INTERNATIONAL BUSINESS MACHINES CORP - 10-Q Quarterly Report

Back to GetFilings.com

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549

FORM 10 - Q

QUARTERLY REPORT
PURSUANT TO SECTION 13 or 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE QUARTER ENDED MARCH 31, 2003

1-2360
------
(Commission file number)

INTERNATIONAL BUSINESS MACHINES CORPORATION
-------------------------------------------
(Exact name of registrant as specified in its charter)

New York 13-0871985
-------- ----------
(State of incorporation) (IRS employer identification number)

Armonk, New York 10504
---------------- ------
(Address of principal executive offices) (Zip Code)

914-499-1900
------------
(Registrant's telephone number)

Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section l3 or l5(d) of the Securities Exchange Act of
1934 during the preceding l2 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes /X/ No / /

Indicate by check mark whether registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). Yes /X/ No / /

The registrant has 1,727,999,767 shares of common stock outstanding at
March 31, 2003.

INDEX

PART I - FINANCIAL INFORMATION

ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS

INTERNATIONAL BUSINESS MACHINES CORPORATION
AND SUBSIDIARY COMPANIES
CONSOLIDATED STATEMENT OF EARNINGS
(UNAUDITED)

(The accompanying notes are an integral part of the financial statements.)

-1-

INTERNATIONAL BUSINESS MACHINES CORPORATION
AND SUBSIDIARY COMPANIES
CONSOLIDATED STATEMENT OF EARNINGS - (CONTINUED)
(UNAUDITED)

* Does not total due to rounding.

(The accompanying notes are an integral part of the financial statements.)

-2-

INTERNATIONAL BUSINESS MACHINES CORPORATION
AND SUBSIDIARY COMPANIES
CONSOLIDATED STATEMENT OF FINANCIAL POSITION

ASSETS

(The accompanying notes are an integral part of the financial statements.)

-3-

INTERNATIONAL BUSINESS MACHINES CORPORATION
AND SUBSIDIARY COMPANIES
CONSOLIDATED STATEMENT OF FINANCIAL POSITION - (CONTINUED)

LIABILITIES AND STOCKHOLDERS' EQUITY

(The accompanying notes are an integral part of the financial statements.)

-4-

INTERNATIONAL BUSINESS MACHINES CORPORATION
AND SUBSIDIARY COMPANIES
CONSOLIDATED STATEMENT OF CASH FLOWS
FOR THE THREE MONTHS ENDED MARCH 31, (UNAUDITED)

* Reclassified to conform with 2003 presentation.

(The accompanying notes are an integral part of the financial statements.)

-5-

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. In the opinion of the management of International Business Machines
Corporation (the company), all adjustments, which are of a normal recurring
nature, necessary to a fair statement of the results for the unaudited
three-month periods have been made.

2. The company applies Accounting Principles Board (APB) Opinion No. 25,
"Accounting for Stock Issued to Employees," and related Interpretations in
accounting for its stock-based compensation plans. Accordingly, the company
records expense for employee stock compensation plans equal to the excess of the
market price of the underlying IBM shares at the date of grant over the exercise
price of the stock-related award, if any (known as the intrinsic value).
Generally, all employee stock options are issued with the exercise price equal
to the market price of the underlying shares at grant date and therefore, no
compensation expense is recorded. In addition, no compensation expense is
recorded for purchases under the Employee Stock Purchase Program (ESPP) in
accordance with APB No. 25. The intrinsic value of restricted stock units and
certain other stock-based compensation issued to employees as of the date of
grant is amortized to compensation expense over the vesting period. To the
extent there are performance criteria that could result in an employee receiving
more or less (including zero) shares than the number of units granted, the
unamortized liability is marked to market during the performance period based
upon the intrinsic value at the end of each quarter.

The following table summarizes the pro forma operating results of the
company had compensation cost for stock options granted and for employee
stock purchases under the ESPP been determined in accordance with the fair
value based method prescribed by Statement of Financial Accounting
Standards (SFAS) No. 123, "Accounting for Stock-Based Compensation".

-6-

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)

3. The following table summarizes Net Income plus gains and losses not
affecting retained earnings.

4. In January 2003, the FASB issued Interpretation No. 46 (FIN 46),
"Consolidation of Variable Interest Entities," which addresses consolidation by
business enterprises of variable interest entities that either: (1) do not have
sufficient equity investment at risk to permit the entity to finance its
activities without additional subordinated financial support, or (2) the equity
investors lack an essential characteristic of a controlling financial interest.
FIN 46 requires disclosure of Variable Interest Entities (VIEs) in financial
statements issued after January 31, 2003, if it is reasonably possible that as
of the transition date: (1) the company will be the primary beneficiary of an
existing VIE that will require consolidation or, (2) the company will hold a
significant variable interest in, or have significant involvement with, an
existing VIE. Pursuant to the transitional requirements of FIN 46, the company
will adopt the consolidation guidance applicable to existing VIEs as of the
reporting period beginning July 1, 2003. Any VIEs created after January 31,
2003, are immediately subject to the consolidation guidance of FIN 46. The
company does not have any entities that require disclosure or new consolidation
as a result of adopting the provisions of FIN 46.

In November 2002, the FASB issued Interpretation No. 45 (FIN 45),
"Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others," which addresses disclosures to
be made by a guarantor in its interim and annual financial statements about its
obligations under guarantees. FIN 45 also requires the recognition of a
liability by a guarantor at the inception of certain guarantees that are entered
into or modified after December 31, 2002. The company adopted the disclosure
requirements of FIN 45 in 2002 and applied the recognition and measurement
provisions for all material guarantees entered into or modified beginning
January 1, 2003. FIN 45 did not have a material impact on the company's
Consolidated Financial Statements. The future impact will depend upon whether
the

-7-

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)

company enters into or modifies any material guarantee arrangements. See note 9
on pages 15 and 16 for the company's required disclosure.

In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities." SFAS No. 146 supersedes Emerging
Issues Task Force (EITF) No. 94-3, "Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit An Activity (Including Certain
Costs Incurred in a Restructuring)," and requires that a liability for a cost
associated with an exit or disposal activity be recognized when the liability is
incurred. Such liabilities should be recorded at fair value and updated for any
changes in the fair value each period. The company adopted this statement
effective January 1, 2003, and its adoption did not have a material effect on
the Consolidated Financial Statements. Going forward, the impact of SFAS No. 146
on the company's Consolidated Financial Statements will depend upon the timing
of facts underlying any future exit or disposal activity.

In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations." SFAS No. 143 provides accounting and reporting guidance
for obligations associated with the retirement of long-lived assets that result
from the acquisition, construction or normal operations of a long-lived asset.
The standard was effective January 1, 2003 and its adoption did not have a
material effect on the Consolidated Financial Statements.

In April 2002, the Financial Accounting Standards Board (FASB) issued SFAS
No. 145, "Rescission of FASB Statement No. 4, 44 and 64, Amendment to FASB
Statement No. 13, and Technical Corrections," effective May 15, 2002. SFAS No.
145 eliminates the requirement that gains and losses from the extinguishment of
debt be aggregated and classified as an extraordinary item, net of tax, and
makes certain other technical corrections. SFAS No. 145 did not have a material
effect on the company's Consolidated Financial Statements.

