Index

	Page
Part I - Financial Information:

Item 1. Consolidated Financial Statements (Unaudited):

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

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

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

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

Consolidated Statement of Changes in Equity for the ~~nine~~three months ended ~~September 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 September 30,						Nine Months Ended September 30,						Three Months Ended March 31,
(Dollars in millions except per share amounts)	2016			2015			2016			2015			2017			2016
Revenue:
Services	$	12,938		$	12,327		$	38,347		$	37,290		$	12,342		$	12,391
Sales	5,872			6,501			18,542			20,990			5,404			5,879
Financing	417			452			1,260			1,403			409			414
Total revenue	19,226			19,280			58,149			59,682			18,155			18,684
Cost:
Services	8,418			8,067			25,492			24,776			8,553			8,382
Sales	1,536			1,544			4,496			4,895			1,551			1,378
Financing	259			233			760			733			279			238
Total cost	10,213			9,844			30,748			30,405			10,383			9,999
Gross profit	9,013			9,436			27,401			29,278			7,772			8,686
Expense and other (income):
Selling, general and administrative	4,732			4,731			16,093			15,273			5,152			6,012
Research, development and engineering	1,397			1,287			4,320			3,885			1,533			1,458
Intellectual property and custom development income	(528		)	(188		)	(1,110		)	(489		)	(445		)	(217		)
Other (income) and expense	(8		)	(133		)	281			(578		)	(28		)	253
Interest expense	158			117			473			340			135			147
Total expense and other (income)	5,751			5,815			20,056			18,431			6,348			7,652
Income from continuing operations before income taxes	3,263			3,621			7,345			10,846			1,424			1,034
Provision for/(benefit from) income taxes	409			659			(31		)	1,943			(329		)	(983		)
Income from continuing operations	$	2,854		$	2,962		$	7,375		$	8,904		$	1,753		$	2,016
Loss from discontinued operations, net of tax	(1		)	(12		)	(4		)	(176		)	(3		)	(3		)
Net income	$	2,853		$	2,950		$	7,371		$	8,727		$	1,750		$	2,014

Earnings/(loss) per share of common stock:
Assuming dilution:
Continuing operations	$	2.98		$	3.02		$	7.67		$	9.03		$	1.85		$	2.09
Discontinued operations	0.00			(0.01		)	0.00			(0.18		)	0.00			0.00
Total	$	2.98		$	3.01		$	7.67		$	8.85		$	1.85		$	2.09
Basic:
Continuing operations	$	2.99		$	3.04		$	7.70		$	9.07		$	1.86		$	2.09
Discontinued operations	0.00			(0.01		)	0.00			(0.18		)	0.00			0.00
Total	$	2.99		$	3.03		$	7.70		$	8.89		$	1.86		$	2.09

Weighted-average number of common shares outstanding: (millions)
Assuming dilution	957.3			979.0			960.7			986.0			947.8			964.4
Basic	954.0			975.1			957.7			981.8			942.4			961.7

Cash dividend per common share	$	1.40		$	1.30		$	4.10		$	3.70		$	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 September 30,						Nine Months Ended September 30,						Three Months Ended March 31,
(Dollars in millions)	2016			2015			2016			2015			2017			2016
Net income	$	2,853		$	2,950		$	7,371		$	8,727		$	1,750		$	2,014
Other comprehensive income/(loss), before tax:
Foreign currency translation adjustments	(99		)	(1,015		)	(109		)	(1,365		)	161			239
Net changes related to available-for-sale securities:
Unrealized gains/(losses) arising during the period	(1		)	(102		)	(36		)	(85		)	(1		)	(36		)
Reclassification of (gains)/losses to net income	(1		)	0			36			0			1			37
Total net changes related to available-for-sale securities	(2		)	(101		)	0			(85		)	0			1
Unrealized gains/(losses) on cash flow hedges:
Unrealized gains/(losses) arising during the period	35			36			(221		)	467			(33		)	(265		)
Reclassification of (gains)/losses to net income	15			(273		)	26			(843		)	(98		)	(91		)
Total unrealized gains/(losses) on cash flow hedges	50			(237		)	(195		)	(376		)	(130		)	(356		)
Retirement-related benefit plans:
Prior service costs/(credits)	—			0			—			6			0			—
Net (losses)/gains arising during the period	11			(2		)	(57		)	14			61			(147		)
Curtailments and settlements	4			11			19			19			(1		)	5
Amortization of prior service (credits)/costs	(28		)	(25		)	(81		)	(76		)	(21		)	(25		)
Amortization of net (gains)/losses	696			823			2,079			2,479			710			690
Total retirement-related benefit plans	683			807			1,960			2,441			748			522
Other comprehensive income/(loss), before tax	632			(547		)	1,656			616			779			406
Income tax (expense)/benefit related to items of other comprehensive income	(192		)	(176		)	(213		)	(895		)	(92		)	202
Other comprehensive income/(loss)	440			(724		)	1,442			(280		)	688			608
Total comprehensive income/(loss)	$	3,293		$	2,227		$	8,813		$	8,448		$	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 September 30,		At December 31,		At March 31,		At December 31,
(Dollars in millions)	2016		2015		2017		2016
Assets:
Current assets:
Cash and cash equivalents	$	9,039	$	7,686	$	10,096	$	7,826
Marketable securities	929		508		599		701
Notes and accounts receivable - trade (net of allowances of $325 in 2016 and $367 in 2015)	8,291		8,333
Short-term financing receivables (net of allowances of $532 in 2016 and $490 in 2015)	16,032		19,020
Other accounts receivable (net of allowances of $48 in 2016 and $51 in 2015)	873		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	433		352		423		358
Work in process and raw materials	1,297		1,199		1,186		1,195
Total inventories	1,729		1,551		1,609		1,553
Prepaid expenses and other current assets	4,539		4,205		4,715		4,564
Total current assets	41,433		42,504		42,889		43,888
Property, plant and equipment	30,842		29,342		30,681		30,133
Less: Accumulated depreciation	19,738		18,615		19,816		19,303
Property, plant and equipment — net	11,104		10,727		10,865		10,830
Long-term financing receivables (net of allowances of $116 in 2016 and $118 in 2015)	8,936		10,013
Long-term financing receivables (net of allowances of $99 in 2017 and $101 in 2016)					8,502		9,021
Prepaid pension assets	3,487		1,734		3,491		3,034
Deferred taxes	4,289		4,822		6,457		5,224
Goodwill	36,401		32,021		36,307		36,199
Intangible assets — net	4,881		3,487		4,436		4,688
Investments and sundry assets	5,075		5,187		4,549		4,585
Total assets	$	115,606	$	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 September 30,			At December 31,			At March 31,			At December 31,
(Dollars in millions)	2016			2015			2017			2016
Liabilities:
Current liabilities:
Taxes	$	2,137		$	2,847		$	2,747		$	3,235
Short-term debt	6,920			6,461			8,340			7,513
Accounts payable	5,271			6,028			5,324			6,209
Compensation and benefits	3,958			3,560			3,197			3,577
Deferred income	10,815			11,021			12,351			11,035
Other accrued expenses and liabilities	5,346			4,353			4,522			4,705
Total current liabilities	34,447			34,269			36,481			36,275
Long-term debt	35,563			33,428			34,441			34,655
Retirement and nonpension postretirement benefit obligations	16,688			16,504			16,967			17,070
Deferred income	3,611			3,771			3,557			3,600
Other liabilities	8,138			8,099			7,601			7,477
Total liabilities	98,447			96,071			99,047			99,078
Equity:
IBM stockholders’ equity:
Common stock, par value $0.20 per share, and additional paid-in capital	53,759			53,262			54,104			53,935
Shares authorized: 4,687,500,000
Shares issued: 2016 - 2,224,594,441
2015 - 2,221,223,449
Shares issued: 2017 - 2,226,175,975
2016 - 2,225,116,815
Retained earnings	149,585			146,124			153,292			152,759
Treasury stock - at cost	(158,170		)	(155,518		)	(160,359		)	(159,050		)
Shares: 2016 - 1,273,739,890
2015 - 1,255,494,724
Shares: 2017 - 1,286,679,091
2016 - 1,279,249,412
Accumulated other comprehensive income/(loss)	(28,164		)	(29,607		)	(28,710		)	(29,398		)
Total IBM stockholders’ equity	17,010			14,262			18,327			18,246
Noncontrolling interests	149			162			121			146
Total equity	17,159			14,424			18,448			18,392
Total liabilities and equity	$	115,606		$	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)

	Nine Months Ended September 30,						Three Months Ended March 31,
(Dollars in millions)	2016			2015			2017			2016
Cash flows from operating activities:
Net income	$	7,371		$	8,727		$	1,750		$	2,014
Adjustments to reconcile net income to cash provided by operating activities
Depreciation	2,106			1,981			709			677
Amortization of intangibles	1,148			884			390			347
Stock-based compensation	403			369			129			133
Net (gain)/loss on asset sales and other	100			584			13			172
Loss on Microelectronics business disposal	—			48
Changes in operating assets and liabilities, net of acquisitions/divestitures	2,174			(864		)	964			2,187		* **
Net cash provided by operating activities	13,301			11,729			3,955			5,530		* **

Cash flows from investing activities:
Payments for property, plant and equipment	(2,594		)	(2,670		)	(740		)	(956		)
Proceeds from disposition of property, plant and equipment	234			314			58			129
Investment in software	(441		)	(407		)	(137		)	(144		)
Acquisition of businesses, net of cash acquired	(5,445		)	(821		)	(109		)	(2,590		)
Divestitures of businesses, net of cash transferred	35			(488		)	(1		)	47
Non-operating finance receivables — net	1,130			1,334			1,570			1,500		*
Purchases of marketable securities and other investments	(4,021		)	(2,101		)	(1,273		)	(1,041		)
Proceeds from disposition of marketable securities and other investments	3,501			2,125			981			1,169
Net cash used in investing activities	(7,600		)	(2,714		)
Net cash (used in)/provided by investing activities							350			(1,886		)*

Cash flows from financing activities:
Proceeds from new debt	8,368			3,701			2,887			8,085
Payments to settle debt	(5,616		)	(5,389		)	(1,531		)	(2,211		)
Short-term borrowings/(repayments) less than 90 days — net	(864		)	1,080			(880		)	(910		)
Common stock repurchases	(2,632		)	(3,846		)	(1,293		)	(939		)
Common stock repurchases for tax withholdings							(50		)	(27		)**
Common stock transactions — other	166			271			54			59
Cash dividends paid	(3,927		)	(3,636		)	(1,321		)	(1,250		)
Net cash used in financing activities	(4,504		)	(7,818		)
Net cash (used in)/provided by financing activities							(2,134		)	2,806		**

Effect of exchange rate changes on cash and cash equivalents	155			(194		)	100			217
Net change in cash and cash equivalents	1,352			1,004			2,270			6,668

Cash and cash equivalents at January 1	7,686			8,476			7,826			7,686
Cash and cash equivalents at September 30	$	9,039		$	9,480
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

7,371

7,371

7,371

Other comprehensive income/(loss)

1,442

1,442

1,442

Total comprehensive income/(loss)

$
8,813

$
8,813

Cash dividends paid — common stock

(3,927
)

(3,927
)

(3,927
)
Common stock issued under employee plans (3,370,992 shares)

513

513

513

Purchases (787,805 shares) and sales (336,480 shares) of treasury stock under employee plans — net

16

(72
)

(56
)

(56
)
Other treasury shares purchased, not retired (17,793,841 shares)

(2,579
)

(2,579
)

(2,579
)
Changes in other equity

(16
)
0

(17
)

(17
)
Changes in noncontrolling interests

(12
)
(12
)
Equity - September 30, 2016

$
53,759

$
149,585

$
(158,170
)
$
(28,164
)
$
17,010

$
149

$
17,159

	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				8,727									8,727					8,727						2,014									2,014						2,014
Other comprehensive income/(loss)										(280		)	(280		)			(280		)										608			608						608
Total comprehensive income/(loss)													$	8,448				$	8,448														$	2,622					$	2,622
Cash dividends paid — common stock				(3,636		)							(3,636		)			(3,636		)				(1,250		)							(1,250		)				(1,250		)
Common stock issued under employee plans (4,349,552 shares)	556												556					556
Purchases (954,158 shares) and sales (484,817 shares) of treasury stock under employee plans — net				14			(93		)				(79		)			(79		)
Other treasury shares purchased, not retired (24,293,844 shares)							(3,861		)				(3,861		)			(3,861		)
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																11		11																		(14		)	(14		)
Equity - September 30, 2015	$	53,220		$	142,898		$	(154,669	)	$	(28,155	)	$	13,294		$	157	$	13,450
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~~Accounting Standards Board (FASB) guidance related to ~~note 6, “Segments,” on pages 27~~intra-entity transfers of assets. This benefit was partially offset by a discrete tax charge related 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.

foreign audit activity of $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 ~~nine months ended September 30, 2016,~~Taxes section of the ~~company’s benefit from income taxes is $31 million and its effective tax rate is (0.4) percent. See Taxes on pages 71 and 72~~Management Discussion for additional information.

Noncontrolling interest amounts of ~~$3.1~~$3.6 million and ~~$2.4~~$1.3 million, net of tax, for the three months ended ~~September 30,~~March 31, 2017 and 2016, ~~and 2015, respectively, and $7.5 million and $5.9 million, net of tax, for the~~ ~~nine months ended September 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.

~~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.

Notes to Consolidated Financial Statements — (continued)

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.~~guidance on its consolidated financial results and expects it will have a material impact on the 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.

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

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

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 $86 million and $74 million at September 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 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 ~~nine~~three months ended ~~September 30,~~March 31, 2016, a pre-tax impairment charge related to

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

certain property, plant and equipment of ~~$218~~$252 million was recorded. There were no material impairments of non-financial assets for the ~~nine~~three months ended ~~September 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 ~~September 30, 2016~~March 31, 2017 and December 31, ~~2015.~~2016.

(Dollars in millions)

At September 30, 2016

Level 1

Level 2

Level 3

Total

Assets:

Cash equivalents (1)

Time deposits and certificates of deposit

$
—

$
1,948

$
—

$
1,948

Money market funds

2,237

—

—

2,237

U.S. government securities

—

1,299

—

1,299

Canadian government securities

—

456

—

456

Other securities

—

34

—

34

Total

2,237

3,737

—

5,974
(6)
Debt securities - current (2)

—

929

—

929
(6)
Debt securities - noncurrent (3)

1

7

—

9

Available-for-sale equity investments (3)

12

—

—

12

Derivative assets (4)

Interest rate contracts

—

919

—

919

Foreign exchange contracts

—

245

—

245

Equity contracts

—

2

—

2

Total

—

1,166

—

1,166
(7)
Total assets

$
2,250

$
5,840

$
—

$
8,090
(7)
Liabilities:

Derivative liabilities (5)

Foreign exchange contracts

$
—

$
277

$
—

$
277

Equity contracts

—

9

—

9

Total liabilities

$
—

$
286

$
—

$
286
(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 theConsolidated 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 investmentsand sundry assets in the Consolidated Statement of Financial Position at September 30, 2016 were $198 million and $967 million, respectively.~~
~~(5)~~	~~The gross balances of derivative liabilities contained within other accrued expenses and liabilities, and otherliabilities in the Consolidated Statement of Financial Position at September 30, 2016 were $282 million and $3 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 ConsolidatedStatement of Financial Position, the total derivative asset and liability positions each would have been reduced by $185 million.~~

Notes to Consolidated Financial Statements — (continued)

(Dollars in millions)
At December 31, 2015	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	$	—	$	2,856	$	—	$	2,856		$	—	$	5,720	$	—	$	5,720
Money market funds	2,069		—		—		2,069			1,440		—		—		1,440
Other securities	—		18		—		18
Total	2,069		2,874		—		4,943		(6)	1,440		5,720		—		7,160		(6)
Debt securities - current (2)	—		506		—		506		(6)	—		599		—		599		(6)
Debt securities - noncurrent (3)	1		6		—		8			1		6		—		7
Trading security investments (3)	28		—		—		28
Available-for-sale equity investments (3)	192		—		—		192			5		—		—		5
Derivative assets (4)
Interest rate contracts	—		656		—		656			—		498		—		498
Foreign exchange contracts	—		332		—		332			—		389		—		389
Equity contracts	—		6		—		6			—		6		—		6
Total	—		994		—		994		(7)	—		894		—		894		(7)
Total assets	$	2,290	$	4,381	$	—	$	6,671	(7)	$	1,447	$	7,218	$	—	$	8,665	(7)
Liabilities:
Derivative liabilities (5)
Foreign exchange contracts	$	—	$	164	$	—	$	164		$	—	$	155	$	—	$	155
Equity contracts	—		19		—		19			—		6		—		6
Interest rate contracts	—		3		—		3			—		5		—		5
Total liabilities	$	—	$	186	$	—	$	186	(7)	$	—	$	166	$	—	$	166	(7)

~~(1)~~

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

~~(2)~~

~~Commercial paper and certificates of deposit reported as marketable securities in the Consolidated Statement of~~Financial Position.

(2) 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 March 31, 2017 were $348 million and $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 March 31, 2017 were $130 million and $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 $122 million.

Notes to Consolidated Financial Statements — (continued)

(Dollars in millions)
At December 31, 2016	Level 1		Level 2		Level 3		Total
Assets:
Cash equivalents (1)
Time deposits and certificates of deposit	$	—	$	3,629	$	—	$	3,629
Money market funds	1,204		—		—		1,204
Total	1,204		3,629		—		4,832		(6)
Debt securities - current (2)	—		699		—		699		(6)
Debt securities - noncurrent (3)	1		6		—		8
Available-for-sale equity investments (3)	7		—		—		7
Derivative assets (4)
Interest rate contracts	—		555		—		555
Foreign exchange contracts	—		560		—		560
Equity contracts	—		11		—		11
Total	—		1,126		—		1,126		(7)
Total assets	$	1,212	$	5,460	$	—	$	6,672	(7)
Liabilities:
Derivative liabilities (5)
Foreign exchange contracts	$	—	$	188	$	—	$	188
Equity contracts	—		10		—		10
Interest rate contracts	—		8		—		8
Total liabilities	$	—	$	206	$	—	$	206	(7)

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

(2) 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, 2016 were $532 million and $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, 2016 were $145 million and $61 million, respectively.

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

~~(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 investmentsand sundry assets in the Consolidated Statement of Financial Position at December 31, 2015 were $292 million and $702 million, respectively.~~

~~(5)~~

~~The gross balances of derivative liabilities contained within other accrued expenses and liabilities, and otherliabilities in the Consolidated Statement of Financial Position at December 31, 2015 were $164 million and $22 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 ConsolidatedStatement of Financial Position, the total derivative asset and liability positions each would have been reduced by $139 million.~~

There were no transfers between Levels 1 and 2 for the ~~nine~~three months ended ~~September 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 ~~September 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 ~~$35,563~~$34,441 million and ~~$33,428~~$34,655 million, and the estimated fair value was ~~$38,455~~$36,733 million and ~~$35,220~~$36,838 million at ~~September 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 September 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)	$	3	$	9	$	0	$	12	$	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 September 30:	2016		2015
For the three months ended March 31:					2017		2016
Proceeds	$	1	$	1	$	5	$	148
Gross realized gains (before taxes)	1		0		1		—
Gross realized losses (before taxes)	—		0		2		37

(Dollars in millions)
For the nine months ended September 30:	2016		2015
Proceeds	$	150	$	7
Gross realized gains (before taxes)	1		1
Gross realized losses (before taxes)	37		1

Notes to Consolidated Financial Statements — (continued)

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 September 30:

2016

2015

Net unrealized gains/(losses) arising during the period

$
(1
)
$
(63
)
Net unrealized (gains)/losses reclassified to net income*

(1
)
0

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

(Dollars in millions)
For the nine months ended September 30:	2016			2015
For the three months ended March 31:							2017			2016
Net unrealized gains/(losses) arising during the period	$	(22	)	$	(52	)	$	(1	)	$	(22	)
Net unrealized (gains)/losses reclassified to net income*	22			0			1			23

* There were no writedowns for the ~~nine~~three months ended ~~September 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 ~~September 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 ~~September 30, 2016~~March 31, 2017 and December 31, ~~2015~~2016 was ~~$64~~$4 million and ~~$28~~$11 million, respectively, for which no collateral was posted at ~~September 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 ~~September 30, 2016~~March 31, 2017 and December 31, ~~2015~~2016 was ~~$1,166~~$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 ~~$185~~$122 million and ~~$139~~$116 million at ~~September 30, 2016~~March 31, 2017 and December 31, ~~2015,~~2016, respectively, of liabilities included in master netting arrangements with those counterparties. Additionally, at ~~September 30, 2016~~March 31, 2017 and December 31, ~~2015,~~2016, this exposure was reduced by ~~$224~~$91 million and ~~$90~~$141 million of cash collateral, respectively, and ~~$100 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 ~~September 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 ~~$656~~$681 million and ~~$726~~$834 million, respectively. At ~~September 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 ~~$100~~$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 ~~September 30,~~

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

~~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 to return cash collateral was ~~$224~~$91 million and ~~$90~~$141 million at ~~September 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 ~~September 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 ~~September 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 ~~September 30, 2016~~March 31, 2017 and December 31, ~~2015~~2016 was approximately ~~6.5~~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 ~~September 30, 2016~~March 31, 2017 and December 31, ~~2015.~~2016.

At ~~September 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 ~~September 30, 2016~~March 31, 2017 and December 31, ~~2015,~~2016, the total notional amount of derivative instruments designated as net investment hedges was ~~$9.1~~$6.4 billion and ~~$5.5~~$6.7 billion, respectively. At ~~September 30, 2016~~March 31, 2017 and December 31, ~~2015,~~2016, the weighted-average remaining maturity of these instruments was approximately 0.2 years at both ~~dates.~~

~~Notes to Consolidated Financial Statements — (continued)~~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 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 ~~September 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 ~~$7.8~~$8.1 billion and ~~$8.2~~$8.3 billion, respectively. The weighted-average remaining maturity of these instruments at ~~September 30, 2016~~March 31, 2017 and December 31, ~~2015~~2016 was ~~0.6 years and~~ 0.7 years ~~respectively.~~at both periods.

At ~~September 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 ~~$45~~$342 million and ~~net gains of $147~~$462 million (before taxes), respectively, in accumulated other comprehensive income/(loss). Within these amounts, ~~$108~~$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 ~~September 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 ~~September 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 $4$19 million and net ~~losses~~gains of $2$29 million (before taxes), respectively, in accumulated other comprehensive income/(loss). Within these amounts, ~~$25~~$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 ~~September 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 ~~$13.7~~$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 ~~September 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 $1.2 billion ~~for~~at both periods.

