Skip to main content

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 2007 versus 2006 reportable segment results. The analysis of 2006 versus 2005 reportable segment results is in “Continuing Operations.”

The following table presents each reportable segment’s external revenue and gross margin results.

($ in millions)
For the year ended December 31: 2007 2006 Yr.-to-Yr.
Percent/
Margin
Change
Yr.-to-Yr.
Percent
Change
Adjusted
For
Currency
Revenue:
Global Technology Services $ 36,103 $ 32,322 11.7% 7.4%
Gross margin 29.9% 29.8% 0.1 pts.  
Global Business Services 18,041 15,969 13.0% 9.0%
Gross margin 23.5% 23.1% 0.4 pts.  
Systems and Technology 21,317 21,970 (3.0)% (5.8)%
Gross margin 39.7% 37.7% 2.0 pts.  
Software 19,982 18,161 10.0% 5.6%
Gross margin 85.2% 85.2% (0.0) pts.  
Global Financing 2,502 2,365 5.8% 2.2%
Gross margin 46.7% 50.3% (3.5) pts.  
Other 842 637 32.1% 29.5%
Gross margin 4.4% 5.7% (1.4) pts.  
Total revenue $ 98,786 $ 91,424 8.1% 4.2%
Gross profit $ 41,729 $ 38,295 9.0%  
Gross margin 42.2% 41.9% 0.4 pts.  

The following table presents each reportable segment’s external revenue as a percentage of total segment revenue and each reportable segment’s pre-tax income as a percentage of total segment pre-tax income.

Revenue Pre-Tax Income*
For the year ended
December 31:
2007 2006 2007 2006

* Segment pre-tax income includes transactions between segments that are intended to reflect an arm’s-length transfer price.

Global Technology Services 36.9% 35.6% 23.5% 24.0%
Global Business Services 18.4 17.6 13.6 12.5
Total Global Services 55.3 53.2 37.1 36.5
Systems and Technology 21.8 24.2 14.2 12.7
Global Financing 2.6 2.6 9.1 10.6
Total Systems and Technology/Financing 24.3 26.8 23.3 23.3
Software 20.4 20.0 39.6 40.1
Total 100.0% 100.0% 100.0% 100.0%

Global Services

The company’s Global Services segments, Global Technology Services and Global Business Services had a combined revenue of $54,144 million, an increase of 12.1 percent (8 percent adjusted for currency) in 2007 when compared to 2006. The Global Services segments delivered combined pre-tax profit of $5,622 million, an increase of 12.6 percent versus the prior year. The company has made considerable progress implementing its strategies across the Global Services offerings. These actions have resulted in improved financial performance with strong and balanced contribution across all geographies and business lines.

($ in millions)
For the year ended December 31: 2007 2006 Yr.-To-Yr.
Change
Global Services revenue: $ 54,144 $ 48,291 12.1%
Global Technology Services $ 36,103 $ 32,322 11.7%
Strategic Outsourcing 18,701 17,044 9.7
Integrated Technology Services 8,438 7,448 13.3
Business Transformation Outsourcing 2,294 1,845 24.4
Maintenance 6,670 5,986 11.4
Global Business Services $ 18,041 $ 15,969 13.0%

Global Technology Services (GTS) revenue increased 11.7 percent (7 percent adjusted for currency) in 2007 versus 2006. The strong performance reflects the extensive transformation which has occurred in this business over the past few years. This transformation included revamping the entire Integrated Technology Services (ITS) portfolio, continued improvement in Strategic Outsourcing (SO) delivery and a disciplined approach to driving new business in existing accounts. Total signings in GTS increased 2 percent, with shorter term signings growth of 4 percent and 1 percent growth in longer term signings.

SO revenue was up 9.7 percent (5 percent adjusted for currency) with growth in all geographies, led by Europe/Middle East/Africa (EMEA) and Asia Pacific. Revenue growth benefited from prior-year signings, sales of new business in existing accounts, lower base contract erosion and good yield from 2007 signings. SO signings in 2007 decreased 1 percent when compared to 2006.

ITS revenue increased 13.3 percent (9 percent adjusted for currency) in 2007 versus 2006. Revenue growth was driven primarily by increased signings and reflects the strength of the ITS portfolio worldwide. The revamped ITS portfolio includes 10 Service Product Lines which complement hardware offerings from Systems and Technology and software offerings from the Software business. The acquisition of Internet Security Systems (ISS), in the fourth quarter of 2006, also contributed to the revenue growth this year. ITS signings increased 4 percent in 2007, with good performance in the key offerings, including Green Data Center, Server Management Services and SOA.

Business Transformation Outsourcing (BTO) revenue increased 24.4 percent (20 percent adjusted for currency), with double-digit growth in all geographies. BTO signings increased 17 percent year over year.

Maintenance revenue increased 11.4 percent (7 percent adjusted for currency) driven primarily by increased availability services on non-IBM IT equipment. Services provided to InfoPrint Solutions, following the divestiture of the printer business in the second quarter, contributed 4 points of growth.

Global Business Services (GBS) revenue increased 13.0 percent (9 percent adjusted for currency) in 2007, with balanced growth across all three geographies. Revenue performance was led by double-digit growth in application management services offerings and growth in all consulting service lines. Total signings in GBS increased 1 percent, led by 5 percent growth in shorter term signings. Longer term signings decreased 7 percent year over year.