In November 2002, the EITF reached a consensus on Issue No. 00-21,
"Accounting for Revenue Arrangements with Multiple Deliverables." This Issue
provides guidance on when and how to separate elements of an arrangement that
may involve the delivery or performance of multiple products, services and
rights to use assets into separate units of accounting. The guidance in the
consensus is effective for revenue arrangements entered into in fiscal periods
beginning after June 15, 2003. The company will adopt Issue No. 00-21 in the
quarter beginning July 1, 2003. The transition provision allows either
prospective application or a cumulative effect adjustment upon adoption. The
company is currently evaluating the impact of adopting this guidance.

-8-

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)

5. The changes in the carrying amount of goodwill, by external reporting
segment, for the quarter ended March 31, 2003, are as follows:

There were no goodwill impairment losses recorded during the quarter and
there was no goodwill written off as a result of divestitures during the
quarter.

The following schedule details the company's intangible asset balances by
major asset class:

(a) Other intangibles are primarily acquired proprietary and non-proprietary
business processes, methodologies and systems.

The net carrying amount of intangible assets increased $384 million during
the first quarter of 2003, primarily due to the acquisition of Rational Software
Corp. (Rational) offset by the amortization of existing intangible asset
balances.

The aggregate intangible amortization expense was $74 million and $40
million for the quarters ended March 31, 2003 and 2002, respectively.

-9-

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)

The future amortization expense for each of the five succeeding years
relating to intangible assets currently recorded in the Consolidated Statement
of Financial Position is estimated to be the following at March 31, 2003:

2003 (for Q2-Q4) $ 276 million
2004 $ 321 million
2005 $ 246 million
2006 $ 125 million
2007 $ 73 million

6. On February 21, 2003, the company purchased the outstanding stock of
Rational for $2,092 million in cash. Rational provides open, industry standard
tools, best practices and services for developing business applications and
building software products and systems. The Rational acquisition provides the
company with the ability to offer a complete development environment for
customers. The transaction was completed on February 21, 2003, from which time
the results of this acquisition were included in the company's Consolidated
Financial Statements. The company merged Rational's business operations and
employees into the IBM Software Group as a new division and brand.

The allocation of the purchase price for this acquisition as of the date of
acquisition is presented in the following table:

The acquisition was accounted for as a purchase transaction, and
accordingly, the assets and liabilities of the acquired entity were recorded at
their estimated fair values at the date of the acquisition. The primary items
that generated this goodwill are the value of the synergies between Rational and
IBM and the acquired assembled workforce, neither of which qualify as an
amortizable intangible asset. None of the goodwill is deductible for tax
purposes. The overall weighted-average life of the identified intangible assets
acquired in the purchase of Rational that are subject to amortization is 4.7
years. With the exception of goodwill, these identified

-10-

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)

intangible assets will be amortized on a straight-line basis over their useful
lives. Goodwill of $1,365 million has been assigned to the Software segment. The
company recorded a pretax charge of $9 million for in-process research and
development. This amount, which reflects the relative value and contribution of
the acquired research and development to the company's existing research or
product lines, was charged to research, development, and engineering expense on
the company's Consolidated Statement of Earnings.

As outlined above, the gross purchase price was $2,092 million. However, as
part of the transaction, IBM assumed cash and cash equivalents held in Rational
of $1,053 million, resulting in a net cash payment of $1,039 million. In
addition, the company assumed $500 million in outstanding convertible debt. The
convertible debt was subsequently called on March 26, 2003.

7. The tables on pages 44 through 46 of this Form 10-Q reflect the results of
the company's segments consistent with its management system used by the
company's chief operating decision maker. These results are not necessarily a
depiction that is in conformity with generally accepted accounting principles
(GAAP). For example, employee retirement plan costs are developed using
actuarial assumptions on a country-by-country basis and allocated to the
segments based on headcount. A different result could occur for any segment if
actuarial assumptions unique to each segment were used. Performance measurement
is based on income before income taxes (pre-tax income). These results are used,
in part, by management, both in evaluating the performance of, and in allocating
resources to, each of the segments.

8. During the second quarter of 2002, the company executed several actions in
its Microelectronics Division. The Microelectronics Division is within the
company's Technology segment. These actions are the result of the company's
announced intentions to refocus and direct its microelectronics business to the
high-end foundry, Application Specific Integrated Circuit (ASICs) and standard
products, while creating its Engineering and Technology Services Division. A
major part of the actions relate to a significant reduction in the company's
manufacturing capacity for aluminum technology.

In addition, the company rebalanced both its workforce and leased space
resources primarily in response to the recent decline in corporate spending on
technology-related services.

-11-

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)

The following table summarizes the significant components of these actions:

(Dollars in millions)

+ Principally represents currency translation adjustments and reclassification
of non-currrent to current.
* Recorded in Accounts payable and accruals on the Consolidated Statement of
Financial Position.
** Recorded in Other liabilities on the Consolidated Statement of Financial
Position.

(A) This amount is comprised of costs incurred to remove abandoned capital
assets and the remaining lease payments for leased equipment that was abandoned
in the second quarter of 2002. The company expects to pay the remaining removal
costs by June 30, 2003. The remaining lease payments will continue through 2005.

(B) The company is subject to certain noncancelable purchase commitments. As a
result of the decision to significantly reduce aluminum capacity, the company no
longer has a need for certain materials subject to these agreements. The
required future payments for materials no longer needed under these contracts
are expected to be paid through June 30, 2004.

(C) The workforce reductions represent 1,400 people of which approximately 96
percent left the company as of March 31, 2003. The non-current portion of the
liability relates to terminated employees who were granted annual payments to
supplement their income in certain countries. Depending on individual country
legal requirements, these required payments will continue until the former
employee begins receiving pension benefits or dies.

-12-

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)

(D) The space accruals are for ongoing obligations to pay rent for vacant space
that could not be sublet or space that was sublet at rates lower than the
committed lease arrangements. The length of these obligations varies by lease
with the longest extending through 2006.

(E) As part of the company's strategic realignment of its Microelectronics
business to exit the manufacture and sale of certain products and component
technologies, the company signed an agreement in the second quarter of 2002 to
sell its interconnect products operations in Endicott to Endicott Interconnect
Technologies, Inc. (EIT). As a result of this transaction, the company incurred
a $223 million loss on sale, primarily relating to the land, buildings,
machinery and equipment. The transaction closed in the fourth quarter of 2002.
The company entered into a limited supply agreement with EIT for future
products, and it will also lease back, at fair market value, rental rates
approximately one third of the Endicott campus' square footage for operations
outside the interconnect OEM business.

(F) As part of the strategic realignment of the company's Microelectronics
business, the company agreed to sell certain assets and liabilities comprising
its Mylex business to LSI Logic Corporation and the company sold part of its
wireless phone chipset operations to TriQuint Semiconductor, Inc. in June 2002.
The Mylex transaction was completed in August 2002. There was a loss of $74
million for the Mylex transaction and a realized gain of $11 million for the
chipset sale.

