INTERNATIONAL BUSINESS MACHINES CORP - 10-Q Quarterly Report

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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10 - Q

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

FOR THE QUARTER ENDED JUNE 30, 2003

1-2360
(Commission file number)

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

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

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

914-499-1900
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(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 1,730,181,246 shares of common stock outstanding at
June 30, 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.)

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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.)

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

ASSETS

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

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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.)

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INTERNATIONAL BUSINESS MACHINES CORPORATION
AND SUBSIDIARY COMPANIES
CONSOLIDATED STATEMENT OF CASH FLOWS
FOR THE SIX MONTHS ENDED JUNE 30, (UNAUDITED)

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

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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-
and six-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".

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)

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

4. The Emerging Issues Task Force (EITF) recently reached a consensus on two
issues relating to the accounting for multiple element arrangements: Issue No.
00-21, "Accounting for Revenue Arrangements with Multiple Deliverables", and
Issue No. 03-05, "Applicability of AICPA SOP 97-2 to Non Software Deliverables
in an Arrangement Containing More Than Incidental Software". The consensus
opinion in EITF No. 03-05 clarifies the guidance in EITF 00-21 and was reached
on July 31, 2003. The company is evaluating the impact of these two EITF
issues on the Consolidated Financial Statements. The transition provisions
allow either prospective application or a cumulative effect adjustment upon
adoption. IBM will adopt prospectively as of July 1, 2003.

In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities". SFAS No. 149 clarifies under
what circumstances a contract with an initial net investment meets the
characteristics of a derivative as discussed in Statement No. 133. It also
specifies when a derivative contains a financing component that warrants special
reporting in the Consolidated Statement of Cash Flows. SFAS No. 149 amends
certain other existing pronouncements in order to improve consistency in
reporting these types of transactions. The new guidance is effective for
contracts entered into or modified after June 30, 2003, and for hedging
relationships designated after June 30, 2003. SFAS No. 149 is not expected to
have a material effect on the Consolidated Financial Statements.

In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity". It establishes
classification and measurement standards for three types of freestanding
financial instruments that have characteristics of both liabilities and equity.
Instruments within the scope of SFAS 150 must be

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)

classified as liabilities within the company's Consolidated Financial
Statements. The provisions of SFAS No. 150 are effective for (1) instruments
entered into or modified after May 31, 2003 and (2) pre-existing instruments as
of July 1, 2003. SFAS 150 is not expected to have a material effect on the
Consolidated Financial Statements.

In January 2003, the Financial Accounting Standards Board (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 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.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)

5. The changes in the carrying amount of goodwill, by external reporting
segment, for the period ended June 30, 2003, are as follows:

There were no goodwill impairment losses recorded during the first six
months of 2003.

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 $290 million during
the first six months of 2003, primarily due to the acquisition of Rational
Software Corp. (Rational) partially offset by amortization of existing
intangible asset balances.

The aggregate intangible amortization expense was $78 million and $152
million for the second quarter and first six months of 2003, respectively,
versus $40 million and $80 million for the second quarter and first six months
of 2002.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)

Future amortization expense relating to intangible assets currently recorded
in the Consolidated Statement of Financial Position is estimated to be the
following at June 30, 2003:

2003 (for second half) $ 182 million
2004 $ 321 million
2005 $ 246 million
2006 $ 126 million
2007 $ 73 million

6. As described in the company's 2002 Annual Report and in connection with
the acquisition of PricewaterhouseCoopers' (PwC) consulting business, the
original recorded amount of net tangible assets transferred to IBM from PwC
was approximately $454 million greater than the estimated amount originally
paid by the company in 2002. The amount of net tangible assets transferred is
subject to a review process between both parties under terms of the
agreement, which process was substantially completed during the second
quarter of 2003. As a result of the review process and other adjustments, the
company paid an additional amount to PwC of $397 million in July 2003. The
company recorded a liability for this amount as of June 30, 2003.
Substantially all of the payment was accounted for as incremental goodwill
due to the fact that the net tangible assets recorded by IBM as of October 1,
2002 included the incremental amount.

The table below presents the updated allocation of purchase price
related to the company's 2002 acquisition of PwC's consulting business.

* Adjustments relate to the amount paid by the company to PwC as a result of the
substantial completion of the review discussed above as well as other purchase
accounting adjustments primarily related to accounts receivable and other
accruals.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)

7. 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 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.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)

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 new 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.

The following table summarizes the significant components of these actions:

+ Principally represents currency translation adjustments and reclassification
of non-current to current. In addition, net adjustments of $18million were
made in the second quarter of 2003 to reduce previously recorded
liabilities. These adjustments, along with $7 million for assets previously
written off, were primarily for differences between the estimated and actual
proceeds on the disposition of certain assets as well as changes in the
estimated cost of employee terminations and in vacant space accrual
estimates.
* Recorded in Accounts payable and accruals on the Consolidated Statement of
Financial Position.
** Recorded in Other liabilities on the Consolidated Statement of Financial
Position.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)

(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 liability at June 30, 2003 relates to the
remaining lease payments, which 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, all of whom left the
company as of June 30, 2003. The remaining 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.

(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, all of whom
left the company as of June 30, 2003. See C above for information on the
remaining 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 2016.

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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:

+ Principally represents currency translation adjustments, adjustments to the
purchase price allocation for the PwC consulting acquisition, and
reclassifications between current and non-current. In addition, net
adjustments of $2 million were made in the second quarter of 2003 to reduce
previously recorded liabilities. These adjustments were changes in the
estimated cost of employee terminations and vacant space. There were also
net adjustments of $5 million made in the second quarter of 2003 to reduce
previously recorded liabilities, that were recorded in purchase accounting,
for changes in the estimated cost of employee terminations and vacant space.

