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    You, with IBM. 2016 IBM Annual Report

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    You who run our financial and energy systems; who design, build and fly our planes, run our trains, manage our cities; who cure us, feed us, clothe us, entertain us and keep us safe; who teach our children. As a professional, you are driven always to advance, and to make a difference through your work. Which is why this moment is so extraordinary for you. Every profession in every industry in every part of the world is changing, simultaneously. You are drawing on a wealth of new data, knowledge, insights and tools. You are being equipped to rethink your job, and freed to do your life’s work. We have reinvented IBM for this moment—to fuel your dreams with Watson, with IBM Cloud, with deep expertise, with trust. We believe in your ambition to be the best in your profession. And we believe that you can make our world healthier, safer, more productive, more creative, fairer. That is a world we all want to live in. The world you’re building, with IBM.

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    1. with IBM: Oncologists can find more targeted cancer treatment options. No doctor can keep up with the onrush of Doctors oncology studies published every week, much less determine which apply to each patient. But Watson can. Trained for 15,000 anywhere can hours by specialists at Memorial Sloan Kettering Cancer Center in New York, Watson has ingested nearly 15 million pages know the latest from relevant journals and textbooks and continues to expand its knowledge. This expertise is now flowing around the advances world and informs evidence-based treat- ment options for clinicians serving patients globally. Sites include six Manipal Hospitals everywhere. in India, Bumrungrad International Hospital in Bangkok, Jupiter Medical Center in Florida and Svet zdravia’s net- work of 16 hospitals in Slovakia and Central and Eastern Europe–and soon across China. Healthcare data is growing 48 percent per year—and Elsewhere, in trials at the University will likely exceed 2,300 exabytes by 2020. It pours in of North Carolina’s Lineberger Comprehensive Cancer Center, Watson from new research, electronic medical records, imaging, suggested potential treatment options that wearables and epidemiological monitoring, along with the tumor board hadn’t considered in one all the environmental factors that affect our health. third of cases. In addition, doctors are better able to It can be overwhelming for doctors, but in all that data understand their patients’ unique needs, lie vital clues to the next medical breakthroughs, cures right down to the genetic level. Watson for and efficiencies. And now best practices and advanced Genomics absorbs 10,000 new medical articles and details from 100 clinical trials expertise can go global quickly, changing the very every month. It applies what it learns to nature of wellness and healthcare. suggest highly targeted therapies for each patient’s individual cancer based on its understanding of a tumor’s molecular profile, allowing doctors to provide more Watson Health personalized treatment for their patients. This powerful new tool is helping even 100M Electronic those patients who cannot travel to a health specialized medical center. Through Quest records Diagnostics, it is available to any oncolo- gist in the United States, as an end-to-end 200M Claims solution. Illumina plans to integrate it with a tumor-sequencing workflow to provide oncologists cognitive information on-site. 30B Medical images 02

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    2. 4. 6. Medical Researchers Hospital Administrators Veterinarians can speed discovery of can improve the health of can now be expert genes that cause diseases. the health system. on every breed. Amyotrophic lateral sclerosis, or ALS (also The Central New York Care Collaborative Medical doctors treat one species: known as Lou Gehrig’s disease), has no (CNYCC) is working with Watson Health to humans. Veterinarians may treat dozens effective treatment and typically kills within create one of the first regional cognitive of species and an even greater number five years. Barrow Neurological Institute population health platforms in the United of cat and dog breeds. And their patients researchers employed Watson for Drug States. It will connect 2,000 care providers can’t describe their symptoms. That’s Discovery to study nearly 1,500 genes in in Upstate New York, integrating clinical, why IBM has worked with vets to build an the human genome, and found five that social and behavioral data to produce online tool that uses Watson. It can scan had never before been associated with ALS. holistic views of patients—helping doctors hundreds of thousands of pages of med- Researchers say that such a discovery, and clinicians make more-informed ical resources, helping vets customize which took months with Watson, would decisions and promote healthier behavior. treatment options, stay current with best have previously taken years and gives them CNYCC’s goal is value-based care that practices and identify medical differences a much clearer idea of what to target for reduces emergency room visits and among even very similar breeds. therapy when developing new drugs. avoidable hospital stays by 25 percent over five years—improving health while lowering Medicaid costs. 5. Endocrinologists will help people manage their diabetes between visits. People with diabetes will benefit from an app called Sugar.IQ that draws data from physician-prescribed Medtronic devices. The app connects to cognitive analysis 3. in the IBM Cloud to reveal patterns and Radiologists personalized insights, helping users better understand in real time how their behaviors can find secrets hidden affect glucose levels. With Watson, a future in every image. version is expected to incorporate features that in tests have predicted hypoglycemic Radiologists review dozens of medical incidents within a 2- to 3-hour window with images for every patient they see—often nearly 90 percent accuracy. hundreds in a day. Watson never gets eyestrain or momentarily distracted, and has been trained by researchers to rapidly 90% analyze huge numbers of images and rank ↑ them for potential anomalies. Radiologists Watson can help can then focus on the ones that matter veterinarians treat hundreds of dog and apply their expertise more quickly. Accuracy and cat breeds with Watson can also retrieve similar images predicting more confidence. hypoglycemic from other cases for comparison to help incidents doctors confirm or refine their diagnoses. 2016 Annual Report 03

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    8. with IBM: Stadium Architects can create winning experiences for every fan. Engineers With IBM, the NFL’s Atlanta Falcons and MLS’ Atlanta United are building the most technologically advanced stadium in the are rebuilding world. Set to open this summer, the new Mercedes-Benz Stadium will deliver personalized experiences for each attendee, the world. while giving the stadium an entirely new feel depending on who’s on the field or on stage. And fans will be able to find the refreshment stands and bathrooms with the shortest lines. ↑ The new Mercedes-Benz Stadium will be the world’s most advanced. 7. ↑ 9. Cognitive Pipeline Engineers technologies help Chemical Engineers can anticipate failures maintain oil and turn social media activity gas pipelines. before they happen. into a test lab. With Watson’s cognitive abilities, Scientists at The Dow Chemical Company specialists for oil and gas companies are listening to social media to quickly can now predict and prevent pipeline identify and speed to market new solutions failures almost a week in advance. IBM that use the company’s advanced polymers. business partner SparkCognition is With analytics from IBM, these engineers using Watson to analyze thousands of can anticipate consumer demand for new pipeline sensors, and monitor cracks, products. These insights allow them to vibrations, overheating and other improve everything from running shoes to factors. Engineers are now able to seals for car windows. predict and address pipeline failures as early as six days in advance, 24x better than before. 04

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    10. 11. 12. Automotive Engineers Geoscientists Shipbuilders are building cars know where and can hit the water that converse with when to drill. more quickly. drivers, passengers Halliburton uses the IBM Cloud to run Italy’s Fincantieri is speeding the creation and each other. sophisticated oil reservoir simulations that of new cruise ships and naval vessels with help it better understand how complex oil a hybrid cloud solution from IBM. By con- By 2020, an estimated 83 million cars and gas fields might behave under different necting 13 private distributed data centers will connect to the Internet—each with development scenarios. With insights from with IBM’s Cloud Data Center in Milan, hundreds of sensors on board. With this hundreds of models, petroleum engineers Fincantieri now has an IT infrastructure that future in mind, General Motors, BMW and geoscientists can optimize drilling supports a compute-intensive design and and Local Motors are now using Watson decisions to reduce costs and increase manufacturing system, allowing designers to build the world’s first generation of production—shaping how billions of dollars and engineers to more fluidly manage the cognitive driving machines. may be spent on large oil fields. process from design to deployment. GM is expanding its OnStar AtYour- Service offers and deals platform by launching new capabilities supported by OnStar Go with IBM Watson. With customers’ consent, Watson will learn drivers’ preferences, apply machine learning and sift through data to Watson IoT recognize patterns in their decisions and habits to deliver individualized location-based interactions. These ca- 6,000+ Clients pabilities are expected to be available in ↑ millions of vehicles in the United States Hybrid cloud is by the end of 2017. Olli, a self-driving electric shuttle 50,000+ Developers speeding up the design, building and deployment of new from Local Motors, holds natural language vessels. conversations with passengers, provid- ing a more engaging user experience. Watson learns from more than 30 sensors embedded throughout the vehicle to 13. enhance its understanding of passengers’ Railway Engineers needs and preferences. The BMW Group has colocated a are going the extra 19,000 team of researchers at the Watson IoT miles for commuters. headquarters in Munich to explore future steps and developments in context of the ↓ Every day, 13.5 million passengers travel Internet of Things. Researchers, IBM and BMW are with SNCF, France’s major railway system. developers and consultants are prototyp- joining forces to work To improve efficiency and customer on the future of ing advanced cognitive interfaces using connected cars. satisfaction, railway engineers are equip- the IBM Cloud and showcasing them in ping 30,000 kilometers of track, 15,000 the BMW i8 hybrid sports car. trains and 3,000 stations with sensors, all connected to the Watson IoT Platform. By monitoring data in real time, engineers and operators can improve quality, security and availability of trains. 13.5M 2016 Annual Report 05

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    15. with IBM: Music Producers compose songs in the key of AI. Grammy Award-winning Alex Da Kid created the first “cognitive song” to hit the top 10 on a Billboard chart. His inspiration came from understanding the emotional state of the world, thanks to Watson’s analysis of five years of natural language texts from sources as diverse as social media, The New York Times and United States Supreme Court rulings, as well as ↑ the lyrics to more than 26,000 Billboard Artists Alex Da Kid used data visualization for lyrical inspiration. Hot 100 hits. are finding their muse in the machine. → Three million people watched the Morgan cognitive trailer on YouTube. 14. 16. Special Effects Artists Filmmakers make thrill-seekers part create buzz with cognitive of the action. movie trailers. With a new IBM Cloud-based infrastruc- In fall 2016, 20th Century Fox released ture that includes more than 1,000 the first-ever AI-generated movie trailer. high-performance servers, special Traditionally, it can take film editors and effects artists at Prana Studios are marketers up to a month to create trailers creating some of the most immersive for an upcoming film. With Watson, they crowd experiences ever seen or heard at did it in days for the horror movie Morgan. the world’s theme parks. At one popular Watson “watched” trailers from 100 of the U.S. attraction, Prana’s high-tech scariest horror films of the past few decades wizards deliver a 3-D stereo show that and then the final cut of Morgan to choose projects ultra-high definition imagery the 10 most relevant scenes for promoting and animation from 12 projectors the movie. simultaneously across a massive 400-foot-wide U-shaped screen, pulling park-goers closer to the action than ever before. 06

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    17. 18. Chefs Bartenders have a new recipe can mix drinks with for delighting diners. a cognitive twist. Watson helps great chefs unleash their Virgin Holidays created a custom rum creativity through its deep understanding blend designed to “taste like a vacation of the science of food chemistry and the feels.” With IBM Chef Watson Twist, psychology of taste. Cognitive Cooking with bartenders can bring together flavors Chef Watson, written with the Institute of that complement one another at the Culinary Education, contains more than molecular level. Watson also analyzed 65 recipes and was named by Gourmand social posts from more than 15 million International as one of the “most innovative” people on holiday, helping a master cookbooks in the United States. blender match their sentiments to corresponding flavors. → 19. Watson reviewed rev vie ewed images of 200 Fashion Designers Marchesa dresses to suggest materials and create dresses colors for the world’s first cognitive dress. with emotional intelligence. For the 2016 Met Gala in New York City, high-fashion design house Marchesa literally lit up the red carpet with a cognitive dress that applied color psychology to match emotions. The resulting piece, created with Watson’s Cognitive Color Tool and worn by supermodel Karolína Kurková, had 150 connected LED flowers that lit up in different colors based on real-time sentiment in the room and on Twitter. 2016 Annual Report 07

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    20. with IBM: Astronauts are sharing their view of the world. Ustream video technology, delivered on the IBM Cloud, enables NASA TV to air live and prerecorded programming to space enthusiasts 24 hours a day, including space walks, repair missions and other out-of-this- world experiences. Stargazers can ask astronauts questions via social channels, giving viewers real-time, personal connec- tions with the men and women of NASA during their missions. Professionals everywhere can reimagine the ways they work… 21. Winemakers can optimize yields from every vine. The E. & J. Gallo Winery developed a precision irrigation system to grow better grapes and conserve H2O in the process. With IBM Research, the winemakers are using a cognitive irrigation system that can identify and deliver the specific amount of water needed to plots as small as 40 vines. Gallo’s crop yield increased by 26 percent— and water consumption was cut by a quarter. 08

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    22. 23. 25. Meteorologists Cyclists Steelworkers inform the world can race faster—and rise balance safety from their backyards. higher on the podium. and efficiency. Hobbyists can now contribute readings In competitive cycling, a tenth of a second is North Star BlueScope Steel recently from backyard personal weather stations everything. Ahead of the Rio Olympics, the partnered with Watson IoT on wearable to improve global forecasts. More than U.S. Women’s Cycling Team tapped IBM safety technology that helps employees 250,000 people worldwide monitor their Analytics and Watson IoT to study every stay safe in dangerous environments. By own weather stations and participate in a pedal stroke and heartbeat. By analyzing analyzing data collected from IoT sensors Personal Weather Station Network run by data streaming in from sensors installed in worn by users and embedded in their Weather Underground, a subsidiary of The the bikes, IBM helped the team calculate personal protective equipment, supervi- Weather Company, an IBM company. These the optimal energy output of each rider at sors can continuously monitor workers’ amateurs—and the data that they collect— certain points in the race. The team ended skin temperatures, heart rates and levels now help inform the up to 45 billion weather up beating their own American record, of activity to correlate health conditions inquiries that The Weather Company handles shaving two full seconds off their time from with sensor data on ambient temperature every day. Their contributions complement the 2016 London World Championships and and humidity. The data can then be used to more than 400 terabytes of data drawn daily ascending the podium in Rio with the 2016 provide personalized safety guidelines, from 800+ diverse data sources, including silver medal. advising workers when to take a break if pollen counts, turbulence, radar, satellite temperatures rise to unsafe levels. imagery, traffic and smartphone pressure sensors. More than a quarter billion people use The Weather Company’s app and website each month, and thanks in part to these amateur meteorologists, the forecasts the world sees are now hyper-accurate and hyper-local, updated every 15 minutes for 2.2 billion locations. The Weather Company 24. 26. Store Managers Flight Attendants 45B are fighting back against help passengers find their Weather inquiries daily online competitors. connecting gates. With Watson Customer Engagement and With IBM’s MobileFirst for iOS, United 2.2B Location forecasts MobileFirst for iOS, shoppers get a unique blend of virtual and physical service. Macy’s On-Call, developed with IBM partner Satisfi Airlines is deploying a new set of apps for more than 50,000 iOS devices now in the hands of its front-line employees, including Labs, is an in-store, Watson-powered flight attendants, who will be better able 250M Users monthly shopping assistant that enables smartphone users to find real-time information about product availability, store layouts and items to advise connecting passengers about their gates upon arrival. Customer service representatives are no longer tethered to on sale. Boots will be launching Sales Assist, gate podiums, allowing them to move freely 800+ Different types of data another MobileFirst for iOS app, across its about the concourse to assist customers. analyzed 2,500 U.K. stores in an effort to make it easier and simpler for customers to find the products they need. 2016 Annual Report 09

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    27. with IBM: Pilots can outmaneuver the wind. Not only is turbulence unpleasant to sit through, it costs airlines more than $100 million every year due to crew and passenger injuries, operational delays and unscheduled aircraft maintenance. Now American Airlines, Alaska Airlines, Cathay Dragon and United Airlines are using Total Turbulence from The Weather Company to analyze sensor data from more than 3,000 flights daily. It identifies patches of rough air and delivers real-time alerts to operation centers and pilots, enabling them to react quicker and take appropriate action to minimize bumpy rides. …and how they make a difference in the world. 10