(G) The majority of the workforce reductions relate to the company's Global
Services business. The workforce reductions represent 14,213 people of which
approximately 94 percent left the company as of March 31, 2003. See C on page 12
for information on the non-current portion of the liability.

(H) The space accruals are for ongoing obligations to pay rent for vacant space
that could not be sublet or space that was sublet at rates lower than the
committed lease arrangements. This space relates primarily to workforce dynamics
in the Global Services business and the downturn in corporate technology
spending on services. The length of these obligations varies by lease with the
longest extending through 2009.

-13-

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)

During the fourth quarter of 2002, the company executed several actions
related to the company's acquisition of PricewaterhouseCoopers' (PwC) consulting
business. Specifically, the company rebalanced both its workforce and its leased
space resources. The following table summarizes the significant components of
these actions:

(Dollars in millions)

+ Principally represents currency translation adjustments, adjustments to
the purchase price allocation for the PwC consulting acquisition, and
reclassifications between current and non-current.
* Recorded in Accounts payable and accruals on the Consolidated Statement of
Financial Position.
** Recorded in Other liabilities on the Consolidated Statement of Financial
Position.

(A) The majority of the workforce reductions relates to the company's Global
Services business. The workforce reductions represent 4,744 people of which
approximately 80 percent left the company as of March 31, 2003. The company
expects that over 95 percent of the employees will leave by June 30, 2003. The
non-current workforce accrual relates to terminated employees in certain
countries outside the United States, for whom the company is required to make
annual payments to supplement their incomes. Depending on individual country
legal requirements, these required payments will continue until the former
employee begins receiving pension benefits or dies.

(B) The majority of the space accruals is for ongoing obligations to pay rent
for vacant space of PwC's consulting business that could not be sublet or space
that was sublet at rates lower than the committed lease arrangements. The length
of these obligations varies by lease with the longest extending through 2019.

-14-

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)

The following table provides the liability balances for the second-quarter
and fourth-quarter 2002 actions discussed above, the 2002 actions associated
with the hard disk drive (HDD) business for reductions in workforce,
manufacturing capacity and space, actions in 1999, and actions that took place
through 1993.

(a) Workforce accruals relate to terminated employees who were granted annual
payments to supplement their income in certain countries. Depending on
individual country legal requirements, these required payments will continue
until the former employee begins receiving pension benefits or dies.
(b) Space accruals are for ongoing obligations to pay rent for vacant space that
could not be sublet or space that was sublet at rates lower than the committed
lease arrangement. The length of these obligations varies by lease with the
longest extending through 2019.
(c) Other accruals are primarily the remaining liabilities associated with the
2002 actions and remaining liabilities associated with the HDD-related
restructuring in 2002.
(d) Principally represents reclassification of non-current to current and
currency translation adjustments.
* Recorded in Accounts payable and accruals on the Consolidated Statement of
Financial Position.
** Recorded in Other liabilities on the Consolidated Statement of Financial
Position.

9. The company has applied the disclosure provisions of FIN 45 to its
agreements that contain guarantee or indemnification clauses. These disclosure
provisions expand those required by FASB Statement No. 5, "Accounting for
Contingencies", by requiring a guarantor to disclose certain types of
guarantees, even if the likelihood of requiring the guarantor's performance is
remote. The following is a description of arrangements in which the company is
the guarantor.

The company is a party to a variety of agreements pursuant to which it may
be obligated to indemnify the other party with respect to certain matters.
Typically, these obligations arise in the context of contracts entered into by
the company, under which the company customarily agrees to hold the party
harmless against losses arising from a breach of representations and covenants
related to such matters as title to the assets sold, certain intellectual
property rights, specified environmental matters, and certain income taxes. In
each of these circumstances, payment by the company is conditioned on the other
party making an adverse claim pursuant to the procedures specified in the
particular contract, which procedures typically allow the company to challenge
the other party's claims. Further, the company's obligations under these
agreements may be limited in terms of time and/or amount, and in some instances,
the company may have recourse against third parties for certain payments made by
the company.

-15-

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)

It is not possible to predict the maximum potential amount of future
payments under these or similar agreements, due to the conditional nature of the
company's obligations and the unique facts and circumstances involved in each
particular agreement. Historically, payments made by the company under these
agreements did not have a material effect on the company's business, financial
condition or results of operations. The company believes that if it were to
incur a loss in any of these matters, such loss should not have a material
effect on the company's business, financial condition or results of operations.

In addition, the company guarantees certain loans and financial
commitments. The maximum potential future payment under these financial
guarantees was $104 million and $126 million at March 31, 2003 and December
31, 2002, respectively. These amounts include a limited guarantee of $67
million and $69 million associated with the company's loans receivable
securitization program at March 31, 2003 and December 31, 2002,
respectively.

Changes in the company's warranty liability balance are illustrated in the
following table:

Other commitments of the company include extended lines of credit, of which
the unused amounts were $3,455 million and $3,482 million at March 31, 2003 and
December 31, 2002, respectively. A portion of these amounts was available to the
company's business partners to support their working capital needs. In addition,
the company committed to provide future financing to its customers in connection
with customer purchase agreements for approximately $273 million and $288
million at March 31, 2003 and December 31, 2002, respectively.

10. Subsequent Events: On April 29, 2003, the company announced that the Board
of Directors approved an increase in the quarterly dividend of approximately 7
percent from $.15 to $.16 per common share. The dividend is payable June 10,
2003, to shareholders of record on May 9, 2003.

ITEM 2.

MANAGEMENT'S DISCUSSION AND ANALYSIS
OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION
FOR THE THREE MONTHS ENDED MARCH 31, 2003

The company generated $20.1 billion of revenue, $1.4 billion of net
earnings from continuing operations and $0.79 in earnings per diluted common
share from continuing operations in the first quarter of 2003 despite the
continued challenging economic environment and the heightened geopolitical
pressures. While the tough business environment resulted in some customer
deferrals of information technology (IT) decisions, the company expects to have
continued to gain market share in key segments.

-16-

For total operations, net income for the first quarter of 2003, including
discontinued operations, was $1.4 billion, (including a loss of $3 million for
discontinued operations) or $0.79 in earnings per diluted common share, compared
with $1.2 billion in net income including a net loss of $92 million for
discontinued operations, or $0.68 in earnings per diluted common share, in the
first quarter of 2002.

The following Results of Continuing Operations discussion does not include
the HDD business that the company sold to Hitachi, Ltd. on December 31, 2002.
The HDD business was accounted for as a discontinued operation under generally
accepted accounting principles.

RESULTS OF CONTINUING OPERATIONS

The amount of shares actually outstanding at March 31, 2003 was 1,728.0
million.

The weighted average number of common shares outstanding assuming dilution
was higher by 5.5 million in the first quarter of 2003 compared to the first
quarter of 2002, primarily as a result of the company's use of common shares to
fund a portion of its fourth quarter 2002 contribution to the (U.S.) IBM
Personal Pension Plan (PPP), partially offset by the company's share repurchase
program. The weighted average number of shares assuming dilution was 1,758.5
million in the first quarter of 2003 and 1,753.0 million for the first quarter
of 2002.

