Exhibit 13

Report of Financials

International Business Machines Corporation and Subsidiary Companies

MANAGEMENT DISCUSSION
Overview		18
Forward-Looking and Cautionary Statements		19
Management Discussion Snapshot		19
Description of Business		22
Year in Review		29
Prior Year in Review		49
Other Information		60
Looking Forward		60
Liquidity and Capital Resources		61
Critical Accounting Estimates		64
Currency Rate Fluctuations		67
Market Risk		68
Financing Risks		68
Cybersecurity		68
Employees and Related Workforce		69
Global Financing		69
Report of Management		74
Report of Independent Registered Public Accounting Firm		75
CONSOLIDATED FINANCIAL STATEMENTS
Earnings		76
Comprehensive Income		77
Financial Position		78
Cash Flows		79
Changes in Equity		80
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS
A	Significant Accounting Policies	82
B	Accounting Changes	92
C	Acquisitions/Divestitures	93
D	Financial Instruments	99
E	Inventories	106
F	Financing Receivables	106
G	Property, Plant and Equipment	109
H	Investments and Sundry Assets	110
I	Intangible Assets Including Goodwill	110
J	Borrowings	111
K	Other Liabilities	114
L	Equity Activity	114
M	Contingencies and Commitments	118
N	Taxes	120
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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OVERVIEW

The financial section of the International Business Machines Corporation (IBM or the company) 2015 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,” beginning on page 19, presents an overview of the key performance drivers in 2015.

·Beginning with the “Year in Review” on page 29, the Management Discussion contains the results of operations for each reportable segment of the business and a discussion of the company’s financial position and cash flows. Other key sections within the Management Discussion include: “Looking Forward” on page 60, and “Liquidity and Capital Resources” on page 61.

·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 69.

·The Consolidated Financial Statements are presented on pages 76 through 81. 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 82 to 92), acquisitions and divestitures (pages 93 to 99), detailed information on specific items within the financial statements, certain contingencies and commitments (pages 118 to 120) and retirement-related plans 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).

·In October 2014, the company announced a definitive agreement to divest its Microelectronics business. The assets and liabilities of the Microelectronics business were reported as held for sale at December 31, 2014. The operating results of the Microelectronics business are reported as discontinued operations. The transaction closed on July 1, 2015. In addition, in 2015, the company renamed its Systems & Technology segment to Systems Hardware and its System z brand to z Systems. Also, in 2015, the company’s business process outsourcing business, Global Process Services, which was previously managed within Global Technology Services, was integrated into Global Business Services, creating an end-to-end business transformation capability for clients and to better leverage the company’s industry knowledge. Prior periods have been reclassified to conform to this presentation in the Management Discussion, the Consolidated Financial Statements and the Notes, where applicable, to allow for a meaningful comparison of continuing operations.

·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 67 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 from continuing operations is a non-GAAP measure that excludes the effects of certain acquisition-related charges, retirement-related costs, discontinued operations 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

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Management Discussion

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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 retirement-related 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. The company’s reportable segment financial results reflect operating earnings from continuing operations, 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 2015 Form 10-K filed on February 23, 2016.

MANAGEMENT DISCUSSION SNAPSHOT

($ and shares in millions except per share amounts)

							Yr.-to -Yr.
							Percent/
							Margin
For the year ended December 31:	2015			2014			Change
Revenue	$	81,741		$	92,793		(11.9	)%*
Gross profit margin	49.8		%	50.0		%	(0.2	) pts.
Total expense and other (income)	$	24,740		$	26,421		(6.4	)%
Total expense and other (income)-to-revenue ratio	30.3		%	28.5		%	1.8	pts.
Income from continuing operations before income taxes	$	15,945		$	19,986		(20.2	)%
Provision for income taxes from continuing operations	$	2,581		$	4,234		(39.1	)%
Income from continuing operations	$	13,364		$	15,751		(15.2	)%
Income from continuing operations margin	16.3		%	17.0		%	(0.6	) pts.
Loss from discontinued operations, net of tax	$	(174	)	$	(3,729	)	(95.3	)%
Net income	$	13,190		$	12,022		9.7	%
Earnings per share from continuing operations:
Assuming dilution	$	13.60		$	15.59		(12.8	)%
Consolidated earnings per share— assuming dilution	$	13.42		$	11.90		12.8	%
Weighted-average shares outstanding
Assuming dilution	982.7			1,010.0			(2.7	)%
Assets**	$	110,495		$	117,271	+	(5.8	)%
Liabilities**	$	96,071		$	105,257	+	(8.7	)%
Equity**	$	14,424		$	12,014		20.1	%

* (4.1) percent adjusted for currency; (1.2) percent adjusted for divestitures and currency.

** At December 31.

+ Reclassified to reflect adoption of the FASB guidance on deferred taxes and debt issuance costs in consolidated financial statements. Refer to note B, “Accounting Changes,” for additional information.

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The following table provides the company’s (non-GAAP) operating earnings for 2015 and 2014.

($ in millions except per share amounts)

							Yr.-to-Yr.
							Percent
For the year ended December 31:	2015			2014			Change
Net income as reported	$	13,190		$	12,022		9.7	%
Loss from discontinued operations, net of tax	(174		)	(3,729		)	(95.3	)
Income from continuing operations	$	13,364		$	15,751		(15.2	)%
Non-operating adjustments (net of tax)
Acquisition-related charges	562			670			(16.1	)
Non-operating retirement-related costs/(income)	734			280			161.8
Operating (non-GAAP) earnings*	$	14,659		$	16,702		(12.2	)%
Diluted operating (non-GAAP) earnings per share	$	14.92		$	16.53		(9.7	)%

* See pages 41 and 42 for a more detailed reconciliation of net income to operating earnings.

In 2015, the company delivered $81.7 billion in revenue, $13.4 billion in income from continuing operations and $14.7 billion in operating (non-GAAP) earnings resulting in diluted earnings per share from continuing operations of $13.60 as reported and $14.92 on an operating (non-GAAP) basis. The results of continuing operations exclude a net loss from discontinued operations of $174 million in 2015 and $3,729 million in 2014 related to the divestiture of the Microelectronics business. On a consolidated basis, net income in 2015 was $13.2 billion, with diluted earnings per share of $13.42. The company generated $17.0 billion in cash from operations and $13.1 billion in free cash flow in 2015 driving shareholder returns of $9.5 billion in gross common stock repurchases and dividends.

Total consolidated revenue in 2015 decreased 11.9 percent as reported and 1 percent year to year adjusted for currency and the divestitures of the System x and customer care businesses reflecting a modest improvement in year-to-year performance compared to the year ago period on an adjusted basis. Currency had an 8 point, or $7.2 billion impact on reported revenue in 2015. Revenue was impacted by 3 points in 2015 from the divested businesses. Combined, the impact of currency and divested businesses reduced the reported revenue growth by 11 points.

In 2014, the company declared its strategic imperatives around big data and analytics, cloud, mobile, social and security, areas where clients were looking to the company to help move them to the future. The company has made significant progress in shifting its business toward these strategic imperatives and is continuing to invest in capabilities which are not yet reflected in its revenue stream. In 2015, strategic imperatives revenue grew 17 percent year to year as reported and 26 percent adjusted for currency and the System x divestiture, with double digit growth in each quarter. In total, the strategic imperatives generated $28.9 billion in revenue in 2015, which represents approximately 35 percent of the company’s total revenue, an increase of 13 points from 2013.

Cloud revenue increased 43 percent as reported in 2015 and 57 percent adjusted for currency and the System x divestiture. In 2015, Cloud revenue was $10.2 billion making the company the largest cloud provider. The company has been building off its extensive relationships in enterprise IT and incumbency in the data center to help clients implement hybrid cloud environments. In addition:

·As-a-Service revenue increased 50 percent (61 percent adjusted for currency) year to year to $4.5 billion and the company exited 2015 with an annual run rate of $5.3 billion.

·2015 Cloud revenue included $5.6 billion of revenue from foundational offerings—where the company provides software, hardware and services for clients to build their own clouds.

·Clients are using cloud not just to reduce costs, but also to gain agility and to enable innovation. The company has been leading clients in making the move to cloud through consuming as-a-Service, or through their own clouds or the implementation of a hybrid environment.

·The company made seven cloud acquisitions in 2015 including; Cleversafe, for object storage, Gravitant, for cloud brokerage services and Clearleap, for cloud video services. The company also invested nearly $1 billion in 2015 to expand its global cloud data center footprint to 46. The company possesses an ecosystem of developers globally and its Bluemix Platform-as-a-Service has already expanded to over a million users, adding 15 thousand developers a week.

Business analytics revenue of $17.9 billion in 2015 increased 7 percent as reported and 16 percent year to year adjusted for currency making the company the largest analytics provider. The company has also been moving into new areas including Watson Health and Watson Internet of Things (IoT).

·In Watson Health, the company is integrating its own organic capabilities with content acquired through Merge Healthcare, Phytel and Explorys. Healthcare represents a new revenue and profit opportunity as the company changes the face of healthcare through its cognitive platform to provide value to providers, payers and partners.

·In the IoT market, The Weather Company acquisition will not only provide the company tremendously valuable data, but also a high-volume, cloud-based, insight-driven platform to integrate with Watson to address significant new opportunities.

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In the area of engagement, revenue increased 64 percent as reported and 77 percent adjusted for currency. Security revenue increased 5 percent as reported (12 percent adjusted for currency), mobile revenue more than tripled year to year and social revenue increased 14 percent as reported (21 percent adjusted for currency).

From a segment perspective, Global Services revenue declined 10.5 percent as reported and 1 percent adjusted for currency (9 points) and divestitures. Global Technology Services (GTS) declined 9.7 percent as reported, but increased 1 percent year to year adjusted for currency (10 points) and the System x divestiture with strong growth in the strategic imperatives on an adjusted basis. Global Business Services (GBS) revenue decreased 12.0 percent as reported and 4 percent adjusted for currency (8 points). GBS revenue continues to be impacted by the shift away from traditional large enterprise application implementations. Software revenue declined 9.8 percent as reported and 4 percent adjusted for currency with growth in annuity-based revenue, including Software-as-a-Service (SaaS), more than offset by declines in transactional revenue reflecting the flexibility the company has provided to its largest enterprise clients. Systems Hardware revenue decreased 24.2 percent as reported, but increased 8 percent adjusted for the System x divestiture (28 points) and currency (4 points), reflecting a successful mainframe cycle in 2015 and the repositioning of Power Systems to address a broader opportunity.