($ in millions)
For the year ended December 31: 2007 2006 Yr.-To-Yr.
Change
Global Services gross profit:
Global Technology Services:
Gross profit $ 10,800 $ 9,623 12.2%
Gross profit margin 29.9% 29.8% 0.1 pts.
Global Business Services:
Gross profit $ 4,240 $ 3,694 14.8%
Gross profit margin 23.5% 23.1% 0.4 pts.

GTS gross profit increased 12.2 percent compared to 2006, with gross profit margin improving 0.1 points, driven primarily by margin expansion in SO due to an improved cost structure and ITS, which benefited from a mix to higher value offerings. Segment pre-tax profit increased 8.2 percent to $3.6 billion with a pre-tax margin of 9.4 percent, a decline of 0.2 points versus 2006. Increased investments in sales and delivery, acquisitions and restructuring charges were essentially offset by productivity improvements and effective expense management.

Transformation actions executed by GBS over the past two years have resulted in profitable growth. GBS gross profit increased 14.8 percent to $4.2 billion in 2007 when compared to 2006, and the gross profit margin improved 0.4 points. Segment pre-tax profit increased 21.0 percent to $2.1 billion with a pre-tax margin of 10.7 percent, an improvement of 0.9 points year over year. The margin expansion has been driven primarily by revenue growth, ongoing productivity and utilization initiatives and expense management.

Global Services Signings

In 2007, total Global Services signings increased 1 percent year to year to $49,895 million. Shorter term signings were $22,014 million, an increase of 5 percent year to year. Longer term signings decreased 1 percent to $27,880 million, however, the average duration of longer term contracts signed in 2007 was 1.1 years shorter than contracts signed in 2006. Therefore, while longer term signings were essentially flat year to year, the annualized revenue expected from these signings is higher versus the prior year. GTS signings were $30,154 million and GBS signings were $19,741 million in 2007. The total Global Services backlog increased $2 billion from the prior year to an estimated $118 billion.

($ in millions)
For the year ended December 31: 2007 2006
Global Technology Services Signings
Longer term $ 21,550 $ 21,337
Shorter term 8,604 8,271
Total $ 30,154 $ 29,608
Global Business Services Signings
Longer term $ 6,330 $ 6,838
Shorter term 13,411 12,727
Total $ 19,741 $ 19,565

Global Services signings are management’s initial estimate of the value of a client’s commitment under a Global Services contract. Signings are used by management to assess period performance of Global Services management. There are no third-party standards or requirements governing the calculation of signings. The calculation used by management is an approximation of constant currency and 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. For example, for longer term contracts that require significant up-front investment by the company, the portions of these contracts that are a signing are those periods in which there is a significant economic impact on the client if the commitment is not achieved, usually through a termination charge or the client incurring significant wind-down costs as a result of the termination. For shorter term contracts that do not require significant upfront investments, a signing is usually equal to the full contract value. Longer term contracts represent SO and BTO contracts as well as GBS contracts with the U.S. Federal government and its agencies and Application Management Services (AMS) for custom and legacy applications. Shorter term contracts represent the remaining GBS offerings of Consulting and Systems Integration, AMS for packaged applications and ITS contracts. These amounts have been adjusted to exclude the impact of year-to-year currency changes.

Signings include SO, BTO, ITS and GBS 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.

Backlog includes SO, BTO, ITS, GBS, and Maintenance. 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 currency assumptions used to approximate constant currency.

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.

Systems and Technology

($ in millions)
For the year ended December 31: 2007 2006 Yr.-To-Yr.
Change
Systems and Technology revenue: $ 21,317 $ 21,970 (3.0)%
System z (11.2)
System i (10.6)
System p 8.8
System x 7.0
System Storage 5.1
Microelectronics (11.8)
Engineering and Technology Services 6.5
Retail Store Solutions 14.5
Printing Systems (63.1)

Systems and Technology revenue decreased 3.0 percent (6 percent adjusted for currency) in 2007 versus 2006. On June 1, 2007, the company completed the divestiture of its printing business to Ricoh. This resulted in the loss of approximately $600 million of Systems and Technology revenue in 2007 when compared to 2006. See note C, “Acquisitions/Divestitures,” for additional information regarding this divestiture. Systems and Technology revenue, excluding the printing business, was flat (declined 3 percent adjusted for currency) in 2007 versus 2006.

System z revenue decreased 11.2 percent (15 percent adjusted for currency) year to year. System z MIPS (millions of instructions per second) shipments increased 3 percent in 2007 versus 2006. System z revenue declined in the second half of 2007 following a long and successful technology cycle of over two-and-a-half years. The expected announcement and availability of the next generation mainframe is late February 2008.

System i revenue decreased 10.6 percent (14 percent adjusted for currency) in 2007 versus 2006. Although System i revenue declined year over year, fourth-quarter 2007 revenue increased 2 percent with growth in POWER6 servers which were introduced late in the third quarter of 2007.

System p revenue increased 8.8 percent (5 percent adjusted for currency) in 2007 versus 2006. The increase was primarily driven by strength in mid-range POWER5+ and POWER6 servers, which increased 23 percent in 2007 versus the prior year. System p revenue increased in all geographies, with particular strength in Asia Pacific. In the first quarter of 2008, the company will announce and ship POWER6 technology in System p’s entry segment.