Throughout this report, the reference to constant currency is made so that
a segment can be viewed without the impacts of changing foreign currency
exchange rates and therefore facilitates a comparative view of business growth.
In the first quarter of 2003 the U.S. dollar generally weakened against other
currencies, so growth at constant currency exchange rates was lower than growth
at actual currency exchange rates.

Revenue for the three months ended March 31, 2003 increased 11.3 percent
from the same period last year (4 percent at constant currency). The growth in
revenue was primarily attributable to market share gains and recent acquisition
activity. These were partially offset by the company's exit of certain
Technology businesses, the impact of declining personal computer revenue driven
by price reductions and a decline in z900 mainframe revenue in advance of a new
product announcement in the second quarter of 2003.

-17-

RESULTS OF CONTINUING OPERATIONS - (CONTINUED)

In the Americas, first-quarter revenue was $8,575 million, an increase of
5.2 percent (7 percent at constant currency) from the same period last year.
Revenue from Europe/Middle East/Africa was $6,306 million, an increase of 22.7
percent (3 percent at constant currency). Asia-Pacific revenue improved 14.3
percent (5 percent at constant currency) to $4,494 million. OEM revenue across
all geographies was $690 million, a 14.9 percent decrease (16 percent at
constant currency) compared with the first quarter of 2002.

The company's total gross profit margin was 36.0 percent in the first
quarter of 2003 compared with 36.1 percent in the first quarter of 2002.

In the first quarter of 2003, total expense and other income of $5.3
billion increased 12.1 percent over the year-earlier period, primarily related
to recent acquisitions as well as higher foreign currency translation losses
partly offset by the benefits of lower workforce reductions charges and lower
provisions for bad debts.

The company's tax rate in the first quarter of 2003 was 30.0 percent
compared with 29.2 percent in the first quarter of last year.

The Global Financing results of operations are included in the separate
Global Financing section on pages 30 through 36.

GLOBAL SERVICES

Global Services revenue, including maintenance, increased 23.6 percent (15
percent at constant currency) in the first quarter of 2003 compared with the
same period last year. Global Services revenue, excluding maintenance, increased
26.5 percent (17 percent at constant currency). Maintenance revenue increased
6.9 percent (flat at constant currency) in the first quarter of 2003 versus the
same period in 2002.

Strategic Outsourcing Services (SO) revenue increased 13 percent to $3,991
million (6 percent at constant currency) as it remains attractive to customers
in both good and bad economies. E-business hosting, an SO offering that provides
Web hosting infrastructure and application management as an Internet service,
continued its strong pattern of revenue growth. Business Consulting Services
(BCS) revenue increased 63 percent to $3,165 million (50 percent at constant
currency) primarily as a result of the acquisition of PwC's consulting business
in the fourth quarter of 2002. The integration of PwC's consulting business into
BCS continues to be on schedule. Integrated Technology Services (ITS) revenue,
excluding maintenance, increased 12

-18-

RESULTS OF CONTINUING OPERATIONS - (CONTINUED)

percent to $1,698 million (4 percent at constant currency) primarily as a result
of growth from existing OEM alliances.

The company signed more than $12 billion in services contracts in the first
quarter of 2003. The signings included 15 contracts each in excess of $100
million, including one contract over $2 billion. The estimated services backlog
including Strategic Outsourcing, BCS, ITS and Maintenance was $113 billion at
March 31, 2003. Backlog estimates are subject to change and are affected by
several factors, including changes in scope of contracts (mainly long-term
contracts), periodic revalidations, and currency assumptions used to approximate
constant currency.

Global Services gross profit dollars increased 18.6 percent in the first
quarter of 2003, compared with the first quarter of 2002, primarily as a result
of the increased revenue as described above. The gross profit margin declined
1.1 points in the first quarter of 2003 versus last year. The net decrease in
gross profit margin was attributable to the changing revenue mix toward the
lower margin BCS business and overall economic factors offset by benefits from
the 2002 special actions.

Looking forward, the company's backlog and success in integrating the
acquired PwC's consulting business are indicators of strength in the business.

HARDWARE

Revenue from hardware for the first quarter of 2003 decreased 1.3 percent
(6 percent at constant currency) when compared with the same period in 2002.

Systems Group revenue increased 6.5 percent to $2,646 million (flat at
constant currency) as pSeries UNIX server revenue grew and continued to gain
share across the pSeries product line. In the first quarter of 2003, the company
introduced the p630 processor with Power-4+ technology and extended the pSeries
on-demand offerings to include the capability for temporary usage-based
capacity. The iSeries servers revenue increased driven partly by strong demand
for the company's e-business on demand offerings. The ability to turn on
additional capacity remotely for short periods of time offers the increased
flexibility customers have been requesting. xSeries revenue increased driven by
the company's technological leadership, particularly in the rack-optimized
servers whereby the company was first to market in the transition to Intel Xeon
processors. xSeries revenue growth was also a result of the fast adoption of the
company's new Bladecenter offering, which brings the integration of servers,
storage and networking into a highly dense enterprise solution. zSeries servers
revenue declined as many of the company's high

-19-

RESULTS OF CONTINUING OPERATIONS - (CONTINUED)

end customers were anticipating a significant new product announcement in the
second quarter of 2003. Although zSeries server revenue declined, total delivery
of computing power as measured in MIPS (millions of instructions per second)
increased 3 percent versus the first quarter of 2002.

Storage Systems revenue increased as demand for high-end "Shark" products
increased and the average footprint size increased for these installations. Tape
products revenue was flat driven by some weakness in the high-end models.

Personal Systems Group revenue decreased 4.8 percent to $2,390 million (10
percent at constant currency) as a result of lower revenue from personal
computers, retail store solutions and printing systems products. The personal
computer revenue decline reflects a reduction in commodity prices resulting in
lower system prices. The company continues to execute on its core strategies for
its personal computer business, improving performance within the end to end
supply chain, resulting in improved inventory turns, improved gross profit
margins and lower days sales outstanding (DSO).

Technology Group revenue declined 20.2 percent to $742 million (21 percent
at constant currency) in the first quarter of 2003 versus the comparable period
of 2002. The decline in Technology Group revenue was driven by the actions taken
in 2002 to refocus and direct its microelectronics business to the high-end
foundry, ASICs and standard products, while creating a technology services
business. The actions included the divestiture of multiple non-core businesses.

Hardware gross profit dollars for the first quarter of 2003 increased 7.4
percent and the gross profit margin increased 2.1 points, from the comparable
period in 2002. These increases were primarily driven by improvements in
Microelectronics and Systems Group. Microelectronics gross profit margins
improved primarily due to the second quarter 2002 capacity reductions and the
divestiture of lower-margin businesses in 2002, as well as improved margins on
custom logic products. Systems Group gross profit margins increased due to
improvements in pSeries, xSeries and Storage Systems products.

