Edgar Filing: INTERNATIONAL BUSINESS MACHINES CORP

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10 - Q/A

Amendment No. 1 to

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

FOR THE QUARTER ENDED SEPTEMBER 30, 2004

1-2360

(Commission file number)

INTERNATIONAL BUSINESS MACHINES CORPORATION

(Exact name of registrant as specified in its charter)

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

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

914-499-1900

(Registrant’s telephone number)

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

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

The registrant has 1,664,697,252 shares of common stock outstanding at September 30, 2004.

EXPLANATORY NOTE

This amendment on Form 10-Q/A amends the Company’s Quarterly Report on Form 10-Q for the period ended September 30, 2004, as initially filed with the Securities and Exchange Commission (the “SEC”) on October 28, 2004, and is being filed to correct typographical errors in certain column headings in four tables contained in such report. Specifically, the column headings under “U.S. Plans” in the two tables on pages 8 and 9 should have indicated that the first column of data in each such table was for 2004 and the second column of data in each such table was for 2003. In addition, the heading "For the period ended March 31:" should be removed from the table on page 34, and the second column in the table on Page 35 should have contained the heading “2003”.

Index

Part I - Financial Information:

	Item 1. Consolidated Financial Statements

	Consolidated Statement of Earnings for the three and nine months ended September 30, 2004 and 2003

	Consolidated Statement of Financial Position at September 30, 2004 and December 31, 2003

	Consolidated Statement of Cash Flows for the nine months ended September 30, 2004 and 2003

	Notes to Consolidated Financial Statements

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

	Item 4. Controls and Procedures

Part II - Other Information

	Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities

	Item 6. Exhibits

Part I - Financial Information

ITEM 1. Consolidated Financial Statements

INTERNATIONAL BUSINESS MACHINES CORPORATION

AND SUBSIDIARY COMPANIES

CONSOLIDATED STATEMENT OF EARNINGS

(UNAUDITED)

(Dollars in millions except	Three Months Ended September 30,						Nine Months Ended September 30,
per share amounts)	2004			2003			2004			2003
Revenue:
Global Services	$	11,392		$	10,383		$	33,818		$	31,187
Hardware	7,501			6,697			21,659			19,118
Software	3,621			3,461			10,545			10,061
Global Financing	638			715			1,951			2,092
Enterprise Investments/Other	277			266			859			760
Total revenue	23,429			21,522			68,832			63,218

Cost:
Global Services	8,544			7,782			25,401			23,298
Hardware	5,368			5,011			15,567			14,104
Software	462			491			1,418			1,452
Global Financing	255			302			780			897
Enterprise Investments/Other	154			124			486			424
Total cost	14,783			13,710			43,652			40,175

Gross profit	8,646			7,812			25,180			23,043

Expense and other income:
Selling, general and administrative	4,978			4,303			14,094			12,978
Research, development and engineering	1,419			1,307			4,212			3,728
Intellectual property and custom development income	(259		)	(406		)	(871		)	(887		)
Other (income) and expense	(55		)	26			(19		)	114
Interest expense	32			33			100			114
Total expense and other income	6,115			5,263			17,516			16,047

Income from continuing operations before income taxes	2,531			2,549			7,664			6,996
Provision for income taxes	731			764			2,271			2,099
Income from continuing operations	1,800			1,785			5,393			4,897

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

(Dollars in millions except	Three Months Ended September 30,						Nine Months Ended September 30,
per share amounts)	2004			2003			2004			2003
Discontinued Operations
Loss from discontinued operations	—			—			3			23
Net income	$	1,800		$	1,785		$	5,390		$	4,874

Earnings/(loss) per share of common stock:
Assuming dilution
Continuing operations	$	1.06		$	1.02		$	3.14		$	2.78
Discontinued operations	(0.00		)	(0.00		)	(0.00		)	(0.01		)
Total	$	1.06		$	1.02		$	3 .14		$	2.77

Basic
Continuing operations	$	1.08		$	1.04		$	3.21		$	2.84
Discontinued operations	(0.00		)	(0.00		)	(0.00		)	(0.01		)
Total	$	1.08		$	1.04		$	3.21		$	2.82	*

Weighted-average number of common shares outstanding: (millions)
Assuming dilution	1,700.4			1,756.4			1,714.6			1,759.5
Basic	1,669.6			1,722.6			1,680.3			1,725.9
Cash dividends per common share	$	0.18		$	0.16		$	0.52		$	0.47

* Does not total due to rounding.

