Index

	Page
Part I - Financial Information:

Item 1. Consolidated Financial Statements (Unaudited):

Consolidated Statement of Earnings for the three ~~and six~~ months ended ~~June 30,~~March 31, 2017 and 2016 ~~and 2015~~	3

Consolidated Statement of Comprehensive Income for the three ~~and six~~ months ended ~~June 30,~~March 31, 2017 and 2016 ~~and 2015~~	4

Consolidated Statement of Financial Position at ~~June 30, 2016~~March 31, 2017 and December 31, ~~2015~~2016	5

Consolidated Statement of Cash Flows for the ~~six~~three months ended ~~June 30,~~March 31, 2017 and 2016 ~~and 2015~~	7

Consolidated Statement of Changes in Equity for the ~~six~~three months ended ~~June 30,~~March 31, 2017 and 2016 ~~and 2015~~	8

Notes to Consolidated Financial Statements	9

Item 2. Management’s Discussion and Analysis of Results of Operations and Financial Condition	4740

Item 4. Controls and Procedures	8969

Part II - Other Information:

Item 1. Legal Proceedings	8969

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds and Issuer Repurchases of Equity Securities	8969

Item 6. Exhibits	9070

Part I - Financial Information

Item 1. Consolidated Financial Statements:

INTERNATIONAL BUSINESS MACHINES CORPORATION

AND SUBSIDIARY COMPANIES

CONSOLIDATED STATEMENT OF EARNINGS

(UNAUDITED)

	Three Months Ended June 30,						Six Months Ended June 30,						Three Months Ended March 31,
(Dollars in millions except per share amounts)	2016			2015			2016			2015			2017			2016
Revenue:
Services	$	13,018		$	12,597		$	25,409		$	24,963		$	12,342		$	12,391
Sales	6,792			7,733			12,671			14,489			5,404			5,879
Financing	429			484			843			950			409			414
Total revenue	20,238			20,813			38,923			40,403			18,155			18,684
Cost:
Services	8,691			8,431			17,074			16,709			8,553			8,382
Sales	1,582			1,726			2,960			3,351			1,551			1,378
Financing	263			266			501			501			279			238
Total cost	10,536			10,423			20,535			20,561			10,383			9,999
Gross profit	9,702			10,390			18,388			19,842			7,772			8,686
Expense and other (income):
Selling, general and administrative	5,349			5,179			11,361			10,541			5,152			6,012
Research, development and engineering	1,465			1,300			2,923			2,598			1,533			1,458
Intellectual property and custom development income	(365		)	(128		)	(582		)	(301		)	(445		)	(217		)
Other (income) and expense	37			(301		)	289			(444		)	(28		)	253
Interest expense	167			115			315			223			135			147
Total expense and other (income)	6,653			6,165			14,306			12,617			6,348			7,652
Income from continuing operations before income taxes	3,049			4,224			4,082			7,225			1,424			1,034
Provision for/(benefit from) income taxes	544			698			(439		)	1,283			(329		)	(983		)
Income from continuing operations	$	2,505		$	3,526		$	4,521		$	5,942		$	1,753		$	2,016
Loss from discontinued operations, net of tax	0			(77		)	(3		)	(165		)	(3		)	(3		)
Net income	$	2,504		$	3,449		$	4,518		$	5,777		$	1,750		$	2,014

Earnings/(loss) per share of common stock:
Assuming dilution:
Continuing operations	$	2.61		$	3.58		$	4.69		$	6.01		$	1.85		$	2.09
Discontinued operations	0.00			(0.08		)	0.00			(0.17		)	0.00			0.00
Total	$	2.61		$	3.50		$	4.69		$	5.84		$	1.85		$	2.09
Basic:
Continuing operations	$	2.62		$	3.59		$	4.71		$	6.03		$	1.86		$	2.09
Discontinued operations	0.00			(0.08		)	0.00			(0.17		)	0.00			0.00
Total	$	2.62		$	3.51		$	4.71		$	5.86		$	1.86		$	2.09

Weighted-average number of common shares outstanding: (millions)
Assuming dilution	960.5			986.7			962.4			989.5			947.8			964.4
Basic	957.4			982.3			959.5			985.2			942.4			961.7

Cash dividend per common share	$	1.40		$	1.30		$	2.70		$	2.40		$	1.40		$	1.30

(Amounts may not add due to rounding.)

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

INTERNATIONAL BUSINESS MACHINES CORPORATION

AND SUBSIDIARY COMPANIES

CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME

(UNAUDITED)

	Three Months Ended June 30,						Six Months Ended June 30,						Three Months Ended March 31,
(Dollars in millions)	2016			2015			2016			2015			2017			2016
Net income	$	2,504		$	3,449		$	4,518		$	5,777		$	1,750		$	2,014
Other comprehensive income/(loss), before tax:
Foreign currency translation adjustments	(248		)	102			(10		)	(350		)	161			239
Net changes related to available-for-sale securities:
Unrealized gains/(losses) arising during the period	1			(15		)	(35		)	17			(1		)	(36		)
Reclassification of (gains)/losses to net income	0			0			37			0			1			37
Total net changes related to available-for-sale securities	1			(15		)	2			16			0			1
Unrealized gains/(losses) on cash flow hedges:
Unrealized gains/(losses) arising during the period	9			(187		)	(256		)	432			(33		)	(265		)
Reclassification of (gains)/losses to net income	102			(321		)	11			(570		)	(98		)	(91		)
Total unrealized gains/(losses) on cash flow hedges	111			(508		)	(245		)	(138		)	(130		)	(356		)
Retirement-related benefit plans:
Prior service costs/(credits)	—			1			—			6			0			—
Net (losses)/gains arising during the period	78			93			(68		)	16			61			(147		)
Curtailments and settlements	10			3			14			7			(1		)	5
Amortization of prior service (credits)/costs	(27		)	(25		)	(53		)	(51		)	(21		)	(25		)
Amortization of net (gains)/losses	693			821			1,383			1,656			710			690
Total retirement-related benefit plans	754			894			1,277			1,635			748			522
Other comprehensive income/(loss), before tax	617			472			1,023			1,163			779			406
Income tax (expense)/benefit related to items of other comprehensive income	(223		)	(62		)	(21		)	(719		)	(92		)	202
Other comprehensive income/(loss)	394			411			1,002			444			688			608
Total comprehensive income/(loss)	$	2,899		$	3,860		$	5,520		$	6,221		$	2,438		$	2,622

(Amounts may not add due to rounding.)

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

INTERNATIONAL BUSINESS MACHINES CORPORATION

AND SUBSIDIARY COMPANIES

CONSOLIDATED STATEMENT OF FINANCIAL POSITION

(UNAUDITED)

ASSETS

	At June 30,		At December 31,		At March 31,		At December 31,
(Dollars in millions)	2016		2015		2017		2016
Assets:
Current assets:
Cash and cash equivalents	$	10,017	$	7,686	$	10,096	$	7,826
Marketable securities	600		508		599		701
Notes and accounts receivable - trade (net of allowances of $352 in 2016 and $367 in 2015)	8,782		8,333
Short-term financing receivables (net of allowances of $526 in 2016 and $490 in 2015)	16,635		19,020
Other accounts receivable (net of allowances of $58 in 2016 and $51 in 2015)	1,130		1,201
Notes and accounts receivable - trade (net of allowances of $302 in 2017 and $290 in 2016)					8,377		9,182
Short-term financing receivables (net of allowances of $351 in 2017 and $337 in 2016)					16,362		19,006
Other accounts receivable (net of allowances of $38 in 2017 and $48 in 2016)					1,130		1,057
Inventories, at lower of average cost or market:
Finished goods	414		352		423		358
Work in process and raw materials	1,271		1,199		1,186		1,195
Total inventories	1,685		1,551		1,609		1,553
Prepaid expenses and other current assets	4,676		4,205		4,715		4,564
Total current assets	43,524		42,504		42,889		43,888
Property, plant and equipment	30,136		29,342		30,681		30,133
Less: Accumulated depreciation	19,044		18,615		19,816		19,303
Property, plant and equipment — net	11,092		10,727		10,865		10,830
Long-term financing receivables (net of allowances of $142 in 2016 and $118 in 2015)	9,267		10,013
Long-term financing receivables (net of allowances of $99 in 2017 and $101 in 2016)					8,502		9,021
Prepaid pension assets	2,957		1,734		3,491		3,034
Deferred taxes	4,387		4,822		6,457		5,224
Goodwill	36,422		32,021		36,307		36,199
Intangible assets — net	5,148		3,487		4,436		4,688
Investments and sundry assets	5,259		5,187		4,549		4,585
Total assets	$	118,056	$	110,495	$	117,495	$	117,470

(Amounts may not add due to rounding.)

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

INTERNATIONAL BUSINESS MACHINES CORPORATION

AND SUBSIDIARY COMPANIES

CONSOLIDATED STATEMENT OF FINANCIAL POSITION — (CONTINUED)

(UNAUDITED)

LIABILITIES AND EQUITY

	At June 30,			At December 31,			At March 31,			At December 31,
(Dollars in millions)	2016			2015			2017			2016
Liabilities:
Current liabilities:
Taxes	$	2,275		$	2,847		$	2,747		$	3,235
Short-term debt	4,887			6,461			8,340			7,513
Accounts payable	5,484			6,028			5,324			6,209
Compensation and benefits	3,950			3,560			3,197			3,577
Deferred income	11,508			11,021			12,351			11,035
Other accrued expenses and liabilities	5,480			4,353			4,522			4,705
Total current liabilities	33,585			34,269			36,481			36,275
Long-term debt	39,638			33,428			34,441			34,655
Retirement and nonpension postretirement benefit obligations	16,723			16,504			16,967			17,070
Deferred income	3,837			3,771			3,557			3,600
Other liabilities	8,385			8,099			7,601			7,477
Total liabilities	102,167			96,071			99,047			99,078
Equity:
IBM stockholders’ equity:
Common stock, par value $0.20 per share, and additional paid-in capital	53,565			53,262			54,104			53,935
Shares authorized: 4,687,500,000
Shares issued:2016 - 2,224,090,577
2015 - 2,221,223,449
Shares issued: 2017 - 2,226,175,975
2016 - 2,225,116,815
Retained earnings	148,071			146,124			153,292			152,759
Treasury stock - at cost	(157,298		)	(155,518		)	(160,359		)	(159,050		)
Shares:2016 - 1,268,246,360
2015 - 1,255,494,724
Shares: 2017 - 1,286,679,091
2016 - 1,279,249,412
Accumulated other comprehensive income/(loss)	(28,604		)	(29,607		)	(28,710		)	(29,398		)
Total IBM stockholders’ equity	15,733			14,262			18,327			18,246
Noncontrolling interests	156			162			121			146
Total equity	15,889			14,424			18,448			18,392
Total liabilities and equity	$	118,056		$	110,495		$	117,495		$	117,470

(Amounts may not add due to rounding.)

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

INTERNATIONAL BUSINESS MACHINES CORPORATION

AND SUBSIDIARY COMPANIES

CONSOLIDATED STATEMENT OF CASH FLOWS

(UNAUDITED)

	Six Months Ended June 30,						Three Months Ended March 31,
(Dollars in millions)	2016			2015			2017			2016
Cash flows from operating activities:
Net income	$	4,518		$	5,777		$	1,750		$	2,014
Adjustments to reconcile net income to cash provided by operating activities
Depreciation	1,382			1,335			709			677
Amortization of intangibles	745			594			390			347
Stock-based compensation	261			257			129			133
Net (gain)/loss on asset sales and other	167			152			13			172
Loss on Microelectronics business disposal	—			37
Changes in operating assets and liabilities, net of acquisitions/divestitures	2,015			(659		)	964			2,187		* **
Net cash provided by operating activities	9,088			7,494			3,955			5,530		* **

Cash flows from investing activities:
Payments for property, plant and equipment	(1,826		)	(1,722		)	(740		)	(956		)
Proceeds from disposition of property, plant and equipment	172			182			58			129
Investment in software	(295		)	(290		)	(137		)	(144		)
Acquisition of businesses, net of cash acquired	(5,405		)	(708		)	(109		)	(2,590		)
Divestitures of businesses, net of cash transferred	35			81			(1		)	47
Non-operating finance receivables — net	1,127			1,338			1,570			1,500		*
Purchases of marketable securities and other investments	(2,386		)	(1,716		)	(1,273		)	(1,041		)
Proceeds from disposition of marketable securities and other investments	2,028			1,464			981			1,169
Net cash used in investing activities	(6,550		)	(1,371		)
Net cash (used in)/provided by investing activities							350			(1,886		)*

Cash flows from financing activities:
Proceeds from new debt	8,263			2,765			2,887			8,085
Payments to settle debt	(3,425		)	(4,463		)	(1,531		)	(2,211		)
Short-term borrowings/(repayments) less than 90 days — net	(909		)	177			(880		)	(910		)
Common stock repurchases	(1,775		)	(2,303		)	(1,293		)	(939		)
Common stock repurchases for tax withholdings							(50		)	(27		)**
Common stock transactions — other	115			221			54			59
Cash dividends paid	(2,590		)	(2,366		)	(1,321		)	(1,250		)
Net cash used in financing activities	(322		)	(5,970		)
Net cash (used in)/provided by financing activities							(2,134		)	2,806		**

Effect of exchange rate changes on cash and cash equivalents	114			(236		)	100			217
Net change in cash and cash equivalents	2,330			(83		)	2,270			6,668

Cash and cash equivalents at January 1	7,686			8,476			7,826			7,686
Cash and cash equivalents at June 30	$	10,017		$	8,393
Cash and cash equivalents at March 31							$	10,096		$	14,354

* Revised classification of certain financing receivables.

** Reclassified to reflect adoption of the FASB guidance on share-based compensation.

(Amounts may not add due to rounding.)

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

INTERNATIONAL BUSINESS MACHINES CORPORATION

AND SUBSIDIARY COMPANIES

CONSOLIDATED STATEMENT OF CHANGES IN EQUITY

(UNAUDITED)

Common

Stock and

Accumulated

Additional

Other

Total IBM

Non-

Paid-in

Retained

Treasury

Comprehensive

Stockholders’

Controlling

Total

(Dollars in millions)

Capital

Earnings

Stock

Income/(Loss)

Equity

Interests

Equity

Equity - January 1, 2016

$
53,262

$
146,124

$
(155,518
)
$
(29,607
)
$
14,262

$
162

$
14,424

Net income plus other comprehensive income/(loss)

Net income

4,518

4,518

4,518

Other comprehensive income/(loss)

1,002

1,002

1,002

Total comprehensive income/(loss)

$
5,520

$
5,520

Cash dividends paid — common stock

(2,590
)

(2,590
)

(2,590
)
Common stock issued under employee plans (2,867,128 shares)

321

321

321

Purchases (769,837 shares) and sales (323,578 shares) of treasury stock under employee plans — net

16

(71
)

(56
)

(56
)
Other treasury shares purchased, not retired (12,305,377 shares)

(1,709
)

(1,709
)

(1,709
)
Changes in other equity

(18
)
2

(16
)

(16
)
Changes in noncontrolling interests

(6
)
(6
)
Equity - June 30, 2016

$
53,565

$
148,071

$
(157,298
)
$
(28,604
)
$
15,733

$
156

$
15,889

	Common
	Stock and								Accumulated
	Additional								Other			Total IBM			Non-
	Paid-in		Retained			Treasury			Comprehensive			Stockholders’			Controlling			Total
(Dollars in millions)	Capital		Earnings			Stock			Income/(Loss)			Equity			Interests			Equity
Equity - January 1, 2017	$	53,935	$	152,759		$	(159,050	)	$	(29,398	)	$	18,246		$	146		$	18,392
Cumulative effect of change in accounting principle *			102									102						102

Net income			1,750									1,750						1,750
Other comprehensive income/(loss)									688			688						688
Total comprehensive income/(loss)												$	2,438					$	2,438
Cash dividends paid — common stock			(1,321		)							(1,321		)				(1,321		)
Common stock issued under employee plans (1,059,160 shares)	169											169						169
Purchases (289,364 shares) and sales (43,179 shares) of treasury stock under employee plans — net			1			(45		)				(44		)				(44		)
Other treasury shares purchased, not retired (7,183,494 shares)						(1,264		)				(1,264		)				(1,264		)
Changes in noncontrolling interests															(25		)	(25		)
Equity - March 31, 2017	$	54,104	$	153,292		$	(160,359	)	$	(28,710	)	$	18,327		$	121		$	18,448

	Common																				Common
	Stock and									Accumulated											Stock and									Accumulated
	Additional									Other			Total IBM			Non-					Additional									Other			Total IBM			Non-
	Paid-in			Retained			Treasury			Comprehensive			Stockholders’			Controlling		Total			Paid-in			Retained			Treasury			Comprehensive			Stockholders’			Controlling			Total
(Dollars in millions)	Capital			Earnings			Stock			Income/(Loss)			Equity			Interests		Equity			Capital			Earnings			Stock			Income/(Loss)			Equity			Interests			Equity
Equity - January 1, 2015	$	52,666		$	137,793		$	(150,715	)	$	(27,875	)	$	11,868		$	146	$	12,014
Net income plus other comprehensive income/(loss)
Equity - January 1, 2016																					$	53,262		$	146,124		$	(155,518	)	$	(29,607	)	$	14,262		$	162		$	14,424

Net income				5,777									5,777					5,777						2,014									2,014						2,014
Other comprehensive income/(loss)										444			444					444												608			608						608
Total comprehensive income/(loss)													$	6,221				$	6,221														$	2,622					$	2,622
Cash dividends paid — common stock				(2,366		)							(2,366		)			(2,366		)				(1,250		)							(1,250		)				(1,250		)
Common stock issued under employee plans (3,929,697 shares)	395												395					395
Purchases (931,120 shares) and sales (475,037 shares) of treasury stock under employee plans — net				14			(91		)				(77		)			(77		)
Other treasury shares purchased, not retired (14,467,545 shares)							(2,356		)				(2,356		)			(2,356		)
Common stock issued under employee plans (1,049,083 shares)																					185												185						185
Purchases (216,803 shares) and sales (40,129 shares) of treasury stock under employee plans — net																								0			(22		)				(22		)				(22		)
Other treasury shares purchased, not retired (6,639,282 shares)																											(863		)				(863		)				(863		)
Changes in other equity	(2		)										(2		)			(2		)	(9		)										(9		)				(9		)
Changes in noncontrolling interests																8		8																		(14		)	(14		)
Equity - June 30, 2015	$	53,059		$	141,218		$	(153,162	)	$	(27,432	)	$	13,684		$	153	$	13,837
Equity - March 31, 2016																					$	53,439		$	146,888		$	(156,404	)	$	(28,998	)	$	14,925		$	147		$	15,072

* Reflects the adoption of the FASB guidance on intra-entity transfers of assets.

(Amounts may not add due to rounding.)

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

Notes to Consolidated Financial Statements:

1. Basis of Presentation: The accompanying Consolidated Financial Statements and footnotes of the International Business Machines Corporation (IBM or the company) have been prepared in accordance with accounting principles generally accepted in the United States of America (GAAP). The financial statements and footnotes are unaudited. In the opinion of the company’s management, these statements include all adjustments, which are only of a normal recurring nature, necessary to present a fair statement of the company’s results of operations, financial position and cash flows.

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amount of assets, liabilities, revenue, costs, expenses and other comprehensive income/(loss) that are reported in the Consolidated Financial Statements and accompanying disclosures. These estimates are based on management’s best knowledge of current events, historical experience, actions that the company may undertake in the future and on various other assumptions that are believed to be reasonable under the circumstances. As a result, actual results may be different from these estimates. Refer to the company’s ~~recast 2015~~2016 Annual Report on ~~Form 8-K, dated June 13, 2016,~~ pages 4871 to ~~51,~~74, for a discussion of the company’s critical accounting estimates.

~~On October 20, 2014,~~The company revised the classification of certain financing receivables for the three months ended March 31, 2016, decreasing net cash provided by operating activities and net cash used in investing activities in the amount of $142 million, which the company ~~announced a definitive agreement~~concluded to ~~divest its Microelectronics business and manufacturing operations~~be immaterial to ~~GLOBALFOUNDRIES.~~the period presented. The ~~assets and liabilities of~~twelve-month revision for the ~~Microelectronics business were reported as held for sale at~~period ended December 31, ~~2014, and~~2016 was provided in the ~~operating results of the Microelectronics business have been reported as discontinued operations. The transaction closed~~company’s 2016 Annual Report on ~~July 1, 2015. Refer~~page 26. There was no impact to ~~note 9, “Acquisitions/Divestitures,” for additional information on the transaction.~~total GAAP cash flows or free cash flow.

~~In January 2016,~~For the ~~company made a number of changes to its organizational structure and management system. These changes impacted~~three months ended March 31, 2017, the company’s ~~reportable segments, but did not impact~~benefit from income taxes was $329 million, and its effective tax rate was (23.1) percent. This was primarily driven by a discrete tax benefit of $582 million from a first-quarter 2017 transaction accounted for under the ~~Consolidated~~new Financial Statements. Refer to note 6, “Segments,” on pages 27 to 29 for additional information on the changes in reportable segments. The periods presented in this Form 10-Q are reported on a comparable basis. The company filed a recast 2015 Annual Report in a Form 8-K on June 13, 2016 to recast its historical segment information to reflect these changes.

In the first quarter of 2016, the company classified certain properties, primarily office space, as held for sale. As a result of the company’s reassessment of its real estate portfolio, certain properties were approved for sale and are beingactively marketed. The sales are expected to be completed within twelve months from the date of classification as held for sale. A pre-tax impairment charge of $252 million was recorded to other income (expense)Accounting Standards Board (FASB) guidance related to ~~the applicable land, buildings and furniture and fixtures as~~intra-entity transfers of ~~March 31, 2016. The pre-tax~~assets. This benefit was partially offset by a discrete tax charge ~~reflected the difference between the net book value and the fair value (estimated proceeds) less the estimated costs~~related to ~~sell the properties. The fair value~~foreign audit activity of ~~these assets is not material.~~

$99 million. In the first quarter of 2016, the company reported a benefit from income taxes of $983 million, and its effective tax rate was (95.1) percent, primarily driven by the resolution of a long-standing ~~non-U.S.~~Japan tax matter in February 2016. ~~For~~Refer to note 2, “Accounting Changes,” and the ~~six months ended June 30, 2016,~~Taxes section of the ~~company’s benefit from income taxes is $439 million and its effective tax rate is (10.8) percent. See Taxes on page 71~~Management Discussion for additional information.

Noncontrolling interest amounts of ~~$3.0~~$3.6 million and ~~$2.4~~$1.3 million, net of tax, for the three months ended ~~June 30,~~March 31, 2017 and 2016, ~~and 2015, respectively, and $4.4 million and $3.5 million, net of tax, for the six months ended June 30, 2016 and 2015,~~ respectively, are included as a reduction within other (income) and expense in the Consolidated Statement of ~~Earnings within the other (income) and expense line item.~~Earnings.

Interim results are not necessarily indicative of financial results for a full year. The information included in this Form 10-Q should be read in conjunction with the company’s ~~2015~~2016 Annual ~~Report and Form 8-K dated June 13, 2016.~~Report.

Within the financial statements and tables presented, certain columns and rows may not add due to the use of rounded numbers for disclosure purposes. Percentages presented are calculated from the underlying whole-dollar amounts. Certain prior year amounts have been reclassified to conform to the current year presentation. This is annotated where applicable.

2. Accounting Changes:

New Standards to be Implemented

In March 2017, the FASB issued guidance that impacts the presentation of net periodic pension and postretirement benefit costs. Under the guidance, the service cost component of net benefit cost will continue to be presented in the same line items as other employee compensation costs, unless eligible for capitalization in the Consolidated Statement of Financial Position. The other components of net benefit costs will be presented separately from service cost as non-operating costs in the Consolidated Statement of Earnings or Notes to the Consolidated Financial Statements. The guidance is effective January 1, 2018 with early adoption permitted. The company will adopt the guidance as of the effective date. The guidance is primarily a change in financial statement presentation and is not expected to have a material impact in the consolidated financial results.

In June 2016, the ~~Financial Accounting Standards Board (FASB)~~FASB issued guidance for credit impairment based on an expected loss model rather than an incurred loss model. The guidance requires the consideration of all available relevant information when estimating expected credit losses, including past events, current conditions and forecasts and their implications for expected credit losses. The guidance is effective January 1, 2020 with a one year early adoption permitted. The company is evaluating the impact of the new ~~guidance and the effective date.~~guidance.

Notes to Consolidated Financial Statements — (continued)

~~In March 2016, the FASB issued guidance which changes the~~ accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, and classification in the Consolidated Statement of Cash Flows. The guidance is effective January 1, 2017 and early adoption is permitted. The impact of the guidance could result in increased volatility of the company’s provision for income taxes and earnings per share in the Consolidated Statement of Earnings, depending on the company’s share price at exercise or vesting of share-based awards compared to grant date. The standard is not expected to have a material impact upon adoption.

In February 2016, the FASB issued guidance which changes the accounting for leases. The guidance requires lessees to recognize right-of-use assets and lease liabilities for most leases in the Consolidated Statement of Financial Position. The guidance makes some changes to lessor accounting, including the elimination of the use of third-party residual value guarantee insurance in the capital lease test, and overall aligns with the new revenue recognition guidance. The guidance also requires qualitative and quantitative disclosures to assess the amount, timing and uncertainty of cash flows arising from leases. The guidance is effective January 1, 2019 and early adoption is permitted. The company will adopt the guidance as of the effective date. A cross-functional implementation team has been established which is evaluating the lease portfolio, system, process and policy change requirements. The company is currently evaluating the impact of the new guidance on its consolidated financial results and expects it will have a material impact on the ~~effective date.~~Consolidated Statement of Financial Position. The company’s operating lease commitments were ~~$6.4~~$6.9 billion at December 31, ~~2015, and in 2015,~~2016. In 2016, the use of third-party residual value guarantee insurance resulted in the company recognizing ~~$608~~$220 million of sales-type lease revenue that would otherwise have been recognized over the lease period as operating lease ~~revenue over the lease term.~~revenue.

In January 2016, the FASB issued guidance which addresses aspects of recognition, measurement, presentation and disclosure of financial instruments. Certain equity investments will be measured at fair value with changes recognized in net income. The amendment also simplifies the impairment test of equity investments that lack readily determinable fair value. The guidance is effective January 1, 2018 and early adoption is not permitted except for limited provisions. The guidance is not expected to have a material impact in the consolidated financial results.

The FASB issued guidance on the recognition of revenue from contracts with customers in May 2014 with amendments in 2015 and 2016. Revenue recognition will depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The guidance also requires disclosures regarding the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers. The guidance permits two methods of adoption: retrospectively to each prior reporting period presented, or retrospectively with the cumulative effect of initially applying the guidance recognized at the date of initial application (the cumulative catch-up transition method). The guidance was initially effective January 1, 2017 and early adoption was not permitted. The amended guidance provides for a one-year deferral of the effective date to January 1, 2018, with an option of applying the standard on the original effective date. The company will adopt the guidance on January 1, 2018 and apply the cumulative catch-up transition method.

Given the scope of work required to implement the recognition and disclosure requirements under the new standard, the company began its assessment process in 2014 and has since made significant progress, including identification of changes to policy, processes, systems and controls. This also includes the assessment of data availability and presentation necessary to meet the additional disclosure requirements of the guidance in the Notes to the Consolidated Financial Statements.

The company expects revenue recognition for its broad portfolio of hardware, software and services offerings to remain largely unchanged. However, the guidance is ~~continuing~~expected to ~~evaluate~~change the ~~impact~~timing of revenue recognition in certain areas, including accounting for certain software licenses. These impacts are not expected to be material. The company expects to continue to recognize revenue for term license (recurring license charge) software arrangements on a monthly basis over the period that the client is entitled to use the license due to the contractual terms in these arrangements.

Since the company currently expenses sales commissions as incurred, the requirement in the new ~~guidance~~standard to capitalize certain in-scope sales commissions is being evaluated to determine its potential impact in the consolidated financial ~~results.~~statements in the year of adoption. There will be no impact to cash flows.

The company continues to assess all potential impacts of the guidance and given normal ongoing business dynamics, preliminary conclusions are subject to change.

Standards Implemented

In ~~November 2015,~~January 2017, the FASB issued guidance which clarifies the definition of a business. The guidance provides a more robust framework to use in determining when a set of assets and activities acquired or sold is a business. The guidance is effective January 1, 2018 and early adoption is permitted. The company adopted the guidance effective January 1, 2017, and it did not have a material impact in the consolidated financial results.

In October 2016, the FASB issued guidance which requires ~~deferred~~an entity to recognize the income tax ~~liabilities~~consequences of intra-entity transfers of assets, other than inventory, at the time of transfer. Assets within the scope of the guidance include intellectual property and ~~assets be classified as noncurrent in the statement of financial position.~~property, plant and equipment. The guidance ~~was~~is effective January 1, ~~2016 with~~2018 and early adoption is

Notes to Consolidated Financial Statements — (continued)

permitted. The company adopted the guidance on January 1, 2017 using the required modified retrospective method. At adoption, $95 million and $47 million were reclassified from investments and sundry assets and prepaid expenses and other current assets, respectively into retained earnings. Additionally, net deferred taxes of $244 million were established in deferred taxes in the ~~fourth quarter~~Consolidated Statement of ~~2015~~Financial Position, resulting in a cumulative-effect net credit to retained earnings of $102 million. In January 2017, the company had one transaction that generated a $582 million benefit to income tax expense, income from continuing operations and net income and a benefit to basic and diluted earnings per share of $0.62 and $0.61 per share, respectively, for the three months ended March 31, 2017. The ongoing impact of this guidance will be dependent on any transaction that is within its scope.

In March 2016, the FASB issued guidance which changes the accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities and classification in the Consolidated Statement of Cash Flows. The guidance was effective and adopted by the company on January 1, 2017, and it did not have a retrospective basis. The company reclassified current deferred tax assets of $2.0 billion at December 31, 2014 to deferred tax assets and current deferred tax liabilities of $19 million at December 31, 2014 to other liabilities from other accrued expenses and liabilitiesmaterial impact in the Consolidated Statement of Financial Position. ~~In order to offset deferred tax assets~~The ongoing impact of the guidance could result in increased volatility in the provision for income taxes and ~~liabilities for presentation as a single noncurrent amount by tax jurisdiction, the company also reclassified $178 million at December 31, 2014 from deferred tax assets to other liabilities~~earnings per share in the Consolidated Statement of ~~Financial Position.~~Earnings, depending on the company’s share price at exercise or vesting of share-based awards compared to grant date, however these impacts are not expected to be material. These impacts are recorded on a prospective basis. See note 5, “Stock-Based Compensation,” for additional information. The company continues to estimate forfeitures in conjunction with measuring stock-based compensation cost. The guidance also requires cash payments on behalf of employees for shares directly withheld for taxes to be presented as financing outflows in the Consolidated Statement of Cash Flows. Prior to adoption, the company reported this activity as an operating cash outflow and as a result, prior periods have been reclassified as required.

In September 2015, the FASB issued guidance eliminating the requirement that an acquirer in a business combination account for a measurement-period adjustment retrospectively. Instead, an acquirer will recognize a measurement-period adjustment during the period in which the amount of the adjustment is determined. In addition, the portion of the amount recorded in current-period earnings by line item that would have been recorded in previous reporting periods if the adjustment to the provisional amounts had been recognized as of the acquisition date should be presented separately on the face of the income statement or disclosed in the notes. The guidance was effective January 1, 2016 on a prospective basis. The guidance did not have a material impact in the consolidated financial results.

In May 2015, the FASB issued guidance which removed the requirement to categorize within the fair value hierarchy all investments for which fair value is measured using the net asset value per share practical expedient. The amendments also removed the requirement to make certain disclosures for all investments that are eligible to be measured at fair value using the net asset value per share practical expedient. Rather, those disclosures are limited to investments for which the entity has elected to measure the fair value using that practical expedient. The guidance was effective January 1, 2016. The guidance was a change in disclosure only and did not have an impact in the consolidated financial results.

~~Notes to Consolidated Financial Statements — (continued)~~

In April 2015, the FASB issued guidance about whether a cloud computing arrangement includes a software license. If a cloud computing arrangement includes a software license, then the customer should account for the software license element of the arrangement consistent with the acquisition of other software licenses. If a cloud computing arrangement does not include a software license, the customer should account for the arrangement as a services contract. All software licenses recognized under this guidance will be accounted for consistent with other licenses of intangible assets. The guidance was effective January 1, 2016 and the company adopted it on a prospective basis. The guidance did not have a material impact in the consolidated financial results.

In April 2015, the FASB issued guidance which requires debt issuance costs related to a recognized debt liability to be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. The guidance was effective January 1, 2016 with early adoption permitted. The company adopted the guidance in the fourth quarter of 2015 on a retrospective basis. The company had debt issuance costs of $90 million and $74 million at June 30, 2016 and December 31, 2015, respectively. Debt issuance costs were previously included in investments and sundry assets in the Consolidated Statement of Financial ~~Position.~~

3. Financial Instruments:

Fair Value Measurements

Accounting guidance defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Under this guidance, the company is required to classify certain assets and liabilities based on the following fair value hierarchy:

· Level 1—Quoted prices (unadjusted) in active markets for identical assets or liabilities that can be accessed at the measurement date;

· Level 2—Inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly; and

· Level 3—Unobservable inputs for the asset or liability.

Notes to Consolidated Financial Statements — (continued)

The guidance requires the use of observable market data if such data is available without undue cost and effort.

When available, the company uses unadjusted quoted market prices in active markets to measure the fair value and classifies such items as Level 1. If quoted market prices are not available, fair value is based upon internally developed models that use current market-based or independently sourced market parameters such as interest rates and currency rates. Items valued using internally generated models are classified according to the lowest level input or value driver that is significant to the valuation.

The determination of fair value considers various factors including interest rate yield curves and time value underlying the financial instruments. For derivatives and debt securities, the company uses a discounted cash flow analysis using discount rates commensurate with the duration of the instrument.

In determining the fair value of financial instruments, the company considers certain market valuation adjustments to the “base valuations” calculated using the methodologies described below for several parameters that market participants would consider in determining fair value:

· Counterparty credit risk adjustments are applied to financial instruments, taking into account the actual credit risk of a counterparty as observed in the credit default swap market to determine the true fair value of such an instrument.

· Credit risk adjustments are applied to reflect the company’s own credit risk when valuing all liabilities measured at fair value. The methodology is consistent with that applied in developing counterparty credit risk adjustments, but incorporates the company’s own credit risk as observed in the credit default swap market.

As an example, the fair value of derivatives is derived utilizing a discounted cash flow model that uses observable market inputs such as known notional value amounts, yield curves, spot and forward exchange rates as well as discount rates. These inputs relate to liquid, heavily traded currencies with active markets which are available for the full term of the derivative.

Certain financial assets are measured at fair value on a nonrecurring basis. These assets include equity method investments that are recognized at fair value at the measurement date to the extent that they are deemed to be other-than-temporarily impaired. Certain assets that are measured at fair value on a recurring basis can be subject to nonrecurring fair value measurements. These assets include available-for-sale equity investments that are deemed to be other-than-temporarily

~~Notes to Consolidated Financial Statements — (continued)~~

impaired. In the event of an other-than-temporary impairment of a financial investment, fair value is measured using a model described above.

Non-financial assets such as property, plant and equipment, land, goodwill and intangible assets are also subject to nonrecurring fair value measurements if they are deemed to be impaired. The impairment models used for nonfinancial assets depend on the type of asset. During the ~~six~~three months ended ~~June 30,~~March 31, 2016, ~~the company recorded an~~a pre-tax impairment oncharge related to certain ~~assets that are classified as held for sale. See note 1, “Basis~~property, plant and equipment of ~~Presentation,” for additional information.~~$252 million was recorded. There were no material impairments of non-financial assets for the ~~six~~three months ended ~~June 30, 2015.~~March 31, 2017.

Accounting guidance permits the measurement of eligible financial assets, financial liabilities and firm commitments at fair value, on an instrument-by-instrument basis, that are otherwise not permitted to be accounted for at fair value under other accounting standards. This election is irrevocable. The company has not applied the fair value option to any eligible assets or liabilities.

The following tables present the company’s financial assets and financial liabilities that are measured at fair value on a recurring basis at ~~June 30, 2016~~March 31, 2017 and December 31, ~~2015.~~2016.

Notes to Consolidated Financial Statements — (continued)

(Dollars in millions)
At June 30, 2016	Level 1		Level 2		Level 3		Total
At March 31, 2017										Level 1		Level 2		Level 3		Total
Assets:
Cash equivalents (1)
Time deposits and certificates of deposit	$	—	$	3,198	$	—	$	3,198		$	—	$	5,720	$	—	$	5,720
Commercial paper	—		—		—		—
Money market funds	2,141		—		—		2,141			1,440		—		—		1,440
U.S. government securities	—		1,500		—		1,500
Canadian government securities	—		462		—		462
Total	2,141		5,160		—		7,301		(6)	1,440		5,720		—		7,160		(6)
Debt securities - current (2)	—		599		—		599		(6)	—		599		—		599		(6)
Debt securities - noncurrent (3)	1		7		—		9			1		6		—		7
Available-for-sale equity investments (3)	11		—		—		11			5		—		—		5
Derivative assets (4)
Interest rate contracts	—		1,015		—		1,015			—		498		—		498
Foreign exchange contracts	—		258		—		258			—		389		—		389
Equity contracts	—		11		—		11			—		6		—		6
Total	—		1,284		—		1,284		(7)	—		894		—		894		(7)
Total assets	$	2,153	$	7,051	$	—	$	9,204	(7)	$	1,447	$	7,218	$	—	$	8,665	(7)
Liabilities:
Derivative liabilities (5)
Foreign exchange contracts	$	—	$	406	$	—	$	406		$	—	$	155	$	—	$	155
Equity contracts	—		8		—		8			—		6		—		6
Interest rate contracts										—		5		—		5
Total liabilities	$	—	$	414	$	—	$	414	(7)	$	—	$	166	$	—	$	166	(7)

(1) Included within cash and cash equivalents in the Consolidated Statement of Financial Position.

(2) U.S. government securities ~~time deposits and certificates of deposit~~ reported as marketable securities in the Consolidated Statement of Financial Position.

(3) Included within investments and sundry assets in the Consolidated Statement of Financial Position.

(4) The gross balances of derivative assets contained within prepaid expenses and other current assets, and investments and sundry assets in the Consolidated Statement of Financial Position at ~~June 30, 2016~~March 31, 2017 were ~~$262~~$348 million and ~~$1,022~~$546 million, respectively.

(5) The gross balances of derivative liabilities contained within other accrued expenses and liabilities, and other liabilities in the Consolidated Statement of Financial Position at ~~June 30, 2016~~March 31, 2017 were ~~$374~~$130 million and ~~$40~~$35 million, respectively.

(6) Available-for-sale securities with carrying values that approximate fair value.

(7) If derivative exposures covered by a qualifying master netting agreement had been netted in the Consolidated Statement of Financial Position, the total derivative asset and liability positions each would have been reduced by ~~$280~~$122 million.

Notes to Consolidated Financial Statements — (continued)

(Dollars in millions)
At December 31, 2015	Level 1			Level 2		Level 3		Total
At December 31, 2016											Level 1		Level 2		Level 3		Total
Assets:
Cash equivalents (1)			��
Time deposits and certificates of deposit	$	—		$	2,856	$	—	$	2,856		$	—	$	3,629	$	—	$	3,629
Money market funds	2,069			—		—		2,069			1,204		—		—		1,204
Other securities	—			18		—		18
Total	2,069			2,874		—		4,943		(6)	1,204		3,629		—		4,832		(6)
Debt securities - current (2)	—			506		—		506		(6)	—		699		—		699		(6)
Debt securities - noncurrent (3)	1			6		—		8			1		6		—		8
Trading security investments (3)	28			—		—		28
Available-for-sale equity investments (3)	192			—		—		192			7		—		—		7
Derivative assets (4)
Interest rate contracts	—			656		—		656			—		555		—		555
Foreign exchange contracts	—			332		—		332			—		560		—		560
Equity contracts	—			6		—		6			—		11		—		11
Total	—			994		—		994		(7)	—		1,126		—		1,126		(7)
Total assets	$	2,290		$	4,381	$	—	$	6,671	(7)	$	1,212	$	5,460	$	—	$	6,672	(7)
Liabilities:
Derivative liabilities (5)
Foreign exchange contracts	$	—		$	164	$	—	$	164		$	—	$	188	$	—	$	188
Equity contracts	—			19		—		19			—		10		—		10
Interest rate contracts	—			3		—		3			—		8		—		8
Total liabilities	$	—		$	186	$	—	$	186	(7)	$	—	$	206	$	—	$	206	(7)

(1) Included within cash and cash equivalents in the Consolidated Statement of Financial Position.

(2) ~~Commercial paper and certificates of deposit~~U.S government securities reported as marketable securities in the Consolidated Statement of Financial Position.

(3) Included within investments and sundry assets in the Consolidated Statement of Financial Position.

(4) The gross balances of derivative assets contained within prepaid expenses and other current assets, and investments and sundry assets in the Consolidated Statement of Financial Position at December 31, ~~2015~~2016 were ~~$292~~$532 million and ~~$702~~$594 million, respectively.

(5) The gross balances of derivative liabilities contained within other accrued expenses and liabilities, and other liabilities in the Consolidated Statement of Financial Position at December 31, ~~2015~~2016 were ~~$164~~$145 million and ~~$22~~$61 million, respectively.

(6) Available-for-sale securities with carrying values that approximate fair value.

There were no transfers between Levels 1 and 2 for the ~~six~~three months ended ~~June 30, 2016~~March 31, 2017 and the year ended December 31, ~~2015.~~2016.

Financial Assets and Liabilities Not Measured at Fair Value

Short-Term Receivables and Payables

Notes and other accounts receivable and other investments are financial assets with carrying values that approximate fair value. Accounts payable, other accrued expenses and short-term debt (excluding the current portion of long-term debt) are financial liabilities with carrying values that approximate fair value. If measured at fair value in the financial statements, these financial instruments would be classified as Level 3 in the fair value ~~hierarchy.~~hierarchy, except for short-term debt, which would be classified as Level 2.

Loans and Long-term Receivables

Fair values are based on discounted future cash flows using current interest rates offered for similar loans to clients with similar credit ratings for the same remaining maturities. At ~~June 30, 2016~~March 31, 2017 and December 31, ~~2015,~~2016, the difference between the carrying amount and estimated fair value for loans and long-term receivables was immaterial. If measured at fair value in the financial statements, these financial instruments would be classified as Level 3 in the fair value hierarchy.

Notes to Consolidated Financial Statements — (continued)

Long-Term Debt

Fair value of publicly-traded long-term debt is based on quoted market prices for the identical liability when traded as an asset in an active market. For other long-term debt for which a quoted market price is not available, an expected present value technique that uses rates currently available to the company for debt with similar terms and remaining maturities is used to estimate fair value. The carrying amount of long-term debt was ~~$39,638~~$34,441 million and ~~$33,428~~$34,655 million, and the estimated fair value was ~~$42,506~~$36,733 million and ~~$35,220~~$36,838 million at ~~June 30, 2016~~March 31, 2017 and December 31, ~~2015,~~2016, respectively. If measured at fair value in the financial statements, long-term debt (including the current portion) would be classified as Level 2 in the fair value hierarchy.

Debt and Marketable Equity Securities

The company’s cash equivalents and current debt securities are considered available-for-sale and recorded at fair value, which is not materially different from carrying value, in the Consolidated Statement of Financial Position.

