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Management discussion
International Business Machines Corporation and Subsidiary Companies

Other information

Looking forward

Looking forward, the company enters 2009 in an excellent operational and financial position. The company has shifted its business to higher value services and software, with less dependence on commoditizing and cyclical businesses. The Global Services business in 2008 contributed 42 percent of total segment pre-tax income and managed over 60 percent of the company’s resources. The company’s software capabilities have grown through internal investment and acquisitions with Software segment pre-tax profit more than doubling in the past five years to over $7 billion in 2008. In 2008, over 80 percent of segment pre-tax profit came from Global Services and Software, and over 90 percent from Global Services, Software and Global Financing. The company has changed the profile of the business to make it more adaptable to different business environments.

The company enters 2009 and the current market from a position of strength. The company will take advantage of the environment to continue to execute its strategies.

The company has a significant global presence, operating in over 170 countries, with approximately 65 percent of its revenue generated outside the U.S. 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 by capturing new infrastructure spending in these markets. While some of these economies have slowed, these markets still offer good growth opportunities relative to the rest of the world.

The company has developed a strong value proposition for the established markets based on cost reduction, capital conservation and risk management. The high value, integrated offerings, including green data centers, outsourcing and virtualization on high-end systems, have performed well in these markets in the current environment.

Looking forward, the company’s “Smarter Planet” agenda will provide an important new opportunity to deliver value to clients. The company anticipates a significant opportunity in “smart infrastructure” projects as governments around the world implement economic stimulus programs focused on next generation smart grids, healthcare-related information technology and broadband. Projects of these types require technology integration and industry insight which should uniquely position the company to participate in these opportunities.

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 2008 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 2008, the company generated $18.8 billion in operating cash flow and ended the year with $12.9 billion in cash and marketable securities. This provides the company with the financial flexibility for investments in changing business environments. The company will also continue to focus on cost and expense reduction and improved efficiency. In 2008, those efforts translated to margin expansion and the company expects this to continue into 2009.

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 in the range of $9 to $10 per share, or 10 to 14 percent growth from 2006 through a combination of revenue growth, margin improvement, growth initiatives, acquisitions and effective capital deployment to fund growth and provide returns to shareholders through dividends and common stock repurchases.

In addition to these elements, the company’s roadmap to the $10 to $11 per share range includes the projected benefit of retire­ment-related costs based on December 31, 2006 assumptions. Actual retirement-related costs will depend on several factors including financial market performance, the interest rate environment and actuarial assumptions. In March 2008, the company met again with investors and analysts and discussed the progress the company is making on its 2010 roadmap.

The company’s performance in 2008 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. Earnings per share growth is dependent on a number of factors and may not be consistent throughout the periods. 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 2008 and 2007. The Software business is differentiated in the industry by both the strength of its individual products and the breadth of the software offerings. Clients continue to rely on the extensive middleware portfolio to help them transform their business, streamline costs and seek new business opportunities. 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. Investments will be aligned to advance the company’s growth strategy through new client acquisition, with specific focus on key industries and local businesses. The company will also continue to focus on expanding its software capabilities through a combination of internal development and strategic acquisitions.

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 in the last few years. The business has been transformed into one that is more flexible and more focused on higher value segments of the market. The Global Services business enters 2009 with a revenue backlog of $117 billion. The portfolio is strong with a complement of offerings and capabilities that deliver both high value and productivity to clients. Going forward the Global Services business will look to build upon its momentum from the strong 2008 performance by continuing its “clients first approach” and by focusing on further enhancements to its offerings/integrated solutions portfolio, continuing to improve both the skills and structure of the business and accelerating the deployment of the Global Delivery Framework, a set of delivery practices that will enable consistent global delivery excellence.

In the Systems and Technology business, the company will continue to focus its investments on differentiating technologies with leadership and high-growth potential including POWER, high-performance computing, virtualization, nanotechnology and energy efficiency. In this market, the value has shifted to the high end to address clients’ needs to consolidate and virtualize their environments. The company will focus on providing clients with a clear path to a fully dynamic infrastructure that not only reduces cost, but is both intelligent and secure.

In 2009, Global Financing will seek to expand its core business by accelerating growth in the participation rates for IBM products and services transactions. In addition, the business will be focused on optimizing its global infrastructure, resources and processes through the deployment of its single operating model initiative.

The company expects 2009 pre-tax retirement-related plan cost to be approximately $1.5 billion, an increase of approximately $100 million compared to 2008. This estimate reflects current pension plan assumptions and the impacts of recent pension plan redesign efforts. See note U, “Retirement-Related Benefits,” for additional information.

The company expects in the normal course of business that its effective tax rate in 2009 will be approximately 26.5 percent. 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.

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