News Column

MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION FOR THE THREE MONTHS ENDED MARCH 31, 2014

April 29, 2014

Snapshot Financial Results Summary: Yr. to Yr. Percent/ (Dollars in millions except per share amounts)



Margin

For the three months ended March 31: 2014 2013 Change Revenue $ 22,484$ 23,408 (3.9) %* Gross profit margin 46.9 % 45.6 % 1.3 pts. Total expense and other (income) $ 7,563$ 7,072 6.9 % Total expense and other (income)-to-revenue ratio 33.6 % 30.2 % 3.4 pts. Provision for income taxes $ 596$ 574 3.8 % Net income $ 2,384$ 3,032 (21.4) % Net income margin 10.6 % 13.0 % (2.3) pts. Earnings per share: Assuming dilution $ 2.29$ 2.70 (15.2) % Basic $ 2.30$ 2.72 (15.4) % Weighted-average shares outstanding: Assuming dilution 1,041.8 1,124.0 (7.3) % Basic 1,035.2 1,113.7 (7.0) % 3/31/14 12/31/13 Assets $ 122,646$ 126,223 (2.8) % Liabilities $ 105,906$ 103,294 2.5 % Equity $ 16,740$ 22,929 (27.0) %



* 2.4 percent decrease adjusted for currency

Currency: The references to "adjusted for currency" or "at constant currency" in the Management Discussion do not include operational impacts that could result from fluctuations in foreign currency rates. Certain financial results are adjusted based on a simple mathematical model that translates current period results in local currency using the comparable prior year period's currency conversion rate. This approach is used for countries where the functional currency is the local country currency. This information is provided so that certain financial results can be viewed without the impact of fluctuations in foreign currency rates, thereby facilitating period-to-period comparisons of business performance. See "Currency Rate Fluctuations" on pages 57 and 58 for additional information.



Operating (non-GAAP) Earnings:

In an effort to provide better transparency into the operational results of the business, the company separates business results into operating and non-operating categories. Operating earnings is a non-GAAP measure that excludes the effects of certain acquisition-related charges and retirement-related costs, and their related tax impacts. For acquisitions, operating earnings exclude the amortization of purchased intangible assets and acquisition-related charges such as in-process research and development, transaction costs, applicable restructuring and related expenses and tax charges related to acquisition integration. For retirement-related costs, the company characterizes certain items as operating and others as non-operating. The company includes defined benefit plan and nonpension postretirement benefit plan service cost, amortization of prior service cost and the cost of defined contribution plans in operating earnings. Non-operating retirement-related cost includes defined benefit plan and nonpension postretirement benefit plan interest cost, expected return on plan assets, amortized actuarial gains/losses, the impacts of any plan curtailments/settlements and multi-employer plan costs, pension insolvency costs and other costs. Non-operating costs are primarily related to changes in pension plan assets and liabilities which are tied to financial market performance and the company considers these costs to be outside the operational performance of the business. 38

--------------------------------------------------------------------------------



Management Discussion - (continued)

Overall, the company believes that providing investors with a view of operating earnings as described above provides increased transparency and clarity into both the operational results of the business and the performance of the company's pension plans; improves visibility to management decisions and their impacts on operational performance; enables better comparisons to peer companies; and allows the company to provide a long-term strategic view of the business going forward. For its 2015 road map, the company is utilizing an operating view to establish its objectives and track its progress. The company's reportable segment financial results reflect operating earnings, consistent with the company's management and measurement system.



The following table provide the company's (non-GAAP) operating earnings for the first quarter of 2014 and 2013.

Yr. to Yr. (Dollars in millions except per share amounts)



Percent

For the three months ended March 31: 2014 2013 Change Net income as reported $ 2,384$ 3,032 (21.4) % Non-operating adjustments (net of tax): Acquisition-related charges 161



140 15.2

Non-operating retirement-related costs/(income) 98 204 (51.9) Operating (non-GAAP) earnings* $ 2,643$ 3,376 (21.7) % Diluted operating (non-GAAP) earnings per share $ 2.54 $



3.00 (15.3) %

* See page 66 for a more detailed reconciliation of net income to operating earnings.

Financial Performance Summary:

In the first quarter of 2014, the company reported $22.5 billion in revenue, expanded gross margin and delivered diluted earnings per share of $2.29 as reported and $2.54 on an operating (non-GAAP) basis. The company generated $3.3 billion in cash from operations and $0.6 billion in free cash flow in the first quarter driving shareholder returns of $9.2 billion in gross common stock repurchases and dividends. The company's performance in the first quarter reflects the actions it is taking to transition to key growth areas and to transform parts of the business. In the first quarter the company:



† Announced a $1.2 billion investment to globally expand its SoftLayer cloud hubs.

† Launched BlueMix, a new platform-as-a-service to speed deployment of hybrid clouds.

† Acquired Aspera and Cloudant to extend the company's big data and cloud capabilities.

† Expanded the ecosystem around OpenPOWER.

† Created an integrated business unit around IBM Watson and announced a $1 billion investment to bring cognitive capabilities to the enterprise.