* 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 95 percent left the company as of 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.

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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 . In addition, net adjustments of $51
million were made in the second quarter of 2003 to reduce previously
recorded liabilities. These adjustments were for differences between the
estimated and actual proceeds on the disposition of certain assets and
changes in the estimated cost of employee terminations and vacant space for
the 2002 actions ($20 million), net adjustments for fourth quarter 2002
actions recorded in purchase accounting ($5 million), HDD-related
restructuring in 2002 ($21 million) and actions prior to 1999 ($5 million).
The 2002 HDD restructuring charges and the second quarter 2003 adjustment
thereto were recorded in Discontinued Operations in the Consolidated
Statement of Earnings.

* 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 tables on pages 49 through 52 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 on headcount. A different result could occur for any segment if
actuarial assumptions unique to each segment were used. Performance measurements
are 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.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)

10. 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 other 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.

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 June 30, 2003 and December 31, 2002, respectively.
These amounts include a limited guarantee of $63 million and $69 million
associated with the company's loans receivable securitization program at June
30, 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 $2,897 million and $3,482 million at June 30, 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 $397 million and $288
million at June 30, 2003 and December 31, 2002, respectively.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)

11. On April 29, 2003, the stockholders of the company approved the adoption of
the IBM 2003 Employees Stock Purchase Plan (the 2003 Plan). The 2003 Plan
permits employees to purchase IBM common shares through payroll deductions
during semiannual offerings. The 2003 Plan is similar to the IBM 2000 Employees
Stock Purchase Plan except that it does not have a specified duration because of
the difficulty in predicting the rate of share consumption, which is based on
stock price and participation rates over time. The 2003 Plan has 50,000,000
shares available for issuance as of July 1, 2003. The company will be required
to seek subsequent stockholder approval prior to the issuance of any
additional shares.

ITEM 2.

MANAGEMENT'S DISCUSSION AND ANALYSIS
OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2003

Second quarter revenue increased 10.1 percent (3 percent at constant
currency) from the prior year second quarter. The company earned $1.7 billion
of income from continuing operations or $0.98 per diluted common share
including $17 million, net of tax, of benefit for adjustments to actions
taken in 2002. Current IT demand is good, but not robust, and these results
reflect the breadth of the company's offerings and its annuity-like core
businesses, which represents over 50 percent of the company's profit. The
advantages of this breadth can be seen during the 2003 second quarter whereby
strength in the company's eServers business offset challenges faced in the
company's Microelectronics business.

For total operations, net income for the second quarter and first half of
2003, including discontinued operations, was $1,705 million and $3,089 million,
respectively, (including a loss of $20 million and $23 million, respectively for
discontinued operations) or $0.97 and $1.75, respectively, in earnings per
diluted common share. This compares to total operations net income for the
second quarter and first half of 2002, including discontinued operations, of $56
million and $1,248 million, respectively, (including a loss of $389 million and
$481 million, respectively, for discontinued operations) or $0.03 and $0.71,
respectively, in earnings per diluted common shares.

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RESULTS OF CONTINUING OPERATIONS

The amount of shares actually outstanding at June 30, 2003 was 1,730.2
million shares.

The weighted average number of common shares outstanding assuming dilution
was higher by 33.3 million than the second quarter of 2002 and by 19.4 million
than the first six months 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). The weighted average number of shares
assuming dilution was 1,763.7 million and 1,730.4 million in the second quarter
of 2003 and 2002, respectively, and 1,761.1 million and 1741.7 million for the
first six months of 2003 and 2002, respectively.

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
second quarter of 2003 and the first six months 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 June 30, 2003 increased 10.1 percent (3
percent at constant currency) from the same period last year. The growth in
revenue was primarily due to improved performance in Systems Group server and
storage products as well as increased revenue as a result of recent
acquisitions. These increases were partially offset by lower revenue from
Technology Group products and the impact of declining personal computer revenue.

In the Americas, second-quarter revenue was $9.5 billion, an increase of 5.3
percent (5 percent at constant currency) from the same period last year. Revenue
from Europe/Middle East/Africa was $6.9 billion, up 22.6 percent (3 percent at
constant currency). Asia-Pacific revenue increased 11.7 percent (6 percent at
constant currency) to $4.6 billion. OEM revenue across all geographies was $588
million, a 30.4 percent decrease (31 percent at constant currency) compared with
the second quarter of 2002.

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RESULTS OF CONTINUING OPERATIONS - (CONTINUED)

The company's total gross profit margin was 37.0 percent in the second
quarter of 2003, unchanged from the same period in 2002.

In the second quarter of 2003, total expense and other income was $5.5
billion, a decline of 17.1 percent from the second quarter of 2002 primarily due
to the Microelectronics and productivity actions taken in the second quarter of
2002, partially offset by higher expenses associated with recent acquisitions.

The company's effective tax rate on continuing operations in the second
quarter of 2003 was 30.0 percent versus 25.3 percent in the second quarter of
2002. The increase was primarily due to the absence of the tax benefit
associated with the second quarter Microelectronics actions taken in 2002.