System x revenue increased 7.0 percent (3 percent adjusted for currency) in 2007 versus 2006. Revenue performance was driven by System x server products which grew 8 percent and System x blades which increased 16 percent in 2007 versus 2006. The new x86 servers with quad-core processors and BladeCenter-S for the Small and Medium Business sector shipped in the fourth quarter and were well received in the market place.

System Storage revenue increased 5.1 percent (2 percent adjusted for currency) in 2007 versus 2006. The increase was primarily driven by 13 percent growth in tape products, while external disk products increased 1 percent in 2007. Enterprise tape products had strong double-digit revenue growth, while Midrange tape products had mid single-digit revenue growth. The company completed the acquisition of XIV in late December, which will further strengthen its storage portfolio in the long term. This acquisition positions the company to grow in emerging opportunities like Web 2.0 applications, digital archives and digital media.

Microelectronics revenue decreased 11.8 percent in 2007 versus 2006, driven by reduced demand for game processors. The Microelectronics OEM business has minimal impact to the company’s overall Net income, but this business continues to deliver key technology to the systems business, which is the fundamental objective of the company’s investment.

Retail Store Solutions revenue increased 14.5 percent (11 percent adjusted for currency) in 2007 versus 2006, primarily due to the continued roll out of new programmable point-of-sale solutions to large retail clients.

Printing Systems revenue decreased as a result of the divestiture of the business. The 2007 results include five months of revenue while the 2006 results include 12 months of revenue.

($ in millions)
For the year ended December 31: 2007 2006 Yr.-To-Yr.
Change
Systems and Technology gross profit:
Gross profit $ 8,468 $ 8,284 2.2%
Gross profit margin 39.7% 37.7% 2.0 pts.

The increase in Systems and Technology gross profit dollars for 2007 versus 2006 was primarily due to higher gross profit margins in System z, System p and System x servers. The Systems and Technology gross profit margin increased 2.0 points to 39.7 percent in 2007. System p performance contributed 1.3 points to the overall margin improvement, while System z and System x contributed 0.7 points and 0.4 points, respectively. These increases were partially offset by lower gross margins in System i of 0.2 points and System Storage 0.2 points.

Systems and Technology pre-tax margin expanded 2.1 points to 9.6 percent in 2007, reflecting a strong combination of operational cost management and the value that virtualization is driving in the enterprise space.

Software

($ in millions)
For the year ended December 31: 2007 2006* Yr.-To-Yr.
Change

* Reclassified to conform with 2007 presentation.

Software revenue: $ 19,982 $ 18,161 10.0%
Middleware $ 15,505 $ 13,891 11.6%
Key Branded Middleware 10,827 9,373 15.5
WebSphere Family 19.1
Information Management 14.7
Lotus 8.7
Tivoli 18.0
Rational 13.7
Other middleware 4,678 4,518 3.5
Operating Systems 2,319 2,273 2.0
Product Lifecycle Management 1,051 1,123 (6.4)
Other 1,107 874 26.7

Software segment revenue of $19,982 million increased 10.0 percent (6 percent adjusted for currency) in 2007 reflecting strong demand for the Key Branded Middleware products. Revenue performance was led by double-digit growth in the Financial Services, Public and Small and Medium Business sectors. Clients are using IBM middleware to effectively improve their operating leverage and business efficiency.

Revenue from Key Branded Middleware, which includes WebSphere, Information Management, Lotus, Tivoli and Rational products, was $10.8 billion, up 15.5 percent (11 percent adjusted for currency) and increased 3 points to 54 percent of total Software segment revenue. The company has invested heavily in these products, through internal investments and targeted acquisitions, and expects the majority of its software revenue growth to come from this portion of the product portfolio.

Revenue from the WebSphere Family of products increased 19.1 percent (14 percent adjusted for currency) and was led by double-digit growth in WebSphere Application Servers and WebSphere Business Integration software. The strong revenue performance reflects the industry’s adoption of SOA. The WebSphere products provide the foundation for Web-enabled applications and are a key product set in deploying a client’s SOA.

Information Management revenue increased 14.7 percent (10 percent adjusted for currency) in 2007 versus the prior year. Information Management software enables clients to leverage Information on Demand. The acquisition of FileNet, in the fourth quarter of 2006, contributed strong revenue growth throughout the year. The Cognos acquisition, completed in the first quarter of 2008, will provide a strong entry in the Business Intelligence marketplace and is expected to provide synergies in software, services, servers and storage.

Lotus revenue increased 8.7 percent (4 percent adjusted for currency) in 2007 driven by the Notes/Domino family of products. Lotus software is well established as a tool for providing improved workplace collaboration and productivity. Lotus Connections, released in the second quarter, has been rapidly adapted by customers. The latest version of Lotus Notes, Lotus Notes 8.0, was delivered in the third quarter of 2007.

Revenue from Tivoli software, infrastructure software that enables clients to centrally manage networks including security and storage capability, increased 18.0 percent (13 percent adjusted for currency) with double-digit growth in each segment of the portfolio, Systems Management, Security and Storage. The acquisitions of MRO, in the fourth quarter of 2006, and Vallent and Consul, in the first quarter of 2007, also contributed to the brand’s revenue growth.