From a geographic perspective, revenue in the major markets declined 9.9 percent as reported and 1 percent adjusted for currency (8 points) and divestitures (2 points) with growth in Germany, Japan and the UK on an adjusted basis. Growth markets revenue decreased 18.4 percent as reported and 3 percent adjusted for currency (9 points) and divestitures (6 points). On an adjusted basis, declines in Asia Pacific were partially offset by growth in Latin America and Middle East and Africa.

The consolidated gross profit margin of 49.8 percent decreased 0.2 points year to year. The operating (non-GAAP) gross margin of 50.8 percent increased 0.2 points compared to the prior year primarily driven by the shift to higher value through portfolio actions and the relative strength of z Systems, partially offset by margin declines in Global Services and Software.

Total expense and other (income) decreased 6.4 percent in 2015 compared to the prior year. Total operating (non-GAAP) expense and other (income) decreased 7.8 percent compared to 2014. The key year-to-year drivers were:

	Total	Operating
	Consolidated	(non-GAAP)
· Currency*	(9) points	(9) points
· System x divestiture	(2) points	(2) points
· Divestiture gains	6 points	6 points
· Workforce rebalancing	(3) points	(3) points

* Reflects impacts of translation and hedging programs.

The reduction in expense was driven primarily by currency impacts, a lower level of workforce rebalancing charges and the impact of the divested System x business. These benefits were partially offset by the impact of lower divestiture gains ($1.6 billion) year to year. The reduction in operating (non-GAAP) expense was driven primarily by the same factors. The company is continuing to shift resources and spending within its operational expense base—driving productivity and efficiency in some areas while increasing investment in support of the strategic imperatives. In 2015, the company shifted over $5 billion of spending across cost, expense and capital expenditures, to the strategic imperatives.

Pre-tax income from continuing operations of $15.9 billion in 2015 decreased 20.2 percent year to year and the pre-tax margin was 19.5 percent, a decrease of 2.0 points. The continuing operations effective tax rate for 2015 was 16.2 percent, a decrease of 5.0 points versus 2014. The tax rate in 2015 reflected benefits from the settlement of the U.S. tax audit and geographic mix of pre-tax profits, partially offset by less utilization of foreign tax credits. Income from continuing operations of $13.4 billion decreased 15.2 percent and the net income margin was 16.3 percent, a decrease of 0.6 points versus 2014. Losses from discontinued operations, net of tax, were $174 million in 2015 compared to $3,729 million in 2014. Net income of $13.2 billion increased 9.7 percent year to year. Operating (non-GAAP) pre-tax income from continuing operations decreased 16.3 percent year to year and the operating (non-GAAP) pre-tax margin from continuing operations decreased 1.1 points to 21.6 percent. Operating (non-GAAP) income from continuing operations of $14.7 billion decreased 12.2 percent including an impact of 7 points from the 2014 gains from the System x and customer care divestitures. The operating (non-GAAP) income margin from continuing operations of 17.9 percent decreased 0.1 points. The operating (non-GAAP) effective tax rate from continuing operations in 2015 was 17.2 percent versus 21.0 percent in 2014. The 2015 profit and margin performance reflect portfolio actions taken as the company shifts to higher value, as well as investments being made to add capabilities to drive the transformation.

Diluted earnings per share from continuing operations of $13.60 in 2015 decreased 12.8 percent year to year. In 2015, the company repurchased 30.3 million shares of its common stock at a cost of $4.7 billion. Operating (non-GAAP) diluted earnings per share of $14.92 decreased 9.7 percent versus 2014 including an impact of 7 points from the 2014 gains from the System x and customer care divestitures. Diluted earnings per share from discontinued operations was ($0.18) in 2015 compared to ($3.69) in 2014.

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At December 31, 2015, the company continued to have the financial flexibility to support the business over the long term. Cash and marketable securities at year end was $8.2 billion, a decrease of $0.3 billion from December 31, 2014. Key drivers in the balance sheet and total cash flows were:

Total assets decreased $6.8 billion ($0.3 billion adjusted for currency) from December 31, 2014 driven by:

·Decreases in total receivables ($4.4 billion), deferred taxes ($1.9 billion) and prepaid expenses and sundry assets ($1.1 billion); partially offset by

·Increased goodwill ($1.5 billion).

Total liabilities decreased $9.2 billion ($4.7 billion adjusted for currency) from December 31, 2014 driven by:

·Decreases in other liabilities ($2.3 billion), taxes ($2.2 billion), retirement-related liabilities ($1.8 billion), deferred income ($0.8 billion), total debt ($0.8 billion) and accounts payable ($0.8 billion).

Total equity of $14.4 billion increased $2.4 billion from December 31, 2014 as a result of:

·Higher retained earnings ($8.3 billion) and higher common stock ($0.6 billion); partially offset by

·Increased treasury stock ($4.8 billion) and increased accumulated other comprehensive losses ($1.7 billion).

The company generated $17.0 billion in cash flow provided by operating activities, an increase of $0.1 billion when compared to 2014, driven primarily by lower income tax payments, offset by net income performance. Net cash used in investing activities of $8.2 billion was $5.2 billion higher than 2014, primarily driven by a decrease in cash provided from divestitures ($2.8 billion) and an increase in net cash used for acquisitions ($2.7 billion). Net cash used in financing activities of $9.2 billion decreased $6.3 billion compared to the prior year, driven primarily by a decrease in cash used for gross common stock repurchases ($9.1 billion), partially offset by lower net debt issuances ($1.8 billion) and higher dividend payments ($0.6 billion).

The 2015 results are a reflection of the continuing transition in the company’s business as it addresses the significant shifts in the industry, as well as some of the cyclical challenges of the global business environment. This transformation is taking place over the longer term. In 2015, the company strengthened its existing portfolio while investing aggressively in new opportunities such as Watson Health, Watson Internet of Things and IBM Cloud. In January 2016, the company disclosed that it is expecting GAAP earnings of at least $12.45 and operating (non-GAAP) earnings of at least $13.50 per diluted share for 2016.

DESCRIPTION OF BUSINESS

Please refer to IBM’s Annual Report on Form 10-K filed with the SEC on February 23, 2016 for a more detailed version of this Description of Business, especially Item 1A. entitled “Risk Factors.”

The company creates value for clients through integrated solutions and products that leverage: data, information technology, deep expertise in industries and business processes, and a broad ecosystem of partners and alliances. IBM solutions typically create value by enabling new capabilities for clients that transform their businesses and help them engage with their customers and employees in new ways. These solutions draw from an industry-leading portfolio of consulting and IT implementation services, cloud and cognitive offerings, and enterprise systems and software; all bolstered by one of the world’s leading research organizations.

Strategy

IBM has transformed throughout its 100+ year history, and in its current transformation, IBM is leading a reordering of the technology industry.

In 2014, the company’s strategic imperatives were declared around the three main forces behind “digital”: big data and analytics, cloud and engagement. Since 2010, IBM has invested approximately $30 billion in these areas, built out the IBM Cloud on a global scale, established the Watson Group, announced 50 acquisitions and entered into major partnerships, including the landmark alliance with Apple to bring mobile to the enterprise.

As IBM’s clients transform, “digital” itself is not the destination, but a foundation to create a truly Cognitive Enterprise. This is resulting in new types of interactions between people, organizations and machines.

Through these developments, IBM is emerging as more than a hardware, software and services company; IBM is transforming into a cognitive solutions and cloud platform company. Key tenets of the company’s highly differentiated strategy include:

Cognitive Solutions: Cognitive, advanced analytics and key data are being integrated into all leading solutions.

Cloud Platform: New solutions will be built on the IBM Cloud and the company’s offerings will be cloud-enabled. The company is continuing to build the premier cloud stack, developer environment and most secure hybrid cloud platform in the industry.

Industry Focus: Because industry context is so important to the value of IBM’s solutions, these solutions will be built for the needs of individual industries and professions.

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Cognitive Solutions

Since 2011 when IBM’s Watson was introduced, IBM has been developing a new generation of cognitive systems that can see and analyze the massive amounts of data that have previously been invisible to computers and enterprises. Cognitive systems have the capability to inject a kind of thinking ability into every digitalized object, process and service. IBM is on the forefront of deploying these systems and assisting clients to become truly Cognitive Enterprises.

Cognitive systems are not programmed; like humans, they learn from experts, from every interaction, and from big data. They are enabled to learn by using advanced algorithms to sense, predict and infer. Ultimately they can augment human intelligence, allowing individuals to make more informed decisions.

For the past five years, IBM has continued to invest in Watson, including dedicating $100 million to venture investments to support start-ups building cognitive apps through the Watson Developer Zone on Bluemix. IBM is also making Watson more widely available through the Watson Ecosystem, which has grown to more than 500 partners.

Paired with Watson is the company’s core big data and analytics business. IBM has invested over $15 billion in these areas since 2010, including over $7 billion on more than 20 acquisitions. Nearly half of IBM Research’s spending is focused on analytics and cognitive.

IBM’s leading-edge cognitive technology is only the starting point. The company is developing entirely new solutions businesses around that cognitive capability. In 2015, the Watson Health unit was formed, which is IBM’s first business unit designed around a single industry. Watson Health will create cognitive solutions that can better help doctors diagnose and anticipate disease; it will recommend treatments that are tailored to individuals; and it will assist researchers to predict and prevent the next generation of diseases.

Another set of cognitive solutions IBM is building is the Internet of Things (IoT). It is estimated that there are more than 9 billion connected devices operating in the world today, generating 2.5 quintillion bytes of new data daily. Watson IoT will bring the power of cognitive to the challenge of extracting and analyzing data embedded in intelligent devices in real time. In addition, the recent closure of The Weather Company acquisition essentially expands the company’s IoT platform; with one that collects, integrates and analyzes data from three billion weather forecast reference points, including satellites, weather stations, airplanes, consumer apps and more for IBM and our clients.

Through Cognitive, IBM is ushering in a new era for the industry and for clients.