GLOBAL SERVICES

Global Services revenue, including maintenance, increased 22.8 percent (14
percent at constant currency) and 23.2 percent (15 percent at constant
currency), respectively, in the second quarter and first six months of 2003,
when compared to the same periods of 2002. Global Services revenue, excluding
maintenance, increased 25.2 percent (17 percent at constant currency) and 25.8
percent (17 percent at constant currency), respectively, for the second quarter
and first six months of 2003 versus comparable periods of last year. Maintenance
revenue increased 8.4 percent to $1,345 million (flat at constant currency) and
7.6 percent to $2,660 million (flat at constant currency), respectively, when
compared to the same periods in 2002.

Strategic Outsourcing Services (SO) revenue increased 12.3 percent to $4,201
million (5 percent at constant currency) in the second quarter of 2003 versus
last year. SO revenue increased 12.5 percent to $8,192 million (5 percent at
constant currency) for the first six months of 2003 versus the same period last
year. Increases in SO revenue reflect the impact of new signings. 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 66.1 percent to
$3,255 million (53 percent at constant currency) in the second quarter of 2003
versus the same period in 2002. BCS revenue increased 64.8 percent to $6,420
million (52 percent at constant currency) for the first six months of 2003
versus the same period in 2002. These increases were primarily the result of the
acquisition of PwC's consulting business in the fourth quarter of 2002.
Integrated Technology Services (ITS) revenue, excluding maintenance, increased
6.6 percent to $1,835 million (declined 1 percent at constant currency) in the
second quarter of 2003 versus the second quarter of 2002. ITS revenue, excluding
maintenance, increased 9.1 percent to $3,533

- 19 -

RESULTS OF CONTINUING OPERATIONS - (CONTINUED)

million (1 percent at constant currency) for the first six months of 2003 versus
the first six months of 2002.

The company signed $10.7 billion in services contracts in the second quarter
of 2003. The signings included 13 contracts each in excess of $100 million,
including five contracts over $250 million. The estimated services backlog
including Strategic Outsourcing, BCS, ITS and Maintenance was $112 billion at
June 30, 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 20.9 percent and 19.8
percent, respectively, for the second quarter and first six months of 2003
versus the same periods last year. These increases were primarily a result of
the increased revenue as described above. The gross profit margins declined 0.4
percentage points and 0.7 percentage points for the second quarter and first six
months, respectively, of 2003 when compared to year-ago periods. These declines
in gross profit margin were attributable to the changing revenue mix toward the
lower margin BCS business, partially offset by benefits from the 2002 special
actions.

Looking forward, the company signed approximately $3 billion of services
contracts, excluding maintenance, during the first half of July 2003. Although
the timing and ultimate number of signings within each quarter is not possible
to predict with precision, the company is encouraged by the level of signings
that closed during the beginning of the new quarter.

HARDWARE

Revenue from hardware decreased 0.9 percent (6 percent at constant currency)
and decreased 1.1 percent (6 percent at constant currency), respectively, for
the second quarter and first six months of 2003, versus the same periods in
2002.

Systems Group revenue increased 9.8 percent to $3,221 million (3 percent at
constant currency) in the second quarter of 2003 versus the same period last
year. Systems Group revenue increased 8.3 percent to $5,867 million (2 percent
at constant currency) for the first six months of 2003 versus the same period
last year. Revenue and share growth continued in the pSeries UNIX servers in
both periods resulting from strength in both high-end and entry servers, as the
company completed the transition to the Power4+ technology. The xSeries server
revenue increased in the second quarter and first six months of 2003 versus the
same periods of 2002 due to growth in sales of servers partially offset by lower
workstation revenue. Strength in server

- 20 -

RESULTS OF CONTINUING OPERATIONS - (CONTINUED)

sales were in multiprocessor and clustered environments as well as in blades.
Revenue from iSeries servers increased in the second quarter and first six
months of 2003 versus year-ago periods due to a shift to larger and more richly
configured servers. Revenue from zSeries mainframes decreased in both the second
quarter and first six months of 2003 versus the same periods of last year. The
total deliveries of zSeries computing power as measured in MIPS (millions of
instructions per second) declined 7 percent in the second quarter of 2003
compared to the second quarter of 2002. Although the company began shipping its
new zSeries z990 mainframe in mid-June in order to meet the needs of certain of
the company's largest customers, the MIPS decline relates to deferrals by other
customers' of purchases in anticipation of new functionality, as described on
page 22.

Storage Systems revenue increased in the second quarter and the first six
months of 2003 versus the same periods of last year as a result of increased
revenue for enterprise disk storage (Shark) and FAStT products. This increase
was partially offset by lower tape products revenue due to sluggish demand for
high-end models.

Personal Systems Group revenue decreased 2.8 percent to $2,723 million (8
percent at constant currency) in the second quarter of 2003 versus the same
period in 2002. Personal Systems Group revenue declined 3.7 percent to $5,113
million (9 percent at constant currency) for the first six months of 2003 versus
the same period in 2002. The revenue declines in both periods were driven by
lower revenue from personal computers, retail store solutions and printing
systems products. The decline in revenue primarily reflects a reduction in
prices, which more than offset gains from increased volumes. The company
continued to yield benefits from the execution of its strategies for personal
computers as inventories were lower, costs declined and the company continues to
differentiate its hardware with unique software and services offerings.

