IBM Annual Report 2004 PDF

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IBM A NNUA L REPOR T
2004 international business machines

chairman’s letter
Dear IBM Investor: Last year, I told you that IBM was in the process of
becoming a very different company. I said that we had achieved a new
degree of clarity about our business model — innovation for the enterprise —
and that this was driving change in every aspect of the corporation. And I
described the deeper level of this reexamination — our collective work to
redefine IBM’s core values.
Now it’s a year later, and I want to tell you about the progress $12.9 billion in cash available for investment and distribution
we have made. IBM today is stronger and more focused than to shareholders. Of that, $3.7 billion went for net capital
it has been in years. The path we set for ourselves several expenditures and $1.7 billion for acquisitions that strength-
years ago is yielding results — in terms of an improved compet- ened our capabilities.
itive position, an enhanced capacity to innovate, and a greater We were able to return a record $8.3 billion to investors —
ability to deliver results to our clients and to you, our owners. $7.1 billion through share repurchase and $1.2 billion through
Our task now comes down to execution. At a recent dividends. We ended the year in a strong cash position,
meeting with IBM’s senior leaders, I said that 2005 is the year with $10.6 billion, including marketable securities. In 2004,
of “small s and big E”: less focus on strategic development, our return on invested capital increased to 29 percent ,
maximum push on execution. This is the appropriate emphasis excluding our Global Financing business and a one-time
for our company today, because most of the major strategic pension settlement charge.*
pieces are now in place for IBM to become the leader of a
rapidly changing information technology industry.
Samuel J. Palmisano
A good year CHAIRMAN, PRESIDENT AND
CHIEF EXECUTIVE OFFICER
I want to explain to you what we did last year to turn strategy
and vision into results. Your company turned in another good
year in 2004. We continued to execute our business plan
effectively, producing share gains in key markets, increasing
revenue and growing both earnings and earnings per share.
Our results from continuing operations saw record
revenue of $96.3 billion, an increase of 8 percent; earnings
of $8.4 billion, an increase of 11 percent; and diluted earnings
per share of $4.94, an increase of 14 percent.
One of the strengths of our business model, from a
financial point of view, is the amount of cash we generate.
After committing $5.7 billion to R&D in 2004, we had
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chairman’s letter
We were able to achieve these results because of our • We grew and expanded our business in the world’s hyper-
performance in the marketplace. growth markets. We have learned over many years that the
best way to pursue opportunities in emerging markets is to
• IBM Global Services is the leading IT services company in
make investments and build relationships for the long haul,
the world, with more than twice the revenue of our nearest to become part of the local economy and to help advance
rival. We are ranked number one in IT outsourcing, application the society’s broader goals. We are doing that in China,
management and e-business hosting. In 2004, Global Services India, Brazil and Russia — and it’s yielding good results. IBM’s
revenue grew 8 percent to $46.2 billion, driven by continued business in these four key emerging markets grew more than
growth in Strategic Outsourcing, as well as revenue increases 25 percent in 2004, to more than $4 billion.
in Integrated Technology Services and Business Consulting
Services (led by strong growth in Business Transformation The year had its share of challenges, and some parts of
Outsourcing). Although signings and backlog declined in the business fell short. But overall, it was a solid year for the
2004, Global Services improved its rate of revenue growth in IBM company. The results confirm that we are in the right
every quarter, excluding the benefit of currency, due to the businesses and the right segments of the industry.
improving yield of our backlog and current signings.
A transaction and a transformation
• Our software revenue totaled $15.1 billion, an increase
Of course, just as significant as the segments we are in are
of 5 percent. We gained share in key segments and held our
those we are not. The industry’s contraction in recent years
leading share position in middleware overall. WebSphere
has forced IT companies to choose between being high-
grew 14 percent, Rational 15 percent and Tivoli 15 percent.
value innovation players or high-volume distributors of other
• We continue as number one in the world in servers, with people’s intellectual capital. Companies that are caught
zSeries, pSeries and xSeries each increasing its share position in the middle run the risk of being hammered from both
in 2004. IBM is the market leader in the super-hot category of below and above.
blade servers, with revenue growing more than 150 percent As I described to you last year, we’ve made our choice: IBM
for the year. Industry analyst IDC estimates that by 2008 is an innovation company. Of course, declaring something like
one of every four servers will be a blade. We had challenging that is easy. It has taken a great deal of discipline to execute.
product transitions in storage systems and iSeries, which For instance, over the past several years, while we increased
hurt us. Personal computer revenue growth was strong for our presence in software, consulting and infrastructure serv-
the year. Technology OEM growth was good, and we continue ices, we exited or reduced our presence in commoditizing
to see yield improvements in our semiconductor operation. businesses like hard disk drives, memory chips and network-
Overall, our hardware revenue was $31.2 billion, an increase ing hardware. And most notably, this past December we
of 10 percent. announced our agreement for Lenovo, China’s computer
leader, to acquire IBM’s Personal Computing Division.
• Revenue in all of IBM’s industry sectors — which is the way These kinds of decisions are hard for many companies —
we serve our largest clients globally — grew for the full year, indeed, some won’t make them — because it means parting
led by the financial services, communications and distribution with business models and technologies that were once their
sectors. We continued our strong growth in sales to small and crown jewels. In our own case, IBM invented the hard disk drive
medium-size businesses, which grew by 8 percent. and DRAM chip, and we set the standard in PCs back in 1981.
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chairman’s letter
We take enormous pride in these achievements. But if you “Understanding Our Company: An IBM Prospectus,” which
intend to remain the innovation leader, you commit yourself accompanies this year’s annual report. I encourage you
to continuous reinvention. You’ve got to do the hard work, to take a look at it. I think it will help explain how we see the
every day, to discover and develop new capabilities — and world, and how that is driving our actions.
new ways of working — that will keep you moving forward.
The new Lenovo will be the world’s third-largest PC busi- The meaning of 2004
ness. It will have greater global reach and greater economies Several major shifts — in business models, in technology
of scale, and we will continue to work together to deliver and in how they together are reshaping our industry — have
world-class PC solutions in the marketplace. There’s no doubt driven everything we’ve done at IBM over the past four
in my mind that this was the best path forward for our years. They continued to do so in 2004.
personal computer business.
For IBM, our PC transaction — perhaps the most widely 1. Because clients now demand that information technology
commented-upon event of the year for us — was certainly be intimately integrated with their business operations, we have
a milestone. But not, I would argue, for the reasons many reshaped IBM’s business skills, assets and delivery capability.
believe. We could simply have sold our PC business.
Instead, what we did was to reposition both that business This has involved everything from our acquisition of
and IBM itself in ways that help each and that align with PricewaterhouseCoopers Consulting in 2002, to the launch
the future trajectory of the IT market. This deal crystallizes, of multiple industry- and process-specific practices and lines
of business. Some people may see this simply as IBM bulking
as well as any single event could, the nature of our business
up in services. It is true that we needed to add a lot of deep
model, strategy and marketplace position today:
business expertise — and we will continue to strengthen our
IBM is an enterprise-focused company. It is not hand here. But clients want more than the consultant’s strategic
our strength or intention to participate directly in advice, the systems integrator’s skills or the IT outsourcer’s
consumer markets. scale. They want new business designs, enabled by technol-
ogy, that give them some quantifiable competitive advantage.
We are all about innovation. We are best at creating
They want new options and alternatives, not only in how
and delivering differentiating value to our clients.
they manage IT, but in how they conceptualize and manage
We are a global business. Much more than marketing their companies.
products and services around the world, this means This is what we mean by On Demand Business. CEOs
establishing deep roots locally and leveraging our might not use that exact term (yet), but a more responsive,
multinational presence for operational advantage. virtually integrated company is increasingly what they are
asking us to help them build. Companies like eBay, Bank
To explain our perspective on both the IT industry and IBM’s of America and METRO Group, and institutions like Miami-
transformation lies beyond the scope of an annual report. Dade County and the new Museum of Modern Art are, to
However, I do believe it is vital for anyone with an interest one degree or another, on demand enterprises.
in IBM to understand this long-term view and what lies I want to highlight one aspect of On Demand Business,
behind it — not a mere cyclical change, but a major structural because it represents a very large new market opportunity for
shift in our industry. That is why we created the document us. We call it Business Performance Transformation Services
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chairman’s letter
(BPTS), and industry analyst IDC sizes it at about $1.4 trillion — Consider: 32,768 Power processors are at the heart of our
as large as the existing global IT industry. We peg the part of Blue Gene supercomputer, which last year set a new record —
BPTS that IBM is addressing at about $500 billion. more than 70 trillion calculations per second. Yet variations
As its name suggests, BPTS involves helping clients opti- of Power chips are also the foundation for our pSeries and
mize their operations through new business designs and iSeries, and are used in our blade servers, our storage systems
processes, and, in some cases, turning over those operations and an expanding array of devices — network routers, mobile
to expert partners to manage. As you can imagine, this is a devices, game consoles — designed by our OEM partners.
very different type of services business—one that is increasingly Built on a Power core, the Cell processor — a “supercomputer
“asset-based.” It requires deep knowledge of business on a chip”— was developed along with Sony and Toshiba
processes like logistics, supply chain and human resource for broadband, high-definition uses.
management, and relies heavily on automated processes Increasing the uses of the Power family is important for
and intellectual capital, not mere labor arbitrage. IBM, because it gives us the advantages of a high-performance
In 2004, we extended our capabilities in BPTS, making processor and high-volume economics. This is one reason
substantial investments in four areas — Business Transformation we’ve opened Power’s technical specifications through our
Outsourcing, Engineering and Technology Services, Strategy
and Change Consulting, and Business Performance Manage-
revenue from continuing income from continuing
ment Software. We generated more than $3 billion in revenue operations operations
in these four areas — up about 45 percent over the previous
year. And our software and services groups are working
(IN BILLIONS OF DOLLARS) (IN BILLIONS OF DOLLARS)
together to build out an infrastructure that fuses business
transformation with information technology — what is called
services-oriented architecture — to support our evolution to
an asset-based services business.
96.3 8.4
2. Because we saw that computing was undergoing a fundamental 8.1
7.9
shift, we developed the architecture and technologies for the 7.6
On Demand Operating Environment, based on open standards.

89.1
The new computing architecture is based on a truly networked
5.3
world and the emergence of open standards — for the first 85.1
time in our industry’s history — as well as some exciting new 83.1
technologies and new ways of accessing and managing IT. 81.2
It builds on our strengths in enterprise computing, core
technology and software.
One of our most important core technologies is our
Power microprocessor family. What’s significant about Power
is not just that it’s fast and packs a lot of punch (plenty of 00 01 02 03 04 00 01 02 03 04
microprocessors do). Power is highly customizable.
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chairman’s letter
Power Everywhere and Power.org initiatives. We are building 3. These two elements of on demand — new business models and
a broader ecosystem of innovation around Power, reflecting a new computing infrastructure — are now coming together in
the fact that innovation today is an increasingly collaborative ways that will redefine the industry and play to IBM’s strengths.
process — and not only in software.
All of these changes — businesses we’ve exited, those we’ve
And speaking of software, through steady internal
entered, our increased investments, the technologies
development and select acquisitions over the past several
and practices we’ve invented — were undertaken not simply
years, IBM has become the leader in enterprise-class
to assemble a portfolio, even a portfolio of high-value busi-
middleware, which helps companies integrate and manage
nesses, but to do something with them. Namely, we aim to
their operations. An important differentiator for our
give our clients capabilities they cannot get either from
software business is that it is entirely built on open standards,
another company or even a collection of other companies.
supporting a wide variety of hardware platforms and
This is why we’ve worked hard to forge connections
applications. This gives our clients flexibility and choice,
between our services and software businesses, our semi-
and makes it easy for them to integrate their infrastructure
conductor unit and our server and storage units, between
and business operations.
IBM Research and every other part of the company, and
between IBM and an increasing variety of business partners.
earnings per share cash available for IBM’s strategy is less about going to market with a more
investment and distribution complete array of capabilities than it is about leveraging
to shareholders
those capabilities to create new intellectual capital for clients.
(IN DOLLARS, ASSUMING DILUTION
FROM CONTINUING OPERATIONS) (IN BILLIONS OF DOLLARS)
Priorities going forward

As we move ahead in 2005, we are guided by the same
priorities that have shaped our progress thus far.
we will make on demand business a fuller reality for clients.

4.94 12.7 12.9
The concept is no longer in dispute. Enterprises are achieving
4.59 12.0
4.32 4.34 11.3 tangible benefits from being on demand—and are increasingly
10.5 embracing its long-term strategic promise for competitive
advantage. We will work with a growing roster of clients who
3.07 want to become on demand enterprises, and we will
continue to build out the technologies and services for the
On Demand Operating Environment.
we will continue to deepen ibm’s capabilities as a company

built on innovation. This is our business model and has been
since the company’s inception. It has shaped our transforma-
tion over the past several years, and it continues to shape
00 01 02 03 04 00 01 02 03 04 the evolution of our workforce strategy, management systems,
economics and client relationships.
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chairman’s letter
FINANCIAL HIGHLIGHTS
International Business Machines Corporation and Subsidiary Companies
(Dollars in millions except per share amounts)
FOR THE YEAR 2004 2003 AT YEAR END 2004 2003
Revenue $««96,293 $««89,131 Cash, cash equivalents and

Income from continuing operations 8,448 7,613 marketable securities $««10,570 $««««7,647
Loss from discontinued operations 18 30 Total assets 109,183 104,457

Working capital 7,172 7,039* *
Net income 8,430 7,583
Total debt 22,927 23,632
Earnings/(loss) per share Stockholders’ equity 29,747 27,864
of common stock:
Assuming dilution: Common shares outstanding (in millions) 1,646 1,695
Continuing operations 4.94 4.34 Market capitalization 162,223 157,047
Discontinued operations (0.01) (0.02) Stock price per common share 98.58 92.68
Number of employees in IBM/
Total 4.93 4.32
wholly owned subsidiaries 329,001 319,273
Basic:
** Reclassified to conform with 2004 presentation.
Continuing operations 5.04 4.42
Discontinued operations (0.01) (0.02)
Total 5.03 4.40
Net cash provided by operating activities

from continuing operations 15,406 14,569
Investment in plant, rental machines
and other property 4,368 4,393
Cash dividends paid on common stock 1,174 1,085
Per share of common stock 0.70 0.63
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chairman’s letter
we will focus in 2005 on execution. This is that “big E” inhibit us from collaborating, innovating and contributing to
message I gave to IBM’s leaders at the beginning of this year. IBM’s growth.
All of our strategic work over the past four years has given These and dozens of other ideas are now in various
us considerable capabilities to seize the growth and profit stages of implementation, and I am confident that they will
opportunities I’ve described. Now, we have to improve our make a material difference to IBM. Our values are also being
ability to integrate all of this capability for our clients. turned into actions every day in countless other ways: how
In other words, we need to become even more of an we work with our clients and colleagues; the actions of IBM’s
On Demand Business ourselves. And a big part of that is crisis response team after the Asian tsunami disaster; or the
what I call “lowering the center of gravity” of our company. progress of the World Community Grid — harnessing vast,
For us, this is neither conventional decentralization nor simple unused computational power to help cure disease and forecast
delegation. It means shifting resources closer to the point of natural disasters.
contact with the client, creating enterprise-wide processes From the point of view of a CEO, perhaps the best aspect
that are commonly shared, and establishing truly global of this entire process has been the broad platform it creates
operations that capitalize on the talent and scale now available to drive change. When your primary organizational challenge
in every part of the world. is one of execution, there is nothing more encouraging than
Every time we have simplified the company and pushed the knowledge that your organization’s direction and sense
authority and resources closer to where the day-to-day of mission come not out of some threat or crisis, but from the
action is, we’ve seen great results — with clients (because we aspirations of your own workforce. For 329,000 IBMers — and
are easier to do business with), in our cost structure (because you can count me among them — what drives us every day is
we eliminate unnecessary layers), in revenue growth (because a determination to make IBM the great company we all want
we differentiate ourselves from the competition) and in how and expect it to be.
individual IBMers feel about their company.
Last year, I told you about the online “jam” in which IBMers
collectively defined our values for the first time in nearly a
century. I told you what an outpouring of passion, imagination
and pride that was.
Well, even more impressive was the follow-up jam Samuel J. Palmisano
CHAIRMAN, PRESIDENT AND CHIEF EXECUTIVE OFFICER
we held last fall. This time, we asked IBMers to contribute
ideas to make our values a day-to-day reality in the com-
pany. Participation was extraordinary — more than 57,000
IBMers contributed more than 32,000 comments and
ideas — and the ideas were concrete, practical and focused
on execution.
The top-rated ideas range from back-office integration
supporting the development and marketing of integrated
solutions; to helping first-line managers by giving them
more authority over budgets and freeing up their time to
* IBM’s Form 8-K dated January 18, 2005 (Attachment III) contains
devote to their people; to clearing away the barriers that information about return on invested capital.
07
ibm annual report 2004
FINANCIAL REPORT
REPORT OF MANAGEMENT . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 09 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

a Significant Accounting Policies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 49
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM . . . . . . . . . . . 10
b Accounting Changes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 55
c Acquisitions/Divestitures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 57
MANAGEMENT DISCUSSION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
d Financial Instruments (excluding derivatives). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 61
Road Map . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
e Inventories . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 61
Management Discussion Snapshot . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12
f Financing Receivables . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 62
Description of Business . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13
g Plant, Rental Machines and Other Property . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 62
Year in Review . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17
h Investments and Sundry Assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 62
Prior Year in Review . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26
i Intangible Assets Including Goodwill . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 63
Looking Forward . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28
j Sale and Securitization of Receivables . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 64
Employees and Related Workforce . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34
k Borrowings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 64
Global Financing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35
l Derivatives and Hedging Transactions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 65
CONSOLIDATED FINANCIAL STATEMENTS m Other Liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 67
Earnings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 40 n Stockholders’ Equity Activity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 69
Financial Position . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 42 o Contingencies and Commitments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 69
Cash Flows . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 44 p Taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 72
Stockholders’ Equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 46 q Advertising and Promotional Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 73
r Research, Development and Engineering . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 73
s 2002 Actions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 73
t Earnings Per Share of Common Stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 77
u Rental Expense and Lease Commitments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 77
v Stock-Based Compensation Plans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 77
w Retirement-Related Benefits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 78
x Segment Information . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 87
FIVE-YEAR COMPARISON OF SELECTED FINANCIAL DATA . . . . . . . . . . . . . . . . . . . . . . . . . 92
SELECTED QUARTERLY DATA . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 93
BOARD OF DIRECTORS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 94
BOARD OF DIRECTORS AND SENIOR EXECUTIVE OFFICERS . . . . . . . . . . . . . . . . . . . . . . 95
STOCKHOLDER INFORMATION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 96
08
REPORT OF MANAGEMENT
management responsibility for financial information The company’s internal control over financial reporting includes those policies and
Responsibility for the integrity and objectivity of the financial information presented in this procedures that (i) pertain to the maintenance of records that, in reasonable detail, accu-
Annual Report rests with IBM management. The accompanying financial statements have rately and fairly reflect the transactions and dispositions of the assets of the company; (ii)
been prepared in accordance with accounting principles generally accepted in the United provide reasonable assurance that transactions are recorded as necessary to permit prepa-
States of America, applying certain estimates and judgments as required. ration of financial statements in accordance with accounting principles generally accepted
IBM maintains an effective internal control structure. It consists, in part, of organizational in the United States of America, and that receipts and expenditures of the company are
arrangements with clearly defined lines of responsibility and delegation of authority, and being made only in accordance with authorizations of management and directors of the
comprehensive systems and control procedures. An important element of the control company; and (iii) provide reasonable assurance regarding prevention or timely detection
environment is an ongoing internal audit program. Our system contains self-monitoring of unauthorized acquisition, use, or disposition of the company’s assets that could have a
mechanisms, and actions are taken to correct deficiencies as they are identified. material effect on the financial statements.
To assure the effective administration of internal controls, we carefully select and train Because of its inherent limitations, internal control over financial reporting may not
our employees, develop and disseminate written policies and procedures, provide appro- prevent or detect misstatements. Also, projections of any evaluation of effectiveness to
priate communication channels, and foster an environment conducive to the effective future periods are subject to the risk that controls may become inadequate because of
functioning of controls. We believe that it is essential for the company to conduct its business changes in conditions, or that the degree of compliance with the policies or procedures
affairs in accordance with the highest ethical standards, as set forth in the IBM Business may deteriorate.
Conduct Guidelines. These guidelines, translated into numerous languages, are distributed Management conducted an evaluation of the effectiveness of internal control over
to employees throughout the world, and reemphasized through internal programs to financial reporting based on the framework in Internal Control — Integrated Framework
assure that they are understood and followed. issued by the Committee of Sponsoring Organizations of the Treadway Commission.
PricewaterhouseCoopers LLP, an independent registered public accounting firm, is Based on this evaluation, management concluded that the company’s internal control over
retained to audit IBM’s consolidated financial statements and management’s assessment of financial reporting was effective as of December 31, 2004. Management’s assessment of the
the effectiveness of the company’s internal control over financial reporting. Its accompany- effectiveness of the company’s internal control over financial reporting as of December 31,
ing report is based on audits conducted in accordance with the standards of the Public 2004 has been audited by PricewaterhouseCoopers LLP, an independent registered public
Company Accounting Oversight Board (United States). accounting firm, as stated in their report which is included herein.
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 registered public accounting firm to be retained for the coming year, sub-
ject to stockholder ratification. The Audit Committee meets periodically and 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 con-
trol structure and financial reporting matters. Samuel J. Palmisano Mark Loughridge
CHAIRMAN, PRESIDENT AND SENIOR VICE PRESIDENT
CHIEF EXECUTIVE OFFICER CHIEF FINANCIAL OFFICER
management’s report on internal control over financial reporting FEBRUARY 22, 2005 FEBRUARY 22, 2005
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 to provide 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.
09
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Stockholders and Board of Directors of International Business Machines Corporation: reporting as of December 31, 2004, based on criteria established in Internal Control-
We have completed an integrated audit of International Business Machines Corporation’s Integrated Framework issued by the COSO. The company’s management is responsible
2004 consolidated financial statements and of its internal control over financial reporting for maintaining effective internal control over financial reporting and for its assessment of
as of December 31, 2004 and audits of its 2003 and 2002 consolidated financial statements the effectiveness of internal control over financial reporting. Our responsibility is to express
in accordance with the standards of the Public Company Accounting Oversight Board opinions on management’s assessment and on the effectiveness of the company’s internal
(United States). Our opinions, based on our audits and the reports of other auditors, are control over financial reporting based on our audit. We did not examine the effectiveness
presented below. of the controls over the initiation and recording of revenue transactions and the recording
of direct costs at the company’s Business Consulting Services Reporting Unit as of Decem-
consolidated financial statements
ber 31, 2004. The effectiveness of those controls was examined by other auditors whose
In our opinion, based on our audits and the report of other auditors, the accompanying
report has been furnished to us, and our opinions expressed herein, insofar as they relate
consolidated financial statements appearing on pages 40 through 91 present fairly, in all
to the effectiveness of those controls, are based solely on the report of the other auditors.
material respects, the financial position of International Business Machines Corporation and
We conducted our audit of internal control over financial reporting in accordance with the
its subsidiary companies at December 31, 2004 and 2003, and the results of their opera-
standards of the Public Company Accounting Oversight Board (United States). Those stan-
tions and their cash flows for each of the three years in the period ended December 31,
dards require that we plan and perform the audit to obtain reasonable assurance about
2004 in conformity with accounting principles generally accepted in the United States of
whether effective internal control over financial reporting was maintained in all material
America. These financial statements are the responsibility of the company’s management.
respects. An audit of internal control over financial reporting includes obtaining an under-
Our responsibility is to express an opinion on these financial statements based on our
standing of internal control over financial reporting, evaluating management’s assessment,
audits. We did not audit the financial statements of the company’s Business Consulting
testing and evaluating the design and operating effectiveness of internal control, and per-
Services Reporting Unit (which includes the consulting practice acquired from us as dis-
forming such other procedures as we consider necessary in the circumstances. We believe
cussed in note c) for the years ended December 31, 2004, December 31, 2003 and the
that our audit and the report of the other auditors provide a reasonable basis for our opinions.
three months ended December 31, 2002, which statements reflect total revenues of 14.3
A company’s internal control over financial reporting is a process designed to provide
percent, 14.5 percent and 4.3 percent of the related consolidated totals in the years ended
reasonable assurance regarding the reliability of financial reporting and the preparation of
December 31, 2004, 2003 and 2002, respectively. Those statements were audited by other
financial statements for external purposes in accordance with generally accepted account-
auditors whose report thereon has been furnished to us, and our opinion expressed herein,
ing principles. A company’s internal control over financial reporting includes those policies
insofar as it relates to the amounts included for the company’s Business Consulting
and procedures that (i) pertain to the maintenance of records that, in reasonable detail,
Services Reporting Unit, is based solely on the report of the other auditors. We conducted
accurately and fairly reflect the transactions and dispositions of the assets of the company;
our audits of these statements in accordance with the standards of the Public Company
(ii) provide reasonable assurance that transactions are recorded as necessary to permit
Accounting Oversight Board (United States). Those standards require that we plan and
preparation of financial statements in accordance with generally accepted accounting
perform the audit to obtain reasonable assurance about whether the financial statements
principles, and that receipts and expenditures of the company are being made only in
are free of material misstatement. An audit of financial statements includes examining, on
accordance with authorizations of management and directors of the company; and (iii)
a test basis, evidence supporting the amounts and disclosures in the financial statements,
provide reasonable assurance regarding prevention or timely detection of unauthorized
assessing the accounting principles used and significant estimates made by management,
acquisition, use, or disposition of the company’s assets that could have a material effect on
and evaluating the overall financial statement presentation. We believe that our audits and
the financial statements.
the report of other auditors provide a reasonable basis for our opinion.
Because of its inherent limitations, internal control over financial reporting may not
internal control over financial reporting prevent or detect misstatements. Also, projections of any evaluation of effectiveness to
Also, in our opinion, based on our audit and the report of other auditors, management’s future periods are subject to the risk that controls may become inadequate because of
assessment, included in Management’s Report on Internal Control over Financial Reporting changes in conditions, or that the degree of compliance with the policies or procedures
appearing on page 9, that the company maintained effective internal control over financial may deteriorate.
reporting as of December 31, 2004 based on criteria established in Internal Control-
Integrated Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission (COSO), is fairly stated, in all material respects, based on those
PricewaterhouseCoopers LLP
criteria. Furthermore, in our opinion, based on our audit and the report of other auditors,
NEW YORK, NEW YORK
the company maintained, in all material respects, effective internal control over financial FEBRUARY 22, 2005
10
MANAGEMENT DISCUSSION
Road Map • In 2004, the company, in accordance with Section 404 of the Sarbanes-Oxley Act of
The financial section of the International Business Machines Corporation (IBM and/or the 2002, conducted an evaluation of its internal control over financial reporting and
company) 2004 Annual Report, consisting of this Management Discussion, the Consoli- concluded that the internal control over financial reporting was effective as of
dated Financial Statements that follow and the notes related thereto, comprises 83 pages December 31, 2004.
of information. This Road Map is designed to provide you with some perspective regard- • The Management Discussion is designed to provide readers with a view of the com-
ing the information contained in the financial section and a few helpful hints for reading pany’s results and certain factors that may affect future prospects from the perspective
the document. of the company’s management. Within the Management Discussion Snapshot, the
key messages and details will give readers the ability to quickly assess the most
ibm’s business model
important drivers of performance within this brief overview.
The company’s business model is built to support two principal goals: helping clients suc-
• The Management Discussion reflects the company’s continued and improving strength
ceed in delivering business value by becoming more efficient and competitive through
in providing broad client solutions, as opposed to a “piece parts” conglomeration of
the use of business insight and information technology (IT) solutions; and providing long-
many hardware, software and services businesses. The Description of the Business on
term value to shareholders. In support of these objectives, the business model has been
page 13, Results of Continuing Operations on page 17, Financial Position on page
developed over time through strategic investments in services and technologies that have
23, and Looking Forward on page 28 sections, all are written from the perspective
the best long-term growth and profitability prospects based on the value they deliver to
of the consolidated entity. Detailed analysis for each of the company’s segments is
clients. In addition, the company is committed to its employees and the communities in
also included and appears on pages 21 to 23.
which it operates.
The model is designed to allow for flexibility and periodic rebalancing. In 2004, • Global Financing is a business segment within the company that is managed on an
14 acquisitions were completed, all in software and services, at an aggregate cost of over arm’s-length basis and measured as if it were a standalone entity. A separate Global
$2 billion, and in the fourth quarter the company announced the agreement to sell its Financing section beginning on page 35 is not included in the consolidated perspec-
Personal Computing Division, a unit of the Personal Systems Group. tive that is referred to above. This section is separately presented given this segment’s
The company’s portfolio of capabilities ranges from services that include business unique impact on the company’s financial condition and leverage.
performance transformation services to software, hardware, fundamental research, financ- • The selected reference to constant currency in the Management Discussion is made
ing and the component technologies used to build larger systems. These capabilities are so that the financial results can be viewed without the impacts of changing foreign
combined to provide business insight and solutions in the enterprise computing space. currency exchange rates and therefore facilitates a comparative view of business
In terms of financial performance, over the last two years, the company has increased growth. The percentages reported in the financial tables throughout the Management
its participation in the high-growth areas of its industry, while at the same time maintaining Discussion are calculated from the underlying whole-dollar numbers. See “Currency
a breadth of capabilities that has allowed it to gain share in key markets during changing Rate Fluctuations” on page 33 for additional information.
economic environments. In general, this strategy results in less volatile returns overall,
because each individual capability has unique financial attributes. Some involve contractual helpful hints
long-term cash and income streams while others involve cyclical transaction-based sales. Organization of Information
The annuity-like business delivers incremental growth with a high degree of stability and • This Management Discussion section provides the reader of the financial statements
provides substantial cash. New engagements deliver more significant revenue growth and with a narrative on the company’s financial results. It contains the results of operations
require a level of investment to generate success. for each segment of the business, followed by a description of the company’s finan-
In terms of marketplace performance — i.e., the ability to deliver client value — it is cial position, as well as certain employee data. It is useful to read the Management
important to understand that the fundamental strength of this business model is not found Discussion in conjunction with note x, “Segment Information,” on pages 87 through 91.
in the breadth of the portfolio alone, but in the way the company creates business solu- • Pages 40 through 48 include the Consolidated Financial Statements. These statements
tions from among its capabilities and relationships. provide an overview of the company’s income and cash flow performance and its
financial position.
transparency
Transparency is a primary goal of successful financial reporting. The following are the key • The notes follow the Consolidated Financial Statements. Among other things, the notes
elements you will find in this year’s Annual Report. contain the company’s accounting policies (pages 49 to 55), detailed information on
specific items within the financial statements, certain contingencies and commit-
ments (pages 69 to 71), and the results of each IBM segment (pages 87 through 91).
11
subsequent event continuing operations

Subsequent to the company’s press release and Form 8-K filing on January 18, 2005, In 2004, the company demonstrated that it could extend its leadership in a growth environ-
announcing 2004 fourth quarter and full year financial results, the company conducted a ment. The company delivered revenue growth of 8.0 percent and diluted earnings per
review of agreements for sales of third-party hardware in Japan. As a result of this review, share growth of 13.8 percent. The increase in the company’s Income from continuing
the company determined that certain IBM Japan employees acted improperly and incon- operations and diluted earnings per share from continuing operations as compared to
sistently with the company’s policies and practices. The company is taking appropriate 2003 was primarily due to:
disciplinary action.
• Improving demand associated with the moderate expansion of the economy and
Therefore, the company has reduced full year Global Services revenue and cost by
continued market share gains for zSeries and xSeries server products
$260 million. The previously announced 2004 fourth quarter financial results included
$50 million of this adjustment. The additional $210 million adjustment is considered a • Continued operational improvements in the Microelectronics business
Type 1 subsequent event under generally accepted accounting principles (GAAP) and • Continued demand growth in emerging countries
must be reflected in the company’s 2004 financial statements. As a result, the company has • Favorable impact of currency translation
reduced Global Services revenue and cost by $75 million, $55 million, and $80 million in
the first, second and third quarters of 2004, respectively. The increase in revenue in 2004 as compared to 2003 was primarily due to:
There was no reduction made to the company’s gross profit dollars, income from • Improved demand in Global Services and key industry sectors
continuing operations or cash flows. • Improving demand associated with the moderate expansion of the economy and
Discontinued Operations continued market share gains for zSeries, xSeries and pSeries server products, as
On December 31, 2002, the company sold its hard disk drive (HDD) business to Hitachi, well as increased revenue for personal computers
Ltd. (Hitachi). The HDD business was accounted for as a discontinued operation under • Continued demand growth in emerging countries (up over 25 percent) and in Business
GAAP which requires that the income statement and cash flow information be reformatted Performance Transformation Services (up approximately 45 percent)
to separate the divested business from the company’s continuing operations. See pages
• Favorable impact of currency translation
60 and 61 for additional information.
With regard to the way that management reviews the business, as-reported and constant
currency revenue trends were positive for all of the company’s segments (except Global
Management Discussion Snapshot
Financing), geographies and industry sectors. See pages 17 and 18 for the summary trend
(Dollars and shares in millions except per share amounts)
rates on an as-reported and constant currency basis, as well as information for each segment
Yr. to Yr. on pages 21 to 23.
Percent/
Margin The consolidated gross profit margin was relatively flat versus 2003, increasing 0.4
FOR THE YEAR ENDED DECEMBER 31: 2004 2003 Change
points. An improvement in Hardware margins (1.8 points) contributed 0.5 points to the
Revenue $÷«96,293 $«««89,131 8.0% * overall margin improvement. In addition, Global Financing margin improved 4.2 points
Gross profit margin 37.4% 37.0% 0.4 pts. compared to 2003, however, this improvement had an immaterial impact on the com-
Total expense and other income $÷«24,004 $«÷22,144 8.4%
pany’s overall margin due to the size of the segment. These improvements were partially
Total expense and other income to revenue ratio 24.9% 24.8% 0.1 pts.
offset by Global Services and Software — while margins in these segments were generally
Provision for income taxes $÷÷«3,580 $÷÷«3,261 9.8%
flat year-to-year, the mix of these segments slightly impacted the overall company margin.
Income from continuing operations $÷÷«8,448 $÷÷«7,613 11.0%
Total expense and other income increased in 2004 versus 2003 due primarily to
Earnings per share from continuing operations:
increased retirement-related plan costs, including the $320 million charge due to the par-
Diluted $«««««««4.94 $«««««««4.34 13.8%
tial settlement of certain legal claims against the company’s IBM Personal Pension Plan
Basic $«««««««5.04 $«««««««4.42 14.0%
(PPP), and unfavorable currency translation.
Weighted-average shares outstanding:
Diluted 1,708.9 1,756.1 (2.7) %
Overall, retirement-related plan costs increased $1,082 million versus 2003, impacting
Basic 1,675.0 1,721.6 (2.7) % both gross margin and expense. See note w, “Retirement-Related Benefits” on pages 78
Assets ** $«109,183 $«104,457 4.5% through 86 for additional information.
Liabilities ** $«««79,436 $÷«76,593 3.7% The provision for income taxes resulted in an effective tax rate of 29.8 percent for
Equity ** $«««29,747 $÷«27,864 6.8% 2004, compared with the 2003 effective tax rate of 30.0 percent. The 0.2 point decrease in
the effective tax rate in 2004 was primarily due to the tax effect of the settlement of certain
* 3.4 percent adjusting for currency
12 ** At December 31 pension claims in the third quarter of 2004 (highlighted above).
With regard to Assets, approximately $3.6 billion of the increase relates to the impact investment in such an infrastructure provides both superior returns and maximum freedom
of currency translation. The remaining increase primarily consists of an increase in Cash and of interoperability and action. Standards have become a core element of IBM’s overall
cash equivalents, an increase in Goodwill associated with recent acquisitions and increased strategy and impact all of our unit strategies.
Prepaid pension assets. The increases were partially offset by lower financing receivables The shift to standards-based technologies has been bolstered significantly in recent
and lower deferred tax assets. years by the rapid growth of the “open source” software movement, a result of large-scale
For additional information, see the Year in Review section on pages 17 to 26. collaboration among members of the worldwide developer and business communities.
Global Financing debt decreased, but the company’s Global Financing debt-to-equity Examples include the Linux operating system, the Eclipse computing platform and the
ratio remained flat at 6.9 to 1 and within the company’s targeted range. Java programming language.
Global Services signings were $43 billion in 2004 as compared to $55 billion in 2003. IBM’s clients include many different kinds of enterprises, from sole proprietorships to
The Global Services backlog is estimated to be $111 billion at December 31, 2004 versus the world’s largest organizations, governments and companies representing every major
$120 billion at December 31, 2003. For additional information, see Global Services Signings industry and endeavor. Over the last decade, IBM has exited or greatly de-emphasized its
on page 29. involvement in consumer markets and divested itself of other noncore businesses to con-
Looking forward, the company’s longer-term financial model targets earnings per centrate on the enterprise market. In IBM’s view, opportunities in the enterprise market are
share to grow at a low double-digit rate with revenue growth in the mid-to-high single superior — representing approximately two-thirds of the IT industry’s revenue. As a result,
digits, continued productivity driven margin improvement, and effective capital deploy- IBM has made acquisitions and invested in emerging business opportunities important to
ment for acquisitions and common stock repurchase. The company’s ability to meet these its enterprise clients. Many of these investments have grown into multibillion dollar busi-
objectives depends on a number of factors, including those outlined on page 17 and on nesses in their own right, and are now contributing to IBM’s growth.
pages 69 to 71. The majority of the company’s enterprise business, which excludes the company’s
original equipment manufacturer (OEM) technology business, occurs in industries that are
broadly grouped into six sectors around which the company’s go-to-market strategies,
Description of Business and sales and distribution activities are organized:
Please refer to IBM’s Annual Report on Form 10-K filed on February 24, 2005, with the • Financial Services: Banking, Financial Markets, Insurance
Securities and Exchange Commission (SEC) for a more detailed version of this Description • Public: Education, Government, Healthcare, Life Sciences
of Business, especially the detailed “Significant Factors Affecting IBM’s Business” section. • Industrial: Aerospace, Automotive, Defense, Chemical and Petroleum, Electronics
IBM is an innovation-based business serving the needs of enterprises and institutions
• Distribution: Consumer Products, Retail, Travel, Transportation
worldwide. It defines innovation as the intersection of business insight and technological
invention. IBM seeks to deliver client success — in whatever ways its clients define success — • Communications: Telecommunications, Media and Entertainment, Energy and Utilities
by giving them differentiating capabilities that provide unique competitive advantage. • Small and Medium Business: Mainly companies with less than 1,000 employees
By helping its clients redesign their business processes and organizational structure,
the it industry and ibm’s strategy
enabled by new operating environments, IBM helps them to become on demand busi-
IBM operates in the IT industry, which comprises three principal categories:
nesses. IBM defines an on demand business as an enterprise whose business processes
are responsive to any demand, opportunity or threat; integrated end-to-end across the • Business Value
company; and capable of integrating fluidly across extended business ecosystems of part- • Infrastructure Value
ners, suppliers and clients. • Component Value
IBM first described this new model and set of capabilities in 2002, believing they
IBM has realized and continues to see a shift in revenue and profit growth from Component
represent the current evolution of information technology architectures and of business
Value to Infrastructure Value and Business Value, where revenue and profit potential are
and institutional models. IBM calls this architecture the On Demand Operating
thought to be greatest in the years ahead.
Environment: an infrastructure based on industry-wide standards (commonly referred to
as “open standards”), rather than on proprietary technologies. In IBM’s view, an enterprise’s
13
Business Value Infrastructure Value