The following tables summarize the company’s noncurrent debt and marketable equity securities which are considered available-for-sale and recorded at fair value in the Consolidated Statement of Financial Position.

			Gross		Gross						Gross		Gross
(Dollars in millions)	Adjusted		Unrealized		Unrealized		Fair		Adjusted		Unrealized		Unrealized		Fair
At June 30, 2016:	Cost		Gains		Losses		Value
At March 31, 2017:									Cost		Gains		Losses		Value
Debt securities — noncurrent(1)	$	6	$	3	$	—	$	9	$	5	$	2	$	—	$	7
Available-for-sale equity investments(1)	$	2	$	9	$	0	$	11	$	1	$	4	$	0	$	5

(1) Included within investments and sundry assets in the Consolidated Statement of Financial Position.

			Gross		Gross						Gross		Gross
(Dollars in millions)	Adjusted		Unrealized		Unrealized		Fair		Adjusted		Unrealized		Unrealized		Fair
At December 31, 2015:	Cost		Gains		Losses		Value
At December 31, 2016:									Cost		Gains		Losses		Value
Debt securities — noncurrent(1)	$	5	$	3	$	—	$	8	$	5	$	3	$	—	$	8
Available-for-sale equity investments(1)	$	186	$	6	$	0	$	192	$	3	$	5	$	0	$	7

(1) Included within investments and sundry assets in the Consolidated Statement of Financial Position.

During the fourth quarter of 2014, the company acquired equity securities in conjunction with the sale of the System x business which were classified as available-for-sale securities. Based on an evaluation of available evidence as of December 31, 2015, the company recorded an other-than-temporary impairment loss of $86 million resulting in an adjusted cost basis of $185 million as of December 31, 2015. In the first quarter of 2016, the company recorded a gross realized loss of $37 million (before taxes) related to the sale of all the outstanding shares. The loss on this sale was recorded in other (income) and expense in the Consolidated Statement of Earnings.

Sales of debt and available-for-sale equity investments during the period were as follows:

(Dollars in millions)
For the three months ended June 30:	2016		2015
For the three months ended March 31:					2017		2016
Proceeds	$	1	$	1	$	5	$	148
Gross realized gains (before taxes)	0		0		1		—
Gross realized losses (before taxes)	0		0		2		37

Notes to Consolidated Financial Statements — (continued)

(Dollars in millions)

For the six months ended June 30:

2016

2015

Proceeds

$
149

$
6

Gross realized gains (before taxes)

0

1

Gross realized losses (before taxes)

37

0

The after-tax net unrealized holding gains/(losses) on available-for-sale debt and marketable equity securities that have

been included in other comprehensive income/(loss) for the period and the after-tax net (gains)/losses reclassified from accumulated other comprehensive income/(loss) to net income were as follows:

~~Notes to Consolidated Financial Statements — (continued)~~

(Dollars in millions)

For the three months ended June 30:

2016

2015

Net unrealized gains/(losses) arising during the period

$
1

$
(10
)
Net unrealized (gains)/losses reclassified to net income*

0

0

*There were no writedowns for the three months ended June 30, 2016 and 2015, respectively.

(Dollars in millions)
For the six months ended June 30:	2016			2015
For the three months ended March 31:						2017			2016
Net unrealized gains/(losses) arising during the period	$	(22	)	$	10	$	(1	)	$	(22	)
Net unrealized (gains)/losses reclassified to net income*	23			0		1			23

* There were no writedowns for the ~~six~~three months ended ~~June 30,~~March 31, 2017 and 2016, ~~and 2015,~~ respectively.

The contractual maturities of substantially all available-for-sale debt securities are less than one year at ~~June 30, 2016.~~March 31, 2017.

Derivative Financial Instruments

The company operates in multiple functional currencies and is a significant lender and borrower in the global markets. In the normal course of business, the company is exposed to the impact of interest rate changes and foreign currency fluctuations, and to a lesser extent equity and commodity price changes and client credit risk. The company limits these risks by following established risk management policies and procedures, including the use of derivatives, and, where cost effective, financing with debt in the currencies in which assets are denominated. For interest rate exposures, derivatives are used to better align rate movements between the interest rates associated with the company’s lease and other financial assets and the interest rates associated with its financing debt. Derivatives are also used to manage the related cost of debt. For foreign currency exposures, derivatives are used to better manage the cash flow volatility arising from foreign exchange rate fluctuations.

As a result of the use of derivative instruments, the company is exposed to the risk that counterparties to derivative contracts will fail to meet their contractual obligations. To mitigate the counterparty credit risk, the company has a policy of only entering into contracts with carefully selected major financial institutions based upon their overall credit profile. The company’s established policies and procedures for mitigating credit risk on principal transactions include reviewing and establishing limits for credit exposure and continually assessing the creditworthiness of counterparties. The right of set-off that exists under certain of these arrangements enables the legal entities of the company subject to the arrangement to net amounts due to and from the counterparty reducing the maximum loss from credit risk in the event of counterparty default.

The company is also a party to collateral security arrangements with most of its major derivative counterparties. These arrangements require the company to hold or post collateral (cash or U.S. Treasury securities) when the derivative fair values exceed contractually established thresholds. Posting thresholds can be fixed or can vary based on credit default swap pricing or credit ratings received from the major credit agencies. The aggregate fair value of all derivative instruments under these collateralized arrangements that were in a liability position at ~~June 30, 2016~~March 31, 2017 and December 31, ~~2015~~2016 was ~~$99~~$4 million and ~~$28~~$11 million, respectively, for which no collateral was posted at ~~June 30, 2016 and December 31, 2015.~~either date. Full collateralization of these agreements would be required in the event that the company’s credit rating falls below investment grade or if its credit default swap spread exceeds 250 basis points, as applicable, pursuant to the terms of the collateral security arrangements. The aggregate fair value of derivative instruments in asset positions as of ~~June 30, 2016~~March 31, 2017 and December 31, ~~2015~~2016 was ~~$1,284~~$894 million and ~~$994~~$1,126 million, respectively. This amount represents the maximum exposure to loss at the reporting date if the counterparties failed to perform as contracted. This exposure was reduced by ~~$280~~$122 million and ~~$139~~$116 million at ~~June 30, 2016~~March 31, 2017 and December 31, ~~2015,~~2016, respectively, of liabilities included in master netting arrangements with those counterparties. Additionally, at ~~June 30, 2016~~March 31, 2017 and December 31, ~~2015,~~2016, this exposure was reduced by ~~$230~~$91 million and ~~$90~~$141 million of cash collateral, respectively, and ~~$96 million and $40~~$35 million of non-cash collateral in U.S. Treasury securities ~~respectively, received by the company.~~at December 31, 2016. There were no non-cash collateral balances in U.S. Treasury securities at March 31, 2017. At ~~June 30, 2016~~March 31, 2017 and December 31, ~~2015,~~2016, the net exposure related to derivative assets recorded in the Consolidated Statement of Financial Position was ~~$678~~$681 million and ~~$726~~$834 million, respectively. At ~~June 30, 2016~~March 31, 2017 and December 31, ~~2015,~~2016, the net exposure related to derivative liabilities recorded in the Consolidated Statement of Financial Position was ~~$134~~$44 million and ~~$47~~$90 million, respectively.

In the Consolidated Statement of Financial Position, the company does not offset derivative assets against liabilities in master netting arrangements nor does it offset receivables or payables recognized upon payment or receipt of cash collateral against the fair values of the related derivative instruments. No amount was recognized in other receivables at ~~June 30, 2016~~March 31, 2017 or December 31, ~~2015~~2016 for the right to reclaim cash collateral. The amount recognized in accounts payable for the obligation

~~Notes to Consolidated Financial Statements — (continued)~~

to return cash collateral was ~~$230~~$91 million and ~~$90~~$141 million at ~~June 30, 2016~~March 31, 2017 and December 31, ~~2015,~~2016, respectively. The company restricts the use of cash collateral received to rehypothecation, and therefore reports it in prepaid

Notes to Consolidated Financial Statements — (continued)

expenses and other current assets in the Consolidated Statement of Financial Position. No amount was rehypothecated at ~~June 30, 2016~~March 31, 2017 and December 31, ~~2015.~~2016.

The company may employ derivative instruments to hedge the volatility in stockholders’ equity resulting from changes in currency exchange rates of significant foreign subsidiaries of the company with respect to the U.S. dollar. These instruments, designated as net investment hedges, expose the company to liquidity risk as the derivatives have an immediate cash flow impact upon maturity which is not offset by a cash flow from the translation of the underlying hedged equity. The company monitors this cash loss potential on an ongoing basis and may discontinue some of these hedging relationships by de-designating or terminating the derivative instrument in order to manage the liquidity risk. Although not designated as accounting hedges, the company may utilize derivatives to offset the changes in the fair value of the de-designated instruments from the date of de-designation until maturity.

In its hedging programs, the company uses forward contracts, futures contracts, interest-rate swaps, cross-currency swaps, and options depending upon the underlying exposure. The company is not a party to leveraged derivative instruments.

A brief description of the major hedging programs, categorized by underlying risk, follows.

Interest Rate Risk

Fixed and Variable Rate Borrowings

The company issues debt in the global capital markets to fund its operations and financing business. Access to cost-effective financing can result in interest rate mismatches with the underlying assets. To manage these mismatches and to reduce overall interest cost, the company uses interest-rate swaps to convert specific fixed-rate debt issuances into variable-rate debt (i.e., fair value hedges) and to convert specific variable-rate debt issuances into fixed-rate debt (i.e., cash flow hedges). At ~~June 30, 2016~~March 31, 2017 and December 31, ~~2015,~~2016, the total notional amount of the company’s interest rate swaps was $7.3 billion at both periods. The weighted-average remaining maturity of these instruments at ~~June 30, 2016~~March 31, 2017 and December 31, ~~2015~~2016 was approximately ~~6.7~~6.0 years and ~~7.2~~6.2 years, respectively.

Forecasted Debt Issuance

The company is exposed to interest rate volatility on future debt issuances. To manage this risk, the company may use forward starting interest-rate swaps to lock in the rate on the interest payments related to the forecasted debt issuance. These swaps are accounted for as cash flow hedges. The company did not have any derivative instruments relating to this program outstanding at ~~June 30, 2016~~March 31, 2017 and December 31, ~~2015.~~2016.

At ~~June 30, 2016~~March 31, 2017 and December 31, ~~2015,~~2016, net gains of less than $1 million (before taxes), respectively, were recorded in accumulated other comprehensive income/(loss) in connection with cash flow hedges of the company’s borrowings. Within these amounts, less than $1 million of gains, respectively, are expected to be reclassified to net income within the next 12 months, providing an offsetting economic impact against the underlying transactions.

Foreign Exchange Risk

Long-Term Investments in Foreign Subsidiaries (Net Investment)

A large portion of the company’s foreign currency denominated debt portfolio is designated as a hedge of net investment in foreign subsidiaries to reduce the volatility in stockholders’ equity caused by changes in foreign currency exchange rates in the functional currency of major foreign subsidiaries with respect to the U.S. dollar. The company also uses cross-currency swaps and foreign exchange forward contracts for this risk management purpose. At ~~June 30, 2016~~March 31, 2017 and December 31, ~~2015,~~2016, the total notional amount of derivative instruments designated as net investment hedges was ~~$8.3~~$6.4 billion and ~~$5.5~~$6.7 billion, respectively. ~~The~~At March 31, 2017 and December 31, 2016, the weighted-average remaining maturity of these instruments ~~at June 30, 2016 and December 31, 2015~~ was approximately ~~0.1 years and~~ 0.2 years ~~respectively.~~at both periods.

Anticipated Royalties and Cost Transactions

The company’s operations generate significant nonfunctional currency, third-party vendor payments and intercompany payments for royalties and goods and services among the company’s non-U.S. subsidiaries and with the parent company. In

~~Notes to Consolidated Financial Statements — (continued)~~

anticipation of these foreign currency cash flows and in view of the volatility of the currency markets, the company selectively employs foreign exchange forward contracts to manage its currency risk. These forward contracts are accounted

Notes to Consolidated Financial Statements — (continued)

for as cash flow hedges. The maximum length of time over which the company has hedged its exposure to the variability in future cash flows is four years. At ~~June 30, 2016~~March 31, 2017 and December 31, ~~2015,~~2016, the total notional amount of forward contracts designated as cash flow hedges of forecasted royalty and cost transactions was $8.1 billion and ~~$8.2~~$8.3 billion, respectively. The weighted-average remaining maturity of these instruments at ~~June 30, 2016~~March 31, 2017 and December 31, ~~2015~~2016 was ~~0.6 years and~~ 0.7 years ~~respectively.~~at both periods.

At ~~June 30, 2016~~March 31, 2017 and December 31, ~~2015,~~2016, in connection with cash flow hedges of anticipated royalties and cost transactions, the company recorded net ~~losses~~gains of ~~$76~~$342 million and ~~net gains of $147~~$462 million (before taxes), respectively, in accumulated other comprehensive income/(loss). Within these amounts, ~~$118~~$245 million ~~of losses~~ and ~~$121~~$397 million of gains, respectively, are expected to be reclassified to net income within the next 12 months, providing an offsetting economic impact against the underlying anticipated transactions.

Foreign Currency Denominated Borrowings

The company is exposed to exchange rate volatility on foreign currency denominated debt. To manage this risk, the company employs cross-currency swaps to convert fixed-rate foreign currency denominated debt to fixed-rate debt denominated in the functional currency of the borrowing entity. These swaps are accounted for as cash flow hedges. The maximum length of time over which the company has hedged its exposure to the variability in future cash flows is approximately nine years. At ~~June 30,~~March 31, 2017 and December 31, 2016, the total notional amount of cross-currency swaps designated as cash flow hedges of foreign currency denominated debt was $1.4 ~~billion. At December 31, 2015, no amounts were outstanding under this program.~~billion at both periods.

At ~~June 30, 2016~~March 31, 2017 and December 31, ~~2015,~~2016, in connection with cash flow hedges of foreign currency denominated borrowings, the company recorded net ~~losses~~gains of ~~$24~~$19 million and net ~~losses~~gains of $2$29 million (before taxes), respectively, in accumulated other comprehensive income/(loss). Within these amounts, ~~$22~~$27 million of gains ~~and less than $1 million of losses, respectively,~~at both periods are expected to be reclassified to net income within the next 12 months, providing an offsetting economic impact against the underlying exposure.

Subsidiary Cash and Foreign Currency Asset/Liability Management

The company uses its Global Treasury Centers to manage the cash of its subsidiaries. These centers principally use currency swaps to convert cash flows in a cost-effective manner. In addition, the company uses foreign exchange forward contracts to economically hedge, on a net basis, the foreign currency exposure of a portion of the company’s nonfunctional currency assets and liabilities. The terms of these forward and swap contracts are generally less than one year. The changes in the fair values of these contracts and of the underlying hedged exposures are generally offsetting and are recorded in other (income) and expense in the Consolidated Statement of Earnings. At ~~June 30, 2016~~March 31, 2017 and December 31, ~~2015,~~2016, the total notional amount of derivative instruments in economic hedges of foreign currency exposure was ~~$11.1~~$10.1 billion and ~~$11.7~~$12.7 billion, respectively.

Equity Risk Management

The company is exposed to market price changes in certain broad market indices and in the company’s own stock primarily related to certain obligations to employees. Changes in the overall value of these employee compensation obligations are recorded in selling, general and administrative (SG&A) expense in the Consolidated Statement of Earnings. Although not designated as accounting hedges, the company utilizes derivatives, including equity swaps and futures, to economically hedge the exposures related to its employee compensation obligations. The derivatives are linked to the total return on certain broad market indices or the total return on the company’s common stock, and are recorded at fair value with gains or losses also reported in SG&A expense in the Consolidated Statement of Earnings. At ~~June 30, 2016~~March 31, 2017 and December 31, ~~2015,~~2016, the total notional amount of derivative instruments in economic hedges of these compensation obligations was ~~$1.1 billion and~~ $1.2 billion ~~respectively.~~at both periods.

Other Risks

The company may hold warrants to purchase shares of common stock in connection with various investments that are deemed derivatives because they contain net share or net cash settlement provisions. The company records the changes in the fair value of these warrants in other (income) and expense in the Consolidated Statement of Earnings. The company did not have any significant warrants qualifying as derivatives outstanding at ~~June 30, 2016~~March 31, 2017 and December 31, ~~2015.~~

~~Notes to Consolidated Financial Statements — (continued)~~2016.

The company is exposed to a potential loss if a client fails to pay amounts due under contractual terms. The company may utilize credit default swaps to economically hedge its credit exposures. The swaps are recorded at fair value with gains

Notes to Consolidated Financial Statements — (continued)

and losses reported in other (income) and expense in the Consolidated Statement of Earnings. The company did not have any derivative instruments relating to this program outstanding at ~~June 30, 2016~~March 31, 2017 and December 31, ~~2015.~~2016.

The company is exposed to market volatility on certain investment securities. The company may utilize options or forwards to economically hedge its market exposure. The derivatives are recorded at fair value with gains and losses reported in other (income) and expense in the Consolidated Statement of Earnings. At ~~June 30,~~March 31, 2017 and December 31, 2016, the company did not have any derivative instruments relating to this program outstanding. ~~At December 31, 2015 the total notional amount of derivative instruments in economic hedges of investment securities was less than $0.1 billion.~~

The following tables provide a quantitative summary of the derivative and non-derivative instrument-related risk management activity as of ~~June 30, 2016~~March 31, 2017 and December 31, ~~2015,~~2016, as well as for the three ~~and six~~ months ended ~~June 30,~~March 31, 2017 and 2016, ~~and 2015,~~ respectively.

~~Notes to Consolidated Financial Statements — (continued)~~

Fair Values of Derivative Instruments in the Consolidated Statement of Financial Position

As of ~~June 30, 2016~~March 31, 2017 and December 31, ~~2015~~2016

	Fair Value of Derivative Assets					Fair Value of Derivative Liabilities					Fair Value of Derivative Assets					Fair Value of Derivative Liabilities
	Balance Sheet					Balance Sheet					Balance Sheet					Balance Sheet
(Dollars in millions)	Classification	6/30/2016		12/31/2015		Classification	6/30/2016		12/31/2015		Classification	3/31/2017		12/31/2016		Classification	3/31/2017		12/31/2016
Designated as hedging instruments:
Interest rate contracts:	Prepaid expenses and other current assets	$	—	$	—	Other accrued expenses and liabilities	$	—	$	—	Prepaid expenses and other current assets	$	—	$	—	Other accrued expenses and liabilities	$	1	$	—
	Investments and sundry assets	1,015		656		Other liabilities	—		3		Investments and sundry assets	498		555		Other liabilities	4		8
Foreign exchange contracts:	Prepaid expenses and other current assets	163		197		Other accrued expenses and liabilities	311		70		Prepaid expenses and other current assets	295		421		Other accrued expenses and liabilities	61		46
	Investments and sundry assets	7		5		Other liabilities	25		19		Investments and sundry assets	47		17		Other liabilities	31		35
											Fair value of derivative assets	$	841	$	993	Fair value of derivative liabilities	$	97	$	89
Fair value of derivative assets		$	1,185	$	858	Fair value of derivative liabilities	$	335	$	92

Not designated as hedging instruments:
Foreign exchange contracts:	Prepaid expenses and other current assets	$	88	$	90	Other accrued expenses and liabilities	$	55	$	75	Prepaid expenses and other current assets	$	47	$	100	Other accrued expenses and liabilities	$	63	$	89
	Investments and sundry assets	0		40		Other liabilities	15		—		Investments and sundry assets	0		22		Other liabilities	—		18
Equity contracts:	Prepaid expenses and other current assets	11		6		Other accrued expenses and liabilities	8		19		Prepaid expenses and other current assets	6		11		Other accrued expenses and liabilities	6		10
	Investments and sundry assets	—		—		Other liabilities	—		—		Investments and sundry assets	—		—		Other liabilities	—		—
											Fair value of derivative assets	$	53	$	133	Fair value of derivative liabilities	$	68	$	117
Fair value of derivative assets		$	99	$	136	Fair value of derivative liabilities	$	79	$	94

Total debt designated as hedging instruments:
Short-term debt		N/A		N/A			$	827	$	—		N/A		N/A			$	788	$	1,125
Long-term debt		N/A		N/A			$	8,359	$	7,945		N/A		N/A			$	7,977	$	7,844

Total		$	1,284	$	994		$	9,600	$	8,131		$	894	$	1,126		$	8,931	$	9,175

N/~~A-not~~A - not applicable

Notes to Consolidated Financial Statements — (continued)

The Effect of Derivative Instruments in the Consolidated Statement of Earnings

For the three months ended ~~June 30,~~March 31, 2017 and 2016 ~~and 2015~~

	Gain (Loss) Recognized in Earnings											Gain (Loss) Recognized in Earnings
	Consolidated	Recognized on					Attributable to Risk					Consolidated	Recognized on						Attributable to Risk
(Dollars in millions)	Statement of	Derivatives(1)					Being Hedged(2)					Statement of	Derivatives						Being Hedged(2)
For the three months ended June 30:	Earnings Line Item	2016		2015			2016			2015
Derivative instruments in fair value hedges(5):
For the three months ended March 31:												Earnings Line Item	2017			2016			2017		2016
Derivative instruments in fair value hedges (1) (5):
Interest rate contracts	Cost of financing	$	77	$	(78	)	$	(55	)	$	102	Cost of financing	$	(1	)	$	137		$	23	$	(112	)
	Interest expense	88		(65		)	(63		)	86		Interest expense	(1		)	147			20		(120		)
Derivative instruments not designated as hedging instruments(1):
Derivative instruments not designated as hedging instruments:
Foreign exchange contracts	Other (income) and expense	184		(91		)	N/A			N/A		Other (income) and expense	(76		)	121			N/A		N/A
Interest rate contracts	Other (income) and expense	0		(1		)	N/A			N/A		Other (income) and expense	—			0			N/A		N/A
Equity contracts	SG&A expense	21		(6		)	N/A			N/A		SG&A expense	46			21			N/A		N/A
	Other (income) and expense	0		2			N/A			N/A		Other (income) and expense	—			(1		)	N/A		N/A

Total		$	370	$	(238	)	$	(118	)	$	189		$	(32	)	$	426		$	42	$	(233	)

	Gain (Loss) Recognized in Earnings and Other Comprehensive Income																	Gain (Loss) Recognized in Earnings and Other Comprehensive Income
													(Ineffectiveness) and																		Ineffectiveness and
(Dollars in millions)	Effective Portion						Consolidated	Effective Portion Reclassified					Amounts Excluded from					Effective Portion						Consolidated	Effective Portion Reclassified						Amounts Excluded from
For the three months	Recognized in OCI						Statement of	from AOCI					Effectiveness Testing(3)					Recognized in OCI						Statement of	from AOCI						Effectiveness Testing(3)
ended June 30:	2016			2015			Earnings Line Item	2016			2015		2016			2015
ended March 31:																		2017			2016			Earnings Line Item	2017			2016			2017		2016
Derivative instruments in cash flow hedges:
Interest rate contracts	$	—		$	—		Interest expense	$	(7	)	$	0	$	—		$	—	$	—		$	—		Interest expense	$	(7	)	$	(2	)	$	—	$	—
Foreign exchange contracts	9			(187		)	Other (income) and expense	(75		)	221		(1		)	3		(33		)	(265		)	Other (income) and expense	65			87			1		1
							Cost of sales	(13		)	58		—			—								Cost of sales*	11			9			—		—
							SG&A expense	(7		)	42		—			—								Cost of services*	8			(6		)	—		—
																								SG&A expense	20			3			—		—
Instruments in net investment hedges(4):
Foreign exchange contracts	(247		)	(175		)	Interest expense	—			—		16			2		(282		)	(693		)	Interest expense	—			—			19		10

Total	$	(238	)	$	(362	)		$	(102	)	$	321	$	15		$	5	$	(315	)	$	(959	)		$	98		$	91		$	20	$	11

* Reclassified to conform to 2017 presentation

N/~~A-not~~A - not applicable

Note: OCI represents ~~Other~~other comprehensive income/(loss) in the Consolidated Statement of Comprehensive Income and AOCI represents ~~Accumulated~~accumulated other comprehensive income/(loss) in the Consolidated Statement of Changes in Equity.

(1) The amount includes changes in clean fair values of the derivative instruments in fair value hedging relationships and the periodic accrual for coupon payments required under these derivative contracts.

(2) The amount includes basis adjustments to the carrying value of the hedged item recorded during the period and amortization of basis adjustments recorded on de-designated hedging relationships during the period.

(3) The amount of gain/(loss) recognized in income represents ineffectiveness on hedge relationships.

(4) Instruments in net investment hedges include derivative and non-derivative instruments.

(5) For the three month periods ended ~~June 30,~~March 31, 2017 and March 31, 2016, ~~and June 30, 2015,~~ fair value hedges resulted in a ~~gains~~loss of less than $1 million and a ~~loss~~gain of $5$2 million in ineffectiveness, respectively.

Notes to Consolidated Financial Statements — (continued)

~~The Effect of Derivative Instruments in the Consolidated Statement of Earnings~~

~~For the six months ended June 30, 2016 and 2015~~

Gain (Loss) Recognized in Earnings

Consolidated

Recognized on

Attributable to Risk

(Dollars in millions)

Statement of

Derivatives(1)

Being Hedged(2)

For the six months ended June 30:

Earnings Line Item

2016

2015

2016

2015

Derivative instruments in fair value hedges(4):

Interest rate contracts

Cost of financing

$
213

$
15

$
(166
)
$
39

Interest expense

236

13

(184
)
32

Derivative instruments not designated as hedging instruments(1):

Foreign exchange contracts

Other (income) and expense

305

(74
)
N/A

N/A

Interest rate contracts

Other (income) and expense

0

(1
)
N/A

N/A

Equity contracts

SG&A expense

43

18

N/A

N/A

Other (income) and expense

(1
)
3

N/A

N/A

Total

$
796

$
(26
)
$
(350
)
$
71

Gain (Loss) Recognized in Earnings and Other Comprehensive Income

(Ineffectiveness) and

Effective Portion

Consolidated

Effective Portion Reclassified

Amounts Excluded from

For the six months

Recognized in OCI

Statement of

from AOCI

Effectiveness Testing

ended June 30:

2016

2015

Earnings Line Item

2016

2015

2016

2015

Derivative instruments in cash flow hedges:

Interest rate contracts

$
—

$
—

Interest expense

$
(9
)
$
0

$
—

$
—

Foreign exchange contracts

(256
)
432

Other (income) and expense

12

380

0

3

Cost of sales

(10
)
108

—

—

SG&A expense

(3
)
82

—

—

Instruments in net investment hedges(3):

Foreign exchange contracts

(940
)
519

Interest expense

—

—

26

3

Total

$
(1,197
)
$
951

$
(11
)
$
570

$
26

$
6

~~N/A-not applicable~~

Note: OCI represents Other comprehensive income/(loss) in the Consolidated Statement of Comprehensive Income and AOCI represents Accumulated other comprehensive income/(loss) in the Consolidated Statement of Changes in Equity.

~~(1)~~ The amount includes changes in clean fair values of the derivative instruments in fair value hedging relationships and the periodic accrual for coupon payments required under these derivative contracts.

~~(2)~~ The amount includes basis adjustments to the carrying value of the hedged item recorded during the period and amortization of basis adjustments recorded on de-designated hedging relationships during the period.

~~(3)~~ ~~Instruments in net investment hedges include derivative and non-derivative instruments.~~

~~(4)~~ ~~For the six month periods ended June 30, 2016 and June 30, 2015, fair value hedges resulted in a gain of $3 million and a loss of $3 million in ineffectiveness, respectively.~~

For the three ~~and six~~ months ending ~~June 30,~~March 31, 2017 and 2016, ~~and 2015,~~ there were no significant gains or losses recognized in earnings representing hedge ineffectiveness or excluded from the assessment of hedge effectiveness (for fair value hedges), or associated with an underlying exposure that did not or was not expected to occur (for cash flow hedges); nor are there any anticipated in the normal course of business.

~~Notes to Consolidated Financial Statements — (continued)~~

4. Financing Receivables: The following table presents financing receivables, net of allowances for credit losses, including residual values.

	At June 30,		At December 31,		At March 31,		At December 31,
(Dollars in millions)	2016		2015		2017		2016
Current:
Net investment in sales-type and direct financing leases	$	3,089	$	3,057	$	2,875	$	2,909
Commercial financing receivables	7,146		8,948		7,460		9,706
Client loan and installment payment receivables (loans)	6,400		7,015		6,027		6,390
Total	$	16,635	$	19,020	$	16,362	$	19,006
Noncurrent:
Net investment in sales-type and direct financing leases	$	4,200	$	4,501	$	3,733	$	3,950
Client loan and installment payment receivables (loans)	5,067		5,512		4,769		5,071
Total	$	9,267	$	10,013	$	8,502	$	9,021

Net investment in sales-type and direct financing leases relates principally to the company’s ~~systems~~Systems products and are for terms ranging generally from two to six years. Net investment in sales-type and direct financing leases includes unguaranteed residual values of ~~$595~~$574 million and ~~$645~~$585 million at ~~June 30, 2016~~March 31, 2017 and December 31, ~~2015,~~2016, respectively, and is reflected net of unearned income of ~~$546~~$496 million and ~~$536~~$513 million, and net of allowance for credit losses of ~~$222~~$140 million and ~~$213~~$133 million at those dates, respectively.

Commercial financing receivables, net of allowance for credit losses of ~~$19~~$26 million ~~both~~and $28 million at ~~June 30, 2016~~March 31, 2017 and December 31, ~~2015,~~2016, respectively, relate primarily to inventory and accounts receivable financing for dealers and remarketers of IBM and OEM products. Payment terms for inventory and accounts receivable financing generally range from 30 to 90 days.

Client loan and installment payment receivables (loans), net of allowance for credit losses of ~~$428~~$285 million and ~~$377~~$276 million at ~~June 30, 2016~~March 31, 2017 and December 31, ~~2015,~~2016, respectively, are loans that are provided primarily to clients to finance the purchase of hardware, software and services. Payment terms on these financing arrangements are generally for terms up to seven years.

Client loan and installment payment financing contracts are priced independently at competitive market rates. The company has a history of enforcing the terms of these financing agreements.

The company utilizes certain of its financing receivables as collateral for nonrecourse borrowings. Financing receivables pledged as collateral for borrowings were ~~$563~~$658 million and ~~$545~~$689 million at ~~June 30, 2016~~March 31, 2017 and December 31, ~~2015,~~2016, respectively.

The company did not have any financing receivables held for sale as of ~~June 30, 2016~~March 31, 2017 and December 31, ~~2015.~~2016.

Financing Receivables by Portfolio Segment

The following tables present financing receivables on a gross basis, excluding the allowance for credit losses and residual value, by portfolio segment and by class, excluding commercial financing receivables and other miscellaneous financing receivables at ~~June 30, 2016~~March 31, 2017 and December 31, ~~2015.~~2016. The company determines its allowance for credit losses based on two portfolio segments: lease receivables and loan receivables, and further segments the portfolio into ~~two~~three classes: Americas, Europe/Middle East/Africa (EMEA), and Asia Pacific. This portfolio segmentation was changed from growth markets and major markets ~~and growth markets.~~in 2017 as the company no longer manages the business under those market delineations. There was no impact to segment reporting or the company’s Consolidated Financial Statements.

Notes to Consolidated Financial Statements — (continued)

(Dollars in millions)	Major			Growth
At June 30, 2016	Markets			Markets			Total
Financing receivables:
At March 31, 2017										Americas			EMEA		Asia Pacific			Total
Financing receivables
Lease receivables	$	5,355		$	1,478		$	6,833		$	3,602		$	1,154	$	1,342		$	6,098
Loan receivables	9,077			2,817			11,894			5,826			3,062		2,193			11,081
Ending balance	$	14,433		$	4,294		$	18,727		$	9,428		$	4,216	$	3,535		$	17,179
Collectively evaluated for impairment	$	14,334		$	3,829		$	18,163		$	9,250		$	4,190	$	3,371		$	16,811
Individually evaluated for impairment	$	99		$	465		$	564		$	179		$	26	$	164		$	368
Allowance for credit losses:
Beginning balance at January 1, 2016
Allowance for credit losses
Beginning balance at January 1, 2017
Lease receivables	$	25		$	188		$	213		$	54		$	4	$	76		$	133
Loan receivables	83			293			377			169			18		89			276
Total	$	109		$	481		$	590		$	223		$	22	$	165		$	410
Write-offs	(3		)	(25		)	(27		)	$	(9	)	$	0	$	0		$	(9	)
Recoveries										0			0		0			0
Provision	12			64			76			6			7		(1		)	12
Other	3			8			11			2			1		8			11
Ending balance at June 30, 2016	$	121		$	528		$	649
Ending balance at March 31, 2017										$	223		$	29	$	172		$	424
Lease receivables	$	36		$	186		$	222		$	61		$	4	$	75		$	140
Loan receivables	$	85		$	343		$	428		$	162		$	26	$	97		$	285

Collectively evaluated for impairment	$	36		$	82		$	119		$	54		$	11	$	14		$	80
Individually evaluated for impairment	$	85		$	446		$	531		$	169		$	18	$	157		$	344

(Dollars in millions)	Major			Growth
At December 31, 2015	Markets			Markets			Total
At December 31, 2016:*										Americas			EMEA			Asia Pacific			Total
Financing receivables:
Lease receivables	$	5,517		$	1,524		$	7,041		$	3,830		$	1,171		$	1,335	��	$	6,336
Loan receivables	9,739			3,165			12,904			6,185			3,309			2,243			11,737
Ending balance	$	15,256		$	4,689		$	19,945		$	10,015		$	4,480		$	3,578		$	18,073
Collectively evaluated for impairment	$	15,180		$	4,227		$	19,406		$	9,847		$	4,460		$	3,419		$	17,726
Individually evaluated for impairment	$	76		$	462		$	539		$	168		$	20		$	159		$	347
Allowance for credit losses:
Beginning balance at January 1, 2015
Allowance for credit losses
Beginning balance at January 1, 2016
Lease receivables	$	32		$	133		$	165		$	52		$	17		$	143		$	213
Loan receivables	79			317			396			122			55			200			377
Total	$	111		$	450		$	561		$	175		$	72		$	343		$	590
Write-offs	(14		)	(48		)	(62		)	$	(36	)	$	(48	)	$	(154	)	$	(237	)
Recoveries										2			0			0			2
Provision	20			122			141			65			(1		)	(6		)	58
Other	(8		)	(43		)	(51		)	17			(1		)	(18		)	(3		)
Ending balance at December 31, 2015	$	109		$	481		$	590
Ending balance at December 31, 2016										$	223		$	22		$	165		$	410
Lease receivables	$	25		$	188		$	213		$	54		$	4		$	76		$	133
Loan receivables	$	83		$	293		$	377		$	169		$	18		$	89		$	276

Collectively evaluated for impairment	$	43		$	36		$	79		$	62		$	13		$	15		$	90
Individually evaluated for impairment	$	65		$	445		$	511		$	161		$	9		$	150		$	320

* Reclassified to conform to 2017 presentation.

When determining the allowances, financing receivables are evaluated either on an individual or a collective basis. For individually evaluated receivables, the company determines the expected cash flow for the receivable and calculates an estimate of the potential loss and the probability of loss. For those accounts in which the loss is probable, the company records a specific reserve. In addition, the company records an unallocated reserve that is determined by applying a reserve rate to its different portfolios, excluding accounts that have been specifically reserved. This reserve rate is based upon credit rating, probability of default, term, characteristics (lease/loan) and loss history.

Notes to Consolidated Financial Statements — (continued)

Financing Receivables on Non-Accrual Status

The following table presents the recorded investment in financing receivables which were on non-accrual status at ~~June 30, 2016~~March 31, 2017 and December 31, ~~2015.~~

~~Notes to Consolidated Financial Statements — (continued)~~2016.

	At June 30,		At December 31,		At March 31,		At December 31,
(Dollars in millions)	2016		2015		2017		2016*
Major markets	$	1	$	2
Growth markets	44		63
Americas					$	28	$	23
EMEA					27		2
Asia Pacific					14		14
Total lease receivables	$	45	$	65	$	68	$	40

Major markets	$	18	$	13
Growth markets	121		91
Americas					$	133	$	128
EMEA					31		5
Asia Pacific					8		12
Total loan receivables	$	139	$	104	$	172	$	145

Total receivables	$	184	$	168	$	241	$	185

* Reclassified to conform to 2017 presentation.

Impaired ~~Loans~~Receivables

The company considers any ~~loan~~receivable with an individually evaluated reserve as an impaired ~~loan.~~receivable. Depending on the level of impairment, ~~loans~~receivables will also be placed on non-accrual status.

The following tables present impaired ~~client~~receivables. This presentation now includes both loan and lease receivables.

	At June 30, 2016				At December 31, 2015				At March 31, 2017				At December 31, 2016*
	Recorded		Related		Recorded		Related		Recorded		Related		Recorded		Related
(Dollars in millions)	Investment		Allowance		Investment		Allowance		Investment		Allowance		Investment		Allowance
Major markets	$	74	$	70	$	50	$	47
Growth markets	319		302		297		284
Americas									$	179	$	169	$	168	$	161
EMEA									26		18		20		9
Asia Pacific									164		157		159		150
Total	$	393	$	372	$	347	$	331	$	368	$	344	$	347	$	320

Interest

Average

Interest

Income

(Dollars in millions)

Recorded

Income

Recognized on

For the three months ended June 30, 2016:

Investment

Recognized

Cash Basis

Major markets

$
70

$
0

$
—

Growth markets

307

0

—

Total

$
377

$
0

$
—

* Reclassified to conform to 2017 presentation.

Interest

Average

Interest

Income

(Dollars in millions)

Recorded

Income

Recognized on

For the three months ended June 30, 2015:

Investment

Recognized

Cash Basis

Major markets

$
51

$
—

$
—

Growth markets

341

0

—

Total

$
392

$
0

$
—

					Interest
	Average		Interest		Income
(Dollars in millions)	Recorded		Income		Recognized on
For the three months ended March 31, 2017:	Investment		Recognized		Cash Basis
Americas	$	173	$	0	$	—
EMEA	23		0		—
Asia Pacific	161		1		—
Total	$	357	$	1	$	—

					Interest
	Average		Interest		Income
(Dollars in millions)	Recorded		Income		Recognized on
For the three months ended March 31, 2016:*	Investment		Recognized		Cash Basis
Americas	$	133	$	0	$	—
EMEA	69		0		—
Asia Pacific	342		0		—
Total	$	544	$	0	$	—

* Reclassified to conform to 2017 presentation.

Notes to Consolidated Financial Statements — (continued)

Interest

Average

Interest

Income

(Dollars in millions)

Recorded

Income

Recognized on

For the six months ended June 30, 2016:

Investment

Recognized

Cash Basis

Major markets

$
64

$
0

$
—

Growth markets

304

0

—

Total

$
367

$
0

$
—

Interest

Average

Interest

Income

(Dollars in millions)

Recorded

Income

Recognized on

For the six months ended June 30, 2015:

Investment

Recognized

Cash Basis

Major markets

$
52

$
—

$
—

Growth markets

327

0

—

Total

$
379

$
0

$
—

Credit Quality Indicators

The company’s credit quality indicators, which are based on rating agency data, publicly available information and information provided by customers, are reviewed periodically based on the relative level of risk. The resulting indicators are a numerical rating system that maps to Moody’s Investors Service credit ratings as shown below. The company uses information provided by Moody’s, where available, as one of many inputs in its determination of customer credit ratings.

The following tables present the ~~gross~~net recorded investment for each class of receivables, by credit quality indicator, at ~~June 30, 2016~~March 31, 2017 and December 31, ~~2015.~~2016. Receivables with a credit quality indicator ranging from Aaa to Baa3 are considered investment grade. All others are considered non-investment grade. The credit quality indicators do not reflect mitigation actions that the company takes to transfer credit risk to third parties.

Lease Receivables

Loan Receivables

(Dollars in millions)

Major

Growth

Major

Growth

At June 30, 2016:

Markets

Markets

Markets

Markets

Credit Rating:

Aaa – Aa3

$
490

$
41

$
831

$
78

A1 – A3

1,235

136

2,093

260

Baa1 – Baa3

1,498

192

2,539

366

Ba1 – Ba2

1,213

359

2,055

684

Ba3 – B1

513

427

870

814

B2 – B3

372

213

631

407

Caa – D

35

109

59

209

Total

$
5,355

$
1,478

$
9,077

$
2,817

	Lease Receivables						Loan Receivables
(Dollars in millions)					Asia						Asia
At March 31, 2017:	Americas		EMEA		Pacific		Americas		EMEA		Pacific
Credit Ratings:
Aaa — Aa3	$	397	$	48	$	57	$	635	$	127	$	95
A1 — A3	703		99		550		1,125		261		910
Baa1 — Baa3	699		355		313		1,117		937		517
Ba1 — Ba2	776		355		180		1,241		937		297
Ba3 — B1	547		207		88		875		546		146
B2 — B3	354		74		62		566		197		103
Caa — D	65		12		17		104		32		28
Total	$	3,541	$	1,150	$	1,267	$	5,664	$	3,036	$	2,096

At ~~June 30, 2016,~~March 31, 2017, the industries which made up Global Financing’s receivables portfolio consisted of: Financial ~~(36~~(35 percent), Government (14 percent), Manufacturing (14 percent), Services ~~(10~~(11 percent), Retail (8 percent), Communications (7 percent), Healthcare (6 percent) and Other (6 percent).

~~Notes~~

Lease Receivables

Loan Receivables

(Dollars in millions)

Asia

Asia

At December 31, 2016:*

Americas

EMEA

Pacific

Americas

EMEA

Pacific

Credit Ratings:

Aaa — Aa3

$
447

$
51

$
53

$
712

$
143

$
90

A1 — A3

782

113

486

1,246

318

832

Baa1 — Baa3

772

366

330

1,230

1,032

565

Ba1 — Ba2

822

350

185

1,309

987

316

Ba3 — B1

574

208

106

914

585

182

B2 — B3

297

71

84

472

201

143

Caa — D

83

9

15

133

25

25

Total

$
3,776

$
1,167

$
1,259

$
6,016

$
3,291

$
2,154

* Reclassified to ~~Consolidated Financial Statements — (continued)~~conform to 2017 presentation.

Lease Receivables

Loan Receivables

(Dollars in millions)

Major

Growth

Major

Growth

At December 31, 2015:

Markets

Markets

Markets

Markets

Credit Rating:

Aaa – Aa3

$
538

$
39

$
949

$
80

A1 – A3

1,324

162

2,338

336

Baa1 – Baa3

1,493

392

2,635

813

Ba1 – Ba2

1,214

352

2,143

732

Ba3 – B1

513

277

905

576

B2 – B3

403

215

711

447

Caa – D

33

87

59

181

Total

$
5,517

$
1,524

$
9,739

$
3,165

At December 31, ~~2015,~~2016, the industries which made up Global Financing’s receivables portfolio consisted of: Financial ~~(36~~(34 percent), Government (14 percent), Manufacturing ~~(14 percent), Government (11~~(13 percent), Services ~~(11percent)~~(12 percent), Retail (9(8 percent), Communications (7 percent), Healthcare (6 percent) and Other (6 percent).

