What will we
make ofthis moment?
2013 IBM Annual Report

Dear IBM Investor:
What will we make of this moment—as businesses,
as individuals, as societies?
What will we make with a planet generating unprecedented
amounts of data? What will we create from—and with—global
networks of consumers, workers, citizens, students, patients?
How will we make use of powerful business and technology
services available on demand? How will we engage with an
emerging global culture, defined not by age or geography,
but by people determined to change the practices of businessand society?
To capture the potential of this moment, IBM is executing a boldagenda. It is reshaping your company, and we believe it will
reshape our industry. In this letter I will describe the actions
we have taken and are taking, and the changed company
that is emerging from this transformation. I believe that if you
understand our strategy, you will share our confidence inIBM’s prospects—for the near term, for this decade and beyond.
Let’s start with the phenomenon of our age—data.

A planet of data
Today, every discussion about changes in technology, businessand society must begin with data. In its exponentially increasing
volume, velocity and variety, data is becoming a new natural
resource. It promises to be for the 21st century what steam power
was for the 18th, electricity for the 19th and hydrocarbons forthe 20th. This is what we mean by enterprises, institutions andour planet becoming smarter.

“Traditional computing systems, which
only do what they are programmed
to do, simply cannot keep up withBig Data in constant motion. For that,
we need a new paradigm.”

Thanks to a proliferation of devices and the infusion of technology
into all things and processes, the world is generating morethan 2.5 billion gigabytes of data every day, and 80 percent of
it is “unstructured”—everything from images, video and audio
to social media and a blizzard of impulses from embedded
sensors and distributed devices.
This is the driver of IBM’s first strategic imperative: To makemarkets by transforming industries and professions with data.
The market for data and analytics is estimated at $187 billion by
2015. To capture this growth potential, we have built the world’s
broadest and deepest capabilities in Big Data and analytics—bothtechnology and expertise. We have invested more than $24 billion,
including $17 billion of gross spend on more than 30 acquisitions.
We have 15,000 consultants and 400 mathematicians. Twothirds of IBM Research’s work is now devoted to data, analytics
and cognitive computing. IBM has earned 4,000 analytics
patents. We have an ecosystem of 6,000 industry partners and
1,000 university partnerships around the world developing new,analytics-related curricula.
IBM provides the full array of capabilities our clients need to
extract the value of Big Data. They can mine multiple structured
and unstructured data sets across their business. They canapply a range of analytics—from descriptive to predictive toprescriptive. And importantly, they can capture the time value ofdata. This matters, because the battle for competitive advantage
in this new world can be lost or won in fractions of a second.

rose 9 percent—led by Global Business Services and Software.
This is already a nearly $16 billion business for us, and we haveraised our expectations for it.

An IT industry remade by cloud
Our data and analytics portfolio today is the deepest in theindustry. It includes decision management, content analytics,
planning and forecasting, discovery and exploration, businessintelligence, predictive analytics, data and content management,
stream computing, data warehousing, information integrationand governance.
This portfolio provides the basis for the next major era incomputing—cognitive systems. Traditional computing systems,
which only do what they are programmed to do, simply cannot
keep up with Big Data in constant motion. For that, we need a newparadigm. These new systems are not programmed; rather, theylearn, from the vast quantities of information they ingest, from theirown experiences, and from their interactions with people.
IBM launched this era three years ago, when our Watson systemdefeated the two all-time champions on the quiz show Jeopardy!
Watson has since matured from a research grand challenge
into a multifaceted business platform, enabled globally via thecloud. Earlier this year we launched the IBM Watson Group.
It will comprise 2,000 professionals, a $1 billion investment andan ecosystem of partners and developers that we expect toscale rapidly. In the process, we believe Watson will change
the nature of computing, as it is already beginning to change
the practice of healthcare, retail, travel, banking and more.
Taken together, our investments in data and analytics are driving
significant growth, with 40,000 service engagements to date,growing by double digits. In 2013 our business analytics revenue

At the same time that industries and professions are being remade
by data, the information technology infrastructure of the world isbeing transformed by the emergence of cloud computing—that
is, the delivery of IT and business processes as digital services.
It is estimated that by 2016, more than one-fourth of the world’s
applications will be available in the cloud, and 85 percent of new
software is now being built for cloud.
This is driving IBM’s second strategic imperative: To remake
enterprise IT infrastructure for the era of cloud.
As important as cloud is, its economic significance is often
misunderstood. That lies less in the technology, which is relatively
straightforward, than in the new business models cloud will
enable for enterprises and institutions. This is creating a market
that is expected to reach $250 billion by 2015.
IBM today is the leader in enterprise cloud, a position we haveenhanced through investments of $7 billion on 15 acquisitions,most notably SoftLayer in 2013. We provide the full spectrum ofcloud delivery models—infrastructure as a service, platform as aservice, software as a service and business process as a service.
IBM’s cloud capabilities are built on 1,500 cloud patents andsupported by thousands of cloud experts. Eighty percent of
Fortune 500 companies use IBM’s cloud capabilities.
Our cloud foundation at the infrastructure level is SoftLayer, themarket’s premier public and private cloud environment, with “baremetal” dedicated servers that provide unmatched compute power,

FPO

Virginia M. Rometty
Chairman, President and Chief Executive Officer

deployed in real time, with hundreds of configuration options. Our
public cloud processes 5.5 million client transactions every day.

of organizations are currently using or planning to use composable business services.

In terms of technology, security, flexibility and pricing, IBM surpasses
all our major competitors. And our rapidly growing roster of 30,000
client engagements—including companies like Honda, Sun Life
Stadium, US Open Tennis and hundreds of top online games witha user base exceeding 100 million—is a testament to that.

Finally, enterprises will want—and need—to manage their data inthe cloud with the same rigor as if it were on-premises. Companies
will do this in order to ensure auditability, visibility, change control,
access control and data loss protection. Indeed, data management will arguably be the single most important design point forenterprise cloud environments, driven not only by security andcost, but also by regulation.

These companies and a growing number of others understandthat their customer-facing applications—which they deploy on
public clouds for reasons of cost, accessibility and speed—must
be integrated with their core enterprise systems—such as finance,
inventory, manufacturing and human resources. This is why one
analyst predicts that by 2017, nearly 50 percent of large enterprises
will use hybrid cloud environments that are part public, part private
and integrated with back-end systems.
It is also why a new class of “cloud middleware services” isemerging to manage these complex environments. Last month
we announced several capabilities that will connect enterprisedata and applications to the cloud. IBM’s entire enterprisesoftware portfolio is becoming available to developers in an open,
composable business environment to build applications withflexibility and scalability. A “cloud first” approach is being
implemented in IBM software development labs globally.
For line-of-business users looking to drive innovation—including
heads of finance, marketing, human resources, procurement
and other functions—we offer an unmatched array of more than
100 software-as-a-service (SaaS) offerings. IBM’s SaaS offerings
today support 24 of the top 25 companies in the Fortune 500.
Going forward, companies will continue to unlock the valueof these business applications. For example, nearly 70 percent

To meet growing demand for greater speed, and legal requirements
for compliance and data residency, IBM is aggressively expanding
its global cloud footprint. We currently have 25 data centers globally,
and the new $1.2 billion investment announced in January will
see the opening of 15 more, in the US, the UK, Australia, Brazil,
Canada, China, France, Germany, India, Japan and Mexico.
The impact of our cloud investments shows up clearly in our
results. IBM’s cloud business grew 69 percent in 2013, delivering$4.4 billion of revenue. As we actively embrace cloud in orderto deliver “IBM as a Service” to our clients, we expect tosee significant benefits in client experience, revenue growthand enterprise productivity.

Engagement in a world of empowered individuals
The phenomena of data and cloud are changing the arena of
global business and society. At the same time, proliferating mobile
technology and the spread of social business are empowering
people with knowledge, enriching them through networks andchanging their expectations.
This leads to IBM’s third strategic imperative: To enable“systems of engagement” for enterprises.

Complementing traditional back-office systems of record,
enterprises are now taking a systematic approach to engagementwith all of their constituencies—customers, employees, partners,
investors and citizens. Indeed, 57 percent of companies now
expect to devote more than a quarter of their IT spending to these
new systems of engagement by 2016, nearly twice the level of
12 months ago.

We have strengthened our already clear leadership in enterpriseclass social business and in security. Our acquisitions in social
include Kenexa, which helps companies use behavioral science
not just to connect with people, but to understand and build lastingengagement with them. And we have made a dozen acquisitions
in security, building a capability of more than 6,000 security experts,
3,000 patents and 25 labs worldwide.

They are doing so because the way their customers and theirown workers expect to engage is undergoing profound change.
Seventy percent of people who contact a company via social
media today expect a response within five minutes. Nearly
80 percent of adult smartphone users keep their phones withthem an average of 22 hours a day. This is why we launched
IBM MobileFirst in 2013, and why we have made eight acquisitions
to advance our mobile initiatives. We have 3,000 mobile experts,
and have been awarded hundreds of patents in mobile andwireless technologies.

Finally, IBM is leading by example in building modern enterprisesystems of engagement and learning. Our social platform,
Connections, has 300,000 IBM users and 200,000 communities.
There are more than 30,000 IBMers active on Client Collaboration
Hubs for our top 300 accounts. Last year, hundreds of thousandsof IBMers worldwide shaped the practices that define how we work.
And they are enhancing their skills daily through a massive open
online learning system called THINK Academy.

When these individuals use their mobile devices to engage
with a company, they expect personalized service. Indeed,
80 percent of people are willing to trade their information fora customized offering.
The good news is that this is increasingly possible, thanks tosocial business and data analytics. But it’s not that simple.
One only needs to follow the news to see rapidly rising concerns—
legitimate concerns—about data security and institutional trust.
Two-thirds of US adults say they would not return to a businessthat lost their confidential information. And the economic stakes
are enormous. One analyst estimates that by 2016, there could
be an additional $1 trillion of growth in global online retail—if theindustry can enhance trust.

In 2013, we achieved year-over-year growth of 69 percent in
mobile, 19 percent in security and 45 percent in social business.

Our performance in 2013
You can learn more about the IBM Strategy on pp. 10–23. Thisis the context in terms of which to understand our performancein 2013.
By many measures, it was a successful year for IBM. Our diluted
operating earnings per share in 2013 were $16.28, a new record.
This marked 11 straight years of operating EPS growth. We grew
operating net income by 2 percent, to $18 billion.
In 2013 we invested $3.1 billion for 10 acquisitions. We invested$3.8 billion in net capital expenditures. We invested $6.2 billion in
R&D, while earning the most US patents for the 21st straight year.

A Letter from the Chairman

Generating Higher Value at IBM
A long-term perspective ensures IBM is well-positioned
to take advantage of major shifts occurring in technology,
business and the global economy.

1. We continuously remix our businesstoward higher-value, more profitable
markets and opportunities.

2. This generates significant profit and cash, whichallows us to invest in future sources of growth andprovide strong returns to shareholders.

Segment Pre-tax Income Mix*($ in billions)Free Cash Flow($ in billions)Primary Uses of Cash Since 2000($ in billions)
Net capital
expenditures$59

Operating Pre-tax Income Margin*
Hardware/Financing  
Services  Software

$170

21%
$108
Net share
repurchases

10%

$30
Dividends

$165

2000

2013

3. We deliver long-term value and performance
while achieving our 2015 operating EPS target
along the way.

2000

$32
Net
acquisitions**

2013
At Least$20

Operating EPS in 2015*$16.28Key drivers:
Revenue Growth
A combination of baserevenue growth, a shift tofaster-growing businesses
and strategic acquisitions.
Operating Leverage
A shift to higher-margin
businesses and enterpriseproductivity derived
from global integrationand process efficiencies.
Share Repurchase
Leveraging our strong cash
generation to return value
to shareholders by reducing
shares outstanding.
Operating Earnings Per Share*2000  * Excludes acquisition-related and nonoperating retirement-related charges.
** Net acquisitions include cash used in acquisitions and from divestitures.

2013

2015

7

While making all these investments in IBM’s future capabilities,
we were able to return $17.9 billion to you in 2013—approximately$13.9 billion through gross share repurchases and $4.1 billion
through dividends. Last year’s dividend increase was 12 percent,marking the 18th year in a row in which we have raised ourdividend, and the 98th consecutive year in which we have
paid one.

“Every generation of IBMers has theopportunity—and, I believe, theresponsibility—to invent a new IBM.
This is our time.”

However, we must acknowledge that while 2013 was an important
year of transformation, our performance did not meet our
expectations. Our operating pre-tax income was down 8 percent.
Our revenue in 2013, at $99.8 billion, was down 5 percent asreported and 2 percent at constant currency.
So, while we continue to remix to higher value, we must also
address those parts of our business that are holding us back.
We have two specific challenges, and we are taking steps toaddress both.
The first involves shifting the IBM hardware business for new
realities and opportunities. We are accelerating the moveof our Systems product portfolio—in particular, Power andstorage—to growth opportunities and to Linux, following
the lead of our successful mainframe business. The modern
demands of Big Data, cloud and mobile require enterprisestrength computing, and no other company can match IBM’s
ongoing capabilities and commitment to developing thoseessential technologies.
We also announced, in January, an agreement to sell much of
our Intel-based x86 server business to Lenovo. This divestiture
is consistent with our continuing strategy of exiting lowermargin businesses, such as PCs, hard-disk drives and retailstore solutions. But let me be clear—we are not exiting hardware.

IBM will remain a leader in high-performance and high-end
systems, storage and cognitive computing, and we will continue
to invest in R&D for advanced semiconductor technology.
The second challenge involves the world’s growth markets.
While IBM’s growth in Latin America and Middle East andAfrica was strong, enterprise spending slowed in other key
growth markets. We are intensifying focus on new growth
opportunities. Overall, the opportunity in the world’s growthmarkets remains attractive.

On being essential

I am deeply proud of the global IBM team for bringing us here,
and I am grateful to you, our shareholders, for your unwavering
support. I hope you share our excitement about your company’s
path and the shared opportunity we have, together, to build
a brighter future on a smarter planet.

Virginia M. Rometty
Chairman, President and Chief Executive Officer

As we have learned throughout our history, the key to success isgetting the big things right, innovating and investing accordingly,
and challenging our organization, operations and especially ourculture to adapt.
When you do all those things, you do more than stay abreastof change. You lead it. You invent entirely new capabilities—
such as cognitive computing and Watson. You translate these
innovations into sustainable economic value—such as building
cloud infrastructure that is enterprise-class and societally robust.
And you make yourself a laboratory for the future—of work, of
engagement, of the modern enterprise.
The progress we are making on these strategic imperatives ishighly encouraging. No company in our industry is positioned
as strongly as 103-year-old IBM for the world now taking shape.
We are confident in our vision, our strategy and our prospects.
Every generation of IBMers has the opportunity—and, I believe,
the responsibility—to invent a new IBM. This is our time. We
are working to make this not just a successful business, but anessential institution for our clients and the world in a new era.

This letter includes selected references to certain non-GAAP financial measures that are madeto facilitate a comparative view of the company’s ongoing operational performance. For information
about the company’s financial results related to (i) operating net income, operating pre-tax income,
operating pre-tax margin and operating earnings per share and (ii) free cash flow, which are in eachcase non-GAAP measures, see the company’s Forms 8-K submitted to the SEC on January 21, 2014
and February 28, 2013 (Attachment II—Non-GAAP Supplementary Materials).

What we see shifting: Competitive advantage
will be created through data and analytics,
business models will be shaped by cloud, andindividual engagement will be powered bymobile and social technologies.
Therefore, IBM is making a new future for ourclients, our industry and our company.
This is how.

The IBM Strategy.

The IBM Strategy

01
We are making markets bytransforming industries andprofessions with data.

02
We are remaking enterprise IT
for the era of cloud.

03
We are enabling systems ofengagement for enterprises.
And leading by example.

11

12

01 We aremaking markets
by transforming
industries
and professions
with data.

The IBM Strategy

WHAT WE SEE SHIFTING:

Data is becoming the world’s
new natural resource.
Today, every discussion about changes in technology, business andsociety must begin with data. In its exponentially increasing volume,
velocity and variety, data is becoming a new natural resource.
It promises to be for the 21st century what steam power was forthe 18th, electricity for the 19th and hydrocarbons for the 20th.

1 trillion  connected objects and devices onthe planet generating data by 2015

2.5 billion

gigabytes of data generated every day

80%of the world’s data is unstructured. Audio.
Video. Sensor data. Social media. All represent
new areas to mine for insights.

13

14

OUR POINT OF VIEW:

Data is the new basisof competitive advantage.
Leaders will:

Drive business outcomes b
 y applying more sophisticatedanalytics across more disparate data sources in more partsof their organization.
Capture the time value of data b
 y developing “speed of insight”
and “speed of action” as core differentiators.
Change the game in their industry or profession with cognitive capability.

THEREFORE:

We have built the world’s
broadest and deepest
portfolio in data and analytics.

24 billion $17billion

15,00040,000

1 billion

500

2/3

$

	invested to date tobuild IBM’s capabilities
in Big Data and analytics,
with $7 billion in organic
investment$	investment in Flashtechnology, providing
industry-leading speed
and efficiency toenable data to be realtime ready for analytics

	of gross spend for Big Dataand analytics acquisitions,
including more than
30 acquired companies

1,000 university partnerships,
and 2,215 IBM
Business Partners analytics consultants
and 400 mathematicians

analytics patents
generated each year

client engagements to dateof IBM Research is
focused on data, analytics
and cognitive computingThe IBM Strategy

We are building Watson solutions
and technologies for theera of cognitive computing.
In January 2014 we launched the IBM Watson Groupto bring cognitive capabilities—built on technologies
like machine learning, complex algorithms and natural
language processing—to enterprises, institutions
and individuals via the cloud.
Watson technology processes information by
understanding natural language, generating hypotheses based on evidence, and learning as it goes.
This means organizations and individuals canmore fully understand the data that surrounds them,and use that data to make better decisions.

1$ billion	investment, including$100 million to equip
an ecosystem of entrepreneurs and partners

2,000

engineers, researchers,
developers, designers
and sellers

We have significantly increased analytics revenue throughstrategic investments, and new skills and capabilities.

Analytics Revenue

16 billion

$

2013

2010

11 billion

$

15

16

02 We areremaking
enterprise IT
for the eraof cloud.

The IBM Strategy

WHAT WE SEE SHIFTING:

The emergence of cloud istransforming IT and businessprocesses into digital services.
At the same time industries and professions are being remade
by data, the information technology infrastructure of the world isbeing transformed by the emergence of cloud computing—that
is, the delivery of IT and business processes as digital services.

85%

of new software is now
being built for the cloud

1/4  of the world’s
applications will
be available inthe cloud by 201672%

of developers alreadyreport that cloud-based
services or APIs arepart of the applications
they’re designing

17

18

OUR POINT OF VIEW:

Cloud demands—and enables—
new business models.
Leaders will:

Integrate public and private clouds w
 ith back-end
systems to create hybrid environments. This will create
demand for cloud middleware services.
Seek—or be required—to manage cloud environments with the same rigor as an on-premises data center.
Use cloud t o reinvent core business processes andto innovate.

THEREFORE:

We have built the world’s most complete cloud
portfolio, delivering our clients’ technology
and business processes as digital services.

7

1,500+

5.5 million 80%
client transactions
processed daily throughIBM’s public cloudof Fortune 500
companies use IBM’s
cloud capabilities

15

2,000

100+

5,000+$ billion	invested to date tobuild cloud capabilities acquired companies,
including SoftLayer,
for cloud infrastructure cloud patents

SoftLayer APIs toprovide a view of theclient’s environment industry-leading Software
as a Service (SaaS)
offerings

private and hybrid cloud
engagements in morethan 100 countries included
IBM Systems in 2013

The IBM Strategy

In 2014, we will expand ourcloud footprint and capabilities.
IBM is investing $1.2 billion to expand a massive networkof local cloud hubs for businesses worldwide, to meetgrowing demands for capacity, choice, compliance anddata residency.
Markets plannedto open in 2014:

Australia (2)BrazilCanada (2)China (2)FranceGermany
India
Japan
MexicoUnited Kingdom
United States (2)15 planned 2014
market expansions

40

total cloud data centers
across five continents

Connecting applications via the cloud“Cloud middleware services” are emerging to connect securely customer applications andcore enterprise systems such as finance, inventory or human resources via the cloud.
In 2014, we are opening up our entire enterprise software portfolio via BlueMix, a platform
to equip the tens of millions of corporate and web developers with an open environment
and tools to build enterprise-class cloud applications at consumer scale.

In 2013 we grew our cloud revenue 69 percent, and we exited the yearwith a run rate for cloud “as a service” double that of 2012.
Cloud Revenue

Cloud “as a Service”
Revenue Run Rate$

4.4 billion

$

2013

2013

2012

2012
$

2.6 billion

2 billion

1 billion

$

19

20

03 We areenabling systemsof engagement
for enterprises.
And we are leadingby example.

The IBM Strategy

WHAT WE SEE SHIFTING:

Social. Mobile. Security. They are empowering
people with knowledge, enriching them throughnetworks and changing expectations.
The phenomena of data and cloud are changing the arena of global
business and society. At the same time, rapidly growing mobile technology
and social business are giving birth to a new category of IT services andcapabilities, aimed at engagement with increasingly empowered individuals.

84%of Millennials say social anduser-generated content has
an influence on what they buy

70%of Boomers agree5

minutesthe response time users
expect from a company
once they have contacted
it via social media

84%
of smartphone users
check an app as soon
as they wake up

80%
of individuals are willing totrade their information fora personalized offering

2 /3of US adults say they would
not return to a business thatlost their personal, confidential
information

21

22

OUR POINT OF VIEW:

A systematic approach toengagement is now required.
Leaders will:

Use mobile and social to increase speed andresponsiveness—and meet customers, partners
and employees where they are.
Want to personalize e
 very meaningful interaction.
Need to earn continuously the right to serve
customers—which demands privacy, security and trust.

THEREFORE:

We have built a portfolio that enables enterprises
and communities to engage customers, employees
and citizens securely.

6,000

4,300

8

12

security experts,
3,000 mobile experts,
2,800 social businessexperts

companies acquired
for mobile capabilities
like mobile messaging
for marketers and secure
mobile app delivery patents in mobile,social and security
technologies companies acquired
for security technologies
like web fraud detection,
sophisticated malware,and device management

1 and #1

7of 1025

15 billion#	market leader for enterprisesocial software; market
leader in security andvulnerability management*

security labs globally,
10 security operations
centers globally* IDC, Worldwide Enterprise Social Software 2013–2017 Forecast and 2012 Vendor Shares, Doc #241323, June, 2013
IDC, Worldwide Security and Vulnerability Management 2013–2017 Forecast and 2012 Vendor Shares, Doc #242465, August, 2013

top banks in the US,
9 of the top 10 in the UK and
2 of the top 4 in Australia
use IBM Security Solutions security events monitored
daily in 130 countries

The IBM Strategy

Our mobile, socialand security portfolio
generated doubledigit revenue growthin 2013.

And we are leading by example.

69%
growth in Mobile

Collectively developing insights
For more than a decade we’ve used Jams—large-scale online collaborations—
to collectively define our corporate values, generate new business ideas and rally
around opportunities for societal improvement. In 2013, IBMers worldwide shaped
nine practices that translate our values into consistent actions and behaviors. These
practices are now shaping our systems for hiring, learning and management.

45%
growth in Social Business

30,000+300,000

250,000

200,000

IBMers active in Client Collaboration
Hubs for our top 300 accounts

employees collaborated in an
online Jam to shape nine practices
that distinguish IBMers

19%
growth in Security

 ctive IBM users on ouraConnections social platform

Connections communities
established by employees for
projects, areas of expertiseor general interests

23

24

Financial Highlights
International Business Machines Corporation and Subsidiary Companies($ in millions except per share amounts)
For the year ended December 31:

2013

2012

Revenue$ 99,751$104,507

Net income$ 16,483$ 16,604

Operating (non-GAAP) earnings*$ 17,959$ 17,627

Assuming dilution$  14.94$  14.37

Basic$  15.06$  14.53

Diluted operating (non-GAAP)*$  16.28$  15.25$ 17,485$ 19,586

Earnings per share of common stock

Net cash provided by operating activities
Capital expenditures, net

3,768

4,307

Share repurchases

13,85911,995

Cash dividends paid on common stock

4,058

3,773

3.70

3.30

Per share of common stock
At December 31:

2013

2012

Cash, cash equivalents and marketable securities$ 11,066$ 11,128

Total assets

126,223

119,213

Working capital

11,196

5,807

Total debt

39,71833,269Total equity

22,92918,984

Common shares outstanding (in millions)

1,054

1,117

Market capitalization$197,772$214,032

Stock price per common share$ 187.57$ 191.55

Number of employees in IBM/wholly owned subsidiaries

431,212434,246* See page 46 for a reconciliation of net income to operating earnings.

Report of Financials
International Business Machines Corporation and Subsidiary Companies

Management Discussion
Overview
Forward-Looking and Cautionary Statements
Management Discussion Snapshot
Description of BusinessYear in Review
Prior Year in Review
Other Information
Looking Forward
Liquidity and Capital Resources
Critical Accounting Estimates
Currency Rate Fluctuations
Market Risk
Financing Risks
Cybersecurity
Employees and Related Workforce
Global Financing

26
26
27
28
35
53
63
63
65
67
70
70
71
71
72
72

Report of Management

76

Report of Independent Registered
Public Accounting Firm

77

Consolidated Financial Statements
Earnings
Comprehensive Income
Financial Position
Cash Flows
Changes in Equity

78
79
80
81
82

Notes to Consolidated
Financial Statements
A Significant Accounting Policies
B Accounting Changes
C Acquisitions/Divestitures
D Financial Instruments
E Inventories
F Financing Receivables
G Property, Plant and Equipment
H Investments and Sundry Assets
I Intangible Assets Including Goodwill
J Borrowings
K Other Liabilities
L Equity Activity
M Contingencies and Commitments
N Taxes
O Research, Development and Engineering
P Earnings Per Share of Common Stock
Q Rental Expense and Lease Commitments
R Stock-Based Compensation
S Retirement-Related Benefits
T Segment Information
U Subsequent Events

84
94
95
100
107
107
110
110
111
112
114
116
119
121
123
123
124
124
127
141
146

Five-Year Comparison of Selected Financial Data

147

Selected Quarterly Data

148

Performance Graph

149

Board of Directors and Senior Leadership

150

Stockholder Information

151

25

26

Management Discussion
International Business Machines Corporation and Subsidiary Companies

Overview

Operating (non-GAAP) Earnings

The financial section of the International Business MachinesCor­por­ation (IBM or the company) 2013 Annual Report includes theManagement Discussion, the Consolidated Financial State­ments
and the Notes to Consolidated Financial State­ments. This Over­view is designed to provide the reader with some perspective
regarding the information contained in the financial section.

In an effort to provide better transparency into the operational resultsof the business, the company separates business results into operating and non-operating categories. Operating earnings is a
non-GAAP measure that excludes the effects of certain acquisitionrelated charges and retirement-related costs, and their related tax
impacts. For acquisitions, operating earnings exclude the amortization of purchased intangible assets and acquisition-related charges
such as in-process research and development, transaction costs,
applicable restructuring and related expenses and tax charges
related to acquisition integration. For retirement-related costs, thecompany characterizes certain items as operating and others as
non-operating. The company includes defined benefit plan andnonpension postretirement benefit plan service cost, amortizationof prior service cost and the cost of defined contribution plans inoperating earnings. Non-operating retirement-related cost includes
defined benefit plan and nonpension postretirement benefit planinterest cost, expected return on plan assets, amortized actuarial
gains/losses, the impacts of any plan curtailments/settlements andmulti-employer plan costs, pension insolvency costs and othercosts. Non-operating costs are primarily related to changes in pension plan assets and liabilities which are tied to financial market
performance and the company considers these costs to be outside
the operational performance of the business.
Overall, the company believes that providing investors with a viewof operating earnings as described above provides increased transparency and clarity into both the operational results of the businessand the performance of the company’s pension plans; improves
visibility to management decisions and their impacts on operational
performance; enables better comparison to peer companies; andallows the company to provide a long-term strategic view of thebusiness going forward. For its 2015 road map, the company is utilizing an operating view to establish its objectives and track its
progress. The company’s reportable segment financial results
reflect operating earnings, consistent with the company’s management and measurement system.

Organization of Information• The Management Discussion is designed to provide readerswith an overview of the business and a narrative on the company’s
financial results and certain factors that may affect its future
prospects from the perspective of the company’s management.
The “Management Discussion Snap­shot,” on pages 27 and 28,
presents an overview of the key performance drivers in 2013.
• Beginning with the “Year in Review” on page 35, the Manage­
ment Discussion contains the results of operations for eachreportable segment of the business and a discussion of thecompany’s financial position and cash flows. Other key sections
within the Management Discussion include: “Looking Forward”
on pages 63 to 65, and “Liquidity and Capital Resources” onpages 65 to 67.
• Global Financing is a reportable segment that is measured as astand-alone entity. A separate “Global Financing” section is
included in the Management Discussion beginning on page 72.
• The Consolidated Financial Statements are presented on pages
78 through 83. These statements provide an overview of thecompany’s income and cash flow performance and its financial
position.
• The Notes follow the Consolidated Financial Statements. Amongother items, the Notes contain the company’s accounting policies (pages 84 through 93), acquisitions and divestitures (pages
95 through 99), detailed information on specific items within thefinancial statements, certain contingencies and commitments(pages 119 to 121) and retirement-related benefits information(pages 127 to 141).
• The Consolidated Financial Statements and the Notes have been
prepared in accordance with accounting principles generally
accepted in the United States (GAAP).
• The references to “adjusted for currency” or “at constant currency” in the Management Discussion do not include operational
impacts that could result from fluctuations in foreign currency
rates. Certain financial results are adjusted based on a simple
mathematical model that translates current period results in local
currency using the comparable prior year period’s currency conversion rate. This approach is used for countries where thefunctional currency is the local country currency. This information is provided so that certain financial results can be viewed
without the impact of fluctuations in foreign currency rates,
thereby facilitating period-to-period comparisons of businessperformance. See “Currency Rate Fluctuations” on page 70 for
additional information.
• Within the financial statements and tables in this Annual Report,
certain columns and rows may not add due to the use of rounded
numbers for disclosure purposes. Percentages reported are
calculated from the underlying whole-dollar numbers.

Forward-Looking andCautionary Statements
Certain statements contained in this Annual Report may constituteforward-looking statements within the meaning of the Private
Secur­ities Litigation Reform Act of 1995. Any forward-looking statement in this Annual Report speaks only as of the date on which it ismade; the company assumes no obligation to update or revise any
such statements. Forward-looking statements are based on thecompany’s current assumptions regarding future business andfinancial performance; these statements, by their nature, address
matters that are uncertain to different degrees. Forward-looking
statements involve a number of risks, uncertainties and other factorsthat could cause actual results to be materially different, as discussed
more fully elsewhere in this Annual Report and in the company’s
filings with the Securities and Exchange Commission (SEC), including the company’s 2013 Form 10-K filed on February 25, 2014.

Management Discussion
International Business Machines Corporation and Subsidiary Companies

Management Discussion Snapshot

The company also continued to shift its investments to addressthekey trends in information technology (IT)—social, mobile, big data/($ and shares in millions except per share amounts)
analytics and cloud. Several years ago, the company identified andYr.-to-Yr.
Percent/
established objectives for four key growth initiatives—Smarter Planet,
Marginbusiness analytics, cloud and growth markets—to address these
For the year ended December 31:
2013
2012
ChangeRevenue$ 99,751$104,507(4.6)%* trends. In 2013, across the business, Smarter Planet, business analytGross profit margin
48.6%
48.1 %
0.5 pts. ics and cloud had strong performance. Smarter Planet revenue grew
about 20 percent compared to 2012, with strength across all areas,
Total expense and other (income)$ 28,981$ 28,396
2.1%
including Smarter Commerce, Smarter Cities, Social Business andTotal expense and other(income)-to-revenue ratio
29.1%
27.2 %
1.9 pts. industry solutions. The company believes that data, as a natural
resource, will drive demand going forward, and that big data/analytics
Income before income taxes$ 19,524$ 21,902(10.9)%
will provide the basis for competitive differentiation. Business analytProvision for income taxes
3,041
5,298
(42.6)%
ics revenue of $15.7 billion increased 9 percent year to year, led by
Net income$ 16,483$ 16,604(0.7)%
Global Business Services and Software. The company’s cloud soluNet income margin
16.5%
15.9 %
0.6 pts.
tions address the full scope of client requirements including private
Earnings per share
clouds, public clouds and hybrid clouds, as well as platform andof common stock
software-as-a-solution (SaaS)-based solutions. In 2013, the company
Assuming dilution$  14.94$  14.37
4.0%
delivered $4.4 billion of cloud-based solutions revenue, an increase
Weighted-average sharesof 69 percent compared to 2012. In addition, within that content, $1.7
outstanding
billion was delivered as a service. Across the company’s performance,
Assuming dilution
1,103.0
1,155.4(4.5)%
there is overlap between these initiatives. In total, software makes up
Assets**$126,223$119,213
5.9%
about half of that combined content. The software content improves
Liabilities**$103,294$100,229
3.1%
the company’s business mix and contributes to margin expansion.
Equity**$ 22,929$ 18,984
20.8%
Segment revenue was led by Software which increased 1.9 percent(3 percent adjusted for currency) driven by key branded  * (2.5) percent adjusted for currency.
middleware which increased 4.8 percent (6 percent adjusted for cur** At December 31.
rency). The key growth initiatives fueled this performance. Global
The following table provides the company’s operating (non-GAAP)
Business Services returned to revenue growth at constant currency
earnings for 2013 and 2012.
(down 0.9 percent as reported; up 3 percent adjusted for currency)
driven by the company’s investments in the Digital Front Office. While($ in millions except per share amounts)
revenue in Global Technology Services declined 4.2 percent (1 perYr.-to-Yr.
cent adjusted for currency), revenue trajectory improved in thePercent
For the year ended December 31:
2013
2012
Changesecond half and was stabilizing. Global Financing revenue improved
Net income as reported$16,483$16,604(0.7)% 0.4 percent (3 percent adjusted for currency) versus 2012. The SoftNon-operating adjustments
ware, Global Services and Global Financing businesses all grew(net of tax)
pre-tax income and expanded their pre-tax margin in 2013 compared
Acquisition-related charges
747
641
16.5
to 2012. Systems and Technology impacted the company’s overall
Non-operating retirement-related
performance in 2013. Revenue decreased 18.7 percent (18 percent
costs/(income)
729
381
91.2
adjusted for currency) year to year driven by the back end of the
Operating (non-GAAP) earnings*$17,959$17,627
1.9%
mainframe product cycle and business model challenges specificDiluted operating (non-GAAP)
to Power Systems, Storage and System x. Pre-tax income in Systems
earnings per share$ 16.28$ 15.25
6.8%
and Technology decreased $1.7 billion compared to the prior year.
Revenue from the company’s growth markets underperformed
* See page 46 for a more detailed reconciliation of net income to operating (non-GAAP)
earnings.
in 2013, particularly in the second half of the year. For the full year,
growth markets revenue decreased 4.9 percent as reported andIn 2013, the company reported revenue of $99.8 billion, expanded
2 percent at constant currency. Overall, the company believes thatgross and net income margins, and delivered diluted earnings per
the opportunity in the growth markets remains attractive, and it isshare growth of 4.0 percent as reported and 6.8 percent on an operintensifying its efforts on new growth opportunities in these markets.
ating (non-GAAP) basis. The company generated $17.5 billion in cash
The consolidated gross profit margin increased 0.5 points versus
from operations and $15.0 billion in free cash flow driving shareholder
2012 to 48.6 percent. This was the tenth consecutive year of improvereturns of $17.9 billion in gross common stock repurchases and diviment in the gross profit margin. The operating (non-GAAP) gross margindends. In 2013, the company continued the transformation of itsof 49.7 percent increased 0.9 points compared to the prior year. The
portfolio to higher value expending $3.1 billion to acquire 10 compaincrease in gross margin in 2013 was driven by margin improvements
nies to expand its capabilities in its key growth areas, in addition toin the Global Services segments and an improved mix driven by Softmaintaining high levels of investment of $6.2 billion in research andware, partially offset by margin decreases in Systems and Technology.
development and $3.8 billion in net capital expenditures.

27

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Management Discussion
International Business Machines Corporation and Subsidiary Companies

Total expense and other (income) increased 2.1 percent in 2013
versus the prior year. Total operating (non-GAAP) expense andother (income) increased 1.4 percent compared to the prior year.
The year-to-year drivers were approximately:				•	Currency*•	Acquisitions**•	Base expense

Total
Consolidated

Operating(non-GAAP)(1) point		
2 points		
1 point		

(1) point
2 points
1 point  * Reflects impacts of translation and hedging programs.
** Includes acquisitions completed in prior 12-month period.

There were several items that had an impact on total expense andother (income) year to year. Workforce rebalancing charges for 2013
were $1,064 million compared to $803 million in the prior year. Bad
debt expense increased $106 million year to year driven by higher
specific account reserves. In addition, in 2012, the company recorded
a gain of $446 million related to the divestiture of the Retail Store
Solutions (RSS) business, and also recorded a charge of $162 million
related to a court ruling in the UK regarding one of IBM’s UK defined
benefit pension plans. This charge was not included in the company’s operating (non-GAAP) expense and other (income). Also, thecompany has a performance-based compensation structure. As aresult of certain parts of the business not performing as expected,
performance-related compensation in 2013 across both cost andexpense was down $777 million compared to the prior year.
Pre-tax income decreased 10.9 percent and the pre-tax margin
was 19.6 percent, a decrease of 1.4 points versus 2012. Net income
decreased 0.7 percent and the net income margin was 16.5 percent,an increase of 0.6 points versus 2012. The effective tax rate for 2013
was 15.6 percent, a decrease of 8.6 points versus the prior year
driven by an improvement in the ongoing tax rate and discrete tax
items, including audit settlements. Operating (non-GAAP) pre-tax
income decreased 7.7 percent and the operating (non-GAAP) pretax margin was 21.4 percent, a decrease of 0.7 points versus theprior year. Operating (non-GAAP) net income increased 1.9 percent
and the operating (non-GAAP) net income margin of 18.0 percent
increased 1.1 points versus the prior year. The operating (non-GAAP)
effective tax rate was 16.0 percent versus 24.0 percent in 2012 driven
by the same factors described above.
Diluted earnings per share improved 4.0 percent year to year reflecting the benefits of the common stock repurchase program. In 2013,
the company repurchased approximately 73 million shares of its
common stock. Diluted earnings per share of $14.94 increased $0.57
from the prior year. Operating (non-GAAP) diluted earnings per shareof $16.28 increased $1.03 versus 2012 driven by the following factors:•	Revenue decrease at actual rates $ (0.69)•	Margin expansion$ 0.98•	Common stock repurchases$ 0.74
At December 31, 2013, the company’s balance sheet and liquidity
positions remained strong and were well positioned to support thebusiness over the long term. Cash and marketable securities atyear end was $11,066 million, consistent with the year-end 2012balance. Key drivers in the balance sheet and total cash flows are:Total assets increased $7,010 million ($9,337 million adjusted for
currency) from December 31, 2012 driven by:• Increases in prepaid pension assets ($4,607 million), goodwill($1,937 million) and total receivables ($1,202 million); partially
offset by• Decreases in deferred taxes ($687 million).
Total liabilities increased $3,065 million ($4,494 million adjusted for
currency) from December 31, 2012 driven by:• Increased total debt ($6,449 million) and increases
in deferred tax liabilities ($1,336 million); partially offset by• Decreased retirement and nonpension postretirement
benefit obligations ($4,176 million) and decreases incompensation and benefits ($853 million).
Total equity of $22,929 million increased $3,945 million from
December 31, 2012 as a result of:• Higher retained earnings ($12,401 million), decreased losses
in accumulated other comprehensive income/(loss) of$4,157 million and increased common stock ($1,484 million);
partially offset by• Increased treasury stock ($14,110 million) driven by share
repurchases.
The company generated $17,485 million in cash flow provided byoperating activities, a decrease of $2,102 million when compared to2012, primarily driven by operational performance and a net increasein the use of cash for taxes of $2,200 million primarily driven by anincrease in cash tax payments. Net cash used in investing activities
of $7,326 million was $1,679 million lower than 2012, primarily due
to a decrease in cash used associated with the net purchases andsales of marketable securities and other investments ($1,232 million)
and decreased net capital investments ($539 million). Net cash usedin financing activities of $9,883 million was $2,094 million lower
compared to 2012, primarily due to increased proceeds from net
debt ($4,708 million), partially offset by increased cash used forgross common stock repurchases ($1,865 million).
In January 2014, the company disclosed that it is expecting GAAP
earnings of at least $17.00 and operating (non-GAAP) earnings of atleast $18.00 per diluted share for the full-year 2014. The company
also stated that in the first quarter of 2014 it expects to close the initial
phase of the sale of its customer care business to SYNNEX and thatit also expects to take the majority of its workforce rebalancing
actions for the year in the same period. As a result, the company
expects its first-quarter 2014 GAAP and operating (non-GAAP) earnings per share to be approximately 14 percent of the full year
expectation, reflecting about half of the divestiture gain, the workforce
rebalancing charges and continued impacts from currency.
For additional information and details, see the “Year in Review”
section on pages 35 through 52.

D escription of Business
Please refer to IBM’s Annual Report on Form 10-K filed with
the SEC on February 25, 2014 for a more detailed version of thisDes­cription of Business, especially Item 1A. entitled “Risk Factors.”

Management Discussion
International Business Machines Corporation and Subsidiary Companies

The company creates value for clients and solves business problems through integrated solutions that leverage information technology
and deep knowledge of business processes. IBM solutions typicallycreate value by reducing a client’s operational costs or by enabling
new capabilities that generate revenue. These solutions draw froman industry-leading portfolio of consulting, delivery and implementation services, enterprise software, systems and financing.

Strategy
IBM’s strategy is one of innovation, transformation and a constantevolution to higher value. The company delivers innovative solutions,software and infrastructure to improve client outcomes. The company
helps enterprises apply technology to capture new value across their
entire organizations, and it provides a differentiated client experiencethrough a highly engaged and skilled global workforce and a broad
ecosystem of partners. The ultimate goal of this strategy is to deliveron IBM’s purpose of making our company essential to clients,
employees, partners, investors and communities.
Three strategic imperatives shape our approach as we continuously transform IBM and align the company for higher value.
1. M ake Markets by Transforming Industries andProfessions with Data
The emergence of big data as the world’s new natural resource is thephenomenon of our time. It is being fueled by the proliferation of mobile
devices, the rise of social media and the infusion of technology into allthings and processes. Today, enterprises must harness data to createcompetitive advantage. The value for enterprises increases as they
apply more sophisticated analytics across more disparate data
sources. Their real-time use of data will increasingly become a competitive differentiator. Enterprises will also need cognitive computing
capabilities as data continues to grow in all dimensions. Therefore,
IBM’s strategy is to make markets by transforming industries and professions with data. The company has invested more than $22 billion,
including $15 billion on more than 30 acquisitions, to build its capabilities in big data and analytics. One third of IBM’s research is focusedon data, analytics and cognitive computing. The company is investing$1 billion in Watson solutions to build out the next era of cognitive
systems and services. In 2013, the company realized $15.7 billion inbusiness analytics revenue. The original target for this business wasto achieve $16 billion in revenue in 2015—as a result of this performance, the company has taken its 2015 objective for businessanalytics revenue to $20 billion.
2. Remake Enterprise IT for the Era of CloudEnterprises are increasingly relying on cloud, which is being fueledby abundant bandwidth, the emergence of standards and thedemand for consumability. They are benefitting from cloud by using
it to transform their IT and business processes into digital services,to reinvent their core business processes and to drive innovation.
Enterprises are integrating public and private clouds with back-end
systems to create hybrid, dynamic environments. They will increasingly need to manage their cloud environments with the same rigor
as an on-premise datacenter. Therefore, IBM’s strategy is to remake
enterprise IT for the era of cloud. The company has invested over $6
billion to acquire more than 15 companies related to cloud, and isinvesting more than $1 billion to expand its global footprint to 40 datacenters worldwide. IBM now has more than 100 SaaS offerings, andIBM cloud supports 24 of the top 25 Fortune 500 companies. All of
this drove $4.4 billion of revenue for cloud-based solutions in 2013.
3. Enable “Systems of Engagement” for Enterprises
and Lead by Example
Social, mobile and unprecedented access to data are changing how
individuals are understood and engaged. A new class of individual isemerging: one that is empowered with knowledge, enriched by networks and expects value in return for its information. Enterprises must
create a systematic approach to engage this new class of individual
and increase its speed and responsiveness by becoming mobile.
Interactions need to be personalized to offer more value. In addition,enterprises will benefit from securing information and increasing trust.
Therefore, IBM’s strategy is to enable “systems of engagement”
for enterprises, and the company is leading by example. IBM has
acquired 20 companies related to mobile, social and security. IBMers
are collaborating in more than 200,000 internal social communities
and 85 percent of IBM’s sellers use the company’s Sales Connect
portal. In 2013, the company’s mobile, social and security portfolio
generated double-digit revenue growth with mobile increasing
69 percent, security 19 percent and social business 45 percent.
To capture the opportunities arising from these strategic imperatives, IBM is focused on four key growth initiatives: Smarter Planet,Business Analytics, Cloud Computing and Growth Markets.
Smarter Planet
Smarter Planet is IBM’s strategy to lead in a technology-enabledworld that is more instrumented, interconnected and intelligent thanever before, allowing people and organizations to address significant
business and societal challenges. At the heart of this strategy aresolutions that drive innovation and outcomes for clients—extending
the boundaries of businesses, industries and communities. It is
about helping the company’s clients become better at what they dofor their customers. IBM does this through advanced, integrated
solutions based on capabilities such as analytics for business andphysical systems, cloud computing, mobile, social business andbusiness process management.
IBM continues to deepen its commitment to delivering on thepromise of Smarter Planet for both line of business executives (CFOs,
CHROs, CMOs, etc.) as well as IT executives across a broad range ofindustries. IBM’s industry-based approach and solutions are
grounded in a deep understanding of the distinct set of challenges
and opportunities that are confronting companies and executives invarious industries. Whether ‘smarter’ means helping a bank to retain
more customers through world-class mobile solutions, a hospitalgroup to deliver highly individualized care coordinated with social
services, a local government to anticipate and alleviate traffic congestion before it happens, or a retail chain to provide a seamless customer
experience across multiple channels, IBM is developing and investingin a portfolio of replicable industry solutions to help clients achieve
their goals and drive important outcomes for their customers.
There are several areas of focus within the Smarter Planet strategy, including IBM’s Social Business, MobileFirst, Smarter Commerceand Smarter Cities initiatives.

29

30

Management Discussion
International Business Machines Corporation and Subsidiary Companies

IBM’s Social Business initiative helps clients integrate social
capabilities across core business processes to drive measurable
business results. The Social Business initiative can unlock the intrinsic knowledge of people within an organization to help companies
fuel customer-centric innovation, improve productivity and expand
sales, loyalty and advocacy. To capitalize on the new market opportunities that arise from a digital economy, IBM Social Business canlet clients apply increasingly sophisticated analytics to gain actionable insight and to more effectively engage with customers. Behavioral,human data is the newest form of data and can be used to build astronger, more agile workforce and reinvent human capital management by applying behavioral sciences across the talent lifecycle. The
Social Business initiative is powered by world class IBM services andsoftware, developed organically by IBM and through acquisitions.
In 2013, the company launched IBM MobileFirst, a unified
approach to help clients and partners deliver best-in-class mobile
solutions, take advantage of more commercial opportunities andprovide a superior customer experience. IBM has a breadth of expertise and technology to help organizations efficiently build and deploy
mobile applications, maintain visibility and control over their mobile
infrastructure, engage customers in context and transform the value
chain in ways that can drive growth and return on investment. The
company can help its clients achieve these goals through a complete
portfolio of IBM mobile software, services and industry expertise.
Throughout 2013, IBM invested in core mobile enterprise capabilities
such as IBM Worklight and IBM Rational, while rounding out its portfolio with strategic acquisitions such as Fiberlink, Trusteer, Xtify and
The Now Factory. Integrated with 270 patents in wireless innovations
and strengthened by thousands of mobile specialists from IBM Mobile
Enterprise Services and IBM Interactive, the company has alreadyhelped more than 1,000 clients become more mobile enterprises.
In addition to Social and Mobile, IBM’s deep commitment tobuilding a smarter planet can be seen in the ongoing efforts around
Smarter Commerce and Smarter Cities. IBM’s Smarter Commerce
model can integrate and transform how companies manage andadapt their buy, market, sell and service processes to place thecustomer experience at the center of their business. IBM’s Smarter
Cities initiative helps federal, state and local governments to makebetter decisions, anticipate issues and coordinate resources acrossagencies more effectively and deliver citizen-centric services thatcan drive sustainable economic growth.
Business Analytics
Business Analytics is the category of software, systems and services that helps organizations take advantage of big data to makebetter and faster decisions and optimize processes. Big data
includes both enterprise data, content and new data from both
structured and unstructured sources: in previously unimaginable
volumes (petabytes), with huge variety (from blogs, tweets, pictures,videos and text), at high velocity (machine-to-machine data from theInternet of things) and with decreasing veracity (from uncertain or
incomplete sources). Big data and analytics are core to achieving
the Smarter Planet strategy, helping data-savvy, insight-driven leaders to infuse intelligence into business decisions, processes andclient interactions for faster actions and better outcomes.

IBM can serve new buyers and make new market segments bybringing IT to industries and professions that are being transformedby data. The company has a unique set of offerings and deep expertise related to big data and analytics to help organizations:• Acquire, grow and retain customers by improving customer
interactions, building long-term, profitable relationships andrealizing new value from customer sentiment.
• Create new business models by tapping into information andinsight to identify and explore strategic options for growth.
• Transform financial management processes by improving
enterprise agility, anticipating outcomes and driving businessmodel innovation through a discipline of performance.
• Better monitor, predict and manage risk to build trust andvalue amidst uncertainty, by having confidence in their data,risk exposures and ability to make risk-aware actionabledecisions.
• Optimize operations and counter fraud and other threats to
reduce costs, increase efficiencies and productivity andimprove public safety.
• Improve IT economics by developing and enabling new value andagility at practically all levels of the organization and across linesof business while helping keep costs low and profitability high.
The company’s approach to big data and analytics helps organizations to succeed in their industries. IBM recommends organizations
do three things to be successful. First, build a culture that infuses
analytics everywhere. Second, be proactive about the privacy, security and governance of their data. Third, invest in the right platform
and solutions to harness and analyze all of their data for new insights
and outcomes.
IBM is committed to continually innovating across the spectrum of
big data and analytics capabilities, solutions, systems, research, services, deployment and skills. For example, in 2013, the company
announced a breakthrough dynamic in-memory database technology
called BLU Acceleration, predictive analytics for big data with IBM Analytic Catalyst, a PureData System for Hadoop that marries IBM’s
enterprise-class Hadoop distribution (InfoSphere BigInsights) with thesimplicity of an appliance, InfoSphere Data Privacy for Hadoop that provides security and protection for sensitive big data, a Watson
Engagement Advisor solution to help transform how brands and theircustomers interact and new academic partnerships to help prepare
students for the expanding scope of careers in big data and analytics.
Cloud Computing
Cloud is a model for consuming and delivering business and IT
services that can result in significant improvements in economies
of scale and business agility and serve as a platform for business
transformation. IBM has developed a portfolio of solutions, services
and products that is helping thousands of clients adopt and leverage
the transformative power of the cloud. IBM’s breadth of capabilities
gives the company a unique advantage to help clients think, build
and tap into the cloud. IBM has the deep industry expertise to help
clients transform business processes, industry optimized software
solutions to support business processes, software development
platforms to create new cloud-based business applications andstandardized infrastructure to run these applications.

Management Discussion
International Business Machines Corporation and Subsidiary Companies

IBM offers a full array of cloud delivery models, including private
clouds, public clouds and a hybrid cloud that includes a mix of both.
The company enables clients to build private, on-premises cloudbased environments that have the control, security and isolation
required for their most mission-critical workloads. IBM also offers
public cloud services, including the newly acquired SoftLayer platform that provides an infrastructure and ecosystem for middlewareand applications. IBM’s public cloud services can be simply provisioned as a self service, pay-as-you-go consumption model. IBM’s
software defined environments can provide a seamless integration
across private and public cloud models, with interoperability, portability and scalability to help clients realize the full value of cloud.
In the new era of computing, IBM’s plans to enable nearly everything as a digital service. During 2013, IBM made several cloudrelated strategic announcements, notably:• IBM’s Watson technology is being made available as adevelopment platform in the cloud to enable a worldwide
community of software application providers to build
a new generation of apps infused with Watson’s cognitive
computing intelligence.
• The acquisition of SoftLayer is enabling IBM to deliverindustry-leading cloud solutions that offer the security,
privacy and reliability of private clouds and the economy
and speed of a public cloud.
• New fast-start industry solutions, which are hosted on a private
cloud using SoftLayer and offered as a managed service
through Global Business Services, designed to meet growing
demand from clients for rapid deployment, implementationand experimentation.
• The acquisition of Xtify Inc., a leading provider of cloudbased mobile messaging tools that help organizations
improve mobile sales, drive in-store traffic and engage
customers with personalized offers.
• An open-standards IBM cloud platform that provides
capabilities to power the next generation of cloud andmobile application development and services.
Growth Markets
IBM continues to invest in growth markets where many countries
and companies are embracing big data, mobile, social and cloud,often at faster rates than mature countries. In China, for example,
32 percent of consumers make their purchases online, compared
to only 14 percent of consumers globally. In Africa, 18 percent of thecontinent’s GDP is expected to be handled through mobile moneytransfers by 2015, while in Singapore, citizens spend 40 minutes on
average each day on Facebook, compared to less than 25 minutes
in the United States. IBM is helping clients in growth markets capitalizeon these trends. For example:• In Mexico, IBM is using its analytics tools to enable
Banorte-Ixe Bank to know and service its more than
13 million customers as individuals.
• Using IBM’s Big Data technologies and predictive analytics,
Da Nang’s (Vietnam) traffic control center is better forecastingand preventing potential congestion and better coordinatingcity responses to issues like accidents and adverse weather.
• In Saudi Arabia, the company developed a public healthsolution for disease management that was implemented

with the Saudi Ministry of Health to help manage the risk ofinfectious and communicable diseases across the Kingdom.
•	Faced with rising fuel costs and a goal to reduce greenhouseemissions, Jet Airways, India’s premier international airline,
turned to IBM to more accurately calculate, track and report aircraft emissions and reduce fuel usage.
IBM continues to build out its shared services facilities and talent tosupport its clients in growth markets. In China, the company has
increased its Big Data software skills, and it will leverage an IBM
Integrated Managed Services Centre to capture the significant
growth in cloud. In November 2013, IBM opened its first Africa
Research Lab in Kenya, IBM’s 12th lab worldwide. The facility willconduct applied and exploratory research into the challenges Africa
faces, and deliver commercially viable solutions to help improve thelives of people across the continent.
Summary
IBM’s strategy is one of innovation, transformation and a constant evolution to higher value. The company has steadily remixed its portfolio
and business model to reflect its strategic beliefs and pursue its growth
initiatives. IBM has a balanced history of exiting commodity businesses
that no longer fit the high-value model while investing in strategicacquisitions and organic capabilities. In 2013, the company invested$3.1 billion for acquisitions, $3.8 billion in net capital expenditures and$6.2 billion in research and development. The company has acquired
more than 150 companies since 2000 to bolster its portfolio in areas
like big data and analytics, cloud and systems of engagement.
As the company looks ahead to 2014 and beyond, it will continuously transform itself to take advantage of new opportunities andpursue bold new plays in areas such as Watson solutions, new offerings for big data and analytics, the mobile enterprise and high-value
cloud services. IBM will continue to deliver differentiated client value
based on its sustained investments in research and development, its
engaged employee base, industry expertise, global reach, and thebreadth and depth of the company’s technologies and capabilities.

Business Model
The company’s business model is built to support two principal goals:
helping enterprise clients to become more innovative, efficient andcompetitive through the application of business insight and IT solutions; and providing long-term value to shareholders. The businessmodel has been developed over time through strategic investments
in capabilities and technologies that have superior long-term growthand profitability prospects based on the value they deliver to clients.
The company’s global capabilities include services, software,systems, fundamental research and related financing. The broad
mix of businesses and capabilities are combined to provide integrated solutions to the company’s clients.
The business model is resilient, adapting to the continuously changing market and economic environment. The company continues todivest certain businesses and strengthen its position through strategicorganic investments and acquisitions in higher-value areas. In addition,
the company has transformed itself into a globally integrated enterprise
which has improved overall productivity and is driving investment andexpanding participation in the world’s fastest growing markets.

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Management Discussion
International Business Machines Corporation and Subsidiary Companies

This business model, supported by the company’s financial
model, has enabled the company to deliver strong earnings, cash
flows and returns to shareholders over the long term.

Business Segments and Capabilities
The company’s major operations consists of five business segments: Global Technology Services and Global Business Services,which the company collectively calls Global Services, Software,
Systems and Technology and Global Financing.
Global Services: is a critical component of the company’s strategy
of providing IT infrastructure and business insight and solutions toclients. While solutions often include industry-leading IBM softwareand systems, other suppliers’ products are also used if a client solution requires it. Approximately 60 percent of external Global Services
segment revenue is annuity based, coming primarily from outsourcing and maintenance arrangements. The Global Services backlog
provides a solid revenue base entering each year. Within Global
Services, there are two reportable segments: Global Technology
Services and Global Business Services.
Global Technology Services (GTS) primarily provides IT infrastructure and business process services, creating business value
for clients through unique technology and IP integrated services
within its global delivery model. By leveraging insights and experience drawn from IBM’s global scale, skills and technology, withapplied innovation from IBM Research, clients gain access to leadingedge, high-quality services with improved productivity, flexibility,
cost and outcomes.

GTS Capabilities
Strategic Outsourcing Services: delivers comprehensive IT outsourcing services dedicated to transforming clients’ existing
infrastructures to consistently deliver improved quality, flexibility, risk
management and financial value. The company integrates longstanding expertise in service management and technology with theability to exploit the power of new technologies from IBM systems
and software, such as cloud computing, analytics and virtualization,
to deliver high performance, innovation and improved ability toachieve business objectives.
Global Process Services: delivers a range of offerings consisting ofstandardized through transformational solutions including processing platforms and business process outsourcing. These services
deliver improved business results to clients through the strategicchange and/or operation of the client’s business processes, applications and infrastructure.
Integrated Technology Services: delivers a portfolio of projectbased and managed services that enable clients to transform andoptimize their IT environments by driving efficiency, flexibility andproductivity, while reducing costs. The standardized portfolio is built
around key assets and patented software, and incorporates bestpractices and proven methodologies that ensure predictive qualityof delivery, security and compliance.
Cloud Services: delivers a comprehensive set of cloud services ranging from assisting clients with building their own private clouds, tobuilding customized dedicated managed clouds, to allowing clientsto leverage standardized cloud infrastructure services from the SoftLayer and SmartCloud Enterprise+ offerings, to creating hybrid
environments linking their private and public workloads together. This
portfolio of cloud offerings spans across the GTS business lines.
Technology Support Services: delivers a complete line of support
services from product maintenance through solution support tomaintain and improve the availability of clients’ IT infrastructures.
Global Business Services (GBS) has the mission to deliver predictable business outcomes to the company’s clients across two
primary business areas: Consulting and Application Management
Services. These professional services deliver business value andinnovation to clients through solutions which leverage industry andbusiness process expertise. The role of GBS is to drive initiatives
that integrate IBM content and solutions and drive the progress ofthe company’s four primary growth initiatives. As clients transformthemselves in response to market trends like big data, social andmobile computing, GBS is aligning its expertise and capabilities toaddress two interdependent categories of opportunity: Front Office
Digitization, which describes the markets forming around newmodels of engagement with all audiences; and the Globally Integrated Enterprise, which describes the mandate to integrate dataand processes in support of the new front-office programs, andbuild far more flexible information applications.

GBS Capabilities
Consulting: delivering client value with solutions in Strategy andTransformation, Application Innovation Services, Enterprise Applications and Smarter Analytics. Consulting is also focused on bringing
to market client solutions that drive Front Office Digitization in
Smarter Commerce, Cloud, Mobile and Social Business.
Application Management Services: application management, maintenance and support services for packaged software, as well as
custom and legacy applications. Value is delivered through advanced
capabilities in areas such as application testing and modernization,
cloud application services, the company’s highly differentiated globally
integrated capability model, industry knowledge and the standardization and automation of application management.
Software consists primarily of middleware and operating systems
software. Middleware software enables clients to integrate systems,
processes and applications across a standard software platform to
improve their business results, solve critical problems and gain competitive advantage within their industries. IBM middleware is designed
on open standards, making it easier to integrate disparate businessapplications, developed by different methods and implemented at
different times. Operating systems are the software engines that run
computers. Approximately two-thirds of external Software segment
revenue is annuity based, coming from recurring license charges andongoing post-contract support. The remaining one-third relates
to one-time charge (OTC) arrangements in which clients pay one,up-front payment for a perpetual license. Typically, the sale of OTC
software includes one year of post-contract support. Clients canalso purchase ongoing post-contract support after the first year,
which includes unspecified product upgrades and technical support.

Management Discussion
International Business Machines Corporation and Subsidiary Companies

Software Capabilities
WebSphere Software: delivers capabilities that enable organizations
to run high-performance business applications. With these applications, clients can integrate and manage business processes acrosstheir organizations with the flexibility and agility they need to respondto changing conditions. Built on services-oriented architecture (SOA),
and open standards support for cloud, mobile and social interactions,
the WebSphere platform enables enterprises to extend their reachand optimize interactions with their key constituents. Smarter Commerce software helps companies better manage and improve eachstep of their value chain and capitalize on opportunities for profitable
growth, efficiency and increased customer loyalty.
Information Management Software: enables clients to integrate,
manage and analyze enormous amounts of data from a large variety
of sources in order to gain competitive advantage and improve theirbusiness outcomes. With this approach, clients can extract real value
out of their data and use it to make better business decisions. IBM’s
middleware and integrated solutions include advanced databasemanagement, information integration, data governance, enterprisecontent management, data warehousing, business analytics and intelligence, predictive analytics and big data analytics.
Watson Solutions: included within Information Management Software, Watson is the first commercially available cognitive computing
platform that has the ability to interact in natural language, processing vast amounts of big data, and learning from its interactions withpeople and computers. As an advisor, Watson is able to sift throughand understand large amounts of data delivering insights with
unprecedented speeds and accuracy.
Tivoli Software: helps clients optimize the value they get from theirinfrastructures and technology assets through greater visibility, control and automation across their end-to-end business operations.
These asset management solutions foster integrated service delivery for cloud and datacenter management, enterprise endpoint
and mobile device management, asset and facilities management,
and storage management. Tivoli includes security systems softwarethat provides clients with a single security intelligence platform thatenables them to better secure all aspects of their enterprise andprevent security breaches.
Social Workforce Solutions: enables businesses to connect people
and processes for more effective communication and increased
productivity through collaboration, messaging and social networking software. By remaining at the forefront of collaboration tools,
IBM’s social business offerings help organizations reap real benefits associated with social networking, as well as create a more
efficient and effective workforce.
Rational Software: supports software development for both IT andcomplex embedded system solutions, with a portfolio of products
and solutions supporting DevOps and Smarter Product Development, transforming the way lines of business, development andoperations work together to deliver innovation via software.
Mobile Software: spans middleware and offers customers true endto-end mobile solutions across platform and application
development, mobile security, and mobile device management.