The company is also taking portfolio actions to divest businesses that no longer fit its strategic portfolio. In January 2014, the company:

† Completed the initial closing for the divestiture of the customer care business process outsourcing business.

† Announced an agreement to sell its x86 industry standard server business to Lenovo.

In addition, as expected, the company took a substantial workforce rebalancing charge to align its resources and skills to the demand profile. This charge significantly impacted the financial results in the first quarter, but the company expects the action to pay back within the current year. Many of the actions taken in the first quarter will impact the company's revenue and profit in the short term, but are expected to have long term benefits. The company has continued to shift its investments to address the key trends in information technology (IT) - driven by data and cloud and changes in the way individuals are engaging. Across the business, the company had good performance in the first quarter of 2014 in the offerings that address these shifts. Business analytics revenue increased 5 percent as reported and 6 percent at constant currency on a large base. Cloud revenue increased over 50 percent, with the cloud delivered as a service content doubling year to year. In addition, in the first quarter, the company had strong growth in mobile and security compared to the prior year. 39

--------------------------------------------------------------------------------



Management Discussion - (continued)

Segment revenue was led by Software which increased 1.6 percent (2 percent adjusted for currency), driven by key branded middleware which increased 4.4 percent (5 percent adjusted for currency). The company is continuing to see strong client demand and strong results in the key areas of mobile, cloud and security where it has been targeting its investments. Total Global Services revenue declined 2.0 percent as reported, but increased 0.3 percent at constant currency; adjusting for the divested customer care business, total Global Services revenue increased 2 percent at constant currency with growth in both Global Technology Services and Global Business Services. The first quarter growth reflects the company's expanded cloud offerings, contribution from some of the large outsourcing contracts signed in 2013, and good performance in Consulting and Systems Integration. Systems and Technology revenue decreased 23.0 percent (23 percent adjusted for currency) from a combination of secular and cyclical challenges. The company is dealing with challenges in its hardware business models specific to Power, Storage and System x. The business has taken actions to address these business model challenges including; 1) selling the industry standard server business to Lenovo, 2) repositioning Power and building an ecosystem around OpenPOWER, and 3) rightsizing the Power and Storage businesses to the market dynamics. System z mainframe revenue decreased 39.7 percent (40 percent adjusted for currency). The decline in System z revenue reflects that the product is six quarters into this product cycle, though on solid ground secularly. From a geographic perspective, revenue in the growth markets declined 10.7 percent as reported and 5 percent adjusted for currency, a one point improvement from the fourth quarter at constant currency. The company views the bulk of the challenges in the growth markets as cyclical, and believes that the opportunity in the growth markets remains attractive over the long term. The company is continuing to invest in these key markets to capture that opportunity. In the first quarter, total consolidated revenue decreased 3.9 percent, 2.4 percent at constant currency. Adjusting for the divested customer care business, revenue decreased 1 percent at constant currency. This performance represents a 2 point sequential improvement at constant currency from the fourth quarter of 2013. The constant currency growth in Software, Global Services and Global Financing was offset by the decline in Systems & Technology. The currency impact to revenue was 1.6 points in the first quarter of 2014. Currency was also a headwind to profit performance - reflecting impacts from the Yen and the devaluation of the Venezuelan currency. The consolidated gross profit margin increased 1.3 points versus the first quarter of 2013 to 46.9 percent. The operating (non-GAAP) gross margin of 47.6 percent increased 0.9 points year to year. The improvement in gross margin was driven by margin improvements in Global Services and an improved mix toward Software, partially offset by a margin decline in Systems & Technology. Total expense and other (income) increased 6.9 percent in the first quarter of 2014 compared to the prior year. Total operating (non-GAAP) expense and other (income) increased 7.9 percent year to year. The year-to-year drivers were approximately: Total Operating Consolidated (non-GAAP) Currency* 0 points 0 points Acquisitions ** 2 points 2 points Base expense 5 points 7 points



* Reflects impacts of translation and hedging programs.

** Includes acquisitions completed in prior 12-month period; operating (non-GAAP) is net of non-operating acquisition-related

charges. There were several items that had an impact on total expense and other (income) year to year. Workforce rebalancing charges in the first quarter of 2014 were $873 million, an increase of $853 million versus the first quarter of 2013. In the first quarter of 2014, the company recorded a gain of $98 million related to the divestiture of the customer care business. A gain of a similar amount is expected in the second quarter of 2014 as the remaining country closings are completed. Adjusting for these items, operating (non-GAAP) base expense would have improved by 4 points compared to the 7 point impact as highlighted above. The 4 point improvement is more indicative of the productivity in the base expense. Within base expense, the company is continuing to shift spending to areas where it sees future growth. As an example, the $1.5 billion of research and development spending in the first quarter of 2014 reflects the shift of development priorities to the growth areas. The recent launch of BlueMix is a great example - the company will be investing $1 billion to deliver unique platform-as-a-service capabilities to connect enterprise data and applications to the cloud. 40 --------------------------------------------------------------------------------



Management Discussion - (continued)