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    28. 30. 32. College Professors Farmers Lawyers can respond to students are harvesting data spend less time on research 24 hours a day. for bumper crops. and more time with clients. The newest digital learning tools are Farmers in established growing regions One of the major impediments to affordable, helping students and professors work have traditionally relied on static climate quality legal representation is the high cost smarter in the classroom. One professor datasets collected by existing government, of legal research. A recent study found at Georgia Tech deployed Jill Watson, city or airport weather stations. Now, with that new associates spend a third of their the world’s “first AI teaching assistant,” a global network of distributed weather time poring over laws, prior cases and legal to join 30 human teaching assistants stations in the field, and with hyper-local journals to support arguments on behalf of in answering questions and providing forecasts from The Weather Company, a plaintiff or defendant. ROSS Intelligence guidance to nearly 1,000 graduate Farmers Edge is providing real-time data is a digital research adviser that uses students. Available at any hour of the day, and highly precise predictive models that Watson’s natural language query Jill was so good that students couldn’t tell enable growers to make more accurate capabilities to enable law firms to sift the difference between her counsel and decisions on how to manage their time, through more than one million legal that of human counterparts. Students also resources and costs. documents per second and return relevant will be able to ask questions and engage in passages and citations for a case. dialogue about courses with Pearson’s new digital learning products, just as they would their professors. Instructors will receive real-time insights on student progress, allowing them to better manage courses 1,000,000 legal documents and flag students who need additional help. per second 29. 31. 33. Digital Merchandisers Copywriters Sanitation Workers can satisfy the most can turn advertising into can nearly double demanding shoppers. personal conversations. their input. With XPS and Watson Customer The world’s first cognitive ads listen In fast-growing Nairobi, potholes and traffic Engagement, 1-800-Flowers.com built and react to individual consumer needs, jams hinder delivery of public services. IBM GWYN (Gifts When You Need), a virtual giving relevant, context-sensitive researchers equipped the city’s fleet of gift concierge that can look through responses tailored just for them. With garbage trucks with mobile phone trackers 1-800-Flowers.com’s 75,000+ products Watson machine learning and natural to monitor truck movements and allow fleet and find the best choices for each shopper. language, the Campbell Soup Company supervisors to track data on location and Shoppers explain what they’re looking and Toyota are pioneering Watson speed in real time. Department supervisors for in their own words. GWYN then sifts Ads on weather.com and The Weather could identify problems on roadways as through structured and unstructured data Channel apps. soon as drivers experienced them and on product descriptions, prices, varieties, suggest more efficient routes on the spot. categories, delivery options and more As a result, garbage collection nearly doubled, to identify the most appropriate gifts to from 800 to 1,400 metric tons per day. feature. Eighty percent of the shoppers who have used the service say they would use it again, and 65 percent click through to the products offered. 2016 Annual Report 11

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    with IBM: IT Specialists are embracing a cognitive future. 12

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    34. 36. Chief Information Developers Security Officers can build applications are calling in cognitive that think. reinforcements. IBM Security serves 12,000 clients in 133 The world is being rewritten in code, and countries, employing a global network of its new builders—21 million software 8,000 security professionals that monitor developers—are transforming entire more than 35 billion events per day. Now industries. Already, 8.2 million of them the team has Watson for Cyber Security to are using cognitive computing, tapping help clients analyze quickly and at scale IBM’s cloud, data analytics and Watson vast amounts of unstructured data capabilities to create whatever they can previously inaccessible to traditional envision. By 2018, it is expected that security tools, including an estimated 35. more than half of developers will embed 10,000 security research papers published IT Managers cognitive services into their applications. per year and 60,000 monthly security blogs. A Stanford University student’s IBM X-Force Exchange, launched in 2016, can easily integrate public DoNotPay app identified legal precedents allows companies to contribute to and and private clouds. to help overturn parking tickets and save draw from a shared pool of security motorists $5 million in fines. Bitly moved information, with 700 terabytes of The partnership between IBM and VMware 25 billion links to the IBM Cloud to give data captured on cyber threats. And in now enables IT managers to more quickly developers faster, more responsive ways Massachusetts, IBM just built the first and seamlessly extend their on-premises to understand online behavior and commercial “cyber range,” a state-of-the- VMware workloads from private data consumer interactions with their brands. art, immersive training facility that enables centers to the IBM Cloud. A unique and Staples’ Easy System allows business companies to prepare for cyberattacks by flexible hybrid approach allows enterprise customers to order supplies via voice, mimicking the way the military prepares– CIOs to customize their cloud adoption, text or email. simulating every likely scenario in advance. maintaining investments while modernizing Cognitive developers are transforming their technology strategy to compete in industries and shifting decision-making today’s transforming landscape. power within organizations. Only IBM provides all the services, tools, training and certifications necessary to help IBM Security developers become next-generation builders. With Watson, IBM Cloud and data, developers are bringing together a 12,000+ Clients set of tools that can infuse intelligence into all digital solutions. 35B+ Security events monitored daily 133 Countries 2016 Annual Report 13

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    39. with IBM: Insurers can prevent damage rather than pay for it. Hailstorms cost car insurers more than $1 billion every year. Meteorologists are now teaming up with leading insurance compa- Financial nies to help car owners avoid damage and reduce claims. The Weather Company’s hyper-local prediction system can pinpoint Professionals the path of an imminent hailstorm down to 500 square meters, an area slightly larger than a basketball court. Policyholders are are making the sent smartphone alerts to notify them when they are in harm’s way, urging them to move their vehicles under cover. smart money smarter. 38. Compliance Officers can save billions on regulatory costs. By 2020, there may be more than 300 million pages of banking regulations worldwide. Keeping pace is daunting and expensive: Banks spend about $100 billion per year on compliance efforts, and $150 billion more on fines and penalties. 37. Promontory Financial Group, an IBM 40. Tax Preparers company, is training Watson on these Customer Service complex financial compliance laws, giving it can find hidden the ability to provide decision support on Professionals credits. everything from reporting requirements for can handle more questions. derivatives to consumer protection for Weighing in at 74,000 pages—with mortgages—helping to safeguard banks, No matter how simple a customer’s ques- thousands of new changes each year— their customers and the global economy. tion, if an agent at one of Banco Bradesco’s the United States tax code is complex 5,000 branches had a query about any of and voluminous, even for the savviest the bank’s 59 products, the agent needed to tax preparer. With Watson, H&R Block’s call the company’s contact center. But now 70,000 professionals can now draw Watson Engagement Advisor can answer connections between tax laws, insights these agents’ written or spoken questions in from the company’s deep database of Portuguese, mining structured and unstruc- 720 million tax returns over the past 60 years, and personal financial documents to maximize outcomes for customers. More than 10 million tax filers are $250B Annual expenses tured data on everything from customer accounts to internal bank documents. Watson has improved response accuracy by 85 percent, leading to more satisfied clients related to expected to benefit this year. compliance for and freeing up branch agents to focus on global banks more complex customer issues. 14

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    41, 42, 43. Bankers, Diamond Brokers and Shippers can transact with trust. The global digital economy depends on trust, not faith. Transactions—from real estate and securities to supply chains and logistics—often have dozens of participants, multiplying the chances for error, delay and fraud. Fortunately, a new technology has arrived that will do for trusted transactions what the Internet did for information. Blockchain brings together shared ledgers with smart contracts, enabling the secure transfer across any network of any asset—whether physical (like a shipping container), financial (like a bond) or digital (like music). With blockchain, researchers, retailers and traders around the world are ensur- ing that all parties can transact with trust. With IBM, Maersk is creating solutions to digitize global trade, including a collab- oration on blockchain to build trust and transparency into global supply chains. Thanks to an application that start- up Everledger runs on IBM’s z Systems Cloud, blockchain can track a diamond’s provenance from mine to finger. For Walmart China, a blockchain pilot is following the journey of pork from farm to table, enabling tracking of details such as farm origins, factory data, expiration dates, storage temperatures and shipping information to better ensure food trace- ability, transparency and safety. CLS is partnering with IBM to build distributed ledger technology to reduce risk and improve liquidity across the $5-trillion-per-day global foreign Blockchain exchange market. The Depository Trust and Clearing Corporation is using the 100+ technology to permanently record and automate the sharing of secured data records of financial agreements. Companies, including IBM, support The U.S. Food and Drug the Hyperledger Project to Administration is exploring the use of accelerate open development blockchain for the secure exchange of and commercial adoption. sensitive medical data such as electronic patient records, clinical trial data and health data from mobile devices. 2016 Annual Report 15

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    44. with IBM: Educators can adapt to every student’s learning style and need. With Watson, learning can be personalized to allow students to learn at their own pace and in the ways that best suit them. Sesame Civic TM and © 2017 Sesame Workshop Workshop is creating a new educational platform that will adapt learning programs to each preschooler’s individual learning Leaders ↑ Sesame Workshop is looking to once again preferences and aptitude. Teachers in Texas’ Coppell Independent School District are using a holistic view of an are ushering transform early individual child’s data to personalize the learning, this time with Watson. ways in which they approach each of the district’s 12,300 students. Hundreds of in a new third-grade teachers in the United States are piloting Teacher Advisor with Watson, created with the American Federation of urban age. Teachers and other partners, to provide customized math lessons and expert teaching strategies that strengthen instruction. 45. Environmental Scientists are improving the quality of life through air quality. With IBM Research, environmental scien- tists in Beijing have built Green Horizons, a cognitive system that can accurately determine where air pollution is coming from, where it will go and what effect it might have on citizens. Drawing from myriad sources—including industrial production, coal shipments, transportation patterns and weather forecasts—Beijing can make adjustments such as closing factories or limiting traffic during risk periods. Ultra-fine ↑ particulate matter was reduced by 20 Green Horizons is percent in 2015. Environmental agencies helping to improve air quality in Beijing, Delhi in Delhi and Johannesburg also adopted and Johannesburg. these technologies in 2016 to address clean air initiatives. 16

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    46. 47. 49. Building Managers Helpline Operators Police Officers are listening to their can give answers in a can stay one step structures—and saving New York minute. ahead of criminals. millions. With Watson IoT, building managers and With Watson, New York’s 311 citizen Police work is shifting from reactive operators can make smarter decisions. helpline will use artificial intelligence crime-fighting to proactively managing Siemens Building Technologies to help people navigate life in the city. public safety—working across boundaries Division’s cloud-based solution captures The system will help provide more to analyze data, spot patterns and avert data generated by more than 70,000 user-friendly, up-to-the-minute and crimes before they happen. With IBM, 6,000 connected buildings to spot energy usage practical responses to 100,000 daily police departments around the world can and equipment problems in advance, saving complaints, inquiries and calls for now access more than a billion shareable millions of dollars and reducing carbon service–nearly 36 million a year. documents from the cloud. They apply emissions by two million tons every year. intelligent analytics to predict and prevent KONE enables one billion people to crime in ways never before possible, move on more than one million elevators leading to reductions in violent crime of up and escalators worldwide. The Watson IoT to 40 percent in some U.S. cities. Cloud lets KONE connect sensors in these conveyances to improve people flow and performance. With this data, KONE can pre- dict potential outages, follow performance in real time, run tests remotely and dispatch technicians with better customer insight. Clean, well-stocked restrooms make good impressions with customers, employees and tenants of any building. Delivered through the IBM Cloud, new technology from Kimberly- Clark Professional allows restroom 48. 50. attendants to monitor conditions remotely Principals Food Inspectors from any device or location, alerting them to potential issues before complaints come in. are preparing “new can thwart epidemics Sensors embedded into towel, tissue and collar workers” using supermarket soap dispensers, as well as door counters, for high-tech jobs. scanners. send real-time alerts to managers regarding supply usage levels, jams and overall traffic. A four-year college degree is no longer From Salmonella to norovirus, foodborne Cleaning staff can then be assigned to those the only route to a good job. High school illnesses afflict almost 1 in 10 people every areas that most need service. Supplies are students from diverse backgrounds are year. The only way to prevent more from better managed, costs are lowered and getting a great education, building their getting sick is to trace the problem back to tenants are happier. skills and landing the “new collar” jobs the source of the contaminated food, which of the emerging cognitive era. Pathways normally can take months. With IBM in Technology Early College High School Research, public health officials can now (P-TECH), created by IBM with leading use the data from simple supermarket educational partners, offers a unique six- scanners to analyze grocery receipts year curriculum (grades 9–14) resulting in connected with as few as 10 reported cases an associate degree. Dozens have already of illness to find tainted sources within 12 graduated ahead of schedule, prepared hours or less. for jobs in high demand at IBM and many other companies. P-TECH will soon be available in 100 schools across six U.S. states and Australia. 2016 Annual Report 17

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    Virginia M. Rometty Chairman, President and Chief Executive Officer 18

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    Dear IBM Investor: It can be hard to assess the progress of a This is why it’s so encouraging that Our strategic imperatives have reached major transformation from a single year’s employee engagement scores continue critical mass. At $33 billion, they now results. And yet, when you look back after to rise year after year. contribute 41 percent of IBM’s revenue. a few years, it becomes clear just how much With double-digit growth, we’re on pace has changed. But understanding IBM at the start of to achieve our goal of growing these 2017 requires a longer view—in particular, businesses to $40 billion by 2018. Most Before I offer a broader perspective, let remembering why we embarked on this importantly, within these businesses we me describe how your company performed journey of transformation. It had nothing have built unique and powerful platforms in 2016. We made substantial progress to do with economic downturn or fixing with Watson and the IBM Cloud: last year: something broken. Rather, our experience over more than a century has trained us • Watson has become the AI platform • We achieved operating earnings per to be vigilant. We began to see that the IT for business. I will have much more to share of $13.59 and free cash flow of industry would radically reorder, driven by say about Watson, but just consider $11.6 billion. the phenomenon of data, the maturation of that, through our clients and ecosystem • We invested heavily for our long-term cloud computing and the emergence of what partners, we expect Watson to touch one competitiveness—nearly $6 billion in many call artificial intelligence or AI. We billion people this year. research and development, nearly $4 were convinced that the source of value— • IBM is now the global leader in cloud billion in capital expenditures and nearly for our clients and for our owners—would for the enterprise. In 2016, our cloud $6 billion to make 15 acquisitions, adding shift, and that the convergence of these business grew an outstanding 35 percent, to our capabilities in the high-growth innovations would usher in a new era in to $13.7 billion (adjusted for the effects areas of cognitive, cloud and security. both technology and business. of currency, as are all revenue growth • We returned $8.8 billion to you, our numbers in this letter). Cloud by itself is shareholders, including dividends of $5.3 We didn’t wait. We got out of commoditizing now more than 17 percent of our total billion and $3.5 billion in gross share businesses—trimming $8 billion from our revenues. Our as-a-Service exit run rate repurchases. We raised our dividend for top line (and nothing from our bottom line) was $8.6 billion, up 63 percent. the 21st consecutive year—and it was over the past five years. We redoubled IBM’s 101st straight year of providing our efforts to reinvent our core hardware, I am so proud of the teams who have one. We are proud of both milestones. software and services franchises, while incubated and scaled these businesses. • IBM’s technical community outdid itself. investing to create new ones—in cloud, data, They are the IBM investor’s “unicorns.” At For the 24th year in a row, IBM led in cognitive, security and the other businesses the same time, we have transformed much U.S. patents earned, becoming the first that comprise our strategic imperatives. We of IBM’s core—the other 59 percent of our company to break the 8,000 mark did this not simply to manage a portfolio company. in one year. of businesses, but to build the integrated • All of this and more is due to the work capability that our clients would need for Global Technology Services (GTS) is the and passion of 380,000 IBMers. They are the new era. market leader in IT services. The next time our greatest competitive advantage and you use your credit or debit card, take the most important reason for confidence While our transformation continues, a strong out an insurance policy, board a plane or in IBM’s prospects in the years ahead. foundation is now in place. drive your car, chances are you are being 2016 Annual Report 19