Technology Group revenue declined 34.3 percent to $659 million (35 percent
at constant currency) in the second quarter of 2003 versus the comparable period
in 2002. Technology Group revenue declined 27.5 percent to $1,401 million (28
percent at constant currency) for the first six months of 2003 versus the
comparable period of 2002. These declines were primarily driven by actions taken
in 2002 to refocus and direct its microelectronics business to the high-end
foundry, ASICs and standard products, while creating a new technology services
business. These actions included the divestiture of multiple non-core
businesses. Second quarter 2003 demand was also sluggish from certain OEM
customers. The company continues to monitor projected customer demand and bring
new tools on-line appropriately. Microelectronics' largest customer is the
Systems Group and played a large part in Systems Group's improved results and
market share gains.

Hardware gross profit dollars for the second quarter and first six months of
2003 increased 7.8 percent and 7.6 percent, respectively, from comparable
periods in 2002. The hardware gross profit margin increased 2.1 percentage
points and 2.2 percentage points, respectively, from the prior year periods. The
increases were primarily driven by Systems Group and personal computers. Systems
Group gross profit margins increased due to improvements across all eServer
Series and Storage Systems products. Personal computer gross profit margin
increased as a result of reduced costs relating to recent supply chain
initiatives and a shift in revenue from desktop to mobile products, which have a
better gross profit.

- 21 -

RESULTS OF CONTINUING OPERATIONS - (CONTINUED)

Looking forward, the company plans to deliver additional z990 functionality
in the second half of 2003 that addresses the needs of other zSeries customers:
Secure-key cryptography and the doubling of available I/O channels. The
company's recent supply chain initiatives such as outsourcing a significant
portion of its low and midrange xSeries server manufacturing and certain mobile
personal computer configuration processes will continue to improve cost of
sales. The company, however, does not anticipate sequential quarterly revenue
improvement for the Technology Group until the fourth quarter of 2003.

SOFTWARE

Revenue from software increased 6.2 percent (declined 2 percent at constant
currency) and 7.1 percent (flat at constant currency), respectively, versus the
second quarter and first six months 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
tools), increased revenue 7 percent to $2,730 million (declined 1 percent at
constant currency) in the second quarter of 2003 compared to the same period in
2002. Middleware revenue increased 8 percent to $5,129 million (1 percent at
constant currency) for the first six months of 2003 compared to the same period
in 2002. Data management software revenue increased in both periods primarily as
a result of growth in DB2 volumes. Revenue from the WebSphere family of products
grew in both periods primarily driven by growth in Portals and Application
Server volumes. Tivoli revenue increased in both periods driven by strong growth
in Security and Storage software offset by a decline in Systems Management
revenue. Lotus Messaging revenue declined in both periods as the company
transitions from the mature Notes/Domino platform into new product areas such as
Workplace Messaging, a Web-based e-mail solution for deskless employees.
Rational Software (acquired during the first quarter of 2003) revenue accounted
for more than 70 percent of the second quarter 2003 middleware revenue increase.

Operating-systems software revenue increased 5 percent to $589 million
(declined 2 percent at constant currency) in the second quarter of 2003 and
increased 7 percent to $1,157 million (flat at constant currency) for the first
six months of 2003, when compared with prior year periods. The revenue increases
in both periods were primarily driven by growth in zSeries, pSeries and xSeries
revenue.

Software gross profit dollars increased 8.2 percent and 10.3 percent,
respectively, for the second quarter and first six months of 2003 versus the
same periods in 2002. The gross profit margin improved 1.5 percentage points and
2.4 percentage points, respectively, for the second

- 22 -

RESULTS OF CONTINUING OPERATIONS - (CONTINUED)

quarter and first six months of 2003 compared to the same periods in 2002. The
improvements in gross profit dollars and gross profit margins were primarily
driven by the growth in software revenue, as a result of currency, and lower
services and support costs.

Looking forward, the company continues to expand and forge new relationships
with independent software application vendors. In addition, the first quarter
2003 acquisition of Rational, the second quarter acquisition of Think Dynamics
($48 million purchase price), and the July 2003 acquisition of Aptrix
(approximately $11 million purchase price) are key to the company's strategy of
targeted acquisitions that strengthen IBM's ability to help customers develop
into on-demand businesses.

ENTERPRISE INVESTMENTS/OTHER

Revenue from Enterprise Investments/Other increased 5.8 percent (declined 1
percent at constant currency) and 6.6 percent (declined 2 percent at constant
currency), respectively, for the second quarter and first six months of 2003,
versus comparable periods in 2002. These increases were primarily driven by
higher revenue from product life-cycle management software.

Enterprise Investments/Other gross profit dollars decreased 3.3 percent and
18.2 percent, respectively, in the second quarter and first six months of 2003
versus the prior year periods. The gross profit margins declined 3.9 percentage
points and 11.9 percentage points, respectively, for the second quarter and
first six months of 2003 versus the same periods in 2002. The decline in the
gross profit margin in the second quarter of 2003 versus 2002 was primarily a
result of a lower margin for product life-cycle management products. The decline
in the gross profit dollars and gross profit margin for the first six months of
2003 versus the first six months of 2002 was primarily the result of foreign
currency hedging losses recorded in the first quarter of 2003 and lower product
life-cycle management product margins.