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

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 ~~September 30, 2016~~March 31, 2017 and December 31, ~~2015.~~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 ~~September 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 ~~September 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 ~~September 30, 2016~~March 31, 2017 and December 31, ~~2015,~~2016, as well as for the three ~~and nine~~ months ended ~~September 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 ~~September 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	9/30/2016		12/31/2015		Classification	9/30/2016		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	919		656		Other liabilities	—		3		Investments and sundry assets	498		555		Other liabilities	4		8
Foreign exchange contracts:	Prepaid expenses and other current assets	123		197		Other accrued expenses and liabilities	200		70		Prepaid expenses and other current assets	295		421		Other accrued expenses and liabilities	61		46
	Investments and sundry assets	49		5		Other liabilities	3		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		$	1,091	$	858	Fair value of derivative liabilities	$	203	$	92

Not designated as hedging instruments:
Foreign exchange contracts:	Prepaid expenses and other current assets	$	73	$	90	Other accrued expenses and liabilities	$	74	$	75	Prepaid expenses and other current assets	$	47	$	100	Other accrued expenses and liabilities	$	63	$	89
	Investments and sundry assets	0		40		Other liabilities	—		—		Investments and sundry assets	0		22		Other liabilities	—		18
Equity contracts:	Prepaid expenses and other current assets	2		6		Other accrued expenses and liabilities	9		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		$	75	$	136	Fair value of derivative liabilities	$	82	$	94
											Fair value of derivative assets	$	53	$	133	Fair value of derivative liabilities	$	68	$	117

Total debt designated as hedging instruments:
Short-term debt		N/A		N/A			$	829	$	—		N/A		N/A			$	788	$	1,125
Long-term debt		N/A		N/A			$	8,412	$	7,945		N/A		N/A			$	7,977	$	7,844

Total		$	1,166	$	994		$	9,526	$	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 ~~September 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 September 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	$	(20	)	$	125		$	40	$	(99	)	Cost of financing	$	(1	)	$	137		$	23	$	(112	)
	Interest expense	(21		)	112			43		(88		)	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	30			208			N/A		N/A			Other (income) and expense	(76		)	121			N/A		N/A
Interest rate contracts	Other (income) and expense	0			0			N/A		N/A			Other (income) and expense	—			0			N/A		N/A
Equity contracts	SG&A expense	45			(81		)	N/A		N/A			SG&A expense	46			21			N/A		N/A
	Other (income) and expense	0			(8		)	N/A		N/A			Other (income) and expense	—			(1		)	N/A		N/A

Total		$	34		$	357		$	83	$	(187	)		$	(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 September 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	35			36		Other (income) and expense	(6		)	185		(1		)	0		(33		)	(265		)	Other (income) and expense	65			87			1		1
						Cost of sales	(4		)	46		—			—								Cost of sales*	11			9			—		—
						SG&A expense	2			43		—			—								Cost of services*	8			(6		)	—		—
																							SG&A expense	20			3			—		—
Instruments in net investment hedges(4):
Foreign exchange contracts	(131		)	73		Interest expense	—			—		25			4		(282		)	(693		)	Interest expense	—			—			19		10

Total	$	(96	)	$	109		$	(15	)	$	273	$	24		$	4	$	(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 ~~September 30,~~March 31, 2017 and March 31, 2016, ~~and September 30, 2015,~~ fair value hedges resulted in a loss of $3less than $1 million and a gain of $1$2 million in ineffectiveness, respectively.

Notes to Consolidated Financial Statements — (continued)

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

~~For the nine months ended September 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 nine months ended September 30:

Earnings Line Item

2016

2015

2016

2015

Derivative instruments in fair value hedges(4):

Interest rate contracts

Cost of financing

$
195

$
145

$
(127
)
$
(63
)

Interest expense

214

121

(140
)
(53
)
Derivative instruments not designated as hedging instruments(1):

Foreign exchange contracts

Other (income) and expense

335

134

N/A

N/A

Interest rate contracts

Other (income) and expense

0

(2
)
N/A

N/A

Equity contracts

SG&A expense

87

(63
)
N/A

N/A

Other (income) and expense

(1
)
(5
)
N/A

N/A

Total

$
830

$
330

$
(267
)
$
(116
)

Gain (Loss) Recognized in Earnings and Other Comprehensive Income

(Ineffectiveness) and

(Dollars in millions)

Effective Portion

Consolidated

Effective Portion Reclassified

Amounts Excluded from

For the nine months

Recognized in OCI

Statement of

from AOCI

Effectiveness Testing

ended September 30:

2016

2015

Earnings Line Item

2016

2015

2016

2015

Derivative instruments in cash flow hedges:

Interest rate contracts

$
—

$
—

Interest expense

$
(17
)
$
0

$
—

$
—

Foreign exchange contracts

(221
)
467

Other (income) and expense

6

565

(1
)
4

Cost of sales

(14
)
154

—

—

SG&A expense

(1
)
124

—

—

Instruments in net investment hedges(3):

Foreign exchange contracts

(1,071
)
592

Interest expense

—

—

51

6

Total

$
(1,292
)
$
1,059

$
(26
)
$
843

$
49

$
10

~~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 nine month periods ended September 30, 2016 and September 30, 2015, fair value hedges resulted in a gain of $1 million and a loss of $2 million in ineffectiveness, respectively.~~

For the three ~~and nine~~ months ending ~~September 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 September 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	$	3,171	$	3,057	$	2,875	$	2,909
Commercial financing receivables	6,856		8,948		7,460		9,706
Client loan and installment payment receivables (loans)	6,005		7,015		6,027		6,390
Total	$	16,032	$	19,020	$	16,362	$	19,006
Noncurrent:
Net investment in sales-type and direct financing leases	$	4,155	$	4,501	$	3,733	$	3,950
Client loan and installment payment receivables (loans)	4,782		5,512		4,769		5,071
Total	$	8,936	$	10,013	$	8,502	$	9,021

Net investment in sales-type and direct financing leases relates principally to the company’s 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 ~~$630~~$574 million and ~~$645~~$585 million at ~~September 30, 2016~~March 31, 2017 and December 31, ~~2015,~~2016, respectively, and is reflected net of unearned income of ~~$533~~$496 million and ~~$536~~$513 million, and net of allowance for credit losses of ~~$194~~$140 million and ~~$213~~$133 million at those dates, respectively.

Commercial financing receivables, net of allowance for credit losses of ~~$22~~$26 million and ~~$19~~$28 million at ~~September 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 ~~$432~~$285 million and ~~$377~~$276 million at ~~September 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 ~~$527~~$658 million and ~~$545~~$689 million at ~~September 30, 2016~~March 31, 2017 and December 31, ~~2015,~~2016, respectively.

The company did not have any financing receivables held for sale as of ~~September 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 ~~September 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 September 30, 2016	Markets			Markets			Total
Financing receivables:
At March 31, 2017										Americas			EMEA		Asia Pacific			Total
Financing receivables
Lease receivables	$	5,180		$	1,626		$	6,806		$	3,602		$	1,154	$	1,342		$	6,098
Loan receivables	8,678			2,541			11,219			5,826			3,062		2,193			11,081
Ending balance	$	13,858		$	4,167		$	18,025		$	9,428		$	4,216	$	3,535		$	17,179
Collectively evaluated for impairment	$	13,781		$	3,703		$	17,483		$	9,250		$	4,190	$	3,371		$	16,811
Individually evaluated for impairment	$	77		$	464		$	542		$	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	(19		)	(26		)	(45		)	$	(9	)	$	0	$	0		$	(9	)
Recoveries										0			0		0			0
Provision	3			69			72			6			7		(1		)	12
Other	4			5			9			2			1		8			11
Ending balance at September 30, 2016	$	97		$	529		$	626
Ending balance at March 31, 2017										$	223		$	29	$	172		$	424
Lease receivables	$	7		$	187		$	194		$	61		$	4	$	75		$	140
Loan receivables	$	90		$	343		$	432		$	162		$	26	$	97		$	285

Collectively evaluated for impairment	$	32		$	80		$	113		$	54		$	11	$	14		$	80
Individually evaluated for impairment	$	64		$	449		$	513		$	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 ~~September 30, 2016~~March 31, 2017 and December 31, ~~2015.~~

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

	At September 30,		At December 31,		At March 31,		At December 31,
(Dollars in millions)	2016		2015		2017		2016*
Major markets	$	2	$	2
Growth markets	42		63
Americas					$	28	$	23
EMEA					27		2
Asia Pacific					14		14
Total lease receivables	$	43	$	65	$	68	$	40

Major markets	$	19	$	13
Growth markets	139		91
Americas					$	133	$	128
EMEA					31		5
Asia Pacific					8		12
Total loan receivables	$	157	$	104	$	172	$	145

Total receivables	$	200	$	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 September 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	$	53	$	50	$	50	$	47
Growth markets	318		307		297		284
Americas									$	179	$	169	$	168	$	161
EMEA									26		18		20		9
Asia Pacific									164		157		159		150
Total	$	371	$	357	$	347	$	331	$	368	$	344	$	347	$	320

Interest

Average

Interest

Income

(Dollars in millions)

Recorded

Income

Recognized on

For the three months ended September 30, 2016:

Investment

Recognized

Cash Basis

Major markets

$
64

$
0

$
—

Growth markets

318

0

—

Total

$
382

$
0

$
—

* Reclassified to conform to 2017 presentation.

Interest

Average

Interest

Income

(Dollars in millions)

Recorded

Income

Recognized on

For the three months ended September 30, 2015:

Investment

Recognized

Cash Basis

Major markets

$
51

$
—

$
—

Growth markets

325

0

—

Total

$
376

$
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 nine months ended September 30, 2016:

Investment

Recognized

Cash Basis

Major markets

$
61

$
0

$
—

Growth markets

307

0

—

Total

$
368

$
0

$
—

Interest

Average

Interest

Income

(Dollars in millions)

Recorded

Income

Recognized on

For the nine months ended September 30, 2015:

Investment

Recognized

Cash Basis

Major markets

$
52

$
—

$
—

Growth markets

320

0

—

Total

$
371

$
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 net recorded investment for each class of receivables, by credit quality indicator, at ~~September 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 September 30, 2016:

Markets

Markets

Markets

Markets

Credit Rating:

Aaa – Aa3

$
449

$
29

$
745

$
44

A1 – A3

1,205

123

2,000

188

Baa1 – Baa3

1,444

181

2,398

276

Ba1 – Ba2

1,171

409

1,944

624

Ba3 – B1

520

403

864

615

B2 – B3

352

196

585

299

Caa – D

32

99

53

151

Total

$
5,173

$
1,439

$
8,588

$
2,199

	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 ~~September 30, 2016,~~March 31, 2017, the industries which made up Global Financing’s receivables portfolio consisted of: Financial ~~(34~~(35 percent), Government (14 percent), Manufacturing (14 ~~percent), Government (13~~ percent), Services (11 percent), Retail (8 percent), Communications (7 percent), Healthcare (6 percent) and Other (6 percent).

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

Lease Receivables

Loan Receivables

(Dollars in millions)

Major

Growth

Major

Growth

At December 31, 2015*;

Markets

Markets

Markets

Markets

Credit Rating:

Aaa – Aa3

$
535

$
34

$
941

$
73

A1 – A3

1,318

142

2,318

305

Baa1 – Baa3

1,486

343

2,613

738

Ba1 – Ba2

1,208

309

2,125

664

Ba3 – B1

510

243

897

522

B2 – B3

401

189

705

406

Caa – D

33

76

58

164

Total

$
5,492

$
1,336

$
9,656

$
2,872

	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 conform ~~with 2016~~to 2017 presentation.

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 ~~(11~~(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 September 30, 2016:

> 90 days (1)

Receivables

Receivables

Receivables

Accruing (2)

Major markets

$
8

$
19

$
5,154

$
5,180

$
133

Growth markets

24

152

1,449

1,626

55

Total lease receivables

$
32

$
171

$
6,603

$
6,806

$
188

Major markets

$
10

$
40

$
8,628

$
8,678

$
162

Growth markets

16

302

2,223

2,541

49

Total loan receivables

$
26

$
342

$
10,851

$
11,219

$
210

Total

$
58

$
513

$
17,454

$
18,025

$
399

			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 ~~nine~~three months ended ~~September 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 September 30,

Nine Months Ended September 30,

(Dollars in millions)

2016

2015

2016

2015

Cost

$
23

$
24

$
67

$
78

Selling, general and administrative

105

82

295

260

Research, development and engineering

14

11

41

37

Other (income) and expense*

—

(5
)
—

(6
)
Pre-tax stock-based compensation cost

142

111

403

369

Income tax benefits

(47
)
(38
)
(131
)
(124
)
Total net stock-based compensation cost

$
95

$
73

$
272

$
244

* 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 ~~September 30, 2016 increased $31~~March 31, 2017 decreased $4 million compared to the corresponding period in the prior year. This was due to ~~increases related to~~decreases in performance share units ($2014 million)~~, restricted stock units ($6 million),~~ and the conversion of stock-based awards previously issued by acquired entities ($56 million) ~~and stock option awards ($1 million).~~

Pre-tax stock-based compensation cost for the nine months ended September 30, 2016 increased $34 million compared to the corresponding period in the prior year. This was due to increases related to performance share units ($29 million), ~~the conversion of stock-based awards previously issued by acquired entities ($16 million) and stock option awards ($3 million);~~ partially offset by ~~decreases~~increases related to restricted stock units ($1416 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 ~~September 30, 2016,~~March 31, 2017, the total unrecognized compensation cost of ~~$1,011~~$804 million related to non-vested awards was expected to be recognized over a weighted-average period of approximately ~~2.6~~2.5 years.

There was no significant capitalized stock-based compensation cost at ~~September 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 Platform, 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 September 30, 2016:
For the three months ended March 31, 2017:
External revenue	$	4,235		$	4,191		$	8,748		$	1,558		$	412		$	19,145		$	4,062		$	4,006		$	8,216		$	1,395		$	405		$	18,083
Internal revenue	667			93			180			176			352			1,468			716			86			160			167			363			1,492
Total revenue	$	4,902		$	4,284		$	8,929		$	1,734		$	763		$	20,613		$	4,778		$	4,092		$	8,376		$	1,562		$	768		$	19,576
Pre-tax income from continuing operations	$	1,574		$	544		$	1,288		$	136		$	355		$	3,897		$	1,274		$	291		$	687		$	(186	)	$	311		$	2,377
Revenue year-to-year change	7.0		%	(1.0		)%	2.6		%	(20.5		)%	(26.0		)%	(1.0		)%	2.8		%	(3.6		)%	(2.5		)%	(17.3		)%	(14.3		)%	(3.4		)%
Pre-tax income year-to-year change	(1.4		)%	(18.0		)%	(2.2		)%	(45.3		)%	(36.8		)%	(11.2		)%	25.7		%	53.4		%	166.1		%	nm			(19.5		)%	29.4		%
Pre-tax income margin	32.1		%	12.7		%	14.4		%	7.8		%	46.5		%	18.9		%	26.7		%	7.1		%	8.2		%	(11.9		)%	40.5		%	12.1		%

*For the three months ended September 30, 2015:**
For the three months ended March 31, 2016:
External revenue	$	4,052		$	4,206		$	8,541		$	1,973		$	447		$	19,219		$	3,979		$	4,131		$	8,424		$	1,675		$	410		$	18,619
Internal revenue	528			120			161			209			584			1,601			668			113			165			212			486			1,645
Total revenue	$	4,580		$	4,326		$	8,702		$	2,182		$	1,031		$	20,821		$	4,647		$	4,245		$	8,589		$	1,888		$	896		$	20,264
Pre-tax income from continuing operations	$	1,596		$	664		$	1,317		$	248		$	562		$	4,387		$	1,013		$	190		$	258		$	(10	)	$	386		$	1,837

Pre-tax income margin	34.9		%	15.4		%	15.1		%	11.4		%	54.5		%	21.1		%	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 September 30:

2016

2015*

Revenue:

Total reportable segments

$
20,613

$
20,821

Eliminations of internal transactions

(1,468
)
(1,601
)
Other revenue

81

60

Total consolidated revenue

$
19,226

$
19,280

Pre-tax income from continuing operations:

Total reportable segments

$
3,897

$
4,387

Amortization of acquired intangible assets

(265
)
(162
)
Acquisition-related (charges)/income

(4
)
(4
)
Non-operating retirement-related (costs)/income

(139
)
(204
)
Eliminations of internal transactions

(185
)
(362
)
Unallocated corporate amounts

(42
)
(35
)
Total pre-tax income from continuing operations

$
3,263

$
3,621

* 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 nine months ended September 30, 2016:

External revenue

$
12,889

$
12,578

$
26,029

$
5,184

$
1,245

$
57,926

Internal revenue

1,929

310

501

594

1,340

4,673

Total revenue

$
14,818

$
12,888

$
26,530

$
5,778

$
2,585

$
62,599

Pre-tax income from continuing operations

$
4,039

$
1,210

$
2,825

$
354

$
1,208

$
9,636

Revenue year-to-year change

3.5
%
(2.7
)%
0.1
%
(20.0
)%
(20.7
)%
(3.0
)%
Pre-tax income year-to-year change

(18.4
)%
(36.2
)%
(26.8
)%
(66.2
)%
(28.5
)%
(28.3
)%
Pre-tax income margin

27.3
%
9.4
%
10.6
%
6.1
%
46.7
%
15.4
%

For the nine months ended September 30, 2015*:

External revenue

$
12,616

$
12,869

$
25,993

$
6,656

$
1,386

$
59,520

Internal revenue

1,695

380

500

571

1,874

5,020

Total revenue

$
14,311

$
13,249

$
26,493

$
7,226

$
3,261

$
64,540

Pre-tax income from continuing operations

$
4,949

$
1,895

$
3,861

$
1,048

$
1,690

$
13,444

Pre-tax income margin

34.6
%
14.3
%
14.6
%
14.5
%
51.8
%
20.8
%

* Recast to conform with 2016 presentation.

~~Reconciliations to IBM as Reported:~~

(Dollars in millions)

For the nine months ended September 30:

2016

2015*

Revenue:

Total reportable segments

$
62,599

$
64,540

Eliminations of internal transactions

(4,673
)
(5,020
)
Other revenue

223

162

Total consolidated revenue

$
58,149

$
59,682

Pre-tax income from continuing operations:

Total reportable segments

$
9,636

$
13,444

Amortization of acquired intangible assets

(742
)
(492
)
Acquisition-related (charges)/income

(1
)
(11
)
Non-operating retirement-related (costs)/income

(444
)
(831
)
Eliminations of internal transactions

(873
)
(1,175
)
Unallocated corporate amounts

(230
)
(88
)
Total pre-tax income from continuing operations

$
7,345

$
10,846

* 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 September 30, 2016:	Amount			Benefit			Amount
For the three months ended March 31, 2017:										Amount			Benefit			Amount
Other comprehensive income/(loss):
Foreign currency translation adjustments	$	(99	)	$	50		$	(49	)	$	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	(1		)	0			(1		)	1			0			1
Total net changes related to available-for-sale securities	$	(2	)	$	1		$	(1	)	$	0		$	0		$	0
Unrealized gains/(losses) on cash flow hedges:
Unrealized gains/(losses) arising during the period	$	35		$	(14	)	$	21		$	(33	)	$	8		$	(25	)
Reclassification of (gains)/losses to:
Cost of sales	4			(2		)	2			(11		)	3			(8		)
Cost of services										(8		)	3			(5		)
SG&A expense	(2		)	(1		)	(3		)	(20		)	5			(15		)
Other (income) and expense	6			(2		)	4			(65		)	25			(40		)
Interest expense	7			(3		)	4			7			(3		)	5
Total unrealized gains/(losses) on cash flow hedges	$	50		$	(22	)	$	29		$	(130	)	$	41		$	(89	)
Retirement-related benefit plans(1):
Prior service costs/(credits)										$	0		$	0		$	0
Net (losses)/gains arising during the period	$	11		$	(5	)	$	6		61			(20		)	41
Curtailments and settlements	4			(1		)	3			(1		)	0			(1		)
Amortization of prior service (credits)/costs	(28		)	9			(19		)	(21		)	7			(15		)
Amortization of net (gains)/losses	696			(225		)	471			710			(229		)	481
Total retirement-related benefit plans	$	683		$	(222	)	$	461		$	748		$	(241	)	$	507
Other comprehensive income/(loss)	$	632		$	(192	)	$	440		$	779		$	(92	)	$	688

~~(1)~~

(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 September 30, 2015:

Amount

Benefit

Amount

Other comprehensive income/(loss):

Foreign currency translation adjustments

$
(1,015
)
$
(28
)
$
(1,043
)
Net changes related to available-for-sale securities:

Unrealized gains/(losses) arising during the period

$
(102
)
$
39

$
(63
)
Reclassification of (gains)/losses to other (income) and expense

0

0

0

Total net changes related to available-for-sale securities

$
(101
)
$
39

$
(62
)
Unrealized gains/(losses) on cash flow hedges:

Unrealized gains/(losses) arising during the period

$
36

$
(9
)
$
27

Reclassification of (gains)/losses to:

Cost of sales

(46
)
13

(33
)
SG&A expense

(43
)
13

(30
)
Other (income) and expense

(185
)
71

(114
)
Interest expense

0

0

0

Total unrealized gains/(losses) on cash flow hedges

$
(237
)
$
88

$
(149
)
Retirement-related benefit plans(1):

Prior service costs/(credits)

$
0

$
0

$
0

Net (losses)/gains arising during the period

(2
)
1

(1
)
Curtailments and settlements

11

(4
)
7

Amortization of prior service (credits)/costs

(25
)
8

(16
)
Amortization of net (gains)/losses

823

(281
)
542

Total retirement-related benefit plans

$
807

$
(275
)
$
531

Other comprehensive income/(loss)

$
(547
)
$
(176
)
$
(724
)

(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)~~

* Reclassified to conform to 2017 presentation.