Pre-tax income decreased 17.3 percent year to year and the pre-tax margin was 13.3 percent, a decrease of 2.1 points versus the first quarter of 2013. Net income decreased 21.4 percent and the net income margin was 10.6 percent, a decrease of 2.3 points year to year. The effective tax rate for the first quarter was 20.0 percent, an increase of 4.1 points year to year. Operating (non-GAAP) pre-tax income decreased 19.1 percent year to year and the operating (non-GAAP) pre-tax margin was 14.7 percent, a decrease of 2.7 points year to year. Operating (non-GAAP) net income decreased 21.7 percent and the operating (non-GAAP) net income margin of 11.8 percent decreased 2.7 points compared to the prior year. The operating (non-GAAP) effective tax rate was 20.0 percent versus 17.3 percent in the first quarter of 2013. Diluted earnings per share of $2.29 decreased 15.2 percent versus the prior year. Operating (non-GAAP) diluted earnings per share of $2.54 decreased $0.46 or 15.3 percent versus the first quarter of 2013. In the first quarter, the company repurchased 45.2 million shares of its common stock. At March 31, 2014, the company's balance sheet and liquidity positions remained strong and are well positioned to support the business over the long term. Cash and marketable securities at quarter end were $9,704 million, a decrease of $1,361 million from December 31, 2013. Key drivers in the balance sheet and total cash flows are:



Total assets decreased $3,577 million ($3,648 million adjusted for currency) from December 31, 2013 driven by:

† Decreases in total receivables ($3,012 million) and cash and cash equivalents ($1,307 million); partially offset by

† Increased prepaid pension assets ($559 million).



Total liabilities increased $2,612 million ($2,493 million adjusted for currency) from December 31, 2013 driven by:

† Increases in total debt ($4,262 million), deferred income ($1,058 million) and other accrued expenses and liabilities ($717 million); partially offset by

† Decreases in taxes payable ($2,388 million) and accounts payable ($596 million).

Total equity of $16,740 million decreased $6,189 million from December 31, 2013 as a result of:

† Increased treasury stock ($8,370 million) driven by share repurchases; partially offset by

† Higher retained earnings ($1,390 million), decreased losses in accumulated other comprehensive income/(loss) ($446 million) and higher common stock ($349 million). The company generated $3,326 million in cash flow provided by operating activities, a decrease of $697 million compared to the first quarter of 2013, driven primarily by cash tax payments of $2,594 million, an increase in the use of cash of $1,375 million. Investing activities provided $35 million in cash flow in the first quarter of 2014 compared to a use of cash of $1,012 million in the first quarter of 2013. This year-to-year decrease in the use of cash was primarily due to lower cash used for net purchases of marketable securities and other investments ($1,098 million). Net cash used in financing activities of $4,673 million increased $1,957 million compared to the prior year, primarily due to increased cash used for gross common stock repurchases ($5,572 million), partially offset by higher net cash proceeds from total debt ($3,743 million). In April 2014, the company stated that it is expecting GAAP earnings per share of at least $17.00 and operating (non-GAAP) earnings of at least $18.00 per diluted share for the full year 2014. The company also stated that its earnings per share expectation does not include the expected gain from the divestiture of its System x server business to Lenovo due to the uncertainty of the timing and the amount. The gain will ultimately be reflected in the company's results, and the company will provide an update later in the year. 41 --------------------------------------------------------------------------------



Management Discussion - (continued)

First Quarter in Review Results of Operations Segment Details The following is an analysis of the first quarter of 2014 versus the first quarter of 2013 reportable segment external revenue and gross margin results. Segment pre-tax income includes transactions between the segments that are intended to reflect an arm's-length transfer price and excludes certain unallocated corporate items. Yr. to Yr. Percent Yr. to Yr. Change (Dollars in millions) Percent/Margin Adjusted For For the three months ended March 31: 2014 2013 Change Currency



Revenue:

Global Technology Services $ 9,330$ 9,605 (2.9) % (0.5) % Gross margin 37.9 % 36.7 % 1.2 pts. Global Business Services 4,483 4,484 (0.0) % 2.0 % Gross margin 30.0 % 28.6 % 1.4 pts. Software 5,661 5,572 1.6 % 2.1 % Gross margin 87.5 % 87.2 % 0.3 pts. Systems and Technology 2,391 3,106 (23.0) % (22.9 )% Gross margin 27.0 % 32.3 % (5.3) pts. Global Financing 512 499 2.6 % 6.2 % Gross margin 46.1 % 45.8 % 0.4 pts. Other 107 142 (24.4 )% (22.8 )% Gross margin (163.7) % (158.5) % (5.2) pts. Total consolidated revenue $ 22,484$ 23,408 (3.9) % (2.4) % Total consolidated gross profit $ 10,543$ 10,678 (1.3) % Total consolidated gross margin 46.9 % 45.6 % 1.3 pts.



