# Management Discussion

## Results of Operations

The past year was a difficult one for the information-handling industry in North America. An uncertain economy and sluggish capital spending by our customers in the U.S. caused an adverse impact on IBM's performance for the full year 1985. Despite this, IBM achieved record worldwide shipments, introduced major new products and, in addition, had excellent financial results from its operations outside the U.S.

Worldwide gross income in 1985 totaled $50.1 billion, an increase of 9.0 percent over 1984. Non-U.S. operations showed strong business growth, with gross income increasing by 16.0 percent to $21.5 billion. Revenue growth for U.S. operations was a modest 4.2 percent, with 1985 gross income reaching $28.5 billion.

Early in 1985 our customers paused to evaluate the advisability of installing IBM 308X processors or waiting for the availability of the new IBM 3090 processors. Volume shipments of the 3090 model 200 began in the third quarter. The high quality of this product, brought about by engineering and manufacturing excellence, contributed to the company's ability to deliver it earlier than expected.

Moderation in the strength of the dollar began to be reflected in the company's financial results in the last two quarters of the year. Although full-year results were still affected unfavorably by currency fluctuations, the effect in the second half of the year was positive.

Worldwide net earnings were essentially flat year-to-year, reflecting the company's resilient response to the adverse North American economic conditions. Worldwide net earnings of $6,555 million were 0.4 percent below the 1984 record of $6,582 million.

Gross income from sales was $34.4 billion, an increase of 15.6 percent over 1984. Sales gross income includes sales to customers who have exercised their option to purchase installed rental equipment. Sales gross income, excluding sales of installed equipment, increased 24.6 percent over 1984, reflecting the purchase of products shipped to our customers during 1985.

Conversely, gross income from rentals declined 37.4 percent to $4.1 billion. Rental gross income was 8.2 percent of total gross income in 1985, down from 14.3 percent a year ago.

Gross income from services continued to grow in 1985 and increased as a percentage of total gross income. Revenue from services reached $11.5 billion in 1985, a 20.1 percent increase over the preceding year. The major increase came from program products which increased 30.3 percent to $4.2 billion. Maintenance services increased 15.9 percent over 1984 to $6.1 billion.

Information on industry segments and classes of similar products or services is presented on page 43. Sales of peripheral equipment showed a significant improvement over 1984, increasing 28.0 percent. This improvement, evident in both the U.S. and non-U.S. operations, was primarily the result of strong growth in shipments of magnetic tape subsystems and direct access storage devices. Total processor sales showed only modest worldwide growth and declined in the U.S. Sales of office systems/workstations increased by 15.1 percent, mostly in non-U.S. operations.

Worldwide gross profit was $29.0 billion, an increase of 7.2 percent over 1984.

Efficiencies derived from the major investments over the past several years in plant capacity and new machinery and equipment continue to result in improved manufacturing cost. Despite this continuing improvement in productivity, gross profit margins declined 1.0 percentage point to 57.8 percent. There are two basic reasons for this decline.

Gross profit margins on low-priced, high-volume products are less than on high-end processors. As relatively more of our revenues are derived from sales of these low-priced, high-volume products, the total gross profit margin is reduced.

In addition, gross profit margins from rentals and from installed rental equipment converted to purchase are higher than gross profit margins on sales of new equipment. Consequently, as IBM's business shifts more to outright sales and away from rental and conversion income, a second downward pressure is brought to bear on gross profit margins. This transition is largely behind us now, and the downward pressure on the margin from this will be less severe in the future.

In 1985 gross profit from services increased 30.2 percent to $6.8 billion. Program products were the primary contributor to this increase.

Selling, general and administrative expense as a ratio to gross income increased slightly in 1985 to 26.0 percent from 25.2 percent in 1984. Rigorous expense and resource controls were implemented throughout the business in 1985; these will continue in 1986 as the company maintains a focus on efficiency and productivity.

Investments in research, development and engineering have resulted in a strong and competitive product line. This investment amounted to $4.7 billion in 1985, an increase of 12.5 percent over 1984.

Other income, which is principally interest, increased 4.0 percent to $832 million.

IBM's overall business health is sound, and the company is well positioned to share in the continued growth of the information-handling industry.

**IBM Consolidated Gross Income:**

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