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A letter from the Chairman

We Enter this Period Strong

Put it all together, IBM today is a very different company, which is evident in our results. Since the dot-com crash in 2002, we have more than doubled our pre-tax income and free cash flow, and more than tripled our earnings per share. Our standout 2008 continued this record of superior performance.

REVENUE AND INCOME: Our revenue was a record $103.6 billion, up 5 percent. In 2008 we grew pre-tax income from continuing operations by 15 percent, to $16.7 billion, the highest ever.

MARGINS: IBM’s gross profit margin rose for the fifth consecutive year — to 44.1 percent, up 7.6 points since 2003. Our pre-tax income margin rose to 16.1 percent. Both margins are at their highest in more than a decade. We achieved this by driving productivity and continuing to shift our business mix to more profitable segments. More than 90 percent of our segment profit in 2008 was from software, services and financing.

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 $8.93, up 24 percent. This marked six straight years of double-digit EPS growth.

CASH FLOW: IBM has consistently generated strong cash flow. In 2008 our free cash flow, excluding the year-to-year change in Global Financing receivables, was $14.3 billion, an increase of $1.9 billion from 2007. Our business model has allowed us to generate more than $84 billion in free cash flow over the past nine years. IBM ended 2008 with $12.9 billion of cash and marketable securities.

INVESTMENT AND RETURN TO SHAREHOLDERS: Our superior cash flow has enabled us to invest in the business and to generate substantial returns to investors. Our 2008 cash investment was $6.3 billion for 15 acquisitions — 10 of them in key areas of software. And after investing $6.3 billion in R&D and $4.5 billion in net capital expenditures, we were able to return more than $13 billion to you—$10.6 billion through share repurchase and $2.6 billion through dividends. Last year’s dividend increase was 25 percent, marking the 13th year in a row in which we have raised our dividend.

In this environment, clients’ immediate needs are very clear: to save money, preserve capital and reduce costs. We help them do that, and our ability to deliver that kind of value is why they are continuing to choose IBM. It’s why our services business achieved its highest margin in the past five years. It’s why our software business continues to grow so robustly — with pre-tax profit doubling over the past five years, to $7 billion in 2008. And it’s why we continue to enjoy strength in high-utilization, high-performance infrastructure.

In sum, with our excellent financial position, strong balance sheet, solid recurring revenue, strong profit streams and unmatched global reach, we are confident about 2009 and are ahead of pace to achieve our 2010 objective of $10 to $11 in earnings per share. The information in “Generating Higher Value at IBM” will help explain why.

A Smarter Planet

The coming era will not be kind to enterprises or institutions that have failed to step up to unresolved issues in their core models, strategies or operations. In our view, this is not simply a cyclical downturn, but a major shift in the global economy and society — one that is simple to state, but profound in its implications.

In the last two decades, we have seen our planet become smaller and “flatter.” In the next two, we will see it become smarter.

This isn’t a metaphor, and I’m not talking about the Knowledge Economy — or even the fact that hundreds of millions of people from developing nations are gaining the education and skills to enter the global workforce. I mean the infusion of intelligence into the way the world actually works: the systems and processes that enable physical goods to be developed, manufactured, bought and sold; services to be delivered; everything from people and money to oil, water and electrons to move; and billions of people to work and live.

Through pervasive instrumentation and interconnection, almost anything — any person, any object, any process or any service, for any organization, large or small — can become digitally aware, networked and intelligent. This means that industries, infrastructures, processes and entire societies can be more productive, efficient and responsive. And problems that have heretofore been insoluble can now be tackled.

Problems like wasting too much energy. Like spending too much time in traffic. Like producing food too expensively, and wasting too much of what we produce. Like missing too many sales opportunities and disappointing too many customers because of inefficient supply chains. Like making too many medical errors, and spending too much to deliver healthcare to too few. And most obviously of late, like failing to manage financial risk.