The company helps its clients transform their businesses and gain competitive advantage Infrastructure Value includes systems, such as high-volume servers; middleware software
by applying its skills and experience to business performance challenges specific to the that can interconnect disparate operating systems and applications with data; storage
client’s industry or across industries and processes. The company enters into long-term networks; and devices. It also refers to such services as infrastructure management —
relationships and creates solutions for clients, driving on demand business innovation, on its whether on the client’s premises or managed remotely at IBM’s own facilities — and consult-
own or in partnership with other companies. The company draws upon its broad product ing about how to improve and strengthen the infrastructure and realize greater return on
and service offerings, including Business Consulting Services, IBM Research, industry-leading investment in it. Central to IBM’s approach for building value in the infrastructure category
middleware, and its deep experience in systems and technology design. is its support of open standards and its active promotion of Linux and other open source
CA PA B I L I T I E S
platforms, which help IBM’s clients control costs and allow them to benefit from the latest
Business Consulting Services ( BCS ). Delivery of value to clients through consulting services advances created by development communities around the world. IBM’s strategic objective
for client relationship management, financial management, human capital, business strategy is to deliver open and integrated offerings and expand partnerships.
and change, and supply chain management, as well as application innovation and the trans- CA PA B I L I T I E S
formation of business processes and operations. (Global Services) Application Management Services. Application development, management, maintenance
Business Performance Management ( BPM ). Enables companies to visualize end-to-end and support services for packaged software, as well as custom and legacy applications.
processes across business and IT systems, analyze execution in real time against goals, and (Global Services)
make adjustments as needed. IBM offers consulting, services and middleware to simulate Commercial financing. Short-term inventory and accounts receivable financing to dealers
and monitor business processes, and provides customers with real-time analysis of the and remarketers of IT products. (Global Financing)
underlying IT systems carrying out those processes. (Software)
DB 2 information management software. Advanced database and content management soft-
Business Transformation Outsourcing ( BTO ). Delivers improved business results to clients ware solutions that enable clients to leverage information on demand. (Software)
through the continual strategic change and the operation and transformation of the client’s
e-business Hosting Services. Solutions for the management of clients’ Web-based infrastruc-
business processes, applications and infrastructure. (Global Services)
ture and business applications, as well as a growing portfolio of industry-specific independ-
Center for Business Optimization ( CBO ). Helps clients continually optimize their business ent software vendor (ISV) solutions that are delivered as a service. (Global Services)
performance by drawing upon massive amounts of real-time data, advanced analytical
Integrated Technology Services ( ITS ). Design, implementation and maintenance of clients’
methods, business expertise and deep computing power. (Global Services)
technology infrastructures. (Global Services)
Customer Financing. Lease and loan financing to external and internal clients for terms gen-
Lotus software. Collaboration and messaging software that allows a company’s employees,
erally between two and five years. (Global Financing)
clients, vendors and partners to engage in real-time and asynchronous communication and
Engineering & Technology Services ( E&TS ). System and component design services, strate- knowledge management. (Software)
gic outsourcing of clients’ design teams, and technology and manufacturing consulting
Personal computers. Notebook and desktop computers featuring ThinkVantage Technolo-
services. (Systems and Technology Group)
gies that provide enterprises and end users with increased productivity and cost-effectiveness.
On Demand Innovation Services ( ODIS ). IBM Research scientists work with BCS consultants (Personal Systems Group)
to analyze and solve clients’ most intractable business challenges. ODIS offers a number of
Printing Systems. Production print solutions, on demand print-related solutions, enterprise
cross-industry micropractices with deep expertise including mobile enablement and infor-
workgroup print technologies, and print management software and services. (Personal
mation mining. (Global Services and IBM Research)
Systems Group)
Software and services to meet industry-specific needs. Solutions and applications built on an
Rational software. Integrated tools designed to improve an organization’s software devel-
on demand, standards-based infrastructure to transform a process that is unique to specific
opment processes and capabilities. (Software)
industries. (Multiple IBM segments)
Remarketing. The sale and lease of used equipment (primarily sourced from the conclusion
Business Performance Transformation Services ( BPTS ). Helps clients transform their spend-
of lease transactions) to new or existing clients. (Global Financing)
ing on business processes, namely Selling, General and Administrative and Research and
Development. BPTS requires advanced technology and deep expertise in industry and/or Retail Store Solutions. Point-of-sale retail checkout equipment, software and solutions.
specific functions like Human Resources (HR), logistics, payroll, sales, customer services and (Personal Systems Group)
procurement, to result in holistic improvement for the performance and success of a busi- Servers. IBM eServer systems using IBM operating systems (zSeries and iSeries), as well as
ness, including efficiency of individual processes and their combined effort. BPTS solutions AIX, the IBM UNIX operating system (pSeries) and the Microsoft Windows operating system
are delivered to clients by several of the company’s business areas: BTO, E&TS, Strategy and (xSeries). All servers can also run Linux, a key open source operating system. (Systems and
Change Consulting and BPM. (Multiple IBM segments) Technology Group and Software)
14
Storage. Data storage products, including disk, tape and storage area networks. (Systems Personal Systems Group includes sales of personal computers, business and computing
and Technology Group) solutions for retail stores and advanced printing capabilities for large enterprise clients
Strategic Outsourcing Services ( SO ). Competitive cost advantages through the outsourcing and small and medium-sized businesses. In December 2004, it was announced that
of processes and operations. (Global Services) Lenovo Group Limited, the largest information technology company in China, will acquire
Tivoli software. Software for infrastructure management, including security, change, config- IBM’s Personal Computing Division. This transaction is expected to close in the second
uration, job scheduling, storage capability, performance and availability. (Software) quarter of 2005.
WebSphere software. Management of a wide variety of business processes using open Software consists primarily of middleware and operating systems software. Middleware
standards to interconnect applications, data and operating systems. (Software)
software enables clients to integrate systems, processes and applications across their
Component Value enterprises. Middleware is designed to be the underlying support for applications provided
Component Value includes advanced semiconductor development and manufacturing for by independent software vendors (ISVs), who build industry- or process-specific applica-
IBM’s server and storage offerings, and services, technology and licenses provided to OEMs tions according to open industry standards. Operating systems are the engines that run
that create and market products requiring advanced chips and other core technology computers. Approximately 40 percent of external Software revenue relates to one-time
elements. IBM leverages components for infrastructure value, while continuing to partici- charge (OTC) arrangements, whereby the client pays one up-front payment for a lifetime
pate in selected markets, focusing on key industry partners. license. The remaining annuity revenue consists of both maintenance revenue sold with
OTC arrangements, as well as revenue from software sold on a monthly license charge
CA PA B I L I T I E S
Application Specific Integrated Circuit ( ASICs). Manufacturing of customized semiconductor (MLC) arrangement. Typically, arrangements for the sale of OTC software include one year
products for clients. (Systems and Technology Group) of maintenance. The client can also purchase ongoing maintenance after the first year,
which includes product upgrades and technical support.
Advanced Foundry. Integrated supply chain services and a full suite of semiconductor manu-
facturing services using either a client’s or IBM’s design. (Systems and Technology Group) Global Financing is described on pages 35 to 39.
Standard products and custom microprocessors. Semiconductors designed and manufactured
primarily based upon IBM’s PowerPC architecture. (Systems and Technology Group) Enterprise Investments develops and provides industry-specific IT solutions supporting the
Hardware, Software and Global Services segments of the company. Primary product lines
business segments include product life cycle management software and document processing technologies.
Organizationally, the company’s major operations comprise a Global Services segment; a Product life cycle management software primarily serves the Industrial sector and helps
Systems and Technology Group; a Personal Systems Group; a Software segment; a Global clients manage the development and manufacturing of their products. Document
Financing segment; and an Enterprise Investments segment. processor products service the Financial Services sector and include products that enable
electronic banking.
Global Services is a critical component of the company’s strategy of providing insight and
solutions to clients. While solutions often include industry-leading IBM software and hard- ibm worldwide organizations
ware, other suppliers’ products are also used if a client solution requires it. Global Services The following three company-wide organizations play key roles in IBM’s delivery of value
outsourcing contracts as well as BCS contracts range from less than one year to ten years. to its clients:
Systems and Technology Group provides IBM’s clients with business solutions requiring • Sales & Distribution Organization and related sales channels
advanced computing power and storage capabilities. More than half of the Systems and • Research, Development and Intellectual Property
Technology Group’s eServer and Storage Systems sales transactions are through business • Integrated Supply Chain
partners; approximately 40 percent are direct to end-user clients, more than half of which
are through the Web at ibm.com. In addition, the group provides leading semiconductor
technology and products, packaging solutions and engineering technology services to
OEM clients (approximately 14 percent of Systems and Technology Group revenue) and
for IBM’s own advanced technology needs. While appropriately not reported as external
revenue, hardware is also deployed to support Global Services solutions.
15
Sales & Distribution Organization In addition to these IP income sources, the company also generates value from its
With a comprehensive knowledge of IBM’s business and infrastructure solutions, as well as the patent portfolio through cross-licensing arrangements and IP licensed in divestiture
individual products, technologies and services offered by IBM and its network of business transactions. The value of these other two sources is not readily apparent in the financial
partners, the company’s global team of account representatives and solutions professionals results and Consolidated Statement of Earnings, because income on cross-licensing
gain a deep understanding of each client’s organizational, infrastructure and industry-specific arrangements is recorded only to the extent that cash is received. The value received by
needs to determine the best approach for addressing the client’s critical business and IT IBM for IP involving the sale of a business is included in the overall gain or loss from the
challenges. These professionals work in integrated teams with IBM consultants and technol- divestiture, not in the separately displayed IP income amounts in financial results and
ogy representatives, combining their deep skills and expertise to deliver high-value solutions. Consolidated Statement of Earnings.
In January 2005, IBM announced that it would pledge 500 of its patents for use by the
I N T E R N A L R O U T E S -TO - M A R K E T
open computing community, representing a major shift in the way IBM manages and
Global Services consultants focused on selling end-to-end solutions for large, complex
deploys its intellectual property portfolio. IBM’s intent is to help form an industry-wide
business challenges.
“patent commons,” in which patents are used to establish a platform for further innovation
Hardware and software brand specialists selling IBM products as parts of discrete technology in areas of broad interest to information technology developers and users. The pledge is
decisions, typically to “self-integrating” IT departments. applicable to any individual, community or company working on or using software that
ibm.com Online and telephone sales and assistance operations handle basic commodity meets the Open Source Initiative (OSI) definition of open source software.
transactions for large enterprises and small-to-medium businesses.
Integrated Supply Chain
B U S I N E S S PA RT N E R S R O U T E S -TO - M A R K E T Just as IBM works to transform its clients’ supply chains for greater efficiency and respon-
Global/major independent software vendors (ISVs). ISVs deliver business process or industry- siveness to market conditions, IBM has undertaken a large-scale initiative to recast its own
specific applications and, in doing so, often influence the sale of IBM hardware, middleware integrated supply chain as an on demand business operation, turning what had previously
and services. been an expense to be managed into a strategic advantage for the company and, ultimately,
improved delivery and outcomes for its clients. IBM spends approximately $41 billion
Global/major systems integrators (SIs). SIs identify business problems and design solutions
annually through its supply chain, procuring materials and services around the world. The
when Global Services is not the preferred systems integrator; they also sell computing
company’s supply, manufacturing and distribution operations are integrated in one oper-
infrastructures from IBM and its competitors.
ating unit that has reduced inventories, improved response to marketplace opportunities
Regional ISVs and SIs. SIs identify the business problems, and ISVs deliver business process
and external risks and converted fixed to variable costs. Simplifying and streamlining
or industry-specific applications to medium-sized and large businesses requiring IBM
internal operations has improved sales force productivity and processes and thereby the
computing infrastructure offerings.
experiences of the company’s clients when working with IBM. Because some of the cost
Solutions providers, resellers and distributors. Resellers sell IBM platforms and value-added savings this unit generates are passed along to clients, they will not always result in a visible
services as part of a discrete technology platform decision to clients wanting third- gross margin improvement in the company’s Consolidated Statement of Earnings. While
party assistance. these efforts are largely concerned with product manufacturing and delivery, IBM is
also applying supply chain principles to service delivery across its solutions and services
Research, Development and Intellectual Property
lines of business. To accomplish this, IBM is creating a new labor resource management
IBM’s research and development (R&D) operations differentiate IBM from its competitors. IBM
system — based on a uniform taxonomy of skills — that will enable the organization to more
annually spends approximately $5 – 6 billion for R&D, including capitalized software costs,
efficiently match its labor resources to the needs of IBM clients, deploy the right expertise
focusing its investments in high-growth opportunities. As a result of innovations in these
quickly, and create a better short-term and long-term balance of labor supply and
and other areas, IBM was once again awarded more U.S. patents in 2004 than any other
demand by comparing the demands of the market against the database of available skills.
company. This marks the 12th year in a row that IBM achieved this distinction.
In addition to its own manufacturing operations, the company uses a number of con-
In addition to producing world-class hardware and software products, IBM innovations
tract manufacturing (CM) companies around the world to manufacture IBM-designed
are a major differentiator in providing solutions for the company’s clients through its
products. The use of CM companies is intended to generate cost efficiencies and reduce
growing services activities. The company’s investments in R&D also result in intellectual
time-to-market for certain IBM products. Some of the company’s relationships with CM
property (IP) income. Some of IBM’s technological breakthroughs are used exclusively in
companies are exclusive. The company has key relationships with Sanmina-SCI for the
IBM products, while others are used by the company’s licensees for their products when
manufacture of some Intel-based products and with Solectron for a significant portion of
that new technology is not strategic to IBM’s business goals. A third group is both used
the manufacturing operations of Global Asset Recovery Services — an operation of Global
internally and licensed externally.
16 Financing that restores end-of-lease personal computers and other IT equipment for resale.
key business drivers client’s internal systems, applications and processes remains a monumental and expensive
The following are some of the key drivers of the company’s business. task. The broad-based acceptance of open standards — rather than closed, proprietary
architectures — also allows the computing infrastructure to more easily absorb (and thus
Economic Environment and Corporate IT Spending Budgets
benefit from) new technical innovations. IBM is committed to fostering open standards
If overall demand for hardware, software and services changes, whether due to general
because they are vital to the On Demand Operating Environment, and because their
economic conditions or a shift in corporate buying patterns, sales performance could be
acceptance will expand growth opportunities across the entire business services and IT
impacted. IBM’s diverse portfolio of products and offerings is designed to gain market
industry. There are a number of competitors in the IT industry with significant resources
share in strong and weak economic climates. The company accomplishes this by not only
and investments who are committed to closed and proprietary platforms as a way to lock
having a mix of offerings with long-term cash and income streams as well as cyclical trans-
customers into a particular architecture. This competition will result in increased pricing
action-based sales, but also by continually developing competitive products and solutions
pressure and/or IP claims and proceedings. IBM’s support of open standards is evidenced
and effectively managing a skilled resource base. IBM continues to transform itself to take
by the enabling of its products to support open standards such as Linux, and the develop-
advantage of shifting demand trends, focusing on client or industry-specific solutions,
ment of Rational software development tools, which can be used to develop and upgrade
business performance and open standards.
any other company’s software products.
Internal Business Transformation and Efficiency Initiatives
Emerging Business Opportunities
IBM continues to drive greater productivity and cost savings as it transforms itself into an
The company is continuing to refocus its business on the higher value segments of enter-
on demand enterprise. This includes the internal supply chain initiatives discussed above,
prise computing — providing technology and transformation services to clients’ businesses.
as well as driving collaboration across the IBM enterprise to stimulate innovation and drive
Consistent with that focus, the company continues to significantly invest in Emerging
growth. Transformation efforts are improving the company’s management of its costs
Business Opportunities, as a way to drive revenue growth and market share gain. Areas of
worldwide: rebalancing of skills, optimizing its workforce to drive growth, keeping the com-
investment include strategic acquisitions, primarily in software and services, information-
pany’s compensation programs competitive, and creating a cost-efficient and cutting-edge
based medicine, on demand retail, sensor and actuator solutions, Business Performance
IT infrastructure to support its transformation. IBM is extending its supply chain initiatives
Transformation Services, key technologies (POWER5 and POWERBlade) and emerging
to labor costs and other internal processes. Continued success in this area will impact the
growth countries such as China, Russia, India and Brazil.
company’s cost structure improvements, as well as the amount of competitive leverage it
can apply by passing savings along to clients.
Innovation Initiatives Year in Review

IBM invests for new and innovative capabilities, products and services. IBM has been moving results of continuing operations
away from commoditized categories of the IT industry and into areas in which it can differ- Revenue
entiate itself through innovation and by leveraging its investments in R&D. Examples (Dollars in millions)
include IBM’s leadership position in the design and fabrication of ASICs; the design of Yr. to Yr.
smaller, faster and energy-efficient semiconductor devices; the design of “grid” comput- Percent
Yr. to Yr. Change
ing networks that allow computers to share processing power; the transformation and Percent Constant
FOR THE YEAR ENDED DECEMBER 31: 2004 2003 Change Currency
integration of business processes; and the company’s efforts to advance open technology
standards and to engage with governments, academia, think tanks and nongovernmental Statement of Earnings
organizations on emerging trends in technology, society and culture. In the highly compet- Revenue Presentation:
itive IT industry, with large diversified competitors as well as smaller and nimble single- Global Services $«46,213 $«42,635 8.4% 3.1%
technology competitors, IBM’s ability to continue its cutting-edge innovation is critical to Hardware 31,154 28,239 10.3 6.5
maintaining and increasing market share. IBM is managing this risk by more closely linking Software 15,094 14,311 5.5 0.6
its R&D organization to industry-specific and client-specific needs, as discussed in Global Financing 2,608 2,826 (7.7) (11.5)
Description of Business — IBM Worldwide Organizations. Enterprise Investments/Other 1,224 1,120 9.3 5.2
Open Standards Total $«96,293 $«89,131 8.0% 3.4%
The broad adoption of open standards is essential to the computing model for an on
demand business and is a significant driver of collaborative innovation across all industries.
Without interoperability among all manner of computing platforms, the integration of any
17
(Dollars in millions) Revenue across all geographies increased in 2004 when compared to 2003. In the
Yr. to Yr. Americas, U.S. (6 percent) and Canada (9 percent) revenue grew as did Latin America
Percent
Yr. to Yr. Change
(12 percent), notably Brazil, which grew at 15 percent.
Percent Constant Within Europe/Middle East /Africa, Eastern Europe, the Nordic countries, Spain (7 per-
FOR THE YEAR ENDED DECEMBER 31: 2004 2003* Change Currency
cent) and France (3 percent) had revenue growth, while the U.K. (2 percent), Germany
Industry Sector: (3 percent) and Italy (8 percent) declined after adjusting for currency. Asia Pacific had
Financial Services $«24,339 $«22,274 9.3% 4.0% strong growth in 2004, led by China, which grew at 25 percent, and the ASEAN region
Public 14,758 13,917 6.0 2.0 (17 percent), while Japan, which is about 60 percent of Asia Pacific’s revenue, also had
Industrial 12,582 11,850 6.2 1.1 growth of 5 percent. Collectively, as a result of the company’s targeted investments, the
Distribution 8,767 8,157 7.5 3.1 emerging countries of China, Russia (75 percent), India (45 percent) and Brazil had revenue
Communications 8,859 8,026 10.4 6.0 growth over 25 percent in 2004 to over $4.0 billion in revenue.
Small & Medium 21,162 19,537 8.3 3.2 OEM revenue increased in 2004 versus 2003 due primarily to continued strong
OEM 2,885 2,634 9.6 9.3 growth in the company’s Engineering & Technology Services business and improved
Other 2,941 2,736 7.5 3.1 operational performance in the Microelectronics business.
Total $«96,293 $«89,131 8.0% 3.4% The increase in Global Services revenue was driven by SO as it continued its steady
growth. BCS and ITS revenue also increased. Maintenance revenue increased due to the
* Reclassified to conform with 2004 presentation.
favorable impact of currency movements.
In addition, significant progress was made in the company’s relatively new BPTS offer-
(Dollars in millions)
ings (see page 14) where revenue grew approximately 45 percent.
Yr. to Yr.
Percent
In Hardware, Systems and Technology Group, revenue increased as zSeries servers,
Yr. to Yr. Change xSeries servers, pSeries servers and Engineering & Technology Services increased. zSeries’
Percent Constant
FOR THE YEAR ENDED DECEMBER 31: 2004 2003 Change Currency strong performance resulted from clients adding new workload to the mainframe as they
build their on demand infrastructures. xSeries had strong growth, driven by its leadership
Geographies:
in Blades. pSeries server revenue increased as the company’s POWER5 technology was
Americas $«40,064 $«38,078 5.2% 4.5%
well received by customers in 2004. Demand for the company’s Engineering & Technology
Europe/Middle East/Africa 32,068 29,102 10.2 0.8
services continued to be strong. Storage Systems revenue increased due to greater
Asia Pacific 21,276 19,317 10.1 4.2
demand for external midrange disk and tape products, offset by decreases in high-end
OEM 2,885 2,634 9.6 9.3
disk products. Microelectronics revenue increased due primarily to improved yields and
Total $«96,293 $«89,131 8.0% 3.4% increased output in the 300 millimeter factory. iSeries server revenue declined as the
transition to POWER5 technology is taking longer than previous cycles.
Revenue from all industry sectors increased in 2004 when compared to 2003, reflecting Personal Systems Group revenue increased in 2004, driven by strong performance
the company’s broad capabilities and industry-specific solutions which combine technol- worldwide by the company’s ThinkPad mobile computers. Retail Store Solutions also
ogy and high value services to solve a client’s business or IT problems. These solutions also delivered strong revenue growth in 2004 due to continued demand for its products as
provide for a longer-term relationship with the client, rather than a transaction-oriented well as the acquisition of Productivity Solutions Inc. in November 2003.
sale. The Financial Services sector revenue growth was led by financial markets (15 per- Software revenue increased due to improved demand for Data Management products,
cent), banking (9 percent) and insurance (8 percent). The Communications sector had Tivoli software products, the WebSphere family of products and Rational products.
strong revenue growth in Telecommunications (15 percent), while the Distribution sector Operating Systems revenue increased slightly primarily due to favorable currency translation.
was led by the retail industry (12 percent). The Small & Medium business sector increased The decline in Global Financing revenue in 2004 versus 2003 was primarily driven by
as the company continued to roll out new products under the Express label that are lower used equipment sales. See pages 35 to 39 for additional information regarding
designed and priced specifically for customers in the 100 to 1,000 employee segment. Global Financing results.
18
The following table presents each segment’s revenue as a percentage of the com- Expense
pany’s total: (Dollars in millions)
Yr. to Yr.
FOR THE YEAR ENDED DECEMBER 31: 2004 2003 FOR THE YEAR ENDED DECEMBER 31: 2004 2003 Change
Global Services 48.0% 47.8% Total expense and other income $«24,004 $«22,144 8.4%
Hardware 32.3 31.7 Expense to Revenue (E/R) 24.9% 24.8% 0.1 pts.
Software 15.7 16.1
Global Financing 2.7 3.2 Total expense and other income increased 8.4 percent (5.4 percent adjusting for currency)
Enterprise Investments/Other 1.3 1.2 in 2004 versus 2003. The increase was primarily due to higher retirement-related plan
Total 100.0% 100.0% costs, Research, development and engineering expense and the effect of currency trans-
lation on expense. For additional information regarding the increase in Total expense and
See segment discussion on pages 21 to 23 for further details on year-to-year revenue other income, see the following analyses by category:
changes by brand. Selling, General and Administrative (SG&A)
Gross Profit
Yr. to Yr.
Yr. to Yr. FOR THE YEAR ENDED DECEMBER 31: 2004 2003* Change
Selling, general and administrative expense:
Gross Profit Margin:
Selling, general and administrative — base $«17,584 $«15,787 11.4%
Global Services 25.1% 25.2% (0.1) pts.
Advertising and promotional expense 1,335 1,406 (5.1)
Hardware 29.6 27.8 1.8
Workforce reductions — ongoing 332 454 (26.9)
Software 87.3 86.5 0.8
Bad debt expense 133 205 (35.3)
Global Financing 60.0 55.8 4.2
Enterprise Investments/Other 40.3 43.4 (3.1) Total $«19,384 $«17,852 8.6%
Total 37.4% 37.0% 0.4 pts. * Reclassified to conform with 2004 presentation.
The modest decline in Global Services gross profit margin was due to continued invest- Total SG&A expense increased 8.6 percent (5.1 percent adjusting for currency). The
ment in on demand infrastructure and business transformation capabilities, and less increase was primarily driven by increased expense for retirement-related plan costs of
contribution from the higher margin Maintenance business. approximately $515 million, which included a one-time charge of $320 million related to
The increase in Hardware margins was primarily due to yield improvements in the the partial settlement of certain legal claims against the company’s PPP (see pages 20 and
Microelectronics business and margin improvements in zSeries servers, xSeries servers, 21 for further information on retirement-related benefits), unfavorable currency translation
storage products and personal computers, as well as the impact of certain hedging trans- of $626 million, and provisions for certain litigation-related expenses of $125 million in
actions (see “Anticipated Royalties and Cost Transactions” on page 66). 2004. These increases were partially offset by lower workforce reductions and lower
The Software margin increased due to growth in software revenue, as well as produc- Advertising and promotional expense. The amount of Workforce reductions — ongoing will
tivity improvements in the company’s support and distribution models. vary from year to year depending upon the required skills, competitive environment and
The increase in the Global Financing margin was primarily driven by a mix change economic conditions. In addition, Bad debt expense declined primarily due to lower reserve
towards higher margin financing revenue and away from lower margin used equipment requirements associated with the improvement in economic conditions and improved
sales and improved margins from financing revenue. credit quality, as well as the lower asset base of the Global Financing receivables portfolio
The cost savings generated by the company’s supply chain initiatives also contributed (see page 37).
to the company’s overall margin improvement, but as discussed on page 16, the company
has passed a portion of the savings to clients to improve competitive leadership and gain
market share in key industry sectors. In addition, an increase in retirement-related plan
costs of approximately $490 million compared to 2003 impacted overall segment margins.
See segment discussion on pages 21 to 23 for further details on gross profit.
19
OT H E R ( I N CO M E ) A N D E X P E N S E I N T E L L E CT UA L P R O P E RTY A N D C U STO M D E V E LO P M E N T I N CO M E
(Dollars in millions) (Dollars in millions)
Yr. to Yr. Yr. to Yr.

FOR THE YEAR ENDED DECEMBER 31: 2004 2003 Change FOR THE YEAR ENDED DECEMBER 31: 2004 2003 Change
Other (income) and expense: Intellectual property and custom

Foreign currency transaction losses $«381 $«411 (7.5) % development income:
Interest income (180) (152) 18.9 Sales and other transfers of intellectual property $÷÷466 $««««562 (17.1) %
Net realized gains on sales of securities and Licensing/royalty-based fees 393 338 16.3
other investments (59) (54) 9.0 Custom development income 310 268 15.7
Writedowns of impaired investment assets 20 50 (59.6) Total $«1,169 $«1,168 0.2%
Net realized (gains)/losses from certain
real estate activities (71) 16 NM
Intellectual property and custom development income was flat in 2004 versus 2003. The
2002 actions* 42 2 NM
timing and amount of Sales and other transfers of IP may vary significantly from period to
Other (156) (35) NM
period depending upon the timing of divestitures, industry consolidation, economic con-
Total $««(23) $«238 NM
ditions and the timing of new patents and know-how development.
* See note s, “2002 Actions” on pages 73 through 76.
I N T E R E ST E X P E N S E
NM — Not Meaningful
Yr. to Yr.
Other (income) and expense was income of $23 million in 2004 versus expense of $238 mil- FOR THE YEAR ENDED DECEMBER 31: 2004 2003 Change
lion in 2003. The improvement was primarily driven by increased gains from various asset
Interest expense:
sales including certain real estate transactions in 2004 versus 2003, additional Interest
Total $«139 $«145 (4.6) %
income generated by the company in 2004 and other nonrecurring gains/settlements
increasing in 2004 when compared to 2003. The Foreign currency transaction losses relate
primarily to losses on certain hedge contracts offset by gains on the settlement of foreign Interest expense is presented in Cost of Global Financing in the Consolidated Statement
currency receivables and payables. See pages 33 and 34 for additional discussion of of Earnings only if the related external borrowings are to support the Global Financing
currency impacts on the company’s financial results. external business. See page 38 for additional information regarding Global Financing
debt and interest expense.
R E S E A R C H , D E V E LO P M E N T A N D E N G I N E E R I N G
(Dollars in millions) Retirement-Related Benefits
Yr. to Yr.
The following table provides the total pre-tax cost for all retirement-related plans. Cost
FOR THE YEAR ENDED DECEMBER 31: 2004 2003 Change amounts are included as an addition to the company’s cost and expense amounts in the
Research, development and engineering: Consolidated Statement of Earnings within the caption (e.g., Cost, SG&A, RD&E) relating to
Total $«5,673 $«5,077 11.7%
the job function of the individuals participating in the plans.
The increase in Research, development and engineering (RD&E) expense in 2004 versus Yr. to Yr.
2003 was primarily the result of increased spending in middleware software including new
acquisitions (approximately $240 million). In addition, RD&E expense increased due to Retirement-related plans cost:
spending related to the POWER5 technology initiatives (approximately $140 million), Defined benefit and contribution pension
increased spending on new storage products (approximately $50 million), and higher plans cost $«1,072 $«««27 NM
retirement-related plan costs (approximately $77 million). Nonpension postretirement benefits costs 372 335 11.0%
Total $«1,444 $«362 NM
20
Overall, retirement-related plan costs increased $1,082 million versus 2003. On Global Services
December 31, 2003, the company lowered its PPP discount rate from 6.75 percent to (Dollars in millions)
6.0 percent which increased pre-tax cost and expense by almost $200 million in 2004. In Yr. to Yr.
addition, the 2004 results include a charge of $320 million due to the partial settlement of FOR THE YEAR ENDED DECEMBER 31: 2004 2003 Change
certain legal claims against the company’s PPP. The 2004 results were also affected by Global Services Revenue: $«46,213 $«42,635 8.4%
changes in the market value of plan assets as well as similar trends in the company’s other Strategic Outsourcing $«19,309 $«17,124 12.8%
defined benefits pension plans that contributed to the increase in costs. See note w, Business Consulting Services 13,767 12,955 6.3
“Retirement-Related Benefits” on pages 78 through 86 for additional information. The Integrated Technology Services 7,441 7,099 4.8
year-to-year increase impacted gross margin, SG&A and RD&E by approximately $490 mil- Maintenance 5,696 5,457 4.4
lion, $515 million and $77 million, respectively.
Provision for Income Taxes Global Services revenue increased 8.4 percent (3.1 percent adjusted for currency). SO
The provision for income taxes resulted in an effective tax rate of 29.8 percent for 2004, continued to demonstrate its competitive advantage in delivering on demand solutions by
compared with the 2003 effective tax rate of 30.0 percent. The 0.2 point decrease in the leveraging its business transformational skills and its scale during 2004. Each geography
effective tax rate in 2004 was primarily due to the tax effect of the settlement of certain continued year-to-year growth, with seven consecutive quarters of double-digit growth in
pension claims in the third quarter of 2004. Europe/Middle East /Africa, excluding currency benefits. Within SO, e-business Hosting
Services, an offering that provides Web infrastructure and application management as
Weighted-Average Common Shares
an Internet based service, continued its pattern of revenue growth. ITS revenue, which
Yr. to Yr. excludes Maintenance, increased driven by growth in Business Continuity and Recovery
Services of 29 percent, partially offset by the revenue reduction for sales of third-party
Earnings per share from continuing operations: hardware in Japan. (See page 12, “Subsequent Event” for additional information.) BCS
Assuming dilution $«««««4.94 $«««««4.34 13.8% revenue increased driven by strong growth in BTO. BCS continued to improve its revenue
Basic 5.04 4.42 14.0 growth rate at constant currency in every quarter of the year. Maintenance revenue
Weighted-average shares outstanding (in millions): increased primarily driven by favorable impacts of currency movements.
Assuming dilution 1,708.9 1,756.1 (2.7) %
Basic 1,675.0 1,721.6 (2.7) (Dollars in millions)
Yr. to Yr.
The average number of common shares outstanding assuming dilution was lower by 47.2 mil-
Global Services:
lion shares in 2004 versus 2003. The decrease was primarily the result of the company’s
Gross profit $«11,576 $«10,732 7.9%
common share repurchase program. See note n, “Stockholders’ Equity Activity,” on page
Gross profit margin 25.1% 25.2% (0.1) pts.
69 for additional information regarding the common share activities. Also see note t,
“Earnings Per Share of Common Stock,” on page 77.
The Global Services gross profit dollars increased primarily due to the corresponding
segment details increase in revenue. The gross profit margin declined due to investment in on demand infra-
The following is an analysis of the 2004 versus 2003 external segment results. The analysis structure and business transformation capabilities, as well as a lower mix of Maintenance
of 2003 versus 2002 external segment results is on pages 26 to 28. revenue (12 percent in 2004 versus 13 percent in 2003), which has a higher gross profit
margin than the other categories of Global Services revenue. These declines were partially
offset by improved profitability in BCS driven by improved utilization, reduced overhead
structure and an improved labor mix.
21
Hardware Storage Systems revenue increased slightly due to increased demand for external
(Dollars in millions) midrange disk (13 percent) and tape products (9 percent). These increases were partially
Yr. to Yr. offset by decreases in high-end disk products (18 percent) as clients anticipated the ship-
FOR THE YEAR ENDED DECEMBER 31: 2004 2003 Change ment of the company’s new POWER5 high-end storage product which will ship in the first
Hardware Revenue: $«30,710 $«27,856 10.2% quarter of 2005. Engineering & Technology Services had strong revenue growth due to
Systems and Technology Group $«17,916 $«16,469 8.8%
increased design and technical services contracts and Microelectronics revenue increased
zSeries 14.9
modestly as yields in the 300 millimeter plant improved.
iSeries (17.2)
Personal Systems Group revenue increased 12.4 percent (8.3 percent adjusting for
pSeries 7.3
currency). The increase was driven by strong performance worldwide by the company’s
xSeries 22.8
ThinkPad mobile computer (22 percent). Desktop personal computer revenue increased
Storage Systems 1.6
(4 percent) in 2004 when compared to 2003 due primarily to favorable currency move-
Microelectronics 0.6
ments. Retail Store Solutions revenue increased due to strong demand for the company’s
Engineering & Technology Services 93.4
products and the acquisition of Productivity Solutions Inc. in November 2003. This acqui-
Personal Systems Group 12,794 11,387 12.4
sition drove 6.9 points of the unit’s revenue growth in 2004. Printer Systems maintenance
Personal Computers 14.4
revenue declined due to lower annuity-based revenue on a declining installed base.
Retail Store Solutions 17.6 (Dollars in millions)
Printer Systems (7.6)
Yr. to Yr.
Systems and Technology Group revenue increased 8.8 percent (5.2 percent adjusting for Hardware:
currency). zSeries revenue increased due to clients continuing to add new workloads on the Gross profit $«9,552 $«8,461 12.9%
zSeries platform as they build their on demand infrastructures, as well as taking advantage Gross profit margin 31.1% 30.4% 0.7 pts.
of the capabilities of the z990 server for consolidation. Mainframes remain the platform of
choice for hosting mission-critical transactions as well as for consolidation and infrastruc-
Hardware gross profit dollars and gross profit margin increased in 2004 versus 2003. The
ture simplification. The total delivery of zSeries computing power as measured in MIPS
increase in gross profit dollars was primarily driven by the increase in Hardware revenue.
(millions of instructions per second) increased 33 percent in 2004 versus 2003, offsetting
The increase in the overall hardware margin was driven by several factors. Improved yields
price declines of 23 percent per MIPS. xSeries server revenue increased (24 percent) due
and lower unit costs in the Microelectronics business contributed 0.8 points of the increase.
to strong growth in both high-end and 1 & 2 Way Servers. xSeries-related BladeCenter
In addition, margin improvements in zSeries, xSeries and Storage Systems contributed 0.5
revenue had strong growth, up over 150 percent, as the company is leading and shaping
points, 0.2 points and 0.1 point, respectively, to the overall margin improvement. These
the blade market. In the fourth quarter of 2004, the company saw strong demand for
improvements were partially offset by lower margins in iSeries, pSeries, Retail Store
the new POWERBlade, which can run Windows, Linux and AIX on different servers in the
Solutions and Printer Systems, which impacted the overall margin by 0.8 points, 0.3 points,
BladeCenter. pSeries server revenue increased reflecting clients very strong acceptance of
0.1 point and 0.1 point, respectively.
the POWER5 systems. The new pSeries high-end system started shipping in November
Differences between the hardware segment gross profit margin and gross profit dollar
2004, marking the completion of a top to bottom refresh of the pSeries server product line
amounts above and the amounts reported on page 19 (and derived from page 40) prima-
in just three months. iSeries server revenue declined driven by lower sales as the transition
rily relate to the impact of certain hedging transactions (see “Anticipated Royalties and
to POWER5 is taking longer than in previous cycles, as customers must transition their
Cost Transactions” on page 66). The recorded amounts for such impact are considered
operating environment to the new level.
unallocated corporate amounts for purposes of measuring the segment’s gross margin
performance and therefore are not included in the segment results above.
22
Software The increase in the Software gross profit dollars and gross profit margin was primarily
(Dollars in millions) driven by growth in software revenue due to favorable currency movements, as well as
Yr. to Yr. productivity improvements in the company’s support and distribution models.
FOR THE YEAR ENDED DECEMBER 31: 2004 2003* Change
Global Financing
Software Revenue: $«15,094 $«14,311 5.5%
See pages 35 and 36 for a discussion of Global Financing’s revenue and gross profit.
Middleware $«11,963 $«11,240 6.4%
WebSphere family 14.2 Enterprise Investments
Data Management 6.6 Revenue from Enterprise Investments increased 10.8 percent (4.2 percent adjusted for
Lotus 2.7 currency). Revenue for product life-cycle management software increased primarily in the
Tivoli 15.0 automotive and aerospace industries, partially offset by lower hardware revenue (48 per-
Rational 15.5 cent), primarily for document processors. Gross profit dollars increased 12.4 percent and
Other middleware 1.8 gross profit margins increased 0.6 points to 44.2 percent in 2004 versus 2003. The increase
Operating systems 2,474 2,452 0.9 in gross profit dollars was primarily driven by the increase in revenue. The gross profit
Other 657 619 6.1 margin increase was primarily driven by higher life-cycle management software margins
driving 0.8 points of the increase, partially offset by lower margins on document processors
* Reclassified to conform with 2004 presentation. due to discounting, which impacted the overall margin by 0.2 points.
Software revenue increased 5.5 percent (0.6 percent adjusted for currency). Middleware financial position
revenue increased 6.4 percent (1.5 percent adjusted for currency). The WebSphere family Dynamics
of software offerings revenue increased 14 percent with growth in business integration The assets and debt associated with the company’s Global Financing business are a sig-
software (14 percent), WebSphere Portal software (12 percent) and application servers nificant part of the company’s financial condition. Accordingly, although the financial
(20 percent). Data Management revenue increased 7 percent with growth of 12 percent in position amounts appearing below and on pages 24 and 25 are the company’s consolidated
DB2 Database software on both the host (13 percent) and distributed platforms (11 per- amounts including Global Financing, to the extent the Global Financing business is a major
cent), DB2 Tools (8 percent), and distributed enterprise content management software driver of the consolidated financial position, reference in the narrative section will be made
(23 percent). Rational software revenue increased (15 percent) with growth across all prod- to the separate Global Financing section in this Management Discussion on pages 35 to
uct areas. Tivoli software revenue increased (15 percent), aided by the Candle acquisition, 39. The amounts appearing in the separate Global Financing section are supplementary
which was completed in the second quarter of 2004. Tivoli systems management, storage data presented to facilitate an understanding of the company’s Global Financing business.
and security software all had revenue growth in 2004 versus 2003. Lotus software revenue
Working Capital
increased 3 percent and Other Foundation middleware products revenue also increased
2 percent due to favorable currency movements.
AT DECEMBER 31: 2004 2003*
Operating system software increased due to growth in xSeries and pSeries, which cor-
relates to the increases in the related server brands. zSeries operating system revenue Current assets $«46,970 $«44,662
declined 1 percent despite the growth in related hardware volumes due to ongoing soft- Current liabilities 39,798 37,623
ware price performance delivered to enterprise clients. iSeries operating system software Working capital $«««7,172 $«««7,039
declined 6 percent in line with related hardware volumes. Overall, operating systems
Current ratio 1.18:1 1.19:1
software revenue increased primarily as a result of favorable currency movements.
Yr. to Yr.
Current assets increased $2,308 million driven by an increase of $2,923 million in Cash
and cash equivalents and Marketable securities. Also, Inventories increased $374 million
Software:
primarily driven by new product transitions and increased capacity in the 300 millimeter
Gross profit $«13,175 $«12,384 6.4%
semiconductor fab. These increases were partially offset by an overall decrease in the
Gross profit margin 87.3% 86.5% 0.8 pts.
company’s current receivables of $787 million. The current receivables net decrease was
23
a combination of several factors: a decline of $1,782 million in Short-term financing The decrease in cash used in financing activities of $179 million was attributable to
receivables as collections exceeded new originations; an increase in Other accounts less net debt payments of $2,454 million, partially offset by higher net payments for
receivable of $499 million as a long-term receivable related to the sale of the HDD business common stock activity of $2,186 million, and higher dividend payments of $89 million.
is now reflected as current; and an increase in Notes and accounts receivable — trade of Within debt, on a net basis, $1,027 million of cash was used to pay off debt in 2004 versus
$496 million as a result of favorable currency movements. $3,481 million in 2003. The net cash payments of $1,027 million in 2004 were made up
Current liabilities increased $2,175 million primarily due to a $1,453 million increase of $4,538 million of cash payments to settle debt, partially offset by $2,438 million of
in Short-term debt, a $984 million increase in Accounts payable, and a $683 million proceeds from new debt and $1,073 million from an increase in short-term borrowings.
increase in Deferred income driven by Global Services business growth in 2004. These The higher payments for common stock were driven by increases of approximately
increases were partially offset by a decrease of $747 million in Taxes payable primarily due $2,802 million in cash payments to repurchase stock which was partially offset by increases
to the Internal Revenue Service (IRS) settlement described in note p, “Taxes” on page 73, of $616 million in cash received for stock issued associated with the company’s stock
and $331 million in Other accrued expenses and liabilities primarily due to decreases of option plan and employee stock purchase plan.
approximately $160 million in restructuring accruals.
Non-current Assets and Liabilities
Cash Flow (Dollars in millions)
The company’s cash flows from operating, investing and financing activities, as reflected in Yr. to Yr.
DECEMBER 31: 2004 2003* Change
the Consolidated Statement of Cash Flows on pages 44 and 45, are summarized in the
table below. These amounts include the cash flows associated with the company’s Global Non-current assets $«62,213 $«59,795 4.0%
Financing business. See pages 35 to 39. Long-term debt 14,828 16,986 (12.7)
Non-current liabilities (excluding debt) 24,810 21,984 12.9
FOR THE YEAR ENDED DECEMBER 31: 2004 2003 * Reclassified to conform with 2004 presentation.
Net cash provided by/(used in) continuing operations:

Operating activities $«15,406 $«14,569
The increase in Non-current assets of $2,418 million was driven by several factors: an
Investing activities (5,346) (5,122)
increase of $1,968 million in Prepaid pension assets (see note w, “Retirement-Related
Financing activities (7,619) (7,798)
Benefits,” on pages 78 through 86); an increase of $1,516 million in Goodwill, driven by
Effect of exchange rate changes on cash and cash equivalents 405 421
acquisitions; and an increase of $486 million in Plant, rental machines and other property —
Net cash used in discontinued operations* (83) (162)
net, driven by currency. These increases were partially offset by a decrease of $1,826 mil-
lion in Investments and sundry assets due to a decrease of $1,264 million in deferred tax
Net change in cash and cash equivalents $«««2,763 $«««1,908
assets primarily due to the IRS settlement (see note p, “Taxes” on page 73) and $647 million
* Does not include approximately $97 million in 2003 of net proceeds from the sale of the HDD business. Such proceeds in non-current derivatives due primarily to the reclassification of derivative instruments.
are included in Net cash provided by Investing activities in the table above. Long-term debt declined $2,158 million primarily due to the transfer of long-term
bonds to short-term debt as these items approach maturity.
Net cash provided from operating activities for the year ended December 31, 2004 Other non-current liabilities increased $2,826 million primarily due to a $1,632 million
increased $837 million as compared to 2003. This increase was driven primarily by increase in Retirement and nonpension postretirement benefit obligations, a $380 million
increased income from continuing operations ($835 million), the cash generated by the increase in Deferred income, a $317 million increase in Derivative liabilities and a $138
change in Global Financing receivables ($582 million) and lower restructuring payments million increase in warranty accruals. The increase in the Retirement and nonpension
($462 million). These increases were partially offset by additional pension funding world- postretirement benefit obligations was primarily attributable to the required accounting
wide in 2004 of $1.2 billion. for the unfunded status of the non-U.S. pension plans as described on page 83, as well as
Net investing activities increased by $224 million on a year-to-year basis. Net capital pension costs and approximately $544 million due to foreign currencies. The increase in
spending decreased $190 million on a year-to-year basis. The primary drivers to the reduc- Deferred income was driven by Global Services resulting from new contracts with long-
tion in net capital spending were increased cash from equipment sales of $272 million term components. The increase in Derivative liabilities was primarily attributable to the
reflecting the cash investments of the company’s Microelectronics business strategic impact of foreign currencies in combination with extending beyond one year the hedging
partners, as well as a $25 million decrease in the company’s internal spending on plant, of anticipated royalties and cost transactions during 2004 (see note l, “Derivatives and
rental machines and other property. This cash savings was partially offset by an increase of Hedging Transactions” on pages 65 to 67). The increase in warranty accruals was primarily
$107 million in capitalized software development. related to personal computers resulting from increased volumes.
24
Debt consolidated fourth quarter results

The company’s funding requirements are continually monitored and strategies are executed (Dollars and shares in millions except per share amounts)
to manage the company’s overall asset and liability profile. Additionally, the company Yr. to Yr.
maintains sufficient flexibility to access global funding sources as needed. FOR FOURTH QUARTER: 2004 2003 Change
(Dollars in millions) Revenue $«27,671 $«25,913 6.8% *
AT DECEMBER 31: 2004 2003

Gross profit margin 39.2% 38.4% 0.8 pts.
Total expense and other income $«««6,488 $«««6,097 6.4%
Total company debt $«22,927 $«23,632
Total expense and other income-to-revenue ratio 23.4% 23.5% (0.1) pts.
Non-Global Financing debt * ««««««607 «««368
Provision for income taxes $«««1,309 $«««1,162 12.7%
Non-Global Financing debt/capitalization 2.2% 1.5%
Income from continuing operations $«««3,055 $«««2,716 12.5%
* Non-Global Financing debt is the company’s total external debt less the Global Financing debt described in the Global Earnings per share from continuing operations:
Financing balance sheet on page 36. Assuming dilution $÷÷«1.81 $«««««1.56 16.0%
Basic $÷÷«1.84 $÷÷«1.59 15.7%
Non-Global Financing debt increased $239 million and the debt-to-capital ratio at
December 31, 2004 was well within acceptable levels at 2.2 percent.
Assuming dilution 1,691.6 1,745.7 (3.1) %
Equity Basic 1,659.0 1,708.5 (2.9) %
* 2.7 percent increase adjusting for currency
Yr. to Yr.
AT DECEMBER 31: 2004 2003 Change
Continuing Operations
Stockholders’ equity: The increase in the company’s fourth quarter 2004 Income from continuing operations and
Total $«29,747 $«27,864 6.8% diluted earnings per share from continuing operations as compared to the fourth quarter
of 2003 was due to:
The company’s total consolidated Stockholders’ equity increased $1,883 million during • The increased demand for the company’s offerings associated with moderate
2004 primarily due to an increase in the company’s retained earnings driven by net expansion of the economy, as well as the company’s continued market share gains
income, partially offset by the company’s ongoing stock repurchase program and higher
• Favorable impact of currency translation partly offset by related hedging activity
dividend payments.
The following is an analysis of the external segment results.
Off-Balance Sheet Arrangements
The company, in the ordinary course of business, entered into off-balance sheet arrange- Global Services revenue increased 10.1 percent (5.7 percent adjusting for currency). SO
ments as defined by the Securities and Exchange Commission (SEC) Financial Reporting revenue increased 12 percent as each geography had year-to-year revenue growth. ITS
Release 67 (FRR-67), “Disclosure in Management’s Discussion and Analysis about Off- revenue increased 8 percent helped by continued growth in Business Continuity and
Balance Sheet Arrangements and Aggregate Contractual Obligations,” including: certain Recovery Services. BCS revenue increased 12 percent year-to-year, with double-digit
guarantees, indemnifications and retained interests in assets transferred to an unconsoli- growth in both the Americas and Asia Pacific and high single-digit growth in EMEA.
dated entity for securitization purposes. The company achieved Global Services signings of $12.7 billion, including 13 signings
None of these off-balance sheet arrangements either has, or is reasonably likely to over $100 million.
have, a material current or future effect on financial condition, changes in financial condi- The company’s Systems & Technology Group revenue grew 4.9 percent (1.3 percent
tion, revenues or expenses, results of operations, liquidity, capital expenditures or capital adjusting for currency). xSeries server revenue increased 25 percent year-to-year driven by
resources. See page 31 for the company’s contractual obligations. solid performance in both high-end and 1 & 2 Way servers. The IBM Blade servers continued
See note o, “Contingencies and Commitments,” on page 71, for detailed information their strong growth in the fourth quarter of 2004. pSeries revenue increased 15 percent
about the company’s guarantees on certain loans and financial commitments, indemnifi- year-to-year in the fourth quarter, reflecting very strong client acceptance of the POWER5
cation arrangements and note j, “Sale and Securitization of Receivables” on page 64 for systems technology. OEM grew 10 percent year-to-year in the fourth quarter driven by
detailed information regarding loans receivable securitization program. improved yields in the 300 millimeter line where output grew 40 percent versus the
third quarter and Engineering & Technology Services business revenue grew at 61 per-
cent year-to-year. These increases were partially offset by lower zSeries server revenue of
25
4 percent on MIPS growth of 6 percent in the fourth quarter of 2004. iSeries server revenue Share repurchases totaled approximately $2.9 billion in the fourth quarter. The
declined 9 percent year-to-year, however, strong customer acceptance of the refreshed weighted-average number of diluted common shares outstanding in the quarter was
POWER5 iSeries drove sequential revenue growth. Storage Products revenue declined 1,691.6 million compared with 1,745.7 million in the 2003 fourth quarter, lower by 54.1
11 percent year-to-year. Total Disk products declined 15 percent as the company transi- million shares. The decreased amount of shares was driven primarily by the company’s
tions to new products. ongoing common share repurchase program.
Personal Systems Group revenue increased 1.8 percent (declined 1.7 percent adjusting The company generated slightly lower cash flows from operations in the 2004 fourth
for currency) driven by increased ThinkPad mobile computers. The company experienced quarter as compared to the 2003 fourth quarter primarily due to higher pension funding
some disruption due to the Lenovo agreement, which was announced in the seasonally driven by the $700 million funding of the PPP and approximately $500 million funding of
strongest month of the year. non-U.S. plans. The company also had an increase in acquisitions (primarily the Maersk
Software revenue increased 7.0 percent (2.9 percent adjusting for currency). The Data/DMdata acquisition in the fourth quarter of 2004) compared to the same period of
WebSphere family of software products grew 18 percent for the quarter. Application servers 2003. Finally, the company repurchased $2,932 million in shares during the 2004 fourth
grew 33 percent following the October announcement of a new release that provided quarter compared with $3,069 million in shares repurchased during the 2003 fourth quarter.
improved security and integration of Web Services. Business Integration products grew
17 percent. Rational revenue grew 8 percent in the quarter, with growth across all product
areas. Data Management software grew 8 percent as DB2 database software grew 15 percent, Prior Year in Review
driven by double-digit growth in both host and distributed platforms and distributed enter- (Dollars and shares in millions except per share amounts)
prise content management software grew 31 percent. Tivoli software increased 25 percent,
Yr. to Yr.
as Systems Management software grew 31 percent, storage software increased 19 percent FOR THE YEAR ENDED DECEMBER 31: 2003 2002 Change
and security software increased 9 percent. Lotus software increased 5 percent as Domino
Revenue $«««89,131 $«81,186 9.8% *
products grew 2 percent for the quarter driven by the Notes messaging products. Other
Gross profit margin 37.0% 37.3% (0.3) pts.
Foundation middleware products declined 2 percent for the quarter.
Total expense and other income $÷«22,144 $«22,760 (2.7) %
Global Financing revenue declined 10.4 percent (13.5 percent adjusting for currency)
Total expense and other income-to-revenue ratio 24.8% 28.0% (3.2) pts.
driven primarily by a decline in used equipment sales.
Provision for income taxes $«÷÷3,261 $«««2,190 48.9%
The company’s gross profit margin increased 0.8 percentage points to 39.2 percent.
Income from continuing operations $÷÷«7,613 $«««5,334 42.7%
The Hardware gross profit margin improved 2 percentage points with improving margins
Earnings per share from continuing operations:
in most product areas. Global Financing gross profit margin improved 7.5 percentage
Assuming dilution $÷÷÷«4.34 $«««««3.07 41.4%
points to 59.7 percent primarily driven by improved used equipment sales and financing
Basic $÷÷÷«4.42 $÷÷«3.13 41.2%
margins and an improvement in mix toward higher margin financing revenue. Global
Discontinued operations:
Services and Software gross profit margin improved slightly year-over-year.
Loss $÷÷÷÷««30 $«««1,755 NM
Total expense and other income increased 6.4 percent in the fourth quarter and rev-
Diluted earnings per share $÷÷««(0.02) $««««(1.01) NM
enue increased 6.8 percent resulting in the total expense-to-revenue ratio improvement of
Basic earnings per share $«÷÷«(0.02) $««««(1.03) NM
0.1 point to 23.4 percent. Retirement-related plan expenses increased $150 million year-
to-year and were partially offset by lower workforce rebalancing expense of $75 million.
Assuming dilution 1,756.1 1,730.9 1.5%
RD&E expense increased 8.2 percent or $112 million, driven by increased spending in the
Basic 1,721.6 1,703.2 1.1%
Software and the Systems and Technology Group segments. In addition, the company
Assets** $«104,457 $«96,484 8.3%
recorded a provision for litigation-related expenses of $125 million in SG&A and the
Liabilities** $«÷76,593 $«73,702 3.9%
effects of currency was an addition to expense of approximately $150 million in the fourth
Equity ** $«÷27,864 $«22,782 22.3%
quarter of 2004.
The company’s 2004 fourth quarter effective tax rate was 30.0 percent, the same as 2003. * 2.8 percent at constant currency
** at December 31
26
continuing operations Global Services

The increase in the company’s 2003 Income from continuing operations and diluted Global Services revenue increased 17.3 percent (9.3 percent at constant currency) in 2003
earnings per share from continuing operations as compared to 2002 was due to: versus 2002. SO revenue increased 14.2 percent in 2003 primarily driven by new signings.
• The results of the company’s productivity and efficiency initiatives, including the SO continued to demonstrate its competitive advantage in delivering on demand solutions
benefits from the 2002 Microelectronics and productivity restructuring actions by leveraging its business transformation skills and its scale during 2003. e-business
Hosting Services, an offering that provides Web infrastructure and application manage-
• Stronger demand associated with the improving economy (especially during the
ment as an Internet-based service, continued its strong pattern of revenue growth. BCS
fourth quarter) and continued market share gains
revenue increased 37.5 percent in 2003 due to the acquisition of PwCC in the fourth quarter
• The charges recorded in 2002 for the 2002 actions (See note s, “2002 Actions” on of 2002. ITS revenue increased 3.3 percent due to the favorable impact of currency move-
pages 73 through 76 for additional information.) ments. During 2003, the company changed its reporting for certain OEM hardware sales
• Favorable impact of currency translation, partly offset by related hedging activities to the company’s clients from gross to net revenue treatment based upon a review of the
terms of these sales. The company determined that the agent-like characteristics of
The increase in revenue in 2003 as compared to 2002 was due to: these transactions were more appropriately recorded on a net revenue basis. Due to the
• Stronger demand associated with the improving economy (especially during the amounts involved, the prior year amounts were not adjusted. As a result of this change in
fourth quarter) and continued market share gains 2003, revenue and costs for ITS were lower by $279 million in 2003 as compared to 2002,
• The impact of the fourth quarter 2002 acquisition of PricewaterhouseCoopers’ con- partially offsetting the currency impact discussed above. This change had no impact on
sulting business (PwCC) and the first quarter 2003 acquisition of Rational, partially the company’s gross profit dollars, net income or cash flows. The company signed $55 bil-
offset by decreases in revenue due to Systems and Technology Group divestitures lion of services contracts in 2003, an increase of $2 billion versus 2002. The estimated
services backlog at December 31, 2003, was $120 billion.
• The favorable impact of currency translation, which contributed 7.0 points of the
9.8 percent revenue increase Hardware Segments
Systems and Technology Group revenue increased 1.7 percent (decreased 4.2 percent at
Revenue for all industry sectors increased in 2003 on an as-reported basis, which has
constant currency) in 2003 versus 2002. xSeries server products revenue increased 16.8 per-
been reclassified to conform with the 2004 presentation. The Financial Services sector
cent due to growth in sales of high-volume servers supported by strong growth in blades.
(12.5 percent), Public sector (14.3 percent), and Industrial sector (14.8 percent) were
The pSeries server revenues increased 12.5 percent due to strong demand for the 64-bit
among the strongest, with continued growth (12.5 percent) in the Small & Medium
POWER systems across both the low-end and high-end server offerings. Revenue from the
Business sector. These results reflect the company’s go-to-market strategy of designing
zSeries servers increased 7.4 percent. The total delivery of zSeries computing power as
industry-specific solutions.
measured in MIPS increased more than 28 percent in 2003 as compared to 2002. This
Full-year geographic revenue increased across all geographies. In the Americas
increase was offset by lower average price per MIPS in 2003 of 19 percent versus 2002.
revenue increased 5 percent. U.S. (3 percent) and Canada (13 percent) revenue grew as
Revenue from the iSeries servers increased in all four quarters of 2003 when compared to
did Latin America (6 percent), notably in Brazil (26 percent). In Europe/Middle East/Africa,
2002. Storage Systems revenue increased 9.8 percent due to growth in external disk and
revenue increased 20 percent and was highest in the U.K. (17 percent), Central Europe and
tape products.
Middle East and Africa. In Asia Pacific revenue increased 13 percent, while 2003 revenue
Microelectronics revenue declined 31.6 percent in 2003 versus 2002 driven by actions
for Japan, which is about 60 percent of the region’s revenue, increased 7 percent com-
taken in 2002 to refocus and redirect its business to high-end foundry, ASICs and standard
pared with 2002. Australia/New Zealand (32 percent) also achieved strong performance
products. These actions included the divestiture of multiple non-core businesses. There
within Asia Pacific.
was also sluggish demand from certain OEM clients that contributed to this decline.
While OEM revenue, representing three percent of the company’s revenue, declined,
Personal Systems Group revenue increased 3.1 percent (down 2.5 percent at constant
the decline was smaller than the prior year decline. The year-to-year percent change in
currency) in 2003 versus 2002. Revenue from mobile personal computers increased
revenue (a decline of 21.4 percent) reflects, in large part, the company’s exit from its inter-
(10.9 percent) due to strong demand and was offset by lower desktop personal computer
connect products business in 2002, as well as sluggish demand from certain OEM clients.
revenue (4.0 percent). The decreased desktop revenue primarily reflects the fact that
The following is an analysis of external segment results.
increased volume gains were not enough to offset a reduction in price due to decreasing
commodity costs.
27
Software With regard to Assets, approximately $7 billion of the increase relates to the impact of
Software revenue increased 9.4 percent (1.9 percent at constant currency) in 2003 versus currency translation. The remaining increase primarily consists of an increase in Goodwill
2002, driven by Middleware software products. The WebSphere family of software offer- of $2.8 billion associated with recent acquisitions, increased pension assets of $2.4 billion,
ings revenue increased 11.8 percent as clients continued to focus on the higher function as well as strong cash performance. The increase in cash during 2003 was due to the com-
products that integrate Web-based applications, including advanced collaboration tech- bination of stronger operating results and lower pension funding. The company reduced
nology, on a user’s desktop. The lower-function WebSphere application server continued non-Global Financing debt in 2003 as a result of strong cash flows from operations. Global
to commoditize. Improved demand was also noted for Data Management DB2 database Financing debt also decreased, but the company’s Global Financing debt-to-equity ratio
software. Revenue from Tivoli products increased 12.0 percent as clients continue to real- remained flat at 6.9 to 1 and within the company’s target range.
ize the on demand attributes of Tivoli products, enabling businesses to securely automate The ratio of unguaranteed residual value as a percentage of the related original
many of their processes and gain operational efficiencies. Operating system software amount financed declined 0.3 point to 3.6 percent at December 31, 2003, as compared
revenue increased 6.2 percent due to the favorable impacts of currency movements. to December 31, 2002, due to an increase in the percentage of leases that contain bargain
Offsetting these increases were lower demand for DB2 tools, Lotus advanced collabora- purchase options.
tion software, and Other middleware software. A new Lotus messaging platform became
generally available during the 2003 fourth quarter and helped to drive momentum in the discontinued operations
Lotus Notes family of products towards the end of 2003. Overall, the increase in total On December 31, 2002, the company sold its HDD business to Hitachi for approximately
Software revenue was mainly due to the acquisition of Rational in the first quarter of 2003. $2 billion. The majority of the cash was received with the remaining payment due in
When compared to the separately reported 2002 external revenue amounts for Rational, December 2005. The HDD business was accounted for as a discontinued operation
its revenue increased approximately 6 percent in 2003. whereby the results of operations and cash flows were removed from the company’s results
from continuing operations for all periods presented.
Global Financing The company incurred a loss from discontinued operations of $1,755 million in 2002,
See pages 35 to 39 for prior year review of Global Financing. net of tax. The loss in 2002 was due to (amounts are net-of-tax):
Enterprise Investments • Loss on operational results ($620 million)
Revenue from Enterprise Investments increased 4.2 percent (down 5.1 percent at constant • Loss on sale ($382 million)
currency) in 2003 versus 2002. The decline was attributable to demand for product life-
• Certain actions taken by the company in the second and fourth quarters of 2002
cycle management software in the European market, especially in the automotive and
($508 million) related to the HDD business
aerospace industries.
The company’s gross profit margins remained relatively flat. Increases in margins for • Inventory write-offs resulting from a strategic decision to cease reworking and selling
Hardware of 0.7 point resulting from the ongoing benefits from the company’s integrated efforts for some of the older HDD products after the announcement of the divesti-
supply chain initiatives and Software of 2.1 points resulting from favorable currency trans- ture plans ($245 million)
lation were offset by decreases in Global Services margins of 1.1 points driven primarily
by investment costs on the early stages of an SO contract and the company’s changing mix
of revenue toward BCS. Looking Forward
As discussed above, there were several charges in 2002 that impacted the year-to- The following key drivers impacting the company’s business are discussed on page 17:
year expense comparison. These items contributed 2.8 points of the improvement in the • Economic environment and corporate IT spending budgets
Total expense and other income-to-revenue ratio. The remaining improvement was prima-
• Internal business transformation and efficiency initiatives
rily due to the results of productivity and efficiency initiatives offset by an increase in retire-
ment-related plans cost. • Innovation initiatives
The company’s effective tax rate increased from 29.1 percent in 2002 to 30.0 percent • Open standards
in 2003. This increase was primarily due to a less favorable mix of geographic income and • Emerging business opportunities
the absence of the tax benefit associated with the Microelectronics actions taken in the
second quarter of 2002.
28
With respect to the economic environment, while it is always difficult to predict future as a signing are those periods in which there is a significant economic impact on the client
economic trends, in 2004 the economic environment improved — shifting from a period of if the commitment is not achieved, usually through a termination charge or the customer
recovery to moderate expansion. Going forward, we anticipate moderate growth for the incurring significant wind-down costs as a result of the termination. For shorter-term con-
traditional IT industry. Several factors — including increasing complexity and globalization — tracts that do not require significant up-front investments, a signing is usually equal to the
are driving clients to transform their businesses. The year-to-year and sequential quarterly full contract value.
growth trend comparisons achieved by the company are indicators of this improvement. Signings includes SO, BCS and ITS contracts. Contract extensions and increases in
With respect to business transformation and the continual conversion of the company scope are treated as signings only to the extent of the incremental new value. Maintenance
into an on demand business, the company’s supply chain initiatives are expected to allow is not included in signings as maintenance contracts tend to be more steady-state, where
continued flexibility to drive additional competitive advantages. The company will con- revenues equal renewals, and therefore, the company does not think they are as useful a
tinue to focus on increased productivity and efficiency to accelerate the globalization and predictor of future performance.
transformation of its global business model. Backlog includes SO, BCS, ITS and Maintenance. Backlog is intended to be a statement
Finally, with respect to technology, in 2004 the company has again been awarded of overall work under contract and therefore does include Maintenance. Backlog estimates
more U.S. patents than any other company for the twelfth year in a row. The company con- are subject to change and are affected by several factors, including terminations, changes
tinues to focus internal development investments on high-growth opportunities and to in scope of contracts (mainly long-term contracts), periodic revalidations, and currency
broaden its ability to deliver industry- and client-specific solutions. assumptions used to approximate constant currency.
From a client-set perspective, the strong momentum in 2004 with respect to the Small Contract portfolios purchased in an acquisition are treated as positive backlog adjust-
& Medium Business sector should continue. We anticipate continued growth in the ments provided those contracts meet the company’s requirements for initial signings. A
Communications, Distribution and Public sectors, however, the Financial Services sector new signing will be recognized if a new services agreement is signed incidental or coinci-
growth may moderate. dent to an acquisition.
The company also will selectively pursue acquisitions, primarily in the Global Services Although signings and backlog declined in 2004, Global Services improved its year-
and Software segments, where it believes these acquisitions will expand its portfolio to to-year revenue growth rate — excluding the benefit of currency — on a sequential basis in
meet clients’ needs. 2004. This increase in Global Services growth rate is due to the improving yield of its back-
log and current signings. The average duration of new contracts has shortened, and the
Global Services Signings
company continues to drive additional revenue from its contract base through volumes
and scope expansion.
FOR THE YEAR ENDED DECEMBER 31: 2004 2003 2002 The combination in 2004 of the company’s Systems Group and Technology Group will
Longer-term* $«22,857 $«34,608 $«33,068 continue to benefit the company’s ability to integrate key semiconductor and other core
Shorter-term* 20,146 20,854 20,020 technology innovations into solutions for clients. The company continues to leverage its
eServer zSeries mainframe technology investments across its server and storage portfolio.
Total $«43,003 $«55,462 $«53,088
The ability to share elements of this technology such as security, automation, and virtual-
* Longer-term contracts are generally 7 to 10 years in length and represent SO and longer-term business transforma- ization, with the more commoditized platforms is a key competitive advantage for IBM.
tion contracts as well as those BCS contracts with the U.S. federal government and its agencies. Shorter-term are con-
tracts generally 3 to 9 months in length and represent the remaining BCS and ITS contracts. These amounts have been
Given the commoditized nature of the personal computer industry and the company’s
adjusted to exclude the impact of year-to-year currency changes. announced agreement to sell its Personal Computing Division, its first half results may be
more volatile than in the company’s other businesses. The company plans to take the nec-
Global Services signings are management’s initial estimate of the value of a client’s com- essary actions to mitigate those impacts. The divestiture is expected to close in the second
mitment under a Global Services contract. Signings are used by management to assess quarter of 2005.
period performance of Global Services management. There are no third-party standards The key to the company’s growth in Software will be clients’ continued adoption of its
or requirements governing the calculation of signings. The calculation used by manage- on demand solutions. The key differentiating factor for the company is the strength and
ment involves estimates and judgments to gauge the extent of a client’s commitment, breadth of its middleware portfolio. Software is a key component of on demand solutions,
including the type and duration of the agreement, and the presence of termination and the company will continue to invest in this strategic area and strengthen its portfolio
charges or wind-down costs. For example, for longer-term contracts that require signifi- through acquisitions. In addition, the company will continue to build a strong partner
cant up-front investment by the company, the portions of these contracts that are counted ecosystem to drive growth.
29
Given the declining interest rate environment, the company reduced its discount rate Cash Flow and Liquidity Trends
assumption for the PPP by 25 basis points to 5.75 percent on December 31, 2004. The (Dollars in billions)
company will keep the expected long-term return on PPP assets at 8 percent. The actual AT DECEMBER 31: 2004 2003 2002 2001 2000
return on PPP plan assets in 2004 was 13 percent. With similar overall trends in these
Net cash from operating activities $«15.4 $«14.6 $«13.8 $«14.0 $«««8.8
assumptions worldwide, as well as the impact of the recent years’ changes in the market
Cash and marketable securities 10.6 7.6 6.0 6.4 3.7
value of plan assets, the year-to-year impact from retirement related plans on pre-tax
Size of global credit facilities 10.0 10.0 12.0 12.0 10.0
income in 2005 will be approximately $1.0 billion higher as compared to 2004, excluding
Trade receivables securitization facility 0.5 — — — —
the 2004 one-time charge of $320 million related to the partial settlement of certain legal
claims against the PPP.
The amount of IP and custom development income has been declining in recent The major rating agencies’ ratings on the company’s debt securities at December 31, 2004
years. Although it was flat in 2004, the overall declining trend may continue as the com- appear in the table below and remain unchanged over the past five years. The company
pany does not expect it to be a contributor to growth. The overall level of IP is dependent has no contractual arrangements that, in the event of a change in credit rating, would
on several factors: divestitures, industry consolidation, economic conditions and the tim- result in a material adverse effect on its financial position or liquidity.
ing of new patent development.
Standard Moody’s
In the normal course of business, the company expects that its effective tax rate will and Investors Fitch
Poor’s Service Ratings
approximate 30 percent. The rate will change year-to-year based on nonrecurring events
(such as the tax effect of the pension claims settlement in 2004 or a possible repatriation Senior long-term debt A+ A1 AA-
charge in 2005 as described in note p, “Taxes” on page 73) as well as recurring factors Commercial paper A-1 Prime-1 f-1+
including the geographic mix of income before taxes, the timing and amount of foreign
dividends, state and local taxes, and the interaction of various global tax strategies. The company prepares its Consolidated Statement of Cash Flows in accordance with
Statement of Financial Accounting Standards (SFAS) No. 95, “Statement of Cash Flows,” on
american jobs creation act of 2004
pages 44 and 45 and highlights causes and events underlying sources and uses of cash in
In 2001, the World Trade Organization (WTO) determined that tax provisions of the FSC
that format on page 24. For purposes of running its business, the company manages,
Repeal and Extraterritorial Income (ETI) Exclusion Act of 2000 constituted an export subsidy
monitors and analyzes cash flows in a different format.
prohibited by the WTO Agreement on Subsidies and Countervailing Measures Agreement.
As discussed on page 35, one of the company’s two primary objectives of its Global
As a result, the U.S. enacted the American Jobs Creation Act of 2004 (the “Act”) in October
Financing business is to generate strong return-on-equity. Increasing receivables is the
2004. The Act repeals the ETI export subsidy for transactions after 2004 with two years of
basis for growth in a financing business. Accordingly, management considers Global
transition relief (2005 – 2006). The Act also provides a nine-percent deduction for income
Financing receivables as a profit-generating investment — not as working capital that
from qualified domestic production activities which will be phased in over 2005– 2010.
should be minimized for efficiency. After classifying the Cash from/(for) Global Financing
While the net impact of certain legislative provisions has not been fully evaluated, the
receivables as an investment, the remaining net cash flow is viewed by the company as the
company does not expect this legislation to affect its ongoing effective tax rate for 2005
Cash available for investment and for distribution to shareholders. With respect to the
or 2006.
company’s cash flow analysis for internal management purposes, Global Financing
Also, the Act includes a temporary incentive for the company to repatriate earnings
accounts receivables are combined with Global Financing debt to represent the Net
accumulated outside the U.S. The current status of the company’s evaluation and potential
Global Financing receivables (a profit-generating investment).
impacts are discussed in note p, “Taxes,” on page 73.
Over the past five years, the company generated over $59.4 billion in Cash available
liquidity and capital resources for investment and for distribution to shareholders. As a result, during the period the
The company generates strong cash flow from operations, providing a source of funds company invested in $21.4 billion of net capital expenditures, invested $8.0 billion in
ranging between $8.8 billion and $15.4 billion per year over the past five years. The com- strategic acquisitions, received $1.4 billion from divestitures and returned $33.0 billion to
pany provides for additional liquidity through several sources — a sizable cash balance, shareholders through dividends and share repurchases. The amount of prospective
access to global funding sources, a committed global credit facility and in 2004, the com- Returns to shareholders in the form of dividends and share repurchases will vary based
pany converted a receivables securitization facility from an “uncommitted” to a “commit- upon several factors including affordability, namely each year’s operating results, capital
ted” facility, adding an additional source of liquidity. (See note j, “Sale and Securitization expenditures, research and development, and acquisitions, as well as the factors discussed
of Receivables” on page 64 for additional information.) The table below provides a sum- in the following table.
mary of these major sources of liquidity as of the end of fiscal years 2000 through 2004.
30
The company’s Board of Directors meets quarterly to approve the dividend payment. Contractual Obligations
The company announced a dividend payment of $0.18 per common share, payable (Dollars in millions)
March 10, 2005, which is the company’s 357th consecutive quarterly payment. The com- Total
pany expects to fund the quarterly dividend payments through cash from operations. Contractual Payments Due In
Payment
The table below represents the way in which management reviews its cash flow as Stream 2005 2006-07 2008-09 After 2009
described above. Long-term debt obligations $«17,664 $«3,175 $«4,396 $«2,614 $÷«7,479
(Dollars in billions) Capital (Finance) lease obligations 56 46 8 1 1

Operating lease obligations 6,607 1,383 2,210 1,603 1,411
FOR THE YEAR ENDED DECEMBER 31: 2004 2003 2002 2001 2000
Purchase obligations 2,268 919 828 479 42
Net cash from operating activities Other long-term liabilities:
(comprised of): $«15.4 $«14.6 $«13.8 $«14.0 $««8.8
Minimum pension funding
Cash from/(for) Global Financing (mandated) * 2,384 361 1,175 848 —
accounts receivable $«««2.5 $«««1.9 $«««3.3 $«««2.0 $«(2.5) Executive compensation 782 95 121 141 425
Cash available for investment and Environmental liabilities 246 28 25 23 170
for distribution to shareholders 12.9 12.7 10.5 12.0 11.3 Long-term termination benefits 2,406 344 483 334 1,245
Net Global Financing receivables 0.7 (0.7) 0.2 0.9 (0.6) Other 457 80 166 136 75
Net capital expenditures (3.7) (3.9) (4.6) (4.9) (4.3) Total $«32,870 $«6,431 $«9,412 $«6,179 $«10,848
Net divestitures/(acquisitions) (1.7) (1.7) (2.0) (0.9) (0.3)
Returns to shareholders (8.3) (5.4) (5.2) (6.5) (7.6) * These amounts represent future pension contributions that are mandated by local regulations or statute for retirees
receiving pension benefits. They are all associated with non-U.S. pension plans. The projected payments beyond 2009
Other 2.9 0.9 0.2 2.2 — are not currently determinable. See note w, “Retirement-related Benefits,” on pages 78 through 86 for additional infor-
mation on the non-U.S. plans’ investment strategies and expected contributions.
Net change in cash and
cash equivalents $«««2.8 $«««1.9 $««(0.9) $«««2.8 $«(1.5)
Purchase obligations include all commitments to purchase goods or services of either a fixed
or minimum quantity that meet any of the following criteria: (1) they are non-cancelable,
Events that could temporarily change the historical cash flow dynamics discussed on page
(2) the company would incur a penalty if the agreement was canceled, or (3) the company
30 include unexpected adverse impacts from litigation or future pension funding during
must make specified minimum payments even if it does not take delivery of the contracted
periods of severe and prolonged downturn in the capital markets. Whether any litigation
products or services (“take-or-pay”). If the obligation to purchase goods or services is non-
has such an adverse impact will depend on a number of variables, which are more completely
cancelable, the entire value of the contract is included in the above table. If the obligation
described on page 71. With respect to pension funding, on January 19, 2005 the company
is cancelable, but the company would incur a penalty if canceled, the dollar amount of the
contributed $1.7 billion to the qualified portion of the company’s PPP. This contribution
penalty is included as a purchase obligation. Contracted minimum amounts specified in
fulfilled a number of short-term and long-term strategic objectives. This contribution
take-or-pay contracts are also included in the above table as they represent the portion of
reduces the probability of large future U.S. pension contributions by building a funding
each contract that is a firm commitment.
buffer above the current liability level. In addition, it positions the company to further
In the ordinary course of business, the company enters into contracts that specify
reduce volatility in pension contributions and earnings over the long term. Finally, the
that the company will purchase all or a portion of its requirements of a specific product,
company will benefit from the return on these additional pension assets in 2005. The
commodity, or service from a supplier or vendor. These contracts are generally entered
increase in pension income produced from this funding will partially offset the impact of
into in order to secure pricing or other negotiated terms. They do not specify fixed or
year-end 2004 pension assumptions changes.
minimum quantities to be purchased and, therefore, the company does not consider
The company is not quantifying any further impact from pension funding because it is
them to be purchase obligations.
not possible to predict future movements in the capital markets. However, for 2005, if
actual returns on plan assets for the PPP were less than 1 percent, the PPP’s accumulated
benefit obligation (ABO) would be greater than its Plan assets (assuming no other assump-
tion change). As discussed on page 83, such a situation may result in a further voluntary
contribution of cash or stock to the PPP or a charge to stockholders’ equity.
31
critical accounting estimates To the extent the outlook for long-term returns changes such that management
The application of GAAP involves the exercise of varying degrees of judgment. While the changes its expected long-term return on plan assets assumption, each 50 basis point
resulting accounting estimates will, by definition, not always precisely equal the related increase or decrease in the expected long-term return on PPP plan assets assumption will
actual results, eight of these estimates involve more judgment than others. Two of these have an estimated increase or decrease, respectively, of $229 million on the following year’s
estimates are the allowance for uncollectible financing receivables and the fair value of pre-tax net periodic pension income (based upon the PPP’s plan assets at December 31,
lease residual values. See page 39 for a discussion of these estimates. The others are dis- 2004 and the January 2005 contribution of $1.7 billion discussed further on page 84).
cussed below. Another key management assumption is the discount rate. See page 83 for informa-
The sensitivity analyses used below are not meant to provide a reader with manage- tion regarding the discount rate assumption. Changes in the discount rate assumptions
ment’s predictions of the variability of the estimates used. Rather, the sensitivity levels will impact the interest cost component of the net periodic pension income calculation
selected (e.g., 5 percent, 10 percent, etc.) are included to allow users of the Annual Report and due to the fact that the ABO is calculated on a net present value basis, changes in the
to understand a general-direction cause and effect of changes in the estimates. discount rate assumption will also impact the current ABO. An increase in the ABO caused
by a decrease in the discount rate may result in a voluntary contribution to a pension plan.
Useful Lives of Microelectronics Plant and Equipment
As discussed on page 30, the company reduced the discount rate assumption for the
The company determines the estimated useful lives and related depreciation charges for
PPP by 25 basis points to 5.75 percent on December 31, 2004. This change will increase
its plants and equipment. For Microelectronics, this estimate is based on projected tech-
pre-tax cost and expense in 2005 by $90 million. Had the discount rate assumption for the
nology, process and product life cycles that could change significantly due to technical
PPP increased by 25 basis points on December 31, 2004, pre-tax cost and expense would
innovations and competitor actions in response to relatively severe industry cycles. To the
have decreased by $91 million in 2005. As mentioned above, changes in the discount rate
extent actual useful lives are less than previously estimated lives, the company will increase
assumption will impact the ABO which in turn, may impact the company’s funding decisions
its depreciation charge or will write-off or writedown technically obsolete or non-strategic
if the ABO exceeds plan assets. In order to analyze the sensitivity of discount rate move-
assets that have been abandoned or sold.
ments, each 25 basis point increase or decrease in the interest rate will cause a correspon-
The company estimates useful lives of its Microelectronics equipment by reference to
ding decrease or increase, respectively, in the PPP’s ABO of an estimated $1.1 billion based
the current and projected dynamics in the semiconductor industry, product/process life
upon December 31, 2004 data. Page 82 presents the PPP’s ABO (after the reduction in
cycles and anticipated competitor actions.
discount rate discussed above) and plan assets as of December 31, 2004.
To the extent that Microelectronics actual useful lives differ from management’s estimates
Impacts of these types of changes on the pension plans in other countries will vary
by 10 percent, consolidated net income would be an estimated $62 million higher/lower
depending upon the status of each respective plan.
based upon 2004 results, depending upon whether the actual lives were longer/shorter,
respectively, than the estimates. To the extent that the actual lives were shorter by 10 per- Costs to Complete Service Contracts
cent, it is estimated that there would have also been a lower-of-cost-or-market inventory The company enters into numerous service contracts through its SO and BCS businesses.
charge of less than $5 million. SO contracts range for periods up to ten years and BCS contracts can be for several years.
During the contractual period, revenue, cost and profits may be impacted by estimates of
Pension Assumptions
the ultimate profitability of each contract, especially contracts for which the company uses
The expected long-term return on plan assets is used in calculating the net periodic pension
the percentage-of-completion method of accounting. See page 50 for the company’s serv-
(income)/cost. See page 83 for information regarding the expected long-term return on
ices revenue recognition accounting policies. If at any time, these estimates indicate the
plan assets assumption. The differences between the actual return on plan assets and
contract will be unprofitable, the entire estimated loss for the remainder of the contract is
expected long-term return on plan assets are recognized in the calculation of net periodic
recorded immediately.
pension (income)/cost over five years.
The company performs ongoing profitability analyses of its services contracts in order
As described on page 83, if the fair value of the pension plan’s assets is below the
to determine whether the latest estimates require updating. Key factors reviewed by the
plan’s ABO, the company will be required to record a minimum liability. In some situations,
company to estimate the future costs to complete each contract are future labor costs and
the pension asset must be partially reversed through a charge to stockholders’ equity.
productivity efficiencies.
The company may voluntarily make contributions or be required, by law, to make contri-
butions to the pension plans. Actual results that differ from the estimates may result in
more or less future company funding into the pension plans than is planned by manage-
ment. See page 31 for additional information and near-term sensitivities of actual returns
on funding decisions.
32
To the extent actual estimated completed contract margins on percentage of completion tax liabilities based on estimates of whether additional taxes and interest will be due. To
services contracts differ from management’s quarterly estimates by 1 percentage point, the the extent that the final tax outcome of these matters is different than the amounts that
company’s consolidated net income would have improved/declined by an estimated were initially recorded, such differences will impact the income tax provision in the period
$69 million using 2004 results, depending upon whether the actual results were higher/ in which such determination is made.
lower, respectively, than the estimates. This amount excludes any accrual resulting from To the extent that the provision for income taxes increases/decreases by 1 percent
contracts in loss positions. For all long-term services contracts that have an estimated of income from continuing operations before income taxes, consolidated income from
completed contract profit of 5 percent or less, if actual profits were 5 percentage points continuing operations would have declined/improved by $120 million in 2004.
less than expected, the consolidated net income would be reduced by an estimated
$85 million. currency rate fluctuations
Changes in the relative values of non-U.S. currencies to the U.S. dollar affect the company’s
Net Realizable Value and Client Demand results. At December 31, 2004, currency changes resulted in assets and liabilities denom-
The company reviews the net realizable value of and demand for its inventory on a quar- inated in local currencies being translated into more dollars than at year-end 2003. The
terly basis to ensure recorded inventory is stated at the lower of cost or net realizable value company uses a variety of financial hedging instruments to limit specific currency risks
and that obsolete inventory is written off. Inventories at higher risk for writedowns or write- related to financing transactions and other foreign currency-based transactions. Further
offs are those in the industries that have lower relative gross margins and that are subject discussion of currency and hedging appears in note l, “Derivatives and Hedging Transac-
to a higher likelihood of changes in industry cycles. The semiconductor and personal tions,” on pages 65 to 67.
computer businesses are two such industries. The company earned approximately 58 percent of its net income in currencies other
Factors that could impact estimated demand and selling prices are the timing and than the U.S. dollar. In general, these currencies appreciated against the U.S. dollar during
success of future technological innovations, competitor actions, supplier prices and 2004 so net income in these countries translated into more dollars than they would have
economic trends. in 2003. The company also maintains hedging programs to limit the volatility of currency
To the extent that semiconductor and personal computer inventory losses differ from impacts on the company’s financial results. These hedging programs limit the impact of
management estimates by 5 percent, the company’s consolidated net income in 2004 currency changes on the company’s financial results but do not eliminate them. In addition
would have improved/declined by an estimated $42 million using 2004 results, depending to the translation of earnings and the company’s hedging programs, the impact of currency
upon whether the actual results were better/worse, respectively, than expected. changes also may affect the company’s pricing and sourcing actions. For example, the
Warranty Claims company may procure components and supplies in multiple functional currencies and sell
The company generally offers three-year warranties for its personal computer products products and services in other currencies. Therefore, it is impractical to quantify the impact
and one-year warranties on most of its other products. The company estimates the amount of currency on these transactions and on consolidated net income. For these reasons, the
and cost of future warranty claims for its current period sales. These estimates are used to company believes that extended periods of dollar weakness are positive for net income
record accrued warranty costs for current period product shipments. The company uses and extended periods of dollar strength are negative, although the precise impact is diffi-
historical warranty claim information as well as recent trends that might suggest that past cult to assess.
cost information may differ from future claims. For non-U.S. subsidiaries and branches that operate in U.S. dollars or whose economic
Factors that could impact the estimated claim information include the success of the environment is highly inflationary, translation adjustments are reflected in results of opera-
company’s productivity and quality initiatives, as well as parts and labor costs. tions, as required by SFAS No. 52, “Foreign Currency Translation.” Generally, the company
To the extent that actual claims costs differ from management’s estimates by 5 per- manages currency risk in these entities by linking prices and contracts to U.S. dollars and
cent, consolidated net income will have improved/declined by an estimated $32 million in by entering into foreign currency hedge contracts.
2004, depending upon whether the actual claims costs were lower/higher, respectively,
market risk
than the estimates.
In the normal course of business, the financial position of the company is routinely subject
Income Taxes to a variety of risks. In addition to the market risk associated with interest rate and currency
The company is subject to income taxes in both the U. S. and numerous foreign jurisdic- movements on outstanding debt and non-U.S. dollar denominated assets and liabilities,
tions. Significant judgment is required in determining the worldwide provision for income other examples of risk include collectibility of accounts receivable and recoverability of
taxes. During the ordinary course of business, there are many transactions and calculations residual values on leased assets.
for which the ultimate tax determination is uncertain. As a result, the company recognizes
33
The company regularly assesses these risks and has established policies and business Interest Rate Risk
practices to protect against the adverse effects of these and other potential exposures. As At December 31, 2004, a 10 percent decrease in the levels of interest rates with all other
a result, the company does not anticipate any material losses from these risks. variables held constant would result in a decrease in the fair market value of the company’s
The company’s debt in support of the Global Financing business and the geographic financial instruments of $172 million as compared with a decrease of $170 million at
breadth of the company’s operations contains an element of market risk from changes in December 31, 2003. A 10 percent increase in the levels of interest rates with all other vari-
interest and currency rates. The company manages this risk, in part, through the use of a ables held constant would result in an increase in the fair value of the company’s financial
variety of financial instruments including derivatives, as explained in note l, “Derivatives instruments of $153 million as compared to $152 million at December 31, 2003. Changes
and Hedging Transactions,” on pages 65 to 67. in the relative sensitivity of the fair value of the company’s financial instrument portfolio for
To meet disclosure requirements, the company performs a sensitivity analysis to deter- these theoretical changes in the level of interest rates are primarily driven by changes in
mine the effects that market risk exposures may have on the fair values of the company’s the company’s debt maturity, interest rate profile and amount.
debt and other financial instruments.
Foreign Currency Exchange Rate Risk
The financial instruments that are included in the sensitivity analysis comprise all of the
At December 31, 2004, a 10 percent weaker U.S. dollar against foreign currencies, with all
company’s cash and cash equivalents, marketable securities, long-term non-lease receiv-
other variables held constant, would result in a decrease in the fair value of the company’s
ables, investments, long-term and short-term debt and all derivative financial instruments.
financial instruments of $692 million as compared with a decrease of $283 million at
The company’s portfolio of derivative financial instruments generally includes interest rate
December 31, 2003. Conversely, a 10 percent stronger U.S. dollar against foreign curren-
swaps, interest rate options, foreign currency swaps, forward contracts and option contracts.
cies, with all other variables held constant, would result in an increase in the fair value of
To perform the sensitivity analysis, the company assesses the risk of loss in fair values
the company’s financial instruments of $679 million compared with $296 million at
from the effect of hypothetical changes in interest rates and foreign currency exchange
December 31, 2003. In 2004 versus 2003, the reported increase in foreign currency
rates on market-sensitive instruments. The market values for interest and foreign currency
exchange rate sensitivity was primarily due to an increase in hedges of foreign cash flow.
exchange risk are computed based on the present value of future cash flows as affected by
the changes in rates that are attributable to the market risk being measured. The discount financing risks
rates used for the present value computations were selected based on market interest and See the Global Financing — Description of Business on page 35 for a discussion of the
foreign currency exchange rates in effect at December 31, 2004 and 2003. The differences financing risks associated with the company’s Global Financing business and management’s
in this comparison are the hypothetical gains or losses associated with each type of risk. goals to mitigate such risks while striving for superior return on Global Financing’s equity.
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 Employees and Related Workforce
are held constant. In addition, the results of the model are constrained by the fact that
certain items are specifically excluded from the analysis, while the financial instruments Percentage Changes
relating to the financing or hedging of those items are included by definition. Excluded
FOR THE YEAR ENDED DECEMBER 31: 2004 2003 2002 2004-03 2003-02
items include leased assets, forecasted foreign currency cash flows and the company’s
net investment in foreign operations. As a consequence, reported changes in the values IBM/wholly owned subsidiaries 329,001 319,273 315,889 3.0 1.1
of some of the financial instruments impacting the results of the sensitivity analysis are not Less-than-wholly owned subsidiaries 19,051 18,189 22,282 4.7 (18.4)
matched with the offsetting changes in the values of the items that those instruments are Complementary 21,225 17,695 17,250 19.9 2.6
designed to finance or hedge.
The results of the sensitivity analysis at December 31, 2004, and December 31, 2003, Employees at IBM and its wholly owned subsidiaries in 2004 increased 9,728 from last
are as follows: year. The company continues to invest in Global Services and Software, growth areas of
the business, through a combination of hiring and acquisitions. The company also contin-
ues to rebalance its workforce to improve IBM’s competitiveness in the marketplace and to
withdraw from certain businesses, thereby offsetting some of the growth.
34
In less-than-wholly owned subsidiaries, the number of employees increased from last results of operations
year. The increase is primarily in the International Information Products Company, a personal (Dollars in millions)
computer-related joint venture in China, which IBM has announced an agreement to sell FOR THE YEAR ENDED DECEMBER 31: 2004 2003 2002
to Lenovo as part of the sale of the Personal Computing Division.
External revenue $«2,607 $«2,827 $«3,203
The company’s complementary workforce is an approximation of equivalent full-time
Internal revenue 1,287 1,300 939
employees hired under temporary, part-time and limited-term employment arrangements
to meet specific business needs in a flexible and cost-effective manner. Total revenue 3,894 4,127 4,142
Cost 1,539 1,846 1,803
Gross profit $«2,355 $«2,281 $«2,339