Leveraging powerful analytics and usage data, customers are provided with the ability to have more compelling interactions with theirclients and workforce, increasing touchpoints and deepening relationships. The mobile offerings provide the ability to increase
workforce productivity through enhanced collaboration, improved
knowledge sharing and increased response speed.
Systems and Technology (STG) provides clients with businesssolutions requiring advanced computing power and storage capabilities. Approximately half of Systems and Technology’s server andstorage sales transactions are through the company’s business
partners; with the balance direct to end-user clients. In addition,
Systems and Technology provides leading semiconductor technology, products and packaging solutions for IBM’s own advanced
technology needs and for external clients.

Systems and Technology Capabilities
Systems: a range of general purpose and integrated systems
designed and optimized for specific business, public and scientificcomputing needs. These systems—System z, Power Systems andSystem x—are typically the core technology in data centers that provide required infrastructure for business and institutions. Also, thesesystems form the foundation for IBM’s integrated offerings, such as
IBM PureSystems, IBM Smart Analytics, IBM PureData System for
Analytics powered by Netezza, IBM SmartCloud Entry and IBM
BladeCenter for Cloud. IBM servers use both IBM and non-IBM microprocessor technology and operating systems. All IBM servers run
Linux, a key open-source operating system, and the company isexpanding its Linux relevance further on the Power platform.
Storage: data storage products and solutions that allow clients toretain and manage rapidly growing, complex volumes of digital information. These solutions address critical client requirements for
information retention and archiving, security, compliance and storage optimization including data deduplication, availability andvirtualization. The portfolio consists of a broad range of disk andtape storage systems, leveraging the breadth of IBM’s software
offerings, and includes Flash storage and solutions.
Microelectronics: semiconductor design and manufacturing primarily
for use in IBM systems and storage products as well as delivering
semiconductors and related services to external clients.
Global Financing facilitates clients’ acquisition of IBM systems, software and services. Global Financing invests in financing assets,
leverages with debt and manages the associated risks with the objectiveof generating consistently strong returns on equity. The primary focus
on the company’s offerings and clients mitigates many of the risks normally associated with a financing company. Global Financing has thebenefit of both a deep knowledge of its client base and a clear insight
into the products and services that are being financed. This combination allows Global Financing to effectively manage two of the major risks(credit and residual value) that are normally associated with financing.

Global Financing Capabilities
Client Financing: lease and loan financing to end users and internalclients for terms generally between one and seven years. Internalfinancing is predominantly in support of Global Services’ long-term

33

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Management Discussion
International Business Machines Corporation and Subsidiary Companies

client service contracts. Global Financing also factors a selected
portion of the company’s accounts receivable, primarily for cash
management purposes. All internal financing arrangements are atarm’s-length rates and are based upon market conditions.
Commercial Financing: short-term inventory and accounts receivable financing to dealers and remarketers of IT products.
Remanufacturing and Remarketing: as equipment is returned at
the conclusion of a lease transaction, these assets are refurbishedand sold or leased to new or existing clients both externally andinternally. Externally remarketed equipment revenue represents
sales or leases to clients and resellers. Internally remarketed equipment revenue primarily represents used equipment that is soldinternally to Systems and Technology and Global Services. Systems
and Technology may also sell the equipment that it purchases from
Global Financing to external clients.

IBM Worldwide Organizations
The following worldwide organizations play key roles in IBM’s deliveryof value to its clients:• Sales and Distribution• Research, Development and Intellectual Property• Enterprise Transformation• Integrated Supply Chain
Sales and Distribution
IBM has a significant global presence, operating in more than 175
countries, with an increasingly broad-based geographic distributionof revenue. The company’s Sales and Distribution organization manages a strong global footprint, with dedicated country-based
operating units focused on delivering client value. Within these units,client relationship professionals work with integrated teams of consultants, product specialists and delivery fulfillment teams to improveclients’ business performance. These teams deliver value by understanding the clients’ businesses and needs, and then bring together
capabilities from across IBM and an extensive network of Business
Partners to develop and implement solutions.
By combining global expertise with local experience, IBM’s
geographic structure enables dedicated management focus for
local clients, speed in addressing new market opportunities andtimely investments in emerging opportunities. The geographic
units align industry-skilled resources to serve clients’ agendas.
IBM extends capabilities to mid-market client segments by leveraging industry skills with marketing, Inside Sales and local Business
Partner resources.
The company continues to invest to capture the long-term opportunity in markets around the world that have market growth rates
greater than the global average—countries within Southeast Asia,
Eastern Europe, the Middle East and Latin America. The company’s
major markets include the G7 countries of Canada, France, Germany,
Italy, Japan, the United States (U.S.) and the United Kingdom (UK)plus Austria, the Bahamas, Belgium, the Caribbean region, Cyprus,
Denmark, Finland, Greece, Iceland, Ireland, Israel, Malta, the Netherlands, Norway, Portugal, Spain, Sweden and Switzerland.

The majority of IBM’s revenue, excluding the company’s original
equipment manufacturer (OEM) technology business, occurs inindustries that are broadly grouped into six sectors:• Financial Services: Banking, Financial Markets, Insurance• Public: Education, Government, Healthcare, Life Sciences• Industrial: Aerospace and Defense, Automotive,
Chemical and Petroleum, Electronics• Distribution: Consumer Products, Retail,Travel and Trans­portation• Communications: Telecommunications,Media and Entertain­ment, Energy and Utilities• General Business: Cross-sector representation of intermediatesized large enterprises as well as mid-market clients
Research, Development and Intellectual Property
IBM’s research and development (R&D) operations differentiate thecompany from its competitors. IBM annually invests approximately$6 billion for R&D, focusing on high-growth, high-value opportunities.
IBM Research works with clients and the company’s business units
through 12 global labs on near-term and mid-term innovations. It
contributes many new technologies to IBM’s portfolio every year
and helps clients address their most difficult challenges. IBM
Research also explores the boundaries of science and technology—from nanotechnology to future systems, big data analytics,
secure clouds and to IBM Watson, a ‘‘cognitive’’ learning system.
IBM Research also focuses on differentiating IBM’s services
businesses, providing new capabilities and solutions. It has theworld’s largest mathematics department of any public company,
enabling IBM to create unique analytic solutions and actively engage
with clients on their toughest challenges.
In 2013, IBM was awarded more U.S. patents than any othercompany for the 21st consecutive year. IBM’s 6,809 patents
awarded in 2013 represent a diverse range of inventions poised toenable significant innovations that will position the company to compete and lead in strategic areas such as Watson, cloud computing
and big data analytics. These inventions also will advance the new
era of cognitive systems where machines will learn, reason and interact with people in more natural ways. It was the most U.S. patents
ever awarded to one company in a single year.
The company continues to actively seek intellectual property
protection for its innovations, while increasing emphasis on otherinitiatives designed to leverage its intellectual property leadership.
Some of IBM’s technological breakthroughs are used exclusively in
IBM products, while others are licensed and may be used in IBM
products and/or the products of the licensee. While the company’svarious proprietary intellectual property rights are important to its
success, IBM believes its business as a whole is not materiallydependent on any particular patent or license, or any particular groupof patents or licenses. IBM owns or is licensed under a number ofpatents, which vary in duration, relating to its products.
Enterprise Transformation
A key element of the company’s strategy is becoming a Smarter
Enterprise. The transformation to a Smarter Enterprise is built on thefoundation of internal transformation undertaken in the recent past,
where IBM standardized business processes, drove enterprisewide

Management Discussion
International Business Machines Corporation and Subsidiary Companies

transformation governance, implemented a global operating model,
instrumented data, and connected employees to drive collaboration
across geographic and functional boundaries.
The Smarter Enterprise is enabled through application ofanalytics, social, mobile and cloud tools, approaches and technologies. Analytics enable data-driven insights for faster, smarter
decision making. Social tools encourage peer-to-peer interactions,and allow data to be shared within and outside IBM in a social way.
Mobile technology allows workers to work seamlessly from anywhere. Cloud infrastructure and services enable application delivery.
Collectively these enablers allow IBM to make decisions differently,
create value differently and deliver value differently, thereby improving employee engagement and client experience and ultimately
driving better business performance. The company primarily reinvests the benefits of its enterprise transformation initiatives inremixing its spending profile and resources to its higher growth,higher margin initiatives, in addition to improving profitability.

Integrated Supply Chain
IBM has an extensive integrated supply chain, procuring materials andservices globally. In 2013, the company also managed approximately$20 billion in procurement spending for its clients through the Global
Process Services organization. The supply, manufacturing and logistics
and sales transaction support operations are integrated in one operating unit that has optimized inventories over time. Simplifying andstreamlining internal processes has improved sales force productivity
and operational effectiveness and efficiency. Supply chain resiliency
enables IBM to reduce its risk during marketplace changes.
The company continues to derive business value from its own
globally integrated supply chain providing a strategic advantage forthe company to create value for clients. IBM leverages its supply
chain expertise for clients through its supply chain business transformation outsourcing service to optimize and help operate clients’end-to-end supply chain processes, from procurement to logistics.
The company has expanded its use of analytics to measure,manage and fine tune its supply chain operations, which will help
reshape its operations and create value for clients.

Year in Review

Segment Details
The following is an analysis of the 2013 versus 2012 reportable segment results. The table below presents each reportable segment’s external
revenue and gross margin results. Segment pre-tax income includes transactions between segments that are intended to reflect an arm’slength transfer price and excludes certain unallocated corporate items; see note T, “Segment Information,” on pages 141 to 146 foradditional information.
($ in millions)

For the year ended December 31:

2013

2012

$38,551$  40,236

Yr.-to-Yr.
Percent/
MarginChangeYr.-to-Yr.
Percent Change
Adjusted for
Currency

Revenue
Global Technology Services
Gross margin
Global Business Services
Gross margin
SoftwareGross margin
Systems and Technology
Gross margin
Global Financing
Gross margin
Other
Gross margin38.1%
18,39630.9%
25,93288.8%
14,371

36.6%
18,56630.0%
25,44888.7%
17,667(4.2)%(0.9)%
1.9%(18.7)%

35.6%

39.1%

2,022

2,013

0.4%

45.6%

46.5%

(0.9 ) pts.

478

577

(17.1)%(195.6)%(71.6)%(124.0) pts.
(4.6)%

Total consolidated gross profit$48,505$  50,298(3.6)%

48.6%

48.1%

388

375

3.5%

5

1

NM

0.5 pts.

Non-operating adjustments

Retirement-related costs/(income)

629

264

138.1%

Operating (non-GAAP) gross profit$49,527$  50,938(2.8)%

Operating (non-GAAP) gross margin
NM—Not meaningful

49.7%

48.7%

(17.9)%(3.5) pts.

$104,507

Acquisition-related charges

2.9%

0.1 pts.

$99,751

Amortization of acquired intangible assets

2.6%

0.9 pts.

Total consolidated revenue

Total consolidated gross margin(1.4)%

1.5 pts.

0.9 pts.

2.8%(16.4)%(2.5)%

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Management Discussion
International Business Machines Corporation and Subsidiary Companies

Global Services
In 2013, the Global Services segments, Global Technology Services(GTS) and Global Business Services (GBS), delivered $56,947 millionof revenue, grew pre-tax income 2.5 percent and expanded pre-tax
margin 1.0 points. GBS returned to revenue growth in 2013, at constant currency, leveraging the investments made in the Digital Front
Office practices. GTS revenue performance improved during thesecond half of 2013 and is stabilizing. Global Services had
good performance in the key growth initiatives of Smarter Planet,business analytics and cloud, and is continuing to invest to expand
its capabilities in these areas. Total outsourcing revenue of $26,157
million decreased 5.1 percent (2 percent adjusted for currency) andtotal transactional revenue of $23,678 million decreased 1.0 percent
as reported, but increased 2 percent adjusted for currency year toyear. The estimated Global Services backlog was $143 billion at
December 31, 2013, an increase of 1.8 percent (5 percent adjusted
for currency) versus the prior year-end balance.

($ in millions)

For the year ended December 31:

Yr.-to-Yr.
Percent
ChangeYr.-to-Yr.
Percent Change
Adjusted for
Currency

2013

2012

Global Services external revenue$56,947$58,802(3.2)%(0.2)%

Global Technology Services$38,551$40,236(4.2)%(1.4)%

Outsourcing

22,06023,344

(5.5)

(2.7)

Integrated Technology Services

9,380

9,550

(1.8)

1.0

Maintenance

7,111

7,343

(3.1)

(0.7)

$18,396$18,566(0.9)%

2.6%

Outsourcing

4,097

4,209

(2.6)

1.5

Consulting and Systems Integration

14,29814,358(0.4)

2.9

Global Business Services

Global Technology Services revenue of $38,551 million in 2013
decreased 4.2 percent (1 percent adjusted for currency) year to year.
From a geographic perspective, revenue declines in North America
and Europe were partially offset by growth in Japan, adjusted for
currency. GTS Outsourcing revenue decreased 5.5 percent (3 percent adjusted for currency) in 2013. Revenue performance was
impacted by a decline in revenue from sales into existing baseaccounts. This activity is more transactional in nature and can be
economically sensitive. Revenue was also impacted by the work done
to improve the profitability of the restructured low margin outsourcing
contracts. GTS Outsourcing had double-digit signings growth in 2013
and started to realize the benefit from several of the large transformational contract signings in its fourth-quarter 2013 revenue.
Integrated Technology Services (ITS) revenue decreased 1.8 percent
as reported, but increased 1 percent adjusted for currency in 2013
compared to 2012. The company continues to shift the ITS businesstoward higher value managed services such as business continuity,
security and cloud. Within the cloud offerings, SoftLayer contributed
2 points of revenue growth to the ITS performance in 2013, and ahalf-point to total GTS revenue for the year. SoftLayer provides
unmatched performance, flexibility and breadth for public and hybrid
cloud workloads. In January 2014, the company announced plans
to invest over $1.2 billion to double its SoftLayer centers, and with
40 cloud datacenters in 15 countries, the company will have cloudcenters in every major geography and key financial center.
Global Business Services revenue of $18,396 million decreased
0.9 percent as reported, but increased 3 percent at constant currency
in 2013 with growth in both GBS Outsourcing and Consulting and
Systems Integration (C&SI), adjusted for currency. GBS revenue
increased 0.5 percent (4 percent at constant currency) in the second
half of the year. On a geographic basis, revenue growth at constantcurrency was led by North America, Japan and the growth markets,

while Europe was flat year to year. By offering, growth was driven by
the practices that address the Digital Front Office. GBS delivered
double-digit growth in each of the strategic growth initiatives of business analytics, Smarter Planet and cloud. The company has been
investing to build capabilities in these key areas and now has nearly
20,000 resources in GBS focused on the growing Digital Front Officeopportunity. In the area of big data, the GBS capabilities span from
Business Analytics and Optimization strategy, through Front Office
Analytics to Fraud and Regulatory Compliance and Risk Management.
Application Outsourcing revenue decreased 2.6 percent as reported,but increased 2 percent adjusted for currency. C&SI revenue decreased
0.4 percent as reported, but increased 3 percent adjusted for currency.
Both lines of business had constant currency revenue growth year
to year in the growth markets. In 2013, the GBS backlog grew for thefifth consecutive year at constant currency led by the major markets.
($ in millions)

For the year ended December 31:

2013

2012

$14,691$14,740

Yr.-to-Yr.
Percent/
MarginChangeGlobal Services
Global Technology Services
External gross profit
External gross profit margin
Pre-tax income
Pre-tax margin

38.1%$ 6,983
17.6%

36.6%
$ 6,96116.8%(0.3)%
1.5 pts.
0.3%
0.8 pts.

Global Business Services
External gross profit
External gross profit margin
Pre-tax income
Pre-tax margin$ 5,676
30.9%$ 3,21416.8%$ 5,564
30.0%$ 2,983
15.5%

2.0%
0.9 pts.
7.7%
1.3 pts.

Management Discussion
International Business Machines Corporation and Subsidiary Companies

GTS gross profit decreased 0.3 percent in 2013 and the gross profit
margin improved 1.5 points year to year with margin expansion ineach line of business, as well as in the growth markets and major
markets. Pre-tax income increased 0.3 percent year to year and thepre-tax margin expanded 0.8 points to 17.6 percent. The 2013
margin improvement was driven by reductions in performancerelated compensation, benefits from the second-quarter 2013
workforce rebalancing activity and efficiency improvements primarily
through the company’s enterprise productivity initiatives, partially
offset by higher year-to-year workforce rebalancing charges.
The GBS gross profit margin expanded 0.9 points in 2013 withimproved profit performance in Application Outsourcing. GBS pre-tax
income increased 7.7 percent in 2013 with a pre-tax margin of 16.8
percent, an improvement of 1.3 points year to year. GBS benefitted
from reductions in performance-related compensation, the company’s enterprise productivity initiatives and the second-quarter 2013
workforce rebalancing activity, partially offset by higher year-to-year
workforce rebalancing charges. The savings from those actions fuelthe investments being made in the key growth initiatives.
The total Global Services business delivered profit growth andmargin expansion throughout 2013. Pre-tax income of $10,197 million in 2013 increased 2.5 percent year to year and the pre-tax
margin expanded 1.0 points to 17.4 percent.

Global Services Backlog
The estimated Global Services backlog at December 31, 2013 was$143 billion, an increase of 1.8 percent as reported and 5 percent
adjusted for currency compared to the December 31, 2012 balance,with growth across both the transactional and outsourcing businesses. Revenue generated from the opening backlog is approximately
70 percent of total services annual revenue in any year. In 2014, theprojected total services revenue from the backlog is expected to be
up 1 percent year to year at consistent foreign currency exchange
rates. The divestiture of the company’s customer care business in thefirst quarter of 2014 will impact performance from the backlog. This
will reduce the total backlog and impact revenue growth from thebacklog by approximately 3 points; including the divestiture, revenue
generated from the backlog is expected to be down 2 percent year
to year. The balance of the revenue, the other approximately 30 percent of total services revenue in any year, comes from yield fromcurrent year signings, and sales and volumes into the existing clientbase. It also includes SoftLayer and some other cloud services, which
generate period revenue that isn’t reflected in the backlog.
The estimated transactional backlog at December 31, 2013
increased 5.3 percent (8 percent adjusted for currency) and the estimated outsourcing backlog increased 1.5 percent (5 percent adjusted
for currency), respectively, from the December 31, 2012 levels.

($ in billions)

At December 31:

Yr.-to-Yr.
Percent
ChangeYr.-to-Yr.
Percent Change
Adjusted for
Currency

2013

2012

$142.8$140.3

1.8%

4.8%

90.8

89.4

1.5

4.7

Backlog
Total backlog
Outsourcing backlog

Total Global Services backlog includes GTS Outsourcing, ITS, GBS
Outsourcing, Consulting and Systems Integration and Maintenance.
Outsourcing backlog includes GTS Outsourcing and GBS Outsourcing. Transactional backlog includes ITS and Consulting and Systems
Integration. Total 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 adjustments for currency.
Global Services signings are management’s initial estimate of
the value of a client’s commitment under a Global Services contract.
There are no third-party standards or requirements governing
the calculation of signings. The calculation used by management

involves estimates and judgments to gauge the extent of a client’s
commitment, including the type and duration of the agreement, andthe presence of termination charges or wind-down costs.
Signings include GTS Outsourcing, ITS, GBS Outsourcing andConsulting and Systems Integration 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, whererevenues equal renewals.
Contract portfolios purchased in an acquisition are treated as
positive backlog adjustments provided those contracts meet thecompany’s requirements for initial signings. A new signing will berecognized if a new services agreement is signed incidental or coincidental to an acquisition or divestiture.

($ in millions)

For the year ended December 31:

Yr.-to-Yr.
Percent
ChangeYr.-to-Yr.
Percent Change
Adjusted for
Currency

2013

2012

$63,203$56,595

11.7%

14.8%

Outsourcing signings$35,027$27,891

25.6%

28.7%

Transactional signings

28,17628,703(1.8)

1.4

Total signings

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Management Discussion
International Business Machines Corporation and Subsidiary Companies

Software($ in millions)

For the year ended December 31:

Yr.-to-Yr.
Percent
ChangeYr.-to-Yr.
Percent Change
Adjusted for
Currency

2013

2012

$25,932$25,448

1.9%

2.9%

$21,557$20,983

2.7%

3.7%

17,322

16,5284.8

5.7

WebSphere Family

8.2

9.1

Information Management

2.8

3.7

Social Workforce Solutions*

10.8

11.9

Tivoli

3.9

4.8

Rational

4.9

6.0

Software external revenue
Middleware
Key Branded Middleware

4,235

4,455

(4.9)

(3.9)

Operating systems

2,447

2,525

(3.1)

(1.9)

Other

1,929

1,940

(0.6)

0.2

Other middleware* Formerly Lotus

Software revenue of $25,932 million increased 1.9 percent asreported and 3 percent adjusted for currency in 2013 compared to2012. The Software business delivered revenue growth, at constantcurrency, in all four quarters of the year. Revenue continued to mix
toward key branded middleware with growth in all five brands. The
Software value proposition remains strong for enterprise clients.
Customers continue to increase deployment of the company’s
middleware products and the business is investing and gaining
share in social, mobile, analytics, cloud and security. Some of this isdelivered in a SaaS model, and the company has over 100 SaaS
offerings in its software portfolio. Across the Software brands, there
was strong performance in the growth initiatives that address the
key market trends—Smarter Planet, business analytics and cloud.
The Software business completed eight acquisitions in 2013, adding
to its capabilities in mobile, big data analytics and security. The Software business grew segment pre-tax profit 2.7 percent to $11.1 billion
and expanded pre-tax margin 0.5 points.
In January 2014, the company announced a $1 billion investment inWatson, and it established a new Watson Group within the Software
business. This new unit is dedicated to the development and commercialization of cloud-delivered cognitive innovations.
Key branded middleware revenue increased 4.8 percent (6 percent
adjusted for currency), with strong performance in the areas of analytics,
cloud, mobile, social and security. The faster growing and higher value
branded middleware accounted for 67 percent of total Software revenue
in 2013, an increase of 2 points from 2012.
WebSphere revenue increased 8.2 percent (9 percent adjusted
for currency) in 2013 and gained share. Revenue performance wasdriven by double-digit growth in the Commerce offerings, andgrowth in Business Integration and the on-premises Application
Server business. Mobile contributed strong revenue growth in 2013.
MobileFirst, the company’s comprehensive portfolio of mobile software and services, was introduced in 2013 and extends value toclients to reach new markets and gain competitive advantage. The
company continues to add capabilities to the WebSphere brand. In
January 2014, the business acquired Aspera, Inc. which provides
best in class transfer speeds for movement of big data.

Information Management revenue increased 2.8 percent (4 percent adjusted for currency) in 2013 compared to 2012. Performancein 2013 included strong growth in the distributed database offerings,
including Netezza, and content management software.
Tivoli revenue increased 3.9 percent (5 percent adjusted for currency) in 2013 and gained share, driven by storage growth and the
security solutions portfolio. Tivoli storage revenue was up 7 percent (8percent adjusted for currency) in 2013. Tivoli security revenue increased
17 percent (19 percent adjusted for currency) and reflects contribution
from the acquisition of Trusteer in the third quarter of 2013, which
extended Tivoli’s data security capabilities further into cloud and mobile
environments. The transformation driven by mobile and cloud computing is raising the importance of security for enterprise customers. The
company has been building and expanding its security capabilities andnow has 6,000 security experts worldwide, 3,000 patents in security
and 25 security laboratories worldwide across software and services.
Social Workforce Solutions revenue increased 10.8 percent(12 percent adjusted for currency) in 2013. Performance was driven
by Kenexa, which provides cloud-based recruiting and talentmanagement solutions.
Rational revenue increased 4.9 percent (6 percent adjusted for
currency) in 2013 year over year.
Operating systems revenue decreased 3.1 percent (2 percent
adjusted for currency) in 2013 compared to 2012, driven by declines in
Systems z and Power Systems.
($ in millions)

For the year ended December 31:

2013

2012

$23,032$22,569

Yr.-to-Yr.
Percent/
MarginChangeSoftwareExternal gross profit
External gross profit margin
Pre-tax income
Pre-tax margin

88.8%$11,106
38.1%

88.7%
$10,81037.6%

2.0%
0.1 pts.
2.7%
0.5 pts.

Management Discussion
International Business Machines Corporation and Subsidiary Companies

Software gross profit increased 2.0 percent in 2013, with a grossprofit margin of 88.8 percent. Software pre-tax income increased
2.7 percent and the pre-tax margin improved 0.5 points to 38.1 percent. The Software business had another successful year leveraging
revenue growth and expense savings, primarily from the company’s

enterprise productivity initiatives, to drive profit growth and margin
expansion. The relative strength of the Software business, fueled by
growth in the key growth initiatives, improved the company’s business mix and contributed to its operating (non-GAAP) consolidated
gross and net margin improvements.

Systems and Technology($ in millions)

For the year ended December 31:

Systems and Technology external revenue

2013

2012

$14,371$17,667

Yr.-to-Yr.
Percent
ChangeYr.-to-Yr.
Percent Change
Adjusted for
Currency(18.7)%(17.9)%

System z(13.4)%(12.6)%

Power Systems(31.4)(30.7)

System x(13.5)(12.7)

Storage(10.8)(9.7)(17.6)(16.8)(11.9)(11.9)(17.0)(16.3)(98.2)(98.2)

Total Systems excluding Retail Store Solutions
Microelectronics OEM
Total Systems and Technology excluding Retail Store Solutions
Retail Store Solutions (Divested in 2012)

Systems and Technology (STG) revenue decreased 18.7 percent(18 percent adjusted for currency) in 2013 versus 2012. Adjusting forthe divested RSS business, revenue declined 17.0 percent (16 percent adjusted for currency) in 2013. Growth markets revenue
decreased 16.5 percent (16 percent adjusted for currency) in 2013,
compared to the prior year, while major markets revenue decreased
21.5 percent (20 percent adjusted for currency). Japan declined 18
percent as reported, but was essentially flat adjusted for currency.
Two issues within the business significantly impacted the segment’s
revenue and profit performance in 2013. First, STG is dealing withchallenges in its hardware business models specific to Power Systems, Storage and x86. In addition, System z revenue was impacted
by the product cycle, particularly in the second half, as the company
entered the back end of the current mainframe cycle with difficult
period-to-period comparisons driving revenue declines.
System z revenue decreased 13.4 percent (13 percent adjusted
for currency) in 2013 versus 2012. The decrease was primarily driven
by lower revenue in North America, while revenue increased in thegrowth markets. MIPS (millions of instructions per second) shipments increased 6 percent in 2013 versus the prior year. The
increase in MIPS was driven by specialty engines, which increased
17 percent year over year and continue to be more than 50 percentof the total volumes. The decline in System z revenue was expectedbased on the product’s movement through the product cycle in2013. In the current mainframe cycle, the company has shipped 28
percent more MIPS compared to the same period in the prior cycle.
The revenue and gross profit in the current cycle are each about 99
percent of the previous cycle, net of currency. Mainframe products
provide the highest levels of availability, reliability, efficiency andsecurity, which position it as the ideal platform for high volume, mission critical workloads. The additional MIPS capacity in the current
product cycle is a reflection of the ongoing relevance of the mainframe to clients, and provides the company with financial returns
consistent with past cycles.

Power Systems revenue decreased 31.4 percent (31 percent
adjusted for currency) in 2013 versus 2012. The Power platform
continues to ship significant capacity into the UNIX market, however
this has been more than offset by significant price performance,
resulting in lower revenue. The company has been very successful
in the UNIX market, and is taking two actions to improve its businessmodel in Power Systems. First, it is making the platform more relevant to clients. To achieve this:• In the fourth quarter of 2013, the company introduced a new
Integrated Facility for Linux offering which enables clients to run
Linux workloads in their existing servers. This mirrors the successful strategy the company executed on the System z platform;• The company will expand its Linux relevance even further
with POWER8 in 2014, which will provide additional big dataand cloud capabilities; and•	Through the company’s OpenPOWER consortium it is making
Power technology available to an open development alliance,building an ecosystem around the Power technologies.
These effects will take some time.
Secondly, even with these additional capabilities, the company
recognizes that the size of the Power platform will not return to priorrevenue levels. The company will take action by right-sizing the business for the demand characteristics it expects.
System x revenue decreased 13.5 percent (13 percent adjusted for
currency) in 2013 versus 2012. High-end System x revenue decreased
16 percent (16 percent adjusted for currency) and blades revenue
declined 45 percent (45 percent adjusted for currency) in 2013 versus
the prior year. These decreases were partially offset by increased
revenue driven by PureSystems.
PureSystems continued to gain momentum. Globally to date, thecompany has shipped over 10,000 systems across its hardware brands.
Storage revenue decreased 10.8 percent (10 percent adjusted for
currency) in 2013 versus 2012. The company’s flash solutions continued to gain momentum in 2013 with positive revenue growth. The

39

40

Management Discussion
International Business Machines Corporation and Subsidiary Companies

Storwize products delivered double-digit growth, which were morethan offset by declines in legacy OEM mid-range offerings, anddeclines in high-end offerings driven by significant pricing pressure.
Retail Store Solutions (RSS) revenue decreased 98.2 percent(98 percent adjusted for currency) in 2013 versus 2012. In the third
quarter of 2012, the company divested the RSS business to ToshibaTec. See the caption, “Divestitures,” on page 98 for additional information regarding the transaction.
Microelectronics OEM revenue decreased 11.9 percent (12 percent
adjusted for currency) in 2013 versus 2012.
($ in millions)

For the year ended December 31:

2013

2012

$5,120$6,903

Yr.-to-Yr.
Percent/
MarginChangeThe decrease in external gross profit in 2013 versus 2012 was due
to lower revenue and a lower overall gross profit margin reflecting
the business model challenges. Overall gross margin decreased 3.5
points in 2013 versus the prior year. The decrease was driven bylower margins in Power Systems (1.0 points), System x (0.9 points),
Microelectronics (0.7 points) and Storage (0.4 points) as well as adecline due to revenue mix (0.7 points), partially offset by margin
improvement in System z (0.1 points).
Systems and Technology’s pre-tax income decreased $1,734
million to a loss of $507 million in 2013, when compared to the prioryear. Pre-tax margin decreased 10.1 points in 2013 versus 2012. The
decline in pre-tax income was driven by the hardware businesses
which are dealing with business model challenges due to market
shifts and System z, as it entered the backend of the mainframe
product cycle late in the year.

Systems and Technology
External gross profit
External gross profit margin

35.6%

Pre-tax income$(507)

Pre-tax margin(3.4)%

39.1%$1,227
6.7%(25.8)%

Global Financing(3.5) pts. See pages 72 through 75 for an analysis of Global Financing’sNMsegment results.

(10.1) pts.

NM—Not meaningful

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 discussed separately below.
($ in millions)

For the year ended December 31:

Yr.-to-Yr.
Percent
ChangeYr.-to-Yr.
Percent Change
Adjusted for
Currency

2013

2012

Total revenue$99,751$104,507(4.6)%(2.5)%

Geographies$97,800$102,268(4.4)%(2.2)%

Americas43,24944,556

(2.9)

(2.0)

Europe/Middle East/Africa

31,62831,775

(0.5)

(2.1)

Asia Pacific

22,92325,937(11.6)(2.8)

Major markets(4.2)%(2.2)%

Growth markets(4.9)%(2.4)%(8.2)%(5.6)%BRIC countries

Total geographic revenue of $97,800 million decreased 4.4 percent (2 percent adjusted for currency) in 2013. Revenue in the
major markets decreased 4.2 percent (2 percent adjusted for currency). Revenue from the growth markets, which represented
approximately 23 percent of the total geographic revenue for theyear, decreased 4.9 percent on a year-to-year basis (2 percent
adjusted for currency). Performance at constant currency in thegrowth markets was mixed, with year-to-year growth in the firsthalf offset by declines in the second half. The company had
strength in Latin America and the Middle East and Africa region.
However, declines in some of the larger growth markets, for example
China and Australia, impacted the overall performance in thegrowth markets. Within the BRIC countries of Brazil, Russia, India

and China, combined revenue declined 8.2 percent (6 percent
adjusted for currency). The company continues to see good opportunity in all regions over the long term and is continuing to invest inthese key markets.
Americas revenue decreased 2.9 percent (2 percent adjusted for
currency) compared to the prior year. The major market countries were
down 3.9 percent (4 percent adjusted for currency), partially offset by
an increase in the Latin America growth markets of 4.4 percent(9 percent adjusted for currency). Within the major market countries,
the U.S. was down 3.4 percent and Canada was down 6.3 percent(3 percent adjusted for currency). Within the growth market countries,
Brazil increased 3.3 percent (10 percent adjusted for currency) andMexico increased 7.8 percent (8 percent adjusted for currency).

Management Discussion
International Business Machines Corporation and Subsidiary Companies

Europe/Middle East/Africa (EMEA) revenue decreased 0.5 percent (2 percent adjusted for currency) compared to the prior year.
The major market countries were down 0.5 percent (3 percent
adjusted for currency), while the growth market countries were down
0.6 percent (up 1 percent adjusted for currency). In the major market
countries, the UK decreased 1.4 percent (flat adjusted for currency),
Germany decreased 0.1 percent (3 percent adjusted for currency),
France decreased 1.8 percent (5 percent adjusted for currency), andItaly decreased 2.1 percent (5 percent adjusted for currency). Within
the EMEA growth markets, the Middle East and Africa region
increased 5.0 percent (11 percent adjusted for currency), but thisgrowth was offset primarily by a decrease in Russia of 22.7 percent(22 percent adjusted for currency).
Asia Pacific revenue decreased 11.6 percent (3 percent adjusted
for currency) year to year. Japan revenue decreased 15.2 percent asreported, but increased 4 percent overall and grew in every quarteron a constant currency basis. This growth reflects the benefits ofshifting investment and redirection of the company’s go-to-market
focus to improve performance in Japan. The Asia Pacific growthmarkets decreased 9.1 percent (7 percent adjusted for currency),with China down 12.2 percent (14 percent adjusted for currency) andAustralia down 15.9 percent (10 percent adjusted for currency).
During 2013, performance in China was impacted by the processsurrounding the implementation of a broad governmental economic
reform plan.
OEM revenue of $1,951 million in 2013 decreased 12.9 percent(12 percent adjusted for currency) compared to the prior year, driven
by the Microelectronics OEM business.

Total Expense and Other (Income)For the year ended December 31:

2013

2012

Total consolidated expenseand other (income)$28,981$28,396

Yr.-to-Yr.
Percent/
MarginChange2.1%

Non-operating adjustments
Amortization of acquired
intangible assets

(370)

(328)

12.9

Acquisition-related charges

(40)

(35)

14.9

Operating (non-GAAP)
expense and other (income)

		
		

Total
Consolidated

Operating(non-GAAP)(1) point		
2 points		
1 point		

(1) point
2 points
1 point•	Currency*•	Acquisitions**•	Base expense  * Reflects impacts of translation and hedging programs.
** Includes acquisitions completed in prior 12-month period.

In the execution of its strategy, the company continues to invest
in its growth initiatives, innovation and strategic acquisitions. The
company also has had an ongoing focus on increasing efficiency
and productivity across the business.
For additional information regarding total expense and other(income), see the following analyses by category.

Selling, General and Administrative($ in millions)

For the year ended December 31:

(433)

(274)

$28,137$27,760

58.3
1.4%

2013

2012

Yr.-to-Yr.
Percent
ChangeSelling, general andadministrative expense
Selling, general andadministrative—other$19,187$19,589

Advertising and promotional expense

1,294

1,339

(3.3)

Workforce rebalancing charges

1,064

803

32.4
5.3

(2.1)%

995

945

Amortization of acquired
intangible assets

370

328

12.9

Stock-based compensation

435

498

(12.6)

Bad debt expense

156

50

210.0

$23,502$23,553

Amortization of acquired
intangible assets

(370)

(328)

12.9

Acquisition-related charges

(25)

(22)

13.3

Non-operating retirement-related(costs)/income

(376)

(294)

28.1

$22,731$22,910Retirement-related costs($ in millions)Non-operating retirement-related(costs)/income

Total expense and other (income) increased 2.1 percent in 2013
versus 2012. Total operating (non-GAAP) expense and other(income) increased 1.4 percent versus the prior year. The key driversof the year-to-year change in total expense and other (income) wereapproximately:

Total consolidated selling, generaland administrative expense(0.2)%

Non-operating adjustments

Total consolidated
expense-to-revenue ratio

29.1%

27.2%

Operating (non-GAAP)
selling, general and1.9 pts.
administrative expense

Operating (non-GAAP)
expense-to-revenue ratio

28.2%

26.6%

1.6 pts.

(0.8)%

41

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Management Discussion
International Business Machines Corporation and Subsidiary Companies

Total selling, general and administrative (SG&A) expense decreased
0.2 percent in 2013 versus 2012. The decrease was primarily driven
by the effects of currency (1 point) and base spending (1 point),
partially offset by acquisition-related spending (2 points). Operating(non-GAAP) SG&A expense decreased 0.8 percent primarily driven
by the effects of currency (1 point) and lower base spending(1 point), partially offset by acquisition-related spending (1 point).
The decrease was driven by lower SG&A—other expense, as thecompany continues to shift its spending. The company is continuing
to drive productivity across the business, primarily through its enterprise productivity initiatives, and is reinvesting most of those savings
into the business to drive its growth areas. The increase in workforce
rebalancing charges was due to actions the company took in thesecond quarter of 2013. Bad debt expense increased $106 million
in 2013 versus 2012, primarily driven by higher specific accountreserves. The accounts receivable provision coverage was 1.6 percent at December 31, 2013, an increase of 20 basis points fromyear-end 2012.

Other (Income) and Expense($ in millions)

For the year ended December 31:

Yr.-to-Yr.
Percent
Change2013

2012

Foreign currency transaction
losses/(gains)$(260)$(240)(Gains)/losses on derivative
instruments

166

72

132.5

Research, Development and Engineering($ in millions)

For the year ended December 31:

2013

2012

$6,226$6,302Non-operating retirement-related(costs)/income

(57)

20

Operating (non-GAAP) research,development and engineering$6,170$6,322

Total consolidated research,development and engineering

Yr.-to-Yr.
Percent
Change(1.2)%

Non-operating adjustment
NM(2.4)%

NM—Not meaningful

The company continues to invest in research and development,
focusing its investments on high-value, high-growth opportunities
and to extend its technology leadership. Total research, development
and engineering (RD&E) expense decreased 1.2 percent in 2013
versus 2012, primarily driven by lower base spending (3 points), partially offset by acquisitions (2 points). Operating (non-GAAP) RD&E
expense decreased 2.4 percent in 2013 compared to the prior year
primarily driven by lower base spending (4 points), partially offset byacquisitions (2 points). Overall, the investment in RD&E represented
6.2 percent of revenue in 2013, compared to 6.0 percent in 2012.

Other (income) and expenseIntellectual Property and Custom Development Income
8.4%Interest income

(74)

(109)

(32.2)Net (gains)/losses from securities
and investment assets

(29)

(55)

(48.0)

Other

(131)

(511)

(74.4)

Total consolidated other(income) and expense$(327)$(843)(61.2)%

Acquisition-related charges

(16)

(13)

17.4

Operating (non-GAAP)
other (income) and expense$(343)$(857)(60.0)%

Non-operating adjustment

Other (income) and expense was income of $327 million and $843
million in 2013 and 2012, respectively. The decrease in income of$516 million in 2013 was primarily driven by lower income from divestitures ($405 million) driven by the gain associated with the divested
RSS business ($446 million) in 2012 reflected in Other in the table
above, and increased losses on derivative instruments ($95 million)
due to foreign currency rate volatility year to year.

($ in millions)Yr.-to-Yr.
Percent
ChangeFor the year ended December 31:

2013

2012

Sales and other transfersof intellectual property$352$  324

8.7%

Licensing/royalty-based fees

150

251

(40.0)

Custom development income

320

500

(36.0)

Total

$822

$1,074(23.5)%The timing and amount of sales and other transfers of intellectual
property (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 individual IP transactions in 2013 or 2012.
Custom development income declined 36 percent compared tothe prior year due to a reduction in payments from the company’s
technology alliance partners.

Interest Expense($ in millions)

For the year ended December 31:

2013

2012

$402

$459

Yr.-to-Yr.
Percent
ChangeInterest expense
Total(12.5)%

Management Discussion
International Business Machines Corporation and Subsidiary Companies

The decrease in interest expense in 2013 versus 2012 was primarily
driven by lower average interest rates, partially offset by higher average debt levels. Interest expense is presented in cost of financing in
the Consolidated State­ment of Earnings only if the related externalborrowings are to support the Global Financing external business.
See page 75 for additional information regarding Global Financing
debt and interest expense. Overall interest expense (excluding capitalized interest) for 2013 was $989 million, a decrease of $15 million
year to year.

Stock-Based Compensation
Total pre-tax stock-based compensation cost of $614 million
decreased $74 million compared to 2012. The decrease was primarily related to performance share units ($48 million), the company’s
assumption of stock-based awards previously issued by acquired
entities ($16 million) and restricted stock units ($10 million). Stockbased compensation cost, and the year-to-year change, wasreflected in the following categories: Cost: $122 million, down $10
million; SG&A expense: $435 million, down $63 million; and RD&E
expense: $57 million, down $2 million.
See note R, “Stock-Based Compensation,” on pages 124 to 127
for additional information on stock-based compensation.

Retirement-Related Plans
The following table provides the total pre-tax cost for all retirementrelated plans. These amounts are included 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:

Yr.-to-Yr.
Percent
Change20132012$  545$  493

10.6%

Retirement-related plans—cost
Service cost
Amortization of priorservice cost/(credits)

(114)

(148)

(22.9)

Cost of defined contribution plans

1,384

1,506

(8.1)

$ 1,815$ 1,851

Interest cost

3,728

4,238

Expected return on plan assets(6,187)(6,356)(2.7)

Recognized actuarial losses

3,434

2,407

42.7

0

1

(30.6)

Total operating costs

Plan amendments/curtailments/
settlements(2.0)%(12.0)

86247(65.4)

Total non-operating costs/(income)$ 1,062$  538

97.5%

Total retirement-relatedplans—cost$ 2,876$ 2,389

20.4%

Multi-employer plan/other costs

In 2013, total retirement-related plan cost increased by $488 million
compared to 2012, primarily driven by an increase in recognizedactuarial losses ($1,027 million) and lower expected return on plan
assets ($169 million), partially offset by lower interest cost ($510 million)
and lower pension litigation cost ($152 million).
As discussed in the “Operating (non-GAAP) Earnings” section
on page 26, the company characterizes certain retirement-related
costs as operating and others as non-operating. Utilizing thischaracterization, operating retirement-related costs in 2013 were
$1,815 million, a decrease of $36 million compared to 2012, driven
by lower cost of defined contribution plans ($122 million), partially
offset by increased service cost ($52 million) and increased amortization of prior service cost ($34 million). Non-operating costs of$1,062 million increased $524 million in 2013, compared to theprior year, driven primarily by the increase in recognized actuarial
losses ($1,027 million) and lower expected return on plan assets($169 million), partially offset by lower interest cost ($510 million)
and lower pension litigation cost ($152 million).

Income Taxes
The effective tax rate for 2013 was 15.6 percent, a decrease of 8.6
points versus the prior year, driven by the following factors:• A benefit resulting from the completion of the U.S. 2008-2010
tax audit, including the associated reserve redeterminations(11.5 points);• A benefit due to a more favorable geographic mix of pre-tax
income in 2013 (2.4 points);• Benefits from the retroactive impact of the 2012 American
Taxpayer Relief Act (0.7 points) and an increase in researchand development credits (0.6 points);• A benefit from a tax agreement which required a reassessment of certain valuation allowances on deferred tax assets(1.5 points); and• Benefits from the resolution of certain non-U.S. tax audits(0.8 points) and newly enacted U.S. state tax legislation(0.6 points); partially offset by• Tax charges related to certain intercompany payments
made by foreign subsidiaries and the intercompany licensingof certain IP (9.1 points); and• The year-over-year impact of the 2012 benefit related to a tax
restructuring in Latin America (0.8 points).
The operating (non-GAAP) effective tax rate was 16.0 percent, adecrease of 8.0 points versus 2012 principally driven by the same
factors described above.

Earnings Per Share
Basic earnings per share is computed on the basis of the weightedaverage number of shares of common stock outstanding during
the period. Diluted earnings per share is computed on the basisof the weighted-average number of shares of common stock outstanding 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
and stock awards.

43

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Management Discussion
International Business Machines Corporation and Subsidiary Companies

For the year ended December 31:

2013

2012

Yr.-to-Yr.
Percent
ChangeEarnings per share of common stock
Assuming dilution$14.94$14.37

4.0%

Basic

$15.06$14.53

3.6%

Diluted operating (non-GAAP)$16.28$15.25

6.8%

Assuming dilution

1,103.0

1,155.4(4.5)%

Basic

1,094.5

1,142.5(4.2)%

Weighted-average shares
outstanding (in millions)

Actual shares outstanding at December 31, 2013 and 2012 were1,054.4 million and 1,117.4 million, respectively. The average numberof common shares outstanding assuming dilution was 52.4 million
shares lower in 2013 versus 2012. The decrease was primarily the
result of the common stock repurchase program. See note L,“Equity Activity,” on page 116 for additional information regarding
common stock activities. Also see note P, “Earnings Per Share ofCommon Stock,” on pages 124 and 125.

During 2013, the company generated $17,485 million in cash fromoperations, a decrease of $2,102 million compared to 2012. In addition, the company generated $15,021 million in free cash flow, adecrease of $3,164 million versus the prior year. See pages 65 to 67
for additional information on free cash flow. The company returned$17,917 million to shareholders in 2013, with $13,859 million in grossshare repurchases and $4,058 million in dividends. In 2013 the company repurchased approximately 73 million shares and had
approximately $14.7 billion remaining in share repurchase authorization at year end. The company’s cash generation permits thecompany to invest and deploy capital to areas with the most attractive long-term opportunities.
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 on page 80 are the consolidated amounts including Global Financing. The amounts
appearing in the separate Global Financing section, beginningon page 72, are supplementary data presented to facilitate anunderstanding of the Global Financing business.
Working Capital

Financial Position

Dynamics
At December 31, 2013, the company continues to have a high degreeof financial flexibility with a strong balance sheet to support the business over the long term. Cash and marketable securities at year end
were $11,066 million, consistent with the prior year-end balance.
During the year, the company continued to manage the investment
portfolio to meet its capital preservation and liquidity objectives.
Total debt of $39,718 million increased $6,449 million from prioryear-end levels. The commercial paper balance at December 31,
2013, was $2,458 million, an increase of $658 million from the prioryear. Within total debt, $27,504 million is in support of the Global
Financing business which is leveraged at a 7.2 to 1 ratio. The company continues to have substantial flexibility in the market. During
2013, the company completed bond issuances totaling $10,956
million, with terms ranging from 2 to 12 years, and priced from 0.22
to 3.38 percent depending on maturity. The company has consistently generated strong cash flow from operations and continues
to have access to additional sources of liquidity through the capital
markets and its $10 billion global credit facility, with 100 percent of
the facility available on a same day basis.
Consistent with accounting standards, the company remeasures
the funded status of its retirement and postretirement plans at
December 31. At December 31, 2013, the overall net underfunded
position was $11,434 million, a decrease of $8,756 million from
December 31, 2012 driven by the increase in discount rates, primarily
in the U.S. At year end, the company’s qualified defined benefit plans
were well funded and the cash requirements related to these plans
remain stable going forward at less than $700 million per year
through 2015. In 2013, the return on the U.S. Personal Pension Plan
assets was 7.1 percent and the plan was 109 percent funded. Overall,
global asset returns were 7.1 percent and the qualified defined benefit
plans worldwide were 102 percent funded. See note S, “RetirementRelated Benefits,” on pages 127 to 141 for additional information.

($ in millions)
At December 31:

2013

2012

Current assets$51,350$49,433

Current liabilities

40,154

43,625Working capital$11,196$ 5,807

1.28:1

1.13:1

Current ratio

Working capital increased $5,388 million from the year-end 2012
position. The key changes are described below:
Current assets increased $1,917 million ($2,815 million adjusted
for currency), due to:• An increase of $1,258 million ($1,886 million adjusted for
currency) in short-term receivables primarily due to higher
volumes related to inventory financing; and• An increase of $463 million ($630 million adjusted for
currency) in prepaid expenses and other assets,
primarily driven by prepaid income taxes ($407 million).
Current liabilities decreased $3,471 million ($2,562 million adjusted
for currency), as a result of:• A decrease in short-term debt of $2,319 million ($2,096 million
adjusted for currency) (see debt analysis on pages 45 and 46);
• A decrease of $853 million ($770 million adjusted for currency)
in compensation and benefits reflecting lower accruals for
performance-related compensation; and• A decrease in accounts payable of $490 million ($409 million
adjusted for currency) reflecting payment of higher 2012 yearend volumes; partially offset by• An increase in deferred income of $605 million ($861 million
adjusted for currency) primarily driven by Software.

Management Discussion
International Business Machines Corporation and Subsidiary Companies

Cash Flow
The company’s cash flows from operating, investing and financing
activities, as reflected in the Consolidated Statement of Cash Flowson page 81, is summarized in the table below. These amounts include
the cash flows associated with the Global Financing business.
($ in millions)
For the year ended December 31:

2013

2012

$17,485$ 19,586

Net cash provided by/(used in)Operating activities
Investing activities(7,326)(9,004)

Financing activities(9,883)(11,976)

Effect of exchange rate changes
on cash and cash equivalents
Net change in cash and cash equivalents

28

(116)

$     304

$ (1,511)

Net cash provided by operating activities decreased by $2,102
million in 2013 driven by operational performance and the following
key factors:• A net increase in the use of cash for taxes (deferred, payable,
reserves) of $2,200 million primarily driven by an increase in
cash income tax payments;• A net decrease from compensation and benefits of approximately $600 million primarily driven by reductions in
performance-related compensation;• An increase in the use of cash of $438 million related to thefulfillment of services contracts;• Higher cash requirements for inventory ($337 million);• Higher cash payments for workforce rebalancing of$332 million; and• Lower net income of $121 million; partially offset by• Lower cash used by accounts receivables of $823 million
primarily driven by financing receivables; and• A decrease in cash funding related to retirement-relatedplans of $723 million driven by a decrease in nonpension
postretirement contributions.

Noncurrent Assets and Liabilities($ in millions)
At December 31:

2013

2012

Noncurrent assets$74,873$69,780

Long-term debt

$32,856$24,088

Noncurrent liabilities (excluding debt)$30,284$32,516

The increase in noncurrent assets of $5,093 million ($6,521 million
adjusted for currency) was driven by:• An increase of $4,607 million ($4,578 million adjusted for
currency) in prepaid pension assets primarily driven by plan
remeasurements; and• An increase in intangible assets and goodwill of $2,022 million($2,385 million adjusted for currency) primarily driven by
current year acquisitions; partially offset by• A decrease of $922 million in deferred taxes ($753 million
adjusted for currency) driven by retirement-related plans
activity.
Long-term debt increased by $8,768 million ($8,779 million adjusted
for currency) primarily driven by new debt issuances of $12,898 million,
partially offset by reclasses to short-term debt of $3,949 million.
Other noncurrent liabilities, excluding debt, decreased $2,232
million ($1,723 million adjusted for currency) primarily driven by:• A decrease in retirement and nonpension benefit obligations of$4,176 million driven by plan remeasurements; partially offset by• An increase of $2,326 million in other liabilities primarily
driven by deferred tax increases related to the pension plan
remeasurements.
Debt
The company’s funding requirements are continually monitored andstrategies are executed to manage the overall asset and liability
profile. Additionally, the company maintains sufficient flexibility toaccess global funding sources as needed.
($ in millions)

Net cash used in investing activities decreased $1,679 million driven by:• An increase in cash of $1,232 million from net sales ofmarketable securities and other investments;• A net decrease of $539 million in cash used for capital
expenditures; and• A net decrease of $363 million in cash used for acquisitions/divestitures; partially offset by• A net decrease in cash provided by non-operating financing
receivables of $455 million.
Net cash used in financing activities decreased $2,094 million ascompared to the prior year driven by the following factors:• An increase in net cash from debt transactions (including
short-term borrowings) of $4,708 million; partially offset by• An increase of $2,330 million of net cash used for common
stock transactions; and• An increase in dividend payments of $285 million.

At December 31:

2013

2012

Total company debt

$39,718$33,269

Total Global Financing segment debt

$27,504$24,501

Debt to support external clients

24,471

21,583

Debt to support internal clients

3,033

2,919

Global Financing provides financing predominantly for the company’s external client assets, as well as for assets under contract byother IBM units. These assets, primarily for Global Services, generate long-term, stable revenue streams similar to the Global Financing
asset portfolio. Based on their attributes, 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 on page 75.
Given the significant leverage, the company presents a debt-tocapitalization ratio which excludes Global Financing debt and equity
as management believes this is more representative of the company’s core business operations. This ratio can vary from period toperiod as the company manages its global cash and debt positions.

45

46

Management Discussion
International Business Machines Corporation and Subsidiary Companies“Core” debt-to-capitalization ratio (excluding Global Financing
debt and equity) was 39.0 percent at December 31, 2013 compared
to 36.1 percent at December 31, 2012. The increase was primarily
driven by an increase in non-Global Financing debt of $3,446 million
partially offset by an increase in non-Global Financing equity of$3,615 million from the December 31, 2012 balances.
Consolidated debt-to-capitalization ratio at December 31, 2013
was 63.4 percent versus 63.7 percent at December 31, 2012.
The “core” debt-to-capitalization ratio and the consolidated
debt-to-capitalization ratio were impacted by the $3,184 million

increase in equity as a result of retirement-related plan remeasurements in December.
EquityTotal equity increased by $3,945 million from December 31, 2012 asa result of an increase in retained earnings of $12,401 million, an
increase in common stock of $1,484 million and lower accumulated
other comprehensive losses of $4,157 million, partially offset by anincrease in treasury stock of $14,110 million related to common stock
repurchases during the year.

GAAP Reconciliation
The tables below provide a reconciliation of the company’s income statement results as reported under GAAP to its operating earnings
presentation which is a non-GAAP measure. The company’s calculation of operating (non-GAAP) earnings, as presented, may differ fromsimilarly titled measures reported by other companies. Please refer to the “Operating (non-GAAP) Earnings” section on page 26 for thecompany’s rationale for presenting operating earnings information.
($ in millions except per share amounts)

For the year ended December 31, 2013:

Gross profit
Gross profit margin

GAAP

AcquisitionRelated
Adjustments

RetirementRelated
Adjustments

Operating(non-GAAP)$48,505$ 394$  629$49,527

48.6%

SG&A

$23,502

RD&E
Other (income) and expense

0.4 pts.

0.6 pts.

49.7%$(394)$ (376)$22,731

6,226

0

(57)

6,170

(327)

(16)

0

(343)

Total expense and other (income)

28,981

(410)

(433)

28,137Pre-tax income

19,524804

1,062

21,390Pre-tax income margin
Provision for income taxes*
Effective tax rate
Net income
Net income margin
Diluted earnings per share

19.6%$  3,041
15.6%$16,483
16.5%$  14.94

0.8 pts.
$   57(0.3) pts.
$ 747
0.7 pts.
$0.68

1.1 pts.
$  3330.8 pts.
$  7290.7 pts.
$ 0.66

21.4%$ 3,43116.0%$17,959
18.0%$ 16.28* The tax impact on operating (non-GAAP) pre-tax income is calculated under the same accounting principles applied to the GAAP pre-tax income which employs an annual effective
tax rate method to the results.

($ in millions except per share amounts)

For the year ended December 31, 2012:

Gross profit
Gross profit margin

GAAP

AcquisitionRelated
Adjustments

RetirementRelated
Adjustments

Operating(non-GAAP)$50,298

$ 376

$ 264

$50,938

48.1%

SG&A

$23,553

RD&E
Other (income) and expense

0.4 pts.

0.3 pts.

48.7%$(349)$ (294)$22,910

6,302

0

20

6,322

(843)

(13)

0

(857)

Total expense and other (income)

28,396

(363)

(274)

27,760Pre-tax income

21,902739

538

23,1790.7 pts.

0.5 pts.

Pre-tax income margin
Provision for income taxes*
Effective tax rate
Net income
Net income margin
Diluted earnings per share

21.0%$ 5,298
24.2%$16,604
15.9%$ 14.37$  98(0.4) pts.
$ 641
0.6 pts.
$0.55

$ 156
0.1 pts.
$ 381
0.4 pts.
$ 0.33

22.2%$ 5,552
24.0%$17,627
16.9%$ 15.25* The tax impact on operating (non-GAAP) pre-tax income is calculated under the same accounting principles applied to the GAAP pre-tax income which employs an annual effective
tax rate method to the results.

Management Discussion
International Business Machines Corporation and Subsidiary Companies

Consolidated Fourth-Quarter Results

Within the company’s segments, revenue performance at constantcurrency was led by growth in Software, Global Services and($ and shares in millions except per share amounts)
Global Financing which was more than offset by a decline in STG.
Yr.-to-Yr.
Percent/
Software revenue improved 2.8 percent as reported and 4 percent
Marginat constant currency. Performance was broad-based with constant
For the fourth quarter:
2013
2012
ChangeRevenue$27,699$29,304(5.5)%* currency growth in all brands and strength in several of the areas
Gross profit margin
51.7%
51.8%
(0.1) pts. where the company has targeted it investments—business analytics, cloud and security. Total Global Services revenue declined 2.3
Total expense and other (income)$ 7,353$ 7,3360.2%
percent as reported, but increased 1 percent at constant currency
Total expense and other(income)-to-revenue ratio
26.5%
25.0%
1.5  pts. consistent with performance in the third-quarter. Performance wasdriven by GBS which increased 0.6 percent as reported and 4 perIncome before income taxes$ 6,962$ 7,831(11.1)%
cent adjusted for currency, driven by offerings that address
Provision for income taxes
777
1,998
(61.1)%
digitization of the front office. Revenue performance in strategic
Net income$ 6,185$ 5,833
6.0%
outsourcing within GTS continued to improve, adjusted for currency.
Net income margin
22.3%
19.9%
2.4 pts.
The Global Services backlog increased 1.8 percent (5 percent
Earnings per share of common stock
adjusted for currency), also driven by GBS. STG revenue decreased
Assuming dilution$  5.73
$   
5.13
11.7%
26.1 percent as reported (25 percent adjusted for currency) andWeighted-average shares outstanding
impacted the overall consolidated performance. The company is
Assuming dilution
1,080.0
1,136.4(5.0)% dealing with challenges in its hardware business models specific toPower Systems, Storage and x86. As expected, System z mainframe* (3.5) percent adjusted for currency.
revenue was impacted by the product cycle and decreased 37.4
percent (37 percent adjusted for currency) compared to a very
The following table provides the company’s operating (non-GAAP)
strong performance in the fourth quarter of 2012. These dynamics
earnings for the fourth quarter of 2013 and 2012.
in the hardware business significantly impacted consolidated($ in millions except per share amounts)
revenue growth and profit in the fourth quarter of 2013.
Yr.-to-Yr.
On a geographic basis, revenue in the growth markets declined
Percent
9.5 percent (6 percent adjusted for currency) with mixed results by
For the fourth quarter:
2013
2012
Changeregion, though disappointing overall. In the two largest regions, Asia
Net income as reported$6,185$5,833
6.0%
Pacific growth markets were down 15.7 percent (12 percent adjusted
Non-operating adjustments (net of tax)
for currency), primarily driven by China, while growth markets in Latin
Acquisition-related charges
268
243
10.6
America were essentially flat as reported, but increased 5 percent
Non-operating retirement-related
at constant currency.
costs/(income)
164
53
207.8
The consolidated gross profit margin was essentially flat year toOperating (non-GAAP) earnings*$6,617$ 6,129
8.0%
year at 51.7 percent. The operating (non-GAAP) gross profit margin
Diluted operating (non-GAAP)
increased 0.3 points to 52.6 percent. Margins expanded in both Global
earnings per share$ 6.13$ 5.3913.7%
Services segments, and the relative strength in the Software business* See page 52 for a more detailed reconciliation of net income to operating (non-GAAP)
drove an improving mix. These improvements were mitigated by a 5.5
earnings.
point margin decline in STG. System z margin improved year to year
Snapshotas expected at this point in the product cycle, but the other hardware
In the fourth quarter of 2013, the company reported $27.7 billion in revbrands declined reflecting the business model challenges.
enue, expanded its net income margin and delivered diluted earnings
Total expense and other (income) increased 0.2 percent in the
per share growth of 11.7 percent as reported and 13.7 percent on an
fourth quarter compared to the prior year. Total operating (nonoperating (non-GAAP) basis. The company generated $6.5 billion inGAAP) expense and other (income) decreased 1.0 percent versus
cash from operations and $8.4 billion in free cash flow in the fourth quarthe prior year. The key drivers of the year-to-year change in total
ter driving shareholder returns of $6.8 billion in gross common stock
expense and other (income) were approximately:
repurchases and dividends. The free cash flow performance repre		
Total
Operatingsented 56 percent of the full year—the highest percent in several years.
		Consolidated(non-GAAP)
Revenue in the fourth quarter decreased 5.5 percent, 3.5 percent•	Currency*(2) points(2) points
at constant currency. The currency impact to revenue was 2.0 points.
•	Acquisitions**
2 points
2 points
Consistent with the full year, currency also impacted profit perfor•	Base expense
0 points(1) point
mance in the fourth quarter as the depreciation of the Yen largely  * Reflects impacts of translation and hedging programs.
flows to profit due to the local services content within the company’s** Includes acquisitions completed in prior 12-month period; operating (non-GAAP) isbusiness in Japan and the inability to hedge these cash flows.
net of non-operating acquisition-related charges.

