Exhibit 13

Report of Financials

International Business Machines Corporation and Subsidiary Companies

MANAGEMENT DISCUSSION
Overview	26
Forward-Looking and Cautionary Statements	26
Management Discussion Snapshot	27
Description of Business	29
Year in Review	35
Prior Year in Review	53
Other Information	63
Looking Forward	63
Liquidity and Capital Resources	65
Critical Accounting Estimates	67
Currency Rate Fluctuations	70
Market Risk	70
Financing Risks	71
Cybersecurity	71
Employees and Related Workforce	72
Global Financing	72
Report of Management	76
Report of Independent Registered Public Accounting Firm	77
CONSOLIDATED FINANCIAL STATEMENTS
Earnings	78
Comprehensive Income	79
Financial Position	80
Cash Flows	81
Changes in Equity	82

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
A	Significant Accounting Policies	84
B	Accounting Changes	94
C	Acquisitions/Divestitures	95
D	Financial Instruments	100
E	Inventories	107
F	Financing Receivables	107
G	Property, Plant and Equipment	110
H	Investments and Sundry Assets	110
I	Intangible Assets Including Goodwill	111
J	Borrowings	112
K	Other Liabilities	114
L	Equity Activity	116
M	Contingencies and Commitments	119
N	Taxes	121
O	Research, Development and Engineering	123
P	Earnings Per Share of Common Stock	123
Q	Rental Expense and Lease Commitments	124
R	Stock-Based Compensation	124
S	Retirement-Related Benefits	127
T	Segment Information	141
U	Subsequent Events	146
Five-Year Comparison of Selected Financial Data		147
Selected Quarterly Data		148
Performance Graph		149
Board of Directors and Senior Leadership		150
Stockholder Information		151

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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) 2013 Annual Report includes the Management Discussion, the Consolidated Financial Statements and the Notes to 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 27 and 28, presents an overview of the key performance drivers in 2013.

·Beginning with the “Year in Review” on page 35, 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 pages 63 to 65, and “Liquidity and Capital Resources” on pages 65 to 67.

·Global Financing is a reportable segment that is measured as a stand-alone entity. A separate “Global Financing” section is included in the Management Discussion beginning on page 72.

·The Consolidated Financial Statements are presented on pages 78 through 83. 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 84 through 93), acquisitions and divestitures (pages 95 through 99), detailed information on specific items within the financial statements, certain contingencies and commitments (pages 119 to 121) and retirement-related benefits information (pages 127 to 141).

·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 70 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 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 2013 Form 10-K filed on February 25, 2014.

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MANAGEMENT DISCUSSION SNAPSHOT

($ and shares in millions except per share amounts)

							Yr.-to-Yr.
							Percent/
							Margin
For the year ended December 31:	2013			2012			Change
Revenue	$	99,751		$	104,507		(4.6	)%*
Gross profit margin	48.6		%	48.1		%	0.5	pts.
Total expense and other (income)	$	28,981		$	28,396		2.1	%
Total expense and other (income)-to-revenue ratio	29.1		%	27.2		%	1.9	pts.
Income before income taxes	$	19,524		$	21,902		(10.9	)%
Provision for income taxes	3,041			5,298			(42.6	)%
Net income	$	16,483		$	16,604		(0.7	)%
Net income margin	16.5		%	15.9		%	0.6	pts.
Earnings per share of common stock
Assuming dilution	$	14.94		$	14.37		4.0	%
Weighted-average shares outstanding
Assuming dilution	1,103.0			1,155.4			(4.5	)%
Assets**	$	126,223		$	119,213		5.9	%
Liabilities**	$	103,294		$	100,229		3.1	%
Equity**	$	22,929		$	18,984		20.8	%

* (2.5) percent adjusted for currency.

** At December 31.

The following table provides the company’s operating (non-GAAP) earnings for 2013 and 2012.

($ in millions except per share amounts)

					Yr.-to-Yr.
					Percent
For the year ended December 31:	2013		2012		Change
Net income as reported	$	16,483	$	16,604	(0.7	)%
Non-operating adjustments (net of tax)
Acquisition-related charges	747		641		16.5
Non-operating retirement-related costs/(income)	729		381		91.2
Operating (non-GAAP) earnings*	$	17,959	$	17,627	1.9	%
Diluted operating (non-GAAP) earnings per share	$	16.28	$	15.25	6.8	%

* See page 46 for a more detailed reconciliation of net income to operating (non-GAAP) earnings.

In 2013, the company reported revenue of $99.8 billion, expanded gross and net income margins, and delivered diluted earnings per share growth of 4.0 percent as reported and 6.8 percent on an operating (non-GAAP) basis. The company generated $17.5 billion in cash from operations and $15.0 billion in free cash flow driving shareholder returns of $17.9 billion in gross common stock repurchases and dividends. In 2013, the company continued the transformation of its portfolio to higher value expending $3.1 billion to acquire 10 companies to expand its capabilities in its key growth areas, in addition to maintaining high levels of investment of $6.2 billion in research and development and $3.8 billion in net capital expenditures.

The company also continued to shift its investments to address the key trends in information technology (IT)—social, mobile, big data/analytics and cloud. Several years ago, the company identified and established objectives for four key growth initiatives—Smarter Planet, business analytics, cloud and growth markets—to address these trends. In 2013, across the business, Smarter Planet, business analytics and cloud had strong performance. Smarter Planet revenue grew about 20 percent compared to 2012, with strength across all areas, including Smarter Commerce, Smarter Cities, Social Business and industry solutions. The company believes that data, as a natural resource, will drive demand going forward, and that big data/analytics will provide the basis for competitive differentiation. Business analytics revenue of $15.7 billion increased 9 percent year to year, led by Global Business Services and Software. The company’s cloud solutions address the full scope of client requirements including private clouds, public clouds and hybrid clouds, as well as platform and software-as-a-solution (SaaS)-based solutions. In 2013, the company delivered $4.4 billion of cloud-based solutions revenue, an increase of 69 percent compared to 2012. In addition, within that content, $1.7 billion was delivered as a service. Across the company’s performance, there is overlap between these initiatives. In total, software makes up about half of that combined content. The software content improves the company’s business mix and contributes to margin expansion.

Segment revenue was led by Software which increased 1.9 percent (3 percent adjusted for currency) driven by key branded middleware which increased 4.8 percent (6 percent adjusted for currency). The key growth initiatives fueled this performance. Global Business Services returned to revenue growth at constant currency (down 0.9 percent as reported; up 3 percent adjusted for currency) driven by the company’s investments in the Digital Front Office. While revenue in Global Technology Services declined 4.2 percent (1 percent adjusted for currency), revenue trajectory improved in the second half and was stabilizing. Global Financing revenue improved 0.4 percent (3 percent adjusted for currency) versus 2012. The Software, Global Services and Global Financing businesses all grew pre-tax income and expanded their pre-tax margin in 2013 compared to 2012. Systems and Technology impacted the company’s overall performance in 2013. Revenue decreased 18.7 percent (18 percent adjusted for currency) year to year driven by the back end of the mainframe product cycle and business model challenges specific to Power Systems, Storage and System x. Pre-tax income in Systems and Technology decreased $1.7 billion compared to the prior year.

Revenue from the company’s growth markets underperformed in 2013, particularly in the second half of the year. For the full year, growth markets revenue decreased 4.9 percent as reported and 2 percent at constant currency.  Overall, the company believes that the opportunity in the growth markets remains attractive, and it is intensifying its efforts on new growth opportunities in these markets.

The consolidated gross profit margin increased 0.5 points versus 2012 to 48.6 percent. This was the tenth consecutive year of improvement in the gross profit margin. The operating (non-GAAP) gross margin of 49.7 percent increased 0.9 points compared to the prior year. The increase in gross margin in 2013 was driven by margin improvements in the Global Services segments and an improved mix driven by Software, partially offset by margin decreases in Systems and Technology.

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Total expense and other (income) increased 2.1 percent in 2013 versus the prior year. Total operating (non-GAAP) expense and other income increased 1.4 percent compared to the prior year. The year-to-year drivers were approximately:

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

* Reflects impacts of translation and hedging programs.

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

There were several items that had an impact on total expense and other (income) year to year. Workforce rebalancing charges for 2013 were $1,064 million compared to $803 million in the prior year. Bad debt expense increased $106 million year to year driven by higher specific account reserves. In addition, in 2012, the company recorded a gain of $446 million related to the divestiture of the Retail Store Solutions (RSS) business, and also recorded a charge of $162 million related to a court ruling in the UK regarding one of IBM’s UK defined benefit pension plans. This charge was not included in the company’s operating (non-GAAP) expense and other (income). Also, the company has a performance-based compensation structure. As a result of certain parts of the business not performing as expected, performance-related compensation in 2013 across both cost and expense was down $777 million compared to the prior year.

Pre-tax income decreased 10.9 percent and the pre-tax margin was 19.6 percent, a decrease of 1.4 points versus 2012. Net income decreased 0.7 percent and the net income margin was 16.5 percent, an increase of 0.6 points versus 2012. The effective tax rate for 2013 was 15.6 percent, a decrease of 8.6 points versus the prior year driven by an improvement in the ongoing tax rate and discrete tax items, including audit settlements. Operating (non-GAAP) pre-tax income decreased 7.7 percent and the operating (non-GAAP) pretax margin was 21.4 percent, a decrease of 0.7 points versus the prior year. Operating (non-GAAP) net income increased 1.9 percent and the operating (non-GAAP) net income margin of 18.0 percent increased 1.1 points versus the prior year. The operating (non-GAAP) effective tax rate was 16.0 percent versus 24.0 percent in 2012 driven by the same factors described above.

Diluted earnings per share improved 4.0 percent year to year reflecting the benefits of the common stock repurchase program. In 2013, the company repurchased approximately 73 million shares of its common stock. Diluted earnings per share of $14.94 increased $0.57 from the prior year. Operating (non-GAAP) diluted earnings per share of $16.28 increased $1.03 versus 2012 driven by the following factors:

· Revenue decrease at actual rates	$	(0.69	)
· Margin expansion	$	0.98
· Common stock repurchases	$	0.74

At December 31, 2013, the company’s balance sheet and liquidity positions remained strong and were well positioned to support the business over the long term. Cash and marketable securities at year end was $11,066 million, consistent with the year-end 2012 balance. Key drivers in the balance sheet and total cash flows are highlighted below.

Total assets increased $7,010 million ($9,337 million adjusted for currency) from December 31, 2012 driven by:

·Increases in prepaid pension assets ($4,607 million), goodwill ($1,937 million) and total receivables ($1,202 million), partially offset by

·Decreases in deferred taxes ($687 million).

Total liabilities increased $3,065 million ($4,494 million adjusted for currency) from December 31, 2012 driven by:

·Increased total debt ($6,449 million) and increases in deferred tax liabilities ($1,336 million), partially offset by

·Decreased retirement and nonpension postretirement benefit obligations ($4,176 million) and decreases in compensation and benefits ($853 million).

Total equity of $22,929 million increased $3,945 million from December 31, 2012 as a result of:

·Higher retained earnings ($12,401 million), decreased losses in accumulated other comprehensive income/(loss) of $4,157 million and increased common stock ($1,484 million), partially offset by

·Increased treasury stock ($14,110 million) driven by share repurchases.

The company generated $17,485 million in cash flow provided by operating activities, a decrease of $2,102 million when compared to 2012, primarily driven by operational performance and a net increase in the use of cash for taxes of $2,200 million primarily driven by an increase in cash tax payments. Net cash used in investing activities of $7,326 million was $1,679 million lower than 2012, primarily due to a decrease in cash used associated with the net purchases and sales of marketable securities and other investments ($1,232 million) and decreased net capital investments ($539 million). Net cash used in financing activities of $9,883 million was $2,094 million lower compared to 2012, primarily due to increased proceeds from net debt ($4,708 million), partially offset by increased cash used for gross common stock repurchases ($1,865 million).

In January 2014, the company disclosed that it is expecting GAAP earnings of at least $17.00 and operating (non-GAAP) earnings of at least $18.00 per diluted share for the full year 2014. The company also stated that in the first quarter of 2014 it expects to close the initial phase of the sale of its customer care business to SYNNEX and that it also expects to take the majority of its workforce rebalancing actions for the year in the same period. As a result, the company expects its first quarter 2014 GAAP and operating (non-GAAP) earnings per share to be approximately 14 percent of the full year expectation, reflecting about half of the divestiture gain, the workforce rebalancing charges and continued impacts from currency.

For additional information and details, see the “Year in Review” section on pages 35 through 52.

DESCRIPTION OF BUSINESS

Please refer to IBM’s Annual Report on Form 10-K filed with the SEC on February 25, 2014 for a more detailed version of this Description of Business, especially Item 1A. entitled “Risk Factors.”

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The company creates 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

IBM’s strategy is one of innovation, transformation and a constant evolution to higher value. The company delivers innovative solutions, software and infrastructure to improve client outcomes. The company helps enterprises apply technology to capture new value across their entire organizations, and it provides a differentiated client experience through a highly engaged and skilled global workforce and a broad ecosystem of partners. The ultimate goal of this strategy is to deliver on IBM’s purpose of making our company essential to clients, employees, partners, investors and communities.

Three strategic imperatives shape our approach as we continuously transform IBM and align the company for higher value.

1. Make Markets by Transforming Industries and Professions with Data

The emergence of big data as the world’s new natural resource is the phenomenon of our time. It is being fueled by the proliferation of mobile devices, the rise of social media and the infusion of technology into all things and processes. Today, enterprises must harness data to create competitive advantage. The value for enterprises increases as they apply more sophisticated analytics across more disparate data sources. Their real-time use of data will increasingly become a competitive differentiator. Enterprises will also need cognitive computing capabilities as data continues to grow in all dimensions. Therefore, IBM’s strategy is to make markets by transforming industries and professions with data. The company has invested more than $22 billion, including $15 billion on more than 30 acquisitions, to build its capabilities in big data and analytics. One third of IBM’s research is focused on data, analytics and cognitive computing. The company is investing $1 billion in Watson solutions to build out the next era of cognitive systems and services. In 2013, the company realized $15.7 billion in business analytics revenue. The original target for this business was to achieve $16 billion in revenue in 2015—as a result of this performance, the company has taken its 2015 objective for business analytics revenue to $20 billion.

2. Remake Enterprise IT for the Era of Cloud

Enterprises are increasingly relying on cloud, which is being fueled by abundant bandwidth, the emergence of standards and the demand for consumability. They are benefitting from cloud by using it to transform their IT and business processes into digital services, to reinvent their core business processes and to drive innovation. Enterprises are integrating public and private clouds with backend systems to create hybrid, dynamic environments. They will increasingly need to manage their cloud environments with the same rigor as an on-premise datacenter. Therefore, IBM’s strategy is to remake enterprise IT for the era of cloud. The company has invested over $6 billion to acquire more than 15 companies related to cloud, and is investing more than $1 billion to expand its global footprint to 40 datacenters worldwide. IBM now has more than 100 SaaS offerings, and IBM cloud supports 24 of the top 25 Fortune 500 companies. All of this drove $4.4 billion of revenue for cloud-based solutions in 2013.

3. Enable “Systems of Engagement” for Enterprises and Lead by Example

Social, mobile and unprecedented access to data are changing how individuals are understood and engaged. A new class of individual is emerging: one that is empowered with knowledge, enriched by networks and expects value in return for its information. Enterprises must create a systematic approach to engage this new class of individual and increase its speed and responsiveness by becoming mobile. Interactions need to be personalized to offer more value. In addition, enterprises will benefit from securing information and increasing trust. Therefore, IBM’s strategy is to enable “systems of engagement” for enterprises, and the company is leading by example. IBM has acquired 20 companies related to mobile, social and security. IBMers are collaborating in more than 200,000 internal social communities and 85 percent of IBM’s sellers use the company’s Sales Connect portal. In 2013, the company’s mobile, social and security portfolio generated double-digit revenue growth with mobile increasing 69 percent, security 19 percent and social business 45 percent.

To capture the opportunities arising from these strategic imperatives, IBM is focused on four key growth initiatives: Smarter Planet, Business Analytics, Cloud Computing and Growth Markets.

Smarter Planet

Smarter Planet is IBM’s strategy to lead in a technology-enabled world that is more instrumented, interconnected and intelligent than ever before, allowing people and organizations to address significant business and societal challenges. At the heart of this strategy are solutions that drive innovation and outcomes for clients—extending the boundaries of businesses, industries and communities. It is about helping the company’s clients become better at what they do for their customers. IBM does this through advanced, integrated solutions based on capabilities such as analytics for business and physical systems, cloud computing, mobile, social business and business process management.

IBM continues to deepen its commitment to delivering on the promise of Smarter Planet for both line of business executives (CFOs, CHROs, CMOs, etc.) as well as IT executives across a broad range of industries. IBM’s industry-based approach and solutions are grounded in a deep understanding of the distinct set of challenges and opportunities that are confronting companies and executives in various industries. Whether ‘smarter’ means helping a bank to retain more customers through world-class mobile solutions, a hospital group to deliver highly individualized care coordinated with social services, a local government to anticipate and alleviate traffic congestion before it happens, or a retail chain to provide a seamless customer experience across multiple channels, IBM is developing and investing in a portfolio of replicable industry solutions to help clients achieve their goals and drive important outcomes for their customers.

There are several areas of focus within the Smarter Planet strategy, including IBM’s Social Business, MobileFirst, Smarter Commerce and Smarter Cities initiatives.

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IBM’s Social Business initiative helps clients integrate social capabilities across core business processes to drive measurable business results. The Social Business initiative can unlock the intrinsic knowledge of people within an organization to help companies fuel customer-centric innovation, improve productivity and expand sales, loyalty and advocacy. To capitalize on the new market opportunities that arise from a digital economy, IBM Social Business can let clients apply increasingly sophisticated analytics to gain actionable insight and to more effectively engage with customers. Behavioral, human data is the newest form of data and can be used to build a stronger, more agile workforce and reinvent human capital management by applying behavioral sciences across the talent lifecycle. The Social Business initiative is powered by world class IBM services and software, developed organically by IBM and through acquisitions.

In 2013, the company launched IBM MobileFirst, a unified approach to help clients and partners deliver best-in-class mobile solutions, take advantage of more commercial opportunities and provide a superior customer experience. IBM has a breadth of expertise and technology to help organizations efficiently build and deploy mobile applications, maintain visibility and control over their mobile infrastructure, engage customers in context and transform the value chain in ways that can drive growth and return on investment. The company can help its clients achieve these goals through a complete portfolio of IBM mobile software, services and industry expertise. Throughout 2013, IBM invested in core mobile enterprise capabilities such as IBM Worklight and IBM Rational, while rounding out its portfolio with strategic acquisitions such as Fiberlink, Trusteer, Xtify and The Now Factory. Integrated with 270 patents in wireless innovations and strengthened by thousands of mobile specialists from IBM Mobile Enterprise Services and IBM Interactive, the company has already helped more than 1,000 clients become more mobile enterprises.

In addition to Social and Mobile, IBM’s deep commitment to building a smarter planet can be seen in the ongoing efforts around Smarter Commerce and Smarter Cities. IBM’s Smarter Commerce model can integrate and transform how companies manage and adapt their buy, market, sell and service processes to place the customer experience at the center of their business. IBM’s Smarter Cities initiative helps federal, state and local governments to make better decisions, anticipate issues and coordinate resources across agencies more effectively and deliver citizen-centric services that can drive sustainable economic growth.

Business Analytics

Business Analytics is the category of software, systems and services that helps organizations take advantage of big data to make better and faster decisions and optimize processes. Big data includes both enterprise data, content and new data from both structured and unstructured sources: in previously unimaginable volumes (petabytes), with huge variety (from blogs, tweets, pictures, videos and text), at high velocity (machine-to-machine data from the Internet of things) and with decreasing veracity (from uncertain or incomplete sources). Big data and analytics are core to achieving the Smarter Planet strategy, helping data-savvy, insight-driven leaders to infuse intelligence into business decisions, processes and client interactions for faster actions and better outcomes.

IBM can serve new buyers and make new market segments by bringing IT to industries and professions that are being transformed by data. The company has a unique set of offerings and deep expertise related to big data and analytics to help organizations:

·Acquire, grow and retain customers by improving customer interactions, building long-term, profitable relationships and realizing new value from customer sentiment.

·Create new business models by tapping into information and insight to identify and explore strategic options for growth.

·Transform financial management processes by improving enterprise agility, anticipating outcomes and driving business model innovation through a discipline of performance.

·Better monitor, predict and manage risk to build trust and value amidst uncertainty, by having confidence in their data, risk exposures and ability to make risk-aware actionable decisions.

·Optimize operations and counter fraud and other threats to reduce costs, increase efficiencies and productivity and improve public safety.

·Improve IT economics by developing and enabling new value and agility at practically all levels of the organization and across lines of business while helping keep costs low and profitability high.

The company’s approach to big data and analytics helps organizations to succeed in their industries. IBM recommends organizations do three things to be successful. First, build a culture that infuses analytics everywhere. Second, be proactive about the privacy, security and governance of their data. Third, invest in the right platform and solutions to harness and analyze all of their data for new insights and outcomes.

IBM is committed to continually innovating across the spectrum of big data and analytics capabilities, solutions, systems, research, services, deployment and skills. For example, in 2013, the company announced a breakthrough dynamic in-memory database technology called BLU Acceleration, predictive analytics for big data with IBM Analytic Catalyst, a PureData System for Hadoop that marries IBM’s enterprise-class Hadoop distribution (InfoSphere BigInsights) with the simplicity of an appliance, InfoSphere Data Privacy for Hadoop that provides security and protection for sensitive big data, a Watson Engagement Advisor solution to help transform how brands and their customers interact and new academic partnerships to help prepare students for the expanding scope of careers in big data and analytics.

Cloud Computing

Cloud is a model for consuming and delivering business and IT services that can result in significant improvements in economies of scale and business agility and serve as a platform for business transformation. IBM has developed a portfolio of solutions, services and products that is helping thousands of clients adopt and leverage the transformative power of the cloud. IBM’s breadth of capabilities gives the company a unique advantage to help clients think, build and tap into the cloud. IBM has the deep industry expertise to help clients transform business processes, industry optimized software solutions to support business processes, software development platforms to create new cloud-based business applications and standardized infrastructure to run these applications.

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IBM offers a full array of cloud delivery models, including private clouds, public clouds and a hybrid cloud that includes a mix of both. The company enables clients to build private, on-premises cloud-based environments that have the control, security and isolation required for their most mission-critical workloads. IBM also offers public cloud services, including the newly acquired SoftLayer platform that provides an infrastructure and ecosystem for middleware and applications. IBM’s public cloud services can be simply provisioned as a self service, pay-as-you-go consumption model. IBM’s software defined environments can provide a seamless integration across private and public cloud models, with interoperability, portability and scalability to help clients realize the full value of cloud.

In the new era of computing, IBM’s plans to enable nearly everything as a digital service. During 2013, IBM made several cloud-related strategic announcements, notably:

·IBM’s Watson technology is being made available as a development platform in the cloud to enable a worldwide community of software application providers to build a new generation of apps infused with Watson’s cognitive computing intelligence.

·The acquisition of SoftLayer is enabling IBM to deliver industry-leading cloud solutions that offer the security, privacy and reliability of private clouds and the economy and speed of a public cloud.

·New fast-start industry solutions, which are hosted on a private cloud using SoftLayer and offered as a managed service through Global Business Services, designed to meet growing demand from clients for rapid deployment, implementation and experimentation.

·The acquisition of Xtify Inc., a leading provider of cloud-based mobile messaging tools that help organizations improve mobile sales, drive in-store traffic and engage customers with personalized offers.

·An open-standards IBM cloud platform that provides capabilities to power the next generation of cloud and mobile application development and services.

Growth Markets

IBM continues to invest in growth markets where many countries and companies are embracing big data, mobile, social and cloud, often at faster rates than mature countries. In China, for example, 32 percent of consumers make their purchases online, compared to only 14 percent of consumers globally. In Africa, 18 percent of the continent’s GDP is expected to be handled through mobile money transfers by 2015, while in Singapore, citizens spend 40 minutes on average each day on Facebook, compared to less than 25 minutes in the United States. IBM is helping clients in growth markets capitalize on these trends. For example:

·In Mexico, IBM is using its analytics tools to enable Banorte-Ixe Bank to know and service its more than 13 million customers as individuals.

·Using IBM’s Big Data technologies and predictive analytics, Da Nang’s (Vietnam) traffic control center is better forecasting and preventing potential congestion and better coordinating city responses to issues like accidents and adverse weather.

·In Saudi Arabia, the company developed a public health solution for disease management that was implemented with the Saudi Ministry of Health to help manage the risk of infectious and communicable diseases across the Kingdom.

·Faced with rising fuel costs and a goal to reduce greenhouse emissions, Jet Airways, India’s premier international airline, turned to IBM to more accurately calculate, track and report aircraft emissions and reduce fuel usage.

IBM continues to build out its shared services facilities and talent to support its clients in growth markets. In China, the company has increased its Big Data software skills, and it will leverage an IBM Integrated Managed Services Centre to capture the significant growth in cloud. In November 2013, IBM opened its first Africa Research Lab in Kenya, IBM’s 12th lab worldwide. The facility will conduct applied and exploratory research into the challenges Africa faces, and deliver commercially viable solutions to help improve the lives of people across the continent.

Summary

IBM’s strategy is one of innovation, transformation and a constant evolution to higher value. The company has steadily remixed its portfolio and business model to reflect its strategic beliefs and pursue its growth initiatives. IBM has a balanced history of exiting commodity businesses that no longer fit the high-value model while investing in strategic acquisitions and organic capabilities. In 2013, the company invested $3.1 billion for acquisition, $3.8 billion in net capital expenditures and $6.2 billion in research and development. The company has acquired more than 150 companies since 2000 to bolster its portfolio in areas like big data and analytics, cloud and systems of engagement.

As the company looks ahead to 2014 and beyond, it will continuously transform itself to take advantage of new opportunities and pursue bold new plays in areas such as Watson solutions, new offerings for big data and analytics, the mobile enterprise and high-value cloud services. IBM will continue to deliver differentiated client value based on its sustained investments in research and development, its engaged employee base, industry expertise, global reach, and the breadth and depth of the company’s technologies and capabilities.

Business Model

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

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

The business model is resilient, adapting to the continuously changing market and economic environment. The company continues to divest certain businesses and strengthen its position through strategic organic investments and acquisitions in higher-value areas. 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.

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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, 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 long-standing expertise in service management and technology with the ability to exploit the power of new technologies from IBM systems and software, such as cloud computing, analytics and virtualization, to deliver high performance, innovation and improved ability to achieve business objectives.

Global Process Services: 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.

Cloud Services: delivers a comprehensive set of cloud services ranging from assisting clients with building their own private clouds, to building customized dedicated managed clouds, to allowing clients to leverage standardized cloud infrastructure services from the Soft-Layer and SmartCloud Enterprise+ offerings, to creating hybrid environments linking their private and public workloads together. This portfolio of cloud offerings spans across the GTS business lines.

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.

Watson Solutions: included within Information Management Software, Watson is the first commercially available cognitive computing platform that has the ability to interact in natural language, processing vast amounts of big data, and learning from its interactions with people and computers. As an advisor, Watson is able to sift through and understand large amounts of data delivering insights with unprecedented speeds and accuracy.

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.

Social Workforce Solutions: 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 and complex embedded system solutions, with a portfolio of products and solutions supporting DevOps and Smarter Product Development, transforming the way lines of business, development and operations work together to deliver innovation via software.

Mobile Software:  spans middleware and offers customers true end-to-end mobile solutions across platform and application development, mobile security, and mobile device management.  Leveraging powerful analytics and usage data, customers are provided with the ability to have more compelling interactions with their clients and workforce, increasing touchpoints and deepening relationships.  The mobile offerings provide the ability to increase workforce productivity through enhanced collaboration, improved knowledge sharing and increased response speed.

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 PureData System for Analytics powered by Netezza, IBM SmartCloud Entry and IBM BladeCenter for Cloud. IBM servers use both IBM and non-IBM micro-processor technology and operating systems. All IBM servers run Linux, a key open-source operating system, and the company is expanding its Linux relevance further on the Power platform.

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, leveraging the breadth of IBM’s software offerings, and includes Flash storage and solutions.

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

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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.

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 175 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.

The company continues to invest to capture the long-term opportunity in 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

Research, Development and Intellectual Property

IBM’s research and development (R&D) operations differentiate the company from its competitors. IBM annually invests approximately $6 billion for R&D, focusing on high-growth, high-value opportunities. IBM Research works with clients and 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, big data analytics, secure clouds and to IBM Watson, a ‘‘cognitive’’ learning system.

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 2013, IBM was awarded more U.S. patents than any other company for the 21st consecutive year. IBM’s 6,809 patents awarded in 2013 represent a diverse range of inventions poised to enable significant innovations that will position the company to compete and lead in strategic areas such as Watson, cloud computing and big data analytics. These inventions also will advance the new era of cognitive systems where machines will learn, reason and interact with people in more natural ways. 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 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 is becoming a Smarter Enterprise. The transformation to a Smarter Enterprise is built on the foundation of internal transformation undertaken in the recent past, where IBM standardized business processes, drove enterprisewide

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transformation governance, implemented a global operating model, instrumented data, and connected employees to drive collaboration across geographic and functional boundaries.

The Smarter Enterprise is enabled through application of analytics, social, mobile and cloud tools, approaches and technologies. Analytics enable data-driven insights for faster, smarter decision making. Social tools encourage peer-to-peer interactions, and allow data to be shared within and outside IBM in a social way. Mobile technology allows workers to work seamlessly from anywhere. Cloud infrastructure and services enable application delivery. Collectively these enablers allow IBM to make decisions differently, create value differently and deliver value differently, thereby improving employee engagement and client experience and ultimately driving better business performance. The company primarily reinvests the benefits of its enterprise transformation initiatives in remixing its spending profile and resources to its higher growth, higher margin initiatives, in addition to improving profitability.

Integrated Supply Chain

IBM has an extensive integrated supply chain, procuring materials and services globally. In 2013, the company also managed approximately $20 billion in procurement spending for its clients through the Global Process Services organization. The supply, manufacturing and logistics and sales transaction support 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. Supply chain resiliency enables IBM to reduce its risk during marketplace changes.

The company continues to derive business value from its own globally integrated supply chain providing 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.

The company has expanded its use of analytics to measure, manage and fine tune its supply chain operations, which will help reshape its operations and create value for clients.

YEAR IN REVIEW

Segment Details

The following is an analysis of the 2013 versus 2012 reportable segment results. The table below presents each reportable segment’s external revenue and gross margin results. Segment pre-tax income includes transactions between segments that are intended to reflect an arm’s-length transfer price and excludes certain unallocated corporate items; see note T, “Segment Information,” on pages 141 to 146 for additional information.

($ in millions)

							Yr.-to-Yr.		Yr.-to-Yr.
							Percent/		Percent Change
							Margin		Adjusted for
For the year ended December 31:	2013			2012			Change		Currency
Revenue
Global Technology Services	$	38,551		$	40,236		(4.2	)%	(1.4	)%
Gross margin	38.1		%	36.6		%	1.5	pts.
Global Business Services	18,396			18,566			(0.9	)%	2.6	%
Gross margin	30.9		%	30.0		%	0.9	pts.
Software	25,932			25,448			1.9	%	2.9	%
Gross margin	88.8		%	88.7		%	0.1	pts.
Systems and Technology	14,371			17,667			(18.7	)%	(17.9	)%
Gross margin	35.6		%	39.1		%	(3.5	)pts.
Global Financing	2,022			2,013			0.4	%	2.8	%
Gross margin	45.6		%	46.5		%	(0.9	)pts.
Other	478			577			(17.1	)%	(16.4	)%
Gross margin	(195.6		)%	(71.6		)%	(124.0	)pts.
Total consolidated revenue	$	99,751		$	104,507		(4.6	)%	(2.5	)%
Total consolidated gross profit	$	48,505		$	50,298		(3.6	)%
Total consolidated gross margin	48.6		%	48.1		%	0.5	pts.
Non-operating adjustments
Amortization of acquired intangible assets	388			375			3.5	%
Acquisition-related charges	5			1			NM
Retirement-related costs/(income)	629			264			138.1	%
Operating (non-GAAP) gross profit	$	49,527		$	50,938		(2.8	)%
Operating (non-GAAP) gross margin	49.7		%	48.7		%	0.9	pts.

NM—Not meaningful

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Global Services

In 2013, the Global Services segments, Global Technology Services (GTS) and Global Business Services (GBS), delivered $56,947 million of revenue, grew pre-tax income 2.5 percent and expanded pre-tax margin 1.0 points. GBS returned to revenue growth in 2013, at constant currency, leveraging the investments made in the Digital Front Office practices. GTS revenue performance improved during the second half of 2013 and is stabilizing. Global Services had good performance in the key growth initiatives of Smarter Planet, business analytics and cloud, and is continuing to invest to expand its capabilities in these areas. Total outsourcing revenue of $26,157 million decreased 5.1 percent (2 percent adjusted for currency) and total transactional revenue of $23,678 million decreased 1.0 percent as reported, but increased 2 percent adjusted for currency year to year. The estimated Global Services backlog was $143 billion at December 31, 2013, an increase of 1.8 percent (5 percent adjusted for currency) versus the prior year-end balance.

($ in millions)

							Yr.-to-Yr.
					Yr.-to-Yr.		Percent Change
					Percent		Adjusted for
For the year ended December 31:	2013		2012		Change		Currency
Global Services external revenue	$	56,947	$	58,802	(3.2	)%	(0.2	)%
Global Technology Services	$	38,551	$	40,236	(4.2	)%	(1.4	)%
Outsourcing	22,060		23,344		(5.5	)	(2.7	)
Integrated Technology Services	9,380		9,550		(1.8	)	1.0
Maintenance	7,111		7,343		(3.1	)	(0.7	)
Global Business Services	$	18,396	$	18,566	(0.9	)%	2.6	%
Outsourcing	4,097		4,209		(2.6	)	1.5
Consulting and Systems Integration	14,298		14,358		(0.4	)	2.9

Global Technology Services revenue of $38,551 million in 2013 decreased 4.2 percent (1 percent adjusted for currency) year to year. From a geographic perspective, revenue declines in North America and Europe were partially offset by growth in Japan, adjusted for currency. GTS Outsourcing revenue decreased 5.5 percent (3 percent adjusted for currency) in 2013. Revenue performance was impacted by a decline in revenue from sales into existing base accounts. This activity is more transactional in nature and can be economically sensitive. Revenue was also impacted by the work done to improve the profitability of the restructured low margin outsourcing contracts. GTS Outsourcing had double-digit signings growth in 2013 and started to realize the benefit from several of the large transformational contract signings in its fourth-quarter 2013 revenue. Integrated Technology Services (ITS) revenue decreased 1.8 percent as reported, but increased 1 percent adjusted for currency in 2013 compared to 2012. The company continues to shift the ITS business toward higher value managed services such as business continuity, security and cloud. Within the cloud offerings, SoftLayer contributed 2 points of revenue growth to the ITS performance in 2013, and a half-point to total GTS revenue for the year. SoftLayer provides unmatched performance, flexibility and breadth for public and hybrid cloud workloads. In January 2014, the company announced plans to invest over $1.2 billion to double its SoftLayer centers, and with 40 cloud datacenters in 15 countries, the company will have cloud centers in every major geography and key financial center.

Global Business Services revenue of $18,396 million decreased 0.9 percent as reported, but increased 3 percent at constant currency in 2013 with growth in both GBS Outsourcing and Consulting and Systems Integration (C&SI), adjusted for currency. GBS revenue increased 0.5 percent (4 percent at constant currency) in the second half of the year. On a geographic basis, revenue growth at constant currency was led by North America, Japan and the growth markets, while Europe was flat year to year. By offering, growth was driven by the practices that address the Digital Front Office. GBS delivered double-digit growth in each of the strategic growth initiatives of business analytics, Smarter Planet and cloud. The company has been investing to build capabilities in these key areas and now has nearly 20,000 resources in GBS focused on the growing Digital Front Office opportunity. In the area of big data, the GBS capabilities span from Business Analytics and Optimization strategy, through Front Office Analytics to Fraud and Regulatory Compliance and Risk Management. Application Outsourcing revenue decreased 2.6 percent as reported, but increased 2 percent adjusted for currency. C&SI revenue decreased 0.4 percent as reported, but increased 3 percent adjusted for currency. Both lines of business had constant currency revenue growth year to year in the growth markets. In 2013, the GBS backlog grew for the fifth consecutive year at constant currency led, in 2013, by the major markets.

($ in millions)

							Yr.-to-Yr.
							Percent/
							Margin
For the year ended December 31:	2013			2012			Change
Global Services
Global Technology Services
External gross profit	$	14,691		$	14,740		(0.3	)%
External gross profit margin	38.1		%	36.6		%	1.5	pts.
Pre-tax income	$	6,983		$	6,961		0.3	%
Pre-tax margin	17.6		%	16.8		%	0.8	pts.
Global Business Services
External gross profit	$	5,676		$	5,564		2.0	%
External gross profit margin	30.9		%	30.0		%	0.9	pts.
Pre-tax income	$	3,214		$	2,983		7.7	%
Pre-tax margin	16.8		%	15.5		%	1.3	pts.

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GTS gross profit decreased 0.3 percent in 2013 and the gross profit margin improved 1.5 points year to year with margin expansion in each line of business, as well as in the growth markets and major markets. Pre-tax income increased 0.3 percent year to year and the pre-tax margin expanded 0.8 points to 17.6 percent. The 2013 margin improvement was driven by reductions in performance-related compensation, benefits from the second-quarter 2013 workforce rebalancing activity and efficiency improvements primarily through the company’s enterprise productivity initiatives, partially offset by higher year-to-year workforce rebalancing charges.

The GBS gross profit margin expanded 0.9 points in 2013 with improved profit performance in Application Outsourcing. GBS pre-tax income increased 7.7 percent in 2013 with a pre-tax margin of 16.8 percent, an improvement of 1.3 points year to year. GBS benefitted from reductions in performance-related compensation, the company’s enterprise productivity initiatives and the second-quarter 2013 workforce rebalancing activity, partially offset by higher year-to-year workforce rebalancing charges. The savings from those actions fuel the investments being made in the key growth initiatives.

The total Global Services business delivered profit growth and margin expansion throughout 2013. Pre-tax income of $10,197 million in 2013 increased 2.5 percent year to year and the pre-tax margin expanded 1.0 points to 17.4 percent.

Global Services Backlog

The estimated Global Services backlog at December 31, 2013 was $143 billion, an increase of 1.8 percent as reported and 5 percent adjusted for currency compared to the December 31, 2012 balance, with growth across both the transactional and outsourcing businesses. Revenue generated from the opening backlog is approximately 70 percent of total services annual revenue in any year. In 2014, the projected total services revenue from the backlog is expected to be up 1 percent year to year at consistent foreign currency exchange rates. The divestiture of the company’s customer care business in the first quarter of 2014 will impact performance from the backlog. This will reduce the total backlog and impact revenue growth from the backlog by approximately 3 points; including the divestiture, revenue generated from the backlog is expected to be down 2 percent year to year. The balance of the revenue, the other approximately 30 percent of total services revenue in any year, comes from yield from current year signings, and sales and volumes into the existing client base. It also includes SoftLayer and some other cloud services, which generate period revenue that isn’t reflected in the backlog.

The estimated transactional backlog at December 31, 2013 increased 5.3 percent (8 percent adjusted for currency) and the estimated outsourcing backlog increased 1.5 percent (5 percent adjusted for currency), respectively, from the December 31, 2012 levels.

($ in billions)

						`	Yr.-to-Yr.
					Yr.-to-Yr.		Percent Change
					Percent		Adjusted for
At December 31:	2013		2012		Change		Currency
Backlog
Total backlog	$	142.8	$	140.3	1.8	%	4.8	%
Outsourcing backlog	90.8		89.4		1.5		4.7

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.
					Yr.-to-Yr.		Percent Change
					Percent		Adjusted for
For the year ended December 31:	2013		2012		Change		Currency
Total signings	$	63,203	$	56,595	11.7	%	14.8	%
Outsourcing signings	$	35,027	$	27,891	25.6	%	28.7	%
Transactional signings	28,176		28,703		(1.8	)	1.4

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Software

($ in millions)

							Yr.-to-Yr.
					Yr.-to-Yr.		Percent Change
					Percent		Adjusted for
For the year ended December 31:	2013		2012		Change		Currency
Software external revenue	$	25,932	$	25,448	1.9	%	2.9	%
Middleware	$	21,557	$	20,983	2.7	%	3.7	%
Key Branded Middleware	17,322		16,528		4.8		5.7
WebSphere Family					8.2		9.1
Information Management					2.8		3.7
Social Workforce Solutions*					10.8		11.9
Tivoli					3.9		4.8
Rational					4.9		6.0
Other middleware	4,235		4,455		(4.9	)	(3.9	)
Operating systems	2,447		2,525		(3.1	)	(1.9	)
Other	1,929		1,940		(0.6	)	0.2

* Formerly Lotus

Software revenue of $25,932 million increased 1.9 percent as reported and 3 percent adjusted for currency in 2013 compared to 2012. The Software business delivered revenue growth, at constant currency, in all four quarters of the year. Revenue continued to mix toward key branded middleware with growth in all five brands. The Software value proposition remains strong for enterprise clients. Customers continue to increase deployment of the company’s middleware products and the business is investing and gaining share in social, mobile, analytics, cloud and security. Some of this is delivered in a SaaS model, and the company has over 100 SaaS offerings in its software portfolio. Across the Software brands, there was strong performance in the growth initiatives that address the key market trends—Smarter Planet, business analytics and cloud. The Software business completed eight acquisitions in 2013, adding to it’s capabilities in mobile, big data analytics and security. The Software business grew segment pre-tax profit 2.7 percent to $11.1 billion and expanded pre-tax margin 0.5 points.

In January 2014, the company announced a $1 billion investment in Watson, and it established a new Watson Group within the Software business. This new unit is dedicated to the development and commercialization of cloud-delivered cognitive innovations.

Key branded middleware revenue increased 4.8 percent (6 percent adjusted for currency), with strong performance in the areas of analytics, cloud, mobile, social and security. The faster growing and higher value branded middleware accounted for 67 percent of total Software revenue in 2013, an increase of 2 points from 2012.

WebSphere revenue increased 8.2 percent (9 percent adjusted for currency) in 2013 and gained share. Revenue performance was driven by double-digit growth in the Commerce offerings, and growth in Business Integration and the on-premises Application Server business. Mobile contributed strong revenue growth in 2013. MobileFirst, the company’s comprehensive portfolio of mobile software and services, was introduced in 2013 and extends value to clients to reach new markets and gain competitive advantage. The company continues to add capabilities to the WebSphere brand. In January 2014, the business acquired Aspera, Inc. which provides best in class transfer speeds for movement of big data.

Information Management revenue increased 2.8 percent (4 percent adjusted for currency) in 2013 compared to 2012. Performance in 2013 included strong growth in the distributed database offerings, including Netezza, and content management software.

Tivoli revenue increased 3.9 percent (5 percent adjusted for currency) in 2013 and gained share, driven by storage growth and the security solutions portfolio. Tivoli storage revenue was up 7 percent (8 percent adjusted for currency) in 2013. Tivoli security revenue increased 17 percent (19 percent adjusted for currency) and reflects contribution from the acquisition of Trusteer in the third quarter of 2013, which extended Tivoli’s data security capabilities further into cloud and mobile environments. The transformation driven by mobile and cloud computing is raising the importance of security for enterprise customers. The company has been building and expanding its security capabilities and now has 6,000 security experts worldwide, 3,000 patents in security and 25 security laboratories worldwide across software and services.

Social Workforce Solutions revenue increased 10.8 percent (12 percent adjusted for currency) in 2013. Performance was driven by Kenexa, which provides cloud-based recruiting and talent management solutions.

Rational revenue increased 4.9 percent (6 percent adjusted for currency) in 2013 year over year.

Operating systems revenue decreased 3.1 percent (2 percent adjusted for currency) in 2013 compared to 2012, driven by declines in Systems z and Power Systems.

($ in millions)

							Yr.-to-Yr.
							Percent/
							Margin
For the year ended December 31:	2013			2012			Change
Software
External gross profit	$	23,032		$	22,569		2.0	%
External gross profit margin	88.8		%	88.7		%	0.1	pts.
Pre-tax income	$	11,106		$	10,810		2.7	%
Pre-tax margin	38.1		%	37.6		%	0.5	pts.

38

Software gross profit increased 2.0 percent in 2013, with a gross profit margin of 88.8 percent. Software pre-tax income increased 2.7 percent and the pre-tax margin improved 0.5 points to 38.1 percent. The Software business had another successful year leveraging revenue growth and expense savings, primarily from the company’s enterprise productivity initiatives, to drive profit growth and margin expansion. The relative strength of the Software business, fueled by growth in the key growth initiatives, improved the company’s business mix and contributed to its operating (non-GAAP) consolidated gross and net margin improvements.

Systems and Technology

($ in millions)

							Yr.-to-Yr.
					Yr.-to-Yr.		Percent Change
					Percent		Adjusted for
For the year ended December 31:	2013		2012		Change		Currency
Systems and Technology external revenue	$	14,371	$	17,667	(18.7	)%	(17.9	)%
System z					(13.4	)%	(12.6	)%
Power Systems					(31.4	)	(30.7	)
System x					(13.5	)	(12.7	)
Storage					(10.8	)	(9.7	)
Total Systems excluding Retail Store Solutions					(17.6	)	(16.8	)
Microelectronics OEM					(11.9	)	(11.9	)
Total Systems and Technology excluding Retail Store Solutions					(17.0	)	(16.3	)
Retail Store Solutions (Divested in 2012)					(98.2	)	(98.2	)

Systems and Technology (STG) revenue decreased 18.7 percent (18 percent adjusted for currency) in 2013 versus 2012. Adjusting for the divested RSS business, revenue declined 17.0 percent (16 percent adjusted for currency) in 2013. Growth markets revenue decreased 16.5 percent (16 percent adjusted for currency) in 2013, compared to the prior year, while major markets revenue decreased 21.5 percent (20 percent adjusted for currency). Japan declined 18 percent as reported, but was essentially flat adjusted for currency. Two issues within the business significantly impacted the segment’s revenue and profit performance in 2013. First, STG is dealing with challenges in its hardware business models specific to Power Systems, Storage and x86. In addition, System z revenue was impacted by the product cycle, particularly in the second half, as the company entered the back end of the current mainframe cycle with difficult period to period comparisons driving revenue declines.

System z revenue decreased 13.4 percent (13 percent adjusted for currency) in 2013 versus 2012. The decrease was primarily driven by lower revenue in North America, while revenue increased in the growth markets. MIPS (millions of instructions per second) shipments increased 6 percent in 2013 versus the prior year. The increase in MIPS was driven by specialty engines, which increased 17 percent year over year and continue to be more than 50 percent of the total volumes. The decline in System z revenue was expected based on the product’s movement through the product cycle in 2013. In the current mainframe cycle, the company has shipped 28 percent more MIPS compared to the same period in the prior cycle. The revenue and gross profit in the current cycle are each about 99 percent of the previous cycle, net of currency. Mainframe products provide the highest levels of availability, reliability, efficiency and security, which position it as the ideal platform for high volume, mission critical workloads. The additional MIPS capacity in the current product cycle is a reflection of the ongoing relevance of the mainframe to clients, and provides the company with financial returns consistent with past cycles.

Power Systems revenue decreased 31.4 percent (31 percent adjusted for currency) in 2013 versus 2012. The Power platform continues to ship significant capacity into the UNIX market, however this has been more than offset by significant price performance, resulting in lower revenue. The company has been very successful in the UNIX market, and is taking two actions to improve its business model in Power Systems. First, it is making the platform more relevant to clients. To achieve this:

·In the fourth quarter of 2013, the company introduced a new Integrated Facility for Linux offering which enables clients to run Linux workloads in their existing servers. This mirrors the successful strategy the company executed on the System z platform;

·The company will expand its Linux relevance even further with POWER8 in 2014, which will provide additional big data and cloud capabilities; and

·Through the company’s OpenPOWER consortium it is making Power technology available to an open development alliance, building an ecosystem around the Power technologies.

These effects will take some time.

Secondly, even with these additional capabilities, the company recognizes that the size of the Power platform will not return to prior revenue levels. The company will take action by right-sizing the business for the demand characteristics it expects.

System x revenue decreased 13.5 percent (13 percent adjusted for currency) in 2013 versus 2012. High-end System x revenue decreased 16 percent (16 percent adjusted for currency) and blades revenue declined 45 percent (45 percent adjusted for currency) in 2013 versus the prior year. These decreases were partially offset by increased revenue driven by Pure Systems.

Pure Systems continued to gain momentum. Globally to date, the company has shipped over 10,000 systems across its hardware brands.

Storage revenue decreased 10.8 percent (10 percent adjusted for currency) in 2013 versus 2012. The company’s flash solutions continued to gain momentum in 2013 with positive revenue growth. The

39

Storwize products delivered double-digit growth, which were more than offset by declines in legacy OEM mid-range offerings, and declines in high-end offerings driven by significant pricing pressure.

Retail Stores Solutions (RSS) revenue decreased 98.2 percent (98 percent adjusted for currency) in 2013 versus 2012. In the third quarter of 2012, the company divested the RSS business to Toshiba Tec. See the caption, “Divestitures,” on page 98 for additional information regarding the transaction.

Microelectronics OEM revenue decreased 11.9 percent (12 percent adjusted for currency) in 2013 versus 2012.

($ in millions)

							Yr.-to-Yr.
							Percent/
							Margin
For the year ended December 31:	2013			2012			Change
Systems and Technology
External gross profit	$	5,120		$	6,903		(25.8	)%
External gross profit margin	35.6		%	39.1		%	(3.5	)pts.
Pre-tax income	$	(507	)	$	1,227		NM
Pre-tax margin	(3.4		)%	6.7		%	(10.1	)pts.

NM—Not meaningful

The decrease in external gross profit in 2013 versus 2012 was due to lower revenue and a lower overall gross profit margin reflecting the business model challenges. Overall gross margin decreased 3.5 points in 2013 versus the prior year. The decrease was driven by lower margins in Power Systems (1.0 points), System x (0.9 points), Microelectronics (0.7 points) and Storage (0.4 points) as well as a decline due to revenue mix (0.7 points), partially offset by margin improvement in System z (0.1 points).

Systems and Technology’s pre-tax income decreased $1,734 million to a loss of $507 million in 2013, when compared to the prior year. Pre-tax margin decreased 10.1 points in 2013 versus 2012. The decline in pre-tax income was driven by the hardware businesses which are dealing with business model challenges due to market shifts and System z, as it entered the backend of the mainframe product cycle late in the year.

Global Financing

See pages 72 through 75 for an analysis of Global Financing’s segment results.

Geographic Revenue

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

($ in millions)

							Yr.-to-Yr.
					Yr.-to-Yr.		Percent Change
					Percent		Adjusted for
For the year ended December 31:	2013		2012		Change		Currency
Total revenue	$	99,751	$	104,507	(4.6	)%	(2.5	)%
Geographies	$	97,800	$	102,268	(4.4	)%	(2.2	)%
Americas	43,249		44,556		(2.9	)	(2.0	)
Europe/Middle East/Africa	31,628		31,775		(0.5	)	(2.1	)
Asia Pacific	22,923		25,937		(11.6	)	(2.8	)
Major markets					(4.2	)%	(2.2	)%
Growth markets					(4.9	)%	(2.4	)%
BRIC countries					(8.2	)%	(5.6	)%

Total geographic revenue of $97,800 million decreased 4.4 percent (2 percent adjusted for currency) in 2013. Revenue in the major markets decreased 4.2 percent (2 percent adjusted for currency). Revenue from the growth markets, which represented approximately 23 percent of the total geographic revenue for the year, decreased 4.9 percent on a year-to-year basis (2 percent adjusted for currency). Performance at constant currency in the growth markets was mixed, with year-to-year growth in the first half offset by declines in the second half. The company had strength in Latin America and the Middle East and Africa region. However, declines in some of the larger growth markets, for example China and Australia, impacted the overall performance in the growth markets. Within the BRIC countries of Brazil, Russia, India and China, combined revenue declined 8.2 percent (6 percent adjusted for currency). The company continues to see good opportunity in all regions over the long term and is continuing to invest in these key markets.

Americas revenue decreased 2.9 percent (2 percent adjusted for currency) compared to the prior year. The major market countries were down 3.9 percent (4 percent adjusted for currency), partially offset by an increase in the Latin America growth markets of 4.4 percent (9 percent adjusted for currency). Within the major market countries, the U.S. was down 3.4 percent and Canada was down 6.3 percent (3 percent adjusted for currency). Within the growth market countries, Brazil increased 3.3 percent (10 percent adjusted for currency) and Mexico increased 7.8 percent (8 percent adjusted for currency).

40

Europe/Middle East/Africa (EMEA) revenue decreased 0.5 percent (2 percent adjusted for currency) compared to the prior year. The major market countries were down 0.5 percent (3 percent adjusted for currency), while the growth market countries were down 0.6 percent (up 1 percent adjusted for currency). In the major market countries, the UK decreased 1.4 percent (flat adjusted for currency), Germany decreased 0.1 percent (3 percent adjusted for currency), France decreased 1.8 percent (5 percent adjusted for currency), and Italy decreased 2.1 percent (5 percent adjusted for currency). Within the EMEA growth markets, the Middle East and Africa region increased 5.0 percent (11 percent adjusted for currency), but this growth was offset primarily by a decrease in Russia of 22.7 percent (22 percent adjusted for currency).

Asia Pacific revenue decreased 11.6 percent (3 percent adjusted for currency) year to year. Japan revenue decreased 15.2 percent as reported, but increased 4 percent overall and grew in every quarter on a constant currency basis. This growth reflects the benefits of shifting investment and redirection of the company’s go-to-market focus to improve performance in Japan. The Asia Pacific growth markets decreased 9.1 percent (7 percent adjusted for currency), with China down 12.2 percent (14 percent adjusted for currency) and Australia down 15.9 percent (10 percent adjusted for currency). During 2013, performance in China was impacted by the process surrounding the implementation of a broad governmental economic reform plan.

OEM revenue of $1,951 million in 2013 decreased 12.9 percent (12 percent adjusted for currency) compared to the prior year, driven by the Microelectronics OEM business.

Total Expense and Other (Income)

($ in millions)

							Yr.-to-Yr.
							Percent/
							Margin
For the year ended December 31:	2013			2012			Change
Total consolidated expense and other (income)	$	28,981		$	28,396		2.1	%
Non-operating adjustments
Amortization of acquired intangible assets	(370		)	(328		)	12.9
Acquisition-related charges	(40		)	(35		)	14.9
Non-operating retirement-related (costs)/income	(433		)	(274		)	58.3
Operating (non-GAAP) expense and other (income)	$	28,137		$	27,760		1.4	%
Total consolidated expense-to-revenue ratio	29.1		%	27.2		%	1.9 pts.
Operating (non-GAAP) expense-to-revenue ratio	28.2		%	26.6		%	1.6 pts.

Total expense and other (income) increased 2.1 percent in 2013 versus 2012. Total operating (non-GAAP) expense and other (income) increased 1.4 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*	(1) point	`	(1) point
· Acquisitions**	2 points		2 points
· Base expense	1 point		1 point

* 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)

							Yr.-to-Yr.
							Percent
For the year ended December 31:	2013			2012			Change
Selling, general and administrative expense
Selling, general and administrative—other	$	19,187		$	19,589		(2.1	)%
Advertising and promotional expense	1,294			1,339			(3.3	)
Workforce rebalancing charges	1,064			803			32.4
Retirement-related costs	995			945			5.3
Amortization of acquired intangible assets	370			328			12.9
Stock-based compensation	435			498			(12.6	)
Bad debt expense	156			50			210.0
Total consolidated selling, general and administrative expense	$	23,502		$	23,553		(0.2	)%
Non-operating adjustments
Amortization of acquired intangible assets	(370		)	(328		)	12.9
Acquisition-related charges	(25		)	(22		)	13.3
Non-operating retirement-related (costs)/income	(376		)	(294		)	28.1
Operating (non-GAAP) selling, general and administrative expense	$	22,731		$	22,910		(0.8	)%

41

Total Selling, general and administrative (SG&A) expense decreased 0.2 percent in 2013 versus 2012. The decrease was primarily driven by the effects of currency (1 point) and base spending (1 point), partially offset by acquisition-related spending (2 points). Operating (non-GAAP) SG&A expense decreased 0.8 percent primarily driven by the effects of currency (1 point) and lower base spending (1 point), partially offset by acquisition-related spending (1 point). The decrease was driven by lower SG&A—other expense, as the company continues to shift its spending. The company is continuing to drive productivity across the business, primarily through its enterprise productivity initiatives, and is reinvesting most of those savings into the business to drive its growth areas. The increase in workforce rebalancing charges was due to actions the company took in the second quarter of 2013. Bad debt expense increased $106 million in 2013 versus 2012, primarily driven by higher specific account reserves. The accounts receivable provision coverage was 1.6 percent at December 31, 2013, an increase of 20 basis points from year-end 2012.

Other (Income) and Expense

($ in millions)

							Yr.-to-Yr.
							Percent
For the year ended December 31:	2013			2012			Change
Other (income) and expense
Foreign currency transaction losses/(gains)	$	(260	)	$	(240	)	8.4	%
(Gains)/losses on derivative instruments	166			72			132.5
Interest income	(74		)	(109		)	(32.2	)
Net (gains)/losses from securities and investment assets	(29		)	(55		)	(48.0	)
Other	(131		)	(511		)	(74.4	)
Total consolidated other (income) and expense	$	(327	)	$	(843	)	(61.2	)%
Non-operating adjustment
Acquisition-related charges	(16		)	(13		)	17.4
Operating (non-GAAP) other (income) and expense	$	(343	)	$	(857	)	(60.0	)%

Other (income) and expense was income of $327 million and $843 million in 2013 and 2012, respectively. The decrease in income of $516 million in 2013 was primarily driven by lower income from divestitures ($405 million) driven by the gain associated with the divested RSS business ($446 million) in 2012 reflected in Other in the table above, and increased losses on derivative instruments ($95 million) due to foreign currency rate volatility year to year.

Research, Development and Engineering

($ in millions)

						Yr.-to-Yr.
						Percent
For the year ended December 31:	2013			2012		Change
Total consolidated research, development and engineering	$	6,226		$	6,302	(1.2	)%
Non-operating adjustment
Non-operating retirement-related (costs)/income	(57		)	20		NM
Operating (non-GAAP) research, development and engineering	$	6,170		$	6,322	(2.4	)%

NM—Not meaningful

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 decreased 1.2 percent in 2013 versus 2012, primarily driven by lower base spending (3 points), partially offset by acquisitions (2 points). Operating (non-GAAP) RD&E expense decreased 2.4 percent in 2013 compared to the prior year primarily driven by lower base spending (4 points), partially offset by acquisitions (2 points). Overall, the investment in RD&E represented 6.2 percent of revenue in 2013, compared to 6.0 percent in 2012.

Intellectual Property and Custom Development Income

($ in millions)

					Yr.-to-Yr.
					Percent
For the year ended December 31:	2013		2012		Change
Sales and other transfers of intellectual property	$	352	$	324	8.7	%
Licensing/royalty-based fees	150		251		(40.0	)
Custom development income	320		500		(36.0	)
Total	$	822	$	1,074	(23.5	)%

The timing and amount of sales and other transfers of intellectual property(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 2013 or 2012. Custom development income declined 36 percent compared to the prior year due to a reduction in payments from the company’s technology alliance partners.

Interest Expense

($ in millions)

					Yr.-to-Yr.
					Percent
For the year ended December 31:	2013		2012		Change
Interest expense
Total	$	402	$	459	(12.5	)%

42

The decrease in interest expense in 2013 versus 2012 was primarily driven by lower average interest rates, partially offset by higher average debt levels. 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 page 75 for additional information regarding Global Financing debt and interest expense. Overall interest expense (excluding capitalized interest) for 2013 was $989 million, a decrease of $15 million year to year.

Stock-Based Compensation

Total pre-tax stock-based compensation cost of $614 million decreased $74 million compared to 2012. The decrease was primarily related to performance share units ($48 million), the company’s assumption of stock-based awards previously issued by acquired entities ($16 million) and restricted stock units ($10 million). Stock-based compensation cost, and the year-to-year change, was reflected in the following categories: Cost: $122 million, down $10 million; SG&A expense: $435 million, down $63 million; and RD&E expense: $57 million, down $2 million.

See note R, “Stock-Based Compensation,” on pages 124 to 127 for additional information on stock-based compensation.

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)

							Yr.-to-Yr.
							Percent
For the year ended December 31:	2013			2012			Change
Retirement-related plans—cost
Service cost	$	545		$	493		10.6	%
Amortization of prior service cost/(credits)	(114		)	(148		)	(22.9	)
Cost of defined contribution plans	1,384			1,506			(8.1	)
Total operating costs	$	1,815		$	1,851		(2.0	)%
Interest cost	3,728			4,238			(12.0	)
Expected return on plan assets	(6,187		)	(6,356		)	(2.7	)
Recognized actuarial losses	3,434			2,407			42.7
Plan amendments/curtailments/ settlements	0			1			(30.6	)
Multi-employer plan/other costs	86			247			(65.4	)
Total non-operating costs/ (income)	$	1,062		$	538		97.5	%
Total retirement-related plans—cost	$	2,876		$	2,389		20.4	%

In 2013, total retirement-related plan cost increased by $488 million compared to 2012, primarily driven by an increase in recognized actuarial losses ($1,027 million) and lower expected return on plan assets ($169 million), partially offset by lower interest cost ($510 million) and lower pension litigation cost ($152 million).

As discussed in the “Operating (non-GAAP) Earnings” section on page 26, the company characterizes certain retirement-related costs as operating and others as non-operating. Utilizing this characterization, operating retirement-related costs in 2013 were $1,815 million, a decrease of $36 million compared to 2012, driven by lower cost of defined contribution plans ($122 million), partially offset by increased service cost ($52 million) and increased amortization of prior service cost ($34 million). Non-operating costs of $1,062 million increased $524 million in 2013, compared to the prior year, driven primarily by the increase in recognized actuarial losses ($1,027 million) and lower expected return on plan assets ($169 million), partially offset by lower interest cost ($510 million) and lower pension litigation cost ($152 million).

Income Taxes

The effective tax rate for 2013 was 15.6 percent, a decrease of 8.6 points versus the prior year, driven by the following factors:

·A benefit resulting from the completion of the U.S. 2008-2010 tax audit, including the associated reserve redeterminations (11.5 points);

·A benefit due to a more favorable geographic mix of pre-tax income in 2013 (2.4 points);

·Benefits from the retroactive impact of the 2012 American Taxpayer Relief Act (0.7 points) and an increase in research and development credits (0.6 points);

·A benefit from a tax agreement which required a reassessment of certain valuation allowances on deferred tax assets (1.5 points); and,

·Benefits from the resolution of certain non-U.S. tax audits (0.8 points) and newly enacted U.S. state tax legislation (0.6 points); partially offset by

·Tax charges related to certain intercompany payments made by foreign subsidiaries and the intercompany licensing of certain IP (9.1 points); and

·The year-over-year impact of the 2012 benefit related to a tax restructuring in Latin America (0.8 points).

The operating (non-GAAP) effective tax rate was 16.0 percent, a decrease of 8.0 points versus 2012 principally driven by the same factors described above.

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.

43

					Yr.-to-Yr.
					Percent
For the year ended December 31:	2013		2012		Change
Earnings per share of common stock
Assuming dilution	$	14.94	$	14.37	4.0	%
Basic	$	15.06	$	14.53	3.6	%
Diluted operating (non-GAAP)	$	16.28	$	15.25	6.8	%
Weighted-average shares outstanding (in millions)
Assuming dilution	1,103.0		1,155.4		(4.5	)%
Basic	1,094.5		1,142.5		(4.2	)%

Actual shares outstanding at December 31, 2013 and 2012 were 1,054.4 million and 1,117.4 million, respectively. The average number of common shares outstanding assuming dilution was 52.4 million shares lower in 2013 versus 2012. The decrease was primarily the result of the common stock repurchase program. See note L, “Equity Activity,” on page 116 for additional information regarding common stock activities. Also see note P, “Earnings Per Share of Common Stock,” on pages 124 and 125.

Financial Position Dynamics

At December 31, 2013, the company continues to have a high degree of financial flexibility with a strong balance sheet to support the business over the long term. Cash and marketable securities at year end were $11,066 million, consistent with the prior year-end balance. During the year the company continued to manage the investment portfolio to meet its capital preservation and liquidity objectives.

Total debt of $39,718 million increased $6,449 million from prior year-end levels. The commercial paper balance at December 31, 2013, was $2,458 million, an increase of $658 million from the prior year. Within total debt, $27,504 million is in support of the Global Financing business which is leveraged at a 7.2 to 1 ratio. The company continues to have substantial flexibility in the market. During 2013, the company completed bond issuances totaling $10,956 million, with terms ranging from 2 to 12 years, and priced from 0.22 to 3.38 percent depending on 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, 2013, the overall net underfunded position was $11,434 million, a decrease of $8,756 million from December 31, 2012 driven by the increase in discount rates, primarily in the U.S. 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 less than $700 million per year through 2015. In 2013, the return on the U.S. Personal Pension Plan assets was 7.1 percent and the plan was 109 percent funded. Overall, global asset returns were 7.1 percent and the qualified defined benefit plans worldwide were 102 percent funded. See note S, “Retirement-Related Benefits,” on pages 127 to 141 for additional information.

During 2013, the company generated $17,485 million in cash from operations, a decrease of $2,102 million compared to 2012. In addition, the company generated $15,021 million in free cash flow, a decrease of $3,164 million versus the prior year. See pages 65 to 67 for additional information on free cash flow. The company returned $17,917 million to shareholders in 2013, with $13,859 million in gross share repurchases and $4,058 million in dividends. In 2013 the company repurchased approximately 73 million shares and had approximately $14.7 billion remaining in share repurchase authorization at year end. The company’s cash generation permits the company to invest and deploy capital to areas with the most attractive long-term opportunities.

The assets and debt associated with the Global Financing business are a significant part of the company’s financial position. The financial position amounts appearing on page 80 are the consolidated amounts including Global Financing. The amounts appearing in the separate Global Financing section, beginning on page 72, are supplementary data presented to facilitate an understanding of the Global Financing business.

Working Capital

($ in millions)

At December 31:	2013		2012
Current assets	$	51,350	$	49,433
Current liabilities	40,154		43,625
Working capital	$	11,196	$	5,807
Current ratio	1.28:1		1.13:1

Working capital increased $5,388 million from the year-end 2012 position. The key changes are described below:

Current assets increased $1,917 million ($2,815 million adjusted for currency), due to:

·An increase of $1,258 million ($1,886 million adjusted for currency) in short-term receivables primarily due to higher volumes related to inventory financing; and

·An increase of $463 million ($630 million adjusted for currency) in prepaid expenses and other assets, primarily driven by prepaid income taxes ($407 million).

Current liabilities decreased $3,471 million ($2,562 million adjusted for currency), as a result of:

·A decrease in short term debt of $2,319 million ($2,096 million adjusted for currency) (see debt analysis on pages 45 and 46);

·A decrease of $853 million ($770 million adjusted for currency) in compensation and benefits reflecting lower accruals for performance-related compensation; and

·A decrease in accounts payable of $490 million ($409 million adjusted for currency) reflecting payment of higher 2012 year-end volumes; partially offset by

·An increase in deferred income of $605 million ($861 million adjusted for currency) primarily driven by Software.

44

Cash Flow

The company’s cash flows from operating, investing and financing activities, as reflected in the Consolidated Statement of Cash Flows on page 81, 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:	2013			2012
Net cash provided by/(used in)
Operating activities	$	17,485		$	19,586
Investing activities	(7,326		)	(9,004		)
Financing activities	(9,883		)	(11,976		)
Effect of exchange rate changes on cash and cash equivalents	28			(116		)
Net change in cash and cash equivalents	$	304		$	(1,511	)

Net cash provided by operating activities decreased by $2,102 million in 2013 driven by operational performance and the following key factors:

·A net increase in the use of cash for taxes (deferred, payable, reserves) of $2,200 million primarily driven by an increase in cash income tax payments;

·A net decrease from compensation and benefits of approximately $600 million primarily driven by reductions in performance-related compensation;

·An increase in the use of cash of $438 million related to the fulfillment of services contracts;

·Higher cash requirements for inventory ($337 million);

·Higher cash payments for workforce rebalancing of $332 million; and

·Lower net income of $121 million, partially offset by;

·Lower cash used by accounts receivables of $823 million primarily driven by financing receivables; and

·A decrease in cash funding related to retirement-related plans of $723 million driven by a decrease in nonpension postretirement contributions.

Net cash used in investing activities decreased $1,679 million driven by:

·An increase in cash of $1,232 million from net sales of marketable securities and other investments;

·A net decrease of $539 million in cash used for capital expenditures; and

·A net decrease of $363 million in cash used for acquisitions/ divestitures; partially offset by

·A net decrease in cash provided by non-operating financing receivables of $455 million.

Net cash used in financing activities decreased $2,094 million as compared to the prior year driven by the following factors:

·An increase in net cash from debt transactions (including short-term borrowings) of $4,708 million; partially offset by,

·An increase of $2,330 million of net cash used for common stock transactions, and

·An increase in dividend payments of $285 million.

Noncurrent Assets and Liabilities

($ in millions)

At December 31:	2013		2012
Noncurrent assets	$	74,873	$	69,780
Long-term debt	$	32,856	$	24,088
Noncurrent liabilities (excluding debt)	$	30,284	$	32,516

The increase in noncurrent assets of $5,093 million ($6,521 million adjusted for currency) was driven by:

·An increase of $4,607 million ($4,578 million adjusted for currency) in prepaid pension assets primarily driven by plan remeasurements; and

·An increase in intangible assets and goodwill of $2,022 million ($2,385 million adjusted for currency) primarily driven by current year acquisitions; partially offset by,

·A decrease of $922 million in deferred taxes ($753 million adjusted for currency) driven by retirement-related plans activity.

Long-term debt increased by $8,768 million ($8,779 million adjusted for currency) primarily driven by new debt issuances of $12,898 million, partially offset by reclasses to short-term debt of $3,949 million.

Other noncurrent liabilities, excluding debt, decreased $2,232 million ($1,723 million adjusted for currency) primarily driven by:

·A decrease in retirement and nonpension benefit obligations of $4,176 million driven by plan remeasurements, partially offset by,

·An increase of $2,326 million in other liabilities primarily driven by deferred tax increases related to the pension plan remeasurements.

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:	2013		2012
Total company debt	$	39,718	$	33,269
Total Global Financing segment debt	$	27,504	$	24,501
Debt to support external clients	24,471		21,583
Debt to support internal clients	3,033		2,919

Global Financing provides financing predominantly for the company’s external client assets, as well as for assets under contract by other IBM units. These assets, primarily for Global Services, generate long-term, stable revenue streams similar to the Global Financing asset portfolio. Based on their attributes, these Global Services assets are leveraged with the balance of the Global Financing asset base. The debt analysis above is further detailed in the Global Financing section on page 75.

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.

45

“Core” debt-to-capitalization ratio (excluding Global Financing debt and equity) was 39.0 percent at December 31, 2013 compared to 36.1 percent at December 31, 2012. The increase was primarily driven by an increase in non-Global Financing debt of $3,446 million partially offset by an increase in non-Global Financing equity of $3,615 million from the December 31, 2012 balances.

Consolidated debt-to-capitalization ratio at December 31, 2013 was 63.4 percent versus 63.7 percent at December 31, 2012.

The “core” debt-to-capitalization ratio and the consolidated debt-to-capitalization ratio were impacted by the $3,184 million increase in equity as a result of retirement-related plan remeasurements in December.

Equity

Total equity increased by $3,945 million from December 31, 2012 as a result of an increase in retained earnings of $12,401 million, an increase in common stock of $1,484 million and lower accumulated other comprehensive losses of $4,157 million, partially offset by an increase in treasury stock of $14,110 million related to common stock repurchases during the year.

GAAP Reconciliation

The tables below provide a reconciliation of the company’s income statement results as reported under GAAP to its operating earnings presentation which is a non-GAAP measure. The company’s calculation of operating (non-GAAP) earnings, as presented, may differ from similarly titled measures reported by other companies. Please refer to the “Operating (non-GAAP) Earnings” section on page 26 for the company’s rationale for presenting operating earnings information.

($ in millions except per share amounts)

				Acquisition-			Retirement-
				Related			Related			Operating
For the year ended December 31, 2013:	GAAP			Adjustments			Adjustments			(non-GAAP)
Gross profit	$	48,505		$	394		$	629		$	49,527
Gross profit margin	48.6		%	0.4		pts.	0.6		pts.	49.7		%
SG&A	$	23,502		$	(394	)	$	(376	)	$	22,731
RD&E	6,226			0			(57		)	6,170
Other (income) and expense	(327		)	(16		)	0			(343		)
Total expense and other (income)	28,981			(410		)	(433		)	28,137
Pre-tax income	19,524			804			1,062			21,390
Pre-tax income margin	19.6		%	0.8		pts.	1.1		pts.	21.4		%
Provision for income taxes*	$	3,041		$	57		$	333		$	3,431
Effective tax rate	15.6		%	(0.3		)pts.	0.8		pts.	16.0		%
Net income	$	16,483		$	747		$	729		$	17,959
Net income margin	16.5		%	0.7		pts.	0.7		pts.	18.0		%
Diluted earnings per share	$	14.94		$	0.68		$	0.66		$	16.28

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

($ in millions except per share amounts)

				Acquisition-			Retirement-
				Related			Related			Operating
For the year ended December 31, 2012:	GAAP			Adjustments			Adjustments			(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.

46

Consolidated Fourth-Quarter Results

($ and shares in millions except per share amounts)

							Yr.-to-Yr.
							Percent/
							Margin
For the fourth quarter:	2013			201 2			Change
Revenue	$	27,699		$	29,304		(5.5	)%*
Gross profit margin	51.7		%	51.8		%	(0.1	)pts.
Total expense and other (income)	$	7,353		$	7,336		0.2	%
Total expense and other (income)-to-revenue ratio	26.5		%	25.0		%	1.5	pts.
Income before income taxes	$	6,962		$	7,831		(11.1	)%
Provision for income taxes	777			1,998			(61.1	)%
Net income	$	6,185		$	5,833		6.0	%
Net income margin	22.3		%	19.9		%	2.4	pts.
Earnings per share of common stock
Assuming dilution	$	5.73		$	5.13		11.7	%
Weighted-average shares outstanding
Assuming dilution	1,080.0			1,136.4			(5.0	)%

* (3.5) percent adjusted for currency.

The following table provides the company’s operating (non-GAAP) earnings for the fourth quarter of 2013 and 2012.

($ in millions except per share amounts)

					Yr.-to-Yr.
					Percent
For the fourth quarter:	2013		201 2		Change
Net income as reported	$	6,185	$	5,833	6.0	%
Non-operating adjustments (net of tax)
Acquisition-related charges	268		243		10.6
Non-operating retirement-related costs/(income)	164		53		207.8
Operating (non-GAAP) earnings*	$	6,617	$	6,129	8.0	%
Diluted operating (non-GAAP) earnings per share	$	6.13	$	5.39	13.7	%

* See page 52 for a more detailed reconciliation of net income to operating (non-GAAP) earnings.

Snapshot

In the fourth quarter of 2013, the company reported $27.7 billion in revenue, expanded its net income margin and delivered diluted earnings per share growth of 11.7 percent as reported and 13.7 percent on an operating (non-GAAP) basis. The company generated $6.5 billion in cash from operations and $8.4 billion in free cash flow in the fourth quarter driving shareholder returns of $6.8 billion in gross common stock repurchases and dividends. The free cash flow performance represented 56 percent of the full year—the highest percent in several years.

Revenue in the fourth quarter decreased 5.5 percent, 3.5 percent at constant currency. The currency impact to revenue was 2.0 points. Consistent with the full year, currency also impacted profit performance in the fourth quarter as the depreciation of the Yen largely flows to profit due to the local services content within the company’s business in Japan and the inability to hedge these cash flows.

Within th