Rational revenue increased 13.7 percent (9 percent adjusted for currency) in 2007 which reflected strong customer acceptance of the integrated product set. Rational provides integrated tools to improve the software development process for clients. The closing of the Telelogic acquisition is conditioned upon satisfactory completion of regulatory reviews in the European Union. Telelogic’s suite of system programming tools complements Rational’s IT tool set, providing a complete tooling solution across a client’s enterprise.

Revenue from Other middleware products increased 3.5 percent (flat adjusted for currency) in 2007 versus the prior year. This software product set includes more mature products which provide a more stable flow of revenue.

Operating Systems revenue increased 2.0 percent (decreased 2 percent adjusted for currency) in 2007 versus 2006.

Product Lifecycle Management (PLM) revenue decreased 6.4 percent (11 percent adjusted for currency) in 2007 driven by declines in the Small and Medium Business sector. PLM software helps companies improve their product development processes and their ability to use product-related information across their businesses.

Other software segment revenue increased 26.7 percent (22 percent adjusted for currency) versus 2006 reflecting growth in software-related services, such as consulting and education.

($ in millions)
For the year ended December 31: 2007 2006 Yr.-To-Yr.
Change
Software gross profit:
Gross profit $ 17,015 $ 15,471 10.0%
Gross profit margin 85.2% 85.2% 0.0 pts.

Software segment gross profit increased 10.0 percent to $17.0 billion in 2007, driven primarily by strong revenue growth. Gross profit margin was 85.2 percent in 2007, flat versus the prior year.

The Software segment contributed $6.0 billion of pre-tax profit in 2007, an increase of 9.3 percent versus 2006. The segment pre-tax profit margin of 26.8 percent was essentially flat (declined 0.1 pt) versus the prior year, reflecting the integration of acquired businesses.

Global Financing

See “Results of Operations” in “Global Financing” for an analysis of Global Financing’s revenue and gross profit.

Geographic revenue

In addition to the revenue presentation by reportable segment, the company also measures revenue performance on a geographic basis.

The following geographic, regional and country-specific revenue performance excludes OEM revenue, which is presented separately.

($ in millions)
For the year ended December 31: 2007 2006 Yr.-To-Yr.
Change
Geographies:
Americas $ 41,122 $ 39,511 4.1%
EMEA 34,699 30,491 13.8
Asia Pacific 19,501 17,566 11.0
OEM 3,465 3,856 (10.1)
Total $ 98,786 $ 91,424 8.1%

From a geographic perspective, revenue increased in all geographies in 2007 when compared to 2006. Adjusted for currency, revenue growth was led by Asia Pacific and steady performance throughout the year in EMEA.

Americas’ revenue increased 4.1 percent (3 percent adjusted for currency) in 2007. Revenue increased in all regions with the U.S. up 2.9 percent, Canada 8.4 percent (2 percent adjusted for currency) and Latin America 8.6 percent (2 percent adjusted for currency).

EMEA revenue increased 13.8 percent (5 percent adjusted for currency) in 2007 when compared to 2006. Within the European market, IT spending grew at a moderate rate, and the company’s mid single-digit revenue growth rates throughout 2007 reflected that environment. In the major countries, Spain’s revenue grew 21.7 percent (11 percent adjusted for currency), while Germany’s revenue increased 14.6 percent (5 percent adjusted for currency) and the U.K.’s revenue increased 11.3 percent (3 percent adjusted for currency). France’s revenue increased 10.2 percent (1 percent adjusted for currency) and Italy’s revenue grew 8.7 percent (decreased 1 percent adjusted for currency).

Asia Pacific revenue increased 11.0 percent (8 percent adjusted for currency) year over year. Growth was led by strong performance in the India, Greater China, Australia/New Zealand, ASEAN and Korea regions, where the economies remain strong, with combined revenue growth of 23.8 percent (17 percent adjusted for currency). Japan revenue, which represents 49 percent of the Asia Pacific revenue base, was flat (increased 1 percent adjusted for currency) in 2007 when compared to 2006, reflecting a slower economy.

Across the geographies, the emerging BRIC countries of Brazil, Russia, India, and China together grew 26.3 percent (18 percent adjusted for currency), reflecting the investments made to build capabilities and capture opportunities in these countries. Brazil’s revenue increased 14.3 percent (1 percent adjusted for currency), while Russia’s revenue grew 30.3 percent (30 percent adjusted for currency). India’s revenue increased 37.9 percent (26 percent adjusted for currency) and China’s revenue increased 32.5 percent (29 percent adjusted for currency). In addition to the BRIC markets, the company has also had strong revenue growth in other nations where there is strong demand for business and IT infrastructure solutions.

Revenue growth rates, as reported, were impacted in 2007 as a result of the divestiture of the printing business on June 1, 2007. Revenue, excluding the printing business in both years, increased as follows compared to 2006:

  • Americas—5.2%
  • EMEA—14.5%
  • Asia Pacific—11.8%
  • IBM Consolidated—8.9%

The company believes that the analysis that excludes the printing business revenues is a better indicator of operational performance on an ongoing basis.

OEM revenue decreased 10.1 percent (10 percent adjusted for currency) in 2007 when compared to 2006, driven by a slowdown in demand for game processors.