47

48

Management Discussion
International Business Machines Corporation and Subsidiary Companies

Pre-tax income declined 11.1 percent year to year and the pre-tax
margin was 25.1 percent. Net income increased 6.0 percent andthe net income margin was 22.3 percent, an increase of 2.4 points
year to year. The effective tax rate for the fourth quarter was 11.2
percent, compared to 25.5 percent in the prior year. The decreasein the tax rate included substantial benefits from tax audit settlements and a modest reduction in the ongoing tax rate. Specifically,
the fourth-quarter tax rate included the conclusion of the U.S. tax
audit for the three-year period from 2008-2010. The company
accrues taxes for uncertain tax matters in the normal tax rate. The
conclusion of the audit in November 2013 resulted in a reductionof tax expense previously recorded in the normal tax rate. While theaudit closure had the most significant impact, there were additional
discrete items impacting the rate in the fourth quarter. Operating(non-GAAP) pre-tax income declined 8.4 percent year to year andthe operating (non-GAAP) pre-tax margin was 26.8 percent, down
0.8 points year to year driven entirely by the hardware business.
Operating (non-GAAP) net income increased 8.0 percent and theoperating (non-GAAP) net income margin of 23.9 percent increased

3.0 points compared to the prior year. The operating (non-GAAP)
effective tax rate was 11.0 percent versus 24.4 percent in the fourth
quarter of 2012 driven by the same factors described above.
Diluted earnings per share of $5.73 increased 11.7 percent versus
the prior year. In the fourth quarter, the company repurchased 33.2
million shares of its common stock. Operating (non-GAAP) diluted
earnings per share of $6.13 increased $0.74 or 13.7 percent versus
the fourth quarter of 2012 driven by the following factors:•	Revenue decrease at actual rates$ (0.29)•	Margin expansion$ 0.73•	Common stock repurchases$ 0.30The operating (non-GAAP) earnings per share growth in the fourth
quarter was achieved through a combination of: continued momentum in key growth areas, which drove a mix to higher-value Softwareand GBS; yield from productivity initiatives; a modest improvementin the ongoing tax rate, along with substantial benefits from tax
audit settlements; and, the effective use of cash to repurchasecommon shares.

Segment Details
The following is an analysis of the fourth quarter of 2013 versus the fourth quarter of 2012 reportable segment external revenue and grossmargin results. Segment pre-tax income includes transactions between the segments that are intended to reflect an arms-length transfer
price and excludes certain unallocated corporate items.
($ in millions)

For the fourth quarter:

2013

2012

$ 9,917$10,284

Yr.-to-Yr.
Percent/
MarginChangeYr.-to-Yr.
Percent Change
Adjusted for
Currency

Revenue
Global Technology Services
Gross margin
Global Business Services
Gross margin
SoftwareGross margin
Systems and Technology
Gross margin(3.6)%

38.8%

37.6%

4,747

4,720

0.6%

30.7%

29.9%

0.7 pts.

8,140

7,915

2.8%

90.5%

90.6%

(0.1) pts.

4,261

5,763

(26.1)%

38.6%

44.1%

(5.5) pts.

Global Financing

534

535

(0.1)%

Gross margin

43.3%

43.8%

(0.4) pts.

Other
Gross margin

100

87

15.2%

(234.8)%(73.2)%(161.6) pts.

Total consolidated revenue$27,699$29,304

Total consolidated gross profit$14,315$15,167

Total consolidated gross margin(5.5)%(5.6)%

51.7%

51.8%

103

99

4.1%

1

0

NM

(0.1) pts.

Non-operating adjustments
Amortization of acquired intangible assets
Acquisition-related charges
Retirement-related costs/(income)

154

60

155.7%

Operating (non-GAAP) gross profit$14,574$15,327(4.9)%

Operating (non-GAAP) gross margin
NM—Not meaningful

52.6%

52.3%

(0.6)%

1.2 pts.

0.3 pts.

4.3%
3.5%(25.4)%
2.6%
16.9%(3.5)%

Management Discussion
International Business Machines Corporation and Subsidiary Companies

Global Services
The Global Services segments, Global Technology Services andGlobal Business Services, generated $14,664 million of revenue inthe fourth quarter, a decrease year to year of 2.3 percent asreported, but an increase of 1 percent adjusted for currency. This
was the second consecutive quarter of constant currency revenue
growth in total Global Services. Pre-tax income of $2,929 million in
the fourth quarter of 2013 was up 2.1 percent year to year and thepre-tax margin improved 0.9 points, with margin expansion in bothsegments. Global Services continued to have good performance inthe key growth areas of cloud, business analytics and Smarter
Planet in the quarter, and the company is continuing to invest to
extend its capabilities. Total outsourcing revenue of $6,662 million
decreased 4.5 percent (1 percent adjusted for currency) and totaltransactional revenue of $6,202 million increased 0.3 percent(4 percent adjusted for currency) year over year.
Global Technology Services revenue of $9,917 million decreased
3.6 percent (1 percent adjusted for currency) in the fourth quarterof 2013 with constant currency performance in line with the third
quarter of 2013. The major markets returned to constant currency
growth for the first time since the first half of 2012, led by Europe,
while the growth markets performance decelerated. GTS Outsourcing revenue decreased 4.2 percent (1 percent adjusted for currency)
in the fourth quarter of 2013; however, constant currency performance improved 2 points from the third quarter. While GTS
Outsourcing is beginning to realize the benefit from several of thelarge client transformational contracts signed earlier in 2013, it continues to see a decline in revenue from sales into existing baseaccounts where the activity is more transactional in nature and canbe economically sensitive. ITS revenue decreased 3.1 percent (flatadjusted for currency) in the fourth quarter. The company continues
to shift the ITS business toward higher value managed services
such as business continuity, security and cloud. Within the cloudofferings, SoftLayer contributed to the ITS revenue performanceand drove one point of constant currency revenue growth to total
GTS in the fourth quarter. The GTS gross profit margin improved 1.2
points in the fourth quarter, with margin expansion across all linesof business, led by ITS and Maintenance. Pre-tax income decreased
1.9 percent to $1,989 million while the pre-tax margin improved 0.4
points to 19.5 percent in the fourth quarter of 2013 compared to theprior year. Profit performance was impacted by the performance inthe growth markets. In addition, the company continues to makeinvestments in key growth areas such as cloud, mobility and security. These initiatives are beginning to contribute to revenue growth,and will yield improved profit results as they achieve scale. Margin
expansion was driven by reductions in performance-related compensation and benefits from the second-quarter 2013 workforce
rebalancing actions.
Global Business Services revenue of $4,747 million increased
0.6 percent as reported and 4 percent at constant currency in the
fourth quarter of 2013 and gained share again in the period. GBS
had constant currency revenue growth in all geographic regions led
by North America and the growth markets. Japan continued its solid
performance, and Europe had constant currency revenue growth
for the second consecutive quarter. On an offering basis, growth

was driven by the practices that address the Digital Front Office.
GBS delivered double-digit growth in each of the strategic growth
initiatives—business analytics, Smarter Planet and cloud. In addition, within the back office solutions that address the Globally
Integrated Enterprise, implementation services that support thetraditional packaged applications increased again in the fourth quarter at constant currency. Application Outsourcing revenue decreased
6.5 percent (2 percent adjusted for currency) and C&SI revenue
increased 2.7 percent (6 percent adjusted for currency), representing
a 1 point sequential improvement at constant currency from the third
quarter of 2013. The GBS gross profit margin improved 0.7 points
in the fourth quarter versus the prior year. GBS pre-tax income of$940 million in the fourth quarter of 2013 increased 11.7 percent,with a pre-tax margin of 19.1 percent, an improvement of 2.0 points
year to year. The primary year-to-year profit drivers were reductions
in performance-related compensation, continued benefits from theenterprise productivity initiatives and the second-quarter 2013 workforce rebalancing actions.

Software
Software revenue of $8,140 million increased 2.8 percent (4 percent
adjusted for currency) in the fourth quarter led by growth in key
branded middleware. Key branded middleware revenue increased
5.5 percent (6 percent adjusted for currency) year to year andgained share.
WebSphere revenue increased 14.3 percent (15 percent adjusted
for currency) in the fourth quarter and gained share. Revenue performance included good growth in both the on-premise Application
Server business and the newer cloud-based offerings. Mobile continued to have strong growth—the comprehensive MobileFirst
portfolio of software and services extends value to clients enablingthem to reach new markets and gain competitive advantage. In addition, the core WebSphere offerings of Business Integration andCommerce delivered strong growth. Information Management revenue increased 4.8 percent (5 percent adjusted for currency) in the
fourth quarter and gained share. Distributed database offerings
were up double-digits at constant currency, and the business analytics software offerings had its strongest growth in 2013 in the
fourth quarter, led by business intelligence and Netezza appliances.
Tivoli revenue increased 0.5 percent (1 percent adjusted for currency) in the fourth quarter compared to the prior year period, driven
by double-digit growth in its security business. The transformation
driven by mobile and cloud computing is raising the importance of
security for enterprise customers, and the company is continuing tobuild its capabilities in this area. Social Workforce Solutions revenue
increased 2.4 percent (3 percent adjusted for currency) in the fourth
quarter and continued to be driven by Kenexa, which provides
cloud-based recruiting and talent management. Rational revenue
increased 0.3 percent (1 percent adjusted for currency) year to year
in the fourth quarter.
The Software business delivered pre-tax income of $4,239
million in the fourth quarter of 2013, an increase of 5.5 percent year
to year, with a pre-tax margin of 47.0 percent, an improvement of
1.0 points.

49

50

Management Discussion
International Business Machines Corporation and Subsidiary Companies

Systems and Technology
Systems and Technology revenue of $4,261 million decreased 26.1
percent (25 percent adjusted for currency) in the fourth quarterversus the same period in 2012.
System z revenue decreased 37.4 percent (37 percent adjusted
for currency) in the fourth quarter of 2013 compared to a very strong
fourth quarter of 2012, when revenue increased 56 percent year toyear. During the fourth quarter, the company entered the back endof the current mainframe cycle and, as expected, delivered a higher
gross margin percentage on a lower base of revenue. Fourth quarter
MIPS shipments decreased 26 percent following the largest MIPS
shipment in mainframe history in the fourth quarter of 2012. In thecurrent mainframe cycle, the company has shipped 28 percent more
MIPS compared to the same period in the prior cycle. The revenue
and gross profit in the current cycle are each approximately 99 percent of the previous cycle, net of currency. The additional capacity
reflects the ongoing relevance of the mainframe to clients, and provides the company with financial returns consistent with past cycles.
Power Systems revenue decreased 31.4 percent (31 percent
adjusted for currency) in the fourth quarter. The company continues
to ship significant capacity into the UNIX market, but this has been
more than offset by significant price performance resulting in lower
revenue. The company is taking actions to improve its businessmodel in Power Systems, including introducing in the fourth quartera new Integrated Facility for Linux offering which enables clients to
run Linux workloads in their existing servers. This mirrors the successful strategy executed on System z.
System x revenue decreased 15.9 percent (15 percent adjusted
for currency) in the fourth quarter of 2013 versus the fourth quarterof 2012. PureSystems continues to gain momentum. Across the
hardware product lines, PureSystems revenue was up more than
30 percent in the fourth quarter compared sequentially to the third
quarter of 2013. Globally, the company shipped over 2,500 systems
in fourth quarter, and over 10,000 total systems to date.
Storage revenue decreased 13.4 percent (12 percent adjusted for
currency) in the fourth quarter. The company’s flash solutions continued to gain momentum and contributed a few points of growth in
the quarter. The Storwize product delivered double-digit growth,which was offset by declines in the legacy OEM midrange offerings.
Highend offerings declined driven by significant pricing pressure.
Microelectronics OEM revenue decreased 33.0 percent(33 percent adjusted for currency) in the fourth quarter.
Systems and Technology’s gross profit margin decreased 5.5
points in the fourth quarter of 2013 versus the prior year. The
decrease was driven by lower margins in Power Systems (1.3 points),
System x (1.2 points), Storage (0.6 points), Microelectronics (0.5 points)
and a decline due to revenue mix (2.2 points). Systems and Technology’s pre-tax income decreased $768 million or 78.8 percent in the
fourth quarter, and pre-tax margin decreased 11.7 points versus theprior year period. Approximately half of the fourth-quarter pre-tax
income decline was driven by System z due to the product cycle
dynamics, though the platform remains secularly strong with a solid
business model. The other System & Technology hardware businesses are dealing with business model challenges due to market
shifts. The company will make these products more relevant whileright-sizing these businesses to meet the new value proposition.

Global Financing
Global Financing revenue of $534 million was essentially flat asreported and increased 3 percent adjusted for currency, withincreased financing revenue offset by a decrease in used equipment
sales revenue. The Global Financing fourth-quarter pre-tax income
increased 13.8 percent to $589 million and the pre-tax marginincreased 2.7 points to 49.6 percent. The increase in pre-tax income
was driven by the increase in internal gross profit ($118 million), partially offset by increases in financing receivables provisions ($33
million) and SG&A expenses ($14 million).
Geographic Revenue
Total geographic revenue of $27,246 million decreased 4.8 percent(3 percent adjusted for currency) in the fourth quarter of 2013 comparedto the prior year. In total, the major markets decreased 3.3 percent(2 percent at constant currency) and the growth markets decreased
9.5 percent as reported and 6 percent at constant currency.
Americas revenue decreased 2.8 percent (2 percent adjusted
for currency) compared to the fourth quarter of 2012. Strong growthin software was more than offset by the impact from the mainframe
product cycle, predominantly in the U.S. The U.S. was down 3.0
percent and Canada was down 4.5 percent as reported, but
increased 1 percent adjusted for currency. Canada improved theiryear-to-year revenue growth rate at constant currency by 3 points
in both the third and fourth quarters of 2013. Revenue in the Latin
America growth markets was essentially flat as reported, but
increased 5 percent at constant currency, led by Brazil which
increased 2.0 percent (7 percent adjusted for currency) year to year.
Europe/Middle East/Africa revenue increased 0.9 percent asreported, but decreased 2 percent adjusted for currency year toyear, consistent with the third-quarter performance. Western Europe
revenue declined year to year at constant currency in line with themarket, although software performed well. Germany grew 3.9 percent (decreased 1 percent at constant currency) and the UK
increased 3.5 percent (3 percent at constant currency). Italy
decreased 6.1 percent (10 percent adjusted for currency).
Overall, Asia Pacific fourth-quarter revenue decreased 15.8
percent (6 percent adjusted for currency) year over year. Japanrevenue decreased 16.0 percent as reported, but increased 4 percent on a constant currency basis. Adjusted for currency, this was
the fifth consecutive quarter of revenue growth in Japan. The company has shifted investment and redirected its go-to-market-focus
to significantly improve performance in Japan. The Asia Pacificgrowth markets decreased 15.7 percent (12 percent adjusted for
currency) and China was down 22.1 percent (23 percent adjusted
for currency).

Management Discussion
International Business Machines Corporation and Subsidiary Companies

Within the growth markets, the company continued to gain
share and deliver growth in Latin America and in the Middle East
and Africa region. Performance in these regions has been consistently strong, and in particular Latin America had a difficultcompare with revenue growth in the fourth quarter of 2012 up 18
percent at constant currency. In Eastern Europe, the declines
moderated, while revenue in the Asia Pacific countries declined ata double-digit rate, primarily driven by China. The largest declines
in China were in the hardware business. The company continues
to be impacted by the process surrounding the implementation ofa broad-based governmental economic plan. While there is moreclarity on the overall plan, the company continues to believe that
it will take some time for its business in China to improve. Whilethe company is disappointed with its performance in certain
regions of the growth markets, the company continues to seegood opportunity in all regions over the long term—and the company continues to invest in these key markets.
Total Expense and Other (Income)($ in millions)

For the fourth quarter:

Yr.-to-Yr.
Percent/
MarginChange2013

2012$7,353$7,336

Amortization of acquired
intangible assets

(93)

(86)

7.9

Acquisition-related charges

(16)

(12)

33.5

Non-operating retirement-related(costs)/income

(104)

(23)

356.8

$7,140$7,215

Total consolidated expenseand other (income)

0.2%

Non-operating adjustments

Operating (non-GAAP)
expense and other (income)(1.0)%

Total consolidated
expense-to-revenue ratio

26.5%

25.0%

1.5 pts.

Operating (non-GAAP)
expense-to-revenue ratio

25.8%

24.6%

1.2 pts.

Total expense and other (income) increased 0.2 percent in the fourth
quarter with an expense-to-revenue ratio of 26.5 percent compared
to 25.0 percent in the fourth quarter of 2012. Total operating (nonGAAP) expense and other (income) decreased 1.0 percent in the
fourth quarter. The decrease in total operating expense and other(income) was primarily driven by currency (2 points), lower baseexpense (1 point), partially offset by increased expense from thecompany’s acquisitions over the past 12 months (2 points). Withinbase expense, the company is continuing to shift its spending—
driving productivity across the business, primarily through theenterprise productivity initiatives. A majority of the savings are reinvested into the business to drive growth in the key growth areas.
Within selling, general and administrative expense, accounts receivable provisions were up approximately $60 million year to year in
the fourth quarter with reserve coverage up less than 20 basis
points, although flat compared to September 2013.
Cash Flow
The company generated $6,528 million in cash flows provided byoperating activities, an increase of $182 million compared to thefourth quarter of 2012, driven primarily by a decrease in cash usedby financing receivables ($1,218 million) and a decrease in cash
funding of retirement-related plans ($495 million), partially offset by
the December payment of the 401(k) employer matching contribution ($541 million), increased cash used for income tax payments($471 million) and declines in operational performance. Net cashused in investing activities of $2,902 million decreased $1,190 million
primarily due to decreased spending for acquisitions ($961 million).
Net cash used in financing activities of $3,013 million decreased$779 million compared to the prior year, primarily due to higher
net cash proceeds from total debt ($3,730 million) partially offset
by increased cash used for gross common stock repurchases($2,791 million).

51

52

Management Discussion
International Business Machines Corporation and Subsidiary Companies

GAAP Reconciliation
The tables below provide a reconciliation of the company’s income statement results as reported under GAAP to its operating earnings
presentation which is a non-GAAP measure. The company’s calculation of operating (non-GAAP) earnings, as presented, may differ fromsimilarly titled measures reported by other companies. Please refer to the “Operating (non-GAAP) Earnings” section on page 26 for thecompany’s rationale for presenting operating earnings information.
($ in millions except per share amounts)

For the fourth quarter 2013:

Gross profit
Gross profit margin

GAAP

AcquisitionRelated
Adjustments

RetirementRelated
Adjustments

Operating(non-GAAP)$14,315

$ 105

$ 154

$14,574

51.7%

SG&A

$ 5,989

RD&E
Other (income) and expense

0.4 pts.

0.6 pts.

52.6%$(101)$ (90)$ 5,798

1,566

0

(14)

1,552

(113)

(8)

0

(121)

Total expense and other (income)

7,353

(109)

(104)

7,140

Pre-tax income

6,962

213

258

7,434

Pre-tax income margin

25.1%

0.8 pts.

0.9 pts.

Provision for income taxes*
Effective tax rate
Net income
Net income margin
Diluted earnings per share$    777
11.2%$ 6,18522.3%$  5.73$  (55)(1.1) pts.
$ 268
1.0 pts.
$0.25$   940.9 pts.
$ 164
0.6 pts.
$0.15

26.8%
$    817
11.0%$ 6,61723.9%$  6.13* The tax impact on operating (non-GAAP) pre-tax income is calculated under the same accounting principles applied to the GAAP pre-tax income which employs an annual effective
tax rate method to the results.

($ in millions except per share amounts)

For the fourth quarter 2012:

Gross profit
Gross profit margin

GAAP

AcquisitionRelated
Adjustments

RetirementRelated
Adjustments

Operating(non-GAAP)$15,167$ 100$   60$15,32751.8%

0.3 pts.

SG&A$ 5,921

RD&E

1,580
(47)

Total expense and other (income)

7,336

(98)

Pre-tax income

7,831

Pre-tax income margin

26.7%

Other (income) and expense

Provision for income taxes*
Effective tax rate
Net income
Net income margin
Diluted earnings per share$ 1,998
25.5%$ 5,833
19.9%$  5.13$ (91)

0.2 pts.

52.3%$ (29)$ 5,801

0

6

1,586

(7)

0

(54)

(23)

7,215

198

83

8,112

0.7 pts.

0.3 pts.

$ (45)(1.2) pts.
$ 243
0.8 pts.
$0.21$   300.1 pts.
$   530.2 pts.
$0.05

27.7%
$ 1,983
24.4%$ 6,12920.9%$  5.39* The tax impact on operating (non-GAAP) pre-tax income is calculated under the same accounting principles applied to the GAAP pre-tax income which employs an annual effective
tax rate method to the results.

Management Discussion
International Business Machines Corporation and Subsidiary Companies

Prior Year in Review

billion in free cash flow driving shareholder returns of $15.8 billion ingross common stock repurchases and dividends. The free cash
flow performance in 2012 was $12.3 billion greater than the company
generated in 2002. The financial results demonstrated the strengthand flexibility of the company’s business model, which is designed
to deliver profit and cash on a sustained basis.
($ and shares in millions except per share amounts)
The company continued to deliver value to its clients and capitalYr.-to-Yr.
ize on key trends in 2012. The company had strong performance inPercent/
Marginbusiness analytics, cloud and Smarter Planet—key growth initiatives
For the year ended December 31:
2012
2011
Changethat leverage the software portfolio and contribute to margin expanRevenue$104,507$106,916(2.3)%*
sion. Within the growth markets, the company continued to expand
Gross profit margin
48.1%
46.9%
1.2 pts. its capabilities and build out IT infrastructures in emerging markets.
Total expense and other (income)$ 28,396$ 29,135(2.5)% In 2012, the growth markets revenue growth rate at constant curTotal expense and otherrency outpaced the major markets by 8 points. The company(income)-to-revenue ratio
27.2%
27.3%
(0.1 )pts. continued to invest for innovation and technological leadership.
Income before income taxes$ 21,902$ 21,003
4.3%
These investments supported the introduction of the new System
Provision for income taxes
5,298
5,148
2.9%
z mainframe, storage and POWER7+ products in hardware, as well
Net income$ 16,604$ 15,855
4.7%
as a series of major launches across software that included more
Net income margin
15.9%
14.8%
1.1 pts. than 400 new or upgraded product announcements. The introduction of PureSystems, a new category of expert integrated systems,
Earnings per share of common stockbrought together hardware and software and provided built-in
Assuming dilution$  14.37$  13.06
10.0%
expertise to deliver a more efficient and effective solution to theWeighted-average shares outstanding
company’s clients. In addition, the company was awarded more U.S.
Assuming dilution
1,155.4
1,213.8(4.8)%
patents in 2012 than any other company for the 20th consecutive
Assets**$119,213$116,433
2.4%
year, with many of the patents in key areas such as business analytics,
Liabilities**$100,229$ 96,197
4.2%
Big Data, cybersecurity, cloud, mobile, social networking and softEquity**$ 18,984$ 20,236(6.2)% ware-defined environments. The company also continued to add toits capabilities to support the growth initiatives by acquiring 11 com  * 0.0 percent adjusted for currency.
** At December 31.
panies in 2012—investing approximately $4 billion. At the same time,
the company divested its RSS business as it focused the Smarter
The following table provides the company’s operating (non-GAAP)
Commerce portfolio on higher value, intellectual property-based
earnings for 2012 and 2011.
opportunities. Throughout the year, the company continued thetransformation of the business—shifting to higher value areas and($ in millions except per share amounts)
improving its structure—resulting in a higher quality revenue stream
Yr.-to-Yr.
Percent
and margin expansion.
For the year ended December 31:
2012
2011
ChangeSegment performance was led by Software which increased
Net income as reported$16,604$15,855
4.7%
revenue 2.0 percent (4 percent adjusted for currency) driven by key
Non-operating adjustments
branded middleware which increased 2.9 percent (5 percent(net of tax)
adjusted for currency). Global Services revenue decreased 2.3 perAcquisition-related charges
641
495
29.5
cent as reported, but was up 0.4 percent on a constant currency
Non-operating retirement-relatedbasis. Global Services revenue performance was led by the growthNMcosts/(income)
381(32)
markets which were up 4.8 percent (9 percent adjusted for currency)
Operating (non-GAAP) earnings*$17,627$16,318
8.0%
and represented more than 20 percent of total Global Services revDiluted operating (non-GAAP)
enue. Systems and Technology revenue decreased 6.9 percent;earnings per share$ 15.25$ 13.44
13.5%
adjusting for the divested RSS business, revenue declined 5.1 percent
NM—Not meaningful(4 percent adjusted for currency). The company’s new mainframe* See page 63 for a more detailed reconciliation of net income to operating (non-GAAP)
was well received in the market, with System z revenue increasing
earnings.
5.4 percent (6 percent adjusted for currency) versus the prior year.
Global Financing revenue decreased 4.2 percent as reported, 1 perSnapshot
cent on a constant currency basis, compared to the prior year.
In 2012, the company reported revenue of $104.5 billion, expanded
Across all of the segments, the company continued to have strong
gross, pre-tax and net income margins, and delivered diluted earnperformance in its key growth initiatives. These are not stand-alone
ings per share growth of 10.0 percent as reported and 13.5 percent
offerings; they are integrated into the overall client offerings and areon an operating (non-GAAP) basis. This was the 10th consecutive
included in the financial results of the segments. In the growth maryear of double-digit earnings per share growth for the company. The
kets, revenue increased 4.2 percent (7 percent adjusted for currency)
company generated $19.6 billion in cash from operations, and $18.2
year to year and represented 24 percent of total geographic revenue,
The “Prior Year in Review” section provides a summary of thecompany’s financial performance in 2012 as compared to 2011.
For a detailed discussion of prior-year performance, see the 2012
Annual Report.

53

54

Management Discussion
International Business Machines Corporation and Subsidiary Companies

an increase of 8 points since 2006. The company has been successful in capturing the opportunity in these faster growing markets.
The company’s business analytics initiative continued to expand.
The company made significant strides and expanded its leadershipin a number of strategic areas including Risk Management, Priceand Promotion Optimization and Sales Performance Management.
The value proposition in business analytics uniquely leverages theintegration between the software portfolio and the GBS consulting
expertise. In 2012, business analytics revenue increased 13 percent
compared to the prior year, led by the GBS consulting practice.
Within cloud computing, the company’s SmartCloud portfolio
addresses the full scope of enterprise client requirements. In 2012,
the company continued to see strong demand for the foundational
offerings in hardware and software that help clients build and run
their private clouds, as well as for cloud-based solutions, like thecompany’s Software as a Service (SaaS) offerings. With strong
global growth, cloud revenue for 2012 increased 80 percent compared to the prior year. The Smarter Planet growth initiative
expanded significantly in the past year—measured in terms of offerings, markets, clients and revenue performance. Clients areleveraging the company’s growing capabilities in areas like: Smarter
Commerce, Social Business and Smarter Cities, and in next generation systems, like Watson, which are helping clients with theircomplex challenges. For the year, Smarter Planet solutions generated revenue growth of over 25 percent versus the prior year.
Overall, within the offerings in business analytics, cloud andSmarter Planet, approximately half of the revenue was software.
Therefore, as these offerings become a larger percentage of total
revenue, they are driving the higher quality revenue stream andimproved mix and margins.
The consolidated gross profit margin increased 1.2 points versus
2011 to 48.1 percent. This was the ninth consecutive year of improvement in the gross profit margin. The operating (non-GAAP) grossmargin of 48.7 percent increased 1.5 points compared to the prioryear. The increase in gross margin in 2012 was driven by margin
improvements in Software and both Global Services segments, andan improved revenue mix driven by Software.
Total expense and other (income) decreased 2.5 percent in 2012versus the prior year. Total operating (non-GAAP) expense and other(income) decreased 3.9 percent compared to the prior year. The
year-to-year drivers were approximately:				•	Currency*•	Acquisitions**•	Base expense

Total
Consolidated

Operating(non-GAAP)(5) points
3 points(0) points(5) points
2 points(2) points  * Reflects impacts of translation and hedging programs.
** Includes acquisitions completed in prior 12-month period, operating (non-GAAP) is
net of non-operating acquisition-related charges.

Pre-tax income grew 4.3 percent and the pre-tax margin was 21.0
percent, an increase of 1.3 points versus 2011. Net income increased
4.7 percent and the net income margin was 15.9 percent, an increaseof 1.1 points versus 2011. The effective tax rate for 2012 was 24.2
percent compared with 24.5 percent in the prior year. Operating(non-GAAP) pre-tax income grew 7.3 percent and the operating(non-GAAP) pre-tax margin was 22.2 percent, an increase of 2.0
points versus the prior year. Operating (non-GAAP) net income
increased 8.0 percent and the operating (non-GAAP) net income
margin of 16.9 percent increased 1.6 points versus the prior year.
The operating (non-GAAP) effective tax rate was 24.0 percent
versus 24.5 percent in 2011.
Diluted earnings per share improved 10.0 percent year to year
reflecting the growth in net income and the benefits of the common
stock repurchase program. In 2012, the company repurchased
approximately 61 million shares of its common stock. Diluted earnings per share of $14.37 increased $1.31 from the prior year. Operating(non-GAAP) diluted earnings per share of $15.25 increased $1.81
versus 2011 driven by the following factors:•	Revenue decrease at actual rates $(0.30)•	Margin expansion$ 1.38•	Common stock repurchases$ 0.73
At December 31, 2012, the company’s balance sheet and liquidity
positions were strong and well positioned to support the company’s
objectives. Cash and marketable securities at year end was $11,128
million. Key drivers in the balance sheet and total cash flows arehighlighted below.
Total assets increased $2,780 million ($3,242 million adjusted for
currency) from December 31, 2011 driven by:• Increases in total receivables ($3,053 million), goodwill($3,034 million), marketable securities ($717 million) andintangible assets ($395 million); partially offset by• Decreases in prepaid pension assets ($1,899 million), cash
and cash equivalents ($1,511 million) and prepaid expenses
and other current assets ($1,224 million).
Total liabilities increased $4,032 million ($4,511 million adjusted for
currency) from December 31, 2011 driven by:• Increased retirement and nonpension postretirement benefit
obligations ($2,044 million), total debt ($1,949 million), taxes($1,635 million) and total deferred income ($399 million);
partially offset by• Decreases in other liabilities ($1,389 million) and accounts
payable ($565 million).
Total equity of $18,984 million decreased $1,252 million from
December 31, 2011 as a result of:• Increased treasury stock ($12,168 million) driven by share
repurchases and increased losses in accumulated othercomprehensive income/(loss) of ($3,874 million) driven
by pension remeasurements; partially offset by• Higher retained earnings ($12,783 million) and common stock($1,980 million).
The company generated $19,586 million in cash flow provided byoperating activities, a decrease of $260 million when compared to2011, primarily driven by a decrease in cash due to receivables ($1,290
million) and an increased use of cash for accounts payable ($675
million), partially offset by a decrease in net taxes paid ($999 million)

Management Discussion
International Business Machines Corporation and Subsidiary Companies

and the increase in net income ($749 million). Net cash used in investing activities of $9,004 million was $4,608 million higher than 2011,
primarily due to an increase in cash used of $2,719 million associatedwith net purchases and sales of marketable securities and otherinvestments, increased cash used for acquisitions ($1,911 million)
and increased net capital investments ($248 million), partially offset
by increased cash from divestitures ($585 million). Net cash usedin financing activities of $11,976 million was $1,719 million lower compared to 2011, primarily due to lower cash used for common stock
repurchases ($3,051 million), partially offset by lower cash provided
by common stock transactions ($914 million) and increased dividend
payments ($300 million).
For additional information regarding 2002 free cash flow, see thecompany’s Form 8-K filed with the SEC on January 22, 2013.

Segment Details
The following is an analysis of the 2012 versus 2011 reportable segment results. The table below presents each reportable segment’s external
revenue and gross margin results. Segment pre-tax income includes transactions between the segments that are intended to reflect anarm’s-length transfer price and excludes certain unallocated corporate items.
($ in millions)

For the year ended December 31:

2012

2011

$ 40,236$ 40,879

Yr.-to-Yr.
Percent/
MarginChangeYr.-to-Yr.
Percent Change
Adjusted for
Currency

Revenue
Global Technology Services
Gross margin
Global Business Services
Gross margin
SoftwareGross margin
Systems and Technology
Gross margin
Global Financing
Gross margin
Other
Gross margin

36.6%
18,56630.0%
25,44888.7%
17,66735.0%
19,28428.8%
24,944
88.5%
18,985(3.7)%
2.0%(6.9)%

2,013

2,102

(4.2)%

46.5%

49.8%

(3.3) pts.

577

722

(20.1)%(71.6)%(54.5)%(17.1) pts.

Total consolidated gross profit$ 50,298$ 50,138

4.3%

0.2 pts.
(0.7) pts.

$106,916(1.6)%

1.2 pts.

39.8%$104,507

1.3%

1.6 pts.

39.1%

Total consolidated revenue

Total consolidated gross margin(1.6)%(2.3)%(5.9)%(1.2)%(18.7)%
0.0%

0.3%

48.1%

46.9%

1.2 pts.

375

340

10.3%

1

1

13.1

Retirement-related costs/(income)

264

2

NM

Operating (non-GAAP) gross profit$ 50,938$ 50,481

Non-operating adjustments
Amortization of acquired intangible assets
Acquisition-related charges

Operating (non-GAAP) gross margin

48.7%

47.2%

0.9%
1.5 pts.

NM—Not meaningful

Global Services
In 2012, the Global Services segments, Global Technology Services
and Global Business Services, delivered revenue of $58,802 million,
grew pre-tax profit 7 percent and expanded pre-tax margin 1.5 points
on an as-reported basis. Revenue performance was led by strength
in the growth markets which were up 4.8 percent (9 percent adjusted
for currency) and represented over 20 percent of total Global Services
revenue. Revenue from the major markets declined 4.0 percent(2 percent adjusted for currency) year to year. The services segments also had strength in all the key growth initiatives, which arebecoming a larger part of the services business as the company
continues to shift toward higher value content. Total outsourcing
revenue of $27,552 million decreased 2.6 percent (flat adjusted
for currency) and total transactional revenue of $23,907 million
decreased 1.8 percent (flat adjusted for currency) year to year.

55

56

Management Discussion
International Business Machines Corporation and Subsidiary Companies($ in millions)

For the year ended December 31:

Yr.-to-Yr.
Percent
ChangeYr.-to-Yr.
Percent Change
Adjusted for
Currency

2012

2011

Global Services external revenue$58,802$60,163(2.3)%

0.4%

Global Technology Services$40,236$40,879(1.6)%

1.3%

Outsourcing

23,34423,911(2.4)

0.5

Integrated Technology Services

9,550

9,453

1.0

3.7

Maintenance

7,343

7,515

(2.3)

0.6

$18,566$19,284(3.7)%(1.6)%

Global Business Services
Outsourcing

4,209

4,390

(4.1)

(1.7)

Consulting and Systems Integration

14,35814,895

(3.6)

(1.6)

Global Technology Services revenue of $40,236 million in 2012
decreased 1.6 percent as reported, but increased 1 percent
adjusted for currency year to year. Revenue growth from the backlog was partially offset by a decline in revenue from new signings
and a decrease in sales in existing accounts. Revenue performance
was led by the growth markets which were up 5.0 percent (9 percent adjusted for currency). GTS Outsourcing revenue decreased
2.4 percent as reported, but increased 1 percent adjusted for currency in 2012. Outsourcing revenue from the growth markets
increased 2.4 percent (7 percent adjusted for currency), as the outsourcing offerings help clients build out their IT infrastructures. ITS
revenue increased 1.0 percent (4 percent adjusted for currency) in2012 compared to 2011, and continued to be led by strength in thegrowth markets which increased 10.3 percent (13 percent adjusted
for currency).
Global Business Services revenue of $18,566 million decreased
3.7 percent (2 percent adjusted for currency) in 2012. On a geographic basis, solid performance in the growth markets, withrevenue up 4.3 percent (8 percent adjusted for currency), was offset
by a 5.1 percent decline (3 percent adjusted for currency) in the major
markets. The growth initiatives—business analytics, Smarter Planetand cloud had solid double-digit revenue growth, and represented
over one-third of total GBS revenue in 2012. As GBS shifts moreof its business to higher value content, these larger, more complex
engagements are having a positive effect on the GBS backlog.
The GBS backlog grew for the fourth consecutive year at constantcurrency—although the backlog was mixing to longer duration
engagements. Application Outsourcing revenue decreased 4.1 percent (2 percent adjusted for currency) in 2012 year to year, and C&SI
revenue decreased 3.6 percent (2 percent adjusted for currency).
Both GBS lines of business had solid revenue performance year toyear in the growth markets with Application Outsourcing and C&SI
up 1.5 percent and 5.3 percent, respectively, as reported, and up 6
percent and 8 percent, respectively, at constant currency.

($ in millions)

For the year ended December 31:

2012

2011

$14,740$14,320

Yr.-to-Yr.
Percent/
MarginChangeGlobal Services
Global Technology Services
External gross profit
External gross profit margin
Pre-tax income
Pre-tax margin

36.6%$ 6,961
16.8%

35.0%
$ 6,284
14.9%

2.9%
1.6 pts.
10.8%
1.9 pts.

Global Business Services
External gross profit
External gross profit margin
Pre-tax income
Pre-tax margin$ 5,564
30.0%$ 2,983
15.5%$ 5,54528.8%$ 3,006
15.0%

0.3%
1.2 pts.
(0.8)%
0.5 pts.

GTS gross profit increased 2.9 percent in 2012 and the gross profit
margin improved 1.6 points year to year with margin expansion ineach line of business, led by Outsourcing. Pre-tax income of $6,961
million in 2012 increased 10.8 percent year to year and the pre-tax
margin expanded 1.9 points to 16.8 percent. Normalized for workforce rebalancing charges of $151 million and $5 million in the third
quarter of 2012 and 2011, respectively, GTS pre-tax income was up
13.1 percent and pre-tax margin expanded 2.2 points versus theprior year. The year-over-year gross and pre-tax margin expansion
was driven by several factors: the work done to improve the profitability of a number of low-margin contracts in the outsourcing
portfolio, increased contribution from the higher margin growthmarkets, and increased efficiency and productivity from the focus
on automation and process primarily through the company’s enterprise productivity initiatives.
The GBS gross profit margin expanded 1.2 points, led primarily
by improved profit performance in Application Outsourcing. GBS
pre-tax income of $2,983 million declined 0.8 percent in 2012 witha pre-tax margin of 15.5 percent, an improvement of 0.5 points year
to year. Normalized for workforce rebalancing charges of $113 million
and $5 million in the third quarter of 2012 and 2011, respectively, GBS
pre-tax income was up 2.8 percent and the pre-tax margin expanded
1.1 points versus the prior year. The gross and pre-tax margins benefitted from improved service delivery and yield from the company’s
enterprise productivity initiatives.

Management Discussion
International Business Machines Corporation and Subsidiary Companies

The total Global Services business delivered strong profit andmargin expansion throughout 2012. Pre-tax income of $9,944 million
in 2012 increased 7.0 percent year to year. Normalized for the higher
level of workforce rebalancing charges in 2012, pre-tax income wasup 9.8 percent and the pre-tax margin expanded 1.9 points comparedto the prior year. The estimated Global Services backlog at December
31, 2012 was $140 billion, a decrease of 0.3 percent as reported,
but an increase of 1 percent adjusted for currency compared to theDecember 31, 2011 balance.

Software($ in millions)Yr.-to-Yr.
Percent
ChangeYr.-to-Yr.
Percent Change
Adjusted for
Currency

For the year ended December 31:

2012

2011

Software external revenue$25,448$24,944

2.0%

4.3%

$20,983$20,650

1.6%

3.9%

16,52816,0552.9

5.2

WebSphere Family

7.8

9.9

Information Management

1.5

3.8

Social Workforce Solutions*

(2.1)

0.3

Tivoli

4.1

6.2

Rational

(1.6)

0.6

Middleware
Key Branded Middleware

Other middleware

4,455

4,596

(3.1)

(0.6)

Operating systems

2,525

2,480

1.8

4.3

Other

1,940

1,813

7.0

9.2

* Formerly Lotus

Software revenue of $25,448 million increased 2.0 percent (4 percent adjusted for currency) in 2012 compared to 2011. Software
revenue growth continued to be led by the key branded middleware
products with constant currency growth in all the brands, and particular strength and share gains in WebSphere and Tivoli. Software
continued its momentum throughout 2012 in the growth initiatives
with strong performance in business analytics, Smarter Commerceand cloud. The Software business delivered $10.8 billion in segment
pre-tax profit, an increase of $840 million from 2011. The results
reflected the company’s sustained investment in strategic branded
software. In addition to organic investments, acquisitions have provided additional capabilities, while leveraging the existing portfolio
of offerings. The Software business completed nine acquisitions in
2012, further increasing the company’s capabilities in analytics,
cloud and Smarter Planet.
Key branded middleware revenue increased 2.9 percent (5 percent
adjusted for currency) and again gained market share in 2012, as
the Software business continued to be the leader in the middleware
market. Revenue continued to mix to the faster growing and higher
value branded middleware products which accounted for 65 percent
of total software revenue in 2012, an increase of 1 point from 2011.
WebSphere revenue increased 7.8 percent (10 percent adjusted
for currency) in 2012, with strong performance throughout the year,and gained share. Revenue performance included strong growth in
the core offerings of commerce and application servers. Commercerevenue increased 14 percent (15 percent adjusted for currency) andapplication server products increased 6 percent (8 percent adjusted
for currency). The company further strengthened its WebSphere
portfolio during the year with the acquisitions of Worklight, DemandTec,
Emptoris and Tealeaf.

Information Management revenue increased 1.5 percent (4 percent adjusted for currency) in 2012 compared to 2011. Performance
was led by growth in the business analytics offerings. The acquisitions of Varicent and Vivisimo expanded the Business Analytics andOptimization software capabilities. Varicent’s analytics software
helps clients optimize sales performance management. Vivisimo
expands the breadth of the company’s big data capabilities andcreates the most complete end-to-end big data solution for clients.
Tivoli revenue increased 4.1 percent (6 percent adjusted for currency) in 2012, led by its storage and security offerings, and gained
share. Tivoli storage revenue was up 12 percent (14 percent adjusted
for currency) in 2012, with double-digit constant currency growth ineach quarter, reflecting the value of storage software. Tivoli security
revenue increased 8 percent (10 percent adjusted for currency), withstrong contribution from Q1 Labs which provides next generation
security intelligence.
Social Workforce Solutions revenue decreased 2.1 percent asreported, but was flat year to year at constant currency in 2012. The
social business offerings performed well, including contribution fromthe acquisition of Kenexa, a leading provider of recruiting and talentmanagement solutions.
Rational revenue decreased 1.6 percent as reported, but increased
1 percent at constant currency in 2012 year over year, and held share.
Operating systems revenue increased 1.8 percent (4 percent
adjusted for currency) in 2012 compared to 2011, driven by Platform
Computing which provides cluster and grid management softwarefor distributed computing environments.

57

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Management Discussion
International Business Machines Corporation and Subsidiary Companies

Other software revenue increased 7.0 percent (9 percent adjusted
for currency) driven by growth in software-related services.
($ in millions)

For the year ended December 31:

2012

2011

$22,569$22,065

SoftwareExternal gross profit
External gross profit margin
Pre-tax income

88.7 %$10,810Pre-tax margin37.6 %

88.5%$ 9,970
35.3%

Software gross profit increased 2.3 percent to $22,569 million in 2012,
with a gross profit margin of 88.7 percent, up 0.2 points year to year.
Software pre-tax income of $10,810 million increased 8.4 percent andthe pre-tax margin improved 2.3 points to 37.6 percent. Normalized
Yr.-to-Yr.
for workforce rebalancing charges of $94 million and $6 million in thePercent/
Marginthird quarter of 2012 and 2011, respectively, software pre-tax income
Changewas up 9.3 percent and the pre-tax margin expanded 2.6 points
versus the prior year. The Software business had another successful
2.3%
year leveraging revenue growth and expense productivity which drove
0.2 pts. significant margin expansion and profit growth.
8.4%
2.3 pts.

Systems and Technology($ in millions)

For the year ended December 31:

Systems and Technology external revenue

2012

2011

$17,667$18,985

Yr.-to-Yr.
Percent
ChangeYr.-to-Yr.
Percent Change
Adjusted for
Currency(6.9)%(5.9)%

System z

5.4%

6.3%

Power Systems

(8.5)

(7.4)

System x

(3.7)

(2.7)

Storage

(5.8)

(4.1)

Total Systems excluding Retail Store Solutions
Microelectronics OEM

(3.7)

(2.5)

(14.4)(14.4)

Total Systems and Technology excluding Retail Store Solutions

(5.1)

(4.0)

Retail Store Solutions (Divested in 2012)(52.6)(51.7)

Systems and Technology revenue decreased 6.9 percent (6 percent
adjusted for currency) in 2012 versus 2011. Adjusting for the divested
RSS business, revenue declined 5.1 percent (4 percent adjusted for
currency) in 2012. Growth markets revenue increased 0.3 percent(1 percent adjusted for currency) in 2012, compared to the prior year
while major markets revenue decreased 8.3 percent (7 percent
adjusted for currency). During 2012, the company’s continued investments for innovation supported the introduction of the new Systemz mainframe, the PureSystems offerings and new Storage and
POWER7+ products. In its introductory year, the company sold morethan 2,300 PureSystems in over 70 countries.
System z revenue increased 5.4 percent (6 percent adjusted for
currency) in 2012 versus 2011. The increase was driven by the new
mainframe which began shipping late in the third quarter. Fourthquarter revenue increased 55.6 percent (56 percent adjusted for
currency), as revenue increased in the major markets over 50 percent and over 65 percent in the growth markets. MIPS shipments
increased 19 percent in 2012 versus the prior year. The increase in
MIPS was driven by the new mainframe shipments, including specialty engines, which increased 44 percent year over year driven by
Linux workloads. This was a good indicator of new workloads
moving to this platform. The performance reflected the technology
leadership and value of the vertically integrated stack that the company’s flagship server delivers to its clients.

Power Systems revenue decreased 8.5 percent (7 percent
adjusted for currency) in 2012 versus 2011. Low-end servers
increased 6 percent (7 percent adjusted for currency) offset by
declines in high-end and mid-range products. Early in October, thecompany announced new POWER7+ based servers. The high-end
and midrange models available in the fourth quarter performed wellin the period. In 2012, the company had nearly 1,200 competitive
displacements resulting in over $1 billion of business; almost equallyfrom Hewlett Packard and Oracle/Sun.
System x revenue decreased 3.7 percent (3 percent adjusted for
currency) in 2012 versus 2011. High-end System x revenue increased
5 percent (6 percent adjusted for currency) in 2012 versus the prioryear, while high-volume and blade servers declined year to year.
Storage revenue decreased 5.8 percent (4 percent adjusted for
currency) in 2012 versus 2011. Total disk revenue decreased 3 percent (1 percent adjusted for currency) in 2012 versus 2011. Taperevenue decreased 16 percent (14 percent adjusted for currency) in2012 versus the prior year. The value in storage solutions continued
to shift to software, as demonstrated by the ongoing success thecompany had in its Tivoli storage software offerings.
Retail Store Solutions revenue decreased 52.6 percent (52 percent adjusted for currency) in 2012 versus 2011. In the third quarter,
the company divested the Retail Store Solutions business to ToshibaTec. See the caption, “Divestitures,” on page 98 for additional information regarding the transaction.

Management Discussion
International Business Machines Corporation and Subsidiary Companies

Microelectronics OEM revenue decreased 14.4 percent(14 percent adjusted for currency) in 2012 versus 2011.
($ in millions)

For the year ended December 31:

2012

2011

$6,903$7,555

Systems and Technology
External gross profit
External gross profit margin
Pre-tax income
Pre-tax margin

39.1%$1,227
6.7%

39.8%$1,633
8.2%

Overall gross margin decreased 0.7 points in 2012 versus theprior year. The decrease was driven by lower margins in System x(0.6 points), Microelectronics (0.6 points), Storage (0.5 points) andPower Systems (0.2 points), partially offset by an improvement due
Yr.-to-Yr.
to revenue mix (1.2 points).
Percent/
MarginSystems and Technology’s pre-tax income decreased $406
Changemillion (24.9 percent) to $1,227 million in 2012, with a pre-tax marginof 6.7 percent. Normalized for workforce rebalancing charges of(8.6)% $46 million and $3 million in the third quarter of 2012 and 2011,(0.7) pts. respectively, pre-tax income decreased 22.2 percent and the pre(24.9)% tax margin decreased by 1.3 points versus the prior year.
(1.5) pts.

The decrease in external gross profit in 2012 versus 2011 was due
to lower revenue and a lower overall gross profit margin.

Global Financing
See pages 72 through 75 for an analysis of Global Financing’s
segment results.

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 discussed separately below.
($ in millions)

For the year ended December 31:

Yr.-to-Yr.
Percent
ChangeYr.-to-Yr.
Percent Change
Adjusted for
Currency

2012

2011

Total revenue$104,507$106,916(2.3)%

0.0%

Geographies$102,268$104,170(1.8)%

0.5%

Americas44,55644,944(0.9)

0.0

Europe/Middle East/Africa

31,77533,952

(6.4)

(1.0)

Asia Pacific

25,93725,2732.6

3.3

Major markets(3.5)%(1.3)%

Growth markets

4.2%

6.9%

7.4%

12.2%

BRIC countries

Total geographic revenue decreased 1.8 percent (flat adjusted for
currency) in 2012; excluding the divested RSS business, revenue
decreased 1.4 percent as reported, but increased 1 percent at constant currency compared to the prior year. Revenue performance atconstant currency was driven by strong results in the growth markets, offsetting a modest decline year to year in the major markets.
Across all geographies, growth markets revenue increased 4.2
percent (7 percent adjusted for currency) and these countries represented 24 percent of total geographic revenue, an increase of 8
points since 2006 when the company introduced its 2010 road map.
Adjusted for currency, revenue growth in these fast growing markets
outpaced the major markets in 2012 by approximately 8 points. The
BRIC countries of Brazil, Russia, India and China combined revenue
increased 7.4 percent (12 percent adjusted for currency) in 2012, withdouble-digit growth in Russia, India and China, adjusted for currency.
Overall in 2012, the company had double-digit constant currency
revenue growth in nearly 35 growth market countries. The company
continued to expand into new countries and territories, building out
IT infrastructures in support of economic growth and taking a leadership position in key industries. To drive market expansion, in 2012,

the company accelerated the opening of new branch offices resulting in a doubling of the number of face-to-face branches whencompared to 2011. At year end, the company had almost 450 faceto-face and virtual branch offices in the growth markets.
Americas revenue decreased 0.9 percent (flat adjusted for
currency) in 2012. Within the major market countries, the U.S.
decreased 1.1 percent and Canada decreased 1.5 percent asreported (flat adjusted for currency). Revenue in the Latin America growth markets increased 1.4 percent (8 percent adjusted
for currency) with constant currency growth in Brazil of 6 percent,down 4.6 percent as reported.
Europe/Middle East/Africa revenue decreased 6.4 percent(1 percent adjusted for currency) in 2012 compared to 2011. Within
the major market countries, the UK was essentially flat (up 1 percent
adjusted for currency), Germany was down 7.6 percent (flatadjusted for currency), France was down 12.6 percent (6 percent
adjusted for currency) and Italy was down 8.4 percent (1 percent
adjusted for currency). The EMEA growth markets increased 0.8
percent (5 percent at constant currency) led by growth in Russia
of 11.7 percent (13 percent adjusted for currency).

59

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Management Discussion
International Business Machines Corporation and Subsidiary Companies

Asia Pacific revenue increased 2.6 percent (3 percent adjusted
for currency) year over year. The Asia Pacific growth markets
increased 6.0 percent (7 percent adjusted for currency), with growth
led by China (17.9 percent as reported, 16 percent at constant currency) and India (decreased 0.9 percent as reported, increased 13
percent at constant currency). Japan revenue decreased 1.9 percent(2 percent adjusted for currency) but improved sequentially throughout the year at constant currency and returned to growth in the
fourth quarter of 2012.
OEM revenue of $2,239 million in 2012 decreased 18.5 percent(18 percent adjusted for currency) compared to 2011, driven by theMicroelectronics OEM business.

Total Expense and Other (Income)($ in millions)

For the year ended December 31:

2012

2011

Total consolidated expenseand other (income)$28,396$29,135

Yr.-to-Yr.
Percent/
MarginChange(2.5)%

Non-operating adjustments
(328)

(289)

13.3

Acquisition-related charges

(35)

(45)

(21.2)

Non-operating retirement-related(costs)/income

(274)

74

NM

$27,760$28,875(3.9)%

Total consolidated
expense-to-revenue ratio

27.2%

27.3%

(0.1) pts.

Operating (non-GAAP)
expense-to-revenue ratio

26.6%

27.0%

(0.4) pts.

Total expense and other (income) decreased 2.5 percent in 2012versus 2011. Total operating (non-GAAP) expense and other (income)decreased 3.9 percent versus the prior year. The key drivers of theyear-to-year change in total expense and other (income) wereapproximately:•	Currency*•	Acquisitions**•	Base expense($ in millions)

For the year ended December 31:

Yr.-to-Yr.
Percent
Change2012

2011$19,589$20,287

1,339

1,373

(2.5)

Workforce rebalancing charges

803

440

82.5

Retirement-related costs

Selling, general andadministrative expense
Selling, general andadministrative—other
Advertising and promotional expense(3.4)%

945

603

56.7

Amortization of acquired
intangible assets

328

289

13.3

Stock-based compensation

498

514

(3.0)

Bad debt expense5088(42.5)$23,553$23,594

Amortization of acquired
intangible assets

(328)

(289)

13.3

Acquisition-related charges

(22)

(20)

10.2

Non-operating retirement-related(costs)/income

(294)

(13)

NM

$22,910$23,272

Total consolidated selling, generaland administrative expense(0.2)%

Operating (non-GAAP)
selling, general andadministrative expense(1.6)%

NM—Not meaningful

NM—Not meaningful				Selling, General and Administrative

Non-operating adjustments

Amortization of acquired
intangible assets

Operating (non-GAAP)
expense and other (income)For additional information regarding total expense and other (income),
see the following analyses by category.

Total
Consolidated

Operating(non-GAAP)(5) points
3 points(0) points(5) points
2 points(2) points  * Reflects impacts of translation and hedging programs.
** Includes acquisitions completed in prior 12-month period, operating (non-GAAP) is
net of non-operating acquisition-related charges.

Total SG&A expense decreased 0.2 percent in 2012 versus 2011.
The decrease was primarily driven by the effects of currency (3points), partially offset by acquisition-related spending (2 points),
while base spending was essentially flat.
Operating (non-GAAP) SG&A expense decreased 1.6 percent
primarily driven by the effects of currency (3 points) and lower basespending (1 point), partially offset by acquisition-related spending (2points). The increase in workforce rebalancing charges was due toactions primarily focused on the company’s non-U.S. operations in
the third quarter of 2012. The increase in retirement-related costs
was primarily driven by the charge related to a court decision
regarding one of IBM UK’s defined benefit plans. As a result of theruling, the company recorded an additional retirement-related obligation of $162 million in the third quarter of 2012. This charge was
not reflected in operating (non-GAAP) SG&A expense. See note M,“Contingencies and Commitments,” on pages 119 to 121 for additional information. Bad debt expense decreased $37 million in 2012versus 2011, as the company increased its provisions in 2011 reflecting the European credit environment. The accounts receivable
provision coverage was 1.4 percent at December 31, 2012, a decreaseof 10 basis points from year-end 2011.

Management Discussion
International Business Machines Corporation and Subsidiary Companies

Other (Income) and Expense($ in millions)

For the year ended December 31:

2012

2011

$(240)$ 513

Yr.-to-Yr.
Percent
ChangeOther (income) and expense
Foreign currency transaction
losses/(gains)(Gains)/losses onderivative instruments

NM%

72

(113)

NM

(109)

(136)

(20.2)Net (gains)/losses from securities
and investment assets

(55)

(227)

(75.5)

Other

(511)

(58)

NM

Total consolidated other(income) and expense$(843)$  (20)NM%

Interest income

Acquisition-related charges

Intellectual Property and Custom Development Income($ in millions)Non-operating adjustment
Operating (non-GAAP) other(income) and expense

The company continued to invest in research and development,
focusing its investments on high-value, high-growth opportunities
and to extend its technology leadership. Total RD&E expense
increased 0.7 percent in 2012 versus 2011, primarily driven by acquisitions (3 points), partially offset by the effects of currency (2 points)
and lower base spending (1 point). Operating (non-GAAP) RD&E
expense decreased 0.4 percent in 2012 compared to the prior year
primarily driven by the effects of currency (2 points) and lower basespending (2 points), partially offset by acquisitions (3 points). RD&E
investments represented 6.0 percent of revenue in 2012, compared
to 5.9 percent in 2011.

For the year ended December 31:(13)$(857)(25)$  (45)(46.0)
NM%

2011

Sales and other transfers ofintellectual property$  324$  309Licensing/royalty-based fees

251

211

19.0

500

588

(14.9)$1,074$1,108Custom development income

NM—Not meaningful

Total

Other (income) and expense was income of $843 million and $20
million in 2012 and 2011, respectively. The increase in income of $823
million in 2012 was primarily driven by higher gains from foreign currency transactions ($753 million) due to rate volatility year to year,
and the gain associated with the divested RSS business ($446 million) reflected in Other in the table above. These increases in income
were partially offset by increased losses on derivative instruments($184 million) and lower gains from securities and investment asset
sales ($171 million). In 2011, the company had investment gains ofover $200 million, primarily from the sale of Lenovo shares.

Yr.-to-Yr.
Percent
Change2012

2011$6,302$6,2580.7%

Non-operating retirement-related(costs)/income

20

88(76.9)

Operating (non-GAAP) research,development and engineering$6,322$6,345

Total consolidated research,development and engineering(3.0)%

Interest Expense($ in millions)

2012

2011

$459

$411

Yr.-to-Yr.
Percent
ChangeInterest expense($ in millions)

For the year ended December 31:

4.7%

The timing and amount of sales and other transfers of IP may varysignificantly from period to period depending upon timing of divestitures, industry consolidation, economic conditions and the timingof new patents and know-how development. There were no significant individual IP transactions in 2012 or 2011.

For the year ended December 31:

Research, Development and Engineering

Yr.-to-Yr.
Percent
Change2012

Non-operating adjustment(0.4)%

Total

11.8%

The increase in interest expense in 2012 versus 2011 was primarily
driven by higher average debt levels, partially offset by lower averageinterest rates. Interest expense is presented in cost of financing in
the Consolidated Statement of Earnings only if the related externalborrowings are to support the Global Financing external business.
See page 75 for additional information regarding Global Financing
debt and interest expense. Overall interest expense (excluding capitalized interest) for 2012 was $1,004 million, an increase of $40
million year to year.

61

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Management Discussion
International Business Machines Corporation and Subsidiary Companies

Income Taxes
The effective tax rate for 2012 was 24.2 percent compared with 24.5
percent in 2011. The operating (non-GAAP) tax rate for 2012 was
24.0 percent compared with 24.5 percent in 2011. The 0.3 point
decrease in the as-reported effective tax rate was primarily driven
by a more favorable geographic mix of pre-tax earnings (2.6 points)
and a one-time benefit in the first quarter associated with a tax
restructuring in Latin America (0.8 points), primarily offset by adecrease in the utilization of foreign tax credits in 2012 (2.9 points)
and the unfavorable tax impact of the gain on the RSS divestiture(0.3 points).The remaining items were individually insignificant.

Financial Position
Cash and marketable securities at year end were $11,128 million,a decrease of $794 million from the prior year-end position. During
the year the company continued to manage the investment portfolio to meet its capital preservation and liquidity objectives. At
December 31, 2012, there were no holdings of European sovereign
debt securities in the investment portfolio.
Total debt of $33,269 million increased $1,949 million from theprior year-end level. The commercial paper balance at December
31, 2012 was $1,800 million, a decrease of $500 million from theprior year. Within total debt, $24,501 million was in support of the
Global Financing business which was leveraged at a 7.0 to 1 ratio.
The company continued to have substantial flexibility in the market.
During 2012, the company completed bond issuances totaling$7,875 million, with terms ranging from three to 30 years and priced
from 0.55 to 4.00 percent depending on the maturity. The company has consistently generated strong cash flow from operations
and continued to have access to additional sources of liquidity
through the capital markets and its $10 billion global credit facility,with 100 percent of the facility available on a same-day basis.

Consistent with accounting standards, the company remeasured
the funded status of its retirement and postretirement plans at
December 31. At December 31, 2012, the overall net underfunded
position was $20,190 million, an increase of $3,800 million from
December 31, 2011, as the increase in the benefit obligation due tothe reduction in discount rates more than offset the returns on plan
assets. At year-end 2012, the company’s qualified defined benefit
plans were well funded and the cash requirements related to theseplans remained stable going forward at approximately $1 billion peryear through 2015. In 2012, the return on the U.S. Personal Pension
Plan assets was 11.3 percent and the plan was 98 percent funded.
Overall, global asset returns were 11.1 percent and the company’s
qualified defined benefit plans worldwide were 94 percent funded.
The company’s qualified defined benefit plans did hold European
sovereign debt securities in their trust funds. See note S, “Retirement-Related Benefits,” on page 135 for additional information.
During 2012, the company generated $19,586 million in cashfrom operations, a decrease of $260 million compared to 2011. In
addition, the company generated $18,185 million in free cash flowin 2012, an increase of $1,581 million over the prior year. See pages
65 to 67 for additional information on free cash flow. The company
returned $15,768 million to shareholders in 2012, with $11,995 million in gross share repurchases and $3,773 million in dividends. In
2012, the company repurchased approximately 61 million sharesand had $8.7 billion remaining in share repurchase authorization
at year end. The company’s strong cash generation permitted
the company to invest and deploy capital to areas with the most
attractive long-term opportunities.

Management Discussion
International Business Machines Corporation and Subsidiary Companies

GAAP Reconciliation
The tables below provide a reconciliation of the company’s income statement results as reported under GAAP to its operating earnings
presentation which is a non-GAAP measure. The company’s calculation of operating (non-GAAP) earnings, as presented, may differ fromsimilarly titled measures reported by other companies. Please refer to the “Operating (non-GAAP) Earnings” section on page 26 for thecompany’s rationale for presenting operating earnings information.
($ in millions except per share amounts)

For the year ended December 31, 2012:

Gross profit
Gross profit margin

GAAP

AcquisitionRelated
Adjustments

RetirementRelated
Adjustments

Operating(non-GAAP)$50,298

$ 376

$ 264

$50,938

48.1%

SG&A

$23,553

RD&E
Other (income) and expense

0.4 pts.

0.3 pts.

48.7%$(349)$(294)$22,910

6,302

0

20

6,322

(843)

(13)

0

(857)

Total expense and other (income)

28,396

(363)

(274)

27,760Pre-tax income

21,902739

538

23,1790.7 pts.

0.5 pts.

Pre-tax income margin
Provision for income taxes*
Effective tax rate
Net income
Net income margin
Diluted earnings per share

21.0%$ 5,298
24.2%$16,604
15.9%$ 14.37$   98(0.4) pts.
$ 641
0.6 pts.
$0.55

$ 156
0.1 pts.
$ 381
0.4 pts.
$0.33

22.2%
$ 5,552
24.0%$17,627
16.9%$ 15.25* The tax impact on operating (non-GAAP) pre-tax income is calculated under the same accounting principles applied to the GAAP pre-tax income which employs an annual
effective tax rate method to the results.

($ in millions except per share amounts)

For the year ended December 31, 2011:

Gross profit
Gross profit margin

GAAP

AcquisitionRelated
Adjustments

RetirementRelated
Adjustments

Operating(non-GAAP)$50,138

$ 341

$   2

$50,481

46.9%

SG&A

$23,594

RD&E

0.3 pts.