- 23 -

RESULTS OF CONTINUING OPERATIONS - (CONTINUED)

EXPENSE AND OTHER INCOME

SG&A expense decreased 15.7 percent (20 percent at constant currency) and
6.8 percent (11 percent at constant currency), respectively, in the second
quarter and first six months of 2003 versus the same periods in 2002. The
decrease in the second quarter of 2003 and the first six months of 2003 was
primarily due to the Microelectronics and productivity actions taken in the
second quarter of 2002 amounting to $1,250 million compared to second quarter
2003 charges for ongoing workforce rebalancing of $116 million. In addition, the
provision for doubtful accounts was $56 million and $136 million in the second
quarter and first six months of 2003, respectively, versus $148 million and $302
million in the second quarter and first six months of 2002. These decreases are
reflective of the increased provisions the company was recording in prior
periods to reflect the general economic environment as well as specific items,
such as the Communications sector and the Latin America region. These issues
have stabilized and contributed to the lower year-to-year charges. Advertising
and promotional expense was $369 million and $678 million in the second quarter
and first six months of 2003, respectively, versus $369 million and $680 million
in the second quarter and first six months of 2002. These decreases in SG&A were
partially offset by higher expenses associated with the recent acquisitions of
PwC's consulting business and Rational, including higher amortization expense
from acquired intangible assets.

Research, development and engineering (RD&E) expense increased 2.3 percent
and 3.8 percent, respectively, for the second quarter and first six months of
2003, when compared with the same periods of 2002. These increases in RD&E
expense were driven primarily by the

- 24 -

RESULTS OF CONTINUING OPERATIONS - (CONTINUED)

Software Group acquisitions, partially offset by benefits from the actions taken
in the second quarter of 2002 to improve productivity.

Intellectual property and custom development income decreased 18.0 percent
and 10.8 percent, respectively, for the second quarter and first six months of
2003 versus the same periods of 2002.

The largest Sales and other transfers of intellectual property transaction
in the second quarter and first half of 2003 was approximately $50 million and
$90 million, respectively. The amount of income from licensing/royalty-based
fees transactions has been declining and this trend may continue.

Second quarter 2003 Other (income) and expense was $4 million versus $399
million for the second quarter of 2002 and was $88 million for the first six
months of 2003 versus $194 million, in the first six months of 2002. The
decreases in the second quarter of 2003 and the first half of 2003 were
primarily due to the Microelectronics and productivity actions taken in the
second quarter of 2002 amounting to $477 million. These decreases were partially
offset by foreign currency transaction losses. Such losses were $52 million in
the second quarter of 2003 versus gains of $58 million in the second quarter of
2002. Foreign currency transaction losses were $157 million in the first six
months of 2003 versus gains of $126 million for the first six months 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.

Although debt balances have declined from December 31, 2002 to June 30,
2003, year to year interest expense increased 25.1 percent and 28.6 percent,
respectively, for the second quarter and first six months of 2003. These
increases were driven by higher levels of average non-Global Financing debt in
the first six months of 2003 versus the same period in 2002. Cost of financing
also includes interest expense as it relates to the Global Financing business.
Such interest expense is not included above. See pages 32 through 38 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 $180 million and $352
million for the second quarter and first six

- 25 -

RESULTS OF CONTINUING OPERATIONS - (CONTINUED)

months of 2003, respectively. Of these amounts, the company capitalized $5
million for the second quarter and $9 million for the first six months of 2003,
respectively.

The following table provides the total pre-tax cost/(income) for
retirement-related plans for the second quarter of 2003 and 2002 and the first
six months of 2003 and 2002. Cost/(income) amounts are included as an addition
to/reduction from, respectively, the company's cost and expense amounts on the
Consolidated Statement of Earnings.

Retirement-Related Benefits

Included in the amounts above, the company realized income of approximately
$147 million and $292 million relating to its defined benefit pension plans for
the quarter ended June 30, 2003 and 2002, respectively. The comparable amounts
for the first six months of 2003 and 2002 were approximately $281 million and
$568 million, respectively.

On January 1, 2003, the company reduced its expected long-term return
assumption on the U.S. IBM Personal Pension Plan's ("PPP") assets from 9.5
percent to 8 percent. Actual return on PPP plan assets for the six months ended
June 30, 2003 was $2.9 billion or 8 percent. As discussed on page 95 of the 2002
IBM Annual Report, any differences between the actual returns and the expected
returns on the pension plan are recognized in the calculation of the 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 percent to 6.75 percent, and lowered its rate of compensation increase from 6
percent to 4 percent. Reductions in these rates also occurred in certain non-US
countries. The company voluntarily fully funded the tax-qualified portion of the
PPP, as measured by its accumulated benefit obligation, through a contribution
of cash and IBM stock totaling $3,963 million in the fourth quarter of 2002.
These assumption changes and funding action had the collective net effect of
causing the reduction in income from defined benefit pension plans referred to
above. These actions are expected to impact pension-related cost trends in a
similar pattern for the remaining 2003 periods.

Through June 30, 2003, interest rates, as evidenced by long-term high-grade
investment instruments, continued to decline. Any corresponding impact to the
year-end discount rate will affect the accumulated benefit obligation (ABO)
calculation. For each quarter point change in rate, there is a corresponding $1
billion movement in the ABO. Any increased obligation

- 26 -

RESULTS OF CONTINUING OPERATIONS - (CONTINUED)

combined with several other factors such as investment performance and normal
payments to retirees may result in an unfunded position at year-end on an ABO
basis.

If the PPP is in an unfunded position at year-end whereby the ABO exceeds
the fair value of the plan assets, the company may make a voluntary contribution
to the plan up to the unfunded position as it did in December 2002 or may be
required to record a non-cash charge to the stockholders' equity section of the
Consolidated Statement of Financial Position.

On July 31, 2003, the U.S. District Court for the Southern District of
Illinois, in Cooper et al. vs. The IBM Personal Pension Plan and IBM
Corporation, held that IBM's pension plan violated the age discrimination
provisions of the Employee Retirement Income Security Act of 1974 (ERISA).

