million, an increase of 16.9 percent year to year. The combined pre-tax margin improved 2.1 points year to year to 17.5 percent.

 

Global Technology Services revenue increased 2.8 percent (3 percent adjusted for currency) to $10,452 million in the fourth quarter versus the same period in 2010. Adjusted for currency, the fourth-quarter revenue growth rate was consistent with the growth rate in the third quarter. GTS Outsourcing revenue increased 3.4 percent (3 percent adjusted for currency) in the fourth quarter and gained share. Integrated Technology Services (ITS) revenue increased 4.6 percent (4 percent adjusted for currency) in the fourth quarter. ITS had strong performance in the growth markets, driven by the benefits of geographic expansion in offerings such as Business Continuity and Resiliency Services. GTS gross profit increased 9.0 percent in the fourth quarter compared to the same period in 2010 and the gross profit margin improved 2.1 points with improvement in all lines of business. GTS fourth-quarter 2011 pre-tax income increased 18.0 percent to $1,930 million with the pre-tax margin expanding 2.3 points to 18.0 percent, versus the prior year, driven by productivity and cost management, along with a mix into the higher margin growth markets.

 

40


 

Global Business Services revenue increased 2.5 percent (2 percent adjusted for currency) to $4,877 million in the fourth quarter of 2011. Application Outsourcing revenue increased 4.7 percent (4 percent adjusted for currency), led by strong performance in the growth markets. Consulting and Systems Integration had revenue growth in the fourth quarter of 1.9 percent (1 percent adjusted for currency), an improved constant currency growth rate compared to the third quarter. Overall GBS revenue continued to be impacted by Japan and the Public Sector; total GBS revenue, excluding Japan and the Public sector, increased 8.1 percent (9 percent adjusted for currency) in the fourth quarter of 2011. Although, revenue declines in Japan and the Public Sector continued in the fourth quarter, performance in the Public Sector improved compared to the prior two quarters of 2011. GBS gross profit increased 7.2 percent in the fourth quarter and gross profit margin expanded 1.3 points versus the prior year. GBS segment pre-tax income increased 14.4 percent to $841 million in the fourth quarter of 2011 with pre-tax margin expanding 1.8 points to 16.6 percent.

 

Software

 

Software revenue increased 8.7 percent (9 percent adjusted for currency) to $7,648 million in the fourth quarter. Key branded middleware revenue increased 11.3 percent (11 percent adjusted for currency) year to year. This was the fifth consecutive quarter of double-digit revenue growth in key branded middleware along with 17 consecutive quarters of share gains as the business continues to extend its leadership in the middleware market. WebSphere revenue increased 21.4 percent (21 percent adjusted for currency) in the fourth quarter of 2011 year to year and gained share. Each of WebSphere’s five product areas had revenue growth of 10 percent or higher in the fourth quarter including the Smarter Commerce offerings, which were up over 25 percent. Information Management revenue increased 8.7 percent (9 percent adjusted for currency) in the fourth quarter year to year and gained share. Distributed Database software revenue grew double digits in the fourth quarter, led by performance from the Netezza offerings which were up nearly 70 percent. Revenue from business analytics software offerings, most of which are part of Information Management, continued to outpace the market with double-digit growth in the fourth quarter. The acquisition of Algorithmics in the fourth quarter of 2011 further strengthens the business analytics and optimization offerings by providing risk analytics capabilities that help customers make informed decisions. Tivoli revenue increased 13.7 percent (14 percent adjusted for currency) year over year in the fourth quarter and gained share, driven by Storage software growth of 30 percent (30 percent adjusted for currency). In addition, Security solutions had revenue growth of 15 percent (15 percent adjusted for currency). With the recent acquisition of Q1 Labs, the company can now offer clients a new level of intelligence around security to enable them to better predict, prevent and detect all types of security threats. Rational revenue increased 3.7 percent (4 percent adjusted for currency) in the fourth quarter and gained share, driven by strong performance in Telelogic. Software gross profit increased 8.9 percent and the gross profit margin expanded 0.2 points. Software delivered segment pre-tax income of $3,710 million in the fourth quarter, a growth of 12.5 percent compared to the fourth quarter of 2010, with a pre-tax margin of 43.7 percent, up 1.4 points.