0.0 pts.

47.2%$(309)$  (13)$23,272

6,258

0

88

6,345

(20)

(25)

0

(45)

Total expense and other (income)

29,135(334)

74

28,875Pre-tax income

21,003675(72)

21,605

0.6 pts.

(0.1) pts.

Other (income) and expense

Pre-tax income margin
Provision for income taxes*
Effective tax rate
Net income
Net income margin
Diluted earnings per share

19.6%$ 5,14824.5%$15,855
14.8%$ 13.06$ 179
0.1 pts.
$ 495
0.5 pts.
$0.41$  (40)(0.1) pts.
$  (32)(0.0) pts.
$(0.03)

20.2%$ 5,28724.5%$16,318
15.3%$ 13.44* The tax impact on operating (non-GAAP) pre-tax income is calculated under the same accounting principles applied to the GAAP pre-tax income which employs an annual
effective tax rate method to the results.

Other Information

Looking Forward

The company measures the success of its business model over thelong 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. A long-term perspective ensuresthat the company is well-positioned to take advantage of major
shifts occurring in technology, business and the global economy.

In May 2010, the company met with investors to describe how thecompany manages its business, allocates it capital and serves its shareholders in a detailed discussion of its strategy. The company discussed how it continuously changes its business mix and resource
allocation toward higher value, higher growth market opportunities.
The company also discussed its transformation to a globally

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Management Discussion
International Business Machines Corporation and Subsidiary Companies

integrated enterprise and how this has allowed the company to capture new growth and productivity. The company highlighted that byaligning its business model with its clients’ needs, the company canachieve its financial goals which will allow the company to invest in
future sources of growth and provide strong returns to its shareholders. This delivers long-term value and performance to all key
stakeholders. The execution of the company’s strategy results in the2015 road map with the expectation of at least $20 of operating(non-GAAP) earnings per share in 2015.
Looking forward, the company expects to continue its transformation in 2014, shifting its investments to the growth areas andmixing to higher value. The company will continue to acquire key
capabilities, divest of certain businesses, rebalance its workforce
and invest in innovation as it continues to return value to its shareholders. In January 2014, the company disclosed that it is expecting
GAAP earnings of at least $17.00 and operating (non-GAAP) earnings
of at least $18.00 per diluted share for the full year 2014. The operating (non-GA AP) earnings per share expectation exclude
acquisition-related charges of $0.76 per share and non-operating
retirement-related costs of $0.24 per share. This expectation results
in an increase year to year of 13.8 percent in GAAP earnings per
share and an increase of 10.5 percent year to year in operating (nonGAAP) earnings per share which keeps the company on track to its
2015 objective. The company’s expectation for 2014 includes: a gainfrom the sale of its customer care business to SYNNEX of approximately $150-$175 million, flat year to year pre-tax income in the
Systems and Technology business, a continued headwind from currency, approximately flat workforce rebalancing charges year to year,
benefits from both the 2013 and 2014 workforce actions, continued
benefits from productivity initiatives and a 23 percent assumption for
the tax rate. The company also stated that in the first quarter of 2014
it expects to close the initial phase of the sale of its customer carebusiness, and that it also expects to take the majority of its workforce
rebalancing charges in the same period. As a result, the company
expects first-quarter 2014 GAAP and operating (non-GAAP) earnings
per share to be approximately 14 percent of the full year expectation,reflecting about half of the divestiture gain, the workforce rebalancing
charges and continued impacts from currency. The year-to-year
dynamics of the workforce rebalancing charges will impact the company’s quarterly earning profile in the first half. The company expects
first-quarter 2014 GAAP and operating (non-GAAP) earnings per
share to be down year to year as a result of the expected workforce
rebalancing charges, and it expects second-quarter 2014 GAAP and
operating (non-GAAP) earnings per share to increase year to year
due to the workforce rebalancing charges recorded in the prior year.
For the first half of 2014, the company expects low double-digit
growth in its GAAP and operating (non-GAAP) earnings per sharecompared to the prior year.
From a segment perspective, the Software business again delivered improved revenue, pre-tax income and margin expansion in
2013. The company continues to invest in the Software businessand is confident in its profit trajectory going into 2014, expecting
the business to grow consistently with its performance the past few
years. The Global Services business delivered pre-tax income andmargin expansion in 2013. The Global Services business continues
to see strength in cloud, Smarter Planet and business analytics andthe company will continue to invest to extend its capabilities. Thereis good momentum in Global Business Services which delivered
double-digit profit growth in the second half of 2013. In Global Technology Services, the company expects the profit base in thissegment to improve in 2014. Contribution from significant contracts
that the business signed in 2013 should improve as the transitional
investments mature and productivity improves. Overall, the business expects Global Services to improve profit in 2014 consistent
with its model for that business, 8-10 percent. In 2013, pre-tax
income in the Systems and Technology business was down $1.7
billion year to year. The performance was driven by the businessmodel issues in the Power Systems, System x and Storage business
units and System z mainframe product cycle. The company remains
confident in the secular strength of the mainframe and the productcycle. However, the business will take actions to address the business model challenges including making the products more
relevant to clients and right-sizing these businesses to meet the
new value proposition. In January 2014, the company announced
a definitive agreement with Lenovo Group Limited in which Lenovo
will acquire the company’s x86 server portfolio. The company
expects to recognize a total pre-tax gain on the sale of approximately $1 billion. See the caption “Divestitures” on page 98 foradditional information. While the company is focused on getting
the Systems and Technology business back to profit growth, in its
earnings per share expectation for 2014, the company has assumed
flat pre-tax income year to year for this business, excluding thedivestiture gain.
Within the growth markets, performance in 2013 was mixed;
however, the company was disappointed with the overall results.
The new governmental economic reforms in China impacted performance. As the company expands its footprint in China, thecompany continues to see good long-term opportunity and it continues to invest to capture that opportunity. Overall, in the growthmarkets, the company believes it is on a trajectory to growth andexpects mid-single-digit revenue growth at constant currency by
the end of 2014.
Currency movements impacted the company’s year-to-year
revenue and earnings per share growth in 2013. Revenue growth
for the full year was impacted by 2.1 points from currency. Currency
also impacted the company’s profit performance. While there werea number of currency movements year to year, the company’s
results were significantly impacted by the depreciation of the Yen.
Due to the fact that the company’s business in Japan is more heavily
skewed to local services, the company has less ability to hedge
cross-border cash flows in Japan as compared to most other countries. As a result, the currency impact related to the Yen largely falls
to profit. In January 2014, the company indicated that at current spot
rates, it expects this impact to continue through 2014.
The company’s free cash flow performance in 2013 comparedto the prior year was impacted by operational performance, changes
in sales cycle working capital and cash tax payments. The company
expects free cash flow in 2014 to increase by approximately $1 billion
year to year, including continued impacts of cash tax payments, andgrow faster than net income. Cash tax payments are expected to bea year-to-year headwind in 2014 of about $2 billion, with the majorityof that impact in the first quarter.

Management Discussion
International Business Machines Corporation and Subsidiary Companies

The company expects 2014 pre-tax retirement-related plan costto be approximately $2.1 billion, a decrease of approximately $800
million compared to 2013. This estimate reflects current pension
plan assumptions at December 31, 2013. Within total retirementrelated plan cost, operating retirement-related plan cost is expected
to be approximately $1.8 billion, flat versus 2013. Non-operating
retirement-related plan cost is expected to be approximately $300
million, a decrease of approximately $800 million compared to 2013,
driven by less recognized actuarial losses. Cash disbursements for
all retirement-related plans are expected to be approximately $2.9
billion in 2014, an increase of approximately $200 million compared
to 2013. See note S, “Retirement-Related Benefits,” on pages 127
to 141 for additional information.
The company’s effective tax rate for 2013 benefitted from therecognition of discrete period tax events, including audit settlements. The company expects, in the normal course of business,that its effective tax rate and operating (non-GAAP) tax rate will
be approximately 23 percent in 2014. The rate will change year toyear based on nonrecurring events, such as the settlement ofincome tax audits and changes in tax laws, as well as recurring
factors including the geographic mix of income before taxes, thetiming and amount of foreign dividend repatriation, state and local
taxes and the effects of various global income tax strategies.

be less than 2.20 to 1.0, as well as a cross default provision withrespect to other defaulted indebtedness of at least $500 million.
The company is in compliance with all of its significant debt covenants and provides periodic certification to its lenders. The failure
to comply with its debt covenants could constitute an event ofdefault with respect to the debt to which such provisions apply. If
certain events of default were to occur, the principal and interest on
the debt to which such event of default applied would become
immediately due and payable.
The company does not have “ratings trigger” provisions in its
debt covenants or documentation, which would allow the holders
to declare an event of default and seek to accelerate payments
thereunder in the event of a change in credit rating. The company’scontractual agreements governing derivative instruments containstandard market clauses which can trigger the termination of theagreement if the company’s credit rating were to fall below investment
grade. At December 31, 2013, the fair value of those instruments thatwere in a liability position was $501 million, before any applicablenetting, and this position is subject to fluctuations in fair value period
to period based on the level of the company’s outstanding instruments and market conditions. The company has no other contractual
arrangements that, in the event of a change in credit rating, would
result in a material adverse effect on its financial position or liquidity.

Liquidity and Capital Resources
The company has consistently generated strong cash flow fromoperations, providing a source of funds ranging between $17.5 billion
and $20.8 billion per year over the past five years. The company
provides for additional liquidity through several sources: maintaining
an adequate cash balance, access to global funding sources, acommitted global credit facility and other committed and uncommitted lines of credit worldwide. The following table provides a summaryof the major sources of liquidity for the years ended December 31,
2009 through 2013.
Cash Flow and Liquidity Trends($ in billions)
2013

2012

2011

2010

2009

Net cash fromoperating activities

$17.5

$19.6

$19.8

$19.5

$20.8

Cash and short-term
marketable securities

$11.1

$11.1

$11.9

$11.7

$14.0

Committed global
credit facility

$10.0

$10.0

$10.0

$10.0

$10.0

The major rating agencies’ ratings on the company’s debt securities
at December 31, 2013 appear in the following table and remainunchanged from December 31, 2012. The company’s indenture
governing its debt securities and its various credit facilities eachcontain significant covenants which obligate the company topromptly pay principal and interest, limit the aggregate amount of
secured indebtedness and sale and leaseback transactions to 10
percent of the company’s consolidated net tangible assets, andrestrict the company’s ability to merge or consolidate unless certain
conditions are met. The credit facilities also include a covenant on
the company’s consolidated net interest expense ratio, which cannot

Standard& Poor’s

Moody’s
Investors
Service

Fitch
Ratings

Senior long-term debt

AA-

Aa3

A+

Commercial paper

A-1+

Prime-1

F1

The company prepares its Consolidated Statement of Cash Flowsin accordance with applicable accounting standards for cash flowpresentation on page 81 and highlights causes and events underlying sources and uses of cash in that format on page 45. For the
purpose of running its business, the company manages, monitors
and analyzes cash flows in a different format.
Management uses a free cash flow measure to evaluate the company’s operating results, plan share repurchase levels, evaluate strategic
investments and assess the company’s ability and need to incur andservice debt. Free cash flow is not a defined term under GAAP and it
should not be inferred that the entire free cash flow amount is available
for discretionary expenditures. The company defines free cash flow as
net cash from operating activities less the change in Global Financing
receivables and net capital expenditures, including the investment insoftware. As discussed on page 33, a key objective of the Global Financing business is to generate strong returns on equity. Increasingreceivables is the basis for growth in a financing business. Accordingly,
management considers Global Financing receivables as a profit-generating investment, not as working capital that should be minimized for
efficiency. After considering Global Financing receivables as an investment, the remaining net operational cash flow less net capital
expenditures is viewed by the company as free cash flow.
From the perspective of how management views cash flow, in
2013, free cash flow was $15.0 billion, a decrease of $3.2 billion
compared to 2012. The decrease was driven by the company’s
operational performance, higher cash tax payments and changes

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Management Discussion
International Business Machines Corporation and Subsidiary Companies

in sales cycle working capital. These decreases were partially offset
by lower capital expenditures and the prepayment of certain postretirement benefit plan contributions in 2012.
In 2013, the company continued to focus its cash utilization on
returning value to shareholders including $4.1 billion in dividends and$12.8 billion in net stock transactions, including the common stock
repurchase program. In addition, $3.1 billion was utilized to acquire
10 companies. For the full year, the company generated $15.0 billion
in free cash flow and utilized $19.9 billion on acquisitions, net share
repurchases and dividends.
Over the past five years, the company generated over $81 billion
in free cash flow. During that period, the company invested nearly$16 billion in strategic acquisitions and returned over $69 billion toshareholders through dividends and net share repurchases. The
company’s performance during this period demonstrates that
there is fungibility across the elements of share repurchases, dividends and acquisitions. The amount of prospective returns toshareholders in the form of dividends and share repurchases willvary based upon several factors including each year’s operating
results, capital expenditure requirements, research and development investments and acquisitions, as well as the factors
discussed below.
The company’s Board of Directors meets quarterly to consider
the dividend payment. In the second quarter of 2013, the Boardof Directors increased the company’s quarterly common stock
dividend from $0.85 to $0.95 per share.

The table below represents the way in which management reviews cash flow as described on page 65 and above.
($ in billions)
For the year ended December 31:

Net cash from operating activities per GAAP

2013

2012

2011

2010

2009

$ 17.5$ 19.6$ 19.8$ 19.5$20.8

Less: the change in Global Financing receivables

(1.3)

(2.9)

(0.8)

(0.7)

1.9

Net cash from operating activities, excluding Global Financing receivables

18.8

22.5

20.7

20.3

18.9

(3.8)

(4.3)

(4.1)

(4.0)

(3.7)

15.0

18.2

16.6

16.3

15.1

Acquisitions

(3.1)

(3.7)

(1.8)

(5.9)

(1.2)

Divestitures

0.3

0.6

0.0

0.1

0.4

Share repurchase(13.9)(12.0)(15.0)(15.4)(7.4)

Dividends

(4.1)

(3.8)

(3.5)

(3.2)

(2.9)

Non-Global Financing debt

3.2

0.7

1.7

2.3

(4.7)

Other (includes Global Financing receivables and Global Financing debt)

2.4

(0.8)

2.3

3.5

1.7

Change in cash, cash equivalents and short-term marketable securities$ (0.1)$ (0.8)$  0.3$ (2.3)$   1.1

Capital expenditures, net
Free cash flow

Events that could temporarily change the historical cash flow dynamics discussed above include significant changes in operating results,
material changes in geographic sources of cash, unexpected
adverse impacts from litigation, future pension funding requirements
during periods of severe downturn in the capital markets or the timingof tax payments. Whether any litigation has such an adverse impact
will depend on a number of variables, which are more completely
described in note M, “Contingencies and Commitments,” on pages
119 to 121. With respect to pension funding, in 2013, the company
contributed $507 million to its non-U.S. defined benefit plans versus$617 million in 2012. As highlighted in the Contractual Obligations
table on page 67, the company expects to make legally mandated
pension plan contributions to certain non-U.S. plans of approximately$3.3 billion in the next five years. The 2014 contributions are currently
expected to be approximately $600 million. Cash disbursements
related to all retirement-related plans is expected to be approximately$2.9 billion in 2014, an increase of approximately $0.2 billion compared to 2013. Financial market performance could increase thelegally mandated minimum contributions in certain non-U.S. countries that require more frequent remeasurement of the funded status.
The company is not quantifying any further impact from pension
funding because it is not possible to predict future movements in thecapital markets or pension plan funding regulations.

The Pension Protection Act of 2006 was enacted into law in2006, and, among other things, increases the funding requirements
for certain U.S. defined benefit plans beginning after December 31,
2007. No mandatory contribution is required for the U.S. defined
benefit plan in 2014 as of December 31, 2013.
The company’s U.S. cash flows continue to be sufficient to fundits current domestic operations and obligations, including investing
and financing activities such as dividends and debt service. The
company’s U.S. operations generate substantial cash flows, and,in those circumstances where the company has additional cash
requirements in the U.S., the company has several liquidity options
available. These options may include the ability to borrow additional
funds at reasonable interest rates, utilizing its committed global
credit facility, repatriating certain foreign earnings and utilizing intercompany loans with certain foreign subsidiaries.
The company does earn a significant amount of its pre-tax
income outside the U.S. The company’s policy is to indefinitely reinvest the undistributed earnings of its foreign subsidiaries, andaccordingly, no provision for federal income taxes has been madeon accumulated earnings of foreign subsidiaries. The company
periodically repatriates a portion of these earnings to the extent thatit does not incur an additional U.S. tax liability. Quantification of thedeferred tax liability, if any, associated with indefinitely reinvested

Management Discussion
International Business Machines Corporation and Subsidiary Companies

earnings is not practicable. While the company currently does
not have a need to repatriate funds held by its foreign subsidiaries,
if these funds are needed for operations and obligations in the U.S.,

the company could elect to repatriate these funds which could
result in a reassessment of the company’s policy and increased
tax expense.

Contractual Obligations($ in millions)Payments Due In

Total Contractual
Payment Stream

2014

2015-162017-18

After 2018

Long-term debt obligations$36,978$3,839$ 8,656$  8,035$16,448

Interest on long-term debt obligations

10,614

1,084

1,943

1,564

6,023

58

16

25

12

5

Operating lease obligations

5,991

1,492

2,302

1,419

778

Purchase obligations

1,394

593

633

106

62

Minimum defined benefit plan pension funding (mandated)*

3,300

600

1,300

1,400

Excess 401(k) Plus Plan

1,757

84

178

192

1,303

Long-term termination benefits

1,519

238

227

178

876

Tax reserves**

2,904

101

Capital (finance) lease obligations

Other long-term liabilities:

Other

1,052

44

93

80

836

Total

$65,567$8,091$15,357$12,986$26,331  * As funded status on plans will vary, obligations for mandated minimum pension payments after 2018 could not be reasonably estimated.
** These amounts represent the liability for unrecognized tax benefits. The company estimates that approximately $101 million of the liability is expected to be settled within the next
12 months. The settlement period for the noncurrent portion of the income tax liability cannot be reasonably estimated as the timing of the payments will depend on the progressof tax examinations with the various tax authorities; however, it is not expected to be due within the next 12 months.

Total contractual obligations are reported in the table above excluding
the effects of time value and therefore, may not equal the amounts
reported in the Consolidated Statement of Financial Position. Certain
noncurrent liabilities are excluded from the table above as their future
cash outflows are uncertain. This includes deferred taxes, derivatives,deferred income, disability benefits and other sundry items.
Purchase obligations include all commitments to purchasegoods or services of either a fixed or minimum quantity that meet
any of the following criteria: (1) they are noncancelable, (2) the company would incur a penalty if the agreement was canceled, or(3) the company must make specified minimum payments even if
it does not take delivery of the contracted products or services(take-or-pay). If the obligation to purchase goods or services is noncancelable, the entire value of the contract is included in the table
above. If the obligation is cancelable, but the company would incura penalty if canceled, the dollar amount of the penalty is included
as a purchase obligation. Contracted minimum amounts specified
in take-or-pay contracts are also included in the table as they represent the portion of each contract that is a firm commitment.
In the ordinary course of business, the company enters into contracts that specify that the company will purchase all or a portion of
its requirements of a specific product, commodity or service froma supplier or vendor. These contracts are generally entered into inorder to secure pricing or other negotiated terms. They do not
specify fixed or minimum quantities to be purchased and, therefore,
the company does not consider them to be purchase obligations.
Interest on floating-rate debt obligations is calculated using theeffective interest rate at December 31, 2013, plus the interest rate
spread associated with that debt, if any.

Off-Balance Sheet Arrangements
From time to time, the company may enter into off-balance sheet
arrangements as defined by SEC Financial Reporting Release 67(FRR-67), “Disclosure in Management’s Discussion and Analysis
about Off-Balance Sheet Arrangements and Aggregate Con­tractual
Obligations.”
At December 31, 2013, the company had no off-balance sheet
arrangements that have, or are reasonably likely to have, a material
current or future effect on financial condition, changes in financial
condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources. See the table above for thecompany’s contractual obligations, and note M, “Contingencies andCommitments,” on page 121, for detailed information about the company’s guarantees, financial commitments and indemnification
arrangements. The company does not have retained interests inassets transferred to unconsolidated entities or other material offbalance sheet interests or instruments.

Critical Accounting Estimates
The application of GAAP requires the company to make estimatesand assumptions about certain items and future events that directly
affect its reported financial condition. The accounting estimatesand assumptions discussed in this section are those that the company considers to be the most critical to its financial statements.
An accounting estimate is considered critical if both (a) the natureof the estimate or assumption is material due to the levels of

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Management Discussion
International Business Machines Corporation and Subsidiary Companies

subjectivity and judgment involved, and (b) the impact within a reasonable range of outcomes of the estimate and assumption ismaterial to the company’s financial condition. Senior management
has discussed the development, selection and disclosure of theseestimates with the Audit Committee of the company’s Board of Directors. The company’s significant accounting policies are described innote A, “Significant Accounting Policies,” on pages 84 through 93.
A quantitative sensitivity analysis is provided where that information is reasonably available, can be reliably estimated and provides
material information to investors. The amounts used to assess sensitivity (e.g., 1 percent, 10 percent, etc.) are included to allow usersof the Annual Report to understand a general direction cause andeffect of changes in the estimates and do not represent management’s predictions of variability. For all of these estimates, it should
be noted that future events rarely develop exactly as forecasted,and estimates require regular review and adjustment.
Pension Assumptions
For the company’s defined benefit pension plans, the measurementof the company’s benefit obligation to employees and net periodic
pension (income)/cost requires the use of certain assumptions,
including, among others, estimates of discount rates and expected
return on plan assets.
Changes in the discount rate assumptions will impact the (gain)/loss amortization and interest cost components of the net periodic
pension (income)/cost calculation (see page 133 for information
regarding the discount rate assumptions) and the projected benefit
obligation (PBO). The company increased the discount rate assumption for the IBM Personal Pension Plan (PPP), a U.S.-based defined
benefit plan, by 90 basis points to 4.50 percent on December 31,
2013. This change will decrease pre-tax cost and expense recognized in 2014 by an estimated $264 million. If the discount rate
assumption for the PPP decreased by 90 basis points on December
31, 2013, pre-tax cost and expense recognized in 2014 would haveincreased by an estimated $195 million. Changes in the discount rate
assumptions will impact the PBO which, in turn, may impact thecompany’s funding decisions if the PBO exceeds plan assets. Each
25 basis point increase or decrease in the discount rate will cause acorresponding decrease or increase, respectively, in the PPP’s PBOof an estimated $1.3 billion based upon December 31, 2013 data.
The expected long-term return on plan assets assumption isused in calculating the net periodic pension (income)/cost (see page133 for information regarding the expected long-term return on plan
assets assumption). Expected returns on plan assets are calculated
based on the market-related value of plan assets, which recognizeschanges in the fair value of plan assets systematically over a fiveyear period in the expected return on plan assets line in net periodic
pension (income)/cost. The differences between the actual returnon plan assets and the expected long-term return on plan assets
are recognized over five years in the expected return on plan assets
line in net periodic pension (income)/cost and also as a componentof actuarial gains/losses, which are recognized over the service lives
or life expectancy of the participants, depending on the plan, provided such amounts exceed thresholds which are based upon thebenefit obligation or the value of plan assets, as provided byaccounting standards.

To the extent the outlook for long-term returns changes suchthat management changes its expected long-term return on plan
assets assumption, each 50 basis point increase or decrease in the
expected long-term return on PPP plan assets assumption will havean estimated decrease or increase, respectively, of $256 million on
the following year’s pre-tax net periodic pension (income)/cost(based upon the PPP’s plan assets at December 31, 2013 andassuming no contributions are made in 2014).
The company may voluntarily make contributions or be required,by law, to make contributions to its pension plans. Actual results thatdiffer from the estimates may result in more or less future company
funding into the pension plans than is planned by management.
Impacts of these types of changes on the company’s pension plansin other countries worldwide will vary depending upon the status ofeach respective plan.
Revenue Recognition
Application of the various accounting principles in GAAP related tothe measurement and recognition of revenue requires the company
to make judgments and estimates. Specifically, complex arrangements with nonstandard terms and conditions may require significant
contract interpretation to determine the appropriate accounting,including whether the deliverables specified in a multiple-element
arrangement should be treated as separate units of accounting.
Other significant judgments include determining whether IBM or
a reseller is acting as the principal in a transaction and whether
separate contracts are considered part of one arrangement.
Revenue recognition is also impacted by the company’s ability
to estimate sales incentives, expected returns and collectibility. The
company considers various factors, including a review of specifictransactions, the creditworthiness of the customers, historical experience and market and economic conditions when calculating theseprovisions and allowances. Evaluations are conducted each quarterto assess the adequacy of the estimates. If these estimates werechanged by 10 percent in 2013, net income would have been
impacted by $97 million (excluding Global Financing receivables
discussed on pages 73 and 74).
Costs to Complete Service Contracts
The company enters into numerous service contracts through its
Global Services business. During the contractual period, revenue,
cost and profits may be impacted by estimates of the ultimate profitability of each contract, especially contracts for which the company
uses the percentage-of-completion (POC) method of accounting. If
at any time these estimates indicate the POC contract will be unprofitable, the entire estimated loss for the remainder of the contract isrecorded immediately in cost. The company performs ongoing profitability analyses of its services contracts in order to determine whether
the latest estimates require updating. Key factors reviewed by thecompany to estimate the future costs to complete each contract are
future labor costs, future product costs and expected productivity
efficiencies. Contract loss provisions recorded as a component ofother accrued expenses and liabilities were approximately $41 million
and $54 million at December 31, 2013 and 2012, respectively.

Management Discussion
International Business Machines Corporation and Subsidiary Companies

Income Taxes
The company is subject to income taxes in the U.S. and numerous
foreign jurisdictions. Significant judgments are required in determining the consolidated provision for income taxes.
During the ordinary course of business, there are many transactions and calculations for which the ultimate tax determination is
uncertain. As a result, the company recognizes tax liabilities basedon estimates of whether additional taxes and interest will be due.
These tax liabilities are recognized when, despite the company’s belief
that its tax return positions are supportable, the company believes
that certain positions may not be fully sustained upon review by tax
authorities. The company believes that its accruals for tax liabilities
are adequate for all open audit years based on its assessment ofmany factors, including past experience and interpretations of tax law.
This assessment relies on estimates and assumptions, and may
involve a series of complex judgments about future events. To theextent that new information becomes available which causes thecompany to change its judgment regarding the adequacy of existing
tax liabilities, such changes to tax liabilities will impact income tax
expense in the period in which such determination is made.
Significant judgment is also required in determining any valuation
allowance recorded against deferred tax assets. In assessing theneed for a valuation allowance, management considers all available
evidence for each jurisdiction including past operating results, estimates of future taxable income and the feasibility of ongoing tax
planning strategies. In the event that the company changes its determination as to the amount of deferred tax assets that can berealized, the company will adjust its valuation allowance with a corresponding impact to income tax expense in the period in whichsuch determination is made.
The consolidated provision for income taxes will change period
to period based on nonrecurring events, such as the settlement ofincome tax audits and changes in tax laws, as well as recurring
factors including the geographic mix of income before taxes, thetiming and amount of foreign dividend repatriation, state and local
taxes and the effects of various global income tax strategies.
To the extent that the provision for income taxes increases/
decreases by 1 percent of income before income taxes, consolidated
net income would have decreased/improved by $195 million in 2013.
Valuation of Assets
The application of business combination and impairment accounting
requires the use of significant estimates and assumptions. The acquisition method of accounting for business combinations requires thecompany to estimate the fair value of assets acquired, liabilities
assumed, and any noncontrolling interest in the acquiree to properly
allocate purchase price consideration between assets that are depreciated and amortized from goodwill and indefinite-lived intangible
assets. Impairment testing for assets, other than goodwill and indefinite-lived intangible assets, requires the allocation of cash flows to
those assets or group of assets and if required, an estimate of fairvalue for the assets or group of assets. The company’s estimates are
based upon assumptions believed to be reasonable, but which are
inherently uncertain and unpredictable. These valuations require theuse of management’s assumptions, which would not reflect unanticipated events and circumstances that may occur.

Valuation of Goodwill
The company reviews goodwill for impairment annually, in the fourth
quarter, and whenever events or changes in circumstances indicate
the carrying value of goodwill may not be recoverable.
The company assesses qualitative factors in each of its reporting
units that carry goodwill. Among other relevant events and circumstances that affect the fair value of reporting units, including
macroeconomic, industry and market conditions, the company
assesses individual factors such as:• A significant adverse change in legal factors
or the business climate;• An adverse action or assessment by a regulator;• Unanticipated competition;• A loss of key personnel; and• A more likely than not expectation that a reporting
unit or a significant portion of a reporting unit will be soldor otherwise disposed of.
The company assesses these qualitative factors to determine
whether it is necessary to perform the two-step quantitative goodwill
impairment test. This quantitative test is required only if the company
concludes that it is more likely than not that a reporting unit’s fairvalue is less than its carrying amount.
In the fourth quarter, the company performed its annual goodwill
impairment analysis. The qualitative assessment illustrated evidenceof a potential impairment triggering event as a result of the financial
performance of the Systems and Technology reporting unit. The
quantitative analysis resulted in no impairment as the reporting
unit’s estimated fair value exceeded the carrying amount by over
100 percent.
Loss Contingencies
The company is currently involved in various claims and legal
proceedings. Quarterly, the company reviews the status of each significant matter and assesses its potential financial exposure. If the potential
loss from any claim or legal proceeding is considered probable and theamount can be reasonably estimated, the company accrues a liability
for the estimated loss. Significant judgment is required in both the determination of probability and the determination as to whether an exposure
is reasonably estimable. Because of uncertainties related to these matters, accruals are based only on the best information available at thetime. As additional information becomes available, the company reassesses the potential liability related to its pending claims and litigation,and may revise its estimates. These revisions in the estimates of thepotential liabilities could have a material impact on the company’s resultsof operations and financial position.
Global Financing Receivables Allowance for Credit Losses
The Global Financing business reviews its financing receivables
port­folio at least quarterly in order to assess collectibility. A description of the methods used by management to estimate the amountof uncollectible receivables is included in note A, “Significant
Accounting Policies,” on page 93. Factors that could result in actual
receivable losses that are materially different from the estim­atedreserve include sharp changes in the economy, or a significant
change in the economic health of a particular client that represents
a concentration in Global Financing’s receivables portfolio.

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Management Discussion
International Business Machines Corporation and Subsidiary Companies

To the extent that actual collectibility differs from management’s
estimates currently provided for by 10 percent, Global Financing’s
segment pre-tax income and the company’s consolidated income
before income taxes would be higher or lower by an estimated $39
million (using 2013 data), depending upon whether the actual collectibility was better or worse, respectively, than the estimates.
Residual Value
Residual value represents the estimated fair value of equipment
under lease as of the end of the lease. Residual value estimates
impact the determination of whether a lease is classified as operatingor capital. Global Financing estimates the future fair value of leased
equipment by using historical models, analyzing the current market
for new and used equipment, and obtaining forward-looking productinformation such as marketing plans and technological innovations.
Residual value estimates are periodically reviewed and “other than
temporary” declines in estimated future residual values are recognized upon identification. Anticipated increases in future residual
values are not recognized until the equipment is remarketed.
Factors that could cause actual results to materially differ fromthe estimates include significant changes in the used-equipment
market brought on by unforeseen changes in technology innovations
and any resulting changes in the useful lives of used equipment.
To the extent that actual residual value recovery is lower thanmanagement’s estimates by 10 percent, Global Financing’s segment
pre-tax income and the company’s consolidated income before
income taxes for 2013 would have been lower by an estimated$94 million. If the actual residual value recovery is higher than management’s estimates, the increase in income will be realized at theend of lease when the equipment is remarketed.

Currency Rate Fluctuations
Changes in the relative values of non-U.S. currencies to the U.S.
dollar affect the company’s financial results and financial position.
At December 31, 2013, currency changes resulted in assets andliabilities denominated in local currencies being translated into fewer
dollars than at year-end 2012. The company uses financial hedging
instruments to limit specific currency risks related to financing transactions and other foreign currency-based transactions. Further
discussion of currency and hedging appears in note D, “Financial
Instruments,” on pages 102 through 106.
Foreign currency fluctuations often drive operational responses
that mitigate the simple mechanical translation of earnings. During
periods of sustained movements in currency, the marketplace andcompetition adjust to the changing rates. For example, when pricing
offerings in the marketplace, the company may use some of theadvantage from a weakening U.S. dollar to improve its position competitively, and price more aggressively to win the business,essentially passing on a portion of the currency advantage toits customers. Competition will frequently take the same action.
Consequently, the company believes that some of the currencybased changes in cost impact the prices charged to clients. The
company also maintains currency hedging programs for cash management purposes which mitigate, but do not eliminate, the volatilityof currency impacts on the company’s financial results.
The company translates revenue, cost and expense in its non-U.S.
operations at current exchange rates in the reported period.

References to “adjusted for currency” or “constant currency” reflect
adjustments based upon a simple constant currency mathematicaltranslation of local currency results using the comparable prior period’s
currency conversion rate. However, this constant currency methodology that the company utilizes to disclose this information does notincorporate any operational actions that management may take inreaction to fluctuating currency rates. Currency movements, particularly the depreciation of the Yen, impacted the company’s year-to-year
revenue and earnings per share growth in 2013. Based on the currency
rate movements in 2013, total revenue decreased 4.6 percent asreported and 2.5 at constant currency versus 2012. On a pre-tax
income basis, these translation impacts offset by the net impact ofhedging activities resulted in a theoretical maximum (assuming no
pricing or sourcing actions) decrease of approximately $400 million
in 2013. The same mathematical exercise resulted in a decrease of
approximately $100 million in 2012. The company views these amounts
as a theoretical maximum impact to its as-reported financial results.
Considering the operational responses mentioned above, movementsof exchange rates, and the nature and timing of hedging instruments,
it is difficult to predict future currency impacts on any particular period,
but the company believes it could be substantially less than the theoretical maximum given the competitive pressure in the marketplace.
For non-U.S. subsidiaries and branches that operate in U.S. dollars
or whose economic environment is highly inflationary, translation adjustments are reflected in results of operations. Generally, the company
manages currency risk in these entities by linking prices and contracts
to U.S. dollars. The company continues to monitor the economic conditions in Venezuela. On December 30, 2010, the official rate for essential
goods was eliminated, with no change to the SITME rate. The SITME
rate remained constant throughout 2012 and 2011. In February 2013, the
SITME rate was eliminated, and the official rate was set at 6.3 bolivares
fuerte (BsF) to the U.S. dollar. This devaluation did not have a material
impact given the size of the company’s operations in Venezuela (lessthan 1 percent of total 2013 and 2012 revenue, respectively).
In addition, in March 2013, the Venezuelan government createda new foreign exchange mechanism called the “Complimentary
System of Foreign Currency Aquirement.” This system operates
similar to an auction system and allows entities in specific sectors
to bid for U.S. dollars to be used for specific import transactions. In
December 2013, the Venezuelan regulation that created this mechanism was amended to expand its use, and to require publication of
the average exchange rates implied by transactions settled in theseauctions. The company did not participate in this exchange mechanism in 2013, and will consider its participation going forward.
In January 2014, the Argentinian government devalued its currency from 6 pesos to the U.S. dollar to 8 pesos to the U.S. dollar.
This devaluation will not have a material impact given the size ofthe company’s operations in Argentina (less than 1 percent of total
2013 revenue).

Market Risk
In the normal course of business, the financial position of thecompany is routinely subject to a variety of risks. In addition to themarket risk associated with interest rate and currency movementson outstanding debt and non-U.S. dollar denominated assets andliabilities, other examples of risk include collectibility of accounts
receivable and recoverability of residual values on leased assets.

Management Discussion
International Business Machines Corporation and Subsidiary Companies

The company regularly assesses these risks and has establishedpolicies and business practices to protect against the adverse
effects of these and other potential exposures. As a result, the company does not anticipate any material losses from these risks.
The company’s debt, in support of the Global Financing businessand the geographic breadth of the company’s operations, contains
an element of market risk from changes in interest and currency
rates. The company manages this risk, in part, through the use of avariety of financial instruments including derivatives, as describedin note D, “Financial Instruments,” on pages 102 through 106.
To meet disclosure requirements, the company performs a sensitivity analysis to determine the effects that market risk exposures
may have on the fair values of the company’s debt and other financial instruments.
The financial instruments that are included in the sensitivity
analysis are comprised of the company’s cash and cash equivalents,
marketable securities, short-term and long-term loans, commercial
financing and installment payment receivables, investments, longterm and short-term debt and derivative financial instruments. The
company’s derivative financial instruments generally include interest
rate swaps, foreign currency swaps and forward contracts.
To perform the sensitivity analysis, the company assesses the riskof loss in fair values from the effect of hypothetical changes in interest
rates and foreign currency exchange rates on market-sensitive instruments. The market values for interest and foreign currency exchange
risk are computed based on the present value of future cash flows asaffected by the changes in rates that are attributable to the market
risk being measured. The discount rates used for the present value
computations were selected based on market interest and foreign
currency exchange rates in effect at December 31, 2013 and 2012.
The differences in this comparison are the hypothetical gains orlosses associated with each type of risk.
Information provided by the sensitivity analysis does not necessarily represent the actual changes in fair value that the company
would incur under normal market conditions because, due to practical limitations, all variables other than the specific market risk factor
are held constant. In addition, the results of the model are constrained by the fact that certain items are specifically excluded fromthe analysis, while the financial instruments relating to the financing
or hedging of those items are included by definition. Excluded items
include short-term and long-term receivables from sales-type anddirect financing leases, forecasted foreign currency cash flows andthe company’s net investment in foreign operations. As a consequence, reported changes in the values of some of the financial
instruments impacting the results of the sensitivity analysis are notmatched with the offsetting changes in the values of the items thatthose instruments are designed to finance or hedge.
The results of the sensitivity analysis at December 31, 2013 and2012, are as follows:
Interest Rate Risk
At December 31, 2013, a 10 percent decrease in the levels of interest
rates with all other variables held constant would result in a decreasein the fair market value of the company’s financial instruments of$322 million as compared with a decrease of $192 million at December 31, 2012. A 10 percent increase in the levels of interest rates withall other variables held constant would result in an increase in thefair value of the company’s financial instruments of $300 million ascompared to an increase of $181 million at December 31, 2012.
Changes in the relative sensitivity of the fair value of the company’s
financial instrument portfolio for these theoretical changes in thelevel of interest rates are primarily driven by changes in the company’s debt maturities, interest rate profile and amount.
Foreign Currency Exchange Rate Risk
At December 31, 2013, a 10 percent weaker U.S. dollar against foreign currencies, with all other variables held constant, would resultin an increase in the fair value of the company’s financial instruments
of $1,340 million as compared with an increase of $1,203 million at
December 31, 2012. Conversely, a 10 percent stronger U.S. dollar
against foreign currencies, with all other variables held constant,would result in a decrease in the fair value of the company’s financial
instruments of $1,340 million compared with a decrease of $1,203
million at December 31, 2012. The change in impact from 2012 to2013 was comprised of: assets ($59 million), debt ($2 million) and
derivatives ($76 million).

Financing Risks
See the “Description of Business” on page 33 for a discussion of
the financing risks associated with the Global Financing businessand management’s actions to mitigate such risks.

Cybersecurity
The company’s approach on cybersecurity leverages its ability
to adapt to a changing environment, as well as the depth andbreadth of its global capabilities, both in terms of its offerings toclients and its internal approaches to cybersecurity issues. The
company has software solutions that deliver identity and accessmanagement, data security, application security, network security
and endpoint security. IBM’s software solutions include a security
intelligence dashboard that can collect information on customer
IT security events and provide detailed information to customers
about potential threats and security posture. The company’s
services businesses offer professional solutions for security fromassessment to deployment. In addition, the company offers managed and outsourced security solutions from multiple security
operations centers around the world. Finally, security is embedded in a multitude of IBM offerings through secure engineering
processes and by critical functions (encryption, access control,etc.) in servers, storage, software, services and other solutions.
From an enterprise perspective, IBM has implemented a multifaceted approach involving people, tools, and processes to identify
and address cybersecurity risks. The company has establishedpolicies and procedures that provide the foundation by which IBM’s
infrastructure and data are managed, which help protect IBM andclient data. In addition, the company utilizes a combination of online
education, Web articles and other awareness initiatives to enable
its workforce to be knowledgeable about cybersecurity threats andtheir responsibilities to identify and mitigate these risks. IBM performs ongoing assessments regarding its technical controls and its
methods for identifying emerging risks related to cybersecurity. The
company uses a layered approach with overlapping controls to defend
against cybersecurity attacks on networks, end-user devices, data
centers and applications.

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Management Discussion
International Business Machines Corporation and Subsidiary Companies

Employees and Related Workforce
Yr.-to-Yr. Percent Change
For the year ended December 31:

2013

2012

2011

431,212434,246

433,362

Less-than-wholly owned subsidiaries

9,018

8,009

7,523

12.6

6.5

Complementary

23,55524,74025,500

(4.8)

(3.0)

IBM/wholly owned subsidiaries

As a globally integrated enterprise, the company operates in more than
175 countries and is continuing to shift its business to the higher value
segments of enterprise computing. The company continually assesses
its resource needs with the objective of balancing its workforce globally to improve the company’s global reach and competitiveness.
The complementary workforce is an approximation of equivalent
full-time employees hired under temporary, part-time and limitedterm employment arrangements to meet specific business needs
in a flexible and cost-effective manner.

Global Financing
Global Financing is a reportable segment that is measured as astand-alone entity.
In 2013, the Global Financing business remained focused on its
core competencies—providing IT financing to the company’s clientsand business partners. For the year, Global Financing delivered
external revenue of $2,022 million and total revenue of $4,304 million, and expanded gross and pre-tax margins. Total pre-tax incomeof $2,171 million increased 6.8 percent compared to 2012 and returnon equity was 40.6 percent.
In addition to the overall health of the economy and its impact
on corporate IT budgets, key drivers of Global Financing’s results
are interest rates and originations. Interest rates directly impact
Global Financing’s business by increasing or decreasing bothfinancing revenue and the associated borrowing costs. Originations,which determine the asset base of Global Financing’s annuity-likebusiness, are impacted by IBM’s non-Global Financing sales andservices volumes and Global Financing’s participation rates. Participation rates are the propensity of IBM’s clients to finance theirtransactions through Global Financing in lieu of paying IBM up-front
cash or financing through a third party.

Results of Operations($ in millions)
For the year ended December 31:

External revenue

2013

2012

2011

$2,022$2,013$2,102

Internal revenue

2,282

2,060

2,092

Total revenue

4,304

4,073

4,195

Cost

1,417

1,400

1,467

Gross profit$2,888$2,673$2,728Gross profit margin

67.1%

65.6%

65.0%

Pre-tax income$2,171$2,034$2,011After-tax income*$1,456$1,362$1,338Return on equity*

40.6%

41.0%

40.7%

* See page 75 for the details of the after-tax income and return on equity calculation.

2013-12(0.7)%

2012-11

0.2%

Total revenue in 2013 increased $232 million versus 2012 as a result of:• An increase in internal revenue of 10.8 percent driven by anincrease in used equipment sales revenue (up 20.0 percent
to $1,871 million), partially offset by a decrease in financing
revenue (down 17.9 percent to $411 million); and• An increase in external revenue of 0.4 percent (3 percent
adjusted for currency) driven by an increase in financing
revenue (up 1.4 percent to $1,493 million), partially offset
by a decrease in used equipment sales revenue (down
2.3 percent to $528 million).
The decrease in internal financing revenue was primarily due tolower asset yields and a decrease in remarketing lease revenue. The
increase in external financing revenue was due to a higher averageasset balance, partially offset by lower asset yields and a decrease
in remarketing lease revenue. Global Financing gross profit increased
8.0 percent compared to 2012 due to an increase in used equipment
sales gross profit, partially offset by a decrease in financing grossprofit. The gross profit margin increased 1.5 points due to anincrease in the used equipment sales margin, partially offset by ashift in mix toward lower margin used equipment sales.
Total revenue in 2012 decreased $122 million versus 2011 as aresult of:• A decline in external revenue of 4.2 percent (1 percent adjusted
for currency) driven by a decrease in financing revenue(down 8.7 percent to $1,471 million), partially offset by
an increase in used equipment sales revenue (up 10.6
percent to $540 million); and• A decline in internal revenue of 1.6 percent driven by adecrease in financing revenue (down 11.3 percent to $500
million), partially offset by an increase in used equipment
sales revenue (up 2.0 percent to $1,559 million).
The decreases in external and internal financing revenue were due
to lower asset yields and a decrease in remarketing lease revenue.
Global Financing gross profit in 2012 decreased 2.0 percent
compared to 2011 due to a decrease in financing gross profit, partially offset by an increase in used equipment sales gross profit. The
gross profit margin increased 0.6 points due to a higher financing
margin, partially offset by a shift in mix toward lower margin usedequipment sales and a lower used equipment sales margin.
Global Financing pre-tax income increased 6.8 percent in 2013
versus 2012, following an increase of 1.1 percent in 2012 versus 2011.
The increase in 2013 was driven by the increase in gross profit ($215
million), partially offset by increases in financing receivables provisions ($60 million) and SG&A expenses ($20 million). The increasein 2012 was driven by decreases in SG&A expenses ($61 million) andManagement Discussion
International Business Machines Corporation and Subsidiary Companies

financing receivables provisions ($16 million), partially offset by thedecrease in gross profit ($55 million). The increase in financing
receivable provisions in 2013 was due to higher specific reserve
requirements, primarily in China. At December 31, 2013, the overall
allowance for credit losses coverage rate was 1.2 percent, flat compared to the prior year.
The decrease in return on equity from 2012 to 2013 was driven
by a higher average equity balance, and the increase in return on
equity from 2011 to 2012 was driven by higher after-tax income.

Financial Condition
Balance Sheet($ in millions)
At December 31:

2013

2012

Cash and cash equivalents$ 1,446$ 1,380

Net investment in sales-typeand direct financing leases

9,739

10,008External clients (a)

947

1,273

Internal clients (b)(c)025Client loans

14,297

13,121

Total client financing assets

24,982

24,428Commercial financing receivables

8,541

7,755

Intercompany financing receivables (b)(c)

4,216

4,328

352

459

Equipment under operating leases

Other receivables
Other assets

601

533

Total assets$40,138$38,882

Intercompany payables (b)$ 5,766$ 6,802

Debt(d)27,50424,501Other liabilities

3,043

4,084

Total liabilities

36,31435,388

Total equity

3,825

3,494

$40,138$38,882

Total liabilities and equity(a)	Includes intercompany mark-up, priced on an arm’s-length basis, on products

purchased from the company’s product divisions, which is eliminated in IBM’s
consolidated results.
(b)	Entire amount eliminated for purposes of IBM’s consolidated results and therefore

does not appear on page 80.
(c)	These assets, along with all other financing assets in this table, are leveraged at thevalue in the table using Global Financing debt. ­primarily for software and services and are unsecured. These loans
are subjected to credit analysis to evaluate the associated risk and,
when deemed necessary, actions are taken to mitigate risks in theloan agreements which include covenants to protect against credit
deterioration during the life of the obligation. Client financing also
includes internal activity as described on pages 33 and 34.
Commercial financing receivables arise primarily from inventory
and accounts receivable financing for dealers and remarketers of
IBM and OEM products. Payment terms for inventory financing andaccounts receivable financing generally range from 30 to 90 days.
These short-term receivables are primarily unsecured and arealso subjected to additional credit analysis in order to evaluate
the associated risk.
In addition to the actions previously described, in certain circumstances, the company may take mitigation actions to transfer credit
risk to third parties.
At December 31, 2013, substantially all financing assets are IT
related assets, and approximately 59 percent of the total external
portfolio was with investment-grade clients with no direct exposure
to consumers.
Originations
The following are total financing originations:($ in millions)
For the year ended December 31:

Client financing

2013

2012

2011

$15,792$16,277$14,390

Commercial financing

41,02736,94435,282

Total$56,819$53,222$49,673

In 2013, new financing originations exceeded cash collections forboth client and commercial financing. This resulted in a net increase
in total financing assets from December 31, 2012. The increase inoriginations in 2013 versus 2012 was due to improving volumes incommercial financing. The increase in originations in 2012 versus
2011 was due to improving volumes in both client and commercial
financing. Internal loan financing with Global Services is executed
under a loan facility and is not considered originations.
Cash generated by Global Financing in 2013 was deployed to pay
intercompany payables and dividends to IBM as well as business
partners and OEM suppliers.

(d)	G lobal Financing debt is comprised of intercompany loans and external debt.

A portion of Global Financing debt is in support of the company’s internal business,or related to intercompany mark-up embedded in the Global Financing assets.
See table on page 75. ­Sources and Uses of Funds
The primary use of funds in Global Financing is to originate client andcommercial financing assets. Client financing assets for end users
consist primarily of IBM systems, software and services, but also
include OEM equipment, software and services to meet IBM clients’total solutions requirements. Client financing assets are primarily
sales-type, direct financing and operating leases for systems products, as well as loans for systems, software and services with terms
generally from one to seven years. Global Financing’s client loans are

Global Financing Receivables and Allowances
The following table presents external financing receivables excluding
residual values, and the allowance for credit losses:($ in millions)
At December 31:

2013

2012

$32,319$30,621

Specific allowance for credit losses

279

240

Unallocated allowance for credit losses

113

115

Total allowance for credit losses

392

355

$31,928$30,266

Gross financing receivables

Net financing receivables
Allowance for credit losses coverage

1.2%

1.2%

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Management Discussion
International Business Machines Corporation and Subsidiary Companies

Roll Forward of Global Financing Receivables
Allowance for Credit Losses

The increase in the gross profit margin was driven by a shift in mix
toward higher margin internal equipment sales and a margin increase
in internal equipment sales.
The table below presents the recorded amount of unguaranteed
residual value for sales-type, direct financing and operating leases
at December 31, 2012 and 2013. In addition, the table presents theresidual value as a percentage of the related original amountfinanced and a run out of when the unguaranteed residual value
assigned to equipment on leases at December 31, 2013 is expected
to be returned to the company. In addition to the unguaranteed
residual value, on a limited basis, Global Financing will obtain guarantees of the future value of the equipment to be returned at end oflease. While primarily focused on IBM products, guarantees are also
obtained for certain OEM products. These third-party guarantees
are included in minimum lease payments as provided for byaccounting standards in the determination of lease classifications
for the covered equipment and provide protection against risk ofloss arising from declines in equipment values for these assets.
The residual value guarantee increases the minimum lease payments that are utilized in determining the classification of a lease asa sales-type lease, direct financing lease or operating lease. The
aggregate asset values associated with the guarantees of sales-typeleases were $479 million and $776 million for the financing transactions originated during the years ended December 31, 2013 and2012, respectively. In 2013, the residual value guarantee program
resulted in the company recognizing approximately $462 million ofrevenue that would otherwise have been recognized in future periods as operating lease revenue. If the company had chosen to notparticipate in a residual value guarantee program in 2013 and prioryears, the 2013 impact would be substantially mitigated by the effectof prior year asset values being recognized as operating lease revenue in the current year. The aggregate asset values associated withthe guarantees of direct financing leases were $218 million and $199
million for the financing transactions originated during the years
ended December 31, 2013 and 2012, respectively. The associatedaggregate guaranteed future values at the scheduled end of lease
were $29 million and $53 million for the financing transactions originated during the years ended December 31, 2013 and 2012,
respectively. The cost of guarantees was $3 million and $5 million
for the years ended December 31, 2013 and 2012, respectively.

($ in millions)January 1, 2013

$355

Allowance
Used*

Additions/(Reductions)

Other**

December 31,
2013

$(44)

$85

$(5)

$392

  * Represents reserved receivables, net of recoveries, that were disposed of during
the period.

** Primarily represents translation adjustments.

The percentage of Global Financing receivables reserved was 1.2
percent at December 31, 2013 and 2012. Specific reserves increased
16 percent from $240 million at December 31, 2012, to $279 million
at December 31, 2013. Unallocated reserves decreased 2 percent
from $115 million at December 31, 2012, to $113 million at December
31, 2013, primarily due to lower general reserve requirements.
Global Financing’s bad debt expense was an increase of $85
million for 2013, compared to an increase of $26 million for 2012.
The year-to-year increase in bad debt expense was due to higher
specific reserve requirements, primarily in China, in the current year.
Residual Value
Residual value is a risk unique to the financing business and management of this risk is dependent upon the ability to accurately
project future equipment values at lease inception. Global Financing
has insight into product plans and cycles for the IBM products underlease. Based upon this product information, Global Financing continually monitors projections of future equipment values andcompares them with the residual values reflected in the portfolio.
See note A, “Significant Accounting Policies,” on page 93 for thecompany’s accounting policy for residual values.
Global Financing optimizes the recovery of residual values by selling assets sourced from end of lease, leasing used equipment to newclients, or extending lease arrangements with current clients. Salesof equipment, which are primarily sourced from equipment returnedat the end of a lease, represented 55.8 percent and 51.6 percent of
Global Financing’s revenue in 2013 and 2012, respectively. The
increase was due to a shift from operating leases to used equipment
sales for internal transactions. The gross profit margins on these sales
were 58.3 percent and 53.6 percent in 2013 and 2012, respectively.
Unguaranteed Residual Value($ in millions)
Total

Estimated Run Out of 2013 Balance

2012

2013

2014

2015

2016

2017 andBeyond$   794$   736

$142

$204

$243

$149

259

200

93

50

42

15

Total unguaranteed residual value$ 1,053$   936

$235

$254

$285

$164

Related original amount financed$18,744$17,642At December 31:

Sales-type and direct financing leases
Operating leases

Percentage

5.6%

5.3%

Management Discussion
International Business Machines Corporation and Subsidiary Companies

Debt
At December 31:

2013

2012

Debt-to-equity ratio

7.2x

7.0x

The company funds Global Financing through borrowings using a
debt-to-equity ratio target of approximately 7 to 1. The debt used tofund Global Financing assets is composed of intercompany loans
and external debt. The terms of the intercompany loans are set by
the company to substantially match the term and currency underlying the financing receivable and are based on arm’s-length pricing.
Both assets and debt are presented in the Global Financing balance
sheet on page 73.
Global Financing provides financing predominantly for the company’s external client assets, as well as for assets under contract byother IBM units. As previously stated, the company measures Global

Financing as a stand-alone entity, and accordingly, interest expense
relating to debt supporting Global Financing’s external client andinternal business is included in the “Global Financing Results ofOperations” on pages 72 and 73 and in note T, “Segment Information,” on pages 141 to 146.
In the company’s Consolidated Statement of Earnings on page78, the external debt-related interest expense supporting Global
Financing’s internal financing to the company is reclassified fromcost of financing to interest expense.
The following table provides additional information on total company debt. In this table, intercompany activity includes internal loans
and leases at arm’s-length pricing in support of Global Services’
long-term contracts and other internal activity. The company
believes these assets should be appropriately leveraged in line withthe overall Global Financing business model.

($ in millions)
December 31, 2013

Global Financing Segment
Debt to support external clients$24,471

Debt to support internal clients

3,033

Non-Global Financing Segments
15,247

Intercompany activity(3,033)

Total company debt

Return on Equity($ in millions)
2013

2012

$1,456$1,362$3,585$3,322

Numerator
Denominator
Average Global Financing equity (b)**Global Financing return on equity (a)/(b)

2,919

40.6%

41.0%

  * Calculated based upon an estimated tax rate principally based on Global Financing’s
geographic mix of earnings as IBM’s provision for income taxes is determined on aconsolidated basis.

** Average of the ending equity for Global Financing for the last five quarters.

Looking Forward
Global Financing’s financial position provides flexibility and funding
capacity which enables the company to be well positioned in thecurrent environment. Global Financing’s assets and new financing
volumes are IBM and OEM products and services financed to thecompany’s clients and business partners, and substantially all
financing assets are IT related assets which provide a stable base

8,767
11,686(2,919)$39,718

Liquidity and Capital Resources
Global Financing is a segment of the company, and therefore is supported by the company’s overall liquidity position and access tocapital markets. Cash generated by Global Financing was deployed
to pay dividends to the company in order to maintain an appropriate
debt-to-equity ratio.

Global Financing after-tax income (a)*$24,501$21,583

12,214

Debt supporting operations

At December 31:

December 31, 2012

$27,504$33,269of business for future growth. Global Financing’s offerings are competitive and available to clients as a result of the company’s
borrowing cost and access to the capital markets. Overall, Global
Financing’s originations will be dependent upon the demand for IT
products and services as well as client participation rates.
IBM continues to access both the short-term commercial paper
market and the medium- and long-term debt markets. A protracted
period where IBM could not access the capital markets would likely
lead to a slowdown in originations.
Interest rates and the overall economy (including currency fluctuations) will have an effect on both revenue and gross profit. The
company’s interest rate risk management policy, however, combinedwith the Global Financing pricing strategy should mitigate grossmargin erosion due to changes in interest rates.
The economy could impact the credit quality of the Global
Financing receivables portfolio and therefore the level of provision
for credit losses. Global Financing will continue to apply rigorous
credit policies in both the origination of new business and the evaluation of the existing portfolio.
As discussed on page 74, Global Financing has historically beenable to manage residual value risk both through insight into the company’s product cycles, as well as through its remarketing business.
Global Financing has policies in place to manage each of the
key risks involved in financing. These policies, combined with product and client knowledge, should allow for the prudent managementof the business going forward, even during periods of uncertainty
with respect to the global economy.

75

76

Report of Management
International Business Machines Corporation and Subsidiary Companies

Management Responsibility
for Financial Information

Management’s Report on Internal Control
Over Financial Reporting

Responsibility for the integrity and objectivity of the financial information presented in this Annual Report rests with IBM management.
The accompanying financial statements have been prepared inaccordance with accounting principles generally accepted in the
United States of America, applying certain estimates and judgments
as required.
IBM maintains an effective internal control structure. It consists,in part, of organizational arrangements with clearly defined linesof responsibility and delegation of authority, and comprehensive
systems and control procedures. An important element of the control
environment is an ongoing internal audit program. Our system also
contains self-monitoring mechanisms, and actions are taken tocorrect deficiencies as they are identified.
To assure the effective administration of internal controls, we
carefully select and train our employees, develop and disseminate
written policies and procedures, provide appropriate communication
channels and foster an environment conducive to the effective functioning of controls. We believe that it is essential for the company toconduct its business affairs in accordance with the highest ethicalstandards, as set forth in the IBM Business Conduct Guidelines.
These guidelines, translated into numerous languages, are distributed to employees throughout the world, and reemphasized throughinternal programs to assure that they are understood and followed.
PricewaterhouseCoopers LLP, an independent registered public
accounting firm, is retained to audit IBM’s Consolidated Financial
Statements and the effectiveness of the internal control over financial
reporting. Its accompanying report is based on audits conductedin accordance with the standards of the Public Company Accounting
Oversight Board (United States).
The Audit Committee of the Board of Directors is composed
solely of independent, non-management directors, and is responsible for recommending to the Board the independent registeredpublic accounting firm to be retained for the coming year, subject tostockholder ratification. The Audit Committee meets periodicallyand privately with the independent registered public accounting firm,with the company’s internal auditors, as well as with IBM management, to review accounting, auditing, internal control structure andfinancial reporting matters.

Management is responsible for establishing and maintaining
adequate internal control over financial reporting of the company.
Internal control over financial reporting is a process designed toprovide reasonable assurance regarding the reliability of financial
reporting and the preparation of financial statements for external
purposes in accordance with accounting principles generally
accepted in the United States of America.
The company’s internal control over financial reporting includes
those policies and procedures that (i) pertain to the maintenanceof records that, in reasonable detail, accurately and fairly reflect thetransactions and dispositions of the assets of the company;(ii) provide reasonable assurance that transactions are recorded
as necessary to permit preparation of financial statements in accordance with accounting principles generally accepted in the UnitedStates of America, and that receipts and expenditures of the company are being made only in accordance with authorizations ofmanagement and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection ofunauthorized acquisition, use, or disposition of the company’s
assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial
reporting may not prevent or detect misstatements. Also, projectionsof any evaluation of effectiveness to future periods are subject tothe risk that controls may become inadequate because of changes
in conditions, or that the degree of compliance with the policies orprocedures may deteriorate.
Management conducted an evaluation of the effectiveness ofinternal control over financial reporting based on the criteria established in Internal Control—Integrated Framework (1992) issued by
the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on this evaluation, management concluded
that the company’s internal control over financial reporting was
effective as of December 31, 2013.

Virginia M. Rometty
Chairman, President and Chief Executive Officer
February 25, 2014

Martin J. Schroeter
Senior Vice President and Chief Financial Officer,
Finance and Enterprise Transformation
February 25, 2014

Report of Independent Registered Public Accounting Firm
International Business Machines Corporation and Subsidiary Companies

To the Stockholders and Board of
Directors of International Business
Machines Corporation:
In our opinion, the accompanying Consolidated Financial State­ments appearing on pages 78 through 146 present fairly, in allmaterial respects, the financial position of International Business
Machines Corporation and its subsidiaries at December 31, 2013
and 2012 and the results of their operations and their cash flows foreach of the three years in the period ended December 31, 2013 inconformity with accounting principles generally accepted in the
United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial
reporting as of December 31, 2013, based on criteria established inInternal Control—Integrated Framework (1992) issued by the Committee of Sponsoring Organ­izations of the Treadway Commission(COSO). The Company’s management is responsible for thesefinancial statements, for maintaining effective internal control overfinancial reporting and for its assessment of the effectiveness ofinternal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial
Reporting appearing on page 76. Our responsibility is to express
opinions on these financial statements and on the Company’s internal control over financial reporting based on our integrated audits.
We conducted our audits in accordance with the standards of the
Public Company Accounting Oversight Board (United States). Thosestandards require that we plan and perform the audits to obtainreasonable assurance about whether the financial statements arefree of material misstatement and whether effective internal control
over financial reporting was maintained in all material respects. Our
audits of the financial statements included examining, on a test
basis, evidence supporting the amounts and disclosures in thefinancial statements, assessing the accounting principles used andsignificant estimates made by management, and evaluating theoverall financial statement presentation. Our audit of internal control
over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material
weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our
audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits
provide a reasonable basis for our opinions.

A company’s internal control over financial reporting is a process
designed to provide reasonable assurance regarding the reliabilityof financial reporting and the preparation of financial statements
for external purposes in accordance with generally accepted
accounting principles. A company’s internal control over financial
reporting includes those policies and procedures that (i) pertain to
the maintenance of records that, in reasonable detail, accurately
and fairly reflect the transactions and dispositions of the assets ofthe company; (ii) provide reasonable assurance that transactions
are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles,
and that receipts and expenditures of the company are being madeonly in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance
regarding prevention or timely detection of unauthorized acquisition,use, or disposition of the company’s assets that could have amaterial effect on the financial statements.
Because of its inherent limitations, internal control over financial
reporting may not prevent or detect misstatements. Also, projectionsof any evaluation of effectiveness to future periods are subject tothe risk that controls may become inadequate because of changes
in conditions, or that the degree of compliance with the policies orprocedures may deteriorate.