IBM disagrees with the district court's ruling and intends to appeal at the
appropriate time. While it is not possible to predict the ultimate outcome of
this matter, IBM believes it should be successful on appeal. The district court
did not make any determination as to remedies, which will be the subject of a
separate hearing. Whether any remedies finally determined have a material effect
on the company's business, financial condition or results of operations will
depend on a number of variables, including the amount of additional
obligations, if any, imposed on the plan, the size of any additional
contributions that IBM may be required to make to the plan in any year, and the
significance of the impact any such additional liabilities may have on IBM's
financial statements.

PROVISION FOR INCOME TAXES

The company's effective tax rate on continuing operations for the second
quarter of 2003 was 30.0 percent versus 25.3 percent for the same period in
2002. The effective tax rate on continuing operations for the first six months
of 2003 was 30.0 percent versus 28.2 percent for the comparable period in 2002.
The increase in the rates for the second quarter and first six months of 2003
was primarily due to the absence of the tax benefit associated with the second
quarter Microelectronics actions taken in 2002. In the normal course of
business, the company expects that the effective tax rate will approximate 30
percent. As illustrated in the second quarter of 2002, the company's effective
tax rate may 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
interaction of various global tax strategies.

RESULTS OF DISCONTINUED OPERATIONS

The loss from discontinued operations was $20 million and $23 million in the
second quarter and first six months of 2003, respectively versus $389 million
and $481 million in the second quarter and first six months of 2002. The
company's discontinued operations, which comprises the HDD business, was sold to
Hitachi, Ltd. on December 31, 2002.

- 27 -

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 29 through 32 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 32 through 38. 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 six months of 2003, the company acquired Rational and
continued to invest in RD&E and in fixed assets. The company ended the second
quarter with $5,821 million in Cash and cash equivalents and current Marketable
securities. Non-Global Financing debt was $878 million at June 30, 2003, a
decrease of $1,311 million from December 31, 2002. The non-Global Financing
debt-to-capital ratio was 3.7 percent.

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.

CASH FLOW

Net cash provided by operating activities for the first six months of 2003
was $133 million higher than the first six months of 2002. This increase was
primarily driven by greater income from continuing operations. In addition,
Global financing receivables - which the company manages more as an
investment than as part of working capital - contributed approximately $3,248
million of cash flow during the first six months of 2003, an increase of $45
million over the same period in 2002. These contributions to cash flows from
operating activities, however, were partially offset by the following items:
The decline in Other accounts receivable, such as trade, during the first six
months of 2003 was lower than such decline in the first six months of 2002
due to better revenue performance in the first six months of 2003. Inventory
grew during the first six months of 2003 versus a decline in the first six
months of 2002, despite inventory turns improving by one turn. Increased
payments of approximately $450 million for

- 28 -

FINANCIAL CONDITION - (CONTINUED)

restructuring payments and non-US pension contributions also caused the decrease
in cash flows from operating activities.

The increase in cash flows used in investing activities from the first six
months of 2002 to the first six months of 2003 was primarily attributable to the
purchase of Rational. The decrease in the cash used in financing activities from
the first six months of 2002 to the same period of 2003 was primarily the result
of lower stock repurchases partially offset by a reduction of debt due to the
company's strategy to reduce stock repurchases and instead pay down its debt
during the first half of 2003.

WORKING CAPITAL

The $1,857 decrease in Current assets was primarily due to declines of
$1,067 million in Short-term financing receivables (see pages 34 through 36),
$683 million in Notes and accounts receivable-trade mainly due to lower revenue
volumes in the 2003 second quarter as compared to year-end volumes, and $154
million in Cash and cash equivalents and current Marketable securities. The
decrease in Cash and cash equivalents and current Marketable securities was
primarily the result of the $1,079 million net cash payment for the purchase of
Rational and Think Dynamics, partially offset by an increase of $383 million for
the monetization of interest rate swaps.

Current liabilities decreased $3,039 million primarily due to declines of
$1,035 million in Accounts payable and accruals and $846 million in Taxes
payable resulting from declines in these balances from typically higher year-end
levels as well as $1,158 million in Short-term debt, see page 30.

INVESTMENTS

The company acquired Rational for $2,092 million. In addition, the company
invested $2,421 million in RD&E and capitalized external software costs of $146
million and internal-use software costs of $151 million. The company also
invested $2,209 million for Plant, rental machines and other property, a
decrease of $315 million from the comparable 2002 period, driven primarily by
lower Microelectronics capital spending.

In the first six months of 2003, the company paid $171 million for the
repurchase of the company's common shares. At June 30, 2003, the company has
remaining authorization to

- 29 -

FINANCIAL CONDITION - (CONTINUED)

purchase $3,693 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.

In addition, the company expects to increase its purchases of common shares
in the second half of 2003. Any increases in the common share repurchase program
in the second half of 2003 will be funded 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.

The major rating agencies' ratings of the company's debt securities at June
30, 2003, appear in the table below and remain unchanged from December 31, 2002:

* Non-global financing debt is the company's total external debt less the Global
Financing debt described in the Global Financing balance sheet on page 34.

The company's non-global financing businesses generate significant cash
from ongoing operations and therefore generally do not require a significant
amount of debt. Cash flows from operations are these businesses' primary source
of funds for future investments.

A review of the company's debt and equity should also consider other
contractual obligations and commitments, which are disclosed on page 16. These
amounts are summarized in the table on page 31 to facilitate a reader's review.