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    “ Watson has become the AI platform for business.” touched by GTS. Their services run the because our mainframe team continues to problems. We are creating domain-specific infrastructure that powers 60 percent of the create new capabilities for new workloads. datasets that we either own or partner banking industry’s daily card transactions, Our latest mainframe runs Linux, processes to access, and we’re applying our deep 61 percent of the automobile industry’s mobile payments instantly, supports hybrid industry expertise to build vertical solutions production of passenger vehicles and nearly clouds and is becoming preferred as the and to train Watson in specific professional half of mobile connections worldwide. And most secure platform for the important new fields. while our GTS team is superb at managing technology blockchain. This is why I call this infrastructure, they are innovators at heart. part of IBM our youngest oldest business. In short, to win in the cognitive era, In recent years, they have built strong data matters. Client control of their data capabilities in hybrid cloud and are applying and insights matters. Public, hybrid and automation and Watson wherever and as Leading a new era enterprise-strength cloud matters. fast as they can. This unique combination Industry expertise matters. Trust and of innovation and trust enables GTS to grow With Watson’s victory on Jeopardy! in 2011, security matter. That is what sets apart signings and revenue, and win new clients. IBM ended the latest so-called “AI winter” Watson on the IBM Cloud—and why and led our industry and the world into the thousands of clients, partners and IBM Global Business Services continues to cognitive era. Today, we’re no longer alone: itself are building powerful solutions and reinvent itself and is growing robustly where The land rush into AI is on—including a lot of businesses on it: we have created new practices. Last year, hype. But we expect to maintain and extend our cloud practice was up more than 60 our lead in cognitive business, because we • IBM Watson Health leverages broad percent, mobile more than 40 percent and uniquely serve the needs of the enterprise. datasets, including 100 million electronic analytics 10 percent. That’s good—though health records, 200 million healthcare not enough yet to offset declines in some Enterprises need cognitive solutions that claims records and millions of images. traditional practices, such as enterprise turn vast amounts of data into insights and You also need clinical data, payer data resource planning. But I remain confident competitive advantage. They need access to and images, all of which are created in our ability to transform this business, a cloud platform not only for IT capability, and owned by clients. (Consider that an and we will continue to invest in these but for speed and agility. Its architecture estimated 80 percent of the world’s data new areas. For example, we created a new must be hybrid, spanning both public and cannot be accessed by search engines.) Watson IoT (Internet of Things) consulting private clouds, because businesses will We capture and integrate all this data, practice that will include 1,500 consultants, want to leverage their existing investments because publicly available data alone is data scientists and security experts. in applications, IT infrastructure and, most not sufficient for work like transforming of all, their data. And they need a partner healthcare or making advances in When it comes to our ability to reinvent they trust, who understands their industry cancer. What’s more, you need deep large, significant businesses, I must say and process flows, and whose platform is domain expertise. Watson Health’s 7,000 a word about the mainframe. Installed secure, scalable, global in scope and local employees include doctors, nurses, mainframe capacity has increased 20-fold in presence. health policy experts and data scientists. in the past 20 years—and is still growing, as Finally, we provide a quality management you saw in our fourth-quarter 2016 results. IBM provides this powerful AI cloud system that is HIPAA-compliant. Only Why do clients love the mainframe? Because platform, and we are using it to build IBM Watson Health offers all of this no other system can do what it can do, and industry-based solutions to real-world capability. 20

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    IBM is already essential to 97% 80% global business… of the world’s largest banks use of the world’s travel reservations are IBM has helped design, build IBM products to run their systems processed on IBM systems and run the systems that underpin global business. 90% 83% of global credit card transactions are of the world’s largest communications processed on IBM mainframes service providers are IBM clients 80% of global retailers are powered by IBM retail solutions As we build what modern Strategic Imperatives Revenue business requires... We have invested in and built the capabilities—cloud, analytics, cognitive, mobile, security—to power the emerging needs of modern $29B $33B business. Our strategic imperatives $25B grew by 14 percent adjusting for currency, generating $33 billion in revenue last year, representing 41 percent of our total revenue. 2014 2015 2016 Our growth is fueled 8,088 by innovation... patents in 2016 Our ability to create high value 97,040 is powered by the prolific inventors total patents since 1993 of IBM. For the 24th year in a row, IBM led in U.S. patents earned. In 2016, we were the first company ever to be granted more than 8,000 U.S. patents in one year. 1993 ’94 ’95 ’96 ’97 ’98 ’99 ’00 ’01 ’02 ’03 ’04 ’05 ’06 ’07 ’08 ’09 ’10 ’11 ’12 ’13 ’14 ’15 2016 Enabling us to generate $15B $8.8B high returns. Our model allows us to continuously invested returned invest in our growth while simultaneously returning value to our shareholders. in 2016 in 2016 Across research and Dividends: $5.3B development, capital Gross Share Repurchase: $3.5B expenditures, and acquisitions 2016 Annual Report 21

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    • IBM Watson IoT has similar unique It is also becoming clear that as IT moves New roads and new rules advantages. The number of new clients to the cloud, transactions must be trusted for a cognitive future and developers using our platform more by all parties involved. That is why we are than doubled last year. Our new global building a complete blockchain platform. As 2017 begins, our industry stands at Watson IoT center in Munich opened in Blockchain brings together shared ledgers an inflection point. The next few years 2017, including the first-ever Cognitive with smart contracts to allow the secure will be critical for information technology IoT Collaboratories, where clients and transfer of any asset—whether a physical providers, as businesses and institutions IBMers work together to drive innovation asset like a shipping container, a financial around the world will make key architectural in automotive, electronics, manufacturing, asset like a bond or a digital asset like decisions—about cloud, about data, healthcare and insurance. music—across any business network. about AI. • Late last year, we launched Watson Blockchain will do for trusted transactions Financial Services. And because top what the Internet did for information. IBM is well positioned to help clients make industry specialists are needed to wise choices—and to lead our competition. train Watson in the risk management IBM is already working with more than 400 We take seriously our responsibility to requirements of financial services, we clients to pioneer blockchain for business. ensure that new technology is adopted in acquired Promontory Financial Group, a They include clients who manage foreign ways that are both ethical and enduring— leader in regulatory compliance and risk exchange settlements, smart contracts, never more essential than in times of rapid management consulting. identity management and trade finance—but economic and societal change. We will the potential goes well beyond financial continue to engage across our industry and IBM is changing industries around the services. For instance, we are collaborating society, and to advocate for a business and world. Watson on the IBM Cloud is available with Walmart to ensure transparency in the policy environment that is open, inclusive, to more than 200 million consumers to way food is tracked, transported and sold global and equitable. And we will do more answer questions, find what they need to consumers across China and the United than advocate. We will innovate. online and make recommendations. Half a States. And Everledger is using a cloud- million students can choose courses and based blockchain to track the provenance An example of such innovation is IBM’s master a subject with Watson, which also of diamonds and other high-value goods as “Principles for Transparency and Trust in the helps teachers address each student’s they move through the supply chain. Cognitive Era,” which we issued in January unique learning needs. IBM Security—which of this year. Its main tenets: monitors 35 billion security events a day This is the real world of cognitive business. for 12,000 clients spanning 133 countries— Unlike the AI we see in movies and pop • We believe AI’s purpose is to augment launched the world’s first commercial culture—which depict machines achieving human intelligence. “cyber range,” where clients can simulate consciousness or independent agency— • We will be transparent about when and and prepare for real-world attacks and draw the true promise of this revolutionary where AI is being applied, and about on the power of Watson to fight cybercrime. technology comes not from replacing but the data and training that went into its With Watson, buildings are reducing from augmenting human intelligence. It recommendations. CO2 emissions by 10 million tons a year; comes from embedding cognitive capability • We believe our clients’ data and insights businesses are accelerating hiring cycles in the processes, systems, products and are theirs. by 75 percent; and airlines are improving services that permeate business, society • We are committed to helping students, maintenance efficiency by 80 percent. and our daily lives. workers and citizens acquire the skills to 22

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    “ IBM is now the global leader in cloud for the enterprise.” engage safely, securely and effectively creating a world that is fairer, more diverse, with cognitive systems, and to do the more tolerant, more just; and to creating new kinds of work that will emerge in a long-term value for you. Our strategy to cognitive economy. reinvent our company is being validated by our clients around the world, and has These principles will be our touchstone for the support of our Board of Directors. I’m everything we do to build this new world. grateful to them and to you, our owners, for We will practice them with our clients, and your continued support. Most of all, I am we believe they can form an important deeply proud of the IBM team for bringing foundation for business and society at large. us here and for what they do every day for our great company. A world with Watson Last October, IBM hosted more than 15,000 entrepreneurs, innovators and other leaders from business, government, healthcare and Virginia M. Rometty civil society who are working with Watson Chairman, President and to transform their industries and sectors. Chief Executive Officer Their work showed that Watson has, indeed, entered the world at scale. But this signature gathering did something more than showcase the reality and reach of Watson. It also presented a vision of the world with Watson. In example after example, we saw a world that is healthier, more secure, less wasteful, more productive, more personalized, more sustainable. That is a world my colleagues and I want to live in. Indeed, this is, in the end, why we are IBMers—and why we remain so deeply committed to the hopeful future that is now In an effort to provide additional and useful information regarding the company’s financial results and other financial information, as determined by generally accepted within our grasp. accounting principles (GAAP), these materials contain certain non-GAAP financial measures on a continuing operations basis, including revenue at constant currency, strategic imperatives revenue at constant currency, as-a-Service run rate at constant currency, operating earnings per share and free cash flow. The rationale for man- As IBM has done throughout its history, we agement’s use of this non-GAAP information is included on pages 26, 27 and 69 of the company’s 2016 Annual Report, which is Exhibit 13 to the Form 10-K submitted remain dedicated to leading the world into a with the SEC on February 28, 2017. For reconciliation of these non-GAAP financial measures to GAAP and other information, please refer to pages 28, 48, 50 and 69 of more prosperous and progressive future; to the company’s 2016 Annual Report. 2016 Annual Report 23

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    24 Financial Highlights International Business Machines Corporation and Subsidiary Companies ($ in millions except per share amounts) For the year ended December 31: 2016 2015 Revenue $ 79,919 $ 81,741 Net Income $ 11,872 $ 13,190 Income from continuing operations $ 11,881 $ 13,364 Operating (non-GAAP) earnings* $ 13,031 $ 14,659 Earnings per share of common stock (continuing operations) Assuming dilution $ 12.39 $ 13.60 Basic $ 12.44 $ 13.66 Diluted operating (non-GAAP)* $ 13.59 $ 14.92 Net cash provided by operating activities $ 16,958 $ 17,008 Capital expenditures, net 3,726 3,780 Share repurchases 3,502 4,609 Cash dividends paid on common stock 5,256 4,897 Per share of common stock $ 5.50 $ 5.00 At December 31: 2016 2015 Cash, cash equivalents and marketable securities $ 8,527 $ 8,195 Total assets $ 117,470 $ 110,495 Working capital $ 7,613 $ 8,235 Total debt $ 42,169 $ 39,890 Total equity $ 18,392 $ 14,424 Common shares outstanding (in millions) 946 966 Market capitalization $ 157,832 $ 133,507 Stock price per common share $ 165.99 $ 137.62 * See pages 48 and 49 for a reconciliation of net income to operating earnings.

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    Report of Financials 25 International Business Machines Corporation and Subsidiary Companies MANAGEMENT DISCUSSION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Overview 26 A Significant Accounting Policies 90 Forward-Looking and Cautionary Statements 27 B Accounting Changes 99 Management Discussion Snapshot 27 C Acquisitions/Divestitures 101 Description of Business 30 D Financial Instruments 107 Year in Review 36 E Inventories 114 Prior Year in Review 56 F Financing Receivables 114 Other Information 67 G Property, Plant and Equipment 118 Looking Forward 67 H Investments and Sundry Assets 119 Liquidity and Capital Resources 68 I Intangible Assets Including Goodwill 119 Critical Accounting Estimates 71 J Borrowings 120 Currency Rate Fluctuations 74 K Other Liabilities 123 Market Risk 74 L Equity Activity 123 Cybersecurity 75 M Contingencies and Commitments 127 Employees and Related Workforce 76 N Taxes 129 Global Financing 76 O Research, Development and Engineering 132 P Earnings Per Share of Common Stock 132 Report of Management 82 Q Rental Expense and Lease Commitments 133 Report of Independent Registered R Stock-Based Compensation 133 Public Accounting Firm 83 S Retirement-Related Benefits 136 T Segment Information 150 CONSOLIDATED FINANCIAL STATEMENTS U Subsequent Events 154 Earnings 84 Comprehensive Income 85 Five-Year Comparison of Selected Financial Data 155 Financial Position 86 Selected Quarterly Data 156 Cash Flows 87 Performance Graph 157 Changes in Equity 88 Board of Directors and Senior Leadership 158 Stockholder Information 159

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    26 Management Discussion International Business Machines Corporation and Subsidiary Companies OVERVIEW • In October 2014, the company announced a definitive The financial section of the International Business Machines agreement to divest its Microelectronics business. The Corporation (IBM or the company) 2016 Annual Report includes assets and liabilities of the Microelectronics business the Management Discussion, the Consolidated Financial were reported as held for sale at December 31, 2014 and Statements and the Notes to Consolidated Financial Statements. the operating results of the Microelectronics business This Over view is designed to provide the reader with have been reported as discontinued operations. The some perspective regarding the information contained in the transaction closed on July 1, 2015. financial section. • In January 2016, the company made a number of changes to its organizational structure and management Organization of Information system. These changes impacted the company’s • The Management Discussion is designed to provide readers reportable segments, but did not impact the company’s with an overview of the business and a narrative on the Consolidated Financial Statements. Refer to Note T, company’s financial results and certain factors that may “Segment Information,” on pages 150 to 154 for additional affect its future prospects from the perspective of the information on the changes in reportable segments. The company’s management. The “Management Discussion company’s reportable segments are: Cognitive Solutions, Snapshot,” beginning on page 27, presents an overview Global Business Services, Technology Services & Cloud of the key performance drivers in 2016. Platforms, Systems, and Global Financing. The company • Beginning with the “Year in Review” on page 36, filed a recast 2015 Annual Report in a Form 8-K on June the Management Discussion contains the results of 13, 2016 to recast its historical segment information operations for each reportable segment of the business to reflect these changes. and a discussion of the company’s financial position and • The references to “adjusted for currency” or “at constant cash flows. Other key sections within the Management currency” in the Management Discussion do not include Discussion include: “Looking Forward” on page 67, and operational impacts that could result from fluctuations in “Liquidity and Capital Resources” on page 68, which foreign currency rates. When the company refers to growth includes a description of management’s definition and rates at constant currency or adjusts such growth rates for use of free cash flow. currency, it is done so that certain financial results can • Global Financing is a reportable segment that is be viewed without the impact of fluctuations in foreign measured as a stand-alone entity. A separate “Global currency exchange rates, thereby facilitating period-to- Financing” section is included in the Management period comparisons of its business performance. Discussion beginning on page 76. Financial results adjusted for currency are calculated by translating current period activity in local currency using • The Consolidated Financial Statements are presented the comparable prior year period’s currency conversion on pages 84 through 89. These statements provide an rate. This approach is used for countries where the overview of the company’s income and cash flow functional currency is the local currency. Generally, performance and its financial position. when the dollar either strengthens or weakens against • Subsequent to the company’s press release and Form other currencies, the growth at constant currency rates 8-K filing on January 19, 2017, announcing 2016 fourth- or adjusting for currency will be higher or lower than quarter and full-year financial results, the company revised growth reported at actual exchange rates. See “Currency the classification of certain financing receivables on a full- Rate Fluctuations” on page 74 for additional information. year basis increasing net cash provided by operating • Within the financial statements and tables in this activities and net cash used in investing activities in the Annual Report, certain columns and rows may not add amount of $441 million. As adjusted, net cash provided due to the use of rounded numbers for disclosure purposes. by operating activities for the three months and twelve Percentages reported are calculated from the underlying months ended December 31, 2016 is $3,968 million whole-dollar numbers. and $16,958 million, respectively, and, net cash used in investing activities is $3,687 million and $10,976 million Operating (non-GAAP) Earnings for the same periods. There was no impact to total GAAP In an effort to provide better transparency into the operational cash flows or free cash flow. results of the business, the company separates business results • The Notes follow the Consolidated Financial Statements. into operating and non-operating categories. Operating earnings Among other items, the Notes contain the company’s from continuing operations is a non-GAAP measure that accounting policies (pages 90 to 99), acquisitions and excludes the effects of certain acquisition-related charges, divestitures (pages 101 to 106), detailed information on retirement-related costs, discontinued operations and related specific items within the financial statements, certain tax impacts. For acquisitions, operating earnings exclude the contingencies and commitments (pages 127 to 129) and amortization of purchased intangible assets and acquisition- retirement-related plans information (pages 136 to 150). related charges such as in-process research and development, transaction costs, applicable restructuring and related expenses • The Consolidated Financial Statements and the Notes and tax charges related to acquisition integration. These charges have been prepared in accordance with accounting are excluded as they may be inconsistent in amount and timing principles generally accepted in the United States (GAAP). from period to period and are dependent on the size, type and

