# Management Discussion

## Financial Condition

During 1985, IBM maintained its strong financial position while continuing to make significant investments in research, development and engineering, and plant and other property. Over the last five years, these investments totaled $38.3 billion.

In 1985, $4.7 billion were directed to research, development and engineering. These expenditures sustained IBM's efforts to maintain its technical leadership, ensured a continuing flow of competitive products to the marketplace, and provided the company with the ability to pursue new growth opportunities.

Investments in plant and other property in 1985 amounted to $6.1 billion, an increase of 32.5 percent over 1984. These investments were made to ensure that IBM continues to reduce unit manufacturing costs, maintains industry leadership in quality and achieves its goal of being the industry's low-cost producer. A significant part of that investment includes IBM products used internally that have helped the company to improve productivity and efficiency in all areas of its business. Manufacturing capacity has also been added and modernized to provide efficient facilities for producing the growing shipment volumes of IBM's expanding product line.

In addition, IBM has continued its investment in program products. Part of this investment, $785 million in 1985, was capitalized and will be amortized over the revenue-producing lives of the products.

IBM's investment in finance subsidiaries and sales-type leases reflects the company's growing participation in financing products purchased by its customers. In 1985, customers financed approximately $5 billion in purchase value of IBM equipment through the IBM Credit Corporation and similar IBM activities around the world.

Two additional actions were taken in 1985 that affected IBM's investments and other assets. The company sold its $503 million of U.S. fixed-income securities, and increased its investment in Satellite Business Systems (SBS).

Investments were also made in joint ventures such as International MarketNet, Trintex and Nippon Information and Communication Corporation. Each of these joint ventures is designed to help capitalize on specific market opportunities.

As part of the ROLM Corporation acquisition, ROLM's Mil-Spec division was sold on June 28, 1985, to Loral Corporation.

IBM's working capital increased by $3.9 billion during the year. This increase was caused by a $2.4 billion growth in notes and accounts receivable, $2.0 billion in inventories, and $1.3 billion in cash and marketable securities. These increases were offset by a rise in current liabilities of $1.8 billion. The growth in accounts receivable was primarily caused by the substantial increase in shipments to customers during the fourth quarter. Inventory growth occurred in work in process, as continued stocking was required to satisfy demand for volume increases throughout the product line. In addition, shelf stock for high-volume products was increased as demand and the distribution system for these products expanded.

During 1985, $12.8 billion, or 82 percent of total funds provided, were generated from operations. These funds, coupled with an increase in long-term debt, were used to finance IBM's investments in the future. The company added $1,614 million to long-term debt from various new issues during 1985. Long-term obligations from prior years were reduced by $928 million, resulting in a net increase of $686 million in long-term debt. IBM's credit rating remains strong, and its long-term debt-to-equity ratio is 12.4 percent.

In 1985, the company continued open-market acquisition of shares to meet most requirements of IBM's stockholder and employee stock plans.

Deferred income taxes increased by $1.6 billion during 1985. This is attributable to tax timing differences related to sales-type leases, installment sales, depreciation, and the deferral of investment tax credits. In addition, one-time events that occurred in 1985 in conjunction with the acquisition of ROLM and SBS also served to reduce the company's current tax liability.

The accounting method for translating the majority of non-U.S. net assets into U.S. dollars requires such items to be translated at current exchange rates. The cumulative effect of this currency translation is included in the equity section of the consolidated statement of financial position as "translation adjustments."

The moderation in the strength of the U.S. dollar during 1985 caused a significant reduction in the "translation adjustments," from $2,948 million at year-end 1984 to $1,466 million at year-end 1985. This year-to-year change of $1,482 million is the result of valuing non-U.S. net assets at the relatively higher foreign currency exchange rates at year-end 1985, and is not a result of the operational performance of the company. The effect of the year-to-year change is to increase stockholders' equity.

Dividends of $2,703 million were paid during the year, up $166 million from 1984, or 78 percent.

During the year, management stressed improvements in all key areas of operations as well as asset management, while investing in areas promising the best possible growth for the future. Competition continues to be keen in all areas of the information-handling industry. Remaining competitive in product cost requires investment in new equipment and modern facilities as well as a low-cost, high-quality manufacturing process. Sustaining a broad, competitive product line requires expenditures in research, development and engineering, along with proper management controls to ensure an adequate return. These factors have been stressed in all IBM operating units with positive results.

IBM continues to manage its costs, expenses and other resources carefully. Product costs and expenses in 1985 reflect increases in productivity over the prior year, and this direction is expected to continue throughout 1986. Management remains optimistic about the future of IBM and the overall computer industry. The company's continuing investments in its business, coupled with the skills and loyalty of its employees, have positioned it for future growth.