Notes to Consolidated Financial Statements — (continued)

Past Due Financing Receivables

Fully

<90 Days

Recorded

Total

Reserved

or Unbilled

Total

Investment

(Dollars in millions)

Past Due

Financing

Financing

Financing

> 90 Days and

At June 30, 2016:

> 90 days (1)

Receivables

Receivables

Receivables

Accruing (2)

Major markets

$
7

$
35

$
5,314

$
5,355

$
106

Growth markets

24

144

1,310

1,478

73

Total lease receivables

$
30

$
179

$
6,624

$
6,833

$
179

Major markets

$
9

$
39

$
9,030

$
9,077

$
130

Growth markets

15

296

2,506

2,817

55

Total loan receivables

$
24

$
335

$
11,536

$
11,894

$
185

Total

$
54

$
513

$
18,160

$
18,727

$
364

			Fully		<90 Days				Recorded
	Total		Reserved		or Unbilled		Total		Investment
(Dollars in millions)	Past Due		Financing		Financing		Financing		> 90 Days and
At March 31, 2017:	> 90 days (1)		Receivables		Receivables		Receivables		Accruing (2)
Americas	$	21	$	27	$	3,554	$	3,602	$	102
EMEA	6		8		1,140		1,154		13
Asia Pacific	11		64		1,267		1,342		16
Total lease receivables	$	38	$	100	$	5,961	$	6,098	$	130

Americas	$	25	$	97	$	5,704	$	5,826	$	141
EMEA	15		10		3,037		3,062		34
Asia Pacific	8		93		2,093		2,193		16
Total loan receivables	$	47	$	200	$	10,833	$	11,081	$	191

Total	$	85	$	300	$	16,794	$	17,179	$	321

(1) Only the portion of a financing receivable which is greater than 90 days past due, excluding amounts that are fully reserved.

(2) At a contract level, which includes total billed and unbilled amounts for aged financing receivables greater than 90 days.

Fully

<90 Days

Recorded

Total

Reserved

or Unbilled

Total

Investment

(Dollars in millions)

Past Due

Financing

Financing

Financing

> 90 Days and

At December 31, 2015*:

> 90 days (1)

Receivables

Receivables

Receivables

Accruing (2)

Major markets

$
5

$
33

$
5,479

$
5,517

$
108

Growth markets

30

140

1,355

1,524

60

Total lease receivables

$
35

$
173

$
6,834

$
7,041

$
168

Major markets

$
7

$
35

$
9,696

$
9,739

$
134

Growth markets

31

309

2,825

3,165

86

Total loan receivables

$
38

$
344

$
12,521

$
12,904

$
220

Total

$
73

$
517

$
19,355

$
19,945

$
388

			Fully		<90 Days				Recorded
	Total		Reserved		or Unbilled		Total		Investment
(Dollars in millions)	Past Due		Financing		Financing		Financing		> 90 Days and
At December 31, 2016:*	> 90 days (1)		Receivables		Receivables		Receivables		Accruing (2)
Americas	$	17	$	20	$	3,793	$	3,830	$	66
EMEA	2		10		1,159		1,171		6
Asia Pacific	12		59		1,264		1,335		40
Total lease receivables	$	31	$	89	$	6,216	$	6,336	$	111

Americas	$	19	$	90	$	6,075	$	6,185	$	80
EMEA	5		5		3,299		3,309		15
Asia Pacific	6		87		2,150		2,243		46
Total loan receivables	$	31	$	182	$	11,524	$	11,737	$	141

Total	$	62	$	271	$	17,740	$	18,073	$	253

(1) Only the portion of a financing receivable which is greater than 90 days past due, excluding amounts that are fully reserved.

(2) At a contract level, which includes total billed and unbilled amounts for aged financing receivables greater than 90 days.

* Reclassified to conform with ~~2016~~2017 presentation.

~~Notes to Consolidated Financial Statements — (continued)~~

Troubled Debt Restructurings

The company did not have any significant troubled debt restructurings during the ~~six~~three months ended ~~June 30, 2016 and~~March 31, 2017 or for the year ended December 31, ~~2015.~~2016.

Notes to Consolidated Financial Statements — (continued)

5. Stock-Based Compensation: Stock-based compensation cost is measured at grant date, based on the fair value of the award, and is recognized over the employee requisite service period. The following table presents total stock-based compensation cost included in income from continuing operations.

Three Months Ended June 30,

Six Months Ended June 30,

(Dollars in millions)

2016

2015

2016

2015

Cost

$
23

$
27

$
44

$
54

Selling, general and administrative

91

92

190

178

Research, development and engineering

14

12

27

26

Other (income) and expense*

—

0

—

(1
)
Pre-tax stock-based compensation cost

128

131

261

257

Income tax benefits

(42
)
(45
)
(84
)
(87
)
Total net stock-based compensation cost

$
86

$
86

$
176

$
171

* Reflects the one-time effects related to divestitures.

(Dollars in millions)
For the three months ended March 31:	2017			2016
Cost	$	23		$	21
Selling, general and administrative	91			99
Research, development and engineering	15			13
Pre-tax stock-based compensation cost	129			133
Income tax benefits	(48		)	(43		)
Total net stock-based compensation cost	$	81		$	90

Pre-tax stock-based compensation cost for the three months ended ~~June 30, 2016~~March 31, 2017 decreased $3$4 million compared to the corresponding period in the prior year. This was due to decreases ~~related to restricted stock units ($9 million) and~~in performance share units ($414 million)~~; partially offset by increases related to~~ and the conversion of stock-based awards previously issued by acquired entities ($86 million) ~~and stock option awards ($1 million).~~

Pre-tax stock-based compensation cost for the six months ended June 30, 2016 increased $3 million compared to the corresponding period in the prior year. This was due to increases related to the conversion of stock-based awards previously issued by acquired entities ($11 million), ~~performance share units ($9 million) and stock option awards ($2 million);~~ partially offset by ~~a decrease~~increases related to restricted stock units ($2016 million).

Income tax benefits for the three months ended March 31, 2017 include an $8 million benefit which resulted from the implementation of the new FASB guidance for share-based payment transactions. Refer to note 2, “Accounting Changes,” for additional information.

The amount of stock-based compensation cost included in discontinued operations, net of tax, was immaterial in all periods presented.

As of ~~June 30, 2016,~~March 31, 2017, the total unrecognized compensation cost of ~~$1,154~~$804 million related to non-vested awards was expected to be recognized over a weighted-average period of approximately ~~2.7~~2.5 years.

There was no significant capitalized stock-based compensation cost at ~~June 30, 2016~~March 31, 2017 and ~~2015.~~2016.

6. Segments: The ~~tables~~table on ~~pages 28 and 29 reflect~~page 27 reflects the results of continuing operations of the company’s segments consistent with the management and measurement system utilized within the company. Performance measurement is based on operating pre-tax income from continuing operations. ~~These results are used, in part,~~The segments represent components of the company for which separate financial information is available that is utilized on a regular basis by the chief operating decision maker ~~both~~(the chief executive officer) in ~~evaluating the performance of,~~determining how to allocate resources and ~~in allocating resources to, each of the segments.~~evaluate performance.

In January 2016, the company made a number of changes to its organizational structure and management system consistent with its ongoing transformation to a cognitive solutions and cloud platform business. With these changes, the company updated its reportable segments. The company continues to have five reportable segments as follows:

The Cognitive Solutions segment includes solutions units that address many of the company’s strategic areas, including analytics, commerce and security, several of the new initiatives around Watson, Watson Health, Watson Internet of Things and Transaction Processing Software. The Technology Services & Cloud Platforms segment includes the company’s cloud infrastructure and platform capabilities, the previously reported Global Technology Services business and Integration Software. Operating Systems Software has been aligned with the underlying hardware platforms in the Systems segment. The Global Business Services and Global Financing segments remain unchanged.

The company also realigned a portion of its software support revenue, which was previously managed and reported in Integrated Technology Services within Global Technology Services, to the underlying software product areas.

Notes to Consolidated Financial Statements — (continued)

SEGMENT INFORMATION

	Cognitive Solutions&																		Cognitive Solutions &
	Industry Services						Technology												Industry Services						Technology
				Global			Services &															Global			Services &
	Cognitive			Business			Cloud						Global			Total			Cognitive			Business			Cloud						Global			Total
(Dollars in millions)	Solutions			Services			Platforms			Systems			Financing			Segments			Solutions			Services			Platforms			Systems			Financing			Segments
For the three months ended June 30, 2016:
For the three months ended March 31, 2017:
External revenue	$	4,675		$	4,255		$	8,857		$	1,950		$	424		$	20,162		$	4,062		$	4,006		$	8,216		$	1,395		$	405		$	18,083
Internal revenue	594			103			156			206			502			1,561			716			86			160			167			363			1,492
Total revenue	$	5,269		$	4,359		$	9,013		$	2,156		$	926		$	21,723		$	4,778		$	4,092		$	8,376		$	1,562		$	768		$	19,576
Pre-tax income/(loss) from continuing operations	$	1,451		$	476		$	1,279		$	229		$	467		$	3,901
Pre-tax income from continuing operations																			$	1,274		$	291		$	687		$	(186	)	$	311		$	2,377
Revenue year-to-year change	4.4		%	(2.6		)%	(0.6		)%	(21.0		)%	(21.7		)%	(3.5		)%	2.8		%	(3.6		)%	(2.5		)%	(17.3		)%	(14.3		)%	(3.4		)%
Pre-tax income year-to-year change	(20.5		)%	(26.1		)%	(9.5		)%	(57.5		)%	(23.8		)%	(22.5		)%	25.7		%	53.4		%	166.1		%	nm			(19.5		)%	29.4		%
Pre-tax income margin	27.5		%	10.9		%	14.2		%	10.6		%	50.5		%	18.0		%	26.7		%	7.1		%	8.2		%	(11.9		)%	40.5		%	12.1		%

*For the three months ended June 30, 2015:**
For the three months ended March 31, 2016:
External revenue	$	4,516		$	4,345		$	8,898		$	2,541		$	478		$	20,778		$	3,979		$	4,131		$	8,424		$	1,675		$	410		$	18,619
Internal revenue	532			130			173			189			704			1,728			668			113			165			212			486			1,645
Total revenue	$	5,049		$	4,475		$	9,071		$	2,730		$	1,182		$	22,506		$	4,647		$	4,245		$	8,589		$	1,888		$	896		$	20,264
Pre-tax income from continuing operations	$	1,825		$	643		$	1,414		$	538		$	613		$	5,033		$	1,013		$	190		$	258		$	(10	)	$	386		$	1,837

Pre-tax income margin	36.1		%	14.4		%	15.6		%	19.7		%	51.9		%	22.4		%	21.8		%	4.5		%	3.0		%	(0.5		)%	43.1		%	9.1		%

* Recast to conform with 2016 presentation.
nm - not meaningful

Reconciliations to IBM as Reported:

(Dollars in millions)

For the three months ended June 30:

2016

2015*

Revenue:

Total reportable segments

$
21,723

$
22,506

Eliminations of internal transactions

(1,561
)
(1,728
)
Other revenue

76

35

Total consolidated revenue

$
20,238

$
20,813

Pre-tax income from continuing operations:

Total reportable segments

$
3,901

$
5,033

Amortization of acquired intangible assets

(265
)
(160
)
Acquisition-related (charges)/income

(23
)
(7
)
Non-operating retirement-related (costs)/income

(163
)
(186
)
Eliminations of internal transactions

(334
)
(473
)
Unallocated corporate amounts

(67
)
18

Total pre-tax income from continuing operations

$
3,049

$
4,224

* Recast to conform with 2016 presentation.

(Dollars in millions)
For the three months ended March 31:	2017			2016
Revenue:
Total reportable segments	$	19,576		$	20,264
Eliminations of internal transactions	(1,492		)	(1,645		)
Other revenue	71			66
Total consolidated revenue	$	18,155		$	18,684

Pre-tax income from continuing operations:
Total reportable segments	$	2,377		$	1,837
Amortization of acquired intangible assets	(249		)	(211		)
Acquisition-related (charges)/income	(13		)	27
Non-operating retirement-related (costs)/income	(378		)	(142		)
Eliminations of internal transactions	(227		)	(355		)
Unallocated corporate amounts	(87		)	(122		)
Total pre-tax income from continuing operations	$	1,424		$	1,034

~~Notes to Consolidated Financial Statements — (continued)~~

~~SEGMENT INFORMATION~~

Cognitive Solutions &

Industry Services

Technology

Global

Services &

Cognitive

Business

Cloud

Global

Total

(Dollars in millions)

Solutions

Services

Platforms

Systems

Financing

Segments

For the six months ended June 30, 2016:

External revenue

$
8,654

$
8,387

$
17,280

$
3,626

$
834

$
38,781

Internal revenue

1,262

216

321

418

988

3,206

Total revenue

$
9,916

$
8,603

$
17,602

$
4,044

$
1,822

$
41,987

Pre-tax income/(loss) from continuing operations

$
2,465

$
665

$
1,537

$
218

$
853

$
5,739

Revenue year-to-year change

1.9
%
(3.6
)%
(1.1
)%
(19.8
)%
(18.3
)%
(4.0
)%
Pre-tax income year-to-year change

(26.5
)%
(46.0
)%
(39.6
)%
(72.7
)%
(24.4
)%
(36.6
)%
Pre-tax income margin

24.9
%
7.7
%
8.7
%
5.4
%
46.8
%
13.7
%

For the six months ended June 30, 2015*:

External revenue

$
8,564

$
8,663

$
17,452

$
4,683

$
939

$
40,301

Internal revenue

1,167

261

339

362

1,290

3,419

Total revenue

$
9,731

$
8,923

$
17,791

$
5,044

$
2,229

$
43,719

Pre-tax income from continuing operations

$
3,353

$
1,231

$
2,544

$
800

$
1,128

$
9,056

Pre-tax income margin

34.5
%
13.8
%
14.3
%
15.9
%
50.6
%
20.7
%

* Recast to conform with 2016 presentation.

~~Reconciliations to IBM as Reported:~~

(Dollars in millions)

For the six months ended June 30:

2016

2015*

Revenue:

Total reportable segments

$
41,987

$
43,719

Eliminations of internal transactions

(3,206
)
(3,419
)
Other revenue

142

102

Total consolidated revenue

$
38,923

$
40,403

Pre-tax income from continuing operations:

Total reportable segments

$
5,739

$
9,056

Amortization of acquired intangible assets

(477
)
(330
)
Acquisition-related charges

3

(8
)
Non-operating retirement-related (costs)/income

(306
)
(627
)
Eliminations of internal transactions

(689
)
(813
)
Unallocated corporate amounts

(189
)
(53
)
Total pre-tax income from continuing operations

$
4,082

$
7,225

* Recast to conform with 2016 presentation.

Notes to Consolidated Financial Statements — (continued)

7. Equity Activity:

Reclassifications and Taxes Related to Items of Other Comprehensive Income

(Dollars in millions)	Before Tax			Tax (Expense)/			Net of Tax			Before Tax			Tax (Expense)/			Net of Tax
For the three months ended June 30, 2016:	Amount			Benefit			Amount
For the three months ended March 31, 2017:										Amount			Benefit			Amount
Other comprehensive income/(loss):
Foreign currency translation adjustments	$	(248	)	$	95		$	(154	)	$	161		$	108		$	270
Net changes related to available-for-sale securities:
Unrealized gains/(losses) arising during the period	$	1		$	0		$	1		$	(1	)	$	0		$	(1	)
Reclassification of (gains)/losses to other (income) and expense	0			0			0			1			0			1
Total net changes related to available-for-sale securities	$	1		$	0		$	1		$	0		$	0		$	0
Unrealized gains/(losses) on cash flow hedges:
Unrealized gains/(losses) arising during the period	$	9		$	5		$	13		$	(33	)	$	8		$	(25	)
Reclassification of (gains)/losses to:
Cost of sales	13			(5		)	8			(11		)	3			(8		)
Cost of services										(8		)	3			(5		)
SG&A expense	7			(3		)	4			(20		)	5			(15		)
Other (income) and expense	75			(29		)	46			(65		)	25			(40		)
Interest expense	7			(3		)	5			7			(3		)	5
Total unrealized gains/(losses) on cash flow hedges	$	111		$	(34	)	$	76		$	(130	)	$	41		$	(89	)
Retirement-related benefit plans(1):
Prior service costs/(credits)										$	0		$	0		$	0
Net (losses)/gains arising during the period	$	78		$	(27	)	$	51		61			(20		)	41
Curtailments and settlements	10			(4		)	6			(1		)	0			(1		)
Amortization of prior service (credits)/costs	(27		)	10			(17		)	(21		)	7			(15		)
Amortization of net (gains)/losses	693			(263		)	431			710			(229		)	481
Total retirement-related benefit plans	$	754		$	(283	)	$	471		$	748		$	(241	)	$	507
Other comprehensive income/(loss)	$	617		$	(223	)	$	394		$	779		$	(92	)	$	688

(1) These AOCI components are included in the computation of net periodic pension cost. (See note 8, “Retirement-Related Benefits,” for additional information.)

~~Notes to Consolidated Financial Statements — (continued)~~

~~Reclassifications and Taxes Related to Items of Other Comprehensive Income~~

(Dollars in millions)

Before Tax

Tax (Expense)/

Net of Tax

For the three months ended June 30, 2015:

Amount

Benefit

Amount

Other comprehensive income/(loss):

Foreign currency translation adjustments

$
102

$
67

$
169

Net changes related to available-for-sale securities:

Unrealized gains/(losses) arising during the period

$
(15
)
$
6

$
(10
)
Reclassification of (gains)/losses to other (income) and expense

0

0

0

Total net changes related to available-for-sale securities

$
(15
)
$
6

$
(10
)
Unrealized gains/(losses) on cash flow hedges:

Unrealized gains/(losses) arising during the period

$
(187
)
$
60

$
(127
)
Reclassification of (gains)/losses to:

Cost of sales

(58
)
17

(41
)
SG&A expense

(42
)
12

(30
)
Other (income) and expense

(221
)
85

(136
)
Interest expense

0

0

0

Total unrealized gains/(losses) on cash flow hedges

$
(508
)
$
175

$
(333
)
Retirement-related benefit plans(1):

Prior service costs/(credits)

$
1

$
0

$
1

Net (losses)/gains arising during the period

93

(31
)
62

Curtailments and settlements

3

(1
)
2

Amortization of prior service (credits)/costs

(25
)
9

(16
)
Amortization of net (gains)/losses

821

(285
)
536

Total retirement-related benefit plans

$
894

$
(310
)
$
585

Other comprehensive income/(loss)

$
472

$
(62
)
$
411

~~(1)~~ ~~These AOCI components are included in the computation of net periodic pension cost. (See note 8, “Retirement-Related Benefits,” for additional information.)~~

Notes to Consolidated Financial Statements — (continued)

Reclassifications and Taxes Related to Items of Other Comprehensive Income

(Dollars in millions)

Before Tax

Tax (Expense)/

Net of Tax

For the six months ended June 30, 2016:

Amount

Benefit

Amount

Other comprehensive income/(loss):

Foreign currency translation adjustments

$
(10
)
$
361

$
351

Net changes related to available-for-sale securities:

Unrealized gains/(losses) arising during the period

$
(35
)
$
14

$
(22
)
Reclassification of (gains)/losses to other (income) and expense

37

(14
)
23

Total net changes related to available-for-sale securities

$
2

$
(1
)
$
1

Unrealized gains/(losses) on cash flow hedges:

Unrealized gains/(losses) arising during the period

$
(256
)
$
96

$
(160
)
Reclassification of (gains)/losses to:

Cost of sales

10

(5
)
5

SG&A expense

3

(2
)
1

Other (income) and expense

(12
)
5

(7
)
Interest expense

9

(4
)
6

Total unrealized gains/(losses) on cash flow hedges

$
(245
)
$
90

$
(156
)
Retirement-related benefit plans(1):

Net (losses)/gains arising during the period

$
(68
)
$
25

$
(43
)
Curtailments and settlements

14

(5
)
9

Amortization of prior service (credits)/costs

(53
)
19

(33
)
Amortization of net (gains)/losses

1,383

(510
)
873

Total retirement-related benefit plans

$
1,277

$
(471
)
$
806

Other comprehensive income/(loss)

$
1,023

$
(21
)
$
1,002

(Dollars in millions)	Before Tax			Tax (Expense)/			Net of Tax
For the three months ended March 31, 2016:	Amount			Benefit			Amount
Other comprehensive income/(loss):
Foreign currency translation adjustments	$	239		$	266		$	505
Net changes related to available-for-sale securities:
Unrealized gains/(losses) arising during the period	$	(36	)	$	14		$	(22	)
Reclassification of (gains)/losses to other (income) and expense	37			(14		)	23
Total net changes related to available-for-sale securities	$	1		$	0		$	0
Unrealized gains/(losses) on cash flow hedges:
Unrealized gains/(losses) arising during the period	$	(265	)	$	91		$	(174	)
Reclassification of (gains)/losses to:
Cost of sales*	(9		)	2			(7		)
Cost of services*	6			(3		)	4
SG&A expense	(3		)	0			(3		)
Other (income) and expense	(87		)	33			(53		)
Interest expense	2			(1		)	1
Total unrealized gains/(losses) on cash flow hedges	$	(356	)	$	124		$	(232	)
Retirement-related benefit plans(1):
Net (losses)/gains arising during the period	$	(147	)	$	53		$	(94	)
Curtailments and settlements	5			(2		)	3
Amortization of prior service (credits)/costs	(25		)	9			(16		)
Amortization of net (gains)/losses	690			(248		)	442
Total retirement-related benefit plans	$	522		$	(187	)	$	335
Other comprehensive income/(loss)	$	406		$	202		$	608

~~(1)~~ ~~These AOCI components are included in the computation of net periodic pension cost. (See note 8, “Retirement-Related Benefits,” for additional information.)~~

~~Notes~~* Reclassified to ~~Consolidated Financial Statements — (continued)~~conform to 2017 presentation.

~~Reclassifications and Taxes Related to Items of Other Comprehensive Income~~

(Dollars in millions)

Before Tax

Tax (Expense)/

Net of Tax

For the six months ended June 30, 2015:

Amount

Benefit

Amount

Other comprehensive income/(loss):

Foreign currency translation adjustments

$
(350
)
$
(199
)
$
(549
)
Net changes related to available-for-sale securities:

Unrealized gains/(losses) arising during the period

$
17

$
(6
)
$
10

Reclassification of (gains)/losses to other (income) and expense

0

0

0

Total net changes related to available-for-sale securities

$
16

$
(6
)
$
10

Unrealized gains/(losses) on cash flow hedges:

Unrealized gains/(losses) arising during the period

$
432

$
(158
)
$
274

Reclassification of (gains)/losses to:

Cost of sales

(108
)
32

(76
)
SG&A expense

(82
)
24

(58
)
Other (income) and expense

(380
)
146

(234
)
Interest expense

0

0

0

Total unrealized gains/(losses) on cash flow hedges

$
(138
)
$
44

$
(94
)
Retirement-related benefit plans(1):

Prior service costs/(credits)

$
6

$
(2
)
$
4

Net (losses)/gains arising during the period

16

(5
)
10

Curtailments and settlements

7

(2
)
5

Amortization of prior service (credits)/costs

(51
)
17

(33
)
Amortization of net (gains)/losses

1,656

(565
)
1,091

Total retirement-related benefit plans

$
1,635

$
(558
)
$
1,077

Other comprehensive income/(loss)

$
1,163

$
(719
)
$
444

(1) These AOCI components are included in the computation of net periodic pension cost. (See note 8, “Retirement-Related Benefits,” for additional information.)

Notes to Consolidated Financial Statements — (continued)

Accumulated Other Comprehensive Income/(Loss) (net of tax)

							Net Change			Net Unrealized												Net Change			Net Unrealized
	Net Unrealized			Foreign			Retirement-			Gains/(Losses)			Accumulated			Net Unrealized			Foreign			Retirement-			Gains/(Losses)			Accumulated
	Gains/(Losses)			Currency			Related			on Available-			Other			Gains/(Losses)			Currency			Related			on Available-			Other
	on Cash Flow			Translation			Benefit			For-Sale			Comprehensive			on Cash Flow			Translation			Benefit			For-Sale			Comprehensive
(Dollars in Millions)	Hedges			Adjustments*			Plans			Securities			Income/(Loss)			Hedges			Adjustments*			Plans			Securities			Income/(Loss)
January 1, 2016	$	100		$	(3,463	)	$	(26,248	)	$	5		$	(29,607	)
January 1, 2017																$	319		$	(3,603	)	$	(26,116	)	$	2		$	(29,398	)
Other comprehensive income before reclassifications	(160		)	351			(34		)	(22		)	135			(25		)	270			40			(1		)	284
Amount reclassified from accumulated other comprehensive income	4			0			840			23			867			(64		)	0			466			1			404
Total change for the period	(156		)	351			806			1			1,002			(89		)	270			507			0			688
June 30, 2016	$	(56	)	$	(3,112	)	$	(25,442	)	$	6		$	(28,604	)
March 31, 2017																$	230		$	(3,333	)	$	(25,609	)	$	2		$	(28,710	)

* Foreign currency translation adjustments are presented gross except for any associated hedges which are presented net of tax.

							Net Change			Net Unrealized												Net Change			Net Unrealized
	Net Unrealized			Foreign			Retirement-			Gains/(Losses)			Accumulated			Net Unrealized			Foreign			Retirement-			Gains/(Losses)			Accumulated
	Gains/(Losses)			Currency			Related			on Available-			Other			Gains/(Losses)			Currency			Related			on Available-			Other
	on Cash Flow			Translation			Benefit			For-Sale			Comprehensive			on Cash Flow			Translation			Benefit			For-Sale			Comprehensive
(Dollars in Millions)	Hedges			Adjustments*			Plans			Securities			Income/(Loss)			Hedges			Adjustments*			Plans			Securities			Income/(Loss)
January 1, 2015	$	392		$	(1,742	)	$	(26,509	)	$	(15	)	$	(27,875	)
January 1, 2016																$	100		$	(3,463	)	$	(26,248	)	$	5		$	(29,607	)
Other comprehensive income before reclassifications	274			(549		)	19			10			(246		)	(174		)	505			(91		)	(22		)	218
Amount reclassified from accumulated other comprehensive income	(368		)	0			1,058			0			690			(58		)	0			426			23			391
Total change for the period	(94		)	(549		)	1,077			10			444			(232		)	505			335			0			608
June 30, 2015	$	298		$	(2,292	)	$	(25,433	)	$	(5	)	$	(27,432	)
March 31, 2016																$	(133	)	$	(2,958	)	$	(25,913	)	$	5		$	(28,998	)

* Foreign currency translation adjustments are presented gross except for any associated hedges which are presented net of tax.

8. Retirement-Related Benefits: The company offers defined benefit pension plans, defined contribution pension plans, as well as nonpension postretirement plans primarily consisting of retiree medical benefits. The following ~~tables provide~~table provides the pre-tax cost for all retirement-related plans.

Yr. to Yr.

(Dollars in millions)

Percent

For the three months ended June 30:

2016

2015

Change

Retirement-related plans — cost

Defined benefit and contribution pension plans — cost

$
455

$
493

(7.7
)%
Nonpension postretirement plans — cost

61

67

(9.8
)
Total

$
516

$
560

(7.9
)%

					Yr. to Yr.						Yr. to Yr.
(Dollars in millions)					Percent						Percent
For the six months ended June 30:	2016		2015		Change
For the three months ended March 31:							2017		2016		Change
Retirement-related plans — cost
Defined benefit and contribution pension plans — cost	$	894	$	1,242	(28.0	)%	$	664	$	439	51.3	%
Nonpension postretirement plans — cost	121		139		(13.0	)	61		60		2.3
Total	$	1,014	$	1,380	(26.5	)%	$	725	$	499	45.4	%

Notes to Consolidated Financial Statements — (continued)

The following ~~tables provide~~table provides the components of the cost/(income) for the company’s pension plans.

Cost/(Income) of Pension Plans

(Dollars in millions)

U.S. Plans

Non-U.S. Plans

For the three months ended June 30:

2016

2015

2016

2015

Service cost

$
—

$
—

$
106

$
116

Interest cost

511

507

267

270

Expected return on plan assets

(922
)
(988
)
(481
)
(482
)
Amortization of prior service costs/(credits)

3

2

(27
)
(24
)
Recognized actuarial losses

324

412

359

393

Curtailments and settlements

—

—

10

3

Multi-employer plans/other costs

—

—

37

8

Total net periodic pension (income)/cost of defined benefit plans

(85
)
(67
)
271

283

Cost of defined contribution plans

161

166

108

111

Total defined benefit and contribution plans cost recognized in the Consolidated Statement of Earnings

$
76

$
99

$
379

$
394

(Dollars in millions)

U.S. Plans

Non-U.S. Plans

For the six months ended June 30:

2016

2015

2016

2015

Service cost

$
—

$
—

$
210

$
224

Interest cost

1,024

1,014

529

541

Expected return on plan assets

(1,845
)
(1,977
)
(951
)
(965
)
Amortization of prior service costs/(credits)

5

5

(52
)
(49
)
Recognized actuarial losses

657

827

706

794

Curtailments and settlements

—

—

14

7

Multi-employer plan/other costs

—

—

55

256

Total net periodic pension (income)/cost of defined benefit plans

(158
)
(131
)
512

808

Cost of defined contribution plans

326

339

215

226

Total defined benefit and contribution plans cost recognized in the Consolidated Statement of Earnings

$
167

$
208

$
727

$
1,034

On March 24, 2014, the Supreme Court of Spain issued a ruling against IBM Spain in litigation involving its defined benefit and defined contribution plans. As a result of the ruling, the company recorded pre-tax retirement-related obligations of $233 million in 2015 ($230 million in the first quarter of 2015) in selling, general and administrative expense in the Consolidated Statement of Earnings. These obligations are reflected in “Non-U.S. Plans - Multi-employer plans/other costs” in the table above.

(Dollars in millions)	U.S. Plans						Non-U.S. Plans
For the three months ended March 31:	2017			2016			2017			2016
Service cost	$	—		$	—		$	101		$	104
Interest cost	479			513			201			262
Expected return on plan assets	(754		)	(922		)	(317		)	(470		)
Amortization of prior service costs/(credits)	4			3			(24		)	(25		)
Recognized actuarial losses	337			333			361			347
Curtailments and settlements	—			—			(1		)	5
Multi-employer plans/other costs	—			—			14			18
Total net periodic pension (income)/cost of defined benefit plans	67			(74		)	335			241
Cost of defined contribution plans	162			165			101			106
Total defined benefit and contribution plans cost recognized in the Consolidated Statement of Earnings	$	228		$	91		$	436		$	348

In March ~~2016,~~2017, the company initiated a change to the investment strategy of its U.S. defined benefit plan. The ~~2016~~2017 target asset allocation was modified by reducing equity securities from 3420 percent to 2112 percent, ~~other investments from 10 percent to 9 percent and~~ increasing debt securities from 5670 percent to 7079 percent and other investments largely remained unchanged at 10 percent of total plan assets. This change is designed to reduce the risk associated with the potential negative impact that equity markets might have on the funded status of the U.S. defined benefit plan. The change is expected to reduce the ~~2017~~2018 expected long-term rate of return on assets from ~~7.00~~5.75 percent to approximately ~~6.25~~5.25 percent. See note S, “Retirement-Related Benefits,” on page ~~118~~144 in the company’s ~~recast 2015~~2016 Annual Report ~~on Form 8-K dated June 13, 2016~~ for additional information regarding the company’s investment strategy.

In ~~2016,~~2017, the company expects to contribute approximately $500 million to its non-U.S. defined benefit and multi-employer plans, the largest of which will be contributed to the defined benefit pension plans in Japan, Spain and the ~~UK and Japan.~~UK. This amount generally represents the legally mandated minimum contribution. Total ~~net~~ contributions to the non-U.S. plans in the first ~~six~~three months of ~~2016~~2017 were ~~$217~~$182 million, of which ~~$83~~$40 million was in cash and ~~$134~~$142 million in U.S. Treasury securities. Total net contributions to the non-U.S. plans in the first ~~six~~three months of ~~2015~~2016 were ~~$186~~$107 million, of which $65 million was in cash and $42 million in ~~cash.~~U.S. Treasury securities. The contribution of U.S. Treasury securities is considered a non-cash transaction in the Consolidated Statement of Cash Flows.

~~Notes to Consolidated Financial Statements — (continued)~~

The following ~~tables provide~~table provides the components of the cost/(income) for the company’s nonpension postretirement plans.

Cost of Nonpension Postretirement Plans

(Dollars in millions)

U.S. Plan

Non-U.S. Plans

For the three months ended June 30:

2016

2015

2016

2015

Service cost

$
4

$
6

$
1

$
2

Interest cost

41

40

11

13

Expected return on plan assets

—

0

(2
)
(2
)
Amortization of prior service costs/(credits)

(2
)
(2
)
(1
)
(1
)
Recognized actuarial losses

5

9

2

2

Curtailments and settlements

—

0

—

0

Total nonpension postretirement plan cost recognized in Consolidated Statement of Earnings

$
49

$
53

$
12

$
14

(Dollars in millions)

U.S. Plan

Non-U.S. Plans

For the six months ended June 30:

2016

2015

2016

2015

Service cost

$
9

$
12

$
3

$
4

Interest cost

82

82

22

27

Expected return on plan assets

—

0

(3
)
(4
)
Amortization of prior service costs/(credits)

(4
)
(4
)
(2
)
(3
)
Recognized actuarial losses

10

20

4

5

Curtailments and settlements

—

0

0

0

Total nonpension postretirement plan cost recognized in Consolidated Statement of Earnings

$
97

$
109

$
23

$
29

The company contributed $200 million in U.S. Treasury securities and $227 million in cash to the U.S. nonpension postretirement benefit plan during the six months ended June 30, 2016 and 2015, respectively. The contribution of U.S. Treasury securities is considered a non-cash transaction in the Consolidated Statement of Cash Flows.

9. ~~Acquisitions/Divestitures:~~

~~Acquisitions:~~ ~~During the six months ended June 30, 2016, the company completed eleven acquisitions at an aggregate cost of $5,674 million.~~

~~The Weather Company (TWC) —~~ On January 29, 2016, the company completed the acquisition of TWC’s B2B, mobile and cloud-based web-properties, weather.com, Weather Underground, The Weather Company brand and WSI, its global business-to-business brand, for cash consideration of $2,278 million. The cable television segment was not acquired by IBM, but will license weather forecast data and analytics from IBM under a long-term contract. TWC was a privately held business. Goodwill of $1,717 million has been assigned to the Cognitive Solutions segment. At the acquisition date, it was expected that none of the goodwill would be deductible for tax purposes. The overall weighted-average useful life of the identified intangible assets acquired is 6.9 years.

~~Truven Health Analytics, Inc. (Truven) —~~ On April 8, 2016, the company completed the acquisition of Truven, a leading provider of healthcare analytics solutions, for cash consideration of $2,612 million, of which $200 million will be paid in July 2017. Truven has developed proprietary analytic methods and assembled analytic content assets, creating extensive national healthcare utilization, performance, quality and cost data. Truven was a privately held business. Goodwill of $1,933 million has been assigned to the Cognitive Solutions segment. At the acquisition date, it was expected that none of the goodwill would be deductible for tax purposes. The overall weighted-average useful life of the identified intangible assets acquired is 6.9 years.

~~Other Acquisitions —~~ The Technology Services & Cloud Platforms segment completed acquisitions of two businesses in the first quarter: Ustream, Inc. (Ustream), a privately held business, and AT&T’s application and hosting services business. Global Business Services (GBS) completed acquisitions of five privately held businesses: in the first quarter, Resource/Ammirati, ecx International AG (ecx.io) and Optevia Limited (Optevia); and in the second quarter, Aperto AG

~~Notes to Consolidated Financial Statements — (continued)~~

(Aperto) and Bluewolf Group LLC (Bluewolf). The Cognitive Solutions segment completed acquisitions of two privately held businesses in the second quarter: Resilient Systems Inc. (Resilient) and EZ Legacy Ltd. (EZSource).

Each acquisition is expected to enhance the company’s portfolio of product and services capabilities. Ustream provides cloud-based video streaming to enterprises and broadcasters. The acquisition of AT&T’s application and hosting services business is expected to strengthen the company’s cloud portfolio. Resource/Ammirati is a leading U.S. based digital marketing and creative agency, addressing the rising demand from businesses seeking to reinvent themselves for the digital economy. Ecx.io will enhance IBM Interactive Experience (IBM iX) with new digital marketing, commerce and platform skills to accelerate clients’ digital transformations. Optevia is a Software-as-a Service systems integrator specializing in CRM solutions for public sector organizations. Aperto will join IBM iX, supporting the company’s growth in Europe, with expertise in digital strategy projects, including website and application development. Bluewolf will extend the company’s analytics, experience design and industry consulting leadership with one of the world’s leading Salesforce consulting practices to deliver differentiated, consumer-grade experiences via the cloud. Resilient, a provider of incident response solutions, automates and orchestrates the many processes needed when dealing with cyber incidents from breaches to lost devices. EZSource helps developers quickly and easily understand and change mainframe code based on data displayed through dashboards

(Dollars in millions)	U.S. Plan						Non-U.S. Plans
For the three months ended March 31:	2017			2016			2017			2016
Service cost	$	4		$	5		$	1		$	1
Interest cost	38			41			14			10
Expected return on plan assets	—			—			(2		)	(1		)
Amortization of prior service costs/(credits)	(2		)	(2		)	0			(1		)
Recognized actuarial losses	5			5			2			2
Curtailments and settlements	—			—			0			—
Total nonpension postretirement plan cost recognized in Consolidated Statement of Earnings	$	46		$	49		$	16		$	11

The company contributed $135 million to the U.S. nonpension postretirement benefit plan in U.S. Treasury securities during the three months ended March 31, 2017, and $100 million in U.S. Treasury securities during the three months ended March 31, 2016. The contribution of U.S. Treasury securities is considered a non-cash transaction in the Consolidated Statement of Cash Flows.

Notes to Consolidated Financial Statements — (continued)

9. Acquisitions/Divestitures:

Acquisitions: During the three months ended March 31, 2017, the company completed the acquisition of 100 percent of Agile 3 Solutions, LLC (Agile 3 Solutions), a privately held business, for cash consideration of $14 million. Agile 3 Solutions is a developer of software used by C-Suite and senior executives to better visualize, understand and manage risks associated with the protection of sensitive data and adds capabilities to the company’s security portfolio. Goodwill of $8 million has been assigned to the Technology Services & Cloud Platforms and Cognitive Solutions segments.

The acquisition was accounted for as a business combination using the acquisition method, and accordingly, the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquired entity were recorded at their estimated fair values at the date of acquisition. The acquisition did not have a material impact in the Consolidated Financial Statements.

Divestitures:

Microelectronics — On October 20, 2014, IBM and GLOBALFOUNDRIES announced a definitive agreement in which GLOBALFOUNDRIES would acquire the company’s Microelectronics business, including existing semiconductor manufacturing assets and operations in East Fishkill, NY and Essex Junction, VT. The commercial OEM business acquired by GLOBALFOUNDRIES includes custom logic and specialty foundry, manufacturing and related operations. The transaction closed on July 1, 2015.

At September 30, 2014, the company concluded that the Microelectronics business met the criteria for discontinued operations reporting. The disposal group constituted a component under accounting guidance. The continuing cash inflows and outflows with the discontinued component are related to the manufacturing sourcing arrangement and the transition, packaging and test services. These cash flows are not direct cash flows as they are not significant and the company has no significant continuing involvement.

All assets and liabilities of the business, classified as held for sale at June 30, 2015, were transferred at closing. The company transferred $515 million of net cash to GLOBALFOUNDRIES in the third quarter of 2015. This amount included $750 million of cash consideration, adjusted by the amount of working capital due from GLOBALFOUNDRIES and other miscellaneous items. A second cash payment in the amount of $500 million was transferred in December 2016. The remaining cash consideration of $250 million is expected to be transferred in December 2017.

Summarized financial information for discontinued operations is shown in the following table.

	Three Months Ended March 31,
(Dollars in millions)	2017			2016
Total revenue	$	—		$	—
Income/(loss) from discontinued operations	$	(6	)	$	(5	)
Gain/(loss) on disposal, before tax	2			1
Total loss from discontinued operations, before income taxes	$	(4	)	$	(5	)
Provision for/(benefit from) income taxes	(2		)	(2		)
Loss from discontinued operations, net of tax	$	(3	)	$	(3	)

Industry Standard Server — On January 23, 2014, IBM and Lenovo Group Limited (Lenovo) announced a definitive agreement in which Lenovo would acquire the company’s industry standard server portfolio (System x) for an adjusted purchase price of $2.1 billion, consisting of approximately $1.8 billion in cash, with the balance in Lenovo common stock. The stock represented less than 5 percent equity ownership in Lenovo. The company sold to Lenovo its System x, BladeCenter and Flex System blade servers and switches, x86-based Flex integrated systems, NeXtScale and iDataPlex servers and associated software, blade networking and maintenance operations. As of March 31, 2016, all Lenovo common stock was sold.

The initial closing was completed on October 1, 2014. A subsequent closing occurred in most other countries in which

Notes to Consolidated Financial Statements — (continued)

there was a large business footprint on December 31, 2014. The remaining countries closed on March 31, 2015. An assessment of the ongoing contractual terms of the transaction resulted in the recognition of pre-tax gains of $63 million, $57 million and $9 million in 2015, 2016 and first three months of 2017, respectively.

Overall, the company expects to recognize a total pre-tax gain on the sale of approximately $1.6 billion, which does not include associated costs related to transition and performance-based costs. Net of these charges, the pre-tax gain was approximately $1.3 billion, of which the cumulative gain recorded as of March 31, 2017 is $1.2 billion. The balance of the gain is expected to be recognized in 2019 upon conclusion of the maintenance agreement.

Others — In the first quarter of 2017, the company completed one research-related divestiture. The financial terms related to this transaction were not material.

10. Intangible Assets Including Goodwill: The following table details the company’s intangible asset balances by major asset class:

	At March 31, 2017
(Dollars in millions)	Gross Carrying		Accumulated			Net Carrying
Intangible asset class	Amount		Amortization			Amount
Capitalized software	$	1,557	$	(691	)	$	865
Client relationships	2,751		(1,254		)	1,497
Completed technology	3,231		(1,688		)	1,542
Patents/trademarks	725		(228		)	496
Other*	52		(17		)	35
Total	$	8,314	$	(3,879	)	$	4,436

* Other intangibles are primarily acquired proprietary and non-proprietary business processes, methodologies and systems.

	At December 31, 2016
(Dollars in millions)	Gross Carrying		Accumulated			Net Carrying
Intangible asset class	Amount		Amortization			Amount
Capitalized software	$	1,537	$	(661	)	$	876
Client relationships	2,831		(1,228		)	1,602
Completed technology	3,322		(1,668		)	1,654
Patents/trademarks	730		(205		)	525
Other*	46		(15		)	31
Total	$	8,466	$	(3,778	)	$	4,688

* Other intangibles are primarily acquired proprietary and non-proprietary business processes, methodologies and systems.

The net carrying amount of intangible assets decreased $252 million during the first quarter of 2017, primarily due to intangible asset amortization, partially offset by additions resulting from capitalized software. The aggregate intangible amortization expense was $390 million and $347 million for the quarters ended March 31, 2017 and 2016, respectively. In addition, in the first three months of 2017, the company retired $289 million of fully amortized intangible assets, impacting both the gross carrying amount and accumulated amortization by this amount.

The 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, 2017:

	Capitalized		Acquired
(Dollars in millions)	Software		Intangibles		Total
2017 (for Q2 - Q4)	$	391	$	707	$	1,098
2018	347		811		1,158
2019	119		648		768
2020	8		549		557
2021	—		437		437

Notes to Consolidated Financial Statements — (continued)

The change in the goodwill balances by reportable segment, for the three months ended March 31, 2017 and for the year ended December 31, 2016 are as follows:

										Foreign
										Currency
					Purchase					Translation
(Dollars in millions)	Balance		Goodwill		Price					And Other		Balance
Segment	01/01/17		Additions		Adjustments			Divestitures		Adjustments*		3/31/17
Cognitive Solutions	$	19,484	$	3	$	4		$	—	$	26	$	19,518
Global Business Services	4,607		—		2			—		35		4,643
Technology Services & Cloud Platforms	10,258		5		(3		)	—		35		10,295
Systems	1,850		—		—			—		1		1,851
Total	$	36,199	$	8	$	3		$	—	$	97	$	36,307

* Primarily driven by foreign currency translation.