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    Management Discussion 27 International Business Machines Corporation and Subsidiary Companies frequency of the company’s acquisitions. For retirement-related FORWARD-LOOKING AND CAUTIONARY STATEMENTS costs, the company characterizes certain items as operating and Certain statements contained in this Annual Report may others as non-operating. The company includes defined benefit constitute forward-looking statements within the meaning of plan and nonpension postretirement benefit plan service cost, the Private Secur ities Litigation Reform Act of 1995. Any amortization of prior service cost and the cost of defined forward-looking statement in this Annual Report speaks only as contribution plans in operating earnings. Non-operating of the date on which it is made; the company assumes no retirement-related cost includes defined benefit plan and obligation to update or revise any such statements. Forward- nonpension postretirement benefit plan interest cost, expected looking statements are based on the company’s current return on plan assets, amortized actuarial gains/losses, the assumptions regarding future business and financial impacts of any plan curtailments/settlements and multi- performance; these statements, by their nature, address employer plan costs, pension insolvency costs and other costs. matters that are uncertain to different degrees. Forward-looking Non-operating retirement-related costs are primarily related statements involve a number of risks, uncertainties and other to changes in pension plan assets and liabilities which are tied factors that could cause actual results to be materially different, to financial market performance and the company considers as discussed more fully elsewhere in this Annual Report and in these costs to be outside of the operational performance of the company’s filings with the Securities and Exchange the business. Commission (SEC), including the company’s 2016 Form 10-K filed on February 28, 2017. 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 comparison 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. MANAGEMENT DISCUSSION SNAPSHOT ($ and shares in millions except per share amounts) Yr.-to-Yr. Percent/ Margin For the year ended December 31: 2016 2015 Change Revenue $ 79,919 $ 81,741 (2.2)%* Gross profit margin 47.9% 49.8% (1.9)pts. Total expense and other (income) $ 25,964 $ 24,740 4.9% Total expense and other (income)-to-revenue ratio 32.5% 30.3% 2.2 pts. Income from continuing operations before income taxes $ 12,330 $ 15,945 (22.7)% Provision for income taxes from continuing operations $ 449 $ 2,581 (82.6)% Income from continuing operations $ 11,881 $ 13,364 (11.1)% Income from continuing operations margin 14.9% 16.3% (1.5) pts. Loss from discontinued operations, net of tax $ (9) $ (174) (95.1)% Net income $ 11,872 $ 13,190 (10.0)% Earnings per share from continuing operations: Assuming dilution $ 12.39 $ 13.60 (8.9)% Consolidated earnings per share—assuming dilution $ 12.38 $ 13.42 (7.7)% Weighted-average shares outstanding Assuming dilution 958.7 982.7 (2.4)% Assets** $ 117,470 $110,495 6.3% Liabilities** $ 99,078 $ 96,071 3.1% Equity** $ 18,392 $ 14,424 27.5% * (1.6) percent adjusted for currency ** At December 31

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    28 Management Discussion International Business Machines Corporation and Subsidiary Companies The following table provides the company’s (non-GAAP) operating earnings for 2016 and 2015 ($ in millions except per share amounts) Yr.-to-Yr. Percent For the year ended December 31: 2016 2015 Change Net income as reported $11,872 $13,190 (10.0)% Loss from discontinued operations, net of tax (9) (174) (95.1) Income from continuing operations $11,881 $13,364 (11.1)% Non-operating adjustments (net of tax) Acquisition-related charges 735 562 30.9 Non-operating retirement-related costs/(income) 415 734 (43.5) Operating (non-GAAP) earnings* $13,031 $14,659 (11.1)% Diluted operating (non-GAAP) earnings per share $ 13.59 $ 14.92 (8.9)% * See pages 48 and 49 for a more detailed reconciliation of net income to operating earnings. In 2016, the company reported $79.9 billion in revenue, The 2016 results reflect the success the company is having in $11.9 billion in income from continuing operations and its strategic imperatives and the investments made to drive that $13.0 billion in operating (non-GAAP) earnings, resulting in shift. The company had continued strong revenue growth diluted earnings per share from continuing operations of $12.39 in cloud, analytics and engagement, which together grew as reported and $13.59 on an operating (non-GAAP) basis. The 13 percent year to year as reported and 14 percent adjusted results of continuing operations exclude a net loss from for currency. In 2016, the strategic imperatives generated discontinued operations of $9 million in 2016 and $174 million $32.8 billion in revenue, which represented 41 percent of the in 2015 related to the divestiture of the Microelectronics company’s revenue, an increase of 6 points from 2015. Total business. On a consolidated basis, net income in 2016 was Cloud revenue of $13.7 billion increased 35 percent both as $11.9 billion, with diluted earnings per share of $12.38. reported and adjusted for currency, with cloud as-a-Service The company generated $17.0 billion in cash from operations revenue up 55 percent as reported and 57 percent adjusted for and $11.6 billion in free cash flow and shareholder returns of currency. The company exited 2016 with an annual run rate for $8.8 billion in gross common stock repurchases and dividends. cloud as-a-Service revenue of $8.6 billion, up from $5.3 billion at the end of 2015. Analytics revenue of $19.5 billion increased There are significant opportunities and shifts occurring in the IT 9 percent as reported and adjusted for currency. Mobile revenue industry, and the company believes that to be successful with increased 34 percent year to year as reported (35 percent enterprise clients, it needs to bring together cognitive adjusted for currency) and Security revenue increased 13 percent technologies on cloud platforms that create industry-based as reported (14 percent adjusted for currency). solutions to solve real-world problems. In 2016, the company continued to: From a segment perspective, Cognitive Solutions revenue increased 1.9 percent as reported and 3 percent adjusted for • Deliver strong results in the strategic imperatives; currency with growth in Solutions Software, led by an increase • Make progress in building new businesses and creating in Analytics and Security revenue; partially offset by a decline new markets; in Transaction Processing Software. Global Business Services (GBS) revenue decreased 2.7 percent as reported and 3 percent • Deliver innovation in the more traditional businesses and adjusted for currency primarily driven by a decline in Consulting monetize core technologies; and revenue. Revenue performance continued to be impacted by the • Return capital to shareholders. company’s shift away from traditional businesses, such as ERP implementations. GBS strategic imperatives revenue had Total consolidated revenue in 2016 decreased 2.2 percent as double-digit growth year to year as reported and adjusted for reported and 1.6 percent year to year adjusted for currency. currency. Technology Services & Cloud Platforms revenue Annuity revenue increased as reported and adjusted for increased 0.6 percent as reported and 1 percent adjusted for currency while transactional revenue declined year to year. currency led by growth in Infrastructure Services as the In addition, acquisitions completed in the past 12 months company assists clients in modernizing and transforming their contributed to revenue growth. infrastructures. Technology Services & Cloud Platforms strategic imperatives revenue was up 39 percent (40 percent adjusted for currency) year to year. Systems revenue decreased 19.2 percent (19 percent adjusted for currency) with z Systems down 27.1 percent (27 percent adjusted for currency) and Power Systems down 27.1 percent (27 percent adjusted for currency).

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    Management Discussion 29 International Business Machines Corporation and Subsidiary Companies From a geographic perspective, Americas revenue decreased pre-tax income from continuing operations of $13.9 billion 2.5 percent as reported (1 percent adjusted for currency) with decreased 21.3 percent year to year and the operating (non- the U.S. down 0.9 percent. Europe/Middle East/Africa (EMEA) GAAP) pre-tax margin from continuing operations decreased revenue decreased 5.0 percent as reported (2 percent adjusted 4.2 points to 17.4 percent. Operating (non-GAAP) income from for currency). Asia Pacific revenue increased 2.6 percent as continuing operations of $13.0 billion decreased 11.1 percent reported, but decreased 1 percent adjusted for currency with and the operating (non-GAAP) income margin from continuing Japan up 10.5 percent as reported, but down 1 percent adjusted operations of 16.3 percent decreased 1.6 points. The operating for currency. (non-GAAP) effective tax rate from continuing operations in 2016 was 6.5 percent versus 17.2 percent in 2015. The consolidated gross profit margin of 47.9 percent decreased 1.9 points year to year and reflects the impact of the company’s Diluted earnings per share from continuing operations of investments, including acquisitions, and mix in as-a-Service $12.39 in 2016 decreased 8.9 percent year to year. In 2016, the which is not yet at scale. The operating (non-GAAP) gross margin company repurchased 23.3 million shares of its common stock of 48.9 percent decreased 1.9 points compared to 2015 driven at a cost of $3.5 billion and had $5.1 billion remaining in primarily by the same factors. the share repurchase authorization at December 31, 2016. Operating (non-GAAP) diluted earnings per share of $13.59 Total expense and other (income) increased 4.9 percent in 2016 decreased 8.9 percent versus 2015. Diluted earnings per share compared to the prior year. Total operating (non-GAAP) expense from discontinued operations was ($0.01) in 2016 compared to and other (income) increased 5.6 percent compared to 2015. ($0.18) in 2015. The key year-to-year drivers were: At December 31, 2016, the company continued to have the financial flexibility to support the business over the long term. Total Operating Consolidated (non-GAAP) Cash and marketable securities at December 31, 2016 were • Currency* 2 points 2 points $8.5 billion, an increase of $0.3 billion from December 31, 2015. Key drivers in the balance sheet and total cash flows were: • Acquisitions** 5 points 4 points • Base (2) points 0 points Total assets increased $7.0 billion ($7.7 billion adjusted for currency) from December 31, 2015 driven by: * Reflects impacts of translation and hedging programs ** Includes acquisitions completed in prior 12-month period; operating • Increases in goodwill ($4.2 billion), retirement plan assets (non-GAAP) is net of non-operating acquisition-related charges. ($1.3 billion), net intangible assets ($1.2 billion), deferred taxes ($0.4 billion) and cash and marketable securities The increase in expense was driven primarily by the impact of ($0.3 billion). acquisitions completed in the prior 12 months and an impact from currency. Base expense performance reflects a higher level Total liabilities increased $3.0 billion ($3.9 billion adjusted of intellectual property (IP) income ($950 million) year to year for currency) from December 31, 2015 driven by: driven primarily by the company ’s software licensing arrangements. Base expense also includes charges in 2016 for • Increases in total debt ($2.3 billion), retirement-related actions taken to accelerate the transformation of the company’s liabilities ($0.6 billion) and taxes ($0.4 billion). workforce and shift its skill base, as well as increased investments in the strategic areas of cognitive, security and Total equity of $18.4 billion increased $4.0 billion from cloud. This included a higher level of workforce rebalancing December 31, 2015 as a result of: charges ($451 million) year to year and real estate capacity • Increases from net income ($11.9 billion) and stock-based charges ($291 million) related to the workforce transformation. compensation ($0.5 billion); partially offset by The company continued to invest at a high level in 2016 and remixed skills in support of the strategic imperatives. • Decreases from dividends ($5.3 billion) and share repurchases ($3.5 billion). Pre-tax income from continuing operations of $12.3 billion decreased 22.7 percent year to year and the pre-tax margin was 15.4 percent, a decrease of 4.1 points versus 2015. The company generated $17.0 billion in cash flow provided by The continuing operations effective tax rate for 2016 was operating activities, essentially flat compared to 2015, driven 3.6 percent, a decrease of 12.5 points versus 2015. The tax rate primarily by operational performance; offset by lower income in 2016 was primarily the result of a refund ($1.0 billion) of tax payments. Net cash used in investing activities of previously paid non-U.S. taxes plus interest in the first quarter $11.0 billion was $2.8 billion higher than 2015, primarily driven of 2016. Income from continuing operations of $11.9 billion by an increase in cash used related to acquisitions ($2.3 billion). decreased 11.1 percent and the net income margin was Net cash used in financing activities of $5.8 billion decreased 14.9 percent, a decrease of 1.5 points versus 2015. Losses from $3.4 billion compared to the prior year, driven primarily by higher discontinued operations, net of tax, were $9 million in 2016 net debt issuances ($2.7 billion) and a decline in cash used for compared to $174 million in 2015. Net income of $11.9 billion common share repurchases ($1.1 billion). decreased 10.0 percent year to year. Operating (non-GAAP)

