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		21
Year in Review		26
Prior Year in Review		44
Other Information		55
Looking Forward		55
Liquidity and Capital Resources		56
Critical Accounting Estimates		59
Currency Rate Fluctuations		61
Market Risk		62
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	87
D	Financial Instruments	92
E	Inventories	98
F	Financing Receivables	99
G	Property, Plant and Equipment	102
H	Investments and Sundry Assets	102
I	Intangible Assets Including Goodwill	102
J	Borrowings	104
K	Other Liabilities	106
L	Equity Activity	107
M	Contingencies and Commitments	110
N	Taxes	113
O	Research, Development and Engineering	115
P	Earnings Per Share of Common Stock	116
Q	Rental Expense and Lease Commitments	116
R	Stock-Based Compensation	117
S	Retirement-Related Benefits	120
T	Segment Information	134
U	Subsequent Events	138
Five-Year Comparison of Selected Financial Data		139
Selected Quarterly Data		140
Performance Graph		141
Board of Directors and Senior Leadership		142
Stockholder Information		143

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Management Discussion

International Business Machines Corporation and Subsidiary Companies

Overview

The financial section of the International Business Machines Corporation (IBM or the company) 2012 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 to 21, presents an overview of the key performance drivers in 2012.

·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 through 58.

·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 87 through 91), detailed information on specific items within the financial statements, certain contingencies and commitments (pages 110 to 113) and retirement-related benefits information (pages 120 to 134).

·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 separates business results into operating and non-operating categories. 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 characterizes 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. The company’s reportable segment financial results reflect operating earnings, consistent with the company’s management and measurement system.

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 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 2012 Form 10-K filed on February 26, 2013.

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Management Discussion Snapshot

($ and shares in millions except per share amounts)

For the year ended December 31:	2012			2011			Yr.-to-Yr.  Percent/  Margin  Change
Revenue	$	104,507		$	106,916		(2.3	)%*
Gross profit margin	48.1		%	46.9		%	1.2	pts.
Total expense and other income	$	28,396		$	29,135		(2.5	)%
Total expense and other income-to-revenue ratio	27.2		%	27.3		%	(0.1)	pts.
Income before income taxes	$	21,902		$	21,003		4.3	%
Provision for income taxes	5,298			5,148			2.9	%
Net income	$	16,604		$	15,855		4.7	%
Net income margin	15.9		%	14.8		%	1.1	pts.
Earnings per share of common stock
Assuming dilution	$	14.37		$	13.06		10.0	%
Weighted-average shares outstanding
Assuming dilution	1,155.4			1,213.8			(4.8	)%
Assets**	$	119,213		$	116,433		2.4	%
Liabilities**	$	100,229		$	96,197		4.2	%
Equity**	$	18,984		$	20,236		(6.2	)%

*	0.0 percent adjusted for currency.
**	At December 31.

The following table provides the company’s operating (non-GAAP) earnings for 2012 and 2011.

($ in millions except per share amounts)

For the year ended December 31:	2012		2011			Yr.-to-Yr.  Percent  Change
Net income as reported	$	16,604	$	15,855		4.7	%
Non-operating adjustments (net of tax)
Acquisition-related charges	641		495			29.5
Non-operating retirement-related costs/(income)	381		(32		)	NM
Operating (non-GAAP) earnings*	$	17,627	$	16,318		8.0	%
Diluted operating (non-GAAP) earnings per share	$	15.25	$	13.44		13.5	%

NM—Not meaningful

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

In 2012, the company reported revenue of $104.5 billion, expanded gross, pre-tax and net income margins, and delivered diluted earnings per share growth of 10.0 percent as reported and 13.5 percent on an operating (non-GAAP) basis. This was the 10th consecutive year of double-digit earnings per share growth for the company. The company generated $19.6 billion in cash from operations, and $18.2 billion in free cash flow driving shareholder returns of $15.8 billion in gross common stock repurchases and dividends. The free cash flow performance in 2012 was $12.3 billion greater than the company generated in 2002. The financial results demonstrate the strength and flexibility of the company’s business model, which is designed to deliver profit and cash on a sustained basis.

The company continued to deliver value to its clients and capitalize on key trends in 2012. The company had strong performance in business analytics, cloud and Smarter Planet—key growth initiatives that leverage the software portfolio and contribute to margin expansion. Within the growth markets, the company continued to expand its capabilities and build out IT infrastructures in emerging markets. In 2012, the growth markets revenue growth rate at constant currency outpaced the major markets by 8 points. The company continues to invest for innovation and technological leadership. These investments supported the introduction of the new System z mainframe, storage and POWER7+ products in hardware, as well as a series of major launches across software that included more than 400 new or upgraded product announcements. The introduction of PureSystems, a new category of expert integrated systems, brings together hardware and software and provides built-in expertise to deliver a more efficient and effective solution to the company's clients. In addition, the company was awarded more U.S. patents in 2012 than any other company for the 20th consecutive year with many of the patents this year in key areas such as business analytics, Big Data, cybersecurity, cloud, mobile, social networking and software-defined environments.  The company also continued to add to its capabilities to support the growth initiatives by acquiring 11 companies in 2012— investing approximately $4 billion. At the same time, the company divested its Retail Store Solutions (RSS) business as it focused the Smarter Commerce portfolio on higher value, intellectual property-based opportunities. Throughout the year, the company continued the transformation of the business—shifting to higher value areas and improving its structure—resulting in a higher quality revenue stream and margin expansion.

Segment performance was led by Software which increased revenue 2.0 percent (4 percent adjusted for currency) driven by key branded middleware which increased 2.9 percent (5 percent adjusted for currency). Global Services revenue decreased 2.3 percent as reported, but was up 0.4 percent on a constant currency basis. Global Services revenue performance was led by the growth markets which were up 4.8 percent (9 percent adjusted for currency) and now represents more than 20 percent of total Global Services revenue. Systems and Technology revenue decreased 6.9 percent; adjusting for the divested RSS business, revenue declined 5.1 percent (4 percent adjusted for currency). The company’s new mainframe was well received in the market, with System z revenue increasing 5.4 percent (6 percent adjusted for currency) versus the prior year. Global Financing revenue decreased 4.2 percent as reported, 1 percent on a constant currency basis, compared to the prior year.

        Across all of the segments, the company continued to have strong performance in its key growth initiatives. These are not stand-alone offerings; they are integrated into the overall client offerings and are included in the financial results of the segments. In the growth markets, revenue increased 4.2 percent (7 percent adjusted for currency) year to year and represented 24 percent of total geographic revenue, an increase of 8 points since 2006. The company has been successful in capturing the opportunity in these faster growing markets. The company’s business analytics initiative continues to expand. The company has made significant strides and expanded its leadership in a number of strategic areas

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including Risk Management, Price and Promotion Optimization and Sales Performance Management. The value proposition in business analytics uniquely leverages the integration between the software portfolio and the Global Business Services (GBS) consulting expertise. In 2012, business analytics revenue increased 13 percent compared to the prior year, led by the GBS consulting practice. Within cloud computing, the company’s SmartCloud portfolio addresses the full scope of enterprise client requirements. In 2012, the company continued to see strong demand for the foundational offerings in hardware and software that help clients build and run their private clouds, as well as for cloud-based solutions, like the company’s Software as a Service (SaaS) offerings. With strong global growth, cloud revenue for 2012 increased 80 percent compared to the prior year. The Smarter Planet growth initiative expanded significantly in the past year—measured in terms of offerings, markets, clients and revenue performance. Clients are leveraging the company’s growing capabilities in areas like: Smarter Commerce, Social Business and Smarter Cities, and in next generation systems, like Watson, which are helping clients with their complex challenges. For the year, Smarter Planet solutions generated revenue growth of over 25 percent versus the prior year. Overall, within the offerings in business analytics, cloud and Smarter Planet, approximately half of the revenue is software. Therefore, as these offerings become a larger percentage of total revenue, they are driving the higher quality revenue stream and improved mix and margins.

The consolidated gross profit margin increased 1.2 points versus 2011 to 48.1 percent. This was the ninth consecutive year of improvement in the gross profit margin. The operating (non-GAAP) gross margin of 48.7 percent increased 1.5 points compared to the prior year. The increase in gross margin in 2012 was driven by margin improvements in Software and both Global Services segments, and an improved revenue mix driven by Software.

Total expense and other income decreased 2.5 percent in 2012 versus the prior year. Total operating (non-GAAP) expense and other income decreased 3.9 percent compared to the prior year. The year-to-year drivers were approximately:

	Total	Operating
	Consolidated	(non-GAAP)
·Currency*	(5) points	(5) points
·Acquisitions**	3 points	2 points
·Base expense	(0) points	(2) points

* Reflects impacts of translation and hedging programs.

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

Pre-tax income grew 4.3 percent and the pre-tax margin was 21.0 percent, an increase of 1.3 points versus 2011. Net income increased 4.7 percent and the net income margin was 15.9 percent, an increase of 1.1 points versus 2011. The effective tax rate for 2012 was 24.2 percent compared with 24.5 percent in the prior year. Operating (non-GAAP) pre-tax income grew 7.3 percent and the operating (non-GAAP) pre-tax margin was 22.2 percent, an increase of 2.0 points versus the prior year. Operating (non-GAAP) net income increased 8.0 percent and the operating (non-GAAP) net income margin of 16.9 percent increased 1.6 points versus the prior year. The operating (non-GAAP) effective tax rate was 24.0 percent versus 24.5 percent in 2011.

Diluted earnings per share improved 10.0 percent year to year reflecting the growth in net income and the benefits of the common stock repurchase program. In 2012, the company repurchased approximately 61 million shares of its common stock. Diluted earnings per share of $14.37 increased $1.31 from the prior year. Operating (non-GAAP) diluted earnings per share of $15.25 increased $1.81 versus 2011 driven by the following factors:

·Revenue decrease at actual rates	$	(0.30	)
·Margin expansion	$	1.38
·Common stock repurchases	$	0.73

At December 31, 2012, the company’s balance sheet and liquidity positions remained strong and were well positioned to support the company’s objectives. Cash and marketable securities at year end was $11,128 million. Key drivers in the balance sheet and total cash flows are highlighted below.

Total assets increased $2,780 million ($3,242 million adjusted for currency) from December 31, 2011 driven by:

·Increases in total receivables ($3,053 million), goodwill ($3,034 million), marketable securities ($717 million) and intangible assets ($395 million), partially offset by

·Decreases in prepaid pension assets ($1,899 million), cash and cash equivalents ($1,511 million) and prepaid expenses and other current assets ($1,224 million).

Total liabilities increased $4,032 million ($4,511 million adjusted for currency) from December 31, 2011 driven by:

·Increased retirement and nonpension postretirement benefit obligations ($2,044 million), total debt ($1,949 million), taxes ($1,635 million) and total deferred income ($399 million), partially offset by

·Decreases in other liabilities ($1,389 million) and accounts payable ($565 million).