 

Systems and Technology

 

Systems and Technology revenue decreased 7.6 percent (8 percent adjusted for currency) to $5,803 million in the fourth quarter versus the same period in 2010. The year-to-year decline reflects very strong growth in the fourth quarter of 2010 of over 20 percent, driven by mainframe growth of nearly 70 percent. System z revenue decreased 31.2 percent (31 percent adjusted for currency) and MIPS (millions of instructions per second) shipments decreased 4 percent year to year. The decline in revenue was a result of the strong fourth quarter of 2010 when the company successfully launched its zEnterprise 196 server. Power Systems revenue increased 6.3 percent (6 percent adjusted for currency) and gained share. This reflected 15 consecutive quarters of share gains in Power Systems. In the fourth quarter, the company had over 350 competitive displacements resulting in over $350 million of business; approximately 60 percent of this business was from Hewlett Packard with most of the balance coming from Oracle/Sun. This was the strongest quarter of competitive displacements since the company started tracking this activity in 2006. System x revenue decreased 2.5 percent (3 percent adjusted for currency) in the fourth quarter year to year. Storage revenue decreased 1.2 percent (1 percent adjusted for currency) in the fourth quarter of 2011 versus the comparable period in 2010. Total disk revenue decreased 1 percent (1 percent adjusted for currency) and tape revenue decreased 4 percent (4 percent adjusted for currency) in the fourth quarter. When combined with the storage software revenue growth of 30 percent, total storage revenue increased 5 percent in the fourth quarter compared to the prior year. Retail Stores Solutions revenue increased 8.9 percent (9 percent adjusted for currency) in the fourth quarter and continued to gain share. Systems and Technology gross margin decreased 3.1 points versus the prior year driven primarily by product mix (approximately 2 points). Systems and Technology’s pre-tax income decreased 32.6 percent to $790 million in the fourth quarter and pre-tax margin decreased 4.8 points to 13.2 percent.

 

Global Financing

 

Global Financing revenue of $548 million decreased 12.9 percent (13 percent adjusted for currency), driven primarily by a decrease in used equipment sales revenue. The Global Financing segment fourth-quarter pre-tax income decreased 9.1 percent to $514 million and the pre-tax margin declined 0.9 points to 46.1 percent.

 

41


 

Geographic Revenue

 

Total geographic revenue increased 1.9 percent (2 percent adjusted for currency) to $28,772 million in the fourth quarter of 2011 compared to the prior year. Revenue in the major markets increased 0.5 percent (flat adjusted for currency) in the fourth quarter. In North America, revenue performance was led by Canada which was up 11.6 percent (13 percent adjusted for currency). The U.S. was up 1.1 percent compared to a strong fourth quarter of 2010, which increased 10 percent driven by mainframe performance. In Europe, the revenue growth rate at constant currency improved sequentially compared to the third quarter of 2011. Germany returned to growth in the quarter with revenue up 2.9 percent (4 percent adjusted for currency). Revenue increased in Spain 8.2 percent (9 percent adjusted for currency) and in the U. K. 8.4 percent (9 percent adjusted for currency). This was the fifth and ninth consecutive quarters of constant currency revenue growth in Spain and the U. K, respectively. Growth markets revenue increased 7.1 percent (8 percent adjusted for currency) in the fourth quarter and outpaced growth in the major markets by 8 points on a constant currency basis. The growth markets gained 4 points of share in the fourth quarter. Revenue performance was broad based with double-digit constant currency revenue growth in 40 growth market countries. In the BRIC countries, combined revenue increased 9.6 percent (11 percent adjusted for currency).