Global Financing Gross profit margin 60.5% 55.3% 56.5%
description of business Pre-tax income $«1,494 $«1,182 $««««955
Global Financing is a business segment within IBM, that is managed on an arm’s-length basis After-tax income* $««««937 $««««766 $««««627
and measured as if it were a standalone entity. Accordingly, the information presented in Return on equity * 28.6% 22.3% 17.2%
this section is consistent with this separate company view.
The mission of Global Financing is to generate a return on equity. It also facilitates the * See page 39 for the details of the After-tax income and the Return on equity calculation.
client’s acquisition of IBM hardware, software and services.

Global Financing invests in financing assets, manages the associated risks, and lever- Global Financing revenue declined 5.6 percent in 2004 as compared with 2003. External
ages with debt, all with the objective of generating consistently strong returns on equity. revenue decreased 7.8 percent (11.5 percent at constant currency) in 2004 versus 2003
The focus on IBM products and IBM clients mitigates the risks normally associated with a primarily driven by external used equipment sales of $708 million in 2004 versus $928 mil-
financing company. Global Financing has the benefit of both a deep knowledge of its lion in 2003, a decrease of 23.7 percent. Global Financing remarkets used equipment,
client base and a clear insight into the products that are being leased. This combination primarily resulting from equipment that is returned at end of lease both externally and
allows Global Financing to effectively manage two of the major risks (credit and residual internally. Externally remarketed equipment revenue represents sales or leases to clients
value) that are normally associated with financing. and resellers. Internally remarketed equipment revenue primarily represents used equip-
ment that is sold or leased internally to the Hardware and Global Services segments. The
Global Financing comprises three lines of business: Hardware segment will also sell the equipment that it purchases from Global Financing to
• Customer financing provides lease and loan financing to end users and internal external customers. Internal revenue decreased 1.0 percent in 2004 versus 2003 driven
customers for terms generally between two and five years. Internal financing is pre- by remarketing revenue of $783 million in 2004 versus $828 million in 2003, a decrease
dominantly in support of Global Services’ long-term customer service contracts. Global of 5.4 percent, partially offset by commercial financing revenue of $269 million in 2004
Financing also factors a selected portion of the company’s accounts receivable, versus $240 million in 2003, an increase of 12.2 percent.
primarily for cash management purposes. All of these internal financing arrangements Global Financing revenue was flat in 2003 as compared with 2002. External revenue
are at arm’s-length rates and are based upon market conditions. decreased 11.7 percent (18.0 percent at constant currency) in 2003 versus 2002 driven by
financing revenue of $1,896 million in 2003 versus $2,224 million in 2002, a decrease of
• Commercial financing provides primarily short-term inventory and accounts receiv-
14.7 percent, due to declining interest rates and a lower average asset base, and external
able financing to dealers and remarketers of IT products.
used equipment sales of $931 million in 2003 versus $979 million in 2002, a decrease of
• Remarketing sells and leases used equipment to new or existing customers. This
4.9 percent. The lower average asset base was primarily due to lower originations in prior
equipment is primarily sourced from the conclusion of lease transactions.
years. Internal revenue increased 38.4 percent in 2003 versus 2002 driven by internal used
In addition to the strength of the economy and its impact on corporate IT budgets, key equipment sales, primarily zSeries.
drivers of Global Financing’s results are interest rates and originations. Originations, which
determine the asset base of Global Financing’s annuity-like business, are impacted by
IBM’s non-Global Financing sales volumes and Global Financing’s participation rates.
Participation rates are the propensity of IBM’s clients to finance their purchases through
Global Financing in lieu of paying IBM up-front cash or financing through a third party.
35
Global Financing gross profit dollars increased 3.2 percent and gross profit margin financial condition
increased 5.2 points in 2004 versus 2003. The increase in gross profit dollars was primarily Balance Sheet
driven by cost of sales on remarketing equipment of $931 million in 2004 versus $1,168 (Dollars in millions)
million in 2003, a decrease of 20.2 percent and borrowing costs of $608 million in 2004 AT DECEMBER 31: 2004 2003
versus $678 million in 2003, a decrease of 10.3 percent related to volumes and the inter-
Cash $««««««850 $««««««813
est rate environment during the year, partially offset by the decrease in revenue discussed
above. The increase in gross profit margin was driven by improved margins in financing Net investment in sales-type leases 11,141 11,969
and equipment sales, and a mix change toward higher margin financing income and away Equipment under operating leases:
from lower margin equipment sales. External customers 1,817 1,707
Global Financing gross profit dollars decreased 2.5 percent and gross profit margin Internal customers (a) (b) 1,906 1,873
declined 1.2 points in 2003 versus 2002. The decrease in gross profit dollars was primarily Customer loans 9,889 10,413
driven by declining interest rates and lower average asset base discussed above, partially Total customer financing assets 24,753 25,962
offset by improved financing margins. The decrease in gross profit margin was driven by Commercial financing receivables 5,710 5,835
a mix change toward lower margin remarketing sales and away from financing income, Intercompany financing receivables (a) (b) 2,172 1,999
partially offset by lower borrowing costs related to the interest rate environment during Other receivables 223 270
the year. Other assets 881 1,037
Global Financing pre-tax income increased 26.4 percent in 2004 versus 2003, com- Total financing assets $«34,589 $«35,916
pared with an increase of 23.8 percent in pre-tax income in 2003 versus 2002. The increase
Intercompany payables (a) $«««6,394 $«««6,754
in 2004 was driven by a decrease of $101 million in bad debt expense, a decrease of
$23 million in selling, general and administration expenses, a decrease of $100 million in Debt (c) 22,320 23,264
other charges primarily driven by income from internal sales, and the increase in gross Other liabilities 2,620 2,546
profit of $74 million discussed above. The decrease in bad debt expense is reflective of Total financing liabilities 31,334 32,564
the improved general economic environment, improved credit quality of the portfolio, and Total financing equity 3,255 3,352
the declining size of the receivables portfolio. (Also see page 37 for an additional discussion Total financing liabilities and equity $«34,589 $«35,916
of IBM Global Financing Allowance for Doubtful Accounts.) The increase in 2003 versus
(a) Amounts eliminated for purposes of IBM’s consolidated results and therefore do not appear on pages 42 and 43.
2002 was driven by a decrease in bad debt expense partially offset by the decrease in
(b) These assets, along with all other financing assets in this table, are leveraged using Global Financing debt.
gross profit discussed above. The decrease in bad debt expense is reflective of the improved
(c) Global Financing debt includes debt of the company and of the Global Financing units that support the Global
general economic environment and reduced exposure in specific sectors, particularly the Financing business.
Communications sector.
The increases in return on equity from 2003 to 2004 and from 2002 to 2003 were also Sources and Uses of Funds
due to higher earnings. The primary use of funds in Global Financing is to originate customer and commercial
financing assets. Customer financing assets for end users consist primarily of IBM hardware,
software and services, but also include non-IBM equipment, software and services to meet
IBM clients’ total solutions requirements. Customer financing assets are primarily sales-
type, direct financing, and operating leases for equipment as well as loans for hardware,
software and services with terms generally for two to five years. Customer financing also
includes internal activity as described on page 35.
Commercial financing originations arise primarily from inventory and accounts receiv-
able financing for dealers and remarketers of IBM and non-IBM products. Payment terms
for inventory financing generally range from 30 to 75 days. Payment terms for accounts
receivable financing generally range from 30 to 90 days.
36
Originations (Dollars in millions)

The following are total external and internal financing originations. AT DECEMBER 31: 2004 2003
(Dollars in millions) Gross financing receivables $«26,836 $«28,451

FOR THE YEAR ENDED DECEMBER 31: 2004 2003 2002 Specific allowance for doubtful accounts 654 666
Customer finance: Unallocated allowance for doubtful accounts 127 199
External $«12,433 $«13,279 $«12,845 Total allowance for doubtful accounts 781 865
Internal 1,185 1,150 1,061 Net financing receivables $«26,055 $«27,586
Commercial finance 25,566 24,291 22,546
Allowance for doubtful account coverage 2.9% 3.0%
Total $«39,184 $«38,720 $«36,452
Roll-Forward of Financing Receivables Allowance for Doubtful Accounts

Cash collections of both customer and commercial financing assets exceeded new financing
originations in 2004, which resulted in a net decline in financing assets from December 31,
Additions:
2003. The increase in originations in 2004 and 2003 from 2003 and 2002 respectively, was Reserve Bad Debts Dec. 31,
due to favorable currency movements offset by a decline in participation rates. The decline Jan. 1, 2004 Used* Expense Other** 2004
in participation rates was in line with industry trends. $«865 $«(237) $«105 $«48 $«781
Cash generated by Global Financing in 2004 was deployed to pay the intercompany
* Represents reserved receivables, net of recoveries, that were disposed of during the period.
payable and dividends to IBM as well as to reduce debt.
** Primarily represents translation adjustments.
Financing Assets by Sector
The following are the percentage of external financing assets by industry sector. The percentage of financing receivables reserved decreased from 3.0 percent at
December 31, 2003, to 2.9 percent at December 31, 2004 primarily due to the decrease
AT DECEMBER 31: 2004 2003 in the unallocated allowance for doubtful accounts. Unallocated reserves decreased
36.2 percent from $199 million at December 31, 2003 to $127 million at December 31,
Financial Services 30% 28%
2004 due to the decline in gross financing receivables combined with improved economic
Industrial 20 17
conditions and improved credit quality of the portfolio. Specific reserves decreased 1.8 per-
Business Partners * 19 18
cent from $666 million at December 31, 2003 to $654 million at December 31, 2004. The
Distribution 9 10
decrease in specific reserves was due to the disposition of reserved receivables during
Public 9 10
the period combined with lower requirements for additional specific reserves. This
Communications 9 11
lower requirement is generally due to improving economic conditions as well as portfolio
Other 4 6
management to reduce risk in areas of concern.
Total 100% 100%
Global Financing’s bad debt expense declined to $105 million for the year ended
* Business Partners financing assets represent a portion of commercial financing inventory and accounts receivable December 31, 2004, compared with $206 million for the year ended December 31, 2003.
financing for terms generally less than 90 days. The decline was primarily attributed to lower reserve requirements associated with the
improvement in economic conditions and improved credit quality of the portfolio in 2004,
Financing Receivables and Allowances as compared with 2003, as well as the lower asset base.
The following table presents external financing receivables, excluding residual values, and
Residual Value
the allowance for doubtful accounts.
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. Global Financing
has insight into product plans and cycles for the IBM products under lease. Based upon
this product information, Global Financing continually monitors projections of future
equipment values and compares them with the residual values reflected in the portfolio.
See note a, “Significant Accounting Policies” on page 55 for the company’s accounting
policy for residual values.
37
Sales of equipment, which are primarily sourced from equipment returned at end of Global Financing funds its operations primarily through borrowings using a debt to equity
lease, represented 36.6 percent of Global Financing’s revenue in 2004 and 40.5 percent ratio of approximately 7 to 1. The debt is used to fund Global Financing assets. The debt
in 2003. The decrease was driven primarily by lower external used equipment sales, due is composed of intercompany loans and external debt. The terms of the intercompany
to a decline in sales to business partners. The gross margin on these sales was 34.6 per- loans are set by the company to substantially match the term and currency underlying the
cent and 30.2 percent in 2004 and 2003, respectively. The increase in gross margin was receivable. The inter-company loans are based on arm’s-length pricing. The following table
primarily due to the improved profitability of internal equipment sales. In addition to sell- illustrates the correlation between Global Financing Assets and Global Financing Debt.
ing assets sourced from end of lease, Global Financing optimizes the recovery of residual Both assets and debt are presented in the Global Financing Balance Sheet on page 36.
values by leasing used equipment to new customers or extending leasing arrangements
with current customers. The following table presents the recorded amount of unguaran- Global Financing Assets and Debt
teed residual value for sales-type and operating leases at December 31, 2003 and 2004. (Dollars in millions)
In addition, the table presents the residual value as a percentage of the original amount
$50
financed, and a run out of the unguaranteed residual value over the remaining lives of
these leases at December 31, 2004. In addition to the unguaranteed residual value below, 40
on a limited basis, Global Financing will obtain guarantees of the future value of the equip-
ment scheduled to be returned at end of lease. These third-party guarantees are used in 30
the determination of lease classifications for the covered equipment and provide protec-
20
tion against risk of loss arising from declines in equipment values for these assets. The
aggregate asset value associated with the guarantees was $700 million and $615 million 10
for financing transactions originated during the years ended December 31, 2004 and
2003, respectively. The associated aggregate guaranteed future value at the scheduled
end of lease was $36 million and $26 million for financing transactions originated during 95 96 97 98 99 00 01 02 03 04
the same time periods, respectively. The cost of guarantees was $4.7 million for each year. Global Financing Assets Global Financing Debt
Residual Value
The company’s Global Financing business provides funding predominantly for the com-
pany’s external customers but also provides intercompany financing for the company
Total Amortization of 2004 Balance (internal), as described in the “Description of Business” on page 35. As previously stated,
2008 and the company manages and measures Global Financing as if it were a standalone entity
2003 2004 2005 2006 2007 Beyond
and accordingly, interest expense relating to debt supporting Global Financing’s external
Sales-type leases $««««««845 $««««««836 $«262 $«269 $«248 $«57 customer and internal business is included in the “Global Financing Results of Operations”
Operating leases 164 164 78 46 36 4 on page 35 and in note x, “Segment Information,” on pages 87 through 91.
Total unguaranteed In the company’s Consolidated Statement of Earnings on pages 40 and 41, however,
residual value $«««1,009 $«««1,000 $«340 $«315 $«284 $«61 the interest expense supporting Global Financing’s internal financing to the company is
reclassified from Cost of financing to Interest expense.
Related original
amount financed $«27,820 $«25,982 Liquidity and Capital Resources
Percentage 3.6% 3.8% Global Financing is a segment of the company and as such, is supported by the company’s
liquidity position and access to capital markets. Cash generated from operations in 2004
Debt was deployed to reduce debt and pay dividends to the company in order to maintain an
AT DECEMBER 31: 2004 2003 appropriate debt to equity ratio.
Debt to equity ratio 6.9x 6.9x
38
return on equity To the extent that actual residual value recovery is lower than management’s estimates
(Dollars in millions) by 5 percent, Global Financing’s net income would be lower by an estimated $16 million
AT DECEMBER 31: 2004 2003 (using 2004 data). If the actual residual value recovery is higher than management’s esti-
mates, the increase in net income will be realized at the end of lease when the equipment
Numerator:
is remarketed.
Global Financing after tax income (A)* $÷««937 $««««766
Denominator: market risk
Average Global Financing equity (B)** $«3,272 $«3,436 See pages 33 and 34 for discussion of the company’s overall market risk.
Global Financing Return on Equity (A) / (B) 28.6% 22.3%
looking forward
* Calculated based upon an estimated tax rate principally based on Global Financing’s geographic mix of earnings as Given Global Financing’s mission of supporting IBM’s hardware, software and services
IBM’s provision for income taxes is determined on a consolidated basis.
** Average of the ending equity for Global Financing for the last five quarters.
businesses, originations for both customer and commercial finance businesses will be
dependent upon the overall demand for IT hardware, software and services, as well as the
customer participation rates.
critical accounting estimates
Interest rates and the overall economy (including currency fluctuations) will have an
As discussed in note a, “Significant Accounting Policies,” on page 49, the application of
effect on both revenue and gross profit. The company’s interest rate risk management
GAAP involves the exercise of varying degrees of judgment. The following areas require
policy, however, combined with the Global Financing funding strategy (see page 38),
more judgment relative to the others and relate to Global Financing. Also see “Critical
should mitigate gross margin erosion due to changes in interest rates. The company’s
Accounting Estimates” on page 32.
policy of matching asset and liability positions in foreign currencies will limit the impacts
Financing Receivables Reserves of currency fluctuations.
Global Financing reviews its financing receivables portfolio at least quarterly in order to The economy could impact the credit quality of the Global Financing receivables port-
assess collectibility. A description of the methods used by management to estimate the folio and therefore the level of provision for bad debts. Global Financing will continue to
amount of uncollectible receivables is included on page 54. Factors that could result in apply rigorous credit policies in both the origination of new business and the evaluation
actual receivable losses that are materially different from the estimated reserve include of the existing portfolio.
sharp changes in the economy, or a large change in the health of a particular industry seg- As discussed above, Global Financing has historically been able to manage residual
ment that represents a concentration in Global Financing’s receivables portfolio. value risk both through insight into the product cycles as well as through its remarket-
To the extent that actual collectibility differs from management’s estimates by 5 per- ing business.
cent, Global Financing net income would be higher or lower by an estimated $24 million Global Financing has policies in place to manage each of the key risks involved in
(using 2004 data), depending upon whether the actual collectibility was better or worse, financing. These policies, combined with product and customer knowledge, should allow
respectively, than the estimates. for the prudent management of the business going forward, even during periods of
uncertainty with respect to the economy.
Residual Value
Residual value represents the estimated fair value of equipment under lease as of the end
of the lease. Global Financing estimates the future fair value of residual values by using
historical models, the current market for used equipment and forward-looking product
Forward-Looking and Cautionary Statements
information such as marketing plans and technological innovations. In addition, Global Certain statements contained in this Annual Report may constitute forward-looking state-
Financing estimates the fair value by analyzing current market conditions for leasing and ments within the meaning of the Private Securities Litigation Reform Act of 1995. These
sales of both new and used equipment. These estimates are periodically reviewed and any statements involve a number of risks, uncertainties and other factors that could cause
other than temporary declines in estimated future residual values are recognized upon actual results to be materially different, as discussed more fully elsewhere in this Annual
identification. Anticipated increases in future residual value are not recognized until the Report and in the company’s filings with the SEC, including the company’s 2004 Form 10-K
equipment is remarketed. Factors that could cause actual results to materially differ from filed on February 24, 2005.
the estimates include severe 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.
39
CONSOLIDATED STATEMENT OF EARNINGS

FOR THE YEAR ENDED DECEMBER 31: Notes 2004 2003 2002
Revenue:
Global Services $«46,213 $«42,635 $«36,360
Hardware 31,154 28,239 27,456
Software 15,094 14,311 13,074
Global Financing 2,608 2,826 3,232
Enterprise Investments/Other 1,224 1,120 1,064
Total Revenue 96,293 89,131 81,186
Cost:
Global Services 34,637 31,903 26,812
Hardware 21,929 20,401 20,020
Software 1,919 1,927 2,043
Global Financing 1,045 1,248 1,416
Enterprise Investments/Other 731 634 611
Total Cost 60,261 56,113 50,902
Gross Profit 36,032 33,018 30,284
Expense and Other Income:

Selling, general and administrative q 19,384 17,852 18,738
Research, development and engineering r 5,673 5,077 4,750
Intellectual property and custom development income (1,169) (1,168) (1,100)
Other (income) and expense (23) 238 227
Interest expense k&l 139 145 145
Total Expense and Other Income 24,004 22,144 22,760
Income from Continuing Operations Before Income Taxes 12,028 10,874 7,524
Provision for income taxes p 3,580 3,261 2,190
Income from Continuing Operations 8,448 7,613 5,334

Discontinued Operations:
Loss from discontinued operations c 18 30 1,755
Net Income $«««8,430 $«««7,583 $«««3,579
40
CONSOLIDATED STATEMENT OF EARNINGS (continued)
FOR THE YEAR ENDED DECEMBER 31: Notes 2004 2003 2002
Earnings/(Loss) per Share of Common Stock:

Assuming Dilution:
Continuing operations t $«««««4.94 $«««««4.34 $«««««3.07
Discontinued operations t (0.01) (0.02) (1.01)
Total t $«««««4.93 $«««««4.32 $«««««2.06
Basic:
Continuing operations t $«««««5.04 $«««««4.42 $«««««3.13
Discontinued operations t (0.01) (0.02) (1.03)
Total t $«««««5.03 $«««««4.40 $«««««2.10
Weighted-Average Number of Common Shares Outstanding:

Assuming dilution 1,708,872,279 1,756,090,689 1,730,941,054
Basic 1,674,959,086 1,721,588,628 1,703,244,345
The accompanying notes on pages 49 through 91 are an integral part of the financial statements.
41
CONSOLIDATED STATEMENT OF FINANCIAL POSITION

AT DECEMBER 31: Notes 2004 2003*
Assets
Current assets:
Cash and cash equivalents $«««10,053 $«««««7,290
Marketable securities d 517 357
Notes and accounts receivable — trade (net of allowances of $277 in 2004 and $352 in 2003) 10,522 10,026
Short-term financing receivables (net of allowances of $681 in 2004 and $733 in 2003) f 15,801 17,583
Other accounts receivable (net of allowances of $13 in 2004 and $16 in 2003) 1,813 1,314
Inventories e 3,316 2,942
Deferred taxes p 2,229 2,542
Prepaid expenses and other current assets 2,719 2,608
Total current assets 46,970 44,662
Plant, rental machines and other property g 36,385 36,153

Less: Accumulated depreciation g 21,210 21,464
Plant, rental machines and other property — net g 15,175 14,689
Long-term financing receivables f 10,950 10,741

Prepaid pension assets w 20,394 18,426
Investments and sundry assets h 5,468 7,294
Goodwill i 8,437 6,921
Intangible assets — net i 1,789 1,724
Total Assets $«109,183 $«104,457
42
CONSOLIDATED STATEMENT OF FINANCIAL POSITION (continued)
AT DECEMBER 31: Notes 2004 2003*
Liabilities and Stockholders’ Equity

Current liabilities:
Taxes p $«««««4,728 $«««««5,475
Short-term debt k&l 8,099 6,646
Accounts payable 9,444 8,460
Compensation and benefits 3,804 3,671
Deferred income 7,175 6,492
Other accrued expenses and liabilities 6,548 6,879
Total current liabilities 39,798 37,623
Long-term debt k&l 14,828 16,986

Retirement and nonpension postretirement benefit obligations w 15,883 14,251
Other liabilities m 8,927 7,733
Total Liabilities 79,436 76,593
Contingencies and commitments o

Stockholders’ equity: n
Common stock, par value $.20 per share and additional paid-in capital 18,355 16,269
Shares authorized: 4,687,500,000
Shares issued (2004—1,962,687,087; 2003—1,937,393,604)
Retained earnings 44,525 37,525
Treasury stock, at cost (shares: 2004—317,094,633; 2003—242,884,969) (31,072) (24,034)
Accumulated gains and (losses) not affecting retained earnings (2,061) (1,896)
Total Stockholders’ Equity 29,747 27,864
Total Liabilities and Stockholders’ Equity $«109,183 $«104,457

43
CONSOLIDATED STATEMENT OF CASH FLOWS

FOR THE YEAR ENDED DECEMBER 31: 2004 2003* 2002*
Cash Flow from Operating Activities from Continuing Operations:

Income from continuing operations $««8,448 $««7,613 $««5,334
Adjustments to reconcile income from continuing operations
to cash provided by operating activities:
Depreciation 3,959 3,961 3,691
Amortization of intangibles 956 955 802
Deferred income taxes 2,081 1,126 (67)
Net gain on assets sales and other (420) (275) (343)
Other than temporary declines in securities and other investments 20 50 58
Noncash portion of special actions — — 1,350
Change in operating assets and liabilities, net of acquisitions/divestitures:
Receivables 2,613 2,024 4,125
Inventories (291) 293 793
Pension assets (1,284) (1,409) (4,227)
Other assets (200) (567) (44)
Accounts payable 411 617 (55)
Pension liabilities (584) (286) 83
Other liabilities (303) 467 2,288
Net Cash Provided by Operating Activities from Continuing Operations 15,406 14,569 13,788
Cash Flow from Investing Activities from Continuing Operations:

Payments for plant, rental machines and other property (4,368) (4,393) (4,753)
Proceeds from disposition of plant, rental machines and other property 1,311 1,039 775
Investments in software (688) (581) (597)
Purchases of marketable securities and other investments (8,718) (6,471) (1,582)
Proceeds from disposition of marketable securities and other investments 8,830 7,023 1,185
Divestiture of businesses 25 97 1,233
Acquisition of businesses (1,738) (1,836) (3,158)
Net Cash Used in Investing Activities from Continuing Operations (5,346) (5,122) (6,897)
44
CONSOLIDATED STATEMENT OF CASH FLOWS (continued)
FOR THE YEAR ENDED DECEMBER 31: 2004 2003* 2002*
Cash Flow from Financing Activities from Continuing Operations:

Proceeds from new debt 2,438 1,573 6,726
Short-term borrowings/(repayments) less than 90 days — net 1,073 777 (4,087)
Payments to settle debt (4,538) (5,831) (5,812)
Common stock transactions — net (5,418) (3,232) (3,087)
Cash dividends paid (1,174) (1,085) (1,005)
Net Cash Used in Financing Activities from Continuing Operations (7,619) (7,798) (7,265)
Effect of exchange rate changes on cash and cash equivalents 405 421 148
Net cash used in discontinued operations (83) (162) (722)
Net change in cash and cash equivalents 2,763 1,908 (948)

Cash and cash equivalents at January 1 7,290 5,382 6,330
Cash and Cash Equivalents at December 31 $«10,053 $«7,290 $«5,382
Supplemental Data:
Cash paid during the year:
Income taxes $«««1,837 $«1,707 $«1,841
Interest $««««««705 $««««853 $««««831
Noncash Investing and Financing Activities:

In 2002, the noncash portion of the purchase price paid to PwCC is a significant noncash investing activity. This transaction is described on pages 59 and 60.

45
CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY

Common Accumulated
Stock Gains and
and (Losses) Not
Additional Affecting
Paid-in Retained Treasury Retained
Capital Earnings Stock Earnings Total
2002
Stockholders’ equity, January 1, 2002 $«14,248 $«30,142 $«(20,114) $««««(828) $«23,448
Net income plus gains and (losses) not affecting retained earnings:
Net income 3,579 $«««3,579
Gains and (losses) not affecting retained earnings (net of tax):
Net unrealized losses on SFAS No. 133 cash flow hedge derivatives during 2002
(net of tax benefit of $372) (659) (659)
Foreign currency translation adjustments (net of tax benefit of $197) 850 850
Minimum pension liability adjustment (net of tax benefit of $1,574) (2,765) (2,765)
Net unrealized losses on marketable securities (net of tax benefit of $8) (16) (16)
Total gains and (losses) not affecting retained earnings (2,590)
Subtotal: Net income plus gains and (losses) not affecting retained earnings $««««««989
Cash dividends declared — common stock (1,005) (1,005)

Common stock issued under employee plans (7,255,995 shares) 440 4 444
Purchases (189,797 shares) and sales (12,873,502 shares) of treasury stock
under employee plans — net (475) 1,311 836
Other treasury shares purchased, not retired (48,481,100 shares) (4,212) (4,212))
Treasury shares issued to fund the U.S. pension fund (24,037,354 shares) (576) 2,447 1,871
Shares issued/to be issued in the PwCC acquisition (3,677,213 shares issued) 43 (114) 355 284
Decrease in shares remaining to be issued in acquisition (9) (9)
Tax effect — stock transactions 136 136
Stockholders’ equity, December 31, 2002 $«14,858 $«31,555 $«(20,213) $«(3,418) $«22,782
46
Common Accumulated
Stock Gains and
and (Losses) Not
2003
Stockholders’ equity, January 1, 2003 $«14,858 $«31,555 $«(20,213) $«(3,418) $«22,782
Net income 7,583 $«««7,583
Foreign currency translation adjustments (net of tax benefit of $125) 1,768 1,768
Minimum pension liability adjustment (net of tax benefit of $124) (162) (162)
Net unrealized gains on marketable securities (net of tax expense of $3) 7 7
Total gains and (losses) not affecting retained earnings 1,522
Subtotal: Net income plus gains and (losses) not affecting retained earnings $«««9,105

Common stock issued under employee plans (16,445,473 shares) 1,205 (282) 923
under employee plans — net (246) 582 336
Other treasury shares purchased, not retired (49,994,514 shares) (4,403) (4,403)
Shares to be issued in the PwCC acquisition 8 8
47

Common Accumulated
Stock Gains and
and (Losses) Not
2004
Stockholders’ equity, January 1, 2004 $«16,269 $«37,525 $«(24,034) $«(1,896) $«27,864
Net income 8,430 $«««8,430
Foreign currency translation adjustments (net of tax benefit of $93) 1,055 1,055
Minimum pension liability adjustment (net of tax benefit of $540) (1,066) (1,066)
Net unrealized gains on marketable securities (net of tax expense of $30) 45 45
Total gains and (losses) not affecting retained earnings (165)
Subtotal: Net income plus gains and (losses) not affecting retained earnings $«««8,265

Common stock issued under employee plans (25,293,484 shares) 1,815 (129) 1,686
under employee plans — net (127) 237 110
Other treasury shares purchased, not retired (78,562,974 shares) (7,275) (7,275)
48
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
a. Significant Accounting Policies client and client acceptance has been obtained, client acceptance provisions have lapsed,
or the company has objective evidence that the criteria specified in the client acceptance
basis of presentation
provisions have been satisfied. The sales price is not considered to be fixed or determinable
On December 31, 2002, the International Business Machines Corporation (IBM and/or the
until all contingencies related to the sale have been resolved.
company) sold its hard disk drive (HDD) business to Hitachi, Ltd. (Hitachi). See note c,
The company reduces revenue for estimated client returns, stock rotation, price pro-
“Acquisitions/Divestitures,” on pages 60 and 61. The HDD business was part of the com-
tection, rebates and other similar allowances. (See Schedule II, ”Valuation and Qualifying
pany’s Systems and Technology Group reporting segment. The HDD business was
Accounts and Reserves” included in the company’s Annual Report on Form 10-K). Revenue
accounted for as a discontinued operation under accounting principles generally accepted
is recognized only if these estimates can be reliably determined and if the client has eco-
in the United States of America (GAAP) and therefore, the HDD results of operations and
nomic substance apart from the company. The company bases its estimates on historical
cash flows have been removed from the company’s results of continuing operations and
results taking into consideration the type of client, the type of transaction and the specifics
cash flows for all periods presented in this document. The financial results reported as
of each arrangement. Payments made under cooperative marketing programs are recog-
discontinued operations include the external original equipment manufacturer (OEM) HDD
nized as an expense only if the company receives from the client an identifiable benefit
business and charges related to HDDs used in the company’s eServer and Storage prod-
sufficiently separable from the product sale whose fair value can be reasonably estimated.
ucts that were reported in the Systems and Technology Group segment. The discontinued
If the company does not receive an identifiable benefit sufficiently separable from the
operations results do not reflect HDD shipments to the company’s internal customers.
product sale whose fair value can be reasonably estimated, such payments are recorded
principles of consolidation as a reduction of revenue.
The Consolidated Financial Statements include the accounts of IBM and its controlled In addition to the aforementioned general policies, the following are the specific rev-
subsidiary companies, which in general are majority-owned. The accounts of variable enue recognition policies for multiple-element arrangements and for each major category
interest entities (VIEs) as defined by the Financial Accounting Standards Board (FASB) of revenue.
Interpretation No. 46(R) (FIN 46(R)) (see note b, “Accounting Changes,” on page 56), are
Multiple-Element Arrangements
included in the Consolidated Financial Statements, if applicable. Investments in business
The company enters into multiple-element revenue arrangements, which may include any
entities in which the company does not have control, but has the ability to exercise signifi-
combination of services, software, hardware and/or financing. To the extent that a deliver-
cant influence over operating and financial policies (generally 20-50 percent ownership),
able(s) in a multiple-element arrangement is subject to specific guidance (like software
are accounted for using the equity method. The accounting policy for other investments
that is subject to the American Institute of Certified Public Accountants (AICPA) Statement
in securities is described on page 54 within “Marketable Securities.” Other investments are
of Position (SOP) No. 97-2, “Software Revenue Recognition”— see “Software” on pages 50
accounted for using the cost method.
and 51) on whether and/or how to separate multiple-deliverable arrangements into sep-
use of estimates arate units of accounting (separability) and how to allocate value among those separate
The preparation of Consolidated Financial Statements in conformity with GAAP requires units of accounting (allocation), that deliverable(s) is accounted for in accordance with
management to make estimates and assumptions that affect the amounts that are reported such specific guidance. For all other deliverables in multiple-element arrangements, the
in the Consolidated Financial Statements and accompanying disclosures. Although these guidance below is applied for separability and allocation. A multiple-element arrangement
estimates are based on management’s best knowledge of current events and actions that is separated into more than one unit of accounting if all of the following criteria are met.
the company may undertake in the future, actual results may be different from the estimates. • The delivered item(s) has value to the client on a standalone basis.
revenue • There is objective and reliable evidence of the fair value of the undelivered item(s).
The company recognizes revenue when it is realized or realizable and earned. The com- • If the arrangement includes a general right of return relative to the delivered item(s),
pany considers revenue realized or realizable and earned when it has persuasive evidence delivery or performance of the undelivered item(s) is considered probable and
of an arrangement, delivery has occurred, the sales price is fixed or determinable, and substantially in the control of the company.
collectibility is reasonably assured. Delivery does not occur until products have been
shipped or services have been provided to the client, risk of loss has transferred to the
49