											Foreign
											Currency
					Purchase						Translation
(Dollars in millions)	Balance		Goodwill		Price						And Other			Balance
Segment	01/01/16		Additions		Adjustments			Divestitures			Adjustments*			12/31/16
Cognitive Solutions	$	15,621	$	3,821	$	5		$	(12	)	$	48		$	19,484
Global Business Services	4,396		303		4			(1		)	(95		)	4,607
Technology Services & Cloud Platforms	10,156		119		(12		)	(5		)	(1		)	10,258
Systems	1,848		—		(4		)	—			5			1,850
Total	$	32,021	$	4,244	$	(7	)	$	(18	)	$	(42	)	$	36,199

* Primarily driven by foreign currency translation.

There were no goodwill impairment losses recorded during the first three months of 2017 or the full year of 2016 and the company has no accumulated impairment losses.

Purchase price adjustments recorded in the first three months of 2017 and full year 2016 were related to acquisitions that were completed on or prior to December 31, 2016 or September 30, 2016, respectively, and were still subject to the measurement period that ends at the earlier of 12 months from the acquisition date or when information becomes available. Net purchase price adjustments of $3 million were recorded during the first three months of 2017, with the primary driver being deferred tax assets. Net purchase price adjustments of $7 million were recorded during 2016, with the primary drivers being deferred tax assets, accounts receivable, deferred income, inventory and other ~~visualizations.~~

Purchase price consideration for all acquisitions as reflected in the following table, was paid primarily in cash. All acquisitions are reported in the Consolidated Statement of Cash Flows net of acquired cash and cash equivalents.

~~The following table reflects the purchase price related to these acquisitions and the resulting purchase price allocations as of June 30, 2016.~~

The

Truven

Amortization

Weather

Health

Other

(Dollars in millions)

Life (in yrs.)

Company

Analytics

Acquisitions

Current assets

$
76

$
171

$
71

Fixed assets/noncurrent assets

123

127

89

Intangible assets:

Goodwill

N/A

1,717

1,933

487

Completed technology

1-7

160

338

75

Client relationships

3-7

313

516

184

Patents/trademarks

2-7

349

54

28

Total assets acquired

2,738

3,141

934

Current liabilities

(88
)
(148
)
(46
)
Noncurrent liabilities

(372
)
(381
)
(64
)
Total liabilities assumed

(460
)
(529
)
(110
)
Bargain purchase gain

—

—

(40
)*
Total purchase price

$
2,278

$
2,612

$
784

~~N/A - not applicable~~

* Bargain purchase gain relating to AT&T’s application and hosting services business was recognized in selling, general and administrative expense in the Consolidated Statement of Earnings in the three months ended March 31, 2016.

The acquisitions were accounted for as business combinations using the acquisition method, and accordingly, the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquired entity were recorded at their estimated fair values at the date of acquisition. The primary items that generated the goodwill are the value of the synergies between the acquired businesses and IBM and the acquired assembled workforce, neither of which qualify as an amortizable intangible asset.

For the “Other Acquisitions”, the overall weighted-average life of the identified amortizable intangible assets acquired is 6.4 years. These identified intangible assets will be amortized on a straight-line basis over their useful lives. Goodwill of $91 million was assigned to the Technology Services & Cloud Platforms segment, goodwill of $278 million was assigned to the GBS segment and goodwill of $118 million was assigned to the Cognitive Solutions segment. It is expected that approximately 50 percent of the goodwill will be deductible for tax purposes.

~~Notes to Consolidated Financial Statements — (continued)~~

~~Divestitures:~~

~~Microelectronics —~~ On October 20, 2014, IBM and GLOBALFOUNDRIES announced a definitive agreement in which GLOBALFOUNDRIES would acquire the company’s Microelectronics business, including existing semiconductor manufacturing assets and operations in East Fishkill, NY and Essex Junction, VT. The commercial OEM business acquired by GLOBALFOUNDRIES includes custom logic and specialty foundry, manufacturing and related operations. The transaction closed on July 1, 2015.

The transaction includes a 10-year exclusive manufacturing sourcing agreement in which GLOBALFOUNDRIES will provide server processor semiconductor technology for use in IBM Systems. The agreement provides the company with capacity and market-based pricing for current semiconductor nodes in production and progression to nodes in the future for both development and production needs. As part of the transaction, the company will provide GLOBALFOUNDRIES with certain transition services, including IT, supply chain, packaging and test services and lab services. The initial term for these transition services is one to three years, with GLOBALFOUNDRIES having the ability to renew.

In the third quarter of 2014, the company recorded a pre-tax charge of $4.7 billion related to the sale of the Microelectronics disposal group, which was part of the Systems reportable segment. The pre-tax charge reflected the fair value less the estimated cost of selling the disposal group including an impairment to the semiconductor long-lived assets of $2.4 billion, $1.5 billion representing the cash consideration expected to be transferred to GLOBALFOUNDRIES and $0.8 billion of other related costs. Additional pre-tax charges of $116 million were recorded during 2015 related to the disposal, and a pre-tax credit of $1 million was recorded during the first half of 2016. The cumulative pre-tax charge was $4.8 billion as of June 30, 2016. Any additional charges that may be recorded in future periods are expected to be immaterial.

All assets and liabilities of the business, classified as held for sale at June 30, 2015, were transferred at closing. The company transferred $515 million of net cash to GLOBALFOUNDRIES in the third quarter of 2015. This amount included $750 million of cash consideration, adjusted by the amount of working capital due from GLOBALFOUNDRIES and other miscellaneous items. The remaining cash consideration will be transferred over two years.

Reporting the related assets and liabilities initially as held for sale at September 30, 2014 was based on meeting all of the criteria for such reporting in the applicable accounting guidance. While the company met certain criteria for held for sale reporting in prior periods, it did not meet all of the criteria until September 30, 2014. In addition, at September 30, 2014, the company concluded that the Microelectronics business met the criteria for discontinued operations reporting. The disposal group constitutes a component under accounting guidance. The continuing cash inflows and outflows with the discontinued component are related to the manufacturing sourcing arrangement and the transition, packaging and test services. These cash flows are not direct cash flows as they are not significant and the company will have no significant continuing involvement.

~~Summarized financial information for discontinued operations is shown in the table below.~~

Three Months Ended June 30,

Six Months Ended June 30,

(Dollars in millions)

2016

2015

2016

2015

Total revenue

$
—

$
381

$
—

$
720

Income/(loss) from discontinued operations

$
(1
)
$
(74
)
$
(6
)
$
(179
)
Gain/(loss) on disposal, before tax

0

(37
)
1

(51
)
Total loss from discontinued operations, before income taxes

$
(1
)
$
(111
)
$
(5
)
$
(230
)
Provision/(benefit) for income taxes

0

(34
)
(2
)
(65
)
Loss from discontinued operations, net of tax

$
0

$
(77
)
$
(3
)
$
(165
)

~~Industry Standard Server —~~ On January 23, 2014, IBM and Lenovo Group Limited (Lenovo) announced a definitive agreement in which Lenovo would acquire the company’s industry standard server portfolio (System x) for an adjusted purchase price of $2.1 billion, consisting of approximately $1.8 billion in cash, with the balance in Lenovo common stock. The stock represented less than 5 percent equity ownership in Lenovo. As of March 31, 2016, all Lenovo common stock has been sold. The company would sell to Lenovo its System x, BladeCenter and Flex System blade servers and switches, x86-based Flex integrated systems, NeXtScale and iDataPlex servers and associated software, blade networking and maintenance operations.

~~Notes to Consolidated Financial Statements — (continued)~~

IBM and Lenovo entered into a strategic relationship which included a global OEM and reseller agreement for sales of IBM’s industry-leading entry and midrange Storwize disk storage systems, tape storage systems, General Parallel File System software, SmartCloud Entry offering, and elements of IBM’s system software, including Systems Director and Platform Computing solutions. Effective with the initial closing of the transaction, Lenovo assumed related customer service and maintenance operations. IBM will continue to provide maintenance delivery on Lenovo’s behalf for an extended period of time. In addition, as part of the transaction agreement, the company will provide Lenovo with certain transition services, including IT and supply chain services. The initial term for these transition services ranges from less than one year to three years. Lenovo can renew certain services for an additional year.

~~The initial closing was completed on October 1, 2014. A subsequent closing occurred in most other countries in which there was a large business footprint on December 31, 2014. T~~he remaining countries closed on March 31, 2015. An assessment of the ongoing contractual terms of the transaction resulted in the recognition of a pre-tax gain of $63 million in 2015 and $32 million in the first half of 2016.

~~Overall, the company expects to recognize a total pre-tax gain on the sale of approximately $1.6 billion~~, which does not include associated costs related to transition and performance-based costs. Net of these charges, the pre-tax gain was approximately $1.3 billion, of which the cumulative gain recorded as of June 30, 2016 is $1.2 billion. The balance of the gain is expected to be recognized in 2019 upon conclusion of the maintenance agreement.

~~Customer Care —~~ On September 10, 2013, IBM and SYNNEX announced a definitive agreement in which SYNNEX would acquire the company’s worldwide customer care business process outsourcing services business for $501 million, consisting of approximately $430 million in cash, net of balance sheet adjustments, and $71 million in SYNNEX common stock, which represented less than 5 percent equity ownership in SYNNEX. As part of the transaction, SYNNEX entered into a multi-year agreement with the company, and Concentrix, SYNNEX’s outsourcing business, became an IBM strategic business partner for global customer care business process outsourcing services.

~~The initial closing was completed on January 31, 2014, with subsequent closings occurring during 2014.~~ ~~For the full year of 2014, the company recorded a pre-tax gain of $202 million related to this transaction.~~

In the second quarter of 2015, resolution of the final balance sheet adjustments was concluded. An assessment of the ongoing contractual terms of the transaction resulted in the recognition of a pre-tax gain of $7 million in 2015. Through June 30, 2016, the cumulative pre-tax gain attributed to this transaction was $211 million.

~~Others —~~ In the first quarter of 2016, the company completed four software product-related divestitures. The financial terms related to these transactions were not material. Overall, the company recorded a pre-tax gain of $36 million related to these transactions in the first quarter of 2016. There were no divestitures in the second quarter of 2016.

~~Notes to Consolidated Financial Statements — (continued)~~

~~10.~~ ~~Intangible Assets Including Goodwill:~~ ~~The following table details the company’s intangible asset balances by major asset class:~~

At June 30, 2016

(Dollars in millions)

Gross Carrying

Accumulated

Net Carrying

Intangible asset class

Amount

Amortization

Amount

Capitalized software

$
1,486

$
(604
)
$
882

Client relationships

2,861

(1,093
)
1,769

Completed technology

3,509

(1,615
)
1,894

Patents/trademarks

762

(190
)
572

Other*

44

(12
)
32

Total

$
8,663

$
(3,515
)
$
5,148

* Other intangibles are primarily acquired proprietary and non-proprietary business processes, methodologies and systems.

At December 31, 2015

(Dollars in millions)

Gross Carrying

Accumulated

Net Carrying

Intangible asset class

Amount

Amortization

Amount

Capitalized software

$
1,348

$
(581
)
$
767

Client relationships

1,856

(927
)
929

Completed technology

2,960

(1,397
)
1,563

Patents/trademarks

335

(142
)
193

Other*

44

(10
)
35

Total

$
6,543

$
(3,057
)
$
3,487

* Other intangibles are primarily acquired proprietary and non-proprietary business processes, methodologies and systems.

The net carrying amount of intangible assets increased $1,662 million during the first six months of 2016, primarily due to intangible asset additions resulting from acquisitions, partially offset by amortization. The aggregate intangible amortization expense was $398 million and $745 million for the second quarter and first six months of 2016, respectively, versus $296 million and $594 million for the second quarter and first six months of 2015, respectively. In addition, in the first six months of 2016, the company retired $283 million of fully amortized intangible assets, impacting both the gross carrying amount and accumulated amortization by this amount.

Capitalized

Acquired

(Dollars in millions)

Software

Intangibles

Total

2016 (for Q3-Q4)

$
260

$
521

$
782

2017

393

945

1,338

2018

204

798

1,001

2019

25

635

660

2020

—

535

535

~~The change in the goodwill balances by reportable segment, for the six months ended June 30, 2016 and for the year ended December 31, 2015 are as follows:~~

~~Notes to Consolidated Financial Statements — (continued)~~

Foreign

Currency

Purchase

Translation

(Dollars in millions)

Balance

Goodwill

Price

And Other

Balance

Segment

1/1/2016*

Additions

Adjustments

Divestitures

Adjustments**

6/30/16

Cognitive Solutions

$
15,621

$
3,769

$
(3
)
$
(12
)
$
98

$
19,474

Global Business Services

4,396

278

4

(1
)
12

4,689

Technology Services & Cloud Platforms

10,156

91

1

(5
)
154

10,398

Systems

1,848

—

2

—

11

1,861

Total

$
32,021

$
4,137

$
5

$
(17
)
$
276

$
36,422

* ~~Recast to conform with 2016 presentation.~~

** ~~Primarily driven by foreign currency translation.~~

Foreign

Currency

Purchase

Translation

(Dollars in millions)

Balance

Goodwill

Price

And Other

Balance

Segment

1/1/2015*

Additions*

Adjustments*

Divestitures*

Adjustments* **

12/31/15*

Cognitive Solutions

$
15,156

$
1,020

$
(2
)
$
(18
)
$
(535
)
$
15,621

Global Business Services

4,555

74

0

(1
)
(232
)
4,396

Technology Services & Cloud Platforms

9,373

1,087

(1
)
(7
)
(296
)
10,156

Systems

1,472

410

0

—

(33
)
1,848

Total

$
30,556

$
2,590

$
(3
)
$
(26
)
$
(1,096
)
$
32,021

* ~~Recast to conform with 2016 presentation.~~

** ~~Primarily driven by foreign currency translation.~~

In January 2016, the company made a number of changes to its organizational structure and management system consistent with the ongoing transformation to a cognitive solutions and cloud platform business. With these changes, the company revised its reportable segments. Goodwill was reallocated to the new reporting segments, and as a result, an impairment assessment was performed. There were no goodwill impairment losses recorded during the first six months of 2016 or the full year of 2015 and the company has no accumulated impairment losses. For further information regarding the segment change, refer to note 6, “Segments”.

Purchase price adjustments recorded in the first six months of 2016 and full year 2015 were related to acquisitions that were completed on or prior to March 31, 2016 or December 31, 2014, respectively, and were still subject to the measurement period that ends at the earlier of 12 months from the acquisition date or when information becomes available. Net purchase price adjustments of $5 million were recorded during the first six months of 2016 with the primary drivers being accounts receivable, inventory, deferred tax assets, deferred revenue and current liabilities.

11. Borrowings:

Short-Term Debt

	At June 30,		At December 31,		At March 31,		At December 31,
(Dollars in millions)	2016		2015		2017		2016
Commercial paper	$	—	$	600	$	—	$	899
Short-term loans	301		590		285		375
Long-term debt — current maturities	4,586		5,271		8,055		6,239
Total	$	4,887	$	6,461	$	8,340	$	7,513

The weighted-average interest rate for commercial paper at December 31, ~~2015~~2016 was ~~0.4~~0.7 percent. The weighted-average interest rate for short-term loans was ~~10.6~~7.7 percent and ~~5.2~~9.5 percent at ~~June 30, 2016~~March 31, 2017 and December 31, ~~2015,~~2016, respectively.

Notes to Consolidated Financial Statements — (continued)

Long-Term Debt

Pre-Swap Borrowing

		Balance		Balance			Balance		Balance
(Dollars in millions)	Maturities	6/30/2016		12/31/2015		Maturities	3/31/2017		12/31/2016
U.S. dollar notes and debentures (average interest rate at June 30, 2016):
3.36%	2016–2017	$	7,198	$	9,351
3.17%	2018–2019	8,841		7,591
1.72%	2020–2021	4,943		3,717
2.35%	2022	1,901		1,900
U.S. dollar debt (average interest rate at March 31, 2017):*
4.69%						2017	$	3,980	$	5,104
3.24%						2018-2019	8,967		8,856
1.86%						2020-2021	6,198		4,941
1.54%						2022	2,903		1,901
3.38%	2023	1,500		1,500		2023	1,500		1,500
3.63%	2024	2,000		2,000		2024	2,000		2,000
7.00%	2025	600		600		2025	600		600
3.45%	2026	1,350		—		2026	1,350		1,350
6.22%	2027	469		469
3.01%						2027	969		469
6.50%	2028	313		313		2028	313		313
5.88%	2032	600		600		2032	600		600
8.00%	2038	83		83		2038	83		83
5.60%	2039	745		745		2039	745		745
4.00%	2042	1,107		1,107		2042	1,107		1,107
7.00%	2045	27		27		2045	27		27
4.70%	2046	650		—		2046	650		650
7.13%	2096	316		316		2096	316		316
		$	32,644	$	30,319		$	32,309	$	30,563
Other currencies (average interest rate at June 30, 2016, in parentheses):
Other currencies (average interest rate at March 31, 2017, in parentheses):*

Euros (1.6%)	2016–2028	$	7,493	$	4,892	2019-2028	$	7,217	$	7,122
Pound sterling (2.7%)	2017–2022	1,400		1,555		2020-2022	1,312		1,296
Japanese yen (0.3%)	2017–2022	1,383		1,180
Swiss francs (6.3%)	2020	8		9
Japanese yen (0.9%)						2017-2026	1,649		1,576
Canadian (2.2%)	2017	385		360		2017	—		373
Other (12.4%)	2016–2020	715		506
Other (10.0%)						2017-2020	305		215
		$	44,027	$	38,820		$	42,792	$	41,145
Less: net unamortized discount		853		838			838		839
Less: net unamortized debt issuance cost		90		74
Add: fair value adjustment*		1,140		790
Less: net unamortized debt issuance costs							84		82
Add: fair value adjustment**							627		669
		$	44,224	$	38,699		$	42,498	$	40,893
Less: current maturities		4,586		5,271			8,055		6,239
Total		$	39,638	$	33,428		$	34,441	$	34,655

*Includes notes, debentures, bank loans, securitized borrowings and capital lease obligations.

** The portion of the company’s fixed-rate debt obligations that is hedged is reflected in the Consolidated Statement of Financial Position as an amount equal to the sum of the debt’s carrying value plus a fair value adjustment representing changes in the fair value of the hedged debt obligations attributable to movements in benchmark interest rates.

There are no debt securities issued and outstanding by IBM International Group Capital LLC, which is an indirect, 100 percent owned finance subsidiary of International Business Machines Corporation, the parent. Any debt securities issued by IBM International Group Capital LLC, would be fully and unconditionally guaranteed by the parent.

The company’s indenture governing its debt securities and its various credit facilities each contain significant covenants which obligate the company to promptly pay principal and interest, limit the aggregate amount of secured indebtedness and sale and leaseback transactions to 10 percent of the company’s consolidated net tangible assets, and restrict the company’s ability to merge or consolidate unless certain conditions are met. The credit facilities also include a covenant on the company’s consolidated net interest expense ratio, which cannot be less than 2.20 to 1.0, as well as a cross default provision with respect to other defaulted indebtedness of at least $500 million.

The company is in compliance with all of its significant debt covenants and provides periodic certifications to its lenders. The failure to comply with its debt covenants could constitute an event of default with respect to the debt to which such provisions apply. If certain events of default were to occur, the principal and interest on the debt to which such event of default applied would become immediately due and payable.

Notes to Consolidated Financial Statements — (continued)

Pre-swap annual contractual maturities of long-term debt outstanding at ~~June 30, 2016,~~March 31, 2017, are as follows:

(Dollars in millions)	Total		Total
2016 (for Q3-Q4)	$	2,128
2017	6,943
2017 (for Q2 - Q4)			$	4,845
2018	4,794		4,995
2019	5,247		5,256
2020	4,751		5,889
2021 and beyond	20,164
2021			3,933
2022 and beyond			17,875
Total	$	44,027	$	42,792

Interest on Debt

(Dollars in millions)
For the six months ended June 30:	2016			2015
For the three months ended March 31:							2017			2016
Cost of financing	$	284		$	276		$	158		$	138
Interest expense	341			225			155			157
Net investment derivative activity	(26		)	(3		)	(19		)	(10		)
Interest capitalized	1			(3		)	0			1
Total interest paid and accrued	$	600		$	496		$	293		$	286

12. Contingencies: As a company with a substantial employee population and with clients in more than 175 countries, IBM is involved, either as plaintiff or defendant, in a variety of ongoing claims, demands, suits, investigations, tax matters and proceedings that arise from time to time in the ordinary course of its business. The company is a leader in the information technology industry and, as such, has been and will continue to be subject to claims challenging its IP rights and associated products and offerings, including claims of copyright and patent infringement and violations of trade secrets and other IP rights. In addition, the company enforces its own IP against infringement, through license negotiations, lawsuits or otherwise. Also, as is typical for companies of IBM’s scope and scale, the company is party to actions and proceedings in various jurisdictions involving a wide range of labor and employment issues (including matters related to contested employment decisions, country-specific labor and employment laws, and the company’s pension, retirement and other benefit plans), as well as actions with respect to contracts, product liability, securities, foreign operations, competition law and environmental matters. These actions may be commenced by a number of different parties, including competitors, clients, current or former employees, government and regulatory agencies, stockholders and representatives of the locations in which the company does business. Some of the actions to which the company is party may involve particularly complex technical issues, and some actions may raise novel questions under the laws of the various jurisdictions in which these matters arise.

The company records a provision with respect to a claim, suit, investigation or proceeding when it is probable that a liability has been incurred and the amount of the loss can be reasonably estimated. Any recorded liabilities, including any changes to such liabilities for the quarter ended ~~June 30, 2016~~March 31, 2017 were not material to the Consolidated Financial Statements.

In accordance with the relevant accounting guidance, the company provides disclosures of matters for which the likelihood of material loss is at least reasonably possible. In addition, the company also discloses matters based on its consideration of other matters and qualitative factors, including the experience of other companies in the industry, and investor, customer and employee relations considerations.

With respect to certain of the claims, suits, investigations and proceedings discussed herein, the company believes at this time that the likelihood of any material loss is remote, given, for example, the procedural status, court rulings, and/or the strength of the company’s defenses in those matters. With respect to the remaining claims, suits, investigations and proceedings discussed in this ~~Note,~~note, except as specifically discussed herein, the company is unable to provide estimates of reasonably possible losses or range of losses, including losses in excess of amounts accrued, if any, for the following reasons. Claims, suits, investigations and proceedings are inherently uncertain, and it is not possible to predict the ultimate outcome of these matters. It is the company’s experience that damage amounts claimed in litigation against it are unreliable and unrelated to possible outcomes, and as such are not meaningful indicators of the company’s potential liability. Further, the company is unable to provide such an estimate due to a number of other factors with respect to these claims, suits, investigations and proceedings, including considerations of the procedural status of the matter in question, the presence of complex or novel legal theories, and/or the ongoing discovery and development of information important to the matters. The company reviews claims, suits, investigations and proceedings at least quarterly, and decisions are made with respect to recording or adjusting provisions and disclosing reasonably possible losses or range of losses (individually or in the aggregate), to reflect the impact

Notes to Consolidated Financial Statements — (continued)

and status of settlement discussions, discovery, procedural and substantive rulings, reviews by counsel and other information pertinent to a particular matter.

Whether any losses, damages or remedies finally determined in any claim, suit, investigation or proceeding could reasonably have a material effect on the company’s business, financial condition, results of operations or cash flows will depend on a number of variables, including: the timing and amount of such losses or damages; the structure and type of any such remedies; the significance of the impact any such losses, damages or remedies may have in the Consolidated Financial Statements; and the unique facts and circumstances of the particular matter that may give rise to additional factors. While the company will continue to defend itself vigorously, it is possible that the company’s business, financial condition, results of operations or cash flows could be affected in any particular period by the resolution of one or more of these matters.

The following is a summary of the more significant legal matters involving the company.

The company is a defendant in an action filed on March 6, 2003 in state court in Salt Lake City, Utah by the SCO Group (SCO v. IBM). The company removed the case to Federal Court in Utah. Plaintiff is an alleged successor in interest to some of AT&T’s UNIX IP rights, and alleges copyright infringement, unfair competition, interference with contract and breach of contract with regard to the company’s distribution of AIX and Dynix and contribution of code to Linux and the company has asserted counterclaims. On September 14, 2007, plaintiff filed for bankruptcy protection, and all proceedings in this case were stayed. The court in another suit, the SCO Group, Inc. v. Novell, Inc., held a trial in March 2010. The jury found that Novell is the owner of UNIX and UnixWare copyrights; the judge subsequently ruled that SCO is obligated to recognize Novell’s waiver of SCO’s claims against IBM and Sequent for breach of UNIX license agreements. On August 30, 2011, the Tenth Circuit Court of Appeals affirmed the district court’s ruling and denied SCO’s appeal of this matter. In June 2013, the Federal Court in Utah granted SCO’s motion to reopen the SCO v. IBM case. In February 2016, the Federal Court ruled in favor of IBM on all of SCO’s remaining claims, and in March 2016, SCO filed a notice of appeal to the Tenth Circuit Court of Appeals.

On May 13, 2010, IBM and the State of Indiana (acting on behalf of the Indiana Family and Social Services Administration) sued one another in a dispute over a 2006 contract regarding the modernization of social service program processing in Indiana. After six weeks of trial, on July 18, 2012, the Indiana Superior Court in Marion County rejected the State’s claims in their entirety and awarded IBM $52 million plus interest and costs. On February 13, 2014, the Indiana Court of Appeals reversed portions of the trial judge’s findings, found IBM in material breach, and ordered the case remanded to the trial judge to determine the State’s damages, if any. The Indiana Court of Appeals also affirmed approximately $50 million of the trial court’s award of damages to IBM. On March 22, 2016, the Indiana Supreme Court affirmed the outcome of the Indiana Court of Appeals and remanded the case to the Indiana Superior Court.

On March 9, 2017, the Commonwealth of Pennsylvania’s Department of Labor and Industry sued IBM in Pennsylvania state court regarding a 2006 contract for the development of a custom software system to manage the Commonwealth’s unemployment insurance benefits programs. The matter is pending in a Pennsylvania court.

On October 29, 2013, Bridgestone Americas, Inc. (Bridgestone) sued IBM regarding a 2009 contract for the implementation of an SAP-based, enterprise-wide order management system. IBM counterclaimed against Bridgestone and its parent, Bridgestone Corp. The case is pending in the Middle District of Tennessee.

On April 16, 2014, Iusacell SA de C.V. (Iusacell) sued IBM, claiming that IBM made fraudulent misrepresentations that induced Iusacell to enter into an agreement with IBM Mexico. Iusacell claims damages for lost profits. Iusacell’s complaint relates to a contractual dispute in Mexico, which is the subject of a pending arbitration proceeding in Mexico initiated by IBM Mexico against Iusacell for breach of the underlying agreement. On November 14, 2014, the District Court in the Southern District of New York granted IBM’s motion to stay Iusacell’s action against the company pending the arbitration in Mexico between Iusacell and IBM Mexico.

IBM United Kingdom Limited (IBM UK) initiated legal proceedings in May 2010 before the High Court in London against the IBM UK Pensions Trust (the UK Trust) and two representative beneficiaries of the UK Trust membership. IBM UK is seeking a declaration that it acted lawfully both in notifying the Trustee of the UK Trust that it was closing its UK defined benefit plans to future accruals for most participants and in implementing the company’s new retirement policy. In April 2014, the High Court acknowledged that the changes made to its UK defined benefit plans were within IBM’s discretion, but ruled that IBM breached its implied duty of good faith both in implementing these changes and in the manner in which it consulted with employees. Proceedings to determine remedies were held in July 2014, and in February 2015 the High Court held that for IBM to make changes to accruals under the plan would require a new consultation of the participants, but other changes (including to early retirement policy) would not require such consultation. IBM UK has

Notes to Consolidated Financial Statements — (continued)

appealed both the breach and remedies judgments. If the appeal is unsuccessful, the Court’s rulings would require IBM to reverse the changes made to the UK defined benefit plans retroactive to their effective dates. This could result in an estimated non-operating one-time pre-tax charge of approximately ~~$250~~$290 million, plus ongoing defined benefit related accruals. In addition, IBM UK is a defendant in approximately 290 individual actions brought since early 2010 by participants of the defined benefits plans who left IBM UK. These actions, which allege constructive dismissal and age discrimination, are pending before the Employment Tribunal in Southampton UK.

~~In March 2011, the company announced that it had agreed to settle a civil enforcement action with the Securities and~~

~~Notes to Consolidated Financial Statements — (continued)~~

Exchange Commission (SEC) relating to alleged violations of the Foreign Corrupt Practices Act of 1977 (FCPA). On July 25, 2013, the court approved that 2011 settlement and required that for a two-year period IBM make reports to the SEC and the court on certain matters, including those relating to compliance with the FCPA. The two-year period expired in July 2015. In early 2012, IBM notified the SEC of an investigation by the Polish Central Anti-Corruption Bureau involving allegations of illegal activity by a former IBM Poland employee in connection with sales to the Polish government. IBM is cooperating with the SEC and Polish authorities in this matter. In April 2013, IBM learned that the U.S. Department of Justice (DOJ) is also investigating allegations related to the Poland matter, as well as allegations relating to transactions in Argentina, Bangladesh and Ukraine. The DOJ is also seeking information regarding the company’s global FCPA compliance program and its public sector business. The company is cooperating with the DOJ in this matter.

In ~~March~~May 2015, a putative class action ~~litigation~~ was commenced in the United States District Court for the Southern District of New York related to the company’s October 2014 announcement that it was divesting its global commercial semiconductor technology business. The company and three of its officers are named as defendants. Plaintiffs allege that defendants violated Sections 20(a) and 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder. In May 2015, a related putative class action was also commenced in the United States District Court for the Southern District of New York based on the same underlying facts,business, alleging violations of the Employee Retirement Income Security ~~Act.~~Act (“ERISA”). The company, management’s Retirement Plans Committee, and three current or former IBM executives ~~are~~were named as defendants. On September 7, 2016, the Court granted the company’s motion to dismiss the plaintiffs’ claims. On October 21, 2016, the plaintiffs filed an amended complaint, dropping the company as a defendant. The matter remains pending in the United States District Court.

In August 2015, IBM learned that the SEC is conducting an investigation relating to revenue recognition with respect to the accounting treatment of certain transactions in the U.S., UK and Ireland. The company is cooperating with the SEC in this matter.

The company is party to, or otherwise involved in, proceedings brought by U.S. federal or state environmental agencies under the Comprehensive Environmental Response, Compensation and Liability Act (CERCLA), known as “Superfund,” or laws similar to CERCLA. Such statutes require potentially responsible parties to participate in remediation activities regardless of fault or ownership of sites. The company is also conducting environmental investigations, assessments or remediations at or in the vicinity of several current or former operating sites globally pursuant to permits, administrative orders or agreements with country, state or local environmental agencies, and is involved in lawsuits and claims concerning certain current or former operating sites.

The company is also subject to ongoing tax examinations and governmental assessments in various jurisdictions. Along with many other U.S. companies doing business in Brazil, the company is involved in various challenges with Brazilian tax authorities regarding non-income tax assessments and non-income tax litigation matters. The total potential amount related to all these matters for all applicable years is approximately ~~$585 million.~~$1 billion, with the increase since the last quarter driven primarily by currency fluctuations and interest. The company believes it will prevail on these matters and that this amount is not a meaningful indicator of liability.

13. Commitments: The company’s extended lines of credit to third-party entities include unused amounts of ~~$5,931~~$7,860 million and ~~$5,477~~$6,542 million at ~~June 30, 2016~~March 31, 2017 and December 31, ~~2015,~~2016, respectively. A portion of these amounts was available to the company’s business partners to support their working capital needs. In addition, the company has committed to provide future financing to its clients in connection with client purchase agreements for approximately ~~$2,252~~$2,341 million and ~~$2,097~~$2,463 million at ~~June 30, 2016~~March 31, 2017 and December 31, ~~2015,~~2016, respectively.

The company has applied the guidance 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 (IP) rights, specified environmental matters, third-party performance of nonfinancial contractual obligations and certain income taxes. In each of these circumstances, payment by the company is conditioned on the other party making a claim pursuant to the procedures specified in the particular contract, the procedures of which typically allow the company to challenge the other party’s claims. While typically indemnification provisions do not include a contractual maximum on the company’s payment,

Notes to Consolidated Financial Statements — (continued)

the company’s obligations under these agreements may be limited in terms of time and/or nature of claim, 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

~~Notes to Consolidated Financial Statements — (continued)~~

agreement. Historically, payments made by the company under these agreements have not had 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 ~~$30~~$23 million and $34 million at ~~June 30, 2016~~March 31, 2017 and December 31, ~~2015,~~2016, respectively. The fair value of the guarantees recognized in the Consolidated Statement of Financial Position is not material.

Changes in the company’s warranty liability for standard warranties and deferred income for extended warranty contracts are presented in the following tables.

Standard Warranty Liability

(Dollars in millions)	2016			2015			2017			2016
Balance at January 1	$	181		$	197		$	156		$	181
Current period accruals	74			82			32			27
Accrual adjustments to reflect actual experience	3			9			1			(2		)
Charges incurred	(89		)	(100		)	(41		)	(41		)
Balance at June 30	$	169		$	188
Balance at March 31							$	147		$	164

Extended Warranty Liability

(Dollars in millions)	2016			2015			2017			2016
Aggregate deferred revenue at January 1	$	538		$	536		$	531		$	538
Revenue deferred for new extended warranty contracts	122			122			58			49
Amortization of deferred revenue	(134		)	(126		)	(68		)	(66		)
Other*	9			(20		)	7			9
Aggregate deferred revenue at June 30	$	535		$	512
Aggregate deferred revenue at March 31							$	528		$	531
Current portion	$	241		$	245		$	250		$	247
Noncurrent portion	$	294		$	267		$	278		$	284

* Other primarily consists of foreign currency translation adjustments.

14. Subsequent Events: On ~~July 26, 2016,~~April 25, 2017, the company announced that the Board of Directors approved a quarterly dividend of ~~$1.40~~$1.50 per common share. The dividend is payable ~~September~~June 10, ~~2016~~2017 to shareholders of record on ~~August~~May 10, ~~2016.~~2017. The dividend declaration represents an increase of $0.10 per common share, which is 7 percent higher than the prior quarterly dividend of $1.40 per common share.

Item 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS
OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION
FOR THE THREE ~~AND SIX~~ MONTHS ENDED ~~JUNE 30, 2016~~MARCH 31, 2017

Snapshot

Financial Results Summary - Three Months Ended ~~June 30:~~March 31:


							Yr. to Yr.								Yr. to Yr.
							Percent/								Percent/
(Dollars and shares in millions except per share amounts)							Margin								Margin
For the three months ended June 30:	2016			2015			Change
For the three months ended March 31:									2017			2016			Change
Revenue	$	20,238		$	20,813		(2.8	)%*	$	18,155		$	18,684		(2.8	)%*
Gross profit margin	47.9		%	49.9		%	(2.0	)pts.	42.8		%	46.5		%	(3.7	)pts.
Total expense and other (income)	$	6,653		$	6,165		7.9	%	$	6,348		$	7,652		(17.0	)%
Total expense and other (income)-to-revenue ratio	32.9		%	29.6		%	3.3	pts.	35.0		%	41.0		%	(6.0	)pts.
Income from continuing operations, before income taxes	$	3,049		$	4,224		(27.8	)%	$	1,424		$	1,034		37.7	%
Provision for income taxes from continuing operations	$	544		$	698		(22.1	)%
Provision for/(benefit from) income taxes from continuing operations									$	(329	)	$	(983	)	(66.5	)%
Income from continuing operations	$	2,505		$	3,526		(29.0	)%	$	1,753		$	2,016		(13.1	)%
Income from continuing operations margin	12.4		%	16.9		%	(4.6	)pts.	9.7		%	10.8		%	(1.1	)pts.
Loss from discontinued operations, net of tax	$	0		$	(77	)	(99.5	)%	$	(3	)	$	(3	)	(6.8	)%
Net income	$	2,504		$	3,449		(27.4	)%	$	1,750		$	2,014		(13.1	)%
Earnings per share from continuing operations:
Assuming dilution	$	2.61		$	3.58		(27.1	)%	$	1.85		$	2.09		(11.5	)%
Basic	$	2.62		$	3.59		(27.0	)%	$	1.86		$	2.09		(11.0	)%
Consolidated earnings per share - assuming dilution	$	2.61		$	3.50		(25.4	)%	$	1.85		$	2.09		(11.5	)%
Weighted-average shares outstanding:
Assuming dilution	960.5			986.7			(2.7	)%	947.8			964.4			(1.7	)%
Basic	957.4			982.3			(2.5	)%	942.4			961.7			(2.0	)%

	3/31/17		12/31/16
Assets	$	117,495	$	117,470	0.0	%
Liabilities	$	99,047	$	99,078	0.0	%
Equity	$	18,448	$	18,392	0.3	%

* ~~(2.6)~~(2.2) percent adjusted for ~~currency~~currency.

Organization of Information:

In January 2016, the company made a number of changes to its organizational structure and management system. These changes impacted the company’s reportable segments, but did not impact the Consolidated Financial Statements. Refer to note 6, “Segments,” on pages 27 to 29 for additional information on the changes in reportable segments. The periods presented in this Form 10-Q are reported on a comparable basis. The company filed a recast 2015 Annual Report in a Form 8-K on June 13, 2016 to recast its historical segment information to reflect these changes.

In October 2014, the company announced a definitive agreement to divest its Microelectronics ~~business. The assets~~business and ~~liabilities of the Microelectronics business were reported as held for sale at December 31, 2014 and June 30, 2015.~~manufacturing operations. The operating results of the Microelectronics business are reported as discontinued operations. The transaction closed on July 1, 2015.

Currency:

The references to “adjusted for currency” or “at constant currency” in the Management Discussion do not include operational impacts that could result from fluctuations in foreign currency rates. When the company refers to growth rates at ~~“constant currency”~~constant currency or ~~“adjusted~~adjusts such growth rates for ~~currency” in the Management Discussion,~~currency, it is done so that certain financial results can be viewed without the impact of fluctuations in foreign currency exchange rates, thereby facilitating period-to-period comparisons of its business performance. Financial results adjusted for currency are calculated by translating current period activity in local currency using the comparable prior year period’s currency conversion rate. This approach is used for countries where the functional currency is the local currency. Generally, when the dollar either strengthens or weakens against other currencies, the growth at constant currency rates or adjusting for currency will be higher or lower than growth reported at actual exchange rates. See “Currency Rate Fluctuations” on ~~pages 77 and 78~~page 59 for additional information.

Management Discussion — (continued)

Operating (non-GAAP) Earnings:

In an effort to provide better transparency into the operational results of the business, the company separates business results into operating and non-operating categories. Operating earnings from continuing operations is a non-GAAP measure that excludes the effects of certain acquisition-related charges, retirement-related costs, discontinued operations and related tax impacts. For acquisitions, operating earnings exclude the amortization of purchased intangible assets and acquisition-related charges such as in-process research and development, transaction costs, applicable restructuring and related expenses and tax charges related to acquisition integration. These charges are excluded as they may be inconsistent in amount and timing from period to period and are dependent on the size, type and frequency of the company’s acquisitions. All other spending for acquired companies is included in both earnings from continuing operations and in operating (non-GAAP) earnings. Throughout the Management Discussion & Analysis, the impact of acquisitions over the prior 12-month period may be a driver of higher expenses year to year. For retirement-related costs, the company characterizes certain items as operating and others as non-operating. The company includes defined benefit plan and nonpension postretirement benefit plan service cost, amortization of prior service cost and the cost of defined contribution plans in operating earnings. Non-operating retirement-related cost includes defined benefit plan and nonpension postretirement benefit plan interest cost, expected return on plan assets, amortized actuarial gains/losses, the impacts of any plan curtailments/settlements and multi-employer plan costs, pension insolvency costs and other costs. Non-operating retirement-related costs are primarily related to changes in pension plan assets and liabilities which are tied to financial market performance and the company considers these costs to be outside of the operational performance of the business.

Overall, the company believes that providing investors with a view of operating earnings as described above provides increased transparency and clarity into both the operational results of the business and the performance of the company’s pension plans; improves visibility to management decisions and their impacts on operational performance; enables better comparisons to peer companies; and allows the company to provide a long-term strategic view of the business going forward. The company’s reportable segment financial results reflect operating earnings from continuing operations, consistent with the company’s management and measurement system.

The following table provides the company’s (non-GAAP) operating earnings for the ~~second~~first quarter of ~~2016~~2017 and ~~2015.~~2016.

						Yr. to Yr.								Yr. to Yr.
(Dollars in millions except per share amounts)						Percent								Percent
For the three months ended June 30:	2016		2015			Change
For the three months ended March 31:								2017			2016			Change
Net income as reported	$	2,504	$	3,449		(27.4	)%	$	1,750		$	2,014		(13.1	)%
Loss from discontinued operations, net of tax	0		(77		)	(99.5	)	(3		)	(3		)	(6.8	)
Income from continuing operations	$	2,505	$	3,526		(29.0	)%	$	1,753		$	2,016		(13.1	)%
Non-operating adjustments (net of tax):
Acquisition-related charges	207		140			47.9		195			138			40.9
Non-operating retirement-related costs/(income)	124		124			(0.2	)	308			115			166.4
Operating (non-GAAP) earnings*	$	2,835	$	3,790		(25.2	)%	$	2,255		$	2,270		(0.7	)%
Diluted operating (non-GAAP) earnings per share	$	2.95	$	3.84		(23.2	)%	$	2.38		$	2.35		1.3	%

* See page 4868 for a more detailed reconciliation of net income to operating earnings.

Financial Performance ~~Summary — Three Months Ended June 30:~~Summary:

In the ~~second~~first quarter of ~~2016,~~2017, the company ~~delivered $20.2~~reported $18.2 billion in revenue, ~~$2.5~~$1.8 billion in income from continuing operations and ~~$2.8~~$2.3 billion in operating (non-GAAP) earnings, resulting in diluted earnings per share from continuing operations of ~~$2.61~~$1.85 as reported and ~~$2.95~~$2.38 on an operating (non-GAAP) basis. The company generated ~~$3.4~~$4.0 billion in cash from operations and ~~$2.1~~$1.1 billion in free cash flow in the ~~second~~first quarter of ~~2016 driving~~2017 and shareholder returns of ~~$2.2~~$2.6 billion in gross common stock repurchases and dividends. In the quarter the company continued to see strength in its strategic imperatives, further built its as-a-Service capabilities and continued a high level of investment as it moves into new areas and builds new markets.

Total consolidated revenue in the first quarter of 2017 decreased 2.8 percent as reported and ~~2.6~~2.2 percent year to year adjusted for ~~currency~~currency. The company continued to deliver strong performance in its strategic imperatives and also continued to deliver core capabilities to clients, running mission-critical systems and processes. Many of these products provide the ~~second~~foundation of hybrid environments, enabling clients to increase value from their on-premise data and applications.