PricewaterhouseCoopers LLP
New York, New York
February 25, 2014

77

78

Consolidated Statement of Earnings
International Business Machines Corporation and Subsidiary Companies($ in millions except per share amounts)
For the year ended December 31:

Notes

2013

2012

2011

Revenue
Services$57,655$ 59,453$ 60,721

Sales

40,04943,01444,063Financing

2,047

2,040

2,132

Total revenue

99,751

104,507

106,916

Services

37,564

39,16640,740Sales

12,572

13,956

14,973Financing

1,110

1,087

1,065

Total cost

51,24654,20956,778Gross profit

48,50550,29850,13823,502

23,553

23,594

6,226

6,302

6,258

(822)

(1,074)(1,108)

(327)

(843)

(20)

402

459

411

Total expense and other (income)

28,981

28,39629,135

Income before income taxes

19,524

21,90221,003

3,041

5,298

5,148

$16,483$ 16,604$ 15,855

Cost

Expense and other income
Selling, general and administrative
Research, development and engineering

OIntellectual property and custom development income
Other (income) and expense
Interest expense

Provision for income taxes

D&J

N

Net income
Earnings per share of common stock
Assuming dilution

P$ 14.94$  14.37$  13.06

Basic

P$ 15.06$  14.53$  13.25

Weighted-average number of common shares outstanding
Assuming dilution

1,103,042,156 1,155,449,317 1,213,767,985

Basic

1,094,486,604 1,142,508,521 1,196,951,006

Amounts may not add due to rounding.
The accompanying notes on pages 84 through 146 are an integral part of the financial statements.

Consolidated Statement of Comprehensive Income
International Business Machines Corporation and Subsidiary Companies($ in millions)
For the year ended December 31:

Notes

Net income

2013

2012

2011

$16,483$16,604$15,855(1,335)

(44)

(693)

Other comprehensive income/(loss), before tax
Foreign currency translation adjustments

L

Net changes related to available-for-sale securities

L

Unrealized gains/(losses) arising during the period

(4)

8

(14)

Reclassification of (gains)/losses to net income

(8)

(42)

(231)

Subsequent changes in previously impaired securities arising during the period
Total net changes related to available-for-sale securities
Unrealized gains/(losses) on cash flow hedges

4

20

4

(8)

(14)

(241)

L

Unrealized gains/(losses) arising during the period

43

32

(266)

Reclassification of (gains)/losses to net income

(166)

(253)

511

Total unrealized gains/(losses) on cash flow hedges

(123)

(220)

245

Retirement-related benefit plans

L

Prior service costs/(credits)
Net (losses)/gains arising during the period

16

—

(28)

5,369

(7,489)(5,463)

(3)

(2)

11

Amortization of prior service (credits)/cost

(114)

(148)

(157)

Amortization of net (gains)/losses

3,499

2,457

1,847

Total retirement-related benefit plans

8,767(5,182)(3,790)(4,479)Curtailments and settlements

Other comprehensive income/(loss), before tax

L

7,301

(5,460)

Income tax (expense)/benefit related to items of other comprehensive incomeL(3,144)

1,587

1,339

Other comprehensive income/(loss)

L

4,157

(3,874)(3,142)$20,641$12,731$12,713

Total comprehensive income
Amounts may not add due to rounding.
The accompanying notes on pages 84 through 146 are an integral part of the financial statements.

79

80

Consolidated Statement of Financial Position
International Business Machines Corporation and Subsidiary Companies($ in millions except per share amounts)
At December 31:

Notes

2013

2012

$   10,716$   10,412

AssetsCurrent assets
Cash and cash equivalents
Marketable securities

D

Notes and accounts receivable—trade (net of allowances of $291 in 2013 and $255 in 2012)
Short-term financing receivables (net of allowances of $308 in 2013 and $288 in 2012)F

Other accounts receivable (net of allowances of $36 in 2013 and $17 in 2012)

350

717

10,465

10,667

19,787

18,038

1,584

1,873

Inventories

E

2,310

2,287

Deferred taxes

N

1,651

1,415

Prepaid expenses and other current assets
Total current assets

4,488

4,024

51,35049,43340,501

G

40,475

Less: Accumulated depreciation

G

26,65426,505

Property, plant and equipment—net

G

13,821

13,996
12,812

Property, plant and equipment

Long-term financing receivables (net of allowances of $80 in 2013 and $66 in 2012)F

12,755Prepaid pension assets

S

5,551

945

Deferred taxes

N

3,051

3,973

GoodwillI

31,18429,247

Intangible assets—net

I

3,871

3,787

Investments and sundry assets

H

4,639

5,021

$ 126,223$ 119,213

Total assets
Liabilities and equity
Current liabilities
Taxes

N

$   4,633$   4,948

Short-term debt

D&J

6,862

9,181

Accounts payable

7,461

7,952

Compensation and benefits

3,893

4,745

Deferred income

12,557

11,952Other accrued expenses and liabilities
Total current liabilities

4,748

4,847

40,154

43,625Long-term debt

D&J

32,85624,088Retirement and nonpension postretirement benefit obligations

S

16,242

20,418Deferred income
Other liabilities

K

Total liabilities
Contingencies and commitments

M

Equity

L

4,108

4,491

9,934

7,607

103,294

100,229

51,594

50,110IBM stockholders’ equity
Common stock, par value $.20 per share, and additional paid-in capital
Shares authorized: 4,687,500,000
Shares issued (2013—2,207,522,548; 2012—2,197,561,159)
Retained earnings

130,042

117,641

Treasury stock, at cost (shares: 2013—1,153,131,611; 2012—1,080,193,483)(137,242)(123,131)

Accumulated other comprehensive income/(loss)(21,602)(25,759)

Total IBM stockholders’ equity

22,792

18,860Noncontrolling interests
Total equity
Total liabilities and equity
Amounts may not add due to rounding.
The accompanying notes on pages 84 through 146 are an integral part of the financial statements.

A

137

124

22,92918,984$ 126,223$ 119,213

Consolidated Statement of Cash Flows
International Business Machines Corporation and Subsidiary Companies($ in millions)
For the year ended December 31:

2013

2012

2011

$ 16,483$ 16,604$ 15,855

Depreciation

3,327

3,392

3,589

Amortization of intangibles

1,351

1,284

1,226

Stock-based compensation

614

688

697

(1,610)

797

1,212

(236)

(729)

(342)

Cash flows from operating activities
Net income
Adjustments to reconcile net income
to cash provided by operating activities

Deferred taxes
Net (gain)/loss on asset sales and other
Change in operating assets and liabilities, net of acquisitions/divestitures(1,407)(2,230)(1,279)Retirement related294(1,008)(1,371)Inventories

(57)

280

(163)

Other assets/other liabilities

(747)

733

(28)

Accounts payable

(529)

(224)

451

17,485

19,586

19,846(4,108)

Receivables (including financing receivables)

Net cash provided by operating activities
Cash flows from investing activities(3,623)(4,082)

Proceeds from disposition of property, plant and equipment

372

410

608

Investment in software

(517)

(635)

(559)

Payments for property, plant and equipment

Purchases of marketable securities and other investments(4,608)(4,109)(1,594)

Proceeds from disposition of marketable securities and other investments

4,873

3,142

3,345

Non-operating finance receivables—net(1,063)

(608)

(291)

Acquisition of businesses, net of cash acquired(3,056)(3,722)(1,811)

297

599

14

(7,326)(9,004)(4,396)

Proceeds from new debt

16,353

12,242

9,996

Payments to settle debt

(10,013)(9,549)(8,947)

Divestiture of businesses, net of cash transferred
Net cash used in investing activities
Cash flows from financing activities

Short-term borrowings/(repayments) less than 90 days—net
Common stock repurchases

621

(441)

1,321

(13,859)(11,995)(15,046)

Common stock transactions—other

1,074

1,540

2,453

Cash dividends paid

(4,058)(3,773)(3,473)

Net cash used in financing activities(13,696)(9,883)(11,976)

Effect of exchange rate changes on cash and cash equivalents

28

(116)

(493)

Net change in cash and cash equivalents

304(1,511)

1,262

10,412

11,922

10,661$ 10,716$ 10,412$ 11,922

Income taxes paid—net of refunds received$  4,024$  3,169$  4,168Interest paid on debt$   982$   1,009$   956

Capital lease obligations$    14$     10$     39

Cash and cash equivalents at January 1
Cash and cash equivalents at December 31
Supplemental data

Amounts may not add due to rounding.
The accompanying notes on pages 84 through 146 are an integral part of the financial statements.

81

82

Consolidated Statement of Changes in Equity
International Business Machines Corporation and Subsidiary Companies($ in millions)
CommonStock andAdditional
Paid-In Capital

Retained
Earnings$45,418$ 92,532

Accumulated
Other
Treasury Comprehensive
Stock Income/(Loss)

Total IBM
Stockholders’EquityNonControlling
Interests

Total
Equity$ 23,046$126$ 23,1722011
Equity, January 1, 2011

$ (96,161)$(18,743)

Net income plus other comprehensive
income/(loss)
Net income

15,85515,855

Other comprehensive income/(loss)(3,142)(3,142)$ 12,713$ 12,713(3,473)(3,473)

2,394

2,394

231

175

175

(15,034)(15,034)(15,034)

Total comprehensive income/(loss)
Cash dividends paid—common stock
Common stock issued under
employee plans (20,669,785 shares)(3,473)
2,394

Purchases (1,717,246 shares) andsales (4,920,198 shares) of treasury
stock under employee plans—net(56)

Other treasury shares purchased,
not retired (88,683,716 shares)
Changes in other equity

317

317

Changes in noncontrolling interests
Equity, December 31, 2011

$48,129

15,855(3,142)$104,857$(110,963)

317
(29)

(29)

$(21,885)$ 20,138$ 97$ 20,236

Accumulated
Other
Treasury Comprehensive
Stock Income/(Loss)

Total IBM
Stockholders’EquityNonControlling
Interests

Total
Equity$ 20,138$ 97$ 20,236

Amounts may not add due to rounding.
The accompanying notes on pages 84 through 146 are an integral part of the financial statements.

($ in millions)
CommonStock andAdditional
Paid-In Capital

Retained
Earnings$48,129$104,857

2012
Equity, January 1, 2012$(110,963)$(21,885)

Net income plus other comprehensive
income/(loss)
Net income

16,604

16,604

Other comprehensive income/(loss)(3,874)(3,874)$ 12,731$ 12,731(3,773)(3,773)

1,532

1,532

(160)

(208)

(208)

(12,008)(12,008)(12,008)

Total comprehensive income/(loss)
Cash dividends paid—common stock
Common stock issued under
employee plans (15,091,320 shares)(3,773)
1,532

Purchases (2,406,007 shares) andsales (2,746,169 shares) of treasury
stock under employee plans—net(48)

Other treasury shares purchased,
not retired (61,246,371 shares)
Changes in other equity

448

448

Changes in noncontrolling interests
Equity, December 31, 2012

$50,110

16,604(3,874)$117,641

Amounts may not add due to rounding.
The accompanying notes on pages 84 through 146 are an integral part of the financial statements.

$(123,131)$(25,759)$ 18,860

448
27

27

$124

$ 18,984

Consolidated Statement of Changes in Equity
International Business Machines Corporation and Subsidiary Companies($ in millions)
CommonStock andAdditional
Paid-In Capital

Retained
Earnings$50,110$117,641

Accumulated
Other
Treasury Comprehensive
Stock Income/(Loss)

Total IBM
Stockholders’EquityNonControlling
Interests

Total
Equity$ 18,860$124$ 18,984

2013
Equity, January 1, 2013$(123,131)$(25,759)

Net income plus other comprehensive
income/(loss)
Net income

16,483

16,483

Other comprehensive income/(loss)

4,157

4,157

$ 20,641$ 20,641(4,058)(4,058)

1,216

1,216

(117)

(142)

(142)

(13,993)(13,993)(13,993)

Total comprehensive income/(loss)
Cash dividends paid—common stock
Common stock issued under
employee plans (9,961,389 shares)(4,058)
1,216

Purchases (1,666,069 shares) andsales (1,849,883 shares) of treasury
stock under employee plans—net(25)

Other treasury shares purchased,
not retired (73,121,942 shares)
Changes in other equity

268

268

Changes in noncontrolling interests
Equity, December 31, 2013

$51,594

16,483

4,157$130,042

Amounts may not add due to rounding.
The accompanying notes on pages 84 through 146 are an integral part of the financial statements.

$(137,242)$(21,602)$ 22,792

268
13

13

$137

$ 22,929

83

84

Notes to Consolidated Financial Statements
International Business Machines Corporation and Subsidiary Companies

Note A.
Significant Accounting Policies

Basis of Presentation
The accompanying Consolidated Financial Statements and footnotes of the International Business Machines Corporation (IBM or
the company) have been prepared in accordance with accounting
principles generally accepted in the United States of America (GAAP).
Within the financial statements and tables presented, certain
columns and rows may not add due to the use of rounded numbers
for disclosure purposes. Percentages presented are calculated fromthe underlying whole-dollar amounts. Certain prior year amounts
have been reclassified to conform to the current year presentation.
This is annotated where applicable.
Noncontrolling interest amounts in income of $7 million, $11 million
and $6 million, net of tax, for the years ended December 31, 2013,2012 and 2011, respectively, are included in the Consolidated Statement of Earnings within the other (income) and expense line item.

Principles of Consolidation
The Consolidated Financial Statements include the accounts of IBM
and its controlled subsidiaries, which are generally majority owned.
Any noncontrolling interest in the equity of a subsidiary is reported
in Equity in the Consolidated Statement of Financial Position. Net
income and losses attributable to the noncontrolling interest isreported as described above in the Consolidated Statement of Earnings. The accounts of variable interest entities (VIEs) are included in
the Consolidated Financial Statements, if required. Investments inbusiness entities in which the company does not have control, but
has the ability to exercise significant influence over operating andfinancial policies, are accounted for using the equity method andthe company’s proportionate share of income or loss is recorded inother (income) and expense. The accounting policy for other investments in equity securities is on page 92 within “Marketable
Securities.” Equity investments in non-publicly traded entities areprimarily accounted for using the cost method. All intercompany
transactions and accounts have been eliminated in consolidation.

Use of Estimates
The preparation of financial statements in conformity with GAAP
requires management to make estimates and assumptions that
affect the amounts of assets, liabilities, revenue, costs, expenses
and other comprehensive income/(loss) (OCI) that are reported in
the Consolidated Financial Statements and accompanying disclosures. These estimates are based on management’s best
knowledge of current events, historical experience, actions that thecompany may undertake in the future and on various other assumptions that are believed to be reasonable under the circumstances.
As a result, actual results may be different from these estimates. See“Critical Accounting Estimates” on pages 67 to 70 for a discussionof the company’s critical accounting estimates.

Revenue
The company recognizes revenue when it is realized or realizableand earned. The company considers revenue realized or realizableand earned when it has persuasive evidence of an arrangement,delivery has occurred, the sales price is fixed or determinable andcollectibility is reasonably assured. Delivery does not occur until
products have been shipped or services have been provided to theclient, risk of loss has transferred to the client, and either client
acceptance has been obtained, client acceptance provisions havelapsed, or the company has objective evidence that the criteria
specified in the client acceptance provisions have been satisfied.
The sales price is not considered to be fixed or determinable until
all contingencies related to the sale have been resolved.
The company recognizes revenue on sales to solution providers,resellers and distributors (herein referred to as “resellers”) when the
reseller has: economic substance apart from the company, credit
risk, title and risk of loss to the inventory; and, the fee to the company
is not contingent upon resale or payment by the end user, the company has no further obligations related to bringing about resale ordelivery and all other revenue recognition criteria have been met.
The company reduces revenue for estimated client returns, stock
rotation, price protection, rebates and other similar allowances. (SeeSchedule II, “Valuation and Qualifying Accounts and Reserves”
included in the company’s Annual Report on Form 10-K). Revenue
is recognized only if these estimates can be reasonably and reliably
determined. The company bases its estimates on historical results
taking into consideration the type of client, the type of transaction
and the specifics of each arrangement. Payments made undercooperative marketing programs are recognized as an expense only
if the company receives from the client an identifiable benefit sufficiently separable from the product sale whose fair value can bereasonably and reliably estimated. If the company does not receive
an identifiable benefit sufficiently separable from the product sale
whose fair value can be reasonably estimated, such payments arerecorded as a reduction of revenue.
Revenue from sales of third-party vendor products or services
is recorded net of costs when the company is acting as an agent
between the client and the vendor, and gross when the company isa principal to the transaction. Several factors are considered todetermine whether the company is an agent or principal, most notably whether the company is the primary obligor to the client, or has
inventory risk. Consideration is also given to whether the company
adds meaningful value to the vendor’s product or service, wasinvolved in the selection of the vendor’s product or service, has latitude in establishing the sales price or has credit risk.
The company reports revenue net of any revenue-based taxes
assessed by governmental authorities that are imposed on andconcurrent with specific revenue-producing transactions. In addition
to the aforementioned general policies, the following are the specificrevenue recognition policies for multiple-deliverable arrangements
and for each major category of revenue.

Notes to Consolidated Financial Statements
International Business Machines Corporation and Subsidiary Companies

Multiple-Deliverable Arrangements
The company enters into revenue arrangements that may consistof multiple deliverables of its products and services based on theneeds of its clients. These arrangements may include any combination of services, software, hardware and/or financing. For example,
a client may purchase a server that includes operating system software. In addition, the arrangement may include post-contract
support for the software and a contract for post-warranty maintenance service for the hardware. These types of arrangements canalso include financing provided by the company. These arrangements consist of multiple deliverables, with the hardware andsoftware delivered in one reporting period and the software supportand hardware maintenance services delivered across multiple
reporting periods. In another example, a client may outsource therunning of its datacenter operations to the company on a long-term,
multiple-year basis and periodically purchase servers and/or software products from the company to upgrade or expand its facility.
The outsourcing services are provided on a continuous basis acrossmultiple reporting periods and the hardware and software products
are delivered in one reporting period. To the extent that a deliverable
in a multiple-deliverable arrangement is subject to specific accounting guidance that deliverable is accounted for in accordance withsuch specific guidance. Examples of such arrangements may
include leased hardware which is subject to specific leasing guidance or software which is subject to specific software revenue
recognition guidance on whether and/or how to separate multipledeliverable arrangements into separate units of accounting(separability) and how to allocate the arrangement consideration
among those separate units of accounting (allocation). For all otherdeliverables in multiple-deliverable arrangements, the guidance
below is applied for separability and allocation. A multiple-deliverable arrangement is separated into more than one unit of accounting
if the following criteria are met:
• The delivered item(s) has value to the client on a stand-alone
basis; and• If the arrangement includes a general right of return relative
to the delivered item(s), delivery or performance of theundelivered item(s) is considered probable and substantiallyin the control of the company.
If these criteria are not met, the arrangement is accounted for as
one unit of accounting which would result in revenue being recognized ratably over the contract term or being deferred until the earlierof when such criteria are met or when the last undelivered element
is delivered. If these criteria are met for each element and there is arelative selling price for all units of accounting in an arrangement,
the arrangement consideration is allocated to the separate units ofaccounting based on each unit’s relative selling price. The following
revenue policies are then applied to each unit of accounting,as applicable.
Revenue from the company’s business analytics, Smarter Planetand cloud offerings follow the specific revenue recognition policies
for multiple deliverable arrangements and for each major categoryof revenue depending on the type of offering which can be comprised of services, hardware and/or software.

Services
The company’s primary services offerings include information technology (IT) datacenter and business process outsourcing, application
management services, consulting and systems integration, technology infrastructure and system maintenance, Web hosting andthe design and development of complex IT systems to a client’s
specifications (design and build). These services are provided on atime-and-material basis, as a fixed-price contract or as a fixed-priceper measure of output contract and the contract terms range fromless than one year to over 10 years.
Revenue from IT datacenter and business process outsourcing
contracts is recognized in the period the services are provided using
either an objective measure of output or on a straight-line basis over
the term of the contract. Under the output method, the amount ofrevenue recognized is based on the services delivered in the period.
Revenue from application management services, technology
infrastructure and system maintenance and Web hosting contracts
is recognized on a straight-line basis over the terms of the contracts.
Revenue from time-and-material contracts is recognized as labor
hours are delivered and direct expenses are incurred. Revenue
related to extended warranty and product maintenance contracts
is recognized on a straight-line basis over the delivery period.
Revenue from fixed-price design and build contracts is recognized under the percentage-of-completion (POC) method. Under
the POC method, revenue is recognized based on the labor costs
incurred to date as a percentage of the total estimated labor costs
to fulfill the contract. If circumstances arise that change the original
estimates of revenues, costs, or extent of progress toward completion, revisions to the estimates are made. These revisions may
result in increases or decreases in estimated revenues or costs,
and such revisions are reflected in income in the period in which
the circumstances that gave rise to the revision become known by
the company.
The company performs ongoing profitability analyses of its
services contracts accounted for under the POC method in orderto determine whether the latest estimates of revenues, costs andprofits require updating. If at any time these estimates indicate thatthe contract will be unprofitable, the entire estimated loss for theremainder of the contract is recorded immediately. For non-POC
method services contracts, any losses are recorded as incurred.
In some services contracts, the company bills the client prior torecognizing revenue from performing the services. Deferred incomeof $7,153 million and $7,281 million at December 31, 2013 and 2012,
respectively, is included in the Consolidated Statement of Financial
Position. In other services contracts, the company performs theservices prior to billing the client. Unbilled accounts receivable of$2,053 million and $1,998 million at December 31, 2013 and 2012,
respectively, is included in notes and accounts receivable-trade in
the Consolidated Statement of Financial Position.
Billings usually occur in the month after the company performs
the services or in accordance with specific contractual provisions.
Unbilled receivables are expected to be billed within four months.

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Notes to Consolidated Financial Statements
International Business Machines Corporation and Subsidiary Companies

Hardware
The company’s hardware offerings include the sale or lease of
system servers, storage solutions and the sale of semiconductors.
The company also offers installation services for its more complex
hardware products.
Revenue from hardware sales and sales-type leases is recognized when risk of loss has transferred to the client and there are nounfulfilled company obligations that affect the client’s final acceptance of the arrangement. Any cost of standard warranties andremaining obligations that are inconsequential or perfunctory are
accrued when the corresponding revenue is recognized. Revenue
from rentals and operating leases is recognized on a straight-line
basis over the term of the rental or lease.
Software
Revenue from perpetual (one-time charge) license software is recognized at the inception of the license term if all revenue recognition
criteria have been met. Revenue from term (recurring license charge)
license software is recognized on a straight-line basis over theperiod that the client is entitled to use the license. Revenue frompost-contract support, which may include unspecified upgrades ona when-and-if-available basis, is recognized on a straight-line basis
over the period such items are delivered. In multiple-deliverable
arrangements that include software that is more than incidental tothe products or services as a whole (software multiple-deliverable
arrangements), software and software-related elements are accounted
for in accordance with software revenue recognition guidance.
Software-related elements include software products and services
for which a software deliverable is essential to its functionality. Tangible products containing software components and non-software
components that function together to deliver the tangible product’s
essential functionality are not within the scope of software revenue
recognition guidance and are accounted for based on other applicable revenue recognition guidance.
A software multiple-deliverable arrangement is separated into
more than one unit of accounting if all of the following criteria are met:
• The functionality of the delivered element(s) is not dependent
on the undelivered element(s);• There is vendor-specific objective evidence (VSOE) of fairvalue of the undelivered element(s). VSOE of fair value is basedon the price charged when the deliverable is sold separatelyby the company on a regular basis and not as part of themultiple-deliverable arrangement; and• Delivery of the delivered element(s) represents the culminationof the earnings process for that element(s).
If any one of these criteria is not met, the arrangement is accounted
for as one unit of accounting which would result in revenue being
recognized ratably over the contract term or being deferred until theearlier of when such criteria are met or when the last undelivered
element is delivered. If these criteria are met for each element andthere is VSOE of fair value for all units of accounting in an arrangement, the arrangement consideration is allocated to the separate
units of accounting based on each unit’s relative VSOE of fair value.
There may be cases, however, in which there is VSOE of fair valueof the undelivered item(s) but no such evidence for the delivered

item(s). In these cases, the residual method is used to allocate thearrangement consideration. Under the residual method, the amountof consideration allocated to the delivered item(s) equals the total
arrangement consideration less the aggregate VSOE of fair value ofthe undelivered elements.
The company’s multiple-deliverable arrangements may havea stand-alone software deliverable that is subject to the existing
software revenue recognition guidance. The revenue for these
multiple-deliverable arrangements is allocated to the software deliverable and the non-software deliverables based on the relative
selling prices of all of the deliverables in the arrangement using thehierarchy: VSOE, third-party evidence (TPE) or best estimate of selling price (BESP). In the limited circumstances where the company
cannot determine VSOE or TPE of the selling price for all of thedeliverables in the arrangement, including the software deliverable,
BESP is used for the purpose of performing this allocation.
Financing
Financing income attributable to sales-type leases, direct financing
leases and loans is recognized on the accrual basis using the effective interest method. Operating lease income is recognized on astraight-line basis over the term of the lease.
Best Estimate of Selling Price
In certain limited instances, the company is not able to establish VSOE
for all elements in a multiple-deliverable arrangement. When VSOE
cannot be established, the company attempts to establish the selling price of each element based on TPE. TPE is determined basedon competitor prices for similar deliverables when sold separately.
When the company is unable to establish selling price using
VSOE or TPE, the company uses BESP in its allocation of arrangement consideration. The objective of BESP is to determine the priceat which the company would transact a sale if the product or service
were sold on a stand-alone basis. Due to the fact that the company
sells its products and services on a stand-alone basis, and therefore
has established VSOE for its products and services offerings, thecompany uses BESP to determine the relative selling price for a
product or service in a multiple-deliverable arrangement on an infrequent basis. An example of when BESP would be used is when thecompany sells a new product, for which VSOE and TPE does not
yet exist, in a multiple-deliverable arrangement prior to selling thenew product on a stand-alone basis.
The company determines BESP by considering multiple factors
including, but not limited to, overall market conditions, including
geographic or regional specific factors, competitive positioning,
competitor actions, internal costs, profit objectives and pricing
practices. The determination of BESP is a formal process that
includes review and approval by the company’s management. In
addition, the company regularly reviews VSOE and TPE for its
products and services, in addition to BESP.

Services Costs
Recurring operating costs for services contracts, including costs
related to bid and proposal activities, are recognized as incurred.
For fixed-price design and build contracts, the costs of external
hardware and software accounted for under the POC method areNotes to Consolidated Financial Statements
International Business Machines Corporation and Subsidiary Companies

deferred and recognized based on the labor costs incurred to date,as a percentage of the total estimated labor costs to fulfill the contract. Certain eligible, nonrecurring costs incurred in the initial
phases of outsourcing contracts are deferred and subsequently
amortized. These costs consist of transition and setup costs related
to the installation of systems and processes and are amortized ona straight-line basis over the expected period of benefit, not toexceed the term of the contract. Additionally, fixed assets associatedwith outsourcing contracts are capitalized and depreciated on astraight-line basis over the expected useful life of the asset. If an
asset is contract specific, then the depreciation period is the shorterof the useful life of the asset or the contract term. Amounts paid toclients in excess of the fair value of acquired assets used in outsourcing arrangements are deferred and amortized on a straight-line
basis as a reduction of revenue over the expected period of benefit
not to exceed the term of the contract. The company performs periodic reviews to assess the recoverability of deferred contract
transition and setup costs. This review is done by comparing theestimated minimum remaining undiscounted cash flows of a contract
to the unamortized contract costs. If such minimum undiscounted
cash flows are not sufficient to recover the unamortized costs, animpairment loss is recognized.
Deferred services transition and setup costs were $2,402 million
and $2,424 million at December 31, 2013 and 2012, respectively.
Amortization of deferred services transition and setup costs wasestimated at December 31, 2013 to be $812 million in 2014, $612
million in 2015, $400 million in 2016, $247 million in 2017 and $332
million thereafter.
Deferred amounts paid to clients in excess of the fair value ofacquired assets used in outsourcing arrangements were $89 million
and $51 million at December 31, 2013 and 2012, respectively. Amortization of deferred amounts paid to clients in excess of the fair valueof acquired assets is recorded as an offset of revenue and wasestimated at December 31, 2013 to be $27 million in 2014, $27 million
in 2015, $8 million in 2016, $5 million in 2017 and $22 million thereafter. In situations in which an outsourcing contract is terminated,
the terms of the contract may require the client to reimburse thecompany for the recovery of unbilled accounts receivable, unamortized deferred costs incurred to purchase specific assets utilized in
the delivery of services and to pay any additional costs incurred by
the company to transition the services.

The company capitalizes certain costs that are incurred to purchase or to create and implement internal-use software programs,
including software coding, installation, testing and certain data
conversions. These capitalized costs are amortized on a straightline basis over periods ranging up to two years and are recorded
in selling, general and administrative expense.

Software Costs

Extended Warranty Liability (Deferred Income)Costs that are related to the conceptual formulation and design oflicensed software programs are expensed as incurred to research,development and engineering expense; costs that are incurred to
produce the finished product after technological feasibility has been
established are capitalized as an intangible asset. Capitalized
amounts are amortized on a straight-line basis over periods ranging
up to three years and are recorded in software cost within costof sales. The company performs periodic reviews to ensure that
unamortized program costs remain recoverable from future revenue.
Costs to support or service licensed programs are charged to software cost within cost of sales as incurred.

Product Warranties
The company offers warranties for its hardware products that generally range up to three years, with the majority being either one or
three years. Estimated costs for warranty terms standard to thedeliverable are recognized when revenue is recorded for the relateddeliverable. The company estimates its warranty costs standard
to the deliverable based on historical warranty claim experienceand estimates of future spending, and applies this estimate to therevenue stream for products under warranty. Estimated future costs
for warranties applicable to revenue recognized in the current
period are charged to cost of sales. The warranty liability is reviewed
quarterly to verify that it properly reflects the remaining obligation
based on the anticipated expenditures over the balance of theobligation period. Adjustments are made when actual warranty claim
experience differs from estimates. Costs from fixed-price support
or maintenance contracts, including extended warranty contracts,are recognized as incurred.
Revenue from separately priced extended warranty contracts
is initially recorded as deferred income and subsequently recognized on a straight-line basis over the delivery period. Changes indeferred income for extended warranty contracts, and in the warranty
liability for standard warranties, which are included in other accrued
expenses and liabilities and other liabilities in the Consolidated
Statement of Financial Position, are presented in the following tables:
Standard Warranty Liability($ in millions)
2013

2012

Balance at January 1

$ 394

$ 407

Current period accruals

346

394

Accrual adjustments to reflect actual experience

22

(15)

Charges incurred

(387)

(392)

Balance at December 31

$ 376

$ 394

($ in millions)

Balance at January 1

2013

2012

$ 606

$ 636

Revenue deferred for new extended
warranty contracts

305

268

Amortization of deferred revenue

(324)

(301)

(8)

4

Balance at December 31

$ 579

$ 606

Current portion

$ 284

$ 289

Other*

Noncurrent portion
Balance at December 31

295

317

$ 579

$ 606

* Other consists primarily of foreign currency translation adjustments.

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Notes to Consolidated Financial Statements
International Business Machines Corporation and Subsidiary Companies

Shipping and Handling
Costs related to shipping and handling are recognized as incurredand included in cost in the Consolidated Statement of Earnings.

Expense and Other Income

Selling, General and Administrative
Selling, general and administrative (SG&A) expense is charged toincome as incurred. Expenses of promoting and selling products
and services are classified as selling expense and include suchitems as compensation, advertising, sales commissions and travel.
General and administrative expense includes such items as compensation, legal costs, office supplies, non-income taxes, insurance
and office rental. In addition, general and administrative expense
includes other operating items such as an allowance for credit losses,
workforce rebalancing accruals for contractually obligated payments
to employees terminated in the ongoing course of business, acquisition costs related to business combinations, amortization of certain
intangible assets and environmental remediation costs.
Advertising and Promotional Expense
The company expenses advertising and promotional costs as
incurred. Cooperative advertising reimbursements from vendors arerecorded net of advertising and promotional expense in the period
in which the related advertising and promotional expense is incurred.
Advertising and promotional expense, which includes media, agency
and promotional expense, was $1,294 million, $1,339 million and$1,373 million in 2013, 2012 and 2011, respectively, and is recorded
in SG&A expense in the Consolidated Statement of Earnings.
Research, Development and Engineering
Research, development and engineering (RD&E) costs are expensed
as incurred. Software costs that are incurred to produce the finishedproduct after technological feasibility has been established arecapitalized as an intangible asset. See “Software Costs” on page 87.
Intellectual Property and Custom Development Income
The company licenses and sells the rights to certain of its intellectual
property (IP) including internally developed patents, trade secrets
and technological know-how. Certain IP transactions to third partiesare licensing/royalty-based and others are transaction-based sales
and other transfers. Licensing/royalty-based fees involve transfers
in which the company earns the income over time, or the amountof income is not fixed or determinable until the licensee sells
future related products (i.e., variable royalty, based upon licensee’s
revenue). Sales and other transfers typically include transfers of
IP whereby the company has fulfilled its obligations and the fee
received is fixed or determinable at the transfer date. The company
also enters into cross-licensing arrangements of patents, andincome from these arrangements is recorded when earned. In addition, the company earns income from certain custom development
projects for strategic technology partners and specific clients. The
company records the income from these projects when the fee isrealized and earned, is not refundable and is not dependent upon
the success of the project.

Other (Income) and Expense
Other (income) and expense includes interest income (other thanfrom Global Financing external business transactions), gains andlosses on certain derivative instruments, gains and losses fromsecurities and other investments, gains and losses from certain realestate transactions, foreign currency transaction gains and losses,
gains and losses from the sale of businesses and amounts related
to accretion of asset retirement obligations.

Business Combinations andIntangible Assets Including Goodwill
The company accounts for business combinations using the acquisition method and accordingly, the identifiable assets acquired, theliabilities assumed, and any noncontrolling interest in the acquiree
are recorded at their acquisition date fair values. Goodwill represents
the excess of the purchase price over the fair value of net assets,
including the amount assigned to identifiable intangible assets. The
primary drivers that generate goodwill are the value of synergies
between the acquired entities and the company and the acquired
assembled workforce, neither of which qualifies as an identifiableintangible asset. Goodwill recorded in an acquisition is assigned toapplicable reporting units based on expected revenues. Identifiableintangible assets with finite lives are amortized over their useful lives.
Amortization of completed technology is recorded in Cost, and amortization of all other intangible assets is recorded in SG&A expense.
Acquisition-related costs, including advisory, legal, accounting,valuation and other costs, are expensed in the periods in which thecosts are incurred. The results of operations of acquired businesses
are included in the Consolidated Financial Statements from theacquisition date.

Impairment
Long-lived assets, other than goodwill and indefinite-lived intangible
assets, are tested for impairment whenever events or changes incircumstances indicate that the carrying amount may not be recoverable. The impairment test is based on undiscounted cash flows and,if impaired, the asset is written down to fair value based on either
discounted cash flows or appraised values. Goodwill and indefinitelived intangible assets are tested annually, in the fourth quarter, for
impairment and whenever changes in circumstances indicate an
impairment may exist. Goodwill is tested at the reporting unit level
which is the operating segment, or a business, which is one level
below that operating segment (the “component” level) if discrete
financial information is prepared and regularly reviewed by management at the segment level. Components are aggregated as a single
reporting unit if they have similar economic characteristics.

Depreciation and Amortization
Property, plant and equipment are carried at cost and depreciatedover their estimated useful lives using the straight-line method. The
estimated useful lives of certain depreciable assets are as follows:buildings, 30 to 50 years; building equipment, 10 to 20 years; land
improvements, 20 years; plant, laboratory and office equipment, 2
to 20 years; and computer equipment, 1.5 to 5 years. Leasehold
improvements are amortized over the shorter of their estimateduseful lives or the related lease term, rarely exceeding 25 years.

Notes to Consolidated Financial Statements
International Business Machines Corporation and Subsidiary Companies

Capitalized software costs incurred or acquired after technological feasibility has been established are amortized over periods
ranging up to 3 years. Capitalized costs for internal-use software
are amortized on a straight-line basis over periods ranging up to 2
years. Other intangible assets are amortized over periods between
1 and 7 years.

Environmental
The cost of internal environmental protection programs that arepreventative in nature are expensed as incurred. When a cleanup
program becomes likely, and it is probable that the company will
incur cleanup costs and those costs can be reasonably estimated,the company accrues remediation costs for known environmental
liabilities. The company’s maximum exposure for all environmental
liabilities cannot be estimated and no amounts are recorded forenvironmental liabilities that are not probable or estimable.

Asset Retirement Obligations
Asset retirement obligations (ARO) are legal obligations associatedwith the retirement of long-lived assets. These liabilities are initially
recorded at fair value and the related asset retirement costs arecapitalized by increasing the carrying amount of the related assets
by the same amount as the liability. Asset retirement costs aresubsequently depreciated over the useful lives of the related assets.
Subsequent to initial recognition, the company records period-toperiod changes in the ARO liability resulting from the passage oftime in interest expense and revisions to either the timing or theamount of the original expected cash flows to the related assets.

Defined Benefit Pension and
Nonpension Postretirement Benefit Plans
The funded status of the company’s defined benefit pension plans
and nonpension postretirement benefit plans (retirement-related
benefit plans) is recognized in the Consolidated Statement of Financial Position. The funded status is measured as the difference
between the fair value of plan assets and the benefit obligation at
December 31, the measurement date. For defined benefit pension
plans, the benefit obligation is the projected benefit obligation (PBO),
which represents the actuarial present value of benefits expected
to be paid upon retirement based on employee services alreadyrendered and estimated future compensation levels. For the nonpension postretirement benefit plans, the benefit obligation is theaccumulated postretirement benefit obligation (APBO), which represents the actuarial present value of postretirement benefits
attributed to employee services already rendered. The fair value ofplan assets represents the current market value of cumulative company and participant contributions made to an irrevocable trust
fund, held for the sole benefit of participants, which are invested by
the trust fund. Overfunded plans, with the fair value of plan assets
exceeding the benefit obligation, are aggregated and recorded asa prepaid pension asset equal to this excess. Underfunded plans,with the benefit obligation exceeding the fair value of plan assets,
are aggregated and recorded as a retirement and nonpension postretirement benefit obligation equal to this excess.

The current portion of the retirement and nonpension postretirement benefit obligations represents the actuarial present value of
benefits payable in the next 12 months exceeding the fair value ofplan assets, measured on a plan-by-plan basis. This obligation isrecorded in compensation and benefits in the Consolidated Statement of Financial Position.
Net periodic pension and nonpension postretirement benefit
cost/(income) is recorded in the Consolidated Statement of Earnings
and includes service cost, interest cost, expected return on plan
assets, amortization of prior service costs/(credits) and (gains)/
losses previously recognized as a component of OCI and amortization of the net transition asset remaining in accumulated othercomprehensive income/(loss) (AOCI). Service cost represents theactuarial present value of participant benefits earned in the current
year. Interest cost represents the time value of money cost associated with the passage of time. Certain events, such as changes inthe employee base, plan amendments and changes in actuarial
assumptions, result in a change in the benefit obligation andthe corresponding change in OCI. The result of these events isamortized as a component of net periodic cost/(income) overthe service lives or life expectancy of the participants, dependingon the plan, provided such amounts exceed thresholds which are
based upon the benefit obligation or the value of plan assets. Net
periodic cost/(income) is recorded in Cost, SG&A and RD&E in theConsolidated Statement of Earnings based on the employees’
respective functions.
(Gains)/losses and prior service costs/(credits) not recognized
as a component of net periodic cost/(income) in the Consolidated
Statement of Earnings as they arise are recognized as a componentof OCI in the Consolidated Statement of Comprehensive Income.
Those (gains)/losses and prior service costs/(credits) are subsequently recognized as a component of net periodic cost/(income)pursuant to the recognition and amortization provisions of applicable accounting guidance. (Gains)/losses arise as a result ofdifferences between actual experience and assumptions or as aresult of changes in actuarial assumptions. Prior service costs/(credits) represent the cost of benefit changes attributable to priorservice granted in plan amendments.
The measurement of benefit obligations and net periodic cost/(income) is based on estimates and assumptions approved by thecompany’s management. These valuations reflect the terms of theplans and use participant-specific information such as compensation,
age and years of service, as well as certain assumptions, including
estimates of discount rates, expected return on plan assets, rate ofcompensation increases, interest crediting rates and mortality rates.

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Notes to Consolidated Financial Statements
International Business Machines Corporation and Subsidiary Companies

Defined Contribution Plans
The company’s contribution for defined contribution plans is recorded
when the employee renders service to the company. The charge isrecorded in Cost, SG&A and RD&E in the Consolidated Statement ofEarnings based on the employees’ respective functions.

Stock-Based Compensation
Stock-based compensation represents the cost related to stockbased awards granted to employees. The company measures
stock-based compensation cost at the grant date, based on theestimated fair value of the award and recognizes the cost on astraight-line basis (net of estimated forfeitures) over the employee
requisite service period. The company estimates the fair value ofstock options using a Black-Scholes valuation model. The company
also grants its employees Restricted Stock Units (RSUs), including
Retention Restricted Stock Units (RRSUs) and Performance Share
Units (PSUs). RSUs are stock awards granted to employees that
entitle the holder to shares of common stock as the award vests,
typically over a one- to five-year period. The fair value of the awards
is determined and fixed on the grant date based on the company’s
stock price, adjusted for the exclusion of dividend equivalents. All
stock-based compensation cost is recorded in Cost, SG&A, andRD&E in the Consolidated Statement of Earnings based on theemployees’ respective functions.
The company records deferred tax assets for awards that result
in deductions on the company’s income tax returns, based on theamount of compensation cost recognized and the statutory tax ratein the jurisdiction in which it will receive a deduction. Differences
between the deferred tax assets recognized for financial reporting
purposes and the actual tax deduction reported on the income tax
return are recorded in additional paid-in capital (if the tax deduction
exceeds the deferred tax asset) or in the Consolidated Statementof Earnings (if the deferred tax asset exceeds the tax deduction andno additional paid-in capital exists from previous awards).

Income Taxes
Income tax expense is based on reported income before income
taxes. Deferred income taxes reflect the tax effect of temporary
differences between asset and liability amounts that are recognized
for financial reporting purposes and the amounts that are recognized for income tax purposes. These deferred taxes are measured
by applying currently enacted tax laws. Valuation allowances arerecognized to reduce deferred tax assets to the amount that willmore likely than not be realized. In assessing the need for a valuation
allowance, management considers all available evidence for eachjurisdiction including past operating results, estimates of future taxable income and the feasibility of ongoing tax planning strategies.
When the company changes its determination as to the amount ofdeferred tax assets that can be realized, the valuation allowance isadjusted with a corresponding impact to income tax expense in the
period in which such determination is made.

The company recognizes tax liabilities when, despite the company’s belief that its tax return positions are supportable, the company
believes that certain positions may not be fully sustained upon review
by tax authorities. Benefits from tax positions are measured at thelargest amount of benefit that is greater than 50 percent likely of
being realized upon settlement. The current portion of tax liabilities
is included in taxes and the noncurrent portion of tax liabilities is
included in other liabilities in the Consolidated Statement of Financial
Position. To the extent that new information becomes available whichcauses the company to change its judgment regarding the adequacy of existing tax liabilities, such changes to tax liabilities will
impact income tax expense in the period in which such determination is made. Interest and penalties, if any, related to accrued liabilities
for potential tax assessments are included in income tax expense.

Translation of Non-U.S. Currency Amounts
Assets and liabilities of non-U.S. subsidiaries that have a local functional currency are translated to United States (U.S.) dollars at
year-end exchange rates. Translation adjustments are recordedin OCI. Income and expense items are translated at weighted-average rates of exchange prevailing during the year.
Inventories, property, plant and equipment—net and other nonmonetary assets and liabilities of non-U.S. subsidiaries andbranches that operate in U.S. dollars are translated at the approximate exchange rates prevailing when the company acquired theassets or liabilities. All other assets and liabilities denominated in acurrency other than U.S. dollars are translated at year-end exchange
rates with the transaction gain or loss recognized in other (income)and expense. Income and expense items are translated at theweighted-average rates of exchange prevailing during the year.
These translation gains and losses are included in net income forthe period in which exchange rates change.

Derivative Financial Instruments
Derivatives are recognized in the Consolidated Statement of Financial Position at fair value and are reported in prepaid expenses andother current assets, investments and sundry assets, other accrued
expenses and liabilities or other liabilities. Classification of each
derivative as current or noncurrent is based upon whether
the maturity of the instrument is less than or greater than 12 months.
To qualify for hedge accounting, the company requires that the
instruments be effective in reducing the risk exposure that they aredesignated to hedge. For instruments that hedge cash flows, hedge
designation criteria also require that it be probable that the under­
lying transaction will occur. Instruments that meet establishedaccounting criteria are formally designated as hedges. These criteria
demonstrate that the derivative is expected to be highly effectiveat offsetting changes in fair value or cash flows of the underlying
exposure both at inception of the hedging relationship and on an
ongoing basis. The method of assessing hedge effectivenessand measuring hedge ineffectiveness is formally documented athedge inception. The company assesses hedge effectiveness andmeasures hedge ineffectiveness at least quarterly throughout thedesignated hedge period.

Notes to Consolidated Financial Statements
International Business Machines Corporation and Subsidiary Companies

Where the company applies hedge accounting, the company
designates each derivative as a hedge of: (1) the fair value of a recognized financial asset or liability, or of an unrecognized firm
commitment (fair value hedge attributable to interest rate or foreign
currency risk); (2) the variability of anticipated cash flows of aforecasted transaction, or the cash flows to be received or paid
related to a recognized financial asset or liability (cash flow hedge
attributable to interest rate or foreign currency risk); or (3) a hedge
of a long-term investment (net investment hedge) in a foreign operation. In addition, the company may enter into derivative contracts
that economically hedge certain of its risks, even though hedge
accounting does not apply or the company elects not to apply
hedge accounting. In these cases, there exists a natural hedging
relationship in which changes in the fair value of the derivative, which
are recognized currently in net income, act as an economic offset
to changes in the fair value of the underlying hedged item(s).
Changes in the fair value of a derivative that is designated as afair value hedge, along with offsetting changes in the fair value of theunderlying hedged exposure, are recorded in earnings each period.
For hedges of interest rate risk, the fair value adjustments arerecorded as adjustments to interest expense and cost of financing
in the Consolidated Statement of Earnings. For hedges of currency
risk associated with recorded financial assets or liabilities, derivative
fair value adjustments are recognized in other (income) and expensein the Consolidated Statement of Earnings. Changes in the fair valueof a derivative that is designated as a cash flow hedge are recorded,
net of applicable taxes, in OCI, in the Consolidated Statement ofComprehensive Income. When net income is affected by the variability of the underlying cash flow, the applicable offsetting amountof the gain or loss from the derivative that is deferred in AOCI isreleased to net income and reported in interest expense, Cost, SG&A
expense or other (income) and expense in the Consolidated Statement of Earnings based on the nature of the underlying cash flow
hedged. Effectiveness for net investment hedging derivatives is measured on a spot-to-spot basis. The effective portion of changes in
the fair value of net investment hedging derivatives and other nonderivative financial instruments designated as net investment hedges
are recorded as foreign currency translation adjustments in OCI.
Changes in the fair value of the portion of a net investment hedging
derivative excluded from the effectiveness assessment are recorded
in interest expense. If the underlying hedged item in a fair value hedge
ceases to exist, all changes in the fair value of the derivative areincluded in net income each period until the instrument matures.
When the derivative transaction ceases to exist, a hedged asset or
liability is no longer adjusted for changes in its fair value except as
required under other relevant accounting standards. Derivatives thatare not designated as hedges, as well as changes in the fair value ofderivatives that do not effectively offset changes in the fair value ofthe underlying hedged item throughout the designated hedge period(collectively, “ineffectiveness”), are recorded in net income for eachperiod and are reported in other (income) and expense. When a cash
flow hedging relationship is discontinued, the net gain or loss in AOCI
must generally remain in AOCI until the item that was hedged affects

earnings. However, when it is probable that a forecasted transaction
will not occur by the end of the originally specified time period orwithin an additional two-month period thereafter, the net gain or loss
in AOCI must be reclassified into earnings immediately. The company
reports cash flows arising from derivative financial instruments designated as fair value or cash flow hedges consistent with theclassification of cash flows from the underlying hedged items thatthese derivatives are hedging. Accordingly, the cash flows associatedwith derivatives designated as fair value or cash flow hedges areclassified in cash flows from operating activities in the Consolidated
Statement of Cash Flows. Cash flows from derivatives designated as
net investment hedges and derivatives that do not qualify as hedges
are reported in cash flows from investing activities. For currency
swaps designated as hedges of foreign currency denominated debt(included in the company’s debt risk management program as
addressed in note D, “Financial Instruments,” on pages 102 through106), cash flows directly associated with the settlement of the principal element of these swaps are reported in payments to settle debt
in cash flows from financing activities in the Consolidated Statementof Cash Flows.

Financial Instruments
In determining the fair value of its financial instruments, the company
uses a variety of methods and assumptions that are based on market
conditions and risks existing at each balance sheet date. See note D,“Financial Instruments,” on pages 100 to 102 for further information.
All methods of assessing fair value result in a general approximationof value, and such value may never actually be realized.

Fair Value Measurement
Accounting guidance defines fair value as the price that would bereceived to sell an asset or paid to transfer a liability in an orderlytransaction between market participants at the measurement date.
Under this guidance, the company is required to classify certain
assets and liabilities based on the following fair value hierarchy:• Level 1—Quoted prices (unadjusted) in active markets
for identical assets or liabilities that can be accessedat the measurement date;• Level 2—Inputs other than quoted prices included within
Level 1 that are observable for the asset or liability, either
directly or indirectly; and• Level 3—Unobservable inputs for the asset or liability.
The guidance requires the use of observable market data if suchdata is available without undue cost and effort.
When available, the company uses unadjusted quoted market
prices in active markets to measure the fair value and classifies suchitems within Level 1. If quoted market prices are not available, fairvalue is based upon internally developed models that use current
market-based or independently sourced market parameters suchas interest rates and currency rates. Items valued using internallygenerated models are classified according to the lowest level input
or value driver that is significant to the valuation.

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International Business Machines Corporation and Subsidiary Companies

The determination of fair value considers various factors including interest rate yield curves and time value underlying the financial
instruments. For derivatives and debt securities, the company uses
a discounted cash flow analysis using discount rates commensuratewith the duration of the instrument.
In determining the fair value of financial instruments, the company considers certain market valuation adjustments to the “basevaluations” calculated using the methodologies described below
for several parameters that market participants would consider indetermining fair value:• Counterparty credit risk adjustments are applied to financial
instruments, taking into account the actual credit risk of acounterparty as observed in the credit default swap market
to determine the true fair value of such an instrument.
• Credit risk adjustments are applied to reflect the company’s
own credit risk when valuing all liabilities measured atfair value. The methodology is consistent with that appliedin developing counterparty credit risk adjustments, but
incorporates the company’s own credit risk as observedin the credit default swap market.
As an example, the fair value of derivatives is derived utilizing a discounted cash flow model that uses observable market inputs suchas known notional value amounts, yield curves, spot and forward
exchange rates as well as discount rates. These inputs relate toliquid, heavily traded currencies with active markets which are available for the full term of the derivative.
Certain financial assets are measured at fair value on a nonrecurring basis. These assets include equity method investments that arerecognized at fair value at the measurement date to the extent thatthey are deemed to be other-than-temporarily impaired. Certain
assets that are measured at fair value on a recurring basis can be
subject to nonrecurring fair value measurements. These assets
include available-for-sale equity investments that are deemed tobe other-than-temporarily impaired. In the event of an other-thantemporary impairment of a financial instrument, fair value is measured
using a model described above.
Accounting guidance permits the measurement of eligible financial assets, financial liabilities and firm commitments at fair value, on
an instrument-by-instrument basis, that are otherwise not permitted
to be accounted for at fair value under other accounting standards.
This election is irrevocable. The company does not apply the fairvalue option to any eligible assets or liabilities.

Cash Equivalents
All highly liquid investments with maturities of three months or less atthe date of purchase are considered to be cash equivalents.

Marketable Securities
Debt securities included in current assets represent securities thatare expected to be realized in cash within one year of the balance
sheet date. Long-term debt securities that are not expected to berealized in cash within one year and alliance equity securities areincluded in investments and sundry assets. Debt and marketable
equity securities are considered available for sale and are reported
at fair value with unrealized gains and losses, net of applicable taxes,
in OCI. The realized gains and losses for available-for-sale securities
are included in other (income) and expense in the Consolidated
Statement of Earnings. Realized gains and losses are calculated
based on the specific identification method.
In determining whether an other-than-temporary decline in market
value has occurred, the company considers the duration that, andextent to which, the fair value of the investment is below its cost; thefinancial condition and near-term prospects of the issuer or underlying collateral of a security; and the company’s intent and ability toretain the security in order to allow for an anticipated recovery in fairvalue. Other-than-temporary declines in fair value from amortizedcost for available-for-sale equity and debt securities that the company
intends to sell or would more likely than not be required to sell before
the expected recovery of the amortized cost basis are charged toother (income) and expense in the period in which the loss occurs.
For debt securities that the company has no intent to sell and believes
that it more likely than not will not be required to sell prior to recovery,
only the credit loss component of the impairment is recognized inother (income) and expense, while the remaining loss is recognizedin OCI. The credit loss component recognized in other (income) and
expense is identified as the amount of the principal cash flows notexpected to be received over the remaining term of the debt security
as projected using the company’s cash flow projections.

Inventories
Raw materials, work in process and finished goods are stated at thelower of average cost or market. Cash flows related to the sale ofinventories are reflected in net cash provided by operating activities
in the Consolidated Statement of Cash Flows.

Allowance for Credit Losses
Receivables are recorded concurrent with billing and shipment of a
product and/or delivery of a service to customers. A reasonableestimate of probable net losses on the value of customer receivables
is recognized by establishing an allowance for credit losses.
Notes and Accounts Receivable—TradeAn allowance for uncollectible trade receivables is estimated basedon a combination of write-off history, aging analysis and any specific,
known troubled accounts.

Notes to Consolidated Financial Statements
International Business Machines Corporation and Subsidiary Companies

Financing Receivables
Financing receivables include sales-type leases, direct financing
leases and loans. Leases are accounted for in accordance withlease accounting standards. Loan receivables are financial assets
recorded at amortized cost which approximates fair value. The company determines its allowances for credit losses on financing
receivables based on two portfolio segments: lease receivables andloan receivables. The company further segments the portfolio into
two classes: major markets and growth markets.
When calculating the allowances, the company considers its ability to mitigate a potential loss by repossessing leased equipment andby considering the current fair market value of any other collateral.
The value of the equipment is the net realizable value. The allowancefor credit losses for capital leases, installment sales and customer
loans includes an assessment of the entire balance of the capitallease or loan, including amounts not yet due. The methodologies
that the company uses to calculate its receivables reserves, which
are applied consistently to its different portfolios, are as follows:

Individually Evaluated—The company reviews all financing receivables considered at risk on a quarterly basis. The review primarily
consists of an analysis based upon current information available
about the client, such as financial statements, news reports, published credit ratings, current market-implied credit analysis, as wellas the current economic environment, collateral net of repossession
cost and prior collection history. For loans that are collateral dependent, impairment is measured using the fair value of the collateralwhen foreclosure is probable. Using this information, the company
determines the expected cash flow for the receivable and calculates
an estimate of the potential loss and the probability of loss. For
those accounts in which the loss is probable, the company records
a specific reserve.
Collectively Evaluated—The company records an unallocatedreserve that is calculated by applying a reserve rate to its different
portfolios, excluding accounts that have been specifically reserved.
This reserve rate is based upon credit rating, probability of default,
term, characteristics (lease/loan) and loss history. Factors that could
result in actual receivable losses that are materially different fromthe estimated reserve include sharp changes in the economy, or asignificant change in the economic health of a particular client that
represents a concentration in the company’s receivables portfolio.
Other Credit-Related Policies
Non-Accrual—Certain receivables for which the company hasrecorded a specific reserve may also be placed on non-accrual
status. Non-accrual assets are those receivables (impaired loans or
nonperforming leases) with specific reserves and other accounts
for which it is likely that the company will be unable to collect all
amounts due according to original terms of the lease or loan agreement. Income recognition is discontinued on these receivables. Cashcollections are first applied as a reduction to principal outstanding.
Any cash received in excess of principal payments outstanding is
recognized as interest income. Receivables may be removed from
non-accrual status, if appropriate, based upon changes in client
circumstances.

Write Off—Receivable losses are charged against the allowance
when management believes the uncollectibility of the receivable
is confirmed. Subsequent recoveries, if any, are credited to theallowance.
Past Due—The company views receivables as past due when
payment has not been received after 90 days, measured from theoriginal billing date.
Impaired Loans—As stated above, the company evaluates all financing receivables considered at-risk, including loans, for impairment
on a quarterly basis. The company considers any loan with an individually evaluated reserve as an impaired loan. Depending on thelevel of impairment, loans will also be placed on non-accrual status
as appropriate. Client loans are primarily for software and services
and are unsecured. These loans are subjected to credit analysis toevaluate the associated risk and, when deemed necessary, actions
are taken to mitigate risks in the loan agreements which include
covenants to protect against credit deterioration during the life of
the obligation.

Estimated Residual Values of Lease Assets
The recorded residual values of lease assets are estimated at the
inception of the lease to be the expected fair value of the assets at
the end of the lease term. The company periodically reassesses therealizable value of its lease residual values. Any anticipated increases
in specific future residual values are not recognized before realization through remarketing efforts. Anticipated decreases in specificfuture residual values that are considered to be other than temporary
are recognized immediately upon identification and are recorded as
an adjustment to the residual value estimate. For sales-type anddirect-financing leases, this reduction lowers the recorded net
investment and is recognized as a loss charged to financing incomein the period in which the estimate is changed, as well as an adjustment to unearned income to reduce future-period financing income.

Common Stock
Common stock refers to the $.20 par value per share capital stock
as designated in the company’s Certificate of Incorporation. Treasury stock is accounted for using the cost method. When treasury
stock is reissued, the value is computed and recorded using aweighted-average basis.

Earnings Per Share of Common Stock
Earnings per share (EPS) is computed using the two-class method.
The two-class method determines EPS for each class of common
stock and participating securities according to dividends and dividend
equivalents and their respective participation rights in undistributed
earnings. Basic EPS of common stock is computed by dividing net
income by the weighted-average number of common shares outstanding for the period. Diluted EPS of common stock is computedon 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 andconvertible notes.

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Notes to Consolidated Financial Statements
International Business Machines Corporation and Subsidiary Companies

Note B.
Accounting Changes

New Standards to be Implemented
In July 2013, the Financial Accounting Standards Board (FASB)
issued guidance regarding the presentation of an unrecognized tax
benefit when a net operating loss carryforward, a similar tax loss,
or a tax credit carryforward exists. Under certain circumstances,
unrecognized tax benefits should be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss
carryforward, a similar tax loss, or a tax credit carryforward. The
guidance was a change in financial statement presentation only andhas no material impact in the consolidated financial results. The
guidance was effective January 1, 2014, and the company will adopt
it on a prospective basis.
In March 2013, the FASB issued guidance on when foreign currency translation adjustments should be released to net income.
When a parent entity ceases to have a controlling financial interestin a subsidiary or group of assets that is a business within a foreign
entity, the parent is required to release any related cumulative translation adjustment into net income. Accordingly, the cumulativetranslation adjustment should be released into net income only if thesale or transfer results in the complete or substantially complete
liquidation of the foreign entity in which the subsidiary or group ofassets had resided. The guidance was effective January 1, 2014 on
a prospective basis. It is not expected to have a material impact in
the consolidated financial results.
In February 2013, the FASB issued guidance for the recognition,measurement and disclosure of obligations resulting from joint andseveral liability arrangements for which the total amount of the obligation within the scope of the guidance is fixed at the reporting date.
Examples include debt arrangements, other contractual obligations
and settled litigation matters. The guidance requires an entity to measure such obligations as the sum of the amount that the reporting
entity agreed to pay on the basis of its arrangement among its coobligors plus additional amounts the reporting entity expects to pay
on behalf of its co-obligors. The guidance was effective January 1,
2014 and is not expected to have a material impact in the consolidated financial results.

Standards Implemented
In July 2013, the FASB issued guidance allowing the use of the Fed
Funds Effective Swap Rate (or Overnight Index Swap Rate) as a benchmark interest rate for hedge accounting purposes in addition to interest
rates on direct Treasury obligations of the United States government
and the LIBOR. In addition, the guidance removes the restriction on
using different benchmark rates for similar hedges. The guidance
became effective on a prospective basis for qualifying new or redesignated hedging relationships entered into on or after July 17, 2013.
The company has not utilized the Fed Funds Effective Swap Rate on
any financial instrument transactions through December 31, 2013.
In February 2013, the FASB issued additional guidance regarding
reclassifications out of AOCI. The guidance requires entities to report
the effect of significant reclassifications out of AOCI on the respective
line items in net income unless the amounts are not reclassified intheir entirety to net income. For amounts that are not required to bereclassified in their entirety to net income in the same reporting period,
entities are required to cross-reference other disclosures that provide
additional detail about those amounts. For the company, the new
guidance was effective on a prospective basis for all interim andannual periods beginning January 1, 2013 with early adoption permitted. The company adopted the guidance in its December 31, 2012financial statements. There was no impact in the consolidated financial results as the guidance related only to additional disclosures.
In July 2012, the FASB issued amended guidance that simplifies
how entities test indefinite-lived intangible assets other than goodwill
for impairment. After an assessment of certain qualitative factors, if
it is determined to be more likely than not that an indefinite-lived
intangible asset is impaired, entities must perform the quantitative
impairment test. Otherwise, the quantitative test is optional. The
amended guidance was effective for annual and interim impairment
tests performed for fiscal years beginning after September 15, 2012,
with early adoption permitted. The company adopted this guidance
for its 2012 impairment testing of indefinite-lived intangible assets
performed in the fourth quarter. There was no impact in the consolidated financial results.
In May 2011, the FASB issued amended guidance and disclosure
requirements for fair value measurements. These changes wereeffective January 1, 2012 on a prospective basis. These amendments
did not have a material impact in the consolidated financial results.
In September 2011, the FASB issued additional disclosure
requirements for entities which participate in multi-employer pension
plans. The purpose of the new disclosures was to provide financial
statement users with information about an employer’s level of participation in these plans and the financial health of significant plans.
The new disclosures were effective beginning with the full year 2011financial statements. The company does not participate in any material multi-employer plans. There was no impact in the consolidated
financial results as the changes relate only to additional disclosures.