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

INTERNATIONAL BUSINESS MACHINES CORPORATION

AND SUBSIDIARY COMPANIES

CONSOLIDATED STATEMENT OF FINANCIAL POSITION

ASSETS

(Dollars in millions)	At September 30, 2004		At December 31, 2003
	(Unaudited)
Assets
Current assets:
Cash and cash equivalents	$	9,178	$	7,290
Marketable securities — at fair value, which approximates market value	493		357
Notes and accounts receivable — trade, net of lowances allowances	9,528		10,026
Short-term financing receivables	13,161		17,583
Other accounts receivable	1,301		1,314
Inventories, at lower of average cost or net realizable value:
Finished goods	1,169		992
Work in process and raw materials	2,162		1,950
Total inventories	3,331		2,942
Deferred taxes	2,505		2,542
Intangible assets — net	306		336
Prepaid expenses and other current assets	2,627		2,608
Total current assets	42,430		44,998

Plant, rental machines and other property	37,156		37,122
Less: Accumulated depreciation	22,548		22,433
Plant, rental machines and other property — net	14,608		14,689
Long-term financing receivables	10,017		10,741
Prepaid pension assets	18,806		18,426
Intangible assets — net	494		574
Goodwill	7,678		6,921
Investments and sundry assets	6,643		8,108

Total assets	$	100,676	$	104,457

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

INTERNATIONAL BUSINESS MACHINES CORPORATION

AND SUBSIDIARY COMPANIES

CONSOLIDATED STATEMENT OF FINANCIAL POSITION

LIABILITIES AND STOCKHOLDERS’ EQUITY

(Dollars in millions except per share amounts)	At September 30, 2004			At December 31, 2003
	(Unaudited)
Liabilities and Stockholders’ Equity
Current liabilities:
Taxes	$	4,295		$	5,475
Short-term debt	8,427			6,646
Accounts payable and accruals	22,445			25,779
Total current liabilities	35,167			37,900

Long-term debt	13,524			16,986
Retirement and nonpension postretirement benefit obligations	14,012			14,251
Other liabilities	8,271			7,456
Total liabilities	70,974			76,593

Stockholders’ equity:

Common stock - par value $0.20 per share	17,691			16,269
Shares authorized: 4,687,500,000
Shares issued: 2004 - 1,953,666,624
2003 - 1,937,393,604
Retained earnings	41,829			37,525

Treasury stock - at cost	(28,254		)	(24,034		)
Shares: 2004 - 288,969,372
2003 - 242,884,969

Accumulated gains and (losses) not affecting retained earnings	(1,564		)	(1,896		)
Total stockholders’ equity	29,702			27,864

Total liabilities and stockholders’ equity	$	100,676		$	104,457

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

INTERNATIONAL BUSINESS MACHINES CORPORATION

AND SUBSIDIARY COMPANIES

CONSOLIDATED STATEMENT OF CASH FLOWS

FOR THE NINE MONTHS ENDED SEPTEMBER 30, (UNAUDITED)

(Dollars in millions)	2004			2003
Cash flow from operating activities from continuing operations:
Income from continuing operations	$	5,393		$	4,897
Adjustments to reconcile income from continuing operations to cash provided by operating activities:
Depreciation	2,921			2,909
Amortization of software	549			560
Gain on disposition of fixed and other assets	(243		)	(124		)
Changes in operating assets and liabilities	2,736			1,575
Net cash provided by operating activities from continuing operations	11,356			9,817

Cash flow from investing activities from continuing operations:
Payments for plant, rental machines and other property, net of proceeds from dispositions	(2,247		)	(2,443		)
Investment in software	(509		)	(431		)
Acquisition of businesses	(972		)	(1,773		)
Purchases of marketable securities and other investments	(6,083		)	(5,618		)
Proceeds from marketable securities and other investments	6,092			5,749
Net cash used in investing activities from continuing operations	(3,719		)	(4,516		)

Cash flow from financing activities from continuing operations:
Proceeds from new debt	1,093			1,298
Payments to settle debt	(3,934		)	(5,220		)
Short-term borrowings less than 90 days — net	1,251			83
Common stock transactions — net	(3,208		)	(620		)
Cash dividends paid	(874		)	(811		)
Net cash used in financing activities from continuing operations	(5,672		)	(5,270		)
Effect of exchange rate changes on cash and cash equivalents	3			202
Net cash used in discontinued operations	(80		)	(164		)
Net change in cash and cash equivalents	1,888			69
Cash and cash equivalents at January 1	7,290			5,382
Cash and cash equivalents at September 30	$	9,178		$	5,451