The first quarter ~~of 2016, with sequential improvement of 1.9 points~~results continued to reflect the success the company is having in its strategic imperatives. The company had continued strong revenue growth in cloud, analytics and engagement, which together grew 12 percent as reported ~~but a decline of 0.6 points~~and 13 percent adjusted for ~~currency from~~currency. In the first quarter ~~growth rates. Sequential performance~~of 2017, the strategic imperatives generated $7.8 billion in Systems decelerated on both an as reported and adjusted for currency basis, Technology Services & Cloud Platforms improved as reported, but decelerated on an adjusted for currency basis, while Cognitive Solutions improved on an as reported and adjusted for currency basis.revenue, which

Management Discussion — (continued)

In the second quarter of 2016, the company had continued strong revenue growth in its strategic imperatives – cloud, analytics and engagement — which grew 12 percent year to year as reported and adjusted for currency. Over the past 12 months, the strategic imperatives generated $30.7 billion in revenue, which represents approximately 38represented 43 percent of the company’s ~~total~~ revenue, an increase of 36 points from ~~full-year 2015.~~the first quarter of 2016. Total Cloud revenue of ~~$3.4~~$3.5 billion increased 3033 percent as reported and 35 percent adjusted for currency, ~~in the second quarter,~~ with ~~Cloud~~cloud as-a-Service revenue up 5059 percent as reported and 61 percent adjusted for currency. The company exited the ~~second~~first quarter of ~~2016~~2017 with an annual run rate for ~~Cloud~~cloud as-a-Service revenue of ~~$6.7 billion, up from $5.4 billion in first-quarter 2016 with a benefit from acquisitions as well as solid organic growth.~~$8.6 billion. Analytics revenue of ~~$4.9~~$4.5 billion ~~in the second quarter~~ increased 56 percent as reported and 47 percent ~~year to year~~ adjusted for currency. ~~On both an as reported and~~Mobile revenue increased 20 percent (22 percent adjusted for ~~currency basis, security~~currency) and Security revenue increased 189 percent ~~and mobile revenue increased 43~~(10 percent ~~year to year.~~adjusted for currency).

The company has been making significant changes to the business by transforming existing businesses, building new markets and addressing new opportunity areas. Over the last twelve months, the company has been investing at a high level by growing organic investment in areas including its Watson platform capabilities and cloud datacenter capacity, and through acquisitions to build its cognitive and cloud capabilities. Enterprise clients are looking to become digital businesses to improve decision making and add intelligence into products and processes. The company’sprovides cognitive solutions ~~bring together digital business~~on cloud platforms that are highly differentiated for industries. The company is the global leader in enterprise cloud with ~~digital intelligence~~over $14.6 billion of Cloud revenue over the prior 12 months. Progress in ~~an industry-based cognitive solution, enabled by~~ the ~~IBM Cloud. In the second~~first quarter ~~the company made continued progress in moving into new areas and becoming a cognitive solutions and cloud platform company, including:~~of 2017 included:

· ~~Broadening~~Scaling and extending the reach of Watson and the ~~Watson Platform, Watson Health and Watson IoT~~IBM Cloud with new solutions, clients and ~~partnerships.~~partnerships; and

· ~~Announced Watson for Cyber Security.~~

· ~~Extended cloud innovations available~~Continuing to build emerging technologies on ~~Bluemix~~the IBM Cloud such as blockchain and ~~expanded partnerships to accelerate~~quantum — including announcing the ~~adoption of enterprise hybrid clouds.~~

· ~~Recent breakthroughs in cloud-enabled~~first commercial quantum ~~computing and Blockchain solutions.~~

· ~~Continued delivery of innovation in core businesses, including Infrastructure Services, Systems and software.~~system.

From a segment perspective, Cognitive Solutions revenue increased ~~3.5~~2.1 percent as reported and 43 percent adjusted for currency with growth in Solutions Software, led by ~~its analytics~~revenue growth in Analytics and ~~cognitive capabilities, and security.~~Security, partially offset by a decline in Transaction Processing Software. Global Business Services (GBS) revenue decreased ~~2.0~~3.0 percent as reported and 32 percent adjusted for currency primarily driven by a decline in Consulting revenue. On a sequential basis compared to the fourth quarter of 2016, GBS revenue growth improved 1.0 points as reported and ~~continues~~2 points adjusted for currency. Consulting revenue performance improved sequentially 1.7 points as reported and 3 points adjusted for currency compared to ~~reflect a~~the fourth quarter of 2016. The GBS business continued to shift inresources to its cognitive services, advanced analytics, and digital platforms and away from the ~~segment’s business. Continued double-digit growth in~~more traditional areas. GBS strategic imperatives revenue had double-digit growth year to year as reported and adjusted for currency, led by cloud and mobile ~~and cloud, were more than offset by declines in the more traditional consulting areas.~~practices. Technology Services & Cloud Platforms revenue ~~declined 0.5~~decreased 2.5 percent as reported ~~but was flat year to year~~and 2 percent adjusted for ~~currency. Continued growth in Infrastructure Services revenue was more than offset~~currency, primarily driven by declines in ~~Technical Support~~Infrastructure Services and Integration Software. ~~Systems~~Technology Services & Cloud Platforms strategic imperatives revenue ~~decreased 23.2~~was up 30 percent ~~(23~~(31 percent adjusted for currency)~~, primarily reflecting the~~ year to year. Systems revenue decreased 16.8 percent (16 percent adjusted for currency) driven by product cycle dynamics, with z Systems ~~product cycle dynamics.~~down 40.2 percent (40 percent adjusted for currency) and Power Systems down 27.8 percent (27 percent adjusted for currency).

From a geographic perspective, Americas revenue ~~decreased 3.4 percent~~was essentially flat year to year as reported, ~~and 2~~but decreased 1 percent adjusted for ~~currency. Performance improved sequentially compared~~currency, with the ~~first quarter of 2016 on both an as reported and adjusted for currency basis. EMEA~~U.S. down 1.3 percent. Europe/Middle East/Africa (EMEA) revenue decreased ~~4.5~~8.1 percent (4 percent adjusted for currency) due primarily to declines in the ~~second quarter of 2016~~U.K and ~~declined sequentially as reported~~Germany. Revenue performance in the geography continued to be impacted by macro- and ~~adjusted for currency driven primarily by Germany and Switzerland.~~geo-political trends. Asia Pacific revenue ~~increased 1.4~~decreased 1.7 percent ~~as reported, but decreased 2~~(3 percent adjusted for ~~currency.~~currency).

The consolidated gross profit margin of ~~47.9~~42.8 percent decreased ~~2.0~~3.7 points year to year ~~with performance reflecting higher levels of investment~~and continued to reflect investments across the segments and the ~~building of scale in the~~mix to as-a-Service businesses. The operating (non-GAAP) gross margin of ~~49.0~~44.5 percent decreased ~~1.9~~3.0 points compared to the prior year driven primarily by the same factors.

Total expense and other (income) ~~increased 7.9~~decreased $1,304 million or 17.0 percent in the ~~second~~first quarter of ~~2016~~2017 compared to the prior year. The year-to-year decrease was primarily the result of reduced expenses for workforce transformation and increases in intellectual property income. This included a lower level of workforce rebalancing charges ($831 million) year to year and a prior year charge for real estate actions ($328 million). Intellectual property income increased $228 million year to year driven primarily by the company’s software licensing arrangements. The year-to-year decrease in expense and other (income) was partially offset by increased spending related to acquisitions (3 points) completed in the prior 12 months. Total operating (non-GAAP) expense and other (income) ~~increased 6.6~~decreased 19.9 percent year to ~~year. The key year-to-year drivers were approximately:~~

~~Management Discussion — (continued)~~

Total

Operating

Consolidated

(non-GAAP)

Currency*

3
points

4
points

Acquisitions

6
points

5
points

Base

(2)
points

(2)
points

* Reflects impacts of translationyear and ~~hedging programs.~~

Base expense performance reflects a higher level of intellectual property income in the second quarter primarily due to a licensing agreement ($175 million) and lower workforce rebalancing charges; partially offset by an increase in investment levels. The decrease in operating (non-GAAP) expense was driven primarily by the same factors.

Pre-tax income from continuing operations of ~~$3.0~~$1.4 billion in the ~~second~~first quarter of ~~2016 decreased 27.8~~2017 increased 37.7 percent year to year and the pre-tax margin was ~~15.1~~7.8 percent, ~~a decrease~~an increase of ~~5.2 points.~~2.3 points compared to the first quarter of 2016. The continuing operations effective tax rate for the ~~second~~first quarter of ~~2016~~2017 was ~~17.8~~(23.1) percent compared to ~~an effective tax rate of 16.5~~(95.1) percent in the ~~second~~first quarter of ~~2015.~~2016. The negative tax rate in the first quarter of 2017 was primarily driven by discrete tax items ($0.5 billion), including the first-quarter intra-entity transfer of assets ($0.6 billion). The prior year negative tax rate was primarily the result of a refund ($1.0 billion) of previously paid Japan taxes plus interest. Income from continuing operations of ~~$2.5~~$1.8 billion decreased ~~29.0~~13.1 percent and the net income margin was ~~12.4~~9.7 percent, a decrease of ~~4.6 points versus the second quarter of 2015.~~1.1 points. Losses from discontinued operations, net of tax, were ~~$0.4~~$3 million in both the ~~second~~first quarter of ~~2016 compared to $77 million in the second quarter of 2015.~~

Management Discussion — (continued)

2017 and 2016. Net income of ~~$2.5~~$1.8 billion decreased ~~27.4~~13.1 percent year to year. Operating (non-GAAP) pre-tax income from continuing operations of ~~$3.5~~$2.1 billion ~~decreased 23.5~~increased 51.7 percent year to year, ~~and~~primarily due to the ~~operating~~higher workforce transformation charges in the prior year. Operating (non-GAAP) pre-tax margin from continuing operations ~~decreased 4.7~~increased 4.1 points to ~~17.3~~11.4 percent. Operating (non-GAAP) income from continuing operations of ~~$2.8~~$2.3 billion decreased ~~25.2 percent. The~~0.7 percent and the operating (non-GAAP) income margin from continuing operations of ~~14.0~~12.4 percent ~~decreased 4.2~~increased 0.3 points. The operating (non-GAAP) effective tax rate from continuing operations in the ~~second~~first quarter of ~~2016~~2017 was ~~19.0~~(9.3) percent versus ~~17.2~~(66.8) percent in the prior year.

Diluted earnings per share from continuing operations of ~~$2.61~~$1.85 in the ~~second~~first quarter of ~~2016~~2017 decreased ~~27.1~~11.5 percent year to year. In the ~~second~~first quarter of ~~2016,~~2017, the company repurchased ~~5.7~~7.2 million shares of its common stock at a cost of ~~$0.8 billion.~~$1.3 billion and had $3.8 billion remaining in the share repurchase authorization at March 31, 2017. Operating (non-GAAP) diluted earnings per share of ~~$2.95 decreased 23.2~~$2.38 increased 1.3 percent versus ~~the second quarter of 2015. Diluted earnings per share from discontinued operations was $0.00 in the second quarter of 2016 compared to ($0.08) in the second quarter of 2015.~~

The company generated $3.4 billion in cash flow provided by operating activities, a decrease of $0.4 billion when compared to the second quarter of 2015, driven primarily by operational performance and sales-cycle working capital; partially offset by a decline in cash income tax payments. Net cash used in investing activities of $4.5 billion in the second quarter of 2016 increased $2.6 billion year to year, primarily driven by an increase in cash used for acquisitions ($2.3 billion). Net cash used in financing activities of $3.2 billion in the second quarter of 2016 increased $0.6 billion compared to the second quarter of 2015, primarily driven by higher net debt payments ($0.8 billion).

In July 2016, the company disclosed that it now expects GAAP earnings per share from continuing operations to be at least $12.23 compared to the prior expectation of at least $12.35, driven primarily by acquisition-related expenses. The company continues to expect operating (non-GAAP) earnings of at least $13.50 per diluted share for 2016. There is no change to the company’s previously provided free cash flow guidance to be at the high end of the $11 billion to $12 billion range. Refer to page 79 in the Liquidity and Capital Resources section for additional information on this non-GAAP measure. Refer to the Looking Forward section on pages 76 and 77 for additional information on the company’s expectations.

~~Management Discussion — (continued)~~

~~Financial Results Summary - Six Months Ended June 30:~~

Yr. to Yr.

Percent/

(Dollars and shares in millions except per share amounts)

Margin

For the six months ended June 30:

2016

2015

Change

Revenue

$
38,923

$
40,403

(3.7
)%*
Gross profit margin

47.2
%
49.1
%
(1.9
)pts.
Total expense and other (income)

$
14,306

$
12,617

13.4
%
Total expense and other (income)-to-revenue ratio

36.8
%
31.2
%
5.5
pts.
Income from continuing operations, before income taxes

$
4,082

$
7,225

(43.5
)%
Provision for/(benefit from) income taxes from continuing operations

$
(439
)
$
1,283

nm

Income from continuing operations

$
4,521

$
5,942

(23.9
)%
Income from continuing operations margin

11.6
%
14.7
%
(3.1
)pts.
Loss from discontinued operations, net of tax

$
(3
)
$
(165
)
(98.1
)%
Net income

$
4,518

$
5,777

(21.8
)%
Earnings per share from continuing operations:

Assuming dilution

$
4.69

$
6.01

(22.0
)%
Basic

$
4.71

$
6.03

(21.9
)%
Consolidated earning per share - assuming dilution

$
4.69

$
5.84

(19.7
)%
Weighted-average shares outstanding:

Assuming dilution

962.4

989.5

(2.7
)%
Basic

959.5

985.2

(2.6
)%

6/30/16

12/31/15

Assets

$
118,056

$
110,495

6.8
%
Liabilities

$
102,167

$
96,071

6.3
%
Equity

$
15,889

$
14,424

10.2
%

* (2.3) percent adjusted for currency

~~nm - not meaningful~~

~~The following table provides the company’s (non-GAAP) operating earnings for the first six months of 2016 and 2015.~~

Yr. to Yr.

(Dollars in millions except per share amounts)

Percent

For the six months ended June 30:

2016

2015

Change

Net income as reported

$
4,518

$
5,777

(21.8
)%
Loss from discontinued operations, net of tax

(3
)
(165
)
(98.1
)
Income from continuing operations

$
4,521

$
5,942

(23.9
)%
Non-operating adjustments (net of tax):

Acquisition-related charges

345

281

22.5

Non-operating retirement-related costs/(income)

239

457

(47.6
)
Operating (non-GAAP) earnings*

$
5,105

$
6,680

(23.6
)%
Diluted operating (non-GAAP) earnings per share

$
5.30

$
6.75

(21.5
)%

* See page 88 for a more detailed reconciliation of net income to operating earnings.

~~Financial Performance Summary — Six Months Ended June 30:~~

In the first six months of 2016, the company reported $38.9 billion in revenue, and delivered $4.5 billion in income from continuing operations resulting in diluted earnings per share from continuing operations of $4.69 as reported and $5.30 on an operating (non-GAAP) basis. The company generated $9.1 billion in cash from operations and $4.4 billion in free cash flow in the first six months of 2016 driving shareholder returns of $4.4 billion in gross common stock repurchases and dividends.

Enterprise clients are looking for greater value from their data and IT environments. They are looking to become digital enterprises that are differentiated by cognitive, using data to improve decision making and outcomes. The company’s strategy is based on the point of view that solving clients’ needs requires solutions, industry expertise and innovative technology, all supported by leading edge skills. The company is creating cognitive solutions that join digital business with digital intelligence, bringing its industry expertise together with these cognitive solutions, and building it all on cloud platforms. The

~~Management Discussion — (continued)~~

company is in a unique position to move its clients to the future as it’s already running their most critical business processes. The company has continued its acceleration of shifting investments and resources to be more aligned with its strategy.

~~Total consolidated revenue decreased 3.7 percent as reported and 2.3 percent year to year adjusted for currency in the first six months of 2016.~~

In the first six months of 2016, the company had strong growth in the strategic imperatives with revenue growth of 13 percent year to year as reported and 14 percent adjusted for currency. Total Cloud revenue of $6.1 billion was up 32 percent as reported and 33 percent year to year adjusted for currency with as-a-Service revenue up 46 percent as reported (48 percent adjusted for currency). Analytics revenue of $9.1 billion increased 5 percent as reported and 6 percent adjusted for currency. Security revenue increased 18 percent as reported (19 percent adjusted for currency) and mobile revenue was up over 60 percent year to year as reported and adjusted for currency.

From a segment perspective, Cognitive Solutions revenue increased 1.1 percent as reported and 2 percent adjusted for currency with growth in Solutions Software partially offset by a decline in Transaction Processing Software. GBS revenue decreased 3.2 percent as reported and 2 percent adjusted for currency driven by a decline in Consulting revenue. GBS strategic imperatives revenue had double-digit growth year to year as reported and adjusted for currency. Technology Services & Cloud Platforms revenue declined 1.0 percent as reported, but increased 1 percent adjusted for currency led by growth in Infrastructure Services which was up 1.1 percent as reported (3 percent adjusted for currency). Systems revenue decreased 22.6 percent as reported (22 percent adjusted for currency).

From a geographic perspective, Americas revenue decreased 5.1 percent as reported (3 percent adjusted for currency) with the U.S. down 2.8 percent. EMEA revenue decreased 4.1 percent as reported (2 percent adjusted for currency). Asia Pacific revenue increased 0.4 percent as reported, but decreased 1 percent adjusted for currency.

The consolidated gross margin of 47.2 percent decreased 1.9 points year to year. The operating (non-GAAP) gross margin of 48.3 percent decreased 1.9 points versus the prior year. Margin declines in Cognitive Solutions, Technology Services & Cloud Platforms and GBS, were largely driven by higher investments.

Total expense and other (income) increased 13.4 percent in the first six months of 2016 compared to the prior year. Total operating (non-GAAP) expense and other (income) increased 15.5 percent compared to the first six months of 2015. The key year-to-year drivers were:

Total

Operating

Consolidated

(non-GAAP)

Currency*

1
point

1
point

Acquisitions

5
points

4
points

Base

7
points

10
points

* Reflects impacts of translation and hedging programs.

In the first quarter of 2016, the company took significant actions to accelerate the transformation of its workforce and shift its skill base to new areas, and also to improve its structure primarily outside the U.S. The increased expense in the first six months of 2016 was primarily driven by first-quarter charges for these actions. The increase in base expense was driven primarily by a higher level of workforce rebalancing charges of $1,013 million in the first six months of 2016 compared to $463 million in the first six months of 2015, and charges in the first quarter for real estate actions of $328 million. The increase in operating (non-GAAP) expense was driven primarily by the same factors.

Pre-tax income from continuing operations of $4.1 billion decreased 43.5 percent and the pre-tax margin was 10.5 percent, a decrease of 7.4 points versus the first six months of 2015. The continuing operations effective tax rate for the first six months of 2016 was (10.8) percent compared to an effective tax rate of 17.8 percent in the first six months of 2015. The negative tax rate in the first six months of 2016 was primarily the result of a refund ($1.0 billion) of previously paid non-U.S. taxes plus interest in the first quarter of 2016. Income from continuing operations of $4.5 billion decreased 23.9 percent and the net income margin was 11.6 percent, a decrease of 3.1 points compared to the first six months of 2015. Losses from discontinued operations, net of tax, were $3 million in the first six months of 2016 versus $165 million in the first six months of 2015. Net income of $4.5 billion decreased 21.8 percent year to year. Operating (non-GAAP) pre-tax income from continuing operations of $4.9 billion decreased 40.6 percent year to year and the operating (non-GAAP) pre-tax margin from continuing operations decreased 7.8 points to 12.5 percent. Operating (non-GAAP) income from continuing operations of

~~Management Discussion — (continued)~~

$5.1 billion decreased 23.6 percent and the operating (non-GAAP) income margin from continuing operations of 13.1 percent decreased 3.4 points. The operating (non-GAAP) effective tax rate from continuing operations in the first six months of 2016 was (5.0) percent versus 18.4 percent in the first six months of 2015. Profit and margin performance in the first six months of 2016 reflects the company’s investments, product cycle dynamics and the actions taken to accelerate its transformation in the first quarter of 2016.

Diluted earnings per share from continuing operations of $4.69 decreased 22.0 percent year to year. In the first six months of 2016, the company repurchased 12.3 million shares of its common stock and had $3.9 billion remaining in the current share repurchase authorization at June 30, 2016. Operating (non-GAAP) diluted earnings per share of $5.30 decreased 21.5 percent versus the prior year. Diluted earnings per share from discontinued operations was $0.00 in the first six months of 2016 compared to ($0.17) in the same period of 2015.

At ~~June 30, 2016,~~March 31, 2017, the company continued to have the financial flexibility to support the business over the long term. Cash and marketable securities at quarter end were ~~$10.6~~$10.7 billion, an increase of ~~$2.4~~$2.2 billion from December 31, ~~2015.~~2016. Key drivers in the balance sheet and total cash flows were:

Total assets ~~increased $7.6 billion ($5.7~~were flat (decreased $1.1 billion adjusted for currency) from December 31, ~~2015~~2016 driven by:

· Increases in ~~goodwill~~cash and marketable securities ($~~4.4~~2.2 billion), ~~cash~~deferred taxes ($~~2.3~~1.2 billion)~~, intangible~~ and retirement plan assets ($~~1.7 billion) and pension assets ($1.2~~0.5 billion); ~~partially~~ offset by

· Decreases in total receivables ($~~2.8~~3.9 billion).

Total liabilities ~~increased $6.1 billion ($3.9~~were flat (decreased $1.0 billion adjusted for currency) from December 31, ~~2015~~2016 driven by:

· Increases in deferred income ($1.3 billion) and total debt ($~~4.6~~0.6 billion); offset by

· Decreases in accounts payable ($0.9 billion), ~~other accrued expenses and liabilities~~taxes payable ($~~1.4~~0.5 billion)~~, deferred income ($0.6 billion),~~ and compensation and benefits ($
($0.4 billion)~~; partially offset by~~

· ~~Decreases in taxes payable ($0.6 billion) and accounts payable ($0.5 billion)~~.

Total equity of ~~$15.9~~$18.4 billion increased ~~$1.5~~$0.1 billion from December 31, ~~2015~~2016 as a result of:

· Increases from net income ($~~4.5~~1.8 billion), retirement-related ($~~0.8~~0.5 billion) and equity translation adjustments ($~~0.4~~0.3 billion); ~~partially~~ offset by

· Decreases from dividends ($~~2.6~~1.3 billion) and share repurchases ($~~1.7~~1.3 billion).

The company generated ~~$9.1~~$4.0 billion in cash flow ~~provided by~~from operating activities, ~~an increase~~a decrease of $1.6 billion compared to the first ~~six months~~quarter of ~~2015, driven primarily by lower income tax payments partially offset by operational performance. Net cash used in investing activities of $6.5 billion was $5.2 billion higher than the prior year,~~2016, primarily driven by ~~an increase~~the prior-year tax refund. Investing activities were a source of cash of $0.3 billion in the first quarter of 2017 compared to a $1.9 billion use of cash in the first quarter of 2016, primarily driven by a decrease in cash used ~~related to~~for acquisitions ($~~4.7~~2.5 billion). ~~Net~~Financing activities were a use of cash ~~used~~of $2.1 billion in ~~financing activities~~the first quarter of ~~$0.3 billion decreased $5.6 billion~~2017 compared to a $2.8 billion source of cash in the first ~~six months~~quarter of ~~2015,~~2016, primarily driven ~~primarily~~ by ~~higher~~lower net debt issuances ($~~5.5~~4.5 billion) and an increase in common stock repurchases ($0.4 billion).

In January 2017, the company disclosed that it is expecting GAAP earnings per share from continuing operations of at least $11.95 and operating (non-GAAP) earnings of at least $13.80 per diluted share for 2017. The company also disclosed its expectation of 2017 free cash flow to be essentially flat year to year. Refer to page 60 in the Liquidity and Capital Resources section for additional information on this non-GAAP measure. In April 2017, the company disclosed that it has maintained these expectations. Refer to the Looking Forward section on pages 58 and 59 for additional information on the company’s expectations.

Management Discussion — (continued)

~~Second~~First Quarter ~~and First Six Months~~ in Review

Results of Continuing Operations

Segment Details

The following is an analysis of the ~~second~~first quarter ~~and first six months~~ of ~~2016~~2017 versus the ~~second~~first quarter ~~and first six months~~ of ~~2015~~2016 reportable segment external revenue and gross margin results. Segment pre-tax income includes transactions between ~~the~~ segments that are intended to reflect an arm’s-length transfer price and excludes certain unallocated corporate items.

Yr. to Yr.

Percent

Yr. to Yr.

Change

(Dollars in millions)

Percent/Margin

Adjusted For

For the three months ended June 30:

2016

2015*

Change

Currency

Revenue:

Cognitive Solutions

$
4,675

$
4,516

3.5
%
3.8
%
Gross margin

82.2
%
85.7
%
(3.6
)pts.

Global Business Services

4,255

4,345

(2.0
)%
(2.5
)%
Gross margin

26.3
%
27.4
%
(1.1
)pts.

Technology Services & Cloud Platforms

8,857

8,898

(0.5
)%
0.0
%
Gross margin

41.6
%
42.2
%
(0.6
)pts.

Systems

1,950

2,541

(23.2
)%
(23.3
)%
Gross margin

56.5
%
56.5
%
0.1
pts.

Global Financing

424

478

(11.3
)%
(10.0
)%
Gross margin

38.7
%
44.7
%
(6.0
)pts.

Other

76

35

118.4
%
119.3
%
Gross margin

(272.1
)%
(220.2
)%
(51.9
)pts.

Total consolidated revenue

$
20,238

$
20,813

(2.8
)%
(2.6
)%
Total consolidated gross profit

$
9,702

$
10,390

(6.6
)%

Total consolidated gross margin

47.9
%
49.9
%
(2.0
)pts.

Non-operating adjustments:

Amortization of acquired intangible assets

129

88

46.4
%

Retirement-related costs/(income)

81

112

(27.8
)%

Operating (non-GAAP) gross profit

$
9,912

$
10,590

(6.4
)%

Operating (non-GAAP) gross margin

49.0
%
50.9
%
(1.9
)pts.

* Recast to conform with 2016 presentation.

~~Management Discussion — (continued)~~

Yr. to Yr.

Percent

Yr. to Yr.

Change

(Dollars in millions)

Percent/Margin

Adjusted For

For the six months ended June 30:

2016

2015*

Change

Currency

Revenue:

Cognitive Solutions

$
8,654

$
8,564

1.1
%
2.2
%
Gross margin

82.1
%
85.1
%
(3.1
)pts.

Global Business Services

8,387

8,663

(3.2
)%
(2.4
)%
Gross margin

26.1
%
27.4
%
(1.3
)pts.

Technology Services & Cloud Platforms

17,280

17,452

(1.0
)%
0.9
%
Gross margin

41.3
%
42.1
%
(0.9
)pts.

Systems

3,626

4,683

(22.6
)%
(22.1
)%
Gross margin

56.9
%
55.7
%
1.2
pts.

Global Financing

834

939

(11.2
)%
(8.2
)%
Gross margin

40.5
%
47.1
%
(6.6
)pts.

Other

142

102

39.0
%
41.3
%
Gross margin

(304.3
)%
(223.1
)%
(81.3
)pts.

Total consolidated revenue

$
38,923

$
40,403

(3.7
)%
(2.3
)%
Total consolidated gross profit

$
18,388

$
19,842

(7.3
)%

Total consolidated gross margin

47.2
%
49.1
%
(1.9
)pts.

Non-operating adjustments:

Amortization of acquired intangible assets

241

179

34.9
%

Retirement-related costs/(income)

160

233

(31.4
)%

Operating (non-GAAP) gross profit

$
18,789

$
20,253

(7.2
)%

Operating (non-GAAP) gross margin

48.3
%
50.1
%
(1.9
)pts.

* Recast to conform with 2016 presentation.

									Yr. to Yr.
									Percent
							Yr. to Yr.		Change
(Dollars in millions)							Percent/Margin		Adjusted For
For the three months ended March 31:	2017			2016			Change		Currency
Revenue:
Cognitive Solutions	$	4,062		$	3,979		2.1	%	2.8	%
Gross margin	77.3		%	82.0		%	(4.7	) pts.
Global Business Services	4,006			4,131			(3.0	)%	(1.9	)%
Gross margin	23.6		%	25.8		%	(2.2	) pts.
Technology Services & Cloud Platforms	8,216			8,424			(2.5	)%	(2.0	)%
Gross margin	38.9		%	40.9		%	(2.0	) pts.
Systems	1,395			1,675			(16.8	)%	(16.1	)%
Gross margin	47.5		%	57.2		%	(9.8	) pts.
Global Financing	405			410			(1.2	)%	(2.1	)%
Gross margin	31.8		%	42.4		%	(10.6	) pts.
Other	71			66			8.7	%	8.6	%
Gross margin	(425.9		)%	(342.0		)%	(83.9	) pts.
Total consolidated revenue	$	18,155		$	18,684		(2.8	)%	(2.2	)%
Total consolidated gross profit	$	7,772		$	8,686		(10.5	)%
Total consolidated gross margin	42.8		%	46.5		%	(3.7	) pts.
Non-operating adjustments:
Amortization of acquired intangible assets	119			112			6.5	%
Retirement-related costs/(income)	193			79			143.8	%
Operating (non-GAAP) gross profit	$	8,083		$	8,877		(8.9	)%
Operating (non-GAAP) gross margin	44.5		%	47.5		%	(3.0	) pts.

Cognitive Solutions

Yr. to Yr.

Percent

Yr. to Yr.

Change

(Dollars in millions)

Percent

Adjusted For

For the three months ended June 30:

2016

2015*

Change

Currency

Cognitive Solutions external revenue:

$
4,675

$
4,516

3.5
%
3.8
%
Solutions Software

$
3,231

$
3,053

5.8
%
6.2
%
Transaction Processing Software

1,444

1,464

(1.3
)
(1.3
)

* Recast to conform with 2016 presentation.

Yr. to Yr.

Percent

Yr. to Yr.

Change

(Dollars in millions)

Percent

Adjusted For

For the six months ended June 30:

2016

2015*

Change

Currency

Cognitive Solutions external revenue:

$
8,654

$
8,564

1.1
%
2.2
%
Solutions Software

$
5,922

$
5,707

3.8
%
4.9
%
Transaction Processing Software

2,732

2,856

(4.4
)
(3.2
)

* Recast to conform with 2016 presentation.

							Yr. to Yr.
							Percent
					Yr. to Yr.		Change
(Dollars in millions)					Percent		Adjusted For
For the three months ended March 31:	2017		2016		Change		Currency
Cognitive Solutions external revenue:	$	4,062	$	3,979	2.1	%	2.8	%
Solutions Software	$	2,792	$	2,691	3.7	%	4.6	%
Transaction Processing Software	1,270		1,287		(1.4	)	(0.8	)

~~In the second quarter of 2016,~~ Cognitive Solutions revenue of ~~$4,675~~$4,062 million grew ~~3.5~~2.1 percent as reported and 43 percent ~~year to year~~ adjusted for ~~currency. Compared with~~currency in the first quarter of 2017 compared to the prior ~~quarter, there was sequential improvement in both Solutions Software and Transaction Processing Software revenue, both as~~year. As reported and adjusted for ~~currency. For the first six months~~currency, revenue growth in Solutions Software, which addresses many of the ~~year, Cognitive Solutions revenue of $8,654 million grew 1.1 percent as reported and 2 percent adjusted for currency. On an as reported and constant currency basis, Solutions Software revenue grew,~~company’s strategic areas, was partially offset by declines in Transaction Processing Software.

~~Management Discussion — (continued)~~

~~In the second quarter,~~ Solutions Software revenue of ~~$3,231~~$2,792 million grew ~~5.8~~3.7 percent as reported (6(5 percent adjusted for currency), compared to the prior year. This growth was led by ~~Analytics~~analytics and ~~Security, with acquisitions contributing to this growth.~~security offerings. Analytics, which is the largest portion of the Solutions Software portfolio, ~~had revenue growth across~~continued to grow as reported and adjusted for currency in key ~~areas. Additionally, The Weather Company acquisition is off~~areas including Watson offerings, such as Watson Health. Security contributed to ~~a good start as it is being integrated with Watson technology. Security had strong revenue~~year-to-year growth as reported and adjusted for currency in the second quarter. The Resilient acquisition, which closed in the quarter, adds leading incident reporting technology and expertise to the company’s portfolio. There was also strong demand for Guardium offerings as clients move to database security offerings across a range of industries. The company continues to grow and broaden the reach of Watson, with new capabilities, partnerships and engagements to accelerate adoption. Watson Health is capitalizing on the Watson technology’s differentiated ability to understand, reason and learn with industry specialization. In April, the company closed the acquisition of Truven, which brings additional data and insights into the Watson Health Cloud.driven by Data Protection

Management Discussion — (continued)

Inand Security Intelligence. Across the ~~second quarter,~~ Solutions portfolio, Software-as-a-Service (SaaS) revenue had strong double-digit growth as reported and adjusted for currency again this quarter.

Transaction Processing Software revenue of ~~$1,444~~$1,270 million declined ~~1.3~~1.4 percent as reported (1 percent adjusted for currency), compared to first quarter 2016, however ~~it had~~there was sequential improvement from the ~~first~~fourth quarter ~~of 2016. Most of this software~~2016 driven by z Systems and Storage middleware. While the overall business is ~~on-premises and annuity in nature, which is not a~~declining, there are some areas that are growing, ~~part~~such as Software Defined Storage. Other parts of the ~~software opportunity.~~business are high value and running mission critical workloads for clients, but the growth profile is stable to declining.

Within Cognitive Solutions, total ~~second~~first quarter ~~2016~~ strategic imperatives revenue of ~~$3,012 million~~$2.6 billion grew ~~9.0~~6 percent as reported (9(7 percent adjusted for currency) year to year. Cloud revenue of ~~$513 million~~$0.6 billion grew ~~54.4~~44 percent as reported ~~(55~~(45 percent adjusted for currency), with an as-a-Service exit run rate of $1,490 million. For the first six months of the year, strategic imperatives revenue within Cognitive Solutions of $5,485 million grew 5.8 percent as reported (7 percent adjusted for currency), with Cloud revenue of $915 million growing 43.8 percent year to year as reported (45 percent adjusted for currency).$1.8 billion.

Yr. to Yr.

Percent/

(Dollars in millions)

Margin

For the three months ended June 30:

2016

2015*

Change

Cognitive Solutions:

External gross profit

$
3,841

$
3,873

(0.8
)%
External gross profit margin

82.2
%
85.7
%
(3.6
)pts.
Pre-tax income

$
1,451

$
1,825

(20.5
)%
Pre-tax margin

27.5
%
36.1
%
(8.6
)pts.

* Recast to conform with 2016 presentation.

Yr. to Yr.

Percent/

(Dollars in millions)

Margin

For the six months ended June 30:

2016

2015*

Change

Cognitive Solutions:

External gross profit

$
7,102

$
7,291

(2.6
)%
External gross profit margin

82.1
%
85.1
%
(3.1
)pts.
Pre-tax income

$
2,465

$
3,353

(26.5
)%
Pre-tax margin

24.9
%
34.5
%
(9.6
)pts.

* Recast to conform with 2016 presentation.

							Yr. to Yr.
							Percent/
(Dollars in millions)							Margin
For the three months ended March 31:	2017			2016			Change
Cognitive Solutions:
External gross profit	$	3,140		$	3,262		(3.7	)%
External gross profit margin	77.3		%	82.0		%	(4.7	)pts.
Pre-tax income	$	1,274		$	1,013		25.7	%
Pre-tax margin	26.7		%	21.8		%	4.8	pts.

~~The~~ Cognitive Solutions gross profit margin decreased ~~3.6~~4.7 points to ~~82.2~~77.3 percent in the ~~second~~first quarter ~~largely driven by~~of 2017 compared to the prior year. Pre-tax income of $1,274 million increased 25.7 percent compared to the prior year with a ~~mix shift to Software-as-a-Service (SaaS) and higher investments, including acquisition content. For the first six months~~pre-tax margin improvement of ~~the year, the gross profit margin declined 3.1~~4.8 points to ~~82.1 percent~~26.7 percent. The year-to-year benefit includes a lower level of charges related to workforce rebalancing and real estate actions as compared to the prior year.

~~In the second quarter, pre-tax income of $1,451 million decreased 20.5 percent~~Gross profit margin declined year to year ~~with a pre-tax margin decline of 8.6 points to 27.5 percent. This performance continues to reflect the company’s higher level of~~driven by continued investment in strategic ~~growth~~ areas, including ~~Watson Platform, Health~~acquisitions and ~~Internet~~an increasing mix toward SaaS. Approximately 25 percent of ~~Things.~~the Cognitive Solutions business is now comprised of services and SaaS offerings, which currently has a different margin profile than the traditional software delivery offerings. In the first quarter, pre-tax margins expanded and pre-tax income improved year to year as the company continues to embed cognitive into more offerings, scaling platforms and building high value vertical solutions.

Global Business Services

							Yr. to Yr.
							Percent
					Yr. to Yr.		Change
(Dollars in millions)					Percent		Adjusted For
For the three months ended March 31:	2017		2016		Change		Currency
Global Business Services external revenue:	$	4,006	$	4,131	(3.0	)%	(1.9	)%
Consulting	$	1,769	$	1,835	(3.6	)%	(2.4	)%
Global Process Services	314		348		(9.6	)	(8.9	)
Application Management	1,923		1,949		(1.3	)	(0.1	)

Global Business Services revenue of $4,006 million decreased 3.0 percent as reported and 2 percent adjusted for currency in first quarter of 2017 compared to the prior year. Strategic imperatives grew double digits as reported and adjusted for currency, led by cloud and mobile practices. This growth was more than offset by declines in the more traditional areas that the company is shifting away from, such as large ERP and on-premise enterprise application implementations.

Consulting revenue of $1,769 million declined 3.6 percent as reported (2 percent adjusted for currency) with lower percentage declines on a sequential basis, as reported and at constant currency. In Consulting, the shift to cognitive services, advanced analytics and digital platforms, away from more traditional areas is reflected in this revenue performance. Global Process Services (GPS) revenue of $314 million decreased 9.6 percent as reported (9 percent adjusted for currency) compared to the prior year. Application Management revenue of $1,923 million decreased 1.3 percent as reported (flat

Management Discussion — (continued)

~~Global Business Services~~

Yr. to Yr.

Percent

Yr. to Yr.

Change

(Dollars in millions)

Percent

Adjusted For

For the three months ended June 30:

2016

2015*

Change

Currency

Global Business Services external revenue:

$
4,255

$
4,345

(2.0
)%
(2.5
)%
Consulting

$
1,885

$
1,955

(3.6
)%
(4.5
)%
Global Process Services

346

360

(3.7
)
(2.5
)
Application Management

2,024

2,034

(0.5
)
(0.7
)

* Recast to conform with 2016 presentation.

Yr. to Yr.

Percent

Yr. to Yr.

Change

(Dollars in millions)

Percent

Adjusted For

For the six months ended June 30:

2016

2015*

Change

Currency

Global Business Services external revenue:

$
8,387

$
8,663

(3.2
)%
(2.4
)%
Consulting

$
3,720

$
3,901

(4.6
)%
(4.5
)%
Global Process Services

694

720

(3.6
)
(1.8
)
Application Management

3,973

4,046

(1.8
)
(0.7
)

* Recast to conform with 2016 presentation.

In the second quarter of 2016, Global Business Services revenue of $4,255 million decreased 2.0 percent as reported and 3 percent adjusted for currency. Performance was similar to recent quarters with revenue growth in the strategic imperatives as reported and at constant currency, more than offset by declines in the more traditional consulting areas. For the first six months of the year, GBS revenue of $8,387 million declined 3.2 percent as reported and 2 percent adjusted for currency.

~~In the second quarter, Consulting revenue of $1,885 million declined 3.6 percent as reported (5 percent~~ adjusted for currency)~~. Application Management revenue of $2,024 million remained relatively stable, decreasing 0.5 percent~~ as ~~reported (1 percent adjusted for currency), compared to the prior year as clients engage with~~ the company continues to ~~manage the life cycle of~~innovate clients’ platforms, helping them migrate to new cloud architectures, increase their ~~applications~~speed and ~~to bring new apps to the market faster through digital cloud platforms. Global Process Services revenue of $346 million decreased 3.7 percent as reported (3 percent adjusted for currency).~~agility and improve their competitiveness.

Within GBS, total ~~second~~first quarter 2017 strategic imperatives revenue of ~~$2,309 million~~$2.2 billion grew ~~13.9~~12 percent as reported (13 percent adjusted for currency) year to year. Cloud revenue of ~~$731 million~~$0.9 billion grew ~~62.9~~56 percent as reported ~~(60~~(57 percent adjusted for currency), with an as-a-Service exit run rate of $581 million. For the first six months of the year, strategic imperatives revenue within GBS of $4,300 million grew 16.3 percent as reported (17 percent adjusted for currency), with Cloud revenue of $1,281 million growing 58.8 percent year to year as reported (58 percent adjusted for currency).$1.0 billion.

The company continues to aggressively shift resources and investments to drive its digital practices around cloud, analytics, mobility, security and cognitive in this segment. The GBS team leads the industry mission for the company as it has amassed over 100,000 industry resources. The company’s consultants build strategies to help clients gain new insights from data and launch new business models for competitive advantage. The company is scaling the industry’s first cognitive consulting practice which draws on the expertise of more than 2,000 consulting professionals spanning machine learning, advanced analytics, data science and development. Additionally, the company continues to ramp the IBM Interactive Experience and opened over 30 digital studios around the globe. It is continuing to shift away from traditional on-premise ERP engagements to cloud-based application management and consulting. In the second quarter, the company also closed the acquisition of Bluewolf, a top Salesforce partner and recognized leader in cloud consulting.

~~Management Discussion — (continued)~~

Yr. to Yr.

Percent/

(Dollars in millions)

Margin

For the three months ended June 30:

2016

2015*

Change

Global Business Services:

External gross profit

$
1,120

$
1,192

(6.1
)%
External gross profit margin

26.3
%
27.4
%
(1.1
)pts.
Pre-tax income

$
476

$
643

(26.1
)%
Pre-tax margin

10.9
%
14.4
%
(3.5
)pts.

* Recast to conform with 2016 presentation.

Yr. to Yr.

Percent/

(Dollars in millions)

Margin

For the six months ended June 30:

2016

2015*

Change

Global Business Services:

External gross profit

$
2,188

$
2,376

(7.9
)%
External gross profit margin

26.1
%
27.4
%
(1.3
)pts.
Pre-tax income

$
665

$
1,231

(46.0
)%
Pre-tax margin

7.7
%
13.8
%
(6.1
)pts.

* Recast to conform with 2016 presentation.

							Yr. to Yr.
							Percent/
(Dollars in millions)							Margin
For the three months ended March 31:	2017			2016			Change
Global Business Services:
External gross profit	$	946		$	1,068		(11.4	)%
External gross profit margin	23.6		%	25.8		%	(2.2	)pts.
Pre-tax income	$	291		$	190		53.4	%
Pre-tax margin	7.1		%	4.5		%	2.6	pts.

~~In the second quarter, the~~ GBS gross profit margin decreased ~~1.1~~2.2 points to ~~26.3~~23.6 percent compared to the prior year. ~~Pre-tax~~There were declines in Consulting and GPS, while the Application Management gross profit margin was essentially flat. In the first quarter of 2017, pre-tax income of ~~$476~~$291 million ~~decreased 26.1~~increased 53.4 percent and the pre-tax margin ~~declined 3.5~~expanded 2.6 points to ~~10.9~~7.1 percent. ~~These margin declines reflect~~The year-to-year benefit includes a lower level of charges related to workforce rebalancing and real estate actions as compared to the ~~investments~~prior year.