Looking forward, the introduction of the new zSeries box, scheduled for the
second quarter of 2003, the planned ramp-up of the Technology Group's new 300
millimeter plant, and the continued supply chain initiatives such as outsourcing
of a significant portion of its low and midrange xSeries server manufacturing
and the outsourcing of certain mobile personal computers configuration
processes, will all impact future results.

SOFTWARE

-20-

RESULTS OF CONTINUING OPERATIONS - (CONTINUED)

Revenue from software for the first quarter of 2003 increased 8.0 percent
(2 percent at constant currency) versus the first quarter of 2002. The company's
middleware brands, which include DB2 database software, WebSphere (facilitates
customers' ability to manage a wide variety of business processes through the
Web), Tivoli (enables customers to centrally manage and efficiently utilize
their network and storage), Lotus (increases customers' ability to communicate,
collaborate and learn in an effective manner), and Rational (comprehensive
software development solutions), grew revenue 9 percent to $2,399 million (3
percent at constant currency) over the first three months of 2002. Data
Management software revenue increased primarily as a result of growth in DB2 and
Content Management offerings, partially offset by a decline in Informix products
as more customers migrated to DB2. The WebSphere family of products had revenue
growth primarily driven by growth in WebSphere Business Integration and Portals.
Lotus messaging revenue declined as new license sales are not expected to grow
until customers' businesses begin growing again. Tivoli revenue declined as
customers delayed purchase decisions. Other middleware revenue from the
company's traditional host software products like CICS, and storage and printer
software increased. In addition, on February 21, 2003, the company completed the
acquisition of Rational. The post-acquisition results of operations for Rational
($82 million of software revenue) are included in the software results and
contributed to the increased revenue this quarter.

Operating-systems software revenue increased 8 percent to $568 million (2
percent at constant currency) in the first quarter of 2003 when compared with
the year-ago period. The increase in the first quarter revenue was primarily
driven by higher revenue across all of the eServer software products.

Software gross profit dollars increased 12.7 percent and the gross profit
margin improved 3.5 points versus the first quarter of 2002. Lower support and
services costs contributed to the increases in 2003 versus 2002. In addition,
the company continues to leverage productivity initiatives such as shared
component development across all software brands.

Looking forward, the acquisition of Rational enhances the company's product
portfolio and will enable customers' development teams to increase
responsiveness and productivity, key performance metrics for an on-demand
business.

ENTERPRISE INVESTMENTS/OTHER

Revenue from Enterprise Investments/Other increased 7.4 percent (declined 2
percent at constant currency) in the first three months of 2003 versus the
comparable period in 2002. The increase in revenue was primarily driven by
higher revenue from product life-cycle management software and document
processor products.

-21-

RESULTS OF CONTINUING OPERATIONS - (CONTINUED)

Enterprise Investments/Other gross profit dollars decreased 29.9 percent
and the gross profit margin decreased 19.5 points in the first quarter of 2003,
versus the same periods of 2002, primarily as a result of foreign currency
hedging losses.

EXPENSE AND OTHER INCOME

Selling, general and administrative (SG&A) expense increased 4.8 percent (1
percent at constant currency) in the first three months of 2003 compared with
the same period in 2002. The increase was primarily associated with the recent
acquisitions of PwC's consulting business and Rational, including higher
amortization expense from acquired intangible assets. Workforce reductions,
which are the ongoing reductions and rebalancing that occur each quarter were
$79 million in first quarter of 2003 versus $138 million in first quarter of
2002. The provision for bad debts was $80 million in first quarter of 2003
versus $154 million in the first quarter of 2002. This decrease was primarily
driven by Global Financing as explained on page 34. Advertising and promotional
expense was $309 million in the first quarter of 2003 and was essentially the
same as the first quarter of 2002.

Research, development and engineering (RD&E) expense increased 5.3 percent
for the first three months of 2003 compared with the same period of 2002. The
increase was driven by the increased headcount in Software Group due to
acquisitions.

-22-

RESULTS OF CONTINUING OPERATIONS - (CONTINUED)

Intellectual property and custom development income declined 4.8 percent
for the first three months of 2003 versus the first quarter of 2002.

Sales and other transfers included $90 million from one intellectual
property transfer agreement and $34 million resulting from a first quarter 2003
transfer of intellectual property associated with the sale of certain operations
to Sanmina-SCI . The amount of income from licensing/royalty-based fee
transactions has been declining and this trend may continue.

Other (income) and expense was $84 million of expense in the first quarter
of 2003 versus $205 million of income in the first quarter of 2002. The change
was primarily the result of foreign currency transaction losses of $105 million
in the first quarter of 2003 versus gains of $68 million in the first quarter of
2002. In addition, during the first quarter of 2002, the company recorded a gain
of $91 million associated with the first quarter 2002 sale of the U.S. and
European desktop personal computer manufacturing operations to Sanmina-SCI. This
compares with a gain of $15 million in the first quarter of 2003 associated with
the first quarter 2003 sale of certain xSeries server manufacturing and certain
mobile personal computer processes to Sanmina-SCI.

Interest expense increased 32.4 percent in the first quarter of 2003
compared with the first quarter of 2002. The increase was a result of higher
levels of non-Global Financing debt. Cost of financing also includes interest
expense as it relates to the Global Financing business. Such interest expense is
not included above. See pages 30 through 36 for additional information on Global
Financing.

Interest on total borrowings of the company and its subsidiaries, which
includes interest expense and Global Financing interest classified as Cost of
financing in the Consolidated Statement of Earnings was $172 million for the
first quarter of 2003, of which the company capitalized $4 million. This
compares to $217 million in 2002, of which $9 million was capitalized.

The table on page 24 provides the total pre-tax (income)/cost for all
retirement-related plans at March 31, 2003 and 2002. (Income)/cost amounts are
included as a reduction from/addition to, respectively, the company's cost and
expense amounts on the Consolidated Statement of Earnings within the caption
(e.g., Cost, SG&A, RD&E) relating to the job function of the individuals
participating in the plans.

-23-

RESULTS OF CONTINUING OPERATIONS - (CONTINUED)

Retirement-Related Benefits

Included in the amounts above, the company realized income of approximately
$133 million associated with its defined benefits pension plans for the quarter
ended March 31, 2003. The comparable amount for the first quarter of 2002 was
approximately $276 million.

On January 1, 2003, the company reduced its expected long-term return
assumption on the PPP assets from 9.5 percent to 8.0 percent. Actual return on
plan assets for the PPP was a 2.0 percent loss or $731 million for the quarter
ended March 31, 2003. Year-to-date through April 30, 2003, the actual return was
a 3.3 percent gain or ($1,185) million. As discussed on page 95 of the 2002 IBM
Annual Report, differences between the actual returns and the expected returns
on pension plans are recognized in the calculation of pension (income)/cost over
five years as provided by the accounting rules. On December 31, 2002, the
company lowered its discount rate assumption from 7.0 percent to 6.75 percent,
and its rate of compensation increase from 6.0 percent to 4.0 percent.
Reductions in these three rates also occurred in certain non-U.S. countries. The
company voluntarily fully funded the qualified portion of the PPP, as measured
by its accumulated benefit obligation, through a total contribution of $3,963
million in the fourth quarter of 2002. These assumption changes and funding
action had the collective effect of causing the reduction in income from
defined benefit pension plans referred to in the first paragraph above. These
actions are expected to impact pension-related cost trends in a similar pattern
for the remaining 2003 quarters.