Notes to Consolidated Financial Statements
International Business Machines Corporation and Subsidiary Companies

In September 2011, the FASB issued amended guidance that
simplified how entities test goodwill for impairment. After an assessment of certain qualitative factors, if it is determined to be more likely
than not that the fair value of a reporting unit is less than its carrying
amount, entities must perform the quantitative analysis of the goodwill impairment test. Otherwise, the quantitative test(s) is optional. The
guidance was effective January 1, 2012 with early adoption permitted.
The company adopted this guidance for the 2011 goodwill impairment test. There was no impact in the consolidated financial results.
In June 2011, the FASB issued amended disclosure requirements
for the presentation of OCI and AOCI. OCI is comprised of costs,
expenses, gains and losses that are included in comprehensive
income but excluded from net income, and AOCI comprises theaggregated balances of OCI in equity. The amended guidance eliminated the option to present period changes in OCI as part of theStatement of Changes in Equity. Under the amended guidance, allperiod changes in OCI are to be presented either in a single continuous statement of comprehensive income, or in two separate, butconsecutive financial statements. Only summary totals are to be
included in the AOCI section of the Statement of Changes in Equity.
These changes were effective January 1, 2012 with early adoption
permitted. The company adopted the two statement approacheffective with its full-year 2011 financial statements. There was no
impact in the consolidated financial results as the amendments
related only to changes in financial statement presentation.
In April 2011, the FASB issued new and clarifying guidance andto help creditors in determining whether a creditor has granted aconcession, and whether a debtor is experiencing financial difficulties for purposes of determining whether a restructuring constitutes
a troubled debt restructuring. The new guidance became effective
July 1, 2011 applied retrospectively to January 1, 2011. Prospective
application was required for any new impairments identified as aresult of this guidance. These changes did not have a material
impact in the consolidated financial results.
In December 2010, the FASB issued amended guidance toclarify the acquisition date that should be used for reporting proforma financial information for business combinations. If comparative
financial statements are presented, the pro-forma revenue and earnings of the combined entity for the comparable prior reporting
period should be reported as though the acquisition date for all
business combinations that occurred during the current year had
been completed as of the beginning of the comparable prior annual
reporting period. The amendments in this guidance were effective
on a prospective basis for business combinations for which theacquisition date was on or after January 1, 2011. There was no
impact in the consolidated financial results as the amendments
related only to additional disclosures.

In December 2010, the FASB issued amendments to the guidance on goodwill impairment testing. The amendments modified
step 1 of the goodwill impairment test for reporting units with zeroor negative carrying amounts. For those reporting units, an entity isrequired to perform step 2 of the goodwill impairment test if it is more
likely than not that a goodwill impairment exists. In making that
determination, an entity should consider whether there are any
adverse qualitative factors indicating that impairment may exist. The
amendments were effective January 1, 2011 and did not have an
impact in the consolidated financial results.

Note C.
Acquisitions/Divestitures

Acquisitions
Purchase price consideration for all acquisitions, as reflectedin the tables in this note, is paid primarily in cash. All acquisitions
are reported in the Consolidated Statement of Cash Flows net ofacquired cash and cash equivalents.
2013
In 2013, the company completed 10 acquisitions at an aggregate
cost of $3,219 million.

SoftLayer Technologies, Inc. (SoftLayer)—On July 3, 2013, thecompany completed the acquisition of 100 percent of the privately
held company, SoftLayer, a cloud computing infrastructure provider
based in Dallas, Texas for cash consideration of $1,977 million. SoftLayer joins the company’s new cloud services division, which
combines SoftLayer with IBM SmartCloud into a global platform.
The new division provides a broad range of choices to the company’sclients, ISVs and channel and technology partners. Goodwill of$1,285 million has been assigned to the Global Technology Services($1,246 million) and Software ($39 million) segments. It is expectedthat none of the goodwill will be deductible for tax purposes. The
overall weighted-average useful life of the identified intangible assets
acquired is 7.0 years.
Other Acquisitions—The Software segment completed acquisitionsof eight privately held companies: in the first quarter, StoredIQ Inc.
(StoredIQ) and Star Analytics, Inc. (Star Analytics); in the second
quarter, UrbanCode Inc. (UrbanCode); and in the third quarter, Trusteer, Ltd. (Trusteer) and Daeja Image Systems, Ltd. (Daeja); and in the
fourth quarter, Xtify, Inc. (Xtify), The Now Factory and Fiberlink Communications (Fiberlink). Systems and Technology (STG) completed
one acquisition: in the third quarter, CSL International (CSL), a
privately held company. All acquisitions were for 100 percent of
the acquired companies.

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Notes to Consolidated Financial Statements
International Business Machines Corporation and Subsidiary Companies

The following table reflects the purchase price related to these acquisitions and the resulting purchase price allocations as of December 31, 2013.

2013 Acquisitions($ in millions)
Amortization
Life (in Years)

Current assets
Fixed assets/noncurrent assets

SoftLayer

Other
Acquisitions$   80$   97300

41Intangible assets
Goodwill

N/A

1,285

961

Completed technology

5—7

290

181

Client relationships

6—7

245

97

In-process R&D

N/A

2

—

Patents/trademarks

2—7

75

32

2,277

1,408

Total assets acquired
Current liabilities

(56)

(61)

Noncurrent liabilities

(244)

(105)

Total liabilities assumed

(300)

(166)

Total purchase price$1,977$1,242

N/A—Not applicable

In addition to SoftLayer, each acquisition further complemented andenhanced the company’s portfolio of product and services offerings.
The acquisition of StoredIQ advances the company’s efforts to help
clients derive value from big data. The combination of the company’s
and Star Analytics’ software will advance the company’s businessanalytics initiatives. UrbanCode automates the delivery of software,
helping businesses quickly release and update mobile, social, bigdata and cloud applications. CSL deepens the consolidation cloudcapabilities by offering simplified management of the virtualization
environment. Trusteer extends the company’s data security capabilities further into the cloud, mobile and endpoint security space. Daeja
delivers software that helps employees across all industries, especially data intensive ones such as banking, insurance and healthcare,get faster access to critical business information, and complements
the company’s big data capabilities. Xtify is a leading provider ofcloud-based mobile messaging tools that help organizations
improve mobile sales, drive in-store traffic and engage customers
with personalized offers. The Now Factory is a provider of analytics
software that helps communications service providers (CSPs)
deliver better customer experiences and drive new revenue opportunities. Fiberlink is a mobile management and security company,that supports the company’s expanding vision for enterprise mobility
management, which encompasses secure transactions between
businesses, partners, and customers.
For the “Other Acquisitions,” the overall weighted-average life of
the identified amortizable intangible assets acquired is 6.6 years.
These identified intangible assets will be amortized on a straight-line
basis over their useful lives. Goodwill of $961 million has been
assigned to the Software ($948 million) and Systems and Technology($13 million) segments. It is expected that approximately 2 percent of
the goodwill will be deductible for tax purposes.

On January 17, 2014, the company completed the acquisition ofAspera, Inc. (Aspera), a privately held company based in Emeryville,
CA. Aspera’s technology helps companies securely speed the
movement of massive data files around the world. At the date ofissuance of the financial statements, the initial purchase accounting
was not complete for this acquisition.
On February 24, 2014, the company announced that it had signed
a definitive agreement to acquire Boston, MA-based Cloudant, Inc.,(Cloudant) a privately held database-as-a-service (DBaaS) provider
that enables developers to easily and quickly create next generation
mobile and web apps. Cloudant will extend the company’s big data
and analytics, cloud, and mobile offerings by further helping clientstake advantage of these key growth initiatives. The acquisition is
expected to close in the first quarter of 2014.
2012
In 2012, the company completed 11 acquisitions at an aggregate
cost of $3,964 million.

Kenexa Corporation (Kenexa)—On December 3, 2012, the company completed the acquisition of 100 percent of Kenexa, a publicly
held company, for cash consideration of $1,351 million. Kenexa, aleading provider of recruiting and talent management solutions,brings a unique combination of cloud-based technology and consulting services that integrates both people and processes,
providing solutions to engage a smarter, more effective workforce
across their most critical businesses functions. Goodwill of $1,014
million was assigned to the Software ($771 million) and Global Technology Services (GTS) ($243 million) segments. As of the acquisitiondate, it was expected that approximately 10 percent of the goodwill
would be deductible for tax purposes. The overall weighted-average
useful life of the identified intangible assets acquired was 6.5 years.

Notes to Consolidated Financial Statements
International Business Machines Corporation and Subsidiary Companies

Other Acquisitions—The Software segment also completed eight
other acquisitions: in the first quarter, Green Hat Software Limited(Green Hat), Emptoris Inc. (Emptoris) and Worklight, Inc.
(Worklight), all privately held companies, and DemandTec, Inc.
(DemandTec), a publicly held company; in the second quarter,
Varicent Software Inc. (Varicent), Vivisimo Inc. (Vivisimo) andTealeaf Technology Inc. (Tealeaf), all privately held companies; andin the third quarter, Butterfly Software, Ltd. (Butterfly), a privately

held company. STG completed two acquisitions: in the first quarter,
Platform Computing Corporation (Platform Computing), a privately
held company; and in the third quarter, Texas Memory Systems(TMS), a privately held company. All acquisitions were for 100 percent of the acquired companies.
The table below reflects the purchase price related to theseacquisitions and the resulting purchase price allocations as ofDecember 31, 2012.

2012 Acquisitions($ in millions)
Amortization
Life (in Years)

Current assets
Fixed assets/noncurrent assets

KenexaOther
Acquisitions$   133$  27898

217

Intangible assets
Goodwill

N/A

1,014

1,880

Completed technology

3—7

169

403

Client relationships

4—7

179

194

In-process R&D

N/A

—

11

Patents/trademarks

1—7

39

37

1,632

3,020

Current liabilities

(93)

(143)

Noncurrent liabilities

(188)

(264)

Total liabilities assumed

(281)

(407)

Total purchase price$1,351$2,613

Total assets acquired

N/A—Not applicable

Each acquisition further complemented and enhanced the company’s portfolio of product and services offerings. Green Hat helps
customers improve the quality of software applications by enabling
developers to use cloud computing technologies to conduct testingof a software application prior to its delivery. Emptoris expands thecompany’s cloud-based analytics offerings that provide supply chain
intelligence leading to better inventory management and cost efficiencies. Worklight delivers mobile application management capabilities
to clients across a wide range of industries. The acquisition enhanced
the company’s comprehensive mobile portfolio, which is designed tohelp global corporations leverage the proliferation of all mobile
devices—from laptops and smartphones to tablets. DemandTecdelivers cloud-based analytics software to help organizations improvetheir price, promotion and product mix within the broad context ofenterprise commerce. Varicent’s software automates and analyzes
data across sales, finance, human resources and IT departments touncover trends and optimize sales performance and operations. Vivisimo software automates the discovery of big data, regardless of its
format or where it resides, providing decision makers with a view of

key business information necessary to drive new initiatives. Tealeaf
provides a full suite of customer experience management software,
which analyzes interactions on websites and mobile devices. Butterfly
offers storage planning software and storage migration tools, helping
companies save storage space, operational time, IT budget andpower consumption. Platform Computing’s focused technical anddistributed computing management software helps clients create,
integrate and manage shared computing environments that are usedin compute-and-data intensive applications such as simulations,computer modeling and analytics. TMS designs and sells highperformance solid state storage solutions.
For the “Other Acquisitions,” the overall weighted-average life of
the identified amortizable intangible assets acquired is 6.6 years.
These identified intangible assets will be amortized on a straight-line
basis over their useful lives. Goodwill of $1,880 million was assigned
to the Software ($1,412 million), Global Business Services (GBS)($5 million), GTS ($21 million) and STG ($443 million) segments.
As of the acquisition dates, it was expected that approximately
15 percent of the goodwill would be deductible for tax purposes.

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Notes to Consolidated Financial Statements
International Business Machines Corporation and Subsidiary Companies

2011
In 2011, the company completed five acquisitions of privately heldcompanies at an aggregate cost of $1,849 million.
These acquisitions were completed as follows: in the second
quarter, TRIRIGA, Inc. (TRIRIGA); and in the fourth quarter, i2, Algorithmics, Inc. (Algorithmics), Q1 Labs and Curam Software Ltd.
(Curam Software). TRIRIGA was integrated into the Software and
GBS segments upon acquisition. All acquisitions were integrated
into the Software segment upon acquisition. All acquisitions
reflected 100 percent ownership of the acquired companies.
TRIRIGA is a provider of facility and real estate management software solutions, which help clients make strategic decisions regarding
space usage, evaluate alternative real estate initiatives, generatehigher returns from capital projects and assess environmental impact
investments. The acquisition added advanced real estate intelligenceto the company’s smarter buildings initiative. i2 expanded the company’s Big Data analytics software for Smarter Cities by helping bothpublic and private entities in government, law enforcement, retail,insurance and other industries access and analyze information theyneed to address crime, fraud and security threats. Algorithmics provides software and services for improved business insights atfinancial and insurance institutions to assess risk and address regulatory challenges. Q1 Labs is a provider of security intelligence softwareand accelerates efforts to help clients more intelligently secure theirenterprises by applying analytics to correlate information from key
security domains and creating security dashboards for their organizations. Curam Software is a provider of software and services which
help governments improve the efficiency, effectiveness and accessibility of social programs for Smarter Cities.
The overall weighted-average life of the indentified intangible
assets acquired was 6.9 years. These identified intangible assets
will be amortized on a straight-line basis over their useful lives.
Goodwill of $1,291 million was assigned to the Software ($1,277 million) and GBS ($14 million) segments. As of the acquisition dates, it
was expected that approximately 25 percent of the goodwill would
be deductible for tax purposes.
The following table reflects the purchase price related to theseacquisitions and the resulting purchase price allocations as ofDecember 31, 2011.

2011 Acquisitions($ in millions)
Amortization
Life (in Years)

Current assets

Total
Acquisitions$  251

Fixed assets/noncurrent assets

88

Intangible assets
N/A

1,291

Completed technology

7

320

Client relationships

7

222

Patents/trademarks

1—7

Goodwill

17

Total assets acquired

2,190

Current liabilities(191)

Noncurrent liabilities(150)

Total liabilities assumed(341)

Total purchase price$1,849N/A—Not applicable

Divestitures

2014
On January 23, 2014, IBM and Lenovo Group Limited (Lenovo)
announced a definitive agreement in which Lenovo will acquire thecompany’s x86 server portfolio for $2.3 billion, consisting of approximately $2 billion in cash, with the balance in Lenovo stock. The stock
will represent less than 5 percent equity ownership in Lenovo. The
company will sell to Lenovo its System x, BladeCenter and Flex
System blade servers and switches, x86-based Flex integrated systems, NeXtScale and iDataPlex servers and associated software,
blade networking and maintenance operations.
IBM and Lenovo plan to enter into a strategic relationship which
will include a global OEM and reseller agreement for sales of IBM’s
industry-leading entry and midrange Storwize disk storage systems,
tape storage systems, General Parallel File System software, SmartCloud Entry offering, and elements of IBM’s system software,
including Systems Director and Platform Computing solutions. Following the closing of the transaction, Lenovo will assume related
customer service and maintenance operations. IBM will continue toprovide maintenance delivery on Lenovo’s behalf for an extended
period of time.
The transaction will be completed as soon as is practical, subject
to the satisfaction of regulatory requirements, customary closing
conditions and any other required approvals. The transaction is
expected to be completed in phases, with the initial closing in thesecond half of 2014. Subsequent local closings will occur subject tosimilar conditions, agreements and the information and consultation
process in applicable countries.
The company expects to recognize a pre-tax gain on the sale.
This gain will be recognized consistent with the closing schedule forthe transaction. The exact amount of the gain and the breakdown
by closing date is not yet determinable. The variables that can
impact the final gain include the valuation of the final balance sheettransferred, the valuation of other related agreements and transaction-related expenses. See “Looking Forward” on page 64 foradditional information.

Notes to Consolidated Financial Statements
International Business Machines Corporation and Subsidiary Companies

The company’s worldwide x86 business is reported in the Systems
and Technology segment, and the associated maintenance operations are part of the Global Technology Services segment. In 2013,
this combined business delivered approximately $4.6 billion ofrevenue, and was essentially breakeven on a pre-tax income basis.
2013
On September 10, 2013, IBM and SYNNEX announced a definitive
agreement in which SYNNEX will acquire the company’s worldwide
customer care business process outsourcing services business for$505 million, consisting of approximately $430 million in cash, netof balance sheet adjustments, and $75 million in SYNNEX stock,which represents less than 5 percent equity ownership in SYNNEX.
As part of the transaction, SYNNEX will enter into a multi-year agreement with the company, and Concentrix, SYNNEX’s outsourcing
business, will become an IBM strategic business partner for global
customer care business process outsourcing services.
The transaction will be completed in phases—the initial closing
was completed on January 31, 2014, with subsequent closings
expected to be completed in the second quarter of 2014, subject tocustomary closing conditions, local agreements and the informationand consultation process in applicable countries. The company
expects to recognize a total pre-tax gain on the sale of between$150 - $175 million. This gain will be recognized consistent with theclosing schedule for the transaction. The company’s worldwide
customer care business process outsourcing services and industry
process services are included in the Global Technology Services
segment. In 2013, the divested business delivered $1.3 billion of revenue, approximately 1 percent of the company’s total revenue,
approximately $0.1 billion of pre-tax income, and had approximately$50 million in tangible assets.
In the first quarter of 2013, the company completed the divestiture of its Showcase Reporting product set to Help/Systems.
Showcase Reporting, which was acquired by the company throughthe SPSS acquisition in 2009, is an enterprise-class business intelligence platform that enables customers to build and manage
analytical reporting environments.
In the fourth quarter of 2013, the company completed two divestitures, the Applicazioni Contabili Gestionali (ACG) business and the
Cognos Application Development Tools (ADT) business.
The ACG business was purchased by TeamSystem. The ACG
product is an Italian Enterprise Resource Planning solution for smalland medium-sized companies. The Cognos ADT business waspurchased by UNICOM Systems, Inc. The Cognos ADT productsuite represents a legacy family of products that provide application
development environments that would enable programmers todevelop COBOL applications at a higher productivity level.
Financial terms of each transaction were not disclosed and did nothave a material impact in the consolidated financial results.

2012
On April 17, 2012, the company announced that it had signed adefinitive agreement with Toshiba TEC for the sale of its Retail Store
Solutions business to Toshiba TEC. As part of the transaction,
Toshiba TEC and the company also signed a multi-year business
partner agreement to integrate retail store solutions for Smarter
Commerce. The transaction price was $850 million, and the company received approximately $800 million in cash, net of closing dateworking capital adjustments.
Through December 31, 2012, the company completed the first
three phases of the sale. For the completed phases, the company
received net proceeds of $546 million, recorded a note receivableof $251 million and recognized a net pre-tax gain of $446 million.
The gain was net of the fair value of certain contractual terms, certain transaction costs and the assets and liabilities sold. The gain
was recorded in other (income) and expense in the Consolidated
Statement of Earnings and the net proceeds are reflected within
divestitures of businesses, net of cash transferred within cash flows
from investing activities in the Consolidated Statement of Cash
Flows. In addition, in the third quarter, the company acquired a 19.9
percent ownership interest for $161 million in Toshiba Global Commerce Solutions Holding Corporation, the new holding company
that Toshiba TEC established for the business. The company willretain this ownership for a period of three years at which time
Toshiba TEC will purchase the company’s equity interest for the
initial acquisition value. This investment was recorded in investments
and sundry assets in the Consolidated Statement of Financial Position and the payment was reflected within purchases of marketablesecurities and other investments within cash flows from investing
activities in the Consolidated Statement of Cash Flows.
The company closed additional phases of the divestiture in 2013.
Overall, the company has recognized a pre-tax gain on the sale of$463 million through December 31, 2013.
2011
During the fourth quarter of 2011, the company completed the divestiture of the iCluster business to Rocket Software. iCluster, which
was acquired in the Data Mirror acquisition in 2007, was part of the
Software business. This transaction was not material to the consolidated financial results.
During the second quarter of 2011, the company completed twodivestitures related to subsidiaries of IBM Japan. The impact of thesetransactions was not material to the consolidated financial results.

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Notes to Consolidated Financial Statements
International Business Machines Corporation and Subsidiary Companies

Note D.
Financial Instruments

Fair Value Measurements
Financial Assets and Liabilities Measured at Fair Value on a Recurring Basis
The following tables present the company’s financial assets and financial liabilities that are measured at fair value on a recurring basis at
December 31, 2013 and 2012.
($ in millions)
At December 31, 2013:

Level 1

Level 2

Level 3Total$    —$4,754$—$4,754

—

1,507

—

1,507

1,728

—

—

1,728

—

8

—

8

1,728

6,269

—

7,997(6)

—

350

—

350(6)

AssetsCash equivalents (1)Time deposits and certificates of deposit
Commercial paper
Money market funds
Other securities
Total
Debt securities—current (2)

1

7

—

9

18

—

—

18

Interest rate contracts

—

308

—

308

Foreign exchange contracts

—

375

—

375

Equity contracts

—

36

—

36

—

719

—

719 (7)$1,747$7,345$—$9,092 (7)Interest rate contracts$    —$     13$—$   13Foreign exchange contracts    —     484

—

  484

—

4

—

4

$    —$   501$—$  501 (7)Debt securities—noncurrent(3)

Available-for-sale equity investments (3)Derivative assets (4)Total
Total assets
Liabilities
Derivative liabilities (5)Equity contracts
Total liabilities(1)	Included within cash and cash equivalents in the Consolidated Statement of Financial Position.
(2)	C ommercial paper reported as marketable securities in the Consolidated Statement of Financial Position.
(3)	Included within investments and sundry assets in the Consolidated Statement of Financial Position.

(4)	The gross balances of derivative assets contained within prepaid expenses and other current assets, and investments in sundry assets in the Consolidated Statement of Financial

Position at December 31, 2013 were $318 million and $401 million, respectively.
(5)	T he gross balances of derivative liabilities contained within other accrued expenses and liabilities, and other liabilities in the Consolidated Statement of Financial Position

at December 31, 2013 were $375 million and $126 million, respectively.
(6)	Available-for-sale securities with carrying values that approximate fair value.
(7)	If derivative exposures covered by a qualifying master netting agreement had been netted in the Consolidated Statement of Financial Position, the total derivative asset and liability

positions would have been reduced by $251 million each.

Notes to Consolidated Financial Statements
International Business Machines Corporation and Subsidiary Companies($ in millions)
At December 31, 2012:

Level 1

Level 2

Level 3Total$    —$3,694$—$3,694

—

2,098

—

2,098

1,923

—

—

1,923

—

30

—

30

1,923

5,823

—

7,746(6)Debt securities—current (2)

—

717

—

717(6)

Debt securities—noncurrent (3)

2

8

—

10

Available-for-sale equity investments (3)

34

—

—

34

Interest rate contracts

—

604

—

604

Foreign exchange contracts

—

305

—

305

Equity contracts

—

9

—

9

—

918

—

918 (7)$1,959$7,466$—$9,424 (7)$    —$   496$—$  496—

7—

7$    —$   503$—$  503 (7)AssetsCash equivalents (1)Time deposits and certificates of deposit
Commercial paper
Money market funds
Other securities
Total

Derivative assets (4)Total
Total assets
Liabilities
Derivative liabilities (5)Foreign exchange contracts
Equity contracts
Total liabilities(1)	Included within cash and cash equivalents in the Consolidated Statement of Financial Position.

(2)	C ommercial paper and certificates of deposit reported as marketable securities in the Consolidated Statement of Financial Position.
(3)	Included within investments and sundry assets in the Consolidated Statement of Financial Position.
(4)	The gross balances of derivative assets contained within prepaid expenses and other current assets, and investments in sundry assets in the Consolidated Statement of Financial

Position at December 31, 2012 were $333 million and $585 million, respectively.
(5)	T he gross balances of derivative liabilities contained within other accrued expenses and liabilities, and other liabilities in the Consolidated Statement of Financial Position

at December 31, 2012 were $426 million and $78 million, respectively.
(6)	Available-for-sale securities with carrying values that approximate fair value.
(7)	If derivative exposures covered by a qualifying master netting agreement had been netted in the Consolidated Statement of Financial Position, the total derivative asset and liability

positions would have been reduced by $262 million each.

There were no transfers between Levels 1 and 2 for the years ended
December 31, 2013 and 2012.
Financial Assets and Liabilities Not Measured at Fair Value
Short-Term Receivables and Payables
Notes and other accounts receivable and other investments arefinancial assets with carrying values that approximate fair value.
Accounts payable, other accrued expenses and short-term debt
(excluding the current portion of long-term debt) are financial liabilities with carrying values that approximate fair value. If measured
at fair value in the financial statements, these financial instruments
would be classified as Level 3 in the fair value hierarchy.

Loans and Long-Term Receivables
Fair values are based on discounted future cash flows using current interest rates offered for similar loans to clients with similar
credit ratings for the same remaining maturities. At December 31,
2013 and 2012, the difference between the carrying amount andestimated fair value for loans and long-term receivables was
immaterial. If measured at fair value in the financial statements,
these financial instruments would be classified as Level 3 in thefair value hierarchy.

Long-Term Debt
Fair value of publicly traded long-term debt is based on quoted
market prices for the identical liability when traded as an asset inan active market. For other long-term debt for which a quoted
market price is not available, an expected present value techniquethat uses rates currently available to the company for debt withsimilar terms and remaining maturities is used to estimate fair value.
The carrying amount of long-term debt is $32,856 million and$24,088 million and the estimated fair value is $34,555 million and$27,119 million at December 31, 2013 and 2012, respectively. If measured at fair value in the financial statements, long-term debt(including the current portion) would be classified as Level 2 in thefair value hierarchy.

Debt and Marketable Equity Securities
The company’s cash equivalents and current debt securities are
considered available-for-sale and recorded at fair value, which is notmaterially different from carrying value, in the Consolidated Statementof Financial Position. The tables on the following page summarize
the company’s noncurrent debt and marketable equity securities
which are also considered available-for-sale and recorded at fairvalue in the Consolidated Statement of Financial Position.

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Notes to Consolidated Financial Statements
International Business Machines Corporation and Subsidiary Companies($ in millions)
Adjusted
Cost

Gross
Unrealized
Gains

Gross
Unrealized
LossesFair
Value

Debt securities—noncurrent (1)

$ 7

$1

$—

$ 9

Available-for-sale equity investments (1)

$20

$2

$   4

$18

Adjusted
Cost

Gross
Unrealized
Gains

Gross
Unrealized
LossesFair
Value

Debt securities—noncurrent (1)

$ 8

$2

$—

$10

Available-for-sale equity investments (1)

$31

$4

$ 1

$34

At December 31, 2013:(1)	Included within investments and sundry assets in the Consolidated Statement of Financial Position.

($ in millions)

At December 31, 2012:(1)	Included within investments and sundry assets in the Consolidated Statement of Financial Position.

Based on an evaluation of available evidence as of December 31,
2013, the company believes that unrealized losses on debt andavailable-for-sale equity securities are temporary and do not represent an other-than-temporary impairment.
Sales of debt and available-for-sale equity investments during theperiod were as follows:($ in millions)
For the year ended December 31:

2013

2012

2011

Proceeds

$41

$112

$405

Gross realized gains (before taxes)

13

45

232

Gross realized losses (before taxes)

5

1

0

The after-tax net unrealized gains/(losses) on available-for-sale debt
and equity securities that have been included in other comprehensive income/(loss) and the after-tax net (gains)/losses reclassified
from accumulated other comprehensive income/(loss) to net income
were as follows:($ in millions)
For the year ended December 31:

2013

2012

Net unrealized gains/(losses)
arising during the period

$0

$ 17

Net unrealized (gains)/losses
reclassified to net income*

(5)

(25)

* Includes writedowns of $2.0 million in 2012.

The contractual maturities of substantially all available-for-sale debt
securities are less than one year at December 31, 2013.

Derivative Financial Instruments
The company operates in multiple functional currencies and is asignificant lender and borrower in the global markets. In the normal
course of business, the company is exposed to the impact of interest rate changes and foreign currency fluctuations, and to a lesser
extent equity and commodity price changes and client credit risk.
The company limits these risks by following established risk management policies and procedures, including the use of derivatives,
and, where cost effective, financing with debt in the currencies inwhich assets are denominated. For interest rate exposures, derivatives are used to better align rate movements between the interest
rates associated with the company’s lease and other financial assets
and the interest rates associated with its financing debt. Derivatives
are also used to manage the related cost of debt. For foreign currency exposures, derivatives are used to better manage the cash
flow volatility arising from foreign exchange rate fluctuations.
As a result of the use of derivative instruments, the company is
exposed to the risk that counterparties to derivative contracts will failto meet their contractual obligations. To mitigate the counterparty
credit risk, the company has a policy of only entering into contracts
with carefully selected major financial institutions based upon theiroverall credit profile. The company’s established policies and procedures for mitigating credit risk on principal transactions include
reviewing and establishing limits for credit exposure and continuallyassessing the creditworthiness of counterparties. The right of set-off
that exists under certain of these arrangements enables the legal
entities of the company subject to the arrangement to net amounts
due to and from the counterparty reducing the maximum loss fromcredit risk in the event of counterparty default.

Notes to Consolidated Financial Statements
International Business Machines Corporation and Subsidiary Companies

The company is also a party to collateral security arrangementswith most of its major derivative counterparties. These arrangements require the company to hold or post collateral (cash or U.S.
Treasury securities) when the derivative fair values exceed contractually established thresholds. Posting thresholds can be fixed or
can vary based on credit default swap pricing or credit ratingsreceived from the major credit agencies. The aggregate fair valueof all derivative instruments under these collateralized arrangementsthat were in a liability position at December 31, 2013 and 2012 was$216 million and $94 million, respectively, for which no collateral
was posted at either date. Full collateralization of these agreements
would be required in the event that the company’s credit rating falls
below investment grade or if its credit default swap spread exceeds
250 basis points, as applicable, pursuant to the terms of the collateral security arrangements. The aggregate fair value of derivative
instruments in net asset positions as of December 31, 2013 and2012 was $719 million and $918 million, respectively. This amountrepresents the maximum exposure to loss at the reporting date asa result of the counterparties failing to perform as contracted. This
exposure was reduced by $251 million and $262 million at December 31, 2013 and 2012, respectively, of liabilities included in masternetting arrangements with those counterparties. Additionally, at
December 31, 2013 and 2012, this exposure was reduced by $29
million and $69 million of cash collateral, respectively, received by
the company. At December 31, 2013 and 2012, the net exposure
related to derivative assets recorded in the Statement of Financial
Position was $439 million and $587 million, respectively. At December 31, 2013 and 2012, the net amount related to derivative liabilities
recorded in the Statement of Financial Position was $250 million
and $242 million, respectively.
In the Consolidated Statement of Financial Position, the company
does not offset derivative assets against liabilities in master netting
arrangements nor does it offset receivables or payables recognized
upon payment or receipt of cash collateral against the fair values of
the related derivative instruments. No amount was recognized inother receivables at December 31, 2013 and 2012 for the right toreclaim cash collateral. The amount recognized in accounts payablefor the obligation to return cash collateral totaled $29 million and$69 million at December 31, 2013 and 2012, respectively. The company restricts the use of cash collateral received to rehypothecation,and therefore reports it in prepaid expenses and other current
assets in the Consolidated Statement of Financial Position. No
amount was rehypothecated at December 31, 2013 and 2012. At
December 31, 2013 and 2012 the company held $0 million and $31
million in non-cash collateral in U.S. Treasury securities. Per accounting guidance, non-cash collateral is not recorded on the Statementof Financial Position.

The company may employ derivative instruments to hedge thevolatility in stockholders’ equity resulting from changes in currency
exchange rates of significant foreign subsidiaries of the company
with respect to the U.S. dollar. These instruments, designated as
net investment hedges, expose the company to liquidity risk as thederivatives have an immediate cash flow impact upon maturity
which is not offset by a cash flow from the translation of the underlying hedged equity. The company monitors this cash loss potential
on an ongoing basis, and may discontinue some of these hedging
relationships by de-designating or terminating the derivative instrument in order to manage the liquidity risk. Although not designatedas accounting hedges, the company may utilize derivatives to offset
the changes in the fair value of the de-designated instruments fromthe date of de-designation until maturity.
In its hedging programs, the company uses forward contracts,
futures contracts, interest-rate swaps and cross-currency swaps,
depending upon the underlying exposure. The company is not a
party to leveraged derivative instruments.
A brief description of the major hedging programs, categorized
by underlying risk, follows.

Interest Rate Risk

Fixed and Variable Rate Borrowings
The company issues debt in the global capital markets, principally
to fund its financing lease and loan portfolio. Access to cost-effective financing can result in interest rate mismatches with theunderlying assets. To manage these mismatches and to reduceoverall interest cost, the company uses interest rate swaps to convert specific fixed-rate debt issuances into variable-rate debt (i.e.,fair value hedges) and to convert specific variable-rate debt issuances into fixed-rate debt (i.e., cash flow hedges). At December 31,
2013 and 2012, the total notional amount of the company’s interest
rate swaps was $3.1 billion and $4.3 billion, respectively. The
weighted-average remaining maturity of these instruments at
December 31, 2013 and 2012 was approximately 10.6 years and
5.1 years, respectively.
Forecasted Debt Issuance
The company is exposed to interest rate volatility on future debt
issuances. To manage this risk, the company may use forwardstarting interest rate swaps to lock in the rate on the interest
payments related to the forecasted debt issuance. These swaps
are accounted for as cash flow hedges. The company did not haveany derivative instruments relating to this program outstanding at
December 31, 2013 and 2012.
At December 31, 2013 and 2012, net gains of approximately$1 million (before taxes), respectively, were recorded in AOCI inconnection with cash flow hedges of the company’s borrowings.
Within these amounts, less than $1 million of gains, respectively,
are expected to be reclassified to net income within the next 12months, providing an offsetting economic impact against theunderlying transactions.

103

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Notes to Consolidated Financial Statements
International Business Machines Corporation and Subsidiary Companies

Foreign Exchange Risk

Long-Term Investments in Foreign Subsidiaries(Net Investment)
A large portion of the company’s foreign currency denominated debt
portfolio is designated as a hedge of net investment in foreign subsidiaries to reduce the volatility in stockholders’ equity caused bychanges in foreign currency exchange rates in the functional currency of major foreign subsidiaries with respect to the U.S. dollar.
The company also uses cross-currency swaps and foreignexchange forward contracts for this risk management purpose. At
December 31, 2013 and 2012, the total notional amount of derivative
instruments designated as net investment hedges was $3.0 billion
and $3.3 billion, respectively. The weighted-average remaining maturity of these instruments at December 31, 2013 and 2012 wasapproximately 0.4 years for both periods.
Anticipated Royalties and Cost Transactions
The company’s operations generate significant nonfunctional currency, third-party vendor payments and intercompany payments forroyalties and goods and services among the company’s non-U.S.
subsidiaries and with the parent company. In anticipation of these
foreign currency cash flows and in view of the volatility of the currency markets, the company selectively employs foreign exchange
forward contracts to manage its currency risk. These forward contracts are accounted for as cash flow hedges. The maximum lengthof time over which the company is hedging its exposure to the variability in future cash flows is four years. At December 31, 2013 and2012, the total notional amount of forward contracts designated as
cash flow hedges of forecasted royalty and cost transactions was$10.2 billion and $10.7 billion, respectively, with a weighted-averageremaining maturity of 0.7 years at both year-end dates.
At December 31, 2013 and 2012, in connection with cash flow
hedges of anticipated royalties and cost transactions, the company
recorded net losses of $252 million and $138 million (before taxes),
respectively, in AOCI. Within these amounts $166 million and $79
million of losses, respectively, are expected to be reclassified to net
income within the next 12 months, providing an offsetting economic
impact against the underlying anticipated transactions.
Foreign Currency Denominated Borrowings
The company is exposed to exchange rate volatility on foreign currency denominated debt. To manage this risk, the company employs
cross-currency swaps to convert fixed-rate foreign currency denominated debt to fixed-rate debt denominated in the functional currencyof the borrowing entity. These swaps are accounted for as cash flow
hedges. The maximum length of time over which the company
hedges its exposure to the variability in future cash flows is approximately seven years. At December 31, 2013 the total notional amountof cross currency swaps designated as cash flow hedges of foreign
currency denominated debt was $1.2 billion. At December 31, 2012,no instruments relating to this program were outstanding.

At December 31, 2013, in connection with cash flow hedges offoreign currency denominated borrowings, the company recorded
net losses of $9 million (before taxes) in AOCI. Within this amount,$3 million of losses is expected to be reclassified to net income
within the next 12 months, providing an offsetting economic impact
against the underlying exposure.
Subsidiary Cash and Foreign Currency
Asset/Liability Management
The company uses its Global Treasury Centers to manage the cashof its subsidiaries. These centers principally use currency swaps toconvert cash flows in a cost-effective manner. In addition, the company uses foreign exchange forward contracts to economicallyhedge, on a net basis, the foreign currency exposure of a portion of
the company’s nonfunctional currency assets and liabilities. The
terms of these forward and swap contracts are generally less than
one year. The changes in the fair values of these contracts and of
the underlying hedged exposures are generally offsetting and arerecorded in other (income) and expense in the Consolidated Statement of Earnings. At December 31, 2013 and 2012, the total notionalamount of derivative instruments in economic hedges of foreign
currency exposure was $14.7 billion and $12.9 billion, respectively.

Equity Risk Management
The company is exposed to market price changes in certain broad
market indices and in the company’s own stock primarily related tocertain obligations to employees. Changes in the overall value ofthese employee compensation obligations are recorded in SG&A
expense in the Consolidated Statement of Earnings. Although notdesignated as accounting hedges, the company utilizes derivatives,
including equity swaps and futures, to economically hedge the exposures related to its employee compensation obligations. The
derivatives are linked to the total return on certain broad market
indices or the total return on the company’s common stock. They
are recorded at fair value with gains or losses also reported in SG&A
expense in the Consolidated Statement of Earnings. At December
31, 2013 and 2012, the total notional amount of derivative instrumentsin economic hedges of these compensation obligations was $1.3
billion and $1.2 billion, respectively.

Other Risks
The company may hold warrants to purchase shares of common
stock in connection with various investments that are deemed derivatives because they contain net share or net cash settlement
provisions. The company records the changes in the fair value ofthese warrants in other (income) and expense in the Consolidated
Statement of Earnings. The company did not have any warrants
qualifying as derivatives outstanding at December 31, 2013 and 2012.
The company is exposed to a potential loss if a client fails to pay
amounts due under contractual terms. The company utilizes credit
default swaps to economically hedge its credit exposures. These
derivatives have terms of one year or less. The swaps are recorded
at fair value with gains and losses reported in other (income) and
expense in the Consolidated Statement of Earnings. The company
did not have any derivative instruments relating to this program outstanding at December 31, 2013 and 2012.

Notes to Consolidated Financial Statements
International Business Machines Corporation and Subsidiary Companies

The following tables provide a quantitative summary of the derivative and non-derivative instrument-related risk management activity as ofDecember 31, 2013 and 2012 as well as for the years ended December 31, 2013, 2012 and 2011, respectively.

Fair Values of Derivative Instruments in the Consolidated Statement of Financial Position($ in millions)
Fair Value of Derivative Assets

At December 31:

Balance
SheetClassification

2013

Fair Value of Derivative Liabilities

2012

Balance
SheetClassification

2013

2012

Other accrued
expensesand liabilities$    0$    —

Designated as hedging instruments:
Prepaid expenses
and othercurrent assets

$ —

$ 47

Investments andsundry assets

308

557

Other liabilities

13

—

135

Other accrued
expensesand liabilities

331

267

5

Other
liabilities

112

78

$744

Fair value ofderivative liabilities$   456$   345$142

Other accrued
expensesand liabilities$   40$   152

23

Otherliabilities

1

—

9

Other accrued
expensesand liabilities

4

7

$197

$174

Fair value ofderivative liabilities$   45$   159

Short-term debt

N/A

N/A

$   190$   578

Long-term debt

N/A

N/A

$6,111$3,035$719$918$6,802$4,116

Interest rate contracts

Foreign exchange contracts

Prepaid expenses
and othercurrent assets
Investments andsundry assets
Fair value ofderivative assets

187
26
$522

Not designated as hedging instruments:

Foreign exchange contracts

Prepaid expenses
and othercurrent assets
Investments andsundry assets

Equity contracts

Prepaid expenses
and othercurrent assets
Fair value ofderivative assets

$ 94
67

36

Total debt designated as hedging instruments

Total
N/A—Not applicable

105

106

Notes to Consolidated Financial Statements
International Business Machines Corporation and Subsidiary Companies

The Effect of Derivative Instruments in the Consolidated Statement of Earnings($ in millions)
Gain/(Loss) Recognized in Earnings
Consolidated
Statement ofEarnings
Line Item
For the year ended December 31:

Recognized on Derivatives(1)Attributable to Risk Being Hedged(2)

2013

2012

2011

2013

2012

2011

Cost of financing$(109)

$  65

$ 271

$202

$  59

$(117)

Interest expense

(74)

55

205

138

50

(89)

Foreign exchange contracts

Other (income)and expense

(328)

(311)

352

N/A

N/A

N/A

Equity contracts

SG&A expense

164

110

42

N/A

N/A

N/A

Warrants

Other (income)and expense

Derivative instruments in fair value hedges
Interest rate contracts
Derivative instruments not designatedas hedging instruments (1)

Total

—

—

10

N/A

N/A

N/A

$(347)$ (81)

$ 880

$340

$108

$(206)($ in millions)
Gain/(Loss) Recognized in Earnings and Other Comprehensive Income
Consolidated
Statement ofEarnings
Line Item

Effective Portion Recognized in OCI
For the year ended December 31:

2013

2012

2011

$  —

$   —

$   —
(266)

Effective Portion
Reclassified from AOCI

Ineffectiveness and Amounts
Excluded from Effectiveness Testing(3)

2013

2012

2011

2013

2012

2011

Interest expense$   —$   (6)$  (8)

$—

$—

$   —

Other (income)and expense

162

237

(247)

(0)

3

(3)

Cost of sales

(34)

7

(182)

—

—

—

SG&A expense

39

16

(74)

—

—

—

Derivative instruments in cash flow hedges
Interest rate contracts
Foreign exchange contracts

43

32

Instruments in net investment hedges(4)Foreign exchange contracts
Total

173

(26)

45

$216

$     6$(221)

Interest expense

—

—

0

3

11

(9)

$167

$253

$(511)

$  3

$14

$(12)

(1)	The amount includes changes in clean fair values of the derivative instruments in fair value hedging relationships and the periodic accrual for coupon payments required underthese derivative contracts.
(2)	The amount includes basis adjustments to the carrying value of the hedged item recorded during the period and amortization of basis adjustments recorded on de-designatedhedging relationships during the period.
(3) The amount of gain/(loss) recognized in income represents ineffectiveness on hedge relationships.
(4)	Instruments in net investment hedges include derivative and non-derivative instruments.

N/A—Not applicable

For the 12 months ending December 31, 2013, 2012 and 2011, there
were no significant gains or losses recognized in earnings representing hedge ineffectiveness or excluded from the assessment ofhedge effectiveness (for fair value hedges), or associated with anunderlying exposure that did not or was not expected to occur (forcash flow hedges); nor are there any anticipated in the normal
course of business.

Refer to note A, “Significant Accounting Policies,” on pages 90
and 91 for additional information on the company’s use of derivative
financial instruments.

Notes to Consolidated Financial Statements
International Business Machines Corporation and Subsidiary Companies

Note E.
Inventories($ in millions)
At December 31:

2013

2012

Finished goods$  444$  475Work in process and raw materials

1,866

1,812

Total

$2,310$2,287Note F.
Financing Receivables
The following table presents financing receivables, net of allowances
for credit losses, including residual values.
($ in millions)
At December 31:

2013

2012

Financing Receivables by Portfolio Segment

Current
Net investment in sales-typeand direct financing leases$ 4,004$ 3,862

Commercial financing receivables

8,541

7,750

Client loan receivables

5,854

5,395

Installment payment receivables

1,389

1,031

$19,787$18,038$ 5,700$ 6,107

—

5

6,360

5,966

695

733

$12,755$12,812

Total
Noncurrent
Net investment in sales-typeand direct financing leases
Commercial financing receivables
Client loan receivables
Installment payment receivables
Total

Installment payment receivables, net of allowance for credit
losses of $41 million and $39 million at December 31, 2013 and2012, respectively, are loans that are provided primarily to clients
to finance hardware, software and services ranging generally from
one to three years.
Client loan receivables and installment payment receivables
financing contracts are priced independently at competitive market
rates. The company has a history of enforcing the terms of theseseparate financing agreements.
The company utilizes certain of its financing receivables as collateral for nonrecourse borrowings. Financing receivables pledged
as collateral for borrowings were $769 million and $650 million at
December 31, 2013 and 2012, respectively. These borrowings areincluded in note J, “Borrowings,” on pages 112 to 114.
The company did not have any financing receivables held forsale as of December 31, 2013 and 2012.

Net investment in sales-type and direct financing leases relates
principally to the company’s systems products and are for terms
ranging generally from two to six years. Net investment in sales-typeand direct financing leases includes unguaranteed residual valuesof $737 million and $794 million at December 31, 2013 and 2012,
respectively, and is reflected net of unearned income of $672 million
and $728 million, and net of the allowance for credit losses of $123
million and $114 million at those dates, respectively. Scheduled
maturities of minimum lease payments outstanding at December
31, 2013, expressed as a percentage of the total, are approximately:
2014, 44 percent; 2015, 30 percent; 2016, 17 percent; 2017, 6 percent; and 2018 and beyond, 3 percent.
Commercial financing receivables, net of allowance for credit
losses of $23 million and $46 million at December 31, 2013 and 2012,
respectively, relate primarily to inventory and accounts receivablefinancing for dealers and remarketers of IBM and OEM products.
Payment terms for inventory and accounts receivable financing generally range from 30 to 90 days.
Client loan receivables, net of allowance for credit losses of $201
million and $155 million at December 31, 2013 and 2012, respectively,
are loans that are provided primarily to clients to finance the purchase of software and services. Separate contractual relationships
on these financing arrangements are for terms ranging generally
from one to seven years.

The following tables present financing receivables on a gross basis,
excluding the allowance for credit losses and residual value, by portfolio segment and by class, excluding current commercial financing
receivables and other miscellaneous current financing receivables
at December 31, 2013 and 2012. The company determines its allowance for credit losses based on two portfolio segments: leasereceivables and loan receivables, and further segments the portfolio
into two classes: major markets and growth markets.
($ in millions)
Major
Markets

GrowthMarkets

Total

Lease receivables$ 6,796$2,200$ 8,996

Loan receivables

10,5294,012

14,542Ending balance$17,325$6,212$23,537

Collectively evaluated for impairment$17,206$6,013$23,219

Individually evaluated for impairment$   119$  199$   318

Lease receivables$    59$   55$   114

Loan receivables

121

84

204

$   180$  138$   318

At December 31, 2013:

Financing receivables

Allowance for credit losses:
Beginning balance atJanuary 1, 2013

Total
Write-offs

(23)

(10)

(33)

Provision

(21)

105

84

1

(6)

(5)

Ending balance at
December 31, 2013$   137$  228$   365

Lease receivables$    42$   80$   123

Loan receivables$    95$  147$   242

Collectively evaluated for impairment$    45$   48$    93

Individually evaluated for impairment$    93$  179$   272

Other

107

108

Notes to Consolidated Financial Statements
International Business Machines Corporation and Subsidiary Companies

Impaired Loans($ in millions)
Major
Markets

GrowthMarkets

Total

Lease receivables$ 7,036$2,138$ 9,174

Loan receivables

9,666

3,670

13,336

Ending balance$16,701$5,808$22,510

Collectively evaluated for impairment$16,570$5,684$22,254

Individually evaluated for impairment$   131$  125$   256

At December 31, 2012:

Financing receivables

Allowance for credit losses:
Beginning balance atJanuary 1, 2012($ in millions)
Recorded
Investment

RelatedAllowance

Major markets

$ 79

$ 67

Growth markets

122

116

Total

$201

$183

Recorded
Investment

RelatedAllowance$ 77

At December 31, 2013:

Lease receivables$    79$   40Loan receivables

125

64

189

$   203$  104$   307

Write-offs

(14)

(1)

(15)

At December 31, 2012:

Provision

(9)

38

28

Major markets

$ 88

Other

0

(2)

(2)

Growth markets

72

65

$160

$143

Average
Recorded
Investment

Interest
IncomeRecognizedInterest
IncomeRecognizedon CashBasis

Major markets

$ 76

$0

$0

Growth markets

97

0

0

$173

$0

$0

Average
Recorded
Investment

Interest
IncomeRecognizedInterest
IncomeRecognizedon CashBasis

Major markets

$ 90

$0

$0

Growth markets

65

0

0

$156

$0

$0

Total

$   118

The company considers any loan with an individually evaluatedreserve as an impaired loan. Depending on the level of impairment,
loans will also be placed on a non-accrual status. The following
tables present impaired client loan receivables at December 31, 2013
and 2012.

Ending balance at
December 31, 2012$   180$  138$   318

Lease receivables$    59$   55$   114

Loan receivables$   121$   84$   204

Collectively evaluated for impairment$    69$   29$    98

Individually evaluated for impairment$   111$  109$   220

When determining the allowances, financing receivables are evaluated either on an individual or a collective basis. For individually
evaluated receivables, the company determines the expected cash
flow for the receivable and calculates an estimate of the potential
loss and the probability of loss. For those accounts in which the loss
is probable, the company records a specific reserve. In addition, thecompany records an unallocated reserve that is calculated by applying a reserve rate to its different portfolios, excluding accounts thathave been specifically reserved. This reserve rate is based uponcredit rating, probability of default, term, characteristics (lease/loan)
and loss history.

($ in millions)

Total($ in millions)

For the year ended December 31, 2013:

Total($ in millions)

For the year ended December 31, 2012:

Total

Financing Receivables on Non-Accrual Status
The following table presents the recorded investment in financing
receivables which were on non-accrual status at December 31, 2013
and 2012.
($ in millions)
At December 31:

2013

2012

Major markets

$ 25

$ 27

34

21

Total lease receivables

$ 59

$ 47

Major markets

$ 40

$ 67

Growth markets

92

25

Total loan receivables

$132

$ 92

Total receivables

$191

$139

Growth markets

Credit Quality Indicators
The company’s credit quality indicators are based on rating
agency data, publicly available information and information provided by customers, and are reviewed periodically based on therelative level of risk. The resulting indicators are a numerical rating
system that maps to Standard & Poor’s Ratings Services credit
ratings as shown on the following page. Standard & Poor’s does
not provide credit ratings to the company on its customers.
The tables present the gross recorded investment for each classof receivables, by credit quality indicator, at December 31, 2013 and2012. Receivables with a credit quality indicator ranging from AAA
to BBB- are considered investment grade. All others are considered
non-investment grade. The credit quality indicators do not reflect
mitigation actions that the company may take to transfer credit risk
to third parties.

Notes to Consolidated Financial Statements
International Business Machines Corporation and Subsidiary Companies

Lease Receivables

Lease Receivables($ in millions)($ in millions)
Major
Markets

GrowthMarkets

Major
Markets

GrowthMarkets

AAA – AA-$  743$   68A+ – A-

1,513

168

AAA – AA-$  646$   86A+ – A-

1,664

BBB+ – BBB-

2,111

223

957

BBB+ – BBB-

2,285

BB+ – BB

776

1,393

350

BB+ – BB

1,367

450

BB- – B+

595

368

BB- – B+

552

418

B – B-

365

214

B – B-399

127

CCC+ – D

76

74

CCC+ – D

124

58$6,796$2,200$7,036$2,138Major
Markets

GrowthMarkets

AAA – AA-$  887$  148A+ – A-

2,286

382

BBB+ – BBB-

3,139

1,333

At December 31, 2013:

Credit rating

Total

At December 31, 2012:

Credit rating

Loan Receivables

Total

Loan Receivables($ in millions)($ in millions)
Major
Markets

GrowthMarkets$ 1,151$  125

A+ – A-

2,344

307

BBB+ – BBB-

3,271

1,745

BB+ – BB

2,158

638

BB+ – BB

1,878

773

BB- – B+

922

672

BB- – B+

758

718

B – B-

565

391

B – B-548

218

CCC+ – D

118

134

CCC+ – D

170

99$10,529$4,012$9,666$3,670At December 31, 2013:

Credit rating
AAA – AA-

Total

At December 31, 2012:

Credit rating

At December 31, 2013, the industries which made up Global Financing’s receivables portfolio consisted of: Financial (39 percent),
Government (14 percent), Manufacturing (14 percent), Services (8percent), Retail (8 percent), Healthcare (6 percent), Communications(6 percent) and Other (4 percent).

Total

At December 31, 2012, the industries which made up Global
Financing’s receivables portfolio consisted of: Financial (38 percent),
Government (16 percent), Manufacturing (14 percent), Retail (9 percent), Services (7 percent), Healthcare (6 percent), Communications(6 percent) and Other (4 percent).

109

110

Notes to Consolidated Financial Statements
International Business Machines Corporation and Subsidiary Companies

Past Due Financing Receivables($ in millions)

Current

Total
Financing
Receivables

Recorded
Investment> 90 Days
and Accruing$ 6,789$ 6,796

$ 5

19

2,181

2,200

11

Total lease receivables$25$ 8,970$ 8,996$16

Major markets$ 9$10,520$10,529$ 6

Growth markets

34

3,979

4,012

18

Total loan receivables$43$14,499$14,542

$25

Total

$68

$23,469$23,537$41

Total
Past Due> 90 Days*

Current

Total
Financing
Receivables

Recorded
Investment> 90 Days
and Accruing

Major markets$ 8$ 7,028$ 7,036$ 5

Growth markets

11

2,127

2,138

8

Total lease receivables$20$ 9,154$ 9,174$13

Major markets$27$ 9,639$ 9,666$ 8

Growth markets

36

3,634

3,670

31

Total loan receivables$63$13,273$13,336

$39

Total

$82

$22,428$22,510$52

Total
Past Due> 90 Days*

Major markets$ 6

Growth markets

At December 31, 2013:* Does not include accounts that are fully reserved.
($ in millions)

At December 31, 2012:* Does not include accounts that are fully reserved.

Troubled Debt Restructurings
The company assessed all restructurings that occurred on or afterJanuary 1, 2012 and determined that there were no troubled debt
restructurings for the years ended December 31, 2012 and 2013.

Note H.
Investments and Sundry Assets($ in millions)
At December 31:

2013

2012

$1,652$1,630401585Equity method

110

120

Non-equity method

200

226

Note G.
Property, Plant and Equipment

Deferred transition and setup costs
and other deferred arrangements*($ in millions)

Alliance investments

At December 31:

Derivatives—noncurrent **
2013

2012

$   706$   747

Buildings and building improvements

9,680

9,610

Prepaid software

352

306

Plant, laboratory and office equipment

28,16927,731Long-term deposits

316

318

Land and land improvements

Plant and other property—gross

38,55538,088Other receivables

174

204

Less: Accumulated depreciation

25,57625,234

Employee benefit-related

392

  439
459

Plant and other property—net

12,97912,854

Prepaid income taxes

305

Rental machines

1,920

2,414

Other assets

738

735

Less: Accumulated depreciation

1,078

1,271

Total

$4,639$5,021

Rental machines—net
Total—net

842

1,142

$13,821$13,996  * Deferred transition and setup costs and other deferred arrangements are related to
Global Services client arrangements. See note A, “Significant Accounting Policies,”on pages 86 and 87 for additional information.

** See note D, “Financial Instruments,” on pages 102 through 106 for the fair value of allderivatives reported in the Consolidated Statement of Financial Position.

Notes to Consolidated Financial Statements
International Business Machines Corporation and Subsidiary Companies

Note I.
Intangible Assets Including Goodwill

Intangible Assets
The following table details the company’s intangible asset balancesby major asset class.
($ in millions)

At December 31, 2013:

Gross
Carrying Accumulated
Amount Amortization

Net
Carrying
AmountIntangible asset class
Capitalized software$1,494$  (699)$  794

Client relationships

2,148

(977)

1,171

Completed technology

2,910(1,224)

1,687

In-process R&D

13

—

13

Patents/trademarks

358

(154)

204

Other*
Total

7

(5)

2

$6,930$(3,059)$3,871($ in millions)
Gross
Carrying Accumulated
Amount Amortization

Net
Carrying
AmountCapitalized software$1,527$  (665)$  861

Client relationships

2,103

(961)

1,142

Completed technology

2,709(1,112)

1,597

In-process R&D

28

—

28

Patents/trademarks

281

(127)

154

At December 31, 2012:

Intangible asset class

Other*
Total

31

(27)

3

$6,679$(2,892)$3,787* O ther intangibles are primarily acquired proprietary and nonproprietary businessprocesses, methodologies and systems.

The net carrying amount of intangible assets increased $84 million
during the year ended December 31, 2013, primarily due to intangible
asset additions resulting from acquisitions, offset by amortization. There
was no impairment of intangible assets recorded in 2013 and 2012.
Total amortization was $1,351 million and $1,284 million for theyears ended December 31, 2013 and 2012, respectively. The aggregate amortization expense for acquired intangible assets (excluding
capitalized software) was $767 million and $709 million for the years
ended December 31, 2013 and 2012, respectively. In addition, in 2013
the company retired $1,177 million of fully amortized intangible
assets, impacting both the gross carrying amount and accumulated
amortization by this amount.
The amortization expense for each of the five succeeding years
relating to intangible assets currently recorded in the Consolidated
Statement of Financial Position is estimated to be the following at
December 31, 2013:($ in millions)
Capitalized
SoftwareAcquired
Intangibles

Total

2014

$484

$784

$1,267
884

2015

247

637

2016

64

595

660

2017

—

477

477

2018

—

322

322

111

112

Notes to Consolidated Financial Statements
International Business Machines Corporation and Subsidiary Companies

Goodwill
The changes in the goodwill balances by reportable segment, for the years ended December 31, 2013 and 2012, are as follows:($ in millions)

Segment

BalanceJanuary 1,
2013

Global Business Services

Goodwill
AdditionsPurchase
Price
Adjustments$ 4,357$    —$ (0)Global Technology Services

2,916

1,246

17

Software20,405987

11

Systems and Technology
Total

Divestitures

Foreign
Currency
Translation
and Other
Adjustments

Balance
December 31,
2013

$ (3)

$ (21)$ 4,334

—

(50)

4,129

(4)

(279)

21,121

1,568

13

33

—

(14)

1,601

$29,247$2,246$61$ (7)$(363)$31,184

Balance
December 31,
2012$ 4,357($ in millions)

Segment

BalanceJanuary 1,
2012

Goodwill
AdditionsPurchase
Price
Adjustments

Divestitures

Foreign
Currency
Translation
and Other
Adjustments

Global Business Services$ 4,313$    5

$ (0)

$ (2)

$ 42

Global Technology Services

2,646

264

—

(0)

6

2,916

Software18,121

2,182

(30)

(6)

137

20,405

Systems and Technology
Total

1,133

443

(0)

(14)

6

1,568

$26,213$2,894

$(30)

$(22)

$192

$29,247

Purchase price adjustments recorded in 2013 and 2012 were related
to acquisitions that were completed on or prior to December 31,
2012 or December 31, 2011, respectively, and were still subject to themeasurement period that ends at the earlier of 12 months from theacquisition date or when information becomes available. There were
no goodwill impairment losses recorded in 2013 or 2012 and thecompany has no accumulated goodwill impairment losses.

Note J.
Borrowings

Short-Term Debt($ in millions)
At December 31:

Commercial paper
Short-term loans

2013

2012

$2,458$1,800551

1,789Long-term debt—current maturities

3,854

5,593

Total

$6,862$9,181

The weighted-average interest rate for commercial paper at both
December 31, 2013 and 2012 was 0.1 percent. The weighted-average interest rates for short-term loans was 5.1 percent and 1.8
percent at December 31, 2013 and 2012, respectively.

Notes to Consolidated Financial Statements
International Business Machines Corporation and Subsidiary Companies

Long-Term Debt
Pre-Swap Borrowing($ in millions)
At December 31:

Maturities

2013

2012

U.S. dollar notes and debentures (average interest rate at December 31, 2013):
0.70%

2014 – 2015

$ 6,456**$ 7,131

3.05%

2016 – 2017

8,465

5,807

3.99%

2018 –2021

6,206

7,457

1.88%

2022

1,000

1,000

3.38%

2023

1,500

—

7.00%

2025

600

600

6.22%

2027

469

469

6.50%

2028

313

313

5.88%

2032

600

600

8.00%

2038

83

83

5.60%

2039

745

745

4.00%

2042

1,107

1,107

7.00%

2045

27

27

7.13%

2096

316

316

27,88725,656
2,338

Other currencies (average interest rate at December 31, 2013, in parentheses):
Euros (2.8%)

2014 – 2025

5,894

Pound sterling (2.75%)

2017 – 2020

1,254

12

Japanese yen (0.6%)

2014 – 2017

1,057

878

Swiss francs (3.8%)

2015 – 2020

181

178

2017

471

502

2015 – 2017

291

95

37,036

29,660Less: net unamortized discount

872

865

Add: fair value adjustment*

546

886

36,71029,680

Canadian (2.2%)
Other (8.81%)

Less: current maturities
Total

3,854

5,593

$32,856$24,088* The portion of the company’s fixed-rate debt obligations that is hedged is reflected in the Consolidated Statement of Financial Position as an amount equal to the sum of the debt’s
carrying value plus a fair value adjustment representing changes in the fair value of the hedged debt obligations attributable to movements in benchmark interest rates.
** Includes $17 million of debt securities issued by IBM International Group Capital, LLC, which is an indirect, 100 percent owned finance subsidiary of the company and will maturein 2014. Debt securities issued by IBM International Group Capital LLC are fully and unconditionally guaranteed by the company.

The company’s indenture governing its debt securities and its various credit facilities each contain significant covenants which
obligate the company to promptly pay principal and interest, limit
the aggregate amount of secured indebtedness and sale and leaseback transactions to 10 percent of the company’s consolidated net
tangible assets, and restrict the company’s ability to merge or consolidate unless certain conditions are met. The credit facilities also
include a covenant on the company’s consolidated net interest
expense ratio, which cannot be less than 2.20 to 1.0, as well as across default provision with respect to other defaulted indebtednessof at least $500 million.
The company is in compliance with all of its significant debt covenants and provides periodic certifications to its lenders. The failure
to comply with its debt covenants could constitute an event ofdefault with respect to the debt to which such provisions apply. If
certain events of default were to occur, the principal and interest on
the debt to which such event of default applied would become
immediately due and payable.