(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 nine months ended September 30, 2016:

Amount

Benefit

Amount

Other comprehensive income/(loss):

Foreign currency translation adjustments

$
(109
)
$
411

$
303

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

36

(14
)
22

Total net changes related to available-for-sale securities

$
0

$
0

$
0

Unrealized gains/(losses) on cash flow hedges:

Unrealized gains/(losses) arising during the period

$
(221
)
$
82

$
(139
)
Reclassification of (gains)/losses to:

Cost of sales

14

(7
)
7

SG&A expense

1

(3
)
(1
)
Other (income) and expense

(6
)
2

(4
)
Interest expense

17

(6
)
10

Total unrealized gains/(losses) on cash flow hedges

$
(195
)
$
68

$
(127
)
Retirement-related benefit plans(1):

Net (losses)/gains arising during the period

$
(57
)
$
20

$
(37
)
Curtailments and settlements

19

(7
)
12

Amortization of prior service (credits)/costs

(81
)
29

(52
)
Amortization of net (gains)/losses

2,079

(735
)
1,344

Total retirement-related benefit plans

$
1,960

$
(693
)
$
1,267

Other comprehensive income/(loss)

$
1,656

$
(213
)
$
1,442

~~(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 nine months ended September 30, 2015:

Amount

Benefit

Amount

Other comprehensive income/(loss):

Foreign currency translation adjustments

$
(1,365
)
$
(227
)
$
(1,593
)
Net changes related to available-for-sale securities:

Unrealized gains/(losses) arising during the period

$
(85
)
$
33

$
(52
)
Reclassification of (gains)/losses to other (income) and expense

0

0

0

Total net changes related to available-for-sale securities

$
(85
)
$
33

$
(52
)
Unrealized gains/(losses) on cash flow hedges:

Unrealized gains/(losses) arising during the period

$
467

$
(166
)
$
301

Reclassification of (gains)/losses to:

Cost of sales

(154
)
46

(109
)
SG&A expense

(124
)
36

(88
)
Other (income) and expense

(565
)
217

(348
)
Interest expense

0

0

0

Total unrealized gains/(losses) on cash flow hedges

$
(376
)
$
132

$
(243
)
Retirement-related benefit plans(1):

Prior service costs/(credits)

$
6

$
(2
)
$
4

Net (losses)/gains arising during the period

14

(5
)
9

Curtailments and settlements

19

(6
)
12

Amortization of prior service (credits)/costs

(76
)
26

(50
)
Amortization of net (gains)/losses

2,479

(846
)
1,633

Total retirement-related benefit plans

$
2,441

$
(833
)
$
1,608

Other comprehensive income/(loss)

$
616

$
(895
)
$
(280
)

~~(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	(139		)	303			(25		)	(22		)	117			(25		)	270			40			(1		)	284
Amount reclassified from accumulated other comprehensive income	12			0			1,292			22			1,326			(64		)	0			466			1			404
Total change for the period	(127		)	303			1,267			0			1,442			(89		)	270			507			0			688
September 30, 2016	$	(28	)	$	(3,161	)	$	(24,981	)	$	4		$	(28,164	)
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	301			(1,593		)	25			(52		)	(1,319		)	(174		)	505			(91		)	(22		)	218
Amount reclassified from accumulated other comprehensive income	(544		)	0			1,583			0			1,039			(58		)	0			426			23			391
Total change for the period	(243		)	(1,593		)	1,608			(52		)	(280		)	(232		)	505			335			0			608
September 30, 2015	$	148		$	(3,335	)	$	(24,901	)	$	(67	)	$	(28,155	)
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 September 30:

2016

2015

Change

Retirement-related plans — cost

Defined benefit and contribution pension plans — cost

$
421

$
505

(16.6
)%
Nonpension postretirement plans — cost

64

68

(4.8
)
Total

$
486

$
573

(15.2
)%

					Yr. to Yr.						Yr. to Yr.
(Dollars in millions)					Percent						Percent
For the nine months ended September 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	$	1,315	$	1,747	(24.7	)%	$	664	$	439	51.3	%
Nonpension postretirement plans — cost	185		206		(10.3	)	61		60		2.3
Total	$	1,500	$	1,953	(23.2	)%	$	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 September 30:

2016

2015

2016

2015

Service cost

$
—

$
—

$
108

$
116

Interest cost

512

507

257

270

Expected return on plan assets

(922
)
(988
)
(468
)
(481
)
Amortization of prior service costs/(credits)

3

2

(28
)
(24
)
Recognized actuarial losses

328

414

357

392

Curtailments and settlements

—

—

4

11

Multi-employer plans/other costs

—

—

8

16

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

(79
)
(65
)
239

300

Cost of defined contribution plans

159

162

103

109

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

$
79

$
96

$
342

$
409

(Dollars in millions)

U.S. Plans

Non-U.S. Plans

For the nine months ended September 30:

2016

2015

2016

2015

Service cost

$
—

$
—

$
318

$
339

Interest cost

1,536

1,521

787

810

Expected return on plan assets

(2,767
)
(2,965
)
(1,419
)
(1,446
)
Amortization of prior service costs/(credits)

8

7

(79
)
(74
)
Recognized actuarial losses

985

1,241

1,062

1,186

Curtailments and settlements

—

—

19

19

Multi-employer plan/other costs

—

—

64

272

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

(238
)
(196
)
751

1,107

Cost of defined contribution plans

484

500

318

335

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

$
246

$
304

$
1,069

$
1,443

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 ~~now~~ expects to contribute approximately ~~$600~~$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 ~~nine~~three months of ~~2016~~2017 were ~~$261~~$182 million, of which ~~$97~~$40 million was in cash and ~~$164~~$142 million in U.S. Treasury securities. Total net contributions to the non-U.S. plans in the first ~~nine~~three months of ~~2015~~2016 were ~~$271~~$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 September 30:

2016

2015

2016

2015

Service cost

$
4

$
6

$
1

$
2

Interest cost

41

41

15

12

Expected return on plan assets

—

—

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

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

5

10

2

2

Curtailments and settlements

—

—

0

0

Total nonpension postretirement plan cost recognized in Consolidated Statement of Earnings

$
49

$
55

$
16

$
13

(Dollars in millions)

U.S. Plan

Non-U.S. Plans

For the nine months ended September 30:

2016

2015

2016

2015

Service cost

$
13

$
18

$
4

$
5

Interest cost

124

122

37

39

Expected return on plan assets

—

—

(5
)
(5
)
Amortization of prior service costs/(credits)

(6
)
(6
)
(4
)
(4
)
Recognized actuarial losses

15

29

7

7

Curtailments and settlements

—

—

0

0

Total nonpension postretirement plan cost recognized in Consolidated Statement of Earnings

$
146

$
164

$
39

$
42

The company contributed $240 million to the U.S. nonpension postretirement benefit plan of which $40 million was in cash and $200 million was in U.S. Treasury securities during the nine months ended September 30, 2016, and $308 million in cash during the nine months ended September 30, 2015. 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 nine months ended September 30, 2016, the company completed twelve acquisitions at an aggregate cost of $5,688 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. It is expected that none of the goodwill will 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. It is expected that approximately 15 percent of the goodwill will 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 three businesses: in the first quarter: Ustream, Inc. (Ustream), a privately held business, and AT&T’s application and hosting services business; and in the third quarter, G4S’s cash solutions business. Global Business Services (GBS) completed acquisitions of

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

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 (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. The acquisition of G4S’s cash solutions business brings together the engineering skills of G4S with the company’s analytics and remote technology capabilities to expand delivery solutions. 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 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 September 30, 2016.~~

The

Truven

Amortization

Weather

Health

Other

(Dollars in millions)

Life (in yrs.)

Company

Analytics

Acquisitions

Current assets

$
76

$
171

$
78

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

189

Patents/trademarks

2-7

349

54

28

Total assets acquired

2,738

3,141

947

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

$
798

~~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)~~

On September 29, 2016, the company announced its intent to acquire Promontory Financial Group, LLC (Promontory), a global market-leading risk management and regulatory compliance consulting firm. Promontory’s capabilities combined with Watson will address clients’ escalating regulations and risk management requirements. The transaction is expected to close in the fourth quarter of 2016 and the business will be integrated within the Cognitive Solutions segment.

~~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

(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 2015 related to the disposal, and a pre-tax credit of $1 million was recorded during the nine months ended September 30, 2016. The cumulative pre-tax charge was $4.8 billion as of September 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, with a payment of $500 million expected in the fourth quarter of 2016.

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 September 30,

Nine Months Ended September 30,

(Dollars in millions)

2016

2015

2016

2015

Total revenue

$
—

$
—

$
—

$
720

Income/(loss) from discontinued operations

$
(2
)
$
2

$
(8
)
$
(177
)
Gain/(loss) on disposal, before tax

0

(57
)
1

(108
)
Total loss from discontinued operations, before income taxes

$
(2
)
$
(54
)
$
(7
)
$
(285
)
Provision/(benefit) for income taxes

(1
)
(43
)
(3
)
(108
)
Loss from discontinued operations, net of tax

$
(1
)
$
(12
)
$
(4
)
$
(176
)

~~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

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

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 was sold. 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.

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 $36 million in the nine months ended September 30, 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 September 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 September 30, 2016, the cumulative pre-tax gain attributed to this transaction was $213 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 and third quarters 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 September 30, 2016

(Dollars in millions)

Gross Carrying

Accumulated

Net Carrying

Intangible asset class

Amount

Amortization

Amount

Capitalized software

$
1,512

$
(630
)
$
882

Client relationships

2,831

(1,163
)
1,668

Completed technology

3,336

(1,577
)
1,759

Patents/trademarks

723

(183
)
540

Other*

46

(14
)
32

Total

$
8,447

$
(3,566
)
$
4,881

* 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 $1,394 million during the first nine months of 2016, primarily due to intangible asset additions resulting from acquisitions, partially offset by amortization. The aggregate intangible amortization expense was $403 million and $1,148 million for the third quarter and first nine months of 2016, respectively, versus $290 million and $884 million for the third quarter and first nine months of 2015, respectively. In addition, in the first nine months of 2016, the company retired $634 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 Q4)

$
138

$
254

$
392

2017

444

944

1,388

2018

250

798

1,048

2019

50

635

685

2020

—

535

535

~~The change in the goodwill balances by reportable segment, for the nine months ended September 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**

9/30/16

Cognitive Solutions

$
15,621

$
3,769

$
4

$
(12
)
$
134

$
19,516

Global Business Services

4,396

278

5

(1
)
16

4,693

Technology Services & Cloud Platforms

10,156

91

1

(5
)
89

10,333

Systems

1,848

—

2

—

10

1,859

Total

$
32,021

$
4,137

$
11

$
(17
)
$
248

$
36,401

* 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 nine 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 nine months of 2016 and full year 2015 were related to acquisitions that were completed on or prior to June 30, 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 $11 million were recorded during the first nine months of 2016, with the primary drivers being ~~accounts receivable, inventory,~~ deferred tax assets, accounts receivable, deferred income, inventory and other current ~~and noncurrent~~ liabilities.

11. Borrowings:

Short-Term Debt

	At September 30,		At December 31,		At March 31,		At December 31,
(Dollars in millions)	2016		2015		2017		2016
Commercial paper	$	—	$	600	$	—	$	899
Short-term loans	359		590		285		375
Long-term debt — current maturities	6,561		5,271		8,055		6,239
Total	$	6,920	$	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 7.7 percent and 9.5 percent ~~and 5.2 percent~~ at ~~September 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	9/30/2016		12/31/2015		Maturities	3/31/2017		12/31/2016
U.S. dollar notes and debentures (average interest rate at September 30, 2016):
3.94%	2016–2017	$	5,151	$	9,351
3.20%	2018–2019	8,846		7,591
1.79%	2020–2021	4,944		3,717
2.35%	2022	1,902		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
		$	30,604	$	30,319		$	32,309	$	30,563
Other currencies (average interest rate at September 30, 2016, in parentheses):
Other currencies (average interest rate at March 31, 2017, in parentheses):*

Euros (1.6%)	2016–2028	$	7,582	$	4,892	2019-2028	$	7,217	$	7,122
Pound sterling (2.7%)	2017–2022	1,366		1,555		2020-2022	1,312		1,296
Japanese yen (0.3%)	2017–2022	1,400		1,180
Swiss francs (6.3%)	2020	8		9
Japanese yen (0.9%)						2017-2026	1,649		1,576
Canadian (2.2%)	2017	381		360		2017	—		373
Other (15.4%)	2016–2020	659		506
Other (10.0%)						2017-2020	305		215
		$	42,001	$	38,820		$	42,792	$	41,145
Less: net unamortized discount		847		838			838		839
Less: net unamortized debt issuance cost		86		74
Add: fair value adjustment*		1,057		790
Less: net unamortized debt issuance costs							84		82
Add: fair value adjustment**							627		669
		$	42,124	$	38,699		$	42,498	$	40,893
Less: current maturities		6,561		5,271			8,055		6,239
Total		$	35,563	$	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 ~~September 30, 2016,~~March 31, 2017, are as follows:

(Dollars in millions)	Total		Total
2016 (for Q4)	$	61
2017	6,961
2017 (for Q2 - Q4)			$	4,845
2018	4,749		4,995
2019	5,262		5,256
2020	4,747		5,889
2021 and beyond	20,220
2021			3,933
2022 and beyond			17,875
Total	$	42,001	$	42,792

Interest on Debt

(Dollars in millions)
For the nine months ended September 30:	2016			2015
For the three months ended March 31:							2017			2016
Cost of financing	$	432		$	407		$	158		$	138
Interest expense	523			346			155			157
Net investment derivative activity	(51		)	(6		)	(19		)	(10		)
Interest capitalized	3			(1		)	0			1
Total interest paid and accrued	$	907		$	746		$	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 ~~September 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

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

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.

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

In March 2011, the company announced that it had agreed to settle a civil enforcement action with the Securities and 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 were 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 (“ERISA”). The company, management’s Retirement Plans Committee, and three current or former IBM executives were named as defendants. On September 7, 2016, the Court granted the company’s ~~motions~~motion to dismiss the plaintiffs’ ~~claims in both actions.~~claims. On October 21, 2016, the ~~ERISA~~ 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. ~~In the third quarter of 2016, the company received a new non-income tax assessment.~~ The total potential amount related to all these matters for all applicable years is approximately ~~$740 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 ~~$7,348~~$7,860 million and ~~$5,477~~$6,542 million at ~~September 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 ~~$2,220~~$2,341 million and ~~$2,097~~$2,463 million at ~~September 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 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 ~~September 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	107			117			32			27
Accrual adjustments to reflect actual experience	4			4			1			(2		)
Charges incurred	(132		)	(147		)	(41		)	(41		)
Balance at September 30	$	160		$	172
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	176			182			58			49
Amortization of deferred revenue	(198		)	(192		)	(68		)	(66		)
Other*	12			(28		)	7			9
Aggregate deferred revenue at September 30	$	528		$	498
Aggregate deferred revenue at March 31							$	528		$	531
Current portion	$	287		$	232		$	250		$	247
Noncurrent portion	$	241		$	267		$	278		$	284

* Other primarily consists of foreign currency translation adjustments.

14. Subsequent Events: On ~~October~~April 25, ~~2016,~~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 ~~December~~June 10, ~~2016~~2017 to shareholders of record on ~~November~~May 10, ~~2016.~~

~~On October 25, 2016,~~2017. The dividend declaration represents an increase of $0.10 per common share, which is 7 percent higher than the ~~company announced that the Board~~prior quarterly dividend of ~~Directors authorized $3.0 billion in additional funds for use in the company’s stock repurchase program.~~$1.40 per common share.

Item 2.

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

Snapshot

Financial Results Summary - Three Months Ended ~~September 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 September 30:	2016			2015			Change
For the three months ended March 31:									2017			2016			Change
Revenue	$	19,226		$	19,280		(0.3	)%*	$	18,155		$	18,684		(2.8	)%*
Gross profit margin	46.9		%	48.9		%	(2.1	)pts.	42.8		%	46.5		%	(3.7	)pts.
Total expense and other (income)	$	5,751		$	5,815		(1.1	)%	$	6,348		$	7,652		(17.0	)%
Total expense and other (income)-to-revenue ratio	29.9		%	30.2		%	(0.2	)pts.	35.0		%	41.0		%	(6.0	)pts.
Income from continuing operations, before income taxes	$	3,263		$	3,621		(9.9	)%	$	1,424		$	1,034		37.7	%
Provision for income taxes from continuing operations	$	409		$	659		(38.0	)%
Provision for/(benefit from) income taxes from continuing operations									$	(329	)	$	(983	)	(66.5	)%
Income from continuing operations	$	2,854		$	2,962		(3.6	)%	$	1,753		$	2,016		(13.1	)%
Income from continuing operations margin	14.8		%	15.4		%	(0.5	)pts.	9.7		%	10.8		%	(1.1	)pts.
Loss from discontinued operations, net of tax	$	(1	)	$	(12	)	(91.2	)%	$	(3	)	$	(3	)	(6.8	)%
Net income	$	2,853		$	2,950		(3.3	)%	$	1,750		$	2,014		(13.1	)%
Earnings per share from continuing operations:
Assuming dilution	$	2.98		$	3.02		(1.3	)%	$	1.85		$	2.09		(11.5	)%
Basic	$	2.99		$	3.04		(1.6	)%	$	1.86		$	2.09		(11.0	)%
Consolidated earnings per share - assuming dilution	$	2.98		$	3.01		(1.0	)%	$	1.85		$	2.09		(11.5	)%
Weighted-average shares outstanding:
Assuming dilution	957.3			979.0			(2.2	)%	947.8			964.4			(1.7	)%
Basic	954.0			975.1			(2.2	)%	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	%

* ~~(1.1)~~(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 78 and 79~~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 ~~third~~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 September 30:	2016			2015			Change
For the three months ended March 31:									2017			2016			Change
Net income as reported	$	2,853		$	2,950		(3.3	)%	$	1,750		$	2,014		(13.1	)%
Loss from discontinued operations, net of tax	(1		)	(12		)	(91.2	)	(3		)	(3		)	(6.8	)
Income from continuing operations	$	2,854		$	2,962		(3.6	)%	$	1,753		$	2,016		(13.1	)%
Non-operating adjustments (net of tax):
Acquisition-related charges	197			170			15.6		195			138			40.9
Non-operating retirement-related costs/(income)	99			140			(29.7	)	308			115			166.4
Operating (non-GAAP) earnings*	$	3,149		$	3,272		(3.8	)%	$	2,255		$	2,270		(0.7	)%
Diluted operating (non-GAAP) earnings per share	$	3.29		$	3.34		(1.5	)%	$	2.38		$	2.35		1.3	%

* See page 8768 for a more detailed reconciliation of net income to operating earnings.

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

In the ~~third~~first quarter of ~~2016,~~2017, the company ~~delivered $19.2~~reported $18.2 billion in revenue, ~~$2.9~~$1.8 billion in income from continuing operations and ~~$3.1~~$2.3 billion in operating (non-GAAP) earnings, resulting in diluted earnings per share from continuing operations of ~~$2.98~~$1.85 as reported and ~~$3.29~~$2.38 on an operating (non-GAAP) basis. The company generated ~~$4.2~~$4.0 billion in cash from operations and ~~$2.4~~$1.1 billion in free cash flow in the ~~third~~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 made progress across the business, with continued strong growth in the strategic imperatives, some moderation in the declines of the core businesses, remixing skills and adding new capabilities through organic investments, acquisitions and partnerships.

Total consolidated revenue in the first quarter of 2017 decreased ~~0.3~~2.8 percent as reported and ~~1.1~~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 ~~third~~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 2.5 points as reported and 1.5 points adjusted for currency from~~results continued to reflect the ~~second quarter growth rates.~~success the company is having in its strategic imperatives. The year to year growth rates in the third quarter improved in each reportable segment sequentially compared to the second quarter on both an as reported and adjusted for currency basis. Clients are focused on becoming digital businesses and the company’s third quartercompany had continued strong revenue growth in cloud, ~~security, mobile~~analytics and ~~across~~engagement, which together grew 12 percent as reported and 13 percent adjusted for currency. In the ~~analytics portfolio reflects this shift. Cloud delivered as-a-Service is part~~first quarter of ~~a solid recurring~~2017, the strategic imperatives generated $7.8 billion in revenue, ~~base across software and services. Annuity revenue continued to grow year to year. In addition, acquisitions made over the past 12 months continued to contribute revenue growth.~~which

Management Discussion — (continued)

The third quarter results reflect the success the company is having in helping its clients leverage cloud for speed and innovation, and become cognitive businesses. In the third quarter, the company had continued strong revenue growth in its strategic imperatives — cloud, analytics and engagement — which grew 16 percent year to year as reported and 15 percent adjusted for currency. Over the past 12 months, the strategic imperatives have generated $31.8 billion in revenue, which represents 40represented 43 percent of the company’s ~~total~~ revenue, an increase of 56 points from ~~full-year 2015.~~the first quarter of 2016. Total Cloud revenue of ~~$3.4~~$3.5 billion increased 4433 percent as reported and 4235 percent adjusted for currency, ~~in the third quarter,~~ with cloud as-a-Service revenue up ~~over 60~~59 percent as reported and 61 percent adjusted for currency. The company exited the ~~third~~first quarter of ~~2016~~2017 with an annual run rate for cloud as-a-Service revenue of ~~$7.5 billion, up from $6.7 billion in the second quarter of 2016 with the majority of the increase from organic growth.~~$8.6 billion. Analytics revenue of ~~$4.8~~$4.5 billion ~~in the third quarter~~ increased 156 percent as reported ~~(14~~and 7 percent adjusted for currency) with contribution from the core analytics platform as well as the cognitive offerings including Watson Platform, Watson Health and Watson IoT. Security revenue increased 11 percent in the third quarter both as reported and adjusted for currency. Mobile revenue increased 1920 percent ~~year to year both as reported and~~(22 percent adjusted for ~~currency.~~currency) and Security revenue increased 9 percent (10 percent adjusted for currency).

~~In the third quarter, the~~The company ~~made continued progress in moving into new areas and becoming a~~provides cognitive solutions ~~and~~on cloud ~~platform~~platforms that are highly differentiated for industries. The company ~~including:~~is the global leader in enterprise cloud with over $14.6 billion of Cloud revenue over the prior 12 months. Progress in the first quarter of 2017 included:

· ~~Delivered significant sequential increase in cloud as-a-Service revenue for~~Scaling and extending the ~~second consecutive quarter.~~reach of Watson and the IBM Cloud with new solutions, clients and partnerships; and

· ~~Continued global expansion of cloud centers.~~

· ~~Expanded partnerships~~Continuing to ~~accelerate cloud adoption.~~

· ~~Added new cognitive offerings~~build emerging technologies on the IBM Cloud such as blockchain and ~~capabilities in Watson Platform, Watson Health and Watson IoT.~~

· ~~Launched an Industry Platforms business to initially address opportunity areas in blockchain solutions and Watson Financial Services.~~quantum — including announcing the first commercial quantum system.

From a segment perspective, Cognitive Solutions revenue increased 4.5 percent as reported and 5 percent adjusted for currency led by growth in Solutions Software. Technology Services & Cloud Platforms revenue increased 2.4 percent as reported and 1 percent adjusted for currency with continued strength in Infrastructure Services and growth in Integration Software as clients build their hybrid cloud capabilities. Global Business Services (GBS) revenue decreased 0.4 percent as reported and 2 percent adjusted for currency and continues to reflect a shift in the segment’s business and mix towards digital offerings. The GBS year-to-year revenue growth rate improved sequentially compared to second-quarter on both an as reported and adjusted for currency basis. Systems revenue decreased 21.0 percent (21 percent adjusted for currency) reflecting the z Systems product cycle dynamics and declines in Power Systems.