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

Notes to Consolidated Financial Statements

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

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

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

(Dollars in millions except	Three Months Ended September 30,				Nine Months Ended September 30,
per share amounts)	2004		2003		2004		2003
Net income	$	1,800	$	1,785	$	5,390	$	4,874
Add: Stock-based compensation expense included in reported net income, net of related tax effects	33		2		95		47
Deduct: Total stock-based employee compensation expense determined under fair value method for all awards, net of related tax effects	279		292		833		803
Pro forma net income	$	1,554	$	1,495	$	4,652	$	4,118
Earnings per share of common stock:
Basic - as reported	$	1.08	$	1.04	$	3.21	$	2.82
Basic - pro forma	$	0.93	$	0.87	$	2.77	$	2.39
Assuming dilution - as reported	$	1.06	$	1.02	$	3.14	$	2.77
Assuming dilution - pro forma	$	0.92	$	0.86	$	2.72	$	2.37

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

	Three Months Ended September 30,						Nine Months Ended September 30,
(Dollars in millions)	2004			2003			2004			2003

Net income	$	1,800		$	1,785		$	5,390		$	4,874
Gains and losses not affecting retained earnings (net of tax):
Foreign currency translation adjustments	310			159			(113		)	1,001
Minimum pension liability adjustments	—			(2		)	52			(45		)
Net unrealized gains on marketable securities	34			1			40			5
Net unrealized (losses)/gains on cash flow hedge derivatives	(12		)	(36		)	353			(20		)
Total gains not affecting retained earnings	332			122			332			941
Net income plus gains and losses not affecting retained earnings	$	2,132		$	1,907		$	5,722		$	5,815

4. In January 2003, the Financial Accounting Standards Board (FASB) issued FASB Interpretation Number 46 (FIN 46), “Consolidation of Variable Interest Entities,” and amended it by issuing FIN 46-R in December 2003. FIN 46-R addresses consolidation by business enterprises of variable interest entities (VIEs) that either: (1) do not have sufficient equity investment at risk to permit the entity to finance its activities without additional subordinated financial support, or (2) have equity investors that lack an essential characteristic of a controlling financial interest.

As of December 31, 2003 and in accordance with the transition requirements of FIN 46-R, the company chose to apply the guidance of FIN 46 to all of its interests in special-purpose entities (SPEs) as defined within FIN 46-R and all non-SPE VIEs that were created after January 31, 2003. Also in accordance with the transition provisions of FIN 46-R, the company adopted FIN 46-R for all VIEs and SPEs as of March 31, 2004. These new accounting pronouncements did not have a material impact on the company’s Consolidated Financial Statements.

5. The company offers defined benefit pension plans, defined contribution pension plans, as well as nonpension postretirement plans primarily consisting of retiree medical benefits. The following tables provide the total retirement-related benefit plans’ impact on income before income taxes for the three- and nine-months ended September 30, 2004 and September 30, 2003, respectively.

(Dollars in millions)	2004		2003			Yr. to Yr. Percent Change
For the three months ended September 30:
Retirement-related plans - cost/(income):
Defined benefit and contribution pension plans - cost/(income)	$	534	$	(10	)	nm	%
Nonpension postretirement benefits-cost	92		79			16.5
Total	$	626	$	69		nm	%

nm - not meaningful

(Dollars in millions)	2004		2003		Yr. to Yr. Percent Change
For the nine months ended September 30:
Retirement-related plans - cost:
Defined benefit and contribution pension plans - cost	$	906	$	14	nm	%
Nonpension postretirement benefits-cost	277		241		14.9
Total	$	1,183	$	255	nm	%

nm - not meaningful

The following tables provides the components of the cost/(income) for the company’s pension plans for the three- and nine-months ended September 30.

Cost/(Income) of Pension Plans

	U.S. Plans						Non-U.S. Plans
(Dollars in millions)	2004			2003			2004			2003
For the three months ended September 30:
Service cost	$	163		$	144		$	152		$	134
Interest cost	613			630			400			360
Expected return on plan assets	(901		)	(926		)	(589		)	(555		)
Settlement for certain legal claims	320			—			—			—
Amortization of transition assets	(18		)	(36		)	(8		)	(6		)
Amortization of prior service cost	15			15			7			9
Recognized actuarial losses	56			—			51			25
Net periodic pension cost/(income)-U.S. Plan and material non-U.S. Plans	248		*	(173		)*	13		**	(33		)**
Cost of other defined benefit plans	32			33			73			23
Total net periodic pension cost/(income) for all defined benefit plans	280			(140		)	86			(10		)
Cost of defined contribution plans	81			79			87			61
Total pension plan cost/(income) recognized in the Consolidated Statement of Earnings	$	361		$	(61	)	$	173		$	51

* Represents the qualified portion of the IBM Personal Pension Plan.