If these criteria are not met, revenue is deferred until the earlier of when such criteria In some of the company’s services contracts, the company bills the client prior to per-
are met or when the last undelivered element is delivered. If there is objective and reliable forming the services. Deferred income of $3.9 billion and $3.3 billion at December 31,
evidence of fair value for all units of accounting in an arrangement, the arrangement con- 2004 and 2003, respectively, is included in the Consolidated Statement of Financial Position.
sideration is allocated to the separate units of accounting based on each unit’s relative fair In other services contracts, the company performs the services prior to billing the client.
value. There may be cases, however, in which there is objective and reliable evidence of Unbilled accounts receivable of $1.9 billion and $1.8 billion at December 31, 2004 and
fair value of the undelivered item(s) but no such evidence for the delivered item(s). In 2003, respectively, are included in Notes and accounts receivable — trade in the
those cases, the residual method is used to allocate the arrangement consideration. Under Consolidated Statement of Financial Position. Billings usually occur in the month after the
the residual method, the amount of consideration allocated to the delivered item(s) equals company performs the services or in accordance with specific contractual provisions.
the total arrangement consideration less the aggregate fair value of the undelivered Unbilled receivables are expected to be billed and collected generally within four months,
item(s). The revenue policies described below are then applied to each unit of accounting, rarely exceeding nine months.
as applicable.
Hardware
Services Revenue from hardware sales or sales-type leases is generally recognized when the product
The company’s primary services offerings include information technology (IT) datacenter is shipped to the client and when there are no unfulfilled company obligations that affect
and business process transformation outsourcing, application management services, the client’s final acceptance of the arrangement. Any cost of warranties and remaining
technology infrastructure and system maintenance, Web hosting, and the design and obligations that are inconsequential or perfunctory are accrued when the corresponding
development of complex IT systems to a client’s specifications (Design and Build). These revenue is recognized. Revenue from rentals and operating leases is recognized on a
services are provided on a time and material basis, as a fixed-price contract or as a fixed straight-line basis over the term of the rental or lease.
price per measure of output contract, and the contract terms generally range from less
Software
than one year to ten years.
Revenue from perpetual (one-time charge) licensed software is recognized at the inception
Revenue from IT datacenter and business process outsourcing contracts is generally
of the license term. Revenue from term (monthly license charge) arrangements is recog-
recognized in the period the services are provided using either an objective measure of
nized on a subscription basis over the period that the client is using the license. Revenue
output or a straight-line basis over the term of the contract. Under the output method, the
from maintenance, unspecified upgrades and technical support is recognized over the
amount of revenue recognized is based on the services delivered in the period as stated
period such items are delivered. In multiple-element revenue arrangements that include
in the contract.
software that is more than incidental to the products or services as a whole (software mul-
Revenue from application management services, technology infrastructure and system
tiple-element arrangements), software and software-related elements are accounted for in
maintenance, and Web hosting contracts is typically recognized on a straight-line basis
accordance with the following policies. Software-related elements include software products
over the term of the contract. Revenue from time and material contracts is recognized at
and services as well as any non-software deliverable(s) for which a software deliverable is
the contractual rates as labor hours are delivered and direct expenses are incurred.
essential to its functionality.
Revenue related to extended warranty and product maintenance contracts is deferred and
A software multiple-element arrangement is separated into more than one unit of
recognized on a straight-line basis over the delivery period.
accounting if all of the following criteria are met:
Revenue from fixed-price Design and Build contracts is recognized in accordance with
SOP No. 81-1, “Accounting for Performance of Construction-Type and Certain Production- • The functionality of the delivered element(s) is not dependent on the undelivered
Type Contracts,” generally under the percentage-of-completion (POC) method. Under the element (s).
POC method, revenue is recognized based on the costs incurred to date as a percentage • There is vendor-specific objective evidence (VSOE) of fair value of the undelivered
of the total estimated costs to fulfill the contract. If circumstances arise that may change element (s).
the original estimates of revenues, costs, or extent of progress toward completion, then
• Delivery of the delivered element(s) represents the culmination of the earnings
revisions to the estimates are made. These revisions may result in increases or decreases
process for that element (s).
in estimated revenues or costs, and such revisions are reflected in income in the period in
which the circumstances that give rise to the revision become known by management.
The company performs ongoing profitability analyses of its services contracts in order
to determine whether the latest estimates — revenue, costs, profits — require updating. If, at
any time, these estimates indicate that the contract will be unprofitable, the entire esti-
mated loss for the remainder of the contract is recorded immediately.
50
If these criteria are not met, the revenue is deferred until the earlier of when such In situations in which an outsourcing contract is terminated, the terms of the contract
criteria are met or when the last undelivered element is delivered. If there is VSOE for all may require the client to reimburse the company for the recovery of unamortized deferred
units of accounting in an arrangement, the arrangement consideration is allocated to the costs, to purchase specific assets utilized in the delivery of services, and to pay any addi-
separate units of accounting based on each unit’s relative VSOE. There may be cases, tional costs incurred by the company to transition the services.
however, in which there is VSOE of the undelivered item(s) but no such evidence for the
expense and other income
delivered item(s). In these cases, the residual method is used to allocate the arrangement
Selling, General and Administrative
consideration. Under the residual method, the amount of consideration allocated to the
Selling, general and administrative (SG&A) expense is charged to income as incurred.
delivered item(s) equals the total arrangement consideration less the aggregate VSOE of
Expenses of promoting and selling products and services are classified as selling expense
the undelivered elements.
and include such items as advertising, sales commissions and travel. General and admin-
Financing istrative expense includes such items as officers’ salaries, office supplies, non-income taxes,
Finance income attributable to sales-type leases, direct financing leases and loans is recog- insurance and office rental. In addition, general and administrative expense includes other
nized at level rates of return over the terms of the leases or loans. Operating lease income operating items such as a provision for doubtful accounts, workforce accruals for contrac-
is recognized on a straight-line basis over the term of the lease. tually obligated payments to employees terminated in the ongoing course of business,
amortization of certain intangible assets and environmental remediation costs. Certain
services cost
special actions discussed in note s, “2002 Actions,” on pages 73 through 76 are also included
Recurring operating costs for outsourcing contracts, including costs related to bid and
in SG&A.
proposal activities, are expensed as incurred. Nonrecurring costs incurred in the initial
phases of outsourcing contracts are deferred and subsequently amortized. These costs Research, Development and Engineering
consist of transition and set-up costs related to the installation of systems and processes Research, development and engineering (RD&E) costs are expensed as incurred.
and are amortized on a straight-line basis over the expected period of benefit, not to
Intellectual Property and Custom Development Income
exceed the term of the contract. Additionally, fixed assets associated with outsourcing
As part of the company’s business model and as a result of the company’s ongoing invest-
contracts are capitalized and depreciated on a straight-line basis over the expected use-
ment in research and development (R&D), the company licenses and sells the rights to certain
ful life of the asset. If an asset is contract-specific, then the depreciation period is the
of its intellectual property (IP) including internally developed patents, trade secrets and
shorter of the useful life of the asset or the contract term. Amounts paid to clients in excess
technological know-how. Certain transfers of IP to third parties are licensing/royalty-based
of the fair value of acquired assets used in outsourcing arrangements are deferred and
and other transfers are transaction-based sales and other transfers. Licensing/royalty-
amortized on a straight-line basis as a reduction of revenue over the expected period of
based fees involve transfers in which the company earns the income over time, or the
benefit not to exceed the term of the contract. The company performs periodic reviews to
amount of income is not fixed or determinable until the licensee sells future related products
assess the recoverability of deferred contract transition and set-up costs. This review is
(i.e., variable royalty, based upon licensee’s revenue). Sales and other transfers typically
done by comparing the estimated minimum remaining undiscounted cash flows of a con-
include transfers of IP whereby the company has fulfilled its obligations and the fee received
tract to the unamortized contract costs. If such minimum undiscounted cash flows are not
is fixed or determinable. The company also enters into cross-licensing arrangements of
sufficient to recover the unamortized costs, a loss is recognized for the excess of the
patents, and income from these arrangements is recorded only to the extent cash is
unamortized costs over the minimum discounted cash flows.
received. Furthermore, the company earns income from certain custom development
Deferred services transition and set-up costs were $628 million and $556 million at
projects for strategic technology partners and specific clients. The company records the
December 31, 2004 and December 31, 2003, respectively. The primary driver of the
income from these projects when the fee is earned, is not refundable, and is not depend-
increase year to year was the continued growth of the company’s Business Consulting
ent upon the success of the project.
Services (BCS) business. Deferred amounts paid to clients in excess of the fair value of
acquired assets used in outsourcing arrangements and other contract origination loans
provided to clients were $353 million and $304 million at December 31, 2004 and
December 31, 2003, respectively. The primary driver of the increase year to year was the
continued growth of the company’s Strategic Outsourcing Services (SO) business.
51

Other (Income) and Expense The following table summarizes the pro forma operating results of the company, had
Other (income) and expense includes interest income (other than from the company’s compensation expense for stock options granted and for employee stock purchases
Global Financing external business transactions), gains and losses from securities and under the ESPP (see note v, “Stock-Based Compensation Plans” on pages 77 and 78), been
other investments, realized gains and losses from certain real estate activity, and foreign determined in accordance with the fair value method prescribed by Statement of Financial
currency transaction gains and losses, and gains and losses from the sale of businesses. Accounting Standards (SFAS) No. 123, “Accounting for Stock-Based Compensation.”
Certain special actions discussed in note s, “2002 Actions” on pages 73 through 76 are
also included in Other (income) and expense.
FOR THE YEAR ENDED DECEMBER 31: 2004 2003 2002
depreciation and amortization Net income as reported $«8,430 $«7,583 $«3,579
Plant, rental machines and other property are carried at cost and depreciated over their Add: Stock-based employee compensation
estimated useful lives using the straight-line method. Asset retirement obligations (ARO) expense included in reported net income,
liabilities are legal obligations associated with the retirement of long-lived assets. These net of related tax effects 129 76 112
liabilities are initially recorded at fair value and the carrying amount of the related assets Deduct: Total stock-based employee compensation
is increased by the same amount. These incremental carrying amounts are depreciated expense determined under the fair value method
over the useful lives of the related assets. for all awards, net of related tax effects 1,080 1,101 1,315
The estimated useful lives of depreciable properties generally are as follows: buildings, Pro forma net income $«7,479 $«6,558 $«2,376
50 years; building equipment, 20 years; land improvements, 20 years; plant, laboratory
and office equipment, 2 to 15 years; and computer equipment, 1.5 to 5 years. Earnings per share of common stock:
Capitalized software costs incurred or acquired after technological feasibility has Basic — as reported $«««5.03 $«««4.40 $«««2.10
been established are amortized over periods up to three years. Capitalized costs for inter- Basic — pro forma $«««4.47 $«««3.81 $«««1.40
nal-use software are amortized on a straight-line basis over 2 years. (See “Software Costs” Assuming dilution — as reported $«««4.93 $«««4.32 $«««2.06
on page 55 for additional information.) Other intangible assets are amortized over peri- Assuming dilution — pro forma $«««4.38 $«««3.74 $«««1.39
ods up to 7 years.
The pro forma amounts that are disclosed in accordance with SFAS No. 123 reflect the
retirement-related benefits
portion of the estimated fair value of awards that was earned for the years ended Decem-
See note w, “Retirement-Related Benefits,” on pages 78 through 86 for the company’s
ber 31, 2004, 2003 and 2002.
accounting policy for retirement-related benefits.
The fair value of stock option grants is estimated using the Black-Scholes option-pricing
stock-based compensation model with the following assumptions:
The company applies Accounting Principles Board (APB) Opinion No. 25, “Accounting for
Stock Issued to Employees,” and related interpretations in accounting for its stock-based
compensation plans. Accordingly, the company records expense for grants of employee Option term (years) * 5 5 5
stock-based compensation awards equal to the excess of the market price of the underly- Volatility ** 37.8% 39.9% 40.4%
ing IBM shares at the date of grant over the exercise price of the stock-related award, if any Risk-free interest rate (zero coupon U.S. treasury note) 3.5% 2.9% 2.8%
(known as the intrinsic value). Generally, all employee stock options are issued with an Dividend yield 0.8% 0.7% 0.7%
exercise price equal to or greater than the market price of the underlying IBM shares at the Weighted-average fair value per option granted $«««34 $«««30 $«««28
grant date and therefore, no compensation expense is recorded. In addition, no compen- * The Option term is the number of years that the company estimates, based upon history, that options will be out-
sation expense is recorded for purchases under the Employees Stock Purchase Plan (ESPP) standing prior to exercise or forfeiture.
in accordance with APB Opinion No. 25. This plan is described on page 78. The intrinsic ** To determine volatility, the company measures the daily price changes of the stock over the option term.
value of restricted stock units and certain other stock-based compensation issued to
employees as of the date of grant is amortized to compensation expense over the vesting In December 2004, the FASB issued SFAS No. 123(R), “Share-based Payment,” which will
period of the grant. To the extent awards contain performance criteria that could result in require companies to expense costs related to share-based awards in 2005. See note b,
an employee receiving more or fewer (including zero) shares than the number of units “Accounting Changes” on page 55 for further discussion.
granted, the unamortized compensation expense is remeasured during the performance
period based upon the intrinsic value at the end of each reporting period.
52
income taxes The company applies hedge accounting in accordance with SFAS No. 133, whereby
Income tax expense is based on reported income before income taxes. Deferred income the company designates each derivative as a hedge of: (1) the fair value of a recognized
taxes reflect the effect of temporary differences between asset and liability amounts that asset or liability or of an unrecognized firm commitment (“fair value” hedge); (2) the vari-
are recognized for financial reporting purposes and the amounts that are recognized for ability of anticipated cash flows of a forecasted transaction or the cash flows to be received
income tax purposes. These deferred taxes are measured by applying currently enacted or paid related to a recognized asset or liability (“cash flow” hedge); or (3) a hedge of a
tax laws. Valuation allowances are recognized to reduce deferred tax assets to the amount long-term investment (“net investment” hedge) in a foreign operation. From time to time,
that will more likely than not be realized. In assessing the likelihood of realization, manage- however, the company may enter into derivative arrangements that economically hedge
ment considers estimates of future taxable income. certain of its risks, even though hedge accounting does not apply under SFAS No. 133 or
the company elects not to apply hedge accounting under SFAS No. 133. In these cases,
translation of non-u.s. currency amounts
there generally exists a natural hedging relationship in which changes in the fair value of
Assets and liabilities of non-U.S. subsidiaries that operate in a local currency environment
the derivative, which are recognized currently in net income, act as an economic offset to
are translated to U.S. dollars at year-end exchange rates. Income and expense items are
changes in the fair value of the underlying hedged item(s).
translated at weighted-average rates of exchange prevailing during the year. Translation
Changes in the fair value of a derivative that is designated as a fair value hedge, along
adjustments are recorded in Accumulated gains and (losses) not affecting retained earn-
with offsetting changes in the fair value of the underlying hedged exposure, are recorded
ings within Stockholders’ equity.
in earnings each period. For hedges of interest rate risk, the fair value adjustments are
Inventories, Plant, rental machines and other property-net, and other non-monetary
recorded as adjustments to Interest expense and Cost of Global Financing in the Consoli-
assets and liabilities of non-U.S. subsidiaries and branches that operate in U.S. dollars, or
dated Statement of Earnings. For hedges of currency risk associated with recorded assets
whose economic environment is highly inflationary, are translated at approximate exchange
or liabilities, derivative fair value adjustments generally are recognized in Other (income)
rates prevailing when the company acquired the assets or liabilities. All other assets and
and expense in the Consolidated Statement of Earnings. Changes in the fair value of a
liabilities are translated at year-end exchange rates. Cost of sales and depreciation are
derivative that is designated as a cash flow hedge are recorded, net of applicable taxes, in
translated at historical exchange rates. All other income and expense items are translated
the Accumulated gains and (losses) not affecting retained earnings, a component of
at the weighted-average rates of exchange prevailing during the year. Gains and losses
Stockholders’ equity. When net income is affected by the variability of the underlying cash
that result from translation are included in net income.
flow, the applicable offsetting amount of the gain or loss from the derivative that is deferred
derivatives in Stockholders’ equity is released to net income and reported in Interest expense, Cost,
All derivatives are recognized in the Consolidated Statement of Financial Position at fair SG&A expense or Other (income) and expense in the Consolidated Statement of Earnings
value and are reported in Prepaid expenses and other current assets, Investments and based on the nature of the underlying cash flow hedged. Effectiveness for net investment
sundry assets, Other accrued expenses and liabilities or Other liabilities. Classification of each hedging derivatives is measured on a spot-to-spot basis. The effective portions of changes
derivative as current or non-current is based upon whether the maturity of the instrument in the fair value of net investment hedging derivatives and other non-derivative risk
is less than or greater than 12 months. To qualify for hedge accounting in accordance with management instruments designated as net investment hedges are recorded as foreign
SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” as amended currency translation adjustments, net of applicable taxes, in the Accumulated gains and
by SFAS No. 138, “Accounting for Certain Derivative Instruments and Certain Hedging (losses) not affecting retained earnings section of Stockholders’ equity. Changes in the fair
Activities,” and SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments value of the portion of a net investment hedging derivative excluded from the effective-
and Hedging Activities,” (SFAS No. 133), the company requires that the instruments be ness assessment are recorded in Interest expense.
effective in reducing the risk exposure that they are designated to hedge. For instruments When the underlying hedged item ceases to exist, all changes in the fair value of the
that hedge cash flows, hedge effectiveness criteria also require that it be probable that the derivative are included in net income each period until the instrument matures. When the
underlying transaction will occur. Instruments that meet established accounting criteria are derivative transaction ceases to exist, a hedged asset or liability is no longer adjusted for
formally designated as hedges at the inception of the contract. These criteria demonstrate changes in its fair value except as required under other relevant accounting standards.
that the derivative is expected to be highly effective at offsetting changes in fair value or Derivatives that are not designated as hedges, as well as changes in the fair value of deriv-
cash flows of the underlying exposure both at inception of the hedging relationship atives that do not effectively offset changes in the fair value of the underlying hedged item
and on an ongoing basis. The assessment of hedge effectiveness and ineffectiveness is throughout the designated hedge period (collectively, “ineffectiveness”), are recorded in
formally documented at hedge inception and reviewed at least quarterly throughout the net income each period and generally are reported in Other (income) and expense.
designated hedge period.
53

The company generally reports cash flows arising from the company’s derivative inventories
financial instruments consistent with the classification of cash flows from the underlying Raw materials, work in process and finished goods are stated at the lower of average cost
hedged items that the derivatives are hedging. Accordingly, the majority of cash flows or net realizable value.
associated with the company’s derivative programs are classified in Cash flows from operat-
ing activities in the Consolidated Statement of Cash Flows. For currency swaps designated allowance for uncollectible receivables
Trade
as hedges of foreign currency denominated debt (included in the company’s debt risk
management program as addressed in note l, “Derivatives and Hedging Transactions” on An allowance for uncollectible trade receivables is recorded based on a combination of
pages 65 to 67), cash flows directly associated with the settlement of the principal element write-off history, aging analysis, and any specific, known troubled accounts.
of these swaps are reported in Payments to settle debt in the Cash flow from financing Financing
activities section of the Consolidated Statement of Cash Flows. Financing receivables include sales-type leases, direct financing leases, and loans. Below
are the methodologies the company uses to calculate both its specific and its unallocated
financial instruments
reserves, which are applied consistently to its different portfolios.
In determining 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 Specific. The company reviews all financing accounts receivable considered at risk on a
sheet date. For the majority of financial instruments, including most derivatives, long-term quarterly basis. The review primarily consists of an analysis based upon current information
investments and long-term debt, standard market conventions and techniques such as available about the client, such as financial statements, news reports and published credit
discounted cash flow analysis, option-pricing models, replacement cost and termination ratings, as well as the current economic environment, collateral net of repossession cost
cost are used to determine fair value. Dealer quotes are used for the remaining financial and prior history. For loans that are collateral dependent, impairment is measured using
instruments. All methods of assessing fair value result in a general approximation of value, the fair value of the collateral when foreclosure is probable. Using this information, the
and such value may never actually be realized. company determines the expected cash flow for the receivable and calculates a recom-
mended estimate of the potential loss and the probability of loss. For those accounts in
cash equivalents
which the loss is probable, the company records a specific reserve.
All highly liquid investments with maturities of three months or less at the date of purchase
are carried at fair value and considered to be cash equivalents. Unallocated. The company records an unallocated reserve that is calculated by applying a
reserve rate to its different portfolios, excluding accounts that have been specifically
marketable securities
reserved. This reserve rate is based upon credit rating, probability of default, term, asset
Marketable securities included in Current assets represent securities with a maturity of
characteristics, and loss history.
less than one year. The company also has marketable securities, including non-equity
Receivable losses are charged against the allowance when management believes the
method alliance investments, with a maturity of more than one year. These non-current
uncollectibility of the receivable is confirmed. Subsequent recoveries, if any, are credited
investments are included in Investments and sundry assets. The company’s marketable
to the allowance.
securities, including certain non-equity method alliance investments, are considered
Certain receivables for which the company recorded specific reserves may also be
available for sale and are reported at fair value with changes in unrealized gains and losses,
placed on nonaccrual status. Nonaccrual assets are those receivables (impaired loans or
net of applicable taxes, recorded in Accumulated gains and (losses) not affecting retained
nonperforming leases) with specific reserves and other accounts for which it is likely that
earnings within Stockholders’ equity. Realized gains and losses are calculated based on
the company will be unable to collect all amounts due according to original terms of the
the specific identification method. Other-than-temporary declines in market value from
lease or loan agreement. Income recognition is discontinued on these receivables.
original cost are charged to Other (income) and expense in the period in which the loss
Receivables may be removed from nonaccrual status, if appropriate, based upon changes
occurs. In determining whether an other-than-temporary decline in the market value has
in client circumstances.
occurred, the company considers the duration that, and extent to which, market value is
below original cost. Realized gains and losses also are included in Other (income) and
expense in the Consolidated Statement of Earnings. All other investment securities not
described above or in “Principles of Consolidation” on page 49, primarily non-publicly
traded equity securities, are accounted for using the cost method.
54
estimated residual values of lease assets common stock

The recorded residual values of the company’s lease assets are estimated at the inception Common stock refers to the $.20 par value capital stock as designated in the company’s
of the lease to be the expected fair value of the assets at the end of the lease term. The Certificate of Incorporation. Treasury stock is accounted for using the cost method.
company periodically reassesses the realizable value of its lease residual values. Any When treasury stock is reissued, the value is computed and recorded using a weighted-
anticipated increases in specific future residual values are not recognized before realiza- average basis.
tion through remarketing efforts. Anticipated decreases in specific future residual values
earnings per share of common stock
that are considered to be other than temporary are recognized immediately upon iden-
Earnings per share of common stock — basic is computed by dividing Net income by the
tification and are recorded as an adjustment to the residual value estimate. For sales-type
weighted-average number of common shares outstanding for the period. Earnings per
and direct financing leases, this reduction lowers the recorded net investment and is rec-
share of common stock — assuming dilution reflects the maximum potential dilution that
ognized as a loss charged to finance income in the period in which the estimate is changed,
could occur if securities or other contracts to issue common stock were exercised or
as well as an adjustment to unearned income to reduce future period finance income.
converted into common stock and would then share in the net income of the company.
software costs See note t, “Earnings Per Share of Common Stock,” on page 77 for additional information.
Costs that are related to the conceptual formulation and design of licensed programs are
expensed as incurred to R&D expense. Also for licensed programs, the company capital-
izes costs that are incurred to produce the finished product after technological feasibility b. Accounting Changes
has been established. Capitalized amounts are amortized using the straight-line method,
new standards to be implemented
which is applied over periods ranging up to three years. The company performs periodic
In December 2004, the FASB issued SFAS No. 123 (Revised 2004), “Share-based Payment”
reviews to ensure that unamortized program costs remain recoverable from future revenue.
that will require the company to expense costs related to share-based payment trans-
Costs to support or service licensed programs are charged to software cost as incurred.
actions with employees. With limited exceptions, SFAS No. 123(R) requires that the fair
The company capitalizes certain costs that are incurred to purchase or to create and
value of share-based payments to employees be expensed over the period service is
implement internal-use computer software, which includes software coding, installation,
received. SFAS No. 123(R) becomes mandatorily effective for the company on July 1, 2005.
testing and certain data conversion. Capitalized costs are amortized on a straight-line
The company intends to adopt this standard using the modified retrospective method of
basis over two years and are recorded in SG&A expense. See note i, “Intangible Assets
transition. This method requires that issued financial statements be restated based on the
including Goodwill” on page 63.
amounts previously calculated and reported in the pro forma footnote disclosures
product warranties required by SFAS No. 123.
The company offers warranties for its hardware products that range up to four years, with SFAS No. 123(R) allows the use of both closed form models (e.g., Black-Scholes Model)
the majority being either one or three years. The company estimates its warranty costs and open form models (e.g., lattice models) to measure the fair value of the share-based
based on historical warranty claim experience and applies this estimate to the revenue payment as long as that model is capable of incorporating all of the substantive charac-
stream for products under warranty. Future costs for warranties applicable to revenue teristics unique to share-based awards. In accordance with the transition provisions of
recognized in the current period are charged to cost of revenue. The warranty accrual is SFAS No. 123(R), the expense attributable to an award will be measured in accordance with
reviewed quarterly to verify that it properly reflects the remaining obligation based on the company’s measurement model at that award’s date of grant.
the anticipated expenditures over the balance of the obligation period. Adjustments The company believes the pro forma disclosures in note a, “Significant Accounting
are made when actual warranty claim experience differs from estimates. See note o, Policies,” on page 52 under “Stock-Based Compensation” provide an appropriate short-
“Contingencies and Commitments” on page 71. term indicator of the level of expense that will be recognized in accordance with SFAS No.
123(R). However, the total expense recorded in future periods will depend on several vari-
ables, including the number of shared-based awards that vest and the fair value of those
vested awards.
55

In December 2004, the FASB issued SFAS No. 153, “Exchanges of Nonmonetary Assets, however, it also required additional annual disclosures describing types of plan assets,
an amendment of APB Opinion No. 29” effective for nonmonetary asset exchanges occur- investment strategy, measurement date(s), expected employer contributions, plan obliga-
ring in the fiscal year beginning January 1, 2006. SFAS No. 153 requires that exchanges of tions, and expected benefit payments of defined benefit pension plans and other defined
productive assets be accounted for at fair value unless fair value cannot be reasonably benefit postretirement plans. In accordance with the transition provisions of SFAS No.
determined or the transaction lacks commercial substance. SFAS No. 153 is not expected 132(R), note w, “Retirement-Related Benefits,” on pages 78 through 86 has been expanded
to have a material effect on the company’s Consolidated Financial Statements. to include the new disclosures required as of December 31, 2003.
In November 2004, the FASB issued SFAS No. 151, “Inventory Costs, an amendment In January 2003, the FASB issued FASB Interpretation No. 46 (FIN 46), “Consolidation
of ARB No. 43, Chapter 4.” SFAS No. 151 requires certain abnormal expenditures to be of Variable Interest Entities,” and amended it by issuing FIN 46(R) in December 2003. FIN
recognized as expenses in the current period. It also requires that the amount of fixed 46(R) addresses consolidation by business enterprises VIEs that either: (1) do not have
production overhead allocated to inventory be based on the normal capacity of the pro- sufficient equity investment at risk to permit the entity to finance its activities without
duction facilities. The standard is effective for the fiscal year beginning January 1, 2006. additional subordinated financial support, or (2) have equity investors that lack an essen-
It is not expected that SFAS No. 151 will have a material effect on the company’s tial characteristic of a controlling financial interest.
Consolidated Financial Statements. As of December 31, 2003 and in accordance with the transition requirements of
FIN 46(R), the company chose to apply the guidance of FIN 46 to all of its interests in
standards implemented
special-purpose entities (SPEs) as defined within FIN 46(R) and all non-SPE VIEs that were
As noted on page 30, the new U.S. tax law provides a deduction for income from qualified
created after January 31, 2003. Also in accordance with the transition provisions of
domestic production activities, which will be phased in from 2005 through 2010. Under
FIN 46(R), the company adopted FIN 46(R) for all VIEs and SPEs as of March 31, 2004.
the guidance in FASB Staff Position (FSP) No. FAS 109-1, “Application of FASB Statement
These accounting pronouncements did not have a material impact on the company’s
No. 109, Accounting for Income Taxes, to the Tax Deduction on Qualified Production
Activities Provided by the American Jobs Creation Act of 2004,” issued in the fourth quar- Consolidated Financial Statements.
ter of 2004, the deduction will be treated as a “special deduction” as described in SFAS In 2003, the Emerging Issues Task Force (EITF) reached a consensus on two revenue
No. 109. As such, the company has not adjusted its deferred tax assets and liabilities as of recognition issues relating to the accounting for multiple-element arrangements: Issue No.
December 31, 2004 to reflect the impact of this special deduction. Rather, the impact of 00-21, “Accounting for Revenue Arrangements with Multiple Deliverables,” (EITF No. 00-21)
this deduction will be reported in the period for which the deduction is claimed on the and Issue No. 03-05, “Applicability of AICPA SOP 97-2 to Non-Software Deliverables in an
company’s U.S. federal income tax return. Arrangement Containing More Than Incidental Software” (EITF No. 03-05). The consensus
As discussed in note p, “Taxes” on pages 72 and 73, the new U.S. tax law enacted in opinion in EITF No. 03-05 clarifies the scope of both EITF No. 00-21 and SOP 97-2, and was
October 2004 creates a temporary incentive for the company to repatriate earnings accu- reached on July 31, 2003. The transition provisions allowed either prospective application
mulated outside the U.S. FSP No. FAS 109-2, “Accounting and Disclosure Guidance for the or a cumulative effect adjustment upon adoption. The company adopted the issues
Foreign Earnings Repatriation Provision within the American Jobs Creation Act of 2004,” prospectively as of July 1, 2003. EITF No. 00-21 and No. 03-05 did not have a material impact
issued in the fourth quarter of 2004, provides that an enterprise is allowed time beyond on the company’s Consolidated Financial Statements.
the financial reporting period of enactment to evaluate the effect of the new tax law on In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instru-
its plan for applying SFAS No. 109. The company has not yet completed its evaluation of ments with Characteristics of both Liabilities and Equity.” It establishes classification and
the possible effect of the new tax law on its plan for repatriation of foreign earnings for measurement standards for three types of freestanding financial instruments that have
purposes of applying SFAS No. 109. Accordingly, as provided for in FSP SFAS No. 109-2, characteristics of both liabilities and equity. Instruments within the scope of SFAS No. 150
the company has not adjusted its income tax expense or deferred tax liability as of must be classified as liabilities within the company’s Consolidated Financial Statements
December 31, 2004 to reflect the possible effect of the new repatriation provision. Income and be reported at settlement date value. The provisions of SFAS No. 150 are effective for
tax expense, if any, associated with any repatriation under the Act will be provided in the (1) instruments entered into or modified after May 31, 2003, and (2) pre-existing instruments
company’s financial statements in the quarter in which the required management and as of July 1, 2003. In November 2003, through the issuance of FSP No. FAS 150-3, the FASB
board approvals have been completed. indefinitely deferred the effective date of certain provisions of SFAS No. 150, including
In December 2003, the FASB revised SFAS No. 132, “Employers’ Disclosures about mandatorily redeemable instruments as they relate to minority interests in consolidated
Pensions and other Postretirement Benefits, an amendment of FASB Statements No. 87, 88 finite-lived entities. The adoption of SFAS No. 150, as modified by FSP No. FAS 150-3, did
and 106.” SFAS No. 132(R) retained all of the disclosure requirements of SFAS No. 132, not have a material effect on the Consolidated Financial Statements.
56
In April 2003, the FASB issued SFAS No. 149, “Amendment of Statement 133 on On January 1, 2003, the company adopted SFAS No. 143, “Accounting for Asset
Derivative Instruments and Hedging Activities.” SFAS No. 149 clarifies under what circum- Retirement Obligations,” which was issued in June 2001. SFAS No. 143 provides accounting
stances a contract with an initial net investment meets the characteristics of a derivative as and reporting guidance for legal obligations associated with the retirement of long-lived
discussed in SFAS No. 133. It also specifies when a derivative contains a financing compo- assets that result from the acquisition, construction or normal operation of a long-lived
nent that requires special reporting in the Consolidated Statement of Cash Flows. SFAS asset. SFAS No. 143 requires the recording of an asset and a liability equal to the present
No. 149 amends certain other existing pronouncements in order to improve consistency in value of the estimated costs associated with the retirement of long-lived assets for which
reporting these types of transactions. The new guidance was effective for contracts entered a legal or contractual obligation exists. The asset is required to be depreciated over the
into or modified after June 30, 2003, and for hedging relationships designated after life of the related equipment or facility, and the liability is required to be accreted each
June 30, 2003. SFAS No. 149 did not have a material effect on the company’s Consolidated year based on a present value interest rate. The adoption of the standard did not have a
Financial Statements. material effect on the company’s Consolidated Financial Statements.
In November 2002, the FASB issued Interpretation No. 45 (FIN 45), “Guarantor’s
Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees
of Indebtedness of Others,” which addresses the disclosures to be made by a guarantor c. Acquisitions/Divestitures
in its interim and annual financial statements about its obligations under guarantees.
acquisitions
FIN 45 also requires the recognition of a liability by a guarantor at the inception of certain
2004
guarantees that are entered into or modified after December 31, 2002. The company
In 2004, the company completed 14 acquisitions at an aggregate cost of $2,111 million.
adopted the disclosure requirements of FIN 45 (see note a, “Significant Accounting
Policies,” on page 55 under “Product Warranties,” and note o, “Contingencies and Commit-
ments,” on page 71) and applied the recognition and measurement provisions for all Candle
material guarantees entered into or modified in periods beginning January 1, 2003. The Original
Amount
adoption of the recognition and measurement provisions of FIN 45 did not have a mate- Disclosed in
rial impact on the company’s Consolidated Financial Statements. The impact of FIN 45 on Amortization Second Purchase Total Other
Life (in Years) Qtr. 2004 Adjustments* Allocation Maersk Acquisitions
the company’s future Consolidated Financial Statements will depend upon whether the
company enters into or modifies any material guarantee arrangements. Current assets $«202 $««(2) $«200 $«319 $«««191
In July 2002, the FASB issued SFAS No. 146, “Accounting for Costs Associated with Exit Fixed assets/non-current 82 (19) 63 123 176
or Disposal Activities.” SFAS No. 146 supersedes EITF No. 94-3, “Liability Recognition for Intangible assets:
Certain Employee Termination Benefits and Other Costs to Exit an Activity (Including Goodwill NA 256 39 295 426 711
Certain Costs Incurred in a Restructuring),” and requires that a liability for a cost associated Completed technology 2–3 23 — 23 11 29
with an exit or disposal activity be recognized when the liability is incurred. Such liabilities Client relationships 3–7 65 — 65 100 50
should be recorded at fair value and updated for any changes in the fair value each Other identifiable
period. The company adopted this statement effective January 1, 2003, and its adoption intangible assets 5 6 — 6 2 13
did not have a material effect on the Consolidated Financial Statements. Going forward, Total assets acquired 634 18 652 981 1,170
the impact of SFAS No. 146 on the company’s Consolidated Financial Statements will Current liabilities (119) (22) (141) (145) (198)
depend upon the timing of and facts underlying any future exit or disposal activity. Non-current liabilities (80) — (80) (44) (84)
In April 2002, the FASB issued SFAS No. 145, “Rescission of FASB Statements No. 4, 44
Total liabilities assumed (199) (22) (221) (189) (282)
and 64, Amendment of FASB Statement No. 13, and Technical Corrections,” effective May 15,
2002. SFAS No. 145 eliminates the requirement that gains and losses from the extinguish- Total purchase price $«435 $««(4) $«431 $«792 $«««888
ment of debt be aggregated and classified as an extraordinary item, net of tax, and makes * Adjustments primarily relate to acquisition costs, deferred taxes and other accruals.
certain other technical corrections. SFAS No. 145 did not have a material effect on the
company’s Consolidated Financial Statements.
57

Candle Corporation. On June 7, 2004, the company acquired 100 percent of the outstanding Other Acquisitions. The company acquired 12 other companies that are shown as other
common shares of Candle Corporation (Candle) for cash consideration of $431 million. acquisitions in the table on page 57. Seven of the acquisitions were for services-related
Candle provides services to develop, deploy and manage enterprise infrastructure. The companies, which were integrated into the Global Services segment and five were for
acquisition will allow the company to provide its clients with an enhanced set of software software companies, which were integrated into the Software segment. The results of
solutions for managing an on demand environment and complements the company’s operations of the acquired businesses were included in the company’s Consolidated
existing middleware solutions. Candle was integrated into the Software segment upon Financial Statements from their respective dates of acquisition. The purchase price alloca-
acquisition and its results of operations from that date are included in the company’s tions resulted in aggregate goodwill of $711 million, of which $329 million was assigned
Consolidated Financial Statements. The purchase price allocation resulted in goodwill of to the Software segment and $382 million was assigned to the Services segment. These
$295 million, which has been assigned to the Software segment. The primary items that assignments were based upon an analysis of the segments expected to benefit from the
generated goodwill are the value of the synergies between Candle and the company and acquisitions. The primary items that generated goodwill are the synergies between the
the acquired assembled workforce, neither of which qualifies as an amortizable intangible acquired businesses and the company and the premiums paid by the company for the
asset. None of the goodwill is deductible for tax purposes. The overall weighted-average right to control the businesses acquired. None of the goodwill is deductible for tax pur-
life of the identified amortizable intangible assets acquired in the purchase of Candle is poses. The overall weighted-average life of the intangible assets purchased is 4.8 years.
5.9 years. These identified intangible assets will be amortized on a straight-line basis over
2003
their useful lives.
In 2003, the company completed nine acquisitions at an aggregate cost of $2,536 million.
Maersk Data/DMdata. On December 1, 2004, the company purchased 100 percent of the
outstanding common stock of Maersk Data and 45 percent of the outstanding common
Rational
stock of DMdata for $792 million. No equity consideration was issued as part of the
purchase price. Maersk Data owned the remaining 55 percent of DMdata’s outstanding Original
Amount
common stock. Maersk Data and DMdata are located in Denmark. Maersk Data is a Disclosed
provider of IT solutions and offers consultancy, application development, operation and Amortization in First Purchase Total Other
Life (in Years) Qtr. 2003 Adjustments* Allocation Acquisitions
support to companies and organizations. DMdata is a provider of IT operations and its
core business areas include the operation of centralized and decentralized IT systems, net- Current assets $«1,179 $««51 $«1,230 $«««19
work establishment and operation as well as print and security solutions for clients in a Fixed assets/non-current 83 28 111 2
number of different industries. These acquisitions significantly increase the company’s Intangible assets:
Business Performance Transformation Services (BPTS) capabilities in serving clients in the Goodwill NA 1,365 40 1,405 335
transportation and logistics industry globally, while also enhancing its capabilities in areas Completed technology 3 229 — 229 12
such as financial services, public sector, healthcare and the food and agriculture industries. Client relationships 7 180 — 180 1
Both Maersk Data and DMdata were integrated into the Global Services segment upon Other identifiable
intangible assets 2–5 32 — 32 21
acquisition and their results of operations from that date are included in the company’s
In-process R&D 9 — 9 —
Consolidated Financial Statements. The purchase price allocation resulted in goodwill of
$426 million, which has been assigned to the Global Services segment. The primary items Total assets acquired 3,077 119 3,196 390
that generated goodwill are the value of the synergies between Maersk Data/DMdata and Current liabilities (347) (81) (428) (28)
the company and the acquired assembled workforce, neither of which qualify as an amorti- Non-current liabilities (638) 33 (605) 11
zable intangible asset. None of the goodwill is deductible for tax purposes. The overall
Total liabilities assumed (985) (48) (1,033) (17)
weighted-average life of the identified amortizable intangible assets acquired in the pur-
chase is 4.7 years. These identified intangible assets will be amortized on a straight-line Total purchase price $«2,092 $««71 $«2,163 $«373
basis over their useful lives. * Adjustments primarily relate to acquisition costs, deferred taxes and other accruals.
58
Rational Software Corporation (Rational). The largest acquisition in 2003 was that of Rational. (Dollars in millions)
The company purchased the outstanding stock of Rational for $2,095 million in cash. In PwCC
addition, the company issued replacement stock options with an estimated fair value of Original
$68 million to Rational employees. Rational provides open, industry-standard tools and Amount
Disclosed in
best practices and services for developing business applications and building software Amortization 2002 Annual Purchase Total Other
products and systems. The Rational acquisition provides the company with the ability to Life (in Years) Report Adjustments* Allocation Acquisitions
offer a complete development environment for clients. The transaction was completed Current assets $«1,197 $«(228) $««««969 $«264
on February 21, 2003, from which time the results of this acquisition were included in Fixed assets/non-current 199 (35) 164 102
the company’s Consolidated Financial Statements. The company merged Rational’s busi- Intangible assets:
ness operations and employees into the company’s Software segment as a new division Goodwill N/A 2,461 694 3,155 364
and brand. Completed technology 3 — — — 66
The primary items that generated the goodwill are the value of the synergies between Strategic alliances 5 103 — 103 —
Rational and the company and the acquired assembled workforce, neither of which qualify Non-contractual client
as an amortizable intangible asset. None of the goodwill is deductible for tax purposes. The relationships 4–7 131 — 131 —
overall weighted-average life of the identified intangible assets acquired in the purchase Client contracts/backlog 3–5 82 — 82 6
of Rational that are subject to amortization is 4.7 years. With the exception of goodwill, Other identifiable intangible assets 3–5 95 — 95 10
these identified intangible assets will be amortized on a straight-line basis over their use- In-process R&D — — — 4
ful lives. Goodwill of $1,405 million has been assigned to the Software segment. Total assets acquired 4,268 431 4,699 816
As indicated above, $2,095 million of the gross purchase price was paid in cash.
Current liabilities (560) (26) (586) (208)
However, as part of the transaction, the company assumed cash and cash equivalents held
Non-current liabilities (234) 9 (225) (124)
in Rational of $1,053 million, resulting in a net cash payment of $1,042 million. In addition,
the company assumed $500 million in outstanding convertible debt. The convertible debt Total liabilities assumed (794) (17) (811) (332)
was subsequently called on March 26, 2003. Total purchase price $«3,474 $««414 $«3,888 $«484
Other Acquisitions. The company paid substantially all cash for the other acquisitions in the * Adjustments relate to the amount paid by the company to PricewaterhouseCoopers as a result of the review discussed
below as well as other purchase accounting adjustments primarily related to accounts receivable, prepaid assets and
table on page 58. Five of the acquisitions were for software companies, two related to other accruals.
Strategic Outsourcing and Business Consulting Services companies and one was a hard-
ware business. The primary items that generated goodwill are the synergies between the PricewaterhouseCoopers’ Global Business Consulting and Technology Services Unit ( PwCC).
acquired businesses and the company, and the premium paid by the company for the On October 1, 2002, the company purchased PwCC for $3,888 million. The acquisition of
right to control the businesses acquired. The company assigned approximately $74 million PwCC provides the company with new expertise in business strategy, industry-based consult-
of the goodwill to the Software segment: $203 million of goodwill to the Global Services ing, process integration and application management. The company paid $3,474 million
segment; and $58 million of goodwill to the Personal Systems Group segment. These of the cost related to the acquisition of PwCC in 2002. The balance was paid in 2003. The
assignments were based upon an analysis of the segments that are expected to benefit purchase price allocation disclosed in the company’s 2002 Annual Report, which was
from the acquisitions. Substantially all of the goodwill is not deductible for tax purposes. based on the initial $3,474 million paid, included an estimated amount of net tangible
The overall weighted-average life of the intangible assets purchased is 4.3 years. The results assets to be transferred of approximately $422 million. The recorded amount of net tangible
of operations of the acquired businesses were included in the company’s Consolidated assets transferred to the company from PricewaterhouseCoopers (PwC) on October 1,
Financial Statements from the respective dates of acquisition. 2002, was approximately $454 million higher than the estimate. The amount of recorded
net tangible assets transferred was subject to a review process between both parties
2002
under the terms of the agreement. As a result of the review process and other adjust-
In 2002, the company completed 12 acquisitions at an aggregate cost of $3,958 million.
ments, the company paid an additional amount to PwC of $397 million in July 2003.
In addition, the company paid an additional $414 million in 2003 resulting from purchase
Substantially all of the payment was accounted for as incremental goodwill due to the fact
price adjustments.
that the net tangible assets recorded by the company as of October 1, 2002, included the
incremental amount. The difference between the $397 million payment in July and the
total purchase price adjustment in the table above is due to transaction costs incurred by
the company. 59

