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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 or the company) 2007 Annual Report, consisting of this Management Discussion, the Consolidated Financial Statements that follow and the notes related thereto, comprises 109 web pages of information. This Road Map is designed to provide the reader with some perspective regarding the information contained in the financial section.

IBM’s business model

The company’s business model is built to support two principal goals: helping clients succeed in delivering business value by becoming more innovative, efficient and competitive through the use of business insight and information technology (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 the best long-term growth and profitability prospects based on the value they deliver to clients. The company’s strategy is to focus on the high-growth, high-value segments of the IT industry.

The company’s global capabilities include services, software, hardware, fundamental research and financing. The broad mix of businesses and capabilities are combined to provide business insight and solutions for the company’s clients.

The business model is flexible, and allows for periodic change and rebalancing. The company has exited commoditizing businesses like personal computers and hard disk drives, and strengthened its position through strategic investments and acquisitions in emerging higher value segments like service oriented architecture (SOA) and Information on Demand. In addition, the company has transformed itself into a globally integrated enterprise which has improved overall productivity and is driving investment and participation in the world’s fastest growing markets. As a result, the company is a higher-performing enterprise today than it was several years ago.

The business model, supported by the company’s long-term financial model, enables the company to deliver consistently strong earnings, cash flows and returns on invested capital in changing economic environments.

Transparency

Transparency is a primary goal of successful financial reporting. The following are several key points for the reader of this year’s Annual Report.

  • 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, 2007.
  • 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.
  • In the first quarter of 2007, the company changed the presentation of revenue and cost in the Consolidated Statement of Earnings to reflect the categories of Services, Sales and Financing. Previously, the presentation included Global Services, Hardware, Software, Global Financing and an Other category. In the past, these categories were aligned with the company’s reportable segment presentation of external revenue and cost. However, as the company moves toward delivering solutions which bring integrated software and services capabilities to its clients, the alignment between segments and categories will diverge. Therefore, there are situations where the Global Services segments could include software revenue, and conversely, the Software segment may have services revenue. The change was made to avoid possible confusion between the segment revenue and cost presentation and the required category presentation in the Consolidated Statement of Earnings. The change only impacts the format for the presentation of the company’s revenue and cost in the Consolidated Statement of Earnings and does not reflect any change in the company’s reportable segment results or in the company’s organizational structure. The periods presented in this Annual Report are reported on a comparable basis. The Management Discussion and Analysis of revenue and gross profit from continuing operations will focus on the segment view, as this is how the business is managed and is the best reflection of the company’s operating results and strategy.
  • On January 29, 2008, IBM International Group Capital LLC, an indirect, wholly owned subsidiary of the company, issued $3.5 billion of 18-month floating rate notes. The proceeds will be utilized to reduce the 364-day bridge loan associated with the 2007 accelerated share repurchase (ASR). (See “Financial Position” for additional information.) In the Consolidated Statement of Financial Position included in the company’s press release and Form 8-K filing on January 17, 2008, the company classified the $3.5 billion related to the 364-day bridge loan as Short-term debt. As a result of this refinancing in January, and consistent with the provisions of Statement of Financial Accounting Standards (SFAS) No. 6, “Classification of Short-Term Obligations Expected to Be Refinanced,” the company has classified this amount as Long-term debt in its Consolidated Statement of Financial Position.
  • Effective December 31, 2006, the company adopted the provisions of SFAS No. 158, “Employer’s Accounting for Defined Benefit Pension and Other Postretirement Plans, an amendment to FASB Statements No. 87, 88, 106, and 132(R).” SFAS No. 158 requires that the funded status of the company’s pension and nonpension postretirement benefit plans be recognized as an asset or a liability in the Consolidated Statement of Financial Position, the recognition of any changes in that funded status in the year in which the changes occur and the recognition of previously unrecognized gains/(losses), prior service costs/(credits) and transition assets as a component of Accumulated gains and (losses) not affecting retained earnings in the Consolidated Statement of Stockholder’s Equity. The adoption of SFAS No. 158 had a significant non-cash impact on the company’s 2006 reported financial position and stockholder’s equity, reducing equity by $9.5 billion, net of tax. The adoption of SFAS No. 158 had no impact on the company’s existing debt covenants, credit ratings or financial flexibility. See note U, “Retirement-Related Benefits” for additional information, including 2007 impacts.
  • 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 do not include any activity in 2007 and 2006, but includes four months of activity for the Personal Computing Division in 2005. This lack of comparable periods has a material impact on the company’s reported revenue growth. Therefore, in the Management Discussion, within the “Prior 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 revenue from the divested Personal Computing business from the 2005 period. The company believes that the analysis that excludes the Personal Computing revenue is a better indicator of operational revenue performance on an ongoing basis.
  • The reference to “adjusted for currency” in the Management Discussion is made so that certain financial results can be viewed without the impacts of fluctuating foreign currency exchange rates and therefore facilitates a comparative view of business performance. See “Currency Rate Fluctuations” for additional information.
  • Within the financial tables in this Annual Report, certain columns and rows may not add due to the use of rounded numbers for disclosure purposes. Percentages reported in the financial tables throughout this Annual Report are calculated from the underlying whole-dollar numbers.

Organization of information

  • 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 V, “Segment Information”.
  • Global Financing is a reportable segment that is measured as if it were a standalone entity. A separate “Global Financing” section is included. This section is separately presented given this segment’s unique impact on the company’s financial condition and leverage, and the information presented in this section is consistent with this separate company view.
  • The Consolidated Financial 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, acquisitions and divestitures, detailed information on specific items within the financial statements, certain contingencies and commitments, and the results of each reportable segment.

Discontinued operations

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 “Discontinued Operations” for additional information.

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