** Represents the qualified and non-qualified portion of material non-U.S. plans.

	U.S. Plans						Non-U.S. Plans
(Dollars in millions)	2004			2003			2004			2003
For the nine months ended September 30:
Service cost	$	490		$	432		$	453		$	399
Interest cost	1,839			1,889			1,200			1,084
Expected return on plan assets	(2,705		)	(2,778		)	(1,761		)	(1,640		)
Settlement for certain legal claims	320			—			—			—
Amortization of transition assets	(54		)	(108		)	(13		)	(13		)
Amortization of prior service cost	46			46			19			18
Recognized actuarial losses	167			—			153			73
Net periodic pension cost/(income)—U.S. Plan and material non-U.S. Plans	103		*	(519		)*	51		**	(79		)**
Cost of other defined benefit plans	97			100			138			67
Total net periodic pension cost/(income) for all defined benefit plans	200			(419		)	189			(12		)
Cost of defined contribution plans	264			263			253			181
Total pension plan cost/(income) recognized in the Consolidated Statement of Earnings	$	464		$	(156	)	$	442		$	170

* Represents the qualified portion of the IBM Personal Pension Plan.

** Represents the qualified and non-qualified portion of material non-U.S. Plans.

Included in the third quarter and first nine months of 2004 is the one-time charge ($320 million) relating to the partial settlement of certain legal claims against the IBM Personal Pension Plan (PPP). In 2004, the company expects to contribute to its material non-U.S. Defined Benefit Plans an amount between $750 million and $850 million. The legally mandated minimum contribution included in the amount above for the company’s non-U.S. Plans is expected to be approximately $320 million. In the first nine months of 2004, the company contributed approximately $620 million to its non-U.S. Plans.

The following table provides the components of the cost for the company’s nonpension postretirement benefits.

Cost/(Income) of Nonpension Post-retirement Benefits

	Three Months Ended September 30,						Nine Months Ended September 30,
(Dollars in millions)	2004			2003			2004			2003
Service cost	$	10		$	9		$	30		$	27
Interest cost	84			96			253			287
Amortization of prior service cost	(15		)	(33		)	(46		)	(98		)
Recognized actuarial losses	3			1			9			4
Net periodic post-retirement benefit cost - U.S. Plan	82			73			246			220
Cost of non-U.S. Plans	10			6			31			21
Total nonpension postretirement plan cost recognized in the Consolidated Statement of Earnings	$	92		$	79		$	277		$	241

Recently Enacted Legislation

The Medicare Prescription Drug Improvement and Modernization Act of 2003 (the Act) was signed into law on December 8, 2003. The Act introduces a prescription drug benefit under Medicare (Medicare Part D) as well as a federal subsidy to sponsors of retiree health care benefit plans that provide a prescription drug benefit that is at least actuarially equivalent to Medicare Part D.

The method of determining whether a sponsor’s plan will qualify for actuarial equivalency is pending until the U.S. Department of Health and Human Services (HHS) completes its interpretative work on the Act. Based on the current interpretation of the guidance provided in the Act and in relation to the company’s current plan design, any savings to the company are expected to be immaterial.

FASB Staff Position No. Financial Accounting Standard 106-2, “Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003”, issued in the second quarter of 2004, provides guidance on the accounting for the effects of the Act, including the accounting for and disclosure of any federal subsidy provided by the Act.

The enactment of the Act was not a “significant event” as defined by paragraph 73 of SFAS No. 106 “Employers’ Accounting for Postretirement Benefits Other than Pensions” for the company’s nonpension postretirement benefit plans (the Plans) and therefore, the company did not remeasure plan assets and obligations. As discussed above, any federal subsidy related to prescription drug benefits provided under the Plans is expected to be immaterial, based on the current interpretation of the Act. As a result, the company’s accumulated pension benefit obligations as of September 30, 2004 and the net periodic post-retirement benefit costs for the nine months ended September 30, 2004 were not impacted by the Act. The company will be

required to reflect any changes to participation rates and other healthcare cost assumptions, as a result of the Act, at the company’s next measurement date. The impact of any such change is not expected to have a material impact on the company’s Consolidated Financial Statements.

6. The changes in the carrying amount of goodwill, by external reporting segment, for the nine months ended September 30, 2004, are as follows:

(Dollars in millions) Segment	Balance 12/31/03		Goodwill Additions		Purchase Price Adjustments			Divestitures			Foreign Currency Translation Adjustments			Balance 9/30/04

Global Services	$	4,184	$	347	$	(21	)	$	(2	)	$	(18	)	$	4,490
Systems and Technology Group	161		—		6			—			—			167
Personal Systems Group	71		—		5			—			—			76
Software	2,505		501		(61		)	—			—			2,945
Global Financing	—		—		—			—			—			—
Enterprise Investments	—		—		—			—			—			—
Total	$	6,921	$	848	$	(71	)	$	(2	)	$	(18	)	$	7,678

There were no goodwill impairment losses recorded during the quarter.