Cloud Platform

Cloud is at the heart of the “digital” revolution. No enterprise is untouched by this revolution and the shifts are occurring rapidly.

Enterprises are benefiting from cloud by using it to transform their information technology (IT) and business processes into digital services. Cloud brings two compelling sources of value:

·Innovation: In addition to cloud enabling the sharing of infrastructure, the real promise of cloud is innovation. By forcing greater levels of standards throughout the technology value chain, new products and services, and even entire business models, can be created in weeks rather than months or years.

·Hybrid: Data, cloud and engagement are powerful forces changing the landscape of technology and businesses. Enterprises need to bring this new world of technology together with their existing systems in order to capture their full value. Hybrid cloud brings together the back-end systems infrastructure with the new strategic imperative “digital” technologies. Unless the new and traditional IT worlds are brought together, they will be isolated within the enterprise. IBM servers and storage can handle mobile transactions, compose and expose APIs and integrate across hybrid clouds to unlock new value from data.

Making applications work across on-premise, public and private cloud environments is what hybrid cloud is all about. This requires a deep understanding of both traditional and new IT models, something that IBM is unique in bringing to its clients:

·In traditional IT, for example, the z Systems mainframe is used by all of the top 25 global banks and almost three-quarters of the top 25 U.S. retailers. In addition, 70 percent of the top 25 Fortune 500 companies rely on IBM to manage their critical IT infrastructures.

·In the new world of IT, the IBM Cloud has become the standard for enterprise-grade cloud —bringing performance and the integration across all IT. The company continues to build cloud into Global Technology Services’ (GTS) large base of outsourcing relationships.

·Each of these areas of IT requires uncompromising security. IBM Security brings to clients advanced technologies in fraud and threat protection, identity and access management, application and data security, mobile and cloud security. IBM’s systems are among the most secure in the world with advanced encryption, threat monitoring and tracking and behavioral analytics. Further, high-end security consulting brings the expertise of 6,000 dedicated security specialists. Built on big data analytics, IBM manages over 20 billion security events per day on 2.5 million desktops for 12,000 clients through its Security Operations Centers.

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IBM’s Cloud platform includes:

·IBM Cloud’s Infrastructure-as-a-Service, which offers bare metal, private cloud and virtual server instances, enabling it to cover many different workloads with unprecedented performance. IBM’s platform also has tremendous geographic reach—with 46 cloud centers around the globe.

·Bluemix is IBM’s Platform-as-a-Service, built on the open standards foundation of Cloud Foundry and powered by IBM Cloud’s infrastructure. Bluemix offers cloud-based services, APIs and leading third-party services to developers in an integrated platform. With $1 billion of investment, Bluemix is now the largest Cloud Foundry development, has a significant number of services and is onboarding thousands of developers per week.

·IBM Cloud Marketplace brings together the company’s extensive portfolio of cloud capabilities, providing a self-service, digital experience for developers, IT and business leaders. IBM has a significant number of Software-as-a-Service offerings and visitors to the Marketplace have access to an extensive and growing portfolio of cloud capabilities from IBM and qualified third-party vendors.

·In 2015, IBM acquired: Blue Box Group, Inc. (private cloud), Compose (database-as-a-service), StrongLoop, Inc. (developer technology), Cleversafe, Inc. (object-based storage), Gravitant, Inc. (cloud brokerage) and Clearleap, Inc. (cloud-based video).

·The Weather Company acquisition in January 2016, whose dynamic cloud data platform powers the fourth most-used daily mobile app in the United States and handles 26 billion inquiries to its cloud-based services each day. This high-volume cloud platform processes, analyzes and distributes enormous data sets at scale in real time. It adds an important dimension to the company’s cloud platform.

·IBM has entered into strategic partnerships all focused on bringing innovative data and analytics solutions to the market. The IBM Cloud is the most powerful platform for enterprise-grade environments, bringing clients unparalleled levels of security, performance and scalability.

Industry Focus

IBM’s solutions and platforms are most relevant in the context of each client’s industry. General-purpose tools have their place, but the company can unlock much greater value in building solutions for the specific needs of an industry. In this context, Industries are the focus.

Watson Health is an example of how the company is defining solutions around industry needs. In addition to Watson Health, in 2015, 20 new industry-specific analytics solutions were launched with pre-built predictive analytics capabilities. These include solutions that allow clients to mine customer data for hidden insights for action, spot fraud or risk and predict vulnerabilities to preempt before they occur. These solutions, which are tailored specifically for retail, banking, telecommunications, insurance and others, will make it easier and faster for organizations to uncover and act on critical business insights. In addition, IBM has announced over 100 apps through its alliance with Apple that bring value in the context of individual industries.

Complementing the power of the company’s technology solutions is the industry expertise of IBM’s Global Business Services consulting business. It is the combination of IBM’s technology and services, which enable clients to achieve their business outcomes.

Summary

Each successive transformation of IBM has brought something new and innovative to the world. More than 50 years ago, IBM brought forward a revolutionary transactional computer called the mainframe. In the decades that followed, IBM commercialized the personal computer, created an industry around IT services and a software market around middleware. Each of these innovations is with the world today; they were built to last.

The company’s next chapter is ushering in an entirely new era of human-organization-computer interaction—embodied in Cognitive Solutions and the Cloud Platform.

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 and platforms to the company’s clients.

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Management Discussion

International Business Machines Corporation and Subsidiary Companies

The business model is dynamic, adapting to the continuously changing industry and economic environment, including the company’s transformation into cloud and -as-a-Service delivery models. The company continues to strengthen its position through strategic organic investments and acquisitions in higher-value areas while divesting certain businesses. In addition, the company is transforming into a more agile enterprise helping to drive productivity, which supports investments for participation in markets with significant long-term opportunity.

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 Hardware and Global Financing.

In late February 2016, the company plans to meet with investors to discuss changes in the business, which will result in a change in the company’s reportable segments beginning in the first quarter of 2016.

Global Services: is a critical component of the company’s strategy of providing IT infrastructure and business insight and solutions to clients. These solutions include industry-leading IBM software and systems, as well as other suppliers’ products if a 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) provides IT infrastructure services, creating business value for clients through integrated services, incorporating unique intellectual property 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: delivers comprehensive IT outsourcing services focused on clients’ enterprise IT infrastructure environments to enable digital transformation and 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, cognitive computing and virtualization, to deliver high performance, innovation and improved ability to achieve business objectives.

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. The portfolio is built around a key set of solutions addressing systems, mobility, resiliency, networking, cloud and security. This portfolio includes key assets and intellectual property and incorporates best practices and proven methodologies that ensure high quality delivery, security and compliance.

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

Technology Support Services (Maintenance 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: Consulting and Systems Integration, Application Management Services and Process 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 strategic imperatives. As clients transform themselves in response to market trends like big data, social and mobile computing, GBS helps clients use these technologies to reinvent relationships with their customers and realize new standards of efficacy and efficiency in the internal processes, data and applications that they use to run their businesses. In 2015, GBS announced the industry’s first practice dedicated to cognitive business, Cognitive Business Solutions.

GBS Capabilities

Consulting and Systems Integration: delivers 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 smarter commerce, cloud, mobile and social business.

Application Management Services: delivers 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.

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Management Discussion

International Business Machines Corporation and Subsidiary Companies

Global Process Services: (included within Application Management 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.

Software consists primarily of middleware and operating systems software. Middleware serves as a software layer that connects operating systems to applications across a standard software platform. The IBM Middleware portfolio allows seamless integration of unrelated systems, processes, and applications all while providing market leading functionality, in both on-premise and hybrid cloud environments. Operating systems are the software engines that run computers. Approximately 70 percent of external Software segment revenue is annuity based, coming from recurring license charges, software sold “as-a-Service” and ongoing post-contract support. The remaining revenue 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.

Software Capabilities

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

Tivoli: 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.

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: 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.

In January 2015, the company made several changes designed to more effectively align its key capabilities and resources to its strategic imperatives. These changes have enabled the company to respond more quickly to critical client agendas and drive higher value. Across Software, the company is transitioning its portfolio to capture growth and continue to drive innovation. The focus is centered around analytics, security, and commerce, utilizing its software assets to improve speed and agility in bringing integrated solutions to its clients and to help clients become cognitive enterprises.

Watson: 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.

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Management Discussion

International Business Machines Corporation and Subsidiary Companies

Watson Health: a business unit focused on the health industry, built upon the foundation of the work done with Watson and the momentum of Cloud. This team of consultants, medical practitioners, clinicians, developers and researchers work with an extensive ecosystem of partners and clients to advance the quality and effectiveness of individual health with advanced data analytics and insights.

Watson Internet of Things (IoT): in today’s world, physical devices of all types are now instrumented with compute capabilities that allow for direct sensing and communication of data. IBM’s focus is enabling companies to use that data to improve operations, drive new business and work directly with clients.

Systems Hardware provides clients with innovative infrastructure technologies to help meet the new requirements of hybrid cloud and cognitive workloads—from deploying advanced analytics, to moving to digital service delivery with the cloud, and securing mobile transaction processing. Approximately half of Systems Hardware’s server and storage sales transactions are through the company’s business partners; with the balance direct to end-user clients. IBM Systems also designs and procures advanced semiconductor devices for use in the company’s systems.

Systems Hardware Capabilities

Servers: a range of high-performing systems designed to address capacity, security, speed and compute power needs for businesses, organizations and technical computing applications. The portfolio includes z Systems, a trusted enterprise platform for integrating data, transactions and insight, and Power Systems, a system designed from the ground up for big data, optimized for scale-out cloud and Linux, and delivering open innovation with OpenPOWER. The company is also a founding member of the OpenPOWER foundation, a group of industry-leading companies working together to develop high-performance compute solutions based on the IBM POWER architecture.

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 software-defined storage solutions, flash storage, disk and tape storage solutions.

Technology: In 2014, the company announced a definitive agreement to divest its Microelectronics business and manufacturing operations. This transaction closed in 2015.

Global Financing facilitates IBM clients’ acquisition of information technology systems, software and services by providing financing solutions in the areas where the company has the expertise. The financing arrangements are predominantly for products or services that are critical to the end users’ business operations. These financing contracts are entered into after a comprehensive credit evaluation and are secured by legal contracts. As a captive financier, Global Financing has the benefit of both deep knowledge of its client base and a clear insight into the products and services financed. These factors allow the business to effectively manage two of the major risks, credit and residual value, associated with financing while generating strong returns on equity. Global Financing also maintains a long-term partnership with the companies’ clients through various stages of IT asset life cycle—from initial purchase and technology upgrades to asset disposition decisions.

