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Chairman’s letter

A Transformed Company

Put it all together, and IBM today is very different from what it was when we entered the decade. We are different strategically, with clarity around our twin imperatives of innovation and global integration. We are different operationally, with a lower center of gravity in our operations and with continually improving efficiency and productivity. And we have a business model that is better aligned with our clients’ needs and that generates stronger profitability and cash flow. We see no major strategic shift on the horizon for our company.

So, how is this transformed company performing? Let me briefly recap 2007. It was, quite simply, a great year for IBM.

Revenue and income: We delivered our strongest revenue growth since 2003 and our strongest profit performance in more than a decade. Our revenue as reported was a record $98.8 billion, up 8 percent. Pretax income from continuing operations was $14.5 billion, an increase of 9 percent and another record.

Margins: IBM’s gross profit margin rose for the fourth consecutive year—to 42.2 percent, up more than five points since 2003. We achieved this by continuing to shift our business mix to more profitable segments, such as software, and by focusing on productivity. Our pretax income margin rose to 14.7 percent. Both margins are at their highest in more than a decade. The improvement in our pretax income margin compares very favorably to our technology peers and to the companies of the Dow 30. We have reversed the margin decline of the late 1990s, and we have a stronger business model today, with less volatility and more high-profit revenue opportunity.

Earnings per share: We have continued to achieve strong EPS growth. Last year was another record, with diluted earnings per share from continuing operations of $7.18, up 18 percent. This marked 20 straight quarters of EPS growth.

Cash flow: IBM has consistently generated strong cash flow. In 2007 our net cash from operations, excluding the year-to-year change in Global Financing receivables, was $17.4 billion—an increase of $2.1 billion from last year. Our business model has allowed us to generate more than $70 billion in cash flow over the past five years. IBM ended 2007 with $16.1 billion of cash and marketable securities.

Investment and return to shareholders: Our superior cash flow has enabled us to invest in the business—through strategic acquisitions and capital expenditures to drive growth—and to generate substantial returns to investors through increased dividends and significant share repurchase. Our 2007 cash investment was $1 billion for 12 acquisitions—six of them in key areas of software. And after investing $6.2 billion in R&D and $5 billion in net capital expenditures, we were able to return a record of nearly $21 billion to you—$18.8 billion through share repurchase and $2.1 billion through dividends—or more than 100 percent of our net earnings. This year’s dividend increase was 33 percent, marking the 12th year in a row in which we have raised our dividend. In the last two years, IBM has doubled its quarterly dividend.

Our balance sheet remains strong, and the company is well positioned to take advantage of new strategic opportunities.

The results of IBM’s strategic choices and actions over the last several years have been better client focus, clearer marketplace differentiation and a stronger financial engine. We have also achieved superior flexibility—a competitive advantage in uncertain economic times. This strengthened business model and our excellent performance in 2007 have increased our confidence that we will meet our 2010 objective of $10 to $11 in earnings per share. I think the information in Generating higher value at IBM will help you understand the sources of that confidence.

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