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

	At September 30, 2004
(Dollars in millions) Intangible asset class	Gross Carrying Amount		Accumulated Amortization			Net Carrying Amount
Client-related	$	809	$	(362	)	$	447
Completed technology	479		(319		)	160
Strategic alliances	118		(56		)	62
Patents/Trademarks	104		(81		)	23
Other(a)	176		(68		)	108
Total	$	1,686	$	(886	)	$	800(b	)

	At December 31, 2003
(Dollars in millions) Intangible asset class	Gross Carrying Amount		Accumulated Amortization			Net Carrying Amount

Client-related	$	704	$	(254	)	$	450
Completed technology	448		(228		)	220
Strategic alliances	118		(38		)	80
Patents/Trademarks	98		(66		)	32
Other(a)	165		(37		)	128
Total	$	1,533	$	(623	)	$	910(b	)

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

(b) The $800 million at September 30, 2004, comprises $306 million recorded as current assets and $494 million recorded as non-current assets. The $910 million at December 31, 2003, comprises $336 million as current assets and $574 million as non-current assets.

The net carrying amount of intangible assets decreased $110 million during the first nine months of 2004 due to amortization of existing intangible asset balances, partially offset by acquisitions. The aggregate intangible asset amortization expense was $88 million and $278 million for the third quarter and first nine months of 2004, respectively, versus $104 million and $256 million for the third quarter and first nine months of 2003, respectively.

The future amortization expense for each of the five succeeding years relating to intangible assets currently recorded in the Consolidated Statement of Financial Position is estimated to be the following at September 30, 2004:

2004 (for Q4)	$	81 million
2005	$	297 million
2006	$	177 million
2007	$	112 million
2008	$	71 million

7. For the first nine months ended September 30, 2004, the company completed 7 acquisitions at an aggregate cost of $1,154 million. The largest acquisition was Candle Corporation (Candle). On June 7, 2004, the company purchased Candle for $435 million. Candle helps customers develop, deploy and manage their enterprise infrastructure. The acquisition will provide the company’s clients with an enhanced set of software solutions for managing an on demand environment and complements the company’s middleware solutions. Candle was integrated into the Software segment upon acquisition.

The company substantially paid cash for all acquisitions in the table below. These acquisitions are disclosed in the Consolidated Statement of Cash Flows net of acquired cash and cash equivalents.

The table below presents the updated purchase price related to the company’s acquisition of Candle and the purchase price allocations for the other acquisitions as of September 30, 2004:

		Original
		Amount
		Disclosed in
		Second Quarter			Candle			Total
	Amortization	2004			Purchase			Candle			Other
(Dollars in millions)	Life (yrs.)	Form 10-Q			Adjustments*			Allocation			Acquisitions
Current assets		$	202		$	(2	)	$	200		$	138
Fixed assets/non-current		82			(19		)	63			176
Intangible assets:
Goodwill	N/A	256			52			308			592
Completed technology	3	23			—			23			13
Client relationships	4-7	65			—			65			46
Other identifiable
intangible assets	5	6			—			6			1
Total assets acquired		634			31			665			966
Current liabilities		(119		)	(35		)	(154		)	(164		)
Non-current liabilities		(80		)	—			(80		)	(79		)
Total liabilities assumed		(199		)	(35		)	(234		)	(243		)
Total purchase price		$	435		$	(4	)	$	431		$	723	*

The Candle acquisition was accounted for as a purchase transaction, and accordingly, the assets and liabilities of the acquired entity were recorded at their estimated fair values at the date of the acquisition. The primary items that generated the goodwill are the value of the synergies between Candle and IBM and the acquired assembled workforce, neither of which qualify as an amortizable intangible asset. None of the goodwill is deductible for tax purposes. The overall weighted-average life of the identified amortizable intangible assets acquired in the purchase of Candle is 5.8 years. With the exception of goodwill, these identified intangible assets will be amortized on a straight-line basis over their useful lives. Goodwill of $308 million has been assigned to the Software segment.

8. The tables on pages 65 to 68 of this Form 10-Q reflect the results of the company’s segments consistent with the management system used by the company’s chief operating decision maker. These results are not necessarily a depiction that is in conformity with generally accepted accounting principles (GAAP). For example, employee retirement plan costs are developed using actuarial assumptions on a country-by-country basis and allocated to the segments based on headcount. A different result could occur for any segment if actuarial assumptions unique to each segment were used. Performance measurement is based on income before income taxes (pre-tax income). These results are used, in part, by management, both in evaluating the performance of, and in allocating resources to, each of the segments.