Stockholders' equity increased $3,791 million from December 31, 2002,
primarily due to an increase in the company's retained earnings.

- 30 -

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 June
30, 2003.

LIQUIDITY

The company maintains two global credit facilities totaling $10.0 billion in
committed credit lines at June 30, 2003, including an $8.0 billion five-year
facility (which has three years remaining) and a $2.0 billion 364-day facility
(which expires on May 27, 2004), as part of its ongoing efforts to ensure
appropriate levels of liquidity. As of June 30, 2003, amounts unused and
available under these facilities were approximately $9.8 billion. At June 30,
2003, the company also had other mostly uncommitted lines of credit of
approximately $9.1 billion, of which approximately $6.8 billion was unused as of
June 30, 2003.

As discussed on page 27, the company may make contributions to its pension
plans. Any such contributions could be funded from various sources including
cash from operations and cash from financing activities. As discussed on page
10, the company paid an additional net cash amount to PwC of $397 million in
July 2003. The amount was funded from operations.

Any increases in the common share repurchase program in the second half of
2003 will be funded from operations. The amount of repurchases will be based
upon market conditions and the company's liquidity requirements.

The company may from time to time seek to retire certain outstanding
indebtedness either through open market repurchases, privately negotiated
transactions, tender offers, or otherwise. Such repurchases, if any, will depend
on prevailing market conditions, the company's liquidity requirements, and other
factors.

- 31 -

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 June 30, 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 second
quarter of 2003 and an unfavorable effect of approximately 1 percentage point in
the second 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

* Quarterly and year-to-date return on equity is calculated using a two-point
and three point, respectively, 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.

- 32 -

GLOBAL FINANCING - (CONTINUED)

Global Financing revenue decreased 2.3 percent for the second quarter of
2003, when compared to the same period last year. The decrease in external
revenue was driven by lower financing income due to a lower average asset base
resulting from decreases in demand for IT equipment caused by the current
economic environment, and also due to a decrease in external used equipment
sales. The decline in external revenue was offset by an increase in internal
revenue due to an increase in internal used equipment sales, primarily zSeries,
and an increase in the average internal asset base resulting from increased
originations through the Global Services segment. Global Financing remarkets
used equipment, primarily resulting from returns off of lease, both externally
and internally. External remarketed equipment represents sales to customers and
resellers, while internally remarketed equipment primarily represents used
equipment, which is sold internally and then remarketed externally through the
Hardware segment.

Global Financing revenue increased 1.0 percent for the first six months of
2003, when compared to the same period last year. The increase in revenue is
driven by an increase in internal revenue partially offset by a reduction in
external revenue due to the same dynamics underlying the second quarter trends
described above.

Global Financing gross profit dollars decreased 5.2 percent and 1.2 percent
while gross profit margin declined 1.7 percent and 1.3 percent, respectively,
for the second quarter and first six months of 2003, when compared to the same
periods last year. The decreases in gross profit dollars were primarily driven
by a decrease in financing revenue discussed above partially offset by lower
borrowing costs related to the current interest rate environment. The decreases
in gross profit margin were driven by a mix change towards lower margin
remarketing sales and away from financing income.

Global Financing Pre-tax income increased 24.9 percent and 24.0 percent,
respectively, for the second quarter and first six months of 2003, when compared
to the same periods last year. The increases were driven by a decrease in bad
debts expense reflective of the required provisions the company was making in
prior periods to reflect the general economic environment as well as specific
customer issues, such as the Communications sector. These issues have stabilized
and contributed to the lower year-to-year changes. (Also see page 36 for an
additional discussion of IBM Global Financing Allowance for Doubtful Accounts.)

The increase in return on equity from the second quarter and first six
months of 2003 when compared to the same periods last year was due to higher net
income.

- 33 -

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.

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 38.

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

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GLOBAL FINANCING - (CONTINUED)

financing generally range from 30 to 90 days. Also included in commercial
financing assets are syndicated loans.

Originations

Cash collections of customer and commercial financing assets exceeded new
financing originations in both the second quarter and first six months of 2003,
which resulted in a net decline in financing assets from December 31, 2002.
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 and debt to
IBM.

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.

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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 written off
during the period.
** Primarily represents translation adjustments.

The percentage of financing receivables reserved increased from 3.5 percent
at December 31, 2002, to 3.6 percent at June 30, 2003. The increase in reserve
percentage was due to an 8.0 percent decline in the asset base from year end.
Unallocated reserves decreased 6.0 percent from $184 million at December 31,
2002 to $173 million at June 30, 2003, while the reserve coverage increased
slightly during the same period. The overall credit quality of the portfolio
continues to remain stable and the unallocated reserve primarily reflects loss
history and the current economic environment. Specific reserves decreased 5.0
percent from $787 million at December 31, 2002 to $748 million at June 30, 2003.
The decrease in specific reserves was due to the write-off of reserved
receivables during the period combined with lower requirements for additional
specific reserves.

Global Financing's bad debts expense declined to $130 million for the six
months ended June 30, 2003, compared with $251 million for the six months ended
June 30, 2002. The decline was primarily attributed to higher reserve additions
required in the first six months of 2002 associated with the Communications
sector and the Latin America region, as compared to the first six months of
2003. These issues have stabilized and contributed to the lower year-to-year
charges.