From a geographic perspective, Americas revenue decreased 0.4 percent as reported and was flat adjusted for currency. There was improvement in the revenue growth trajectory compared with the second quarter of 2016 on both an as reported and adjusted for currency basis. EMEA revenue decreased 3.4 percent, but was flat adjusted for currency in the third quarter of 2016 and improved sequentially as reported and adjusted for currency driven primarily by Germany, France and the Nordics. Asia Pacific revenue increased 4.6 percent as reported, but decreased 4 percent adjusted for currency.

~~The consolidated gross profit margin of 46.9 percent decreased~~ 2.1 points year to year. The decline was driven primarily by higher levels of investments including acquisitions and the mix to as-a-Service capabilities that are not yet at scale. The operating (non-GAAP) gross margin of 48.0 percent decreased 2.1 points compared to the prior year driven primarily by the same factors.

~~Management Discussion — (continued)~~

Total expense and other (income) decreased 1.1 percent in the third quarter of 2016 compared to the prior year. Total operating (non-GAAP) expense and other (income) decreased 1.8 percent year to year. The key year-to-year drivers were approximately:

	~~Total~~	~~Operating~~
	~~Consolidated~~	~~(non-GAAP)~~
Currency*	~~3 points~~	~~3 points~~
Acquisitions**	~~6 points~~	~~5 points~~
~~Base~~	~~(10) points~~	~~(10) points~~

*	~~Reflects impacts of translation and hedging programs.~~
**	~~Includes acquisitions completed in prior 12-month period; operating (non-GAAP) is net of non-operating acquisition-related charges.~~

~~Base expense performance reflects a higher level of intellectual property (IP) income ($341 million) in the third quarter year to year a~~s the company revitalizes its IP income base by utilizing partnerships that enable innovation in some of the more traditional high-value areas of the business. The company is continuing to invest in new opportunity areas and building new markets, as well as delivering innovation in its existing businesses. This includes investing at a higher level in organic capabilities such as cognitive, security, cloud and blockchain as well as through acquisitions. The decrease in operating (non-GAAP) expense was driven primarily by the same factors.

Pre-tax income from continuing operations of $3.3 billion in the third quarter of 2016 decreased 9.9 percent year to year and the pre-tax margin was 17.0 percent, a decrease of 1.8 points. The continuing operations effective tax rate for the third quarter of 2016 was 12.5 percent compared to an effective tax rate of 18.2 percent in the third quarter of 2015. Income from continuing operations of $2.9 billion decreased 3.6 percent and the net income margin was 14.8 percent, a decrease of 0.5 points versus the third quarter of 2015. Losses from discontinued operations, net of tax, were $1 million in the third quarter of 2016 compared to $12 million in the third quarter of 2015. Net income of $2.9 billion decreased 3.3 percent year to year. Operating (non-GAAP) pre-tax income from continuing operations of $3.7 billion decreased 8.0 percent year to year and the operating (non-GAAP) pre-tax margin from continuing operations decreased 1.6 points to 19.1 percent. Operating (non-GAAP) income from continuing operations of $3.1 billion decreased 3.8 percent. The operating (non-GAAP) income margin from continuing operations of 16.4 percent decreased 0.6 points. The operating (non-GAAP) effective tax rate from continuing operations in the third quarter of 2016 was 14.2 percent versus 18.0 percent in the prior year.

In the third quarter of 2016, the company repurchased 5.5 million shares of its common stock at a cost of $0.9 billion. Diluted earnings per share from continuing operations of $2.98 in the third quarter of 2016 decreased 1.3 percent year to year. Operating (non-GAAP) diluted earnings per share of $3.29 decreased 1.5 percent versus the third quarter of 2015.

The company generated $4.2 billion in cash flow provided by operating activities which was flat compared to the third quarter of 2015. Net cash used in investing activities of $1.0 billion in the third quarter of 2016 decreased $0.3 billion year to year, primarily due to the net payment made in the third quarter of 2015 associated with the Microelectronics divestiture. Net cash used in financing activities of $4.2 billion in the third quarter of 2016 increased $2.3 billion compared to the third quarter of 2015, primarily driven by higher net debt payments ($3.0 billion), partially offset by a decline in common stock repurchases ($0.7 billion).

In October 2016, the company disclosed that it continues to expect GAAP earnings per share from continuing operations of at least $12.23 and operating (non-GAAP) earnings of at least $13.50 per diluted share for 2016. The company continues to expect free cash flow 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 77 and 78 for additional information on the company’s expectations.

~~Management Discussion — (continued)~~

~~Financial Results Summary - Nine Months Ended September 30:~~

Yr. to Yr.

Percent/

(Dollars and shares in millions except per share amounts)

Margin

For the nine months ended September 30:

2016

2015

Change

Revenue

$
58,149

$
59,682

(2.6
)%*
Gross profit margin

47.1
%
49.1
%
(1.9
)pts.
Total expense and other (income)

$
20,056

$
18,431

8.8
%
Total expense and other (income)-to-revenue ratio

34.5
%
30.9
%
3.6
pts.
Income from continuing operations, before income taxes

$
7,345

$
10,846

(32.3
)%
Provision for/(benefit from) income taxes from continuing operations

$
(31
)
$
1,943

nm

Income from continuing operations

$
7,375

$
8,904

(17.2
)%
Income from continuing operations margin

12.7
%
14.9
%
(2.2
)pts.
Loss from discontinued operations, net of tax

$
(4
)
$
(176
)
(97.6
)%
Net income

$
7,371

$
8,727

(15.5
)%
Earnings per share from continuing operations:

Assuming dilution

$
7.67

$
9.03

(15.1
)%
Basic

$
7.70

$
9.07

(15.1
)%
Consolidated earning per share - assuming dilution

$
7.67

$
8.85

(13.3
)%
Weighted-average shares outstanding:

Assuming dilution

960.7

986.0

(2.6
)%
Basic

957.7

981.8

(2.5
)%

9/30/16

12/31/15

Assets

$
115,606

$
110,495

4.6
%
Liabilities

$
98,447

$
96,071

2.5
%
Equity

$
17,159

$
14,424

19.0
%

* (1.9) percent adjusted for currency

~~nm - not meaningful~~

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

Yr. to Yr.

(Dollars in millions except per share amounts)

Percent

For the nine months ended September 30:

2016

2015

Change

Net income as reported

$
7,371

$
8,727

(15.5
)%
Loss from discontinued operations, net of tax

(4
)
(176
)
(97.6
)
Income from continuing operations

$
7,375

$
8,904

(17.2
)%
Non-operating adjustments (net of tax):

Acquisition-related charges

542

452

19.9

Non-operating retirement-related costs/(income)

338

597

(43.4
)
Operating (non-GAAP) earnings*

$
8,255

$
9,953

(17.1
)%
Diluted operating (non-GAAP) earnings per share

$
8.59

$
10.09

(14.9
)%

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

~~Financial Performance Summary — Nine Months Ended September 30:~~

In the first nine months of 2016, the company reported $58.1 billion in revenue, and delivered $7.4 billion in income from continuing operations resulting in diluted earnings per share from continuing operations of $7.67 as reported and $8.59 on an operating (non-GAAP) basis. The company generated $13.3 billion in cash from operations and $6.9 billion in free cash flow in the first nine months of 2016 driving shareholder returns of $6.6 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

~~Management Discussion — (continued)~~

intelligence, bringing its industry expertise together with these cognitive solutions, and building it all on cloud platforms. The company is in a unique position to move its clients to the future as it is 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 2.6 percent as reported and 1.9 percent year to year adjusted for currency in the first nine months of 2016.~~

In the first nine months of 2016, the company had strong revenue growth in the strategic imperatives of 14 percent year to year as reported and adjusted for currency. Total Cloud revenue of $9.5 billion was up 36 percent as reported and adjusted for currency year to year with as-a-Service revenue up 53 percent as reported (54 percent adjusted for currency). Analytics revenue of $13.9 billion increased 9 percent as reported and adjusted for currency. Security revenue increased 16 percent as reported and adjusted for currency and mobile revenue was up 42 percent year to year as reported and adjusted for currency.

~~From a segment perspective, Cognitive Solutions revenue increased 2.2~~ percent as reported and 3 percent adjusted for currency with growth in Solutions Software, led by revenue growth in Analytics and Security, partially offset by a decline in Transaction Processing Software. ~~GBS~~Global Business Services (GBS) revenue decreased ~~2.3~~3.0 percent as reported and 2 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 2 points adjusted for currency. Consulting revenue performance improved sequentially 1.7 points as reported and 3 points adjusted for currency compared to the fourth quarter of 2016. The GBS business continued to shift resources to its cognitive services, advanced analytics, and digital platforms and away from the more traditional areas. GBS strategic imperatives revenue had double-digit growth year to year as reported and adjusted for ~~currency.~~currency, led by cloud and mobile practices. Technology Services & Cloud Platforms revenue ~~was essentially flat year to year~~decreased 2.5 percent as reported ~~but increased 1~~and 2 percent adjusted for currency, ~~led~~primarily driven by ~~growth~~declines in Infrastructure Services ~~which was up 1.8 percent as reported (3 percent adjusted for currency) as the hybrid cloud strategy continues to resonate with clients.~~and Integration Software. Technology Services & Cloud Platforms strategic imperatives revenue was up 4030 percent ~~(41~~(31 percent adjusted for currency) year to year. Systems revenue decreased ~~22.1~~16.8 percent ~~as reported (22~~(16 percent adjusted for currency) driven by product cycle dynamics, with z Systems down 40.2 percent (40 percent adjusted for currency) and Power Systems down ~~23.5~~27.8 percent ~~(23~~(27 percent adjusted for currency).

From a geographic perspective, Americas revenue ~~decreased 3.6 percent~~was essentially flat year to year as reported, (2but decreased 1 percent adjusted for currency, with the U.S. down 1.3 percent. Europe/Middle East/Africa (EMEA) revenue decreased 8.1 percent (4 percent adjusted for currency) ~~with~~due primarily to declines in the ~~U.S. down 2.0 percent. EMEA~~U.K and Germany. Revenue performance in the geography continued to be impacted by macro- and geo-political trends. Asia Pacific revenue decreased ~~3.8~~1.7 percent ~~as reported (2~~(3 percent adjusted for currency). ~~Asia Pacific revenue increased 1.7 percent as reported, but decreased 2 percent adjusted for currency.~~

The consolidated gross profit margin of ~~47.1~~42.8 percent decreased ~~1.9~~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~~mix to as-a-Service ~~capabilities.~~businesses. The operating (non-GAAP) gross margin of ~~48.2~~44.5 percent decreased ~~1.9~~3.0 points ~~versus~~compared to the prior year driven primarily by the same factors.

Total expense and other (income) ~~increased 8.8~~decreased $1,304 million or 17.0 percent in the first ~~nine months~~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 9.9~~decreased 19.9 percent ~~compared to the first nine months of 2015. The key year-to-year drivers were:~~

	~~Total~~	~~Operating~~
	~~Consolidated~~	~~(non-GAAP)~~
Currency*	~~2 points~~	2 ~~points~~
Acquisitions**	~~5 points~~	4 ~~points~~
~~Base~~	~~2 points~~	4 ~~points~~

*	~~Reflects impacts of translation and hedging programs.~~
**	~~Includes acquisitions completed in prior 12-month period; operating (non-GAAP) is net of non-operating acquisition-related charges.~~

The increase in base expense in the first nine months of 2016 was primarily driven by first-quarter 2016 charges for actions taken to accelerate the transformation of the company’s workforce and shift its skill base, as well as increased investments in the strategic areas of cognitive, security and cloud. This included a higher level of workforce rebalancing charges ($464 million) year to year and ~~charges for real estate actions ($294 million); partially offset by a higher level of intellectual property income ($621 million). The increase in operating (non-GAAP) expense~~ was driven primarily by the same factors.

Pre-tax income from continuing operations of ~~$7.3~~$1.4 billion ~~decreased 32.3~~in the first quarter of 2017 increased 37.7 percent year to year and the pre-tax margin was ~~12.6~~7.8 percent, ~~a decrease~~an increase of ~~5.5~~2.3 points ~~versus~~compared to the first ~~nine months~~quarter of ~~2015.~~2016. The continuing operations effective tax rate for the first ~~nine months~~quarter of ~~2016~~2017 was ~~(0.4)~~(23.1) percent compared to ~~an effective tax rate of 17.9~~(95.1) percent in the ~~prior year.~~first quarter of 2016. The negative tax rate in the first ~~nine months~~quarter of ~~2016~~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 ~~non-U.S.~~Japan taxes plus ~~interest in the first quarter of 2016.~~interest. Income from continuing operations of ~~$7.4~~$1.8 billion decreased ~~17.2~~13.1 percent and the net income margin was ~~12.7~~9.7 percent, a decrease of ~~2.2 points compared to the first nine months of 2015.~~1.1 points. Losses from discontinued operations, net of tax, were $4$3 million in both the first ~~nine months~~quarter of ~~2016 versus $176 million in the first nine~~

Management Discussion — (continued)

~~months of 2015.~~2017 and 2016. Net income of ~~$7.4~~$1.8 billion decreased ~~15.5~~13.1 percent year to year. Operating (non-GAAP) pre-tax income from continuing operations of ~~$8.5~~$2.1 billion ~~decreased 30.0~~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 5.7~~increased 4.1 points to ~~14.7~~11.4 percent. Operating (non-GAAP) income from continuing operations of ~~$8.3~~$2.3 billion decreased ~~17.1~~0.7 percent and the operating (non-GAAP) income margin from continuing operations of ~~14.2~~12.4 percent ~~decreased 2.5~~increased 0.3 points. The operating (non-GAAP) effective tax rate from continuing operations in the first ~~nine months~~quarter of ~~2016~~2017 was ~~3.2~~(9.3) percent versus ~~18.3~~(66.8) percent in the first nine months of 2015. Profit and margin performance in the first nine 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.prior year.

Diluted earnings per share from continuing operations of ~~$7.67~~$1.85 in the first quarter of 2017 decreased ~~15.1~~11.5 percent year to year. In the first ~~nine months~~quarter of ~~2016,~~2017, the company repurchased ~~17.8~~7.2 million shares of its common stock at a cost of $1.3 billion and had ~~$3.0~~$3.8 billion remaining in the ~~current~~ share repurchase authorization at ~~September 30, 2016.~~March 31, 2017. Operating (non-GAAP) diluted earnings per share of ~~$8.59 decreased 14.9~~$2.38 increased 1.3 percent versus the ~~prior year. Diluted earnings per share from discontinued operations was $0.00 in the~~ first ~~nine months~~quarter of ~~2016 compared to ($0.18) in the same period of 2015.~~2016.

At ~~September 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 ~~$10.0~~$10.7 billion, an increase of ~~$1.8~~$2.2 billion from December 31, ~~2015.~~2016. Key drivers in the balance sheet and total cash flows were:

Total assets ~~increased $5.1 billion ($3.0~~were flat (decreased $1.1 billion adjusted for currency) from December 31, ~~2015~~2016 driven by:

·Increases in ~~goodwill ($4.4 billion),~~ cash and marketable securities ($~~1.8~~2.2 billion), deferred taxes ($1.2 billion) and retirement plan assets ($~~1.8 billion) and intangible assets ($1.4~~0.5 billion); ~~partially~~ offset by

·Decreases in total receivables ($~~4.4~~3.9 billion).

Total liabilities ~~increased $2.4 billion~~were flat (decreased ~~$0.2~~$1.0 billion adjusted for currency) from December 31, ~~2015~~2016 driven by:

·Increases in deferred income ($1.3 billion) and total debt ($~~2.6~~0.6 billion); offset by

· Decreases in accounts payable ($0.9 billion), ~~other accrued expenses and liabilities~~taxes payable ($~~1.0~~0.5 billion) and compensation and benefits ($
($0.4 billion)~~; partially offset by~~

·~~Decreases in accounts payable ($0.8 billion) and taxes payable ($0.7 billion)~~.

Total equity of ~~$17.2~~$18.4 billion increased ~~$2.7~~$0.1 billion from December 31, ~~2015~~2016 as a result of:

·Increases from net income ($~~7.4~~1.8 billion), retirement-related ($~~1.3~~0.5 billion) and equity translation adjustments ($0.3 billion); ~~partially~~ offset by

·Decreases from dividends ($~~3.9~~1.3 billion) and share repurchases ($~~2.6~~1.3 billion).

The company generated ~~$13.3~~$4.0 billion in cash flow ~~provided by~~from operating activities, ~~an increase~~a decrease of $1.6 billion compared to the first ~~nine months~~quarter of ~~2015,~~2016, primarily driven by 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 for acquisitions ($2.5 billion). Financing activities were a use of cash of $2.1 billion in the first quarter of 2017 compared to a $2.8 billion source of cash in the first quarter of 2016, primarily driven by lower ~~income tax payments~~net debt issuances ($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 ~~provided by financing receivables; partially offset by operational performance. Net cash used~~flow to be essentially flat year to year. Refer to page 60 in ~~investing activities of $7.6 billion was $4.9 billion higher than~~ the ~~prior year, primarily driven by an increase in cash used related to acquisitions ($4.6 billion). Net cash used in financing activities of $4.5 billion decreased $3.3 billion compared~~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 ~~first nine months of 2015, driven primarily by higher net debt issuances ($2.5 billion)~~Looking Forward section on pages 58 and ~~a decline in common share repurchases ($1.2 billion).~~59 for additional information on the company’s expectations.

Management Discussion — (continued)

~~Third~~First Quarter ~~and First Nine Months~~ in Review

Results of Continuing Operations

Segment Details

The following is an analysis of the ~~third~~first quarter ~~and first nine months~~ of ~~2016~~2017 versus the ~~third~~first quarter ~~and first nine 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 September 30:

2016

2015*

Change

Currency

Revenue:

Cognitive Solutions

$
4,235

$
4,052

4.5
%
4.5
%
Gross margin

80.4
%
84.4
%
(3.9
)pts.

Global Business Services

4,191

4,206

(0.4
)%
(1.6
)%
Gross margin

28.8
%
29.7
%
(0.9
)pts.

Technology Services & Cloud Platforms

8,748

8,541

2.4
%
1.4
%
Gross margin

42.0
%
42.2
%
(0.2
)pts.

Systems

1,558

1,973

(21.0
)%
(21.5
)%
Gross margin

51.1
%
55.9
%
(4.8
)pts.

Global Financing

412

447

(7.9
)%
(9.2
)%
Gross margin

37.8
%
48.4
%
(10.6
)pts.

Other

81

60

34.7
%
33.4
%
Gross margin

(279.2
)%
(260.4
)%
(18.7
)pts.

Total consolidated revenue

$
19,226

$
19,280

(0.3
)%
(1.1
)%
Total consolidated gross profit

$
9,013

$
9,436

(4.5
)%

Total consolidated gross margin

46.9
%
48.9
%
(2.1
)pts.

Non-operating adjustments:

Amortization of acquired intangible assets

129

89

44.8
%

Retirement-related costs/(income)

79

118

(33.3
)%

Operating (non-GAAP) gross profit

$
9,221

$
9,643

(4.4
)%

Operating (non-GAAP) gross margin

48.0
%
50.0
%
(2.1
)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 nine months ended September 30:

2016

2015*

Change

Currency

Revenue:

Cognitive Solutions

$
12,889

$
12,616

2.2
%
2.9
%
Gross margin

81.5
%
84.9
%
(3.4
) pts.

Global Business Services

12,578

12,869

(2.3
)%
(2.2
)%
Gross margin

27.0
%
28.2
%
(1.2
) pts.

Technology Services & Cloud Platforms

26,029

25,993

0.1
%
1.0
%
Gross margin

41.5
%
42.2
%
(0.6
) pts.

Systems

5,184

6,656

(22.1
)%
(21.9
)%
Gross margin

55.1
%
55.8
%
(0.6
) pts.

Global Financing

1,245

1,386

(10.2
)%
(8.5
)%
Gross margin

39.6
%
47.5
%
(7.9
) pts.

Other

223

162

37.4
%
38.4
%
Gross margin

(295.2
)%
(237.0
)%
(58.2
) pts.

Total consolidated revenue

$
58,149

$
59,682

(2.6
)%
(1.9
)%
Total consolidated gross profit

$
27,401

$
29,278

(6.4
)%

Total consolidated gross margin

47.1
%
49.1
%
(1.9
) pts.

Non-operating adjustments:

Amortization of acquired intangible assets

371

268

38.2
%

Retirement-related costs/(income)

238

350

(32.0
)%

Operating (non-GAAP) gross profit

$
28,010

$
29,896

(6.3
)%

Operating (non-GAAP) gross margin

48.2
%
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 September 30:

2016

2015*

Change

Currency

Cognitive Solutions external revenue:

$
4,235

$
4,052

4.5
%
4.5
%
Solutions Software

$
2,919

$
2,710

7.7
%
7.9
%
Transaction Processing Software

1,316

1,343

(2.0
)
(2.2
)

* Recast to conform with 2016 presentation.

Yr. to Yr.

Percent

Yr. to Yr.

Change

(Dollars in millions)

Percent

Adjusted For

For the nine months ended September 30:

2016

2015*

Change

Currency

Cognitive Solutions external revenue:

$
12,889

$
12,616

2.2
%
2.9
%
Solutions Software

$
8,842

$
8,417

5.0
%
5.8
%
Transaction Processing Software

4,048

4,199

(3.6
)
(2.9
)

* 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 third quarter of 2016,~~ Cognitive Solutions revenue of ~~$4,235~~$4,062 million grew 4.5 percent as reported and 5 percent year to year adjusted for currency with sequential improvement in the year to year growth rate for the third consecutive quarter, both as reported and adjusted for currency. For the first nine months of the year, Cognitive Solutions revenue of $12,889 million grew 2.22.1 percent as reported and 3 percent adjusted for ~~currency. On an as~~currency in the first quarter of 2017 compared to the prior year. As reported and ~~constant~~adjusted for currency, ~~basis,~~revenue growth in Solutions Software, ~~revenue grew,~~which addresses many of the company’s strategic areas, was partially offset by declines in Transaction Processing Software.

~~In the third quarter,~~ Solutions Software revenue of ~~$2,919~~$2,792 million grew ~~7.7~~3.7 percent as reported (8(5 percent adjusted for currency)~~, while Transaction Processing~~ compared to the prior year. This growth was led by analytics and security offerings. Analytics, which is the largest portion of the Solutions Software ~~of $1,316 million declined 2.0 percent~~portfolio, continued to grow as reported ~~(2 percent~~and adjusted for currency in key areas including Watson offerings, such as Watson Health. Security contributed to year-to-year growth as reported and adjusted for currency driven by Data Protection

Management Discussion — (continued)

~~currency). Analytics, which is~~and Security Intelligence. Across the ~~largest portion of the Software~~ Solutions portfolio, ~~continued to grow in key areas including Watson. There was strong~~ Software-as-a-Service (SaaS) ~~performance in the quarter with double digit~~revenue had strong double-digit growth ~~in revenue~~ as reported and adjusted for ~~currency.~~currency again this quarter.