Over recent years, the company has been developing and enhancing a “one team” approach to the collaboration between the Systems Group and Technology Group. This relationship is crucial given that the core technology of the Systems Group products is a key competitive differentiator for the company. The degree of this collaboration has increased whereby in the first quarter of 2004, the company consolidated these organizations into one entity and one reporting segment. The new Systems and Technology Group segment generates one consolidated set of financial results, which senior management uses for joint strategy, budgets, and resource allocation decisions, as well as performance and compensation scoring. As of September 30, 2004, the integration of the businesses is essentially complete, from development to supply chain to finance. The tables on pages 65 to 68 have been reclassified to reflect this change in segments. The company filed a Form 8-K, with the Securities and Exchange Commission (SEC), on April 16, 2004, disclosing the 2003 and 2002 quarterly and full year Technology Group and Systems Group segments results reclassified to conform with the one reporting segment in Attachment V of the Form 8-K. In addition, the company filed a Form 8-K with the SEC on June 18, 2004 that discloses the company’s financial results from 2003, 2002 and 2001 reclassified to conform with the one reporting segment for the Systems and Technology Group.

9. The following table provides the liability balances for actions taken in 1) the second-quarter of 2002 associated with the Microelectronics Division and the rebalancing of both the company’s workforce and leased space resources, 2) fourth-quarter 2002 actions associated with the acquisition of PricewaterhouseCoopers consulting business, 3) 2002 actions associated with the hard disk drive (HDD) business for reductions in workforce, manufacturing capacity and space, 4) other actions in 1999, and 5) actions that took place through 1993.

	Liability as of							Liability as of
(Dollars in millions)	12/31/2003		Payments		Other Adj.*			9/30/2004
Current:
Workforce	$	222	$	185	$	73		$	110
Space	129		86		58			101
Other	39		29		—			10
Total	$	390	$	300	$	131		$	221
Non-current:
Workforce	$	587	$	—	$	(58	)	$	529
Space	282		—		(43		)	239
Other	2		—		(2		)	—
Total	$	871	$	—	$	(103	)	$	768

* The other adjustments column in the table above includes the reclassification of non-current to current as well as foreign currency translation adjustments. In addition, net adjustments to increase previously recorded liabilities for changes in the estimated cost of vacant space for the 2002 actions ($31 million), offset by reductions in previously recorded liabilities for the HDD-related restructuring in 2002 ($4 million) and actions through 1993 ($19 million) were recorded during the nine month period ended September 30, 2004. Of the $8 million of net adjustments, a $4 million credit was included in Discontinued Operations (for the HDD-related restructuring actions) and $12 million of charges were included in Other (income) and expense in the Consolidated Statement of Earnings. Additionally, adjustments for $7 million were made to Goodwill during the nine months ended September 30, 2004, to decrease previously recorded liabilities for changes to estimated vacant space and workforce reserves.

10. The company is involved in a variety of claims, suits, investigations and proceedings that arise from time to time in the ordinary course of its business, including actions with respect to contracts, intellectual property (IP), product liability, employment, securities, and environmental matters. The following is a discussion of some of the more significant legal matters involving the company.

On July 31, 2003, the U.S. District Court for the Southern District of Illinois, in Cooper et al. vs. The IBM Personal Pension Plan and IBM Corporation, held that IBM’s pension plan violated the age discrimination provisions of the Employee Retirement Income Security Act of 1974 (ERISA). On September 29, 2004, IBM announced that IBM and plaintiffs agreed in principle to resolve certain claims in the litigation. Under the terms of the agreement, plaintiffs will receive an incremental pension benefit in exchange for the settlement of some claims, and a stipulated remedy on remaining claims if plaintiffs prevail on appeal. Under the terms of the settlement, the judge will issue no further rulings on remedies. This settlement, together with a previous settlement of a claim referred to as the partial plan termination claim resulted in IBM taking a one-time charge of $320 million in the third quarter of 2004.

This agreement ends the litigation on all but two claims, which are associated with IBM’s cash balance formula. IBM will appeal the rulings on these claims. IBM continues to believe that its pension plan formulas are fair and legal. The company has reached this agreement in the interest of the business and IBM shareholders, and to allow for a review of its cash balance formula by the Court of Appeals. IBM continues to believe it is likely to be successful on appeal.

The agreement stipulates that if IBM is not successful on appeal of the two remaining claims, the agreed remedy will be increased by up to $1.4 billion — a $780 million remedy for the claim that IBM’s cash balance formula is age discriminatory, and a $620 million remedy for the claim that transition arrangements regarding opening account balances during the 1999 conversion were also age discriminatory (referred to as the “always cash balance” claim). The maximum additional liability the company could face as a result of the claims being appealed in this case is therefore capped at $1.4 billion.