Non-operating adjustments:

Amortization of acquired intangible assets 102 94 9.0 % Acquisition-related charges 2 1 13.7 Retirement-related costs/(income) 52 164 (68.1 ) Operating (non-GAAP) gross profit $ 10,699$ 10,937 (2.2) % Operating (non-GAAP) gross margin 47.6 % 46.7 % 0.9 pts. Global Services In the first quarter of 2014, the Global Services segments, Global Technology Services (GTS) and Global Business Services (GBS), delivered revenue of $13,813 million, a decrease of 2.0 percent as reported, but up 0.3 percent at constant currency compared to the prior year. Normalizing for the divestiture of the company's customer care business, Global Services revenue decreased 0.5 percent as reported, but increased 2 percent adjusted for currency. Adjusted for the divestiture, this is the third consecutive quarter of constant currency growth in total Global Services. Pre-tax income in the first quarter declined 13.7 percent and pre-tax margin declined 1.9 points to 13.9 percent; excluding workforce rebalancing charges in both periods, pre-tax income increased 7.1 percent with a pre-tax margin of 17.3 percent, up 1.5 points year to year. 42 --------------------------------------------------------------------------------



Management Discussion - (continued)

Yr. to Yr. Percent Yr. to Yr. Change (Dollars in millions) Percent Adjusted For For the three months ended March 31: 2014 2013 Change Currency Global Services external revenue: $ 13,813$ 14,089 (2.0) % 0.3 % Global Technology Services $ 9,330$ 9,605 (2.9) % (0.5) % Outsourcing 5,280 5,558 (5.0) (2.8) Integrated Technology Services 2,329 2,277 2.3 4.7 Maintenance 1,721 1,770 (2.8) (0.1) Global Business Services $ 4,483$ 4,484 (0.0) % 2.0 % Outsourcing 934 1,041 (10.3) (7.7) Consulting and Systems Integration 3,549 3,443 3.1 4.9 Global Technology Services revenue of $9,330 million decreased 2.9 percent (1 percent adjusted for currency) in the first quarter of 2014. Normalizing for the divestiture of the customer care business, revenue decreased 0.7 percent, but increased 2 percent adjusted for currency. Within GTS, the Softlayer platform, which provides a highly differentiated solution for clients looking to deploy across public, private or hybrid clouds all unified on one platform, continued to perform well and contributed about 1 point of constant currency growth for total GTS in the first quarter. The company announced it will invest $1.2 billion to expand its global cloud footprint and will double the number of its Softlayer centers - with 40 cloud centers in 15 countries, they will be located in every major geography and key financial center. GTS Outsourcing revenue declined 5.0 percent (3 percent adjusted for currency) compared with the prior year. Normalizing for the customer care divestiture, revenue declined 1.3 percent as reported, but returned to growth on a constant currency basis with an increase of 1 percent year to year. This growth was driven by new contracts that were brought on during 2013. Global Business Services revenue of $4,483 million was flat year to year, but increased 2 percent at constant currency. Consulting and Systems Integration (C&SI) revenue grew 3.1 percent (5 percent adjusted for currency). This growth was driven by the practices that address the Digital Front Office. The company delivered growth across cloud and business analytics, and in projects for clients on systems of engagement and helping clients connect these front-end capabilities to their back-end systems and processes. A good indication of this success is the company's number one ranking in both Overall Business Consulting and Cloud Professional Services by IDC, and Mobility Consulting Services by Forrester. The company continues to invest strategically and committed $100 million in March, 2014 to expand its consulting services capability with ten new IBM Interactive Labs and 1,000 experts to address client experience design and engagement. Application Outsourcing revenue decreased 10.3 percent (8 percent adjusted for currency) reflecting increased pricing pressure and client contract renegotiations, as well as a reduction in elective projects. Yr. to Yr. Percent/ (Dollars in millions) Margin For the three months ended March 31: 2014 2013



Change

Global Technology Services:

External gross profit $ 3,539$ 3,529 0.3 % External gross profit margin 37.9 % 36.7 % 1.2 pts. Pre-tax income $ 1,345$ 1,585 (15.1) % Pre-tax margin 14.1 % 16.1 % (2.0) pts. Global Business Services: External gross profit $ 1,343$ 1,283 4.7 % External gross profit margin 30.0 % 28.6 % 1.4 pts. Pre-tax income $ 628$ 703 (10.6) % Pre-tax margin 13.6 % 15.1 % (1.5) pts. GTS first quarter gross profit grew 0.3 percent and its gross profit margin improved 1.2 points to 37.9 percent versus the prior year. Pre-tax income decreased 15.1 percent to $1,345 million and the pre-tax margin declined 2.0 points to 14.1 percent. Normalizing for workforce rebalancing charges of $325 million and $4 million in the first quarter of 2014 and 2013, respectively, GTS pre-tax income grew 5.2 percent and pre-tax margin expanded 1.3 points. GTS pre-tax income for the quarter included a gain of $98 million related to the customer care divestiture, however the business performance has also been impacted by the divestiture of those operations. The company continues to make investments in key growth areas such as mobile, security and cloud. These initiatives are gaining traction, but they are not yet at scale. 43 --------------------------------------------------------------------------------



Management Discussion - (continued)