113

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Notes to Consolidated Financial Statements
International Business Machines Corporation and Subsidiary Companies

Post-Swap Borrowing (Long-Term Debt, Including Current Portion)(in millions)2013
For the year ended December 31:

AmountFixed-rate debt

AmountAverage Rate

$30,1233.07%$24,049

3.43%

6,587

0.87%

5,631

1.91%

Floating-rate debt*
Total

2012
Average Rate

$36,710$29,680* Includes $3,106 million in 2013 and $4,252 million in 2012 of notional interest rate swaps that effectively convert the fixed-rate long-term debt into floating-rate debt. (See note D,“Financial Instruments,” on pages 102 through 106.)Pre-swap annual contractual maturities of long-term debt outstandingat December 31, 2013, are as follows:($ in millions)
Total

2014

$ 3,854

2015

4,566

2016

4,114

2017

5,386

2018

2,662

2019 and beyond

16,453

Total$37,036

Interest on Debt($ in millions)
For the year ended December 31:

2013

2012

2011

Cost of financing$  587$  545$553

Interest expense

405

470

402

Net investment derivative activity

(3)

(11)

9

Interest capitalized

22

18

9

$1,011$1,022$973

Total interest paid and accrued

Refer to the related discussion on page 143 in note T, “Seg­ment
Infor­mation,” for total interest expense of the Global Financing
segment. See note D, “Financial Instruments,” on pages 102 through106 for a discussion of the use of currency and interest rate swaps
in the company’s debt risk management program.

commitments under the Credit Agreement up to an additional$2.0 billion. Subject to certain terms of the Credit Agreement, thecompany and Subsidiary Borrowers may borrow, prepay and reborrow amounts under the Credit Agreement at any time during theCredit Agreement. Interest rates on borrowings under the Credit
Agreement will be based on prevailing market interest rates, as further
described in the Credit Agreement. The Credit Agreement contains
customary representations and warranties, covenants, events ofdefault, and indemnification provisions. The company believes thatcircumstances that might give rise to breach of these covenants oran event of default, as specified in the Credit Agreement, are remote.
As of December 31, 2013, there were no borrowings by the company,or its subsidiaries, under the Credit Agreement.
The company also has other committed lines of credit in someof the geographies which are not significant in the aggregate.
Interest rates and other terms of borrowing under these lines ofcredit vary from country to country, depending on local market
conditions.

Note K.
Other Liabilities($ in millions)
At December 31:

2013

2012*

Income tax reserves$3,189$2,527

Excess 401(k) Plus Plan

1,673

1,501

Disability benefits

699

890

Derivative liabilities

126

78

Special restructuring actions

440

430

500

473

1,741

448

Lines of Credit

Workforce reductions

In 2013, the company extended the term of its five-year, $10 billion
Credit Agreement (the “Credit Agreement”) by one year to November 10, 2018. The total expense recorded by the company related
to this global credit facility was $5.4 million in 2013, $5.3 million in2012 and $5.0 million in 2011. The Credit Agreement permits thecompany and its Subsidiary Borrowers to borrow up to $10 billion
on a revolving basis. Borrowings of the Subsidiary Borrowers will
be unconditionally backed by the company. The company may also,
upon the agreement of either existing lenders, or of the additionalbanks not currently party to the Credit Agreement, increase theDeferred taxes
Other taxes payable

186

24

Environmental accruals

231

216

Warranty accruals

171

167

Asset retirement obligations

129

127

Acquisition-related accruals

205

35

Other

644

691

Total

$9,934$7,607* Reclassified to conform with 2013 presentation.

Notes to Consolidated Financial Statements
International Business Machines Corporation and Subsidiary Companies

In response to changing business needs, the company periodically takes workforce reduction actions to improve productivity,
cost competitiveness and to rebalance skills. The noncurrent
contractually obligated future payments associated with these
activities are reflected in the workforce reductions caption in theprevious table.

In addition, the company executed certain special restructuringrelated actions prior to 2006. The table below provides a roll forwardof the current and noncurrent liabilities associated with these special
actions. The current liabilities presented in the table are included inother accrued expenses and liabilities in the Consolidated Statementof Financial Position.

(in millions)
Liability
as ofJanuary 1,
2013

Payments

Other
Adjustments*

Liability
as ofDecember 31,
2013

$ 28

$(29)

$29

$ 27

2

(1)

(1)

0

$ 30

$(30)

$28

$ 27

Workforce

$430

$  —

$10

$440

Total noncurrent

$430

$  —

$10

$440

Current
WorkforceSpace
Total current
Noncurrent* The other adjustments column in the table above principally includes the reclassification of noncurrent to current, remeasurement of actuarial assumptions, foreign currencytranslation adjustments and interest accretion.

The workforce accruals primarily relate to terminated employees who
are no longer working for the company who were granted annual payments to supplement their incomes in certain countries. Dependingon the individual country’s legal requirements, these required payments will continue until the former employee begins receiving pension
benefits or passes away. The space accruals are for ongoing obligations to pay rent for vacant space that could not be sublet or spacethat was sublet at rates lower than the committed lease arrangement.
These obligations for vacant space were settled through 2013.
The company employs extensive internal environmental protection programs that primarily are preventive in nature. The company
also participates in environmental assessments and cleanups at anumber of locations, including operating facilities, previously owned
facilities and Superfund sites. The company’s maximum exposure
for all environmental liabilities cannot be estimated and no amounts
have been recorded for non-ARO environmental liabilities that are
not probable or estimable. The total amounts accrued for non-ARO
environmental liabilities, including amounts classified as current in
the Consolidated Statement of Financial Position, that do not reflect
actual or anticipated insurance recoveries, were $245 million and$229 million at December 31, 2013 and 2012, respectively. Estimatedenvironmental costs are not expected to materially affect the consolidated financial position or consolidated results of the company’s
operations in future periods. However, estimates of future costs are
subject to change due to protracted cleanup periods and changing
environmental remediation regulations.

As of December 31, 2013, the company was unable to estimate
the range of settlement dates and the related probabilities for certain
asbestos remediation AROs. These conditional AROs are primarily
related to the encapsulated structural fireproofing that is not subject
to abatement unless the buildings are demolished and non-encapsulated asbestos that the company would remediate only if it
performed major renovations of certain existing buildings. Because
these conditional obligations have indeterminate settlement dates,
the company could not develop a reasonable estimate of their fairvalues. The company will continue to assess its ability to estimate
fair values at each future reporting date. The related liability will berecognized once sufficient additional information becomes available.
The total amounts accrued for ARO liabilities, including amounts
classified as current in the Consolidated Statement of Financial Position, were $160 million and $171 million at December 31, 2013 and2012, respectively.

115

116

Notes to Consolidated Financial Statements
International Business Machines Corporation and Subsidiary Companies

Note L.
Equity Activity
The authorized capital stock of IBM consists of 4,687,500,000
shares of common stock with a $.20 per share par value, of which
1,054,390,937 shares were outstanding at December 31, 2013 and150,000,000 shares of preferred stock with a $.01 per share parvalue, none of which were outstanding at December 31, 2013.

Stock Repurchases
The Board of Directors authorizes the company to repurchase IBMcommon stock. The company repurchased 73,121,942 commonshares at a cost of $13,993 million, 61,246,371 common shares at a
cost of $12,008 million and 88,683,716 common shares at a cost of$15,034 million in 2013, 2012 and 2011, respectively. These amounts
reflect transactions executed through December 31 of each year.
Actual cash disbursements for repurchased shares may differ due
to varying settlement dates for these transactions. At December 31,
2013, $14,659 million of Board common stock repurchase authorization was still available. The company plans to purchase shares on the
open market or in private transactions from time to time, dependingon market conditions.

Other Stock Transactions
The company issued the following shares of common stock as partof its stock-based compensation plans and employees stock purchase plan: 9,961,389 shares in 2013, 15,091,320 shares in 2012,
and 20,669,785 shares in 2011. The company issued 1,849,883
treasury shares in 2013, 2,746,169 treasury shares in 2012 and
4,920,198 treasury shares in 2011, as a result of RSU releases andexercises of stock options by employees of certain acquired businesses and by non-U.S. employees. Also, as part of the company’s
stock-based compensation plans, 1,666,069 common shares at a
cost of $336 million, 2,406,007 common shares at a cost of $468
million, and 1,717,246 common shares at a cost of $289 million in2013, 2012 and 2011, respectively, were remitted by employees tothe company in order to satisfy minimum statutory tax withholding
requirements. These amounts are included in the treasury stockbalance in the Consolidated Statement of Financial Position and theConsolidated Statement of Changes in Equity.

Reclassifications and Taxes Related to Items of Other Comprehensive Income($ in millions)
For the year ended December 31, 2013:

Before Tax
AmountTax (Expense)/
Benefit

Net of Tax
Amount$(1,335)$   (66)$(1,401)

Other comprehensive income/(loss)
Foreign currency translation adjustments
Net changes related to available-for-sale securities$    (4)$     2$    (3)Reclassification of (gains)/losses to other (income) and expense

(8)

2

(5)

Subsequent changes in previously impaired securities arising during the period

4

(1)

3

$    (8)$     3$    (5)$   43$   (15)$   28

Cost of sales

34

(14)

21

SG&A expense

(39)

14

(25)

Other (income) and expense

(162)

62

(99)

0

(0)

0

$   (123)$     47$   (76)$      16$       (0)$   16

5,369(1,974)

3,395

(3)

1

(2)

(114)

40

(75)

Unrealized gains/(losses) arising during the period

Total net changes related to available-for-sale securities
Unrealized gains/(losses) on cash flow hedges
Unrealized gains/(losses) arising during the period
Reclassification of (gains)/losses to:Interest expense
Total unrealized gains/(losses) on cash flow hedges
Retirement-related benefit plans(1)Prior service costs/(credits)
Net (losses)/gains arising during the period
Curtailments and settlements
Amortization of prior service (credits)/cost
Amortization of net (gains)/losses

3,499(1,195)

2,304

Total retirement-related benefit plans$ 8,767$(3,128)$ 5,639$ 7,301$(3,144)$ 4,157

Other comprehensive income/(loss)(1)

These AOCI components are included in the computation of net periodic pension cost. (See note S, “Retirement-Related Benefits,” on pages 127 to 141 for additional information.)

Notes to Consolidated Financial Statements
International Business Machines Corporation and Subsidiary Companies($ in millions)
For the year ended December 31, 2012:

Before Tax
AmountTax (Expense)/
Benefit

Net of Tax
Amount$   (44)$   10$   (34)

Other comprehensive income/(loss)
Foreign currency translation adjustments
Net changes related to available-for-sale securities
Unrealized gains/(losses) arising during the period$    8$   (4)$    4

Reclassification of (gains)/losses to other (income) and expense

(42)

17

(25)

Subsequent changes in previously impaired securities arising during the period

20

(8)

12

$   (14)$    5$    (9)$     32$  (27)$    5

Cost of sales

(7)

(6)

(13)

SG&A expense

(16)

4

(12)

Other (income) and expense

(237)

91

(146)

Total net changes related to available-for-sale securities
Unrealized gains/(losses) on cash flow hedges
Unrealized gains/(losses) arising during the period
Reclassification of (gains)/losses to:Interest expense
Total unrealized gains/(losses) on cash flow hedges

6

(3)

3

$ (220)$   59$   (161)$(7,489)$2,327$(5,162)

(2)

0

(2)

(148)

59

(89)

Retirement-related benefit plans(1)Net (losses)/gains arising during the period
Curtailments and settlements
Amortization of prior service (credits)/cost
Amortization of net (gains)/losses

2,457

(874)

1,583

Total retirement-related benefit plans$(5,182)$1,513$(3,669)$(5,460)$1,587$(3,874)

Other comprehensive income/(loss)(1)

These AOCI components are included in the computation of net periodic pension cost. (See note S, “Retirement-Related Benefits,” on pages 127 to 141 for additional information.)

117

118

Notes to Consolidated Financial Statements
International Business Machines Corporation and Subsidiary Companies($ in millions)
For the year ended December 31, 2011:

Before Tax
AmountTax (Expense)/
Benefit

Net of Tax
Amount$   (693)$  (18)$   (711)$   (14)$    5$    (9)

(231)

88

(143)

4

(1)

3

$   (241)$   91$   (150)$ (266)$   105$   (162)
121

Other comprehensive income/(loss)
Foreign currency translation adjustments
Net changes related to available-for-sale securities
Unrealized gains/(losses) arising during the period
Reclassification of (gains)/losses to other (income) and expense
Subsequent changes in previously impaired securities arising during the period
Total net changes related to available-for-sale securities
Unrealized gains/(losses) on cash flow hedges
Unrealized gains/(losses) arising during the period
Reclassification of (gains)/losses to:
Cost of sales

182

(61)

SG&A expense

75

(23)

52

Other (income) and expense

247

(3)

244

Interest expense

8

(95)

(88)

$  245$  (77)$  167

Prior service costs/(credits)$   (28)$    7$   (22)

Net (losses)/gains arising during the period(5,463)

1,897(3,566)

11

(3)

7

(157)

62

(94)

Total unrealized gains/(losses) on cash flow hedges
Retirement-related benefit plans(1)Curtailments and settlements
Amortization of prior service (credits)/cost
Amortization of net (gains)/losses

1,847

(619)

1,227

Total retirement-related benefit plans$(3,790)$1,343$(2,448)$(4,479)$1,339$(3,142)

Other comprehensive income/(loss)(1)

These AOCI components are included in the computation of net periodic pension cost. (See note S, “Retirement-Related Benefits,” on pages 127 to 141 for additional information.)

Accumulated Other Comprehensive Income/(Loss) (net of tax)($ in millions)
Net Unrealized
Gains/(Losses)
on Cash Flow
HedgesForeign
Currency
Translation
Adjustments*

Net Change
RetirementRelated
BenefitPlans

Net Unrealized
Gains/(Losses)
on AvailableFor-Sale
Securities

Accumulated
Other
Comprehensive
Income/(Loss)

December 31, 2010$  (96)$ 2,478$(21,289)$164$(18,743)

Other comprehensive income before reclassifications

(162)

(711)

(3,581)(7)(4,461)

Amount reclassified from accumulated other comprehensive income

329

0

1,133

(143)

1,319

Total change for the period

167

(711)

(2,448)(150)(3,142)

December 31, 2011

71

1,767

(23,737)

13(21,885)

Other comprehensive income before reclassifications

5

(34)

(5,164)16(5,177)

Amount reclassified from accumulated other comprehensive income

(167)

0

1,495

(25)

1,303

Total change for the period

(161)

(34)

(3,669)(9)(3,874)

December 31, 2012

(90)

1,733

(27,406)

4(25,759)

Other comprehensive income before reclassifications

28(1,401)

3,409

0

2,036

(103)

0

2,229

(5)

2,121

Amount reclassified from accumulated other comprehensive income
Total change for the period
December 31, 2013(76)

(1,401)

5,639

(5)

4,157

$(165)$    332$(21,767)$   (1)$(21,602)* Foreign currency translation adjustments are presented gross except for any associated hedges which are presented net of tax.

Notes to Consolidated Financial Statements
International Business Machines Corporation and Subsidiary Companies

Note M.
Contingencies and Commitments

Contingencies
As a company with a substantial employee population and with clientsin more than 175 countries, IBM is involved, either as plaintiff or defendant, in a variety of ongoing claims, demands, suits, investigations, tax
matters and proceedings that arise from time to time in the ordinary
course of its business. The company is a leader in the information
technology industry and, as such, has been and will continue to be
subject to claims challenging its IP rights and associated products
and offerings, including claims of copyright and patent infringement
and violations of trade secrets and other IP rights. In addition, thecompany enforces its own IP against infringement, through license
negotiations, lawsuits or otherwise. Also, as is typical for companiesof IBM’s scope and scale, the company is party to actions and proceedings in various jurisdictions involving a wide range of labor andemployment issues (including matters related to contested employment decisions, country-specific labor and employment laws, andthe company’s pension, retirement and other benefit plans), as wellas actions with respect to contracts, product liability, securities, foreign
operations, competition law and environmental matters. These
actions may be commenced by a number of different parties, including competitors, clients, current or former employees, governmentand regulatory agencies, stockholders and representatives of thelocations in which the company does business. Some of the actions
to which the company is party may involve particularly complex technical issues, and some actions may raise novel questions under thelaws of the various jurisdictions in which these matters arise.
The company records a provision with respect to a claim, suit,
investigation or proceeding when it is probable that a liability has
been incurred and the amount of the loss can be reasonably estimated. Any recorded liabilities, including any changes to suchliabilities for the years ended December 31, 2013, 2012 and 2011were not material to the Consolidated Financial Statements.
In accordance with the relevant accounting guidance, the company provides disclosures of matters for which the likelihood ofmaterial loss is at least reasonably possible. In addition, the company also discloses matters based on its consideration of othermatters and qualitative factors, including the experience of othercompanies in the industry, and investor, customer and employee
relations considerations.
With respect to certain of the claims, suits, investigations and proceedings discussed herein, the company believes at this time that thelikelihood of any material loss is remote, given, for example, the procedural status, court rulings, and/or the strength of the company’s
defenses in those matters. With respect to the remaining claims, suits,investigations and proceedings discussed in this note, the company
is unable to provide estimates of reasonably possible losses or rangeof losses, including losses in excess of amounts accrued, if any, forthe following reasons. Claims, suits, investigations and proceedings
are inherently uncertain, and it is not possible to predict the ultimate
outcome of these matters. It is the company’s experience thatdamage amounts claimed in litigation against it are unreliable andunrelated to possible outcomes, and as such are not meaningful indicators of the company’s potential liability. Further, the company isunable to provide such an estimate due to a number of other factors

with respect to these claims, suits, investigations and proceedings,
including considerations of the procedural status of the matter inquestion, the presence of complex or novel legal theories, and/or theongoing discovery and development of information important to thematters. The company reviews claims, suits, investigations and proceedings at least quarterly, and decisions are made with respect torecording or adjusting provisions and disclosing reasonably possible
losses or range of losses (individually or in the aggregate), to reflect
the impact and status of settlement discussions, discovery, procedural and substantive rulings, reviews by counsel and otherinformation pertinent to a particular matter.
Whether any losses, damages or remedies finally determined inany claim, suit, investigation or proceeding could reasonably have amaterial effect on the company’s business, financial condition, resultsof operations or cash flows will depend on a number of variables,
including: the timing and amount of such losses or damages; thestructure and type of any such remedies; the significance of the
impact any such losses, damages or remedies may have in theConsolidated Financial Statements; and the unique facts and circumstances of the particular matter that may give rise to additional
factors. While the company will continue to defend itself vigorously,
it is possible that the company’s business, financial condition, resultsof operations or cash flows could be affected in any particular periodby the resolution of one or more of these matters.
The following is a summary of the more significant legal matters
involving the company.
The company is a defendant in an action filed on March 6, 2003
in state court in Salt Lake City, Utah by the SCO Group (SCO v. IBM).
The company removed the case to Federal Court in Utah. Plaintiff
is an alleged successor in interest to some of AT&T’s UNIX IP
rights, and alleges copyright infringement, unfair competition, interference with contract and breach of contract with regard to thecompany’s distribution of AIX and Dynix and contribution of code
to Linux. The company has asserted counterclaims, including
breach of contract, violation of the Lanham Act, unfair competition,
intentional torts, unfair and deceptive trade practices, breach of
the General Public License that governs open source distributions,promissory estoppel and copyright infringement. Motions for summary judgment were heard in March 2007, and the court has not
yet issued its decision. On September 14, 2007, plaintiff filed forbankruptcy protection, and all proceedings in this case werestayed. On August 25, 2009, the U.S. Bankruptcy Court for theDistrict of Delaware approved the appointment of a Trustee of SCO.
The court in another suit, the SCO Group, Inc. v. Novell, Inc., helda trial in March 2010. The jury found that Novell is the owner ofUNIX and UnixWare copyrights; the judge subsequently ruled that
SCO is obligated to recognize Novell’s waiver of SCO’s claims
against IBM and Sequent for breach of UNIX license agreements.
On August 30, 2011, the Tenth Circuit Court of Appeals affirmed the
district court’s ruling and denied SCO’s appeal of this matter. In June
2013, the Federal Court in Utah granted SCO’s motion to reopen the
SCO v. IBM case. On July 10, 2013, the Court entered an order dismissing seven of SCO’s ten claims, specifically its breach of contract
and copyright claims, and one tortious interference claim.
On May 13, 2010, IBM and the State of Indiana (acting on behalf of
the Indiana Family and Social Services Administration) sued one anotherin a dispute over a 2006 contract regarding the modernization of social

119

120

Notes to Consolidated Financial Statements
International Business Machines Corporation and Subsidiary Companies

service program processing in Indiana. The State terminated the contract, claiming that IBM was in breach, and the State is seeking damages.
IBM believes the State’s claims against it are without merit and is seeking
payment of termination amounts specified in the contract. After six
weeks of trial, on July 18, 2012, the Indiana Superior Court in Marion
County rejected the State’s claims in their entirety and awarded IBM $52
million plus interest and costs. On February 13, 2014, the Indiana Courtof Appeals reversed portions of the trial judge’s findings, found IBM in
material breach, and ordered the case remanded to the trial judge todetermine the State’s damages, if any. The Indiana Court of Appeals
also affirmed approximately $50 million of the trial court’s award of damages to IBM. This matter remains pending in the Indiana courts.
IBM United Kingdom Limited (IBM UK) initiated legal proceedings in May 2010 before the High Court in London against the IBM
UK Pensions Trust (the UK Trust) and two representative beneficiaries of the UK Trust membership. IBM UK is seeking adeclaration that it acted lawfully both in notifying the Trustee of the
UK Trust that it was closing its UK defined benefit plans to future
accruals for most participants and in implementing the company’s
new retirement policy. The trial in the High Court concluded in April
2013 and the company is awaiting a ruling from the Court. In addition, IBM UK is a defendant in approximately 290 individual actions
brought since early 2010 by participants of the defined benefits
plans who left IBM UK. These actions, which allege constructive
dismissal and age discrimination, are pending before the Employment Tribunal in Southampton UK and are currently stayed pending
resolution of the above-referenced High Court proceedings.
In a separate but related proceeding, in March 2011, the Trusteeof the IBM UK Trust was granted leave to initiate a claim before theHigh Court in London against IBM UK and one member of the UK
Trust membership, seeking an order modifying certain documents
and terms relating to retirement provisions in IBM UK’s largest
defined benefit plan (the C Plan) dating back to 1983. The trial ofthese proceedings began in May 2012 and finished in early June.
On October 12, 2012, the High Court in London issued its ruling,holding that the 1983 Trust Deeds and Rules should be modified toallow certain categories of current IBM UK employees who aremembers of the C Plan to retire from the age of 60 (rather than fromthe age of 63) without actuarial reduction of their defined benefit
pension. In a supplementary ruling on December 13, 2012, the Court
declined to similarly modify the Trust Deeds and Rules for former
employees who were C Plan members and who left the company
prior to retirement. On February 7, 2013, the Court issued an orderagreed to by all parties, under which there will be no appeals of theOctober 2012 and December 2012 judgments. As a result of theOctober 2012 ruling, IBM recorded an additional pre-tax retirementrelated obligation of $162 million in the third quarter of 2012.
In March 2011, the company announced that it had agreed to settle
a civil enforcement action with the Securities and Exchange Commission (SEC) relating to activities by employees of IBM Korea, LG IBM, IBM(China) Investment Company Limited and IBM Global Services (China)
Co., Ltd., during the period from 1998 through 2009, allegedly in violationof the Foreign Corrupt Practices Act of 1977. As part of that settlement,
IBM consented to the entry of a judgment relating to the books andrecords and internal control provisions of the securities laws, and also
agreed to pay a total of $10 million, categorized by the SEC as follows:(i) $5.3 million, representing profits gained as a result of the conduct
alleged in the SEC’s complaint, (ii) prejudgment interest on that amountof $2.7 million, and (iii) a civil penalty of $2 million. On July 25, 2013, thecourt approved that 2011 settlement and required that for a two-year
period IBM make reports to the SEC and the court on certain matters,
including those relating to compliance with the FCPA. In early 2012, IBM
notified the SEC of an investigation by the Polish Central Anti-Corruption
Bureau involving allegations of illegal activity by a former IBM Poland
employee in connection with sales to the Polish government. IBM is
cooperating with the SEC and Polish authorities in this matter. In April
2013, IBM learned that the U.S. Department of Justice (DOJ) is also
investigating allegations related to the Poland matter, as well as allegations relating to transactions in Argentina, Bangladesh and Ukraine. The
DOJ is also seeking information regarding the company’s global FCPA
compliance program and its public sector business. The company iscooperating with the DOJ in this matter.
In May 2013, IBM learned that the SEC is conducting an investigation into how IBM reports cloud revenue. IBM is cooperatingwith the SEC in this matter.
In December 2013, a putative class action lawsuit was filed
in the United States District Court for the Southern District of
New York related to the company’s third-quarter 2013 financial
results disclosure. The company, its Chairman, President andChief Executive Officer, and a former Senior Vice President andChief Financial Officer of the company are named as defendants.
Plaintiffs allege that defendants violated Section 20(a) and Section
10(b) of the Securities Exchange Act of 1934, and Rule 10b-5
thereunder.
The company is a defendant in numerous actions filed afterJanuary 1, 2008 in the Supreme Court for the State of New York,county of Broome, on behalf of hundreds of plaintiffs. The complaints allege numerous and different causes of action, including
for negligence and recklessness, private nuisance and trespass.
Plaintiffs in these cases seek medical monitoring and claim damages in unspecified amounts for a variety of personal injuries andproperty damages allegedly arising out of the presence of groundwater contamination and vapor intrusion of groundwatercontaminants into certain structures in which plaintiffs reside or
resided, or conducted business, allegedly resulting from therelease of chemicals into the environment by the company at its
former manufacturing and development facility in Endicott. These
complaints also seek punitive damages in an unspecified amount.
The company is party to, or otherwise involved in, proceedings
brought by U.S. federal or state environmental agencies under theComprehensive Environmental Response, Compensation andLiability Act (CERCLA), known as “Superfund,” or laws similar to
CERCLA. Such statutes require potentially responsible parties toparticipate in remediation activities regardless of fault or ownershipof sites. The company is also conducting environmental investigations, assessments or remediations at or in the vicinity of several
current or former operating sites globally pursuant to permits,administrative orders or agreements with country, state or local
environmental agencies, and is involved in lawsuits and claims
concerning certain current or former operating sites.
The company is also subject to ongoing tax examinations andgovernmental assessments in various jurisdictions. Along with many

Notes to Consolidated Financial Statements
International Business Machines Corporation and Subsidiary Companies

other U.S. companies doing business in Brazil, the company is
involved in various challenges with Brazilian authorities regarding
non-income tax assessments and non-income tax litigation matters.
These matters include claims for taxes on the importation of computer software. In November 2008, the company won a significant
case in the Superior Chamber of the federal administrative tax courtin Brazil, and in late July 2009, the company received written confirmation regarding this decision. The total potential amount related
to the remaining matters for all applicable years is approximately$700 million. The company believes it will prevail on these mattersand that this amount is not a meaningful indicator of liability.

Commitments
The company’s extended lines of credit to third-party entities
include unused amounts of $5,028 million and $4,719 million at
December 31, 2013 and 2012, respectively. A portion of theseamounts was available to the company’s business partners to support their working capital needs. In addition, the company has
committed to provide future financing to its clients in connection
with client purchase agreements for approximately $1,769 million
and $1,513 million at December 31, 2013 and 2012, respectively.
The company has applied the guidance requiring a guarantor
to disclose certain types of guarantees, even if the likelihood of
requiring the guarantor’s performance is remote. The following is a
description of arrangements in which the company is the guarantor.
The company is a party to a variety of agreements pursuant towhich it may be obligated to indemnify the other party with respect
to certain matters. Typically, these obligations arise in the context ofcontracts entered into by the company, under which the company
customarily agrees to hold the other party harmless against losses
arising from a breach of representations and covenants related
to such matters as title to assets sold, certain IP rights, specified
environmental matters, third-party performance of nonfinancial
contractual obligations and certain income taxes. In each of thesecircumstances, payment by the company is conditioned on the otherparty making a claim pursuant to the procedures specified in
the particular contract, the procedures of which typically allow thecompany to challenge the other party’s claims. While typicallyindemnification provisions do not include a contractual maximum
on the company’s payment, the company’s obligations under these
agreements may be limited in terms of time and/or nature of claim,
and in some instances, the company may have recourse against
third parties for certain payments made by the company.
It is not possible to predict the maximum potential amount of
future payments under these or similar agreements due to the conditional nature of the company’s obligations and the unique facts
and circumstances involved in each particular agreement. Historically, payments made by the company under these agreements
have not had a material effect on the company’s business, financial
condition or results of operations.
In addition, the company guarantees certain loans and financial
commitments. The maximum potential future payment under thesefinancial guarantees was $44 million and $65 million at December
31, 2013 and 2012, respectively. The fair value of the guarantees
recognized in the Consolidated Statement of Financial Position is
not material.

Note N.
Taxes($ in millions)
For the year ended December 31:

2013

2012

2011

U.S. operations$ 6,857$ 9,668$ 9,716

Non-U.S. operations

12,667

12,234

11,287$19,524$21,902$21,003

Income before income taxes

Total income before income taxes

The provision for income taxes by geographic operations is asfollows:($ in millions)
For the year ended December 31:

U.S. operations

2013

2012

2011

$ 993

$2,582$2,141

Non-U.S. operations

2,048

2,716

3,007

Total provision for income taxes$3,041$5,298$5,148The components of the provision for income taxes by taxing jurisdiction are as follows:($ in millions)
For the year ended December 31:

2013

2012

2011

Current$1,406$1,361$  268Deferred

(652)

403

909

754

1,764

1,177

Current

178

134

429

Deferred

(321)

289

81

(143)

423

510

Current

3,067

3,006

3,239

Deferred

(637)

105

222

2,430

3,111

3,461

3,041

5,298

5,148

U.S. federal

U.S. state and local

Non-U.S.

Total provision for income taxes
Provision for social security,
real estate, personal property
and other taxes

4,198

4,331

4,289

Total taxes included in net income$7,239$9,629$9,437

A reconciliation of the statutory U.S. federal tax rate to the company’s
effective tax rate is as follows:
2013*

2012*

Statutory rate

35%

35%

35%

Foreign tax differential

(14)

(11)

(10)

State and local

(0)

1

2

Domestic incentives

(3)

(1)

(1)

For the year ended December 31:

2011*

Other

(2)

(0)

(1)

Effective rate

16%

24%

25%

* Percentages rounded for disclosure purposes.

121

122

Notes to Consolidated Financial Statements
International Business Machines Corporation and Subsidiary Companies

The significant components reflected within the tax rate reconciliation labeled “Foreign tax differential” include the effects of foreignsubsidiaries’ earnings taxed at rates other than the U.S. statutory
rate, foreign export incentives, the U.S. tax impacts of non-U.S.
earnings repatriation and any net impacts of intercompany transactions. These items also reflect audit settlements or changes in
the amount of unrecognized tax benefits associated with each ofthese items.
In the fourth quarter of 2013, the Internal Revenue Service (IRS)
concluded its examination of the company’s income tax returns for2008 through 2010 and issued a final Revenue Agent Report (RAR).
The company agreed with all of the adjustments. The company has
redetermined its unrecognized tax benefits, including similar items
in open tax years, based on the agreed adjustments in the RAR andassociated information and analysis.
The 2013 effective tax rate benefitted by 11.5 points from thecompletion of the IRS examination discussed above including associated reserve redeterminations. In addition, the effective tax rate also
benefitted from the company’s geographic mix of pre-tax income andincentives, the impact of foreign tax credits, benefits realized during
the year related to the American Taxpayer Relief Act, a favorable tax
agreement which required a reassessment of certain valuation allowances on deferred taxes and certain non-U.S. audit settlements.
These benefits were partially offset by 2013 tax charges related tocertain intercompany payments made by foreign subsidiaries and thetax costs associated with the intercompany licensing of certain IP.
The effect of tax law changes on deferred tax assets and liabilities
did not have a material impact on the company’s effective tax rate.
The significant components of deferred tax assets and liabilities
that are recorded in the Consolidated Statement of Financial Position
were as follows:

Deferred Tax Assets

Retirement benefits
Share-based and other compensation($ in millions)
At December 31:

2013

2012*

Depreciation$1,346$1,378Retirement benefits

1,219

257

Goodwill and intangible assets

1,173

957

Leases

1,119

2,216

Software development costs

558

542

Deferred transition costs

424

440

Other

841

993

$6,680$6,783Gross deferred tax liabilities* Reclassified to conform with 2013 presentation.

For income tax return purposes, the company has foreign anddomestic loss carryforwards, the tax effect of which is $626 million,
as well as domestic and foreign credit carryforwards of $1,007 million. Substantially all of these carryforwards are available for at least
two years or are available for 10 years or more.
The valuation allowance at December 31, 2013 principally applies
to certain foreign, state and local loss carryforwards that, in theopinion of management, are more likely than not to expire unutilized.
However, to the extent that tax benefits related to these carry­
forwards are realized in the future, the reduction in the valuation
allowance will reduce income tax expense.
The amount of unrecognized tax benefits at December 31, 2013
decreased by $1,214 million in 2013 to $4,458 million. A reconciliationof the beginning and ending amount of unrecognized tax benefits
is as follows:($ in millions)
2013

2012

2011

$ 5,672$5,575$5,293

Additions based on tax positions
related to the current year

829

401

672

Additions for tax positionsof prior years

417

215

379

(2,201)

(425)

(538)

(259)

(94)

(231)

$ 4,458$5,672$5,575

Balance at January 1($ in millions)
At December 31:

Deferred Tax Liabilities

2013

2012*

$ 3,704$ 5,870

1,262

1,666

Reductions for tax positionsof prior years (including impacts
due to a lapse in statute)

Domestic tax loss/credit carryforwards

982

954

Deferred income

964

1,018

Foreign tax loss/credit carryforwards

651

681

Settlements

Bad debt, inventory and warranty reserves

592

586

Balance at December 31

382

456

Other

1,774

1,659
12,890Depreciation
Gross deferred tax assets

10,311

Less: valuation allowance

734

1,187

Net deferred tax assets$ 9,577$11,703* Reclassified to conform with 2013 presentation.

The additions to unrecognized tax benefits related to the current
and prior years are primarily attributable to non-U.S. issues, certain
tax incentives and credits, acquisition-related matters and stateissues. The settlements and reductions to unrecognized tax benefits
for tax positions of prior years are primarily attributable to the completion of the IRS examination for 2008-2010, non-U.S. audits andimpacts due to lapses in statutes of limitation.
In April 2010, the company appealed the determination of anon-U.S. taxing authority with respect to certain foreign tax
losses. The tax benefit of these losses totals $1,141 million as ofDecember 31, 2013. The 2013 decrease was driven by currency

Notes to Consolidated Financial Statements
International Business Machines Corporation and Subsidiary Companies

and has been included in the 2013 reductions for tax positions ofprior years. In April 2011, the company received notification that theappeal was denied. In June 2011, the company filed a lawsuit challenging this decision. The company filed its latest brief in December
2013. No final determination has been reached on this matter.
The liability at December 31, 2013 of $4,458 million can be
reduced by $556 million of offsetting tax benefits associated withthe correlative effects of potential transfer pricing adjustments, state
income taxes and timing adjustments. The net amount of $3,902
million, if recognized, would favorably affect the company’s effective
tax rate. The net amounts at December 31, 2012 and 2011 were
$5,099 million and $5,090 million, respectively.
Interest and penalties related to income tax liabilities are included
in income tax expense. During the year ended December 31, 2013,
the company recognized a $93 million benefit in interest expenseand penalties; in 2012, the company recognized $134 million in interest expense and penalties, and in 2011, the company recognized$129 million in interest expense and penalties. The company has $417
million for the payment of interest and penalties accrued at December
31, 2013, and had $533 million accrued at December 31, 2012.
Within the next 12 months, the company believes it is reasonably
possible that the total amount of unrecognized tax benefits associatedwith certain positions may be reduced. The company expects that certain foreign and state issues may be concluded in the next 12 months.
The company estimates that the unrecognized tax benefits at December
31, 2013 could be reduced by approximately $101 million.
The company is subject to taxation in the U.S. and various stateand foreign jurisdictions. With respect to major U.S. state and foreign
taxing jurisdictions, the company is generally no longer subject totax examinations for years prior to 2008. The company is no longer
subject to income tax examination of its U.S. federal tax return foryears prior to 2011. The open years contain matters that could be
subject to differing interpretations of applicable tax laws and regulations related to the amount and/or timing of income, deductions andtax credits. Although the outcome of tax audits is always uncertain,

the company believes that adequate amounts of tax and interest
have been provided for any adjustments that are expected to result
for these years.
In the fourth quarter of 2013, the company received a draft tax
assessment notice for approximately $866 million from the Indian
Tax Authorities for 2009. The company believes it will prevail on
these matters and that this amount is not a meaningful indicator of
liability. At December 31, 2013, the company has recorded $433
million as prepaid income taxes in India. A significant portion of thisbalance represents cash tax deposits paid over time to protect thecompany’s right to appeal various income tax assessments madeby the Indian Tax Authorities.
The company has not provided deferred taxes on $52.3 billionof undistributed earnings of non-U.S. subsidiaries at December 31,
2013, as it is the company’s policy to indefinitely reinvest these earnings in non-U.S. operations. However, the company periodicallyrepatriates a portion of these earnings to the extent that it does notincur an additional U.S. tax liability. Quantification of the deferred tax
liability, if any, associated with indefinitely reinvested earnings is notpracticable.

Note O.
Research, Development and Engineering
RD&E expense was $6,226 million in 2013, $6,302 million in 2012
and $6,258 million in 2011.
The company incurred expense of $5,959 million, $6,034 million
and $5,990 million in 2013, 2012 and 2011, respectively, for scientificresearch and the application of scientific advances to the development of new and improved products and their uses, as well as
services and their application. Within these amounts, softwarerelated expense was $3,077 million, $3,078 million and $3,097 million
in 2013, 2012 and 2011, respectively.
Expense for product-related engineering was $267 million,$268 million and $267 million in 2013, 2012 and 2011, respectively.

Note P.
Earnings Per Share of Common Stock
The following table presents the computation of basic and diluted earnings per share of common stock.
($ in millions except per share amounts)
For the year ended December 31:

2013

2012

2011

Weighted-average number of shares on which earnings per share calculations are based
Basic

1,094,486,604

1,142,508,521

1,196,951,006

Add—incremental shares under stock-based compensation plans

6,751,240

10,868,426

14,241,131

Add—incremental shares associated with contingently issuable shares

1,804,313

2,072,370

2,575,848

1,103,042,156

1,155,449,317

1,213,767,985

Net income on which basic earnings per share is calculated$16,483$16,604$15,855

Less—net income applicable to contingently issuable shares

1

1

0

$16,483$16,603$15,855

Assuming dilution$ 14.94$ 14.37$ 13.06

Basic$ 15.06$ 14.53$ 13.25

Assuming dilution

Net income on which diluted earnings per share is calculated
Earnings/(loss) per share of common stock

123

124

Notes to Consolidated Financial Statements
International Business Machines Corporation and Subsidiary Companies

Weighted-average stock options to purchase 8,797 common sharesin 2013 were outstanding, but were not included in the computationof diluted earnings per share because the exercise price of theoptions was greater than the average market price of the commonshares for the full year, and therefore, the effect would have been
antidilutive. There were no stock options outstanding in 2012 and2011 that were considered antidilutive and not included in the diluted
earnings per share calculation.

Note Q.
Rental Expense and Lease Commitments
Rental expense, including amounts charged to inventories and fixed
assets, and excluding amounts previously reserved, was $1,759 million in 2013, $1,767 million in 2012 and $1,836 million in 2011. Rental
expense in agreements with rent holidays and scheduled rent
increases is recorded on a straight-line basis over the lease term.
Contingent rentals are included in the determination of rental

expense as accruable. The table below depicts gross minimum
rental commitments under noncancelable leases, amounts related
to vacant space associated with infrastructure reductions, sublease
income commitments and capital lease commitments. Theseamounts reflect activities primarily related to office space, as well as
manufacturing facilities.

($ in millions)
2014

2015

2016

2017

2018

Beyond 2018

Operating lease commitments
Gross minimum rental commitments(including vacant space below)$1,492$1,286$1,016

$799

$620

$778

Vacant space$   24$   16$    6

$  4

$  1

$  0

Sublease income commitments$   22$   16$   14

$  9

$  4

$  7

$   16$   12$   13

$  3

$  9

$  5

Capital lease commitments

Incentive Awards

Note R.
Stock-Based Compensation
Stock-based compensation cost is measured at grant date, basedon the fair value of the award, and is recognized over the employee
requisite service period. See note A, “Significant Accounting Policies,”on page 90 for additional information.
The following table presents total stock-based compensation
cost included in the Consolidated Statement of Earnings.
($ in millions)
For the year ended December 31:

Cost

2013

2012

2011

$ 122

$ 132

$ 120

Selling, general and administrative

435

498

514

Research, development
and engineering

57

59

62

Other (income) and expense

—

(1)

—

Pre-tax stock-based
compensation cost

614

688

697

Income tax benefits

(213)

(240)

(246)

Total stock-based
compensation cost

$ 402

$ 448

$ 450

Total unrecognized compensation cost related to non-vested
awards at December 31, 2013 and 2012 was $995 million and $1,101
million, respectively. The amount at December 31, 2013 is expected
to be recognized over a weighted-average period of approximately
three years.
There was no significant capitalized stock-based compensation
cost at December 31, 2013, 2012 and 2011.

Stock-based incentive awards are provided to employees under
the terms of the company’s long-term performance plans (the“Plans”). The Plans are administered by the Executive Compen­
sation and Management Resources Com­mittee of the Board of
Directors (the “Committee”). Awards available under the Plans principally include stock options, restricted stock units, performance
share units or any combination thereof.
The amount of shares originally authorized to be issued under thecompany’s existing Plans was 274.1 million at December 31, 2013. In
addition, certain incentive awards granted under previous plans, if andwhen those awards were canceled, could be reissued under the company’s existing Plans. As such, 66.2 million additional awards wereconsidered authorized to be issued under the company’s existing
Plans as of December 31, 2013. There were 118.6 million unused sharesavailable to be granted under the Plans as of December 31, 2013.
Under the company’s long-standing practices and policies, allawards are approved prior to or on the date of grant. The awards
approval process specifies the individual receiving the grant, thenumber of options or the value of the award, the exercise price orformula for determining the exercise price and the date of grant. Allawards for senior management are approved by the Committee. Allawards for employees other than senior management are approvedby senior management pursuant to a series of delegations that wereapproved by the Committee, and the grants made pursuant to thesedelegations are reviewed periodically with the Committee. Awards
that are given as part of annual total compensation for senior management and other employees are made on specific cycle dates
scheduled in advance. With respect to awards given in connection
with promotions or new hires, the company’s policy requires approvalof such awards prior to the grant date, which is typically the date of
the promotion or the date of hire.

Notes to Consolidated Financial Statements
International Business Machines Corporation and Subsidiary Companies

Stock Options
Stock options are awards which allow the employee to purchaseshares of the company’s stock at a fixed price. Stock options are
granted at an exercise price equal to the company’s average highand low stock price on the date of grant. These awards, which
generally vest 25 percent per year, are fully vested four years fromthe date of grant and have a contractual term of 10 years.
The company estimates the fair value of stock options at the dateof grant using the Black-Scholes valuation model. Key inputs andassumptions used to estimate the fair value of stock options include

the grant price of the award, the expected option term, volatility of
the company’s stock, the risk-free rate and the company’s dividend
yield. Estimates of fair value are not intended to predict actual
future events or the value ultimately realized by employees who
receive equity awards, and subsequent events are not indicativeof the reasonableness of the original estimates of fair value madeby the company.
During the years ended December 31, 2013, 2012 and 2011, thecompany did not grant stock options.

The following table summarizes option activity under the Plans during the years ended December 31, 2013, 2012 and 2011.
2013

2012

2011

WeightedAverage
Exercise Price

Number of
SharesUnder Option

WeightedAverage
Exercise Price

Number of
SharesUnder Option

WeightedAverage
Exercise Price

Balance at January 1$94

11,389,721$90

20,662,322$ 94

39,197,728

Options exercised

90(5,585,127)

86(9,080,170)

98(18,144,309)

Number of
SharesUnder Option

Options canceled/expired

86(181,643)

75(192,431)

107(391,097)

Balance at December 31$97

5,622,951$94

11,389,721$ 90

20,662,322

Exercisable at December 31$97

5,622,951$94

11,389,721$ 90

20,662,322

The shares under option at December 31, 2013 were in the following exercise price ranges:
Options Outstanding and Exercisable

Exercise Price Range$85 and under$86 – $105
$106 and overIn connection with various acquisition transactions, there was anadditional 0.6 million stock-based awards, consisting of stock
options and restricted stock units, outstanding at December 31,
2013, as a result of the company’s assumption of stock-based
awards previously granted by the acquired entities. The weightedaverage exercise price of these awards was $67 per share.
Exercises of Employee Stock Options
The total intrinsic value of options exercised during the years ended
December 31, 2013, 2012 and 2011 was $614 million, $1,005 million
and $1,269 million, respectively. The total cash received from
employees as a result of employee stock option exercises for theyears ended December 31, 2013, 2012 and 2011 was approximately$505 million, $785 million and $1,786 million, respectively. In connection with these exercises, the tax benefits realized by thecompany for the years ended December 31, 2013, 2012 and 2011were $199 million, $341 million and $412 million, respectively.

WeightedAverage
Exercise Price

Weighted-Average
Remaining
Contractual Life(in Years)

Number of
SharesUnder Option

Aggregate
Intrinsic
Value

$ 82

468,427$ 49,244,658

2.1

98

4,908,689

440,012,196

1.1

106

245,835

20,055,475

0.2

$ 97

5,622,951$509,312,330

1.1

The company settles employee stock option exercises primarily
with newly issued common shares and, occasionally, with treasury
shares. Total treasury shares held at December 31, 2013 and 2012 wereapproximately 1,153 million and 1,080 million shares, respectively.
Stock Awards
In lieu of stock options, the company currently grants its employees
stock awards. These awards are made in the form of Restricted
Stock Units (RSUs), including Retention Restricted Stock Units(RRSUs), or Performance Share Units (PSUs).

125

126

Notes to Consolidated Financial Statements
International Business Machines Corporation and Subsidiary Companies

The tables below summarize RSU and PSU activity under the Plans during the years ended December 31, 2013, 2012 and 2011.

RSUs
2013
WeightedAverage
Grant Price

2012
Numberof Units

WeightedAverage
Grant Price

2011
Numberof Units

WeightedAverage
Grant Price

Numberof Units

11,196,446

Balance at January 1$148

9,841,461$129

12,218,601$110

RSUs granted

189

2,541,081

184

2,635,772

154

5,196,802

RSUs released

131(2,952,363)

117(4,338,787)

106(3,508,700)

RSUs canceled/forfeited154(794,862)

139(674,125)122(665,947)

Balance at December 31$166

8,635,317$148

9,841,461$129

12,218,601

WeightedAverage
Grant Price

Numberof Units

WeightedAverage
Grant Price

Numberof Units

WeightedAverage
Grant Price

Numberof Units

Balance at January 1$151

3,172,201$122

3,686,991$111

3,649,288

PSUs granted at target

195

869,875

185

1,004,003

154

1,055,687

Additional shares earned above target*

118

152,069102

550,399

118

230,524

PSUs released

118(1,321,784)

102(1,998,746)

118(1,189,765)

PSUs
2013

2012

2011

PSUs canceled/forfeited170(48,067)131(70,446)

118(58,743)

Balance at December 31**$178

2,824,294$151

3,172,201$122

3,686,991  * Represents additional shares issued to employees after vesting of PSUs because final performance metrics exceeded specified targets.
** Represents the number of shares expected to be issued based on achievement of grant date performance targets. The actual number of shares issued depends on the company’s
performance against specified targets over the vesting period.

RSUs are stock awards granted to employees that entitle the holder
to shares of common stock as the award vests, typically over aone- to five-year period. For RSUs, dividend equivalents are notpaid. The fair value of such RSUs is determined and fixed on the
grant date based on the company’s stock price adjusted for the
exclusion of dividend equivalents.
The remaining weighted-average contractual term of RSUs at
December 31, 2013, 2012 and 2011 is the same as the period overwhich the remaining cost of the awards will be recognized, which
is approximately three years. The fair value of RSUs granted during
the years ended December 31, 2013, 2012 and 2011 was $481 million,$486 million and $803 million, respectively. The total fair value of
RSUs vested and released during the years ended December 31,
2013, 2012 and 2011 was $386 million, $509 million and $373 million, respectively. As of December 31, 2013, 2012 and 2011, there
was $871 million, $938 million and $1,021 million, respectively, of
unrecognized compensation cost related to non-vested RSUs. The
company received no cash from employees as a result of employee
vesting and release of RSUs for the years ended December 31,
2013, 2012 and 2011. In the second quarter of 2011, the company
granted equity awards valued at approximately $1 thousand eachto about 400,000 non-executive employees. These awards weremade under the Plans and vest in December 2015.

PSUs are stock awards where the number of shares ultimately
received by the employee depends on the company’s performanceagainst specified targets and typically vest over a three-year period.
For PSUs, dividend equivalents are not paid. The fair value of each
PSU is determined on the grant date, based on the company’s stock
price, adjusted for the exclusion of dividend equivalents, andassumes that performance targets will be achieved. Over the performance period, the number of shares of stock that will be issued
is adjusted upward or downward based upon the probability ofachievement of performance targets. The ultimate number of sharesissued and the related compensation cost recognized as expense
will be based on a comparison of the final performance metrics tothe specified targets. The fair value of PSUs granted at target during
the years ended December 31, 2013, 2012 and 2011 was $170 million, $186 million and $165 million, respectively. Total fair value of
PSUs vested and released during the years ended December 31,
2013, 2012 and 2011 was $156 million, $203 million and $141 million,
respectively.
In connection with vesting and release of RSUs and PSUs,
the tax benefits realized by the company for the years ended
December 31, 2013, 2012 and 2011 were $312 million, $454 million
and $283 million, respectively.

Notes to Consolidated Financial Statements
International Business Machines Corporation and Subsidiary Companies

IBM Employees Stock Purchase Plan
The company maintains a non-compensatory Employees Stock
Pur­chase Plan (ESPP). The ESPP enables eligible participants topurchase full or fractional shares of IBM common stock at a 5 percent discount off the average market price on the day of purchasethrough payroll deductions of up to 10 percent of eligible compensation. Eligible compensation includes any compensation received by
the employee during the year. The ESPP provides for offering periods during which shares may be purchased and continues as longas shares remain available under the ESPP, unless terminated earlier
at the discretion of the Board of Directors. Individual ESPP participants are restricted from purchasing more than $25,000 of common
stock in one calendar year or 1,000 shares in an offering period.
Employees purchased 1.5 million, 1.6 million and 1.9 million
shares under the ESPP during the years ended December 31, 2013,2012 and 2011, respectively. Cash dividends declared and paid by
the company on its common stock also include cash dividends onthe company stock purchased through the ESPP. Dividends arepaid on full and fractional shares and can be reinvested in the ESPP.
The company stock purchased through the ESPP is considered outstanding and is included in the weighted-average outstanding sharesfor purposes of computing basic and diluted earnings per share.
Approximately 2.3 million, 3.8 million and 5.4 million shares wereavailable for purchase under the ESPP at December 31, 2013, 2012
and 2011, respectively.

Note S.
Retirement-Related Benefits

Description of Plans
IBM sponsors defined benefit pension plans and defined contributionplans that cover substantially all regular employees, a supplemental
retention plan that covers certain U.S. executives and nonpension
postretirement benefit plans primarily consisting of retiree medical
and dental benefits for eligible retirees and dependents.
U.S. Plans
Defined Benefit Pension Plans
IBM Personal Pension Plan
IBM provides U.S. regular, full-time and part-time employees hired
prior to January 1, 2005 with noncontributory defined benefit pension benefits via the IBM Personal Pension Plan. Prior to 2008, theIBM Personal Pension Plan consisted of a tax qualified (qualified)plan and a non-tax qualified (nonqualified) plan. Effective January
1, 2008, the nonqualified plan was renamed the Excess Personal
Pension Plan (Excess PPP) and the qualified plan is now referred
to as the Qualified PPP. The combined plan is now referred to as
the PPP. The Qualified PPP is funded by company contributions
to an irrevocable trust fund, which is held for the sole benefit ofparticipants and beneficiaries. The Excess PPP, which is unfunded,
provides benefits in excess of IRS limitations for qualified plans.

Benefits provided to the PPP participants are calculated using
benefit formulas that vary based on the participant. The first method
uses a five-year, final pay formula that determines benefits basedon salary, years of service, mortality and other participant-specificfactors. The second method is a cash balance formula that calculates benefits using a percentage of employees’ annual salary, as
well as an interest crediting rate.
Benefit accruals under the IBM Personal Pension Plan ceased
December 31, 2007 for all participants.
U.S. Supplemental Executive Retention Plan
The company also sponsors a nonqualified U.S. Supplemental
Executive Reten­tion Plan (Retention Plan). The Retention Plan,
which is unfunded, provides benefits to eligible U.S. executives
based on average earnings, years of service and age at termination of
employment.
Benefit accruals under the Retention Plan ceased December 31,
2007 for all participants.

Defined Contribution Plans
IBM 401(k) Plus Plan
U.S. regular, full-time and part-time employees are eligible toparticipate in the IBM 401(k) Plus Plan, which is a qualified defined
contribution plan under section 401(k) of the Internal Revenue Code.
Effective January 1, 2008, under the IBM 401(k) Plus Plan, eligible
employees receive a dollar-for-dollar match of their contributions up
to 6 percent of eligible compensation for those hired prior to January
1, 2005, and, generally up to 5 percent of eligible compensation for
those hired on or after January 1, 2005. In addition, eligible employees receive automatic contributions from the company equal to 1, 2
or 4 percent of eligible compensation based on their eligibility toparticipate in the PPP as of December 31, 2007. Employees generally receive automatic contributions and matching contributions after
the completion of one year of service. Further, through June 30,
2009, IBM contributed transition credits to eligible participants’401(k) Plus Plan accounts. The amount of the transition credits was
based on a participant’s age and service as of June 30, 1999.
The company’s matching contributions vest immediately andparticipants are always fully vested in their own contributions. All
contributions, including the company match, are made in cash andinvested in accordance with participants’ investment elections.
There are no minimum amounts that must be invested in company
stock, and there are no restrictions on transferring amounts out ofcompany stock to another investment choice, other than excessive
trading rules applicable to such investments. Effective January 1,
2013, matching and automatic contributions are made once annuallyat the end of the year. In order to receive such contributions each year,
a participant must be employed on December 15 of the plan year.
However, if a participant separates from service prior to December
15, and has completed certain service and/or age requirements,
then the participant will be eligible to receive such matching andautomatic contributions following separation from service.

127

128

Notes to Consolidated Financial Statements
International Business Machines Corporation and Subsidiary Companies

IBM Excess 401(k) Plus Plan
Effective January 1, 2008, the company replaced the IBM Exec­utive
Deferred Compensation Plan, an unfunded, nonqualified, defined
contribution plan, with the IBM Excess 401(k) Plus Plan (Excess
401(k)), an unfunded, nonqualified defined contribution plan.
Employees who are eligible to participate in the 401(k) Plus Plan andwhose eligible compensation is expected to exceed the IRS compensation limit for qualified plans are eligible to participate in the
Excess 401(k). The purpose of the Excess 401(k) is to provide benefits that would be provided under the qualified IBM 401(k) Plus Plan
if the compensation limits did not apply.
Amounts deferred into the Excess 401(k) are record-keeping(notional) accounts and are not held in trust for the participants.
Participants in the Excess 401(k) may invest their notional accounts
in investments which mirror the primary investment options available
under the 401(k) Plus Plan. Participants in the Excess 401(k) are also
eligible to receive company match and automatic contributions on
eligible compensation deferred into the Excess 401(k) and on compensation earned in excess of the Internal Revenue Code pay limit
once they have completed one year of service. Through June 30,
2009, eligible participants also received transition credits. Amounts
deferred into the Excess 401(k), including company contributions
are recorded as liabilities in the Consolidated Statement of Financial
Position. Effective January 1, 2013, matching and automatic contributions are recorded once annually at the end of the year. In orderto receive such contributions each year, a participant must be
employed on December 15 of the plan year. However, if a participant
separates from service prior to December 15, and has completed
certain service and/or age requirements, then the participant will
be eligible to receive such matching and automatic contributions
following separation from service.

Nonpension Postretirement Benefit Plan
U.S. Nonpension Postretirement Plan
The company sponsors a defined benefit nonpension postretirement benefit plan that provides medical and dental benefits toeligible U.S. retirees and eligible dependents, as well as life insurance
for eligible U.S. retirees. Effective July 1, 1999, the company established a Future Health Account (FHA) for employees who were morethan five years from retirement eligibility. Employees who were within
five years of retirement eligibility are covered under the company’s
prior retiree health benefits arrangements. Under either the FHA or
the prior retiree health benefit arrangements, there is a maximum
cost to the company for retiree health benefits. Effective January 1,
2014, the company amended the plan to establish a Health Reimbursement Arrangement (HRA) for each Medicare-eligible plan
retiree, surviving spouse and long-term disability plan participant
who is eligible for company subsidized coverage and who enrolls in
an individual plan under the Medicare Exchange. The company also
amended its life insurance plan. Employees retiring on or after January 1, 2015, will no longer be eligible for life insurance. Existing
retirees and employees retiring during 2014 continue to be eligible
for retiree life insurance.
Since January 1, 2004, new hires, as of that date or later, are noteligible for company subsidized nonpension postretirement benefits.
Non-U.S. Plans
Certain subsidiaries and branches outside the United States sponsor defined benefit and/or defined contribution plans that coversubstantially all regular employees. The company deposits funds
under various fiduciary-type arrangements, purchases annuities
under group contracts or provides reserves for these plans. Benefits under the defined benefit plans are typically based either on
years of service and the employee’s compensation (generally during
a fixed number of years immediately before retirement) or on annual
credits. The range of assumptions that are used for the non-U.S.
defined benefit plans reflect the different economic environments
within the various countries.
In addition, certain of the company’s non-U.S. subsidiaries sponsor nonpension postretirement benefit plans that provide medical
and dental benefits to eligible non-U.S. retirees and eligible dependents, as well as life insurance for certain eligible non-U.S. retirees.
However, most non-U.S. retirees are covered by local governmentsponsored and -administered programs.

Notes to Consolidated Financial Statements
International Business Machines Corporation and Subsidiary Companies

Plan Financial Information
Summary of Financial Information
The following table presents a summary of the total retirement-related benefits net periodic (income)/cost recorded in the Consolidated
Statement of Earnings.
($ in millions)
U.S. Plans

Non-U.S. Plans

Total

For the year ended December 31:

2013

2012

2011

2013

2012

2011

2013

2012

2011

Defined benefit pension plans$(223)$(526)$(774)$1,396$1,040$  734$1,173$   515$  (40)

21

18

15

—

—

—

21

18

15

Total defined benefit
pension plans (income)/cost$(202)$(507)$(759)$1,396$1,040$  734$1,195$   533$  (25)

IBM 401(k) Plus Plan
and non-U.S. plans

$ 785

$ 857

$ 875

$  575$  621$  608$1,361$1,478$1,483

24

29

30

—

—

—

24

29

30

Total defined contribution plans cost

$ 809

$ 885

$ 905

$  575$  621$  608$1,384$1,506$1,513

Nonpension postretirement
benefit plans cost

$ 218

$ 268

$ 269

$   79$   82$   76$  298$  350$  345

Total retirement-related
benefits net periodic cost

$ 826

$ 646

$ 415

$2,051$1,743$1,418$2,876$2,389$1,832Retention Plan

Excess 401(k)The following table presents a summary of the total PBO for defined benefit pension plans, APBO for nonpension postretirement benefit
plans, fair value of plan assets and the associated funded status recorded in the Consolidated Statement of Financial Position.
($ in millions)Benefit Obligations
At December 31:

Funded Status*

Fair Value of Plan Assets

2013

2012

2013

2012

2013

2012

$49,315$     —

$53,954$    —$   4,639$     —

Qualified PPP$        —$ 54,907$        —$53,630$         —

$  (1,277)

Excess PPP

1,425

1,576

    —

    —

(1,425)(1,576)

Retention Plan

294

327

—

—

(294)

(327)

4,633

5,282

177

433

(4,456)(4,849)$ 6,352$ 62,092$   177$54,063$ (6,175)$ (8,029)$ 9,336$  6,944$10,240$ 7,889$    904$    945

10

12

11

12

1

0

$ 9,346$  6,956$10,251$ 7,901$    905$    945

U.S. Plans
Overfunded plans
Qualified PPP
Underfunded plans

Nonpension postretirement benefit plan
Total underfunded U.S. plans
Non-U.S. Plans
Overfunded plans
Qualified defined benefit pension plans
Nonpension postretirement benefit plans
Total overfunded non-U.S. plans
Underfunded plans$32,697$ 35,956$29,223$30,169$ (3,474)$ (5,788)

Nonqualified defined benefit pension plans

6,587

6,418

—

—

(6,587)(6,418)Nonpension postretirement benefit plans

822

1,007

81

107

(741)

(900)

$40,106$ 43,381$29,304$30,276$(10,802)$(13,106)

Total overfunded plans$58,661$  6,956$64,205$ 7,901$ 5,544$    945

Total underfunded plans$46,458$105,473$29,481$84,338$(16,977)$(21,134)

Qualified defined benefit pension plans

Total underfunded non-U.S. plans* Funded status is recognized in the Consolidated Statement of Financial Position as follows: Asset amounts as prepaid pension assets; (Liability) amounts as compensation andbenefits (current liability) and retirement and nonpension postretirement benefit obligations (noncurrent liability).

At December 31, 2013, the company’s qualified defined benefit pension plans worldwide were 102 percent funded compared to the benefit
obligations, with the U.S. Qualified PPP 109 percent funded. Overall, including nonqualifed plans, the company’s defined benefit pension plans
were 94 percent funded.

129

130

Notes to Consolidated Financial Statements
International Business Machines Corporation and Subsidiary Companies

Defined Benefit Pension and Nonpension Postretirement
Benefit Plan Financial Information
The following tables through page 132 represent financial information
for the company’s retirement-related benefit plans, excluding defined
contribution plans. The defined benefit pension plans under U.S.
Plans consists of the Qualified PPP, the Excess PPP and the Retention Plan. The defined benefit pension plans and the nonpension
postretirement benefit plans under Non-U.S. Plans consists of allplans sponsored by the company’s subsidiaries. The nonpension
postretirement benefit plan under U.S. Plan consists of only the U.S.
Non­pension Postretirement Benefit Plan.
The tables below present the components of net periodic (income)/
cost of the retirement-related benefit plans recognized in the Consoli­
dated Statement of Earnings, excluding defined contribution plans.