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    30 Management Discussion International Business Machines Corporation and Subsidiary Companies In January 2017, the company disclosed that it is expecting Cloud Platform: IBM Cloud is the leading cloud platform for the GAAP earnings per share from continuing operations of at least enterprise, providing what enterprises need for speed, agility $11.95 and operating (non-GAAP) earnings of at least $13.80 and, combined with Watson, for cognitive capability. per diluted share for 2017. The company expects 2017 free cash Industry Focus: As IBM brings higher levels of value to its flow realization to be in excess of 90 percent of GAAP net income clients, as its offerings are being built for the needs of individual and free cash flow to be essentially flat year to year. Refer to industries. Healthcare and Financial Services are two examples page 69 in the Liquidity and Capital Resources section for of the company’s initial cognitive focus. additional information on this non-GAAP measure. Refer to the Looking Forward section on pages 67 and 68 for additional Cognitive Solutions information on the company’s expectations. Since IBM’s Watson was introduced in 2011, the company has been developing a new generation of cognitive systems that can see and analyze the massive amounts of data that have DESCRIPTION OF BUSINESS previously been invisible to computers and enterprises. IBM’s Please refer to IBM’s Annual Report on Form 10-K filed with the cognitive systems have the capability to inject a kind of thinking SEC on February 28, 2017 for Item 1A. entitled “Risk Factors.” ability into every digitized object, process and service, and learn The company creates value for clients through integrated from interactions. IBM is on the forefront of deploying these solutions and products that leverage: data, information systems and helping clients to embrace the cognitive era. technology, deep expertise in industries and business Cognitive systems are not programmed; like humans, they learn processes, and a broad ecosystem of partners and alliances. from experts and from every interaction, and they are uniquely IBM solutions typically create value by enabling new capabilities able to find patterns in big data. They learn by using advanced for clients that transform their businesses and help them engage algorithms to sense, predict and infer. Doing so, they augment with their customers and employees in new ways. These human intelligence, allowing individuals to make faster and more solutions draw from an industry-leading portfolio of consulting informed decisions. and IT implementation services, cloud and cognitive offerings, and enterprise systems and software; all bolstered by one of the Since Watson’s debut, many technologies have entered the world’s leading research organizations. market under the banner of artificial intelligence. However, IBM’s approach to cognitive systems is quite unique: Strategy • Highly adaptable intelligence systems: Watson has broad IBM has a history of continuous re-invention, transforming itself applicability and can help clients tackle challenges ranging throughout its 100-plus year history. In the past five decades from oncology to customer support. alone, IBM has ushered in the eras of the mainframe, the • Protect and respect client data: Watson learns through personal computer, IT services and enterprise software. In its data, both public data as well as clients’ private data. current transformation, IBM is once again leading the reordering Clients choose whether their data or insights are shared. of the technology industry. IBM respects the clients’ ownership and control of their A number of years ago, the company declared its focus on the own data. strategic forces behind the “digital” revolution; data, cloud and • Easy entry points: Watson’s open APIs offer easy on-ramps engagement, driven by mobile and social, and underpinned by to experiment with speech, vision and other data. security. Since 2010, IBM has invested approximately $40 billion in these areas, built out the IBM Cloud on a global scale and • Trained in domain depth: Watson is trained to be an extended cognitive systems to numerous enterprises and expert in industries and functional specialties. It augments industries. The company made 55 acquisitions and has formed the knowledge of professionals, giving them access to partnerships with organizations that are leading players in the insights of their best colleagues and the world’s key industries. leading experts. Because of this transformation, IBM today is much more than a • Transformational services: IBM’s Cognitive Solutions and hardware, software and services company; IBM is a cognitive Watson Internet of Things (IoT) practices help clients build solutions and cloud platform company, with a focus on industry their cognitive strategies. GBS provides outcome-focused capabilities and expertise: methodologies, domain skills and deep industry expertise. Cognitive Solutions: With the highest level of intelligence that exists in technology systems, these solutions tackle challenges ranging from answering client inquiries to helping physicians fight cancer.

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    Management Discussion 31 International Business Machines Corporation and Subsidiary Companies Cloud Platform • IBM continues to partner with financial services clients Cloud represents more than a new architecture for delivering to build a robust infrastructure addressing increasingly infrastructure and applications as services; it is also a catalyst complex and fast-changing demands. From preventing for innovation, speed and agility. Cloud enables companies to fraud to supporting cybersecurity efforts, IBM is becoming focus on differentiating their strategies, capabilities and ever-more essential to the financial industry. business models rather than on the underlying technology. • IBM offers analytics to help clients assess their risk and The IBM Cloud brings a unique set of characteristics to clients: compliance against industry guidelines, and uses a cognitive approach to provide deeper and faster findings. • It is a world-class cloud platform designed for enterprises, In late 2016, the company acquired Promontory Financial where security, reliability, scalability and performance Group, LLC (Promontory), one of the world’s leading are critical. regulatory consulting firms. Promontory is training Watson • It is the industry-leading hybrid cloud, enabling clients to to be a market-leading expert in the regulatory field, which extend their existing IT investments, connecting valuable will allow the company to deliver services at new levels of data and applications across public and private clouds. efficiency and transparency. • It is a world-class cognitive cloud platform with • IBM is committed to blockchain to provide a highly secure IBM Watson services that developers can embed into method of facilitating multi-step transactions, reducing their applications to create differentiating customer the number of disputes and points of friction, including experiences and powerful insights. its participation in the Hyperledger Project. This cross- industry consortium is working to build the blockchain The IBM Cloud has a strong global presence, with more than network in the cloud, doing for trusted transactions 50 cloud data centers around the world giving clients the what the Internet did for information, and setting industry flexibility to optimize the deployment of data and application, standards for years to come. Blockchain will enable for performance, security and compliance. financial institutions to settle securities in minutes instead of days; manufacturers to reduce product recalls by sharing production logs along their supply chain; and businesses of The IBM Cloud is also continually expanding its base of advanced all types to more closely manage the flow of goods and capabilities including cloud data services, cloud object storage, payments. IBM is working with companies ranging from cloud video services, as well as Internet of Things, blockchain retailers, banks and shippers to apply this technology to and analytics services. In 2016, IBM brought new cognitive transform their ecosystems through open standards and solutions to professionals in marketing, commerce, supply chain open platforms. and human resources, extending industry clouds to further differentiate its cloud offerings. • IBM’s Global Business Services consulting business, with broad expertise across industries and a strong global Industry Focus footprint and scale, provides a unique combination of To bring higher value to clients, IBM is providing solutions that technologies and services to help clients achieve their are specific and tailored to challenges clients face in their business outcomes. industry, using the power of IBM’s advanced cognitive computing capabilities built on the IBM Cloud. In 2016, IBM deepened its commitment to delivering higher value in several key ways: • In the healthcare industry, IBM Watson Health combines the power of cloud and cognitive with value-based solutions to optimize performance, engage consumers, enable effective care and manage population health. Significant investment in the healthcare space, including the acquisition of Merge and Truven, has enabled the company to expand the scope of solutions aimed at solving some of the most pressing health challenges.

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    32 Management Discussion International Business Machines Corporation and Subsidiary Companies Transforming Core Businesses The business model is dynamic, adapting to the continuously While the company is focused on cognitive solutions, cloud changing industry and economic environment, including the platform and industry, it is important to note cognitive, cloud company’s transformation into cloud and as-a-Service delivery and industry are being embedded across IBM’s offerings. These models. The company continues to strengthen its position core businesses continue to run clients’ most critical business through strategic organic investments and acquisitions in higher- processes. IBM’s hardware systems are being designed from value areas, strengthening its industry expertise and applying the ground up to power the cloud and cognitive systems of the advanced analytics across virtually all its offerings. In addition, future. The company’s technology services help clients move to the company is transforming into a more agile enterprise to drive the cloud, embedding cognitive capabilities tailored for their innovation and speed, as well as helping to drive productivity, industry. The company’s software offerings are simultaneously which supports investments for participation in markets with being made available for the cloud as well as being connected significant long-term opportunity. to the cloud where our clients choose to keep them on premises. This business model, supported by the company’s financial Additionally, cognitive capabilities are being added to these model, has enabled the company to deliver strong earnings, cash offerings to provide new levels of innovation. In short, all of IBM flows and returns to shareholders over the long term. is transforming to support the way its clients are transforming. Summary Business Segments and Capabilities Each transformation of IBM ushers in a new capability to the The company’s major operations consist of five business world. More than 50 years ago, IBM introduced the program- segments: Cognitive Solutions, Global Business Services, mable era and transformed the world’s transactions through the Technology Ser vices & Cloud Platforms, Systems and mainframe. In the decades that followed, IBM commercialized Global Financing. the personal computer, created an industry around IT services and a software market around middleware. Each of these Cognitive Solutions comprises a broad portfolio of capabilities innovations remains essential to business and the world today. that help IBM’s clients to identify actionable new insights and inform decision-making for competitive advantage. Leveraging The company’s current chapter is ushering in an entirely new era IBM’s research, technology and industry expertise, this business of human-computer interaction, embodied in cognitive solutions delivers a full spectrum of capabilities, from descriptive, and the cloud platform for the needs of industries. The company predictive and prescriptive analytics to cognitive systems. is embarking on an era where it will create new capabilities at Cognitive Solutions includes Watson, the first commercially speeds and depth never previously witnessed. available cognitive computing platform that has the ability to interact in natural language, process vast amounts of big data, Business Model and learn from interactions with people and computers. These The company’s business model is built to support two principal solutions are provided through the most contemporary delivery goals: helping enterprise clients to become more innovative, methods including through cloud environments and “as-a- efficient and competitive through the application of business Service” models. Cognitive Solutions consists of Solutions insight and IT solutions; and providing long-term value to Software and Transaction Processing Software. shareholders. The business model has been developed over Cognitive Solutions Capabilities time through strategic investments in capabilities and Solutions Software: provides the basis for many of the technologies that have superior long-term growth and company’s strategic areas including analytics, security and profitability prospects based on the value they deliver to clients. social. IBM has established the world’s deepest portfolio of data The company’s global capabilities as a cognitive solutions and and analy tics solutions, including analy tics and data cloud platform company include services, software, systems, management platforms, cloud data services, enterprise social fundamental research and related financing. The broad mix of software, talent management solutions, and solutions tailored businesses and capabilities are combined to provide integrated by industry. Watson Platform, Watson Health and Watson solutions and platforms to the company’s clients. Internet of Things capabilities are included in Solutions Software. IBM’s world-class security platform delivers integrated security intelligence across clients’ entire operations, including their cloud, applications, networks and data, helping them to prevent, detect and remediate potential threats.

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    Management Discussion 33 International Business Machines Corporation and Subsidiary Companies Transaction Processing Software: includes software that Te c h n o l o g y S e r v i c e s & C l o u d P l at f o rm s provides primarily runs mission-critical systems in industries such as comprehensive IT infrastructure services creating business banking, airlines and retail. Most of this software is on-premise value for clients through integrated services that incorporate and annuity in nature. unique intellectual property within its global delivery model. By leveraging insights and experience drawn from IBM’s global Global Business Services (GBS) provides clients with scale, skills and technology, with applied innovation from consulting, application management services and global process IBM Research, clients gain access to leading edge, high-quality services. These professional services deliver business value and ser vices with improved productivit y, flexibilit y, cost innovation to clients through solutions which leverage industry, and outcomes. technology and business process expertise. GBS is the digital reinvention partner for IBM clients, combining industry Technology Services & Cloud Platforms Capabilities knowledge, functional expertise, and applications with the Infrastructure Services: delivers a portfolio of cloud, project- power of design, cognitive and cloud. The full portfolio of GBS based, outsourcing and other managed services focused on services is backed by its globally integrated delivery network clients’ enterprise IT infrastructure environments to enable and integration with IBM solutions and services including digital transformation and deliver improved quality, flexibility, Watson, cloud, blockchain, and Technology Services. To deepen risk management and financial value. The portfolio includes a its capabilities, in 2016 IBM acquired four consulting and design comprehensive set of hybrid cloud services and solutions to firms to enhance the GBS global network of 35 digital experience assist clients in building and running enterprise IT environments design studios. IBM also announced Watson IoT Consulting that utilize public and private clouds and traditional IT. The IBM Solutions, a new practice that brings together IBM’s industry Cloud Platform offers leading edge services to developers and and technical expertise to help clients introduce IoT innovation IBM’s Cloud Infrastructure-as-a-Service covers a wide variety into their businesses. of workloads with unprecedented performance. These offerings integrate long-standing expertise in service management and GBS Capabilities technology with the ability to utilize the power of new Consulting: provides business consulting services focused on technologies, including those from other IBM business bringing to market solutions that help clients shape their digital segments. The portfolio is built around a key set of predictive blueprints and customer experiences, define their cognitive and proactive solutions addressing systems, mobility, resiliency, operating models, set their next-generation talent strategies networking, cloud and security. The company’s capabilities, and create new technology visions and architectures in a cloud- including IBM Cloud, cognitive computing and hybrid cloud centric world. implementation, can help to deliver high-performance, end-to- Application Management: delivers system integration, end innovation and an improved ability to achieve business application management, maintenance and support services for objectives. packaged software, as well as custom and legacy applications. Technical Support Services: delivers a comprehensive line of Value is delivered through advanced capabilities in areas such support services to maintain and improve the availability of as security and privacy, application testing and modernization, clients’ IT infrastructures. These offerings include maintenance cloud application migration and automation. for IBM products and other technology platforms, as well as Global Process Services: GBS’ business process outsourcing software and solution support. service line, delivers finance, procurement, HR, and industry- Integration Software: delivers industry-leading hybrid cloud specific business processes. These services deliver improved solutions that empower clients to achieve rapid innovation, business results to clients through the strategic change and/or hybrid integration, and process transformation with choice and operation of the client’s business processes, applications and consistency across public, dedicated and local cloud infrastructure. GBS is redefining the efficiency and cost profiles environments, leveraging IBM’s Bluemix Platform-as-a-Service of clients’ core processes through the application of the power solution. Integration Software offerings and capabilities help of Watson, cognitive and deep analytics. clients address the digital imperatives to create, connect and optimize their applications, data and infrastructure on their journey to become cognitive businesses.

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    34 Management Discussion International Business Machines Corporation and Subsidiary Companies Systems provides clients with innovative infrastructure Global Financing facilitates IBM clients’ acquisition of technologies to help meet the new requirements of hybrid cloud information technology systems, software and services by and cognitive workloads—from deploying advanced analytics, providing financing solutions in the areas where the company to moving to digital service delivery with the cloud, and securing has the expertise. The financing arrangements are predom- mobile transaction processing. Approximately half of Systems inantly for products or services that are critical to the end users’ Hardware’s server and storage sales transactions are through business operations. These financing contracts are entered into the company’s business partners, with the balance direct to end- after a comprehensive credit evaluation and are secured by legal user clients. IBM Systems also designs advanced semiconductor contracts. As a captive financier, Global Financing has the and systems technology in collaboration with IBM Research, benefit of both deep knowledge of its client base and a clear primarily for use in the company’s systems. insight into the products and services financed. These factors allow the business to effectively manage two of the major risks, Systems Capabilities credit and residual value, a ssociated with financing Servers: a range of high-performance systems designed to while generating strong returns on equity. Global Financing address computing capacity, security and performance needs also maintains a long-term partnership with the companies’ of businesses, hyperscale cloud service providers and scientific clients through various stages of IT asset life cycle—from computing organizations. The portfolio includes z Systems, initial purcha se and technolog y upgr ades to a sset a trusted enterprise platform for integrating data, transactions disposition decisions. and insight, and Power Systems, a system designed from the ground up for big data and analytics, optimized for Global Financing Capabilities scale-out cloud and Linux, and delivering open innovation Client Financing: lease, installment payment plan and loan with OpenPOWER. financing to end users and internal clients for terms up to seven years. Assets financed are primarily new and used IT hardware, The company is a founding member of the OpenPOWER software and services where the company has expertise. foundation, a group of industry-leading companies developing Internal financing is predominantly in support of Technology high-performance compute technologies and solutions based Services & Cloud Platforms’ long-term client service contracts. on the IBM POWER architecture. All internal financing arrangements are at arm’s-length rates Storage: data storage products and solutions that allow clients and are based upon market conditions. to retain and manage rapidly growing, complex volumes of digital Commercial Financing: short-term inventory and accounts information and to fuel data-centric cognitive applications. receivable financing to suppliers, distributors and remarketers These solutions address critical client requirements for of IBM and OEM products. This includes internal activity where information retention and archiving, security, compliance and Global Financing factors a selected portion of the company’s storage optimization including data deduplication, availability accounts receivable primarily for cash management purposes, and virtualization. The portfolio consists of a broad range of at arm’s-length rates. software-defined storage solutions, flash storage, disk and tape storage solutions. Remanufacturing and Remarketing: assets include used equipment returned from lease transactions, or used and Operating Systems Software: The company’s z/OS is a security- surplus equipment acquired internally or externally. These rich, scalable, high-performance enterprise operating system assets may be refurbished or upgraded and sold or leased to for z Systems. Power Systems offers a choice of AIX or Linux new or existing clients both externally or internally. Externally operating systems. These operating systems leverage POWER remarketed equipment revenue represents sales or leases to architecture to deliver secure, reliable and high- performing clients and resellers. Internally remarketed equipment revenue enterprise-class workloads across a breadth of server offerings. primarily represents used equipment that is sold internally to Systems and Technology Services & Cloud Platforms. Systems may also sell the equipment that it purchases from Global Financing to external clients.