GBS profit performance in the first quarter reflects the company’s continued investment in the strategic imperatives and the expansion of practices around cognitive, cloud, mobile and digital ~~practices~~design, as well as ~~some execution issues~~additional spending in certain accounts to deliver on important client commitments. In parallel, the company is in the ~~quarter. Additionally,~~process of streamlining the practices infrastructure and driving efficiencies in ~~some traditional services areas, which are not as differentiated, there is price~~the delivery model through new methods, solutions, and profit pressure. The company continues to invest and shift resources to higher value services around digital and cognitive. It is also taking actions to improve delivery efficiency and execution while remaining focused on commitment to client success.project management.

Technology Services & Cloud Platforms

							Yr. to Yr.								Yr. to Yr.
							Percent								Percent
					Yr. to Yr.		Change						Yr. to Yr.		Change
(Dollars in millions)					Percent		Adjusted For						Percent		Adjusted For
For the three months ended June 30:	2016		2015*		Change		Currency
For the three months ended March 31:									2017		2016		Change		Currency
Technology Services & Cloud Platforms external revenue:	$	8,857	$	8,898	(0.5	)%	0.0	%	$	8,216	$	8,424	(2.5	)%	(2.0	)%
Infrastructure Services	$	5,930	$	5,817	1.9	%	2.2	%	$	5,485	$	5,626	(2.5	)%	(1.9	)%
Technical Support Services	1,829		1,881		(2.8	)	(1.8	)	1,761		1,786		(1.4	)	(1.6	)
Integration Software	1,098		1,200		(8.5	)	(7.9	)	969		1,012		(4.2	)	(3.2	)

* RecastTechnology Services & Cloud Platforms revenue of $8,216 million decreased 2.5 percent as reported and 2 percent adjusted for currency in the first quarter of 2017 compared to ~~conform with 2016 presentation.~~the prior year. There was continued strong double-digit growth, as reported and adjusted for currency, in the strategic imperatives, particularly in cloud as the company builds out hybrid cloud environments for clients. Cloud as-a-Service revenue grew over 50 percent, as reported and adjusted for currency, compared to the prior year.

Yr. to Yr.

Percent

Yr. to Yr.

Change

(Dollars in millions)

Percent

Adjusted For

For the six months ended June 30:

2016

2015*

Change

Currency

Technology Services & Cloud Platforms external revenue:

$
17,280

$
17,452

(1.0
)%
0.9
%
Infrastructure Services

$
11,556

$
11,431

1.1
%
2.8
%
Technical Support Services

3,614

3,762

(3.9
)
(1.3
)
Integration Software

2,110

2,259

(6.6
)
(5.3
)

Infrastructure Services revenue of $5,485 million declined 2.5 percent as reported (2 percent adjusted for currency) compared to the prior year and was impacted by the wind-down of certain contracts and certain signings that did not close during the quarter. In Infrastructure Services, the business model is to deliver productivity to clients and then grow by expanding the scope of work and adding new clients to the platform.

* RecastTechnical Support Services revenue of $1,761 million decreased 1.4 percent as reported (2 percent adjusted for currency). While revenue declined year to ~~conform with 2016 presentation.~~year, the company continued its shift to multi-vendor support services which had revenue growth again this quarter as reported and adjusted for currency.

Management Discussion — (continued)

~~In the second quarter of 2016, Technology Services & Cloud Platforms~~Integration Software revenue of ~~$8,857~~$969 million decreased ~~0.5~~4.2 percent as reported ~~and was flat~~(3 percent adjusted for ~~currency~~currency) in the first quarter of 2017 compared to the prior year. ~~Infrastructure Services~~Within Integration Software, there was growth as reported and adjusted for currency in hybrid integration software that connects and integrates applications, data, and processes across on-premise and cloud environments. Websphere Application Server revenue grew as reported and adjusted for currency ~~but was offset by declines~~demonstrating the importance of middleware in ~~Technical Support Services~~public, private and ~~Integration Software. As reported~~hybrid enviroments. On-premise Development Operations (“DevOps”) tools and ~~adjusted for currency, there was strong year-to-year performance in signings and backlog in the segment. For the first six months of the~~IT services management software declined year ~~Technology Services & Cloud Platforms revenue of $17,280 million decreased 1.0 percent as reported, but grew 1 percent adjusted for currency.~~

Infrastructure Services revenue of $5,930 million grew 1.9 percent as reported (2 percent adjusted for currency) in the second quarter. Technical Support Services second quarter revenue of $1,829 million decreased 2.8 percent as reported (2 percent adjusted for currency). Integration Software revenue of $1,098 million decreased 8.5 percent as reported and 8 percent adjusted for currency compared to ~~the second quarter of the prior year.~~

In Infrastructure Services, there was continued momentum as clients engage the company to optimize their IT environments and move to the cloud. The company is shifting from systems integration to services integration as it connects multiple environments and is building out hybrid infrastructures delivered as-a-Service to clients. The company also continues to sign transformative agreements with clients to optimize their infrastructure and help digitize their operations. There was strong revenue growthyear as reported and adjusted for currency ~~in the IBM Cloud.~~

~~Overall, Integration Software revenue declined~~ as ~~the company shifts~~ these ~~offerings~~types of workloads continue to shift from on-premise to the cloud. From a product perspective, there was continued strength in Connect products as clients integrate applications, data, and processes for both on-premises and cloud-based applications. Across Integration Software, the annuity content grew year to year in the second quarter (as reported and adjusted for currency) as the company continues the shift to an as-a-Service consumption model through new cloud capabilities delivered on IBM’s Bluemix cloud platform.

Within Technology Services & Cloud Platforms, total ~~second~~first quarter 2017 strategic imperatives revenue of ~~$2,047 million~~$2.4 billion grew ~~35.3~~30 percent as reported ~~(35~~(31 percent adjusted for currency) year to year. Cloud revenue of ~~$1,418 million~~$1.7 billion grew ~~42.7~~41 percent as reported ~~(43~~(42 percent adjusted for currency), with an as-a-Service exit run rate of $4,677 million. For the first six months of the year, strategic imperatives revenue within Technology Services & Cloud Platforms of $3,895 million grew 38.1 percent as reported (40 percent adjusted for currency), with Cloud revenue of $2,591 million growing 44.1 percent as reported (46 percent adjusted for currency).$5.7 billion.

Yr. to Yr.

Percent/

(Dollars in millions)

Margin

For the three months ended June 30:

2016

2015*

Change

Technology Services & Cloud Platforms:

External Technology Services gross profit

$
2,746

$
2,717

1.1
%
External Technology Services gross profit margin

35.4
%
35.3
%
0.1
pts.
External Integration Software gross profit

$
936

$
1,037

(9.7
)%
External Integration Software gross profit margin

85.3
%
86.4
%
(1.2
)pts.
External total gross profit

$
3,683

$
3,754

(1.9
)%
External total gross profit margin

41.6
%
42.2
%
(0.6
)pts.
Pre-tax income

$
1,279

$
1,414

(9.5
)%
Pre-tax margin

14.2
%
15.6
%
(1.4
)pts.

* Recast to conform with 2016 presentation.

~~Management Discussion — (continued)~~

Yr. to Yr.

Percent/

(Dollars in millions)

Margin

For the six months ended June 30:

2016

2015*

Change

Technology Services & Cloud Platforms:

External Technology Services gross profit

$
5,351

$
5,416

(1.2
)%
External Technology Services gross profit margin

35.3
%
35.6
%
(0.4
)pts.
External Integration Software gross profit

$
1,779

$
1,935

(8.1
)%
External Integration Software gross profit margin

84.3
%
85.7
%
(1.3
)pts.
External total gross profit

$
7,130

$
7,351

(3.0
)%
External total gross profit margin

41.3
%
42.1
%
(0.9
)pts.
Pre-tax income

$
1,537

$
2,544

(39.6
)%
Pre-tax margin

8.7
%
14.3
%
(5.6
)pts.

* Recast to conform with 2016 presentation.

							Yr. to Yr.
							Percent/
(Dollars in millions)							Margin
For the three months ended March 31:	2017			2016			Change
Technology Services & Cloud Platforms:
External Technology Services gross profit	$	2,429		$	2,605		(6.7	)%
External Technology Services gross profit margin	33.5		%	35.1		%	(1.6	)pts.
External Integration Software gross profit	$	769		$	843		(8.8	)%
External Integration Software gross profit margin	79.3		%	83.3		%	(4.0	)pts.
External total gross profit	$	3,198		$	3,447		(7.2	)%
External total gross profit margin	38.9		%	40.9		%	(2.0	)pts.
Pre-tax income	$	687		$	258		166.1	%
Pre-tax margin	8.2		%	3.0		%	5.2	pts.

~~The~~ Technology Services & Cloud Platforms gross profit margin decreased ~~0.6~~2.0 points to ~~41.6~~38.9 percent in the ~~second~~first quarter ~~driven by mix impact within the segment. For the first six months~~ of ~~2016, gross margin decreased 0.9 points to 41.3 percent~~2017 compared to the prior ~~year. Gross profit detail is provided within this segment for additional information due to the new alignment~~year, with declines across all lines of ~~software content into this segment beginning in~~business. In the first ~~quarter.~~

~~In the second~~ quarter of 2017, pre-tax income of ~~$1,279~~$687 million ~~decreased 9.5~~increased 166.1 percent and the pre-tax margin ~~declined 1.4~~expanded 5.2 points to ~~14.2~~8.2 percent. The year-to-year benefit includes a lower level of charges related to workforce rebalancing and real estate actions as compared to the prior year.

Across the segment, the company’s workforce rebalancing actions in 2016 resulted in savings driving gross profit improvement, which was offset by additional investment in new skill hiring and in existing skills. Within Infrastructure Services, the combination of the winding down of some large contracts, signing delays of new contracts, and investment ahead of some of the delayed signings, impacted profit margins and pre-tax ~~margin also reflects~~income during the ~~mix impact as well as ongoing investments to build out cloud platforms. This quarter~~quarter. In Technical Support Services, margins were impacted by the ~~company entered into an agreement with one of its strategic business partners to license the intellectual property of select assets within the~~shift toward multi-vendor services. In Integration Software, ~~portfolio, while jointly going~~margins were negatively impacted in the quarter from mix to ~~market to ensure clients’ success.This will shift~~SaaS and royalty cost associated with IP partnerships. Ongoing benefits associated with these partnerships include lower development expense (RD&E) and royalties from the ~~spending profile for these assets to a more variable cost structure going forward.~~IP partners associated with their sales (IP income).

Services Backlog and Signings

Yr. to Yr.

Percent

Yr. to Yr.

Change

At June 30,

At June 30,

Percent

Adjusted For

(Dollars in billions)

2016

2015*

Change

Currency

Total backlog

$
123.6

$
124.1

(0.4
)%
0.3
%

* Recast to conform with 2016 presentation.

							Yr. to Yr.
							Percent
					Yr. to Yr.		Change
	At March 31,		At March 31,		Percent		Adjusted For
(Dollars in billions)	2017		2016		Change		Currency
Total backlog	$	116.4	$	122.4	(4.9	)%	(2.4	)%

The estimated total services backlog at ~~June 30, 2016~~March 31, 2017 was ~~$124~~$116 billion, a decrease of ~~0.4~~4.9 percent as reported, and ~~flat~~2 percent adjusted for currency. While both Global Technology Services (GTS) and GBS declined year to year as reported, GTS grew modestly year to year adjusted for currency, ~~compared to the June 30, 2015 balance.~~but was more than offset by a decline in GBS.

Total services backlog includes Infrastructure Services, Consulting, Global Process Services, Application Management and Technical Support Services. Total backlog is intended to be a statement of overall work under contract for these businesses and therefore includes Technical Support Services. It does not include as-a-Service offerings ~~given the~~that have flexibility in contractual commitment ~~terms provided to these clients.~~terms. Backlog estimates are subject to change and are affected by several factors, including

Management Discussion — (continued)

terminations, changes in the scope of contracts, periodic revalidations, adjustments for revenue not materialized and adjustments for currency.

Services signings are management’s initial estimate of the value of a client’s commitment under a services contract. There are no third-party standards or requirements governing the calculation of signings. The calculation used by management involves estimates and judgments to gauge the extent of a client’s commitment, including the type and duration of the agreement, and the presence of termination charges or wind-down costs.

Signings include Infrastructure Services, Consulting, Global Process Services and Application Management contracts. Contract extensions and increases in scope are treated as signings only to the extent of the incremental new value. Technical Support Services is not included in signings as maintenance contracts tend to be more steady state, where revenues equal renewals.

~~Management Discussion — (continued)~~

Contract portfolios purchased in an acquisition are treated as positive backlog adjustments provided those contracts meet the company’s requirements for initial signings. A new signing will be recognized if a new services agreement is signed incidental or coincidental to an acquisition or divestiture.

							Yr. to Yr.								Yr. to Yr.
							Percent								Percent
					Yr. to Yr.		Change						Yr. to Yr.		Change
(Dollars in millions)					Percent		Adjusted For						Percent		Adjusted For
For the three months ended June 30:	2016		2015*		Change		Currency
For the three months ended March 31:									2017		2016		Change		Currency
Total signings	$	13,053	$	11,191	16.6	%	16.2	%	$	7,906	$	8,024	(1.5	)%	(0.2	)%

* Recast to conform with 2016 presentation.

Systems

Yr. to Yr.

Percent

Yr. to Yr.

Change

(Dollars in millions)

Percent

Adjusted For

For the three months ended June 30:

2016

2015*

Change

Currency

Systems external revenue:

$
1,950

$
2,541

(23.2
)%
(23.3
)%
Systems Hardware

$
1,489

$
2,056

(27.6
)%
(27.7
)%
z Systems

(40.1
)
(40.4
)
Power Systems

(24.0
)
(23.6
)
Storage Systems

(13.3
)
(13.4
)
Operating Systems Software

462

485

(4.7
)
(4.5
)

* Recast to conform with 2016 presentation.

Yr. to Yr.

Percent

Yr. to Yr.

Change

(Dollars in millions)

Percent

Adjusted For

For the six months ended June 30:

2016

2015*

Change

Currency

Systems external revenue:

$
3,626

$
4,683

(22.6
)%
(22.1
)%
Systems Hardware

$
2,724

$
3,714

(26.7
)%
(26.3
)%
z Systems

(41.6
)
(41.2
)
Power Systems

(19.6
)
(19.0
)
Storage Systems

(10.5
)
(10.3
)
Operating Systems Software

902

969

(6.9
)
(5.7
)

* Recast to conform with 2016 presentation.

							Yr. to Yr.
							Percent
					Yr. to Yr.		Change
(Dollars in millions)					Percent		Adjusted For
For the three months ended March 31:	2017		2016		Change		Currency
Systems external revenue:	$	1,395	$	1,675	(16.8	)%	(16.1	)%
Systems Hardware	$	1,000	$	1,235	(19.0	)%	(18.3	)%
z Systems					(40.2	)	(39.7	)
Power Systems					(27.8	)	(27.4	)
Storage Systems					6.1		7.3
Operating Systems Software	394		440		(10.5	)	(10.0	)

~~In the second quarter of 2016,~~ Systems revenue of ~~$1,950~~$1,395 million decreased ~~23.2~~16.8 percent as reported and 23 percent adjusted for currency compared to the prior year, reflecting the product cycle dynamics. For the first six months of the year, Systems revenue of $3,626 million declined 22.6 percent as reported (22 percent adjusted for currency).

~~Systems Hardware revenue of $1,489 million decreased 27.6 percent as reported (28~~(16 percent adjusted for currency) in the ~~second quarter. Operating Systems Software second~~first quarter ~~revenue~~ of ~~$462 million decreased 4.7 percent as reported (4 percent adjusted for currency),~~2017 compared to the prior year. ~~Although there was modest sequential improvement~~Systems Hardware revenue of $1,000 million decreased 19.0 percent as reported (18 percent adjusted for currency) year to year reflecting expected declines in ~~year-to-year performance (both~~z Systems and Power Systems indicative of the product cycles, partially offset by growth in Storage Systems as a result of repositioning for flash across the portfolio. Operating Systems Software revenue of $394 million decreased 10.5 percent as reported (10 percent adjusted for currency) compared to the prior year.

Within Systems Hardware, z Systems revenue decreased 40.2 percent as reported (40 percent adjusted for currency) year to year reflecting product cycle dynamics. However, nine quarters into the z13 cycle, the company continued to add new clients to the platform, with 7 new clients in the first quarter of 2017 and a total of 87 since introduction of the z13.

Power Systems revenue decreased 27.8 percent as reported (27 percent adjusted for currency) year to year reflecting the company’s shift to a growing Linux market while continuing to serve a high value, but declining UNIX market. While Linux had continued revenue growth as reported and adjusted for ~~currency), Operating~~currency in the first quarter of 2017, UNIX declined as reported and adjusted for currency driven by midrange and low-end systems.

Storage Systems ~~Software~~revenue increased by 6.1 percent as reported (7 percent adjusted for currency) year to year led by growth in all-flash array offerings. In the storage market, there is ~~expected~~a continued shift in value towards software-defined environments, where the company continues to ~~continue to impact growth.~~lead the market. Although not reported in the Systems segment, Software-Defined Storage also grew as reported and adjusted for currency in the first quarter of 2017.

Management Discussion — (continued)

Within Systems, Hardware, z Systems second quarter revenue decreased 40.1 percent as reported (40 percent adjusted for currency) year to year consistent with the product cycle. The company continues to expand the client base, adding thirteen new clients in the quarter and nearly seventy since the beginning of the cycle. The company continues to drive innovation in the z Systems platform, including the acquisition of EZSource (closed in the second quarter of 2016), which will help clients modify applications for their digital transformation while also supporting agility and hybrid cloud.

Power Systems second quarter revenue decreased 24.0 percent as reported (24 percent adjusted for currency) year to year with growth in the mid-range offset by declines in the high and low end products. The Unix market is a high value area that has been declining and the company represents the majority of the market. Performance in the second quarter reflects the replacement dynamic, following strong performance in the high end of Power 8 in the second quarter of 2015. While the mid-range has been growing year to year, a similar replacement dynamic is expected to occur in the third quarter of 2016. The company is addressing the growing Linux market with its Linux on Power strategy. This market is becoming a more meaningful part of the business, representing over 10 percent of Power revenue in the second quarter.

Storage Systems revenue decreased in the second quarter 2016 compared to 2015 by 13.3 percent as reported (13 percent adjusted for currency), as value in storage continues to shift to software. The second quarter performance reflected continued weakness in the traditional disk storage market. In the second quarter, the new all flash DS8K storage offering was released giving the company competitive differentiation, with plans to deliver all-flash offerings across the entire portfolio.

~~Within Systems,~~ total ~~second~~first quarter strategic imperatives revenue of ~~$937 million~~$0.5 billion decreased ~~14.3~~16 percent as reported ~~(14~~(15 percent adjusted for currency) year to year. Cloud revenue of ~~$767 million~~$0.4 billion decreased ~~10.9~~16 percent as reported ~~(11 percent~~and adjusted for currency). For the first six months of the year, strategic imperatives revenue within Systems of $1,590 million decreased 11.1 percent as reported (11 percent adjusted for currency), with Cloud revenue of $1,276 million decreasing 6.4 percent as reported (6 percent adjusted for currency).currency.

							Yr. to Yr.								Yr. to Yr.
							Percent/								Percent/
(Dollars in millions)							Margin								Margin
For the three months ended June 30:	2016			2015*			Change
For the three months ended March 31:									2017			2016			Change
Systems:
External Systems Hardware gross profit	$	687		$	992		(30.8	)%	$	319		$	572		(44.2	)%
External Systems Hardware gross profit margin	46.1		%	48.2		%	(2.1	)pts.	31.9		%	46.4		%	(14.4	)pts.
External Operating Systems Software gross profit	$	416		$	442		(6.0	)%	$	343		$	387		(11.4	)%
External Operating Systems Software gross profit margin	90.1		%	91.3		%	(1.2	)pts.	86.9		%	87.8		%	(0.9	)pts.
External total gross profit	$	1,103		$	1,434		(23.1	)%	$	662		$	959		(31.0	)%
External total gross profit margin	56.5		%	56.5		%	0.1	pts.	47.5		%	57.2		%	(9.8	)pts.
Pre-tax income/(loss)	$	229		$	538		(57.5	)%	$	(186	)	$	(10	)	nm	%
Pre-tax margin	10.6		%	19.7		%	(9.1	)pts.	(11.9		)%	(0.5		)%	(11.4	)pts.

* Recast to conform with 2016 presentation.

~~Management Discussion — (continued)~~

Yr. to Yr.

Percent/

(Dollars in millions)

Margin

For the six months ended June 30:

2016

2015*

Change

Systems:

External Systems Hardware gross profit

$
1,259

$
1,731

(27.3
)%
External Systems Hardware gross profit margin

46.2
%
46.6
%
(0.4
)pts.
External Operating Systems Software gross profit

$
802

$
877

(8.5
)%
External Operating Systems Software gross profit margin

89.0
%
90.5
%
(1.6
)pts.
External total gross profit

$
2,062

$
2,608

(21.0
)%
External total gross profit margin

56.9
%
55.7
%
1.2
pts.
Pre-tax income/(loss)

$
218

$
800

(72.7
)%
Pre-tax margin

5.4
%
15.9
%
(10.5
)pts.

* Recast to conform with 2016 presentation.nm - not meaningful

The Systems gross profit margin ~~increased 0.1~~decreased 9.8 points to ~~56.5~~47.5 percent in the ~~second~~first quarter of ~~2016~~2017 compared to the prior ~~year. This increase was due to margin (0.4 points)~~year with ~~improvements in z Systems and Power, offset by~~ declines ~~in Storage~~across all hardware brands and Operating Systems ~~Software margins~~software, and an impact from mix. For the first three months of 2017, the pre-tax loss was $186 million compared with a ~~less favorable product mix (0.3 points). The Systems gross profit margin increased 1.2 points to 56.9 percent~~pre-tax loss of $10 million in the ~~first six months~~prior year which included a higher level of ~~2016 compared~~charges related to workforce rebalancing and real estate actions. Pre-tax margin declined 11.4 points year to year consistent with the ~~prior year. This increase was due to margin (1.9 points) with improvements in z Systems~~product cycle, portfolio transition dynamics, and ~~Power~~hardware price pressure impacting revenue and offset by declines in the Operating Systems Software and Storage margins and a less favorable product mix (0.7 points). Gross profit detail is provided within this segment for additional information due to the new alignment of software content into this segment beginning in the first quarter.profit.

InThe company continues to expand its footprint and add new capabilities, which address changing workloads. While it is faced with shifting market dynamics and ongoing product transitions, the ~~second quarter, pre-tax income of $229 million decreased 57.5 percent~~portfolio remains optimized for cognitive and ~~the pre-tax margin declined 9.1 points to 10.6 percent. The decline in pre-tax income reflects the revenue performance year to year.~~cloud computing.

Global Financing

See pages 8062 through 8667 for a discussion of Global Financing’s segment results.

~~Total Software~~

Under the company’s new segment structure total Software no longer exists as a segment, instead the company’s software revenue is included within the Cognitive Solutions, Technology Services & Cloud Platforms, and Systems segments. Given the current focus on IBM’s software revenue performance, the company will continue to report total software revenue performance throughout 2016. Total Software revenue, which includes Cognitive Solutions, Integration Software and Operating Systems Software, of $6,235 million increased 0.5 percent as reported and 1 percent adjusted for currency in the second quarter of 2016 compared to the prior year period. Year-to-year performance was driven by acceleration of annuity content (as reported and adjusted for currency) within Cognitive Solutions and Integration Software; partially offset by declines in annuity content within Operating Systems. Investments are driving growth in SaaS, both on an organic basis and from acquisitions. Overall, second quarter performance reflected sequential improvement of 3 points from the first quarter of 2016 as reported and 2 points adjusted for currency. From a product offering perspective, revenue growth in Solutions Software was partially offset by declines in Operating Systems Software, Transaction Processing Software and Integration Software (as reported and adjusted for currency).

For the first six months of 2016, total Software revenue of $11,666 million decreased 1.1 percent as reported and was flat adjusted for currency, with declines across all software lines except Solutions Software.

Geographic Revenue

In addition to the revenue presentation by reportable segment, the company also measures revenue performance on a geographic basis. The following geographic, regional and country-specific revenue performance excludes OEM revenue.

~~Management Discussion — (continued)~~

Yr. to Yr.

Percent

Yr. to Yr.

Change

(Dollars in millions)

Percent

Adjusted For

For the three months ended June 30:

2016

2015

Change

Currency

Total Revenue

$
20,238

$
20,813

(2.8
)%
(2.6
)%
Geographies:

$
20,163

$
20,730

(2.7
)%
(2.6
)%
Americas

9,486

9,817

(3.4
)
(1.8
)
Europe/Middle East/Africa (EMEA)

6,274

6,570

(4.5
)
(4.0
)
Asia Pacific

4,402

4,343

1.4

(2.2
)

							Yr. to Yr.								Yr. to Yr.
							Percent								Percent
					Yr. to Yr.		Change						Yr. to Yr.		Change
(Dollars in millions)					Percent		Adjusted For						Percent		Adjusted For
For the six months ended June 30:	2016		2015		Change		Currency
For the three months ended March 31:									2017		2016		Change		Currency
Total Revenue	$	38,923	$	40,403	(3.7	)%	(2.3	)%	$	18,155	$	18,684	(2.8	)%	(2.2	)%
Geographies:	$	38,773	$	40,228	(3.6	)%	(2.3	)%	$	18,072	$	18,611	(2.9	)%	(2.2	)%
Americas	18,159		19,130		(5.1	)	(2.9	)	8,678		8,673		0.1		(1.0	)
Europe/Middle East/Africa (EMEA)	12,181		12,695		(4.1	)	(2.3	)	5,430		5,906		(8.1	)	(3.7	)
Asia Pacific	8,433		8,404		0.4		(0.8	)	3,964		4,031		(1.7	)	(2.8	)

Total geographic revenue of ~~$20,163~~$18,072 million decreased ~~2.7~~2.9 percent as reported and 32 percent adjusted for currency in the ~~second~~first quarter of ~~2016~~2017 compared to the prior year. Americas revenue of ~~$9,486~~$8,678 million ~~decreased 3.4 percent~~was essentially flat year to year as reported, ~~and 2~~but decreased 1 percent adjusted for currency. EMEA ~~second-quarter~~ revenue of ~~$6,274~~$5,430 million decreased ~~4.5~~8.1 percent as reported and 4 percent adjusted for currency. Asia Pacific revenue of ~~$4,402~~$3,964 million ~~grew 1.4 percent as reported, but~~ decreased ~~2 percent adjusted for currency.~~

~~Within Americas, the U.S. second-quarter revenue decreased 2.1 percent compared to the prior year, but improved sequentially from the prior quarter. Canada was down 2.4~~1.7 percent as reported and ~~grew 2 percent adjusted for currency. Latin America decreased 12.9 percent as reported and~~ 3 percent adjusted for currency in the second quarter compared to the prior year. Within Latin America, Brazil decreased 14.9 percent as reported and 6 percent adjusted for currency, but improved sequentially from the prior quarter (both as reported and adjusted for currency).

~~In the second quarter, within EMEA, revenue in the UK declined 8.2 percent as reported and 2 percent adjusted for currency.~~ In late June 2016, a referendum by U.K. voters to exit the European Union (“Brexit”) adversely impacted global markets. It did not have a material impact to the company in the quarter. Germany decreased 7.2 percent as reported and 9 percent adjusted for currency. France decreased 4.8 percent as reported and 7 percent adjusted for currency. In addition, other countries had declines, including Switzerland which decreased 28.2 percent as reported and 26 percent adjusted for currency, that significantly impacted the overall growth rate. While overall there was a revenue decline as reported and on an adjusted basis in the Central and Eastern European region, in the second quarter Russia grew 1.1 percent compared to the prior year and improved sequentially from the prior quarter. The Middle East and Africa region grew 1.8 percent as reported and 6 percent adjusted for currency.

Within Asia Pacific, Japan grew 12.7 percent as reported and was flat adjusted for currency. Australia decreased 19.9 percent as reported and 16 percent adjusted for currency. India had strong growth of 11.3 percent as reported and 17 percent adjusted for currency. China decreased 3.6 percent as reported and 1 percent adjusted for currency. In the second quarter, both India and China improved sequentially from the prior quarter (as reported and adjusted for currency).

Total geographic revenue of $38,773 million decreased 3.6 percent as reported and 2 percent adjusted for currency in the first six months of 2016 compared to the prior year. Americas revenue of $18,159 million decreased 5.1 percent as reported and 3 percent adjusted for currency. EMEA revenue of $12,181 million decreased 4.1 percent as reported and 2 percent adjusted for currency. Asia Pacific revenue of $8,433 million grew 0.4 percent as reported, but declined 1 percent adjusted for currency.

Management Discussion — (continued)

Within Americas, ~~the~~ U.S. revenue decreased ~~2.8~~1.3 percent compared to ~~the first six months of~~ the prior year. Canada was ~~down 6.4~~up 3.2 percent as reported, but was essentially flat year to year adjusted for currency. Latin America increased 7.0 percent as reported, and was essentially flat year to year adjusted for currency. Within Latin America, Brazil was up 18.6 percent as reported, but down 1 percent adjusted for currency, and Mexico decreased ~~18.4~~2.4 percent as reported, but was up 4 percent adjusted for currency.

The EMEA year-to-year revenue decline as reported and adjusted for currency was driven by the UK down 19.0 percent (7 percent adjusted for currency) and Germany down 7.7 percent (5 percent adjusted for currency), while Norway was up 18.0 percent (15 percent adjusted for currency) and Italy declined 1.7 percent as reported, but increased 2 percent adjusted for currency. The Middle East and Africa region grew 2.7 percent as reported, but was essentially flat year to year adjusted for currency.

Within Asia Pacific, Japan revenue was up 0.9 percent as reported and essentially flat adjusted for currency. India grew 5.6 percent as reported and 5 percent adjusted for currency. ~~Within Latin America, Brazil declined 29.0~~China decreased 12.6 percent as reported ~~and 15~~(10 percent adjusted for ~~currency.~~

Within EMEA, revenue in the UK decreased 6.3 percent as reported, but was flat adjusted for currency compared to the first six months of the prior year. Germany decreased 4.9 percent as reported and 5 percent adjusted for currency. France decreased 3.5 percent as reported and 3 percent adjusted for currency. Italy grew 2.3 percent as reported and 2 percent adjusted for currency year to year. There was a decline in the Central and Eastern European region as reported and adjusted for currency including a year-to-year decline in Russia of 20.1 percent. The Middle East and Africa region grew 1.6 percent as reported and 7 percent adjusted for currency.

~~Within Asia Pacific, Japan grew 9.0 percent as reported and 1 percent adjusted for currency compared to the first six months of the prior year.~~currency). Australia decreased 12.5 percent ~~as reported and 7~~(17 percent adjusted for ~~currency. India grew 8.0 percent as reported and 15 percent adjusted for currency. China decreased 5.5 percent as reported and 3 percent adjusted for currency.~~currency).

Expense

Total Expense and Other (Income)

Yr. to Yr.

(Dollars in millions)

Percent

For the three months ended June 30:

2016

2015

Change

Total consolidated expense and other (income)

$
6,653

$
6,165

7.9
%
Non-operating adjustments:

Amortization of acquired intangible assets

$
(136
)
$
(72
)
88.7
%
Acquisition-related charges

(23
)
(7
)
214.2

Non-operating retirement-related (costs)/income

(83
)
(74
)
11.5

Operating (non-GAAP) expense and other (income)

$
6,411

$
6,012

6.6
%
Total consolidated expense-to-revenue ratio

32.9
%
29.6
%
3.3
pts.
Operating (non-GAAP) expense-to-revenue ratio

31.7
%
28.9
%
2.8
pts.

							Yr. to Yr.								Yr. to Yr.
(Dollars in millions)							Percent								Percent
For the six months ended June 30:	2016			2015			Change
For the three months ended March 31:									2017			2016			Change
Total consolidated expense and other (income)	$	14,306		$	12,617		13.4	%	$	6,348		$	7,652		(17.0	)%
Non-operating adjustments:
Amortization of acquired intangible assets	$	(235	)	$	(151	)	55.5	%	$	(130	)	$	(99	)	31.1	%
Acquisition-related charges	3			(8		)	nm		(13		)	27			nm
Non-operating retirement-related (costs)/income	(146		)	(395		)	(63.0	)	(185		)	(63		)	192.2
Operating (non-GAAP) expense and other (income)	$	13,928		$	12,063		15.5	%	$	6,020		$	7,516		(19.9	)%
Total consolidated expense-to-revenue ratio	36.8		%	31.2		%	5.5	pts.	35.0		%	41.0		%	(6.0	)pts.
Operating (non-GAAP) expense-to-revenue ratio	35.8		%	29.9		%	5.9	pts.	33.2		%	40.2		%	(7.1	)pts.

nm - not meaningful

Total expense and other (income) increased 7.9 percent in the second quarter and increased 13.4 percent in the first six months of 2016 compared to the prior year periods. Total operating (non-GAAP) expense and other (income) increased 6.6 percent in the second quarter and increased 15.5 percent in the first six months of 2016 compared to the second quarter and first six months of 2015, respectively. The key drivers of the year-to-year change in total expense and other (income) were approximately:

~~Management Discussion — (continued)~~

Total Consolidated

Operating (non-GAAP)

For the three and six months ended June 30, 2016:

Three Months

Six Months

Three Months

Six Months

Currency*

3

points

1

point

4

points

1

point

Acquisitions

6

points

5

points

5

points

4

points

Base

(2
)
points

7

points

(2
)
points

10

points

* Reflects impacts of translation and hedging programs.

For additional information regarding total expense and other (income) for both expense presentations, see the following analyses by category.

Selling, ~~general~~General and ~~administrative expense~~Administrative Expense

							Yr. to Yr.								Yr. to Yr.
(Dollars in millions)							Percent								Percent
For the three months ended June 30:	2016			2015			Change
For the three months ended March 31:									2017			2016			Change
Selling, general and administrative expense:
Selling, general and administrative — other	$	4,522		$	4,230		6.9	%	$	4,127		$	4,192		(1.5	)%
Advertising and promotional expense	361			341			6.1		363			348			4.4
Workforce rebalancing charges	15			178			(91.6	)	167			998			(83.3	)
Retirement-related costs	198			193			2.8		258			179			44.7
Amortization of acquired intangible assets	136			72			88.7		130			99			31.1
Stock-based compensation	91			92			(1.1	)	91			99			(7.6	)
Bad debt expense	26			74			(65.4	)	15			97			(84.9	)
Total consolidated selling, general and administrative expense	$	5,349		$	5,179		3.3	%	$	5,152		$	6,012		(14.3	)%
Non-operating adjustments:
Amortization of acquired intangible assets	$	(136	)	$	(72	)	88.7	%	$	(130	)	$	(99	)	31.1	%
Acquisition-related charges	(23		)	(2		)	nm		(9		)	32			nm
Non-operating retirement-related (costs)/income	(75		)	(63		)	19.7		(136		)	(55		)	148.1
Operating (non-GAAP) selling, general and administrative expense	$	5,114		$	5,042		1.4	%	$	4,877		$	5,890		(17.2	)%

nm — not meaningful

Yr. to Yr.

(Dollars in millions)

Percent

For the six months ended June 30:

2016

2015

Change

Selling, general and administrative expense:

Selling, general and administrative — other

$
8,714

$
8,307

4.9
%
Advertising and promotional expense

709

653

8.5

Workforce rebalancing charges

1,013

463

118.8

Retirement-related costs

377

631

(40.3
)
Amortization of acquired intangible assets

235

151

55.5

Stock-based compensation

190

178

6.3

Bad debt expense

123

157

(21.8
)
Total consolidated selling, general and administrative expense

$
11,361

$
10,541

7.8
%
Non-operating adjustments:

Amortization of acquired intangible assets

$
(235
)
$
(151
)
55.5
%
Acquisition-related charges

9

(2
)
nm

Non-operating retirement-related (costs)/income

(130
)
(371
)
(64.9
)
Operating (non-GAAP) selling, general and administrative expense

$
11,004

$
10,017

9.9
%

~~nm - not meaningful~~Management Discussion — (continued)

Total selling, general and administrative (SG&A) expense ~~increased 3.3~~decreased 14.3 percent in the ~~second~~first quarter of ~~2016~~2017 versus the prior year driven primarily by the following factors:

· ~~Acquisition-related spending (5 points); partially offset by~~

·Lower workforce rebalancing charges ~~(3 points).~~

~~Operating (non-GAAP) expense increased 1.4 percent year to year in the second quarter of 2016 driven primarily by:~~

~~Management Discussion — (continued)~~

· ~~Acquisition-related spending (4 points); partially offset by~~

· ~~Lower workforce rebalancing charges (3 points).~~

~~SG&A expense increased 7.8 percent in the first six months of 2016 versus the first six months of 2015 driven primarily by the following factors:~~

· ~~Higher workforce rebalancing charges (5 points); and~~

· ~~Acquisition-related spending (4 points); partially offset by~~

· ~~A prior year pension obligation related to litigation in Spain (2~~(14 points); and

· The effects of currency (1 point); partially offset by

· The impact of acquisitions completed in the prior 12-month period (2 points).

Operating (non-GAAP) expense ~~increased 9.9~~decreased 17.2 percent year to year driven by primarily by the same ~~factors excluding the benefit from the prior-year pension obligation which was not reflected in operating (non-GAAP) expense.~~factors.

Bad debt expense decreased ~~$34~~$82 million year to year, primarily driven by increased reserves in Brazil in the prior year. The receivables provision coverage was ~~2.9~~2.2 percent at ~~June 30, 2016,~~March 31, 2017, an increase of ~~30 basis points from year-end 2015 and~~ 20 basis points from ~~June 30, 2015.~~December 31, 2016 and a decrease of 60 basis points from March 31, 2016. The decrease year to year in the receivables provision coverage was due to write-offs of previously reserved receivables in December 2016.

Research, Development and Engineering

Yr. to Yr.

(Dollars in millions)

Percent

For the three months ended June 30:

2016

2015

Change

Total consolidated research, development and engineering expense

$
1,465

$
1,300

12.7
%
Non-operating adjustment:

Non-operating retirement-related (costs)/income

$
(7
)
$
(11
)
(35.0
)%
Operating (non-GAAP) research, development and engineering expense

$
1,458

$
1,289

13.1
%

							Yr. to Yr.								Yr. to Yr.
(Dollars in millions)							Percent								Percent
For the six months ended June 30:	2016			2015			Change
For the three months ended March 31:									2017			2016			Change
Total consolidated research, development and engineering expense	$	2,923		$	2,598		12.5	%	$	1,533		$	1,458		5.2	%
Non-operating adjustment:
Non-operating retirement-related (costs)/income	$	(16	)	$	(24	)	(34.4	)%	$	(49	)	$	(9	)	475.6	%
Operating (non-GAAP) research, development and engineering expense	$	2,907		$	2,574		12.9	%	$	1,484		$	1,449		2.4	%

Research, development and engineering (RD&E) expense was ~~7.2 percent and 7.5~~8.4 percent of revenue in the ~~second~~first quarter ~~and first six months~~ of ~~2016, respectively,~~2017 compared to ~~6.2~~7.8 percent ~~and 6.4 percent~~of revenue in ~~prior year periods, respectively. The company continues to grow its investment in research & development as it builds new markets and maintains its leadership in enterprise IT.~~the first quarter of 2016.

RD&E expense ~~increased 12.7 percent~~ in the ~~second~~first quarter of ~~2016 versus the second quarter of 2015~~2017 increased 5.2 percent year to year primarily driven by:

· ~~Higher expense due to~~The impact of acquisitions ~~(8 points); and~~

· ~~Increased base spending (5~~completed in the prior 12-month period (4 points); partially offset by

· The effects of currency (1 point).

Operating (non-GAAP) RD&E expense increased ~~13.1 percent in the second quarter of 2016 compared to the prior year driven primarily by the same factors.~~

~~Management Discussion — (continued)~~

~~RD&E expense increased 12.5~~2.4 percent in the first ~~six months~~quarter of ~~2016 versus the first six months of 2015 primarily driven by:~~

· ~~Increased base spending (7 points); and~~

· ~~Higher expense due to acquisitions (7 points); partially offset by~~

· ~~The effects of currency (2 points).~~

~~Operating (non-GAAP) RD&E expense increased 12.9 percent in the first six months of 2016~~2017 compared to the prior year driven primarily by the same factors.

Intellectual Property and Custom Development Income

					Yr. to Yr.						Yr. to Yr.
(Dollars in millions)					Percent						Percent
For the three months ended June 30:	2016		2015		Change
For the three months ended March 31:							2017		2016*		Change
Intellectual Property and Custom Development Income:
Sales and other transfers of intellectual property	$	275	$	30	806.4	%
Licensing/royalty-based fees	37		27		33.9
Licensing of intellectual property including royalty-based fees							$	381	$	157	143.2	%
Custom development income	53		71		(24.3	)	64		51		24.2
Sales/other transfers of intellectual property							1		9		(92.7	)
Total	$	365	$	128	184.3	%	$	445	$	217	105.2	%

Yr. to Yr.

(Dollars in millions)

Percent

For the six months ended June 30:

2016

2015

Change

Intellectual Property and Custom Development Income:

Sales and other transfers of intellectual property

$
400

$
102

293.0
%
Licensing/royalty-based fees

78

59

32.6

Custom development income

105

141

(25.7
)
Total

$
582

$
301

93.3
%

* Reclassified to conform to 2017 presentation.

~~Sales and other transfers~~Licensing of intellectual property including royalty-based fees increased in the ~~second~~first quarter ~~and first six months~~ of ~~2016~~2017 compared to the prior year ~~periods,~~period, primarily due to ~~$175 million reflected in the second quarter~~licensing of ~~2016 as the result of a licensing agreement for~~ certain intellectual property ~~primarily~~ within the company’s ~~Integration Software~~Cognitive Solutions software portfolio. ~~This~~The company had three new partnership ~~will accelerate product innovation and~~agreements in the first quarter of 2017, which included one transaction with period income greater than $100 million. The company is licensing IP to partners who are allocating their skills to extend the ~~capabilities to hybrid cloud.~~value of assets that are high value, but may be in mature markets. There were no significant individual IP transactions in the ~~second~~first quarter of ~~2015.~~2016. The timing and amount of ~~Sales and~~licensing, sales or other transfers of IP may vary significantly from period to period depending upon the timing of ~~divestitures/~~licensing agreements, economic conditions, industry consolidation and the timing of new patents and know-how development.

~~Other (income) and expense~~

Yr. to Yr.

(Dollars in millions)

Percent

For the three months ended June 30:

2016

2015

Change

Other (income) and expense:

Foreign currency transaction losses/(gains)

$
195

$
(25
)
nm

(Gains)/losses on derivative instruments

(108
)
(134
)
(19.5
)%
Interest income

(29
)
(18
)
62.0

Net (gains)/losses from securities and investment assets

(5
)
(22
)
(76.3
)
Other

(16
)
(102
)
(84.4
)
Total consolidated other (income) and expense

$
37

$
(301
)
nm

Non-operating adjustment:

Acquisition-related charges

$
—

$
(5
)
(100.0
)%
Operating (non-GAAP) other (income) and expense

$
37

$
(306
)
nm

~~nm - not meaningful~~

~~Table of Contents~~

Management Discussion — (continued)

Yr. to Yr.