Total expense and other income

($ in millions)
For the year ended December 31: 2007 2006 Yr.-To-Yr.
Change
Total expense and other income $ 27,240 $ 24,978 9.1%
Expense to Revenue 27.6% 27.3% 0.3 pts.

Total expense and other income increased 9.1 percent (5 percent adjusted for currency) in 2007 versus 2006. Overall, the increase was primarily due to increased Selling, general and administrative (SG&A) expense and Interest expense. SG&A expense increased $1,801 million primarily due to acquisition related spending, as well as increased investments in emerging countries and the software and services businesses. Interest expense increased $333 million primarily due to higher debt associated with the financing of the ASR agreements. In addition, Other (income) and expense declined $140 million in income primarily due to higher losses on derivative instruments. The expense-to-revenue ratio increased 0.3 points to 27.6 percent in 2007, as revenue increased 8.1 percent and expense increased 9.1 percent in 2007 versus 2006. For additional information regarding the increase in Total expense and other income, see the following analyses by category:

Selling, General and Administrative
($ in millions)
For the year ended December 31: 2007 2006* Yr.-To-Yr.
Change

* Reclassified to conform with 2007 presentation as the Restructuring category ($33 million in 2007 and $15 million in 2006) was combined into the SG&A—base category.

NM—Not meaningful
Selling, general and administrative—base $ 19,078 $ 17,457 9.3%
Advertising and promotional expense 1,242 1,195 3.9
Workforce reductions—ongoing 318 272 16.6
Amortization expense—acquired intangibles 234 220 6.7
Retirement-related expense 607 587 3.5
Stock-based compensation 480 541 (11.3)
Bad debt expense 100 (13) NM
Total $ 22,060 $ 20,259 8.9%

Total SG&A expense increased 8.9 percent (6 percent adjusted for currency). The increase was primarily driven by acquisition-related spending (3 points), the effects of currency (3 points) and investments in the software and services businesses, as well as emerging markets. These investments reflect the continuing business mix shift to higher value offerings which require higher operating expenses. The returns on these investments are reflected in the momentum in Key Branded Middleware offerings, growth in emerging markets and improved Global Services revenue. In addition, Bad debt expense increased $113 million primarily due to an increase in the provision for doubtful accounts. The reserve coverage for receivables at year end was 1.5 percent, essentially flat versus year-end 2006. Workforce reductions—ongoing increased as a result of actions taken to address cost issues in GTS, primarily in SO, during the second quarter of 2007.

Other (Income) and Expense
($ in millions)
For the year ended December 31: 2007 2006* Yr.-To-Yr.
Change

* Reclassified to conform with 2007 presentation deleting 2006 categories for Restructuring $(7) million and $(45) million for Lenovo/Microsoft gains and combining these items in the Other category for both years.

Foreign currency transaction gains $ (143) $ (130) 10.1%
Losses on derivative instruments 382 135 183.5
Interest income (565) (536) 5.3
Net gains from securities and investments assets (68) (40) 68.5
Net realized gains from certain real estate activities (18) (41) (56.0)
Other (214) (154) 39.3
Total $ (626) $ (766) (18.3)%

Other (income) and expense was income of $626 million and $766 million in 2007 and 2006, respectively. The decrease in income was primarily due to higher losses on derivative instruments. The company hedges its major cross-border cash flows to mitigate the effect of currency volatility in the year-over-year results. The impact of these hedging programs is primarily reflected in Other (income) and expense, as well as cost of goods sold. This year, losses from derivatives, as a result of currency movements, resulted in $247 million of year-to-year impact to Other (income) and expense. This decrease in income was partially offset by a gain from the divestiture of the printing business in the second quarter and sales of Lenovo stock in the first and second quarters of 2007 (see note C, “Acquisitions/Divestitures,” for additional information).

Research, Development and Engineering
($ in millions)
For the year ended December 31: 2007 2006 Yr.-To-Yr.
Change
Research, development and engineering:
Total $ 6,153 $ 6,107 0.8%

The increase in Research, development and engineering (RD&E) expense was primarily driven by acquisitions and investments to maintain technology leadership across the product offerings. Software spending increased $339 million partially offset by lower Systems and Technology spending of $204 million in 2007 versus 2006. Retirement-related expense increased $13 million in 2007 versus 2006, while stock-based compensation expense decreased $21 million year over year.

Intellectual Property and Custom Development Income
($ in millions)
For the year ended December 31: 2007 2006 Yr.-To-Yr.
Change
Sales and other transfers of intellectual property $ 138 $ 167 (17.7)%
Licensing/royalty-based fees 368 352 4.6
Custom development income 452 381 18.8
Total $ 958 $ 900 6.4%

The timing and amount of Sales and other transfers of IP may vary significantly from period to period depending upon timing of divestitures, industry consolidation, economic conditions and the timing of new patents and know-how development. There were no significant IP transactions in 2007 and 2006.

Interest Expense
($ in millions)
For the year ended December 31: 2007 2006 Yr.-To-Yr.
Change
Interest expense:
Total $ 611 $ 278 119.6%

The increase in Interest expense was primarily due to the increase in debt to finance the ASR agreements. See note M, “Stockholders’ Equity,” for additional information regarding this transaction. Interest expense is presented in Cost of Financing in the Consolidated Statement of Earnings only if the related external borrowings are to support the Global Financing external business. See “Global Financing” for additional information regarding Global Financing debt and interest expense.