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GLOBAL FINANCING - (CONTINUED)

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
products under lease. Based upon this product 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 35.7 percent and 35.0 percent of Global Financing's
revenue in the second quarter and first six months, respectively, of 2003 and
30.7 percent and 27.2 percent in the second quarter and first six months,
respectively, of 2002. The gross margins on these sales were 26.4 percent and
31.1 percent in the second quarter of 2003 and 2002, respectively. The gross
margins were 26.2 percent for both the first six months of 2003 and 2002. In
addition to selling assets sourced off 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 June 30, 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 June 30, 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 34.

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GLOBAL FINANCING - (CONTINUED)

[CHART]

GLOBAL FINANCING

* As of June 30, 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 34 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 32 and in Segment Information on pages 49 through 52.

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 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

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FORWARD LOOKING AND CAUTIONARY STATEMENTS - (CONTINUED)

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.

ITEM 4. CONTROLS AND PROCEDURES

The company's management evaluated, with the participation of the Chief
Executive Officer and Chief Financial Officer, the effectiveness of the
company's disclosure controls and procedures as of the end of the period covered
by this report. Based on that evaluation, the Chief Executive Officer and Chief
Financial Officer have concluded that the company's disclosure controls and
procedures were effective as of the end of the period covered by this report.
There has been no change in the company's internal control over financial
reporting that occurred during the quarter covered by this report that has
materially affected, or is reasonably likely to materially affect, the company's
internal control over financial reporting.

PART II - OTHER INFORMATION

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

The International Business Machines Corporation held its Annual Meeting of
Stockholders on April 29, 2003. For more information on the following proposals,
see the company's proxy statement dated March 10, 2003, the relevant portions of
which are incorporated herein by reference.

(1) The stockholders elected each of the ten nominees to the Board of Directors
for a one-year term:

(2) The stockholders ratified the appointment of PricewaterhouseCoopers LLP as
independent accountants of the company:

For 1,280,682,086
Against 86,191,883
Abstain 17,468,362
-------------
Total 1,384,342,331

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ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS - (CONTINUED)

(3) The stockholders ratified the appointment of Ernst & Young LLP as
independent accountants for the company's Business Consulting Services Unit:

For 1,347,357,342
Against 17,833,299
Abstain 19,151,690
-------------
Total 1,384,342,331

(4) The stockholders approved the adoption of the IBM 2003 Employees Stock
Purchase Plan:

For 1,324,821,566
Against 40,150,872
Abstain 19,369,893
-------------
Total 1,384,342,331

(5) The stockholders defeated a shareholder proposal on Cumulative Voting:

For 301,282,401
Against 688,608,526
Abstain 60,535,993
Broker No Vote 333,915,411
-------------
Total 1,384,342,331

(6) The stockholders defeated a shareholder proposal on Pension and Retirement
Medical:

For 143,921,813
Against 874,375,728
Abstain 32,129,379
Broker No Vote 333,915,411
-------------
Total 1,384,342,331

(7) The stockholders defeated a shareholder proposal on Executive Compensation:

For 186,772,744
Against 833,877,111
Abstain 29,777,065
Broker No Vote 333,915,411
-------------
Total 1,384,342,331

(8) The stockholders defeated a shareholder proposal on Poison Pills:

For 380,336,597
Against 639,318,590
Abstain 30,771,733
Broker No Vote 333,915,411
-------------
Total 1,384,342,331

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ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS - (CONTINUED)

(9) The stockholders defeated a shareholder proposal on Expensing Stock Options:

For 475,733,092
Against 530,708,486
Abstain 43,985,342
Broker No Vote 333,915,411
-------------
Total 1,384,342,331

ITEM 6 (a). EXHIBITS

EXHIBIT NUMBER

3 The By-laws of IBM as amended through June 24, 2003.

11 Statement re: computation of per share earnings.

12 Statement re: computation of ratios.

22 The company's proxy statement dated March 10, 2003, containing the full
text of the proposals referred to in Item 4, which was previously filed
electronically, is hereby incorporated by reference.

31.1 Certification by CEO pursuant to Rule 13A-14 or 15D of the Securities
Exchange Act of 1934, as adopted pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.

31.2 Certification by CFO pursuant to Rule 13A-14 or 15D of the Securities
Exchange Act of 1934, as adopted pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.

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

32.2 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 a Form 8-K on April 14, 2003, with respect to the
company's financial results for the period ended March 31, 2003, and included
the unaudited Consolidated Statement of Earnings, Consolidated Statement of
Financial Position and Segment Data for the period ended March 31, 2003. In
addition, IBM's Chief Financial Officer, John R. Joyce's first-quarter earnings
presentation to security analysts on Monday, April 14, 2003, was filed as
Attachment II of the Form 8-K.

The company filed a Form 8-K on April 15, 2003, to correct the page numbers
in Attachment II that were furnished pursuant to Item 9 in the Form 8-K filed on
April 14, 2003. No financial statements were filed with this Form 8-K.

- 41 -

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

The company filed a Form 8-K on May 14, 2003, with IBM's Chairman and CEO
Samuel J. Palmisano's charts presented at the 2003 Spring Security Analysts
Meeting held on Wednesday, May 14, 2003. No financial statements were filed with
this Form 8-K.

The company filed a Form 8-K on June 2, 2003, with the registrant's press
release regarding a notice of a formal, nonpublic investigation by the
Securities and Exchange Commission. No financial statements were filed with this
Form 8-K.

The company filed a Form 8-K on June 24, 2003, with the registrant's press
release announcing that Lorenzo H. Zambrano had been elected to the company's
board of directors. No financial statements were filed with this Form 8-K.

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: August 14, 2003

By:

Robert F. Woods
----------------------

Robert F. Woods
Vice President and Controller

- 42 -