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NYSE_IBM_2018.pdf
2018 IBM Annual Report
2018 IBM Annual Report
2018 Annual Report
Dear IBM Investor: 2018 was a defining year for IBM and our clients. Your company returned to growth, just as businesses readied to enter Chapter 2 of their digital reinventions. For years, we have focused on building the tools businesses need in the 21st century. Our investments have reshaped IBM to lead in the emerging, high-value segments of the IT market, including analytics, artificial intelligence, cloud, security, blockchain and quantum computing. At the same time, we have deepened our longstanding commitment to the responsible stewardship of technology.
IBM is now ready to help our clients advance their business transformations.
In my letter to you this year, I will describe IBM’s performance in 2018. I will outline how clients are poised to enter Chapter 2 of their digital reinventions, with help from IBM, and how this translates to growth for IBM, for businesses and for the world.
2018: Return to Growth In 2018, IBM achieved $79.6 billion in revenue and operating earnings per share of $13.81. For the full year, we returned to revenue growth, grew earnings per share and stabilized margins.
Our strategic and continued investment in innovative technology drove our improved competitive position and profit dynamics. Offerings that address data, AI, cloud, analytics and cybersecurity now represent more than half of our revenue—up from a quarter just four years ago—accounting for approximately $40 billion in revenue in 2018.
Our investment of more than $5 billion in research and development produced thousands of breakthrough innovations, which led to IBM’s 26th consecutive year of U.S. patent leadership. Of the 9,100 patents granted to IBM in 2018, more than 1,600 were related to AI and 1,400 to cybersecurity—more than any other company in either area.
This focus on breakthrough innovation has created IBM’s strongest portfolio ever and has driven results:
– Total cloud revenues were more than $19 billion in 2018, up 12 percent. In the fourth quarter alone, IBM signed 16 client services agreements worth more than $100 million to help optimize business performance on the IBM Cloud. Today, 47 of the Fortune 50 depend on the IBM Cloud.
– IBM is the world’s enterprise AI leader. Solutions enabled by IBM Watson are helping produce better decision-making and business outcomes through more than 20,000 client engagements, across 20 industries to date. IDC ranked IBM number one in AI market share. We continue to pioneer innovations in natural language processing, speech processing, computer vision and machine learning.
– IBM Blockchain is the global leader in improving trust and transparency across business networks by creating a new way for clients to share and secure data. IBM Blockchain now powers more than 500 client projects, with more than 85 active networks transforming supply chains, global shipping and cross-border finance.
– IBM Security, the world’s largest cybersecurity enterprise, has 8,000 subject matter experts serving more than 17,000 clients in more than 130 countries. The industry’s leading AI and cloud-based security solutions include IBM Security Connect, launched in 2018, which allows clients to gather, integrate and analyze security data across multiple applications and tools, in a vendor-agnostic way.
– IBM Systems produces innovative infrastructure for AI and hybrid cloud. The z14 is one of IBM’s most successful mainframe programs in history, with broad global adoption across 27 different industry segments. In addition, the U.S. Department of Energy’s POWER9-based supercomputers, Summit and Sierra, were ranked the most powerful supercomputers in the world in 2018.
– IBM Services was a key driver of IBM’s performance in 2018. Forty-seven engagements worth more than $100 million each helped major clients—like Bank of the Philippine Islands, Juniper Networks, Nordea, Westpac and Aditya Birla Retail— move to the next stage of their digital transformations.
New IBM investments are further energizing our portfolio. In late 2018, we announced plans to acquire Red Hat, the world’s leading open source technology provider for the enterprise. With this acquisition, which is expected to close in the second half of 2019, IBM will enhance our position as the world’s number one hybrid cloud provider, helping clients unlock the full business value of the cloud.
We also continued to divest stand-alone software and services assets that are no longer strategic for IBM.
At the same time, we remained committed to returning capital to our shareholders. In 2018, we returned more than $10 billion to you, our shareholders, including dividends of $5.7 billion and gross share repurchases of $4.4 billion. We raised our dividend for the 23rd consecutive year—IBM’s 103rd straight year of providing one.
Moving Clients to the Next Chapter of Digital Reinvention For the past several years, businesses around the world have been driving their digital reinventions to take advantage of data, their most powerful source of competitive advantage.
This first chapter has been defined largely by experimenting with narrow and disparate AI applications and moving simple workloads—typically consumer and customer-facing applications— to the cloud.
Now, we are beginning to see the contours of Chapter 2 among pioneering businesses: moving from experimentation to true business transformation at scale with AI and hybrid cloud.
This next chapter of digital reinvention will be enterprise- driven. It will be characterized first by scaling AI and embedding it everywhere in business. Second, in cloud, it will be characterized by moving mission-critical applications to hybrid cloud— using a combination of multiple public clouds, private clouds, and on-premise IT capabilities, so businesses can create the environment most suitable for their enterprise workloads. Underpinning it all is the growing importance of trust, both in technologies and in their impact on the world.
Scaling AI throughout the Enterprise In Chapter 2 of their digital reinventions, businesses will begin to scale AI across the enterprise, as some first movers are already demonstrating.
Take the world’s leading banks, for example. While many have been applying AI to specific challenges, some first movers are scaling AI across the enterprise. Orange Bank, one of the fastest growing mobile banks in France, now manages all customer
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Virginia M. Rometty Chairman, President and Chief Executive Officer
service through IBM Watson. Similarly, Banco Bradesco is now using IBM Watson to assist every member of its services team—resolving customer inquiries in seconds with nearly 95 percent accuracy.
IBM brought AI for business into the mainstream with the introduction of our Watson platform in 2014. Today, IBM Watson is the most open and trusted AI for business, available to run on any environment—on premise, and in private and public clouds. Businesses can apply Watson to data wherever it is hosted and infuse AI into their applications, regardless of where they reside.
With Watson Studio, Watson Machine Learning and Watson OpenScale, IBM delivers a suite of tools that allow enterprises to build, deploy and manage their AI models in a hybrid cloud environment. IBM Watson OpenScale, a first-of-a-kind platform introduced in 2018, also enables businesses to manage their AI— no matter where it was built or where it runs—with transparency, explainability and bias mitigation. Addressing these factors, which traditionally have held businesses back, is critical for scaling AI throughout an enterprise.
Through IBM Services, we are helping our clients around the world apply AI to core business processes and workflows, infusing their businesses with automation, intelligence and continuous learning to transform everything from supply chains and HR to finance and operations.
In 2018, we also launched a new service called IBM Talent and Transformation that addresses the often overlooked cultural aspects of AI. This service helps our clients ensure their teams have the right skills and talent—and the supporting culture and work environment—to support a new way of working that is critical to scaling AI for business.
Moving Mission-Critical Work to Hybrid Cloud In the first chapter of digital reinvention, cloud deployments largely focused on easily portable workloads for productivity and commodity computing. This primarily was driven by user-facing applications inspired by advances in consumer technology. As a result, only 20 percent of enterprise workloads today have moved to the cloud.
The remaining 80 percent of enterprise workloads provides the real value opportunity for business—transforming mission- critical workloads and applications for the cloud. The challenge is that most businesses have unique regulatory or data requirements and anywhere from five to 15 clouds across multiple providers.
That is why businesses moving to Chapter 2 will need to embrace a new, hybrid cloud approach. It is one that will allow them to more easily move data and scale AI and other applications across public, private and on-premise IT in their enterprises, with consistent management and security protocols, using open source technology.
For example, BNP Paribas, a leading European bank, is working with IBM to speed and scale the launch of new digital and AI customer services across the cloud, while protecting the security and confi dentiality of customer data. Similarly, global telecom leader Vodafone Business is partnering with IBM to innovate the way it delivers multicloud and digital capabilities—including AI, edge computing, 5G and software-defi ned networking solutions—to its customers.
IBM Services provides end-to-end cloud integration capabilities and is helping thousands of businesses migrate, integrate and manage applications and workloads seamlessly and securely across any cloud environment. Industry experts from IBM Services are co-creating cloud-enabled solutions with clients in our IBM Garages. Using design thinking and agile methods, we are helping clients implement new ways of working, such as rapid prototyping and iteration to more quickly move technology projects from pilot to production at scale.
We are ready for this moment of moving clients to Chapter 2 of their digital reinventions with our unique integration of innovative technology, industry expertise and a reputation for trust and security earned over decades. IBM is now moving the world’s major enterprises to the next era, an effort that will be enhanced by our planned acquisition of Red Hat.
Chapter 2 of Trust and Responsible Stewardship We recognize that our clients and the consumers they serve expect more than groundbreaking innovation and industry expertise. They want to work with technology partners they can trust to protect their data and handle it responsibly. They want to work with partners who know how to bring new technologies into the world safely and help society benefi t from them. And they want their partners to create inclusive workplaces and communities where diversity thrives.
#1 AI for business 20,000+ IBM Watson client engagements across 20 industries.
#1 in hybrid cloud 47 of the Fortune 50 rely on IBM Cloud. Revenue for IBM Cloud topped $19 billion in 2018.
#1 in enterprise services IBM Services, with end-to-end cloud and AI capabilities, closed 47 client agreements worth more than $100 million each in 2018.
#1 in enterprise security IBM Security manages 70 billion cybersecurity events per day for clients in more than 130 countries.
#1 in enterprise systems IBM Z is at the heart of world commerce with 30 billion transactions per day, including 87 percent of all credit card transactions.
#1 in U.S. patents for the 26th consecutive year IBM inventors received a record 9,100 patents, including more than 3,000 in AI, cloud and quantum computing.
#1 in blockchain IBM Blockchain Platform was ranked number one by analyst fi rms Juniper Research and Everest Group.
#1 and #2 fastest supercomputers in the world Built by IBM for the U.S. Department of Energy, based on IBM POWER9 CPUs tuned for AI workloads.
IBM Leadership
“We are ready for this moment of moving clients to Chapter 2 of their digital reinventions with our unique integration of innovative technology, industry expertise and a reputation for trust and security earned over decades.”
In an effort to provide additional and useful information regarding the company’s financial results and other financial information, as determined by generally accepted accounting principles (GAAP), these materials contain non-GAAP financial measures on a continuing operations basis, including operating earnings per share and operating pre-tax income. The rationale for management’s use of this non-GAAP information is included on pages 18 and 19 of the company’s 2018 Annual Report, which is Exhibit 13 to the Form 10-K submitted with the SEC on February 26, 2019. For reconciliation of these non-GAAP financial measures to GAAP and other information, please refer to page 41 of the company’s 2018 Annual Report.
These expectations are linked by a common theme: responsibility. Responsibility has been a hallmark of IBM’s culture for 107 years—from our labs to our boardroom. IBMers’ unwavering global commitment to the responsible stewardship of data and powerful new technologies has earned us the trust of clients and society as a whole.
In 2018, as trust in technology came under heightened global scrutiny, we published our IBM Principles for Trust and Transparency, which have long guided our company. They stress our belief that the purpose of new technologies is to augment— not replace—human intelligence, and that the data and insights derived from technology belong to the businesses who own them. The principles also emphasize that new technologies brought into the world must be open, transparent, explainable and free of bias.
We know that AI, like other transformative technologies before it, will have a profound impact on peoples’ jobs and the workplace. That is why, in 2018, IBM further expanded access to the pathways through which students and professionals can build skills for today’s technology era. That includes “new collar” jobs, where having the right skills matters more than having a specific degree. Through our work in 11 U.S. states and 13 countries, there will be 200 Pathways in Technology Early College High Schools— or P-TECHs—serving a pipeline of 125,000 students in the 2019 school year.
2018 also saw the rapid growth of our IBM Apprenticeship Program, which trains people in 21st-century skills ranging from blockchain and digital design to cybersecurity—and which expanded nearly twice as fast as we had projected in its first year.
Yet skills are only part of today’s workforce opportunity. In 2018, fueled by record diverse hiring, promotion and retention, we achieved our greatest progress in a decade on diversity representation among global executive women and underrepresented minorities. We also continued advocating with governments around the world for policies that help ensure workplaces are as inclusive and diverse as the world we live in.
Recognizing that responsible stewardship should not be confined within IBM’s walls, we also are working aggressively to empower others to do lasting good. We are, for example, a founding partner in Call for Code, a global initiative that works with software developers to create solutions that can help save lives. Last year, 100,000 open source developers from 156 countries responded to the call, creating more than 2,500 applications to help communities recover from natural disasters.
As IBM sees it, the promise of technology is to empower people to do good, access new opportunities and make the world better, safer and smarter—for the many, not just the few.
IBM Poised to Lead In summary, we have returned your company to growth. We have positioned IBM’s products, services and people to enable clients to write the next chapter of their digital reinventions. And we have done it all while reaffirming IBM’s longstanding reputation for trust, integrity and responsibility.
Our work ahead is to build on this progress and bring these capabilities to life for our clients. I want to thank all of our clients for partnering with us while we reinvented IBM, and for choosing us for their own journeys of transformation.
I also would like to thank our investors for their confidence in IBM. Finally, I would like to thank the hundreds of thousands of IBMers whose expertise has prepared us to lead in this new chapter of digital reinvention.
I am honored to steward this great company, and I am filled with optimism about what we can achieve in partnership with our clients and society. Together, we are changing work and business— and ultimately, the world.
Virginia M. Rometty Chairman, President and Chief Executive Officer
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Leading businesses are reinventing themselves with IBM Services and Solutions across AI, cloud, blockchain, quantum and more.
IBM Services
even report an issue while a plane is still in the air, so the ground crew can get to work as soon as the plane lands. Customers on the next flight are far less likely to be affected because the app streamlines communication. “It’s been a game changer for us,” Deb says. “It lets us care for our customers right in the moment— and nothing’s better than that.”
The agile IBM Garage method helps organizations think beyond their existing systems and focus on what customers actually need. When combined with IBM Cloud and IBM Watson, it’s nothing less than a way for organizations to reinvent themselves—an approach that’s being adopted by enterprises around the world as they move to the next stage of digital reinvention. For example, it has helped create a startup culture in Banco Bradesco, one of Brazil’s largest banks. Bradesco can now quickly respond to the rising demand from its 75 million mobile banking customers. It has also showed East Carolina University new value in discarded data that enabled the school to predict possible outcomes, report strengths, weaknesses and deficits, and enable advisors to better assist students and improve educational programs. Digital reinvention isn’t just a product or a platform. And it’s certainly more than just a buzzword. It’s a promise: a new way to innovate and rethink a company from the ground up and help customers and businesses alike.
To ignite a major business transformation, United Airlines turned to IBM iX—the business design arm of IBM Services—and a set of business applications from a global partnership between IBM and Apple called IBM MobileFirst for iOS. These applications combine the power of enterprise data and analytics with an elegant user experience, allowing United to broadly rethink how its crews work and how its work flows.
United and IBM used the IBM Garage method to design apps for the airline’s growing deployment of iOS devices. The IBM Garage method, used by IBM Services with clients around the world, emphasizes co-creation and frequent iteration. It has allowed United to build complete, integrated mobile platforms that start with a user’s experience and extend to all the airline’s core business processes. United is now able to foster better and faster collaboration across diverse teams and time zones, enabling it to focus on its core mission of transporting customers to their destinations on time. The apps are also giving flight attendants like Deb Winchell new ways to help customers enjoy their flights, which makes everyday travel just a little less stressful for everyone involved.
Frontline crews know that many factors can contribute to delays. “Most challenges stem from things I can’t control,” Deb says. “But when I can make a difference in a customer’s travel experience, it can be huge.” That’s why it’s important to resolve issues before they affect customers. Deb can now be more proactive with apps co-designed by United and IBM iX. Deb can
With new mobile tools, United staff can quickly report and resolve issues that previously required multiple steps.
United Airlines: Reinvention takes flight
Flight attendant Deb Winchell knows better than most how stressful a delay can be—for customers and staff alike.
More than 60% savings in app development costs, compared to a traditional approach
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It starts with a single report of severe food-borne illness. Then more reports pour in from around the country and from them, a culprit emerges: a common type of lettuce. But where, specifically, did the tainted lettuce come from? The work of Walmart and IBM, powered by IBM Blockchain, is giving us a better way to answer this question.
Until recently, tracing food hasn’t been easy or fast. And the risk that represents is significant. The World Health Organization has estimated that there are 600 million cases of foodborne illness each year, leading to 420,000 deaths. And it can be daunting to trace how food goes through the supply chain. For example, four days of a farm’s production of red- and green-leaf lettuce and cauliflower can generate more than 200 separate tracking numbers that are printed onto cartons and pallets for shipping to buyers. Finding individual boxes of particular at-risk produce in this environment means searching through a haystack of paper records. IBM Food Trust—using blockchain technology—connects growers, processors, distributors and retailers through a permissioned, permanent and shared record of food-system data that drastically cuts the time needed to trace produce from farm to store. In a pilot program,
tracing time was reduced from seven days to just 2.2 seconds. “With blockchain, all the trace media’s already there,” explains Tejas Bhatt, senior director, Food Safety, for Walmart.
Blockchain technology is also changing the way companies like Walmart collaborate with their supply chains—even with potential competitors. The IBM Food Trust ecosystem connects supply chains like Walmart’s and also those of other major retailers and global companies such as Carrefour, Dole, Golden State Foods, Driscoll’s and Nestlé—all without sharing any information they don’t want to share. Beyond safety, consumers increasingly value the kind of information that a system built on IBM Blockchain can provide. With blockchain, growers, distributors and retailers can provide consumers digitized certifications of existing organic or fair trade products along with detailed documentation from different points in the process, from farm to table. Ed Treacy, vice president, Supply Chain and Sustainability at the Produce Marketing Association, says blockchain “can speed up investigations into contaminated food, authenticating the origin of food and providing insights about the conditions and pathway through which the food traveled.”
As more companies adopt a digital, end-to-end traceability protocol, the IBM Food Trust’s goal is to make the world’s food supply safer—something that is sorely needed. In 2018, the U.S. Food and Drug Administration and U.S. Department of Agriculture issued more than 300 food recalls. In addition to the societal and business impact, these recalls waste huge stocks of food and erode consumer trust. And if outbreaks multiply and answers are slow in coming, customers can become desensitized and begin to ignore overly broad warnings such as “throw away all lettuce in your refrigerator.” Work by companies like Walmart and other participants in the IBM Food Trust are laying the foundation for better management of our global food supply: rapid insight into what’s happened when something goes wrong, reducing waste, and a safer journey from the farm to our local markets and, ultimately, to our dinner table.
With the IBM Food Trust, Walmart’s food safety professionals can trace produce back to its source in just seconds.
Walmart: Linked by safer food
IBM Blockchain adds new transparancy to the global food supply chain.
From
7 days Down to
2.2 seconds
IBM Blockchain
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Watson eliminates distractions that come between branch director François-Xavier Maille and his clients.
When Crédit Mutuel embarked on its “together#newworld” initiative—a five-year project to become a leading digital bank— it brought in IBM to help it reinvent itself.
Crédit Mutuel’s goal: to engage with customers more deeply, both online and offline, while providing new products and the fastest service—all in an environment of trust and security. To do that, the bank is infusing IBM Watson into the applications its advisors use and is embracing IBM Cloud as a platform for innovation, trust and security.
François-Xavier Maille, director of one of the premier branches of Crédit Mutuel bank in Paris, was the first to deploy the initial AI solution: a Watson virtual assistant that helps employees answer customers’ questions. “The application has liberated our people from a few recurring tasks so they can devote their time and talents to understanding our clients’ aspirations, challenges, and circumstances,” says François-Xavier. Today, 23,000 Crédit Mutuel advisors across France rely on the Watson tool, which helps employees answer business-related questions 60% faster. The bank intends to use Watson across all of its business lines.
But that’s just the start. Crédit Mutuel is making important decisions—about data, compliance and regulation, cybersecurity, and managing applications across the enterprise. To achieve digital banking at scale, IBM and Crédit Mutuel are crafting a hybrid cloud strategy that encompasses multiple clouds and on-premise systems, including the mainframe. At the same time, experts from Crédit Mutuel and IBM Services are working together in a “Cognitive Factory” that provides a fertile environment for identifying, building and deploying new AI solutions. With many internal IT teams involved, IBM and Crédit Mutuel are also creating industrial tools and training assets to efficiently expand cognitive solutions to 100% of the business lines of the company.
Crédit Mutuel’s reinvention represents a synthesis of human and machine that gives banking new power. Employees can find the optimal blend of talent and data, use their talents to the fullest, delve more deeply into clients’ financial challenges and develop smarter, more creative solutions. Extrapolate IBM’s immediate impact on Crédit Mutuel to the entire world of financial services,
Experts from Crédit Mutuel and IBM Services are working together in a “Cognitive Factory.”
60% faster responses to business inquiries
175,000 daily emails routed and prioritized
and you can see the implications for how banking consumers experience and engage with their financial institutions: More relevant innovation for customers. Lower client turnover for banks. Greater confidence in asset management for consumers. Higher employee engagement and contributions. Growing customer satisfaction. And more predictable performance for institutions. AI accelerates access to relevant information and liberates people to provide a human touch.
Crédit Mutuel: A bank thinks bigger
IBM Cloud · IBM Watson
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DeKalb Medical takes a systems-based, data-intensive approach to fighting dangerous infections with the help of IBM Watson Health. One of the lesser-known challenges it faces is sepsis, which is caused by an infection that triggers an inflammatory immune response. Sepsis is notoriously difficult to diagnose and treat, making it the third-leading cause of death in the U.S.
Nurses see it all, and sepsis requires them to race against the clock. But with the intelligent use of data, delivered by IBM Watson Health and deployed by a team led by Christina English, a quality management specialist and former bedside nurse, clinicians at DeKalb are getting a step ahead to help patients get better, faster. Previously, Christina and her team had to fight sepsis with siloed and sometimes subjective information. “We knew what to look for, but we didn’t understand the importance of the symptoms, how they worked together and how a clearly defined set of treatment measures is critical to success,” she says. Using IBM CareDiscovery, part of Watson Health’s set of performance-improvement solutions for healthcare providers, Christina and her team were able to gather and analyze industry benchmarks as well as their own performance metrics in order to identify sepsis “flags” and pinpoint where DeKalb could take proactive measures.
DeKalb is shifting to a systems-based approach to care. The IBM Watson Health solution helped Ellen Hargett, executive director of DeKalb’s Quality Institute, and her team change the way they measure system-wide performance by organizing data and analysis into a usable dashboard. For each key performance metric on the dashboard, Ellen established tactical teams to fully understand the metrics, determine the “why” behind them and recommend tactics for improvement. Across healthcare, a systems-based approach can also produce a significant positive impact on resources. For example, sepsis is not only a medical challenge for hospitals. It’s also the most costly reason for hospitalization, consuming $24 billion each year in the U.S. alone. DeKalb’s efforts to quantify, analyze and shift the diagnosis and treatment of sepsis have not only led to a lower mortality rate but also significantly reduced the length of stay for patients.
Individual treatments are now based on data informed by large-scale findings across large populations. Historically, doctors diagnosed through trained intuition. In recent decades, however, this approach has been replaced by “empirical medicine” that’s based on data. The result is more standardized treatments and improved outcomes. At DeKalb, data is shared with healthcare professionals, providing them with information to spot large patterns or gaps. Watson Health’s data-driven tools allow healthcare institutions to organize and visualize data and take fast action to address weaknesses or roll out improvements. A data-driven approach to challenges like sepsis also helps doctors expand their understanding of the syndrome, improving diagnosis and treatment. This trajectory will eventually create a new era of healthcare. As medical professionals tap data at both the systemic and individual levels, an age of “precision medicine” will arise. It will be a time when understanding derived from the many can be tailored and applied to the needs of the individual.
Christina English is helping to lead DeKalb Medical’s fight against sepsis.
This data-driven approach will eventually create a new era of healthcare.
30% fewer lives lost to sepsis
DeKalb Medical: Stronger medicine
IBM Watson Health
Predictive intelligence is starting to create new options that can make extreme weather more manageable and less disruptive.
33% faster electricity restoration than similar storms
Emergency Recovery Award from the Edison Electric Institute
Another late spring storm was rolling toward the Canadian utility Hydro One. But in its ongoing battle with ice, snow, wind and thunderstorms, this time the utility found calm in the predictive power of The Weather Company and IBM Watson.
Derek Roles, director, Emergency Preparedness and Restoration, is Hydro One’s first line of defense for a service area that covers most of Ontario. Twenty years of experience and an encyclopedic knowledge of winter storms have helped him manage through many major disruptions, so Derek can usually plan for the worst. Now, though, he can predict it. And that changes everything. In the past, recovery teams were deployed only after the weather had passed. Now, however, Derek doesn’t just keep up with the weather—he stays ahead of it. This shift was made possible because Derek and his team put data and AI to work: they trained Watson to predict outages using five years of Hydro One historical outage data and a massive amount of Ontario’s historical weather information. Derek’s new predictive tools help him paint a clearer picture of how a storm will affect the utility’s electrical distribution network.
Hydro One has committed itself to a more proactive approach, and the utility has not only gained a new way to fight storms, but has also changed its basic business operations to strengthen its customers’ experience and service quality. The predictive power of AI enables Hydro One to activate its emergency organization structure in advance and create detailed team deployment plans, positioning some crews in the storm’s predicted path while making sure other crews are well rested. The utility is also able to staff call centers more effectively and notify customers of a storm’s potential impact on their service. So when a storm hits, restoration plans are already in motion and work crews can spring into action faster than ever before, quickly and safely scaling repairs from the main transmission grid to smaller circuits to individual customer locations in remote areas.
Weather exerts a tremendous influence on the economy. It affects productivity, sales and energy consumption, and it can disrupt supply chains and transportation systems. Severe weather can upend lives and businesses for hours, weeks, years or even forever. So there’s a logic behind the expression “ride out the storm”—that’s often been the only option. But predictive intelligence is starting to create new options that can make extreme weather more manageable and less disruptive. This is especially critical at a time when severe weather is the leading cause of power disruptions in many countries. Global economic losses resulting from weather disasters totaled $215 billion last year. By putting the power of data and Watson to work, Hydro One is modeling new solutions for previously intractable weather problems everywhere—problems that can now be better understood and managed, along with human risks that can now be met head-on with artificial intelligence.
With Watson, Hydro One’s Derek Roles, director, Emergency Preparedness and Restoration, can restore power more quickly after a storm.
Hydro One: Outsmarting the storm
IBM Watson
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Vijay Swarup, ExxonMobil vice president for Research and Development, says energy research requires curiosity, optimism, patience and dissatisfaction. Dissatisfaction because he believes things can be better. But what, exactly, can be better? Nothing less than our understanding of the world.
Researchers now have a new tool to explore new ways to solve problems: quantum computing. And Vijay’s quite precise about the trouble with our current understanding. “There are some problems so big, all we can do is approximate,” he says. Whether he’s in a business suit or the lab coat he wears at ExxonMobil’s expansive New Jersey research facility, Vijay clearly enjoys trying to solve what he calls today’s pressing dual challenge: ensuring that people have access to scalable, affordable energy, and doing so in the context of climate change and the need for sustainable solutions. This is where IBM Q comes into the picture. Quantum computers have long been considered theoretical. But today, they’re becoming a reality, with huge potential for energy companies like ExxonMobil. That said, using a quantum computer also calls for significant change in how researchers think about approaching their work. “Computation has always been an integral part of the research we’ve done here, but quantum’s radically different,” Vijay explains. “Now, we must first figure out which problems are most suited to a quantum approach and only then can we answer a more interesting question: How can you program a quantum computer to solve energy problems?”
ExxonMobil joins a group of global corporations partnering with IBM to work side-by-side on IBM’s fully functional quantum computers. As Vijay says, quantum’s a priority that requires pairing the “best minds with the best minds.” So ExxonMobil has a team that will meet regularly with IBM’s quantum researchers. Barclays has its own team working
on quantum, as do Samsung and Daimler. Working as part of the IBM Q Network alongside global universities and national research labs, these corporations see the potential of a massive shift in how computers can help solve some of the most enduring challenges— issues that, once solved, could transform entire industries. “IBM Q System One is the world’s first integrated universal quantum computing system designed for scientific and commercial use,” says Dario Gil, director, IBM Research. “We are at the beginning of an exciting journey. Our research, systems and business teams— along with our IBM Q Network partners—have a bold vision. They are thinking big. These are the true pioneers.”
Nature is no longer estimated but predicted and understood. That’s the goal. So when IBM unveiled its quantum machines, companies like ExxonMobil saw great promise. But when you talk to Vijay about promise, his thoughts turn to the great needs that are facing the world. “Our global population is increasing from 7 billion to 9 billion and, all across the world, a growing middle class requires more resources and, especially, more energy.” Quantum might be well suited to solve super-complex problems, such as advanced models which could lead to better approaches to carbon capture and lower emissions sources of energy. But what excites Vijay most is that the collaboration with IBM researchers could lead to a fresh ability to predict and anticipate how nature operates—which could lead to an understanding of what’s actually happening, as opposed to an approximation of what might be happening. “With a little curiosity, patience and not settling for the status quo, I know we can get there,” he says.
ExxonMobil: Quantum understanding
ExxonMobil’s vice president for Research and Development, Vijay Swarup, is leading the company’s exploration of quantum computing.
IBM Q System One is the world’s first integrated quantum computing system for commercial use.
Provide access to scalable, affordable energy
Reduce the risks of climate change
Every energy company’s dual challenge:
IBM Quantum
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Thought Machine, a London-based fintech startup, has built Vault, a new, cloud-native core banking infrastructure launching on IBM Cloud. It has also partnered with IBM Services to provide advisory and delivery capabilities to its clients.
Japan Airlines is using an IBM Watson- powered chatbot, Makana-chan, to answer customers’ questions about its popular Tokyo-to-Honolulu flights. Makana-chan eases the burden on live agents and is very popular with passengers.
Travelport, a travel commerce platform, is working with IBM Watson to integrate disparate information sources and make stronger corporate travel recommendations. As a result, finding the lowest travel costs for a company will be quicker and easier.
Maersk, the container logistics giant, is using IBM Blockchain to create TradeLens, a global blockchain solution for the shipping ecosystem. This global transformation will lead to faster delivery times, lower costs and a noticeable difference in the way we get the things we use every day.
Suunto, creator of the Movesense microsensor, launched a Movesense development community enabled in the IBM Cloud. This let Suunto dramatically scale its offerings. Today, more than 800 developers are working with Movesense, helping Suunto bring the device to new customers all over the world.
KMD, Denmark’s largest technology company, is dedicated to connecting its clients to the latest technologies. The company is using IBM Services to provide a critical foundation of servers, networks and other technologies that help it handle large volumes of data with high levels of security.
Smart Dubai, working with IBM Blockchain and IBM Cloud, has launched the region’s first government-endorsed blockchain service: Dubai Blockchain Platform. It is designed to make the technology more accessible to the Dubai government, the UAE national government and private companies.
Whirlpool Corporation is using IBM Cloud to help manage all the data from its manufacturing of connected home appliances. Whirlpool will be using the cloud to manage critical enterprise applications, which will give it more flexibility to scale and innovate.
Fluor Corporation builds mega- projects across the globe. Data generated by these projects has been harnessed by working with IBM Research and IBM Services. Fluor recently introduced two new AI-powered systems to uncover and predict how unmitigated trends could affect key project indicators.
Telefónica turned to IBM Blockchain to capture call data in real time and save it in a format that’s trusted, traceable and accessible to network providers and carriers worldwide, making international phone calls feel seamless despite all the technological leaps they require.
View these stories and more at ibm.com/annualreport
Bausch + Lomb simplified the service and maintenance process for its high-tech Stellaris Elite Vision Enhancement System for cataract and retina surgery. Using IBM Cloud, the company can now pinpoint or respond to technical and service requests and limit or minimize downtime.
KPMG is using IBM Watson to power a contract analysis solution for its clients. The solution examines contracts, breaks them into their component parts and interprets each part with a high degree of accuracy. It’s faster and less expensive than manual methods, while freeing up skilled resources to perform more productive tasks.
More clients are partnering with IBM to write the next chapters of their digital reinventions.
Belron applied IBM Watson Visual Recognition to its Autoglass Body Repair business to speed up insurance processing, move repairs along quickly and help its customers get back on the road fast.
BNP Paribas is accelerating its digital transformation and improving its operational efficiency. The bank will now integrate IBM Cloud-hosted data centers dedicated to the bank, and will strengthen its hybrid cloud “as a service” capabilities while ensuring the security and confidentiality of their customers’ data—including not using public clouds for hosting any customer or other production environments with sensitive information.
The Australian Federal Government has set its sights on being one of the world’s top three digital governments by 2025. In July 2018, it announced a five-year agreement that covers solutions from IBM Cloud, IBM Watson, IBM Security, IBM Research and the IBM Q quantum computing initiative.
Profility, a post-surgery rehabilitation solutions provider, needed to integrate large volumes of data as well as meet stringent HIPAA regulations. They chose IBM Cloud because of its flexible software and secure, dedicated hardware. Their system is widely used and has resulted in shorter rehab stays and fewer hospital readmissions.
Krungsri Bank, one of Thailand’s largest financial institutions, is working with IBM Services to lay the foundation for its future. An IBM Blockchain pilot is in progress, and the bank is planning to develop new services for its customers.
13
Responsible stewardship and trust have been hallmarks of IBM’s culture— from our labs to the boardroom— for more than a century.
Data Responsibility At IBM, we’ve always followed straightforward principles to act responsibly and earn trust. Today, our principles include:
– The purpose of new technologies is to augment—not replace— human intelligence.
– Data and insights belong to their owner. – New technology, including AI, must be transparent and explainable.
Recent actions demonstrate our principles at work, including:
• Advocating for public policies to protect the privacy and security of data and working with governments worldwide on strategies that will ensure privacy and responsible handling of data, without undermining innovation.
• Partnering with STOP THE TRAFFIK, law enforcement and financial services institutions to stop human trafficking by using IBM software analytics to identify suspicious trends, hotspots and financial transactions.
• Launching AI Fairness 360, an open source software toolkit to help developers actively detect and reduce bias in datasets and AI.
• Releasing Diversity in Faces, a first-of-its-kind dataset, to help reduce bias in facial recognition systems, making them fairer and more accurate.
1 million annotated human facial images
Modern slavery, a $150 billion business, has a new foe: an AI data hub on the IBM Cloud.
IBM is recognized as one of the World’s Most Ethical Companies by the Ethisphere Institute, highlighting our influence in driving positive change in business and society around the world.
14
Diversity and Inclusion In 2018, fueled by record diverse hiring, promotion and retention, IBM achieved our greatest progress in a decade on diversity representation among global executive women and underrepresented minorities. We also continued advocating with governments around the world for policies that help ensure workplaces are as inclusive and diverse as the world we live in. We received widespread recognition in 2018 for this leadership, including:
• Being honored with a 2018 Catalyst Award for leadership in advancing women in business, becoming the first company to win the award four times and the only tech company so honored in the last 20 years.
• Being named a 2018 Diversity Best Practices Leading Inclusion Index Company by Working Mother.
• Scoring a perfect 100 percent for the 15th consecutive year in the Human Rights Campaign Corporate Equality Index.
Jobs and Skills In the 1940s, IBM partnered with Columbia University to create a new discipline: computer science. In 2018, we continued this tradition by expanding training and education for the growing number of “new collar” jobs for today’s era of data and AI. Recent examples include:
• Developing new talent with our 12-month IBM Apprenticeship Program in areas including cybersecurity, digital design, mainframe administration and software development. Hundreds of apprentices—ranging in age from 18 to 59—have joined the program, which includes training and on-the-job experience guided by an IBM mentor.
• Launching Skills Build, an IBM volunteer initiative that helps more than three million primary and secondary school students learn about new technologies.
• Continuing to transform education via P-TECH—Pathways to Technology Early College High School. In the 2019 school year, there will be:
200 P-TECH schools serving a pipeline of 125,000 students across 13 countries and 11 U.S. states
Brandon Whittington, IBM Blockchain Solutions support engineer and graduate of the IBM’s Apprenticeship Program
IBMers at the Pride March in New York
P-TECH students at a graduation ceremony
15
Financial Highlights International Business Machines Corporation and Subsidiary Companies
($ in millions except per share amounts)
For the year ended December 31: 2018 2017
Revenue $ 79,591 $ 79,139 Net Income $ 8,728* $ 5,753* Income from continuing operations $ 8,723* $ 5,758* Operating (non-GAAP) earnings** $ 12,657 $ 12,807***
Earnings per share of common stock—continuing operations
Assuming dilution $ 9.51* $ 6.14* Basic $ 9.56* $ 6.17* Diluted operating (non-GAAP)** $ 13.81 $ 13.66***
Net cash provided by operating activities $ 15,247 $ 16,724 Capital expenditures, net $ 3,716 $ 3,312 Share repurchases $ 4,443 $ 4,340 Cash dividends paid on common stock $ 5,666 $ 5,506
Per share of common stock $ 6.21 $ 5.90
At December 31: 2018 2017
Cash, cash equivalents, restricted cash and marketable securities $ 12,222 $ 12,842**** Total assets $123,382 $125,356 Working capital $ 10,918 $ 12,373 Total debt $ 45,812 $ 46,824 Total equity $ 16,929 $ 17,725 Common shares outstanding (in millions) 892 922 Stock price per common share $ 113.67 $ 153.42
* Includes charges of $2.0 billion in 2018 and $5.5 billion in 2017 associated with U.S. tax reform. ** See page 41 for a reconciliation of net income to operating earnings. *** Recast to reflect adoption of the FASB guidance on presentation of net periodic pension and nonpension postretirement benefit costs. ****Recast to reflect adoption of the FASB guidance on restricted cash.
16
17Report of Financials International Business Machines Corporation and Subsidiary Companies
MANAGEMENT DISCUSSION Overview 18
Forward-Looking and Cautionary Statements 19
Management Discussion Snapshot 19
Description of Business 22
Year in Review 27
Prior Year in Review 48
Other Information 59
Looking Forward 59
Liquidity and Capital Resources 60
Critical Accounting Estimates 63
Currency Rate Fluctuations 66
Market Risk 66
Cybersecurity 67
Employees and Related Workforce 67
Report of Management 68
Report of Independent Registered Public Accounting Firm 69
CONSOLIDATED FINANCIAL STATEMENTS Earnings 70
Comprehensive Income 71
Financial Position 72
Cash Flows 73
Changes in Equity 74
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS A Significant Accounting Policies 76
B Accounting Changes 89
C Acquisitions/Divestitures 91
D Financial Instruments 95
E Inventories 103
F Financing Receivables 103
G Property, Plant and Equipment 106
H Investments and Sundry Assets 107
I Intangible Assets Including Goodwill 107
J Borrowings 108
K Other Liabilities 111
L Equity Activity 111
M Contingencies and Commitments 115
N Taxes 117
O Revenue Recognition 120
P Research, Development and Engineering 122
Q Earnings Per Share of Common Stock 123
R Rental Expense and Lease Commitments 124
S Stock-Based Compensation 124
T Retirement-Related Benefits 127
U Segment Information 141
V Subsequent Events 146
Five-Year Comparison of Selected Financial Data 147
Selected Quarterly Data 148
Performance Graphs 149
Stockholder Information 150
Board of Directors and Senior Leadership 151
18 Management Discussion International Business Machines Corporation and Subsidiary Companies
OVERVIEW The financial section of the International Business Machines Corpor ation (IBM or the company) 2018 Annual Report includes the Management Discussion, the Consolidated Financial Statements and the Notes to Consolidated Financial State- ments. This Over view is designed to provide the reader with some perspective regarding the information contained in the financial section.
Organization of Information • The Management Discussion is designed to provide readers
with an overview of the business and a narrative on the company’s financial results and certain factors that may affect its future prospects from the perspective of the company’s management. The “Management Discussion Snap shot,” beginning on page 19, presents an overview of the key performance drivers in 2018.
• Beginning with the “Year in Review” on page 27, the Manage- ment Discussion contains the results of operations for each reportable segment of the business and a discussion of the company’s financial position and cash flows. Other key sections within the Management Discussion include: “Looking Forward” on page 59, and “Liquidity and Capital Resources” on page 60, which includes a description of management’s definition and use of free cash flow.
• The Consolidated Financial Statements are presented on pages 70 through 75. These statements provide an overview of the company’s income and cash flow performance and its financial position.
• The Notes follow the Consolidated Financial Statements. Among other items, the Notes contain the company’s accounting policies (pages 76 to 88), acquisitions and divestitures (pages 91 to 94), certain contingencies and commitments (pages 115 to 117), revenue (pages 120 to 122) and retirement-related plans information (pages 127 to 141).
• The Consolidated Financial Statements and the Notes have been prepared in accordance with accounting principles generally accepted in the United States (GAAP).
• On December 22, 2017, the Tax Cuts and Jobs Act (U.S. tax reform) was enacted in the U.S. This Act resulted in the company recording a charge of $5.5 billion in the fourth- quarter 2017. For the full-year 2018, the company recorded additional charges of $2.0 billion, including $1.9 billion in the fourth quarter, primarily related to the election to include Global Intangible Low-Taxed Income (GILTI) in measuring deferred taxes. Refer to note N, “Taxes,” on pages 117 to 119 for additional information.
• Effective January 1, 2018, the company adopted the Financial Accounting Standards Board (FASB) guidance on presentation of net periodic pension and nonpension postretirement benefit costs (net benefit cost). The guidance is primarily a change in financial statement presentation, but it did impact the consolidated and reportable segment gross profit margins and expense and other income. As a result, the company aligned its presentation of operating (non-GAAP) earnings to conform to the FASB presentation of these costs in the Consolidated Statement of Earnings. The periods presented in this Annual Report are reported on a comparable basis.
• 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. When the company refers to growth rates at constant currency or adjusts such growth rates for currency, it is done so that certain financial results can be viewed without the impact of fluctuations in foreign currency exchange rates, thereby facilitating period-to- period comparisons of its business performance. Financial results adjusted for currency are calculated by translating current period activity 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 currency. Generally, when the dollar either strengthens or weakens against other currencies, the growth at constant currency rates or adjusting for currency will be higher or lower than growth reported at actual exchange rates. See “Currency Rate Fluctuations” on page 66 for additional information.
• Within the financial statements and tables in this Annual Report, certain columns and rows may not add due to the use of rounded numbers for disclosure purposes. Percentages reported are calculated from the underlying whole-dollar numbers.
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 from continuing operations is a non-GAAP measure that excludes the effects of certain acquisition-related charges, intangible asset amortization expense resulting from basis differences on equity method investments, retirement-related costs, discontinued operations and related tax impacts. Due to the unique, non- recurring nature of the enactment of U.S. tax reform, the company characterizes the one-time provisional charge recorded in the fourth quarter of 2017 and all 2018 adjustments to that charge as non-operating. Adjustments include true-ups, accounting elections, any changes to regulations, laws, audit adjustments, etc. that affect the recorded one-time charge. For acquisitions, operating (non-GAAP) 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, tax charges related to acquisition integration and pre-closing charges. For the 2019 operating (non-GAAP) earnings per share expectation, acquisition-related charges associated with the Red Hat, Inc. (Red Hat) acquisition exclude pre-closing charges, such as financing costs. These charges are excluded as they may be inconsistent in amount and timing from period to period and are dependent on the size, type and frequency of the company’s acquisitions. All other spending for acquired companies is included in both earnings from continuing operations and in operating (non-GAAP) earnings. Throughout the Management Discussion and Analysis, the impact of acquisitions over the prior 12-month period may be a driver of higher expense year to year. For retirement-related costs, the company characterizes certain items as operating and others as non-operating, consistent with GAAP. The company includes defined benefit plan and nonpension postretirement benefit plan service cost, multi-employer plan costs and the cost of defined contribution plans in operating earnings. Non- operating retirement-related costs include defined benefit plan and nonpension postretirement benefit plan amortization of prior service cost, interest cost, expected return on plan
19Management Discussion International Business Machines Corporation and Subsidiary Companies
assets, amortized actuarial gains/losses, the impacts of any plan curtailments/settlements, pension insolvency costs and other costs. Non-operating retirement-related 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 of the operational performance of the business.
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 comparison to peer companies; and allows the company to provide a long-term strategic view of the business going forward. The company’s reportable segment financial results reflect operating earnings from continuing operations, consistent with the company’s management and measurement system.
FORWARD-LOOKING AND CAUTIONARY STATEMENTS Certain statements contained in this Annual Report may constitute forward-looking statements within the meaning of the Private Secur ities Litigation Reform Act of 1995. Any forward- looking statement in this Annual Report speaks only as of the date on which it is made; the company assumes no obligation to update or revise any such statements. Forward-looking statements are based on the company’s current assumptions regarding future business and financial performance; these statements, by their nature, address matters that are uncertain to different degrees. Forward-looking statements involve a number of risks, uncertainties and other factors that could cause actual results to be materially different, as discussed more fully elsewhere in this Annual Report and in the company’s filings with the Securities and Exchange Commission (SEC), including the company’s 2018 Form 10-K filed on February 26, 2019.
MANAGEMENT DISCUSSION SNAPSHOT
($ and shares in millions except per share amounts)
For the year ended December 31: 2018 2017
Yr.-to-Yr. Percent/Margin
Change
Revenue $ 79,591 $ 79,139 0.6%* Gross profit margin 46.4% 46.7%** (0.3) pts. Total expense and other (income) $ 25,594 $ 25,543** 0.2% Total expense and other (income)-to-revenue ratio 32.2% 32.3%** (0.1 ) pts. Income from continuing operations before income taxes $ 11,342 $ 11,400 (0.5)% Provision for income taxes from continuing operations $ 2,619+ $ 5,642+ (53.6)% Income from continuing operations $ 8,723+ $ 5,758+ 51.5% Income from continuing operations margin 11.0% 7.3% 3.7 pts. Income/(loss) from discontinued operations, net of tax $ 5 $ (5) NM Net income $ 8,728+ $ 5,753+ 51.7% Earnings per share from continuing operations:
Assuming dilution $ 9.51+ $ 6.14+ 54.9% Consolidated earnings per share—assuming dilution $ 9.52+ $ 6.14+ 55.0% Weighted-average shares outstanding
Assuming dilution 916.3 937.4 (2.2)% Assets++ $123,382 $125,356 (1.6)% Liabilities++ $106,452 $107,631 (1.1)% Equity++ $ 16,929 $ 17,725 (4.5)%
* 0.0 percent adjusted for currency. ** Recast to reflect adoption of FASB guidance on presentation of net periodic pension and nonpension postretirement benefit costs. + Includes charges of $2.0 billion or $2.23 of diluted earnings per share in 2018 and $5.5 billion or $5.84 of diluted earnings per share in 2017
associated with U.S. tax reform. ++At December 31 NM—Not meaningful
20 Management Discussion International Business Machines Corporation and Subsidiary Companies
The following table provides the company’s operating (non- GAAP) earnings for 2018 and 2017.
($ in millions except per share amounts)
For the year ended December 31: 2018 2017 Yr.-to-Yr.
Percent Change
Net income as reported $ 8,728+ $ 5,753 + 51.7% Income/(loss) from discontinued operations, net of tax 5 (5) NM Income from continuing operations $ 8,723+ $ 5,758 + 51.5% Non-operating adjustments (net of tax)
Acquisition-related charges 649 718 (9.7) Non-operating retirement-related costs/(income) 1,248 856** 45.9 U.S. tax reform charge 2,037 5,475 NM
Operating (non-GAAP) earnings* $12,657 $12,807** (1.2)% Diluted operating (non-GAAP) earnings per share $ 13.81 $ 13.66** 1.1%
* See page 41 for a more detailed reconciliation of net income to operating (non-GAAP) earnings. ** Recast to reflect adoption of FASB guidance on presentation of net periodic pension and nonpension postretirement benefit costs. + Includes charges of $2.0 billion in 2018 and $5.5 billion in 2017 associated with U.S. tax reform. NM—Not meaningful
In 2018, the company reported $79.6 billion in revenue and $8.7 billion in income from continuing operations, which included charges of $2.0 billion associated with U.S. tax reform. Operating (non-GAAP) earnings were $12.7 billion, which excludes the tax reform charges. Diluted earnings per share from continuing operations were $9.51 as reported and $13.81 on an operating (non-GAAP) basis. The company generated $15.2 billion in cash from operations, $11.9 billion in free cash flow and delivered shareholder returns of $10.1 billion in gross common stock repurchases and dividends.
Total consolidated revenue in 2018 increased 0.6 percent as reported and was flat adjusted for currency compared to the prior year. Cognitive Solutions increased 0.2 percent as reported and was essentially flat adjusted for currency. Solutions Software grew 0.8 percent as reported (essentially flat adjusted for currency), while Transaction Processing Software declined 1.2 percent as reported (2 percent adjusted for currency). Global Business Services (GBS) increased 2.9 percent as reported and 2 percent adjusted for currency led by growth in Consulting. Technology Services & Cloud Platforms (TS&CP) grew 0.5 percent as reported and was flat adjusted for currency, with growth in Infrastructure Services and Integration Software offset by declines in Technical Support Services. Within TS&CP, there was continued strong growth in cloud revenue which increased 23 percent year to year as reported and adjusted for currency. Systems decreased 2 percent as reported and adjusted for currency, with IBM Z declining year to year reflecting product cycle dynamics. Storage Systems also decreased in a competitive environment with ongoing pricing pressures, while Power Systems grew as reported and adjusted for currency, with strong performance in Power9-based processors and Linux throughout the year.
In 2018, the company delivered solid strategic imperatives revenue growth, generating $39.8 billion of revenue and growing 9 percent as reported and adjusted for currency, with double-digit growth in cloud and security. Cloud revenue of $19.2 billion increased 12 percent as reported and adjusted for currency, with as-a-Service revenue up 22 percent as reported and adjusted for currency. The annual exit run rate for as-a-Service revenue increased to $12.2 billion in 2018 compared to $10.3 billion in 2017.
From a geographic perspective, Americas revenue declined 1.7 percent year to year as reported (1 percent adjusted for currency) with a decline in the U.S. of 2.4 percent. Europe/Middle East/Africa (EMEA) increased 4.5 percent (1 percent adjusted for currency). Asia Pacific was essentially flat year to year as reported and adjusted for currency.
The consolidated gross margin of 46.4 percent decreased 0.3 points year to year and reflects the impacts of portfolio mix and investment, partially offset by benefits from productivity and improving services margins through the year. The operating (non- GAAP) gross margin of 46.9 percent decreased 0.4 points versus the prior year primarily driven by the same factors.
21Management Discussion International Business Machines Corporation and Subsidiary Companies
Total expense and other (income) increased 0.2 percent in 2018 compared to the prior year. The year-to-year performance was driven by decline in intellectual property (IP) income (2 points) and a higher level of workforce rebalancing charges (1 point), offset by continued focus on efficiency resulting in lower spending (3 points). Total operating (non-GAAP) expense and other (income) decreased 0.4 percent year to year, driven primarily by the same factors.
Pre-tax income from continuing operations of $11.3 billion decreased 0.5 percent and the pre-tax margin was 14.3 percent, a decrease of 0.2 points versus 2017. The continuing operations effective tax rate for 2018 was 23.1 percent, including charges of $2.0 billion associated with U.S. tax reform. This is compared to an effective tax rate of 49.5 percent in 2017 which included a $5.5 billion charge associated with U.S. tax reform. Without these impacts, the continuing operations tax rate for 2018 would have been 5.4 percent, compared to a 2017 rate of 1.5 percent. Net income of $8.7 billion increased 51.7 percent year to year as a result of the lower tax reform charges in 2018. Operating (non-GAAP) pre-tax income from continuing operations of $13.7 billion was flat year to year and the operating (non-GAAP) pre-tax margin from continuing operations decreased 0.1 points to 17.3 percent. Operating (non-GAAP) income from continuing operations of $12.7 billion decreased 1.2 percent with an operating (non-GAAP) income margin from continuing operations of 15.9 percent, down 0.3 points year to year. The operating (non-GAAP) effective tax rate from continuing operations in 2018 was 7.9 percent, compared to 6.8 percent in the prior year.
Diluted earnings per share from continuing operations of $9.51 in 2018 increased 54.9 percent year to year, which included lower year-to-year charges associated with U.S. tax reform. Operating (non-GAAP) diluted earnings per share of $13.81 increased 1.1 percent versus 2017. In 2018, the company repurchased 32.9 million shares of its common stock at a cost of $4.4 billion and had $3.3 billion remaining in the current share repurchase authorization at December 31, 2018.
At December 31, 2018, the balance sheet remains strong and the company continues to be committed to maintaining a strong investment grade rating. Cash, restricted cash and marketable securities at December 31, 2018 were $12.2 billion, a decrease of $0.6 billion from December 31, 2017. Key drivers in the balance sheet and total cash flows were:
Total assets decreased $2.0 billion (increased $1.2 billion adjusted for currency) from December 31, 2017 driven by:
• A decline in receivables of $1.6 billion ($0.6 billion adjusted for currency) driven by a decline in trade receivables of $1.5 billion, and
• A decrease in net intangibles and goodwill of $1.2 billion ($0.6 billion adjusted for currency) resulting from currency impacts and intangibles amortization; partially offset by
• An increase in deferred costs of $1.0 billion ($1.2 billion adjusted for currency) driven primarily by capitalized sales commissions costs due to the adoption of the new revenue standard.
Total liabilities decreased $1.2 billion (increased $1.3 billion adjusted for currency) from December 31, 2017 driven by:
• Decreases in total debt ($1.0 billion), deferred income ($0.7 billion) and compensation and benefits ($0.5 billion); partially offset by
• Increases in taxes ($1.1 billion).
Total equity of $16.9 billion decreased $0.8 billion from December 31, 2017 as a result of:
• Decreases from dividends ($5.7 billion) and treasury stock ($4.6 billion) primarily due to share repurchases; partially offset by
• Increases from net income ($8.7 billion) and the transition adjustment related to the adoption of the new revenue standard ($0.6 billion).
The company generated $15.2 billion in cash flow provided by operating activities, a decrease of $1.5 billion compared to 2017, driven primarily by a decrease in cash provided by financing receivables ($0.8 billion), a decrease in cash sourced from sales cycle working capital ($0.2 billion) and an increase in cash income tax payments ($0.1 billion). Net cash used in investing activities of $4.9 billion was $2.2 billion lower than the prior year, primarily driven by decreases in cash used for net non-operating receivables ($1.5 billion) and lower net purchases of marketable securities and other investments ($0.5 billion). Net cash used in financing activities of $10.5 billion increased $4.1 billion compared to 2017, driven primarily by a decrease in net cash sourced from debt transactions ($3.7 billion), with a lower level of issuances and a higher level of maturities in the current year.
In January 2019, the company disclosed that it is expecting GAAP earnings per share from continuing operations of at least $12.45 and operating (non-GAAP) earnings of at least $13.90 per diluted share for 2019. The company expects free cash flow to be approximately $12 billion in 2019. Free cash flow realization is expected to be approximately 100 percent of GAAP net income. Refer to page 61 in the Liquidity and Capital Resources section for additional information on this non-GAAP measure. Refer to the Looking Forward section on pages 59 and 60 for additional information on the company’s expectations.
22 Management Discussion International Business Machines Corporation and Subsidiary Companies
DESCRIPTION OF BUSINESS Please refer to IBM’s Annual Report on Form 10-K filed with the SEC on February 26, 2019 for Item 1A. entitled “Risk Factors.”
The company creates value for clients by providing integrated solutions and products that leverage: data, information technology, deep expertise in industries and business processes, with trust and security and a broad ecosystem of partners and alliances. IBM solutions typically create value by enabling new capabilities for clients that transform their businesses and help them engage with their customers and employees in new ways. These solutions draw from an industry-leading portfolio of consulting and IT implementation services, cloud, digital and cognitive offerings, and enterprise systems and software which are all bolstered by one of the world’s leading research organizations.
IBM Strategy IBM’s strategy is wholly focused on the needs of its clients. IBM is a technology company, but first and foremost it is an enterprise company. IBM serves enterprises of all sizes, and IBM’s longest- standing clients are leaders in their industries—the world’s leading financial services institutions, airlines, manufacturers, consumer goods and retail companies. IBM’s mission is to help its clients transform their companies and lead in their industries.
One of the biggest priorities for IBM clients is to derive competitive advantage through insights and the latest digital technologies. Better insight about the wants and needs of their customers will help them distinguish themselves in the marketplace. Data-driven insight will also influence how they design and produce their own products, as well as help them identify opportunities in new markets.
However, most companies are harnessing only a small percent of the valuable data they collect. As IBM clients embark on the next chapter of their digital journey, the proper collection, use, safeguarding and management of data is of paramount importance. Choosing the right digital technologies to analyze the data is also necessary.
IBM helps clients harness the power of their data through technologies like AI, analytics and blockchain; on a hybrid cloud that connects data across traditional and new environments; with services that put a client’s data and insight to use in and for their business. Underpinning all of this, IBM safeguards client data with world-class technologies and approaches to security.
By reinventing themselves digitally around insight, clients become what IBM calls Cognitive Enterprises.
What IBM Brings to Clients Businesses are choosing IBM because they want to partner with a company that can uniquely integrate three core capabilities:
1. They want the most innovative technology, like AI, blockchain, cybersecurity and quantum delivered in a hybrid cloud environment.
2. They want industry expertise—from a partner that deeply understands their industry and can apply innovation to their business processes to drive transformation and competitive advantage.
3. And, finally, they want a total commitment to trust and security. Clients want to partner with a company that will protect their valuable data and insights, and one that develops and deploys new innovations with a commitment to do so responsibly.
IBM is unique in that it can integrate all three core capabilities for clients.
Innovative Technology IBM has a long history of bringing innovative technology to the world. For 26 years, IBM has led the world in U.S. patents; six IBMers are Nobel Laureates; and IBM engineers have developed innumerable first-of-its-kind products and services. Current examples of IBM’s innovative technology include:
• Analytics and AI: IBM’s long-standing leadership in managing and extracting insights from data starts with a portfolio of analytics and database offerings. A few years ago, IBM brought AI into the mainstream with the Watson platform, which to date has been the foundation of many Enterprise AI implementations in production. Recently, IBM augmented its Watson platform with a set of AI tools that enable clients to trace the origins of the data their AI models use, explain what is behind their recommendations and ensure that bias has not crept into results. These innovations are making AI more consumable by everyday users—not just data scientists.
• Security: Businesses built around data require an unparalleled level of data security. IBM is the leader in information security for enterprises—with leadership in both security software and services. Security is embedded inside all of IBM’s products and services. For example, IBM Z offers pervasive security by building data encryption directly in its computing processor. In addition, IBM’s services businesses are world class in embedding security into the solutions they build and run for IBM clients.
• Blockchain is an exciting technology that is just beginning to transform business processes. IBM’s platform has been rated number one by leading analyst firms such as Juniper Research and Everest Group. Blockchain technology enables multiple parties to conduct business with each other on a single, unified distributed system, eliminating the costly and time-consuming hand-offs of fragmented systems. IBM is deploying blockchain technology with clients to transform how global trade is transacted, how food safety is tracked and how supply chains are managed.
23Management Discussion International Business Machines Corporation and Subsidiary Companies
• Cloud: Enterprise clients are in the very early stages of the move to cloud. IBM estimates that only 20 percent of workloads have moved to the cloud—with work ahead for the remaining 80 percent. The first part was to move business workloads that exist as a layer over core processes. The hard part is ahead: moving the mission- critical systems that run banking, retail, telecom and other industries. Some of these workloads will remain in traditional IT systems, some will move to a private cloud inside the safety of a client’s firewall, others will move to public clouds, and some will surge between all of these. Wherever a workload may reside, it will need to share its data across environments. All of this requires an approach that is open, highly interoperable between environments, and even interoperable between different public clouds. This is what IBM has long called hybrid cloud—and this describes the solution for the 80 percent of the workloads that is to come. With in-depth experience across all three environments, IBM brings the strongest hybrid cloud solution to the market for enterprises—which will be strengthened through the acquisition of Red Hat.
Industry Expertise Changing a business requires in-depth understanding of how a business works and how technology can make it work differently.
IBM brings both industry expertise and innovative technology to clients through the IBM services and products businesses. This combination makes IBM unique and essential.
A few examples of this capability are highlighted below:
• Global Business Services: the IBM GBS business is one of the world’s largest professional services businesses. Its mission is to help clients along the journey to becoming a Cognitive Enterprise.
• Global Technology Services: the IBM GTS business runs some of the world’s largest data centers—and thereby some of the world’s most mission-critical workflows and franchises. GTS helps clients along their journey to the hybrid cloud—leveraging the best of their existing systems in the context of the regulatory, security and workflow of their industry.
• Industry and Domain-Specific Solutions: augmenting IBM’s services businesses are software and solutions designed for specific industries and domains. For example:
Health: IBM has become a leader in applying advanced digital technologies to healthcare, including the application of AI and data analytics to the diagnosis and treatment of patients, bringing smart decisions to Health Care payers, and helping Life Sciences companies develop innovative products and services.
Financial Services: IBM is a leading provider in the Financial Services industry; with IBM’s Promontory Financial Group, a leading advisor in Financial Regulation and Compliance, IBM offers an advanced set of solutions for managing Risk and Compliance, a critical workflow in the Financial Services industry.
Trust and Security Data and AI—together, they are both the opportunity and the issue of current times. They can make the world a better, healthier and more productive place; but only if businesses and consumers trust the companies putting data and AI to work.
IBM is a 107-year old business—and the reason it has been successful for so long is because it has earned the trust of its clients. IBM has not only followed guidelines around the responsible handling of data and the stewardship of new technology, but created them, published them, and invited others to adopt similar commitments. IBM’s principles make clear that:
• The purpose of new technologies is to augment—not replace—human expertise;
• Data and insights derived from AI belong to their owners and creators (not their IT partners); and,
• New technologies must be transparent and explainable.
There are many companies in the IT industry who bring technology products to the marketplace. Many bring technology services to the marketplace. A few companies do both, but no one can do it as well as IBM when it comes to meeting the needs of clients. By bringing together technology and workflow, combining it with industry expertise, innovation and deployment, IBM helps clients and industries truly transform themselves.
This is what truly sets IBM apart.
Business Model The company’s business model is built to support two principal goals: helping enterprise clients to move from one era to the next by bringing together innovative technology and industry expertise, and providing long-term value to shareholders. The business model has been developed over time through strategic investments in capabilities and technologies that have long-term growth and profitability prospects based on the value they deliver to clients.
The company’s global capabilities include services, software, systems, fundamental research and related financing. The broad mix of businesses and capabilities are combined to provide integrated solutions and platforms to the company’s clients.
The business model is dynamic, adapting to the continuously changing industry and economic environment, including the company’s transformation into cloud and as-a-Service delivery models. The company continues to strengthen its position through strategic organic investments and acquisitions in higher- value areas, broadening its industry expertise and integrating AI into more of what the company offers. In addition, the company is transforming into a more agile enterprise to drive innovation and speed, as well as helping to drive productivity, which supports investments for participation in markets with significant
24 Management Discussion International Business Machines Corporation and Subsidiary Companies
long-term opportunity. The company also regularly evaluates its portfolio and proactively maximizes shareholder value of non- strategic assets by bringing products to end of life, engaging in IP partnerships or executing divestitures.
This business model, supported by the company’s financial model, has enabled the company to deliver strong earnings, cash flows and returns to shareholders over the long term.
Business Segments and Capabilities The company’s major operations consist of five business segments: Cognitive Solutions, Global Business Services, Technology Services & Cloud Platforms, Systems and Global Financing.
Cognitive Solutions comprises a broad portfolio of primarily software capabilities that help IBM’s clients to identify actionable new insights and inform decision-making for competitive advantage. Leveraging IBM’s research, technology and industry expertise, this business delivers a full spectrum of capabilities, from descriptive, predictive and prescriptive analytics to artificial intelligence. Cognitive Solutions includes Watson, the first enterprise AI platform that specializes in driving value and knowledge from the 80 percent of the world’s data that sits behind company firewalls. It enables businesses to reimagine their workflows across a variety of industries and professions and gives organizations complete control of their insights, data, training and IP.
Additionally, Cognitive Solutions includes the new Watson OpenScale technology—a first of a kind, open technology platform that addresses key challenges of AI adoption. It enables companies to manage AI transparently throughout the full AI lifecycle, irrespective of where their AI applications were built or in which environment they currently run.
IBM’s solutions are provided through the most contemporary delivery methods including through cloud environments and as-a-Service models. Cognitive Solutions consists of Solutions Software and Transaction Processing Software.
Cognitive Solutions Capabilities Solutions Software: provides the basis for many of the company’s strategic areas. IBM has established the world’s deepest portfolio of enterprise AI, including analytics and data management platforms, cloud data services, talent management solutions, and solutions tailored by industry. Watson Platform, Watson Health and Watson Internet of Things (IoT) are certain capabilities included in Solutions Software. IBM’s world-class security platform weaves in AI to deliver integrated security intelligence across clients’ entire operations, including their cloud, applications, networks and data, helping them to prevent, detect and remediate potential threats.
Transaction Processing Software: includes software that primarily runs mission-critical systems in industries such as banking, airlines and retail.
Global Business Services (GBS) provides clients with consulting, application management and business process services. These professional services deliver value and innovation to clients through solutions which leverage industry, technology and business strategy and process expertise. GBS is the digital reinvention partner for IBM clients, combining industry knowledge, functional expertise, and applications with the power of business design and cognitive and cloud technologies. The full portfolio of GBS services is backed by its globally integrated delivery network and integration with technologies, solutions and services from IBM units including IBM Watson, IBM Cloud, IBM Research, and Global Technology Services.
In 2018, focused on digital reinvention, GBS assisted clients on their journeys to becoming Cognitive Enterprises, helping them engage their customers with new digital value propositions, transform workflows using AI, and build hybrid, open cloud infrastructures. This was delivered by the operating model rolled out in 2017—Digital Strategy and iX, Cognitive Process Transformation and Cloud Application Innovation, cross industry and globally.
GBS Capabilities Consulting: provides business consulting services focused on bringing to market solutions that help clients shape their digital blueprints and customer experiences, define their cognitive operating models, unlock the potential in all data to improve decision-making, set their next-generation talent strategies and create new technology architectures in a cloud-centric world.
Application Management: delivers system integration, application management, maintenance and support services for packaged software, as well as custom and legacy applications. Value is delivered through advanced capabilities in areas such as security and privacy, application testing and modernization, cloud application migration and automation.
Global Process Services (GPS): delivers finance, procurement, talent and engagement, and industry-specific business process outsourcing services. These services deliver improved business results to clients through a consult-to-operate model which includes the strategic change and/or operation of the client’s processes, applications and infrastructure. GBS is redefining process services for both growth and efficiency through the application of the power of cognitive technologies like Watson, as well as the IoT, blockchain and deep analytics.
Technology Services & Cloud Platforms (TS&CP) provides compre hensive IT infrastructure and platform services that create business value for clients. Clients gain access to leading- edge, high-quality services, flexibility and economic value. This is enabled through leverage of insights drawn from IBM’s decades of experience across thousands of engagements, the skills of practitioners, advanced technologies, applied innovation from IBM Research and global scale.
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TS&CP Capabilities Infrastructure Services: delivers a portfolio of project services, managed and outsourcing services, and cloud-delivered services focused on clients’ enterprise IT infrastructure environments to enable digital transformation and deliver improved quality, flexibility and economic value. The portfolio includes a comprehensive set of hybrid cloud services and solutions to assist enterprise clients in building and running contemporary IT environments. These offerings integrate long-standing expertise in service management and technology with the ability to utilize the power of new technologies, drawn from across IBM’s businesses and ecosystem partners. The portfolio is built using the IBM Services Platform with Watson, designed to augment human intelligence with cognitive technologies, and addresses hybrid cloud, digital workplace, business resiliency, network, managed applications, cloud and security. The company’s capabilities, including IBM Cloud, cognitive computing and hybrid cloud implementation, provide high-performance, end-to-end innovation and an improved ability for clients to achieve business objectives.
Technical Support Services: delivers comprehensive support services to maintain and improve the availability of clients’ IT infrastructures. These offerings include maintenance for IBM products and other technology platforms, as well as open source and vendor software and solution support, drawing on innovative technologies and leveraging the IBM Services Platform with Watson capabilities.
Integration Software: delivers industry-leading hybrid cloud solutions that empower clients to achieve rapid innovation, hybrid integration and process transformation with choice and consistency across public, dedicated and local cloud environments, leveraging the IBM Platform-as-a-Service solution. Integration Software offerings and capabilities help clients address the digital imperatives to create, connect and optimize their applications, data and infrastructure on their journey to become cognitive businesses.
Systems provides clients with innovative infrastructure platforms to help meet the new requirements of hybrid cloud and enterprise AI workloads. More than one-third of Systems Hardware’s server and storage sales transactions are through the company’s business partners, with the balance direct to end-user clients. IBM Systems also designs advanced semiconductor and systems technology in collaboration with IBM Research, primarily for use in the company’s systems.
Systems Capabilities Systems Hardware: includes IBM’s servers: IBM Z, Power Systems and Storage Systems.
Servers: a range of high-performance systems designed to address computing capacity, security and performance needs of businesses, hyperscale cloud service providers and scientific computing organizations. The portfolio includes IBM Z, a trusted enterprise platform for integrating data, transactions and insight, and Power Systems, a system designed from the ground up for big data and enterprise AI, optimized for hybrid cloud and Linux, and delivering open innovation with OpenPOWER.
Storage Systems: data storage products and solutions that allow clients to retain and manage rapidly growing, complex volumes of digital information and to fuel data-centric cognitive applications. These solutions address critical client requirements for information retention and archiving, security, compliance and storage optimization, including data deduplication, availability and virtualization. The portfolio consists of a broad range of flash storage, disk and tape storage solutions.
Operating Systems Software: IBM Z operating system environments include z/OS, a security-rich, high-performance enterprise operating system, as well as Linux. Power Systems offers a choice of AIX, IBM i or Linux operating systems. These operating systems leverage POWER architecture to deliver secure, reliable and high performing enterprise-class workloads across a breadth of server offerings.
Global Financing encompasses two primary businesses: financing, primarily conducted through IBM Credit LLC (IBM Credit), and remanufacturing and remarketing. IBM Credit is a wholly owned subsidiary of IBM that accesses the capital markets directly. IBM Credit, through its financing solutions, facilitates IBM clients’ acquisition of information technology systems, software and services in the areas where the company has expertise. The financing arrangements are predominantly for products or services that are critical to the end users’ business operations. The company conducts a comprehensive credit evaluation of its clients prior to extending financing. As a captive financier, Global Financing has the benefit of both deep knowledge of its client base and a clear insight into the products and services financed. These factors allow the business to effectively manage two of the major risks associated with financing, credit and residual value, while generating strong returns on equity. Global Financing also maintains a long-term partnership with the company’s clients through various stages of the IT asset life cycle—from initial purchase and technology upgrades to asset disposition decisions.
Global Financing Capabilities Client Financing: lease, installment payment plan and loan financing to end users and internal clients for terms up to seven years. Assets financed are primarily new and used IT hardware, software and services where the company has expertise. Internal financing is predominantly in support of Technology Services & Cloud Platforms’ long-term client service contracts. All internal financing arrangements are at arm’s-length rates and are based upon market conditions.
Commercial Financing: short-term working capital financing to suppliers, distributors and resellers of IBM and Original Equipment Manufacturer (OEM) products and services. The OEM portion will begin winding down starting in the second quarter of 2019 and continuing throughout the calendar year. Commercial Financing also includes internal activity where Global Financing factors a selected portion of the company’s accounts receivable primarily for cash management purposes, at arm’s-length rates.
26 Management Discussion International Business Machines Corporation and Subsidiary Companies
Remanufacturing and Remarketing: assets include used equipment returned from lease transactions, or used and surplus equipment acquired internally or externally. These assets may be refurbished or upgraded, and sold or leased to new or existing clients both externally or internally. Externally remarketed equipment revenue represents sales or leases to clients and resellers. Internally remarketed equipment revenue primarily represents used equipment that is sold internally to Systems and Technology Services & Cloud Platforms. Systems may also sell the equipment that it purchases from Global Financing to external clients.
IBM Worldwide Organizations The following worldwide organizations play key roles in IBM’s delivery of value to its clients:
• Global Markets
• Research, Development and Intellectual Property
Global Markets IBM has a global presence, operating in more than 175 countries with a broad-based geographic distribution of revenue. The company’s Global Markets organization manages IBM’s global footprint, working closely with dedicated country-based operating units to serve clients locally. These country teams have client relationship managers who lead integrated teams of consultants, solution specialists and delivery professionals to enable clients’ growth and innovation.
By complementing local expertise with global experience and digital capabilities, IBM builds deep and broad-based client relationships. This local management focus fosters speed in supporting clients, addressing new markets and making investments in emerging opportunities. The Global Markets organization serves clients with expertise in their industry as well as through the products and services that IBM and partners supply. IBM continues to expand its reach to new and existing clients through digital marketplaces, digital sales and local Business Partner resources.
Research, Development and Intellectual Property IBM’s research and development (R&D) operations differentiate the company from its competitors. IBM annually invests approximately 7 percent of total revenue for R&D, focusing on high-growth, high-value opportunities. IBM Research works with clients and the company’s business units through global labs on near-term and mid-term innovations. It delivers many new technologies to IBM’s portfolio every year and helps clients address their most difficult challenges. IBM Research scientists are conducting pioneering work in artificial intelligence, quantum computing, blockchain, security, cloud, nanotechnology, silicon and post-silicon computing architectures and more—applying these technologies across industries including financial services, healthcare, blockchain and IoT.
In 2018, for the 26th consecutive year, IBM was awarded more U.S. patents than any other company. IBM’s 9,100 patents awarded in 2018 represent a diverse range of inventions in strategic growth areas for the company, including more than 3,000 patents related to work in artificial intelligence, cloud, cybersecurity and quantum computing.
The company actively continues to seek IP protection for its innovations, while increasing emphasis on other initiatives designed to leverage its IP leadership. Some of IBM’s technological breakthroughs are used exclusively in IBM products, while others are licensed and may be used in IBM products and/or the products of the licensee. As part of its business model, the company licenses certain of its intellectual property assets, which constitute high-value technology, but may be applicable in more mature markets. The licensee drives the future development of the IP and ultimately expands the customer base. This generates IP income for the company both upon licensing, and with any ongoing royalty arrangements between it and the licensee. While the company’s various proprietary IP rights are important to its success, IBM believes its business as a whole is not materially dependent on any particular patent or license, or any particular group of patents or licenses. IBM owns or is licensed under a number of patents, which vary in duration, relating to its products.
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YEAR IN REVIEW Results of Continuing Operations Segment Details The following is an analysis of the 2018 versus 2017 reportable segment results. The table below presents each reportable segment’s external revenue and gross margin results. Segment pre-tax income includes transactions between segments that are intended to reflect an arm’s-length transfer price and excludes certain unallocated corporate items.
($ in millions)
For the year ended December 31: 2018 2017
Yr.-to-Yr. Percent/
Margin Change
Yr.-to-Yr. Percent Change
Adjusted for Currency
Revenue Cognitive Solutions $18,481 $18,453 0.2% (0.4)%
Gross margin 77.5% 78.6%* (1.1) pts. Global Business Services 16,817 16,348 2.9% 2.0%
Gross margin 26.7% 24.9%* 1.7 pts. Technology Services & Cloud Platforms 34,462 34,277 0.5% (0.1)%
Gross margin 40.5% 40.3%* 0.2 pts. Systems 8,034 8,194 (2.0)% (2.3)%
Gross margin 49.8% 53.2%* (3.4) pts. Global Financing 1,590 1,696 (6.3)% (6.5)%
Gross margin 29.1% 29.3% (0.2) pts. Other 207 171 21.0% 19.9%
Gross margin (140.7)% (173.9)%* 33.2 pts. Total consolidated revenue $79,591 $79,139 0.6% 0.0%
Total consolidated gross profit $36,936 $36,943* 0.0% Total consolidated gross margin 46.4% 46.7%* (0.3) pts.
Non-operating adjustments Amortization of acquired intangible assets 372 449 (17.2)% Retirement-related costs/(income) — —* —%
Operating (non-GAAP) gross profit $37,307 $37,392* (0.2)% Operating (non-GAAP) gross margin 46.9% 47.2%* (0.4) pts.
* Recast to reflect adoption of the FASB guidance on presentation of net benefit cost.
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Cognitive Solutions
($ in millions)
For the year ended December 31: 2018 2017
Yr.-to-Yr. Percent Change
Yr.-to-Yr. Percent Change
Adjusted for Currency
Cognitive Solutions external revenue $18,481 $18,453 0.2% (0.4)% Solutions Software $12,903 $12,806 0.8% 0.3% Transaction Processing Software 5,578 5,647 (1.2) (1.9)
Cognitive Solutions revenue of $18,481 million was essentially flat as reported and adjusted for currency in 2018 compared to the prior year. On an as-reported and constant currency basis, there was growth in Solutions Software, while Transaction Processing Software declined year to year.
Solutions Software revenue of $12,903 million grew 0.8 percent as reported (essentially flat adjusted for currency) compared to the prior year, led by the company’s analytics and security platforms. Within analytics, the company had broad-based growth across the Db2 portfolio, including analytics appliances and increasing demand for IBM Cloud Private for Data, which accelerated in the fourth quarter of 2018. The company continued to have solid demand for integrated security and services solutions with strong growth in security intelligence and orchestration offerings. Across the industry verticals, Watson Health and Watson Media & Weather grew revenue as reported and adjusted for currency compared to the prior year. Certain Solutions Software offerings which address horizontal domains, specifically collaboration, commerce and talent, have been impacted by secular shifts in the market. In December 2018, the company announced its intent to divest its collaboration and on-premise marketing and commerce products to HCL. This transaction is expected to close by mid-year 2019.
Transaction Processing Software revenue of $5,578 million decreased 1.2 percent as reported (2 percent adjusted for currency) in 2018 compared to the prior year. There was improved revenue performance sequentially in the fourth quarter 2018 versus the third quarter 2018 reflecting clients’
commitment to the company’s platform for the long-term and the value it provides in managing mission-critical workloads and predictability in spending.
Cognitive Solutions total strategic imperatives revenue of $12.3 billion grew 3 percent as reported and 2 percent adjusted for currency year to year. Cloud revenue of $2.6 billion grew 2 percent as reported and adjusted for currency, with an as-a-Service exit run rate of $2.0 billion.
($ in millions)
For the year ended December 31: 2018 2017*
Yr.-to-Yr. Percent/
Margin Change
Cognitive Solutions External gross profit $14,319 $14,503 (1.3)% External gross profit
margin 77.5% 78.6% (1.1) pts. Pre-tax income $ 7,154 $ 6,795 5.3% Pre-tax margin 33.8% 32.2% 1.5 pts.
* Recast to reflect adoption of the FASB guidance on presentation of net benefit cost.
Cognitive Solutions gross profit margin decreased 1.1 points to 77.5 percent in 2018 compared to the prior year. The gross profit margin decline was driven by an increasing mix toward SaaS and increased royalty cost associated with IP licensing agreements in 2018 compared to the prior year.
Pre-tax income of $7,154 million increased 5.3 percent compared to the prior year with a pre-tax margin improvement of 1.5 points to 33.8 percent, primarily driven by operational efficiencies and mix.
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Global Busi