~~In the third~~Transaction Processing Software revenue of $1,270 million declined 1.4 percent as reported (1 percent adjusted for currency) compared to first quarter 2016, ~~Watson technology, which underpins~~however there was sequential improvement from the ~~company’s cognitive strategy, continued~~fourth quarter 2016 driven by z Systems and Storage middleware. While the overall business is declining, there are some areas that are growing, such as Software Defined Storage. Other parts of the business are high value and running mission critical workloads for clients, but the growth profile is stable to gain momentum, as the company continued to expand cognitive capabilities in the IBM Cloud. Across Watson, focus continues on scaling Watson Health, growing Watson IoT and expanding industry differentiation.declining.

Within Cognitive Solutions, total ~~third~~first quarter ~~2016~~ strategic imperatives revenue of ~~$2.7~~$2.6 billion grew 116 percent as reported ~~(11~~(7 percent adjusted for currency) year to year. Cloud revenue of $0.6 billion grew 7444 percent as reported ~~(75~~(45 percent adjusted for currency), with an as-a-Service exit run rate of ~~$1.6~~$1.8 billion. For the first nine months of the year, strategic imperatives revenue within Cognitive Solutions of $8.2 billion grew 7 percent as reported (8 percent adjusted for currency), with Cloud revenue of $1.5 billion growing 54 percent year to year as reported (55 percent adjusted for currency).

Yr. to Yr.

Percent/

(Dollars in millions)

Margin

For the three months ended September 30:

2016

2015*

Change

Cognitive Solutions:

External gross profit

$
3,407

$
3,418

(0.3
)%
External gross profit margin

80.4
%
84.4
%
(3.9
) pts.
Pre-tax income

$
1,574

$
1,596

(1.4
)%
Pre-tax margin

32.1
%
34.9
%
(2.7
) pts.

* Recast to conform with 2016 presentation.

Yr. to Yr.

Percent/

(Dollars in millions)

Margin

For the nine months ended September 30:

2016

2015*

Change

Cognitive Solutions:

External gross profit

$
10,509

$
10,709

(1.9
)%
External gross profit margin

81.5
%
84.9
%
(3.4
) pts.
Pre-tax income

$
4,039

$
4,949

(18.4
)%
Pre-tax margin

27.3
%
34.6
%
(7.3
) 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 ~~3.9~~4.7 points to ~~80.4~~77.3 percent in the ~~third~~first quarter ~~primarily due~~of 2017 compared to ~~investments in Software-as-a-Service and acquisition content. For~~ the ~~first nine months~~prior year. Pre-tax income of $1,274 million increased 25.7 percent compared to the prior year ~~the gross profit~~with a pre-tax margin ~~declined 3.4~~improvement of 4.8 points to ~~81.5 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 third quarter, pre-tax income of $1,574 million decreased 1.4 percent~~Gross profit margin declined year to year ~~with~~driven by continued investment in strategic areas, including acquisitions and an increasing mix toward SaaS. Approximately 25 percent of the Cognitive Solutions business is now comprised of services and SaaS offerings, which currently has a ~~pre-tax~~different margin ~~decline of 2.7 points to 32.1 percent. For~~profile than the traditional software delivery offerings. In the first ~~nine months of 2016,~~quarter, pre-tax margins expanded and pre-tax income ~~decreased 18.4 percent with a pre-tax margin of 27.3 percent down 7.3 points~~improved year to ~~year. Performance continued~~year as the company continues to ~~reflect the company’s higher level of investment in the strategic growth areas, including the Watson businesses.~~

~~Management Discussion — (continued)~~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 September 30:

2016

2015*

Change

Currency

Global Business Services external revenue:

$
4,191

$
4,206

(0.4
)%
(1.6
)%
Consulting

$
1,799

$
1,863

(3.4
)%
(5.1
)%
Global Process Services

354

359

(1.3
)
(0.9
)
Application Management

2,038

1,981

2.9

1.6

* Recast to conform with 2016 presentation.

Yr. to Yr.

Percent

Yr. to Yr.

Change

(Dollars in millions)

Percent

Adjusted For

For the nine months ended September 30:

2016

2015*

Change

Currency

Global Business Services external revenue:

$
12,578

$
12,869

(2.3
)%
(2.2
)%
Consulting

$
5,520

$
5,763

(4.2
)%
(4.7
)%
Global Process Services

1,048

1,078

(2.8
)
(1.5
)
Application Management

6,011

6,027

(0.3
)
0.1

* 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
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	)

~~In the third quarter of 2016,~~ Global Business Services revenue of ~~$4,191~~$4,006 million decreased ~~0.4~~3.0 percent as reported and 2 percent adjusted for ~~currency. There was improvement~~currency in ~~the revenue growth trajectory~~first quarter of 2017 compared ~~with~~to the prior ~~quarter both as reported and adjusted for currency. Digital practices, which now make up more than half of GBS,~~year. Strategic imperatives grew double digits as reported and adjusted for currency, ~~including strong growth in~~led by cloud ~~analytics~~ and ~~mobile.~~mobile practices. This growth was more than offset by declines in the more traditional ~~areas. For~~areas that the ~~first nine months of the year, GBS~~company is shifting away from, such as large ERP and on-premise enterprise application implementations.

Consulting revenue of ~~$12,578~~$1,769 million declined ~~2.3 percent as reported and 2 percent adjusted for currency.~~

~~In the third quarter, Application Management revenue of $2,038 million grew 2.9~~3.6 percent as reported (2 percent adjusted for currency)~~, compared to the prior year driven by growth in the company’s digital foundation and mobile platforms. Consulting revenue of $1,799 million declined 3.4 percent~~ with lower percentage declines on a sequential basis, as reported ~~(5 percent adjusted for currency) as some larger contracts wound down~~ and ~~clients continue~~at constant currency. In Consulting, the shift to ~~move~~cognitive services, advanced analytics and digital platforms, away from ~~on-premise enterprise application work to new business models focused on digital and cloud.~~more traditional areas is reflected in this revenue performance. Global Process Services (GPS) revenue of ~~$354~~$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 ~~(1 percent~~ (flat

Management Discussion — (continued)

adjusted for currency). as the company continues to innovate clients’ platforms, helping them migrate to new cloud architectures, increase their speed and agility and improve their competitiveness.

Within GBS, total ~~third~~first quarter 2017 strategic imperatives revenue of ~~$2.3~~$2.2 billion grew 1312 percent as reported ~~(12~~(13 percent adjusted for currency) year to year. Cloud revenue of ~~$0.8~~$0.9 billion grew 7456 percent as reported ~~(69~~(57 percent adjusted for currency), with an as-a-Service exit run rate of ~~$0.8~~$1.0 billion. For the first nine months of the year, strategic imperatives revenue within GBS of $6.6 billion grew 15 percent as reported (15 percent adjusted for currency), with Cloud revenue of $2.1 billion growing 64 percent year to year as reported (62 percent adjusted for currency).

The company continues to respond to enterprises looking for new ways to reach their customers and empower their employees to make faster decisions. There was continued revenue growth, as reported and adjusted for currency, in enterprise mobility solutions that are helping clients redesign work flows with specific industry context. The growing collection of MobileFirst for iOS applications are delivered on the cloud and can connect back to clients’ core systems and infrastructure. A new IBM MobileFirst Garage was opened in Bangalore, which is part of a network of centers that helps clients around the world achieve mobile-led digital transformations at speed and at scale.

~~Management Discussion — (continued)~~

Yr. to Yr.

Percent/

(Dollars in millions)

Margin

For the three months ended September 30:

2016

2015*

Change

Global Business Services:

External gross profit

$
1,206

$
1,249

(3.4
)%
External gross profit margin

28.8
%
29.7
%
(0.9
) pts.
Pre-tax income

$
544

$
664

(18.0
)%
Pre-tax margin

12.7
%
15.4
%
(2.6
) pts.

* Recast to conform with 2016 presentation.

Yr. to Yr.

Percent/

(Dollars in millions)

Margin

For the nine months ended September 30:

2016

2015*

Change

Global Business Services:

External gross profit

$
3,393

$
3,625

(6.4
)%
External gross profit margin

27.0
%
28.2
%
(1.2
) pts.
Pre-tax income

$
1,210

$
1,895

(36.2
)%
Pre-tax margin

9.4
%
14.3
%
(4.9
) 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 third quarter, the~~ GBS gross profit margin decreased ~~0.9~~2.2 points to ~~28.8~~23.6 percent compared to the prior ~~year, with an improvement in Application Management offset by~~year. There were declines in Consulting and ~~GPS. Margin expanded in~~GPS, while the Application Management ~~as the mix moves to the new cloud and digital platforms and as a result of workforce rebalancing driving productivity in the delivery model. Consulting~~ gross profit margin ~~declined, reflecting the company’s investments to grow the digital practices. In addition, similar to last quarter, there~~ was ~~additional spending incurred to meet commitments. These dynamics are also reflected in the pre-tax margin for the quarter.~~essentially flat. In the ~~third~~first quarter of 2017, pre-tax income of ~~$544~~$291 million ~~decreased 18.0~~increased 53.4 percent and the pre-tax margin ~~declined~~expanded 2.6 points to ~~12.7~~7.1 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.

~~The company continues to shift~~GBS profit performance in the ~~business to~~first quarter reflects the company’s continued investment in the strategic imperatives ~~within GBS. While recent acquisitions impact near term profit, they have added important capabilities, including~~and the expansion of practices around cognitive, cloud, ~~consulting skills. The IBM Interactive Experience has been expanded~~mobile and digital design, as well as ~~digital design capabilities. The~~additional spending in certain accounts to deliver on important client commitments. In parallel, the company is ~~focused on integrating~~in the process of streamlining the practices infrastructure and ~~scaling these~~driving efficiencies in the delivery model through new ~~skills as it continues to expand the digital practices.~~methods, solutions, and 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 September 30:	2016		2015*		Change		Currency
For the three months ended March 31:									2017		2016		Change		Currency
Technology Services & Cloud Platforms external revenue:	$	8,748	$	8,541	2.4	%	1.4	%	$	8,216	$	8,424	(2.5	)%	(2.0	)%
Infrastructure Services	$	5,901	$	5,714	3.3	%	1.9	%	$	5,485	$	5,626	(2.5	)%	(1.9	)%
Technical Support Services	1,831		1,841		(0.5	)	(1.5	)	1,761		1,786		(1.4	)	(1.6	)
Integration Software	1,016		986		3.1		3.6		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.

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.

Technical Support Services revenue of $1,761 million decreased 1.4 percent as reported (2 percent adjusted for currency). While revenue declined year to 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)

Yr. to Yr.

Percent

Yr. to Yr.

Change

(Dollars in millions)

Percent

Adjusted For

For the nine months ended September 30:

2016

2015*

Change

Currency

Technology Services & Cloud Platforms external revenue:

$
26,029

$
25,993

0.1
%
1.0
%
Infrastructure Services

$
17,458

$
17,146

1.8
%
2.5
%
Technical Support Services

5,446

5,603

(2.8
)
(1.4
)
Integration Software

3,126

3,244

(3.7
)
(2.6
)

* Recast to conform with 2016 presentation.

~~In the third quarter of 2016, Technology Services & Cloud Platforms~~Integration Software revenue of ~~$8,748~~$969 million ~~grew 2.4~~decreased 4.2 percent as reported ~~and 1~~(3 percent adjusted for ~~currency~~currency) in the first quarter of 2017 compared to the prior year. ~~As the business shifts from systems~~Within Integration Software, there was growth as reported and adjusted for currency in hybrid integration ~~to services integration, there is continued momentum in new offerings. Infrastructure Services~~software that connects and ~~Integration Software~~integrates applications, data, and processes across on-premise and cloud environments. Websphere Application Server revenue grew as reported and adjusted for currency ~~partially offset by declines~~demonstrating the importance of middleware in ~~Technical Support Services. For the first nine months of the~~public, private and hybrid enviroments. On-premise Development Operations (“DevOps”) tools and IT services management software declined year ~~Technology Services & Cloud Platforms revenue of $26,029 million increased 0.1 percent~~to year as reported and ~~1 percent~~ adjusted for ~~currency.~~

~~Infrastructure Services revenue~~currency as these types of $5,901 million grew 3.3 percent as reported (2 percent adjusted for currency) in the third quarter. Technical Support Services third quarter revenue of $1,831 million decreased 0.5 percent as reported (1 percent adjusted for currency). Integration Software revenue of $1,016 million grew 3.1 percent as reported (4 percent adjusted for currency) comparedworkloads continue to shift from on-premise to the ~~third quarter of the prior year.~~

In Infrastructure Services, the company’s hybrid cloud strategy continues to resonate with clients moving to enterprise grade cloud solutions that are secure, agile and leverage the data and investments in their core systems. The company continues to expand its cloud infrastructure, announcing the opening of new cloud data centers in South Korea and Norway in the third quarter. The company now has 49 cloud centers around the world, enabling low latency connectivity to cloud infrastructure.

In Integration Software, there was continued strength in Connect products that integrate applications, data and processes for on-premise and cloud environments. There was also a continued shift of the portfolio to an as-a-Service model through IBM’s Bluemix cloud platform which continues to scale across a broad catalog of high value services.cloud.

Within Technology Services & Cloud Platforms, total ~~third~~first quarter 2017 strategic imperatives revenue of ~~$2.3~~$2.4 billion grew 4530 percent as reported ~~(42~~(31 percent adjusted for currency) year to year. Cloud revenue of ~~$1.5~~$1.7 billion grew 5841 percent as reported ~~(55~~(42 percent adjusted for currency), with an as-a-Service exit run rate of ~~$5.1~~$5.7 billion. For the first nine months of the year, strategic imperatives revenue within Technology Services & Cloud Platforms of $6.2 billion grew 40 percent as reported (41 percent adjusted for currency), with Cloud revenue of $4.1 billion growing 49 percent as reported (49 percent adjusted for currency).

Yr. to Yr.

Percent/

(Dollars in millions)

Margin

For the three months ended September 30:

2016

2015*

Change

Technology Services & Cloud Platforms:

External Technology Services gross profit

$
2,825

$
2,774

1.8
%
External Technology Services gross profit margin

36.5
%
36.7
%
(0.2
) pts.
External Integration Software gross profit

$
851

$
833

2.2
%
External Integration Software gross profit margin

83.8
%
84.5
%
(0.7
) pts.
External total gross profit

$
3,676

$
3,607

1.9
%
External total gross profit margin

42.0
%
42.2
%
(0.2
) pts.
Pre-tax income

$
1,288

$
1,317

(2.2
)%
Pre-tax margin

14.4
%
15.1
%
(0.7
) pts.

* Recast to conform with 2016 presentation.

~~Management Discussion — (continued)~~

Yr. to Yr.

Percent/

(Dollars in millions)

Margin

For the nine months ended September 30:

2016

2015*

Change

Technology Services & Cloud Platforms:

External Technology Services gross profit

$
8,176

$
8,190

(0.2
)%
External Technology Services gross profit margin

35.7
%
36.0
%
(0.3
) pts.
External Integration Software gross profit

$
2,630

$
2,768

(5.0
)%
External Integration Software gross profit margin

84.2
%
85.3
%
(1.2
) pts.
External total gross profit

$
10,806

$
10,958

(1.4
)%
External total gross profit margin

41.5
%
42.2
%
(0.6
) pts.
Pre-tax income

$
2,825

$
3,861

(26.8
)%
Pre-tax margin

10.6
%
14.6
%
(3.9
) 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 ~~0.2~~2.0 points to ~~42.0~~38.9 percent in the ~~third~~first quarter of 2017 compared to the prior year, with ~~improvement in Infrastructure Services offset by~~ declines in Technical Support Services and Integration Software. The margin expansion in Infrastructure Services reflects the benefits from productivity actions to streamline processes. The company is investing in its technology and using its cognitive capabilities to shift to a more automated delivery model to improve performance and drive efficiencies. The Technical Support Services margin decline was driven by the mix to multi-vendor support offerings. Foracross all lines of business. In the first ~~nine months~~quarter of ~~2016, gross~~2017, pre-tax income of $687 million increased 166.1 percent and the pre-tax margin ~~decreased 0.6~~expanded 5.2 points to ~~41.5 percent~~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.

InAcross the ~~third quarter,~~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 income ~~of $1,288 million decreased 2.2 percent~~during the quarter. In Technical Support Services, margins were impacted by the shift toward multi-vendor services. In Integration Software, margins were negatively impacted in the quarter from mix to SaaS and ~~pre-tax margin declined 0.7 points to 14.4 percent. For~~royalty cost associated with IP partnerships. Ongoing benefits associated with these partnerships include lower development expense (RD&E) and royalties from the ~~first nine months of 2016, pre-tax income decreased 26.8 percent~~IP partners associated with ~~a pre-tax margin of 10.6 percent down 4.0 points year to year. The pre-tax margins reflect the dynamics impacting gross profit as well as the continued investments to build out the cloud platform.~~their sales (IP income).

Services Backlog and Signings

Yr. to Yr.

Percent

Yr. to Yr.

Change

At September

At September

Percent

Adjusted For

(Dollars in billions)

2016

2015*

Change

Currency

Total backlog

$
121.3

$
120.1

0.9
%
(0.7
)%

* 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 ~~September 30, 2016~~March 31, 2017 was ~~$121~~$116 billion, ~~an increase~~a decrease of ~~0.9~~4.9 percent as reported, and ~~a decrease of 1~~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 September 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 that have flexibility in contractual commitment 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 September 30:	2016		2015*		Change		Currency
For the three months ended March 31:									2017		2016		Change		Currency
Total signings	$	8,955	$	8,918	0.4	%	(1.1	)%	$	7,906	$	8,024	(1.5	)%	(0.2	)%

* Recast to conform with 2016 presentation.

* Recast and reclassified 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 September 30:

2016

2015*

Change

Currency

Systems external revenue:

$
1,558

$
1,973

(21.0
)%
(21.5
)%
Systems Hardware

$
1,128

$
1,491

(24.3
)%
(24.8
)%
z Systems

(35.0
)
(35.3
)
Power Systems

(30.8
)
(31.2
)
Storage Systems

(8.0
)
(8.8
)
Operating Systems Software

430

482

(10.8
)
(11.3
)

* Recast to conform with 2016 presentation.

Yr. to Yr.

Percent

Yr. to Yr.

Change

(Dollars in millions)

Percent

Adjusted For

For the nine months ended September 30:

2016

2015*

Change

Currency

Systems external revenue:

$
5,184

$
6,656

(22.1
)%
(21.9
)%
Systems Hardware

$
3,852

$
5,204

(26.0
)%
(25.9
)%
z Systems

(40.2
)
(40.0
)
Power Systems

(23.5
)
(23.2
)
Storage Systems

(9.7
)
(9.8
)
Operating Systems Software

1,332

1,451

(8.2
)
(7.5
)

* 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 third quarter of 2016,~~ Systems revenue of ~~$1,558~~$1,395 million decreased ~~21.0~~16.8 percent as reported and 21 percent adjusted for currency compared to the prior year reflecting important market shifts in this business and product cycle dynamics. For the first nine months of the year, Systems revenue of $5,184 million declined 22.1 percent as reported and 22 percent adjusted for currency.

~~Systems Hardware revenue of $1,128 million decreased 24.3 percent as reported (25~~(16 percent adjusted for currency) in the ~~third quarter.~~first quarter of 2017 compared to the prior year. 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 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 ~~third quarter~~ revenue of ~~$430~~$394 million decreased ~~10.8~~10.5 percent as reported ~~(11~~(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 in the first quarter of 2017, UNIX declined as reported and adjusted for currency driven by midrange and low-end systems.

Storage Systems 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 a continued shift in value towards software-defined environments, where the company continues to 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)

Across Systems, the company faces product cycle headwinds and some transitions in Power and Storage, while continuing to deliver innovative technologies and significant new capabilities to address cognitive and cloud.

Within Systems Hardware, z Systems third quarter revenue decreased 35.0 percent as reported (35 percent adjusted for currency) year to year. Seven quarters into the z13 cycle, this performance reflects product cycle dynamics. The company continues to add new clients to the platform and introduce new technologies including blockchain. As the blockchain platform is built, it is being engineered to run on multiple platforms, but it is optimized for scale, security and resilience on both the IBM mainframe and IBM Cloud. The company’s z Systems are well suited for these new workloads due to their advanced security features that help protect data and ensure the integrity of the overall blockchain networks.

Power Systems third quarter revenue decreased 30.8 percent as reported (31 percent adjusted for currency) year to year reflecting the company’s performance in a declining UNIX market partially offset by growth in an expanding Linux market. The company is shifting its platform to address Linux which now represents over 15 percent of Power revenue in the third quarter. There has been success with HANA where the company is bringing in new clients and replicating this strategy with others. The UNIX market remains a high-value space for clients and, at the end of the third quarter, new midrange and high end systems were introduced. These systems are designed for hybrid cloud computing and flexible consumption models to transform on-premise IT to the Cloud. In Power, the company is shifting to Linux while continuing to serve the UNIX space, but it is a long transition. In the near term, the company is focused on stabilizing the margin base.

Storage Systems third quarter revenue decreased by 8.0 percent as reported (9 percent adjusted for currency) year to year, with continued market shift to software. The third quarter decline was mainly driven by low-end and midrange traditional disk storage. High-end disk storage revenue grew this quarter both as reported and adjusted for currency. The company recently rolled out new products and transitioned to a full suite of flash offerings improving its competitive position. While not within the Systems segment, Software-Defined Storage had continued double-digit revenue growth as reported and adjusted for currency in the third quarter.

Within Systems, total ~~third~~first quarter strategic imperatives revenue of ~~$0.7~~$0.5 billion decreased 1816 percent as reported ~~(18~~(15 percent adjusted for currency) year to year. Cloud revenue of ~~$0.5~~$0.4 billion decreased 16 percent as reported ~~(16 percent~~and adjusted for currency). For the first nine months of the year, strategic imperatives revenue within Systems of $2.3 billion decreased 13 percent as reported (13 percent adjusted for currency), with Cloud revenue of $1.8 billion decreasing 9 percent as reported (9 percent adjusted for currency).currency.