 

Expense

 

($ in millions)

 

For the fourth quarter:

 

2011

 

2010

 

Yr.-to-Yr.
Percent/
Margin
Change

 

Total consolidated expense and other (income)

 

$

7,448

 

$

7,271

 

2.4

%

Non-operating adjustments

 

 

 

 

 

 

 

Amortization of acquired intangible assets

 

(72

)

(75

)

(4.2

)

Acquisition-related charges

 

(13

)

(23

)

(42.8

)

Non-operating retirement-related (costs)/income

 

25

 

61

 

(58.9

)

Total operating (non-GAAP) expense and other (income)

 

$

7,388

 

$

7,235

 

2.1

%

Total consolidated expense-to-revenue ratio

 

25.3

%

25.1

%

0.2 pts.

 

Operating (non-GAAP) expense-to-revenue ratio

 

25.1

%

24.9

%

0.1 pts.

 

 

Total expense and other income increased 2.4 percent year to year with an expense-to-revenue-ratio of 25.3 percent compared to 25.1 percent in the fourth quarter of 2010. The increase in total expense and other income was primarily driven by the company’s acquisitions over the past 12 months (1 point) and higher base expense (1 point). There was effectively no year-to-year impact from the combination of currency translation and hedging dynamics in the fourth quarter. Within Selling, general and administrative expense, accounts receivable provisions increased approximately $55 million in the fourth quarter of 2011 year to year due to higher receivables balances and the European credit environment. The accounts receivable reserve coverage at December 31, 2011 decreased 30 basis points compared to December 31, 2010, and decreased 20 basis points since September 2011.

 

Cash Flow

 

The company generated $7,097 million in cash flow from operations, an increase of $302 million compared to the fourth quarter of 2010, primarily driven by higher net income. Net cash used in investing activities of $3,505 million decreased $577 million, primarily due to less cash used for acquisitions ($1,340 million), partially offset by a net reduction of $762 million from purchases and sales of marketable securities and other investments in 2011 versus 2010. Net cash used in financing activities of $2,810 million increased $950 million compared to the prior year, primarily due to a net decrease in cash from common stock transactions ($704 million).

 

In the fourth quarter, the company repurchased 19 million shares of its common stock. The weighted-average number of diluted common shares outstanding in the fourth quarter of 2011 was 1,188.7 million compared with 1,258.4 million in the fourth quarter of 2010.

 

42

 

GAAP Reconciliation

 

The tables below provide a reconciliation of the company’s income statement results as reported under GAAP to its operating earnings presentation which is a non-GAAP measure. The company’s calculation of operating earnings, as presented, may differ from similarly titled measures reported by other companies. Please refer to the “Operating (non-GAAP) Earnings” section on page 18 for the company’s rationale for presenting operating earnings information.

 

($ in millions)

 

For the fourth quarter 2011:

 

GAAP

 

Acquisition-
related
Adjustments

 

Retirement-related
Adjustments

 

Operating
(non-GAAP)

 

Gross profit

 

$

14,722

 

$

81

 

$

(10

)

$

14,793

 

Gross profit margin

 

49.9

%

0.3

pts.

(0.0

)pts.

50.2

%

SG&A

 

$

6,076

 

$

(82

)

$

2

 

$

5,996

 

RD&E

 

1,555

 

0

 

23

 

1,578

 

Other (income) and expense

 

(44

)

(2

)

0

 

(46

)

Total expense and other (income)

 

7,448

 

(85

)

25

 

7,388

 

Pre-tax income

 

7,274

 

166

 

(35

)

7,405

 

Pre-tax income margin

 

24.7

%

0.6

pts.

(0.1

)pts.

25.1

%

Provision for income taxes*

 

$

1,784

 

$

47

 

$

(24

)

$

1,808

 

Effective tax rate

 

24.5

%

0.1

pts.

(0.2

)pts.

24.4

%

Net income

 

$