Stock-based compensation

Total pre-tax stock-based compensation cost of $713 million decreased $134 million compared to 2006. The decrease was principally the result of a reduction in the level of stock option grants ($159 million), offset by an increase related to restricted and performance-based stock units ($25 million). The effects of stock-based compensation cost related to the divestiture of the printing business (a decrease of $1 million) were included in Other (income) and expense in the Consolidated Statement of Earnings. The year-to-year reductions in pre-tax stock-based compensation cost were reflected in the following categories: Cost ($50 million); SG&A expense ($61 million); RD&E expense ($21 million) and Other (income) and expense ($1 million).

There was no significant capitalized stock-based compensation cost at December 31, 2007 and 2006.

See note T, “Stock-Based Compensation,” for additional information on the company’s stock-based incentive awards.

Retirement-related benefits

The following table provides the total pre-tax cost for all retirement-related plans. Cost amounts are included as an addition to the cost and expense amounts 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)
For the year ended December 31: 2007 2006 Yr.-To-Yr.
Change
Defined benefit and contribution pension plans cost $ 2,198 $ 2,040 7.7%
Nonpension postretirement plans costs 399 388 2.8
Total $ 2,597 $ 2,428 7.0%

Overall, retirement-related plan costs increased $169 million versus 2006. The increase in retirement-related plan costs was driven primarily as a result of changes in retirement plan assumptions as well as the impact of changes in foreign currency.

Retirement-related plan costs increased approximately $131 million in Cost, $21 million in SG&A expense, $13 million in RD&E expense and $5 million in Other (income) and expense year to year. See note U, “Retirement-Related Benefits,” for additional information on the company’s benefit plans including a description of the plans, plan financial information and assumptions.

Acquired intangible asset amortization

The company has been investing in targeted acquisitions primarily in its Software and Global Services segments to increase its capabilities in higher value market segments. The following table presents the total acquired intangible asset amortization included in the Consolidated Statement of Earnings. See note I, “Intangible Assets Including Goodwill,” for additional information.

($ in millions)
For the year ended December 31: 2007 2006* Yr.-To-Yr.
Change

* Reclassified to conform with 2007 presentation of Services and Selling, general and administrative expense categories.

NM—Not meaningful
Cost:
Software $ 91 $ 81 12.6%
Services 42 12 252.7
Hardware 3 NM
Selling, general and administrative expense 234 220 6.7
Total $ 367 $ 316 16.3%

Income taxes

The effective tax rate for 2007 was 28.1 percent, compared with 29.3 percent in 2006. The 1.2 point decrease was primarily driven by the absence of the one-time tax cost associated with the intercompany transfer of certain intellectual property in the fourth quarter of 2006 (4.3 points) and the absence of the benefit from the settlement of the U.S. federal income tax audit for the years 2001 through 2003, also in the fourth quarter of 2006 (3.0 points). The company also benefitted in 2007 from a more favorable mix of income in lower tax rate jurisdictions and increased capital loss and state credit benefits, offset by a reduction in certain tax incentives.

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 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, stock awards, convertible notes and shares which may be required to settle ASR agreements.

For the year ended December 31: 2007 2006 Yr.-To-Yr.
Change
NM—Not meaningful
Earnings per share of common stock:
Assuming dilution:
Continuing operations $ 7.18 $ 6.06 18.5%
Discontinued operations (0.00) 0.05 NM
Total $ 7.18 $ 6.11 17.5%
Basic:
Continuing operations $ 7.32 $ 6.15 19.0%
Discontinued operations (0.00) 0.05 NM
Total $ 7.32 $ 6.20 18.1%
Weighted-average shares outstanding (in millions):
Assuming dilution 1,450.6 1,553.5 (6.6)%
Basic 1,423.0 1,530.8 (7.0)%

Actual shares outstanding at December 31, 2007 and December 31, 2006 were 1,385.2 million and 1,506.5 million, respectively. The average number of common shares outstanding assuming dilution was 103.0 million shares lower in 2007 versus 2006. The decrease was primarily the result of the company’s common share repurchase program. See note M, “Stockholders’ Equity Activity,” for additional information regarding common share activities. Also see note R, “Earnings Per Share of Common Stock”.

Dynamics

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 below are the consolidated amounts including Global Financing. The amounts appearing in the separate “Global Financing” section are supplementary data presented to facilitate an understanding of the Global Financing business.

In 2007, the company repurchased $18.8 billion of its outstanding common stock, of which $12.5 billion was the initial purchase price of the shares repurchased through ASR agreements. Under the agreements, which were executed on May 25, 2007, the company repurchased 118.8 million shares from three banks for an initial price of $105.18 per share. The banks were expected to purchase an equivalent number of shares in the open market in the nine month period following May 25, 2007. As discussed in note M, “Stockholders’ Equity Activity,” the initial price of the ASR is subject to an adjustment based on the volume weighted average price of the shares during this period and this adjustment will be recorded in Stockholders’ equity in the Consolidated Statement of Financial Position on each of the settlement dates. The first settlement occurred on September 6, 2007, resulting in a settlement payment by the company of $151.8 million; the second settlement occurred on December 5, 2007, resulting in a settlement payment by the company of $253.1 million. The final settlement is expected to occur in March 2008.