Total equity of $18,984 million decreased $1,252 million from December 31, 2011 as a result of:

·Increased treasury stock ($12,168 million) driven by share repurchases and increased losses in accumulated other comprehensive income/(loss) of ($3,874 million) driven by pension remeasurements, partially offset by

·Higher retained earnings ($12,783 million) and common stock ($1,980 million).

The company generated $19,586 million in cash flow provided by operating activities, a decrease of $260 million when compared to 2011, primarily driven by a decrease in cash due to receivables ($1,290 million) and an increased use of cash for accounts payable ($675 million), partially offset by a decrease in net taxes paid ($999 million) and the increase in net income ($749 million). Net cash used in investing activities of $9,004 million was $4,608 million higher than 2011, primarily due to an increase in cash used of $2,719 million associated with net purchases and sales of marketable securities

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and other investments, increased cash used for acquisitions ($1,911 million) and increased net capital investments ($248 million), partially offset by increased cash from divestitures ($585 million). Net cash used in financing activities of $11,976 million was $1,719 million lower, compared to 2011, primarily due to lower cash used for common stock repurchases ($3,051 million), partially offset by lower cash provided by common stock transactions ($914 million) and increased dividend payments ($300 million).

In January 2013, the company disclosed that it is expecting GAAP earnings of at least $15.53 and operating (non-GAAP) earnings of at least $16.70 per diluted share for the full year 2013.

For additional information and details, see the “Year in Review” section on pages 26 through 43. For additional information regarding 2002 free cash flow, see the company’s Form 8-K filed with the SEC on January 22, 2013.

Description of Business

Please refer to IBM’s Annual Report on Form 10-K filed with the SEC on February 26, 2013 for a more detailed version of this Description of Business, especially Item 1A. entitled “Risk Factors.”

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

Strategy

Despite the volatility of the information technology (IT) industry over the past decade, IBM has consistently delivered strong performance, with a steady track record of sustained earnings per share growth and cash generation. 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 more than 140 companies since 2000, complementing and scaling its portfolio of products and offerings.

IBM’s strategy of delivering high value solutions to enterprise clients has yielded consistent business results. Working with enterprise clients across the full spectrum of their business and technical opportunities, IBM delivers leadership innovation in technology, high value solutions and insights that improve client and industry outcomes. A highly engaged, global workforce with deep technical and business skills, teamed with an unmatched ecosystem of partners provides a world-class client experience.

These priorities reflect a broad shift in client spending toward innovation and efficiency, 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, sustained investment in core and applied research and development (R&D), global reach and the breadth and depth of the company’s capabilities.

New types of solutions, new market opportunities and new decision makers are emerging as clients look to make use of technology to generate innovation and competitive advantage. These opportunities are driven by a new era of computing that is enabled by analytics, cloud computing, Big Data, mobility, social computing and supported by enterprise grade security solutions. The company’s strategy is to establish leadership in this new era of smarter computing — computing that is designed for Big Data, built on software-defined environments and open — in order to enhance the value we deliver, create new markets and engage new clients.

To capture the opportunities arising from these market trends, IBM is focused on four key growth initiatives: 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 toward a “smarter planet” by equipping clients with the advanced, integrated capabilities they need to thrive in this exciting new world that is unfolding before us—capabilities such as analytics for business and physical systems, business process management, social business, mobile computing and cloud computing.

IBM has continued to deepen its commitment to understanding and delivering on the promise of Smarter Planet for both line of business and IT executives 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 healthcare, 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 helps these clients achieve their goals.

Three initiatives that drive significant value illustrate IBM’s deep commitment to building a smarter planet: Smarter Commerce, Smarter Cities and Social Business. 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 federal, state and local governments to make smarter decisions, anticipate issues and coordinate resources more effectively, while delivering citizen-centric services that underpin sustainable economic growth. IBM’s Social Business initiative helps clients integrate social technologies and practices into their front-end processes to more effectively create and share knowledge to accelerate innovation, improve customer service, and build a smarter workforce.  Each of these initiatives is powered by market-leading IBM innovations and software, developed both by IBM and through acquisitions.

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Growth Markets

The company has benefited from its investments over the past several years in the 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-outs 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 effort 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 continues to invest significantly in these markets to expand capacity, to develop talent and to deepen its R&D capabilities on the ground. At the same time, IBM continues to leverage talent across the growth markets under its globally integrated enterprise model to the benefit of both its clients and the company worldwide.

Business Analytics and Optimization

Business Analytics and Optimization (BAO) is the category of software, systems and services that help organizations take advantage of all the data available to them for better and faster decision making and process optimization. This includes data that is being labeled “Big Data,” which is data of extreme volume, data being generated at a high velocity, and newer varieties of data like blogs, tweets, pictures, videos, unstructured text created by the explosion of social media websites and the instrumentation of nearly everything. BAO is core to achieving a smarter planet, helping leaders of this new information-centric and insight-driven world infuse intelligence into their business processes.

Smarter Analytics is IBM’s unique offering for the BAO category. With Smarter Analytics and the company’s deep expertise, IBM can help organizations: 1) grow, retain and satisfy customers through deep insight on individual customers and similar segments; 2) increase operational efficiency through, for example, supply chain optimization, predictive maintenance, fraud reduction and optimization of sales incentives and compensation; 3) transform their financial processes such as planning, budgeting, forecasting, financial consolidation, regulatory filing and financial reporting; and 4) better manage risk and regulatory compliance.

The company’s approach to analytics is to ensure clients have complete end-to-end solutions across industries and functional focus areas like finance, sales, marketing, operations and risk. These solutions are designed to help organizations: 1) align around all their data—both traditional and big data—and establish a strong information foundation; 2) apply analytics to their data so they can anticipate and shape business outcomes, identify patterns and gain insights into future performance; 3) enable workers on the front lines who collectively make thousands and even millions of decisions daily with insight that is immediately actionable so they can make the best possible decision—decisions like what claims to fast track in an insurance call center, or what offer is the best for each individual customer who calls a call center; and 4) create a culture that takes action on analytics and that truly transforms.

IBM is committed to continually innovating across the spectrum of analytic capabilities, systems, research, services, deployment and skills. For example, in 2012, the game changing innovations in Watson were applied to Healthcare and Financial Services, analytic research like the ground-breaking work being done on temporal causal modeling and visualization, and investments in analytic skills and deployment ability in our new Analytics research centers in Columbus, Ohio and Halifax, Nova Scotia.

Cloud Computing

Cloud is a model for consuming and delivering business and IT services. It can deliver significant economies, enable new levels of speed, flexibility and agility and even serve as a transformative platform for business innovation. From a business perspective, cloud computing is reshaping industry ecosystems, invigorating product innovation and enabling new business models that leverage new sources of competitive differentiation. From an IT perspective, cloud offers improved access to and utilization of information technology through use of highly efficient virtualization and management technology, consumer-style user interfaces and ubiquitous connectivity, including via mobile technologies.

IBM has already helped thousands of its clients adopt and leverage cloud computing through its broad portfolio of IBM SmartCloud products, solutions and services. Organizations moving beyond initial exploration of cloud computing seek solutions that align with their specific needs. IBM’s breadth of cloud capabilities gives it a unique ability to help clients exploit the advantages of cloud. IBM has cloud solutions that span infrastructure, platform, applications and business process services all geared to enable clients to drive significant business value through the rapid adoption and exploitation of new cloud capabilities. IBM’s expert consulting, breakthrough technologies and a portfolio of cloud-based services are squarely focused on the requirements of the enterprise.

The company offers a full array of cloud delivery models, including private clouds, public clouds and a hybrid of both. IBM helps build out private, on-premises cloud-based environments that provide the control, security and isolation that clients require for their most mission-critical workloads. IBM public clouds provide infrastructure, platforms and applications as rapidly provisioned and highly-scalable cloud services on a pay-as-you-go basis. Hybrid clouds provide seamless integration across private and public cloud models, ensuring the interoperability, portability and scalability that clients need to realize the full value of cloud.

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.

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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 and Global Business Services, which the company collectively calls Global Services, and 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 and business process services, creating business value for clients through unique technology and IP integrated services within its global delivery model. 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.

GTS Capabilities

Strategic Outsourcing Services: delivers comprehensive IT outsourcing services dedicated to transforming clients’ existing infrastructures to consistently deliver improved quality, flexibility, risk management and financial value. The company integrates longstanding 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: delivers a range of offerings consisting of standardized through transformational solutions 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: delivers a portfolio of project-based and managed services that enable clients to transform and 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.

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

Global Business Services (GBS) has the mission to deliver predictable business outcomes to the company’s clients across two primary business areas: Consulting and Application Management Services. These professional services deliver business value and innovation to clients through solutions which leverage industry and business process expertise. The role of GBS is to drive initiatives that integrate IBM content and solutions and drive the progress of the company’s four primary growth initiatives.

As clients transform themselves in response to market trends like Big Data, social and mobile computing, GBS is aligning its expertise and capabilities to address two interdependent categories of opportunity: Front Office Digitization, which describes the markets forming around new models of engagement with all audiences; and the Globally Integrated Enterprise, which describes the mandate to integrate data and processes in support of the new front-office programs, and build far more flexible information applications.

GBS Capabilities

Consulting: delivering client value with solutions in Strategy and Transformation; Application Innovation Services; Enterprise Applications and Smarter Analytics. Consulting is also focused on bringing to market client solutions that drive Front Office Digitization in Smarter Commerce, Cloud, Mobile and Social Business.

Application Management Services: application 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 application testing and modernization, cloud application services, the company’s highly differentiated globally integrated capability model, industry knowledge and the standardization and automation of application management.

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 post-contract 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 post-contract support. Clients can also purchase ongoing post-contract support after the first year, which includes unspecified product upgrades and technical support.

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Software Capabilities

WebSphere Software: delivers capabilities that enable organizations to run high-performance business applications. With these applications, clients can integrate and manage business processes across their organizations with the flexibility and agility they need to respond to changing conditions. Built on services-oriented architecture (SOA), and open standards support for cloud, mobile and social interactions, the WebSphere platform enables enterprises to extend their reach and optimize interactions with their key constituents. Smarter Commerce software helps companies better manage and improve each step of their value chain and capitalize on opportunities for profitable growth, efficiency and increased customer loyalty.

Information Management Software: enables clients to integrate, manage and analyze enormous amounts of data from a large variety of sources in order to gain competitive advantage and improve their business outcomes. With this approach, clients can extract real value out of their data and use it to make better business decisions. IBM’s middleware and integrated solutions include advanced database management, information integration, data governance, enterprise content management, data warehousing, business analytics and intelligence, predictive analytics and big data analytics.