These and other systems by which the world works are increasingly unsustainable. They may be networked, but it turns out that being connected isn’t enough. It doesn’t make them smart. But the good news is, they can be.

We know this because IBM is building these systems today, in collaboration with forward-thinking clients around the world. In them, we can see a foreshadowing of how banking will work, how telecommunications will work, how energy, healthcare, transportation and retail will work. We can see a world that is becoming smarter before our eyes.

SMARTER TRAFFIC: Stockholm’s intelligent traffic system, created by IBM, has resulted in 20 percent less gridlock, a 12-percent drop in emissions and a reported 40,000 additional daily users of public transport. IBM is building smart traffic systems in cities from London to Brisbane to Singapore — with many more being planned.

SMARTER POWER GRIDS: IBM today is leading seven of the world’s top ten automated meter management projects. Our intelligent utility network with CenterPoint Energy enables remote sensing and operation of the electric grid, connection and disconnection of service, fewer and shorter outages, improved customer service and the integration of new, environmentally friendly power sources such as wind and solar — as well as the charging of plug-in electric vehicles. In Malta, we will build the world’s first national smart grid, which will also instrument and monitor the country’s water systems.

SMARTER HEALTHCARE: The cost of therapy is being lowered by as much as 90 percent. For example, IBM technology is being used to monitor the proper delivery of injections and vaccines to more than 2 million patients in 38 states. And, partnering with Google and the Continua Health Alliance, we have introduced software that will enable data from personal medical devices to feed a patient’s electronic health record.

SMARTER FOOD SYSTEMS: IBM built a system for Norway’s largest food supplier that uses RFID technology to trace meat and poultry from the farm, through the supply chain, all the way to supermarket shelves.

SMARTER MONEY: Foreign currency exchange is the world’s largest single market. Thanks to a smart financial system IBM developed, intraday settlement risk for more than $2 trillion in daily volume — more than 60 percent of the world’s foreign exchange transactions — has been effectively eliminated. And through technology-enabled microfinance, organizations like Grameen Foundation and Financial Information Network and Operations Ltd. (FINO) are providing poor people around the world with collateral-free loans and financial services to support income-generating businesses.

SMARTER TELECOMMUNICATIONS: IBM is helping traditional telecom service providers, mobile and broadband operators and broadcasters transform their networks and services. IBM’s solutions are being used in India to deliver new services dynamically to support 185 million mobile phone subscribers — more than half of the total Indian market for mobile services.

SMARTER WATER: We can even use computer modeling to simulate, monitor — and potentially manage — the behavior of river basins around the world, as Water for Tomorrow, a collaboration between IBM and The Nature Conservancy, is now doing in Brazil, China and the U.S.

In every one of these examples — and there are many more — we see improved productivity, efficiency, responsiveness, profitability and societal benefit.

With so much technology and networking abundantly available at such low cost, what service wouldn’t you provide a customer, citizen, student or patient? What wouldn’t you connect? What information wouldn’t you mine for insight? The answer is, you — or your competitor — will do all of that. You will do it because you can, because the technology is both available and affordable.

And governments and societies around the world will do it because they must. As I talk to leaders everywhere from business, government and across civil society, I am hearing the same urgency for action, the same need for significant investment, and the same focus on not simply repairing what’s broken, but preparing for a new economy in a new century. In particular, there is widespread and growing recognition of the importance of smart infrastructure. Our conversations around the world are giving us confidence that IBM is well positioned to address society’s and businesses’ most urgent needs.

We will be aggressive in our pursuit of this opportunity. Indeed, you will be hearing and seeing much more about our smarter planet vision in the weeks and months ahead, as we establish our point of view, build the right relationships and offer smart solutions in the marketplace.

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Generating Higher Value

Annual Report page

Learn how IBM’s transformation has positioned us to help our clients and our shareholders succeed in turbulent times.

Smarter Planet

Earth

Will be instrumented, interconnected, intelligent. People want it. We can do it.