The ASR transaction was guaranteed by the company and was executed through IBM International Group (IIG), a wholly owned foreign subsidiary of the company. The formation of IIG enabled the company to create a centralized foreign holding subsidiary to own most of its non-U.S. operations. IIG funded the repurchases with $1 billion in cash and an $11.5 billion, 364-day bridge loan with a number of financial institutions. The bridge loan was guaranteed by the company and carries an interest rate of the LIBOR plus 10 basis points. Principal and interest on IIG debt will be paid by IIG with cash generated by its non-U.S. operating subsidiaries. The execution of the ASR enabled the company to achieve a substantial share reduction, a lower cost of capital and an effective use of non-U.S. cash.

In the second half of 2007, IBM International Group Capital LLC (IIGC), an indirect, wholly owned subsidiary of the company, issued $4.1 billion in long-term debt and $2.8 billion in commercial paper. These proceeds were utilized to refinance the bridge loan associated with the ASR. In addition, approximately $750 million of the original amount has been repaid. At December 31, 2007, the outstanding balance of the bridge loan was $3.9 billion.

In addition, on January 29, 2008, IIGC issued $3.5 billion of 18-month floating rate notes. The proceeds will be utilized to further reduce the bridge loan associated with the ASR.

Consistent with retirement and postretirement plan accounting standards, the company remeasures the funded status of its plans at December 31. The funded status is measured as the difference between the fair value of the plan assets and the benefit obligation. The funded status is recognized in the Consolidated Statement of Financial Position. (See note A, “Significant Accounting Policies,” for additional information). At December 31, 2007, as a result of the company’s plan contributions, returns on plan assets and changes in certain retirement plan assumptions, the overall net funded status improved $7.2 billion from December 31, 2006 to a net over-funded position of $3.3 billion. This change is primarily reflected in Prepaid pension assets in the Consolidated Statement of financial position which increased $6.8 billion from the prior year-end balance.

In addition, Stockholders’ equity improved $4.7 billion as a result of changes from pension remeasurements and current year activity within Accumulated gains and (losses) not affecting retained earnings. See note U, “Retirement-Related Benefits,” for additional information.

Working capital

($ in millions)
At December 31: 2007 2006
Current assets $ 53,177 $ 44,660
Current liabilities 44,310 40,091
Working capital $ 8,867 $ 4,569
Current ratio 1.20 1.11

Working capital increased $4,298 million compared to the prior year primarily as a result of a net increase in Current assets. The key drivers are described below:

Current assets increased $8,517 million due to:

  • An increase of $5,490 million in Cash and cash equivalents and Marketable securities including a $299 million currency impact. See Cash Flow analysis below.
  • An increase of $1,941 million in short-term receivables driven by:
    • increase of $460 million in financing receivables due to asset growth in commercial financing and client loans; and
    • approximately $1,325 million currency impact.
  • An increase of $1,351 million in Prepaid expenses and other current assets primarily resulting from:
    • an increase of $335 million in derivative assets primarily due to changes in foreign currency rates for certain cash flow hedges;
    • an increase of $164 million due to prepaid software for services contracts ($94 million) and maintenance agreements ($70 million);
    • an increase of $170 million in prepaid taxes;
    • an increase of $128 million in deferred services arrangements transition costs; and
    • approximately $158 million currency impact.

Current liabilities increased $4,220 million as a result of:

  • An increase of $3,333 million in Short-term debt primarily driven by increases in commercial paper;
  • An increase of $1,215 million in Deferred income mainly driven by Software ($502 million) and Global Technology Services ($543 million);
  • An increase of $528 million in Other accrued liabilities primarily due to an increase in derivative liabilities as a result of changes in foreign currency rates for hedges of net investment; partially offset by
  • A decrease of $997 million in Taxes payable primarily due to the adoption of FASB Interpretation Number (FIN) 48, “Accounting for Uncertainty in Income Taxes” (FIN 48); consistent with the provisions of FIN 48, $2,066 million of income tax liabilities on January 1, 2007 was reclassified from current to noncurrent liabilities; this was offset by current year income tax activity.

Cash flow

The company’s cash flow from operating, investing and financing activities, as reflected in the Consolidated Statement of Cash Flows, is summarized in the following table. These amounts include the cash flows associated with the Global Financing business.

($ in millions)
For the year ended December 31: 2007 2006
Net cash provided by/(used in) continuing operations:
Operating activities $ 16,094 $ 15,019
Investing activities (4,675) (11,549)
Financing activities (4,740) (8,204)
Effect of exchange rate changes on cash and cash equivalents 294 201
Net cash used in discontinued operations—Operating activities (5) (12)
Net change in cash and cash equivalents $ 6,969 $ (4,546)

Net cash from operating activities for 2007 increased $1,075 million as compared to 2006 driven by the following key factors:

  • An increase in Net income of $925 million;
  • A decrease in cash related to deferred income taxes of $984 million primarily due to the impact of pension activity;
  • Retirement-related cash flows increased $622 million primarily due to lower pension funding of $795 million year to year;
  • Growth in accounts receivable drove a use of cash of $896 million; this was driven by Global Financing receivables ($1,045 million) as a result of asset growth;
  • Other assets/other liabilities drove an increase in cash of $1,587 million primarily resulting from:
    • an increase in cash from tax liabilities of $1,185 million mainly driven by an increase in income tax provisions and reserves; and
    • an increase in cash from deferred income of $398 million primarily due to prepayment of future services to be provided to Infoprint.