							Yr. to Yr.								Yr. to Yr.
							Percent/								Percent/
(Dollars in millions)							Margin								Margin
For the three months ended September 30:	2016			2015*			Change
For the three months ended March 31:									2017			2016			Change
Systems:
External Systems Hardware gross profit	$	416		$	668		(37.6	)%	$	319		$	572		(44.2	)%
External Systems Hardware gross profit margin	36.9		%	44.8		%	(7.9	) pts.	31.9		%	46.4		%	(14.4	)pts.
External Operating Systems Software gross profit	$	380		$	435		(12.8	)%	$	343		$	387		(11.4	)%
External Operating Systems Software gross profit margin	88.3		%	90.2		%	(2.0	) pts.	86.9		%	87.8		%	(0.9	)pts.
External total gross profit	$	796		$	1,103		(27.8	)%	$	662		$	959		(31.0	)%
External total gross profit margin	51.1		%	55.9		%	(4.8	) pts.	47.5		%	57.2		%	(9.8	)pts.
Pre-tax income/(loss)	$	136		$	248		(45.3	)%	$	(186	)	$	(10	)	nm	%
Pre-tax margin	7.8		%	11.4		%	(3.5	) 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 nine months ended September 30:

2016

2015*

Change

Systems:

External Systems Hardware gross profit

$
1,676

$
2,399

(30.1
)%
External Systems Hardware gross profit margin

43.5
%
46.1
%
(2.6
) pts.
External Operating Systems Software gross profit

$
1,182

$
1,312

(9.9
)%
External Operating Systems Software gross profit margin

88.7
%
90.4
%
(1.7
) pts.
External total gross profit

$
2,858

$
3,711

(23.0
)%
External total gross profit margin

55.1
%
55.8
%
(0.6
) pts.
Pre-tax income/(loss)

$
354

$
1,048

(66.2
)%
Pre-tax margin

6.1
%
14.5
%
(8.4
) pts.

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

The Systems gross profit margin decreased ~~4.8~~9.8 points to ~~51.1~~47.5 percent in the ~~third~~first quarter of ~~2016~~2017 compared to the prior ~~year. This decrease was due to margin (4.7 points)~~year with declines ~~in Power~~across all hardware brands and ~~Storage partially offset by expansion in z~~Operating Systems ~~margins. The Systems gross profit margin decreased 0.6 points to 55.1 percent~~software, and an impact from mix. For the first three months of 2017, the pre-tax loss was $186 million compared with a pre-tax loss of $10 million in the ~~first nine months~~prior year which included a higher level of ~~2016 compared~~charges related to ~~the prior year. This decrease was due to a less favorable product mix (0.5 points)~~workforce rebalancing and ~~decline in margin (0.1 points).~~

~~In the third quarter, pre-tax income of $136 million decreased 45.3 percent and the pre-tax~~real estate actions. Pre-tax margin declined ~~3.5~~11.4 points year to ~~7.8 percent,~~year consistent with the product cycle, ~~and~~ portfolio transition dynamics, and hardware price pressure impacting revenue and profit.

The 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 portfolio remains optimized for cognitive and cloud computing.

Global Financing

See pages 8162 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 focus on IBM’s software revenue performance, the company will continue to report total software revenue performance throughout 2016. The company has a broad software portfolio, from solutions that provide cognitive, analytics and security solutions, to core transaction processing, to connecting on-premises data and processes to private and public cloud environments. This software is open, running on IBM and non-IBM environments.

Total software revenue, which includes Cognitive Solutions, Integration Software and Operating Systems software, of $5,681 million increased 2.9 percent as reported and 3 percent adjusted for currency in the third quarter of 2016 compared to the prior year period. Overall, third quarter performance reflected sequential improvement of 2 points from the second quarter of 2016 as reported and adjusted for currency. This represents the third consecutive quarter of improvement in constant currency software revenue growth trajectory. From a business area perspective, there was growth in Cognitive Solutions and Integration Software as reported and adjusted for currency, while Operating Systems was down year to year, in line with the longer term secular trend. Across software, annuity revenue grew mid-single digits year to year as reported and adjusted for currency. This growth was led by the SaaS offerings which grew both on an organic basis and from acquisitions. Transactional revenue declined mid-single digits as reported and adjusted for currency in the quarter.

For the first nine months of 2016, total Software revenue of $17,347 million grew 0.2 percent as reported and 1 percent adjusted for currency, with growth in Cognitive Solutions, partially offset by declines in Integration Software and Operating Systems software.

~~Management Discussion — (continued)~~

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.

Yr. to Yr.

Percent

Yr. to Yr.

Change

(Dollars in millions)

Percent

Adjusted For

For the three months ended September 30:

2016

2015

Change

Currency

Total Revenue

$
19,226

$
19,280

(0.3
)%
(1.1
)%
Geographies:

$
19,159

$
19,214

(0.3
)%
(1.1
)%
Americas

9,070

9,105

(0.4
)
(0.2
)
Europe/Middle East/Africa (EMEA)

5,851

6,059

(3.4
)
(0.3
)
Asia Pacific

4,238

4,051

4.6

(4.4
)

							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 nine months ended September 30:	2016		2015		Change		Currency
For the three months ended March 31:									2017		2016		Change		Currency
Total Revenue	$	58,149	$	59,682	(2.6	)%	(1.9	)%	$	18,155	$	18,684	(2.8	)%	(2.2	)%
Geographies:	$	57,932	$	59,442	(2.5	)%	(1.9	)%	$	18,072	$	18,611	(2.9	)%	(2.2	)%
Americas	27,229		28,234		(3.6	)	(2.0	)	8,678		8,673		0.1		(1.0	)
Europe/Middle East/Africa (EMEA)	18,032		18,753		(3.8	)	(1.7	)	5,430		5,906		(8.1	)	(3.7	)
Asia Pacific	12,671		12,454		1.7		(1.9	)	3,964		4,031		(1.7	)	(2.8	)

Total geographic revenue of ~~$19,159~~$18,072 million decreased 0.3 percent as reported and 1 percent adjusted for currency in the third quarter of 2016 compared to the prior year. Americas revenue of $9,070 million decreased 0.4 percent as reported and was flat adjusted for currency. EMEA third quarter revenue of $5,851 million decreased 3.4 percent as reported, but was flat adjusted for currency. Both Americas and EMEA third quarter revenue improved sequentially from the prior quarter (both as reported and adjusted for currency). Asia Pacific revenue of $4,238 million grew 4.6 percent as reported, but decreased 4 percent adjusted for currency.

Within Americas, the U.S. third quarter revenue was flat compared to the prior year, but improved sequentially from the prior quarter. Canada was down 6.3 percent as reported and 7 percent adjusted for currency. Latin America increased 3.7 percent as reported and 5 percent adjusted for currency in the third quarter compared to the prior year. Within Latin America, Brazil increased 23.5 percent as reported and 17 percent adjusted for currency, reflecting the importance of z Systems software and hardware to the banking sector.

In the third quarter, within EMEA, revenue in the UK decreased 12.5 percent as reported, but increased 3 percent adjusted for currency. Germany decreased 2.7 percent as reported and 3 percent adjusted for currency. France decreased 3.2 percent as reported and 4 percent adjusted for currency. The Nordics increased 4.2 percent as reported and 4 percent adjusted for currency. Third quarter revenue in EMEA improved sequentially from the prior quarter as reported and adjusted for currency, including Germany, France and the Nordics. In the Central and Eastern European region, third quarter revenue decreased as reported and adjusted for currency, with Russia declining 24.7 percent. The Middle East and Africa region grew 5.0 percent as reported and 6 percent adjusted for currency.

Within Asia Pacific, Japan grew 15.9 percent as reported, but decreased 3 percent adjusted for currency. Australia decreased 0.8 percent as reported and 5 percent adjusted for currency, but improved sequentially from the prior quarter (both as reported and adjusted for currency). India increased 6.5 percent as reported and 9 percent adjusted for currency. China decreased 20.8 percent as reported and 18 percent adjusted for currency.

~~Total geographic revenue of $57,932 million decreased 2.5~~2.9 percent as reported and 2 percent adjusted for currency in the first ~~nine months~~quarter of ~~2016~~2017 compared to the prior year. Americas revenue of ~~$27,229~~$8,678 million ~~decreased 3.6 percent~~was essentially flat year to year as reported, ~~and 2~~but decreased 1 percent adjusted for currency. EMEA revenue of ~~$18,032~~$5,430 million decreased ~~3.8~~8.1 percent as reported and 24 percent adjusted for currency. Asia Pacific revenue of ~~$12,671~~$3,964 million ~~grew~~decreased 1.7 percent as reported ~~but declined 2~~and 3 percent adjusted for currency.

Management Discussion — (continued)

Within Americas, ~~the~~ U.S. revenue decreased ~~2.0~~1.3 percent compared to ~~the first nine months of~~ the prior year. Canada was ~~down 6.4~~up 3.2 percent as reported, ~~and 2 percent~~but was essentially flat year to year adjusted for currency. Latin America ~~decreased 11.4~~increased 7.0 percent as reported, and ~~2 percent~~was essentially flat year to year adjusted for currency. Within Latin America, Brazil ~~declined 13.8~~was up 18.6 percent as reported, but down 1 percent adjusted for currency, and 6Mexico decreased 2.4 percent as reported, but was up 4 percent adjusted for currency.

~~Within~~The EMEA year-to-year revenue in the UK decreased 8.4 percent as reported, but increased 1 percent adjusted for currency compared to the first nine months of the prior year. Germany decreased 4.2 percent as reported and 4 percent adjusted for currency. France decreased 3.4 percent as reported and 3 percent adjusted for currency. Italy grew 1.6 percent as reported and 1 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 21.6 percent.~~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, ~~and 7 percent~~but was essentially flat year to year adjusted for currency.

Within Asia Pacific, Japan ~~grew 11.3 percent as reported, but~~revenue was ~~flat adjusted for currency compared to the first nine months of the prior year. Australia decreased 9.0~~up 0.9 percent as reported and ~~6 percent~~essentially flat adjusted for currency. India grew ~~7.5~~5.6 percent as reported and 135 percent adjusted for currency. China decreased ~~10.5~~12.6 percent as reported ~~and 8~~(10 percent adjusted for ~~currency.~~currency). Australia decreased 12.5 percent (17 percent adjusted for currency).

Expense

Total Expense and Other (Income)

Yr. to Yr.

(Dollars in millions)

Percent

For the three months ended September 30:

2016

2015

Change

Total consolidated expense and other (income)

$
5,751

$
5,815

(1.1
)%
Non-operating adjustments:

Amortization of acquired intangible assets

$
(136
)
$
(73
)
87.2
%
Acquisition-related charges

(4
)
(4
)
19.2

Non-operating retirement-related (costs)/income

(60
)
(86
)
(30.3
)
Operating (non-GAAP) expense and other (income)

$
5,550

$
5,652

(1.8
)%
Total consolidated expense-to-revenue ratio

29.9
%
30.2
%
(0.2
)pts.
Operating (non-GAAP) expense-to-revenue ratio

28.9
%
29.3
%
(0.4
)pts.

							Yr. to Yr.								Yr. to Yr.
(Dollars in millions)							Percent								Percent
For the nine months ended September 30:	2016			2015			Change
For the three months ended March 31:									2017			2016			Change
Total consolidated expense and other (income)	$	20,056		$	18,431		8.8	%	$	6,348		$	7,652		(17.0	)%
Non-operating adjustments:
Amortization of acquired intangible assets	$	(371	)	$	(224	)	65.8	%	$	(130	)	$	(99	)	31.1	%
Acquisition-related charges	(1		)	(11		)	(88.7	)	(13		)	27			nm
Non-operating retirement-related (costs)/income	(206		)	(481		)	(57.1	)	(185		)	(63		)	192.2
Operating (non-GAAP) expense and other (income)	$	19,478		$	17,715		9.9	%	$	6,020		$	7,516		(19.9	)%
Total consolidated expense-to-revenue ratio	34.5		%	30.9		%	3.6	pts.	35.0		%	41.0		%	(6.0	)pts.
Operating (non-GAAP) expense-to-revenue ratio	33.5		%	29.7		%	3.8	pts.	33.2		%	40.2		%	(7.1	)pts.

Total expense and other (income) decreased 1.1 percent in the third quarter and increased 8.8 percent in the first nine months of 2016 compared to the prior year periods. Total operating (non-GAAP) expense and other (income) decreased 1.8 percent in the third quarter and increased 9.9 percent in the first nine months of 2016 compared to the third quarter and first nine months of 2015, respectively. The key drivers of the year-to-year change in total expense and other (income) were approximately:

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

	~~Total Consolidated~~		~~Operating (non-GAAP)~~
~~For the three and nine months ended September 30, 2016:~~	~~Three Months~~	~~Nine Months~~	~~Three Months~~	~~Nine Months~~
Currency*	~~3 points~~	~~2 points~~	~~3 points~~	~~2 points~~
Acquisitions**	~~6 points~~	~~5 points~~	~~5 points~~	~~4 points~~
~~Base~~	~~(10) points~~	~~2 points~~	~~(10) points~~	~~4 points~~

*	~~Reflects impacts of translation and hedging programs.~~
**	~~Includes acquisitions completed in prior 12-month period; operating (non-GAAP) is net of non-operating acquisition-related charges.~~

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 September 30:	2016			2015			Change
For the three months ended March 31:									2017			2016			Change
Selling, general and administrative expense:
Selling, general and administrative — other	$	3,983		$	3,922		1.6	%	$	4,127		$	4,192		(1.5	)%
Advertising and promotional expense	341			315			8.4		363			348			4.4
Workforce rebalancing charges	25			112			(77.3	)	167			998			(83.3	)
Retirement-related costs	174			202			(13.7	)	258			179			44.7
Amortization of acquired intangible assets	136			73			87.2		130			99			31.1
Stock-based compensation	105			82			28.9		91			99			(7.6	)
Bad debt expense	(32		)	27			nm		15			97			(84.9	)
Total consolidated selling, general and administrative expense	$	4,732		$	4,731		0.0	%	$	5,152		$	6,012		(14.3	)%
Non-operating adjustments:
Amortization of acquired intangible assets	$	(136	)	$	(73	)	87.2	%	$	(130	)	$	(99	)	31.1	%
Acquisition-related charges	(3		)	(4		)	(25.9	)	(9		)	32			nm
Non-operating retirement-related (costs)/income	(53		)	(74		)	(28.5	)	(136		)	(55		)	148.1
Operating (non-GAAP) selling, general and administrative expense	$	4,541		$	4,581		(0.9	)%	$	4,877		$	5,890		(17.2	)%

nm –— not meaningful

Yr. to Yr.

(Dollars in millions)

Percent

For the nine months ended September 30:

2016

2015

Change

Selling, general and administrative expense:

Selling, general and administrative — other

$
12,697

$
12,234

3.8
%
Advertising and promotional expense

1,051

968

8.5

Workforce rebalancing charges

1,038

575

80.7

Retirement-related costs

551

827

(33.4
)
Amortization of acquired intangible assets

371

224

65.8

Stock-based compensation

295

260

13.4

Bad debt expense

90

184

(50.9
)
Total consolidated selling, general and administrative expense

$
16,093

$
15,273

5.4
%
Non-operating adjustments:

Amortization of acquired intangible assets

$
(371
)
$
(224
)
65.8
%
Acquisition-related charges

6

(6
)
nm

Non-operating retirement-related (costs)/income

(183
)
(445
)
(58.8
)
Operating (non-GAAP) selling, general and administrative expense

$
15,545

$
14,598

6.5
%

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

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

· Lower workforce rebalancing charges ~~(2 points); and~~

· ~~Lower base spending (4 points); offset by~~

~~Management Discussion — (continued)~~

· ~~Higher acquisition-related spending (6~~(14 points); and

· The effects of currency (1 point).

~~Operating (non-GAAP) expense decreased 0.9 percent year to year in the third quarter of 2016 driven primarily by:~~

· ~~Lower workforce rebalancing charges (2 points); and~~

· ~~Lower base spending (4 points)~~; partially offset by

· ~~Acquisition-related spending (4 points); and~~

·The ~~effects~~impact of ~~currency (1 point).~~

~~SG&A expense increased 5.4 percent~~acquisitions completed in the ~~first nine months of 2016 versus the first nine months of 2015 driven primarily by the following factors:~~

· ~~Acquisition-related spending (4 points); and~~

· ~~Higher workforce rebalancing charges (3 points); partially offset by~~

· A prior ~~year pension obligation related to litigation in Spain~~12-month period (2 points).

Operating (non-GAAP) expense ~~increased 6.5~~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 ~~$94~~$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 ~~September 30, 2016,~~March 31, 2017, an increase of 3020 basis points from December 31, ~~2015~~2016 and ~~an increase~~a decrease of 1060 basis points from ~~September 30, 2015.~~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 September 30:

2016

2015

Change

Total consolidated research, development and engineering expense

$
1,397

$
1,287

8.5
%
Non-operating adjustment:

Non-operating retirement-related (costs)/income

$
(7
)
$
(12
)
(41.3
)%
Operating (non-GAAP) research, development and engineering expense

$
1,390

$
1,275

9.0
%

							Yr. to Yr.								Yr. to Yr.
(Dollars in millions)							Percent								Percent
For the nine months ended September 30:	2016			2015			Change
For the three months ended March 31:									2017			2016			Change
Total consolidated research, development and engineering expense	$	4,320		$	3,885		11.2	%	$	1,533		$	1,458		5.2	%
Non-operating adjustment:
Non-operating retirement-related (costs)/income	$	(23	)	$	(36	)	(36.7	)%	$	(49	)	$	(9	)	475.6	%
Operating (non-GAAP) research, development and engineering expense	$	4,297		$	3,849		11.6	%	$	1,484		$	1,449		2.4	%

Research, development and engineering (RD&E) expense was ~~7.3 percent and 7.4~~8.4 percent of revenue in the ~~third~~first quarter ~~and first nine months~~ of ~~2016, respectively,~~2017 compared to ~~6.7~~7.8 percent ~~and 6.5 percent~~of revenue in ~~prior year periods, respectively. The company continues to increase 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 8.5 percent~~ in the ~~third~~first quarter of ~~2016 versus the third quarter of 2015~~2017 increased 5.2 percent year to year primarily driven by:

· ~~Higher expense due to~~The impact of acquisitions ~~(9 points); and~~

~~Management Discussion — (continued)~~

· ~~Increased base spending (1 point); partially offset by~~

· ~~The effects of currency (1 point).~~

~~Operating (non-GAAP) RD&E expense increased 9.0 percent~~completed in the ~~third quarter of 2016 compared to the~~ prior ~~year driven primarily by the same factors.~~

~~RD&E expense increased 11.2 percent in the first nine months of 2016 versus the first nine months of 2015 primarily driven by:~~

· ~~Higher expense due to acquisitions (7 points); and~~

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

· The effects of currency (1 point).

Operating (non-GAAP) RD&E expense increased ~~11.6~~2.4 percent in the first ~~nine months~~quarter 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 September 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	$	443	$	99	345.8	%
Licensing/royalty-based fees	32		27		21.3
Licensing of intellectual property including royalty-based fees							$	381	$	157	143.2	%
Custom development income	53		62		(14.2	)	64		51		24.2
Sales/other transfers of intellectual property							1		9		(92.7	)
Total	$	528	$	188	181.2	%	$	445	$	217	105.2	%

Yr. to Yr.

(Dollars in millions)

Percent

For the nine months ended September 30:

2016

2015

Change

Intellectual Property and Custom Development Income:

Sales and other transfers of intellectual property

$
843

$
201

319.1
%
Licensing/royalty-based fees

110

85

29.1

Custom development income

158

203

(22.2
)
Total

$
1,110

$
489

127.1
%

* Reclassified to conform to 2017 presentation.

~~Sales and other transfers~~Licensing of intellectual property including royalty-based fees increased in the ~~third~~first quarter ~~and first nine months~~ of ~~2016~~2017 compared to the prior year ~~periods,~~period, primarily due to ~~transfers~~licensing of certain intellectual property ~~in the second and third quarters of 2016~~ within the company’s Cognitive Solutions software ~~portfolio,~~portfolio. The company had three new partnership agreements in the first quarter of 2017, which included ~~three transactions~~one transaction with period income greater than $100 ~~million in the nine-month period.~~million. The company is licensing IP to partners who are allocating their skills to extend the value of assets that are high value, but ~~not necessarily~~may be in ~~growing~~mature markets. There were no significant individual IP transactions in the ~~three or nine month periods~~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.

Management Discussion — (continued)

Other ~~(income)~~(Income) and ~~expense~~Expense

Yr. to Yr.

(Dollars in millions)

Percent

For the three months ended September 30:

2016

2015

Change

Other (income) and expense:

Foreign currency transaction losses/(gains)

$
93

$
329

(71.8
)%
(Gains)/losses on derivative instruments

(23
)
(385
)
(93.9
)
Interest income

(22
)
(16
)
41.2

Net (gains)/losses from securities and investment assets

(5
)
(8
)
(41.3
)
Other

(51
)
(53
)
(5.1
)
Total consolidated other (income) and expense

$
(8
)
$
(133
)
(93.7
)%
Non-operating adjustment:

Acquisition-related charges

$
(2
)
$
0

nm

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

$
(10
)
$
(133
)
(92.5
)%

~~nm - not meaningful~~

Yr. to Yr.

(Dollars in millions)

Percent

For the nine months ended September 30:

2016

2015

Change

Other (income) and expense:

Foreign currency transaction losses/(gains)

$
514

$
394

30.4
%
(Gains)/losses on derivative instruments

(339
)
(696
)
(51.3
)
Interest income

(76
)
(52
)
44.6

Net (gains)/losses from securities and investment assets

29

(31
)
nm

Other

153

(193
)
nm

Total consolidated other (income) and expense

$
281

$
(578
)
nm

Non-operating adjustment:

Acquisition-related charges

$
(7
)
$
(5
)
38.0
%
Operating (non-GAAP) other (income) and expense

$
274

$
(583
)
nm

~~nm - not meaningful~~

							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

Total consolidated other (income) and expense was income of $8$28 million in the ~~third~~first quarter of ~~2016~~2017 compared to ~~income~~expense of ~~$133~~$253 million in the ~~third quarter of 2015.~~prior year. The decrease in ~~income~~expense of ~~$125~~$280 million year over year was primarily driven by:

· ~~Lower gains on derivative instruments~~Real estate capacity charges (reflected in Other in the above table) in the prior year related to workforce transformation ($~~362~~328 million); ~~partially offset by~~and

· Lower foreign currency transaction losses ($~~236~~210 million).; and

~~The consolidated other (income)~~

· Reduced losses from securities and ~~expense was expense~~investment assets ($33 million), primarily related to the sale of ~~$281 million~~Lenovo shares in the ~~first nine months of 2016 compared to income of $578 million in the first nine months of 2015. The decrease in income of $859 million year over year was primarily driven by:~~prior year; partially offset by

· Lower gains on derivative instruments ($~~357~~218 million); and

· ~~Real estate capacity charges related to the first-quarter 2016 workforce transformation~~Lower gains on divestitures ($~~294~~53 million)~~; and~~

· ~~Higher foreign currency transaction losses ($120 million); and~~

· ~~Increased losses from securities and investment assets ($60 million) primarily related to the sale of Lenovo shares ($37 million) in the first quarter of 2016.~~

~~Management Discussion — (continued)~~.