($ in millions)Defined Benefit Pension Plans
U.S. Plans
For the year ended December 31:

Service cost

Non-U.S. Plans

2013

2012

2011

2013

2012

2011

$    —$    —$    —$  501$  443$  505Interest cost

1,980

2,196

2,456

1,524

1,779

1,843

Expected return on plan assets(3,981)(4,043)(4,043)(2,195)(2,303)(2,521)

Amortization of transition assets

—

—

—

0

(0)

(0)

Amortization of prior service costs/(credits)

10

10

10

(119)

(154)

(162)

Recognized actuarial losses

1,790

1,331

818

1,600

1,027

957

Curtailments and settlements

—

—

—

0

0

1

Multi-employer plans/other costs*

—

—

—

85

247

111

Total net periodic (income)/cost$  (202)$  (507)$  (759)$ 1,396$ 1,040$  734($ in millions)
Nonpension Postretirement Benefit Plans
U.S. Plan

Non-U.S. Plans

For the year ended December 31:

2013

2012

2011

2013

2012

2011

Service cost

$ 35

$ 36

$ 33

$10

$14

$ 11

Interest cost

164

200

236

60

64

67

Expected return on plan assets

(1)

—

—

(9)

(9)

(10)

Amortization of transition assets

—

—

—

0

0

0

Amortization of prior service costs/(credits)

—

—

—

(5)

(4)

(4)

Recognized actuarial losses

21

32

—

23

17

13

Curtailments and settlements

—

—

—

0

0

—

$218

$268

$269

$79

$82

$ 76

Total net periodic cost

* The 2012 Non-U.S. plans amount includes $162 million related to the IBM UK pension litigation. See page 132 for additional information.

Notes to Consolidated Financial Statements
International Business Machines Corporation and Subsidiary Companies

The following table presents the changes in benefit obligations and plan assets of the company’s retirement-related benefit plans, excluding
defined contribution plans.
($ in millions)Defined Benefit Pension Plans
U.S. Plans

Nonpension Postretirement Benefit Plans

Non-U.S. Plans

U.S. Plan

Non-U.S. Plans

2013

2012

2013

2012

2013

2012

2013

2012

Change in benefit obligation$56,810$54,085$49,319$ 42,861$ 5,282$ 5,273$1,019$   901

Service cost

—

—

501

443

35

36

10

14

Interest cost

1,980

2,196

1,524

1,779

164

200

60

64

Plan participants’ contributions

—

—

42

47

191

200

—

—

Acquisitions/divestitures, net

—

—

89

26

(2)

2

(0)

—

Actuarial losses/(gains)(4,344)

3,810

(362)

6,365

(481)

104

(89)

76

Benefits paid from trust(3,303)(3,184)(1,920)(1,987)

(557)

(551)

(6)

(6)

Direct benefit payments

(108)

(97)

(464)

(454)

(43)

(35)

(28)

(27)
(24)

Benefit obligation at January 1

Foreign exchange impact

—

—

(115)

77

—

—

(89)

Medicare/Government subsidies

—

—

—

—

30

53

—

—

Amendments/curtailments/settlements/other

—

—

6

161

15

—

(44)

21

$51,034$56,810$48,620$ 49,319$ 4,633$ 5,282$  832$1,019$53,630$51,218$38,058$ 35,362$  433$   38$  119$  112

3,626

5,596

2,515

3,742

0

0

5

10

Employer contributions

—

—

449

557

110

746

0

1

Acquisitions/divestitures, net

—

—

35

40

—

—

0

—

Benefit obligation at December 31
Change in plan assets
Fair value of plan assets at January 1
Actual return on plan assets

—

—

42

47

191

200

—

—

(3,303)(3,184)(1,920)(1,987)

(557)

(551)

(6)

(6)

Foreign exchange impact

—

—

121

305

—

—

(14)

(8)

Amendments/curtailments/settlements/other

—

—

164*

(8)

—

—

(12)

10

Fair value of plan assets at December 31$53,954$53,630$39,464$ 38,058$  177$  433$    92$  119Funded status at December 31$  2,920$ (3,180)$ (9,157)$(11,261)$(4,456)$(4,849)$ (740)$ (900)

Accumulated benefit obligation**$51,034$56,810$47,806$ 48,369

N/A

N/A

N/A

N/A

Plan participants’ contributions
Benefits paid from trust  * Includes the reinstatement of certain plan assets in Brazil due to government rulings in 2011 and 2013 allowing certain previously restricted plan assets to be returned to IBM. The
assets will be returned to IBM monthly over a three-year period, starting June 2011 and September 2013 respectively, with approximately $204 million returned during 2013. The
remaining surplus in Brazil at December 31, 2013 remains excluded from total plan assets due to continued restrictions imposed by the government on the use of those plan
assets.

** Represents the benefit obligation assuming no future participant compensation increases.
N/A—Not applicable

The following table presents the net funded status recognized in the Consolidated Statement of Financial Position.
($ in millions)Defined Benefit Pension Plans
U.S. Plans
At December 31:

Prepaid pension assets
Current liabilities—compensation and benefits

Nonpension Postretirement Benefit Plans

Non-U.S. Plans

U.S. Plan

Non-U.S. Plans

2013

2012

2013

2012

2013

2012

2013

2012

$ 4,639$    0$  912$   944$    0$    0

$   1

$   0

(107)

(102)

(364)

(356)

(256)

(239)

(16)

(20)

Noncurrent liabilities—retirement and nonpension
postretirement benefit obligations(1,612)(3,078)(9,705)(11,849)(4,200)(4,610)

(725)

(880)

Funded status—net$ 2,920$(3,180)$(9,157)$(11,261)$(4,456)$(4,849)$(740)$(900)

131

132

Notes to Consolidated Financial Statements
International Business Machines Corporation and Subsidiary Companies

The following table presents the pre-tax net loss and prior service costs/(credits) and transition (assets)/liabilities recognized in OCI and thechanges in the pre-tax net loss, prior service costs/(credits) and transition (assets)/liabilities recognized in AOCI for the retirement-related
benefit plans.
($ in millions)Defined Benefit Pension Plans
U.S. Plans

Net loss at January 1
Current period loss/(gain)
Curtailments and settlements
Amortization of net loss included
in net periodic (income)/cost

Nonpension Postretirement Benefit Plans

Non-U.S. Plans

U.S. Plan

Non-U.S. Plans

2013

2012

2013

2012

2013

2012

2013

2012

$19,488$18,561$22,188$18,309

$ 806

$734

$269

$211

(3,989)

2,258

(814)

4,905

(480)

104

(85)

75

—

—

3

2

—

—

0

—

(1,790)(1,331)(1,600)(1,027)

(21)

(32)

(23)

(17)

Net loss at December 31$13,709$19,488$19,777$22,188

$ 304

$806

$161

$269

Prior service costs/(credits) at January 1$   130$   139$  (614)$  (768)$    —$  —$   (6)$ (10)

—

—

0

—

15

—

(31)

—

Current period prior service costs/(credits)
Amortization of prior service (costs)/credits
included in net periodic (income)/cost

(10)

(10)

119

154

—

—

5

4

Prior service costs/(credits) at December 31$   120$   130$  (496)$  (614)

$  15

$  —

$ (32)$   (6)

Transition (assets)/liabilities at January 1$    —$     —

$     0$    (0)$    —

$  —

$  0

$  0

Amortization of transition assets/(liabilities)
included in net periodic (income)/cost

—

—

0

0

—

—

0

(0)

Transition (assets)/liabilities at December 31$    —$     —

$     0$    (0)$    —

$  —

$  0

$  0

Total loss recognized in accumulated othercomprehensive income/(loss)*$13,829$19,618$19,281$21,574

$ 319

$806

$129

$263

* See note L, “Equity Activity,” on pages 116 through 118 for the total change in AOCI, and the Consolidated Statement of Comprehensive Income for the components of net periodic(income)/cost, including the related tax effects, recognized in OCI for the retirement-related benefit plans.

The following table presents the pre-tax estimated net loss, estimated prior service costs/(credits) and estimated transition (assets)/
liabilities of the retirement-related benefit plans that will be amortized from AOCI into net periodic (income)/cost in 2014.
($ in millions)Defined Benefit
Pension Plans

Nonpension Postretirement
Benefit Plans

U.S. Plans

Non-U.S. Plans

U.S. Plan

Non-U.S. Plans$1,076$1,461$—$11

Prior service costs/(credits)

10

(127)

(7)

(6)

Transition (assets)/liabilities

—

0

—

0

Net loss

During the years ended December 31, 2013, 2012 and 2011, thecompany paid $14 million, $22 million and $16 million, respectively,
for mandatory pension insolvency insurance coverage premiumsin certain non-U.S. countries (Germany, Canada and the UK).
During the year ended December 31, 2013, the company
amended the U.S. nonpension postretirement benefit plan. A planamendment effective January 1, 2014, which established an HRA
for Medicare eligible participants increased the benefit obligation$91 million. A plan amendment which ended life insurance eligibility
for employees who retire on or after January 1, 2015 reduced thebenefit obligation $76 million.
On October 12, 2012, the High Court in London issued a rulingagainst IBM United Kingdom Limited and IBM United Kingdom
Holdings Limited, both wholly-owned subsidiaries of the company,in litigation involving one of IBM UK’s defined benefit plans. As aresult of the ruling, the company recorded an additional pre-tax
retirement-related obligation of $162 million in 2012 in selling, generaland administrative expense in the Consolidated Statement of Earnings. See note M, “Contingencies and Commitments,” on page 120
for additional information.
Assumptions Used to Determine Plan Financial Information
Underlying both the measurement of benefit obligations and net
periodic (income)/cost are actuarial valuations. These valuations
use participant-specific information such as salary, age and yearsof service, as well as certain assumptions, the most significant of
which include estimates of discount rates, expected return on plan
assets, rate of compensation increases, interest crediting rates andmortality rates. The company evaluates these assumptions, at aminimum, annually, and makes changes as necessary.

Notes to Consolidated Financial Statements
International Business Machines Corporation and Subsidiary Companies

The table below presents the assumptions used to measure the net periodic (income)/cost and the year-end benefit obligations for retirementrelated benefit plans.
Defined Benefit Pension Plans
U.S. Plans

Non-U.S. Plans

2013

2012

2011

2013

2012

2011

3.23%

4.28%

4.33%

Weighted-average assumptions used to measure net
periodic (income)/cost for the year ended December 31
Discount rate

3.60%

4.20%

5.00%

Expected long-term returns
on plan assets

8.00%

8.00%

8.00%

6.21%

6.26%

6.41%

Rate of compensation increase*

N/A

N/A

N/A

2.51%

2.43%

2.37%

Discount rate

4.50%

3.60%

4.20%

3.32%

3.23%

4.28%

Rate of compensation increase*

N/A

N/A

N/A

2.52%

2.51%

2.43%

Weighted-average assumptions used to measure
benefit obligations at December 31* Rate of compensation increase is not applicable to the U.S. defined benefit pension plans as benefit accruals ceased December 31, 2007 for all participants.
N/A—Not applicable

Nonpension Postretirement Benefit Plans
U.S. Plan

Non-U.S. Plans

2013

2012

2011

2013

2012

2011

Discount rate

3.30%

3.90%

4.80%

6.43%

7.37%

7.75%

Expected long-term returns
on plan assets

0.35%

N/A

N/A

9.01%

9.01%

9.07%

4.10%

3.30%

3.90%

7.78%

6.43%

7.37%

Weighted-average assumptions used to measure net
periodic cost for the year ended December 31

Weighted-average assumptions used to measure
benefit obligations at December 31
Discount rate
N/A—Not applicable

Discount Rate
The discount rate assumptions used for retirement-related benefit
plans accounting reflect the yields available on high-quality, fixedincome debt instruments at the measurement date. For the U.S. andcertain non-U.S. countries, a portfolio of high-quality corporate bonds
is used to construct a yield curve. The cash flows from the company’s
expected benefit obligation payments are then matched to the yield
curve to derive the discount rates. In other non-U.S. countries, where
the markets for high-quality long-term bonds are not generally aswell developed, a portfolio of long-term government bonds is used
as a base, to which a credit spread is added to simulate corporatebond yields at these maturities in the jurisdiction of each plan, as thebenchmark for developing the respective discount rates.
For the U.S. defined benefit pension plans, the changes in the
discount rate assumptions impacted the net periodic (income)/cost
and the PBO. The changes in the discount rate assumptions resulted
in a decrease in 2013 net periodic income of $162 million, a decreasein 2012 net periodic income of $258 million and a decrease in 2011
net periodic income of $171 million. The changes in the discountrate assumptions resulted in a decrease in the PBO of $4,785 million
and an increase of $3,414 million at December 31, 2013 and 2012,
respectively.

For the nonpension postretirement benefit plans, the changes inthe discount rate assumptions had no material impact on net periodic
cost for the years ended December 31, 2013, 2012 and 2011 andresulted in a decrease in the APBO of $298 million and an increaseof $252 million at December 31, 2013 and 2012, respectively.

Expected Long-Term Returns on Plan Assets
Expected returns on plan assets, a component of net periodic(income)/cost, represent the expected long-term returns on plan
assets based on the calculated market-related value of plan assets.
Expected long-term returns on plan assets take into account longterm expectations for future returns and the investment policies andstrategies as described on page 135. These rates of return aredeveloped by the company and are tested for reasonablenessagainst historical returns. The use of expected long-term returns onplan assets may result in recognized pension income that is greateror less than the actual returns of those plan assets in any given year.
Over time, however, the expected long-term returns are designed
to approximate the actual long-term returns, and therefore result ina pattern of income and cost recognition that more closely matches
the pattern of the services provided by the employees. Differences

133

134

Notes to Consolidated Financial Statements
International Business Machines Corporation and Subsidiary Companies

between actual and expected returns are recognized as a component of net loss or gain in AOCI, which is amortized as a componentof net periodic (income)/cost over the service lives or life expectancyof the plan participants, depending on the plan, provided such amounts
exceed certain thresholds provided by accounting standards. The
market-related value of plan assets recognizes changes in the fairvalue of plan assets systematically over a five-year period in the
expected return on plan assets line in net periodic (income)/cost.
For the U.S. defined benefit pension plan, the Qualified PPP, theexpected long-term rate of return on plan assets of 8.00 percent
remained constant for the years ended December 31, 2013, 2012
and 2011 and, consequently, had no incremental impact on net
periodic (income)/cost.
For the nonpension postretirement benefit plans, the company
maintains a highly liquid trust fund balance to ensure timely payments are made. As a result, for the years ended December 31, 2013,2012 and 2011, the expected long-term return on plan assets andthe actual return on those assets were not material.

Rate of Compensation Increases and Mortality Rate
The rate of compensation increases is determined by the com­pany,
based upon its long-term plans for such increases. The rate ofcompensation increase is not applicable to the U.S. defined benefit
pension plans as benefit accruals ceased December 31, 2007 for allparticipants. Mortality rate assumptions are based on life expectancy and death rates for different types of participants. Mortality
rates are periodically updated based on actual experience.
Interest Crediting Rate
Benefits for certain participants in the PPP are calculated using acash balance formula. An assumption underlying this formula is aninterest crediting rate, which impacts both net periodic (income)/
cost and the PBO. This assumption provides a basis for projecting
the expected interest rate that participants will earn on the benefits
that they are expected to receive in the following year and is basedon the average from August to October of the one-year U.S. Treasury
Constant Maturity yield plus one percent.

For the PPP, the change in the interest crediting rate to 1.2 percent for the year ended December 31, 2013, from 1.1 percent for theyear ended December 31, 2012, resulted in a decrease in 2013 net
periodic income of $6 million. The change in the interest crediting
rate to 1.1 percent for the year ended December 31, 2012, from 1.3
percent for the year ended December 31, 2011, resulted in an
increase in 2012 net periodic income of $10 million. The change in
the interest crediting rate to 1.3 percent for the year ended December 31, 2011, from 1.4 percent for the year ended December 31, 2010,
resulted in an increase in 2011 net periodic income of $4 million.

Healthcare Cost Trend Rate
For nonpension postretirement benefit plan accounting, the company reviews external data and its own historical trends forhealthcare costs to determine the healthcare cost trend rates. However, the healthcare cost trend rate has an insignificant effect onplan costs and obligations as a result of the terms of the plan which
limit the company’s obligation to the participants. The company
assumes that the healthcare cost trend rate for 2014 will be 6.5
percent. In addition, the company assumes that the same trend rate
will decrease to 5 percent over the next three years. A one percentage point increase or decrease in the assumed healthcare costtrend rate would not have had a material effect on 2013, 2012 and2011 net periodic cost or the benefit obligations as of December 31,
2013 and 2012.
Healthcare Legislation
The expected effects of the U.S. healthcare reform legislation
enacted in March 2010 were incorporated into the remeasurementsof the U.S. nonpension postretirement benefit plan at December 31,
2013 and 2012. The impact was insignificant as a result of the termsof the plan which limit the company’s obligation to the participants.

Notes to Consolidated Financial Statements
International Business Machines Corporation and Subsidiary Companies

Plan Assets
Retirement-related benefit plan assets are recognized and measured
at fair value as described in note A, “Significant Accounting Policies,”on pages 91 and 92. Because of the inherent uncertainty of valuations, these fair value measurements may not necessarily reflect theamounts the company could realize in current market transactions.

Investment Policies and Strategies
The investment objectives of the Qualified PPP portfolio aredesigned to generate returns that will enable the plan to meet its
future obligations. The precise amount for which these obligations
will be settled depends on future events, including the retirement
dates and life expectancy of the plans’ participants. The obligations are estimated using actuarial assumptions, based on thecurrent economic environment and other pertinent factors describedon pages 132 through 134. The Qualified PPP portfolio’s investment
strategy balances the requirement to generate returns, using potentially higher yielding assets such as equity securities, with the needto control risk in the portfolio with less volatile assets, such as fixedincome securities. Risks include, among others, inflation, volatility inequity values and changes in interest rates that could cause the plan
to become underfunded, thereby increasing its dependence on
contributions from the company. To mitigate any potential concentration risk, careful consideration is given to balancing the portfolio
among industry sectors, companies and geographies, taking into
account interest rate sensitivity, dependence on economic growth,currency and other factors that affect investment returns. As a result,the Qualified PPP portfolio’s target allocation is 42 percent equity
securities, 47 percent fixed-income securities, 6 percent real estate
and 5 percent other investments, which is consistent with the allocation decisions made by the company’s management and is similar
to the prior year target allocation. The table on page 136 details theactual equity, fixed income, real estate and other types of investments in the Qualified PPP portfolio.
The assets are managed by professional investment firms andinvestment professionals who are employees of the company. They arebound by investment mandates determined by the company’s management and are measured against specific benchmarks. Amongthese managers, consideration is given, but not limited to, balancing
security concentration, issuer concentration, investment style andreliance on particular active and passive investment strategies.

Market liquidity risks are tightly controlled, with $6,809 millionof the Qualified PPP portfolio invested in private market assets
consisting of private equities and private real estate investments,
which are less liquid than publicly traded securities. As of December
31, 2013, the Qualified PPP portfolio had $2,830 million in commitments for future investments in private markets to be made over anumber of years. These commitments are expected to be fundedfrom plan assets.
Derivatives are used as an effective means to achieve investment
objectives and/or as a component of the plan’s risk management
strategy. The primary reasons for the use of derivatives are fixedincome management, including duration, interest rate management
and credit exposure, cash equitization and to manage currency andcommodity strategies.
Outside the U.S., the investment objectives are similar to thosedescribed above, subject to local regulations. The weighted-averagetarget allocation for the non-U.S. plans is 33 percent equity securities, 54 percent fixed-income securities, 2 percent real estate and11 percent other investments, which is consistent with the allocation
decisions made by the company’s management. The table on page
136 details the actual equity, fixed income, real estate and othertypes of investments for non-U.S. plans. In some countries, a higher
percentage allocation to fixed income is required to manage solvency and funding risks. In others, the responsibility for managing
the investments typically lies with a board that may include up to 50
percent of members elected by employees and retirees. This canresult in slight differences compared with the strategies previously
described. Generally, these non-U.S. plans do not invest in illiquid
assets and their use of derivatives is consistent with the U.S. planand mainly for currency hedging, interest rate risk management,
credit exposure and alternative investment strategies.
The company’s defined benefit pension plans include investments in certain European government securities. At December
31, 2013, the U.S. plan held $828 million and the non-U.S. plans
held approximately $11 billion in European sovereign debt investments, primarily in AAA-rated securities. Investments in government
debt securities in Italy, Spain and Ireland were de minimis in the U.S.
plan and represented less than 1 percent of total non-U.S. plan
assets. The plans hold no direct investments in government debt
securities of Greece and Portugal.
The company’s nonpension postretirement benefit plans areunderfunded or unfunded. For some plans, the company maintains
a nominal, highly liquid trust fund balance to ensure timely benefit
payments.

135

136

Notes to Consolidated Financial Statements
International Business Machines Corporation and Subsidiary Companies

Defined Benefit Pension Plan Assets
The following table presents the company’s defined benefit pension plans’ asset classes and their associated fair value at December 31, 2013.
The U.S. Plan consists of the Qualified PPP and the Non-U.S. Plans consist of all plans sponsored by the company’s subsidiaries.
($ in millions)
U.S. Plan

Non-U.S. Plans

Level 1

Level 2

Level 3

Total

Level 1

Level 2

Level 3

Total

$15,929$    —$    —$15,929$6,489$     —

$    —$ 6,489

216

2,593

—

2,809

132

8,325

—

8,457

EquityEquity securities (a)Equity commingled/mutual funds (b)(c)Fixed income
Government and related (d)

—

7,093

1

7,094

—

8,682

42

8,724

Corporate bonds (e)—14,6395

14,644

—

1,881

4

1,885

Mortgage and asset-backed securities

—

691

19

709

—

8

—

8

Fixed income commingled/mutual funds (b)(f)

221

716

274

1,211

75

8,596

—

8,670
1,196

—

—

—

—

—

1,196

—

Cash and short-term investments (g)

427

1,915

—

2,343

154

451

—

605

Hedge funds

—

1,368

860

2,228

—

740

—

740

Private equity (h)

—

—

3,771

3,771

—

—

410

410

Private real estate (h)

—

—

3,038

3,038

—

—

655

655

Derivatives (i)

1

6

—

7

1

150

—

151

Other commingled/mutual funds (b)(j)

—

—

—

—

36

1,518

—

1,554

16,79529,021

7,968

53,784

6,886

31,547

1,110

39,544

—

—

—

170

—

—

—

(80)

$16,795$29,021$7,968$53,954$6,886$31,547$1,110$39,464

Insurance contracts

Subtotal
Other (k)Fair value of plan assets(a)	R epresents U.S. and international securities. The U.S. Plan includes IBM common stock of $83 million, representing 0.2 percent of the U.S. Plan assets. Non-U.S. Plans include

IBM common stock of $31 million, representing 0.1 percent of the non-U.S. Plans assets.
(b)	C ommingled funds represent pooled institutional investments.
(c) Invests in predominantly equity securities.
(d) Includes debt issued by national, state and local governments and agencies.
(e) The U.S. Plan includes IBM corporate bonds of $9 million, representing 0.02 percent of the U.S. Plan assets. Non-U.S. plans include IBM corporate bonds of $1 million

representing 0.001 percent of the non-U.S. Plan assets.
(f) Invests in predominantly fixed-income securities.
(g) Includes cash and cash equivalents and short-term marketable securities.
(h) Includes limited partnerships and venture capital partnerships.
(i)Primarily includes interest rate derivatives and, to a lesser extent, forwards, exchange traded and other over-the-counter derivatives.

(j) Invests in both equity and fixed-income securities.
(k) Represents net unsettled transactions, relating primarily to purchases and sales of plan assets.

The U.S. nonpension postretirement benefit plan assets of $177 million were invested in cash, categorized as Level 1 in the fair value hierarchy. The Non-U.S. nonpension postretirement benefit plan assets of $92 million, primarily in Brazil, and, to a lesser extent, in Mexico andSouth Africa, were invested primarily in government and related fixed-income securities and corporate bonds, categorized as Level 2 in
the fair value hierarchy.

Notes to Consolidated Financial Statements
International Business Machines Corporation and Subsidiary Companies

The following table presents the company’s defined benefit pension plans’ asset classes and their associated fair value at December 31, 2012.
The U.S. Plan consists of the Qualified PPP and the Non-U.S. Plans consist of all plans sponsored by the company’s subsidiaries.
($ in millions)
U.S. Plan

Non-U.S. Plans

Level 1

Level 2

Level 3

Total

Level 1

Level 2

Level 3

Total

$15,161$     1$    —$15,163$6,395$     —

$    —$ 6,395

96

2,556

—

2,652

138

7,641

—

7,779

EquityEquity securities (a)Equity commingled/mutual funds (b)(c)Fixed income
Government and related (d)—12,945

6

12,951

—

8,978

76

9,054

Corporate bonds (e)

—

8,499

11

8,510

—

1,878

5

1,883

Mortgage and asset-backed securities

—

922

45

968

—

9

—

9

Fixed income commingled/mutual funds (b)(f)

155

804

267

1,226

78

8,018

—

8,096
1,019

—

—

—

—

—

1,019

—

Cash and short-term investments (g)Insurance contracts

244

3,198

—

3,442

134

373

—

507

Hedge funds

—

1,402

756

2,159

—

646

—

646

Private equity (h)

—

—

4,085

4,085

—

—

353

353

Private real estate (h)

—

—

2,861

2,861

—

—

609

609

Derivatives (i)

(6)

62

—

56

0

856

—

857

Other commingled/mutual funds (b)(j)

—

—

—

—

12

907

—

919

15,65030,3908,032

54,072

6,757

30,325

1,042

38,124

Subtotal

—

—

—

(442)

—

—

—

(66)

$15,650$30,390$8,032$53,630$6,757$30,325$1,042$38,058

Other (k)Fair value of plan assets(a)	R epresents U.S. and international securities. The U.S. Plan includes IBM common stock of $113 million, representing 0.2 percent of the U.S. Plan assets. Non-U.S. Plans include

IBM common stock of $40 million, representing 0.1 percent of the non-U.S. Plans assets.
(b)	C ommingled funds represent pooled institutional investments.
(c) Invests in predominantly equity securities.
(d) Includes debt issued by national, state and local governments and agencies.
(e) The U.S. Plan includes IBM corporate bonds of $6 million, representing 0.01 percent of the U.S. Plan assets. Non-U.S. plans include IBM corporate bonds of $2 million

representing 0.004 percent of the non-U.S. Plan assets.
(f) Invests in predominantly fixed-income securities.
(g) Includes cash and cash equivalents and short-term marketable securities.
(h) Includes limited partnerships and venture capital partnerships.
(i)Primarily includes interest rate derivatives and, to a lesser extent, forwards, exchange traded and other over-the-counter derivatives.

(j) Invests in both equity and fixed-income securities.
(k) Represents net unsettled transactions, relating primarily to purchases and sales of plan assets.

The U.S. nonpension postretirement benefit plan assets of $433 million were invested in cash, categorized as Level 1 in the fair value hierarchy. The Non-U.S. nonpension postretirement benefit plan assets of $119 million, primarily in Brazil, and, to a lesser extent, in Mexico andSouth Africa, were invested primarily in government and related fixed-income securities and corporate bonds, categorized as Level 2 in
the fair value hierarchy.

137

138

Notes to Consolidated Financial Statements
International Business Machines Corporation and Subsidiary Companies

The following tables present the reconciliation of the beginning and ending balances of Level 3 assets for the years ended December 31, 2013
and 2012 for the U.S. Plan.
($ in millions)

Balance at January 1, 2013

Government
and Related

Corporate
Bonds

$6

$11

Mortgageand Asset- Fixed Income
Backed Commingled/
Securities Mutual Funds

$ 45

Hedge
Funds

PrivateEquityPrivateReal Estate

Total

$267

$756

$4,085$2,861$ 8,032
2,103

Return on assets held at end of year

0

(0)

(1)

7

104

1,104

889

Return on assets sold during the year

0

(0)

(0)

—

(0)

(528)

(412)

(939)

Purchases, sales and settlements, net

(5)

3

(0)

—

(0)

(891)

(301)

(1,194)

Transfers, net
Balance at December 31, 2013

0

(8)

(26)

—

—

—

—

(33)

$1

$ 5

$ 19

$274

$860

$3,771$3,038$ 7,968

Mortgageand Asset- Fixed Income
Backed Commingled/
Securities Mutual Funds

Hedge
Funds

PrivateEquityPrivateReal Estate

Total

$713

$4,098$2,790$7,932
1,135($ in millions)

Balance at January 1, 2012

Government
and Related

Corporate
Bonds

$ 29

$12

$45

$246

Return on assets held at end of year

0

0

1

21

56

855

202

Return on assets sold during the year

0

2

1

—

14

(334)

(41)

(359)

Purchases, sales and settlements, net

(1)

(2)

(9)

—

(26)

(533)

(90)

(660)

Transfers, net

(22)

(1)

8

—

—

—

—

(15)

Balance at December 31, 2012

$   6

$11

$45

$267

$756

$4,085$2,861$8,032

The following tables present the reconciliation of the beginning and ending balances of Level 3 assets for the years ended December 31, 2013
and 2012 for the non-U.S. Plans.
($ in millions)
Government
and Related

Corporate
Bonds

PrivateEquityPrivateReal Estate

Total

Balance at January 1, 2013

$ 76

$5

$353

$609

$1,042Return on assets held at end of year

(12)

(0)

1

33

22

Return on assets sold during the year

1

(0)

18

(3)

16

Purchases, sales and settlements, net

(24)

(1)

26

1

1

2

0

12

15

29

$ 42

$4

$410

$655

$1,110Government
and Related

Corporate
Bonds

PrivateEquityPrivateReal Estate

Total

$ 96

$ 39

$262

$580

$  977Return on assets held at end of year

3

(1)

9

(5)

6

Return on assets sold during the year

3

1

9

0

14

Purchases, sales and settlements, net

(26)

(29)

62

14

21

Transfers, net

(2)

(5)

(0)

(3)

(10)

Foreign exchange impact
Balance at December 31, 2013($ in millions)

Balance at January 1, 2012

Foreign exchange impact
Balance at December 31, 2012

1

(0)

11

23

34

$ 76

$   5

$353

$609

$1,042

Notes to Consolidated Financial Statements
International Business Machines Corporation and Subsidiary Companies

Valuation Techniques
The following is a description of the valuation techniques used tomeasure plan assets at fair value. There were no changes in valuation techniques during 2013 and 2012.
Equity securities are valued at the closing price reported on thestock exchange on which the individual securities are traded. IBM
common stock is valued at the closing price reported on the New
York Stock Exchange. Equity commingled/mutual funds are typicallyvalued using the net asset value (NAV) provided by the administratorof the fund and reviewed by the company. The NAV is based on thevalue of the underlying assets owned by the fund, minus liabilities
and divided by the number of shares or units outstanding. Theseassets are classified as Level 1, Level 2 or Level 3 depending on
availability of quoted market prices.
The fair value of fixed-income securities is typically estimatedusing pricing models, quoted prices of securities with similar characteristics or discounted cash flows and are generally classified as
Level 2. If available, they are valued using the closing price reported
on the major market on which the individual securities are traded.
Cash includes money market accounts that are valued at theircost plus interest on a daily basis, which approximates fair value.
Short-term investments represent securities with original maturities
of one year or less. These assets are classified as Level 1 or Level 2.
Private equity and private real estate partnership valuations
require significant judgment due to the absence of quoted market
prices, the inherent lack of liquidity and the long-term nature of such
assets. These assets are initially valued at cost and are reviewed
periodically utilizing available and relevant market data to determine
if the carrying value of these assets should be adjusted. These
investments are classified as Level 3. The valuation methodology isapplied consistently from period to period.
Exchange traded derivatives are valued at the closing pricereported on the exchange on which the individual securities aretraded, while forward contracts are valued using a mid-close price.
Over-the-counter derivatives are typically valued using pricing
models. The models require a variety of inputs, including, for example, yield curves, credit curves, measures of volatility and foreignexchange rates. These assets are classified as Level 1 or Level 2
depending on availability of quoted market prices.

Expected Contributions
Defined Benefit Pension Plans
It is the company’s general practice to fund amounts for pensions
sufficient to meet the minimum requirements set forth in applicable
employee benefits laws and local tax laws. From time to time, thecompany contributes additional amounts as it deems appropriate.
The company contributed $449 million and $557 million in cash
to non-U.S. defined benefit pension plans and $57 million and $60
million in cash to non-U.S. multi-employer plans during the years
ended December 31, 2013 and 2012, respectively. The cash contributions to multi-employer plans represent the annual cost included
in net periodic (income)/cost recognized in the Consolidated Statement of Earnings. The company has no liability for participants in
multi-employer plans other than its own employees. As a result, thecompany’s participation in multi-employer plans has no material
impact on the company’s financial statements.
In 2014, the company is not legally required to make any contributions to the U.S. defined benefit pension plans. However,depending on market conditions, or other factors, the company
may elect to make discretionary contributions to the Qualified PPP
during the year.
The Pension Protection Act of 2006 (the Act), enacted into law in2006, is a comprehensive reform package that, among other provisions, increases pension funding requirements for certain U.S.
defined benefit plans, provides guidelines for measuring pension plan
assets and pension obligations for funding purposes and raises tax
deduction limits for contributions to retirement-related benefit plans.
The additional funding requirements by the Act apply to plan years
beginning after December 31, 2007. The Act was updated by theWorker, Retiree and Employer Recovery Act of 2008, which revised
the funding requirements in the Act by clarifying that pension plans
may smooth the value of pension plans over 24 months. At December
31, 2013, no mandatory contribution was required for 2014.
In 2014, the company estimates contributions to its non-U.S.
defined benefit and multi-employer plans to be approximately$600 million, which will be mainly contributed to defined benefit
pension plans in Japan, the UK and Switzerland. This amountrepresents the legally mandated minimum contributions. Financial
market performance in 2014 could increase the legally mandated
minimum contribution in certain countries which require monthly or
daily remeasurement of the funded status. The company could also
elect to contribute more than the legally mandated amount basedon market conditions or other factors.

Defined Contribution Plans
The company contributed $1,361 million and $1,478 million in cash
to the defined contribution plans during the years ended December
31, 2013 and 2012, respectively. In 2014, the company estimatescash contributions to the defined contribution plans to be approximately $1.3 billion.

139

140

Notes to Consolidated Financial Statements
International Business Machines Corporation and Subsidiary Companies

Nonpension Postretirement Benefit Plans
The company contributed $80 million and $693 million to the nonpension postretirement benefit plans during the years ended
December 31, 2013 and 2012, respectively. These contribution
amounts exclude the Medicare-related subsidy discussed on page141. The 2012 amount includes a $400 million voluntary cash contribution to the U.S. nonpension postretirement benefit plan. This advanced
funding was to be utilized to fund post-2012 benefit payments for
Medicare-eligible prescription drugs. In 2013, the prefunding was used
for this purpose. However, effective January 1, 2014, IBM will not be
eligible for the Medicare subsidy. The remainder of the prefunding isbeing utilized to fund other eligible benefits under the plan.

Expected Benefit Payments
Defined Benefit Pension Plan Expected Payments
The following table presents the total expected benefit payments todefined benefit pension plan participants. These payments have been
estimated based on the same assumptions used to measure theplans’ PBO at December 31, 2013 and include benefits attributableto estimated future compensation increases, where applicable.

($ in millions)
Qualified
U.S. Plan
Payments

Nonqualified
U.S. Plans
Payments

Qualified
Non-U.S. Plans
Payments

Nonqualified
Non-U.S. Plans
Payments

Total
Expected
Benefit
Payments

2014$ 3,393$109$ 2,026$  382$ 5,910

2015

3,430

112

2,021

382

5,945

2016

3,460

114

2,062

385

6,022
6,073

2017

3,477

116

2,086

394

2018

3,441

118

2,121

407

6,087

2019–2023

17,454600

11,3272,325

31,706The 2014 expected benefit payments to defined benefit pension plan participants not covered by the respective plan assets (underfundedplans) represent a component of compensation and benefits, within current liabilities, in the Consolidated Statement of Financial Position.

Nonpension Postretirement Benefit Plan Expected Payments
The following table reflects the total expected benefit payments to nonpension postretirement benefit plan participants. These payments
have been estimated based on the same assumptions used to measure the plans’ APBO at December 31, 2013.
($ in millions)

U.S. Plan
Payments

Qualified
Non-U.S. Plans
Payments

Nonqualified
Non-U.S. Plans
Payments

Total
Expected
Benefit
Payments2014$  427$ 8$ 32$  467

2015

422

8

36

466

2016

416

9

39

464

2017

409

10

42

461

2018

393

10

46

449

1,799

63

286

2,148

2019–2023

The 2014 expected benefit payments to nonpension postretirement benefit plan participants not covered by the respective plan assets
represent a component of compensation and benefits, within current liabilities, in the Consolidated Statement of Financial Position.

Notes to Consolidated Financial Statements
International Business Machines Corporation and Subsidiary Companies

Medicare Prescription Drug Act
In connection with the Medicare Prescription Drug Improvement andModernization Act of 2003, the company qualified to receive a federal
subsidy through 2013. Due to benefit plan changes effective January
1, 2014, the company will not qualify for the subsidy as of that date. The
company received total subsidies of $30 million and $53 million forprescription drug-related coverage during the years ended December
31, 2013 and 2012, respectively, which were utilized to reduce the company contributions to the U.S. nonpension postretirement benefit plan.

The company is also expected to receive additional subsidies after
2013 to true up the final subsidy amount due to IBM under the Act.
The company has included the impact of its portion of the subsidy in the determination of net periodic cost for the U.S. nonpension
postretirement benefit plan for the years ended December 31, 2013,2012, and 2011. The impact of the subsidy resulted in a reduction in2013, 2012 and 2011 net periodic cost of $45 million, $35 million and$37 million, respectively.

Other Plan Information
The following table presents information for defined benefit pension plans with accumulated benefit obligations (ABO) in excess of plan
assets. For a more detailed presentation of the funded status of the company’s defined benefit pension plans, see the table on page 131.
($ in millions)
2013

2012

At December 31:

BenefitObligation

Plan
AssetsBenefitObligation

Plan
AssetsPlans with PBO in excess of plan assets$41,003$29,223$99,184$83,799

Plans with ABO in excess of plan assets

40,31529,213

98,263

83,677

Plans with assets in excess of PBO

58,65164,194

6,944

7,889

Note T.
Segment Information
The company’s major operations consist of five business segments:
Global Tech­nol­ogy Services, Global Business Services, Software,
Systems and Technology, and Global Financing. The segments
represent components of the company for which separate financial
information is available that is utilized on a regular basis by the chief
executive officer in determining how to allocate resources and evaluate performance. The segments are determined based on several
factors, including client base, homogeneity of products, technology,
delivery channels and similar economic characteristics.
Information about each segment’s business and the products
and services that generate each segment’s revenue is located in the“Description of Business” section on pages 32 to 34, and in “Segment Details,” on pages 35 to 40 in the Management Discussion.
Segment revenue and pre-tax income include transactions
between the segments that are intended to reflect an arm’s-length,
market-based transfer price. Systems and software that are used by
Global Technology Services in outsourcing engagements are primarily sourced internally from Systems and Technology andSoftware. For providing IT services that are used internally, Global
Technology Services and Global Business Services recover cost,
as well as a reasonable fee, that is intended to reflect the arm’slength value of providing the services. The Global Services segments
enter into arm’s-length loans at prices equivalent to market rates
with Global Financing to facilitate the acquisition of equipment usedin services engagements. All internal transaction prices are reviewed
annually, and reset if appropriate.

The company utilizes globally integrated support organizations
to realize economies of scale and efficient use of resources. As aresult, a considerable amount of expense is shared by all of thesegments. This shared expense includes sales coverage, certain
marketing functions and support functions such as Accounting,Treasury, Procurement, Legal, Human Re­sources, and Billing andCollections. Where practical, shared expenses are allocated basedon measurable drivers of expense, e.g., headcount. When a clear
and measurable driver cannot be identified, shared expenses areallocated on a financial basis that is consistent with the company’s
management system, e.g., advertising expense is allocated based on
the gross profits of the segments. A portion of the shared expenses,
which are recorded in net income, are not allocated to the segments.
These expenses are associated with the elimination of internaltransactions and other miscellaneous items.

141

142

Notes to Consolidated Financial Statements
International Business Machines Corporation and Subsidiary Companies

The following tables reflect the results of operations of the company’s segments consistent with the management and measurement
system utilized within the company. Performance measurement is based on pre-tax income. These results are used, in part, by senior
management, both in evaluating the performance of, and in allocating resources to, each of the segments.

Management System Segment View($ in millions)Global Services Segments
GlobalTechnology
Services

GlobalBusiness
Services

Software

Systems andTechnology

GlobalFinancing

Total
Segments

External revenue$38,551$18,396$25,932$ 14,371$2,022$ 99,273

Internal revenue

1,063

714

3,191

593

2,282

7,843

Total revenue$39,615$19,109$29,123$14,964$4,304$107,115

Pre-tax income$ 6,983$ 3,214$11,106$  (507)$2,171$ 22,967

For the year ended December 31:

2013

Revenue year-to-year change(4.3)%(0.9)%

1.4%(18.4)%

5.7%

Pre-tax income year-to-year change

0.3%

7.7%

2.7%

(141.3)%6.8%(4.2)%(4.4)%

Pre-tax income margin

17.6%

16.8%

38.1%

(3.4)%

50.4%

21.4%

2012
External revenue$40,236$18,566$25,448$ 17,667$2,013

Internal revenue

1,166

719

3,274

676

2,060

$103,930
7,896

Total revenue$41,402$19,286$28,722$18,343$4,073$111,826

Pre-tax income$ 6,961$ 2,983$10,810$ 1,227$2,034$ 24,015

Revenue year-to-year change(1.7)%(4.0)%

1.8%(7.5)%(2.9)%

Pre-tax income year-to-year change

10.8%(0.8)%

8.4%(24.9)%

1.1%(2.3)%
4.8%

Pre-tax income margin

16.8%

15.5%

37.6%

6.7%

49.9%

21.5%

2011
External revenue$40,879$19,284$24,944$ 18,985$2,102

Internal revenue

1,242

797

3,276

838

2,092

$106,194
8,246

Total revenue$42,121$20,081$28,219$19,823$4,195$114,440

Pre-tax income$ 6,284$ 3,006$ 9,970$ 1,633$2,011$ 22,904

Revenue year-to-year change

6.6%

5.6%

10.9%

5.6%

2.8%

7.1%

Pre-tax income year-to-year change

14.3%

18.1%

5.3%

12.2%

2.8%

9.5%

Pre-tax income margin

14.9%

15.0%

35.3%

8.2%

47.9%

20.0%

Notes to Consolidated Financial Statements
International Business Machines Corporation and Subsidiary Companies

Immaterial Items

Reconciliations of IBM as Reported($ in millions)
For the year ended December 31:

2013

2012

2011

$114,440

Revenue$107,115$111,826

Other revenue and adjustments

478

577

722

Elimination of internal transactions(7,843)(7,896)(8,246)

Total IBM consolidated revenue$ 99,751$104,507$106,916

Total reportable segments($ in millions)
For the year ended December 31:

2013

2012

2011

Pre-tax income$22,967$24,015$22,904

Amortization of acquired
intangible assets

(758)

(703)

(629)

Acquisition-related charges

(46)

(36)

(46)

Non-operating retirementrelated (costs)/income(1,062)(538)

72

Elimination of internal transactions(1,480)(1,197)(1,243)

Unallocated corporate amounts*

(98)

361

(56)

$19,524$21,902$21,003

Total reportable segments

Total IBM consolidated
pre-tax income* The 2013 and 2012 amounts include the gain related to the Retail Store Solutions divestiture. The 2011 amount includes gains related to the sale of Lenovo common stock.

Investment in Equity Alliancesand Equity Alliances Gains/(Losses)
The investments in equity alliances and the resulting gains and(losses) from these investments that are attributable to the segments
did not have a material effect on the financial position or the financial
results of the segments.

Segment Assets and Other Items
Global Technology Services assets are primarily plant, property andequipment including the assets associated with the outsourcing
business, goodwill, accounts receivable, deferred services arrangement transition costs, maintenance parts inventory and acquired
intangible assets. Global Business Services assets are primarily
goodwill and accounts receivable. Software assets are mainly goodwill, acquired intangible assets and accounts receivable. Systems
and Technology assets are primarily plant, property and equipment,
goodwill, manufacturing inventory and accounts receivable. Global
Financing assets are primarily financing receivables and fixed assets
under operating leases.
To ensure the efficient use of the company’s space and equipment, several segments may share plant, property and equipment
assets. Where assets are shared, landlord ownership of the assets
is assigned to one segment and is not allocated to each user segment. This is consistent with the company’s management system
and is reflected accordingly in the table on page 144. In those cases,
there will not be a precise correlation between segment pre-tax
income and segment assets.
Similarly, the depreciation amounts reported by each segment
are based on the assigned landlord ownership and may not be consistent with the amounts that are included in the segments’ pre-tax
income. The amounts that are included in pre-tax income reflect
occupancy charges from the landlord segment and are not specifically identified by the management reporting system. Capital
expenditures that are reported by each segment also are consistent
with the landlord ownership basis of asset assignment.
Global Financing amounts for interest income and interest
expense reflect the interest income and interest expense associatedwith the Global Financing business, including the intercompany
financing activities discussed on pages 33 and 34, as well as
the income from investment in cash and marketable securities.
The explanation of the difference between cost of financing andinterest expense for segment presentation versus presentation in
the Consolidated Statement of Earnings is included on page 75 of
the Management Discussion.

143

144

Notes to Consolidated Financial Statements
International Business Machines Corporation and Subsidiary Companies

Management System Segment View($ in millions)Global Services Segments

For the year ended December 31:

GlobalTechnology
Services

GlobalBusiness
Services

Software

Systems andTechnology

GlobalFinancing

Total
Segments

2013$18,048$8,311$27,101$7,960$40,138$101,558

Depreciation/amortization of intangibles*

1,670

72

1,211

855

574

4,383

Capital expenditures/investments in intangibles

1,938

69

540

781

467

3,796

Interest income

—

—

—

—

1,904

1,904

Interest expense

—

—

—

—

405

405

$ 97,310

Assets2012
Assets$15,884$8,022$26,291$8,232$38,882

Depreciation/amortization of intangibles*

1,597

75

1,157

786

853

4,470

Capital expenditures/investments in intangibles

1,760

42

618

1,106

708

4,233

Interest income**

—

—

—

—

1,972

1,972

Interest expense

—

—

—

—

410

410

$ 91,557

2011
Assets$15,475$8,078$23,926$7,649$36,427

Depreciation/amortization of intangibles*

1,713

83

1,062

737

1,145

4,739

Capital expenditures/investments in intangibles

1,838

56

469

1,032

930

4,325

Interest income**

—

—

—

—

2,176

2,176

Interest expense

—

—

—

—

538

538

  * Segment pre-tax income does not include the amortization of intangible assets.
** Reclassified to conform with 2013 presentation.

Notes to Consolidated Financial Statements
International Business Machines Corporation and Subsidiary Companies

Geographic Information

Reconciliations of IBM as Reported($ in millions)
At December 31:

2013

2012

2011

$101,558$ 97,310$ 91,557(4,740)(4,943)(5,407)

AssetsTotal reportable segments
Elimination of internal transactions
Unallocated amounts
Cash and marketable securities

9,697

9,779

10,575

Notes and accounts receivable

2,741

3,769

3,526

Deferred tax assets

4,532

5,194

4,865

Plant, other property
and equipment

2,505

2,555

2,918

Pension assets

5,551

945

2,837

Other
Total IBM consolidated assets

4,378

4,604

5,562

$126,223$119,213$116,433

The following provides information for those countries that are
10 percent or more of the specific category.
Revenue*($ in millions)
For the year ended December 31:

United States

No single client represented 10 percent or more of the company’s
total revenue in 2013, 2012 or 2011.

2012

2011

$ 36,270$ 37,041
10,968

Japan

9,071

10,697

Other countries

55,87157,54058,906

Total IBM consolidated revenue$99,751$104,507$106,916* Revenues are attributed to countries based on the location of the client.

Plant and Other Property—Net($ in millions)
At December 31:

Major Clients

2013$34,809

United States
Other countries
Total

2013

2012

2011

$ 6,723$ 6,555$ 6,271

6,257

6,299

6,186

$12,979$12,854$12,457

145

146

Notes to Consolidated Financial Statements
International Business Machines Corporation and Subsidiary Companies

Revenue by Classes ofSimilar Products or Services

Note U.
Subsequent Events

The following table presents external revenue for similar classes of
products or services within the company’s reportable segments.
Within Global Technology Services and Global Business Services,client solutions often include IBM software and systems and othersuppliers’ products if the client solution requires it. Within Software,
product license charges and ongoing subscription and support arereported as Software, and software as a service, consulting, education, training and other product-related services are reported asServices. Within Systems and Technology, Microelectronics original
equipment manufacturer (OEM) revenue is primarily from the saleof semiconductors. Microelectronics Services revenue includes
circuit and component design services and technology and manufacturing consulting services. See “Description of the Business,”
beginning on page 28 for additional information.
($ in millions)
For the year ended December 31:

2013

2012

2011

Global Technology Services$29,953$31,161$31,746

Maintenance

7,111

7,343

7,515

Systems

1,322

1,574

1,478

Software

164

159

140

Services

Global Business Services
Services$18,065$18,216$18,956

Software

221

208

211

Systems

109

142

118

Software$23,420$23,144$22,921

Services

2,512

2,304

2,022

Software

Systems and Technology
Servers$ 9,646$11,980$12,362

Storage

3,041

3,411

3,619

Microelectronics OEM

1,463

1,572

1,975

Retail Store Solutions

6

357

753

215

346

277

$ 1,493$ 1,471$ 1,612

529

542

490

Microelectronics Services
Global Financing
Financing
Used equipment sales

On January 23, 2014, the company and Lenovo Group Limited(Lenovo) announced a definitive agreement in which Lenovo will
acquire the company’s x86 server portfolio. See the caption, “Divestitures,” on page 98 for additional information.
On January 28, 2014, the company announced that the Boardof Directors approved a quarterly dividend of $0.95 per commonshare. The dividend is payable March 10, 2014 to shareholders ofrecord on February 10, 2014.
On January 31, 2014, the company completed the initial closingof the sale of its customer care business process outsourcing services business to SYNNEX. See the caption, “Divestitures” on page
98 for additional information.
On February 6, 2014, the company issued $4.5 billion in bonds
as follows: $1 billion of 2-year floating-rate bonds priced at 3-month
LIBOR plus 7 basis points; $750 million of 5-year floating-rate bonds
priced at 3-month LIBOR plus 37 basis points; $750 million of 5-year
fixed-rate bonds with a 1.95 percent coupon; and $2 billion of
10-year fixed-rate bonds with a 3.625 percent coupon.

Five-Year Comparison of Selected Financial Data
International Business Machines Corporation and Subsidiary Companies($ in millions except per share amounts)
For the year ended December 31:

2013

2012

2011

2010

2009

Revenue$ 99,751$104,507$106,916$ 99,870$ 95,758

Net income$ 16,483$ 16,604$ 15,855$ 14,833$ 13,425

Operating (non-GAAP) earnings*$ 17,959$ 17,627$ 16,318$ 15,023$ 13,452

Assuming dilution$  14.94$  14.37$  13.06$  11.52$  10.01

Basic$  15.06$  14.53$  13.25$  11.69$  10.12

Diluted operating (non-GAAP)*$  16.28$  15.25$  13.44$  11.67$  10.03

Cash dividends paid on common stock$  4,058$  3,773$  3,473$  3,177$  2,860

3.70

3.30

2.90

2.50

2.15

$  3,623$  4,082$  4,108$  4,185$  3,447

Earnings per share of common stock

Per share of common stock
Investment in property, plant and equipment
Return on IBM stockholders’ equity

At December 31:

83.8%

81.6%

71.2%

66.8%

80.4%

2013

2012

2011

2010

2009

Total assets$126,223$119,213$116,433$113,452$109,022

Net investment in property, plant and equipment$ 13,821$ 13,996$ 13,883$ 14,096$ 14,165

Working capital$ 11,196$  5,807$  8,805$  7,554$ 12,933

Total debt

$ 39,718$ 33,269$ 31,320$ 28,624$ 26,099

Total equity$ 22,929$ 18,984$ 20,236$ 23,172$ 22,755* Refer to page 62 of the company’s first-quarter 2011 Form 10-Q filed on April 26, 2011 for the reconciliation of non-GAAP financial information for the years 2009 and 2010 and“GAAP Reconciliation,” on page 63 for the reconciliation of non-GAAP financial information for 2011. Also see “GAAP Reconciliation,” on page 46 for the reconciliation of non-GAAP
financial information for 2013 and 2012.

147

148

Selected Quarterly Data
International Business Machines Corporation and Subsidiary Companies($ in millions except per share amounts and stock prices)First
Quarter

SecondQuarter

Third
Quarter

FourthQuarter

Full
Year

Revenue$23,408$24,924$23,720$27,699$99,751

Gross profit$10,678$12,132$11,380$14,315$48,505

Net income$ 3,032$ 3,226$ 4,041$ 6,185$16,483

Operating (non-GAAP) earnings*$ 3,376$ 3,579$ 4,387$ 6,617$17,959

Assuming dilution$  2.70$  2.91$  3.68$  5.73$ 14.94**Basic$  2.72$  2.93$  3.70$  5.77$ 15.06**

Diluted operating (non-GAAP)*$  3.00$  3.22$  3.99$  6.13$ 16.28**

Dividends per share of common stock$  0.85$  0.95$  0.95$  0.95$  3.70High$215.90$214.89$200.94$187.79Low

190.39187.68181.10172.57First
Quarter

SecondQuarter

Third
Quarter

FourthQuarter

Full
Year

Revenue$24,673$25,783$24,747$29,304$104,507

Gross profit$11,118$12,281$11,732$15,167$ 50,298

Net income$ 3,066$ 3,881$ 3,824$ 5,833$ 16,604

Operating (non-GAAP) earnings*$ 3,265$ 4,077$ 4,155$ 6,129$ 17,627

Assuming dilution$  2.61$  3.34$  3.33$  5.13$  14.37**

Basic$  2.65$  3.38$  3.36$  5.19$  14.53**

Diluted operating (non-GAAP)*$  2.78$  3.51$  3.62$  5.39$  15.25**

Dividends per share of common stock$  0.75$  0.85$  0.85$  0.85$   3.30

High$209.12$210.69$208.32$211.79Low

177.34187.00181.85184.782013

Earnings per share of common stock

Stock prices+($ in millions except per share amounts and stock prices)

2012

Earnings per share of common stock

Stock prices+  * Refer to page 64 of the company’s first-quarter 2013 Form 10-Q filed on April 30, 2013, pages 80 and 81 of the company’s second-quarter 2013 Form 10-Q filed on July 30, 2013,
pages 81 and 82 of the company’s third-quarter 2013 Form 10-Q filed on October 29, 2013 and page 52 under the heading “GAAP Reconciliation,” for the reconciliation of nonGAAP information for the quarterly periods of 2013 and 2012. Also see “GAAP Reconciliation,” on page 46 for the reconciliation of non-GAAP financial information for full-year2013 and 2012.

** Earnings Per Share (EPS) in each quarter is computed using the weighted-average number of shares outstanding during that quarter while EPS for the full year is computed using
the weighted-average number of shares outstanding during the year. Thus, the sum of the four quarters’ EPS does not equal the full-year EPS.

  + The stock prices reflect the high and low prices for IBM’s common stock on the New York Stock Exchange composite tape for the periods presented.

Performance Graph
International Business Machines Corporation and Subsidiary Companies

Comparison of Five-Year Cumulative Total Return for IBM,S&P 500 Stock Index and S&P Information Technology Index
The adjacent graph compares the five-year cumulative total returns
for IBM common stock with the comparable cumulative return ofcertain Standard & Poor’s (S&P) indices. Due to the fact that IBM is
a company included in the S&P 500 Stock Index, the SEC’s rules
require the use of that index. Under those rules, the second index
used for comparison may be a published industry or line-of-business index. The S&P Information Technology Index is such an index.
IBM is also included in this index.
The graph assumes $100 invested on December 31 (of the initial
year shown in the graph) in IBM common stock and $100 investedon the same date in each of the S&P indices. The comparisonsassume that all dividends are reinvested.

280

240

200

160

120

80

08

09

10

12

11

13

2008

2009

2010

2011

2012

2013

IBM Common Stock$100.00$158.61$181.26$230.96$244.67$244.22

S & P 500 Index

100.00126.46145.51148.59172.37228.19S & P Information Technology Index

100.00161.72

178.20182.50209.55269.13(U.S. Dollar)

149

150

Board of Directors and Senior Leadership
International Business Machines Corporation and Subsidiary Companies

Board of Directors
Alain J.P. Belda
Managing Director
Warburg Pincus LLC

Shirley Ann Jackson
President
Rensselaer Polytechnic InstituteWilliam R. Brody
President
Salk Institute for Biological Studies

Andrew N. Liveris
Chairman, President andChief Executive Officer
The Dow Chemical Company

Kenneth I. Chenault
Chairman and Chief Executive Officer
American Express Company
Michael L. Eskew
Retired Chairman andChief Executive Officer
United Parcel Service, Inc.
David N. Farr
Chairman and Chief Executive Officer
Emerson Electric Co.

W. James McNerney, Jr.
Chairman and Chief Executive Officer
The Boeing Company
James W. Owens
Retired Chairman andChief Executive Officer
Caterpillar Inc.

Virginia M. Rometty
Chairman, President andChief Executive Officer
IBM
Joan E. Spero
Adjunct Senior Research Scholar
Columbia University School ofInternational and Public Affairs
Sidney Taurel
Senior Advisor
Capital Royalty L.P.
Lorenzo H. Zambrano
Chairman andChief Executive Officer
CEMEX, S.A.B. de C.V.

Senior Leadership
Rodney C. Adkins
Senior Vice President
Corporate Strategy

John E. Kelly III
Senior Vice President and Director
Research

Linda S. Sanford
Senior Vice President
Enterprise Transformation

Colleen F. Arnold
Senior Vice President
Sales and Distribution

Robert J. LeBlanc
Senior Vice President
Software and Cloud Solutions Group

Michelle H. Browdy
Vice President, AssistantGeneral Counsel and Secretary

Steven A. Mills
Senior Vice President
and Group Executive
Software and Systems

Martin J. Schroeter
Senior Vice President
and Chief Financial Officer
Finance and Enterprise Transformation

Erich Clementi
Senior Vice President
Global Technology Services
Bruno V. Di Leo Allen
Senior Vice President
Sales and Distribution
Diane J. Gherson
Senior Vice President
Human Resources
Jon C. Iwata
Senior Vice President
Marketing and Communications
James J. Kavanaugh
Vice President and Controller

Robert J. Picciano
Senior Vice President
Information and Analytics Group
Michael D. Rhodin
Senior Vice President
IBM Watson Group
Virginia M. Rometty
Chairman, President andChief Executive Officer
Thomas W. Rosamilia
Senior Vice President
Systems and Technology Groupand IBM Integrated Supply Chain

Timothy S. Shaughnessy
Senior Vice President
GTS Solutions
Stanley J. Sutula III
Vice President and Treasurer
Bridget A. van Kralingen
Senior Vice President
Global Business Services
Robert C. Weber
Senior Vice President
Legal and Regulatory Affairs,
and General Counsel

Stockholder Information
International Business Machines Corporation and Subsidiary Companies

IBM Stockholder Services

Annual Meeting

Stockholders with questions about their accounts should contact:

The IBM Annual Meeting of Stockholders will be held on Tuesday,
April 29, 2014, at 10 a.m. in the Prime F. Osborn III Convention Center,
Jacksonville, Florida.

Computershare Trust Company, N.A.
P.O. Box 43078
Providence, Rhode Island 02940-3078(888) IBM-6700
Investors residing outside the United States, Canada and Puerto Ricoshould call (781) 575-2727.
Stockholders can also reach Computershare Trust Company, N.A.
via e-mail at: ibm@computershare.com
Hearing-impaired stockholders with access to a telecommunications
device (TDD) can communicate directly with Computershare Trust
Company, N.A., by calling (800) 490-1493. Stockholders residing outside
the United States, Canada and Puerto Rico should call (781) 575-2694.

IBM on the Internet
Topics featured in this Annual Report can be found on the IBM home
page on the Internet (www.ibm.com). Financial results, news on IBM
products, services and other activities can also be found at that address.
IBM files reports with the Securities and Exchange Commission (SEC),
including the annual report on Form 10-K, quarterly reports on Form 10-Q,
current reports on Form 8-K and any other filings required by the SEC.
IBM’s website (www.ibm.com) contains a significant amount of information
about IBM, including the company’s annual report on Form 10-K, quarterly
reports on Form 10-Q, current reports on Form 8-K, and all amendments
to those reports as soon as reasonably practicable after such material
is electronically filed with or furnished to the SEC (www.ibm.com/investor).
These materials are available free of charge on or through our website.
The public may read and copy any materials the company files with the
SEC at the SEC’s Public Reference Room at 100 F Street, NE, Washington,
DC 20549. The public may obtain information on the operation of the
Public Reference Room by calling the SEC at (800) SEC-0330. The SEC
maintains an Internet site (www.sec.gov) that contains reports, proxy andinformation statements, and other information regarding issuers that fileelectronically with the SEC.

IBM Investor Services Program
The Investor Services Program brochure outlines a number of services
provided for IBM stockholders and potential IBM investors, including
the reinvestment of dividends, direct purchase and the deposit of IBM
stock certificates for safe­keeping. Call (888) IBM-6700 for a copy ofthe brochure. Investors residing outside the United States, Canada andPuerto Rico should call (781) 575-2727.
Investors with other requests may write to: IBM Stockholder Relations,
New Orchard Road, Armonk, New York 10504

IBM Stock
IBM common stock is listed on the New York Stock Exchange,
the Chicago Stock Exchange, and outside the United States.

Stockholder Communications
Stockholders can get quarterly financial results, a summary of theAnnual Meeting remarks, and voting results from the meeting by calling(914) 499-7777, by sending an e-mail to infoibm@us.ibm.com, or by
writing to International Business Machines Corporation, 1 New Orchard
Road, M/D 325, Armonk, New York 10504.

Literature for IBM Stockholders
The literature mentioned below on IBM is available without charge from:
Computershare Trust Company, N.A.
P.O. Box 43078
Providence, Rhode Island 02940-3078(888) IBM-6700
Investors residing outside the United States, Canada andPuerto Rico should call (781) 575-2727.
The company’s annual report on Form 10-K and the quarterly reports
on Form 10-Q provide additional information on IBM’s business. The 10-K
report is released by the end of February; 10-Q reports are released byearly May, August and November.
An audio recording of the 2013 Annual Report will be available forsight-impaired stockholders in June 2014.
The IBM Corporate Responsibility Report highlights IBM’s values andits integrated approach to corporate responsibility, including its innovative
strategies to transforming communities through global citizenship.
The full Corporate Responsibility Report is online with downloadable
sections at http://www.ibm.com/responsibility.

General Information
Stockholders of record can receive online account information andanswers to frequently asked questions regarding stockholder accounts
on the Internet (www.ibm.com/investor). Stockholders of record canalso consent to receive future IBM Annual Reports and Proxy Statements
online through the Internet at this site.
For answers to general questions about IBM from within the continental
United States, call (800) IBM-4YOU. From outside the United States,
Canada and Puerto Rico, call (914) 499-1900.

151

International Business Machines Corporation
New Orchard Road, Armonk, New York 10504(914) 499-1900
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