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Management discussion
International Business Machines Corporation and Subsidiary Companies

Other Information

Looking forward

Looking forward, the company enters 2008 in an excellent operational and financial position.

The company has a significant global presence, operating in 170 countries, with approximately 63 percent of its revenue generated outside the U.S. In addition, approximately 69 percent of the company’s employees are located outside the United States, including about 35 percent in Asia Pacific. This global reach gives the company access to markets, with well-established organizations and management systems who understand the clients and their challenges and who can respond to these opportunities with value-add solutions. The company’s transformation to a globally integrated enterprise provides the capabilities to service clients globally and deliver the best skills and cost from anywhere in the world.

In emerging markets, the company will continue to invest for revenue growth and leadership. The company is focused on identifying growth opportunities and following a disciplined investment policy to capitalize on these opportunities. The company has had good success in the emerging markets of Brazil, Russia, India and China. In addition, there are additional opportunities around the world that are growing at a rapid rate; countries and markets within Southeast Asia, Eastern Europe, the Middle East and Latin America that have market growth rates greater than the global average. Through its investments, the company has developed extensive capabilities in emerging countries to capture these growth opportunities. In 2008, the company will also implement a new organization and management structure that will focus on these emerging nations and markets.

The company is a proven infrastructure provider of IT technology. Through its history, the company has built the infrastructure in most countries that are now considered to have “mature” economies. This track record will enable the company to capture opportunities in new, expanding markets worldwide. The company’s broad product and services portfolio delivers value to clients—through a combination of services, hardware and software. The portfolio is focused on high-value solutions that can deliver measurable benefit to clients with offerings that can address a wide scope of client issues including: energy savings, security and resiliency, risk management and cost reduction among many others.

The company remains committed to technology leadership and will continue to focus internal investments, complemented with strategic acquisitions, on high-value, high-growth opportunities. The company invested over $6 billion in RD&E in 2007 and approximately $30 billion over the past five years.

In addition, the company’s financial position is strong. Through its efficient cash generation business model based on disciplined balance sheet management, in 2007, the company generated $12.4 billion in free cash flow and ended the year with $16.1 billion in cash and marketable securities. This provides the company with the financial flexibility for investments in changing business environments. The company also has a significant annuity content in its business which reduces its business risk versus more transaction-dependent business models.

In May 2007, the company met with investors and analysts and discussed a road map to deliver earnings per share in 2010 in the range of $10 to $11 per share, or 14 to 16 percent compound growth rate from 2006. The company’s 2010 road map is to generate earnings per share growth through a combination of revenue growth, margin improvement, growth initiatives, acquisitions, the current projected benefit of retirement-related cost and effective capital deployment to fund growth and provide returns to shareholders through dividends and common stock repurchases.

The company’s performance in 2007 highlighted the benefits of its global reach and the strength of its business model. The financial results reflected solid progress on major elements of the long-term goals, however, the company measures the success of its business model over the long term, not any individual quarter or year. The company’s strategies, investments and actions are all taken with an objective of optimizing long-term performance.

The continued investments in Software have led to this segment’s emergence as a strong source of revenue growth and the largest contributor to the company’s profit in 2007. The Software business is differentiated in the industry by both the strength of its individual products and the breadth of the software offerings. The key to continued Software growth stems from the ability to maintain and grow this industry-leading software business, and by continuing to capitalize on industry trends such as SOA and Information on Demand. The company expects to accomplish this through a combination of internal development and strategic acquisitions. These products will be rapidly developed and integrated to bring continued value to clients.

Within the Global Services business, revenue and profit growth improved and the company saw significant results from the targeted actions and investments it has made the last few years. The Global Services business enters 2008 with a revenue backlog of $118 billion, an increase of $2 billion from the prior year. The portfolio is strong with a complement of offerings and capabilities that deliver both high value and productivity to clients. The overall Global Services business is well-positioned going forward.

In the Systems and Technology business, the company will focus its investments on differentiating technologies with high-growth potential including POWER6, BladeCenter-S, high-performance computing, virtualization and energy efficiency. The transition to POWER6 technology will be completed in the first half of 2008. New POWER-based virtualization offerings will be announced to extend the company’s lead in UNIX virtualization. The next generation mainframe product will be available beginning late in the first quarter—that quarter will likely be a period of transition with benefits coming in the second quarter. This product will have fifty percent more capacity than the current system and will extend the company’s leadership in energy efficiency, security and resiliency. The December, 2007 acquisition of XIV will strengthen the storage portfolio with solutions based on XIV architecture expected to be announced in 2008.

The company expects 2008 pre-tax retirement-related plan cost to be approximately $1.6 billion—a decrease of $950 million to $1 billion compared to 2007. This estimate reflects current pension plan assumptions and the impacts of pension plan redesign efforts. See note U, “Retirement-Related Benefits,” for additional information. The actual return on the IBM Personal Pension Plan (PPP) assets in 2007 was 14 percent, compared to a 15 percent return in 2006.

The company expects that its effective tax rate in 2008 will be approximately 27.5 percent. This rate is lower than the 2007 tax rate of 28.1 percent due to an expectation of a more favorable mix of income in lower tax jurisdictions. The rate will change year to year based on non-recurring events, such as the settlement of income tax audits, as well as recurring factors including the geographic mix of income before taxes, the timing and amount of foreign dividend repatriation, state and local taxes and the effects of various global income tax strategies.

In 2007 and 2006, the company’s cash tax rate was approximately 18 percent and 16 percent, respectively.

The company’s cash tax rate represents the amount of income taxes paid during the year over Income from continuing operations before income taxes. The cash tax rate differs from the company’s effective tax rate due to a number of variables including, but not limited to, certain items of income and expense that are recognized in different years for financial reporting purposes than for income tax purposes, differences in currency rates used in the translation of the non-U.S. income tax provision and income tax payments and current year cash tax payments or refunds that are related to prior years. The company anticipates that its cash tax rate may increase in the near term as a result of the settlement of audits.

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