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    Management Discussion 35 International Business Machines Corporation and Subsidiary Companies IBM Worldwide Organizations data-centric systems and more—applying these technologies The following worldwide organizations play key roles in IBM’s across industries including healthcare, Internet of Things, delivery of value to its clients: education and financial services. • Global Markets (formerly Sales and Distribution) In 2016, IBM was awarded more U.S. patents than any other company for the 24th consecutive year. IBM’s 8,088 patents • Research, Development and Intellectual Property awarded in 2016 represent a diverse range of inventions in • Integrated Supply Chain artificial intelligence and cognitive computing, cognitive health, cloud, cybersecurity and other strategic growth areas for Global Markets the company. IBM has a global presence, operating in more than 175 countries The company continues to actively seek intellectual property with a broad-based geographic distribution of revenue. The (IP) protection for its innovations, while increasing emphasis on company’s Global Markets organization manages IBM’s global other initiatives designed to leverage its IP leadership. Some of footprint, working closely with dedicated country-based IBM’s technological breakthroughs are used exclusively in IBM operating units to serve clients locally. These country teams products, while others are licensed and may be used in IBM have client relationship managers who lead integrated teams of products and/or the products of the licensee. As part of its consultants, solution specialists and delivery professionals to business model, the company licenses certain of its intellectual enable clients’ growth and innovation. These local teams property, which is high-value technology, but may be in more develop deep relationships with their clients to bring together mature markets. The licensee drives the future development of capabilities from IBM and its network of Business Partners to the IP and ultimately expands the customer base. This generates develop and implement solutions. IP income for the company both upon licensing, and with By complementing local expertise with global experience and ongoing royalty arrangements between it and the licensee. While digital capabilities, IBM builds broad-based client relationships. the company’s various proprietary IP rights are important to its This local management focus fosters speed in addressing new success, IBM believes its business as a whole is not materially markets and making investments in emerging opportunities. The dependent on any particular patent or license, or any particular Global Markets organization serves clients with expertise in their group of patents or licenses. IBM owns or is licensed under a industry as well as through the products and services that IBM number of patents, which vary in duration, relating to its and partners supply. IBM is also expanding its reach to smaller products. clients through digital marketing, digital marketplaces, inside sales and local Business Partner resources. Integrated Supply Chain IBM has an extensive integrated supply chain, procuring IBM continues to invest to capture opportunities in key growth materials and services globally. Additionally, growth in client markets around the world—India, China and Southeast Asia; spend managed by IBM’s procurement organization continues Eastern Europe; the Middle East and Africa; and Latin America. to demonstrate clients’ faith that IBM can reduce clients’ cost Major IBM markets include the G7 countries of Canada, France, through the transformation of source-to-pay operations. The Germany, Italy, Japan, the United States (U.S.) and the United supply, manufacturing and logistics operations are seamlessly Kingdom (U.K.), as well as Austria, the Bahamas, Belgium, the integrated and have optimized inventories over time. Simplifying Caribbean, Cyprus, Denmark, Finland, Greece, Iceland, Ireland, and streamlining internal processes has improved sales force Israel, Malta, the Netherlands, Norway, Portugal, Spain, Sweden productivity and operational effectiveness and efficiency. and Switzerland. Supply chain resiliency enables IBM to reduce its risk during marketplace changes. Research, Development and Intellectual Property IBM’s research and development (R&D) operations differentiate The company continues to derive business value from its own the company from its competitors. IBM annually invests 6 to 7 globally integrated supply chain providing a strategic advantage percent of total revenue for R&D, focusing on high-growth, high- for the company to create value for clients. IBM leverages its value opportunities. IBM Research works with clients and the supply chain expertise for clients through its supply chain company’s business units through global labs on near-term and business transformation outsourcing service to optimize and midterm innovations. It contributes many new technologies to help operate clients’ end-to-end supply chain processes, from IBM’s portfolio every year and helps clients address their most procurement to logistics. Utilizing analytics, mobile, cloud and difficult challenges. IBM Research scientists are conducting social—with numerous projects, has allowed the integrated pioneering work in artificial intelligence, analytics, security, supply chain to drive positive business outcomes for the nanotechnology, cloud computing, blockchain, quantum company and its clients. computing, silicon and post-silicon computing architectures,

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    36 Management Discussion International Business Machines Corporation and Subsidiary Companies YEAR IN REVIEW Results of Continuing Operations Segment Details The following is an analysis of the 2016 versus 2015 reportable segment results. The table below presents each reportable segment’s external revenue and gross margin results. Segment pre-tax income includes transactions between segments that are intended to reflect an arm’s-length transfer price and excludes certain unallocated corporate items. ($ in millions) Yr.-to-Yr. Yr.-to-Yr. Percent Percent/ Change Margin Adjusted for For the year ended December 31: 2016 2015 Change Currency Revenue Cognitive Solutions $ 18,187 $ 17,841 1.9% 2.7% Gross margin 81.9% 85.1% (3.3) pts. Global Business Services 16,700 17,166 (2.7)% (2.5)% Gross margin 27.0% 28.2% (1.2) pts. Technology Services & Cloud Platforms 35,337 35,142 0.6% 1.4% Gross margin 41.9% 42.7% (0.8) pts. Systems 7,714 9,547 (19.2)% (18.9)% Gross margin 55.7% 55.8% (0.1) pts. Global Financing 1,692 1,840 (8.0)% (6.9)% Gross margin 38.7% 45.6% (6.9) pts. Other 289 206 40.4% 41.3% Gross margin (293.9)% (253.0)% (41.0) pts. Total consolidated revenue $ 79,919 $ 81,741 (2.2)% (1.6)% Total consolidated gross profit $ 38,294 $ 40,684 (5.9)% Total consolidated gross margin 47.9% 49.8% (1.9) pts. Non-operating adjustments Amortization of acquired intangible assets 494 373 32.6% Retirement-related costs/(income) 316 469 (32.7)% Operating (non-GAAP) gross profit $ 39,104 $ 41,526 (5.8)% Operating (non-GAAP) gross margin 48.9% 50.8% (1.9 )pts. Cognitive Solutions ($ in millions) Yr.-to-Yr. Percent Yr.-to-Yr. Change Percent Adjusted for For the year ended December 31: 2016 2015 Change Currency Cognitive Solutions external revenue $ 18,187 $ 17,841 1.9% 2.7% Solutions Software $ 12,589 $ 12,021 4.7% 5.5% Transaction Processing Software 5,598 5,819 (3.8) (3.1) Cognitive Solutions revenue of $18,187 million grew 1.9 percent Watson offerings such as Watson Health. Security also as reported and 3 percent adjusted for currency in 2016 contributed to year-to-year growth, as the company continues compared to the prior year. On an as reported and constant to invest to build its security platform. There was strong currency basis, growth in Solutions Software, which addresses Software-as-a-Service (SaaS) performance during the year with many of the company’s strategic areas, was partially offset by double-digit growth in revenue as reported and adjusted for declines in Transaction Processing Software. currency. In 2016, five acquisitions, including The Weather Company and Truven, added substantial new capabilities to the Solutions Software revenue of $12,589 million grew 4.7 percent Solutions Software portfolio. as reported (6 percent adjusted for currency) compared to the prior year. This growth was led by analytics and security Throughout the year, the Watson platform, which underpins the offerings. Analytics, which is the largest portion of the Solutions company’s cognitive strategy, continued to gain momentum, as Software portfolio, continued to grow in key areas including the company expanded cognitive capabilities in the IBM Cloud.

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    Management Discussion 37 International Business Machines Corporation and Subsidiary Companies The company broadened the reach of Watson, with new ($ in millions) capabilities, partnerships and engagement to accelerate Yr.-to-Yr. adoption. Focus continues on scaling Watson Health and Percent/ bringing real world benefits to researchers and clinicians. For the year ended Margin December 31: 2016 2015 Change Watson IoT is growing and clients are using the power of Watson Cognitive Solutions across the immense data pool created by the Internet of Things. The company is expanding its industry differentiation and focus External gross profit $14,890 $15,189 (2.0)% on building industry verticals including the acquisition of External gross profit Promontory in the fourth quarter. margin 81.9% 85.1% (3.3) pts. Pre-tax income $ 6,352 $ 7,245 (12.3)% Transaction Processing Software revenue of $5,598 million Pre-tax margin 30.5% 36.1% (5.6) pts. declined 3.8 percent as reported (3 percent adjusted for currency) compared to the prior year. Most of this software is on-premise and annuity in nature which is not a growing part of Cognitive Solutions gross profit margin decreased 3.3 points to the software opportunity. 81.9 percent in 2016. Pre-tax income of $6,352 million decreased 12.3 percent compared to the prior year with a pre- Within Cognitive Solutions, total 2016 strategic imperatives tax margin decline of 5.6 points to 30.5 percent. This overall revenue of $11.7 billion grew 7 percent as reported (8 percent margin performance for the year reflects impacts of the adjusted for currency) year to year. Cloud revenue of $2.1 billion company’s continued investment into strategic areas, including grew 53 percent as reported (54 percent adjusted for currency), acquisition content, and the mix toward the SaaS business which with an as-a-Service exit run rate of $1.8 billion. is not yet at scale, partially offset by the impact of IP partnership agreements entered into during the year. Global Business Services ($ in millions) Yr.-to-Yr. Percent Yr.-to-Yr. Change Percent Adjusted for For the year ended December 31: 2016 2015 Change Currency Global Business Services external revenue $16,700 $17,166 (2.7)% (2.5)% Consulting $ 7,332 $ 7,678 (4.5)% (4.8)% Global Process Services 1,388 1,435 (3.3) (2.0) Application Management 7,980 8,053 (0.9) (0.5) Global Business Services revenue of $16,700 million decreased to respond to clients looking to create new business models with 2.7 percent as reported and 3 percent adjusted for currency in cognitive technologies. There was continued revenue growth in 2016 compared to the prior year. Digital practices, which made 2016, both as reported and adjusted for currency, in enterprise up more than half of GBS revenue in 2016, grew strong double mobility solutions that are helping clients redesign workflows digits as reported and adjusted for currency including double- with specific industry content. The company’s growing collection digit growth in cloud, analytics and mobile. This growth was of MobileFirst for iOS applications can now be integrated with a more than offset by declines in the more traditional areas broad set of Watson technologies to increase productivity. The that the company is shifting away from, such as large company is scaling the industry’s first cognitive consulting ERP implementations. practice which draws on the exper tise of consulting professionals spanning machine learning, advanced analytics, Consulting revenue of $7,332 million declined 4.5 percent as data science and development. During 2016, six acquisitions reported (5 percent adjusted for currency). Global Process added substantial new capabilities in digital design, cloud Services (GPS) revenue of $1,388 million decreased 3.3 percent consulting and other skill areas. as reported (2 percent adjusted for currency) compared to the prior year. Application Management revenue of $7,980 million ($ in millions) decreased 0.9 percent as reported (flat adjusted for currency). Yr.-to-Yr. Percent/ Within GBS, total 2016 strategic imperatives revenue of For the year ended Margin $8.9 billion grew 16 percent as reported and adjusted for December 31: 2016 2015 Change currency year to year. Cloud revenue of $3.0 billion grew Global Business Services 68 percent as reported (66 percent adjusted for currency), External gross profit $4,501 $4,837 (6.9)% with an as-a-Service exit run rate of $1.1 billion. External gross profit The company continues to aggressively shift the business to the margin 27.0% 28.2% (1.2) pts. strategic imperatives, or digital practices in GBS. The IBM Pre-tax income $1,732 $2,602 (33.4)% Interactive Experience, the largest global digital agency, now Pre-tax margin 10.1% 14.7% (4.6) pts. has more than 30 studios worldwide. The company continues

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    38 Management Discussion International Business Machines Corporation and Subsidiary Companies GBS gross profit margin decreased 1.2 points to 27.0 percent The company continues to invest and shift resources to higher compared to the prior year, with declines in Consulting and GPS. value services around digital and cognitive. The company is Overall, this reflects the company’s investments to grow the investing in enablement, hiring top talent and bringing in new digital practices, additional spending in certain accounts to skills through acquisitions and focusing on integrating and deliver on client commitments, and price and profit pressure in scaling these new skills. While this impacts near-term profit, this more traditional engagements. These dynamics are also investment has added important capabilities as the company reflected in the pre-tax margin for the year. In 2016, pre-tax continues to expand the digital practices. income of $1,732 million decreased 33.4 percent and the pre-tax margin declined 4.6 points to 10.1 percent. Technology Services & Cloud Platforms ($ in millions) Yr.-to-Yr. Percent Yr.-to-Yr. Change Percent Adjusted for For the year ended December 31: 2016 2015 Change Currency Technology Services & Cloud Platforms external revenue $35,337 $35,142 0.6% 1.4% Infrastructure Services $23,543 $23,075 2.0% 2.7% Technical Support Services 7,272 7,426 (2.1) (1.0) Integration Software 4,521 4,641 (2.6) (1.5) Technolog y Ser vices & Cloud Plat forms revenue of contributing to growth in as-a-Service content. The company $35,337 million grew 0.6 percent as reported and 1 percent continues to expand its cloud infrastructure and now has adjusted for currency in 2016 compared to the prior year. As the 50 cloud centers around the world, enabling low latency business shifts from systems integration to services integration, connectivity to cloud infrastructure. there is continuing momentum in new offerings. Infrastructure Although revenue declined year to year, Technical Support Services revenue grew as reported and adjusted for currency, Services continues to generate substantial revenue and profit. partially offset by declines in Technical Support Services and There was year-to-year revenue growth as reported and Integration Software. In 2016, four acquisitions have expanded adjusted for currency in multi-vendor services, which is capabilities and strengthened the company’s portfolio. leveraging the company’s global scale and deep technical skills. Infrastructure Services revenue of $23,543 million grew In Integration Software, there was revenue growth in Connect 2.0 percent as reported (3 percent adjusted for currency) products that integrate applications, data and processes for compared to the prior year. Technical Support Services revenue on-premise and cloud environments. There was also a continued of $7,272 million decreased 2.1 percent as reported (1 percent shift of the portfolio to an as-a-Service model through IBM’s adjusted for currency). Integration Software revenue of Bluemix cloud platform which continues to scale across a broad $4,521 million decreased 2.6 percent as reported (1 percent catalog of high value services. adjusted for currency) in 2016 compared to the prior year. Within Technology Services & Cloud Platforms, total 2016 In Infrastructure Services, clients continue to turn to the strategic imperatives revenue of $8.7 billion grew 39 percent as company as the trusted partner to modernize and transform reported (40 percent adjusted for currency) year to year. Cloud their most critical IT systems and navigate the complexities of revenue of $5.9 billion grew 49 percent as reported (50 percent the hybrid cloud environment. The company’s hybrid cloud adjusted for currency), with an as-a-Service exit run rate of strategy is resonating with clients as they move to enterprise- $5.8 billion. grade cloud solutions that are secure, agile and leverage the data and investments in their core systems. Enterprise workloads on the company’s public cloud continue to scale,