If a company's defined benefit pension plan is in an unfunded position at
year end on an ABO basis, the company may make a contribution to the plan or may
be required to record a charge to the stockholder's equity section of the
Consolidated Statement of Financial Position. Future contributions or charges to
equity as well as the future effects of retirement-related plans on operating
results of the company will depend upon investment performance, interest rates,
economic conditions, employee demographics, and mortality rates. Certain of
these factors can be volatile.

PROVISION FOR INCOME TAXES

The effective tax rate for the first three months of 2003 was 30.0 percent
versus 29.2 percent in the first quarter of 2002. The company's effective tax
rate will change period to period based on nonrecurring events as well as
recurring factors including the geographical mix of income before taxes, the
timing and amount of foreign dividends, state and local taxes, and the

-24-

RESULTS OF CONTINUING OPERATIONS - (CONTINUED)

interaction of various global tax strategies. In the normal course of business,
the company expects that its effective tax rate will approximate 30 percent.

RESULTS OF DISCONTINUED OPERATIONS

The loss from discontinued operations in the first-quarter 2003 was $3
million as compared with a loss of $92 million in the first quarter of 2002. The
company's discontinued operations, which comprises the HDD business, was sold to
Hitachi, Ltd. on December 31, 2002.

FINANCIAL CONDITION

DYNAMICS

The assets and debt associated with the company's Global Financing business
are a significant part of IBM's financial position. Accordingly, although the
financial position amounts appearing below and on pages 26 through 30 are the
company's consolidated amounts including Global Financing, to the extent the
Global Financing business is a major driver of the Consolidated Financial
Position, reference in the narrative section will be made to a separate Global
Financing section in this Management Discussion on pages 30 through 36. The
amounts appearing in the separate Global Financing section are supplementary
data presented to facilitate an understanding of the company's Global Financing
business.

OVERALL

During the first quarter of 2003, the company acquired Rational and
continued to invest in RD&E and in fixed assets. The company ended the first
quarter with $5,577 million in Cash and cash equivalents and current Marketable
securities. Non-Global Financing debt was $1,669 million at March 31, 2003, a
slight decrease from December 31, 2002. The non-Global Financing debt-to-capital
ratio was 7.3 percent.

CASH FLOW

The company's cash flow from operating, investing and financing activities,
as reflected in the Consolidated Statement of Cash Flows on page 5, is
summarized in the table below. These amounts include the cash flows associated
with the company's Global Financing business.

-25-

FINANCIAL CONDITION - (CONTINUED)

CASH FLOW

Net cash provided by operating activities for the first quarter of
2003 was $500 million lower than the first quarter of 2002 driven by
changes in operating assets and liabilities. Income from continuing
operations increased approximately $100 million from the 2002 first quarter
to the 2003 first quarter. Global financing receivables - which the company
manages more as an investment than as part of working capital - contributed
approximately $160 million of cash flow from operating activities. The
company also realized approximately $400 million from the monetization of
interest rate swaps. The monetization of interest rate swaps did not affect
the first quarter net earnings. These contributions to cash flows from
operating activities, however, were more than offset by the following
items: The decline in Other accounts receivable, such as trade, during the
first quarter of 2003 was lower than such decline in the first quarter of
2002 due to better revenue performance in the 2003 first quarter. Inventory
growth during the first quarter of 2003 was slightly higher than such
growth during the 2002 first quarter, even though inventory turns improved
by one turn. In addition to these two decreases in cash flows from
operating activities were approximately $400 million of first quarter 2003
payments that related to 2002: second and fourth quarter special actions
payments and contributions to non-US pension plans.

The increase in cash flows used in investing activities from the first
quarter of 2002 to the first quarter of 2003 was primarily attributable to the
purchase of Rational. The decrease in the cash used in financing activities from
the first quarter of 2002 to the first quarter of 2003 was primarily the result
of lower stock repurchases and lower short-term debt net repayments.

WORKING CAPITAL

-26-

FINANCIAL CONDITION - (CONTINUED)

The $1,915 decrease in Current assets was primarily due to declines of
$1,311 million in Short-term financing receivables (see pages 32 through 34),
$373 million in Notes and accounts receivable-trade mainly due to lower revenue
volumes in the first quarter and collection of typically higher year-end
volumes, and $398 million in Cash and cash equivalents and current Marketable
securities. The decrease in Cash and cash equivalents and current Marketable
securities is primarily resulting from the $1,039 million net cash payment for
the purchase of Rational, partially offset by an increase of $383 million for
the monetization of interest rate swaps.

Current liabilities decreased $2,764 million primarily due to declines of
$1,697 million in Accounts payable and accruals and $803 million in Taxes
payable (resulting from declines in these balances from typically higher
year-end levels) and $264 million in Short-term debt, see below and page 28.

INVESTMENTS

The company acquired Rational for $2,092 million. In addition, $1,195
million was invested in RD&E and the company capitalized external software costs
of $66 million and $70 million of internal-use software costs. The company
invested $984 million for Plant, rental machines and other property, a decrease
of $323 million from the comparable 2002 period, driven primarily by lower
Microelectronics capital spending.

In the first quarter of 2003, the company spent $65 million for the
repurchase of the company's common shares. At March 31, 2003, the company has
remaining authorization to purchase $3,799 million of IBM common shares in the
open market from time to time, based on market conditions.

The company funded these investments primarily with cash from operations.

DEBT AND EQUITY

The company's funding requirements are continually monitored and strategies
are executed to manage the company's overall asset and liability profile.
Additionally, the company maintains sufficient flexibility to access global
funding sources as needed.

On January 21, 2003, the company filed with the Securities and Exchange
Commission (SEC) a shelf registration to periodically sell up to $20 billion in
debt securities, preferred and capital stock, depositary shares and warrants.
The SEC declared this shelf registration effective on February 4, 2003. Under
this shelf, the company may sell securities in one or more separate offerings
with the size, price and terms to be determined at the time of sale. The net
proceeds from the sale of the securities will be used for general corporate
purposes, which may include debt repayment, investments in or extensions of
credit to its subsidiaries, redemption of any preferred stock the company may
issue, or financing of possible acquisitions or business expansion. The net
proceeds may be invested temporarily or applied to repay short-term debt until
they are used for their stated purpose.

Consistent with the company's strategy to increase the concentration of
borrowings at the IBM level, this shelf registration eliminates the need for a
shelf registration associated with its

-27-

FINANCIAL CONDITION - (CONTINUED)

CONTRACTUAL OBLIGATIONS

COMMITMENTS

Unused lines of credit represent amounts available to the company's
distributors to support their working capital needs and available lines of
credit relating to the company's syndicated loan activities. Other commitments
primarily include the company's commitments to provide financing for future
purchases of the company's products. Financial guarantees represent guarantees
for certain loans and financial commitments that the company had made as of
March 31, 2003.