Net cash used in investing activities decreased $6,874 million on a year-to-year basis driven by:

  • The net impact of the purchases and sales of marketable securities and other investments resulted in an increase in cash of $4,006 million;
  • A decrease of $2,790 million utilized for acquisitions (See note C, “Acquisitions/Divestitures,” for additional information); and
  • An increase of $310 million received from divestitures driven by the printing business transaction;

Partially offset by:

  • An increase in net capital spending of $231 million resulting from:
    • an increase of $160 million primarily driven by Global Technology Services to support the outsourcing business; and
    • an increase of $71 million in capitalized software development expenditures.

Net cash used in financing activities decreased $3,464 million compared to 2006 as a result of:

  • An increase of $12,233 million in net cash proceeds from debt transactions primarily from issuances in support of the ASR; and
  • An increase of $2,438 million due to higher other common stock transactions mainly due to stock option exercises;

Partially offset by:

  • Higher common stock repurchases of $10,744 million driven by the ASR; and
  • Higher dividend payments of $464 million as a result of the increase in the common stock dividend from $1.10 to $1.50 per share.

Within total debt, on a net basis, the company had $12,112 million in net cash proceeds from new debt versus $121 million in net cash used in 2006 to retire debt. The net proceeds from new debt in 2007 was comprised of: $21,744 million of new debt issuances and $1,674 million in net short-term borrowings, partially offset by $11,306 million in cash payments to settle debt. See note J, “Borrowings,” for a listing of the company’s debt securities.

Noncurrent assets and liabilities

($ in millions)
At December 31: 2007 2006
Noncurrent assets $ 67,254 $ 58,574
Long-term debt $ 23,039 $ 13,780
Noncurrent liabilities (excluding debt) $ 24,612 $ 20,857

The increase in Noncurrent assets of $8,680 million compared to the prior year-end balance was primarily driven by:

  • An increase of $6,788 million ($505 million due to currency) in Prepaid pension assets primarily resulting from an increase in overfunded pension plans reflecting year-end remeasurements;
  • An increase of $1,535 million ($526 million due to currency) in Long-term financing receivables mainly due to increased Global Financing volumes;
  • An increase of $1,431 million ($347 million due to currency) in Goodwill driven by acquisitions in 2007; and
  • An increase of $642 million in Plant, rental machines and other property (net) effectively all due to currency effects.

These increases were partially offset by:

  • A decrease of $1,621 million in Investments and sundry assets primarily resulting from:
    • a decrease of $2,367 million in noncurrent deferred tax assets primarily related to the pension remeasurements;
    • growth of $243 million in noncurrent deferred transition costs driven by an increase in long-term services arrangements with clients; and
    • $170 million due to increased investments in long-term marketable securities.

Long-term debt increased $9,259 million due to new borrowings in 2007 primarily to finance the ASR agreements. See note M, “Stockholders’ Equity Activity,” for detailed discussion.

Other Noncurrent liabilities, excluding debt, increased $3,755 million primarily driven by:

  • An increase in noncurrent tax reserves of $2,107 million as a result of a reclassification from current ($2,066 million) related to FIN 48 implementation and current year activity;
  • Growth of $558 million in noncurrent deferred income mainly driven by Global Technology Services;
  • An increase of $399 million in noncurrent deferred tax liabilities primarily due to pension remeasurement; and
  • An increase of $298 million in long-term derivative liabilities due to changes in foreign currency rates for hedge of net investments.

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: 2007 2006
Total company debt $ 35,274 $ 22,682
Total Global Financing segment debt $ 24,532 $ 22,287
Debt to support external clients 21,072 18,990
Debt to support internal clients 3,460 3,297

The Global Financing business provides funding 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 nature, 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.

Non-Global Financing debt increased $10,348 million and the debt-to-capital ratio at December 31, 2007 was 30.0 percent. Non-Global Financing debt increased versus 2006 primarily due to the financing of the ASR agreements in the second quarter of 2007. The debt-to-capital ratio was 46.7 percent at June 30, 2007. A reduction of $1,034 million in non-Global Financing debt and an increase of $11,554 million in equity has reduced the ratio from the half-year point. See note M, “Stockholders’ Equity Activity,” for detailed information.

Equity

($ in millions)
At December 31: 2007 2006
Stockholders’ equity:
Total $ 28,470 $ 28,506

The company’s consolidated Stockholders’ equity decreased $36 million in 2007 as a result of several key factors:

  • A decrease related to net stock transactions of $13,732 million, driven by common stock repurchases which resulted in an increase in Treasury stock in 2007.

This reduction was offset by:

  • An increase of $8,208 million in Retained earnings primarily driven by Net income of $10,418 million, partially offset by dividends ($2,147 million); and
  • An increase of $5,487 million in Accumulated gains and (losses) not affecting retained earnings primarily resulting from the non-cash equity impacts related to an increase in overfunded pension plans reflecting year-end remeasurements.
Previous
|Next
Back to Top