Interest Expense

Yr. to Yr.

(Dollars in millions)

Percent

For the three months ended September 30:

2016

2015

Change

Interest expense

$
158

$
117

34.7
%

					Yr. to Yr.						Yr. to Yr.
(Dollars in millions)					Percent						Percent
For the nine months ended September 30:	2016		2015		Change
For the three months ended March 31:							2017		2016		Change
Interest expense	$	473	$	340	39.0	%	$	135	$	147	(8.0	)%

~~The increase in interest expense in the third quarter and first nine 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 ~~third~~first quarter ~~and first nine months~~ of ~~2016~~2017 was ~~$306~~$293 million, ~~and $904 million, respectively,~~ an increase of ~~$57~~$8 million ~~and $157 million, respectively,~~ versus the ~~comparable prior-year periods.~~prior year, primarily driven by higher average interest rates.

Retirement-Related Plans

The following ~~tables provide~~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.

Yr. to Yr.

(Dollars in millions)

Percent

For the three months ended September 30:

2016

2015

Change

Retirement-related plans — cost:

Service cost

$
114

$
123

(7.7
)%
Amortization of prior service costs/(credits)

(28
)
(25
)
13.3

Cost of defined contribution plans

262

271

(3.3
)
Total operating costs/(income)

$
347

$
369

(5.9
)%
Interest cost

$
826

$
829

(0.4
)%
Expected return on plan assets

(1,392
)
(1,471
)
(5.4
)
Recognized actuarial losses

692

818

(15.3
)
Curtailments/settlements

4

11

(61.8
)
Multi-employer plans/other costs

8

16

(50.1
)
Total non-operating costs/(income)

$
139

$
204

(32.1
)%
Total retirement-related plans — cost

$
486

$
573

(15.2
)%

Management Discussion — (continued)

							Yr. to Yr.								Yr. to Yr.
(Dollars in millions)							Percent								Percent
For the nine months ended September 30:	2016			2015			Change
For the three months ended March 31:									2017			2016			Change
Retirement-related plans — cost:
Service cost	$	335		$	362		(7.5	)%	$	106		$	110		(3.8	)%
Amortization of prior service costs/(credits)	(81		)	(76		)	6.9		(21		)	(25		)	(15.7	)
Cost of defined contribution plans	802			835			(4.0	)	263			271			(3.3	)
Total operating costs/(income)	$	1,056		$	1,122		(5.9	)%	$	347		$	356		(2.6	)%
Interest cost	$	2,483		$	2,493		(0.4	)%	$	732		$	827		(11.4	)%
Expected return on plan assets	(4,190		)	(4,416		)	(5.1	)	(1,073		)	(1,394		)	(23.0	)
Recognized actuarial losses	2,069			2,464			(16.0	)	705			687			2.7
Curtailments/settlements	19			19			(1.0	)	(1		)	5			(131.2	)
Multi-employer plans/other costs	64			272			(76.6	)
Multi-employer plan/other costs									14			18			(20.5	)
Total non-operating costs/(income)	$	444		$	831		(46.6	)%	$	378		$	142		165.4	%
Total retirement-related plans — cost	$	1,500		$	1,953		(23.2	)%	$	725		$	499		45.4	%

In the ~~third~~first quarter of ~~2016,~~2017, total pre-tax retirement-related plan cost ~~decreased~~increased by ~~$87~~$226 million compared to the ~~third~~first quarter of ~~2015,~~2016, primarily driven ~~by a decrease in recognized actuarial losses ($125 million); partially offset~~ by lower expected return on plan assets ($79321 million)~~. Total cost for the first nine months of 2016 decreased by $453 million versus the first nine months of 2015, primarily driven by a decrease~~ and an increase in recognized actuarial losses ($~~394 million), a prior year pension obligation related to litigation ($230 million), and lower defined contribution plan costs ($33~~19 million); partially offset by lower ~~expected return on plan assets~~interest costs ($~~226~~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 ~~third~~first quarter of ~~2016~~2017 were $347 million, a decrease of ~~$22~~$9 million compared to the ~~third~~first quarter of ~~2015,~~2016, primarily driven by lower ~~service cost ($9 million) and lower~~ defined contribution plans ~~cost ($9 million).~~cost. Non-operating costs of ~~$139~~$378 million in the ~~third~~first quarter of ~~2016 decreased $65~~2017 increased $235 million year to year, driven primarily by ~~a decrease in recognized actuarial losses ($125 million); partially offset by~~ lower expected return on plan assets ($79 million). For the first nine months of 2016, operating retirement-related costs were $1,056 million, a decrease of $66 million compared to the first nine months of 2015, primarily driven by lower defined contribution plan costs ($33321 million) and ~~lower service cost ($27 million). Non-operating costs of $444 million decreased $387 million in the first nine months of 2016 compared to the prior year, driven primarily by a decrease~~an increase in recognized actuarial losses ($~~394 million) and a prior year pension obligation related to litigation ($230~~19 million); partially offset by lower ~~expected return on plan assets~~interest costs ($~~226~~94 million).

Taxes

~~The continuing operations effective tax rate for the third quarter of 2016 was 12.5 percent, a decrease of 5.7 points compared to the third quarter of 2015. The~~The continuing operations effective tax rate for the first ~~nine months~~quarter of ~~2016~~2017 was ~~(0.4)~~(23.1) percent, ~~a decrease~~an increase of ~~18.3~~72.0 points compared to the first ~~nine months of 2015. The operating (non-GAAP) tax rate for the third~~ quarter of ~~2016 was 14.2 percent, a decrease of 3.8 points compared to the third quarter of 2015.~~2016. The operating (non-GAAP) tax rate for the first ~~nine months~~quarter of ~~2016~~2017 was ~~3.2~~(9.3) percent, ~~a decrease~~an increase of ~~15.0~~57.6 points compared to the first ~~nine months~~quarter of ~~2015.~~2016.

The lower continuing operations effective tax rate and the lower operating (non-GAAP) tax rates for the third quarter of 2016 were primarily driven by a one-time discrete benefit in the quarter due to foreign tax audit activity ($91 million), and a more favorable mix of geographic income year to year. The decreasechange in the continuing operations effective tax rate ~~for~~in the first ~~nine 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~~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 ~~the company in Japan (15.9~~a discrete tax charge related to foreign audit activity (6.9 points), the ~~discrete~~prior year tax benefit for the Japan tax matter (113.2 points), the favorable settlement in the ~~third~~first quarter of 2016 ~~due to foreign tax audit activity (1.2 points), a favorable settlement~~ of the remaining open audit items on the company’s U.S. income tax returns for 2011 and 2012 ~~(0.5~~(3.6 points)~~, a~~ and, the benefit related to the ~~first quarter~~first-quarter 2016 real estate capacity actions (0.7 points), as well as a more favorable mix of geographic income year to year. These benefits were partially offset by a 2016 tax charge related to intercompany royalties from foreign subsidiaries (1.0 points) and the year-to-year impact of the 2015 foreign tax audit benefit (1.2(5.2 points). The ~~decline~~change in the operating (non-GAAP) tax rate was primarily driven by the same factors.

~~Management Discussion — (continued)~~

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.

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.

The amount of unrecognized tax benefits at December 31, ~~2015 decreased~~2016 increased by ~~$40 million in the third quarter of 2016 and decreased by $917~~$563 million in the first ~~nine months~~quarter of ~~2016~~2017 to ~~$3,657~~$4,303 million. The ~~overall decrease~~increase was primarily ~~due~~related to ~~the first quarter favorable resolution of the Japan tax matter.~~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 ~~$2,767~~$3,180 million at ~~September 30, 2016.~~March 31, 2017.

InThe company is involved in a number of income tax-related matters in India challenging tax assessments issued by the ~~fourth quarter~~India Tax Authorities. As of 2013, the company received a draft tax assessment notice for approximately $866 million (approximately $804 million at third 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 September 30, 2016,March 31, 2017, the company has recorded ~~$582~~$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.

~~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~~believes it will ~~be completed by the end of 2017.~~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 September 30:

2016

2015

Change

Earnings per share of common stock from continuing operations:

Assuming dilution

$
2.98

$
3.02

(1.3
)%
Basic

$
2.99

$
3.04

(1.6
)%
Diluted operating (non-GAAP)

$
3.29

$
3.34

(1.5
)%
Weighted-average shares outstanding: (in millions)

Assuming dilution

957.3

979.0

(2.2
)%
Basic

954.0

975.1

(2.2
)%

~~Management Discussion — (continued)~~

					Yr. to Yr.						Yr. to Yr.
					Percent						Percent
For the nine months ended September 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	$	7.67	$	9.03	(15.1	)%	$	1.85	$	2.09	(11.5	)%
Basic	$	7.70	$	9.07	(15.1	)%	$	1.86	$	2.09	(11.0	)%
Diluted operating (non-GAAP)	$	8.59	$	10.09	(14.9	)%	$	2.38	$	2.35	1.3	%
Weighted-average shares outstanding: (in millions)
Assuming dilution	960.7		986.0		(2.6	)%	947.8		964.4		(1.7	)%
Basic	957.7		981.8		(2.5	)%	942.4		961.7		(2.0	)%

Actual shares outstanding at ~~September 30, 2016~~March 31, 2017 were ~~950.9~~939.5 million. The weighted-average number of common shares outstanding assuming dilution during the ~~third~~first quarter ~~and first nine months~~ of ~~2016~~2017 were ~~21.6 million and 25.3~~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 ~~$1 million and $4~~$3 million in both the ~~third~~first quarter of 2017 and the first ~~nine months~~quarter of ~~2016, respectively, compared to $12 million and $176 million in the third quarter and first nine months of 2015, respectively.~~2016. The discontinued operations effective tax rate ~~in the third quarter of 2016 was 39.0 percent compared to 78.8 percent in the third quarter of 2015 and~~ was 38.4 percent in ~~the first nine months of 2016 compared to 38.0 percent in the prior-year period.~~both periods.

Management Discussion — (continued)

Financial Position

Dynamics

At ~~September 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 ~~$9,968~~$10,695 million. Total debt of $42,483 million increased $2,594 million from prior year-end levels, driven by new debt issuances of $8,342 million, partially offset by maturities of $5,582 million. Within total debt, $26,133 million, or approximately 62 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 ~~nine~~three months of ~~2016,~~2017, the company generated ~~$13,301~~$3,955 million in cash from operations, ~~an increase~~a decrease of ~~$1,572~~$1,575 million versus the first ~~nine~~three months of ~~2015.~~2016, primarily due to the 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 2016, the size of the global credit facility was increased to $10.25 billion and the term of the five-year global credit facility was extended by one year. It now expires on November 10, 2021.

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 September 30,

At December 31,

(Dollars in millions)

2016

2015

Current assets

$
41,433

$
42,504

Current liabilities

34,447

34,269

Working capital

$
6,986

$
8,235

Current ratio

1.20:1

1.24:1

~~Management Discussion — (continued)~~

	At March 31,		At December 31,
(Dollars in millions)	2017		2016
Current assets	$	42,889	$	43,888
Current liabilities	36,481		36,275
Working capital	$	6,408	$	7,613

Current ratio	1.18:1		1.21:1

Working capital decreased ~~$1,250~~$1,205 million from the year-end ~~2015~~2016 position. The key changes are described below:

Current assets decreased ~~$1,072~~$999 million ($~~1,931~~1,593 million adjusted for currency) due to:

· A decline in receivables of ~~$2,987~~$3,374 million ($~~3,401~~3,763 million adjusted for currency) ~~in financing receivables~~ primarily ~~due to~~as a result of collections of higher year-end balances; partially offset by

· An increase in cash and cash equivalents of ~~$1,352~~$2,270 million ($~~1,197~~2,170 million adjusted for currency) ~~in cash and cash equivalents; and~~

· ~~An increase of $421 million ($400 million adjusted for currency) in marketable securities.~~.

Current liabilities increased ~~$178~~$206 million (decreased ~~$1,097~~$161 million adjusted for currency) as a result of:

· An increase in ~~other accrued expenses and liabilities~~deferred income of ~~$993~~$1,316 million ($~~332~~1,161 million adjusted for currency) driven by ~~workforce rebalancing net accruals ($467 million);~~annual customer billings; and

· An increase in short-term debt of ~~$459~~$827 million ($~~381~~819 million adjusted for currency) primarily as a result of reclassifications of ~~$6,438~~$3,243 million from long term to reflect upcoming ~~maturities;~~maturities, partially offset by maturities of ~~$5,582~~$1,556 million and a decrease in commercial paper of ~~$600~~$899 million; partially offset by

· A decrease in accounts payable of ~~$757~~$885 million ($~~849~~950 million adjusted for currency) reflecting declines from typically higher year-end balances; and

· A decrease in taxes payable of ~~$710~~$488 million ($~~805~~527 million adjusted for currency) ~~primarily~~; and

· A decrease in compensation and benefits of $381 million ($428 million adjusted for currency) driven by ~~tax payments.~~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.

(Dollars in millions)
For the nine months ended September 30:	2016			2015
For the three months ended March 31:							2017			2016
Net cash provided by/(used in) continuing operations:
Operating activities	$	13,301		$	11,729		$	3,955		$	5,530	***
Investing activities	(7,600		)	(2,714		)	350			(1,886		)*
Financing activities	(4,504		)	(7,818		)	(2,134		)	2,806		**
Effect of exchange rate changes on cash and cash equivalents	155			(194		)	100			217
Net change in cash and cash equivalents	$	1,352		$	1,004		$	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 ~~$1,572~~$1,575 million as compared to the first ~~nine~~three months of ~~2015~~2016 driven by the following factors:

· ~~A decline~~An increase in net income tax payments of ~~$1,898 million;~~$1,207 million, driven by the prior year Japan tax refund received; and

· ~~An increase in cash provided by financing receivables of $1,684 million; and~~

· ~~A decline in cash contributions for postretirement plans of $442 million; partially offset by~~

· Performance-related declines within net ~~income.~~income; partially offset by

~~Net~~· Working capital improvements of $765 million driven by strong cash ~~used~~collections.

Investing activities were a net source of cash of $350 million in ~~investing activities increased $4,886 million~~the first quarter of 2017 compared to a net use of cash of $1,886 million in the first ~~nine 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 ~~$4,624~~$2,481 million.

~~Management Discussion — (continued)~~

~~Net~~Financing activities were a use of net cash ~~used~~of $2,134 million in ~~financing activities decreased $3,314 million as~~the first quarter of 2017 compared to a source of cash of $2,806 million in the first ~~nine 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 ~~$2,495~~$4,487 million primarily driven by higher levels of issuances in the ~~current period; and~~

· ~~A decrease of $1,214 million of cash used for gross share repurchases.~~prior-year period.

Noncurrent Assets and Liabilities

	At September 30,		At December 31,		At March 31,		At December 31,
(Dollars in millions)	2016		2015		2017		2016
Noncurrent assets	$	74,173	$	67,991	$	74,606	$	73,582
Long-term debt	$	35,563	$	33,428	$	34,441	$	34,655
Noncurrent liabilities (excluding debt)	$	28,437	$	28,374	$	28,125	$	28,147

The increase in noncurrent assets of ~~$6,183~~$1,024 million ($~~4,942~~461 million adjusted for currency) was driven by:

· An increase of ~~$4,380~~$1,234 million in ~~goodwill~~deferred taxes ($~~4,132~~1,139 million adjusted for currency) ~~and $1,394 million in net intangible assets driven by acquisitions;~~primarily due to intra-entity transfers ($827 million); and

· An increase in retirement plans assets of ~~$1,753~~$456 million ($~~1,786~~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 ~~$1,077~~$519 million in long-term financing receivables ($~~1,439~~653 million adjusted for currency) reflecting seasonal reductions from higher year-end balances.

Management Discussion — (continued)

Long-term debt ~~increased $2,135~~decreased $214 million ($~~1,831~~395 million adjusted for currency) from the year-end balance primarily driven by:

· ~~Issuances~~Reclassification to short-term debt of ~~$8,031 million;~~$3,243 million to reflect upcoming maturities; partially offset by

· ~~Reclassification to short-term debt~~Issuances of ~~$6,438 million to reflect upcoming maturities.~~$2,819 million.

The ~~increase~~decrease in noncurrent liabilities (excluding debt) of ~~$63~~$22 million (a decrease of ~~$953~~$460 million adjusted for
currency) was driven by:

· ~~An increase~~A decrease in retirement and nonpension postretirement liabilities of ~~$184~~$103 million ($314 million adjusted for currency); partially offset by

· An increase in other liabilities of $124 million driven by a currency impact of ~~$611~~$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 September 30,		At December 31,		At March 31,		At December 31,
(Dollars in millions)	2016		2015		2017		2016
Total company debt	$	42,483	$	39,890	$	42,781	$	42,169
Total Global Financing segment debt	$	26,133	$	27,205	$	28,475	$	27,859
Debt to support external clients	22,200		23,934		24,341		24,034
Debt to support internal clients	3,933		3,271		4,134		3,825
Non-Global Financing debt	$	16,351	$	12,684	$	14,306	$	14,309

Total debt of ~~$42,483~~$42,781 million ~~was up $2,594~~increased $613 million from December 31, ~~2015.~~2016 consistent with the company’s 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

~~Management Discussion — (continued)~~

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 ~~$16,351~~$14,306 million was ~~up $3,666~~down $3 million from December 31, ~~2015~~2016 and ~~up $2,734~~down $4,468 million from ~~September 30, 2015.~~March 31, 2016.

Consolidated debt-to-capitalization ratio at ~~September 30, 2016~~March 31, 2017 was ~~71.2~~69.9 percent versus ~~73.4~~69.6 percent at December 31, ~~2015~~2016 and ~~74.6~~75.1 percent at ~~September 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 ~~54.6~~48.3 percent at ~~September 30, 2016~~March 31, 2017 compared to ~~54.3~~49.5 percent at December 31, ~~2015~~2016 and ~~58.3~~62.2 percent at ~~September 30, 2015.~~March 31, 2016.

Equity

Total equity increased by ~~$2,735~~$56 million from December 31, ~~2015~~2016 as a result of an increase in retained earnings of ~~$3,460~~$533 million, an increase in retirement-related amounts of ~~$1,267~~$507 million and an increase of ~~$303~~$270 million related to currency translation, partially offset by an increase in treasury stock of ~~$2,652~~$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.

The company’s strategic direction is clear and compelling, and the company will continue to shift to the higher value areas of enterprise IT and manage clients’ most critical business processes. 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 its progress 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.~~company, focused on industry differentiation. The company’s strategic imperatives—cloud, analytics, mobile, social and security solutions—are focused on these market shifts.

~~Overall,~~In 2017, the company will continue to focus on growing the strategic imperatives and the transformation of its core businesses, with a continued high level of investment, although the higher-level investment that 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 company expects growth in operating (non-GAAP) pre-tax income in 2017. The company expects gross profit margin improvement from the first-quarter level. The company expects to continue to ~~grow~~monetize its technology, including through IP licensing arrangements in ~~many~~2017. Consistent with the long-term model, the company also expects over the course of 2017 to continue to acquire key capabilities, remix skills, invest in areas of ~~the business, including continued strong~~ growth and return value to shareholders. This is all taken into account in the ~~strategic imperatives. In addition,~~full-year view. Overall, the company expects GAAP earnings per share from continuing operations for 2017 to ~~continue to allocate its capital efficiently~~be at least $11.95. Excluding acquisition-related charges of $0.75 per share and ~~effectively to investments, and to return value to its shareholders through a combination~~non-operating retirement-related items of ~~dividends and~~$1.10 per share, repurchases. Over the long term, in consideration of the opportunities it will continue to develop, the company expects to have 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~~is expected to be at least $13.80. For the 90first half of 2017, the company expects operating (non-GAAP) earnings per share to ~~100~~be approximately 37 percent ~~range.~~of the full year expectation.

InDuring the ~~third~~first quarter of 2016, the company made progress across the business, with continued strong growth in the strategic imperatives, some moderation in the declines in the core businesses, remixing skills, and adding new capabilities through organic investments, acquisitions and partnerships.

~~In the first nine months of 2016,~~2017, the company had strong ~~performance~~growth in its strategic imperatives ~~with~~ revenue, ~~growth of 14~~which grew 12 percent ~~year to year~~ 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. ~~Over the past 12 months, the strategic imperatives generated $31.8 billion in revenue, which represents 40 percent of the company’s total revenue.~~ From a segment perspective, in the first ~~nine months of 2016,~~quarter 2017, Cognitive Solutions revenue grew, led by ~~analytics in Solutions Software~~Analytics and ~~the company broadened the reach of Watson with new services, products and partnerships. Services backlog of $121.3 billion increased 0.9 percent~~Security. GBS revenue declined year to year, however the decline improved sequentially in Consulting revenue, as ~~reported, but~~the business continues to shift towards cognitive and digital. Technology Services & Cloud Platforms revenue decreased ~~1 percent~~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. In GBS, the engineered shift to digital has driven strong revenue growth~~that did not close in the ~~strategic imperatives, but GBS gross margins~~first quarter, and with the cost savings and yield on investments that have declined year to year, reflecting increased investment in digital and additional spending incurred to meet commitments. In Systems, z Systems mainframe revenues decreased and margins improved consistent with product cycle dynamics. Under the new segment structure introduced in January, 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 high renewal rates, growth in the Software-as-a-Service offerings and contribution from acquisitions.

~~Looking forward to the fourth quarter of 2016, given third quarter performance,~~made, the company expects to improve the ~~second half improvement~~GTS second-half 2017 profit dynamics. In addition, the improved trajectory in GBS performance is expected to ~~be in line with~~continue throughout the ~~expectations provided in July. Less~~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 that improvement may result from software revenue mix, though the company has been more successful in monetizing software through IP partnerships. The company continues to expect the annuity business to grow year to year in the fourth quarter and with good opportunity pipeline would expect the typical third quarter to fourth quarter sequential increase in transactional business of $2.5 billion.