Tivoli Software: helps clients optimize the value they get from their infrastructures and technology assets through greater visibility, control and automation across their end-to-end business operations. These asset management solutions foster integrated service delivery for cloud and datacenter management, enterprise endpoint and mobile device management, asset and facilities management, and storage management. Tivoli includes security systems software that provides clients with a single security intelligence platform that enables them to better secure all aspects of their enterprise and prevent security breaches.

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, IBM’s social business offerings help organizations reap real benefits associated with social networking, as well as create a more efficient and effective workforce.

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.

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

Systems and Technology (STG) 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 PureSystems, 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.

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 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.

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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, Inside Sales 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 (UK) 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: Cross-sector representation of intermediate-sized large enterprises as well as mid-market clients (less than 1,000 employees)

Research, Development and Intellectual Property

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

IBM Research works with clients and the company’s business units through 12 global labs on near-term and mid-term innovations. It contributes many new technologies to IBM’s portfolio every year and helps clients address their most difficult challenges. IBM Research also explores the boundaries of science and technology— from nanotechnology, to future systems, to big data analytics, to secure clouds, to IBM Watson, a “cognitive” learning system that applied advanced analytics to defeat the all-time champions on the television quiz show, Jeopardy!. The Watson system is being introduced to the market for advanced healthcare applications and is being further developed and extended within healthcare and in other industries.

IBM Research also focuses on differentiating IBM’s services businesses providing new capabilities and solutions. It has the world’s largest mathematics department of any public company, enabling IBM to create unique analytic solutions and actively engage with clients on their toughest challenges.

In 2012, IBM was awarded more U.S. patents than any other company for the 20th consecutive year. IBM’s 6,478 patents in 2012 included inventions that will enable fundamental advancements in analytics, big data, cybersecurity, cloud, mobile, social networking and software defined environments, as well as industry solutions for retail, banking, healthcare and transportation. It was the most U.S. patents ever awarded to one company in a single year.

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. 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.

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 standardized, the company implemented a new operating model with work shared in global resource centers of excellence located where it made the most business sense. The company has shifted resources toward building client relationships and employee 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 company replicated in countries around the world, to a global model with one set of processes, shared services and broadly distributed decision making.

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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, end-to-end process transformation and integrated operations. The company primarily reinvests the benefits of its enterprise transformation initiatives in remixing its spending profile and resources to the higher growth, higher margin initiatives such as business analytics, Smarter Planet and cloud computing, in addition to improving profitability.

Integrated Supply Chain

IBM spends approximately $35 billion annually through its supply chain, procuring materials and services globally. In addition, in 2012, 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 marketplace changes and risks have been particularly valuable in maintaining continuity during natural disasters and other disruptive events.

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.

Increasingly the company is using analytics to measure, manage and fine tune its supply chain operations, which will help to reshape its operations and create value for clients. The goal is to continue to increase the use of analytics in the five major areas of supply chain: 1) Supply Chain Visibility, 2) Risk Management, 3) Customer Insight, 4) Cost Containment, and 5) Global Supply Chain and Sustainability.

Year in Review

Segment Details

The following is an analysis of the 2012 versus 2011 reportable segment results. The table below presents each reportable segment’s external revenue and gross margin results.

($ in millions)

							Yr.-to-Yr.		Yr.-to-Yr.
							Percent/ Margin		Percent Change Adjusted for
For the year ended December 31:	2012			2011			Change		Currency
Revenue
Global Technology Services	$	40,236		$	40,879		(1.6	)%	1.3	%
Gross margin	36.6		%	35.0		%	1.6	pts.
Global Business Services	18,566			19,284			(3.7	)%	(1.6	)%
Gross margin	30.0		%	28.8		%	1.2	pts.
Software	25,448			24,944			2.0	%	4.3	%
Gross margin	88.7		%	88.5		%	0.2	pts.
Systems and Technology	17,667			18,985			(6.9	)%	(5.9	)%
Gross margin	39.1		%	39.8		%	(0.7	)pts.
Global Financing	2,013			2,102			(4.2	)%	(1.2	)%
Gross margin	46.5		%	49.8		%	(3.3)	pts.
Other	577			722			(20.1	)%	(18.7	)%
Gross margin	(71.6		)%	(54.5		)%	(17.1	)pts.
Total consolidated revenue	$	104,507		$	106,916		(2.3	)%	0.0	%
Total consolidated gross profit	$	50,298		$	50,138		0.3	%
Total consolidated gross margin	48.1		%	46.9		%	1.2	pts.
Non-operating adjustments
Amortization of acquired intangible assets	375			340			10.3	%
Acquisition-related charges	1			1			13.1
Retirement-related costs/(income)	264			2			NM
Operating (non-GAAP) gross profit	$	50,938		$	50,481		0.9	%
Operating (non-GAAP) gross margin	48.7		%	47.2		%	1.5	pts.

NM—Not meaningful

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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:	2012		2011		2012		2011
Global Technology Services	38.7	%	38.5	%	29.0	%	27.4	%
Global Business Services	17.9		18.2		12.4		13.1
Total Global Services	56.6		56.7		41.4		40.6
Software	24.5		23.5		45.0		43.5
Systems and Technology	17.0		17.9		5.1		7.1
Global Financing	1.9		2.0		8.5		8.8
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 134 to 138 for additional information.

Global Services

In 2012, the Global Services segments, Global Technology Services (GTS) and Global Business Services (GBS), delivered revenue of $58,802 million, grew pre-tax profit 7 percent and expanded pre-tax margin 1.5 points on an as-reported basis. Revenue performance was led by strength in the growth markets which were up 4.8 percent (9 percent adjusted for currency) and now represents over 20 percent of total Global Services revenue. Revenue from the major markets declined 4.0 percent (2 percent adjusted for currency) year to year. The services segments also had strength in all the key growth initiatives, which are becoming a larger part of the services business as the company continues to shift toward higher value content. Total outsourcing revenue of $27,552 million decreased 2.6 percent (flat adjusted for currency) and total transactional revenue of $23,907 million decreased 1.8 percent (flat adjusted for currency) year to year.

($ in millions)

For the year ended December 31:	2012		2011		Yr.-to-Yr.  Percent  Change		Yr.-to-Yr. Percent Change Adjusted for Currency
Global Services external revenue	$	58,802	$	60,163	(2.3	)%	0.4	%
Global Technology Services	$	40,236	$	40,879	(1.6)%		1.3	%
Outsourcing	23,344		23,911		(2.4	)	0.5
Integrated Technology Services	9,550		9,453		1.0		3.7
Maintenance	7,343		7,515		(2.3	)	0.6
Global Business Services	$	18,566	$	19,284	(3.7	)%	(1.6	)%
Outsourcing	4,209		4,390		(4.1	)	(1.7	)
Consulting and Systems Integration	14,358		14,895		(3.6	)	(1.6	)

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Global Technology Services revenue of $40,236 million in 2012 decreased 1.6 percent as reported, but increased 1 percent adjusted for currency year to year. Revenue growth from the backlog was partially offset by a decline in revenue from new signings and a decrease in sales in existing accounts. Revenue performance was led by the growth markets which were up 5.0 percent (9 percent adjusted for currency). GTS Outsourcing revenue decreased 2.4 percent as reported, but increased 1 percent adjusted for currency in 2012. Outsourcing revenue from the growth markets increased 2.4 percent (7 percent adjusted for currency), as the outsourcing offerings help clients build out their IT infrastructures. Integrated Technology Services (ITS) revenue increased 1.0 percent (4 percent adjusted for currency) in 2012 compared to 2011, and continued to be led by strength in the growth markets which increased 10.3 percent (13 percent adjusted for currency).

Global Business Services revenue of $18,566 million decreased 3.7 percent (2 percent adjusted for currency) in 2012. On a geographic basis, solid performance in the growth markets, with revenue up 4.3 percent (8 percent adjusted for currency), was offset by a 5.1 percent decline (3 percent adjusted for currency) in the major markets. The growth initiatives—business analytics, Smarter Planet and cloud had solid double-digit revenue growth, and represented over one-third of total GBS revenue in 2012. As GBS shifts more of its business to higher value content, these larger, more complex engagements are having a positive effect on the GBS backlog. The GBS backlog grew for the fourth consecutive year at constant currency—although the backlog is mixing to longer duration engagements. Application Outsourcing revenue decreased 4.1 percent (2 percent adjusted for currency) in 2012 year to year, and Consulting and Systems Integration (C&SI) revenue decreased 3.6 percent (2 percent adjusted for currency). Both GBS lines of business had solid revenue performance year to year in the growth markets with Application Outsourcing and C&SI up 1.5 percent and 5.3 percent, respectively, as reported, and up 6 percent and 8 percent, respectively, at constant currency.

($ in millions)

							Yr.-to-Yr. Percent/ Margin
For the year ended December 31:	2012			2011			Change
Global Services
Global Technology Services
External gross profit	$	14,740		$	14,320		2.9	%
External gross profit margin	36.6		%	35.0		%	1.6	pts.
Pre-tax income	$	6,961		$	6,284		10.8	%
Pre-tax margin	16.8		%	14.9		%	1.9	pts.
Global Business Services
External gross profit	$	5,564		$	5,545		0.3	%
External gross profit margin	30.0		%	28.8		%	1.2	pts.
Pre-tax income	$	2,983		$	3,006		(0.8	)%
Pre-tax margin	15.5		%	15.0		%	0.5	pts.

GTS gross profit increased 2.9 percent in 2012 and the gross profit margin improved 1.6 points year to year with margin expansion in each line of business, led by Outsourcing. Pre-tax income of $6,961 million in 2012 increased 10.8 percent year to year and the pre-tax margin expanded 1.9 points to 16.8 percent. Normalized for workforce rebalancing charges of $151 million and $5 million in the third quarter of 2012 and 2011, respectively, GTS pre-tax income was up 13.1 percent and pre-tax margin expanded 2.2 points. The year over-year gross and pre-tax margin expansion was driven by several factors: the work done to improve the profitability of a number of low margin contracts in the outsourcing portfolio, increased contribution from the higher margin growth markets, and increased efficiency and productivity from the focus on automation and process primarily through the company’s enterprise productivity initiatives.

The GBS gross profit margin expanded 1.2 points, led primarily by improved profit performance in Application Outsourcing. GBS pre-tax income of $2,983 million declined 0.8 percent in 2012 with a pre-tax margin of 15.5 percent, an improvement of 0.5 points year to year. Normalized for workforce rebalancing charges of $113 million and $5 million in the third quarter of 2012 and 2011, respectively, GBS pre-tax income was up 2.8 percent and the pre-tax margin expanded 1.1 points. The gross and pre-tax margins benefitted from improved service delivery and yield from the company’s enterprise productivity initiatives.