In the coming months, class members will receive formal notice of the settlement and the judge will hold a fairness hearing. Once the settlement is approved, IBM will appeal the liability rulings for the cash balance claims. As a result, the entire process could take over 2 years before reaching final conclusion.

The company is the defendant in an action brought by Compuware in the District Court for the Eastern District of Michigan in 2002, asserting causes of action for copyright infringement, trade secret misappropriation, Sherman Act violations, breach of contract, tortious interference and unfair competition under various state statutes. IBM asserted counterclaims for copyright infringement and patent infringement in the Michigan action. In December 2003, the court denied Compuware’s attempt to obtain a preliminary injunction. IBM has also asserted patent infringement claims against Compuware in a separate action that IBM brought in the District Court for the Southern District of New York in January 2004. In September 2004, the court heard IBM’s motion for summary judgment on Compuware’s antitrust and tortious interference claims and Compuware’s motion for summary judgment on IBM’s copyright infringement counterclaims. Trial in the Michigan action on all claims other than IBM’s patent infringement counterclaims will not begin prior to February 2005.

The company is a defendant in an action filed on March 6, 2003 in state court in Salt Lake City, Utah by the SCO Group. The company removed the case to Federal Court in Utah. Plaintiff is successor in interest to some of AT&T’s Unix IP rights, and alleges misappropriation of trade secrets, unfair competition, interference with contract and breach of contract with regard to the company’s contribution of unspecified code to Linux. The company has asserted counterclaims, including breach of contract, violation of the Lanham Act, unfair competition, intentional torts, unfair and deceptive trade practices, breach of the General Public License that governs open source distributions, patent infringement, promissory estoppel and copyright infringement. Trial is scheduled for April, 2005.

On June 2, 2003 IBM announced that it received notice of a formal, nonpublic investigation by the Securities and Exchange Commission (SEC). The SEC is seeking information relating to revenue recognition in 2000 and 2001 primarily concerning certain types of client transactions. IBM believes that the investigation arises from a separate investigation by the SEC of Dollar General Corporation, a client of IBM’s Retail Stores Solutions unit, which markets and sells point of sale products.

On January 8, 2004, IBM announced that it received a “Wells Notice” from the staff of the SEC in connection with the staff’s investigation of Dollar General Corporation, which as noted above, is a client of IBM’s Retail Stores Solutions unit. It is IBM’s understanding that an employee in IBM’s Sales & Distribution unit also received a Wells Notice from the SEC in connection with this matter. The Wells Notice notifies IBM that the SEC staff is considering recommending that the SEC bring a civil action against IBM for possible violations of the U.S. securities laws relating to Dollar General’s accounting for a specific transaction, by participating in and aiding and abetting Dollar General’s misstatement of its 2000 results. In that transaction, IBM paid Dollar General $11 million for certain used equipment as part of a sale of IBM replacement equipment in Dollar General’s 2000 fourth fiscal quarter. Under the SEC’s procedures, IBM responded to the SEC staff regarding whether any action should be brought against IBM by the SEC. The separate SEC investigation noted above, relating to the recognition of revenue by IBM in 2000 and 2001 primarily concerning certain types of client transactions, is not the subject of this Wells Notice.

In January 2004, the Seoul District Prosecutors Office in South Korea announced it had brought criminal bid rigging charges against several companies, including IBM Korea and LG IBM (a joint venture between IBM Korea and LG Electronics) and had also charged employees of some of those entities with, among other things, bribery of certain officials of government-controlled entities in Korea, and bid rigging. IBM Korea and LG cooperated fully with authorities in these matters. A number of individuals, including former IBM Korea and LG IBM employees, were subsequently found guilty and sentenced. IBM Korea and LG IBM were also required to pay fines. Effective October 1, 2004, IBM Korea was debarred from doing business directly with certain government controlled entities in Korea until August 31, 2005. That order does not prohibit IBM Korea from selling products and services to business partners who sell to government controlled entities in Korea. In addition, the U.S. Department of Justice and the SEC have both contacted IBM in connection with this matter.

In accordance with SFAS No. 5, the company records a provision with respect to a claim, suit, investigation or proceeding when it is probable that a liability has been incurred and the amount of the loss can reasonably be estimated. Any provisions are reviewed at least quarterly and are adjusted to reflect the impact and status of settlements, rulings, advice of counsel and other information pertinent to a particular matter. Any recorded liabilities for the above items, including any changes to such liabilities for the three months and nine months ended September 30, 2004, were not material to the Consolidated Financial Statements with the exception of the $320 million one-time charge to settle certain legal claims associated with the IBM Personal Pension Plan (PPP). Based on its experience, the company believes that the damage amounts claimed in the matters referred to above are not a meaningful indicator of the potential liability.