GBS first quarter gross profit grew 4.7 percent and its gross profit margin improved 1.4 points to 30.0 percent versus the prior year. Pre-tax income decreased 10.6 percent to $628 million and the pre-tax margin declined 1.5 points to 13.6 percent. Normalizing for workforce rebalancing charges of $159 million and $3 million in the first quarter of 2014 and 2013, respectively, GBS pre-tax income grew 11.5 percent and pre-tax margin expanded 1.9 points reflecting improved productivity in the base. Global Services Backlog The estimated Global Services backlog at March 31, 2014 was $138 billion, a decrease of 2.3 percent (2 percent adjusted for currency) compared to the March 31, 2013 balance. This includes a backlog reduction of $3.8 billion associated with the customer care divestiture. Normalizing for this divestiture, backlog was up 0.4 percent (1 percent adjusted for currency) year to year. The estimated transactional backlog at March 31, 2014 increased 5.4 percent (6 percent adjusted for currency) from the March 31, 2013 levels. The estimated outsourcing backlog decreased 5.3 percent (5 percent adjusted for currency) including the backlog reduction from the customer care divestiture. Normalizing for this divestiture, the estimated outsourcing backlog decreased 1.2 percent (1 percent adjusted for currency) compared to the March 31, 2013 balance. Yr. to Yr. Percent Yr. to Yr. Change At March 31, At March 31, Percent Adjusted For (Dollars in billions) 2014 2013 Change Currency Backlog: Total backlog $ 137.6$ 140.8 (2.3) % (2.1) % excl. customer care 0.4 % 0.6 % Outsourcing backlog $ 86.2$ 91.0 (5.3) % (5.2) % excl. customer care (1.2) % (1.0) % Total Global Services backlog includes GTS Outsourcing, ITS, GBS Outsourcing, Consulting and Systems Integration and Maintenance. Outsourcing backlog includes GTS Outsourcing and GBS Outsourcing. Transactional backlog includes ITS and Consulting and Systems Integration. Total backlog is intended to be a statement of overall work under contract and therefore does include Maintenance. Backlog estimates are subject to change and are affected by several factors, including terminations, changes in the scope of contracts, periodic revalidations, adjustments for revenue not materialized and adjustments for currency. Global Services signings are management's initial estimate of the value of a client's commitment under a Global Services contract. There are no third-party standards or requirements governing the calculation of signings. The calculation used by management involves estimates and judgments to gauge the extent of a client's commitment, including the type and duration of the agreement, and the presence of termination charges or wind-down costs. Signings include GTS Outsourcing, ITS, GBS Outsourcing and Consulting and Systems Integration contracts. Contract extensions and increases in scope are treated as signings only to the extent of the incremental new value. Maintenance is not included in signings as maintenance contracts tend to be more steady state, where revenues equal renewals. Contract portfolios purchased in an acquisition are treated as positive backlog adjustments provided those contracts meet the company's requirements for initial signings. A new signing will be recognized if a new services agreement is signed incidental or coincidental to an acquisition or divestiture. Yr. to Yr. Percent Yr. to Yr. Change (Dollars in millions) Percent Adjusted For For the three months ended March 31: 2014 2013 Change Currency Total signings: $ 11,153$ 16,930 (34.1) % (33.0) % Outsourcing signings $ 5,488$ 10,732 (48.9) % (47.8) % Transactional signings 5,665 6,198 (8.6) % (7.5) % 44

--------------------------------------------------------------------------------



Management Discussion - (continued)

Software Yr. to Yr. Percent Yr. to Yr. Change (Dollars in millions) Percent Adjusted For For the three months ended March 31: 2014 2013 Change Currency Software external revenue: $ 5,661$ 5,572 1.6 % 2.1 % Middleware: $ 4,695$ 4,547 3.3 % 3.7 % Key branded middleware: 3,656 3,504 4.4 4.8 WebSphere Family 12.0 12.4 Information Management 1.3 1.9 Workforce Solutions (4.4) (4.2) Tivoli 6.6 6.9 Rational 1.0 1.9 Other middleware 1,039 1,044 (0.5) (0.1) Operating systems 519 578 (10.2) (9.5) Other 447 447 0.0 1.1 Software revenue of $5,661 million increased 1.6 percent (2 percent adjusted for currency) year to year in the first quarter of 2014. As enterprise clients continue to rely on the company's middleware solutions to transform their infrastructure and handle their business critical transactions, first quarter growth was led by key branded middleware. The company delivers software solutions through a combination of on-premise and software-as-a-solution (SaaS) offerings. SaaS offerings span across the software brands - and in the first quarter SaaS revenue grew more than 25 percent year to year. Key branded middleware revenue, which accounted for 65 percent of the total software revenue this quarter, increased 4.4 percent (5 percent adjusted for currency) year to year.