The total Global Services business delivered strong profit and margin expansion throughout 2012. Pre-tax income of $9,944 million in 2012 increased 7.0 percent year to year. Normalized for the higher level of workforce rebalancing charges in 2012, pre-tax income was up 9.8 percent and the pre-tax margin expanded 1.9 points compared to the prior year.

Global Services Backlog

The estimated Global Services backlog at December 31, 2012 was $140 billion, a decrease of 0.3 percent as reported, but an increase of 1 percent adjusted for currency compared to the December 31, 2011 balance, and an increase of 1.9 percent (3 percent adjusted for currency) compared to the September 30, 2012 balance. Revenue generated from the backlog is approximately 70 percent of total services annual revenue in any year, with the remainder coming from transactional signings in the year, and sales and volumes into the existing client base. In 2013, the projected total services revenue from the backlog is expected to be up 1 percent year to year at consistent foreign currency exchange rates. This includes 2 percent growth from the run out of the opening backlog and a 1 percent impact from the work done to restructure a number of lower margin contracts in the outsourcing business. Despite the impact to revenue growth, these restructured contracts have improved the profitability of the backlog. These contracts provided year-to-year profit improvement in 2012. This impact, which will carryforward to 2013, will contribute modest profit growth in 2013 off this higher profit base, with the gross profit coming from the backlog more representative of a 2 percent backlog growth versus a 1 percent growth.

The total estimated growth markets backlog at December 31, 2012 increased 13.6 percent (15 percent adjusted for currency) year to year. The estimated transactional backlog at December 31, 2012 increased 8.7 percent (9 percent adjusted for currency) and the estimated outsourcing backlog decreased 3.3 percent (2 percent adjusted for currency), respectively, from the December 31, 2011 levels.

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($ in billions)

At December 31:	2012		2011		Yr.-to-Yr. Percent Change		Yr.-to-Yr. Percent Change Adjusted for Currency
Backlog
Total backlog	$	140.3	$	140.6	(0.3	)%	0.6	%
Outsourcing backlog	89.4		92.5		(3.3	)	(2.4	)

Total Global Services backlog includes GTS Outsourcing, ITS, GBS Outsourcing, Consulting and Systems Integration and Maintenance. Outsourcing backlog includes GTS Outsourcing and GBS Outsourcing. Transactional backlog includes ITS and Consulting and Systems Integration. 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)

					Yr.-to-Yr. Percent		Yr.-to-Yr. Percent Change Adjusted for
For the year ended December 31:	2012		2011		Change		Currency
Total signings	$	56,595	$	57,435	(1.5	)%	1.1	%
Outsourcing signings	$	27,891	$	29,251	(4.6	)%	(1.9	)%
Transactional signings	28,703		28,184		1.8		4.1

Software

($ in millions)

					Yr.-to-Yr. Percent		Yr.-to-Yr. Percent Change Adjusted for
For the year ended December 31:	2012		2011*		Change		Currency
Software external revenue	$	25,448	$	24,944	2.0	%	4.3	%
Middleware	$	20,983	$	20,650	1.6	%	3.9	%
Key Branded Middleware	16,528		16,055		2.9		5.2
WebSphere Family					7.8		9.9
Information Management					1.5		3.8
Lotus					(2.1	)	0.3
Tivoli					4.1		6.2
Rational					(1.6	)	0.6
Other middleware	4,455		4,596		(3.1	)	(0.6	)
Operating systems	2,525		2,480		1.8		4.3
Other	1,940		1,813		7.0		9.2

* Reclassified to conform with 2012 presentation.

Software revenue of $25,448 million increased 2.0 percent (4 percent adjusted for currency) in 2012 compared to 2011. Software revenue growth continued to be led by the key branded middleware products with constant currency growth in all the brands, and particular strength and share gains in WebSphere and Tivoli. Software continued its momentum throughout 2012 in the growth initiatives with strong performance in business analytics, Smarter Commerce and cloud. The Software business delivered $10.8 billion in segment

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pre-tax profit, an increase of $840 million from 2011. The results reflect the company’s sustained investment in strategic branded software. In addition to organic investments, acquisitions have provided additional capabilities, while leveraging the existing portfolio of offerings. The software business completed nine acquisitions in 2012, further increasing the company’s capabilities in analytics, cloud and Smarter Planet.

Key branded middleware revenue increased 2.9 percent (5 percent adjusted for currency) and again gained market share in 2012, as the Software business continued to be the leader in the middleware market. Revenue continued to mix to the faster growing and higher value branded middleware products which accounted for 65 percent of total software revenue in 2012, an increase of 1 point from 2011.

WebSphere revenue increased 7.8 percent (10 percent adjusted for currency) in 2012, with strong performance throughout the year, and gained share. Revenue performance included strong growth in the core offerings of commerce and application servers. Commerce revenue increased 14 percent (15 percent adjusted for currency) and application server products increased 6 percent (8 percent adjusted for currency). The company further strengthened its WebSphere portfolio during the year with the acquisitions of Worklight, DemandTec, Emptoris and Tealeaf.

Information Management revenue increased 1.5 percent (4 percent adjusted for currency) in 2012 compared to 2011. Performance was led by growth in the business analytics offerings. The acquisitions of Varicent and Vivisimo expanded the Business Analytics and Optimization software capabilities. Varicent’s analytics software helps clients optimize sales performance management. Vivisimo expands the breadth of the company’s big data capabilities and creates the most complete end-to-end big data solution for clients.

Tivoli revenue increased 4.1 percent (6 percent adjusted for currency) in 2012, led by its storage and security offerings, and gained share. Tivoli storage revenue was up 12 percent (14 percent adjusted for currency) in 2012, with double-digit constant currency growth in each quarter, reflecting the value of storage software. Tivoli security revenue increased 8 percent (10 percent adjusted for currency), with strong contribution from Q1 Labs which provides next generation security intelligence.

Lotus revenue decreased 2.1 percent as reported, but was flat year to year at constant currency in 2012. The social business offerings performed well, including contribution from the acquisition of Kenexa, a leading provider of recruiting and talent management solutions.

Rational revenue decreased 1.6 percent as reported, but increased 1 percent at constant currency in 2012 year over year, and held share.

Operating systems revenue increased 1.8 percent (4 percent adjusted for currency) in 2012 compared to 2011, driven by Platform Computing which provides cluster and grid management software for distributed computing environments.

Other software revenue increased 7.0 percent (9 percent adjusted for currency) driven by growth in software-related services.

($ in millions)

For the year ended December 31:	2012			2011			Yr.-to-Yr. Percent/ Margin Change
Software
External gross profit	$	22,569		$	22,065		2.3	%
External gross profit margin	88.7		%	88.5		%	0.2	pts.
Pre-tax income	$	10,810		$	9,970		8.4	%
Pre-tax margin	37.6		%	35.3		%	2.3	pts.

Software gross profit increased 2.3 percent to $22,569 million in 2012, with a gross profit margin of 88.7 percent, up 0.2 points year to year. Software pre-tax income of $10,810 million increased 8.4 percent and the pre-tax margin improved 2.3 points to 37.6 percent. Normalized for workforce rebalancing charges of $94 million and $6 million in the third quarter of 2012 and 2011, respectively, software pre-tax income was up 9.3 percent and the pre-tax margin expanded 2.6 points. The Software business had another successful year leveraging revenue growth and expense productivity to drive significant margin expansion and profit growth.

Systems and Technology

($ in millions)

For the year ended December 31:	2012		2011*		Yr.-to-Yr. Percent Change		Yr.-to-Yr. Percent Change Adjusted for Currency
Systems and Technology external revenue	$	17,667	$	18,985	(6.9	)%	(5.9	)%
System z					5.4	%	6.3	%
Power Systems					(8.5	)	(7.4	)
System x					(3.7	)	(2.7	)
Storage					(5.8	)	(4.1	)
Total Systems excluding Retail Store Solutions					(3.7	)	(2.5	)
Microelectronics OEM					(14.4	)	(14.4	)
Total Systems and Technology excluding Retail Store Solutions					(5.1	)	(4.0	)
Retail Store Solutions (Divested in 2012)					(52.6	)	(51.7	)

* Reclassified to conform with 2012 presentation.

30

Systems and Technology revenue decreased 6.9 percent (6 percent adjusted for currency) in 2012 versus 2011. Adjusting for the divested RSS business, revenue declined 5.1 percent (4 percent adjusted for currency) in 2012. Growth markets revenue increased 0.3 percent (1 percent adjusted for currency) in 2012, compared to the prior year while major markets revenue decreased 8.3 percent (7 percent adjusted for currency). During 2012, the company’s continued investments for innovation supported the introduction of the new System z mainframe, the PureSystems offerings and new Storage and POWER7+ products. In its introductory year, the company sold more than 2,300 PureSystems in over 70 countries.

System z revenue increased 5.4 percent (6 percent adjusted for currency) in 2012 versus 2011. The increase was driven by the new mainframe which began shipping late in the third quarter. Fourth quarter revenue increased 55.6 percent (56 percent adjusted for currency), as revenue increased in the major markets over 50 percent and over 65 percent in the growth markets. MIPS (millions of instructions per second) shipments increased 19 percent in 2012 versus the prior year. The increase in MIPS was driven by the new mainframe shipments, including specialty engines, which increased 44 percent year over year driven by Linux workloads. This is a good indicator of new workloads moving to this platform. The performance reflects the technology leadership and value of the vertically integrated stack that the company’s flagship server is delivering to its clients.

Power Systems revenue decreased 8.5 percent (7 percent adjusted for currency) in 2012 versus 2011. Low-end servers increased 6 percent (7 percent adjusted for currency) offset by declines in high-end and mid-range products. Early in October, the company announced new POWER7+ based servers. The high-end and midrange models available in the fourth quarter performed well in the period. The company will continue to refresh the Power portfolio in the first half of 2013. In 2012, the company had nearly 1,200 competitive displacements resulting in over $1 billion of business; almost equally from Hewlett Packard and Oracle/Sun.

System x revenue decreased 3.7 percent (3 percent adjusted for currency) in 2012 versus 2011. High-end System x revenue increased 5 percent (6 percent adjusted for currency) in 2012 versus the prior year, while high-volume and blade servers declined year to year.

Storage revenue decreased 5.8 percent (4 percent adjusted for currency) in 2012 versus 2011. Total disk revenue decreased 3 percent (1 percent adjusted for currency) in 2012 versus 2011. Tape revenue decreased 16 percent (14 percent adjusted for currency) in 2012 versus the prior year. The value in storage solutions continues to shift to software, as demonstrated by the ongoing success the company is having in its Tivoli storage software offerings.

Retail Stores Solutions revenue decreased 52.6 percent (52 percent adjusted for currency) in 2012 versus 2011. In the third quarter, the company divested the Retail Stores Solutions business to Toshiba Tec. See the caption, “Divestitures,” on page 91 for additional information regarding the transaction.