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    Management Discussion 39 International Business Machines Corporation and Subsidiary Companies ($ in millions) Technology Services & Cloud Platforms gross profit margin Yr.-to-Yr. decreased 0.8 points to 41.9 percent in 2016 compared to the Percent/ prior year. While partially due to mix within the segment, there For the year ended Margin December 31: 2016 2015* Change was improvement in the Infrastructure Services margin offset Technology Services & by declines in Technical Support Services and Integration Cloud Platforms Software. The margin improvement in Infrastructure Services reflects the benefits from delivery transformation and ongoing External Technology Services gross productivity actions related to automation, process optimization profit $10,969 $11,008 (0.4)% and leveraging the company’s scale, technology and talent. The External Technology company is investing in cognitive capabilities to further improve Services gross its delivery model and drive efficiencies. The Technical Support profit margin 35.6% 36.1% (0.5) pts. Services margin decline reflects the mix to multi-vendor support External Integration offerings. The Integration Software margin declined as the shift Software gross of the portfolio to an as-a-Service model continues. profit $ 3,830 $ 4,005 (4.4)% Pre-tax income of $4,707 million decreased 17.0 percent and External Integration pre-tax margin declined 2.8 points year to year to 13.1 percent. Software gross The pre-tax margin reflects the dynamics impacting gross profit profit margin 84.7% 86.3% (1.6) pts. and the continued investments to build out the cloud platform, External total gross partially offset by the impact of IP partnership agreements profit $14,800 $15,014 (1.4)% entered into during the year. External total gross profit margin 41.9% 42.7% (0.8) pts. Pre-tax income $ 4,707 $ 5,669 (17.0)% Pre-tax margin 13.1% 15.8% (2.8) pts. * Recast to conform with 2016 presentation Services Backlog and Signings ($ in billions) Yr.-to-Yr. Percent Yr.-to-Yr. Change Percent Adjusted for At December 31: 2016 2015 Change Currency Total backlog $118.7 $122.6 (3.2)% (1.8)% The estimated total services backlog at December 31, 2016 was no third-party standards or requirements governing the $119 billion, a decrease of 3.2 percent as reported, and calculation of signings. The calculation used by management 2 percent adjusted for currency, with an increase in GTS more involves estimates and judgments to gauge the extent of a than offset by a decline in GBS as reported and adjusted for client’s commitment, including the type and duration of the currency, compared to the December 31, 2015 balance. agreement, and the presence of termination charges or wind- down costs. Total services backlog includes Infrastructure Services, Consulting, Global Process Services, Application Management Signings include Infrastructure Services, Consulting, Global and Technical Support Services. Total backlog is intended to be Process Services and Application Management contracts. a statement of overall work under contract for these businesses Contract extensions and increases in scope are treated as and therefore includes Technical Support Services. It does not signings only to the extent of the incremental new value. include as-a-Service offerings that have flexibility in contractual Technical Support Services is not included in signings as the commitment terms. Backlog estimates are subject to change maintenance contracts tend to be more steady state, where and are affected by several factors, including terminations, revenues equal renewals. changes in the scope of contracts, periodic revalidations, Contract portfolios purchased in an acquisition are treated as adjustments for revenue not materialized and adjustments positive backlog adjustments provided those contracts meet the for currency. company’s requirements for initial signings. A new signing will Services signings are management’s initial estimate of the value be recognized if a new services agreement is signed incidental of a client’s commitment under a services contract. There are or coincidental to an acquisition or divestiture. ($ in millions) Yr.-to-Yr. Percent Yr.-to-Yr. Change Percent Adjusted for For the year ended December 31: 2016 2015 Change Currency Total signings $44,645 $46,432 (3.8)% (2.7)%

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    40 Management Discussion International Business Machines Corporation and Subsidiary Companies Systems ($ in millions) Yr.-to-Yr. Percent Yr.-to-Yr. Change Percent Adjusted for For the year ended December 31: 2016 2015 Change Currency Systems external revenue $7,714 $9,547 (19.2)% (18.9)% Systems Hardware $5,926 $7,574 (21.8)% (21.6)% z Systems (27.1) (26.8) Power Systems (27.1) (26.8) Storage Systems (10.0) (10.0) Operating Systems Software 1,788 1,973 (9.4) (8.7) Systems revenue of $7,714 million decreased 19.2 percent as continues to be the market leader, partially offset by growth in reported (19 percent adjusted for currency) in 2016 compared the expanding Linux market. During the year, there was success to the prior year reflecting market shifts and product cycle with HANA where the company is bringing in new clients. The dynamics. Systems Hardware revenue of $5,926 million UNIX market remains a high-value space for clients, and in 2016 decreased 21.8 percent as reported (22 percent adjusted for new midrange and high-end systems were introduced. These currency) year to year. Operating Systems Software revenue of systems are designed for hybrid cloud computing and flexible $1,788 million decreased 9.4 percent as reported (9 percent consumption models to transform on-premise IT to the cloud. adjusted for currency) compared to the prior year. In Power, the company is shifting to Linux while continuing to serve the UNIX space, but this is a long transition. Within Systems Hardware, z Systems revenue decreased 27.1 percent as reported (27 percent adjusted for currency) year Storage Systems revenue decreased by 10.0 percent as reported to year reflecting product cycle dynamics. However, eight and adjusted for currency year to year reflecting the weakness quarters into the z13 cycle at the end of 2016, the company in the traditional disk storage market. In 2016, the company continues to add new clients to the platform, drive innovation introduced new products and transitioned to a full suite of flash and introduce new technologies. During 2016, 29 new clients array offerings to improve its competitive position, and this were added, with a total of 80 since introduction of the z13, portfolio grew revenue in the fourth quarter of the year as validating its value and ongoing commitment to the company’s reported and adjusted for currency. While not reported within platform. Throughout the year, the company continued to the Systems segment, Software-Defined Storage had revenue optimize z Systems to drive new workloads such as blockchain growth as reported and adjusted for currency in 2016. and instant payments. The acquisition of EZSource, which helps Within Systems, total 2016 strategic imperatives revenue of clients modify applications for their digital transformation while $3.4 billion decreased 15 percent as reported and adjusted for supporting agility and hybrid cloud, also drove innovation in the currency year to year. Cloud revenue of $2.7 billion decreased z Systems platform. 11 percent as reported and adjusted for currency as a result of Power Systems revenue decreased 27.1 percent as reported a strong 2015 with the mainframe cycle. (27 percent adjusted for currency) year to year reflecting the underlying dynamics of a declining market for UNIX, where IBM

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    Management Discussion 41 International Business Machines Corporation and Subsidiary Companies ($ in millions) The company has reinvented its core systems for work in a new Yr.-to-Yr. era of computing. It has optimized systems to drive new types Percent/ of workloads and is expanding its footprint, building new For the year ended Margin December 31: 2016 2015* Change capabilities and solving new types of problems for its clients. While facing some shifting market dynamics and product Systems transitions, the Systems portfolio remains optimized to address External Systems the demands of the cognitive era and cloud computing. Hardware gross profit $2,720 $3,536 (23.1)% Global Financing External Systems Hardware gross See pages 76 through 81 for an analysis of Global Financing’s profit margin 45.9% 46.7% (0.8) pts. segment results. External Operating Systems Software Total Software gross profit $1,577 $1,790 (11.9)% Under the company’s new segment structure, total software no External Operating longer exists as a segment. Given the focus on IBM’s software Systems Software revenue performance, the company continued to report total gross profit margin 88.2% 90.7% (2.5) pts. software revenue performance through 2016. The company’s External total gross software revenue is reported discretely within the Cognitive profit $4,298 $5,326 (19.3)% Solutions, Technology Services & Cloud Platforms and Systems External total gross segments and can be added together to calculate total software. profit margin 55.7% 55.8% (0.1) pts. The company has a broad software portfolio, from solutions that Pre-tax income $ 933 $1,722 (45.8)% provide cognitive, analytics and security solutions, to core Pre-tax margin 11.0% 16.7% (5.7) pts. transaction processing, to connecting on-premises data and processes to private and public cloud environments. This * Recast to conform with 2016 presentation software is open, running on IBM and non-IBM environments. Total software revenue, which includes Cognitive Solutions, The Systems gross profit margin decreased 0.1 points to Integration Software and Operating Systems Software, of 55.7 percent in 2016 compared to the prior year with declines $24,496 million increased 0.2 percent as reported and 1 percent in Power and Storage partially offset by expansion in z Systems adjusted for currency in 2016 compared to 2015. From a margins. Pre-tax income of $933 million decreased 45.8 percent business area perspective, there was growth in Cognitive and the pre-tax margin declined 5.7 points year to year to Solutions as reported and adjusted for currency, while 11.0 percent, consistent with the product cycle and portfolio Integration Software and Operating Systems Software were transition dynamics impacting revenue and profit. down year to year as reported and adjusted for currency. Across software, annuity revenue grew year to year as reported and adjusted for currency led by SaaS offerings. Transactional revenue declined as reported and adjusted for currency. Geographic Revenue In addition to the revenue presentation by reportable segment, the company also measures revenue performance on a geographic basis. The following geographic, regional and country-specific revenue performance excludes OEM revenue. ($ in millions) Yr.-to-Yr. Percent Yr.-to-Yr. Change Percent Adjusted for For the year ended December 31: 2016 2015 Change Currency Total revenue $79,919 $81,741 (2.2)% (1.6)% Geographies $79,594 $81,430 (2.3)% (1.6)% Americas 37,513 38,486 (2.5) (1.4) Europe/Middle East/Africa 24,769 26,073 (5.0) (2.1) Asia Pacific 17,313 16,871 2.6 (1.2)

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    42 Management Discussion International Business Machines Corporation and Subsidiary Companies Total geographic revenue of $79,594 million in 2016 decreased Total Expense and Other (Income) 2.3 percent as reported and 2 percent adjusted for currency ($ in millions) compared to the prior year. Yr.-to-Yr. Percent/ Americas revenue of $37,513 million decreased 2.5 percent as For the year ended Margin reported and 1 percent adjusted for currency with declines in December 31: 2016 2015 Change North America and Latin America as reported and adjusted for Total consolidated expense currency. Within North America, the U.S. decreased 0.9 percent and other (income) $25,964 $24,740 4.9% and Canada decreased 6.2 percent (3 percent adjusted for Non-operating adjustments currency). In Latin America, Brazil decreased 10.5 percent Amortization of acquired (7 percent adjusted for currency) and Mexico decreased intangible assets (503) (304) 65.7 14.5 percent (7 percent adjusted for currency). Acquisition-related charges (5) (26) (81.0) EMEA revenue of $24,769 million decreased 5.0 percent as Non-operating retirement- reported and 2 percent adjusted for currency. Within EMEA, related revenue declined in the UK, Germany and France, as reported (costs)/income (282) (581) (51.4) and adjusted for currency, while revenue grew in Italy as Operating (non-GAAP) reported and adjusted for currency. The UK decreased expense and other 12.8 percent (1 percent adjusted for currency). Germany (income) $25,174 $23,830 5.6% decreased 5.1 percent (5 percent adjusted for currency). Total consolidated Revenue declined in France 3.4 percent (3 percent adjusted for expense-to-revenue ratio 32.5% 30.3% 2.2 pts. currency). Italy increased 4.0 percent (4 percent adjusted for Operating (non-GAAP) currency) year to year. The Middle East and Africa region grew expense-to-revenue ratio 31.5% 29.2% 2.3 pts. 0.6 percent (3 percent adjusted for currency), while there was a decline in the Central and Eastern European region as reported The key drivers of the year-to-year change in total expense and and adjusted for currency including a year-to-year decline in other (income) were approximately: Russia of 27.1 percent. Total Operating Asia Pacific revenue of $17,313 million grew 2.6 percent as Consolidated (non-GAAP) reported, but declined 1 percent adjusted for currency. Japan • Currency* 2 points 2 points grew 10.5 percent as reported, but declined 1 percent adjusted • Acquisitions** 5 points 4 points for currency. India grew 5.2 percent as reported and 10 percent • Base (2) points 0 points adjusted for currency. China decreased 2.4 percent as reported, but was flat on an adjusted for currency basis. Australia * Reflects impacts of translation and hedging programs decreased 9.7 percent (8 percent adjusted for currency). ** 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.

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    Management Discussion 43 International Business Machines Corporation and Subsidiary Companies Selling, General and Administrative Research, Development and Engineering ($ in millions) ($ in millions) Yr.-to-Yr. Yr.-to-Yr. For the year ended Percent For the year ended Percent December 31: 2016 2015 Change December 31: 2016 2015 Change Selling, general and Total consolidated administrative research, expense development and Selling, general and engineering $5,751 $5,247 9.6% administrative—other $16,971 $16,643 2.0% Non-operating adjustment Advertising and Non-operating retirement- promotional expense 1,327 1,290 2.8 related Workforce rebalancing (costs)/income (29) (48) (38.6) charges 1,038 587 76.7 Operating (non-GAAP) Retirement-related costs 742 1,052 (29.5) research, development and Amortization of acquired engineering $5,722 $5,200 10.1% intangible assets 503 304 65.7 Stock-based Research, development and engineering (RD&E) expense was compensation 401 322 24.3 7.2 percent of revenue in 2016 and 6.4 percent of revenue Bad debt expense 87 231 (62.3) in 2015. Total consolidated selling, general and RD&E expense increased 9.6 percent in 2016 versus 2015 administrative expense $21,069 $20,430 3.1% primarily driven by: Non-operating • Higher expense due to acquisitions (7 points); and adjustments Amortization of acquired • Increased base spending (4 points); partially offset by intangible assets (503) (304) 65.7 • The effects of currency (1 point). Acquisition-related charges 2 (21) NM Operating (non-GAAP) RD&E expense increased 10.1 percent Non-operating retirement- in 2016 compared to the prior year, driven primarily by the same related (costs)/income (253) (533) (52.6) factors. Operating (non-GAAP) selling, general and administrative expense $20,315 $19,573 3.8% Intellectual Property and Custom Development Income NM—Not meaningful ($ in millions) Yr.-to-Yr. Total selling, general and administrative (SG&A) expense For the year ended Percent increased 3.1 percent in 2016 versus 2015, driven primarily by December 31: 2016 2015* Change the following factors: Licensing of intellectual property including • Acquisition-related spending (4 points); and royalty-based fees $1,390 $407 241.8% • Higher workforce rebalancing charges (2 points); partially Custom development offset by income 214 262 (18.4) Sales/other transfers of • The effects of currency (1 point); and intellectual property 27 13 113.4 • A year-to-year decrease in charges for pension obligations Total $1,631 $682 139.3% related to litigation in Spain (1 point). * Reclassified to conform to 2016 presentation Operating (non-GAAP) expense increased 3.8 percent year to year driven primarily by the same factors excluding the year- Licensing of intellectual property including royalty-based fees to-year decrea se in charges for pension obligations increased in 2016 compared to the prior-year period, primarily related to litigation which is not reflected in operating due to licensing of certain intellectual property in 2016 within the (non-GAAP) expense. company’s Integration Software and Cognitive Solutions software portfolio, which included four transactions each with period Bad debt expense decreased $144 million in 2016 compared to income greater than $100 million. The company is licensing IP 2015. The receivables provision coverage was 2.0 percent at to partners who are allocating their skills to extend the value of December 31, 2016, a decrease of 60 basis points from assets that are high value, but may be in mature markets. There December 31, 2015 due to write-offs of previously reserved were no significant individual IP transactions in 2015. The receivables in 2016.