The company paid $3,266 million of the purchase price in cash, $294 million primarily Overall
in the form of restricted shares of IBM common stock and $328 million in notes convert- The company’s acquisitions were accounted for as purchase transactions, and accordingly,
ible into restricted shares of IBM common stock. the assets and liabilities of the acquired entities were recorded at their estimated fair
In connection with the acquisition, the company incurred approximately $196 million values at the dates of acquisition. The company determines fair value through third-party
of pre-tax, one-time compensation costs for certain PwCC partners and employees. This appraisals and assumptions provided by management.
amount relates to restricted shares and the compensation element of the convertible notes The acquired tangible net assets comprise primarily cash, accounts receivable, land,
issued as part of the purchase consideration and was recorded in the fourth quarter of buildings and leasehold improvements. The acquired identifiable intangible assets com-
2002. The portion of this amount recorded as part of SG&A in the Consolidated Statement prise primarily completed technology, trademarks, client lists, employee agreements and
of Earnings as compensation expense for the convertible notes equals the difference leasehold interests. The identifiable intangible assets are amortized on a straight-line basis,
between the fair value and the face value of the notes. generally not to exceed seven years. Goodwill from acquisitions that were consummated
As a result of its acquisition of PwCC, the company recorded a liability of approximately prior to July 1, 2001, was amortized over five years. The company adopted SFAS No. 142,
$601 million in the fourth quarter of 2002 to rebalance its workforce and to vacate excess “Goodwill and Other Intangible Assets,” on January 1, 2002, and ceased amortizing good-
leased space. All employees affected by this action were notified as of December 31, 2002. will as of that date. The results of operations of all acquired businesses were included in
The portion of the liability relating to the company’s people and space was approximately the company’s Consolidated Financial Statements from the respective dates of acquisition.
$318 million, substantially all of which was recorded as part of SG&A in the Consolidated
Statement of Earnings. The portion of the liability relating to acquired PwCC workforce and divestitures
leased space was approximately $283 million and was included as part of the liabilities 2004
assumed for purchase accounting and is included in the table on page 59. Also see page On December 7, 2004, the company signed an agreement to sell its Personal Computing
76 for additional information on these initiatives. Division (a division of the Personal Systems Group segment) to Lenovo Group Limited, a
Almost half of the goodwill was estimated to be generated by the value of the acquired publicly traded company in China. Lenovo Group will acquire substantially all the assets
assembled workforce. The acquired assembled workforce is treated as goodwill under and assume certain liabilities of the Personal Computing Division. Under the terms of the
SFAS No. 141, “Business Combinations.” The remaining items that generated goodwill are agreement, IBM will receive consideration at closing in the form of cash and equity in Lenovo
synergies between PwCC and the company created by the combination, and the premium Group. IBM, as part of the agreement, retained the right and will be given a preference to
paid by the company for the right to control PwCC. The goodwill has been assigned to the provide maintenance, warranty and financing services to Lenovo Group. In addition, IBM
Global Services segment. The company estimates that approximately two-thirds of the will provide certain agreed to transition services to Lenovo Group. This transaction is
goodwill is deductible for tax purposes. The overall weighted-average life of amortizable expected to close in the second quarter of 2005.
intangible assets purchased from PwC is 4.8 years. The results of operations of PwCC were
2002
included in the company’s Consolidated Financial Statements as of October 1, 2002.
On December 31, 2002, the company sold its HDD business to Hitachi. The total gross
Other Acquisitions. The company paid cash for the other acquisitions. Six of the acquisi- proceeds of the sale were $2 billion (excluding purchase price adjustments), of which
tions were for software companies, including Crossworlds Software, Inc., and Access360. $1,414 million was received by the company at closing. According to the terms of the
The other five acquisitions were Strategic Outsourcing and Business Consulting Services agreement, the remaining proceeds were to be received one and three years after closing.
companies. The primary items that generated goodwill are the synergies between the The remaining proceeds are fixed and are not dependent or variable based upon the sold
acquired businesses and the company, and the premium paid by the company for the right business’ earnings or performance. The company transferred approximately $244 million
to control the businesses acquired. Approximately $300 million of the goodwill has been of cash as part of the HDD business, resulting in a net cash inflow in 2002 related to the
assigned to the Software segment and the balance to the Global Services segment. The HDD transaction of $1,170 million. The company received approximately $156 million
goodwill is not deductible for tax purposes. The overall weighted-average life of the from Hitachi on December 31, 2003 for the payment due one year after closing and paid
intangible assets purchased is 3.4 years. The results of operations of the acquired busi- approximately $59 million to Hitachi for certain contractual items resulting in a net cash
nesses were included in the company’s Consolidated Financial Statements from the inflow in 2003 of $97 million.
respective dates of acquisition.
60
The company entered into an arm’s-length five-year supply agreement with Hitachi, marketable securities *
effective January 1, 2003, designed to provide the company with a majority of its on- The following table summarizes the company’s marketable securities, all of which are
going internal disk drive requirements for the company’s Server, Storage and Personal considered available for sale, and alliance investments.
Systems products. (Dollars in millions)
The loss on disposal recorded in 2002 was approximately $382 million, net of tax,
Fair Value
and was recorded in Loss from discontinued operations in the Consolidated Statement
of Earnings. AT DECEMBER 31: 2004 2003
See note a, “Significant Accounting Policies,” on page 49 for the “Basis of Presentation” Marketable securities — current:
for the discontinued operations. Time deposits and other obligations $«517 $«357
In the second and fourth quarters of 2002, the company announced certain asset and
Marketable securities — non-current: **
workforce reduction actions, and excess leased space charges related to its discontinued
Time deposits and other obligations $«««36 $«««36
HDD business. The company recorded a charge of approximately $508 million, net of tax,
Non-U.S. government securities and other
in discontinued operations associated with these announced actions.
fixed-term obligations 22 23
Summarized selected financial information for the discontinued operations is as follows:
Total $«««58 $«««59
Non-equity method alliance investments ** $«309 $«234
FOR THE YEAR ENDED DECEMBER 31: 2004 2003 2002*
Revenue $««— $«— $«1,946 * Gross unrealized gains (before taxes) on marketable securities and alliance investments were $85 million and $11 mil-
lion at December 31, 2004 and 2003, respectively. Gross unrealized losses (before taxes) on marketable securities
Loss before income taxes $««29 $«29 $«2,037 and alliance investments were $1 million and $2 million at December 31, 2004 and 2003, respectively. See note n,
“Stockholders’ Equity Activity,” on page 69 for net change in unrealized gains and losses on marketable securities and
Income tax (benefit)/expense «(11) 1 (282)) certain other information regarding unrealized losses.
Loss from discontinued operations $««18 $«30 $«1,755 ** Included within Investments and sundry assets in the Consolidated Statement of Financial Position. See note h,
“Investments and Sundry Assets,” on page 62.
* At closing, the company incurred a significant U.S. tax charge of approximately $248 million related to the repatriation
of divestiture proceeds from certain countries with low tax rates. This amount was included in the Income tax (benefit)/
expense line item of discontinued operations.
e. Inventories
d. Financial Instruments (excluding derivatives) AT DECEMBER 31: 2004 2003
fair value of financial instruments Finished goods $«1,179 $««««992
Cash and cash equivalents, marketable securities, notes and other accounts receivable, Work in process and raw materials 2,137 1,950
and other investments are financial assets with carrying values that approximate fair value.
Total $«3,316 $«2,942
Accounts payable, other accrued expenses and liabilities, short-term and long-term debt
are financial liabilities with carrying values that approximate fair value.
61

f. Financing Receivables g. Plant, Rental Machines and Other Property

(Dollars in millions) (Dollars in millions)
AT DECEMBER 31: 2004 2003 AT DECEMBER 31: 2004 2003*
Short-term: Land and land improvements $««««««840 $««««««865

Net investment in sales-type leases $«««5,074 $«««5,940 Buildings and building improvements 9,100 9,261
Commercial financing receivables 5,571 5,653 Plant, laboratory and office equipment 22,701 22,317
Customer loans receivable 4,485 5,235 32,641 32,443
Installment payment receivables 641 657 Less: Accumulated depreciation 18,973 19,190
Other non-Global Financing related 30 98
13,668 13,253
Total $«15,801 $«17,583
Rental machines 3,744 3,710
Long-term: Less: Accumulated depreciation 2,237 2,274
Net investment in sales-type leases $«««6,049 $«««6,010
1,507 1,436
Commercial financing receivables 139 197
Customer loans receivable 4,491 4,300 Total $«15,175 $«14,689
Installment payment receivables 271 217

Other non-Global Financing related — 17
Total $«10,950 $«10,741

h. Investments and Sundry Assets
Net investment in sales-type leases is for leases that relate principally to the company’s (Dollars in millions)
equipment and are generally for terms ranging from two to five years. Net investment in
AT DECEMBER 31: 2004 2003*
sales-type leases includes unguaranteed residual values of $836 million and $845 million
at December 31, 2004 and 2003, respectively, and is reflected net of unearned income of Deferred taxes $«3,024 $«4,288
$1,077 million and $1,227 million and of allowance for uncollectible accounts of $269 mil- Alliance investments:
lion and $337 million at those dates, respectively. Scheduled maturities of minimum lease Equity method 550 560
payments outstanding at December 31, 2004, expressed as a percentage of the total, Cost method 309 234
are approximately as follows: 2005, 48 percent; 2006, 28 percent; 2007, 16 percent; 2008, Deferred transition and set-up costs** 357 227
6 percent; and 2009 and beyond, 2 percent. Other deferred arrangements** 215 161
Customer loans receivable are provided by Global Financing to the company’s clients Long-term deposits 209 143
to finance the purchase of the company’s software and services. Global Financing is one Marketable securities — non-current 58 59
of many sources of funding from which clients can choose. Separate contractual relation- Derivatives — non-current + 48 695
ships on these financing arrangements are generally for terms ranging from two to five Receivable from Hitachi ++ — 358
years requiring straight-line payments over the term. Each financing contract is priced Other assets 698 569
independently at competitive market rates. The company has a history of enforcing the Total $«5,468 $«7,294
terms of these separate financing agreements.
** Deferred transition and set-up costs and other deferred arrangements are related to Global Services client arrange-
ments. Also see note a, “Significant Accounting Policies” on page 51 for additional information.
+ See note l, “Derivatives and Hedging Transactions” on pages 65 to 67 for the fair value of all derivatives reported in
the Consolidated Statement of Financial Position.
++ At December 31, 2004, this balance was transferred to Other accounts receivable as amount is collectible in 2005.
Also, see note c, “Acquisitions/Divestitures” on pages 60 and 61 for additional information.
62
i. Intangible Assets Including Goodwill Total amortization was $956 million, $955 million and $802 million for the years ended
The following schedule details the company’s intangible asset balances by major asset class: December 31, 2004, 2003 and 2002, respectively. The aggregate amortization expense for
acquired intangibles (excluding capitalized software) was $370 million, $349 million and
$181 million for the years ended December 31, 2004, 2003 and 2002, respectively.
At December 31, 2004
The future amortization expense for each of the five succeeding years relating to all
Gross Net intangible assets that are currently recorded in the Consolidated Statement of Financial
Carrying Accumulated Carrying
Intangible Asset Class Amount Amortization Amount Position is estimated to be the following at December 31, 2004:
Capitalized software $«1,565 $««««(680) $««««885

Client-related 861 (335) 526
2005 $«875
Completed technology 364 (206) 158
2006 494
Strategic alliances 104 (47) 57
2007 200
Patents/trademarks 33 (11) 22
2008 93
Other ** 247 (106) 141
2009 72
Total $«3,174 $«(1,385) $«1,789
goodwill
The changes in the carrying amount of goodwill, by reporting segment, for the year ended
At December 31, 2003 December 31, 2004, are as follows:
Gross Net (Dollars in millions)
Carrying Accumulated Carrying
Intangible Asset Class Amount Amortization Amount Foreign
Currency
Capitalized software* $«1,616 $««««(802) $««««814 Balance Purchase Translation Balance
Client-related 704 (254) 450 Jan. 1, Goodwill Price and Other Dec. 31,
Segment 2004 Additions Adjustments Divestitures Adjustments 2004
Completed technology 448 (228) 220
Strategic alliances 118 (38) 80
Global Services $«4,184 $««««808 $«««(41) $«(2) $«222 $«5,171
Patents/trademarks 98 (66) 32
Systems and
Technology Group 161 — — — 8 169
Other ** 165 (37) 128
Personal Systems Group 71 — — — 5 76
Total $«3,149 $«(1,425) $«1,724
Software 2,505 585 (75) — 6 3,021
* Reclassified to conform with 2004 presentation. In prior years, capitalized software was recorded in Investments and Global Financing — — — — — —
sundry assets. Enterprise Investments — — — — — —
** Other intangibles are primarily acquired proprietary and nonproprietary business processes, methodologies and systems,
and impacts from currency translation. Total $«6,921 $«1,393 $«(116) $«(2) $«241 $«8,437
The company amortizes the cost of intangible assets over their estimated useful lives Goodwill is tested annually for impairment using a fair value approach, at the “reporting
unless such lives are deemed indefinite. Amortizable intangible assets are tested for unit” level. A reporting unit is the operating segment, or a business which is one level
impairment based on undiscounted cash flows and, if impaired, written down to fair value below that operating segment (the “component” level) if discrete financial information is
based on either discounted cash flows or appraised values. Intangible assets with indefinite prepared and regularly reviewed by management at the component level. No impairment
lives are tested annually for impairment and written down to fair value as required. No of goodwill has been identified during any of the periods presented.
impairment of intangible assets has been identified during any of the periods presented.
The net carrying amount of intangible assets increased by $65 million for the year
ended December 31, 2004, primarily due to increased investments in Software.
63

j. Sale and Securitization of Receivables long-term debt

The company periodically sells receivables through the securitization of loans, leases and Pre-Swap Activity
trade receivables. The company retains servicing rights in the securitized receivables for (Dollars in millions)
which it receives a servicing fee. Any gain or loss incurred as a result of such sales is recog- Maturities 2004 2003
nized in the period in which the sale occurs. U.S. Dollars:

During 2004, the company renewed its trade receivables securitization facility that Debentures:
allows for the ongoing sale of up to $500 million of trade receivables. At the time of 5.875% 2032 $««««««600 $««««««600
renewal, the facility was changed from an uncommitted to a committed facility. This facility 6.22% 2027 469 500
was originally put in place in 2001 primarily to provide backup liquidity and can be 6.5% 2028 313 319
accessed on three days’ notice. The company did not have any amounts outstanding under 7.0% 2025 600 600
the trade receivables securitization facility in 2004 or 2003. In addition, the company has 7.0% 2045 150 150
a securitization program to sell loans receivable from state and local government clients. 7.125% 2096 850 850
This program was established in 1990 and has been used from time to time since then. 7.5% 2013 532 550
No receivables were sold under either of these programs in 2004 or 2003. 8.375% 2019 750 750
At December 31, 2004, there were no state and local receivables securitized and 3.43% convertible notes * 2007 278 309
under the company’s management. At December 31, 2003, $21 million was securitized Notes: 5.9% average 2006–2013 2,724 3,034
and under the company’s management. Servicing assets net of servicing liabilities were Medium-term note program: 4.5% average 2005–2018 3,627 4,690
insignificant. Other: 3.0% average** 2005–2010 1,555 508
The company utilizes certain of its financing receivables as collateral for nonrecourse
12,448 12,860
borrowings. Financing receivables pledged as collateral for borrowings were $249 million
Other currencies (average interest rate at
and $153 million at December 31, 2004 and 2003, respectively. These borrowings are
December 31, 2004, in parentheses):
included in note k, “Borrowings,” below.
Euros (5.0%) 2005–2009 1,095 1,174
Japanese yen (1.2%) 2005–2015 3,435 4,363
Canadian dollars (7.8%) 2005–2011 9 201
k. Borrowings Swiss francs (1.5%) 2008 220 —
short-term debt Other (5.5%) 2005–2014 513 770
(Dollars in millions) 17,720 19,368
AT DECEMBER 31: 2004 2003 Less: Net unamortized discount 49 15
Commercial paper $«3,151 $«2,349

Add: SFAS No. 133 fair value adjustment + 765 806
Short-term loans 1,340 1,124 18,436 20,159

Long-term debt — current maturities 3,608 3,173 Less: Current maturities 3,608 3,173
Total $«8,099 $«6,646 Total $«14,828 $«16,986
* On October 1, 2002, as part of the purchase price consideration for the PwCC acquisition, as addressed in note c,
The weighted-average interest rates for commercial paper at December 31, 2004 and “Acquisitions/Divestitures,” on pages 59 and 60, the company issued convertible notes bearing interest at a stated
rate of 3.43 percent with a face value of approximately $328 million to certain of the acquired PwCC partners. The
2003, were 2.2 percent and 1.0 percent, respectively. The weighted-average interest
notes are convertible into 4,764,543 shares of IBM common stock at the option of the holders at any time after the
rates for short-term loans were 1.5 percent and 2.5 percent at December 31, 2004 and first anniversary of their issuance based on a fixed conversion price of $68.81 per share of the company’s common
2003, respectively. stock. As of December 31, 2004, a total of 720,034 shares had been issued under this provision.
** Includes $249 million and $153 million of debt collateralized by financing receivables at December 31, 2004 and
2003, respectively. See note j, “Sale and Securitization of Receivables” above for further details.
+ In accordance with the requirements of SFAS No. 133, 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 an SFAS No. 133 fair value adjustment representing changes recorded in the fair value of the hedged
debt obligations attributable to movements in market interest rates and applicable foreign currency exchange rates.
64
Annual contractual maturities on long-term debt outstanding, including capital lease (Dollars in millions)
obligations, at December 31, 2004, are as follows: AT DECEMBER 31: 2004 2003
(Dollars in millions) Unused lines:

2005 $«3,221 From the committed global credit facility $«««9,804 $«««9,907
2006 3,104 From other committed and uncommitted lines 6,477 5,976
2007 1,300 Total unused lines of credit $«16,281 $«15,883

2008 499
2009 2,116
2010 and beyond 7,480
l. Derivatives and Hedging Transactions
The company operates in approximately 35 functional currencies and is a significant
interest on debt
lender and borrower in the global markets. In the normal course of business, the company
(Dollars in millions) is exposed to the impact of interest rate changes and foreign currency fluctuations, and to
FOR THE YEAR ENDED DECEMBER 31: 2004 2003 2002 a lesser extent equity price changes and client credit risk. The company limits these risks
Cost of Global Financing $«428 $«503 $«633
by following established risk management policies and procedures including the use of
Interest expense 139 145 145 derivatives and, where cost-effective, financing with debt in the currencies in which assets
Interest expense — discontinued operations — — 2 are denominated. For interest rate exposures, derivatives are used to align rate movements
Interest capitalized 4 15 35 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 man-
Total interest paid and accrued $«571 $«663 $«815
age the related cost of debt. For foreign currency exposures, derivatives are used to limit
the effects of foreign exchange rate fluctuations on financial results.
Refer to the related discussion on page 89 in note x, “Segment Information,” for total The company does not use derivatives for trading or speculative purposes, nor is it a
interest expense of the Global Financing segment. See note l, “Derivatives and Hedging party to leveraged derivatives. Further, the company has a policy of only entering into
Transactions,” on pages 65 to 67 for a discussion of the use of currency and interest rate contracts with carefully selected major financial institutions based upon their credit ratings
swaps in the company’s debt risk management program. and other factors, and maintains strict dollar and term limits that correspond to the institu-
tion’s credit rating.
lines of credit
In its hedging programs, the company employs the use of forward contracts, futures
On May 27, 2004, the company completed the renegotiation of a new $10 billion 5-year
contracts, interest rate and currency swaps, options, caps, floors or a combination thereof
Credit Agreement with JP Morgan Chase Bank, as Administrative Agent, and Citibank,
depending upon the underlying exposure.
N.A., as Syndication Agent, replacing credit agreements of $8 billion (5-year) and $2 bil-
A brief description of the major hedging programs follows.
lion (364 day). The total expense recorded by the company related to these facilities was
$8.9 million, $7.8 million and $9.1 million for the years ended December 31, 2004, 2003, debt risk management
and 2002, respectively. The new facility is irrevocable unless the company is in breach of The company issues debt in the global capital markets, principally to fund its financing
covenants, including interest coverage ratios, or if it commits an event of default, such as lease and loan portfolio. Access to cost-effective financing can result in interest rate and/or
failing to pay any amount due under this agreement. The company believes that circum- currency mismatches with the underlying assets. To manage these mismatches and to
stances that might give rise to a breach of these covenants or an event of default, as reduce overall interest cost, the company primarily uses interest-rate and currency instru-
specified in these agreements, are remote. The company’s other lines of credit, most of ments, principally swaps, to convert specific fixed-rate debt issuances into variable-rate
which are uncommitted, totaled $9,041 million and $8,202 million at December 31, 2004 debt (i.e., fair value hedges) and to convert specific variable-rate debt and anticipated
and 2003, respectively. Interest rates and other terms of borrowing under these lines of commercial paper issuances to fixed rate (i.e., cash flow hedges). The resulting cost of funds
credit vary from country to country, depending on local market conditions. is lower than that which would have been available if debt with matching characteristics
was issued directly. At December 31, 2004, the weighted-average remaining maturity of
all swaps in the debt risk management program was approximately three years.
65

long-term investments in foreign subsidiaries (net investment) other derivatives

A significant portion of the company’s foreign currency denominated debt portfolio is The company holds warrants in connection with certain investments that, although not
designated as a hedge of net investment to reduce the volatility in stockholders’ equity designated as hedging instruments, are deemed derivatives since they contain net share
caused by changes in foreign currency exchange rates in the functional currency of major settlement clauses. During the year, the company recorded the change in the fair value of
foreign subsidiaries with respect to the U.S. dollar. The company also uses currency swaps these warrants in net income.
and foreign exchange forward contracts for this risk management purpose. The currency The company is exposed to a potential loss if a client fails to pay amounts due the
effects of these hedges (approximately $156 million in 2004 and approximately $200 mil- company under contractual terms (“credit risk”). The company has established policies and
lion in 2003, net of tax) are reflected as a loss in the Accumulated gains and (losses) not procedures for mitigating credit risk on principal transactions, including reviewing and estab-
affecting retained earnings section of the Consolidated Statement of Stockholders’ Equity, lishing limits for credit exposure, maintaining collateral, and continually assessing the credit-
thereby offsetting a portion of the translation adjustment of the applicable foreign sub- worthiness of counterparties. Master agreements with counterparties include master netting
sidiaries’ net assets. arrangements as further mitigation of credit exposure to counterparties. These arrangements
permit the company to net amounts due from the company to a counterparty with amounts
anticipated royalties and cost transactions due to the company from a counterparty reducing the maximum loss from credit risk in the
The company’s operations generate significant nonfunctional currency, third-party vendor event of counterparty default. Also, in 2003, the company began utilizing credit default swaps
payments and intercompany payments for royalties, and goods and services among the to economically hedge certain credit exposures. These derivatives have terms of two years.
company’s non-U.S. subsidiaries and with the parent company. In anticipation of these The swaps are not designated as accounting hedges and are recorded at fair value with
foreign currency cash flows and in view of the volatility of the currency markets, the com- gains and losses reported in SG&A expense in the Consolidated Statement of Earnings.
pany selectively employs foreign exchange forward and option contracts to manage its The following table and the table on page 67 summarize the net fair value of the
currency risk. In general, these hedges have maturities of one year or less, but from time company’s derivative and other risk management instruments at December 31, 2004 and
to time extend beyond one year commensurate with the underlying hedged anticipated 2003 (included in the Consolidated Statement of Financial Position).
cash flow. At December 31, 2004, the weighted-average remaining maturity of these
derivative instruments was approximately one year. risk management program
subsidiary cash and foreign currency asset / liability management
Hedge Designation
The company uses its Global Treasury Centers to manage the cash of its subsidiaries.
Net Non-Hedge/
These centers principally use currency swaps to convert cash flows in a cost-effective AT DECEMBER 31, 2004 Fair Value Cash Flow Investment Other
manner. In addition, the company uses foreign exchange forward contracts to hedge, on
Derivatives — net asset/(liability):
a net basis, the foreign currency exposure of a portion of the company’s nonfunctional cur-
Debt risk management $«221 $«««(53) $«««««««— $«(14)
rency assets and liabilities. The terms of these forward and swap contracts are generally
Long-term investments in foreign
less than one year. The changes in fair value from these contracts and from the underlying
subsidiaries (net investments) — — (58) —
hedged exposures are generally offsetting and are recorded in Other (income) and
Anticipated royalties and
expense in the Consolidated Statement of Earnings. cost transactions — (939) — —
Subsidiary cash and foreign currency
equity risk management
asset/liability management — — — (19)
The company is exposed to certain equity price changes related to certain obligations to
Equity risk management — — — (7)
employees. These equity exposures are primarily related to market value movements in
certain broad equity market indices and in the company’s own stock. Changes in the over- Total derivatives 221(a) (992) (b) (58) (c) (40) (d)
all value of this employee compensation obligation are recorded in SG&A expense in the Debt:
Consolidated Statement of Earnings. Although not designated as accounting hedges, the Long-term investments in foreign
company utilizes equity derivatives, including equity swaps and futures to economically subsidiaries (net investments) — — (2,490) (e) —
hedge the equity exposures relating to this employee compensation obligation. To match Total $«221 $«(992) $«(2,548) $«(40)
the exposures relating to this employee compensation obligation, these derivatives are
(a) Comprises assets of $440 million and liabilities of $219 million.
linked to the total return of certain broad equity market indices and/or the total return of (b) Comprises assets of $12 million and liabilities of $1,004 million.
the company’s common stock. These derivatives are recorded at fair value with gains or (c) Comprises liabilities of $58 million.
losses also reported in SG&A expense in the Consolidated Statement of Earnings. (d) Comprises assets of $60 million and liabilities of $100 million.
66 (e) Represents fair value of foreign denominated debt issuances formally designated as a hedge of net investment.
(Dollars in millions, net of tax) Debit/(Credit)
Hedge Designation
December 31, 2001 $«(296)
Net Non-Hedge/
AT DECEMBER 31, 2003 Fair Value Cash Flow Investment Other Net losses reclassified into earnings from equity during 2002 (5)
Derivatives — net asset /(liability): Changes in fair value of derivatives in 2002 664
Debt risk management $«297 $«««(23) $«««««««— $«(10) December 31, 2002 $««363
Long-term investments in foreign Net losses reclassified into earnings from equity during 2003 (713)
subsidiaries (net investments) — — (27) —
Changes in fair value of derivatives in 2003 804
Anticipated royalties and cost transactions — (643) — —
December 31, 2003 $««454
Subsidiary cash and foreign currency
asset /liability management — — — (31) Net losses reclassified into earnings from equity during 2004 (463)
Equity risk management — — — 39 Changes in fair value of derivatives in 2004 662
Other derivatives — — — 8 December 31, 2004 $««653
Total derivatives 297 (a) (666) (b) (27) (c) 6 (d)
Debt: For the years ending December 31, 2004 and 2003, respectively, there were no significant
Long-term investments in foreign gains or losses on derivative transactions or portions thereof that were either ineffective as
subsidiaries (net investments) — — (2,470) (e) —
hedges, excluded from the assessment of hedge effectiveness, or associated with an
Total $«297 $«(666) $«(2,497) $«÷«6 underlying exposure that did not or was not expected to occur; nor are there any antici-
pated in the normal course of business.
(a) Comprises assets of $1,083 million and liabilities of $786 million.
(b) Comprises liabilities of $666 million.
(c) Comprises liabilities of $27 million.
(d) Comprises assets of $73 million and liabilities of $67 million. m. Other Liabilities
(e) Represents fair value of foreign denominated debt issuances formally designated as a hedge of net investment.
accumulated derivative gains or losses
AT DECEMBER 31: 2004 2003*
As illustrated above, the company makes extensive use of cash flow hedges, principally in
the Anticipated royalties and cost transactions risk management program. In connection with Deferred taxes $«1,879 $«1,834
the company’s cash flow hedges, it has recorded approximately $653 million of net losses Deferred income 2,222 1,842
in Accumulated gains and (losses) not affecting retained earnings as of December 31, Executive compensation accruals 1,163 1,036
2004, net of tax, of which approximately $492 million is expected to be reclassified to net Restructuring actions 787 871
income within the next year, providing an offsetting economic impact against the underly- Postemployment/preretirement liability 562 579
ing anticipated cash flows hedged. Derivatives liabilities 434 117
The following table summarizes activity in the Accumulated gains and (losses) not Non-current warranty accruals 415 277
affecting retained earnings section of the Consolidated Statement of Stockholders’ Equity Disability benefits 357 349
related to all derivatives classified as cash flow hedges held by the company during the Environmental accruals 218 214
periods January 1, 2001 (the date of the company’s adoption of SFAS No. 133) through Other 890 614
December 31, 2004: Total $«8,927 $«7,733
In response to changing business needs, periodically the company takes certain workforce
rebalancing actions to improve productivity and competitive position. The non-current
contractually obligated future payments associated with these ongoing activities are
reflected in the postemployment/preretirement liability caption in the table above.
67

In addition, the company executed certain actions prior to 1994, and in 1999 and The company employs extensive internal environmental protection programs that
2002. The reconciliation of the December 31, 2003 to 2004 balances of the current and primarily are preventive in nature. The company also participates in environmental assess-
non-current liabilities for restructuring actions is presented in the table below. The current ments and cleanups at a number of locations, including operating facilities, previously
liabilities presented in the table are included in Other accrued expenses and liabilities in owned facilities and Superfund sites.
the Consolidated Statement of Financial Position. The cost of internal environmental protection programs that are preventative in nature
are expensed as incurred. When a cleanup program becomes likely, and it’s probable that
the company will incur cleanup costs and those costs can be reasonably estimated, the
Balance at Balance at
company accrues remediation costs for known environmental liabilities. In addition, esti-
Dec. 31, Other Dec. 31,
2003 Payments Adjustments* 2004 mated environmental costs that are associated with AROs (for example, the required removal
Current: and restoration of chemical storage facilities and monitoring) are also accrued when it is
Workforce $««««222 $«211 $««128 $«139 probable that the costs will be incurred and the costs are reasonably estimable. The
Space 129 111 68 86 accounting for AROs is further discussed in note a, “Significant Accounting Policies,” and in
Other 39 32 2 9 “Depreciation and Amortization” on page 52. Our maximum exposure for all environmen-
tal liabilities cannot be estimated and no amounts have been recorded for environmental
Total $««««390 $«354 $««198 $«234
liabilities that are not probable or estimable.
Non-current: Estimated environmental costs are not expected to materially affect the consolidated
Workforce $««««587 $«««— $«««(44) $«543 financial position or consolidated results of the company’s operations in future periods.
Space 282 — (38) 244 However, estimates of future costs are subject to change due to protracted cleanup periods
Other 2 — (2) — and changing environmental remediation regulations.
Total $««««871 $«««— $«««(84) $«787 The European Commission (EC) has issued a directive that requires member states of
the European Union (EU) to meet certain targets for collection, re-use and recovery of
* The other adjustments column in the table above includes the reclassification of non-current to current and foreign
currency translation adjustments. In addition, during the year ended December 31, 2004, net adjustments to increase
waste electrical and electronic equipment. In February 2003, the EU published the Waste
previously recorded liabilities for changes in the estimated cost of employee terminations and vacant space for the Electrical and Electronic Equipment directive, or WEEE (Directive 2002/96/EC, which was
2002 actions ($42 million), offset by reductions in previously recorded liabilities for the HDD-related restructuring in
amended in December 2003 by Directive 2003/108/EC). The WEEE directive regulates the
2002 ($1 million) and actions prior to 1999 ($28 million) were recorded. Of the $13 million of net adjustments
recorded during the year ended December 31, 2004 in the Consolidated Statement of Earnings, $14 million (net) was collection, reuse and recycling of waste from many electrical and electronic products. The
predominantly included in Other (income) and expense offset by a $1 million credit included in Discontinued WEEE directive must be implemented by August 13, 2005. Under the WEEE directive,
Operations (for the HDD-related restructuring actions). Additionally, adjustments of $8 million were recorded to
Goodwill during the year ended December 31, 2004 for changes to estimated vacant space and workforce reserves. equipment producers are required to finance the collection, recovery and disposal of
electronic scrap. The company is continuing to evaluate the impact of adopting this guid-
The workforce accruals primarily relate to the company’s Global Services business. The ance. As most member states have yet to issue their implementation requirements, it is not
remaining liability relates to terminated employees who are no longer working for the possible to determine the full amount of accruals necessary to comply with the directive.
company, but who were granted annual payments to supplement their incomes in certain Another directive, the Restrictions of Hazardous Substances (RoHS) directive (2002/95/EC)
countries. Depending on the individual country’s legal requirements, these required pay- bans the use of certain hazardous materials in electric and electrical equipment, which are
ments will continue until the former employee begins receiving pension benefits or dies. put on the market in member states of the EU after July 1, 2006. As most member states
Included in the December 31, 2004 workforce accruals above is $62 million associated have yet to issue their implementation requirements, the company is continuing the eval-
with the HDD-related restructuring discussed in note c, “Acquisitions/Divestitures,” on uate the full impact of adopting this guidance.
pages 60 and 61. The total amounts accrued for environmental liabilities, including amounts classified
The space accruals are for ongoing obligations to pay rent for vacant space that could as current in the Consolidated Statement of Financial Position, that do not reflect actual or
not be sublet or space that was sublet at rates lower than the committed lease arrangement. anticipated insurance recoveries, were $246 million and $243 million at December 31,
The length of these obligations varies by lease with the longest extending through 2016. 2004 and 2003, respectively.
Other accruals are primarily the remaining liabilities (other than workforce or space)
associated with the 2002 second quarter actions described in note s, “2002 Actions,”
on pages 73 through 76. In addition, there are $7 million of remaining liabilities at
December 31, 2004 associated with the HDD-related restructuring discussed in note c,
“Acquisitions/Divestitures,” on pages 60 and 61.
68
n. Stockholders’ Equity Activity net change in unrealized gains/(losses) on marketable securities (net of tax)
In the fourth quarter of 2002, in connection with the PwCC acquisition, the company issued (Dollars in millions)
3,677,213 shares of restricted stock valued at approximately $254 million and recorded an AT DECEMBER 31: 2004 2003
additional $30 million for stock to be issued in future periods as part of the purchase price Net unrealized gains arising during the period $«52 $«4
consideration paid to the PwCC partners. See note c, “Acquisitions/Divestitures,” on pages Less: net gains/(losses) included in net income for the period 7 (3) *
59 and 60, for further information regarding this acquisition and related payments made
Net change in unrealized gains on marketable securities $«45 $«7
by the company. Additionally, in the fourth quarter of 2002, in conjunction with the funding
of the company’s U.S. pension plan, the company issued an additional 24,037,354 shares * Includes writedowns of $0.1 million and $7 million in 2004 and 2003, respectively.
of common stock from treasury shares valued at $1,871 million.
The following table shows the company’s investments’ gross unrealized losses and fair
stock repurchases
value, aggregated by investment category and length of time that individual securities
From time to time, the Board of Directors authorizes the company to repurchase IBM
have been in a continuous unrealized loss position, at December 31, 2004.
common stock. The company repurchased 78,562,974 common shares at a cost of
$7,275 million, 49,994,514 common shares at a cost of $4,403 million and 48,481,100 (Dollars in millions)
common shares at a cost of $4,212 million in 2004, 2003 and 2002, respectively. The com- Less than 12 Months 12 Months or More Total
pany issued 2,840,648 treasury shares in 2004, issued 2,120,293 treasury shares in 2003 Unrealized Unrealized Unrealized
and 979,246 treasury shares in 2002, as a result of exercises of stock options by employ- Description of Securities Fair Value Losses Fair Value Losses Fair Value Losses
ees of certain recently acquired businesses and by non-U.S. employees. At December 31, U.S. Treasury obligations and
2004, $3,686 million of Board-authorized repurchases remained. The company plans to direct obligations of
purchase shares on the open market or in private transactions from time to time, depend- U.S. government agencies $«— $«— $«— $«— $«— $«—
ing on market conditions. In connection with the issuance of stock as part of the company’s Foreign government bonds — — 22 — 22 —
stock compensation plans, 422,338 common shares at a cost of $38 million, 291,921 com- Corporate bonds — — — — — —
mon shares at a cost of $24 million and 189,797 common shares at a cost of $18 million in Subtotal, debt securities — — 22 — 22 —
2004, 2003 and 2002, respectively, were remitted by employees to the company in order Common stock 3 1 — — 3 1
to satisfy minimum statutory tax withholding requirements. Such amounts are included in
Total temporarily impaired
the Treasury stock balance in the Consolidated Statement of Financial Position and the
securities $«««3 $«««1 $«22 $«— $«25 $«««1
Consolidated Statement of Stockholders’ Equity.
accumulated gains and (losses) not affecting retained earnings *