(Dollars in millions)

Percent

For the six months ended June 30:

2016

2015

Change

Other (income) and expense:

Foreign currency transaction losses/(gains)

$
421

$
65

548.0
%
(Gains)/losses on derivative instruments

(316
)
(311
)
1.4

Interest income

(53
)
(37
)
46.1

Net (gains)/losses from securities and investment assets

34

(23
)
nm

Other

204

(139
)
nm

Total consolidated other (income) and expense

$
289

$
(444
)
nm

Non-operating adjustment:

Acquisition-related charges

$
(6
)
$
(5
)
6.6
%
Operating (non-GAAP) other (income) and expense

$
284

$
(450
)
nm

Other (Income) and Expense

							Yr. to Yr.
(Dollars in millions)							Percent
For the three months ended March 31:	2017			2016			Change
Other (income) and expense:
Foreign currency transaction losses/(gains)	$	16		$	226		(93.0	)%
(Gains)/losses on derivative instruments	11			(207		)	nm
Interest income	(30		)	(24		)	24.0
Net (gains)/losses from securities and investment assets	(5		)	39			nm
Other	(19		)	219			nm
Total consolidated other (income) and expense	$	(28	)	$	253		nm	%
Non-operating adjustment:
Acquisition-related charges	$	(4	)	$	(6	)	(36.5	)
Operating (non-GAAP) other (income) and expense	$	(31	)	$	247		nm	%

nm - not meaningful

~~nm - not meaningful~~

Total consolidated other (income) and expense was ~~expense~~income of ~~$37~~$28 million in the ~~second~~first quarter of ~~2016~~2017 compared to ~~income~~expense of ~~$301~~$253 million in the ~~second quarter of 2015.~~prior year. The decrease in ~~income~~expense of ~~$338~~$280 million year over year was primarily driven by:

· ~~Higher foreign currency transaction losses~~Real estate capacity charges (reflected in Other in the above table) in the prior year related to workforce transformation ($~~220~~328 million); and

· ~~Prior year~~Lower foreign currency transaction losses ($210 million); and

· Reduced losses from securities and investment assets ($33 million), primarily related to the sale of Lenovo shares in the prior year; partially offset by

· Lower gains on ~~real estate asset dispositions~~derivative instruments ($55218 million); and

· Lower gains on divestitures ($4453 million)~~, primarily associated with the System x divestiture; and~~

· ~~Lower gains on derivative instruments ($26 million)~~.

The consolidated other (income) and expense was expense of $289 million in the first six months of 2016 compared to income of $444 million in the first six months of 2015. The decrease in income of $734 million year over year was primarily driven by:

· ~~Higher foreign currency transaction losses ($356 million); and~~

· ~~Real estate capacity charges related to the first-quarter 2016 workforce transformation ($328 million); and~~

· ~~Increased losses from securities and investment assets ($56 million) primarily related to the sale of Lenovo shares ($37 million) in the first quarter of 2016.~~

Interest Expense

Yr. to Yr.

(Dollars in millions)

Percent

For the three months ended June 30:

2016

2015

Change

Interest expense

$
167

$
115

45.3
%

					Yr. to Yr.						Yr. to Yr.
(Dollars in millions)					Percent						Percent
For the six months ended June 30:	2016		2015		Change
For the three months ended March 31:							2017		2016		Change
Interest expense	$	315	$	223	41.2	%	$	135	$	147	(8.0	)%

~~The increase in interest expense in the second quarter and first six months of 2016 versus the same periods of 2015 was primarily driven by higher average debt levels and~~ ~~higher average interest rates.~~ Interest expense is presented in cost of financing in the Consolidated Statement of Earnings only if the related external borrowings are to support the Global Financing external business. Overall interest expense (excluding capitalized interest) for the ~~second~~first quarter ~~and first six months~~ of ~~2016~~2017 was ~~$314~~$293 million, ~~and $599 million, respectively,~~ an increase of ~~$62~~$8 million ~~and $100 million, respectively,~~ versus the ~~comparable prior-year periods.~~

~~Management Discussion — (continued)~~prior year, primarily driven by higher average interest rates.

Retirement-Related Plans

The following table provides the total pre-tax cost for all retirement-related plans. These amounts are included in the Consolidated Statement of Earnings within the caption (e.g., Cost, SG&A, RD&E) relating to the job function of the plan participants.

Management Discussion — (continued)

Yr. to Yr.

(Dollars in millions)

Percent

For the three months ended June 30:

2016

2015

Change

Retirement-related plans — cost:

Service cost

$
111

$
123

(10.1
)%
Amortization of prior service costs/(credits)

(27
)
(25
)
7.7

Cost of defined contribution plans

269

276

(2.7
)
Total operating costs/(income)

$
353

$
375

(5.9
)%
Interest cost

$
831

$
830

0.1
%
Expected return on plan assets

(1,405
)
(1,472
)
(4.6
)
Recognized actuarial losses

690

816

(15.5
)
Curtailments/settlements

10

3

189.9

Multi-employer plans/other costs

37

8

379.4

Total non-operating costs/(income)

$
163

$
186

(12.1
)%
Total retirement-related plans — cost

$
516

$
560

(7.9
)%

							Yr. to Yr.								Yr. to Yr.
(Dollars in millions)							Percent								Percent
For the six months ended June 30:	2016			2015			Change
For the three months ended March 31:									2017			2016			Change
Retirement-related plans — cost:
Service cost	$	221		$	239		(7.5	)%	$	106		$	110		(3.8	)%
Amortization of prior service costs/(credits)	(53		)	(51		)	3.7		(21		)	(25		)	(15.7	)
Cost of defined contribution plans	540			565			(4.3	)	263			271			(3.3	)
Total operating costs/(income)	$	709		$	753		(5.9	)%	$	347		$	356		(2.6	)%
Interest cost	$	1,657		$	1,664		(0.4	)%	$	732		$	827		(11.4	)%
Expected return on plan assets	(2,798		)	(2,945		)	(5.0	)	(1,073		)	(1,394		)	(23.0	)
Recognized actuarial losses	1,377			1,646			(16.3	)	705			687			2.7
Curtailments/settlements	14			7			94.1		(1		)	5			(131.2	)
Multi-employer plans/other costs	55			256			(78.4	)
Multi-employer plan/other costs									14			18			(20.5	)
Total non-operating costs/(income)	$	306		$	627		(51.3	)%	$	378		$	142		165.4	%
Total retirement-related plans — cost	$	1,014		$	1,380		(26.5	)%	$	725		$	499		45.4	%

In the ~~second~~first quarter of ~~2016,~~2017, total pre-tax retirement-related plan cost ~~decreased~~increased by ~~$44~~$226 million compared to the ~~second~~first quarter of ~~2015,~~2016, primarily driven ~~by a decrease in recognized actuarial losses ($126 million); partially offset~~ by lower expected return on plan assets ($67321 million)~~. Total cost for the first six months of 2016 decreased by $366 million versus the first six months of 2015, primarily driven by a decrease~~ and an increase in recognized actuarial losses ($~~269 million), a prior year pension obligation related to litigation ($230 million), and lower defined contribution plan costs ($24~~19 million); partially offset by lower ~~expected return on plan assets~~interest costs ($~~147~~94 million).

As discussed in the “Snapshot” on page ~~48,~~41, the company characterizes certain retirement-related costs as operating and others as non-operating. Utilizing this characterization, operating retirement-related costs in the ~~second~~first quarter of ~~2016~~2017 were ~~$353~~$347 million, a decrease of ~~$22~~$9 million compared to the ~~second~~first quarter of ~~2015,~~2016, primarily driven by lower ~~service cost ($12 million) and lower~~ defined contribution plans ~~cost ($8 million).~~cost. Non-operating costs of ~~$163~~$378 million in the ~~second~~first quarter of ~~2016 decreased $23~~2017 increased $235 million year to year, driven primarily by ~~a decrease in recognized actuarial losses ($126 million); partially offset by~~ lower expected return on plan assets ($67 million). For the first six months of 2016, operating retirement-related costs were $709 million, a decrease of $44 million compared to the first six months of 2015, primarily driven by lower defined contribution plan costs ($24321 million) and ~~lower service cost ($18 million). Non-operating costs of $306 million decreased $322 million~~an increase in ~~the first six months of 2016 compared to the prior year, driven primarily by a decrease in~~

~~Management Discussion — (continued)~~

recognized actuarial losses ($~~269 million) and a prior year pension obligation related to litigation ($230~~19 million); partially offset by lower ~~expected return on plan assets~~interest costs ($~~147~~94 million).

Taxes

~~The continuing operations effective tax rate for the second quarter of 2016 was 17.8 percent, an increase of 1.3 points compared to the second quarter of 2015. The~~The continuing operations effective tax rate for the first ~~six months~~quarter of ~~2016~~2017 was ~~(10.8)~~(23.1) percent, ~~a decrease~~an increase of ~~28.5~~72.0 points compared to the first ~~six months of 2015. The operating (non-GAAP) tax rate for the second~~ quarter of ~~2016 was 19.0 percent, an increase of 1.8 points compared to the second quarter of 2015.~~2016. The operating (non-GAAP) tax rate for the first ~~six months~~quarter of ~~2016~~2017 was ~~(5.0)~~(9.3) percent, ~~a decrease~~an increase of ~~23.5~~57.6 points compared to the first ~~six months~~quarter of ~~2015.~~2016.

The higher continuing operations effective tax rate and the higher operating (non-GAAP) tax rate for the second quarter of 2016 were primarily driven by a one-time net discrete benefit in the second quarter of 2015 due to foreign tax audit activity (approximately $127 million), partially offset by a more favorable mix of geographic income year to year. The decreasechange in the continuing operations effective tax rate ~~for~~in the first ~~six months~~quarter of ~~2016 compared to 2015~~2017 was primarily driven by ~~the favorable resolution of~~ a ~~long-standing~~discrete tax ~~matter in February 2016~~benefit related to the ~~determination~~intra-entity transfer recognized in the first quarter of ~~certain~~2017 (40.9 points), a benefit related to increased foreign tax ~~losses incurred by the company in Japan (28.7~~credits (4.2 points), a more favorable mix of earnings (2.4 points), as well as the first quarter 2016 tax charge related to intercompany royalties from foreign subsidiaries (6.9 points).

These benefits were more than offset by a discrete tax charge related to foreign audit activity (6.9 points), the prior year tax benefit for the Japan tax matter (113.2 points), the favorable settlement in the first quarter of 2016 of the remaining open audit items on the company’s U.S. income tax returns for 2011 and 2012 ~~(0.9~~(3.6 points) and, athe benefit related to the ~~first quarter~~first-quarter 2016 real estate capacity actions (1.3 points). These benefits were partially offset by a 2016 tax charge related to intercompany royalties from foreign subsidiaries (1.7 points) and the year-to-year impact of the 2015 foreign tax audit benefit (1.8(5.2 points). The ~~decline~~change in the operating (non-GAAP) tax rate was primarily driven by the same factors.

In April 2010, the company appealed the determination of the Japanese Tax Authorities with respect to certain foreign tax losses. The tax benefit of these losses, approximately $1.0 billion adjusted for currency, had been included in unrecognized tax benefits as of December 2015. In April 2011, the company received notification that the appeal was denied, and in June 2011, the company filed a lawsuit challenging this decision. In May 2014, the Tokyo District Court ruled in favor of the company. The Japanese government appealed the ruling to the Tokyo High Court. On March 25, 2015, the Tokyo High Court ruled in favor of IBM and, on April 7, 2015, the Japanese government appealed the ruling to the Japan Supreme Court. On February 18, 2016, the Japan Supreme Court denied the government appeal thereby upholding the Tokyo High Court’s decision in favor of the company as the final judgment in this matter. This led to a refund of the taxes previously paid of $1.0 billion, which the company received in the first quarter of 2016 and included in the effective tax rate. Interest of $0.2 billion was also received.

With respect to major U.S. state and foreign taxing jurisdictions, the company is generally no longer subject to tax examinations for years prior to ~~2011.~~2012. The company is no longer subject to income tax examination of its U.S. federal tax return for years prior to 2013. The open years contain matters that could be subject to differing interpretations of applicable tax laws and regulations as it relates to the amount and/or timing of income, deductions and tax credits. Although the

Management Discussion — (continued)

outcome of tax audits is always uncertain, the company believes that adequate amounts of tax and interest have been provided for any adjustments that are expected to result for these years.

The amount of unrecognized tax benefits at December 31, 2015 increased by $31 million in the second quarter of 2016 and decreased by $877 million in the first six months of 2016 to $3,697 million. The overall decrease was primarily due to the first quarter favorable resolution of the Japan tax matter. The total amount of unrecognized tax benefits that, if recognized, would favorably affect the effective tax rate was $2,820 million at June 30, 2016.

In the fourth quarter of 2013, the company received a draft tax assessment notice for approximately $866 million (approximately $793 million at second quarter 2016 currency rates) from the Indian Tax Authorities for 2009. In July 2016, the Karnataka High Court in Bangalore set aside this assessment by way of court order and the company has reached a mutual agreement with the Income Tax Department for a new assessment, which will take place over an 18 month period. At June 30, 2016, the company has recorded $557 million as prepaid income taxes in India. A significant portion of this balance represents cash tax deposits paid over time to protect the company’s right to appeal various income tax assessments made by the Indian Tax Authorities.

In the first quarter of 2016, the IRS commenced its audit of the company’s U.S. tax returns for 2013 and 2014. The company anticipates that this audit will be completed by the end of 2017.

~~Management Discussion — (continued)~~

The amount of unrecognized tax benefits at December 31, 2016 increased by $563 million in the first quarter of 2017 to $4,303 million. The increase was primarily related to potential foreign and U.S. audit issues. The total amount of unrecognized tax benefits that, if recognized, would favorably affect the effective tax rate was $3,180 million at March 31, 2017.

The company is involved in a number of income tax-related matters in India challenging tax assessments issued by the India Tax Authorities. As of March 31, 2017, the company has recorded $546 million as prepaid income taxes in India. A significant portion of this balance represents cash tax deposits paid over time to protect the company’s right to appeal various income tax assessments made by the Indian Tax Authorities. The company believes it will prevail on these matters.

Earnings Per Share

Basic earnings per share is computed on the basis of the weighted-average number of shares of common stock outstanding during the period. Diluted earnings per share is computed on the basis of the weighted-average number of shares of common stock outstanding plus the effect of dilutive potential common shares outstanding during the period using the treasury stock method. Dilutive potential common shares include outstanding stock options and stock awards.

Yr. to Yr.

Percent

For the three months ended June 30:

2016

2015

Change

Earnings per share of common stock from continuing operations:

Assuming dilution

$
2.61

$
3.58

(27.1
)%
Basic

$
2.62

$
3.59

(27.0
)%
Diluted operating (non-GAAP)

$
2.95

$
3.84

(23.2
)%
Weighted-average shares outstanding: (in millions)

Assuming dilution

960.5

986.7

(2.7
)%
Basic

957.4

982.3

(2.5
)%

					Yr. to Yr.						Yr. to Yr.
					Percent						Percent
For the six months ended June 30:	2016		2015		Change
For the three months ended March 31:							2017		2016		Change
Earnings per share of common stock from continuing operations:
Assuming dilution	$	4.69	$	6.01	(22.0	)%	$	1.85	$	2.09	(11.5	)%
Basic	$	4.71	$	6.03	(21.9	)%	$	1.86	$	2.09	(11.0	)%
Diluted operating (non-GAAP)	$	5.30	$	6.75	(21.5	)%	$	2.38	$	2.35	1.3	%
Weighted-average shares outstanding: (in millions)
Assuming dilution	962.4		989.5		(2.7	)%	947.8		964.4		(1.7	)%
Basic	959.5		985.2		(2.6	)%	942.4		961.7		(2.0	)%

Actual shares outstanding at ~~June 30, 2016~~March 31, 2017 were ~~955.8~~939.5 million. The weighted-average number of common shares outstanding assuming dilution during the ~~second~~first quarter ~~and first six months~~ of ~~2016~~2017 were ~~26.2 million and 27.1~~16.5 million shares lower ~~respectively,~~ than the ~~same periods~~first quarter of ~~2015.~~2016. The decrease was primarily the result of the common stock repurchase program.

Results of Discontinued Operations

The loss from discontinued operations, net of tax, was ~~$0.4 million and~~ $3 million in both the ~~second~~first quarter of 2017 and the first ~~six months~~quarter of ~~2016, respectively, compared to $77 million and $165 million in the second quarter and first six months of 2015, respectively.~~2016. The discontinued operations effective tax rate ~~in the second quarter of 2016~~ was ~~36.9 percent compared to 30.5~~38.4 percent in ~~the second quarter of 2015 and was 38.2 percent in the first six months of 2016 compared to 28.3 percent in the prior-year period.~~both periods.

Management Discussion — (continued)

Financial Position

Dynamics

At ~~June 30, 2016,~~March 31, 2017, the company continued to have the financial flexibility to support the business over the long term. Cash and marketable securities at quarter end were ~~$10,616~~$10,695 million. Total debt of $44,525 million increased $4,635 million from prior year-end levels, driven by new debt issuances of $8,239 million, partially offset by maturities of $3,347 million. Within total debt, $26,517 million, or approximately 60 percent, is in support of the Global Financing business. The company continues to manage the investment portfolio to meet its capital preservation and liquidity objectives. Total debt of $42,781 million increased $613 million from prior year-end levels, driven by new debt issuances of $2,880 million, partially offset by maturities of $1,556 million. Within total debt, $28,475 million, or approximately 67 percent, is in support of the Global Financing business. In the first ~~six~~three months of ~~2016,~~2017, the company generated ~~$9,088~~$3,955 million in cash from operations, ~~an increase~~a decrease of ~~$1,594~~$1,575 million ~~compared~~versus the first three months of 2016, primarily due to the ~~first six months of 2015.~~prior year Japan tax refund. The company has consistently generated strong cash flow from operations and continues to have access to additional sources of liquidity through the capital markets and its ~~$10~~$10.25 billion global credit facility. ~~In October 2015, the term of the five-year global credit facility was extended by one year, and now expires on November 10, 2020.~~

~~Management Discussion — (continued)~~

The assets and debt associated with the Global Financing business are a significant part of the company’s financial position. The financial position amounts appearing on pages 5 and 6 are the consolidated amounts including Global Financing. The amounts appearing in the separate Global Financing section, beginning on page ~~82,~~63, are supplementary data presented to facilitate an understanding of the Global Financing business.

Working Capital

	At June 30,		At December 31,		At March 31,		At December 31,
(Dollars in millions)	2016		2015		2017		2016
Current assets	$	43,524	$	42,504	$	42,889	$	43,888
Current liabilities	33,585		34,269		36,481		36,275
Working capital	$	9,939	$	8,235	$	6,408	$	7,613

Current ratio	1.30:1		1.24:1		1.18:1		1.21:1

Working capital ~~increased $1,704~~decreased $1,205 million from the year-end ~~2015~~2016 position. The key changes are described below:

Current assets ~~increased $1,019~~decreased $999 million ($~~310~~1,593 million adjusted for currency) due to:

· ~~An increase of $2,330 million ($2,216 million adjusted for currency) in cash and cash equivalents; and~~

· ~~An increase of $471 million ($403 million adjusted for currency) in prepaid expenses and other current assets; and~~

· ~~An increase of $448 million ($320 million adjusted for currency) in trade and other accounts receivable; partially offset by~~

·A decline in receivables of ~~$2,385~~$3,374 million ($~~2,760 million adjusted for currency) in financing receivables primarily due to collections of higher year-end balances.~~

~~Current liabilities decreased $684 million ($1,785 million adjusted for currency) as a result of:~~

· ~~A decrease in short-term debt of $1,574 million ($1,654~~3,763 million adjusted for currency) primarily as a result of ~~maturities~~collections of ~~$3,347 million and a decrease in commercial paper of $600 million, partially offset by reclassifications of $2,379 million from long term to reflect upcoming maturities; and~~

· ~~A decrease in taxes payable of $571 million ($652 million adjusted for currency) primarily driven by income tax payments; and~~

· ~~A decrease in accounts payable of $543 million ($618 million adjusted for currency) reflecting declines from typically~~ higher year-end balances; partially offset by

· An increase in ~~other accrued expenses~~cash and ~~liabilities~~cash equivalents of ~~$1,127~~$2,270 million ($~~558~~2,170 million adjusted for currency) ~~driven by workforce rebalancing net accruals ($661 million) and derivative positions ($210 million); and~~.

Current liabilities increased $206 million (decreased $161 million adjusted for currency) as a result of:

· An increase in deferred income of ~~$487~~$1,316 million ($1,161 million adjusted for currency) driven by ~~currency related increases~~annual customer billings; and

· An increase in short-term debt of ~~$231 million.~~$827 million ($819 million adjusted for currency) primarily as a result of reclassifications of $3,243 million from long term to reflect upcoming maturities, partially offset by maturities of $1,556 million and a decrease in commercial paper of $899 million; partially offset by

· A decrease in accounts payable of $885 million ($950 million adjusted for currency) reflecting declines from typically higher year-end balances; and

· A decrease in taxes payable of $488 million ($527 million adjusted for currency); and

· A decrease in compensation and benefits of $381 million ($428 million adjusted for currency) driven by payouts of prior-year performance-related compensation.

Management Discussion — (continued)

Cash Flow

The company’s cash flows from operating, investing and financing activities, as reflected in the Consolidated Statement of Cash Flows on page 7, are summarized in the following table. These amounts include the cash flows associated with the Global Financing business.

~~Management Discussion — (continued)~~

(Dollars in millions)
For the six months ended June 30:	2016			2015
For the three months ended March 31:							2017			2016
Net cash provided by/(used in) continuing operations:
Operating activities	$	9,088		$	7,494		$	3,955		$	5,530	***
Investing activities	(6,550		)	(1,371		)	350			(1,886		)*
Financing activities	(322		)	(5,970		)	(2,134		)	2,806		**
Effect of exchange rate changes on cash and cash equivalents	114			(236		)	100			217
Net change in cash and cash equivalents	$	2,330		$	(83	)	$	2,270		$	6,668

* Revised classification of certain financing receivables. See note 1 for additional information.

** Reclassified to reflect adoption of the FASB guidance on share-based compensation.

Net cash provided by operating activities ~~increased~~decreased by ~~$1,594~~$1,575 million as compared to the first ~~six~~three months of ~~2015~~2016 driven by the following factors:

· ~~A decline~~An increase in net income tax payments of ~~$2,313 million;~~$1,207 million, driven by the prior year Japan tax refund received; and

· ~~A decline in cash contributions for postretirement plans of $330 million; and~~

· ~~A decline in cash payments for workforce rebalancing of $303 million; and~~

· ~~A decline in performance based compensation payments of $226 million;~~Performance-related declines within net income; partially offset by

· ~~Performance related declines within net income.~~Working capital improvements of $765 million driven by strong cash collections.

~~Net~~Investing activities were a net source of cash ~~used~~of $350 million in ~~investing activities increased $5,179 million~~the first quarter of 2017 compared to a net use of cash of $1,886 million in the first ~~six months~~quarter of ~~2015~~2016. The year-to-year increase in cash flow of $2,235 million was driven by:

· ~~An increase~~A decrease in net cash used related to acquisitions of ~~$4,696~~$2,481 million.

~~Net~~Financing activities were a use of net cash ~~used~~of $2,134 million in ~~financing activities decreased $5,648 million as~~the first quarter of 2017 compared to a source of cash of $2,806 million in the first ~~six months~~quarter of ~~2015~~2016. The year-to-year decrease in cash flow of $4,940 million was driven by:

· ~~An increase~~A decrease in net cash sourced from debt transactions of ~~$5,451~~$4,487 million primarily driven by higher levels of issuances in the ~~current~~prior-year period.

Noncurrent Assets and Liabilities

	At June 30,		At December 31,		At March 31,		At December 31,
(Dollars in millions)	2016		2015		2017		2016
Noncurrent assets	$	74,533	$	67,991	$	74,606	$	73,582
Long-term debt	$	39,638	$	33,428	$	34,441	$	34,655
Noncurrent liabilities (excluding debt)	$	28,945	$	28,374	$	28,125	$	28,147

The increase in noncurrent assets of ~~$6,542~~$1,024 million ($~~5,375~~461 million adjusted for currency) was driven by:

· An increase of ~~$4,401~~$1,234 million in ~~goodwill~~deferred taxes ($~~4,125~~1,139 million adjusted for currency) ~~and $1,662 million in net intangible assets driven by acquisitions;~~primarily due to intra-entity transfers ($827 million); and

· An increase in retirement plans assets of ~~$1,223~~$456 million ($~~1,252~~430 million adjusted for currency) driven by the expected returns on plan ~~assets;~~assets, partially offset by interest costs; partially offset by

· A decrease of ~~$747~~$519 million in long-term financing receivables ($~~1,081~~653 million adjusted for currency) reflecting seasonal reductions from higher year-end balances.

Management Discussion — (continued)

Long-term debt ~~increased $6,209~~decreased $214 million ($~~5,957~~395 million adjusted for currency) from the year-end balance primarily driven by:

· ~~Issuances~~Reclassification to short-term debt of ~~$8,041 million;~~$3,243 million to reflect upcoming maturities; partially offset by

· ~~Reclassification to short-term debt~~Issuances of ~~$2,379 million to reflect upcoming maturities.~~

~~Management Discussion — (continued)~~$2,819 million.

The ~~increase~~decrease in noncurrent liabilities (excluding debt) of ~~$571~~$22 million (a decrease of ~~$297~~$460 million adjusted for currency) was driven by:

· ~~An increase~~A decrease in retirement and nonpension postretirement liabilities of ~~$286~~$103 million ($2314 million adjusted for currency) ~~in other liabilities associated with acquisition-related liabilities; and~~; partially offset by

· An increase in ~~retirement and nonpension postretirement~~other liabilities of ~~$220~~$124 million driven by a currency impact of ~~$500~~$176 million.

Debt

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

	At June 30,		At December 31,		At March 31,		At December 31,
(Dollars in millions)	2016		2015		2017		2016
Total company debt	$	44,525	$	39,890	$	42,781	$	42,169
Total Global Financing segment debt	$	26,517	$	27,205	$	28,475	$	27,859
Debt to support external clients	22,643		23,934		24,341		24,034
Debt to support internal clients	3,874		3,271		4,134		3,825
Non-Global Financing debt	$	18,008	$	12,684	$	14,306	$	14,309

Total debt of ~~$44,525~~$42,781 million ~~was up $4,635~~increased $613 million from December 31, ~~2015, driven by the timing of~~2016 consistent with the company’s ~~current year term debt issuances.~~expectations at year-end 2016 to increase leverage in the Global Financing business.

Global Financing provides financing predominantly for the company’s external client assets, as well as for assets under contract by other IBM units. These assets, primarily for Technology Services & Cloud Platforms, generate long-term, stable revenue streams similar to the Global Financing asset portfolio. Based on their attributes, these Technology Services & Cloud Platforms assets are leveraged with the balance of the Global Financing asset base. The debt analysis above is further detailed in the Global Financing section on page ~~85.~~66.

Non-Global Financing debt of ~~$18,008~~$14,306 million was ~~up $5,324~~down $3 million from December 31, ~~2015~~2016 and ~~up $5,514~~down $4,468 million from ~~the second quarter of 2015.~~March 31, 2016.

Consolidated debt-to-capitalization ratio at ~~June 30, 2016~~March 31, 2017 was ~~73.7~~69.9 percent versus ~~73.4~~69.6 percent at December 31, ~~2015~~2016 and ~~73.6~~75.1 percent at ~~June 30, 2015.~~March 31, 2016.

Given the significant leverage, the company also presents a debt-to-capitalization ratio which excludes Global Financing debt and equity as management believes this is more representative of the company’s core business operations. This ratio can vary from period to period as the company manages its global cash and debt positions. “Core” debt-to-capitalization ratio (excluding Global Financing debt and equity) was ~~59.5~~48.3 percent at ~~June 30, 2016~~March 31, 2017 compared to ~~54.3~~49.5 percent at December 31, ~~2015~~2016 and ~~55.3~~62.2 percent at ~~June 30, 2015.~~March 31, 2016.

Equity

Total equity increased by ~~$1,465~~$56 million from December 31, ~~2015~~2016 as a result of an increase in retained earnings of ~~$1,946~~$533 million, an increase in retirement-related amounts of ~~$806~~$507 million and an increase of ~~$351~~$270 million related to currency translation, partially offset by an increase in treasury stock of ~~$1,780~~$1,309 million primarily due to common stock repurchases.

Management Discussion — (continued)

Looking Forward

The company’s strategies, investments and actions are all taken with an objective of optimizing long-term performance. A long-term perspective ensures that the company is well-positioned to take advantage of the major shifts ~~occurring~~ in technology, business and the global economy.

Within the IT industry, there are major shifts occurring—driven by cognitive; including data and analytics, cloud and changes in the ways individuals and enterprises are engaging. The company ~~has differentiated~~is bringing together its cognitive technologies on cloud platforms that create industry-based solutions in order to solve enterprise clients’ real problems. The company continues to address the higher value areas of enterprise IT and is amassing a unique set of capabilities and is differentiating itself from other technology providers ~~by moving~~as it moves into new spaces, and in some cases, creating entirely new markets.

~~In January 2016, to support this ongoing shift, the company made a number of changes to its management system and organizational structure.~~ ~~In February, the company met with investors to discuss the progress of the transformation, and detailed how~~ IBM is ~~becoming~~ more than a hardware, software and services company; it ~~is emerging~~has emerged as a cognitive solutions and cloud platform ~~company.~~

~~In the first half of 2016, the~~ company, ~~had continued strong performance in its strategic imperatives that are~~ focused on ~~these market shifts.~~industry differentiation. The company’s strategic ~~imperatives -~~imperatives— cloud, analytics, mobile, social and security solutions revenue grew 13 percent year to year as reported and 14 percent adjusted for currency. Over the past 12 months, the strategic imperatives generated $30.7 billion in revenue, which represents approximately 38 percent of the company’s total revenue. In the first half, the company continued to take significant actions to drive the shift towards its strategic imperatives with targeted investments, including acquisitions in Cognitive Solutions (including the Truven acquisition) and GBS, as well as the continued build-out of as-a-Service capabilities. The company has also taken actions to transform the workforce and accelerate the move away from non-strategic areas. While these actions impacted profit and margins in the first half of the year, they improve the position for the future. These actions weresolutions—are focused on ~~rebalancing skills more than capacity reduction, enabling reinvestment to build capabilities as well as contributing savings. The majority of the gross savings in the current year from~~ these ~~actions are expected in the fourth quarter of 2016.~~market shifts.

~~The company’s strategic direction is clear and compelling, and~~In 2017, the company will continue to ~~shift to the higher value areas of enterprise IT. The strong revenue growth in~~focus on growing the strategic imperatives ~~confirms~~and the transformation of its core businesses, with a continued high level of investment, although the higher-level investment that ~~as does~~began in 2015 has now fully wrapped on a year-to-year basis. While pre-tax income is expected to decline year to year on a GAAP basis due to higher non-operating pension expense, the ~~overall profitability of~~company expects growth in operating (non-GAAP) pre-tax income in 2017. The company expects gross profit margin improvement from the ~~business. These offerings are as high value as the other more traditional parts of the business, which continue to manage clients’ most critical business processes. In addition, the~~first-quarter level. The company expects to continue to ~~allocate~~monetize its ~~capital efficiently and effectively to investments, and to return value to its shareholders~~technology, including through ~~a combination of dividends and share repurchases. Over~~IP licensing arrangements in 2017. Consistent with the ~~longer term, in consideration of the opportunities it will continue to develop,~~long-term model, the company also expects ~~to have~~over the ability to generate low single-digit revenue growth, and with a higher value business mix, high single-digit operating (non-GAAP) earnings per share growth, with free cash flow realization in the 90’s percent range.

~~In the near term, there are a few dynamics that are inconsistent with that longer term trajectory. Specifically, in 2016, the company will be continuing to manage and drive the ongoing transformation~~course of the business. As an example, GBS continues its transition, with strong growth in strategic imperatives offset by declines in the more traditional areas. The company will continue to engineer this shift. In addition, while the company is fully participating in the shift to cloud and as-a-Service, the margins in that business are impacted by the level of investment the company is making and the fact that the business is not yet at scale.

~~Overall, looking forward, the company expects~~2017 to continue to grow in many areas of the business, including continued strong growth in the strategic imperatives. Recent acquisitions are contributing to revenue and while they impact profit negatively initially, the acquisitions will provide profit contribution over time. Many of the capabilities being built are cloud-based and delivered as-a-Service. This profile and level of investment will impact margin in the short-term, but achieve the company’s long-term strategy and profit model. In January 2016, the company provided expectations for the year that it would acquire key capabilities, ~~rebalance its workforce, resolve various matters including tax matters,~~remix skills, invest in areas of growth and return value to shareholders. This ~~was~~is all taken into account in the full-year ~~view of earnings per share. With the successful resolution of a significant tax matter and large workforce rebalancing action, the company made significant progress in the first half.~~view. Overall, the company ~~now~~ expects GAAP earnings per share from continuing operations for 2017 to be at least ~~$12.23 compared~~$11.95. Excluding acquisition-related charges of $0.75 per share and non-operating retirement-related items of $1.10 per share, operating (non-GAAP) earnings per share is expected to ~~the prior expectation of~~be at least ~~$12.35, driven primarily by higher acquisition-related expenses. The~~$13.80. For the first half of 2017, the company ~~continues to expect~~expects operating (non-GAAP) earnings per share to be at least $13.50, which excludes acquisition-related charges of $0.84 per share and non-operating retirement-related items of $0.43 per share. For the third quarter of 2016, the company expects GAAP and operating (non-GAAP) earnings per share to be between 22 and 24approximately 37 percent of the full year ~~most likely in the middle to the high end of that range.~~

~~Management Discussion — (continued)~~expectation.

During the first quarter of 2017, the company had strong growth in its strategic imperatives revenue, which grew 12 percent as reported and 13 percent adjusted for currency, compared to a high growth first-quarter 2016. Total Cloud revenue of $3.5 billion increased 33 percent as reported and 35 percent adjusted for currency, with cloud as-a-Service revenue up 59 percent as reported and 61 percent adjusted for currency. From a segment perspective, in the first ~~half,~~quarter 2017, Cognitive Solutions revenue grew, led by ~~analytics~~Analytics and ~~security in Solutions Software and the company broadened the reach of Watson with new services, products and partnerships. Services backlog of $123.6 billion was flat~~Security. GBS revenue declined year to year, however the decline improved sequentially in Consulting revenue, as the business continues to shift towards cognitive and digital. Technology Services & Cloud Platforms revenue decreased primarily driven by declines in Infrastructure Services and Integration Software revenue. The decline in Systems was driven by anticipated product cycle dynamics.

Looking at ~~constant currency, with~~first to second half of 2017 dynamics, the new products expected in z Systems and Power will drive improvement in gross profit and lower development spending in Systems. With the expectation to sign certain of the larger contracts in Technology Services & Cloud Platforms ~~and declines in GBS. GBS gross margins declined~~that did not close in the first quarter, ~~reflecting increased investment in digital~~ and ~~some execution issues. The engineered shift~~with the cost savings and yield on investments that have been made, the company expects to ~~digital drove strong growth in~~improve the ~~strategic imperatives. Mainframe revenues decreased and margins~~GTS second-half 2017 profit dynamics. In addition, the improved consistent with product cycle dynamics. Under the new segment structure, software value has been integrated into three of the segments: Cognitive Solutions, Technology Services & Cloud Platforms, and Systems. The software annuity base continued to grow with steady renewal rates and growth in the Software-as-a-Service business. The company continues to expect acquisitions to drive improvement in the software revenue trajectory in ~~2016.~~GBS performance is expected to continue throughout the year. Currency is expected to impact revenue growth during the year. At mid-April spot rates, the impact to revenue growth for the second-quarter 2017 is expected to a headwind of 2 points, plus or minus a point.

Free cash flow realization, defined as free cash flow to income from continuing operations (GAAP), was 9897 percent as reported in ~~2015~~2016 and ~~now~~ is again expected to be in ~~the high 90’s percent level in 2016. At the profit level associated~~line with the ~~earnings per share expectations, this translates to a~~longer-term model of over 90 percent in 2017. The company expects free cash flow ~~range of $11 billion~~ to ~~$12 billion in 2016.~~ be essentially flat year to year.

The company continues to expect ~~free cash flow for 2016 at~~that the ~~high end of that range at the expected profit level. Free cash flow realization is also expected to be in the 90’s percent level in 2017.~~

Looking forward to the second half of 2016, the company expects profit contribution from the transformation actions taken in the first quarter of the year, nominal impact to earnings per share from the mainframe cycle, and less of an impact from organic investments than the first half. As the company builds cognitive and cloud capabilities, acquisitions have had an impact to earnings per share growth rates, and while they will be dilutive in the second half, they are expected to have a lower level of impact. Currency impacts to the company’s profit growth, which is primarily due to the roll-off effect of 2015’s hedging gains, may moderate (at mid-July spot rates) due to year-to-year hedging dynamics and a slightly better translational environment. Given “Brexit” occurred in late June, which did not have a material impact to the quarter, the company has not seen sufficient impact to change full year expectations. In total, the company expects an improved trajectory in GAAP and operating (non-GAAP) earnings per share growth in the second half as compared to the first half.

~~The~~2017 GAAP tax rate ~~is expected to~~will be approximately ~~1 point~~3 points lower than the operating (non-GAAP) tax rate ~~which the company expects to be 19 percent~~expectation. Expectations for the ~~rest of the year. However, other factors could impact the rate and the~~ operating (non-GAAP) tax rate ~~could be in the range of 18~~are approximately 15 percent plus or minus ~~a couple of percentage points.~~three points, excluding discrete items. The rate will change year to year based on nonrecurring events, such as the settlement of income tax audits and changes in tax laws, as well as recurring factors including the geographic mix of income before taxes, the timing and amount of foreign dividend repatriation, state and local taxes and the effects of various global income tax strategies. The tax rates for the first quarter 2017, excluding discrete items, were in line with the company’s January 2017 expectations.

Management Discussion — (continued)

In January 2017, the company reorganized its client and commercial financing business as a wholly owned subsidiary, IBM Credit, LLC. As announced, the financing business leverage was increased from 7:1 to 9:1, with an increase in Global Financing debt of $0.6 billion. The subsidiary is expected to begin accessing capital markets directly in 2017. See page 67 for additional information.

The company expects ~~2016~~2017 pre-tax retirement-related plan cost to be approximately ~~$2.0~~$2.9 billion, ~~a decrease~~an increase of approximately ~~$600~~$900 million compared to ~~2015.~~2016. This estimate reflects current pension plan assumptions at December 31, ~~2015.~~2016. Within total retirement-related plan cost, operating retirement-related plan cost is expected to be approximately $1.4 billion, ~~a decrease of~~ approximately ~~$100 million~~flat versus ~~2015.~~2016. Non-operating retirement-related plan cost is expected to be approximately ~~$600 million, a decrease~~$1.5 billion, an increase of approximately ~~$400~~$900 million compared to ~~2015,~~2016, driven by ~~decreased recognized actuarial losses and the Spanish pension litigation impacts in 2015.~~lower income from expected return on assets. Contributions for all retirement-related plans are expected to be approximately ~~$2.6~~$2.5 billion in ~~2016,~~2017, an increase of approximately ~~flat~~$100 million compared to ~~2015.~~

The company uses December 31 as the year-end measurement date for all its retirement-related plans. If a significant event, such as curtailment occurs, a remeasurement would be performed. No curtailment gains or losses were recorded for the six months ended June 30, 2016 and the company continues to evaluate the impact of actions on its worldwide postretirement defined benefit plans.2016.

Currency Rate Fluctuations

Changes in the relative values of non-U.S. currencies to the U.S. dollar (USD) affect the company’s financial results and financial position. At ~~June 30, 2016,~~March 31, 2017, currency changes resulted in assets and liabilities denominated in local currencies being translated into more dollars than at year-end ~~2015.~~2016. The company uses financial hedging instruments to limit specific currency risks related to financing transactions and other foreign currency-based transactions.

~~Foreign currency fluctuations often drive operational responses that mitigate the simple mechanical translation of earnings.~~ During periods of sustained movements in currency, the marketplace and competition adjust to the changing rates. For example, when pricing offerings in the marketplace, the company may use some of the advantage from a weakening U.S. dollar to improve its position competitively, and price more aggressively to win the business, essentially passing on a portion of the currency advantage to its customers. Competition will frequently take the same action. Consequently, the company

~~Management Discussion — (continued)~~

believes that some of the currency-based changes in cost impact the prices charged to clients. The company also maintains currency hedging programs for cash management purposes which temporarily mitigate, but do not eliminate, the volatility of currency impacts on the company’s financial results.

The company translates revenue, cost and expense in its non-U.S. operations at current exchange rates in the reported period. References to “adjusted for currency” or “constant currency” reflect adjustments based upon a simple mathematical formula. However, this constant currency methodology that the company utilizes to disclose this information does not incorporate any operational actions that management could take to mitigate fluctuating currency rates. Currency movements impacted the company’s year-to-year revenue and earnings per share growth in the first ~~six~~three months of ~~2016.~~2017. Based on the currency rate movements in the first ~~six~~three months of ~~2016,~~2017, total revenue decreased ~~3.7~~2.8 percent as reported and decreased ~~2.3~~2.2 percent at constant currency versus the first ~~six~~three months of ~~2015.~~2016. On an income from continuing operations before income tax basis, these translation impacts offset by the net impact of hedging activities resulted in a theoretical maximum (assuming no pricing or sourcing actions) increase of approximately $10 million in the first ~~six~~three months of ~~2016~~2017 on both an as-reported basis and ~~had no impact on~~ an operating (non-GAAP) basis. The same mathematical exercise resulted in a decrease of approximately ~~$450~~$20 million in the first ~~six~~three months of ~~2015~~2016 on both an as-reported basis and ~~a decrease of approximately $600 million on~~ an operating (non-GAAP) basis. The company views these amounts as a theoretical maximum impact to its as-reported financial results. Considering the operational responses mentioned above, movements of exchange rates, and the nature and timing of hedging instruments, it is difficult to predict future currency impacts on any particular period, but the company believes it could be substantially less than the theoretical maximum given the competitive pressure in the marketplace.

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. Generally, the company manages currency risk in these entities by linking prices and contracts to U.S. dollars.

The company continues to monitor the economic conditions in Venezuela. In mid-February 2016, changes to the currency exchange systems were announced which eliminated the SICAD exchange rate and replaced the SIMADI rate with DICOM, which is expected to be a floating exchange rate. The company recorded a pre-tax loss of $43 million in the first quarter of 2016 in other (income) and expense in the Consolidated Statement of Earnings as a result of the elimination of SICAD and devaluation in the new exchange. The system for currency exchange in Venezuela has remained ~~the same~~constant through the ~~second~~first quarter of 2017 and the company ~~continues~~continued to use the SIMADI rate since the DICOM rate ~~has~~had not been instrumented by the authorities. Total pre-tax loss for the first ~~six~~three months of ~~2016~~2017 was ~~$45 million.~~not material. The company’s net assets denominated in local currency were $4$10 million at ~~June 30, 2016.~~March 31, 2017. The company’s operations in Venezuela comprised less than 1 percent of total ~~2015~~2016 and ~~2014~~2015 revenue, respectively.

Management Discussion — (continued)

Liquidity and Capital Resources

In the company’s ~~recast 2015~~2016 Annual Report, on ~~Form 8-K dated June 13, 2016, on~~ pages 4568 to ~~48,~~71, there is a discussion of the company’s liquidity including two tables that present five years of data. The table presented on page 4568 includes net cash from operating activities, cash and marketable securities and the size of the company’s global credit facilities for each of the past five years. For the ~~six~~three months ended, or as of, as applicable, ~~June 30, 2016,~~March 31, 2017, those amounts are ~~$9.1~~$4.0 billion for net cash from operating activities, ~~$10.6~~$10.7 billion of cash and marketable securities and ~~$10~~$10.25 billion in global credit facilities, respectively.