Global Financing Capabilities

Client Financing: lease, installment payment plan and loan financing to end users and internal clients for terms up to seven years. Assets financed are primarily IT products and services where the company has expertise. Internal financing is predominantly in support of Global Services’ long-term client service contracts. Global Financing also factors a selected portion of the company’s accounts receivable, primarily for cash management purposes. All internal financing arrangements are at arm’s-length rates and are based upon market conditions.

Commercial Financing: short-term inventory and accounts receivable financing to suppliers, distributors and remarketers of IBM and OEM products.

Remanufacturing and Remarketing: assets include used equipment returned from lease transactions, or used surplus equipment acquired internally or externally. These assets may be refurbished or upgraded and sold or leased to new or existing clients both externally or 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 Hardware and Global Services. Systems Hardware may also sell the equipment that it purchases from Global Financing to external clients.

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Management Discussion

International Business Machines Corporation and Subsidiary Companies

IBM Worldwide Organizations

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

·Sales and Distribution

·Research, Development and Intellectual Property

·Integrated Supply Chain

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 the IBM global footprint, with dedicated country-based operating units focused on delivering unique value and a superior client experience. Within these units, client relationship professionals work with integrated teams of consultants, product specialists and delivery fulfillment teams to enable clients’ business growth and innovation. These teams deliver value by understanding the clients’ business and needs, and then bringing together capabilities from across IBM and an extensive network of Business Partners to develop and implement client solutions.

By combining global expertise and digital sales capabilities with local experience, IBM’s geographic structure enables client relationships through dedicated management focus for local clients, speed in addressing new market opportunities and timely investments in emerging opportunities. The geographic units align industry solution, product and services expertise to serve clients’ agendas. IBM also extends the reach of its capabilities to commercial clients by leveraging industry skills with digital marketing, digital sales and local Business Partner resources.

The company continues to invest to capture the long-term opportunity in key growth markets around the world—India, China and countries within Southeast Asia, Eastern Europe, the Middle East, Africa 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.

Research, Development and Intellectual Property

IBM’s research and development (R&D) operations differentiate the company from its competitors. IBM annually invests approximately 6 percent of total revenue for R&D, focusing on high-growth, high-value opportunities. IBM Research works with clients and the company’s business units through global labs on near-term and midterm 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 and future systems, to big data analytics, secure clouds and advancing the world’s first cognitive computing platform, IBM Watson.

In 2015, IBM was awarded more U.S. patents than any other company for the 23rd consecutive year. IBM’s 7,355 patents awarded in 2015 position the company to compete and lead in the emerging opportunities represented by big data and analytics, security, social and mobile technologies. These inventions will advance IBM’s cloud platform and the new era of computing in which machines will learn, reason and interact with people in more natural ways.

The company continues to actively seek intellectual property (IP) protection for its innovations, while increasing emphasis on other initiatives designed to leverage its IP 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 IP 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.

Integrated Supply Chain

IBM has an extensive integrated supply chain, procuring materials and services globally. In 2015, the company also managed approximately $24 billion in procurement spending for its clients through the Global Process Services organization. The supply, manufacturing and logistics operations are seamlessly integrated and have 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. Utilizing analytics, mobile, cloud and social—with numerous projects, has allowed the integrated supply chain to drive positive business outcomes for the company and its clients.

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Management Discussion

International Business Machines Corporation and Subsidiary Companies

YEAR IN REVIEW

Results of Continuing Operations

Segment Details

The following is an analysis of the 2015 versus 2014 reportable segment results. The table below presents each reportable segment’s external revenue and gross margin results. Segment pre-tax income includes transactions between segments that are intended to reflect an arm’s-length transfer price and excludes certain unallocated corporate items.

($ in millions)

							Yr.-to-Yr.		Yr.-to-Yr.
							Percent/		Percent Change
							Margin		Adjusted for
For the year ended December 31:	2015			2014**			Change		Currency
Revenue
Global Technology Services	$	32,017		$	35,442		(9.7	)%	0.5	%*
Gross margin	37.4		%	39.0		%	(1.5	)pts.
Global Business Services	17,166			19,512			(12.0	)%	(4.1	)%*
Gross margin	28.2		%	30.4		%	(2.2	)pts.
Software	22,932			25,434			(9.8	)%	(3.5	)%
Gross margin	87.3		%	88.6		%	(1.3	)pts.
Systems Hardware	7,581			9,996			(24.2	)%	7.6	%*
Gross margin	46.6		%	39.5		%	7.2	pts.
Global Financing	1,840			2,034			(9.5	)%	1.5	%
Gross margin	45.6		%	49.4		%	(3.7	)pts.
Other	206			374			(45.0	)%	(39.1	)%
Gross margin	(253.0		)%	(215.0		)%	(38.0	)pts.
Total consolidated revenue	$	81,741		$	92,793		(11.9	)%	(1.2	)%*
Total consolidated gross profit	$	40,684		$	46,407		(12.3	)%
Total consolidated gross margin	49.8		%	50.0		%	(0.2	)pts.
Non-operating adjustments
Amortization of acquired intangible assets	373			416			(10.5	)%
Retirement-related costs/(income)	469			173			170.7	%
Operating (non-GAAP) gross profit	$	41,526		$	46,996		(11.6	)%
Operating (non-GAAP) gross margin	50.8		%	50.6		%	0.2	pts.

* Adjusted for divestitures and currency.

** Reclassified to conform with 2015 presentation.

Global Services

In 2015, the Global Services segments, GTS and GBS, delivered combined revenue of $49,182 million, a decrease of 10.5 percent as reported and 1 percent adjusted for currency (9 points) and divestitures. Total outsourcing revenue of $21,889 million decreased 10.7 percent as reported and 1 percent adjusted for currency (10 points) and divestitures. Total transactional revenue of $21,161 million decreased 10.3 percent and 2 percent adjusted for currency. The estimated Global Services backlog at December 31, 2015 of $121 billion increased 1 percent year to year, adjusted for currency. Combined pre-tax income for the year decreased 18.2 percent and the pre-tax margin decreased 1.4 points to 15.1 percent.

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Management Discussion

International Business Machines Corporation and Subsidiary Companies

($ in millions)

							Yr.-to-Yr.
					Yr.-to-Yr.		Percent Change
					Percent		Adjusted for
For the year ended December 31:	2015		2014**		Change		Currency
Global Services external revenue	$	49,182	$	54,954	(10.5	)%	(1.1	)%*
Global Technology Services	$	32,017	$	35,442	(9.7	)%	0.5	%*
Outsourcing	16,992		19,082		(11.0	)	(0.5	)
Integrated Technology Services	8,893		9,506		(6.4	)	2.5
Maintenance	6,132		6,853		(10.5	)	1.2	*
Global Business Services	$	17,166	$	19,512	(12.0	)%	(4.1	)%*
Outsourcing	4,898		5,438		(9.9	)	(2.0	)*
Consulting and Systems Integration	12,268		14,075		(12.8	)	(4.9	)

* Adjusted for divestitures and currency.

** Reclassified to conform with 2015 presentation.

Global Technology Services revenue of $32,017 million decreased 9.7 percent as reported in 2015 compared to the prior year, but increased 1 percent adjusted for currency (10 points) and the System x divestiture, as the company helps clients transition to a hybrid cloud services platform bringing cloud, mobility and security to infrastructure services. Within GTS, outsourcing revenue of $16,992 million decreased 11.0 percent as reported and 1 percent adjusted for currency as the company continues to reinvent its portfolio, providing the most modern IT services that connect clients to the cloud-based mobile world. Integrated Technology Services (ITS) revenue of $8,893 million decreased 6.4 percent as reported, but grew 3 percent adjusted for currency compared to the prior year with strong performance in SoftLayer through-out the year. Maintenance revenue of $6,132 million decreased 10.5 percent as reported, but grew 1 percent adjusted for currency (9 points) and the System x divestiture (3 points). This business continues to contribute significant revenue by delivering a wide range of support services to maintain and improve clients’ IT infrastructure. Throughout 2015, there was continued strong demand for Multi-Vendor Support services where clients can leverage the company’s global distribution and inventory capabilities.

Within GTS, the strategic imperatives, including hybrid cloud services, grew strong double digits at constant currency for the full year, including strong demand for SoftLayer. The company continues to increase its cloud capacity with 46 cloud data centers opened around the world as of December 31, 2015. This Infrastructure-as-a-Service cloud platform provides clients with a range of cloud services, including virtual and bare metal servers along with a dedicated dark fiber network infrastructure. As clients evaluate their technology roadmap, they look for agility and innovation and to gain insight into data from all sources. The company’s hybrid cloud stack is an open platform that enables this innovation. Clients can choose from public, private and dedicated environments based on their needs, such as workload, performance, data sovereignty and regulatory requirements. Entire industries and value chains are being disrupted, and clients are looking to the company for competitive advantage.

Global Business Services revenue of $17,166 million decreased 12.0 percent as reported and 4 percent adjusted for currency (8 points) compared to the prior year. Within GBS, outsourcing revenue of $4,898 million decreased 9.9 percent as reported and 2 percent adjusted for currency (8 points). Consulting and Systems Integration (C&SI) revenue of $12,268 million declined 12.8 percent as reported and 5 percent adjusted for currency.

As the company continued to transform the GBS business during the year, revenue from the strategic imperative practices grew at strong rates. However, overall revenue performance continues to be impacted by the company’s shift away from traditional enterprise application implementations. Clients are moving away from ERP engagements to initiatives that focus on digitizing their business with analytics, cloud and mobile technologies. As part of the company’s partnership with Apple, it has now delivered over 100 MobileFirst for iOS applications. This unique partnership brings together the simplicity of design and ease of use of the Apple mobile device with IBM’s ability to build applications that scale securely and efficiently to the enterprise, helping to transform the way work gets done across 14 industries and 65 professions. These applications allow clients to securely access their most critical data and processes, so that they can redesign workflows and drive productivity. Since the partnership with Apple was announced in 2014, the company has generated over $1 billion in signings from the program.

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Management Discussion

International Business Machines Corporation and Subsidiary Companies

($ in millions)

							Yr.-to-Yr.
							Percent/
							Margin
For the year ended December 31:	2015			2014*			Change
Global Services
Global Technology Services
External gross profit	$	11,981		$	13,808		(13.2	)%
External gross profit margin	37.4		%	39.0		%	(1.5	) pts.
Pre-tax income	$	5,002		$	5,931		(15.7	)%
Pre-tax margin	15.2		%	16.3		%	(1.1	) pts.
Global Business Services
External gross profit	$	4,837		$	5,923		(18.3	)%
External gross profit margin	28.2		%	30.4		%	(2.2	) pts.
Pre-tax income	$	2,634		$	3,408		(22.7	)%
Pre-tax margin	14.9		%	17.0		%	(2.1	) pts.

* Reclassified to conform with 2015 presentation.

The GTS gross profit margin decreased 1.5 points to 37.4 percent in 2015 compared to prior year. Pre-tax income decreased 15.7 percent to $5,002 million. The GTS pre-tax margin declined 1.1 points to 15.2 percent compared to the prior year, primarily due to investments being made in this business. The company continues to invest to deliver the most contemporary offerings that are built with cloud, analytics, mobile, security and cognitive technologies enabling it to transform clients’ enterprises. In addition, currency had a large year-to-year impact on profit given the strong dollar currency environment.

The GBS gross profit margin decreased 2.2 points to 28.2 percent in 2015 compared to the prior year. Pre-tax income decreased 22.7 percent to $2,634 million and pre-tax margin declined 2.1 points to 14.9 percent compared to the prior year. This year-to-year profit decline reflects the market shifts in the GBS business. In parts of the portfolio where the market is declining, there is price and profit pressure and action is being taken to optimize the cost structure in these areas. The company continues to shift and add significant resources to the high-growth analytics, cloud and mobility practices, which impacts productivity and margin in the near term.

Global Services Backlog

The estimated Global Services backlog at December 31, 2015 was $121 billion, a decrease of 6.0 percent as reported, but an increase of 1 percent adjusted for currency, compared to the December 31, 2014 balance. The estimated transactional backlog at December 31, 2015 decreased 6.5 percent as reported, but was flat year to year adjusted for currency. The estimated outsourcing backlog decreased 5.4 percent as reported, but grew 2 percent adjusted for currency compared to the prior year.

Clients are looking to transform their most critical systems into hybrid cloud environments, and the complexity of these partnerships in many cases results in larger engagements. For the full year of 2015, over 70 services deals greater than $100 million were signed, which was 40 percent more than in 2014. About 70 percent of those transactions feature hybrid cloud content, which reflects both the value IBM’s clients see in hybrid and the reality that not all their workloads are optimized for the cloud.

($ in billions)

							Yr.-to-Yr.
					Yr.-to-Yr.		Percent Change
					Percent		Adjusted for
At December 31:	2015		2014		Change		Currency
Backlog
Total backlog	$	120.7	$	128.4	(6.0	)%	0.8	%
Outsourcing backlog	76.4		80.8		(5.4	)	1.7

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.

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Management Discussion

International Business Machines Corporation and Subsidiary Companies

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:	2015		2014		Change		Currency
Total signings	$	48,243	$	51,569	(6.5	)%	2.8	%
Outsourcing signings	$	25,196	$	26,517	(5.0	)%	4.9	%
Transactional signings	23,046		25,052		(8.0	)	0.5

Software

($ in millions)

							Yr.-to-Yr.
					Yr.-to-Yr.		Percent Change
					Percent		Adjusted for
For the year ended December 31:	2015		2014		Change		Currency
Software external revenue	$	22,932	$	25,434	(9.8	)%	(3.5	)%
Middleware	$	19,473	$	21,474	(9.3	)%	(3.0	)%
Key branded middleware	15,778		17,098		(7.7	)	(1.5	)
WebSphere					(5.3	)	0.2
Information Management					(8.0	)	(1.6	)
Workforce Solutions					(8.1	)	(0.6	)
Tivoli					(6.3	)	0.1
Rational					(20.3	)	(15.1	)
Other middleware	3,695		4,376		(15.6	)	(8.7	)
Operating systems	1,815		2,119		(14.3	)	(8.1	)
Other	1,644		1,841		(10.7	)	(4.9	)

Software revenue of $22,932 million decreased 9.8 percent as reported and 4 percent adjusted for currency in 2015 compared to the prior year. Year-to-year software revenue performance reflected a decrease in middleware with declines in transactional revenue and a continuing headwind from operating systems.

Key branded middleware revenue of $15,778 million, which accounted for approximately 69 percent of total software revenue in 2015, decreased 7.7 percent as reported and 2 percent adjusted for currency compared to the prior year. Within key branded middleware, WebSphere decreased 5.3 percent (flat adjusted for currency), Information Management decreased 8.0 percent (2 percent adjusted for currency), Workforce Solutions decreased 8.1 percent (1 percent adjusted for currency), Tivoli decreased 6.3 percent (flat adjusted for currency), and Rational decreased 20.3 percent (15 percent adjusted for currency). Other middleware decreased 15.6 percent as reported and 9 percent adjusted for currency. Operating systems decreased 14.3 percent as reported and 8 percent adjusted for currency.

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Management Discussion

International Business Machines Corporation and Subsidiary Companies

On an annual basis, approximately 70 percent of the company’s software business is annuity-like, including Software-as-a-Service and subscription and support. Renewal rates are steady, the SaaS business is growing, and overall annuity revenue grew for the full year. Transactional revenue declined year to year as large clients with multi-year contracts continued to utilize the flexibility the company has provided in deployment of their software. Outside the company’s top 250 clients, software revenue increased low single digits adjusted for currency on a year-to-year basis.

($ in millions)

							Yr.-to-Yr.
							Percent/
							Margin
For the year ended December 31:	2015			2014			Change
Software
External gross profit	$	20,013		$	22,533		(11.2	)%
External gross profit margin	87.3		%	88.6		%	(1.3	)pts.
Pre-tax income	$	9,066		$	10,699		(15.3	)%
Pre-tax margin	34.6		%	37.0		%	(2.4	)pts.

Software gross profit margin decreased 1.3 points to 87.3 percent. Software pre-tax income of $9,066 million decreased 15.3 percent, with a pre-tax margin of 34.6 percent, a decrease of 2.4 points. Profit performance for the year reflected the overall revenue trajectory, a higher level of investments in areas such as Watson, Watson Health, Watson IoT and Bluemix, and an impact from currency.

The company continues to transform and invest in the Software business. Middleware serves the purpose of integrating different environments, such as, on premise and cloud. Key capabilities have now been delivered on SoftLayer or as part of the Bluemix platform to enable hybrid environments. The company’s middle-ware remains the number one integration platform in the world and now integrates across cloud environments. This allows clients’ existing applications to access the cloud, and new “born to the cloud” applications to access clients’ existing assets.

The company is also adding substantial new capabilities to its software and solutions portfolio, including the Weather Company acquisition, which closed in January 2016. This acquisition will bring with it a high-volume platform that can ingest sensor data at scale. The power of this platform is its ability to use Watson cognitive capabilities to gather new insights by connecting data at scale from multiple industry domains.

Systems Hardware

($ in millions)

							Yr.-to-Yr.
					Yr.-to-Yr.		Percent Change
					Percent		Adjusted for
For the year ended December 31:	2015		2014		Change		Currency
Systems Hardware external revenue	$	7,581	$	9,996	(24.2	)%	7.6	%*
z Systems					28.1	%	34.7	%
Power Systems					(0.4	)	4.5
Storage					(11.9	)	(7.0	)

* Adjusted for the System x divestiture and currency.

Systems Hardware revenue of $7,581 million decreased 24.2 percent as reported, but grew 8 percent year to year adjusted for the divestiture of the System x business (28 points) and currency (4 points) driven by z Systems and Power Systems. Systems Hardware had a successful mainframe product cycle in 2015 and Power Systems grew as it was repositioned to address a broader opportunity. The company continued to deliver innovation to its systems to enable them to run the most contemporary workloads. Approximately half of the Systems Hardware revenue in 2015 was for solutions that address analytics workloads, or hybrid and private clouds.

33

Management Discussion

International Business Machines Corporation and Subsidiary Companies

z Systems revenue increased 28.1 percent as reported and 35 percent adjusted for currency compared to the prior year, with strong double-digit growth adjusted for currency in each quarter since the launch of the z13 system in the first quarter of 2015. MIPS (millions of instructions per second) shipments increased 33 percent in 2015. The z13 system was contemporized for the workloads around mobile, hybrid cloud and analytics. These innovations continue to resonate with existing customers and the company continues to add new customers to the platform. In 2015, the z Systems business added 50 new clients across 25 countries.

Power Systems revenue decreased 0.4 percent as reported, but grew 4 percent adjusted for currency in 2015 compared to the prior year, the first year of revenue growth since 2011. The Power Systems performance reflects the progress being made to transform the platform to align around data and cloud opportunities, while embracing an open ecosystem. The company continues to address the high value opportunity in the UNIX market. Simultaneously, the company has introduced a low-end Linux-based Power system to capture the growing Linux market. The OpenPOWER initiative continues to progress as the company integrates innovation from the broader ecosystem with its own products and licenses IP to support third-party Power-based offerings.

Storage revenue decreased 11.9 percent as reported and 7 percent adjusted for currency in 2015 driven by continued weakness in traditional disk and tape. Value in the storage market continues to shift to software and offering requirements that are driving demand for flash and object-based storage. The company is well positioned in these new areas with its FlashSystems offerings and the recent acquisition of Cleversafe, Inc.

($ in millions)

							Yr.-to-Yr.
							Percent/
							Margin
For the year ended December 31:	2015			2014			Change
Systems Hardware
External gross profit	$	3,535		$	3,945		(10.4	)%
External gross profit margin	46.6		%	39.5		%	7.2	pts.
Pre-tax income	$	604		$	34		NM
Pre-tax margin	7.5		%	0.3		%	7.2	pts.

NM—Not meaningful

Systems Hardware gross profit margin of 46.6 percent increased 7.2 points versus the prior year. The increase was due to mix (11.8 points) driven by strong growth in z Systems and the divestiture of the lower margin System x business. This improvement was offset by lower margins (4.6 points) in z Systems and Power Systems compared to the prior year. Pre-tax income was $604 million in 2015, an increase of $570 million compared to 2014. Pre-tax margin increased 7.2 points year to year to 7.5 percent. Systems Hardware results reflect a successful transformation and repositioning of the business including a solid mainframe product cycle and successful Power Systems transformation.

Global Financing

See pages 69 through 73 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.

($ in millions)

							Yr.-to-Yr.
					Yr.-to-Yr.		Percent Change
					Percent		Adjusted for
For the year ended December 31:	2015		2014		Change		Currency*
Total revenue	$	81,741	$	92,793	(11.9	)%	(1.2	)%
Geographies	$	81,430	$	92,326	(11.8	)%	(1.1	)%
Americas	38,486		41,410		(7.1	)	(1.8	)
Europe/Middle East/Africa	26,073		30,700		(15.1	)	0.3
Asia Pacific	16,871		20,216		(16.5	)	(1.7	)
Major markets					(9.9	)%	(0.5	)%
Growth markets					(18.4	)%	(3.1	)%
BRIC countries					(27.1	)%	(10.1	)%

* Adjusted for divestitures and currency.

34

Management Discussion

International Business Machines Corporation and Subsidiary Companies

Total geographic revenue of $81,430 million in 2015 decreased 11.8 percent as reported and 1 percent adjusted for currency (8 points) and the divestitures of the System x and customer care businesses (3 points) compared to 2014. Major market countries decreased 9.9 percent as reported and 1 percent adjusted for currency (8 points) and the divested businesses (2 points). Within the major markets, performance varied in 2015. While the U.S. was down compared to the prior year, revenue in Germany, Japan and the UK grew year to year on an adjusted basis. Overall, growth market countries decreased 18.4 percent as reported and 3 percent adjusted for currency (9 points) and the divested businesses (6 points). From a regional perspective, on an adjusted basis, growth in Latin America and the Middle East and Africa region was more than offset by declines in the Asia Pacific growth market countries.

Americas revenue of $38,486 million decreased 7.1 percent as reported and 2 percent adjusted for currency (3 points) and divestitures (2 points) compared to 2014 with a decline in North America and growth in Latin America on an adjusted basis. The U.S. decreased 4.4 percent as reported and 3 percent adjusted for divestitures. Canada was down 17.2 percent as reported and 2 percent adjusted for currency (13 points) and divestitures (2 points). In Latin America, Brazil decreased 26.0 percent as reported and 2 percent adjusted for currency (22 points) and the divested businesses (2 points), while Mexico had growth of 0.5 percent as reported and 14 percent adjusted for currency (9 points) and divestitures (4 points).

Europe/Middle East/Africa (EMEA) revenue of $26,073 million in 2015 decreased 15.1 percent as reported, but was flat year to year adjusted for currency (13 points) and the divested businesses (3 points). On an adjusted basis, there was growth in Germany and the UK. Germany decreased 13.2 percent as reported, but grew 7 percent adjusted for currency (17 points) and the divested businesses (3 points). The UK decreased 6.3 percent year to year as reported, but grew 3 percent adjusted for currency (7 points) and the divested businesses (2 points). The Middle East and Africa region decreased 4.8 percent as reported, but grew 5 percent adjusted for the divested businesses (6 points) and currency (4 points). Russia decreased 32.2 percent as reported and 24 percent adjusted for the divestitures.

Asia Pacific revenue of $16,871 million decreased 16.5 percent as reported and 2 percent adjusted for currency (9 points) and the divested businesses (6 points) compared to the prior year. Japan decreased 9.9 percent as reported, but had growth of 5 percent adjusted for currency (13 points) and the divested businesses (2 points). On an adjusted basis, the Japan growth was more than offset by a decline in other markets. China decreased 34.4 percent as reported and 21 percent adjusted for the divested businesses (12 points) and currency (1 point). India decreased 3.8 percent as reported, but had growth of 8 percent adjusted for the divested businesses (7 points) and currency (5 points).

Total Expense and Other (Income)

($ in millions)

					Yr.-to-Yr.
					Percent/
					Margin
For the year ended December 31:	2015		2014		Change
Total consolidated expense and other (income)	$24,740		$26,421		(6.4	)%
Non-operating adjustments
Amortization of acquired intangible assets	(304	)	(374	)	(18.8	)
Acquisition-related charges	(26	)	(12	)	112.6
Non-operating retirement-related (costs)/income	(581	)	(180	)	222.4
Operating (non-GAAP) expense and other (income)	$23,830		$25,855		(7.8	)%
Total consolidated expense-to-revenue ratio	30.3	%	28.5	%	1.8	pts.
Operating (non-GAAP) expense-to-revenue ratio	29.2	%	27.9	%	1.3	pts.

The key drivers of the year-to-year change in total expense and other (income) were approximately:

	Total	Operating
	Consolidated	(non-GAAP)
· Currency*	(9) points	(9) points
· System x divestiture	(2) points	(2) points
· Divestiture gains	6 points	6 points
· Workforce rebalancing	(3) points	(3) points

* Reflects impacts of translation and hedging programs.

For additional information regarding total expense and other (income) for both expense presentations, see the following analyses by category.

35

Management Discussion

International Business Machines Corporation and Subsidiary Companies

Selling, General and Administrative

($ in millions)

							Yr.-to-Yr.
							Percent
For the year ended December 31:	2015			2014			Change
Selling, general and administrative expense
Selling, general and administrative—other	$	16,643		$	18,532		(10.2	)%
Advertising and promotional expense	1,290			1,307			(1.3	)
Workforce rebalancing charges	587			1,472			(60.1	)
Retirement-related costs	1,052			811			29.7
Amortization of acquired intangible assets	304			374			(18.8	)
Stock-based compensation	322			350			(8.0	)
Bad debt expense	231			334			(30.8	)
Total consolidated selling, general and administrative expense	$	20,430		$	23,180		(11.9	)%
Non-operating adjustments
Amortization of acquired intangible assets	(304		)	(374		)	(18.8	)
Acquisition-related charges	(21		)	(11		)	81.1
Non-operating retirement-related (costs)/income	(533		)	(257		)	107.3
Operating (non-GAAP) selling, general and administrative expense	$	19,573		$	22,537		(13.2	)%

Total selling, general and administrative (SG&A) expense decreased 11.9 percent in 2015 versus 2014, driven primarily by the following factors:

· The effects of currency (7 points); and

· Lower workforce rebalancing charges (3 points); and

· The impact of the divested System x business (1 point).

Operating (non-GAAP) expense decreased 13.2 percent year to year driven primarily by the same factors.

Bad debt expense decreased $103 million in 2015 compared to 2014. The receivables provision coverage was 2.6 percent at December 31, 2015, an increase of 40 basis points from December 31, 2014.

Research, Development and Engineering

($ in millions)

						Yr.-to-Yr.
						Percent
For the year ended December 31:	2015			2014		Change
Total consolidated research, development and engineering	$	5,247		$	5,437	(3.5	)%
Non-operating adjustment
Non-operating retirement-related (costs)/income	(48		)	77		NM
Operating (non-GAAP) research, development and engineering	$	5,200		$	5,514	(5.7	)%

NM—Not meaningful

Research, development and engineering (RD&E) expense was 6.4 percent of revenue in 2015 and 5.9 percent of revenue in 2014.

RD&E expense decreased 3.5 percent in 2015 versus 2014 primarily driven by:

· The effects of currency (5 points); and

· The impact of the divested System x business (4 points); partially offset by

· Increased base spending (4 points); and

· Higher expense due to acquisitions (1 point).

Operating (non-GAAP) RD&E expense decreased 5.7 percent in 2015 compared to the prior year, driven primarily by the same factors.

Intellectual Property and Custom Development Income

($ in millions)

					Yr.-to-Yr.
					Percent
For the year ended December 31:	2015		2014		Change
Sales and other transfers of intellectual property	$	303	$	283	7.1	%
Licensing/royalty-based fees	117		129		(9.8	)
Custom development income	262		330		(20.5	)
Total	$	682	$	742	(8.1	)%

The timing and amount of Sales and other transfers of IP may vary significantly from period to period depending upon the timing of divestitures, economic conditions, industry consolidation and the timing of new patents and know-how development. There were no material individual IP transactions in 2015 or 2014.

36

Management Discussion

International Business Machines Corporation and Subsidiary Companies

Other (Income) and Expense

($ in millions)

							Yr.-to-Yr.
							Percent
For the year ended December 31:	2015			2014			Change
Other (income) and expense
Foreign currency transaction losses/(gains)	$	414		$	(599	)	NM
(Gains)/losses on derivative instruments	(853		)	654			NM
Interest income	(72		)	(90		)	(19.8	)%
Net (gains)/losses from securities and investment assets	47			(26		)	NM
Other	(260		)	(1,878		)	(86.1	)%
Total consolidated other (income) and expense	$	(724	)	$	(1,938	)	(62.6	)%
Non-operating adjustment
Acquisition-related charges	(5		)	(1		)	NM
Operating (non-GAAP) other (income) and expense	$	(729	)	$	(1,939	)	(62.4	)%

NM—Not meaningful

The decrease in income of $1,214 million year over year was primarily driven by:

· Lower gains on divestitures ($1,623 million) primarily associated with the divestitures of the System x and customer care businesses in 2014; and

· Higher foreign currency transaction losses ($1,013 million); partially offset by

· Increased gains on derivative instruments ($1,507 million).

Interest Expense

($ in millions)

					Yr.-to-Yr.
					Percent
For the year ended December 31:	2015		2014		Change
Interest expense
Total	$	468	$	484	(3.2	)%

The decrease in interest expense in 2015 versus 2014 was primarily driven by lower average debt levels, partially offset by higher average interest rates. Interest expense is presented in cost of financing in the Consolidated Statement of Earnings only if the related external borrowings are to support the Global Financing external business. Overall interest expense (excluding capitalized interest) in 2015 was $1,009 million, a decrease of $16 million year to year.

Stock-Based Compensation

Pre-tax stock-based compensation cost of $468 million decreased $44 million compared to 2014. This was due primarily to decreases related to performance share units ($32 million), the conversion of stock-based awards previously issued by acquired entities ($6 million) and restricted stock units ($6 million). Stock-based compensation cost, and the year-to-year change, was reflected in the following categories: Cost: $100 million, down $21 million; SG&A expense: $322 million, down $28 million; RD&E expense: $51 million, down $3 million and Other (income) and expense: ($6 million), down $8 million. The amount of stock-based compensation cost included in the loss from discontinued operations, net of tax, was immaterial in 2015 and 2014.

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:	2015			2014			Change
Retirement-related plans—cost
Service cost	$	484		$	482		0.5	%
Amortization of prior service costs/(credits)	(100		)	(114		)	(12.0	)
Cost of defined contribution plans	1,138			1,253			(9.2	)
Total operating costs/(income)	$	1,522		$	1,621		(6.1	)%
Interest cost	3,316			3,994			(17.0	)
Expected return on plan assets	(5,879		)	(6,351		)	(7.4	)
Recognized actuarial losses	3,283			2,467			33.1
Curtailments/settlements	36			25			41.2
Multi-employer plan/other costs	293			218			34.8
Total non-operating costs/ (income)	$	1,050		$	353		197.2	%
Total retirement-related plans—cost	$	2,572		$	1,974		30.3	%

37

Management Discussion

International Business Machines Corporation and Subsidiary Companies

In 2015, total pre-tax retirement-related plan cost increased by $598 million compared to 2014, primarily driven by an increase in recognized actuarial losses ($816 million), lower expected return on plan assets ($472 million) and higher pension obligations related to litigation in Spain ($85 million), partially offset by lower interest cost ($678 million) and lower defined contribution plans cost ($115 million).

As discussed in the “Operating (non-GAAP) Earnings” section on pages 18 and 19, the company characterizes certain retirement-related costs as operating and others as non-operating. Utilizing this characterization, operating retirement-related costs in 2015 were $1,522 million, a decrease of $99 million compared to 2014, primarily driven by lower defined contribution plans cost ($115 million). Non-operating costs of $1,050 million increased $696 million in 2015 compared to the prior year, driven primarily by an increase in recognized actuarial losses ($816 million), lower expected return on plan assets ($472 million), higher pension obligations related to litigation in Spain ($85 million), partially offset by lower interest cost ($678 million).

Income Taxes

The continuing operations effective tax rate for 2015 was 16.2 percent, a decrease of 5.0 points versus the prior year, driven by the following factors:

· The benefit resulting from the completion of the U.S. 2011—2012 tax audit, including the associated reserve redeterminations (3.9 points); and

· A benefit due to the geographic mix of pre-tax income in 2015 (3.5 points); and

· A benefit due to the 2014 tax charge related to the divestiture of the System x business (0.9 points); partially offset by

· A reduced benefit year to year in the utilization of foreign tax credits (2.5 points); and

· The year-to-year increase in tax charges related to intercompany payments made by foreign subsidiaries and the intercompany licensing of certain IP (0.8 points).

The continuing operations operating (non-GAAP) effective tax rate was 17.2 percent, a decrease of 3.8 points versus 2014 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.

					Yr.-to-Yr.
					Percent
For the year ended December 31:	2015		2014		Change
Earnings per share of common stock from continuing operations
Assuming dilution	$	13.60	$	15.59	(12.8	)%
Basic	$	13.66	$	15.68	(12.9	)%
Diluted operating (non-GAAP)	$	14.92	$	16.53	(9.7	)%
Weighted-average shares outstanding (in millions)
Assuming dilution	982.7		1,010.0		(2.7	)%
Basic	978.7		1,004.3		(2.5	)%

Actual shares outstanding at December 31, 2015 and 2014 were 965.7 million and 990.5 million, respectively. The average number of common shares outstanding assuming dilution was 27.3 million shares lower in 2015 versus 2014. The decrease was primarily the result of the common stock repurchase program.

Results of Discontinued Operations

The loss from discontinued operations, net of tax, was $0.2 billion in 2015 and $3.7 billion in 2014. The loss from discontinued operations in 2014 included a nonrecurring pre-tax charge of $4.7 billion, or $3.4 billion, net of tax, which included an impairment to reflect the fair value less estimated costs to sell the Microelectronics business and other estimated costs related to the transaction, including cash consideration. The discontinued operations effective tax rate in 2015 was 40.3 percent compared to 30.2 percent in 2014.

38

Management Discussion

International Business Machines Corporation and Subsidiary Companies

Financial Position

Dynamics

At December 31, 2015, the company continued to have the financial flexibility to support the business over the long term. Cash and marketable securities at year end were $8,195 million. During the year, the company continued to manage the investment portfolio to meet its capital preservation and liquidity objectives.

Total debt of $39,890 million decreased $832 million from prior year-end levels. The commercial paper balance at December 31, 2015, was $600 million, a decrease of $50 million from the prior year end. Within total debt, $27,205 million is in support of the Global Financing business which is leveraged at a 7.3 to 1 ratio. The company continues to have substantial flexibility in the debt markets. During 2015, the company completed bond issuances totaling $3,368 million, with terms ranging from 3 to 7 years, and interest rates ranging from 0.53 to 2.88 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, 2015, the overall net under-funded position was $15,513 million, a decrease of $1,419 million from December 31, 2014 driven by an increase in discount rates. At year end, the company’s qualified defined benefit plans were well funded and the cash requirements related to these plans remain stable going forward at approximately $500 million per year through 2020. In 2015, the return on the U.S. Personal Pension Plan assets was negative 1.0 percent and the plan was 101 percent funded at December 31. Overall, global asset returns were negative 0.2 percent and the qualified defined benefit plans worldwide were 97 percent funded at December 31, 2015.

During 2015, the company generated $17,008 million in cash from operations, an increase of $139 million compared to 2014. In addition, the company generated $13,075 million in free cash flow, an increase of $703 million versus the prior year. See pages 62 to 63 for additional information on free cash flow. The company returned $9,507 million to shareholders in 2015, with $4,897 million in dividends and $4,609 million in gross share repurchases. In 2015, the company repurchased 30.3 million shares and had $5.6 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 78 are the consolidated amounts including Global Financing. The amounts appearing in the separate Global Financing section, beginning on page 69, are supplementary data presented to facilitate an understanding of the Global Financing business.

Working Capital

($ in millions)

At December 31:	2015		2014
Current assets	$	42,504	$	47,377	*
Current liabilities	34,269		39,581		* **
Working capital	$	8,235	$	7,797	* **
Current ratio	1.24:1		1.20:1		* **

* Reclassified to reflect adoption of the FASB guidance on deferred taxes in consolidated financial statements. Refer to note B, “Accounting Changes,” for additional information.

** Reclassified to reflect adoption of the FASB guidance on debt issuance costs in consolidated financial statements. Refer to note B, “Accounting Changes,” for additional information.

Working capital increased $439 million from the year-end 2014 position. The key changes are described below:

Current assets decreased $4,873 million ($2,074 million adjusted for currency), as a result of:

·  A decline of $3,277 million ($1,316 million adjusted for currency) in receivables driven by the receipt of tax refunds; and

·  A decrease of $762 million ($470 million adjusted for currency) in prepaid expenses and other current assets due to decreases in counterparty collateral postings and derivative assets, partially offset by an increase in prepaid income taxes; and

·  A decline of $553 million ($480 million adjusted for currency) in inventories primarily driven by the Microelectronics divestiture.

Current liabilities decreased $5,311 million ($3,418 million adjusted for currency), as a result of:

·  A decrease in taxes of $2,237 million ($1,995 million adjusted for currency) primarily driven by income tax payments, settlement of the U.S. tax audit and a tax benefit associated with the Microelectronics divestiture; and

39

Management Discussion

International Business Machines Corporation and Subsidiary Companies

·A decrease in other accrued expenses and liabilities of $1,641 million ($1,281 million adjusted for currency) driven by net activity associated with the Microelectronics divestiture and workforce rebalancing payments; and

·A decrease in deferred income of $856 million ($226 million adjusted for currency); and a decline of $837 million ($568 million adjusted for currency) in accounts payable reflecting the wind down of the divested System x business payables and decreases in counterparty collateral postings; partially offset by

·An increase in short-term debt of $731 million ($872 million adjusted for currency).

Cash Flow

The company’s cash flows from operating, investing and financing activities, as reflected in the Consolidated Statement of Cash Flows on page 79 are 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:	2015			2014
Net cash provided by/(used in) continuing operations
Operating activities	$	17,008		$	16,868
Investing activities	(8,159		)	(3,001		)
Financing activities	(9,166		)	(15,452		)
Effect of exchange rate changes on cash and cash equivalents	(473		)	(655		)
Net change in cash and cash equivalents	$	(790	)	$	(2,240	)

Net cash provided by operating activities increased by $139 million in 2015 driven by the following key factors:

·A decline in cash income tax payments ($3,092 million); and

·An improvement in sales cycle working capital of $1,192 million; partially offset by

·Performance-related declines within net income; and

·An increase in performance-related compensation payments of $470 million.

Net cash used in investing activities increased $5,158 million driven by:

·A decrease in cash provided by divestitures of $2,758 million; and

·An increase in cash used related to acquisitions of $2,693 million.

Net cash used in financing activities decreased $6,286 million as compared to the prior year driven by the following factors:

·A decrease of $9,070 million of cash used for gross share repurchases; partially offset by

·A decrease in net cash sourced from debt transactions of $1,764 million driven by a lower level of issuances in the current year; and

·An increase in dividend payments of $632 million.

Noncurrent Assets and Liabilities

($ in millions)

At December 31:	2015		2014
Noncurrent assets	$	67,991	$	69,894	* **
Long-term debt	$	33,428	$	34,991	**
Noncurrent liabilities (excluding debt)	$	28,374	$	30,686	*

* Reclassified to reflect adoption of the FASB guidance on deferred taxes in consolidated financial statements. Refer to note B, “Accounting Changes,” for additional information.

** Reclassified to reflect adoption of the FASB guidance on debt issuance costs in consolidated financial statements. Refer to note B, “Accounting Changes,” for additional information.