WebSphere had a strong quarter with revenue increasing 12.0 percent (12 percent adjusted for currency). For the thirteenth consecutive year, Gartner designated the company the market share leader in the application infrastructure and middleware segment. The company's market share of 30 percent is nearly double the size of its closest competitor. The first quarter performance included continued strong growth in MobileFirst, the comprehensive portfolio of mobile software and services that enable clients to manage, integrate and leverage mobile devices. The company has been building capabilities to address this space and now has over 3,000 mobile experts. Across software and services, the company's mobile business doubled in the first quarter compared to the prior year. The application server business, which is an example of clients utilizing on-premise software to manage the infrastructure workloads driven by mobile, big data and analytics, delivered strong growth for the fourth consecutive quarter. Information Management revenue increased 1.3 percent (2 percent adjusted for currency) in the first quarter of 2014. This growth was led by distributed database and master data management which are key elements of the company's big data and analytics solutions. With the first quarter acquisition of Cloudant, the company has added DataBase-as-a-Service capability. Cloudant extends the company's mobile and cloud platforms by enabling developers to easily and quickly create next generation mobile and web-based applications. Tivoli revenue increased 6.6 percent (7 percent adjusted for currency) compared to the prior year with growth in all three product segments. Performance was led by Tivoli security which increased 27.0 percent (28 percent adjusted for currency) year to year, marking the sixth consecutive quarter of double-digit growth at constant currency. These strong results are being driven, in part, by incremental requirements for security as clients expand into cloud and mobile computing. Across the company, the portfolio of security offerings grew more than 20 percent in the first quarter versus the prior year. Tivoli storage, which enables customers to manage their rapidly growing data, was up 3.7 percent (4 percent adjusted for currency), and Tivoli systems management increased 2.4 percent (2 percent adjusted for currency) year to year. Workforce Solutions revenue decreased 4.4 percent (4 percent adjusted for currency) in the first quarter. Although there was strong growth in SaaS offerings, it was more than offset by a decline in the on-premise Notes business. The company is working to transform this business and build recurring revenue streams from the SaaS offerings.



Rational revenue increased 1.0 percent (2 percent adjusted for currency) year to year in the first quarter.

45 --------------------------------------------------------------------------------



Management Discussion - (continued)

Operating systems revenue decreased 10.2 percent (9 percent adjusted for currency) and other software revenue was flat (increased 1 percent adjusted for currency) year to year in the first quarter. In the first quarter of 2014, the company launched BlueMix which will make the company's middleware portfolio accessible via the cloud. With BlueMix, developers can efficiently build cloud applications with reusable pieces of code tied to their enterprise systems. This enables businesses to leverage the flexibility that cloud applications provide. Yr. to Yr. Percent/ (Dollars in millions) Margin



For the three months ended March 31: 2014 2013 Change Software:

External gross profit $ 4,956$ 4,860



2.0 %

External gross profit margin 87.5 % 87.2 % 0.3 pts. Pre-tax income $ 1,918$ 2,014 (4.7) % Pre-tax margin 29.1 % 31.5 % (2.4) pts. The Software gross profit margin improved 0.3 points to 87.5 percent year to year in the first quarter of 2014. Software pre-tax income of $1,918 million decreased 4.7 percent and the pre-tax margin of 29.1 percent declined 2.4 points. Normalized for workforce rebalancing charges of $165 million and $7 million in the first quarter of 2014 and 2013, respectively, Software pre-tax income was up 3.1 percent and the pre-tax margin was flat year to year. Systems and Technology Yr. to Yr. Percent Yr. to Yr. Change (Dollars in millions) Percent Adjusted For For the three months ended March 31: 2014 2013 Change Currency Systems and Technology external revenue: $ 2,391$ 3,106 (23.0) % (22.9) % System z (39.7) % (40.2) % Power Systems (21.7) (21.3) System x (17.6) (17.1) Storage (22.9) (22.9) Total Systems (24.0) (23.8) Microelectronics OEM (15.9) (15.9) Systems and Technology revenue decreased 23.0 percent (23 percent adjusted for currency) in the first quarter of 2014 versus the same period in 2013. The decline in revenue reflects both the product cycle of System z and the secular challenges in Power, Storage and System x. In January 2014, the company entered into a definitive agreement with Lenovo to divest its System x business. Also, in the first quarter, the company continued to reposition offerings in other parts of its hardware business to make them more relevant, in addition to taking actions to realign its structure to the demand profile the company projects going forward. System z revenue decreased 39.7 percent (40 percent adjusted for currency) in the first quarter of 2014 versus the first quarter of 2013. MIPS (millions of instructions per second) shipments decreased 19 percent in the first quarter of 2014 versus the same period in 2013. The decline in System z revenue was expected as the product is in the sixth quarter of the product cycle since general availability. In the current mainframe cycle, the company has shipped approximately 26 percent more MIPS compared to the same period in the prior cycle. System z is a core franchise which provides mission critical infrastructure for the company's clients, and the company continues to invest in the platform. In April 2014, the company celebrated the mainframe's 50thyear. Power Systems revenue decreased 21.7 percent (21 percent adjusted for currency) in the first quarter of 2014 versus the first quarter of 2013. The company is aggressively repositioning this platform with a couple of key initiatives. First, the OpenPOWER consortium makes Power technology available to an open development alliance. In the first quarter of 2014, the company expanded its OpenPOWER ecosystem. Second, the company is expanding its Linux capabilities through its POWER8 launch this year. POWER8 is the first processor built for big data, and delivers better cloud economics. 46 --------------------------------------------------------------------------------



Management Discussion - (continued)

System x revenue decreased 17.6 percent (17 percent adjusted for currency) in the first quarter of 2014 versus the first quarter of 2013.