Microelectronics OEM revenue decreased 14.4 percent (14 percent adjusted for currency) in 2012 versus 2011.

($ in millions)

For the year ended December 31:	2012			2011			Yr.-to-Yr. Percent/ Margin Change
Systems and Technology
External gross profit	$	6,903		$	7,555		(8.6	)%
External gross profit margin	39.1		%	39.8		%	(0.7	)pts.
Pre-tax income	$	1,227		$	1,633		(24.9	)%
Pre-tax margin	6.7		%	8.2		%	(1.5	)pts.

The decrease in external gross profit in 2012 versus 2011 was due to lower revenue and a lower overall gross profit margin.

Overall gross margin decreased 0.7 points in 2012 versus the prior year. The decrease was driven by lower margins in System x (0.6 points), Microelectronics (0.6 points), Storage (0.5 points) and Power Systems (0.2 points), partially offset by improvement due to revenue mix (1.2 points).

Systems and Technology’s pre-tax income decreased $406 million (24.9 percent) to $1,227 million in 2012, with a pre-tax margin of 6.7 percent. Normalized for workforce rebalancing charges of $46 million and $3 million in the third quarter of 2012 and 2011, respectively, pre-tax income decreased 22.2 percent and the pre-tax margin decreased by 1.3 points.

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:	2012		2011		Yr.-to-Yr. Percent Change		Yr.-to-Yr. Percent Change Adjusted for Currency
Total revenue	$	104,507	$	106,916	(2.3	)%	0.0	%
Geographies	$	102,268	$	104,170	(1.8	)%	0.5	%
Americas	44,556		44,944		(0.9	)	0.0
Europe/Middle East/Africa	31,775		33,952		(6.4	)	(1.0	)
Asia Pacific	25,937		25,273		2.6		3.3
Major markets					(3.5	)%	(1.3	)%
Growth markets					4.2	%	6.9	%
BRIC countries					7.4	%	12.2	%

Total geographic revenue decreased 1.8 percent (flat adjusted for currency) in 2012; excluding the divested RSS business, revenue decreased 1.4 percent as reported, but increased 1 percent at constant currency compared to the prior year. Revenue performance at constant currency was driven by strong results in the growth markets, offsetting a modest decline year to year in the major markets.

Across all geographies, growth markets revenue increased 4.2 percent (7 percent adjusted for currency) and these countries now represent 24 percent of total geographic revenue, an increase of 8 points since 2006 when the company introduced its 2010 road map. Adjusted for currency, revenue growth in these fast growing markets outpaced the major markets in 2012 by approximately 8 points. The BRIC countries of Brazil, Russia, India and China combined revenue increased 7.4 percent (12 percent adjusted for currency) in 2012, with double-digit growth in Russia, India and China, adjusted for currency. Overall in 2012, the company had double-digit constant currency revenue growth in nearly 35 growth market countries. The company is continuing to expand into new countries and territories, to build out IT infrastructures in support of economic growth and to take a leadership position in key industries. To drive market expansion, in 2012 the company accelerated the opening of new branch offices resulting in a doubling of the number of face-to-face branches when compared to 2011. The company now has almost 450 face-to-face and virtual branch offices in the growth markets.

Americas revenue decreased 0.9 percent (flat adjusted for currency) in 2012. Within the major market countries, the U.S. decreased 1.1 percent and Canada decreased 1.5 percent as reported (flat adjusted for currency). Revenue in the Latin America growth markets increased 1.4 percent (8 percent adjusted for currency) with constant currency growth in Brazil of 6 percent, down 4.6 percent as reported.

Europe/Middle East/Africa (EMEA) revenue decreased 6.4 percent (1 percent adjusted for currency) in 2012 compared to 2011. Within the major market countries, the UK was essentially flat (up 1 percent adjusted for currency), Germany was down 7.6 percent (flat adjusted for currency), France was down 12.6 percent (6 percent adjusted for currency) and Italy was down 8.4 percent (1 percent adjusted for currency). The EMEA growth markets increased 0.8 percent (5 percent at constant currency) led by growth in Russia of 11.7 percent (13 percent adjusted for currency).

Asia Pacific revenue increased 2.6 percent (3 percent adjusted for currency) year over year. The Asia Pacific growth markets increased 6.0 percent (7 percent adjusted for currency), with growth led by China (17.9 percent as reported, 16 percent at constant currency) and India (decreased 0.9 percent as reported, increased 13 percent at constant currency). Japan revenue decreased 1.9 percent (2 percent adjusted for currency) but improved sequentially throughout the year at constant currency and returned to growth in the fourth quarter of 2012.

OEM revenue of $2,239 million in 2012 decreased 18.5 percent (18 percent adjusted for currency) compared to 2011, driven by the Microelectronics OEM business.

Total Expense and Other Income

($ in millions)

For the year ended December 31:	2012			2011			Yr.-to-Yr. Percent/ Margin Change
Total consolidated expense and other (income)	$	28,396		$	29,135		(2.5	)%
Non-operating adjustments
Amortization of acquired intangible assets	(328		)	(289		)	13.3
Acquisition-related charges	(35		)	(45		)	(21.2	)
Non-operating retirement-related (costs)/income	(274		)	74			NM
Total operating (non-GAAP) expense and other (income)	$	27,760		$	28,875		(3.9	)%
Total consolidated expense-to-revenue ratio	27.2		%	27.3		%	(0.1	)pts.
Operating (non-GAAP) expense-to-revenue ratio	26.6		%	27.0		%	(0.4	)pts.

NM—Not meaningful

32

Total expense and other (income) decreased 2.5 percent in 2012 versus 2011. Total operating (non-GAAP) expense and other (income) decreased 3.9 percent versus the prior year. The key drivers of the year-to-year change in total expense and other (income) were approximately:

		Total	Operating
		Consolidated	(non-GAAP)
·	Currency*	(5) points	(5) points
·	Acquisitions**	3 points	2 points
·	Base expense	(0) points	(2) 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:	2012			2011			Yr.-to-Yr. Percent Change
Selling, general and administrative expense
Selling, general and administrative—other	$	19,589		$	20,287		(3.4	)%
Advertising and promotional expense	1,339			1,373			(2.5	)
Workforce rebalancing charges	803			440			82.5
Retirement-related costs	945			603			56.7
Amortization of acquired intangible assets	328			289			13.3
Stock-based compensation	498			514			(3.0	)
Bad debt expense	50			88			(42.5	)
Total consolidated selling, general and administrative expense	$	23,553		$	23,594		(0.2	)%
Non-operating adjustments
Amortization of acquired intangible assets	(328		)	(289		)	13.3
Acquisition-related charges	(22		)	(20		)	10.2
Non-operating retirement-related (costs)/income	(294		)	(13		)	NM
Operating (non-GAAP) selling, general and administrative expense	$	22,910		$	23,272		(1 .6	)%

NM—Not meaningful

Total Selling, general and administrative (SG&A) expense decreased 0.2 percent in 2012 versus 2011. The decrease was primarily driven by the effects of currency (3 points), partially offset by acquisition-related spending (2 points), while base spending was essentially flat.

Operating (non-GAAP) SG&A expense decreased 1.6 percent primarily driven by the effects of currency (3 points) and lower base spending (1 point), partially offset by acquisition-related spending (2 points). The increase in workforce rebalancing charges was due to actions primarily focused on the company’s non-U.S. operations in the third quarter of 2012. The increase in retirement-related costs was primarily driven by the charge related to a court decision regarding one of IBM UK’s defined benefit plans. As a result of the ruling, the company recorded an additional retirement-related obligation of $162 million in the third quarter of 2012. This charge is not reflected in operating (non-GAAP) SG&A expense. See note M, “Contingencies and Commitments,” on pages 110 through 112 for additional information. Bad debt expense decreased $37 million in 2012 versus 2011, as the company increased its provisions in 2011 reflecting the European credit environment. The accounts receivable provision coverage is 1.4 percent at December 31, 2012, a decrease of 10 basis points from year-end 2011.

Other (Income) and Expense

($ in millions)

For the year ended December 31:	2012			2011			Yr.-to-Yr. Percent Change
Other (income) and expense
Foreign currency transaction losses/(gains)	$	(240	)	$	513		NM	%
(Gains)/losses on derivative instruments	72			(113		)	NM
Interest income	(109		)	(136		)	(20.2	)
Net (gains)/losses from securities and investment assets	(55		)	(227		)	(75.5	)
Other	(511		)	(58		)	NM
Total consolidated other (income) and expense	$	(843	)	$	(20	)	NM	%
Non-operating adjustment
Acquisition-related charges	(13		)	(25		)	(46.0	)
Operating (non-GAAP) other (income) and expense	$	(857	)	$	(45	)	NM	%

NM—Not meaningful

Other (income) and expense was income of $843 million and $20 million in 2012 and 2011, respectively. The increase in income of $823 million in 2012 was primarily driven by higher gains from foreign currency transactions ($753 million) due to rate volatility year to year, and the gain associated with the divested RSS business ($446 million) reflected in Other in the table above. These increases in income were partially offset by increased losses on derivative instruments ($184 million) and lower gains from securities and investment asset sales ($171 million). In 2011, the company had investment gains of over $200 million, primarily from the sale of Lenovo shares.

33

Research, Development and Engineering

($ in millions)

For the year ended December 31:	2012		2011		Yr.-to-Yr. Percent Change
Total consolidated research, development and engineering	$	6,302	$	6,258	0.7	%
Non-operating adjustment
Non-operating retirement-related (costs)/income	20		88		(76.9	)
Operating (non-GAAP) research, development and engineering	$	6,322	$	6,345	(0.4	)%

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 0.7 percent in 2012 versus 2011, primarily driven by acquisitions (3 points), partially offset by the effects of currency (2 points) and lower base spending (1 point). Operating (non-GAAP) RD&E expense decreased 0.4 percent in 2012 compared to the prior year primarily driven by the effects of currency (2 points) and lower base spending (2 points), partially offset by acquisitions (3 points). RD&E investments represented 6.0 percent of revenue in 2012, compared to 5.9 percent in 2011.

Intellectual Property and Custom Development Income

($ in millions)

For the year ended December 31:	2012		2011		Yr.-to-Yr. Percent Change
Sales and other transfers of intellectual property	$	324	$	309	4.7	%
Licensing/royalty-based fees	251		211		19.0
Custom development income	500		588		(14.9	)
Total	$	1,074	$	1,108	(3.0	)%

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 2012 or 2011.

Interest Expense

($ in millions)

For the year ended December 31:	2012		2011		Yr.-to-Yr. Percent Change
Interest expense
Total	$	459	$	411	11.8	%

The increase in interest expense in 2012 versus 2011 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 2012 was $1,004 million, an increase of $40 million year to year.

Stock-Based Compensation

Total pre-tax stock-based compensation cost of $688 million decreased $9 million compared to 2011. The decrease was primarily related to the company’s performance share units ($30 million), partially offset by increases related to restricted stock units ($16 million) and the assumption of stock-based awards previously issued by acquired entities ($5 million). Cost, and the year-to-year change, was reflected in the following categories: Cost: $132 million, up $11 million; SG&A expense: $498 million, down $16 million; and RD&E expense: $59 million, down $4 million.

See note R, “Stock-Based Compensation,” on pages 117 to 120 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:	2012			2011			Yr.-to-Yr. Percent Change
Retirement-related plans—cost
Service cost	$	493		$	549		(10.2	)%
Amortization of prior service cost/(credits)	(148		)	(157		)	(5.5	)
Cost of defined contribution plans	1,506			1,513			(0.4	)
Total operating costs	$	1,851		$	1,905		(2.8	)%
Interest cost	4,238			4,601			(7.9	)
Expected return on plan assets	(6,356		)	(6,574		)	(3.3	)
Recognized actuarial losses	2,407			1,788			34.6
Plan amendments/curtailments/ settlements	1			1			14.4
Multi-employer plan/other costs	247			112			121.3
Total non-operating costs/ (income)	$	538		$	(72	)	NM	%
Total retirement-related plans—cost	$	2,389		$	1,832		30.3	%

NM—Not meaningful

In 2012, total retirement-related plans cost increased by $556 million compared to 2011, primarily driven by an increase in recognized actuarial losses of $619 million, lower expected return on plan assets ($219 million) and the charge related to the UK pension litigation ($162 million). These increases were partially offset by lower interest cost of $363 million and lower service cost of $56 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 2012 were $1,851 million, a decrease of $54 million compared to 2011, primarily driven by the $56 million decrease in service cost. Non-operating costs of $538 million increased $610 million in 2012, compared to the prior year, driven primarily by the increase in recognized actuarial losses ($619 million), lower expected return on plan assets ($219 millon) and the charge related to the UK pension litigation ($162 million), partially offset by lower interest cost ($363 million).

Income Taxes

The effective tax rate for 2012 was 24.2 percent compared with 24.5 percent in 2011. The operating (non-GAAP) tax rate for 2012 was 24.0 percent compared with 24.5 percent in 2011. 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 (2.6 points) and the one-time benefit in the first quarter associated with a tax restructuring in Latin America (0.8 points), primarily offset by a decrease in the utilization of foreign tax credits in 2012 (2.9 points) and the unfavorable tax impact of the gain on the RSS divestiture (0.3 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:	2012		2011		Yr.-to-Yr. Percent Change
Earnings per share of common stock
Assuming dilution	$	14.37	$	13.06	10.0	%
Basic	$	14.53	$	13.25	9.7	%
Diluted operating (non-GAAP)	$	15.25	$	13.44	13.5	%
Weighted-average shares outstanding (in millions)
Assuming dilution	1,155.4		1,213.8		(4.8	)%
Basic	1,142.5		1,197.0		(4.5	)%

Actual shares outstanding at December 31, 2012 and 2011 were 1,117.4 million and 1,163.2 million, respectively. The average number of common shares outstanding assuming dilution was 58.3 million shares lower in 2012 versus 2011. The decrease was primarily the result of the common stock repurchase program. See note L, “Equity Activity,” on page 107 for additional information regarding common stock activities. Also see note P, “Earnings Per Share of Common Stock,” on page 116.

Financial Position

Dynamics

At December 31, 2012, the company’s balance sheet and liquidity positions remained strong and well-positioned to support the company’s long-term objectives. Cash and marketable securities at year end were $11,128 million, a decrease of $794 million from the prior year-end position. During the year the company continued to manage the investment portfolio to meet its capital preservation and liquidity objectives. At December 31, 2012, there were no holdings of European sovereign debt securities in the investment portfolio.

Total debt of $33,269 million increased $1,949 million from the prior year-end level. The commercial paper balance at December 31, 2012 was $1,800 million, a decrease of $500 million from the prior year. Within total debt, $24,501 million is in support of the Global Financing business which is leveraged at a 7.0 to 1 ratio. The company continues to have substantial flexibility in the market. During 2012, the company completed bond issuances totaling $7,875 million, with terms ranging from three to 30 years and priced from 0.55 to 4.00 percent depending on the maturity. The company has consistently generated strong cash flow from operations and continues to have access to additional sources of liquidity through the capital markets and its $10 billion global credit facility, 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, 2012, the overall net underfunded position was $20,190 million, an increase of $3,800 million from December 31, 2011, 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 the cash requirements related to these plans remain stable going forward at approximately $1 billion per year through 2015. In 2012, the return on the U.S. Personal Pension Plan assets was 11.3 percent and the plan was 98 percent funded. Overall, global asset returns were 11.1 percent and the company’s qualified defined benefit plans worldwide were 94 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 128 for additional information.

During 2012, the company generated $19,586 million in cash from operations, a decrease of $260 million compared to 2011. In addition, the company generated $18,185 million in free cash flow in 2012, an increase of $1,581 million over the prior year. See pages 56 and 57 for additional information on free cash flow. The company returned $15,768 million to shareholders in 2012, with $11,995 million in gross share repurchases and $3,773 million in dividends. In 2012, the company repurchased approximately 61 million shares and had $8.7 billion remaining in share repurchase authorization at year end. The company’s strong cash generation permits the company to invest and deploy capital to areas with the most attractive long-term opportunities.

35

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 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:	2012		2011
Current assets	$	49,433	$	50,928
Current liabilities	43,625		42,123
Working capital	$	5,807	$	8,805
Current ratio	1.13:1		1.21:1

Working capital decreased $2,998 million from the year-end 2011 position. The key changes are described below:

Current assets decreased $1,496 million ($1,212 million adjusted for currency) due to:

·A decrease of $1,224 million in prepaid expenses and other current assets due to:

oA decrease of $610 million related to derivatives; $398 million in cash collateral received, and $213 million primarily related to currency rate volatility; and

oA decrease of $614 million in various prepaid expenses (taxes, maintenance, insurance, deposits)

·A decline of $794 million ($661 million adjusted for currency) in cash and cash equivalents, and marketable securities (see cash flow analysis in the following column); and

·A decrease of $308 million in inventory, primarily in Systems and Technology; partially offset by

·An increase of $1,016 million ($1,047 million adjusted for currency) in short-term receivables primarily attributable to higher volumes of financing receivables driven by customer loans and inventory financing.

Current liabilities increased $1,502 million ($1,682 million adjusted for currency) as a result of:

·An increase of $1,635 million in taxes primarily due to the reclassification of long-term tax liabilities to short term; and

·An increase of $719 million ($879 million adjusted for currency) in short-term debt due to:

oReclassifications of $5,638 million from long-term debt and short-term additions of $4,541 million, offset by

oMaturities of approximately $8,792 million, and a decline of approximately $500 million in commercial paper; partially offset by

·A decrease of $565 million in accounts payable primarily related to the obligation to return cash collateral received related to derivative valuations.

Cash Flow

The company’s cash flows 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:	2012			2011
Net cash provided by/(used in)
Operating activities	$	19,586		$	19,846
Investing activities	(9,004		)	(4,396		)
Financing activities	(11,976		)	(13,696		)
Effect of exchange rate changes on cash and cash equivalents	(116		)	(493		)
Net change in cash and cash equivalents	$	(1,511	)	$	1,262

Net cash provided by operating activities decreased by $260 million in 2012 as compared to 2011 driven by the following key factors:

·A decrease in cash due to receivables of $1,290 million (normalized for a $339 million tax refund received in 2012), as a result of higher volumes in 2012;

·A decrease in vendor payables of $675 million;

·An increase in cash used for workforce rebalancing payments of $236 million, primarily in the non-U.S.; and

·An increase in cash used for retirement-related plans of $181 million driven by an increase in nonpension post-retirement contributions, partially offset by

·Lower net tax payments of $999 million compared to 2011;

·Improved net income of $749 million; and

·Lower cash requirements for inventory of $442 million.

Net cash used in investing activities increased $4,608 million primarily driven by:

·A net increase of $1,325 million in net cash used for acquisitions/divestitures; and

·A decrease in cash of $2,719 million from net purchases of marketable securities and other investments.

Net cash used in financing activities decreased $1,719 million primarily as a result of:

·A decrease of $2,137 million of net cash used for common stock transactions; partially offset by

·An increase of $300 million in cash dividends paid.

36

Noncurrent Assets and Liabilities

($ in millions)

At December 31:	2012		2011
Noncurrent assets	$	69,780	$	65,505
Long-term debt	$	24,088	$	22,857
Noncurrent liabilities (excluding debt)	$	32,516	$	31,217

The increase in noncurrent assets of $4,276 million ($4,454 million adjusted for currency) was driven by:

·An increase of $3,429 million ($3,236 million adjusted for currency) in goodwill and intangible assets driven by acquisitions;

·An increase of $470 million in deferred taxes ($580 million adjusted for currency) driven by retirement-related activity; and

·An increase of $2,036 million in financing receivables ($2,214 million adjusted for currency) driven by increased volumes, partially offset by

·A decrease of $1,899 million in prepaid pension assets ($1,922 million adjusted for currency) primarily driven by plan remeasurements.

Long-term debt increased by $1,231 million primarily driven by new debt issuances of $7,700 million, partially offset by reclasses to short-term debt of $5,638 million, and debt repurchased as a result of the debt exchange of $665 million.

Other noncurrent liabilities, excluding debt, increased $1,299 million ($1,558 million adjusted for currency) primarily driven by:

·An increase in retirement and nonpension benefit obligations of $2,044 million ($2,264 million adjusted for currency) as a result of pension remeasurements; and

·An increase in deferred income of $644 million driven by services and software arrangements; partially offset by

·A decrease of $1,389 million in other liabilities driven by a reclass of tax-related liabilities to short term.

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:	2012		2011
Total company debt	$	33,269	$	31,320
Total Global Financing segment debt	$	24,501	$	23,332
Debt to support external clients	21,583		20,051
Debt to support internal clients	2,919		3,281

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 in the previous column 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 36.1 percent at December 31, 2012 compared to 32.0 percent at December 31, 2011. The increase was primarily driven by an increase in non-Global Financing debt of $780 million and a decrease in non-Global Financing equity of $1,497 million from the December 31, 2011 balances.

Consolidated debt-to-capitalization ratio at December 31, 2012 was 63.7 percent versus 60.7 percent at December 31, 2011.

The increase in both the “core” debt-to-capitalization ratio and the consolidated debt-to-capitalization ratio was impacted by the $5.2 billion impact to equity as a result of retirement-related plan remeasurements in December.

Debt Exchange

In the second quarter of 2012, the company completed an exchange of approximately $6 million of principal of its 7.125 percent debentures due in 2096, $104 million principal of its 8.00 percent notes due in 2038 and $800 million of principal of its 5.60 percent senior notes due in 2039 for approximately $1,107 million of 4.00 percent senior notes due in 2042 and cash of approximately $121 million. The exchange was completed to retire high coupon debt in the current favorable interest rate environment.

The debt exchange was accounted for as a non-revolving debt modification in accordance with accounting guidance, and therefore it did not result in any gain or loss recorded in the Consolidated Statement of Earnings. Cash payments will be amortized over the life of the new debt. Administrative fees with third parties in relation to the exchange were expensed as incurred.

Equity

Total equity decreased by $1,252 million as a result of an increase in treasury stock of $12,168 million; pension adjustments of $3,669 million reflecting the impact of retirement-related plan remeasurements; partially offset by an increase in retained earnings of $12,783 million, and an increase of $1,980 million in common stock primarily driven by stock option exercises and stock based compensation.

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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, 2012:	GAAP			Acquisition- Related Adjustments			Retirement- Related Adjustments			Operating (non-GAAP)
Gross profit	$	50,298		$	376		$	264		$	50,938
Gross profit margin	48.1		%	0.4		pts.	0.3		pts.	48.7		%
SG&A	$	23,553		$	(349	)	$	(294	)	$	22,910
RD&E	6,302			0			20			6,322
Other (income) and expense	(843		)	(13		)	0			(857		)
Total expense and other (income)	28,396			(363		)	(274		)	27,760
Pre-tax income	21,902			739			538			23,179
Pre-tax income margin	21.0		%	0.7		pts.	0.5		pts.	22.2		%
Provision for income taxes*	$	5,298		$	98		$	156		$	5,552
Effective tax rate	24.2		%	(0.4		)pts.	0.1		pts.	24.0		%
Net income	$	16,604		$	641		$	381		$	17,627
Net income margin	15.9		%	0.6		pts.	0.4		pts.	16.9		%
Diluted earnings per share	$	14.37		$	0.55		$	0.33		$	15.25

*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, 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.

38

Consolidated Fourth-Quarter Results

($ and shares in millions except per share amounts)

							Yr.-to-Yr.
							Percent/
							Margin
For the fourth quarter:	2012			2011			Change
Revenue	$	29,304		$	29,486		(0.6	)%*
Gross profit margin	51.8		%	49.9		%	1.8	pts.
Total expense and other income	$	7,336		$	7,448		(1.5	)%
Total expense and other income-to-revenue ratio	25.0		%	25.3		%	(0.2	)pts.
Income before income taxes	$	7,831		$	7,274		7.7	%
Provision for income taxes	1,998			1,784			12.0	%
Net income	$	5,833		$	5,490		6.3	%
Net income margin	19.9		%	18.6		%	1.3	pts.
Earnings per share of common stock
Assuming dilution	$	5.13		$	4.62		11.0	%
Weighted-average shares outstanding
Assuming dilution	1,136.4			1,188.7			(4.4	)%

*0.3 percent adjusted for currency.

The following table provides the company’s operating (non-GAAP) earnings for the fourth quarter of 2012 and 2011.

($ in millions except per share amounts)

For the fourth quarter:	2012		2011			Yr.-to-Yr.  Percent  Change
Net income as reported	$	5,833	$	5,490		6.3	%
Non-operating adjustments (net of tax)
Acquisition-related charges	243		119			103.4
Non-operating retirement-related costs/(income)	53		(12		)	NM
Operating (non-GAAP) earnings*	$	6,129	$	5,597		9.5	%
Diluted operating (non-GAAP) earnings per share	$	5.39	$	4.71		14.4	%

*See page 43 for a more detailed reconciliation of net income to operating earnings. NM—Not meaningful

Snapshot

In the fourth quarter of 2012, the company improved its year-to-year revenue growth rate, primarily in higher margin areas, while driving significant margin expansion and profit growth. The company delivered diluted earning per share of $5.13, a growth of 11.0 percent, and $5.39, an increase of 14.4 percent on an operating (non-GAAP) basis. The company generated $6.3 billion in cash from operations in the fourth quarter driving shareholder returns of $4.0 billion in gross common stock repurchases and dividends.

Revenue in the fourth quarter declined 0.6 percent as reported, but was flat at constant currency. Normalized for the RSS divestiture, revenue increased 1 point at constant currency in the quarter, a 2 point improvement from the third quarter of 2012 constant currency growth rate. Consistent with the company’s business model to move to higher value areas, revenue continued to grow in the higher margin businesses which contributed to the overall margin expansion and profit growth in the fourth quarter.

On a geographic basis, revenue performance was led by the growth markets which increased 6.8 percent as reported and 7 percent at constant currency. The BRIC countries delivered combined growth of 11.4 percent (14 percent adjusted for currency). In the fourth quarter, over 30 growth market countries grew constant currency revenue at a double-digit rate reflecting ongoing broad-based strength.

Within the company’s segments, performance was led by continued momentum in the growth initiatives and successful product launches in high-end systems – both of which drove a more profitable mix. Software revenue increased 3.5 percent (4 percent adjusted for currency), driven by business analytics, Smarter Commerce and cloud with strength in several emerging areas where the company has been targeting its investments – Social Business, mobile and security. Systems and Technology revenue declined 0.7 percent (1 percent adjusted for currency); adjusted for the RSS divestiture, revenue increased 3.6 percent (4 percent adjusted for currency) versus the prior year. New product introductions performed well in the quarter. System z revenue increased 55.6 percent (56 percent adjusted for currency) reflecting strong acceptance of the new mainframe. System z revenue increased over 50 percent in the major markets and over 65 percent in the growth markets. Global Services revenue decreased 2.1 percent (1 percent adjusted for currency) with the constant currency growth rate consistent with the third quarter of 2012. Global Services continued to have strong performance in all of the key growth initiatives which are becoming a larger part of the services business.

The consolidated gross profit margin increased 1.8 points versus the fourth quarter of 2011 to 51.8 percent. The operating (non-GAAP) gross margin increased 2.1 points to 52.3 percent. The improvement was driven by a combination of strong mainframe growth, good margin expansion in both services segments and an improving segment mix due to the relative strength of software.

Total expense and other income decreased 1.5 percent in the fourth quarter compared to the prior year. Total operating (nonGAAP) expense and other income decreased 2.3 percent. The year-to-year drivers for both categories were approximately:

	Total	Operating
	Consolidated	(non-GAAP)
·Currency*	(1) point	(1) point
·Acquisitions**	2 points	2 points
·Base expense	(3) points	(3) points

* Reflects impacts of translation and hedging programs.

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

Pre-tax income grew 7.7 percent and the pre-tax margin was 26.7 percent, an increase of 2.1 points versus the fourth quarter of 2011. Net income increased 6.3 percent and the net income margin increased 1.3 points to 19.9 percent. The effective tax rate for the fourth quarter was 25.5 percent, an increase of 1 point versus the prior year. Operating (non-GAAP) pre-tax income grew 9.5 percent and the operating (non-GAAP) pre-tax margin was 27.7 percent, an increase of 2.6 points versus the prior year. Operating (non-GAAP) net income increased 9.5 percent and the operating (non-GAAP) net income margin was 20.9 percent, an

39

increase of 1.9 points compared to the prior year. The operating (non-GAAP) effective tax rate was 24.4 percent, flat compared to the fourth quarter of 2011.

Diluted earnings per share of $5.13 increased $0.51 or 11.0 percent from the fourth quarter of 2011. In the fourth quarter, the company repurchased 15.4 million shares of its common stock. Operating (non-GAAP) diluted earnings per share increased 14.4 percent reflecting the growth in operating (non-GAAP) net income and the benefits of the common stock repurchase program. Operating (non-GAAP) diluted earnings per share of $5.39 increased $0.68 versus the fourth quarter of 2011 driven by the following factors:

·Revenue decrease at actual rates	$(0.03	)
·Margin expansion	$0.47
·Common stock repurchases	$0.24

Margin expansion was the largest contributor to the growth in operating (non-GAAP) earnings per share in the fourth quarter. This was achieved through a combination of gross margin improvements and expense productivity.

Segment Details

The following is an analysis of the fourth quarter of 2012 versus the fourth quarter of 2011 reportable segment external revenue and gross margin results. Segment pre-tax income includes transactions between the segments that are intended to reflect an arms-length transfer price and excludes certain unallocated corporate items.

($ in millions)

For the fourth quarter:	2012			2011			Yr.-to-Yr. Percent/ Margin Change		Yr.-to-Yr. Percent Change Adjusted for Currency
Revenue	$	10,284		$	10,452		(1.6	)%	(0.3	)%
Global Technology Services	37.6		%	36.6		%	1.1	pts.
Gross margin	4,720			4,877			(3.2	)%	(2.0	)%
Global Business Services	29.9		%	29.3		%	0.7	pts.
Gross margin	7,915			7,648			3.5	%	4.2	%
Software	90.6		%	89.8		%	0.8	pts.
Gross margin	5,763			5,803			(0.7	)%	(0.6	)%
Systems and Technology	44.1		%	40.5		%	3.6	pts.
Gross margin	535			548			(2.3	)%	(0.9	)%
Global Financing	43.8		%	49.7		%	(5.9	)pts.
Gross margin	87			159			(45.3	)%	(45.1	)%
Other	(73.2		)%	(11.0		)%	(62.2	)pts.
Gross margin	$	29,304		$	29,486		(0.6	)%	0.3	%
Total consolidated revenue
Total consolidated gross profit	$	15,167		$	14,722		3.0	%
Total consolidated gross margin	51.8		%	49.9		%	1.8	pts.
Non-operating adjustments
Amortization of acquired intangible assets	99			81			22.4	%
Acquisition-related charges	0			0			50.8
Retirement-related costs/(income)	60			(10		)	NM
Operating (non-GAAP) gross profit	$	15,327		$	14,793		3.6	%
Operating (non-GAAP) gross margin	52.3		%	50.2		%	2.1	pts.

NM—Not meaningful

Global Services

The Global Services segments, Global Technology Services and Global Business Services delivered $15,004 million of revenue in the fourth quarter, a decrease of 2.1 percent (1 percent adjusted for currency) year to year. Overall revenue performance in the quarter was led by the growth markets with revenue up 5.8 percent (7 percent adjusted for currency). Total outsourcing revenue of $6,978 million decreased 3.2 percent (2 percent adjusted for currency) and total transactional revenue of $6,184 million decreased 1.0 percent (flat adjusted for currency) year over year. Total Global Services pre-tax income was $2,868 million, an increase of 3.5 percent year to year. The combined pre-tax margin improved 1 point year to year to 18.5 percent.