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    44 Management Discussion International Business Machines Corporation and Subsidiary Companies timing and amount of licensing, sales or other transfers of IP The increase in interest expense in 2016 versus 2015 was may vary significantly from period to period depending upon the primarily driven by higher average debt levels and higher average timing of licensing agreements, economic conditions, industry interest rates. Interest expense is presented in cost of financing consolidation and the timing of new patents and know-how in the Consolidated Statement of Earnings only if the related development. external borrowings are to support the Global Financing external business. Overall interest expense (excluding capitalized Other (Income) and Expense interest) in 2016 was $1,206 million, an increase of $197 million year to year. ($ in millions) Yr.-to-Yr. For the year ended Percent Stock-Based Compensation December 31: 2016 2015 Change Pre-tax stock-based compensation cost of $544 million Other (income) and increased $76 million compared to 2015. This was due primarily expense to increases related to performance share units ($72 million) Foreign currency and the conversion of stock-based awards previously issued by transaction acquired entities ($15 million); partially offset by decreases losses/(gains) $ (116) $ 414 NM related to restricted stock units ($15 million). Stock-based (Gains)/losses on compensation cost, and the year-to-year change, was reflected derivative instruments 260 (853) NM in the following categories: Cost: $88 million, down $13 million; Interest income (108) (72) 49.1% SG&A expense: $401 million, up $78 million and RD&E expense: $55 million, up $5 million. Net (gains)/losses from securities and investment assets 23 47 (50.5) Retirement-Related Plans The following table provides the total pre-tax cost for all retire- Other 85 (260) NM ment-related plans. These amounts are included in the Total consolidated other Consolidated Statement of Earnings within the caption (e.g., (income) and expense $ 145 $(724) NM Cost, SG&A, RD&E) relating to the job function of the plan Non-operating adjustment participants. Acquisition-related charges (7) (5) 35.2 ($ in millions) Operating (non-GAAP) Yr.-to-Yr. other (income) and For the year ended Percent December 31: 2016 2015 Change expense $ 138 $(729) NM Retirement-related NM—Not meaningful plans—cost Service cost $ 443 $ 484 (8.6)% Total consolidated other (income) and expense was expense of Amortization of prior $145 million in 2016 compared to income of $724 million in service costs/ 2015. The decrease in income of $869 million year over year (credits) (107) (100) 7.0 was primarily driven by: Cost of defined contribution • Lower net exchange gains ($593 million); and plans 1,070 1,138 (6.0) • Real estate capacity charges related to the first-quarter Total operating costs/ 2016 workforce transformation ($291 million). (income) $1,405 $1,522 (7.7)% Interest cost $3,300 $3,316 (0.5)% Interest Expense Expected return on plan assets (5,563) (5,879) (5.4) ($ in millions) Yr.-to-Yr. Recognized actuarial For the year ended Percent losses 2,751 3,283 (16.2) December 31: 2016 2015 Change Curtailments/ Interest expense settlements (16) 36 NM Total $630 $468 34.4% Multi-employer plan/ other costs 126 293 (57.0) Total non-operating costs/(income) $ 598 $1,050 (43.0)% Total retirement-related plans—cost $2,003 $2,572 (22.1)% NM—Not meaningful

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    Management Discussion 45 International Business Machines Corporation and Subsidiary Companies In 2016, total pre-tax retirement-related plan cost decreased Earnings Per Share by $569 million compared to 2015, primarily driven by a Basic earnings per share is computed on the basis of the decrease in recognized actuarial losses ($532 million), a weighted-average number of shares of common stock decrease in pension obligations related to litigation in Spain outstanding during the period. Diluted earnings per share is ($177 million) and lower defined contribution plans cost computed on the basis of the weighted-average number of ($68 million); partially offset by lower expected return on plan shares of common stock outstanding plus the effect of dilutive assets ($316 million). potential common shares outstanding during the period using the treasury stock method. Dilutive potential common shares As discussed in the “Operating (non-GAAP) Earnings” section include outstanding stock options and stock awards. on pages 26 and 27, the company characterizes certain retirement-related costs as operating and others as non- oper ating. Utilizing this char ac teriz ation, oper ating Yr.-to-Yr. For the year ended Percent retirement-related costs in 2016 were $1,405 million, a December 31: 2016 2015 Change decrease of $117 million compared to 2015, primarily driven by Earnings per share of lower defined contribution plans cost ($68 million) and lower common stock from service cost ($42 million). Non-operating costs of $598 million continuing operations decreased $452 million in 2016 compared to the prior year, Assuming dilution $12.39 $13.60 (8.9)% driven primarily by a decrease in recognized actuarial losses Basic $12.44 $13.66 (8.9)% ($532 million) and a decrease in pension obligations related to litigation in Spain ($177 million); partially offset by lower Diluted operating (non-GAAP) $13.59 $14.92 (8.9)% expected return on plan assets ($316 million). Weighted-average shares outstanding (in millions) Income Taxes Assuming dilution 958.7 982.7 (2.4)% The continuing operations effective tax rate for 2016 was 3.6 percent, a decrease of 12.5 points versus the prior year. The Basic 955.4 978.7 (2.4)% benefit resulting from the favorable resolution of a long standing tax matter related to the determination of certain foreign tax Actual shares outstanding at December 31, 2016 and 2015 losses incurred by the company in Japan drove a 9.5 point were 945.9 million and 965.7 million, respectively. The average reduction in the rate. Without that discrete item, the continuing number of common shares outstanding assuming dilution operations effective tax rate for 2016 would have been 13.1 was 24.0 million shares lower in 2016 versus 2015. The percent, with the remaining change in the rate year to year driven decrease was primarily the result of the common stock by the following factors: repurchase program. • A benefit due to the year-to-year decrease in tax charges Results of Discontinued Operations related to intercompany payments made by foreign The loss from discontinued operations, net of tax, was $9 million subsidiaries and the intercompany licensing of certain IP of in 2016 and $174 million in 2015. The discontinued operations 5.7 points; and effective tax rate in 2016 was 21.7 percent compared to • A benefit due to the geographic mix of pre-tax earnings in 40.3 percent in 2015. 2016 of 0.3 points; partially offset by • A reduced benefit year to year related to audit settlements of 2.3 points; and • The decreased benefit year to year in the utilization of foreign tax credits of 0.6 points. The continuing operations operating (non-GAAP) effective tax rate was 6.5 percent, a decrease of 10.7 points versus 2015 principally driven by the same factors described above. Without the Japan benefit, the continuing operations (non-GAAP) effective tax rate would have been 14.9 percent.

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    46 Management Discussion International Business Machines Corporation and Subsidiary Companies Financial Position The assets and debt associated with the Global Financing Dynamics business are a significant part of the company’s financial At December 31, 2016, the company continued to have the position. The financial position amounts appearing on page 86 financial flexibility to support the business over the long term. are the consolidated amounts including Global Financing. The Cash and marketable securities at year end were $8,527 million. amounts appearing in the separate Global Financing section, During the year, the company continued to manage the beginning on page 77, are supplementary data presented to investment portfolio to meet its capital preservation and facilitate an understanding of the Global Financing business. liquidity objectives. Total debt of $42,169 million increased $2,279 million from Working Capital prior year-end levels. The commercial paper balance at ($ in millions) December 31, 2016, was $899 million, an increase of At December 31: 2016 2015 $299 million from the prior year end. Within total debt, Current assets $43,888 $42,504 $27,859 million was in support of the Global Financing business Current liabilities 36,275 34,269 which is leveraged at a 7.3 to 1 ratio. The company continues to have substantial flexibility in the debt markets. During 2016, the Working capital $ 7,613 $ 8,235 company completed bond issuances totaling $7,873 million, Current ratio 1.21:1 1.24:1 with terms ranging from 1.5 to 30 years, and interest rates ranging from 0.50 to 4.70 percent depending on maturity. The Working capital decreased $622 million from the year-end 2015 company has consistently generated strong cash flow from position. The key changes are described below: operations and continues to have access to additional sources Current assets increased $1,383 million ($1,920 million of liquidity through the capital markets and its $10.25 billion adjusted for currency), as a result of: global credit facility, with 100 percent of the facility available on a same day basis. • An increase of $690 million ($1,013 million adjusted for currency) in receivables driven by trade receivables; and Consistent with accounting standards, the company remeasured the funded status of its retirement and postretirement plans at • An increase of $359 million ($457 million adjusted for December 31. At December 31, 2016, the overall net under- currency) in prepaid expenses and other current assets; funded position was $14,840 million, a decrease of $674 million and from December 31, 2015 driven by asset returns partially offset • An increase of $332 million ($427 million adjusted for by a decrease in discount rates. At year end, the company’s currency) in cash and marketable securities. qualified defined benefit plans were well funded and the cash requirements related to these plans remain stable going Current liabilities increased $2,006 million ($2,471 million forward at approximately $500 million per year through 2020. adjusted for currency), as a result of: In 2016, the return on the U.S. Personal Pension Plan assets was 6.2 percent and the plan was 102 percent funded at • An increase in short-term debt of $1,052 million December 31. Overall, global asset returns were 8.5 percent ($1,033 million adjusted for currency); and and the qualified defined benefit plans worldwide were • An increase in taxes of $388 million ($442 million adjusted 98 percent funded at December 31, 2016. for currency) primarily driven by the reclass from non- During 2016, the company generated $16,958 million in cash current liabilities based on the anticipated settlement of from operations, a decrease of $49 million compared to 2015. various U.S. and non-U.S. tax audits; and In addition, the company generated $11,574 million in free cash • An increase in other accrued expenses and liabilities of flow, a decrease of $1,501 million versus the prior year. See $352 million ($571 million adjusted for currency); and page 69 for additional information on free cash flow. The company returned $8,758 million to shareholders in 2016, with • An increase in accounts payable of $181 million $5,256 million in dividends and $3,502 million in gross share ($244 million adjusted for currency). repurchases. In 2016, the company repurchased 23.3 million shares and had $5.1 billion remaining in share repurchase authorization at year end. The company’s cash generation permits the company to invest and deploy capital to areas with the most attractive long-term opportunities.

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    Management Discussion 47 International Business Machines Corporation and Subsidiary Companies Cash Flow Noncurrent Assets and Liabilities The company’s cash flows from operating, investing and ($ in millions) financing activities, as reflected in the Consolidated Statement At December 31: 2016 2015 of Cash Flows on page 87 are summarized in the table below. These amounts include the cash flows associated with the Noncurrent assets $73,582 $67,991 Global Financing business. Long-term debt $34,655 $33,428 Noncurrent liabilities (excluding debt) $28,147 $28,374 ($ in millions) The increase in noncurrent assets of $5,591 million For the year ended December 31: 2016 2015 ($5,788 million adjusted for currency) was driven by: Net cash provided by/(used in) continuing operations • An increase in intangible assets and goodwill of Operating activities $ 16,958 $17,008 $5,379 million ($5,420 million adjusted for currency) resulting from acquisitions during the year; and Investing activities (10,976) (8,159) Financing activities (5,791) (9,166) • An increase in prepaid pension assets of $1,301 million Effect of exchange rate changes on ($1,427 million adjusted for currency) primarily driven by cash and cash equivalents (51) (473) the expected returns on plan assets partially offset by Net change in cash and cash interest costs and plan remeasurements; partially offset by equivalents $ 140 $ (790) • A decrease of $993 million ($1,054 million adjusted for currency) in long-term financing receivables primarily Net cash provided by operating activities decreased by due to lower volumes. $49 million in 2016 driven by the following key factors: • Performance-related declines within net income; offset by Long-term debt increased $1,227 million ($1,595 million adjusted for currency) driven by: • A decline in cash income tax payments ($1,579 million). • Bond issuances of $7,873 million; partially offset by Net cash used in investing activities increased $2,817 million • Reclassification of $6,239 million to short-term debt to driven by: reflect upcoming maturities. • An increase in cash used related to acquisitions of $2,330 million. Other noncurrent liabilities, excluding debt, decreased $227 million ($195 million adjusted for currency) primarily driven by: Net cash used in financing activities decreased $3,375 million as compared to the prior year driven by the following factors: • A decrease of $622 million ($769 million adjusted for currency) in other liabilities driven by the reclass to • An increase in net cash sourced from debt transactions of current taxes based on the anticipated settlement of $2,744 million driven by a higher level of issuances in the various U.S. and non-U.S. tax audits; partially offset by current year; and • An increase in retirement and nonpension postretirement • A decrease of $1,107 million of cash used for gross share liabilities of $567 million ($706 million adjusted for repurchases; partially offset by currency) driven by plan remeasurements. • An increase in dividend payments of $358 million.

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    48 Management Discussion International Business Machines Corporation and Subsidiary Companies Debt Given the significant leverage, the company also presents a The company’s funding requirements are continually monitored debt-to-capitalization ratio which excludes Global Financing and strategies are executed to manage the overall asset and debt and equity as management believes this is more liability profile. Additionally, the company maintains sufficient representative of the company’s core business operations. This flexibility to access global funding sources as needed. 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 ($ in millions) 49.5 percent at December 31, 2016 compared to 54.3 percent At December 31: 2016 2015 at December 31, 2015. Total company debt $ 42,169 $ 39,890 Total Global Financing segment debt $ 27,859 $ 27,205 Equity Debt to support external clients 24,034 23,934 Total equity increased by $3,968 million from December 31, Debt to support internal clients 3,825 3,271 2015 as a result of an increase in retained earnings of Non-Global Financing debt 14,309 12,684 $6,634 million, an increase in common stock of $673 million and lower accumulated other comprehensive losses of $209 million; partially offset by an increase in treasury stock of $3,532 million Global Financing provides financing predominantly for the mainly due to gross common stock repurchases. company’s external client assets, as well as for assets under contract by other IBM units. These assets, primarily for Technology Services & Cloud Platforms, generate long-term, GAAP Reconciliation stable revenue streams similar to the Global Financing asset The tables below provide a reconciliation of the company’s portfolio. Based on their attributes, these Technology Services income statement results as reported under GAAP to its & Cloud Platforms assets are leveraged with the balance of the operating earnings presentation which is a non-GAAP measure. Global Financing asset base. The debt analysis above is further The company’s calculation of operating (non-GAAP) earnings, detailed in the Global Financing section on page 80. as presented, may differ from similarly titled measures reported by other companies. Please refer to the “Operating (non-GAAP) Consolidated debt-to-capitalization ratio at December 31, 2016 Earnings” section on pages 26 and 27 for the company’s was 69.6 percent versus 73.4 percent at December 31, 2015. rationale for presenting operating earnings information. ($ in millions except per share amount) Acquisition- Retirement- Related Related Operating For the year ended December 31, 2016: GAAP Adjustments Adjustments (non-GAAP) Gross profit $ 38,294 $ 494 $ 316 $39,104 Gross profit margin 47.9% 0.6 pts. 0.4 pts. 48.9% SG&A $ 21,069 $ (501) $ (253) $20,315 RD&E 5,751 — (29) 5,722 Other (income) and expense 145 (7) — 138 Total expense and other (income) 25,964 (508) (282) 25,174 Pre-tax income from continuing operations 12,330 1,003 598 13,931 Pre-tax margin from continuing operations 15.4% 1.3 pts. 0.7 pts. 17.4% Provision for income taxes* $ 449 $ 268 $ 183 $ 900 Effective tax rate 3.6% 1.7 pts. 1.2 pts. 6.5% Income from continuing operations $ 11,881 $ 735 $ 415 $13,031 Income margin from continuing operations 14.9% 0.9 pts. 0.5 pts. 16.3% Diluted earnings per share from continuing operations $ 12.39 $ 0.77 $ 0.43 $ 13.59 * The tax impact on operating (non-GAAP) pre-tax income 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.

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