(Dollars in millions) o. Contingencies and Commitments
Net Net Accumulated
Unrealized Foreign Minimum Unrealized Gains/(Losses)
contingencies
Losses Currency Pension (Losses)/Gains Not Affecting The company is involved in a variety of claims, suits, investigations and proceedings that
on Cash Flow Translation Liability on Marketable Retained
Hedge Derivatives Adjustments Adjustment Securities Earnings arise from time to time in the ordinary course of its business, including actions with respect
to contracts, IP, product liability, employment, securities, and environmental matters. The
December 31, 2002 $«(363) $««««238 $«(3,291) $««(2) $«(3,418)
following is a discussion of some of the more significant legal matters involving the company.
Change for period (91) 1,768 (162) 7 1,522
On July 31, 2003, the U.S. District Court for the Southern District of Illinois, in Cooper
December 31, 2003 (454) 2,006 (3,453) 5 (1,896) et al. vs. The IBM Personal Pension Plan and IBM Corporation, held that the company’s pen-
Change for period (199) 1,055 (1,066) 45 (165) sion plan violated the age discrimination provisions of the Employee Retirement Income
December 31, 2004 $«(653) $«3,061 $«(4,519) $«50 $«(2,061) Security Act of 1974 (ERISA). On September 29, 2004, the company announced that IBM
and plaintiffs agreed in principle to resolve certain claims in the litigation. Under the terms
* Net of tax of the agreement, plaintiffs will receive an incremental pension benefit in exchange for the
69

settlement of some claims, and a stipulated remedy on remaining claims if plaintiffs prevail The company has asserted counterclaims, including breach of contract, violation of the
on appeal. Under the terms of the settlement, the judge will issue no further rulings on Lanham Act, unfair competition, intentional torts, unfair and deceptive trade practices,
remedies. This settlement, together with a previous settlement of a claim referred to as the breach of the General Public License that governs open source distributions, patent
partial plan termination claim resulted in the company taking a one-time charge of $320 mil- infringement, promissory estoppel and copyright infringement. Trial was scheduled for
lion in the third quarter of 2004. November 1, 2005 but the scheduling order has been suspended and is under revision.
This agreement ends the litigation on all claims except the two claims associated with On June 2, 2003 the company announced that it received notice of a formal, nonpub-
IBM’s cash balance formula. The company will appeal the rulings on these claims. The com- lic investigation by the Securities and Exchange Commission (SEC). The SEC is seeking
pany continues to believe that its pension plan formulas are fair and legal. The company information relating to revenue recognition in 2000 and 2001 primarily concerning certain
has reached this agreement in the interest of the business and the company shareholders, types of client transactions. The company believes that the investigation arises from a sep-
and to allow for a review of its cash balance formula by the Court of Appeals. The com- arate investigation by the SEC of Dollar General Corporation, a client of the company’s
pany continues to believe it is likely to be successful on appeal. Retail Stores Solutions unit, which markets and sells point-of-sale products.
The agreement stipulates that if the company is not successful on appeal of the two On January 8, 2004, the company announced that it received a “Wells Notice” from
remaining claims, the agreed remedy will be increased by up to $1.4 billion — $780 million the staff of the SEC in connection with the staff’s investigation of Dollar General
for the claim that the company’s cash balance formula is age discriminatory, and $620 mil- Corporation, which as noted above, is a client of the company’s Retail Stores Solutions unit.
lion for the claim that the method used to establish opening account balances during the It is the company’s understanding that an employee in the company’s Sales & Distribution
1999 conversion discriminated on the basis of age (referred to as the “always cash balance” unit also received a Wells Notice from the SEC in connection with this matter. The Wells
claim). The maximum additional liability the company could face in this case if it is not success- Notice notifies the company that the SEC staff is considering recommending that the SEC
ful on appeal is therefore capped at $1.4 billion. bring a civil action against the company for possible violations of the U.S. securities laws
In the coming months, class members will receive formal notice of the settlement and relating to Dollar General’s accounting for a specific transaction, by participating in and
the judge will hold a fairness hearing. Once the settlement is approved, IBM will appeal aiding and abetting Dollar General’s misstatement of its 2000 results. In that transaction,
the liability rulings for the cash balance claims. As a result, the entire process could take the company paid Dollar General $11 million for certain used equipment as part of a sale
up to two years before reaching final conclusion. of IBM replacement equipment in Dollar General’s 2000 fourth fiscal quarter. Under the
The company is the defendant in an action brought by Compuware in the District SEC’s procedures, the company responded to the SEC staff regarding whether any action
Court for the Eastern District of Michigan in 2002, asserting causes of action for copyright should be brought against the company by the SEC. The separate SEC investigation noted
infringement, trade secret misappropriation, Sherman Act violations, tortious interference above, relating to the recognition of revenue by the company in 2000 and 2001 primarily
with contracts and unfair competition under various state statutes. The company asserted concerning certain types of client transactions, is not the subject of this Wells Notice.
counterclaims for copyright infringement and patent infringement in the Michigan action. In January 2004, the Seoul District Prosecutors Office in South Korea announced it had
The court ruled that the company’s patent claims against Compuware will be addressed in brought criminal bid rigging charges against several companies, including IBM Korea and
a separate trial, which has not yet been scheduled, and granted Compuware’s motion to LG IBM (a joint venture between IBM Korea and LG Electronics) and had also charged
dismiss the company’s copyright infringement claims on summary judgment. The court employees of some of those entities with, among other things, bribery of certain officials of
granted in part and denied in part the company’s motion for summary judgment dismiss- government-controlled entities in Korea, and bid rigging. IBM Korea and LG IBM cooper-
ing Compuware’s antitrust claims. Trial began during the week of February 14, 2005. The ated fully with authorities in these matters. A number of individuals, including former IBM
company has also asserted patent infringement claims against Compuware in a separate Korea and LG IBM employees, were subsequently found guilty and sentenced. IBM Korea
action that the company brought in the District Court for the Southern District of New York and LG IBM were also required to pay fines. IBM Korea has been debarred from doing busi-
in January 2004. ness directly with certain government controlled entities in Korea. The orders, imposed at
The company is a defendant in an action filed on March 6, 2003 in state court in Salt different times, cover a period of no more than a year from the date of issuance. The
Lake City, Utah by The SCO Group. The company removed the case to Federal Court in orders do not prohibit IBM Korea from selling products and services to business partners
Utah. Plaintiff is successor in interest to some of AT&T’s Unix IP rights, and alleges copyright who sell to government controlled entities in Korea. In addition, the U.S. Department of
infringement, unfair competition, interference with contract and breach of contract with Justice and the SEC have both contacted the company in connection with this matter.
regard to the company’s distribution of AIX and contribution of unspecified code to Linux.
70
The company is party to, or otherwise involved in, proceedings brought by U.S. federal The company has applied the disclosure provisions of FIN 45 to its agreements that
or state environmental agencies under the Comprehensive Environmental Response, contain guarantee or indemnification clauses. These disclosure provisions expand those
Compensation and Liability Act (“CERCLA”), known as “Superfund,” or laws similar to CERCLA. required by SFAS No. 5, by requiring a guarantor to disclose certain types of guarantees,
Such statutes require potentially responsible parties to participate in remediation activities even if the likelihood of requiring the guarantor’s performance is remote. The following is
regardless of fault or ownership of sites. The company is also conducting environmental a description of arrangements in which the company is the guarantor.
investigations or remediations at or in the vicinity of several current or former operating The company is a party to a variety of agreements pursuant to which it may be obligated
sites pursuant to permits, administrative orders or agreements with state environmental to indemnify the other party with respect to certain matters. Typically, these obligations
agencies, and is involved in lawsuits and claims concerning certain current or former arise in the context of contracts entered into by the company, under which the company
operating sites. customarily agrees to hold the other party harmless against losses arising from a breach
In accordance with SFAS No. 5, “Accounting for Contingencies,” the company records of representations and covenants related to such matters as title to assets sold, certain
a provision with respect to a claim, suit, investigation or proceeding when it is probable that IP rights, specified environmental matters, and certain income taxes. In each of these
a liability has been incurred and the amount of the loss can reasonably be estimated. Any circumstances, payment by the company is conditioned on the other party making a
provisions are reviewed at least quarterly and are adjusted to reflect the impact and status claim pursuant to the procedures specified in the particular contract, which procedures
of settlements, rulings, advice of counsel and other information pertinent to a particular typically allow the company to challenge the other party’s claims. Further, the company’s
matter. Under SFAS No. 5, provisions for litigation-related expenses increased $125 million obligations under these agreements may be limited in terms of time and/or amount, and
in 2004 versus 2003. Any other recorded liabilities for the above items, including any in some instances, the company may have recourse against third parties for certain pay-
changes to such liabilities for the twelve months ended December 31, 2004, were not ments made by the company.
material to the Consolidated Financial Statements. Based on its experience, the company It is not possible to predict the maximum potential amount of future payments under
believes that the damage amounts claimed in the matters referred to above are not a these or similar agreements due to the conditional nature of the company’s obligations
meaningful indicator of the potential liability. Litigation is inherently uncertain and it is not and the unique facts and circumstances involved in each particular agreement. Historically,
possible to predict the ultimate outcome of the matters previously discussed. While the payments made by the company under these agreements have not had a material effect
company will continue to defend itself vigorously in all such matters, it is possible that on the company’s business, financial condition or results of operations. The company
the company’s business, financial condition, results of operations, or cash flows could be believes that if it were to incur a loss in any of these matters, such loss should not have a
affected in any particular period by the resolution of one or more of these matters. material effect on the company’s business, financial condition or results of operations.
Whether any losses, damages or remedies finally determined in any such claim, suit, inves- In addition, the company guarantees certain loans and financial commitments. The
tigation or proceeding could reasonably have a material effect on the company’s business, maximum potential future payment under these financial guarantees was $58 million and
financial condition, results of operations, or cash flow will depend on a number of variables, $74 million at December 31, 2004 and 2003, respectively. These amounts include the limited
including the timing and amount of such losses or damages, the structure and type of any guarantee associated with the company’s loans receivable securitization program. See
such remedies, the significance of the impact any such losses, damages or remedies may note j, “Sale and Securitization of Receivables,” on page 64.
have on the company’s Consolidated Financial Statements, and the unique facts and Changes in the company’s warranty liability balance are illustrated in the following table:
circumstances of the particular matter which may give rise to additional factors. (Dollars in millions)
2004 2003
commitments
The company’s extended lines of credit include unused amounts of $2,714 million and Balance at January 1 $«780 $«614
$2,208 million at December 31, 2004 and 2003, respectively. A portion of these amounts Current period accruals 924 971
was available to the company’s business partners to support their working capital needs. Accrual adjustments to reflect actual experience 42 65
In addition, the company committed to provide future financing to its clients in connection Charges incurred (802) (870)
with client purchase agreements for approximately $1,686 million and $763 million at Balance at December 31 $«944 $«780
December 31, 2004 and 2003, respectively. The change over the prior year is due to
increased signings of long-term IT infrastructure arrangements in which financing is com- The increase in the balance was primarily driven by increased warranty activity associated
mitted by the company to fund a client’s future purchases from the company. with personal computers due to increased sales volumes.
71

p. Taxes A reconciliation of the company’s continuing operations effective tax rate to the statutory
U.S. federal tax rate is as follows:
FOR THE YEAR ENDED DECEMBER 31: 2004 2003 2002 FOR THE YEAR ENDED DECEMBER 31: 2004 2003 2002
Income from continuing operations before Statutory rate 35% 35% 35%
income taxes: Foreign tax differential (5) (5) (7)
U.S. operations $«««5,280 $«««4,611 $«3,838 State and local 1 1 1
Non-U.S. operations 6,748 6,263 3,686
Other (1) (1) —
Total income from continuing operations Effective rate 30% 30% 29%
before income taxes $«12,028 $«10,874 $«7,524
The continuing operations provision for income taxes by geographic operations is as follows: 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 activities that gave rise to deferred tax assets and liabil-
ities that are recorded in the Consolidated Statement of Financial Position were as follows:
U.S. operations $«1,765 $«1,234 $««««934
Non-U.S. operations 1,815 2,027 1,256 deferred tax assets
Total continuing operations provision for
income taxes $«3,580 $«3,261 $«2,190 AT DECEMBER 31: 2004 2003
Retirement benefits $«««3,908 $«««3,566

The components of the continuing operations provision for income taxes by taxing juris- Capitalized research and development 1,794 1,907
diction are as follows: Employee benefits 1,168 1,021
(Dollars in millions) Bad debt, inventory and warranty reserves 1,050 1,092

Alternative minimum tax credits 1,032 1,344
Deferred income 612 598
U.S. federal:
Infrastructure reduction charges 333 440
Current $«««(608) * $««««234 $««««287
Foreign tax loss carryforwards 298 311
Deferred 1,823* 339 (3)
Capital loss carryforwards 220 195
1,215 573 284
State and local tax loss carryforwards 95 205
U.S. state and local: General business credits — 884
Current 50 46 184 Other 2,266 2,253
Deferred 110 183 3
Gross deferred tax assets 12,776 13,816
160 229 187 Less: valuation allowance 603 722
Non-U.S.: Net deferred tax assets $«12,173 $«13,094
Current 2,057 1,855 1,786
Deferred 148 604 (67)
2,205 2,459 1,719
Total continuing operations provision

for income taxes 3,580 3,261 2,190
Provision for social security, real estate,

personal property and other taxes 3,347 3,277 2,789
Total continuing operations provision for taxes $«6,927 $«6,538 $«4,979
* Included in the U.S. federal current and deferred tax provisions are a benefit of $848 million and a charge of $848 mil-
72 lion, respectively, due to the Internal Revenue Service settlement noted on page 73.
deferred tax liabilities The company has not provided deferred taxes on $19,664 million of undistributed
(Dollars in millions) earnings of non-U.S. subsidiaries at December 31, 2004, as it is the company’s policy to
AT DECEMBER 31: 2004 2003 indefinitely reinvest these earnings in non-U.S. operations. However, the company peri-
odically repatriates a portion of these earnings to the extent that it does not incur an
Retirement benefits $«7,057 $«6,644
additional U.S. tax liability. Quantification of the deferred tax liability, if any, associated with
Leases 622 693
indefinitely reinvested earnings is not practicable. Also, the company’s intention with
Software development costs 381 285
respect to the indefinite reinvestment of foreign earnings at December 31, 2004 does not
Other 1,324 1,188
consider the possible distribution of such earnings under the favorable repatriation provi-
Gross deferred tax liabilities $«9,384 $«8,810 sion of the Act.
The valuation allowance at December 31, 2004, principally applies to capital loss carry-
forwards and certain foreign, and state and local loss carryforwards that, in the opinion of q. Advertising and Promotional Expense
management, are more likely than not to expire before the company can use them. Advertising and promotional expense, which includes media, agency and promotional
For tax return purposes, the company has available tax credit carryforwards of approxi- expense, was $1,335 million, $1,406 million and $1,427 million in 2004, 2003 and 2002,
mately $1,032 million, which have an indefinite carryforward period. The company also has respectively, and is recorded in SG&A expense in the Consolidated Statement of Earnings.
foreign, state and local, and capital loss carryforwards, the tax effect of which is $613 mil-
lion. Substantially all of these carryforwards are available for at least four years or have an
indefinite carryforward period. r. Research, Development and Engineering
During the fourth quarter of 2004, the Internal Revenue Service (IRS) and the company
RD&E expense was $5,673 million in 2004, $5,077 million in 2003 and $4,750 million in 2002.
resolved the tax audit of 1998-2000 which had commenced in 2003. The resolution of this
The company incurred expense of $5,167 million in 2004, $4,609 million in 2003 and
IRS audit resulted in the reduction of existing tax credit carryforwards as well as a payment
$4,247 million in 2002 for scientific research and the application of scientific advances to
of $130 million, including tax and interest. The company was fully reserved for the matters
the development of new and improved products and their uses as well as services and their
that were resolved.
application. Of these amounts, software-related expense was $2,546 million, $2,300 mil-
The company anticipates that the IRS audit of 2001 through 2003 will commence early
lion and $1,974 million in 2004, 2003 and 2002, respectively. Included in the expense
in 2005. Although the outcome of tax audits is always uncertain, the company believes that
was a charge of $9 million and $4 million in 2003 and 2002, respectively, for acquired
adequate amounts of tax and interest have been provided for any adjustments that are
in-process R&D.
expected to result for these years.
Expense for product-related engineering was $506 million, $468 million and $503 mil-
On October 22, 2004, the President signed the American Jobs Creation Act of 2004
lion in 2004, 2003 and 2002, respectively.
(the “Act”). The Act creates a temporary incentive for the company to repatriate earnings
accumulated outside the U.S. by allowing the company to reduce its taxable income by 85
percent of certain eligible dividends received from non-U.S. subsidiaries by the end of
2005. In order to benefit from this incentive, the company must reinvest the qualifying
s. 2002 Actions
dividends in the U.S. under a domestic reinvestment plan approved by the chief executive second quarter actions
officer and board of directors. As discussed in note b, “Accounting Changes” on page 56, During the second quarter of 2002, the company executed several actions in its
the company has commenced an evaluation of the possible effects of the Act’s repatria- Microelectronics Division. The Microelectronics Division is within the company’s Systems and
tion provision and expects to complete this evaluation within a reasonable period of time Technology Group segment. These actions were the result of the company’s announced
following the issuance of additional clarifying language and guidance from Congress and intentions to refocus and direct its Microelectronics business to the high-end foundry,
the Treasury Department on key elements of the repatriation provision. It is reasonably Application Specific Integrated Circuits (ASICs) and standard products, while creating a
possible that the company may repatriate up to approximately $8 billion of the undistrib- technology services business. A major part of the actions related to a significant reduction
uted earnings noted below under the Act and the corresponding income tax expense may in the company’s manufacturing capacity for aluminum-based semiconductor technology.
be as much as approximately $550 million. The resulting income tax expense, if any, will
be provided in the company’s financial statements in the quarter in which the evaluation
and approvals have been completed.
73

In addition, the company rebalanced both its workforce and its leased space resources primarily in response to the decline in corporate spending on technology services in 2001
and 2002. The following table summarizes the significant components of these actions:
Liability Liability Liability Liability

Recorded in as of as of as of
Pre-Tax Write-off 2nd Qtr. Other Dec. 31, Other Dec. 31, Other Dec. 31,
Charges of Assets 2002 Payments Adjustments+ 2002 Payments Adjustments+ 2003 Payments Adjustments+ 2004
Microelectronics:
Machinery/equipment: $««««423 $«323 (a)
Current * $««««««67 (b) $«««38 $«13 $«««42 $«««39 $«13 $«««16 $«16 $«««2 $«««««2
Non-current ** 33 (b) — (16) 17 — (15) 2 — ««(2) —
Non-cancelable purchase commitments: 60
Current * 35 (c) 15 4 24 24 15 15 15 — —
Non-current ** 25 (c) — (12) 13 — (13) — — — —
Employee terminations: 45
Current * 44 (d) 35 (8) 1 1 — — — — —
Non-current ** 1 (d) — — 1 — — 1 — — 1
Vacant space: 11
Current * 5 (e) 1 1 5 5 3 3 3 3 3
Non-current ** 6 (e) — (1) 5 — (2) 3 — (3) —
Sale of Endicott facility * 223 221 (f ) 2 (f ) 3 11 10 6 (3) 1 1 — —
Sale of certain operations * 63 53 (g) 10 (g) 9 — 1 1 — — — — —
Global Services and other:
Employee terminations: 722
Current * 671 (h) 505 (23) 143 109 (2) 32 27 26 31
Non-current ** 51 (h) — 27 78 — (3) 75 — (13) 62
Vacant space: 180 29 (i)
Current * 57 (i) 29 16 44 72 71 43 32 21 32
Non-current ** 94 (i) — (8) 86 — (55) 31 — (3) 28
Total $«1,727 $«626 $«1,101 $«635 $«««4 $«470 $«257 $«««9 $«222 $«94 $«31 $«159
* Recorded in Accounts payable and accruals in the Consolidated Statement of Financial Position.
** Recorded in Other liabilities in the Consolidated Statement of Financial Position.
+ Principally represents currency translation adjustments and reclassification of non-current to current. In addition, net adjustments of $1 million, $(26) million and $(40) million were recorded in SG&A expense in 2004, 2003 and the fourth quarter
of 2002, respectively, to adjust previously recorded liabilities and $14 million, $4 million, and $10 million were recorded in Other (income) and expense to increase previously recorded liabilities in 2004, 2003 and the fourth quarter of 2002,
respectively. These adjustments, along with adjustments of $(7) million and $(19) million recorded in SG&A expense in 2003 and the fourth quarter of 2002, respectively, as well as $(2) million and $9 million recorded in Other (income) and
expense for assets previously written off, were for differences between the estimated and actual proceeds on the disposition of certain assets and changes in the estimated cost of employee terminations and vacant space accruals for the years
ended December 31, 2003 and 2002, respectively. No such adjustments were made in 2004.
74
(a) This amount was recorded in SG&A expense in 2002 and primarily represents the aban- (g) As part of the strategic realignment of the company’s Microelectronics business, the
donment and loss on sale of certain capital assets during the second quarter of 2002. company agreed to sell certain assets and liabilities comprising its Mylex storage prod-
(b) These amounts comprise costs incurred to remove abandoned capital assets and the ucts business to LSI Logic Corporation and the company sold part of its wireless phone
remaining lease payments for leased equipment that was abandoned in the second chipset operations to TriQuint Semiconductor, Inc. in June 2002. The Mylex transaction
quarter of 2002. Such amounts were recorded in SG&A expense in 2002. The liability was completed in August 2002. The loss of $74 million for the Mylex transaction and the
at December 31, 2003 and 2004 relates to the remaining lease payments, which will realized gain of $11 million for the chipset sale were recorded in Other (income) and
continue through 2005. expense in 2002.
(c) The company was subject to certain non-cancelable purchase commitments. As a result
(h) The majority of the workforce reductions related to the company’s Global Services busi-
of the decision to significantly reduce aluminum manufacturing capacity, the company ness. The workforce reductions comprised 14,213 people, all of whom left the company
no longer had a need for certain materials subject to these agreements. The required as of June 30, 2003. These charges were recorded in SG&A expense in 2002. The
future payments for materials no longer needed under these contracts were paid remaining liability relates to terminated employees who were granted annual payments
through 2004. This amount was recorded in SG&A expense in 2002. to supplement their income in certain countries. Depending on individual country legal
requirements, these required payments will continue until the former employee begins
(d) The Microelectronics workforce reductions comprised 1,400 people, all of whom left
receiving pension benefits or dies.
the company as of June 30, 2003. This amount was recorded in SG&A expense in 2002.
The remaining liability relates to terminated employees who were granted annual
(i) The space accruals are for ongoing obligations to pay rent for vacant space that could
payments to supplement their income in certain countries. Depending on individual not be sublet or space that was sublet at rates lower than the committed lease arrange-
country legal requirements, these required payments will continue until the former ments. This space relates primarily to workforce dynamics in the Global Services business
employee begins receiving pension benefits or dies. and the downturn in corporate technology spending on services. The lengths of these
obligations vary by lease with the longest extending through 2016. These amounts
(e) The vacant space accruals are for ongoing obligations to pay rent for vacant space that
were recorded in Other (income) and expense in 2002.
could not be sublet or space that was sublet at rates lower than the committed lease
arrangements. The length of these obligations varies by lease with the longest extending
through 2006. These amounts were recorded in Other (income) and expense in 2002.
(f) As part of the company’s strategic realignment of its Microelectronics business to exit the
manufacture and sale of certain products and component technologies, the company
signed an agreement in the second quarter of 2002 to sell its interconnect products
operations in Endicott to Endicott Interconnect Technologies, Inc. (EIT). As a result of this
transaction, the company incurred a $223 million loss on sale, primarily relating to land,
buildings, machinery and equipment. This loss was recorded in Other (income) and
expense in 2002. This transaction closed in the fourth quarter of 2002. The company
entered into a limited supply agreement with EIT for future products, and it will also
lease back, at fair market value rental rates, approximately one-third of the Endicott
campus’ square footage for operations outside the interconnect OEM business.
75

fourth quarter actions

During the fourth quarter of 2002, the company executed several actions related to the company’s acquisition of PwCC. Specifically, the company rebalanced both its workforce and its
leased space resources. The following table summarizes the significant components of these actions.
Recorded in
Purchase
Recorded in the Accounting
Consolidated Statement of Earnings (see Note C)
Total Liability
Total Sale or Liability Liability Liability as of
Pre-tax Write-off Recorded Recorded Recorded Other Dec. 31,
Charges of Assets in 4th Qtr. in 4th Qtr. in 4th Qtr. Payments Adjustments+ 2002
Workforce: $«305 (a) $«—

Current * $«248 $«««48 (a) $«296 $«16 $«(2) $«278
Non-current ** 57 (a) — 57 — — 57
Vacant space: 17 (b) 4
Current * 6 62 (b) 68 1 — 67
Non-current ** 7 173 (b) 180 — — 180
Total $«322 $«««4 $«318 $«283 $«601 $«17 $«(2) $«582
Total Liability Liability Liability

as of as of as of
Dec. 31, Other Dec, 31, Other Dec. 31,
2002 Payments Adjustments+ 2003 Payments Adjustments+ 2004
Workforce:
Current * $«278 $«246 $«««6 $«««38 $«29 $«21 $«««30
Non-current ** 57 — 22 79 — (13) 66
Vacant space:
Current * 67 64 37 40 49 45 36
Non-current ** 180 — (47) 133 — (14) 119
Total $«582 $«310 $«18 $«290 $«78 $«39 $«251
* Recorded in Accounts payable and accruals in the Consolidated Statement of Financial Position. receiving pension benefits or dies. These charges ($305 million in the table above) were
** Recorded in Other liabilities in the Consolidated Statement of Financial Position. included in SG&A expense. The workplace reductions also affected 1,203 acquired
+ Principally represents currency translation adjustments and reclassifications between current and non-current. In
addition, net adjustments of $28 million were recorded predominantly in Other (income) and expense in 2004 and
PwCC employees, all of whom left the company as of December 31, 2003 ($48 million
$(6) million recorded in SG&A expense in 2003 to adjust previously recorded liabilities. These adjustments were for in the table above). These costs were included as part of the liabilities assumed for
changes in the estimated cost of employee terminations and vacant space. There were also net adjustments of $8 mil-
lion and $36 million in 2004 and 2003, respectively, to reduce goodwill and previously recorded liabilities for changes
purchase accounting in 2002.
in the estimated cost of employee terminations and vacant space relating to people and space acquired from PwCC. (b) The majority of the space accruals are for ongoing obligations to pay rent for vacant space
(a) The majority of the workforce reductions relate to the company’s Global Services busi- of PwCC that could not be sublet or space that was sublet at rates lower than the committed
ness. The workforce reductions represent 3,541 people, all of whom left the company lease arrangements. The length of these obligations vary by lease with the longest
as of December 31, 2003. The remaining liability relates to terminated employees in extending through 2012. The charges related to IBM space ($17 million) were included
certain countries outside the United States, for whom the company is required to make in Other (income) and expense in 2002. The costs related to acquired PwCC space are
annual payments to supplement their incomes. Depending on individual country legal included as part of the liabilities assumed for purchase accounting in 2002 ($235 mil-
requirements, these required payments will continue until the former employee begins lion in the table above comprise $62 million current and $173 million non-current).
76
t. Earnings Per Share of Common Stock Stock options to purchase 133,220,730 common shares in 2004, 124,840,510 common
The following table sets forth the computation of basic and diluted earnings per share of shares in 2003 and 111,713,072 common shares in 2002 were outstanding, but were not
common stock. included in the computation of diluted earnings per share because the exercise price of
the options was greater than the average market price of the common shares for the full
FOR THE YEAR ENDED DECEMBER 31: 2004 2003 2002 year and, therefore, the effect would have been antidilutive.
Weighted-average number of shares
on which earnings per share
calculations are based: u. Rental Expense and Lease Commitments
Basic 1,674,959,086 1,721,588,628 1,703,244,345
Rental expense from continuing operations, including amounts charged to inventories
Add — incremental shares under and fixed assets, and excluding amounts previously reserved, was $1,442 million in 2004,
stock compensation plans 28,545,624 29,399,287 24,807,025
$1,419 million in 2003 and $1,377 million in 2002. The table below depicts gross minimum
Add — incremental shares associated
rental commitments from continuing operations under noncancelable leases, amounts
with convertible notes 4,273,541 4,695,956 1,191,136
related to vacant space associated with infrastructure reduction and restructuring actions
Add — incremental shares associated
taken through 1993, and in 1999 and 2002 (previously reserved), and sublease income
with contingently issuable shares 1,094,028 406,818 1,698,548
commitments. These amounts reflect activities primarily related to office space as well as
Assuming dilution 1,708,872,279 1,756,090,689 1,730,941,054
manufacturing equipment.
(Dollars in millions except per share amounts) (Dollars in millions)
Income from continuing operations $«8,448 $«7,613 $«5,334 Beyond

2005 2006 2007 2008 2009 2009
Loss from discontinued operations 18 30 1,755
Gross minimum
Net income from total operations on which rental commitments
basic earnings per share is calculated $«8,430 $«7,583 $«3,579
(including Vacant space) $«1,383 $«1,183 $«1,027 $«907 $«696 $«1,411
Income from continuing operations $«8,448 $«7,613 $«5,334 Vacant space 100 68 88 32 26 18
Add — income effect of contingently Sublease income commitments (55) (42) (42) (34) (18) (18)
issuable shares (5) 2 (18)
Income from continuing operations

on which diluted earnings
v. Stock-Based Compensation Plans
per share is calculated 8,443 7,615 5,316
Loss from discontinued operations The following is a description of the terms of the company’s stock-based compensation plans:
on which basic and diluted earnings
incentive plans
per share are calculated 18 30 1,755
Incentive awards are provided to employees and members of the company’s Board of
Net income from total operations on which Directors under the terms of the company’s plans (the Plans). Employee awards are admin-
diluted earnings per share is calculated $«8,425 $«7,585 $«3,561
istered by the Executive Compensation and Management Resources Committee of the
Earnings/(loss) per share of common stock: Board of Directors (the Committee). The Committee determines the type and terms of the
Assuming dilution: awards to be granted to employees, including vesting provisions.
Continuing operations $«««4.94 $«««4.34 $«««3.07 Awards under the Plans may include at-the-money stock options, premium-priced
Discontinued operations (0.01) (0.02) (1.01) stock options, stock appreciation rights, restricted stock, cash or stock awards, or any
Total $«««4.93 $«««4.32 $«««2.06 combination thereof. The amount of shares originally authorized to be issued under the
Basic: company’s existing Plans is 274.1 million at December 31, 2004. Certain incentive awards
Continuing operations $«««5.04 $«««4.42 $«««3.13
granted under previous plans, if and when those awards are canceled, can be reissued
Discontinued operations (0.01) (0.02) (1.03)
under the company’s existing Plans. As such, 41.9 million additional awards are con-
sidered authorized to be issued under the company’s Plans as of December 31, 2004.
Total $«««5.03 $«««4.40 $«««2.10
77

There were 76.2 million option awards outstanding under previous plans included in the In connection with various acquisition transactions, there are an additional 2.9 million
total number of shares under option at December 31, 2004. There were 126.3 million and options outstanding at December 31, 2004, as a result of the company’s assumption of
148.1 million unused shares available to be granted under the Plans as of December 31, options granted by the acquired entities. The weighted-average exercise price of these
2004 and 2003, respectively. Awards under the Plans resulted in pre-tax compensation options is $89.
expense of $219 million, $117 million and $183 million in 2004, 2003 and 2002, respectively.
ibm employees stock purchase plan
Stock Option Grants In July 2003, the IBM 2003 ESPP became effective and 50 million additional shares of
Stock options are granted to employees and directors at an exercise price equal to or authorized common stock were reserved and approved for issuance. The ESPP enables
greater than the fair market value of the company’s stock at the date of grant. Generally, substantially all regular employees to purchase full or fractional shares of IBM common
options vest 25 percent per year, are fully vested four years from the grant date and have stock through payroll deductions of up to 10 percent of eligible compensation. The 2003
a term of ten years. The following tables summarize option activity under the Plans during ESPP provides for semiannual offerings commencing July 1, 2003, and continuing as long
2004, 2003 and 2002. as shares remain available under the ESPP, unless terminated earlier at the discretion of the
Board of Directors. The share price paid by an employee equals the lesser of 85 percent
2004 2003 2002
of the average market price on the first business day of each offering period or 85 percent
Wtd. Avg. Wtd. Avg. Wtd. Avg.
of the average market price on the last business day of each pay period. Individual ESPP
Exercise No. of Shares Exercise No. of Shares Exercise No. of Shares
Price Under Option Price Under Option Price Under Option participants are restricted from purchasing more than $25,000 of common stock in one
Balance at Jan. 1 $««86 244,966,052 $««84 222,936,700 $««85 177,956,490 calendar year or 1,000 shares in an offering period. Approximately 32.8 million, 44.2 mil-
Options granted 97 26,537,055 83 41,275,832 77 59,966,106 lion and 4.6 million reserved unissued shares were available for purchase under the 2003
Options exercised 47 (14,035,038) 40 (11,205,228) 33 (7,490,424) ESPP (or a predecessor plan) at December 31, 2004, 2003 and 2002, respectively.
Options canceled/
pro forma disclosure
expired 93 (8,120,163) 100 (8,041,252) 103 (7,495,472)
See “Stock-Based Compensation” on page 52, in note a, “Significant Accounting Policies,”
Balance at Dec. 31 $««89 249,347,906 $««86 244,966,052 $««84 222,936,700 for the pro forma disclosures of net income and earnings per share required under
Exercisable at SFAS No. 123.
Dec. 31 $««89 159,607,886 $««85 134,735,326 $««75 108,347,895
During the year ended December 31, 2004, the company granted approximately 5 mil- w. Retirement-Related Benefits
lion stock options with an exercise price greater than the stock price at the date of grant. IBM offers defined benefit pension plans, defined contribution pension plans, as well as
These stock options had a weighted-average exercise price of $105.85 and are included nonpension postretirement plans primarily consisting of retiree medical benefits. These
in the table above. benefits form an important part of the company’s total compensation and benefits pro-
The shares under option at December 31, 2004, were in the following exercise gram that is designed to attract and retain highly skilled and talented employees. The
price ranges: table on page 79 provides the total retirement-related benefit plans’ impact on income
before income taxes.
Options Outstanding Options Currently Exercisable
Wtd. Avg.
Wtd. Avg. Number Remaining Wtd. Avg. Number
Exercise of Shares Contractual Exercise of Shares
Exercise Price Range Price Under Option Life (in years) Price Under Option
$18 – $60 $««46 45,610,909 4 $««44 39,083,439

$61– $85 77 55,717,463 8 75 19,450,291
$86 – $105 98 80,640,962 7 98 39,507,144
$106 and over 117 67,378,572 6 117 61,567,012
$««89 249,347,906 6 $««89 159,607,886
78
U.S. Non-U.S. Total
FOR THE YEAR ENDED DECEMBER 31: 2004 2003 2002 2004 2003 2002 2004 2003 2002
Total retirement-related plans — cost /(income) $«827 $««««67 $«(154) $«617 $«295 $«(17) $«1,444 $«362 $«(171) *
Comprise:
Defined benefit and contribution pension plans — cost /(income) $«500 $«(227) $«(478) $«572 $«254 $«(46) $«1,072 $«««27 $«(524)
Nonpension postretirement benefits — cost 327 294 324 45 41 29 372 335 353
* Includes amount for discontinued operations cost of $77 million for 2002.
accounting policy The discount rate assumptions used for pension and nonpension postretirement bene-
Defined Benefit Pension and Nonpension Postretirement Benefit Plans fit plan accounting reflect the prevailing rates available on high-quality, fixed-income debt
The company accounts for its defined benefit pension plans and its nonpension post- instruments with maturities that match the benefit obligation. The rate of compensation
retirement benefit plans using actuarial models required by SFAS No. 87, “Employers’ increase is another significant assumption used in the actuarial model for pension
Accounting for Pensions,” and SFAS No. 106, “Employers’ Accounting for Postretirement accounting and is determined by the company, based upon its long-term plans for such
Benefits Other Than Pensions,” respectively. These models use an attribution approach that increases. For retiree medical plan accounting, the company reviews external data and its
generally spreads individual events over the service lives of the employees in the plan. own historical trends for health care costs to determine the health care cost trend rates.
Examples of “events” are plan amendments and changes in actuarial assumptions such as As required by SFAS No. 87, for instances in which pension plan assets are less than
discount rate, rate of compensation increases and mortality. The principle underlying this the accumulated benefit obligation (ABO) as of the end of the reporting period (defined
required attribution approach is that employees render service over their service lives on as an unfunded ABO position), a minimum liability equal to this difference is recognized in
a relatively smooth basis and therefore, the income statement effects of pensions or non- the Consolidated Statement of Financial Position. The ABO is the present value of the actu-
pension postretirement benefit plans are earned in, and should follow, the same pattern. arially determined company obligation for pension payments assuming no further salary
One of the principal components of the net periodic pension cost/(income) calcula- increases for the employees. The offset to the minimum liability is a charge to equity, net
tion is the expected long-term rate of return on plan assets. The required use of expected of tax. In addition, any prepaid pension asset in excess of unrecognized prior service cost
long-term rates of return on plan assets may result in recognized pension income that is must be reversed through a net-of-tax charge to equity. The charge to equity is included in
greater or less than the actual returns of those plan assets in any given year. Over time, the Accumulated gains and (losses) not affecting retained earnings section of Stockholders’
however, the expected long-term returns are designed to approximate the actual long-term equity in the Consolidated Statement of Financial Position.
returns and therefore result in a pattern of income and expense recognition that more closely The company uses a December 31 measurement date for the majority of its pension
matches the pattern of the services provided by the employees. Differences between actual plans and nonpension postretirement plans.
and expected returns are recognized in the calculation of net periodic pension cost/
Defined Contribution Pension Plans
(income) over five years as provided for in SFAS No. 87.
The company records pension expense for defined contribution plans when the employee
These expected returns on plan assets are developed by the company in conjunction
renders service to the company, essentially coinciding with the cash contributions to
with external advisors, and take into account long-term expectations for future returns and
the plans.
investment strategy. This assumption is tested for reasonableness against the historical
return average, usually over a ten-year period.
79

defined benefit and defined contribution plans I B M E X E C U T I V E D E F E R R E D CO M P E N S AT I O N P L A N
The company and its subsidiaries have defined benefit and defined contribution pension The company also maintains an unfunded, non-tax-qualified, defined contribution plan,
plans that cover substantially all regular employees, and supplemental retirement plans the IBM Executive Deferred Compensation Plan (EDCP), which allows eligible U.S. execu-
that cover certain executives. tives to defer compensation, and to receive company matching contributions under the
applicable IBM Savings Plan formula described above, with respect to amounts in excess
U.S. Plans
of IRS limits for tax-qualified plans. The total cost of the IBM EDCP was $9 million, $9 mil-
IBM PERSONAL PENSION PLAN
lion and $8 million for the years ended December 31, 2004, 2003 and 2002, respectively.
IBM provides U.S. regular, full-time and part-time employees with noncontributory defined
These amounts are included in the total cost of all of the company’s defined contribution
benefit pension benefits (the IBM Personal Pension Plan, “PPP”). The PPP comprises a tax
plans of $338 million, $333 million and $315 million for the years ended December 31,
qualified plan and a non-qualified plan. The qualified plan is funded by company contri-
2004, 2003 and 2002, respectively.
butions to an irrevocable trust fund, which is held for the sole benefit of participants. The
non-qualified plan, which provides benefits in excess of IRS limitations for qualified plans, U. S . S U P P L E M E N TA L E X E C U T I V E R E T E N T I O N P L A N
is unfunded. The company also has a non-qualified U.S. Supplemental Executive Retention Plan (SERP).
The number of individuals receiving benefits from the PPP at December 31, 2004 and The SERP, which is unfunded, provides defined benefit pension benefits in addition to the
2003, was 139,804 and 136,302, respectively. The net periodic pension cost/(income) for PPP to eligible executives based on average earnings, years of service and age at retire-
the qualified plan for the years ended December 31, 2004, 2003 and 2002, was $30 mil- ment. Effective July 1, 1999, the company adopted the SERP (which replaced the previous
lion, $(692) million and $(917) million, respectively. The net periodic pension cost for the Supplemental Executive Retirement Plan). Some participants of the prior SERP will still be
non-qualified plan was $108 million, $107 million and $106 million for the years ended eligible for benefits under that plan if those benefits are larger than benefits provided
December 31, 2004, 2003 and 2002, respectively. The costs of the non-qualified plan are under the new plan. Certain former partners of PwCC also participate in the SERP under
reflected in Cost of other defined benefit plans on page 81. two separate benefit formulas. The total cost of this plan for the years ended December 31,
The funded status reconciliation for the qualified plan is on page 82. The benefit obli- 2004, 2003 and 2002, was $22 million, $25 million and $18 million, respectively. These
gation of the non-qualified plan was $1,116 million and $1,068 million at December 31, amounts are reflected in Cost of other defined benefit plans on page 81. At December 31,
2004 and 2003, respectively, and the amounts included in Retirement and nonpension 2004 and 2003, the benefit obligation was $191 million and $181 million, respectively, and
postretirement benefit obligations in the Consolidated Statement of Financial Position at the amounts included in Retirement and nonpension postretirement benefit obligations in
December 31, 2004 and 2003, were liabilities of $968 million and $901 million, respectively. the Consolidated Statement of Financial Position at December 31, 2004 and 2003, were
Effective January 1, 2005, the company amended the PPP to provide that employees liabilities of $203 million and $186 million, respectively.
hired on and after such date, including rehires, will not be eligible to participate in this plan.
Non-U.S. Plans
I B M S AV I N G S P L A N Most subsidiaries and branches outside the United States have defined benefit and/or
U.S. regular, full-time and part-time employees are eligible to participate in the IBM defined contribution retirement plans that cover substantially all regular employees, under
Savings Plan, which is a tax-qualified defined contribution plan under section 401(k) of which the company deposits funds under various fiduciary-type arrangements, purchases
the Internal Revenue Code. For employees hired prior to January 1, 2005, the company annuities under group contracts or provides reserves. Benefits under the defined benefit
matches 50 percent of the employee’s contribution up to the first 6 percent of the plans are typically based either on years of service and the employee’s compensation,
employee’s compensation. For employees hired or rehired after December 31, 2004 generally during a fixed number of years immediately before retirement, or on annual
who have also completed one year of service, the company matches 100 percent of the credits. The range of assumptions that are used for the non-U.S. defined benefit plans
employee’s contribution up to the first 6 percent of compensation. All contributions, reflects the different economic environments within various countries. The total non-U.S.
including the company match, are made in cash, in accordance with the participants’ pension plan cost/(income) of these plans for the years ended December 31, 2004, 2003
investment elections. There are no minimum amounts that must be invested in company and 2002, was $572 million, $254 million and $(46) million, respectively. The funded status
stock, and there are no restrictions on transferring amounts out of the company’s stock to reconciliation for the principal non-U.S. pension plans is on page 82.
another investment choice. The total cost of all of the company’s U.S. defined contribution
plans was $338 million, $333 million and $315 million for the years ended December 31,
2004, 2003 and 2002, respectively.
80
Cost /(Income) of Pension Plans

U.S. Plans* Non-U.S. Plans
FOR THE YEAR ENDED DECEMBER 31: 2004 2003 2002 2004 2003 2002
Service cost $««««652 $««««576 $««««650 $««««611 $««««537 $««««505

Interest cost 2,453 2,518 2,591 1,618 1,477 1,270
Expected return on plan assets (3,607) (3,703) (4,121) (2,380) (2,228) (2,132)
Amortization of transition assets (72) (144) (144) (10) (15) (12)
Amortization of prior service cost 61 61 61 5 17 28
Settlement of certain legal claims 320 — — — — —
Recognized actuarial losses 223 — — 221 101 33
Divestitures/settlement losses — — 46 — — 26
Net periodic pension cost /(income) — U.S. Plan and material non-U.S. Plans 30* (692) * (917) * 65 (111) (282)
Cost of other defined benefit plans 132 132 124 187 100 58
Total net periodic pension cost/(income) for all defined benefit plans 162 (560) (793) 252 (11) (224)
Cost of defined contribution plans 338 333 315 320 265 178
Total pension plans cost /(income) recognized in the

Consolidated Statement of Earnings $««««500 $«««(227) $«««(478) $««««572 $««««254 $«««««(46)
* Represents the qualified portion of the PPP.
See beginning of note w, “Retirement-Related Benefits,” on page 79 for the company’s total retirement-related benefits cost/(income).
81

The changes in the benefit obligations and plan assets of the qualified portion of the PPP and the significant non-U.S. defined benefit plans for 2004 and 2003 were as follows:
PPP-Qualified Portion Non-U.S. Plans
2004 2003 2004 2003
Change in benefit obligation:

Benefit obligation at beginning of year $«42,104 $«38,357 $«31,875 $«25,699
Service cost 652 576 611 537
Interest cost 2,453 2,518 1,620 1,477
Plan participants’ contributions — — 50 43
Acquisitions/divestitures, net — — 93 75
Settlement of certain legal claims 320 — — —
Actuarial losses 1,856 3,472 3,729 1,167
Benefits paid from trust (2,748) (2,819) (1,305) (1,093)
Direct benefit payments — — (287) (253)
Foreign exchange impact — — 2,352 4,166
Plan curtailments/settlements/termination benefits — — (8) 57
Benefit obligation at end of year 44,637 42,104 38,730 31,875
Change in plan assets:

Fair value of plan assets at beginning of year 41,679 36,984 26,546 20,637
Actual return on plan assets 5,214 7,514 2,588 2,829
Employer contribution 700 — 1,085 542
Acquisitions/divestitures, net — — 59 7
Plan participants’ contributions — — 50 43
Benefits paid from trust (2,748) (2,819) (1,305) (1,093)
Foreign exchange impact — — 2,117 3,581
Fair value of plan assets at end of year 44,845 41,679 31,140 26,546
Fair value of plan assets in excess/(deficit) of benefit obligation 208 (425) (7,590) (5,329)
Unrecognized net actuarial losses 11,874 11,849 14,737 10,775
Unrecognized prior service costs 461 523 (160) (170)
Unrecognized net transition assets — (72) (3) (26)
Net prepaid pension assets recognized in the Consolidated Statement of Financial Position $«12,543 $«11,875 $«««6,984 $«««5,250
Amounts recognized in the Consolidated Statement of Financial Position captions include:

Prepaid pension assets $«12,543 $«11,875 $«««7,476 $«««6,129
Intangible assets — — 44 52
Total prepaid pension assets 12,543 11,875 7,520 6,181

Retirement and nonpension postretirement benefit obligation — — (8,429) (6,982)
Accumulated gains and (losses) not affecting retained earnings — — 5,088 3,888
Deferred tax assets (investments and sundry assets) — — 2,805 2,163
Net amount recognized $«12,543 $«11,875 $«««6,984 $«««5,250
Accumulated benefit obligation $«43,327 $«40,423 $«36,755 $«30,240

82
Differences between the aggregate balance sheet amounts listed on page 82 (approximately $300 million) and changes in the non-U.S. expected long-term return on
(material pension plans) and on page 85 (material nonpension postretirement plan) and assets assumptions (approximately $100 million). In addition to changes in assumptions,
the totals listed in the Consolidated Statement of Financial Position and Consolidated the net periodic pension cost will increase due to the recognition of previously deferred
Statement of Stockholders’ Equity, relate to the non-material plans. The increase in the pension costs as a result of changes in the market value of plan assets in accordance with
company’s Prepaid pension asset balance from 2003 to 2004 was primarily due to the SFAS No. 87. The increases in net periodic pension cost will be offset partially by the com-
$700 million contribution made by the company to the PPP during 2004. The increase in pany’s contributions in December 2004 ($700 million) and January 2005 ($1.7 billion) to
the company’s pension plan benefit obligation was primarily attributable to the required the PPP. These contributions are expected to yield approximately $200 million of income
accounting for the unfunded status of the non-U.S. pension plans as discussed below, as from invested assets during 2005.
well as accrued pension costs and foreign exchange impacts.
Funded Status of Defined Benefit Pension Plans
Assumptions used to determine the year-end benefit obligations for principal pension
It is the company’s general practice to fund amounts for pensions sufficient to meet the
plans follow:
minimum requirements set forth in applicable employee benefits laws and local tax laws.
U.S. Plans Non-U.S. Plans The company may also voluntarily make contributions up to the ABO level. From time to
WEIGHTED-AVERAGE ASSUMPTIONS time, the company contributes additional amounts as it deems appropriate.
AT DECEMBER 31: 2004 2003 2002 2004 2003 2002 In the fourth quarter of 2004, the company contributed $700 million to the qualified
Discount rate 5.75% 6.0% 6.75% 3.0–6.0% 3.0–6.0% 4.25–6.5% portion of the PPP in cash. There were no contributions to the PPP during the year ended
Rate of compensation increase 4.0% 4.0% 4.0% 1.9–4.6% 1.5–5.0% 2.2–5.0% December 31, 2003. There were contributions of $1,085 million and $542 million to the
material non-U.S. plans during the years ended December 31, 2004 and 2003, respectively.
The company decided not to fund certain of the company’s non-U.S. plans that had
Assumptions used to determine the net periodic pension cost/(income) for principal
unfunded positions to the ABO level. As a result and consistent with the accounting rules
pension plans during the year follow:
required by SFAS No. 87 for these “unfunded” positions as described on page 79, the com-
U.S. Plans Non-U.S. Plans pany recorded an additional minimum liability adjustment of $1,827 million and a reduction
WEIGHTED-AVERAGE ASSUMPTIONS to stockholders’ equity of $1,008 million as of December 31, 2004. The differences between
FOR YEARS ENDED DECEMBER 31: 2004 2003 2002 2004 2003 2002 these amounts and the amounts included in the Consolidated Statement of Financial
Discount rate 6.0% 6.75% 7.0% 3.0–6.0% 4.25–6.5% 4.5–7.1% Position and Consolidated Statement of Stockholders’ Equity relate to the non-material
Expected long-term return plans. This accounting transaction did not impact 2004 retirement-related plans cost.
on plan assets 8.0% 8.0% 9.50% 5.0–8.0% 5.0–8.0% 5.0–9.25% The company’s Benefit Obligation (BO) for its significant plans is disclosed at the top
Rate of compensation increase 4.0% 4.0% 6.0% 1.5–5.0% 2.2–5.0% 2.0–6.1% of page 82. BO is calculated similarly to ABO except for the fact that BO includes an
estimate for future salary increases. SFAS No. 132 (revised 2003), “Employers’ Disclosures
The change in the discount rate assumption for the year ended December 31, 2004, for about Pensions and Other Postretirement Benefits — an amendment of FASB Statements
the PPP from 6.75 percent to 6.0 percent resulted in an increase in net periodic pension No. 87, 88 and 106,” requires that companies disclose the aggregate BO and plan assets
cost of $197 million for the year ended December 31, 2004, when compared with the year of all plans in which the BO exceeds plan assets. Similar disclosure is required for all plans
ended December 31, 2003. The change in discount rate assumption for the PPP for the in which the ABO exceeds plan assets. The aggregate BO and plan assets are also dis-
year ended December 31, 2003 from 7.0 percent to 6.75 percent did not have a material closed for plans in which the plan assets exceed the BO. The following table excludes the
impact on net periodic pension cost. U.S. plans due to the fact that these plans’ BO and plan assets, if any, appear in either the
The changes in the expected long-term return on plan assets assumptions for the year narrative on pages 79 and 80 or the table on page 82.
ended December 31, 2004 for certain non-U.S. plans when compared with the year ended (Dollars in millions)
December 31, 2003 resulted in an increase net periodic pension cost of $54 million.
2004 2003
For the year ending December 31, 2005, the company expects net periodic pension
Benefit Plan Benefit Plan
cost to be approximately $1.7 billion, an increase of approximately $700 million when Obligation Assets Obligation Assets
compared with the year ended December 31, 2004. This increase however, is lower as
Plans with BO in excess of plan assets $«29,949 $«19,921 $«21,101 $«12,985
a result of the inclusion of a $320 million one-time pension settlement in the 2004
Plans with ABO in excess of plan assets $«23,813 $«15,428 $«19,902 $«12,985
results. The increase in the 2005 net periodic pension cost is driven by several factors
Plans with assets in excess of BO $«««8,781 $«11,219 $«10,774 $«13,561
including December 31, 2004 changes in the U.S. and non-U.S. discount rate assumptions
83

plan assets The assets are managed by professional investment firms as well as by investment
The company’s pension plan weighted-average asset allocations at December 31, 2004 professionals who are employees of the company. They are bound by precise mandates
and 2003 and target allocation for 2005, by asset category, are as follows: and are measured against specific benchmarks. Among managers, consideration is given,
among others, to balancing security concentration, issuer concentration, investment style
U.S. Plans
and reliance on particular active investment strategies. Market liquidity risks are tightly
Plan Assets controlled, with only a small percentage of the PPP portfolio invested in private market
at December 31:
2005 assets consisting of private equities and private real estate investments, which are less liq-
Target
Asset Category 2004 2003 Allocation uid than publicly traded securities. The PPP included private market assets comprising
approximately 10.1 percent and 10.5 percent of total assets at December 31, 2004 and
Equity securities * 65.4% 67.5% 64.0%
2003, respectively. The target allocation for private market assets in 2005 is 10.1 percent.
Debt securities 31.6% 29.2% 32.0%
The Fund has $2,628 million in commitments for future private market investments to be
Real estate 3.0% 3.3% 4.0%
made over a number of years. These commitments are expected to be fulfilled from plan
Total 100.0% 100.0% 100.0% assets. Derivatives are primarily used to hedge currency, adjust portfolio duration, and
reduce specific market risks.
Non-U.S. Plans Outside the U.S., the investment objectives are similar, subject to local regulations. In
some countries, a higher percentage allocation to fixed income securities is required. In
Plan Assets
at December 31: 2005 others, the responsibility for managing the investments typically lies with a board that may
Target
include up to 50 percent of members elected by employees and retirees. This can result
Asset Category 2004 2003 Allocation
in slight differences compared with the strategies described above. Generally, these non-
Equity securities 58.4% 59.1% 58.5% U.S. funds are not permitted to invest in illiquid assets, such as private equities, and their
Debt securities 38.8% 38.5% 39.2% use of derivatives is usually limited to passive currency hedging. During 2004, there was
Real estate 2.0% 1.9% 1.9% no significant change in the investment strategies of these plans.
Other 0.8% 0.5% 0.4% Equity securities include IBM common stock in the amounts of $1,376 million (3.1 per-
Total 100.0% 100.0% 100.0% cent of total PPP plan assets at December 31, 2004) and $2,144 million (5.1 percent of total
PPP plan assets at December 31, 2003).
* See discussion below regarding certain private market assets, and future funding commitments thereof, that are not
as liquid as the rest of the publicly traded securities. expected contributions
In 2005, the company estimates contributions to its non-U.S. plans to be an amount that is
The investment objectives of the PPP portfolio of assets (the Fund) are designed to gen- equivalent to such contributions in 2004 ($1,085 million). The company could elect to con-
erate returns that will enable the Fund to meet its future obligations. The precise amount tribute more or less than the amount based on market conditions. The legally mandated
for which these obligations will be settled depends on future events, including the life minimum contributions to the company’s non-U.S. plans is expected to be $361 million.
expectancy of the Plan’s members and salary inflation. The obligations are estimated using On January 19, 2005, the company elected to make a $1.7 billion contribution to the qual-
actuarial assumptions, based on the current economic environment. The Fund’s investment ified portion of PPP. Depending upon market conditions, the company may elect to further
strategy balances the requirement to generate return, using higher-returning assets such contribute to the qualified portion of the PPP during 2005.
as equity securities, with the need to control risk in the Fund with less volatile assets, such
as fixed income securities. Risks include, among others, inflation, volatility in equity values
and changes in interest rates that could cause the Plans to become underfunded, thereby
increasing their dependence on contributions from the company. Within each asset class,
careful consideration is given to balancing the portfolio among industry sectors, geogra-
phies, interest rate sensitivity, dependence on economic growth, currency and other factors
that affect investment returns.
84
expected benefit payments The net periodic postretirement benefit cost for the U.S. plan for the years ended
The following table reflects the total expected benefit payments to plan participants. December 31 includes the following components:
These payments have been estimated based on the same assumptions used to measure (Dollars in millions)
the company’s BO at year-end and include benefits attributable to estimated future com-
2004 2003 2002
pensation increases.
Service cost $«««40 $«««36 $«««49
(Dollars in millions) Interest cost 337 382 421
Total Amortization of prior service costs (62) (130) (147)
U.S. Plans U.S. Plans Non-U.S. Plans Non-U.S. Plans Expected
Qualified Non-qualified Qualified Non-qualified Benefit
Recognized actuarial losses 12 6 30
Payments Payments Payments Payments Payments Divestiture — — (29)
2005 $««2,907 $««68 $«1,532 $«««301 $««4,808 Net periodic postretirement benefit cost $«327 $«294 $«324
2006 2,914 70 1,577 304 4,865
2007 2,952 73 1,655 307 4,987
The changes in the benefit obligation and plan assets of the U.S. plan for 2004 and 2003
2008 2,999 76 1,698 305 5,078
are as follows:
2009 3,053 80 1,757 290 5,180
2010 – 2014 16,315 473 9,520 1,449 27,757
2004 2003
nonpension postretirement benefits Change in benefit obligation:

The total cost of the company’s nonpension postretirement benefits for the years ended Benefit obligation at beginning of year $««6,181 $««5,882
December 31, 2004, 2003 and 2002, was $372 million, $335 million and $353 million, Service cost 40 36
respectively. The company has a defined benefit postretirement plan that provides med- Interest cost 337 382
ical and dental benefits as well as life insurance for U.S. retirees and eligible dependents. Actuarial losses/(gains) (146) 419
The total cost of this plan for the years ended December 31, 2004, 2003 and 2002, was Direct benefit payments (518) (538)
$327 million, $294 million and $324 million, respectively. The changes in the benefit obli- Benefit obligation at end of year 5,894 6,181
gation and plan assets for this plan are presented in the following table. Effective July 1,
Change in plan assets:
1999, the company established a “Future Health Account” (FHA) for employees who were
Fair value of plan assets at beginning of year 14 10
more than five years away from retirement eligibility. Employees who were within five years
Actual return on plan assets — —
of retirement eligibility are covered under the company’s prior retiree health benefits
Employer contributions 35 —
arrangements. Under either the FHA or the prior retiree health benefit arrangements, there
Participant contributions 187 153
is a maximum cost to the company for retiree health benefits. For employees who retired
Benefits paid from trust (186) (149)
before January 1, 1992, that maximum became effective in 2001. For all other employees,
the maximum is effective upon retirement. Effective January 1, 2004, the company amended Fair value of plan assets at end of year 50 14
its postretirement plan to provide that new hires will no longer be eligible for company- Benefit obligation in excess of plan assets (5,844) (6,167)
subsidized benefits. Unrecognized net actuarial losses 846 1,004
Certain of the company’s non-U.S. subsidiaries have similar plans for retirees. How- Unrecognized prior service costs (301) (363)
ever, most of the retirees outside the United States are covered by government-sponsored Accrued postretirement benefit liability recognized
and administered programs. The total cost of these plans for the years ended December 31, in the Consolidated Statement of Financial Position $«(5,299) $«(5,526)
2004, 2003 and 2002, was $45 million, $41 million and $29 million, respectively. At
December 31, 2004 and 2003, Retirement and nonpension postretirement benefit obliga-
tions in the Consolidated Statement of Financial Position include non-U.S. postretirement
benefit liabilities of $322 million and $270 million, respectively.
85

The benefit obligation was determined by applying the terms of medical, dental and plan assets
life insurance plans, including the effects of established maximums on covered costs, The company’s nonpension postretirement benefit plan assets at December 31, 2004 and
together with relevant actuarial assumption. 2003 are comprised of short-term fixed-income investments.
This plan is not funded. The company makes payments from company funds as they
WEIGHTED-AVERAGE DISCOUNT RATE
ASSUMPTIONS USED TO DETERMINE: 2004 2003 2002 become due and also maintains a nominal, highly liquid fund balance to ensure payments
are made timely.
The year-end benefit obligation at December 31 «««5.75% «««6.0% «««6.75%
The net periodic post-retirement benefit costs recently enacted legislation
for years ended December 31 6.0% 6.75% 7.0%
The Medicare Prescription Drug Improvement and Modernization Act of 2003 (the
Medicare Act) was signed into law on December 8, 2003. The Act introduces a prescription
For the years ended December 31, 2004, 2003 and 2002, the plan assets of $50 million, drug benefit under Medicare (Medicare Part D) as well as a federal subsidy to sponsors of
$14 million and $10 million, respectively, were invested in short-term highly liquid fixed retiree health care benefit plans that provide a prescription drug benefit that is at least
income securities, and as a result, the expected long-term return on plan assets and the actuarially equivalent to Medicare Part D.
actual return on those assets were not material for those years. The method of determining whether a sponsor’s plan will qualify for actuarial equiva-
The company evaluates its actuarial assumptions on an annual basis and considers lency was issued in January 2005 by the U.S. Department of Health and Human Services
changes in these long-term factors based upon market conditions and the requirements (HHS). While the company is currently evaluating the guidance provided by HHS, based on
of SFAS No. 106, “Employers’ Accounting for Postretirement Benefits Other Than Pensions.” the current interpretation of the guidance and in relation to the company’s current plan
The discount rate changes did not have a material effect on net postretirement benefit design, any savings to the company are expected to be immaterial.
cost for the years ended December 31, 2004, 2003 and 2002. FSP No. 106-2, “Accounting and Disclosure Requirements Related to the Medicare
Prescription Drug, Improvement and Modernization Act of 2003,” issued in the second
ASSUMED HEALTH CARE COST TREND RATES AT DECEMBER 31: 2004 2003 quarter of 2004, provides guidance on the accounting for the effects of the Medicare Act,
Health care cost trend rate assumed for next year 10.0% 8.9% including the accounting for and disclosure of any federal subsidy provided by the
Rate to which the cost trend rate is assumed to decline Medicare Act.
(the ultimate trend rate) 5.0% 4.5% The enactment of the Medicare Act was not a “significant event” as defined by SFAS
Number of years to ultimate trend rate 5 4 No. 106 for the company’s nonpension postretirement benefit plans (the Plans) and there-
fore, the company did not remeasure plan assets and obligations. As discussed above, any
The health care cost trend rate has an insignificant effect on plan costs and obliga- federal subsidy related to prescription drug benefits provided under the Plans is expected
tions. A one-percentage-point change in the assumed health care cost trend rate would to be immaterial, based on the current interpretation of the Medicare Act. As a result, the
have the following effects as of December 31, 2004: company’s accumulated postretirement benefit obligations as of December 31, 2004 and
the net periodic postretirement benefit costs for the year ended December 31, 2004, were
not impacted by the Medicare Act. The company will be required to reflect any changes
One-Percentage- One-Percentage- to participation rates and other health care cost assumptions, as a result of the Medicare
Point Increase Point Decrease
Act, at the company’s next measurement date in 2005. The impact of any such change is not
Effect on total service and interest cost NM NM
expected to have a material impact on the company’s Consolidated Financial Statements.
Effect on postretirement benefit obligation $«3 $«(5)
NM — Not Meaningful as the impact would be less than $1 million.
86
x. Segment Information Segment revenue and pre-tax income include transactions between the segments
The company uses business insight and its portfolio of IT capabilities to create client that are intended to reflect an arm’s-length transfer price. Specifically, semiconductors
solutions. The company operates primarily in a single industry using several segments that are sourced internally from the Systems and Technology Group segment for use in the
manufacture of the Personal Systems Group segment products. In addition, hardware
create value by offering solutions that include, either singularly or in some combination,
and software that are used by the Global Services segment in outsourcing engagements
services, software, hardware and financing.
are mostly sourced internally from the Systems and Technology Group, Personal Systems
Organizationally, the company’s major operations comprise a Global Services segment;
Group and Software segments. For the internal use of IT services, the Global Services
a Software segment; two hardware product segments — Systems and Technology Group
segment recovers cost, as well as a reasonable fee, reflecting the arm’s-length value of
and Personal Systems Group; a Global Financing segment; and an Enterprise Investments
providing the services. The Global Services segment enters into arm’s-length leases at
segment. The segments represent components of the company for which separate finan-
prices equivalent to market rates with the Global Financing segment to facilitate the acqui-
cial information is available that is utilized on a regular basis by the chief executive officer
sition of equipment used in services engagements. Generally, all internal transaction
in determining how to allocate the company’s resources and evaluate performance. The
prices are reviewed and reset annually, if appropriate.
segments are determined based on several factors, including client base, homogeneity of
The company uses shared-resources concepts to realize economies of scale and
products, technology, delivery channels and similar economic characteristics.
efficient use of resources. Thus, a considerable amount of expense is shared by all of the
Information about each segment’s business and the products and services that gener-
company’s segments. This expense represents sales coverage, marketing and support func-
ate each segment’s revenue is located in the “Description of Business” section of the
tions such as Accounting, Treasury, Procurement, Legal, Human Resources, and Billing and
Management Discussion on pages 15 and pages 21 to 23. Collections. Where practical, shared expenses are allocated based on measurable drivers
In 2003, the company renamed all of its hardware segments without changing the of expense, e.g., headcount. When a clear and measurable driver cannot be identified,
organization of these segments. The Enterprise Systems segment was renamed the shared expenses are allocated on a financial basis that is consistent with the company’s
Systems Group segment, the Personal and Printing Systems segment was renamed the management system; e.g., image advertising is allocated based on the gross profits of the
Personal Systems Group segment and the Technology segment was renamed the Technol- segments. The unallocated corporate amounts arising from certain acquisitions, indirect
ogy Group segment. infrastructure reductions, certain IP income, miscellaneous tax items and the unallocated
Over recent years, the company has been developing and enhancing a “one team” corporate expense pool are recorded in net income but are not allocated to the segments.
approach to the collaboration between the Systems Group and the Technology Group. The following tables reflect the results of continuing operations of the segments con-
This relationship is crucial given the core technology of the Systems Group products is a sistent with the company’s management system. These results are not necessarily a depic-
key competitive differentiator for the company. The degree of this collaboration has tion that is in conformity with GAAP; e.g., employee retirement plan costs are developed
increased whereby in 2004, the company is managing these groups as one. Accordingly, using actuarial assumptions on a country-by-country basis and allocated to the segments
in the first quarter of 2004, the company combined the two segments into one reporting based on headcount. Different amounts could result if actuarial assumptions that are
segment. The new Systems and Technology Group segment generates one consolidated unique to the segment were used. Performance measurement is based on income before
set of financial results, which senior management uses for joint strategy, budgets, and income taxes (pre-tax income). These results are used, in part, by management, both in
resource allocation decisions, as well as performance and compensation scoring. evaluating the performance of, and in allocating resources to, each of the segments.
87

management system segment view

Hardware
Systems and Personal

Global Technology Systems Global Enterprise Total
FOR THE YEAR ENDED DECEMBER 31: Services Group Group Software Financing Investments Segments
2004:
External revenue $«46,213 $«17,916 $«12,794 $«15,094 $«2,607 $«1,180 $«««95,804
Internal revenue 3,131 1,051 173 1,805 1,287 8 7,455
Total revenue $«49,344 $«18,967 $«12,967 $«16,899 $«3,894 $«1,188 $«103,259
Pre-tax income/(loss) $«««4,657 $«««2,265 $««««««162 $«««4,541 $«1,494 $«««(187) $«««12,932
Revenue year-to-year change 8.5% 9.4% 12.2% 6.1% (5.6) % 11.0% 8.1%
Pre-tax income year-to-year change 3.5% 23.9% NM 19.2% 26.4% 25.8% 18.1%
Pre-tax income margin 9.4% 11.9% 1.2% 26.9% 38.4% (15.7) % 12.5%
2003:
Internal revenue 2,837 865 171 1,613 1,300 5 6,791
Total revenue $«45,472 $«17,334 $«11,558 $«15,924 $«4,127 $«1,070 $«««95,485
Pre-tax income/(loss) $«««4,499 $«««1,828 $«««««(118) $«««3,808 $«1,182 $«««(252) $«««10,947
Revenue year-to-year change 16.0% 2.5% 3.3% 11.4% (0.4) % 4.3% 10.0%
Pre-tax income year-to-year change 23.0% NM NM 7.1% 23.8% 14.0% 29.2%
Pre-tax income margin 9.9% 10.5% (1.0) % 23.9% 28.6% (23.6) % 11.5%
2002:
Internal revenue 2,854 711 139 1,225 939 4 5,872
Total revenue $«39,214 $«16,906 $«11,188 $«14,299 $«4,142 $«1,026 $«««86,775
Pre-tax income/(loss) $«««3,657 $««««««538 $««««««««57 $«««3,556 $««««955 $«««(293) $«««««8,470
Revenue year-to-year change 4.3% (10.8) % (7.2) % 2.7% (2.4) % (8.6) % (1.3) %
Pre-tax income year-to-year change (29.1) % (74.1) % 137.3% 12.2% (16.4) % 7.6% (23.6) %
Pre-tax income margin 9.3% 3.2% 0.5% 24.9% 23.1% (28.6) % 9.8%
88
Reconciliations to IBM as Reported segment assets and other items

(Dollars in millions) The Global Services assets are primarily accounts receivable, goodwill, maintenance
FOR THE YEAR ENDED DECEMBER 31: 2004 2003 2002 inventory, and plant, property and equipment including those associated with the seg-
ment’s outsourcing business. The Software segment assets are mainly goodwill, plant,
Revenue:
property and equipment, and investment in capitalized software. The assets of the
Total reportable segments $«103,259 $«95,485 $«86,775
Hardware segments are primarily inventory and plant, property and equipment. The assets
Other revenue and adjustments 489 437 283
of the Global Financing segment are primarily financing receivables and fixed assets under
Elimination of internal revenue (7,455) (6,791) (5,872)
operating leases.
Total IBM consolidated $«««96,293 $«89,131 $«81,186
To accomplish the efficient use of the company’s space and equipment, it usually is
necessary for several segments to share plant, property and equipment assets. Where
(Dollars in millions) assets are shared, landlord ownership of the assets is assigned to one segment and is not
FOR THE YEAR ENDED DECEMBER 31: 2004 2003 2002 allocated to each user segment. This is consistent with the company’s management system
and is reflected accordingly in the schedule on page 90. In those cases, there will not be
Pre-Tax Income:
a precise correlation between segment pre-tax income and segment assets.
Total reportable segments $«12,932 $«10,947 $«8,470
Similarly, the depreciation amounts reported by each segment are based on the
Elimination of internal transactions (152) (89) (198)
assigned landlord ownership and may not be consistent with the amounts that are
Unallocated corporate amounts (752) 16 (748)
included in the segments’ pre-tax income. The amounts that are included in pre-tax
Total IBM consolidated $«12,028 $«10,874 $«7,524
income reflect occupancy charges from the landlord segment and are not specifically
identified by the management reporting system. Capital expenditures that are reported by
immaterial items each segment also are in line with the landlord ownership basis of asset assignment.
Investment in Equity Alliances and Equity Alliances Gains /(Losses) The Global Financing segment amounts on page 90 for Interest income and Cost of
The investments in equity alliances and the resulting gains and (losses) from these invest- Global Financing interest expense reflect the interest income and interest expense associ-
ments that are attributable to the segments do not have a material effect on the financial ated with the Global Financing business, including the intercompany financing activities
position or the financial results of the segments. discussed on page 35 as well as the income from the investment in cash and marketable
securities. The explanation of the difference between Cost of Global Financing and Interest
expense for segment presentation versus presentation in the Consolidated Statement of
Earnings is included on page 38 of the Management Discussion.
89

management system segment view

Hardware
Systems and Personal

Global Technology Systems Global Enterprise Total
FOR THE YEAR ENDED DECEMBER 31: Services Group Group Software Financing Investments Segments
2004:
Assets $«19,123 $«8,669 $«1,940 $«5,278 $«34,589 $««68 $«69,667
Depreciation/amortization of intangibles:
Continuing operations 1,713 1,175 87 658 2,013 6 5,652
Discontinued operations — — — — — — —
Capital expenditures/investment in intangibles:
Continuing operations 1,953 968 71 434 2,229 6 5,661
Discontinued operations — — — — — — —
Interest income — — — — 2,355 — 2,355
Interest expense — — — — 584 — 584
2003:
Assets* $«16,683 $«8,751 $«1,894 $«4,682 $«35,916 $««69 $«67,995
Depreciation/amortization of intangibles:*
Discontinued operations — 10 — — — — 10
Capital expenditures/investment in intangibles:*
Interest income — — — — 2,349 — 2,349
2002:
Assets* $«14,462 $«8,827 $«1,776 $«2,992 $«35,242 $««88 $«63,387
Depreciation /amortization of intangibles:*
Capital expenditures/investment in intangibles:*
Interest income — — — — 2,703 — 2,703
90
Reconciliations to IBM as Reported (Dollars in millions)

(Dollars in millions) Consolidated
AT DECEMBER 31: 2004 2003* 2002*
Assets:
Global Services:
Total reportable segments $«««69,667 $«««67,995 $«63,387
Services $«40,517 $«37,178 $«31,290
Elimination of internal transactions (5,814) (5,596) (4,993)
Maintenance 5,696 5,457 5,070
Unallocated amounts:
Systems and Technology Group:
Cash and marketable securities 9,421 6,523 4,568
Servers $«12,460 $«11,148 $«10,047
Notes and accounts receivable 3,872 3,334 3,553
Storage 2,898 2,849 2,581
Deferred tax assets 4,899 6,486 6,631
Microelectronics OEM «««2,131 «««2,142 «««3,226
Plant, other property and equipment 3,522 3,380 3,239
Technology services 424 325 323
Pension assets 20,381 18,416 15,996
Networking products 3 5 18
Other 3,235 3,919 4,103
Enterprise Investments:
Total IBM consolidated $«109,183 $«104,457 $«96,484 Software $«««1,131 $««««««981 $««««««916
* Reclassified to conform with 2004 presentation. Hardware 37 72 95

Others 12 12 11
revenue by classes of similar products or services

For the Personal Systems Group, Software and Global Financing segments, the segment major clients
data on page 88 represents the revenue contributions from the products that are con- No single client represents 10 percent or more of the company’s total revenue.
tained in the segments and that are basically similar in nature. The following table provides
external revenue for similar classes of products within the Systems and Technology Group, geographic information
Global Services and Enterprise Investments segments. The Systems and Technology Group (Dollars in millions)
segment’s OEM hardware comprises revenue primarily from the sale of semiconductors Revenue* Long-Lived Assets ** +
and display devices. Technology services comprise the Systems and Technology Group’s
circuit design business for its OEM clients as well as the component design services, FOR THE YEAR ENDED DECEMBER 31: 2004 2003 2002 2004 2003++ 2002++
strategic outsourcing of clients’ design team work, and technology and manufacturing United States $«35,637 $«33,762 $«32,759 $«29,780 $«29,929 $«28,064
consulting services associated with the Engineering & Technology Services Division. The Japan 12,295 11,694 10,939 2,701 2,738 2,814
Systems and Technology Group segment’s storage comprises revenue from TotalStorage Other countries 48,361 43,675 37,488 20,600 16,373 13,027
disk storage systems, tape subsystems and networking hardware. Enterprise Investments Total $«96,293 $«89,131 $«81,186 $«53,081 $«49,040 $«43,905
software revenue is primarily from product life-cycle management products. The following
table is presented on a continuing operations basis. * Revenues are attributed to countries based on location of client and are for continuing operations.
** Includes all non-current assets except non-current financial instruments and deferred tax assets.
+ At December 31
++ Reclassified to conform with 2004 presentation.
91
Five-Year Comparison of Selected Financial Data

FOR THE YEAR: 2004 2003 2002 2001 2000
Revenue $«««96,293 $«89,131 $«81,186 $«83,067 $«85,089

Income from continuing operations 8,448 7,613 5,334 8,146 7,874
(Loss)/income from discontinued operations (18) (30) (1,755) (423) 219
Net income 8,430 7,583 3,579 7,723 8,093
Earnings/(loss) per share of common stock:
Assuming dilution:
Continuing operations 4.94 4.34 3.07 4.59 4.32
Discontinued operations (0.01) (0.02) (1.01) (0.24) 0.12
Total 4.93 4.32 2.06 4.35 4.44

Basic:
Continuing operations 5.04 4.42 3.13 4.69 4.45
Discontinued operations (0.01) (0.02) (1.03) (0.24) 0.12
Total 5.03 4.40 2.10 4.45 4.58*

Cash dividends paid on common stock 1,174 1,085 1,005 956 909
Per share of common stock 0.70 0.63 0.59 0.55 0.51
Investment in plant, rental machines and other property 4,368 4,398 5,022 5,660 5,616
Return on stockholders’ equity 29.3% 29.9% 15.5% 35.3% 40.0%
AT END OF YEAR: 2004 2003 2002 2001 2000
Total assets $«109,183 $«104,457 $«96,484 $«90,303 $«90,412

Net investment in plant, rental machines and other property 15,175 14,689 14,440 16,504 16,714
Working capital ** 7,172 7,039 7,257 7,483 7,474
Total debt 22,927 23,632 26,017 27,151 28,576
Stockholders’ equity 29,747 27,864 22,782 23,448 20,550
* Does not total due to rounding.

** Reclassified to conform with 2004 presentation.
92
Selected Quarterly Data
(Dollars in millions (Dollars in millions
except per share amounts and stock prices) except per share amounts and stock prices)
First Second Third Fourth Full First Second Third Fourth Full
2004: Quarter Quarter Quarter Quarter Year 2003: Quarter Quarter Quarter Quarter Year
Revenue $«22,175* $«23,098* $«23,349* $«27,671 $«96,293* Revenue $«20,065 $«21,631 $«21,522 $«25,913 $«89,131
Gross profit 8,009 8,525 8,646 10,852 36,032 Gross profit 7,233 7,998 7,812 9,975 33,018
Income from continuing Income from continuing
operations 1,603 1,990 1,800 3,055 8,448 operations 1,387 1,725 1,785 2,716 7,613
Loss from discontinued Loss from discontinued
operations (1) (2) — (15) (18) operations (3) (20) — (7) (30)
Net income 1,602 1,988 1,800 3,040 8,430 Net income 1,384 1,705 1,785 2,709 7,583
Earnings/(loss) per share of Earnings/(loss) per share of
common stock: common stock:
Assuming dilution: Assuming dilution:
Continuing operations 0.93 1.16 1.06 1.81 4.94** Continuing operations 0.79 0.98 1.02 1.56 4.34**
Discontinued operations — — — (0.01) (0.01) Discontinued operations — (0.01) — — (0.02) **
Total 0.93 1.16 1.06 1.80 4.93** Total 0.79 0.97 1.02 1.55+ 4.32**
Basic: Basic:
Continuing operations 0.95 1.18 1.08 1.84 5.04** Continuing operations 0.80 1.00 1.04 1.59 4.42**
Discontinued operations — — — (0.01) (0.01) Discontinued operations — (0.01) — — (0.02) **
Total 0.95 1.18 1.08 1.83 5.03** Total 0.80 0.99 1.04 1.59 4.40**
Dividends per share of Dividends per share of
common stock 0.16 0.18 0.18 0.18 0.70 common stock 0.15 0.16 0.16 0.16 0.63
Stock prices ++: Stock prices ++:
High $«100.43 $«««94.55 $«««88.44 $«««99.00 High $«««88.95 $«««90.40 $«««93.47 $«««94.54
Low 89.01 85.12 81.90 84.29 Low 73.17 78.12 78.73 87.53
* See page12, “Subsequent Event” for additional information regarding 2004 quarterly revenue.
** Earnings Per Share (EPS) in each quarter is computed using the weighted-average number of shares outstanding dur-
ing 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.
+ Does not total due to rounding.
++ The stock prices reflect the high and low prices for IBM’s common stock on the New York Stock Exchange composite
tape for the last two years.
93
ibm board of directors
94
IBM ANNUAL REPORT 2004
Board of Directors
Seated left to right: Standing left to right:
Cathleen Black John B. Slaughter * Minoru Makihara Kenneth I. Chenault Joan E. Spero
PRESIDENT PRESIDENT AND SENIOR CORPORATE ADVISOR AND CHAIRMAN AND PRESIDENT
HEARST MAGAZINES CHIEF EXECUTIVE OFFICER FORMER CHAIRMAN CHIEF EXECUTIVE OFFICER DORIS DUKE
NATIONAL ACTION COUNCIL FOR MITSUBISHI CORPORATION AMERICAN EXPRESS COMPANY CHARITABLE FOUNDATION
Samuel J. Palmisano MINORITIES IN ENGINEERING, INC.
CHAIRMAN, PRESIDENT AND Nannerl O. Keohane * Juergen Dormann Michael L. Eskew
CHIEF EXECUTIVE OFFICER Lorenzo H. Zambrano RETIRED PRESIDENT CHAIRMAN CHAIRMAN AND
IBM CHAIRMAN AND DUKE UNIVERSITY ABB LTD CHIEF EXECUTIVE OFFICER
CHIEF EXECUTIVE OFFICER UNITED PARCEL SERVICE, INC.
Carlos Ghosn CEMEX, S.A. DE C.V. Sidney Taurel Charles F. Knight
CO-CHAIRMAN, PRESIDENT AND CHAIRMAN, PRESIDENT AND CHAIRMAN EMERITUS Charles M. Vest
CHIEF EXECUTIVE OFFICER CHIEF EXECUTIVE OFFICER EMERSON ELECTRIC CO. PRESIDENT EMERITUS
NISSAN MOTOR CO., LTD. ELI LILLY AND COMPANY MASSACHUSETTS INSTITUTE
Lucio A. Noto OF TECHNOLOGY
MANAGING PARTNER
MIDSTREAM PARTNERS LLC * Term on Board will end on April 26, 2005
Senior Executive Officers

Nicholas M. Donofrio Paul M. Horn Abby F. Kohnstamm Steven A. Mills Linda S. Sanford
SENIOR VICE PRESIDENT SENIOR VICE PRESIDENT SENIOR VICE PRESIDENT SENIOR VICE PRESIDENT AND SENIOR VICE PRESIDENT
TECHNOLOGY AND RESEARCH MARKETING GROUP EXECUTIVE ENTERPRISE ON DEMAND
MANUFACTURING SOFTWARE GROUP TRANSFORMATION AND
Jon C. Iwata Edward M. Lineen INFORMATION TECHNOLOGY
Douglas T. Elix SENIOR VICE PRESIDENT SENIOR VICE PRESIDENT AND Robert W. Moffat, Jr.
SENIOR VICE PRESIDENT AND COMMUNICATIONS GENERAL COUNSEL SENIOR VICE PRESIDENT Timothy S. Shaughnessy
GROUP EXECUTIVE INTEGRATED SUPPLY CHAIN VICE PRESIDENT AND
SALES AND DISTRIBUTION GROUP John R. Joyce Mark Loughridge CONTROLLER
SENIOR VICE PRESIDENT AND SENIOR VICE PRESIDENT AND Daniel E. O’Donnell
Jesse J. Greene, Jr. GROUP EXECUTIVE CHIEF FINANCIAL OFFICER VICE PRESIDENT Stephen M. Ward, Jr.
VICE PRESIDENT AND TREASURER GLOBAL SERVICES ASSISTANT GENERAL COUNSEL SENIOR VICE PRESIDENT AND
J. Randall MacDonald AND SECRETARY GENERAL MANAGER
J. Bruce Harreld John E. Kelly, III SENIOR VICE PRESIDENT PERSONAL SYSTEMS GROUP
SENIOR VICE PRESIDENT SENIOR VICE PRESIDENT HUMAN RESOURCES Samuel J. Palmisano
STRATEGY TECHNOLOGY AND CHAIRMAN OF THE BOARD William M. Zeitler
INTELLECTUAL PROPERTY PRESIDENT AND SENIOR VICE PRESIDENT AND
CHIEF EXECUTIVE OFFICER GROUP EXECUTIVE
SYSTEMS AND TECHNOLOGY GROUP
95
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20 0 4

IBM A NNUA L REPOR T

2004 international business machines

On Demand Operating Environment, based on open standards.

Priorities going forward

we will make on demand business a fuller reality for clients.

we will continue to deepen ibm’s capabilities as a company

(Dollars in millions except per share amounts)

FOR THE YEAR 2004 2003 AT YEAR END 2004 2003

Revenue $««96,293 $««89,131 Cash, cash equivalents and

Loss from discontinued operations 18 30 Total assets 109,183 104,457

Continuing operations 4.94 4.34 Market capitalization 162,223 157,047

Total 5.03 4.40

Net cash provided by operating activities

REPORT OF MANAGEMENT . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 09 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

CONSOLIDATED FINANCIAL STATEMENTS m Other Liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 67

Stockholders’ Equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 46 q Advertising and Promotional Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 73

r Research, Development and Engineering . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 73

t Earnings Per Share of Common Stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 77

u Rental Expense and Lease Commitments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 77

v Stock-Based Compensation Plans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 77

FIVE-YEAR COMPARISON OF SELECTED FINANCIAL DATA . . . . . . . . . . . . . . . . . . . . . . . . . 92

SELECTED QUARTERLY DATA . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 93

BOARD OF DIRECTORS AND SENIOR EXECUTIVE OFFICERS . . . . . . . . . . . . . . . . . . . . . . 95

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

subsequent event continuing operations

Business Value Infrastructure Value

Innovation Initiatives Year in Review

Open Standards Total $«96,293 $«89,131 8.0% 3.4%

Yr. to Yr. Yr. to Yr.

Other (income) and expense: Intellectual property and custom

(Dollars in millions) Retirement-Related Benefits

Total $«1,444 $«362 NM

Net cash provided by/(used in) continuing operations:

Debt consolidated fourth quarter results

(Dollars in millions) Revenue $«27,671 $«25,913 6.8% *

AT DECEMBER 31: 2004 2003

continuing operations Global Services

(Dollars in billions) Capital (Finance) lease obligations 56 46 8 1 1

Gross profit $«2,355 $«2,281 $«2,339

client’s acquisition of IBM hardware, software and services.

Originations (Dollars in millions)

(Dollars in millions) Gross financing receivables $«26,836 $«28,451

Roll-Forward of Financing Receivables Allowance for Doubtful Accounts

Debt to equity ratio 6.9x 6.9x

CONSOLIDATED STATEMENT OF EARNINGS

(Dollars in millions except per share amounts)

Total Revenue 96,293 89,131 81,186

Total Cost 60,261 56,113 50,902

Gross Profit 36,032 33,018 30,284

Expense and Other Income:

Total Expense and Other Income 24,004 22,144 22,760

Income from Continuing Operations 8,448 7,613 5,334

Net Income $«««8,430 $«««7,583 $«««3,579

(Dollars in millions except per share amounts)

Earnings/(Loss) per Share of Common Stock:

Total t $«««««4.93 $«««««4.32 $«««««2.06

Total t $«««««5.03 $«««««4.40 $«««««2.10

Weighted-Average Number of Common Shares Outstanding: