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Management discussion
International Business Machines Corporation and Subsidiary Companies
Road map
The financial section of the International Business Machines Corporation (IBM and/or the company) 2005 Annual Report, consisting of this Management Discussion, the Consolidated Financial Statements that follow and the notes related thereto, comprises 67 Web pages of information. This Road Map is designed to provide you with some perspective regarding the information contained in the financial section.
The company’s business model is built to support two principal goals: helping clients succeed in delivering business value by becoming more efficient and competitive through the use of business insight and information technology (IT) solutions; and providing long-term value to shareholders. In support of these objectives, the business model has been developed over time through strategic investments in services and technologies that have the best long-term growth and profitability prospects based on the value they deliver to clients. In addition, the company is committed to its employees and the communities in which it operates.
The model is designed to allow for flexibility and periodic rebalancing. In 2005, 16 acquisitions were completed, primarily in software and services, at an aggregate cost of approximately $2 billion, and the company completed the sale of its Personal Computing business to Lenovo Group Limited (Lenovo).
The company’s portfolio of capabilities ranges from services that include Business Performance Transformation Services to software, hardware, fundamental research, financing and the component technologies used to build larger systems. These capabilities are combined to provide business insight and solutions in the enterprise computing space.
In terms of financial performance, the company has continued to focus on its participation in the high-growth, high-profit segments of the IT industry that will enable the company to deliver consistently strong earnings, high returns on invested capital and excellent cash flows. The company’s business model is based on a balanced portfolio of services, systems and technology and software maintaining a broad range of capabilities that will allow the company to compete effectively and grow in key markets even during changing economic environments. This strategy results in less volatile returns overall, as the portfolio has an effective segmentation of businesses that drive transactional revenue and profits, as well as businesses that drive annuity-based revenue and profits. The strength of the business model is not any single component — it is the company’s ability to generate consistent financial performance with balanced contributions across the portfolio.
In terms of marketplace performance — i.e., the ability to deliver client value — it is important to understand that the fundamental strength of this business model is not found in the breadth of the portfolio alone, but in the way the company creates business solutions from among its capabilities and relationships.
Strategically, the company has exited commoditized businesses, increased its concentration in higher-value businesses and created a more balanced portfolio. The company integrates across its portfolio to create solution offerings for its global client-base, driving profit and cash growth over the long term.
Transparency is a primary goal of successful financial reporting. The following are the key elements you will find in this year’s Annual Report.
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The company, in accordance with Section 404 of the Sarbanes-Oxley Act of 2002, conducted an evaluation of its internal control over financial reporting and concluded that the internal control over financial reporting was effective as of December 31, 2005. |
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The Management Discussion is designed to provide readers with a view of the company’s results and certain factors that may affect future prospects from the perspective of the company’s management. Within the “Management Discussion Snapshot,” the key messages and details will give readers the ability to quickly assess the most important drivers of performance within this brief overview. |
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The Management Discussion reflects the company’s continued and improving strength in providing client- and industry-specific solutions utilizing the broad capabilities of its portfolio. The sections on “Description of the Business,” “Results of Continuing Operations,” “Financial Position,” and “Looking Forward,” are all written from the perspective of the consolidated entity. Detailed analysis for each of the company’s segments is also included. |
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Global Financing is a business segment within the company that is measured as if it were a standalone entity. A separate “Global Financing” section is not included in the consolidated perspective that is referred to above. This section is separately presented given this segment’s unique impact on the company’s financial condition and leverage. |
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The company divested its Personal Computing business to Lenovo on April 30, 2005. The details of this significant transaction are discussed in note C, “Acquisitions/Divestitures.” As a result of this divestiture, the company’s reported financial results include four months of activity for the Personal Computing business in 2005 as compared to 12 months in 2004. This lack of comparable periods has a material impact on the company’s reported revenue results. Therefore, in the Management Discussion, within the “Year in Review” section, the company has presented an analysis of revenue both on an as-reported basis and on a basis that excludes the revenues from the divested Personal Computing business from both the 2005 and 2004 periods. The company believes that the analysis that excludes the Personal Computing revenues is a better indicator of the company’s operational revenue performance in 2005 as compared to 2004. |
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The selected reference to constant currency in the Management Discussion is made so that the financial results can be viewed without the impacts of changing foreign currency exchange rates and therefore facilitates a comparative view of business growth. The percentages reported in the financial tables throughout the Management Discussion are calculated from the underlying whole-dollar numbers. See “Currency Rate Fluctuations” for additional information. |
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This Management Discussion section provides the reader of the financial statements with a narrative on the company’s financial results. It contains the results of operations for each segment of the business, followed by a description of the company’s financial position, as well as certain employee data. It is useful to read the Management Discussion in conjunction with note W, “Segment Information”. |
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The “Consolidated Financial Statements” section contains the consolidated financial statements. These statements provide an overview of the company’s income and cash flow performance and its financial position. |
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The notes follow the Consolidated Financial Statements. Among other things, the notes contain the company’s accounting policies, detailed information on specific items within the financial statements, certain contingencies and commitments, and the results of each IBM segment. |
Effective January 1, 2005, the company adopted the provisions of Statement of Financial Accounting Standards (SFAS) No. 123(R), “Share-Based Payment,” (“SFAS 123(R)”). The company elected to adopt the modified retrospective application method provided by SFAS 123(R). This method permits the restatement of historical financial statement amounts. See note A, “Significant Accounting Policies” and note U, “Stock-Based Compensation” for additional information.
In addition, as a result of the divestiture of the Personal Computing business in 2005, the company revised its operating segments in the second quarter. See note W, “Segment Information,” for additional information. Accordingly, as a result of these actions, the company filed a restated 2004 Annual Report with the Securities and Exchange Commission (SEC) on Form 8-K on July 27, 2005.
On December 31, 2002, the company sold its hard disk drive (HDD) business to Hitachi, Ltd. (Hitachi). The HDD business was accounted for as a discontinued operation under generally accepted accounting principles (GAAP) which requires that the income statement and cash flow information be reformatted to separate the divested business from the company’s continuing operations. See the “Discontinued Operations” section for additional information.
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