LIQUIDITY

The company maintains two global credit facilities totaling $12.0 billion
in committed credit lines at March 31, 2003, including an $8.0 billion five-year
facility (which has three years remaining) and a $4.0 billion 364-day facility
(which expires on May 30, 2003), as part of its ongoing efforts to ensure
appropriate levels of liquidity. As of March 31, 2003, amounts unused and
available under these facilities were approximately $11.9 billion. Based upon
the company's forward looking liquidity requirements, management decided to
renew the 364-day facility, upon its expiration, in the amount of $2 billion,
thereby reducing the total global facilities to $10 billion. At March 31, 2003,
the company also had other mostly uncommitted lines of credit of approximately
$7.6 billion, of which approximately $2.4 billion was unused as of March 31,
2003.

As discussed on page 24, the company may make contributions to its
pension plans. In addition, under the terms of the company's agreement to
purchase PwC's consulting business, the company may be required to pay the
sellers additional funds. As described in the company's 2002 Annual Report,
the seller delivered net assets on October 1, 2002, that were approximately
$454 million greater than the estimated amount originally paid by the
company in 2002. This additional amount is subject to a contractual review
by both parties. The review and any final payments are expected to be
completed in the second quarter of 2003. The company expects to fund these
requirements primarily from cash flow from operations. The company
continues to monitor these matters to determine that they will not impair
the independence of PricewaterhouseCoopers as the company's accountants
under applicable regulations and professional guidelines.

-29-

FINANCIAL CONDITION - (CONTINUED)

CURRENCY RATE FLUCTUATIONS

Changes in the relative values of non-U.S. currencies to the U.S. dollar
affect the company's results. At March 31, 2003, currency changes resulted in
assets and liabilities denominated in local currencies being translated into
more dollars than at year-end 2002. The currency rate changes had a favorable
effect on revenue growth of approximately 7 percentage points in the first
quarter of 2003 and an unfavorable effect of approximately 3 percentage points
in the first quarter of 2002.

For non-U.S. subsidiaries and branches that operate in U.S. dollars or
whose economic environment is highly inflationary, translation adjustments are
reflected in results of operations, as required by SFAS No. 52, "Foreign
Currency Translation." Generally, the company manages currency risk in these
entities by linking prices and contracts to U.S. dollars and entering into
foreign currency hedge contracts.

The company uses a variety of financial hedging instruments to limit
specific currency risks related to financing transactions and other foreign
currency-based transactions. The impact of the company's hedging activities are
recorded in Cost of goods sold, SG&A, and Other (income) and expense in the
Consolidated Statement of Earnings. Further discussion of currency and hedging
appears in note L, "Derivatives and Hedging Transactions," on pages 84 to 86 of
the 2002 IBM Annual Report.

GLOBAL FINANCING

Global Financing is a business segment within IBM, but is managed (on an
arm's-length basis) and measured as if it were a standalone entity. Accordingly,
the information presented in this section is consistent with this separate
company view.

RESULTS OF OPERATIONS

* Return on equity is calculated using a two-point average of equity and an
estimated tax rate principally based on Global Financing's geographic mix of
earnings as IBM's provision for income taxes is determined on a consolidated
basis.

-30-

GLOBAL FINANCING - (CONTINUED)

Global Financing revenue increased 4.4 percent (flat at constant currency)
in the first quarter of 2003 versus the same period in 2002. The increase in
2003 was driven by an increase in used equipment sales partially offset by lower
financing income due to a lower asset base. The lower asset base is due to
decreases in demand for IT equipment associated with the current economic
environment.

Global Financing gross profit dollars increased 2.9 percent while gross
profit margin declined 0.9 percentage points in the first quarter of 2003 versus
the same period 2002. The increases in the first quarter of 2003 gross profit
dollars were primarily driven by lower borrowing costs related to the current
interest rate environment and improved margins in used equipment sales due to a
mix change to higher margin products.

Global Financing Pre-tax income increased 23.0 percent in the first quarter
of 2003 versus the same period in 2002. The increase in 2003 was driven by a
decrease in the provision for bad debt due to reduced exposure to the
Communications Sector. (Also see page 34 for an additional discussion of IBM
Global Financing allowance for doubtful accounts.)

The increase in return on equity from the first quarter of 2003 versus the
same period in 2002 was primarily due to a 22.6 percent rise in after-tax income
and due to a decline in the equity balance from 2002 to 2003 as evidenced by the
increase in the debt to equity ratio from 6.6x to 6.8x. See pages 35 and 36 for
a discussion on debt.

-31-

GLOBAL FINANCING - (CONTINUED)

FINANCIAL CONDITION

Balance Sheet

* Amounts eliminated for purposes of IBM's consolidated results. These assets,
along with the other assets in this table are, however, leveraged using Global
Financing debt.

** Global Financing debt includes debt of the company and of the Global
Financing units that support the Global Financing business.

See page 46 for segment information regarding the Global Financing Balance
Sheet.

Sources and Uses of Funds

The primary use of funds in Global Financing is to originate customer and
commercial financing assets. Customer financing assets for end users consist
primarily of IBM hardware, software and services, but also include non-IBM
equipment, software and services to meet IBM customers' total solutions
requirements. Customer financing assets are primarily sales-type, direct
financing and operating leases for equipment as well as loans for software and
services with terms generally two to five years. Customer financing also
includes internal activity as described on page 36.

-32-

GLOBAL FINANCING - (CONTINUED)

Commercial financing originations arise primarily from inventory and
accounts receivable financing for dealers and remarketers of IBM and non-IBM
products. Payment terms for inventory financing generally range from 30 to 75
days. Payment terms for accounts receivable financing generally range from 30 to
90 days. Also included in commercial financing assets are syndicated loans.

Originations

Cash collections of both customer and commercial financing assets exceeded
new financing originations in both the first quarter of 2003 and 2002, which
resulted in a net decline in financing assets in these periods. Funds were also
generated through the sale and lease of used equipment sourced primarily from
prior year's lease originations.

Cash generated by Global Financing was deployed to pay dividends to IBM and
to reduce the intercompany payable to the company.

Financing Assets by Sector

The following are the percentage of external financing assets by industry
sector.

* Business Partner assets represent a portion of commercial financing inventory
and accounts receivable financing for terms generally less than 90 days.

-33-

GLOBAL FINANCING - (CONTINUED)

Financing Receivables and Allowances

The following table presents financing receivables, excluding residual
values, and the allowance for doubtful accounts.

Roll-Forward of Financing Receivables Allowance for Doubtful Accounts
(Dollars in millions)

* Represents reserved receivables, net of recoveries, that were disposed of
during the period.
** Primarily represents translation adjustments.

The percentage of financing receivables reserved increased from 3.5 percent
at December 31, 2002, to 3.7 percent at March 31, 2003. Unallocated reserves
increased 11.4 percent from $184 million in 2002 to $205 million in 2003, even
though the average receivables balance declined 7.4 percent over the same
period. The increase in reserve percentage was due to a seasonal decline in the
asset base from year end. Specific reserves decreased 2.9 percent from $787
million to $764 million in 2003. The decrease in specific reserves was due to
the disposal of reserved receivables during the period combined with lower
requirements for additional specific reserves.