Overall for 2016, the company continues to expect GAAP earnings per share from continuing operations to be at least $12.23. The company continues to expect 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.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 is again expected to be ~~above~~in line with the longer-term model of over 90 percent ~~again~~ in ~~2016. At the profit level associated with the earnings per share expectations, this translates to an expected~~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 to 100 percent range in 2017.~~

~~Management Discussion — (continued)~~

~~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 18 percent~~expectation. Expectations for the ~~rest of the year, excluding discrete tax benefits. 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. Consistent with accounting guidance, the company will remeasure its defined benefit pension plans at December 31,~~ 2016. As described in the company’s Critical Accounting Estimates (refer to the company’s recast 2015 Annual Report on Form 8-K, pages 48 to 51), the measurement of the benefit obligation to employees requires the use of certain assumptions, including, among others, estimates of discount rates. If the company were to use September 2016 discount rates, there would be a material impact to Stockholders’ Equity but it would not impact the company’s cash flows.

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 ~~September 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 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 ~~nine~~three months of ~~2016.~~2017. Based on the currency rate movements in the first ~~nine~~three months of ~~2016,~~2017, total revenue decreased ~~2.6~~2.8 percent as reported and decreased ~~1.9~~2.2 percent at constant currency versus the first ~~nine~~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 ~~$50~~$10 million in the first ~~nine~~three months of ~~2016~~2017 on both an as-reported basis and ~~an increase of approximately $75 million on~~ an operating (non-GAAP) basis. The same mathematical exercise resulted in a decrease of approximately ~~$700~~$20 million in the first ~~nine~~three months of ~~2015~~2016 on both an as-reported basis and ~~a decrease of approximately $900 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.

~~Management Discussion — (continued)~~

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 constant through the ~~third~~first quarter of 2017 and the company continued to use the SIMADI rate since the DICOM rate had not been instrumented by the authorities. Total pre-tax loss for the first ~~nine~~three months of ~~2016~~2017 was ~~$46 million.~~not material. The company’s net assets denominated in local currency were $8$10 million at ~~September 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 ~~nine~~three months ended, or as of, as applicable, ~~September 30, 2016,~~March 31, 2017, those amounts are ~~$13.3~~$4.0 billion for net cash from operating activities, ~~$10.0~~$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 ~~September 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 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 ~~September 30, 2016,~~March 31, 2017, the fair value of those instruments that were in a liability position was ~~$286~~$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.

	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 ~~pages 74 and 75.~~page 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 ~~nine~~three months of ~~2016~~2017 and ~~2015~~2016 prepared in a manner consistent with the description above.

(Dollars in millions)
For the nine months ended September 30:	2016			2015
For the three months ended March 31:							2017			2016
Net cash from operating activities per GAAP	$	13,301		$	11,729		$	3,955		$	5,530	* **
Less: change in Global Financing receivables	3,647			1,962			2,047			2,236		*
Net cash from operating activities, excluding Global Financing receivables	9,655			9,767			1,907			3,294		**
Capital expenditures, net	(2,801		)	(2,764		)	(819		)	(971		)
Free cash flow	6,854			7,003
Free cash flow (FCF)							1,088			2,323		**
Acquisitions	(5,445		)	(821		)	(109		)	(2,590		)
Divestitures	35			(488		)	(1		)	47
Share repurchases	(2,632		)	(3,846		)
Share repurchase							(1,293		)	(939		)
Common stock repurchases for tax withholdings							(50		)	(27		) **
Dividends	(3,927		)	(3,636		)	(1,321		)	(1,250		)
Non-Global Financing debt	3,365			770			244			5,871
Other (includes Global Financing receivables and Global Financing debt)	3,523			2,108			3,610			3,239
Change in cash, cash equivalents and short-term marketable securities	$	1,773		$	1,091		$	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 ~~nine~~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 ~~$6.9~~$1.1 billion, ~~declined $0.1~~a decrease of $1.2 billion ~~year~~versus the prior year. The year-to-year decrease was 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 largely offset~~the first quarter of 2017, driven by ~~a reduction in~~strong cash ~~tax payments.~~collections. Net capital expenditures of ~~$2.8~~$0.8 billion ~~were flat year to year.~~included investments in Watson and Cloud Platforms, as well as in support of the services and systems businesses. In the first ~~nine~~three months of ~~2016,~~2017, the company continued to focus its cash utilization on returning value to shareholders including ~~$3.9~~$1.3 billion in dividends and ~~$2.6~~$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 ~~$600~~$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 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 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						Nine Months Ended
	September 30,						September 30,
(Dollars in millions)	2016			2015			2016			2015
For the three months ended March 31:													2017			2016
External revenue	$	412		$	447		$	1,245		$	1,386		$	405		$	410
Internal revenue	352			584			1,340			1,874			363			486
Total revenue	763			1,031			2,585			3,261			768			896
Cost	267			328			836			1,045			271			272
Gross profit	$	497		$	703		$	1,748		$	2,216		$	497		$	624
Gross profit margin	65.1		%	68.2		%	67.6		%	68.0		%	64.7		%	69.6		%
Pre-tax income	$	355		$	562		$	1,208		$	1,690		$	311		$	386
After-tax income	$	244		$	376		$	829		$	1,131		$	219		$	261
Return on equity*	27.2		%	40.5		%	30.3		%	39.7		%	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 ~~third~~first quarter, as compared to the same period in ~~2015,~~2016, was due to:

· A decline in internal revenue of ~~39.8~~25.3 percent, due to a decrease in used equipment sales ~~revenue~~ (down ~~46.5~~33.4 percent to $268 million), partially offset by an increase in financing revenue (up 12.7 percent to $95 million); and

· A decline in external revenue of ~~7.9~~1.2 percent ~~(9.2~~(2.1 percent adjusted for currency), due to a decrease in financing ~~revenue~~ (down ~~12.2~~6.6 percent to ~~$305~~$297 million), partially offset by an increase in used equipment sales ~~revenue~~ (up ~~6.7~~17.6 percent to ~~$107~~$108 million).

The ~~decrease in revenue in the first nine months, as compared to the same period in 2015, was due to:~~

· ~~A decline in internal revenue of 28.5 percent, due to decreases in used equipment sales revenue (down 32.1 percent to $1,100 million) and financing revenue (down 5.8 percent to $239 million); and~~

· A decline in external revenue of 10.2 percent (8.5 percent adjusted for currency), due to decreases in financing revenue (down 11.8 percent to $935 million) and used equipment sales revenue (down 4.9 percent to $310 million).

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

Global Financing gross profit decreased ~~29.4 percent and 21.1~~20.4 percent in the ~~third~~first quarter ~~and the first nine 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 ~~3.1 points in the third quarter and 0.3~~5.0 points in the first ~~nine months respectively,~~quarter of ~~2016,~~2017, compared to the same ~~periods~~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.~~mix towards higher margin financing.

Global Financing pre-tax income decreased ~~36.8~~19.5 percent to ~~$355~~$311 million in the ~~third~~first quarter of ~~2016,~~2017, compared to the same period in ~~2015,~~2016, due to lower gross profit ($~~207~~127 million) and an increase in selling, general and administrative ~~expenses~~expense ($1613 million), partially offset by a decrease in financing receivables provisions ($~~16 million). Pre-tax income decreased 28.5 percent to $1,208 million in the first nine months of 2016, compared to the same period in 2015, due to lower gross profit~~

~~Management Discussion — (continued)~~

~~($468 million) and an increase in selling, general and administrative expenses ($47 million), partially offset by a decrease in financing receivables provisions ($33~~65 million). The decrease in financing receivables provisions in the ~~third~~first quarter of ~~2016,~~2017, compared to the same period in ~~2015,~~2016, was due to lower specific reserve requirements in China in the current year. The decrease in financing receivables provisions in the first nine months of 2016, compared to the same period in 2015, was due to lower specific reserve requirements in China, partially offset by higher general reserve requirements in Brazil in the ~~current~~prior year.

The decrease in return on equity in the ~~third~~first quarter ~~and first nine 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 September 30,		At December 31,		At March 31,		At December 31,
(Dollars in millions)	2016		2015		2017		2016
Cash and cash equivalents	$	1,830	$	1,555	$	1,947	$	1,844
Net investment in sales-type and direct financing leases	7,361		7,594		6,640		6,893
Equipment under operating leases — external clients (1)	616		605		543		548
Client loans	10,757		12,525		10,779		11,478
Total client financing assets	18,734		20,725		17,961		18,920
Commercial financing receivables	6,855		8,948		7,458		9,700
Intercompany financing receivables (2) (3)	4,932		4,245		4,935		4,959
Other receivables	175		308		194		196
Other assets	625		378		1,627		872
Total assets	$	33,152	$	36,157	$	34,123	$	36,492
Intercompany payables (2)	$	1,268	$	3,089	$	464	$	2,189
Debt (4)	26,133		27,205		28,475		27,859
Other liabilities	2,192		2,134		2,020		2,631
Total liabilities	29,593		32,428		30,959		32,679
Total equity	3,559		3,729		3,164		3,812
Total liabilities and equity	$	33,152	$	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.~~

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

~~Management Discussion — (continued)~~

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 ~~September 30, 2016,~~March 31, 2017, substantially all financing assets were IT related assets, and approximately 5152 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. Additionally, as noted above, the company takes actions to transfer exposure to third parties. On that basis, the investment grade content would increase by 14 points to 6566 percent, ~~a reduction~~an increase of ~~3 points~~1 point year to year.

Management Discussion — (continued)

Originations

~~The following~~Originations are ~~total~~management’s estimate of the gross additions for client and commercial financing ~~originations:~~assets. 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 table below provide insight into the future cash flows and earnings of the company.

Three Months Ended

Nine Months Ended

September 30,

September 30,

(Dollars in millions)

2016

2015

2016

2015

Client financing

$
2,525

$
2,598

$
7,863

$
9,561

Commercial financing

10,177

9,828

29,714

28,143

Total

$
12,702

$
12,425

$
37,576

$
37,705

~~Cash collections of both commercial financing and~~The origination values below for client financing ~~assets exceeded new~~includes leases and loans, excluding the company’s loan financing ~~originations in both the third quarter of 2016 and in the first nine months of 2016 which resulted in a net decline in financing assets compared~~ to the same periods in 2015. The increase in originations in the three month period ending September 30, 2016 versus 2015 was due to an increase in commercial financing volumes. The decrease in originations in the first nine months of 2016, versus 2015 was due to a decrease in client financing volumes.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 September 30,			At December 31,			At March 31,			At December 31,
(Dollars in millions)	2016			2015			2017			2016
Gross financing receivables	$	25,082		$	29,086		$	24,871		$	28,043
Specific allowance for credit losses	527			517			359			335
Unallocated allowance for credit losses	121			93			92			103
Total allowance for credit losses	648			610			451			438
Net financing receivables	$	24,434		$	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)	(Dollars in millions)	Allowance			Additions/						(Dollars in millions)	Allowance			Additions/
January 1, 2016		Used*			(Reductions)		Other**		September 30, 2016
January 1, 2017											January 1, 2017	Used*			(Reductions)		Other**		March 31, 2017
$	610	$	(45	)	$	75	$	7	$	648	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 ~~September 30,~~March 31, 2017, primarily driven by the overall decline in gross receivables. Specific reserves increased 7 percent from $335 million at December 31, 2016, ~~primarily due~~ to ~~an increase in unallocated reserve requirements.~~$359 million at March 31, 2017. Unallocated reserves decreased 11 percent from $103 million at December 31, 2016, to $92 million at March 31, 2017.

Management Discussion — (continued)

increased 30 percent from $93 million at December 31, 2015, to $121 million at September 30, 2016, primarily due to Brazil. Specific reserves increased 2 percent from $517 million at December 31, 2015, to $527 million at September 30, 2016.

Global Financing’s bad debt expense was ~~($2)~~$10 million for the three months ended ~~September 30, 2016,~~March 31, 2017, compared to ~~$14~~$75 million for the same period in ~~2015.~~ ~~Global Financing’s bad debt expense was $75 million for the nine months ended September 30, 2016, compared to $108 million for the same period in 2015.~~2016. The year-to-year decrease in bad debt expense for the three months ended ~~September 30, 2016,~~March 31, 2017, compared to the same period in ~~2015,~~2016, was due to higher specific reserve requirements in China in the prior year. The year-to-year decrease in bad debt expense for the nine months ended September 30, 2016, compared to the same period in 2015, was due to lower specific reserve requirements in China, partially offset by highergeneral reserve requirements 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 ~~49.1 percent and 54.6~~48.9 percent of Global Financing’s revenue in the ~~third~~first quarter of 2017, and ~~first nine months, respectively, of 2016, and 58.2 percent and 59.7~~55.1 percent in the ~~third~~first quarter ~~and first nine 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 ~~54.6~~51.5 percent and ~~65.6 percent in the third quarter of 2016 and 2015, respectively. The gross profit margins were 60.8 percent and 65.5~~63.8 percent in the first ~~nine months~~quarter of ~~2016~~2017 and ~~2015,~~2016, respectively. The decrease in the gross profit margin for the three ~~months~~month period ending ~~September 30, 2016~~March 31, 2017 was driven by a shift in mix away from higher margin internal equipment sales and from decreases in ~~external~~internal and ~~internal~~external equipment sales margins. The decrease in the gross profit margin for the nine months period ending September 30, 2016 was driven by a shift in mix away from higher margin internal equipment sales and a decrease in external equipment sales margin, partially offset by an increase in internal equipment sales margin.

The table ~~on page 85~~below presents the recorded amount of unguaranteed residual value for sales-type, direct financing and operating leases at January 1, ~~2016~~2017 and ~~September 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 ~~September 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 $43 million and ~~$105~~$91 million for the financing transactions originated during the quarters ended ~~September 30,~~March 31, 2017 and 2016, ~~and 2015, respectively and $201 million and $565 million for the nine months ended September 30, 2016 and 2015,~~ respectively. The aggregate asset values associated with the guarantees of direct financing leases were ~~$43~~$34 million and ~~$44~~$39 million for the financing transactions originated during the quarters ended ~~September 30,~~March 31, 2017 and 2016, ~~and 2015, respectively and $128 million and $141 million for the nine months ended September 30, 2016 and 2015,~~ respectively. The associated aggregate guaranteed future values at the scheduled end of lease were ~~$4 million and $6~~$3 million for the financing transactions originated during each of the quarters ended ~~September 30,~~March 31, 2017 and 2016, ~~and 2015, respectively and $12 million and $39 million for the nine months ended September 30, 2016 and 2015,~~ respectively. The cost of guarantees was ~~$0.4 million and $0.6~~$0.3 million for ~~the quarters ended September 30, 2016 and 2015, respectively and $1.2 million and $3.9 million for the nine months ended September 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			September 30, 2016 Balance														March 31, 2017 Balance
	January 1,			September 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		$	630		$	37	$	137	$	197	$	258	$	585		$	574		$	102	$	172	$	189	$	112
Operating leases	144			152			31		47		38		36		140			150			57		44		40		9
Total unguaranteed residual value	$	789		$	782		$	68	$	184	$	235	$	294	$	725		$	724		$	159	$	216	$	229	$	121
Related original amount financed	$	14,223		$	13,806										$	12,845		$	12,493
Percentage	5.6		%	5.7		%									5.6		%	5.8		%

Management Discussion — (continued)

Debt

At September 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 8162 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 September 30, 2016					At December 31, 2015					At March 31, 2017					At December 31, 2016
Global Financing Segment				$	26,133				$	27,205				$	28,475				$	27,859
Debt to support external clients	$	22,200				$	23,934				$	24,341				$	24,034
Debt to support internal clients	3,933					3,271					4,134					3,825
Non-Global Financing Segments				16,351					12,684					14,306					14,309
Debt supporting operations	20,283					15,955					18,440					18,134
Intercompany activity	(3,933		)			(3,271		)			(4,134		)			(3,825		)
Total company debt				$	42,483				$	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						Nine Months Ended
	September 30,						September 30,
(Dollars in millions)	2016			2015			2016			2015
For the three months ended March 31:													2017			2016
Numerator
Global Financing after-tax income*	$	244		$	376		$	829		$	1,131		$	219		$	261
Annualized after-tax income (a)	$	977		$	1,504		$	1,106		$	1,508
Annualized after-tax income (1)*													$	878		$	1,042
Denominator
Average Global Financing equity (b)**	$	3,595		$	3,716		$	3,647		$	3,799
Global Financing return on equity (a)/(b)	27.2		%	40.5		%	30.3		%	39.7		%
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 4 quarters, for the three months ended September 30, and for the nine months ended September 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 September 30, 2016	GAAP			adjustments			adjustments			(Non-GAAP)
For the three months ended March 31, 2017													GAAP			adjustments			adjustments			(Non-GAAP)
Gross profit	$	9,013		$	129		$	79		$	9,221		$	7,772		$	119		$	193		$	8,083
Gross profit margin	46.9		%	0.7		pts.	0.4		pts.	48.0		%	42.8		%	0.7		pts.	1.1		pts.	44.5		%
S,G&A	$	4,732		$	(138	)	$	(53	)	$	4,541		$	5,152		$	(139	)	$	(136	)	$	4,877
R,D&E	1,397			—			(7		)	1,390			1,533			—			(49		)	1,484
Other (income) and expense	(8		)	(2		)	—			(10		)	(28		)	(4		)	—			(31		)
Total expense and other (income)	5,751			(140		)	(60		)	5,550			6,348			(143		)	(185		)	6,020
Pre-tax income from continuing operations	3,263			269			139			3,671			1,424			262			378			2,063
Pre-tax margin from continuing operations	17.0		%	1.4		pts.	0.7		pts.	19.1		%	7.8		%	1.4		pts.	2.1		pts.	11.4		%
Provision for income taxes*	$	409		$	73		$	40		$	521
Provision for/(benefit from) income taxes*													$	(329	)	$	67		$	70		$	(192	)
Effective tax rate	12.5		%	1.1		pts.	0.7		pts.	14.2		%	(23.1		)%	6.2		pts.	7.6		pts.	(9.3		)%
Income from continuing operations	$	2,854		$	197		$	99		$	3,149		$	1,753		$	195		$	308		$	2,255
Income margin from continuing operations	14.8		%	1.0		pts.	0.5		pts.	16.4		%	9.7		%	1.1		pts.	1.7		pts.	12.4		%
Diluted earnings per share from continuing operations	$	2.98		$	0.21		$	0.10		$	3.29		$	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 September 30, 2015

GAAP

adjustments

adjustments

(Non-GAAP)

Gross profit

$
9,436

$
89

$
118

$
9,643

Gross profit margin

48.9
%
0.5
pts.
0.6
pts.
50.0
%
S,G&A

$
4,731

$
(76
)
$
(74
)
$
4,581

R,D&E

1,287

—

(12
)
1,275

Other (income) and expense

(133
)
0

—

(133
)
Total expense and other (income)

5,815

(76
)
(86
)
5,652

Pre-tax income from continuing operations

3,621

165

204

3,991

Pre-tax margin from continuing operations

18.8
%
0.9
pts.
1.1
pts.
20.7
%
Provision for income taxes*

$
659

$
(5
)
$
64

$
718

Effective tax rate

18.2
%
(0.9
)pts.
0.7
pts.
18.0
%
Income from continuing operations

$
2,962

$
170

$
140

$
3,272

Income margin from continuing operations

15.4
%
0.9
pts.
0.7
pts.
17.0
%
Diluted earnings per share from continuing operations

$
3.02

$
0.18

$
0.14

$
3.34

~~Management Discussion — (continued)~~

(Dollars in millions except per share amounts)

Acquisition-related

Retirement-related

Operating

For the nine months ended September 30, 2016

GAAP

adjustments

adjustments

(Non-GAAP)

Gross profit

$
27,401

$
371

$
238

$
28,010

Gross profit margin

47.1
%
0.6
pts.
0.4
pts.
48.2
%
S,G&A

$
16,093

$
(365
)
$
(183
)
$
15,545

R,D&E

4,320

—

(23
)
4,297

Other (income) and expense

281

(7
)
—

274

Total expense and other (income)

20,056

(372
)
(206
)
19,478

Pre-tax income from continuing operations

7,345

743

444

8,532

Pre-tax margin from continuing operations

12.6
%
1.3
pts.
0.8
pts.
14.7
%
Provision for/(benefit from) income taxes*

$
(31
)
$
201

$
106

$
277

Effective tax rate

(0.4
)%
2.5
pts.
1.4
pts.
3.2
%
Income from continuing operations

$
7,375

$
542

$
338

$
8,255

Income margin from continuing operations

12.7
%
0.9
pts.
0.6
pts.
14.2
%
Diluted earnings per share from continuing operations

$
7.67

$
0.57

$
0.35

$
8.59

(Dollars in millions except per share amounts)				Acquisition-related			Retirement-related			Operating						Acquisition-related			Retirement-related			Operating
For the nine months ended September 30, 2015	GAAP			adjustments			adjustments			(Non-GAAP)
For the three months ended March 31, 2016													GAAP			adjustments			adjustments			(Non-GAAP)
Gross profit	$	29,278		$	268		$	350		$	29,896		$	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	$	15,273		$	(230	)	$	(445	)	$	14,598		$	6,012		$	(67	)	$	(55	)	$	5,890
R,D&E	3,885			—			(36		)	3,849			1,458			—			(9		)	1,449
Other (income) and expense	(578		)	(5		)	—			(583		)	253			(6		)	—			247
Total expense and other (income)	18,431			(235		)	(481		)	17,715			7,652			(73		)	(63		)	7,516
Pre-tax income from continuing operations	10,846			503			831			12,181			1,034			185			142			1,361
Pre-tax margin from continuing operations	18.2		%	0.8		pts.	1.4		pts.	20.4		%	5.5		%	1.0		pts.	0.8		pts.	7.3		%
Provision for income taxes*	$	1,943		$	52		$	234		$	2,228
Provision for/(benefit from) income taxes*													$	(983	)	$	47		$	27		$	(909	)
Effective tax rate	17.9		%	(0.3		)pts.	0.7		pts.	18.3		%	(95.1		)%	16.3		pts.	11.9		pts.	(66.8		)%
Income from continuing operations	$	8,904		$	452		$	597		$	9,953		$	2,016		$	138		$	115		$	2,270
Income margin from continuing operations	14.9		%	0.8		pts.	1.0		pts.	16.7		%	10.8		%	0.7		pts.	0.6		pts.	12.1		%
Diluted earnings per share from continuing operations	$	9.03		$	0.46		$	0.60		$	10.09		$	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 ~~third~~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*

July 1, 2016 - July 31, 2016

1,300,447

$
157.41

1,300,447

$
3,649,644,866

August 1, 2016 - August 31, 2016

2,145,783

$
160.86

2,145,783

$
3,304,478,461

September 1, 2016 - September 30, 2016

2,042,234

$
156.89

2,042,234

$
2,984,081,850

Total

5,488,464

$
158.56

5,488,464

				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 27, 2015, the Board of Directors authorized $4.0 billion in funds for use in the company’s common stock repurchase program. ~~The~~On October 25, 2016, the Board of Directors authorized an additional $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~~
Exhibit Number

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:
~~October~~April 25, ~~2016~~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