Storage revenue decreased 22.9 percent (23 percent adjusted for currency) in the first quarter versus the comparable period in 2013. The company's Flash solutions contributed growth again this quarter, but high-end storage experienced substantial weakness versus the first quarter of 2013.

Microelectronics OEM revenue decreased 15.9 percent (16 percent adjusted for currency) in the first quarter of 2014 versus the comparable period of 2013. Yr. to Yr. Percent/ (Dollars in millions) Margin



For the three months ended March 31: 2014 2013 Change Systems and Technology:

External gross profit $ 645$ 1,003



(35.7) %

External gross profit margin 27.0 % 32.3 % (5.3) pts. Pre-tax income $ (660)$ (405) (63.1) % Pre-tax margin (25.8) % (12.5) % (13.2) pts. Systems and Technology's gross profit margin decreased 5.3 points in the first quarter of 2014 versus the prior year. The decrease was driven by a decline due to revenue mix as a result of less mainframe content (2.3 points), lower margins in Power Systems (1.7 points), Microelectronics (1.3 points) and Storage (0.9 points), partially offset by higher margins in System z (0.2 points) and System x (0.1 points). Systems and Technology's pre-tax loss increased $255 million to a loss of $660 million in the first quarter 2014, when compared to the prior year. Pre-tax margin decreased 13.2 points in the first quarter versus the prior year period. Normalized for workforce rebalancing charges of $218 million and $3 million in the first quarter of 2014 and 2013, respectively, Systems and Technology's first quarter pre-tax income was a loss of $442 million compared to a loss of $402 million in the prior year, and the pre-tax margin declined 4.8 points.



Global Financing

See pages 60 to 65 for a discussion of Global Financing's segment results.

Geographic Revenue

In addition to the revenue presentation by reportable segment, the company also measures revenue performance on a geographic basis. The following geographic, regional and country-specific revenue performance excludes OEM revenue, which is discussed separately.

Yr. to Yr. Percent Yr. to Yr. Change (Dollars in millions) Percent Adjusted For For the three months ended March 31: 2014 2013 Change Currency Total Revenue $ 22,484$ 23,408 (3.9) % (2.4) % Geographies: $ 22,129$ 22,981 (3.7) % (2.1) % Americas 9,596 10,042 (4.4) (2.2) Europe/Middle East/Africa (EMEA) 7,578 7,278 4.1 0.7 Asia Pacific 4,955 5,661 (12.5) (5.6) Major markets (1.6) % (1.2) % Growth markets (10.7) % (5.0) % BRIC countries (11.2) % (6.0) % 47

--------------------------------------------------------------------------------



Management Discussion - (continued)

Total geographic revenue of $22,129 million decreased 3.7 percent (2 percent adjusted for currency) in the first quarter of 2014 compared to the prior year. While as reported revenue for the quarter decreased year to year in both the major markets and growth markets, both markets improved their growth rate at constant currency compared to the fourth quarter of 2013. Growth markets revenue across all geographies decreased 10.7 percent as reported and 5 percent at constant currency in the first quarter. Revenue grew at a high single-digit rate on a constant currency basis in Latin America, but revenue in the Asia Pacific countries was down driven by continued weakness in China which declined at a double-digit rate. This performance is consistent with the past two quarters and it is expected to take some time for business to improve in China. The company still sees good opportunity in the growth markets over the long term and continues to invest in these key markets to capture this opportunity. Americas revenue decreased 4.4 percent (2 percent adjusted for currency) compared to the first quarter of 2013. This is consistent with performance in the fourth quarter of 2013 on a constant currency basis. Within the major markets, the U.S. was down 3.6 percent and Canada was down 9.6 percent (1 percent adjusted for currency). There was strong growth in software, but hardware performance, especially in the U.S., remained a challenge. Revenue in the Latin America growth markets decreased 2.8 percent as reported, but increased 8 percent adjusted for currency. This performance was led by Brazil which was flat year to year as reported, but increased 12 percent on a constant currency basis. EMEA revenue increased 4.1 percent (1 percent adjusted for currency) year to year in the first quarter of 2014. This represents a 3 point improvement compared to last quarter's growth rate. This improvement was driven by growth in Germany and Italy. Germany grew 13.1 percent (9 percent adjusted for currency) and Italy increased 9.4 percent (5 percent adjusted for currency). The UK increased 0.4 percent as reported, but decreased 6 percent year to year on a constant currency basis. Revenue in the EMEA growth markets decreased 2.0 percent (increased 1 percent adjusted for currency). Russia had strong performance compared to recent quarters with growth of 12.4 percent (17 percent adjusted for currency). Asia Pacific first quarter revenue decreased 12.5 percent (6 percent adjusted for currency) year over year. Japan revenue decreased 7.8 percent as reported, but increased 2 percent on a constant currency basis. Adjusted for currency, this was the sixth consecutive quarter of revenue growth in Japan. The Asia Pacific growth markets decrease of 15.8 percent (11 percent adjusted for currency) was driven by China which declined 19.4 percent (20 percent adjusted for currency). India was down 17.4 percent (6 percent adjusted for currency) on a year-to-year basis.