Global Financing's bad debts expense declined to $77 million for the
quarter ended March 31, 2003, compared with $123 million for the quarter ended
March 31, 2002. The decline was primarily attributed to higher reserve additions
recorded in the first quarter of 2002 associated with the Communications sector
as compared to the first quarter of 2003.

Residual Value

Residual value is a risk unique to the financing business and management of
this risk is dependent upon the ability to accurately project future equipment
values. Global Financing has insight into product plans and cycles for the IBM
product under lease. Based upon this product

-34-

GLOBAL FINANCING - (CONTINUED)

information, Global Financing continually monitors projections of future
equipment values and compares them to the residual values reflected in the
portfolio.

Sales of equipment, which are primarily sourced from equipment returned at
end of lease, represents 34.3 percent of Global Financing's revenue in the first
quarter of 2003 and 23.6 percent in the first quarter of 2002. The gross margins
on these sales were 26.1 percent and 19.4 percent in the first quarter of 2003
and 2002, respectively. In addition to selling assets sourced from end of lease,
Global Financing also leases used equipment to new customers or extends leasing
arrangements with current customers. These are other ways that Global Financing
profitably recovers the residual values. The following table presents the
recorded amount of unguaranteed residual value for sales-type and operating
leases at December 31, 2002 and March 31, 2003. In addition, the table presents
the residual value as a percentage of the original amount financed, and a run
out of the unguaranteed residual value over the remaining lives of these leases
as of March 31, 2003.

Residual Value

* Reclassified to conform with 2003 presentation.

Debt

Global Financing funds its operations primarily through borrowings using a
debt-to-equity ratio of approximately 7 to 1. The following table illustrates
the correlation between Global Financing assets and Global Financing debt. Both
assets and debt are presented in the Global Financing balance sheet on page 32.

-35-

FINANCIAL CONDITION - (CONTINUED)

[CHART]

* As of March 31, 2003.

The company's Global Financing business provides funding predominantly for
the company's external customers but also provides intercompany financing for
the company (internal). See page 32 for further information. IBM manages and
measures Global Financing as if it were a standalone entity and accordingly,
interest expense relating to debt supporting Global Financing's external
customer and internal business is included in the "Global Financing Results of
Operations" on page 30 and in Segment Information on pages 44 through 46.

In the company's Consolidated Statement of Earnings on page one, however,
the interest expense supporting Global Financing's internal financing to the
company is reclassified from Cost of financing to Interest expense.

Liquidity

Global Financing is a segment of IBM and as such is supported by IBM's
liquidity position and access to capital markets.

FORWARD LOOKING AND CAUTIONARY STATEMENTS

Except for the historical information and discussions contained herein,
statements contained in this Form 10-Q may constitute "forward looking
statements" within the meaning of the Private Securities Litigation Reform Act
of 1995. These statements involve a number of risks, uncertainties and other
factors that could cause actual results to differ materially, including the
company's failure to continue to develop and market new and innovative products
and services and to keep pace with technological change; competitive pressures;
failure to obtain or protect intellectual property rights; quarterly
fluctuations in revenues and volatility of stock prices; the company's ability
to attract and retain key personnel; currency fluctuations and customer
financing risks; dependence on certain suppliers; changes in the financial or
business condition of the company's distributors or resellers; the company's
ability to successfully manage acquisitions and alliances; legal, political and
economic changes and other risks, uncertainties and factors discussed elsewhere
in this Form 10-Q, in the company's other filings with the Securities and
Exchange Commission or in materials incorporated therein by reference.

-36-

ITEM 4. CONTROLS AND PROCEDURES

Based on their evaluation of the company's disclosure controls and
procedures as of a date within 90 days of the filing of this Report, the Chief
Executive Officer and Chief Financial Officer have concluded that such controls
and procedures are effective.

There were no significant changes in the company's internal controls or in
other factors that could significantly affect such controls subsequent to the
date of their evaluation.

PART II - OTHER INFORMATION

ITEM 6 (a). EXHIBITS

EXHIBIT NUMBER

3 The By-laws of IBM as amended through April 29, 2003.

11 Statement re: computation of per share earnings.

12 Statement re: computation of ratios.

99.1 Certification by CEO pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

99.2 Certification by CFO pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

ITEM 6 (b). REPORTS ON FORM 8-K

The company filed Form 8-K on January 2, 2003, its press release regarding
the company's funding of the U.S. Pension plan. No financial statements were
filed with this Form 8-K.

The company filed Form 8-K on January 17, 2003, with respect to the
company's financial results for the periods ended December 31, 2002, and
included the unaudited Consolidated Statement of Earnings, Consolidated
Statement of Financial Position and Segment Data for the periods ended December
31, 2002. In addition, IBM's Chief Financial Officer, John R. Joyce's
fourth-quarter earnings presentation to security analysts on Thursday, January
16, 2003 was filed as Attachment II of the Form 8-K.

The company filed Form 8-K on February 10, 2003, charts presented by Doug
Elix, Senior Vice President & Group Executive, IBM Global Services, at meeting
with security analysts. No financial statements were filed with this Form 8-K.

The company filed Form 8-K on February 21, 2003, its press release
regarding the company's acquisition of Rational Software Corp. No financial
statements were filed with this Form 8-K.

-37-

SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.

International Business Machines Corporation
-------------------------------------------
(Registrant)

Date: May 14, 2003

By:

/s/ Robert F. Woods
--------------------

Robert F. Woods
Vice President and Controller

-38-

CERTIFICATION PURSUANT TO RULE 13A-14 OR 15D-14 OF THE SECURITIES
EXCHANGE ACT OF 1934, AS ADOPTED PURSUANT TO SECTION 302 OF THE
SARBANES-OXLEY ACT OF 2002

I, Samuel J. Palmisano, certify that:

1. I have reviewed this quarterly report on Form 10-Q of International
Business Machines Corporation;

2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;

3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;

4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:

i. designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;

ii. evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and

iii. presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;

5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):

i. all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and

ii. any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and

6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.

Date: May 14, 2003

/s/ Samuel J. Palmisano
-----------------------
Samuel J. Palmisano

Chairman, President and Chief Executive Officer

-39-

CERTIFICATION PURSUANT TO RULE 13A-14 OR 15D-14 OF THE SECURITIES
EXCHANGE ACT OF 1934, AS ADOPTED PURSUANT TO SECTION 302 OF THE
SARBANES-OXLEY ACT OF 2002

I, John R. Joyce, certify that:

1. I have reviewed this quarterly report on Form 10-Q of International
Business Machines Corporation;

2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;

3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;

4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:

i. designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;

ii. evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and

iii. presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;

5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):

i. all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and

ii. any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and

6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.

Date: May 14, 2003

/s/ John R. Joyce
-----------------
John R. Joyce

Senior Vice President,

Chief Financial Officer

-40-