The major rating agencies’ ratings on the company’s debt securities at ~~June 30, 2016~~March 31, 2017 appear in the table below. The agency ratings remain unchanged from December 31, ~~2015.~~2016. Standard and Poor’s, Moody’s Investors Service and Fitch Ratings reaffirmed their credit ratings on April 27, 2016, March 30, 2016 and ~~June 24, 2015,~~September 30, 2016, respectively. The company does not have “ratings trigger” provisions in its debt covenants or documentation, which would allow the holders to declare an event of default and seek to accelerate payments thereunder in the event of a change in credit rating. The company’s contractual agreements governing derivative instruments contain standard market clauses which can trigger the termination of the agreement if the company’s credit rating were to fall below investment grade. At ~~June 30, 2016,~~March 31, 2017, the fair value of those instruments that were in a liability position was ~~$414~~$166 million, before any applicable netting, and this position is subject to fluctuations in fair value period to period based on the level of the company’s outstanding instruments and market conditions. The company has no other contractual arrangements that, in the event of a change in credit rating, would result in a material adverse effect on its financial position or liquidity.

~~Management Discussion — (continued)~~

	STANDARD	MOODY’S
	AND	INVESTORS	FITCH
	POOR’S	SERVICE	RATINGS
Senior long-term debt	AA-	Aa3	A+
Commercial paper	A-1+	Prime-1	F1

The company prepares its Consolidated Statement of Cash Flows in accordance with applicable accounting standards for cash flow presentation on page 7 of this Form 10-Q and highlights causes and events underlying sources and uses of cash in that format on page ~~74.~~56. For the purpose of running its business, the company manages, monitors and analyzes cash flows in a different manner.

~~The company~~Management uses free cash flow as a measure to evaluate its operating results, plan share repurchase levels, strategic investments and assess its ability and need to incur and service debt. The entire free cash flow amount is not necessarily available for discretionary expenditures. The company defines free cash flow as net cash from operating activities less the change in Global Financing receivables and net capital expenditures, including the investment in software. A key objective of the Global Financing business is to generate strong returns on equity, and increasing receivables is the basis for growth. Accordingly, management considers Global Financing receivables as a profit-generating investment, not as working capital that should be minimized for efficiency. Therefore, management includes presentations of both free cash flow and net cash from operating activities that exclude the effect of Global Financing receivables. Free cash flow guidance is derived using an estimate of profit, working capital and operational cash outflows. ~~The~~As previously noted, the company views Global Financing receivables as a profit-generating investment which it seeks to maximize and therefore it is not considered when formulating guidance for free cash flow. As a result the company does not estimate a GAAP ~~net cash~~Net Cash from ~~operating activities~~Operations expectation metric.

Management Discussion — (continued)

The following is management’s view of cash flows for the first ~~six~~three months of ~~2016~~2017 and ~~2015~~2016 prepared in a manner consistent with the description above.

(Dollars in millions)
For the six months ended June 30:	2016			2015
For the three months ended March 31:							2017			2016
Net cash from operating activities per GAAP	$	9,088		$	7,494		$	3,955		$	5,530	* **
Less: change in Global Financing receivables	2,713			1,214			2,047			2,236		*
Net cash from operating activities, excluding Global Financing receivables	6,375			6,280			1,907			3,294		**
Capital expenditures, net	(1,949		)	(1,830		)	(819		)	(971		)
Free cash flow	4,426			4,450
Free cash flow (FCF)							1,088			2,323		**
Acquisitions	(5,405		)	(708		)	(109		)	(2,590		)
Divestitures	35			81			(1		)	47
Share repurchases	(1,775		)	(2,303		)
Share repurchase							(1,293		)	(939		)
Common stock repurchases for tax withholdings							(50		)	(27		) **
Dividends	(2,590		)	(2,366		)	(1,321		)	(1,250		)
Non-Global Financing debt	5,061			391			244			5,871
Other (includes Global Financing receivables and Global Financing debt)	2,670			739			3,610			3,239
Change in cash, cash equivalents and short-term marketable securities	$	2,421		$	284		$	2,168		$	6,674

* Revised classification of certain financing receivables.

** Reclassified to reflect adoption of the FASB guidance on share-based compensation.

In the first ~~six~~three months of ~~2016 net cash from operating activities increased $1.6 billion year to year and~~2017, the company generated free cash flow of ~~$4.4~~$1.1 billion, a decrease of $1.2 billion versus the prior year. The year-to-year decrease was ~~essentially flat year~~driven primarily by a cash tax refund related to the Japan tax matter in the prior year. ~~Within~~In addition, working capital contributed to the free cash flow ~~performance-related declines~~performance in ~~net income were offset~~the first quarter of 2017, driven by ~~a reduction in~~strong cash ~~tax payments.~~collections. Net capital expenditures of ~~$1.9~~$0.8 billion ~~increased $0.1 billion year to year.~~included investments in Watson and Cloud Platforms, as well as in support of the services and systems businesses. In the first ~~six~~three months of ~~2016,~~2017, the company continued to focus its cash utilization on returning value to shareholders including ~~$2.6~~$1.3 billion in dividends and ~~$1.8~~$1.3 billion in gross common stock repurchases.

Events that could temporarily change the historical cash flow dynamics discussed ~~above~~previously and in the company’s ~~recast 2015~~2016 Annual Report ~~on Form 8-K dated June 13, 2016~~ include significant changes in operating results, material changes in geographic sources of cash, unexpected adverse impacts from litigation, future pension funding requirements during periods of severe downturn in the capital markets or the timing of tax payments. Whether any litigation has such an adverse impact will depend on a number of variables, which are more completely described in note 12, “Contingencies,” in this Form 10-Q. With respect to pension funding, the company expects to make legally mandated pension plan contributions ~~which are generally legally mandated,~~ to certain non-U.S. plans of approximately $500 million in ~~2016.~~2017. Contributions related to all retirement-related plans are expected to be approximately ~~$2.6~~$2.5 billion in ~~2016.~~2017. Financial market performance could ~~change~~increase the legally mandated minimum contributions in certain non-U.S. countries that require more frequent remeasurement of the funded

~~Management Discussion — (continued)~~

status. The company is not quantifying any further impact from pension funding because it is not possible to predict future movements in the capital markets or pension plan funding regulations.

The company’s U.S. cash flows continue to be sufficient to fund its current domestic operations and obligations, including investing and financing activities such as dividends and debt service. The company’s U.S. operations generate substantial cash flows, and, in those circumstances where the company has additional cash requirements in the U.S., the company has several liquidity options available. These options may include the ability to borrow additional funds at reasonable interest rates, utilizing its committed global credit facility, repatriating certain foreign earnings and utilizing intercompany loans with certain foreign subsidiaries.

The company does earn a significant amount of its pre-tax income outside the U.S. The company’s policy is to indefinitely reinvest the undistributed earnings of its foreign subsidiaries, and accordingly, no provision for federal income taxes has been made on accumulated earnings of foreign subsidiaries. The company periodically repatriates a portion of these earnings to the extent that it does not incur an additional U.S. tax liability. Quantification of the deferred tax liability, if any, associated with indefinitely reinvested earnings is not practicable. While the company currently does not have a need to repatriate funds held by its foreign subsidiaries, if these funds are needed for operations and obligations in the U.S., the company could elect to repatriate these funds which could result in a reassessment of the company’s policy and increased tax expense.

Management Discussion — (continued)

Global Financing

Global Financing is a reportable segment that is measured as a stand-alone entity. Global Financing facilitates IBM clients’ acquisition of information technology systems, software and services by providing financing solutions in the areas where the company has the ~~expertise,~~experience, while generating ~~strong~~solid returns on equity.

The company changed the structure of its financing business in January 2017 to drive operational benefits. The Global Financing segment remains unchanged, and will continue to include the client and commercial financing operations, as well as the hardware remanufacturing and remarketing operations.

Results of Operations

	Three Months Ended						Six Months Ended
	June 30,						June 30,
(Dollars in millions)	2016			2015			2016			2015
For the three months ended March 31:													2017			2016
External revenue	$	424		$	478		$	834		$	939		$	405		$	410
Internal revenue	502			704			988			1,290			363			486
Total revenue	926			1,182			1,822			2,229			768			896
Cost	298			375			570			717			271			272
Gross profit	$	628		$	807		$	1,252		$	1,513		$	497		$	624
Gross profit margin	67.8		%	68.3		%	68.7		%	67.9		%	64.7		%	69.6		%
Pre-tax income	$	467		$	613		$	853		$	1,128		$	311		$	386
After-tax income	$	324		$	410		$	585		$	755		$	219		$	261
Return on equity*	35.5		%	43.9		%	31.8		%	39.4		%	25.2		%	28.2		%

* See page 8666 for the details of the ~~after-tax income and~~ return on equity calculation.

The decrease in revenue in the ~~second~~first quarter, as compared to the same period in ~~2015,~~2016, was due to:

· A decline in internal revenue of ~~28.7~~25.3 percent, due to ~~decreases~~a decrease in used equipment sales ~~revenue~~ (down ~~31.3~~33.4 percent to ~~$431~~$268 million) ~~and~~, partially offset by an increase in financing revenue ~~(down 8.1~~(up 12.7 percent to ~~$71~~$95 million); and

· A decline in external revenue of ~~11.3~~1.2 percent ~~as reported (10.0~~(2.1 percent adjusted for currency), due to ~~decreases~~a decrease in financing ~~revenue~~ (down ~~9.0~~6.6 percent to ~~$313~~$297 million) ~~and~~, partially offset by an increase in used equipment sales ~~revenue (down 17.0~~(up 17.6 percent to ~~$111~~$108 million).

The ~~decrease~~increase in internal financing revenue in the first ~~six months, as~~quarter of 2017, compared to the same period in ~~2015,~~2016, was due ~~to:~~

· ~~A decline in internal revenue of 23.4 percent, due~~ to ~~decreases in used equipment sales revenue (down 25.7 percent to $833 million)~~higher asset yields and ~~financing revenue (down 8.6 percent to $155 million); and~~

~~Management Discussion — (continued)~~

· A decline in external revenue of 11.2 percent as reported (8.2 percent adjusted for currency), due to decreases in financing revenue (down 11.6 percent to $631 million) and used equipment sales revenue (down 10.0 percent to $203 million).

a higher average asset balance. The decrease in ~~internal~~external financing revenue in the ~~second~~first quarter of ~~2016,~~2017, compared to the same period in ~~2015,~~2016, was due to lower asset yields, partially offset by an increase in average asset balance. The decrease in internal financing revenue for the first six months of 2016, compared to the same period in 2015, was due to lower asset yields. The decreases in external financing revenue in the second quarter of 2016 and for the first six months of 2016, compared to the same periods in 2015, were due to lower asset yields and a decrease in the average asset balance.

Global Financing gross profit decreased ~~22.2 percent and 17.3~~20.4 percent in the ~~second~~first quarter ~~and the first six months respectively,~~ of ~~2016,~~2017, compared to the same ~~periods~~period in ~~2015,~~2016, due to decreases in used equipment sales ~~gross profit~~ and financing gross profit. The gross profit margin decreased ~~0.5~~5.0 points in the ~~second~~first quarter of ~~2016,~~2017, compared to the same period in ~~2015,~~2016, due to a decrease in the used equipment sales margin, partially offset by ~~an increase~~a shift in ~~the financing margin. The gross profit~~mix towards higher margin ~~increased 0.9 points in the first six months of 2016, compared to the same period in 2015, due to an increase in the financing margin, partially offset by a decrease in sales margin.~~financing.

Global Financing pre-tax income decreased ~~23.8~~19.5 percent to ~~$467~~$311 million in the ~~second~~first quarter of ~~2016,~~2017, compared to the same period in ~~2015,~~2016, due to lower gross profit ($~~179~~127 million) and an increase in selling, general and administrative ~~expenses~~expense ($713 million), partially offset by a decrease in financing receivables provisions ($41 million). Pre-tax income decreased 24.4 percent to $853 million in the first six months of 2016, compared to the same period in 2015, due to lower gross profit ($261 million) and an increase in selling, general and administrative expenses ($31 million), partially offset by a decrease in financing receivables provisions ($1765 million). The decrease in financing receivables provisions in the ~~second~~first quarter of ~~2016,~~2017, compared to the same period in ~~2015,~~2016, was due to ~~lower specific~~higher general reserve requirements in China in the current year. The decrease in financing receivables provisions in the first six months of 2016, compared to the same period in 2015, was due to lower specific reserve requirements in China, partially offset by higher reserve requirements due to deteriorating conditions in Brazil in the ~~current~~prior year.

The decrease in return on equity in the ~~second~~first quarter ~~and first six months~~ of ~~2016,~~2017, compared to the same ~~periods~~period of ~~2015,~~2016, was due to the decrease in net income, partially offset by a decrease in equity.

Management Discussion — (continued)

Financial Position

Balance Sheet

	At June 30,		At December 31,		At March 31,		At December 31,
(Dollars in millions)	2016		2015		2017		2016
Cash and cash equivalents	$	1,679	$	1,555	$	1,947	$	1,844
Net investment in sales-type and direct financing leases	7,326		7,594		6,640		6,893
Equipment under operating leases — external clients (1)	603		605		543		548
Client loans	11,427		12,525		10,779		11,478
Total client financing assets	19,356		20,725		17,961		18,920
Commercial financing receivables	7,145		8,948		7,458		9,700
Intercompany financing receivables (2) (3)	4,875		4,245		4,935		4,959
Other receivables	303		308		194		196
Other assets	475		378		1,627		872
Total assets	$	33,833	$	36,157	$	34,123	$	36,492
Intercompany payables (2)	$	1,673	$	3,089	$	464	$	2,189
Debt (4)	26,517		27,205		28,475		27,859
Other liabilities	2,012		2,134		2,020		2,631
Total liabilities	30,201		32,428		30,959		32,679
Total equity	3,631		3,729		3,164		3,812
Total liabilities and equity	$	33,833	$	36,157	$	34,123	$	36,492

(1) Includes intercompany mark-up, priced on an arm’s-length basis, on products purchased from the company’s product

divisions which is eliminated in IBM’s consolidated results.

(2) Entire amount eliminated for purposes of IBM’s consolidated results and therefore does not appear on pages 5 and 6.

(3) These assets, along with all other financing assets in this table, are leveraged at the value in the table using Global Financing

debt.

(4) Global Financing debt is comprised of intercompany loans and external debt. A portion of Global Financing debt is in support

of the company’s internal business, or related to intercompany mark-up embedded in the Global Financing assets.

Sources and Uses of Funds

The primary use of funds in Global Financing is to originate client and commercial financing assets. Client financing assets for end users consist primarily of IBM systems, software and services, but also OEM equipment, software and services to meet IBM clients’ total solutions requirements. Client financing assets are primarily sales-type, direct financing and operating leases for systems products, as well as loans and installment payment plans for systems, software and services, with terms up to seven years. Global Financing’s client loans and installment payment plans are primarily for software and services and are unsecured. These agreements are subjected to credit analysis to evaluate the associated risk and, when deemed necessary, actions are taken to mitigate risks, which include covenants to protect against credit deterioration during the life of the obligation.

Commercial financing receivables arise primarily from inventory and accounts receivable financing for dealers and remarketers of IBM and OEM products. Payment terms for inventory financing and accounts receivable financing generally range from 30 to 90 days. These short-term receivables are primarily unsecured and are also subjected to additional credit analysis in order to evaluate the associated risk.

In addition to the actions previously described, the company has a long-standing practice of taking mitigation actions, in certain circumstances, to transfer credit risk to third parties, including credit insurance, financial guarantees, non-recourse borrowings, transfers of receivables recorded as true sales in accordance with accounting guidance or sales of equipment under operating lease.

At ~~June 30, 2016,~~March 31, 2017, substantially all financing assets were IT related assets, and approximately 52 percent of the total external portfolio was with investment grade clients with no direct exposure to consumers. The ~~reduction in~~percent of investment grade content increased modestly year to ~~year (4 points) was driven primarily by rating changes within the existing portfolio, not by changing the company’s approach to the market.~~year. This investment grade percentage is based on the credit ratings of the companies in the portfolio.

~~Management Discussion — (continued)~~

Additionally, as noted above, the company takes actions to transfer exposure to third parties. On that basis, the investment grade content would increase by 1214 points to ~~65 percent.~~66 percent, an increase of 1 point year to year.

Management Discussion — (continued)

Originations

~~The following~~Originations are ~~total financing originations:~~

Three Months Ended
June 30,

Six Months Ended
June 30,

(Dollars in millions)

2016

2015

2016

2015

Client financing

$
2,791

$
3,960

$
5,337

$
6,964

Commercial financing

10,213

9,488

19,537

18,315

Total

$
13,005

$
13,448

$
24,874

$
25,279

~~Cash collections~~management’s estimate of ~~both commercial financing~~the gross additions for client and client financing assets exceeded new financing originations in the first six months of 2016 which resulted in a net decline in financing assets from December 2015. Client financing cash collections exceeded new originations in the second quarter ending June 30, 2016, which resulted in a net decrease in client financing assets. Commercial financing originations exceeded cash collections in the second quarter ending June 30, 2016, which resulted in an increase in commercial financing assets. ~~The decreases in~~There are no industry standards or requirements governing the reporting of financing asset originations. Management believes the estimated values of financing asset originations disclosed in the ~~first six months~~table below provide insight into the future cash flows and earnings of ~~2016 and~~ the ~~three month period ending June 30, 2016 versus 2015 were due to a decrease in~~company.

The origination values below for client financing ~~volumes.~~includes leases and loans, excluding the company’s loan financing to Technology Services & Cloud Platforms. Internal loan financing with Technology Services & Cloud Platforms is executed under a loan facility and is not considered originations.The origination values below for commercial financing exclude factored receivables with IBM.

(Dollars in millions)
For the three months ended March 31:	2017		2016
Client financing	$	2,437	$	2,546
Commercial financing	10,321		9,323
Total	$	12,758	$	11,869

Cash collections of both commercial financing and client financing assets exceeded new financing originations in the first quarter of 2017 which resulted in a net decline in financing assets compared to the same period in 2016. The increase in originations in the three month period ending March 31, 2017 versus 2016 was due to an increase in commercial financing volumes.

Cash generated by Global Financing was deployed to pay intercompany payables and dividends to IBM as well as business partners and OEM suppliers.

Global Financing Receivables and Allowances

The following table presents external financing receivables, excluding residual values, and the allowance for credit losses.

	At June 30,			At December 31,			At March 31,			At December 31,
(Dollars in millions)	2016			2015			2017			2016
Gross financing receivables	$	26,023		$	29,086		$	24,871		$	28,043
Specific allowance for credit losses	541			517			359			335
Unallocated allowance for credit losses	128			93			92			103
Total allowance for credit losses	669			610			451			438
Net financing receivables	$	25,354		$	28,475		$	24,420		$	27,605
Allowance for credit losses coverage	2.6		%	2.1		%	1.8		%	1.6		%

Roll Forward of Global Financing Receivables Allowance for Credit Losses

~~(Dollars in millions)~~

		Allowance			Additions/
January 1, 2016		Used*			(Reductions)		Other**		June 30, 2016
(Dollars in millions)											(Dollars in millions)	Allowance			Additions/
January 1, 2017											January 1, 2017	Used*			(Reductions)		Other**		March 31, 2017
$	610	$	(28	)	$	78	$	9	$	669	438	$	(9	)	$	10	$	12	$	451

* Represents reserved receivables, net of recoveries, that were written off during the period.

** Primarily represents translation adjustments.

The percentage of Global Financing receivables reserved increased from ~~2.1~~1.6 percent at December 31, ~~2015,~~2016, to ~~2.6~~1.8 percent at ~~June 30, 2016,~~March 31, 2017, primarily ~~due to an increase~~driven by the overall decline in ~~unallocated reserve requirements. Unallocated~~gross receivables. Specific reserves increased 387 percent from ~~$93~~$335 million at December 31, ~~2015,~~2016, to ~~$128~~$359 million at ~~June 30, 2016, primarily due to Brazil. Specific~~March 31, 2017. Unallocated reserves ~~increased 5~~decreased 11 percent from ~~$517~~$103 million at December 31, ~~2015,~~2016, to ~~$541~~$92 million at ~~June 30, 2016.~~March 31, 2017.

Management Discussion — (continued)

Global Financing’s bad debt expense was $2$10 million for the three months ended ~~June 30, 2016,~~March 31, 2017, compared to ~~$43~~$75 million for the same period in ~~2015.~~ ~~Global Financing’s bad debt expense was $78 million for the six months ended June 30, 2016, compared to $94 million for the same period in 2015.~~2016. The year-to-year decrease in bad debt expense for the three months ended ~~June 30, 2016,~~March 31, 2017, compared to the same period in ~~2015,~~2016, was due to higher ~~specific~~general reserve requirements ~~in China, in the prior year. The year-to-year decrease in bad debt expense for the six months ended June 30, 2016, compared to the same~~

~~Management Discussion — (continued)~~

~~period in 2015, was due to lower specific reserve requirements in China, partially offset by higher reserve requirements due to deteriorating conditions~~ in Brazil in the ~~current~~prior year.

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 at lease inception. 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 with the residual values reflected in the portfolio.

Global Financing optimizes the recovery of residual values by selling assets sourced from end of lease, leasing used equipment to new clients, or extending lease arrangements with current clients. Sales of equipment include equipment returned at the end of a lease, surplus internal equipment, or used equipment purchased externally. These sales represented ~~58.5 percent and 56.8~~48.9 percent of Global Financing’s revenue in the ~~second~~first quarter of 2017, and ~~first six months, respectively, of 2016, and 64.4 percent and 60.4~~55.1 percent in the ~~second~~first quarter ~~and first six months, respectively,~~ of ~~2015.~~2016. The ~~decreases in both periods were~~decrease was due to a lower volume of used equipment sales for internal transactions. The gross profit margins on these sales were ~~62.4~~51.5 percent and ~~66.8 percent in the second quarter of 2016 and 2015, respectively. The gross profit margins were 63.1 percent and 65.4~~63.8 percent in the first ~~six months~~quarter of ~~2016~~2017 and ~~2015,~~2016, respectively. The decrease in the gross profit margin for the three ~~months~~month period ending June 30, 2016 was driven by a shift in mix away from higher margin internal equipment sales, as well as by decreases in external and internal equipment sales margins. The decrease in the gross profit margin for the six months period ending June 30, 2016March 31, 2017 was driven by a shift in mix away from higher margin internal equipment sales and ~~a decrease~~from decreases in internal and external equipment sales ~~margin, partially offset by an increase in internal equipment sales margin.~~margins.

The table below presents the recorded amount of unguaranteed residual value for sales-type, direct financing and operating leases at January 1, ~~2016~~2017 and ~~June 30, 2016.~~March 31, 2017. In addition, the table presents the residual value as a percentage of the related original amount financed and a run out of when the unguaranteed residual value assigned to equipment on leases at ~~June 30, 2016~~March 31, 2017 is expected to be returned to the company. In addition to the unguaranteed residual value, on a limited basis, Global Financing will obtain guarantees of the future value of the equipment to be returned at end of lease. While primarily focused on IBM products, guarantees are also obtained for certain OEM products. These third-party guarantees are included in minimum lease payments as provided for by accounting standards in the determination of lease classifications for the covered equipment and provide protection against risk of loss arising from declines in equipment values for these assets.

The residual value guarantee increases the minimum lease payments that are utilized in determining the classification of a lease as a sales-type lease, direct financing lease or operating lease. The aggregate asset values associated with the guarantees of sales-type leases were ~~$67~~$43 million and ~~$360~~$91 million for the financing transactions originated during the quarters ended ~~June 30,~~March 31, 2017 and 2016, ~~and 2015, respectively and $158 million and $461 million for the six months ended June 30, 2016 and 2015,~~ respectively. The aggregate asset values associated with the guarantees of direct financing leases were ~~$45~~$34 million and ~~$47~~$39 million for the financing transactions originated during the quarters ended ~~June 30,~~March 31, 2017 and 2016, ~~and 2015, respectively and $85 million and $96 million for the six months ended June 30, 2016 and 2015,~~ respectively. The associated aggregate guaranteed future values at the scheduled end of lease were ~~$5 million and $25~~$3 million for the financing transactions originated during each of the quarters ended ~~June 30,~~March 31, 2017 and 2016, ~~and 2015, respectively and $8 million and $33 million for the six months ended June 30, 2016 and 2015,~~ respectively. The cost of guarantees was ~~$0.5 million and $2.5~~$0.3 million for ~~the quarters ended June 30, 2016 and 2015, respectively and $0.8 million and $3.3 million for the six months ended June 30, 2016 and 2015, respectively.~~

~~Management Discussion — (continued)~~each of those periods.

Unguaranteed Residual Value

							Estimated Run Out of														Estimated Run Out of
	At			At			June 30, 2016 Balance														March 31, 2017 Balance
	January 1,			June 30,									2019 and		At January 1,			At March 31,									2020 and
(Dollars in millions)	2016			2016			2016		2017		2018		Beyond		2017			2017			2017		2018		2019		Beyond
Sales-type and direct financing leases	$	645		$	595		$	61	$	140	$	182	$	212	$	585		$	574		$	102	$	172	$	189	$	112
Operating leases	144			140			42		47		31		20		140			150			57		44		40		9
Total unguaranteed residual value	$	789		$	735		$	103	$	187	$	213	$	232	$	725		$	724		$	159	$	216	$	229	$	121
Related original amount financed	$	14,223		$	13,737										$	12,845		$	12,493
Percentage	5.6		%	5.3		%									5.6		%	5.8		%

Management Discussion — (continued)

Debt

At June 30,

At December 31,

2016

2015

Debt-to-equity ratio

7.3x

7.3x

	At March 31,	At December 31,
	2017	2016
Debt-to-equity ratio	9.0x	7.3x

The financing business increased its leverage from approximately 7:1 to 9:1, which represents an increase of approximately $600 million in Global Financing debt. This is consistent with expectations provided in the company’s 2016 Annual Report.

The debt used to fund Global Financing assets is composed of intercompany loans and external debt. Total debt changes generally correspond with the level of client and commercial financing receivables, the level of cash and cash equivalents, the change in intercompany and external payables and the change in intercompany investment from IBM. The terms of the intercompany loans are set by the company to substantially match the term and currency underlying the financing receivable and are based on arm’s-length pricing.

Global Financing provides financing predominantly for the company’s external client assets, as well as for assets under contract by other IBM units. As previously stated, the company measures Global Financing as a stand-alone entity, and accordingly, interest expense relating to debt supporting Global Financing’s external client and internal business is included in the “Global Financing Results of Operations” on page 8062 and in “Segment Information” on ~~pages 28 and 29.~~page 27.

In the company’s Consolidated Statement of Earnings, the external debt-related interest expense supporting Global Financing’s internal financing to the company is reclassified from cost of financing to interest expense.

The following table provides additional information on total company debt. In this table, intercompany activity includes internal loans and leases at arm’s-length pricing in support of long-term services contracts and other internal activity. The company believes these assets should be appropriately leveraged in line with the overall Global Financing business model.

(Dollars in millions)	At June 30, 2016					At December 31, 2015					At March 31, 2017					At December 31, 2016
Global Financing Segment				$	26,517				$	27,205				$	28,475				$	27,859
Debt to support external clients	$	22,643				$	23,934				$	24,341				$	24,034
Debt to support internal clients	3,874					3,271					4,134					3,825
Non-Global Financing Segments				18,008					12,684					14,306					14,309
Debt supporting operations	21,883					15,955					18,440					18,134
Intercompany activity	(3,874		)			(3,271		)			(4,134		)			(3,825		)
Total company debt				$	44,525				$	39,890				$	42,781				$	42,169

Liquidity and Capital Resources

Global Financing is a segment of the company, and therefore is supported by the company’s overall liquidity position and access to capital markets. Cash generated by Global Financing was deployed to pay dividends to the company in order to maintain an appropriate debt-to-equity ratio.

~~Management Discussion — (continued)~~

~~Return on Equity~~

	Three Months Ended						Six Months Ended
	June 30,						June 30,
(Dollars in millions)	2016			2015			2016			2015
For the three months ended March 31:													2017			2016
Numerator
Global Financing after-tax income*	$	324		$	410		$	585		$	755		$	219		$	261
Annualized after-tax income (a)	$	1,297		$	1,638		$	1,170		$	1,510
Annualized after-tax income (1)*													$	878		$	1,042
Denominator
Average Global Financing equity (b)**	$	3,649		$	3,734		$	3,676		$	3,828
Global Financing return on equity (a)/(b)	35.5		%	43.9		%	31.8		%	39.4		%
Average Global Financing equity (2)**													$	3,488		$	3,698
Global Financing return on equity (1)/(2)													25.2		%	28.2		%

*Calculated based upon 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.

**Average of the ending equity for Global Financing for the last 2 ~~quarters and 3 quarters, for the three months ended June 30, and for the six months ended June 30, respectively.~~quarters.

Management Discussion — (continued)

Looking Forward

Global Financing’s financial position provides flexibility and funding capacity which enables the company to be well positioned in the current environment. Global Financing’s assets and new financing volumes are IBM and OEM products and services financed to the company’s clients and business partners, and substantially all financing assets are IT related assets which provide a stable base of business for future growth. Global Financing’s offerings are competitive and available to clients as a result of the company’s borrowing cost and access to the capital markets. Overall, Global Financing’s originations will be dependent upon the demand for IT products and services as well as client participation rates.

IBM continues to access both the short-term commercial paper market and the medium- and long-term debt markets. A protracted period where IBM could not access the capital markets would likely lead to a slowdown in originations.

The client and commercial financing businesses have been reorganized as a wholly owned subsidiary, IBM Credit LLC in January 2017. This will drive operational benefits by consolidating the operations of the financing business. Debt will be issued directly out of the new entity, and the new entity is expected to be able to access the capital markets later in 2017.

Interest rates and the overall economy (including currency fluctuations) will have an effect on both revenue and gross profit. The company’s interest rate risk management policy, however, combined with the Global Financing pricing strategy should mitigate gross margin erosion due to changes in interest rates.

The economy could impact the credit quality of the Global Financing receivables portfolio and therefore the level of provision for credit losses. Global Financing will continue to apply rigorous credit policies in both the origination of new business and the evaluation of the existing ~~portfolio.~~portfolio and will take risk mitigation actions when necessary.

As previously discussed, Global Financing has historically been able to manage residual value risk both through insight into the company’s product cycles, as well as through its remarketing business.

Global Financing has policies in place to manage each of the key risks involved in financing. These policies, combined with product and client knowledge, should allow for the prudent management of the business going forward, even during periods of uncertainty with respect to the global economy.

Management Discussion — (continued)

GAAP Reconciliation

The tables below provide a reconciliation of the company’s income statement results as reported under GAAP to its operating earnings presentation which is a non-GAAP measure. The company’s calculation of operating (non-GAAP) earnings, as presented, may differ from similarly titled measures reported by other companies. Refer to the “Snapshot” section on page 4841 for the company’s rationale for presenting operating earnings information.

(Dollars in millions except per share amounts)				Acquisition-related			Retirement-related			Operating						Acquisition-related			Retirement-related			Operating
For the three months ended June 30, 2016	GAAP			adjustments			adjustments			(Non-GAAP)
For the three months ended March 31, 2017													GAAP			adjustments			adjustments			(Non-GAAP)
Gross profit	$	9,702		$	129		$	81		$	9,912		$	7,772		$	119		$	193		$	8,083
Gross profit margin	47.9		%	0.6		pts.	0.4		pts.	49.0		%	42.8		%	0.7		pts.	1.1		pts.	44.5		%
S,G&A	$	5,349		$	(159	)	$	(75	)	$	5,114		$	5,152		$	(139	)	$	(136	)	$	4,877
R,D&E	1,465			—			(7		)	1,458			1,533			—			(49		)	1,484
Other (income) and expense	37			—			—			37			(28		)	(4		)	—			(31		)
Total expense and other (income)	6,653			(159		)	(83		)	6,411			6,348			(143		)	(185		)	6,020
Pre-tax income from continuing operations	3,049			289			163			3,501			1,424			262			378			2,063
Pre-tax margin from continuing operations	15.1		%	1.4		pts.	0.8		pts.	17.3		%	7.8		%	1.4		pts.	2.1		pts.	11.4		%
Provision for income taxes*	$	544		$	82		$	39		$	665
Provision for/(benefit from) income taxes*													$	(329	)	$	67		$	70		$	(192	)
Effective tax rate	17.8		%	0.9		pts.	0.3		pts.	19.0		%	(23.1		)%	6.2		pts.	7.6		pts.	(9.3		)%
Income from continuing operations	$	2,505		$	207		$	124		$	2,835		$	1,753		$	195		$	308		$	2,255
Income margin from continuing operations	12.4		%	1.0		pts.	0.6		pts.	14.0		%	9.7		%	1.1		pts.	1.7		pts.	12.4		%
Diluted earnings per share from continuing operations	$	2.61		$	0.21		$	0.13		$	2.95		$	1.85		$	0.21		$	0.32		$	2.38

* The tax impact on operating (non-GAAP) pre-tax income from continuing operations is calculated under the same accounting principles applied to the GAAP pre-tax income which employs an annual effective tax rate method to the results.

(Dollars in millions except per share amounts)

Acquisition-related

Retirement-related

Operating

For the three months ended June 30, 2015

GAAP

adjustments

adjustments

(Non-GAAP)

Gross profit

$
10,390

$
88

$
112

$
10,590

Gross profit margin

49.9
%
0.4
pts.
0.5
pts.
50.9
%
S,G&A

$
5,179

$
(74
)
$
(63
)
$
5,042

R,D&E

1,300

—

(11
)
1,289

Other (income) and expense

(301
)
(5
)
—

(306
)
Total expense and other (income)

6,165

(80
)
(74
)
6,012

Pre-tax income from continuing operations

4,224

168

186

4,578

Pre-tax margin from continuing operations

20.3
%
0.8
pts.
0.9
pts.
22.0
%
Provision for income taxes*

$
698

$
28

$
61

$
788

Effective tax rate

16.5
%
0.0
pts.
0.7
pts.
17.2
%
Income from continuing operations

$
3,526

$
140

$
124

$
3,790

Income margin from continuing operations

16.9
%
0.7
pts.
0.6
pts.
18.2
%
Diluted earnings per share from continuing operations

$
3.58

$
0.14

$
0.12

$
3.84

~~Management Discussion — (continued)~~

(Dollars in millions except per share amounts)

Acquisition-related

Retirement-related

Operating

For the six months ended June 30, 2016

GAAP

adjustments

adjustments

(Non-GAAP)

Gross profit

$
18,388

$
241

$
160

$
18,789

Gross profit margin

47.2
%
0.6
pts.
0.4
pts.
48.3
%
S,G&A

$
11,361

$
(227
)
$
(130
)
$
11,004

R,D&E

2,923

—

(16
)
2,907

Other (income) and expense

289

(6
)
—

284

Total expense and other (income)

14,306

(232
)
(146
)
13,928

Pre-tax income from continuing operations

4,082

473

306

4,861

Pre-tax margin from continuing operations

10.5
%
1.2
pts.
0.8
pts.
12.5
%
Provision for/(benefit from) income taxes*

$
(439
)
$
129

$
66

$
(244
)
Effective tax rate

(10.8
)%
3.9
pts.
2.3
pts.
(5.0
)%
Income from continuing operations

$
4,521

$
345

$
239

$
5,105

Income margin from continuing operations

11.6
%
0.9
pts.
0.6
pts.
13.1
%
Diluted earnings per share from continuing operations

$
4.69

$
0.36

$
0.25

$
5.30

(Dollars in millions except per share amounts)				Acquisition-related			Retirement-related			Operating						Acquisition-related			Retirement-related			Operating
For the six months ended June 30, 2015	GAAP			adjustments			adjustments			(Non-GAAP)
For the three months ended March 31, 2016													GAAP			adjustments			adjustments			(Non-GAAP)
Gross profit	$	19,842		$	179		$	233		$	20,253		$	8,686		$	112		$	79		$	8,877
Gross profit margin	49.1		%	0.4		pts.	0.6		pts.	50.1		%	46.5		%	0.6		pts.	0.4		pts.	47.5		%
S,G&A	$	10,541		$	(154	)	$	(371	)	$	10,017		$	6,012		$	(67	)	$	(55	)	$	5,890
R,D&E	2,598			—			(24		)	2,574			1,458			—			(9		)	1,449
Other (income) and expense	(444		)	(5		)	—			(450		)	253			(6		)	—			247
Total expense and other (income)	12,617			(159		)	(395		)	12,063			7,652			(73		)	(63		)	7,516
Pre-tax income from continuing operations	7,225			338			627			8,190			1,034			185			142			1,361
Pre-tax margin from continuing operations	17.9		%	0.8		pts.	1.6		pts.	20.3		%	5.5		%	1.0		pts.	0.8		pts.	7.3		%
Provision for income taxes*	$	1,283		$	56		$	170		$	1,510
Provision for/(benefit from) income taxes*													$	(983	)	$	47		$	27		$	(909	)
Effective tax rate	17.8		%	0.0		pts.	0.7		pts.	18.4		%	(95.1		)%	16.3		pts.	11.9		pts.	(66.8		)%
Income from continuing operations	$	5,942		$	281		$	457		$	6,680		$	2,016		$	138		$	115		$	2,270
Income margin from continuing operations	14.7		%	0.7		pts.	1.1		pts.	16.5		%	10.8		%	0.7		pts.	0.6		pts.	12.1		%
Diluted earnings per share from continuing operations	$	6.01		$	0.28		$	0.46		$	6.75		$	2.09		$	0.14		$	0.12		$	2.35

Management Discussion — (continued)

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. Forward-looking statements are based on the company’s current assumptions regarding future business and financial performance. These statements involve a number of risks, uncertainties and other factors that could cause actual results to differ materially, including the following: a downturn in the economic environment and client spending budgets; the company’s failure to meet growth and productivity objectives; a failure of the company’s innovation initiatives; risks from investing in growth opportunities; failure of the company’s intellectual property portfolio to prevent competitive offerings and the failure of the company to obtain necessary licenses; cybersecurity and data privacy considerations; fluctuations in financial results; impact of local legal, economic, political and health conditions; adverse effects from environmental matters, tax matters and the company’s pension plans; ineffective internal controls; the company’s use of accounting estimates; the company’s ability to attract and retain key personnel and its reliance on critical skills; impacts of relationships with critical suppliers; product quality issues; impacts of business with government clients; currency fluctuations and customer financing risks; impact of changes in market liquidity conditions and customer credit risk on receivables; reliance on third party distribution channels and ecosystems; the company’s ability to successfully manage acquisitions, alliances and dispositions; risks from legal proceedings; risk factors related to IBM securities; and other risks, uncertainties and factors discussed in the company’s Form 10-Qs, Form 10-K and in the company’s other filings with the U.S. Securities and Exchange Commission (SEC) or in materials incorporated therein or herein by reference. The company assumes no obligation to update or revise any forward-looking statements.

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 1. Legal Proceedings

Refer to note 12, “Contingencies,” on pages 4336 to 4538 of this Form 10-Q.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds and Issuer Repurchases of Equity Securities

The following table provides information relating to the company’s repurchase of common stock for the ~~second~~first quarter of ~~2016.~~2017.

Total Number

Approximate

of Shares

Dollar Value

Purchased as

of Shares that

Total Number

Average

Part of Publicly

May Yet Be

of Shares

Price Paid

Announced

Purchased Under

Period

Purchased

per Share

Program

The Program*

April 1, 2016 - April 30, 2016

2,825,817

$
149.37

2,825,817

$
4,277,900,618

May 1, 2016 - May 31, 2016

1,791,067

$
148.22

1,791,067

$
4,012,435,101

June 1, 2016 - June 30, 2016

1,049,211

$
150.68

1,049,211

$
3,854,344,814

Total

5,666,095

$
149.25

5,666,095

				Total Number	Approximate
				of Shares	Dollar Value
				Purchased as	of Shares that
	Total Number	Average		Part of Publicly	May Yet Be
	of Shares	Price Paid		Announced	Purchased Under
Period	Purchased	per Share		Program	The Program*
January 1, 2017 - January 31, 2017	2,326,097	$	170.13	2,326,097	$	4,712,769,649

February 1, 2017 - February 28, 2017	4,198,757	$	179.09	4,198,757	$	3,960,803,683

March 1, 2017 - March 31, 2017	658,640	$	176.69	658,640	$	3,844,428,767

Total	7,183,494	$	175.97	7,183,494

* On October ~~28, 2014,~~27, 2015, the Board of Directors authorized ~~$5.0~~$4.0 billion in funds for use in the company’s common stock repurchase program. On October ~~27, 2015~~25, 2016, the Board of Directors authorized an additional ~~$4.0~~$3.0 billion in funds for use in such program. In each case, the company stated that it would repurchase shares on the open market or in private transactions depending on market conditions. The common stock repurchase program does not have an expiration date. This table does not include shares tendered to satisfy the exercise price in connection with cashless exercises of employee stock options or shares tendered to satisfy tax withholding obligations in connection with employee equity awards.

Item 6. Exhibits

~~Exhibit Number~~

~~10.1~~Exhibit Number		~~Terms and Conditions of IBM LTPP Equity Awards, effective August 1, 2016.~~

~~10.2~~		~~Amendment No. 7 of the IBM Excess 401 (k) Plus Plan, a compensatory plan, dated as of June 30, 2016.~~

~~10.3~~		~~Form of Noncompetition Agreement.~~

11		Statement re: computation of per share earnings.

12		Statement re: computation of ratios.

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

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

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

101.INS		XBRL Instance Document

101.SCH		XBRL Taxonomy Extension Schema Document

101.CAL		XBRL Taxonomy Extension Calculation Linkbase Document

101.DEF		XBRL Taxonomy Extension Definition Linkbase Document

101.LAB		XBRL Taxonomy Extension Label Linkbase Document

101.PRE		XBRL Taxonomy Extension Presentation Linkbase Document

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: ~~July 26, 2016~~	April 25, 2017
		By:	/s/ ~~Stanley J. Sutula III~~Robert F. Del Bene
			~~Stanley J. Sutula III~~ Robert F. Del Bene
			Vice President and Controller

9070

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

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

Large accelerated filer x		Accelerated filer ¨o

Non-accelerated filer ¨o		Smaller reporting company ¨o
(Do not check if a smaller reporting company)
		Emerging growth company o

		The			Truven
	Amortization	Weather			Health			Other
(Dollars in millions)	Life (in yrs.)	Company			Analytics			Acquisitions
Current assets		$	76		$	171		$	71
Fixed assets/noncurrent assets		123			127			89
Intangible assets:
Goodwill	N/A	1,717			1,933			487
Completed technology	1-7	160			338			75
Client relationships	3-7	313			516			184
Patents/trademarks	2-7	349			54			28
Total assets acquired		2,738			3,141			934
Current liabilities		(88		)	(148		)	(46		)
Noncurrent liabilities		(372		)	(381		)	(64		)
Total liabilities assumed		(460		)	(529		)	(110		)
Bargain purchase gain		—			—			(40		)*
Total purchase price		$	2,278		$	2,612		$	784

	6/30/16		12/31/15
Assets	$	118,056	$	110,495	6.8	%
Liabilities	$	102,167	$	96,071	6.3	%
Equity	$	15,889	$	14,424	10.2	%

	Three Months Ended June 30,				Six Months Ended June 30,
(Dollars in millions)	2016		2015		2016		2015
Client financing	$	2,791	$	3,960	$	5,337	$	6,964
Commercial financing	10,213		9,488		19,537		18,315
Total	$	13,005	$	13,448	$	24,874	$	25,279