OEM revenue decreased 16.8 percent (17 percent adjusted for currency) year to year in the first quarter of 2013, driven by the Microelectronics OEM business.

Expense



Total Expense and Other (Income)

Yr. to Yr. (Dollars in millions)



Percent

For the three months ended March 31: 2014 2013



Change

Total consolidated expense and other (income) $ 7,563$ 7,072

6.9 % Non-operating adjustments: Amortization of acquired intangible assets (92) (90) 2.1 Acquisition-related charges (6) (9) (35.4) Non-operating retirement-related (costs)/income (70) (120) (41.3)



Operating (non-GAAP) expense and other (income) $ 7,395$ 6,853

7.9 % Total consolidated expense-to-revenue ratio 33.6 % 30.2 % 3.4 pts. Operating (non-GAAP) expense-to-revenue ratio 32.9 % 29.3 % 3.6 pts. 48

--------------------------------------------------------------------------------



Management Discussion - (continued)

Total expense and other (income) increased 6.9 percent in the first quarter compared to the prior year. Total operating (non-GAAP) expense and other (income) increased 7.9 percent versus the first quarter of 2013. The key drivers of the year-to-year change in total expense and other (income) were approximately: Total Operating Consolidated (non-GAAP) † Currency * 0 points 0 points † Acquisitions** 2 points 2 points † Base expense 5 points 7 points



* Reflects impacts of translation and hedging programs.

** Includes acquisitions completed in prior 12-month period; operating (non-GAAP) is net of non-operating acquisition-related

charges.



For additional information regarding total expense and other (income) for both expense presentations, see the following analyses by category.

Selling, general and administrative expense

Yr. to Yr. (Dollars in millions) Percent For the three months ended March 31: 2014 2013 Change Selling, general and administrative expense: Selling, general and administrative - other $



4,612 $ 4,759 (3.1) %

Advertising and promotional expense



338 323 4.6

Workforce rebalancing charges 873 20 nm Retirement-related costs



231 264 (12.4)

Amortization of acquired intangible assets 92 90 2.1 Stock-based compensation 88 99 (10.5) Bad debt expense 55 23 140.9



Total consolidated selling, general and administrative expense $ 6,289$ 5,577 12.8 %

Non-operating adjustments:

Amortization of acquired intangibles assets



(92) (90) 2.1

Acquisition-related charges



(6) (3) 117.1

Non-operating retirement-related (costs)/income



(87) (104) (15.8)

Operating (non-GAAP) selling, general and administrative expense $ 6,104$ 5,381 13.4 %

nm - not meaningful Total Selling, general and administrative (SG&A) expense increased 12.8 percent (14 percent adjusted for currency) in the first quarter of 2014 versus the first quarter of 2013. The increase was primarily driven by higher base expense (12 points) and acquisition-related spending (2 points), partially offset by the effects of currency (1 point). Operating (non-GAAP) SG&A expense increased 13.4 percent (15 percent adjusted for currency) primarily driven by higher base expense (13 points) and acquisition-related spending (2 points), partially offset by the effects of currency (1 point). Base expense includes workforce rebalancing charges in the first quarter of 2014 of $873 million, an increase of $853 million year to year, which resulted in a 16 point year-to-year impact in the operating (non-GAAP) SG&A base performance. Normalized for the workforce rebalancing charges in both first-quarter periods, operating (non-GAAP) SG&A base expense decreased 3 points year to year compared to the 13 point impact above. Bad debt expense increased $32 million year to year driven by specific provision additions. The receivables provision coverage was 1.8 percent at March 31, 2014, an increase of 20 basis points from year-end 2013 and 30 basis points from March 31, 2013. 49

--------------------------------------------------------------------------------



Management Discussion - (continued)

Other (income) and expense Yr. to Yr. (Dollars in millions) Percent For the three months ended March 31: 2014 2013 Change Other (income) and expense: Foreign currency transaction losses/(gains) $ 43$ (415) nm % (Gains)/losses on derivative instruments 5



402 (98.7)

Interest income (22)



(23) (4.9)

Net (gains)/losses from securities and investment assets 6

(5) nm Other (158)



(19) 710.2

Total consolidated other (income) and expense $ (126) $



(60) 108.2 %

Non-operating adjustment:

Acquisition-related charges 0 (7) nm Operating (non-GAAP) other (income) and expense $ (126)$ (67) 87.6 % nm - not meaningful

Other (income) and expense was income of $126 million and $60 million in the first quarter of 2014 and 2013, respectively. The increase in income of $65 million year over year was primarily driven by the gain associated with the divestiture of the customer care business ($98 million) in the first quarter of 2014 reflected in Other in the table above. In addition, a reduction in losses on derivative instruments ($397 million) year to year was more than offset by lower foreign currency transaction gains ($458 million) year to year due to foreign currency rate volatility.


For more stories on investments and markets, please see HispanicBusiness' Finance Channel



Source: Edgar Glimpses


Story Tools






HispanicBusiness.com Facebook Linkedin Twitter RSS Feed Email Alerts & Newsletters