The decrease in noncurrent assets of $1,903 million (an increase of $1,735 million adjusted for currency) was driven by:

·A decrease of $1,853 million ($1,417 million adjusted for currency) in deferred taxes driven by the utilization of the tax benefit associated with the Microelectronics divestiture; and

·A decrease of $1,096 million ($186 million adjusted for currency) in long-term financing receivables; partially offset by

·An increase in goodwill of $1,466 million ($2,561 adjusted for currency) resulting from acquisitions during the year.

Long-term debt decreased $1,563 million ($862 million adjusted for currency) driven by:

·Reclassification of $5,549 million to short-term debt to reflect upcoming maturities; partially offset by

·Debt issuances of $4,647 million.

Other noncurrent liabilities, excluding debt, decreased $2,312 million ($387 million adjusted for currency) primarily driven by:

·A decrease in retirement and nonpension postretirement liabilities of $1,757 million driven by a currency impact of $1,295 million; and

·A decline of $635 million ($207 million adjusted for currency) in other liabilities associated with a reclass to short-term payables of a portion of the consideration payment associated with the Microelectronics divestiture.

40

Management Discussion

International Business Machines Corporation and Subsidiary Companies

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:	2015		2014
Total company debt	$	39,890	$	40,722	*
Total Global Financing segment debt	$	27,205	$	29,103
Debt to support external clients	23,934		25,531
Debt to support internal clients	3,271		3,572
Non-Global Financing debt	12,684		11,619		*

* Reclassified to reflect adoption of the FASB guidance on debt issuance costs in consolidated financial statements. Refer to note B, “Accounting Changes,” for additional information.

Global Financing provides financing predominantly for the company’s external client assets, as well as for assets under contract by other IBM units. These assets, primarily for Global Services, generate long-term, stable revenue streams similar to the Global Financing asset portfolio. Based on their attributes, these Global Services assets are leveraged with the balance of the Global Financing asset base. The debt analysis above is further detailed in the Global Financing section on pages 72 and 73.

Given the significant leverage, the company presents a debt-to-capitalization ratio which excludes Global Financing debt and equity as management believes this is more representative of the company’s core business operations. This ratio can vary from period to period as the company manages its global cash and debt positions. “Core” debt-to-capitalization ratio (excluding Global Financing debt and equity) was 54.3 percent at December 31, 2015 compared to 59.2 percent at December 31, 2014.

Consolidated debt-to-capitalization ratio at December 31, 2015 was 73.4 percent versus 77.2 percent at December 31, 2014.

Equity

Total equity increased by $2,410 million from December 31, 2014 as a result of an increase in retained earnings of $8,332 million and common stock of $596 million offset by an increase in treasury stock of $4,803 million mainly due to gross common stock repurchases and an increase in other comprehensive losses of $1,731 million primarily due to foreign currency translation adjustments.

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 pages 18 and 19 for the company’s rationale for presenting operating earnings information.

($ in millions except per share amount)

				Acquisition-			Retirement-
				Related			Related			Operating
For the year ended December 31, 2015:	GAAP			Adjustments			Adjustments			(non-GAAP)
Gross profit	$	40,684		$	373		$	469		$	41,526
Gross profit margin	49.8		%	0.5		pts.	0.6		pts.	50.8		%
SG&A	$	20,430		$	(324	)	$	(533	)	$	19,573
RD&E	5,247			—			(48		)	5,200
Other (income) and expense	(724		)	(5		)	—			(729		)
Total expense and other (income)	24,740			(330		)	(581		)	23,830
Pre-tax income from continuing operations	15,945			703			1,050			17,697
Pre-tax margin from continuing operations	19.5		%	0.9		pts.	1.3		pts.	21.6		%
Provision for income taxes*	$	2,581		$	141		$	316		$	3,037
Effective tax rate	16.2		%	0.2		pts.	0.9		pts.	17.2		%
Income from continuing operations	$	13,364		$	562		$	734		$	14,659
Income margin from continuing operations	16.3		%	0.7		pts.	0.9		pts.	17.9		%
Diluted earnings per share from continuing operations	$	13.60		$	0.57		$	0.75		$	14.92

* 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.

41

Management Discussion

International Business Machines Corporation and Subsidiary Companies

($ in millions except per share amount)

				Acquisition-			Retirement-
				Related			Related			Operating
For the year ended December 31, 2014:	GAAP			Adjustments			Adjustments			(non-GAAP)
Gross profit	$	46,407		$	416		$	173		$	46,996
Gross profit margin	50.0		%	0.4		pts.	0.2		pts.	50.6		%
SG&A	$	23,180		$	(385	)	$	(257	)	$	22,537
RD&E	5,437			—			77			5,514
Other (income) and expense	(1,938		)	(1		)	—			(1,939		)
Total expense and other (income)	26,421			(386		)	(180		)	25,855
Pre-tax income from continuing operations	19,986			803			353			21,142
Pre-tax margin from continuing operations	21.5		%	0.9		pts.	0.4		pts.	22.8		%
Provision for income taxes*	$	4,234		$	133		$	73		$	4,440
Effective tax rate	21.2		%	(0.2		) pts.	0.0		pts.	21.0		%
Income from continuing operations	$	15,751		$	670		$	280		$	16,702
Income margin from continuing operations	17.0		%	0.7		pts.	0.3		pts.	18.0		%
Diluted earnings per share from continuing operations	$	15.59		$	0.66		$	0.28		$	16.53

* 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.

Consolidated Fourth-Quarter Results

($ and shares in millions except per share amounts)

							Yr.-to-Yr.
							Percent/
							Margin
For the fourth quarter:	2015			2014			Change
Revenue	$	22,059		$	24,113		(8.5	)%*
Gross profit margin	51.7		%	53.3		%	(1.6	) pts.
Total expense and other (income)	$	6,308		$	5,767		9.4	%
Total expense and other (income)-to-revenue ratio	28.6		%	23.9		%	4.7	pts.
Income from continuing operations before income taxes	$	5,098		$	7,094		(28.1	)%
Provision for income taxes from continuing operations	$	638		$	1,580		(59.6	)%
Income from continuing operations	$	4,460		$	5,515		(19.1	)%
Income from continuing operations margin	20.2		%	22.9		%	(2.7	) pts.
Income/(loss) from discontinued operations, net of tax	$	3		$	(31	)	NM
Net income	$	4,463		$	5,484		(18.6	)%
Earnings per share from continuing operations:
Assuming dilution	$	4.59		$	5.54		(17.1	)%
Consolidated earnings per share— assuming dilution	$	4.59		$	5.51		(16.7	)%
Weighted-average shares outstanding
Assuming dilution	972.8			995.4			(2.3	)%

* (2.3) percent adjusted for currency.

NM—Not meaningful

The following table provides the company’s operating (non-GAAP) earnings for the fourth quarter of 2015 and 2014.

($ in millions except per share amounts)

						Yr.-to -Yr.
						Percent
For the fourth quarter:	2015		2014			Change
Net income as reported	$	4,463	$	5,484		(18.6	)%
Income/(loss) from discontinued operations, net of tax	3		(31		)	NM
Income from continuing operations	4,460		5,515			(19.1	)
Non-operating adjustments (net of tax)
Acquisition-related charges	110		186			(41.0	)
Non-operating retirement-related costs/(income)	137		84			63.8
Operating (non-GAAP) earnings*	$	4,707	$	5,785		(18.6	)%
Diluted operating (non-GAAP) earnings per share	$	4.84	$	5.81		(16.7	)%

* See page 48 for a more detailed reconciliation of net income to operating earnings.

NM—Not meaningful

42

Management Discussion

International Business Machines Corporation and Subsidiary Companies

Snapshot

In the fourth quarter of 2015, the company reported $22.1 billion in revenue and delivered $4.5 billion in income from continuing operations with diluted earnings per share from continuing operations of $4.59 as reported and $4.84 on an operating (non-GAAP) basis. The results of continuing operations exclude net income from discontinued operations of $3 million related to the divestiture of the company’s Microelectronics business. The company generated $5.3 billion in cash from operations and $6.1 billion in free cash flow in the fourth quarter and continued a high level of investment, including $2.5 billion in acquisitions and driving shareholder returns of $2.0 billion in gross common stock repurchases and dividends.

Performance in the fourth quarter continued to reflect the transitions in the business as the company addressed both the significant shifts in the industry as well as some of the cyclical challenges of the global business environment.

In the fourth quarter, total consolidated revenue decreased 8.5 percent as reported and 2 percent adjusted for currency, with a year-to-year impact of $1.5 billion due to currency. Revenue in the strategic imperatives grew 10 percent as reported and 16 percent adjusted for currency.

Within the company’s segments, total Global Services revenue declined 8.1 percent as reported and 1 percent adjusted for currency. Global Technology Services revenue decreased 7.1 percent as reported but grew 1 percent adjusted for currency as the company continues to help clients transition to a hybrid cloud services platform bringing more mobility and security to infrastructure services. Global Business Services revenue decreased 9.9 percent (4 percent adjusted for currency). GBS has continued to add resources and transition to the strategic areas while shifting away from some of the more traditional areas of the business. Software revenue decreased 10.7 percent (6 percent adjusted for currency). Software annuity content grew but transactional performance continued to be impacted by the flexibility the company has provided in Enterprise License Agreements with clients. Systems Hardware revenue decreased 1.4 percent but grew 3 percent adjusted for currency driven by z Systems and Power Systems.

From a geographic perspective, revenue in the major markets declined 6.9 percent and 2 percent adjusted for currency. While the U.S. was down, revenue in Europe and Japan grew on an adjusted basis. Growth markets revenue decreased 13.6 percent and 4 percent adjusted for currency with growth in Latin America and the Middle East and Africa region more than offset by declines in Asia Pacific.

The consolidated gross profit margin decreased 1.6 points versus the fourth quarter of 2014 to 51.7 percent. The operating (non-GAAP) gross margin of 52.7 percent decreased 1.2 points with year-to-year declines across all business segments.

Total expense and other (income) increased 9.4 percent in the fourth quarter of 2015 compared to the prior year. Total operating (non-GAAP) expense and other (income) increased 9.2 percent year to year. The key drivers of the year-to-year change in total expense and other (income) were approximately:

	Total	Operating
	Consolidated	(non-GAAP)
· Currency*	(8) points	(8) points
· Divestiture gains	23 points	24 points