Global Technology Services revenue of $10,284 million decreased 1.6 percent as reported, but was flat on a constant currency basis in the fourth quarter versus the same period in 2011. There were two major factors within the major markets that impacted outsourcing

40

revenue growth in the quarter. First, GTS did a tremendous amount of work to address a number of low margin contracts to improve the profitability of the outsourcing portfolio. The benefits of that work were realized in profit and margin performance, though it did have some impact on revenue. In the fourth quarter, the impact was 1 point of year-to-year revenue growth to GTS, and to Global Services in total. Second, revenue from sales and volumes into existing base accounts declined year to year in the fourth quarter. This activity tends to be more transactional in nature and economically sensitive. The impact of these factors are reflected in GTS Outsourcing revenue, which decreased 3.1 percent (2 percent adjusted for currency) in the fourth quarter. Outsourcing revenue in the growth markets increased 6.1 percent, 8 percent at constant currency, and the outsourcing backlog in these markets was up 9 percent at constant currency. The backlog growth reflects an ongoing trend as clients are building out their infrastructures and scaling to meet the growth objectives of their businesses. ITS revenue of $2,542 million increased 2.1 percent (3 percent adjusted for currency) in the fourth quarter with the growth markets up 10.1 percent (10 percent at constant currency). GTS gross profit increased 1.3 percent and the gross profit margin improved 1.1 points to 37.6 percent with margin improvement across all lines of business. GTS fourth-quarter 2012 pre-tax income increased 5.0 percent to $2,027 million with the pre-tax margin expanding 1.2 points to 19.2 percent, versus the fourth quarter of 2011. Margin expansion resulted from increased efficiency and productivity from the focus on automation and process, primarily through the company’s enterprise productivity initiatives.

Global Business Services revenue of $4,720 million decreased 3.2 percent (2 percent adjusted for currency) in the fourth quarter of 2012. From a geographic perspective, the growth markets increased 2.0 percent (3 percent at constant currency), and Japan improved 0.3 percent (6 percent at constant currency)—the second consecutive quarter of revenue growth in Japan. The growth initiatives continued to drive strong performance with double-digit revenue growth in business analytics, Smarter Planet and cloud offerings in the quarter. Application Outsourcing revenue decreased 3.8 percent (2 percent adjusted for currency) and C&SI revenue decreased 3.0 percent (2 percent adjusted for currency). GBS has been taking actions to address the more traditional customized packaged application work including: adding partners, increasing sales capability and targeting and closing large transformational opportunities in the growth markets. GBS gross profit decreased 1.0 percent in the fourth quarter with the gross profit margin expanding 0.7 points versus the prior year. GBS pre-tax income of $841 million was essentially flat year to year with a pre-tax margin of 17.2 percent, an improvement of 0.6 points. Improved utilization and improved services delivery more than offset the impact from revenue.

Software

Software revenue of $7,915 million increased 3.5 percent (4 percent adjusted for currency) in the fourth quarter with growth in all the key brands, and particular strength and share gains in WebSphere, Lotus and Rational. Key branded middleware revenue increased 5.4 percent (6 percent adjusted for currency) year to year and gained share as the software business continued to be the leader in the middleware market. The software business had continued momentum across its brands in the growth initiatives in the fourth quarter with strong performance in business analytics, Smarter Commerce and cloud. WebSphere revenue increased 10.6 percent (11 percent adjusted for currency) in the fourth quarter year to year and gained share. The company continued to expand its portfolio to capture the emerging opportunity around mobile computing and had solid revenue growth in several of its core WebSphere offerings, such as application servers and commerce in the fourth quarter. Information Management revenue increased 2.2 percent (3 percent adjusted for currency) and held share with strong performance in Information Integration and predictive analytics, both driven by big data. Tivoli revenue increased 4.3 percent (5 percent adjusted for currency) and held share, led by its storage and security offerings. Revenue from the storage portfolio increased 12 percent (13 percent adjusted for currency), reflecting the continued value of storage software. Tivoli security increased 16 percent (16 percent adjusted for currency) driven by Q1 Labs. Lotus revenue increased 8.6 percent (9 percent adjusted for currency) and gained share as the Lotus portfolio continues to transform to the faster-growing social business offerings. Revenue growth was driven by strong performance from the existing social business offerings and the recent acquisition of Kenexa, which closed in December 2012. Kenexa helps clients create a more efficient and effective workforce, and brings a unique combination of cloud-based technology and consulting services to an already extensive portfolio of social business solutions. Rational revenue increased 11.6 percent (12 percent adjusted for currency) in the fourth quarter and gained share. Growth was driven by double-digit growth in both analysis, modeling and design software and the Automated Software Quality business. Software gross profit increased 4.5 percent and the gross profit margin expanded 0.8 points to 90.6 percent. Software delivered pre-tax income of $4,017 million in the fourth quarter, a growth of 8.3 percent compared to the fourth quarter of 2011, with a pre-tax margin of 46.0 percent, up 2.4 points.

Systems and Technology

Systems and Technology revenue of $5,763 million decreased 0.7 percent (1 percent adjusted for currency); adjusted for the RSS divestiture, revenue increased 3.6 percent (4 percent adjusted for currency). Performance was driven by the company’s new mainframe and momentum in PureSystems– the company’s new expert integrated systems. System z revenue increased 55.6 percent (56 percent adjusted for currency) driven by the first full quarter of the new mainframe product. MIPS shipments increased 66 percent year to year; the largest quarter of MIPS shipments in history. Approximately half of these MIPS were specialty engines, which were up over 80 percent year to year driven by Linux workloads. Revenue growth in System z was over 50 percent in the major markets and over 65 percent in the growth markets. In the growth markets, the company had strong sales to established as well as new mainframe customers. Power Systems revenue decreased 18.9 percent (19 percent adjusted for currency), although both the new POWER7+ midrange and high-end Power servers performed well in the quarter. In the fourth quarter, the company had over 350 competitive displacements resulting in over $335 million of business; approximately half of which came from

41

Oracle/Sun and half from Hewlett Packard. System x revenue decreased 2.5 percent (3 percent adjusted for currency) in the fourth quarter year to year. Storage hardware revenue decreased 5.4 percent (5 percent adjusted for currency) driven by tape products. Total tape revenue decreased 23 percent (23 percent adjusted for currency) while total disk revenue was essentially flat year to year. Within disk, the company announced the new high-end DS8870 in October 2012, and the product was sold out in the fourth quarter. Systems and Technology gross margin increased 3.6 points to 44.1 percent driven primarily by a mix to the higher margin System z in the fourth quarter of 2012. Systems and Technology’s pre-tax income increased 23.2 percent to $974 million in the fourth quarter and the pre-tax margin increased 3.2 points to 16.4 percent. Systems and Technology’s profit performance was driven by the new product introductions in mainframe, Power, Storage and PureSystems.

Global Financing

Global Financing revenue of $535 million decreased 2.3 percent (1 percent adjusted for currency), driven by a decrease in financing revenue, partially offset by an increase in used equipment sales revenue. The Global Financing fourth-quarter pre-tax income increased 0.7 percent to $518 million and the pre-tax margin increased 0.9 points to 46.9 percent.

Geographic Revenue

Total geographic revenue of $28,624 million decreased 0.5 percent (flat adjusted for currency) in the fourth quarter of 2012 compared to the prior year. Americas revenue of $12,550 million increased 0.3 percent (1 percent adjusted for currency) in 2012, led by strong growth in Latin America (up 13.5 percent as reported and 18 percent adjusted for currency). The U.S. was down 0.7 percent, but the growth rate improved 3 points compared to the third quarter of 2012. Canada was down 6.2 percent (9 percent adjusted for currency) compared to strong year-to-year growth of 13 percent at constant currency in the fourth quarter of 2011. EMEA revenue of $9,091 million decreased 5.0 percent (3 percent adjusted for currency), reflecting the macroeconomic climate in that region. Germany was down 7.0 percent (4 percent adjusted for currency) and the UK was down 4.7 percent (7 percent adjusted for currency). Italy revenue decreased 3.4 percent (flat adjusted for currency), an improvement sequentially from the third-quarter constant currency growth rate. Asia Pacific revenue of $6,984 million increased 4.2 percent (5 percent adjusted for currency) led by Japan, which returned to growth (0.2 percent as reported, 5 percent at constant currency) in the fourth quarter of 2012. Across all geographies, revenue from the growth markets increased 6.8 percent (7 percent adjusted for currency) in the fourth quarter and outpaced growth in the major markets by 9 points on a constant currency basis. Revenue performance was again broad based with over 30 growth market countries delivering double-digit revenue growth year to year, adjusted for currency. Within the BRIC countries, combined revenue increased 11.4 percent (14 percent adjusted for currency), the strongest quarterly growth in 2012. Brazil returned to growth in the fourth quarter with revenue up 15.5 percent (24 percent adjusted for currency). The growth markets also had good performance in Africa, led by South Africa, and in the Middle East.

OEM revenue of $679 million in the fourth quarter decreased 4.9 percent (5 percent adjusted for currency) compared to the prior year.

Total Expense and Other Income

($ in millions)

For the fourth quarter:	2012			2011			Yr.-to-Yr.  Percent/  Margin  Change
Total consolidated expense and other (income)	$	7,336		$	7,448		(1.5	)%
Non-operating adjustments
Amortization of acquired intangible assets	(86		)	(72		)	19.6
Acquisition-related charges	(12		)	(13		)	(8.2	)
Non-operating retirement-related (costs)/income	(23		)	25			NM
Total operating (non-GAAP) expense and other (income)	$	7,215		$	7,388		(2.3	)%
Total consolidated expense-to-revenue ratio	25.0		%	25.3		%	(0.2	)pts.
Operating (non-GAAP) expense-to-revenue ratio	24.6		%	25.1		%	(0.4	)pts.

NM—Not meaningful

Total expense and other income decreased 1.5 percent year to year in the fourth quarter with an expense-to-revenue-ratio of 25.0 percent compared to 25.3 percent in the fourth quarter of 2011. Total operating (non-GAAP) expense and other income decreased 2.3 percent in the fourth quarter. The decrease in total expense and other income was primarily driven by lower base expense (3 points) and currency (1 point), partially offset by increased expense from the company’s acquisitions over the past 12 months (2 points). Within Selling, general and administrative expense, accounts receivable provisions were approximately $20 million in the fourth quarter of 2012 an improvement of nearly $70 million from the fourth quarter of 2011 when provisions were increased to reflect the European credit environment.

Cash Flow

The company generated $6,346 million in cash flow provided by operating activities, a decrease of $751 million compared to the fourth quarter of 2011, driven primarily by an increase in cash used in operating assets and liabilities ($889 million). Net cash used in investing activities of $4,092 million increased $587 million primarily due to an increase in cash used by non-operating finance receivables ($501 million) and an increase in cash used