Litigation is inherently uncertain and it is not possible to predict the ultimate outcome of the matters discussed above. While the company will continue to defend itself vigorously in all such matters, it is possible that the company’s business, financial condition, results of operations, or cash flows could be affected in any particular period by the resolution of one or more of these matters. Whether any losses, damages or remedies finally determined in any such claim, suit, investigation or proceeding could reasonably have a material effect on the company’s business, financial condition, results of operations, or cash flow will depend on a number of variables, including the timing and amount of such losses or damages, the structure and type of any such remedies, the significance of the impact any such losses, damages or remedies may have on

IBM’s Consolidated Financial Statements, and the unique facts and circumstances of the particular matter which may give rise to additional factors.

11. The European Commission (EU) has issued two directives which require member states of the EU to meet certain targets for collection, re-use and recovery of waste electrical and electronic equipment. In February 2003, the EU published the Waste Electrical and Electronic Equipment directive, or WEEE (Directive 2002/96/EC, which was amended in December 2003 by Directive 2003/108/EC). The WEEE directive, regulates the collection, reuse and recycling of waste from many electrical and electronic products, and the Restrictions of Hazardous Substances directive, or RoHS (Directive 2002/95/EC), bans the use of certain hazardous materials in electric and electrical equipment. The WEEE directive must be implemented by August 13, 2005. Under the WEEE directive, equipment producers are required to finance the collection, recovery and disposal of electronic scrap. The company is currently evaluating the impact of adopting this guidance. As most member states have yet to issue their implementation requirements, it is not possible to determine the amount of any accruals necessary to comply with the directive. Under the RoHS directive, manufacturers have a transition period until July 1, 2006 to phase out the use of certain hazardous materials from its equipment.

12. The company’s extended lines of credit include unused amounts of $2,797 million and $2,208 million at September 30, 2004 and December 31, 2003, respectively. A portion of these amounts was available to the company’s business partners to support their working capital needs. In addition, the company committed to provide future financing to its customers in connection with customer purchase agreements for approximately $1,100 million and $763 million at September 30, 2004 and December 31, 2003, respectively.

The company has applied the disclosure provisions of FIN 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others,” to its agreements that contain guarantee or indemnification clauses. These disclosure provisions expand those required by SFAS No. 5, “Accounting for Contingencies”, by requiring a guarantor to disclose certain types of guarantees, even if the likelihood of requiring the guarantor’s performance is remote. The following is a description of arrangements in which the company is the guarantor.

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

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

In addition, the company guarantees certain loans and financial commitments. The maximum potential future payment under these financial guarantees was $63 million and $74 million at September 30, 2004 and December 31, 2003, respectively. The amount at December 31, 2003 includes a limited guarantee of $14 million associated with the company’s loans receivable securitization program. The amount at September 30, 2004 for loans receivable securitization program was zero, as a result of this program being terminated during the third quarter of 2004.

Changes in the company’s warranty liability balance are presented in the following table:

(Dollars in millions)	2004			2003
Balance at January 1	$	780		$	614
Current period accruals	639			640
Accrual adjustments to reflect actual experience	40			58
Charges incurred	(590		)	(637		)
Balance at September 30	$	869		$	675

The increase in the current year accruals was primarily driven by increased warranty activity associated with personal computers due to increased volumes and certain capacitor repairs.

13. On May 27, 2004, IBM completed the renegotiation of a new $10 billion 5-year Credit Agreement with JPMorgan Chase Bank, as Administrative Agent, and Citibank, N.A., as Syndication Agent, replacing credit agreements of $8 billion (5-year) and $2 billion (364 day). The text of the Credit Agreement is set forth in its entirety as Exhibit 10 of the company’s second quarter 2004 Form 10-Q dated July 30, 2004.

14. Subsequent Events: On October 21, 2004, IBM and Francisco Partners, LP announced a definitive agreement for Francisco Partners to acquire IP and selected assets associated with IBM’s global electronic data interchange and business exchange services offerings. The transaction is expected to close by country in November and December, 2004.

On October 26, 2004, the Board of Directors authorized the company to repurchase up to an additional $4.0 billion of IBM common shares. The company plans to repurchase the shares in the open market from time to time, based on market conditions.

ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS

OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION

FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2004*

Snapshot

(Dollars in millions except per share amounts)	2004			2003			Yr. To Yr. Percent/ Margin Change
Three months ended September 30:
Revenue	$	23,429		$	21,522		8.9	%**
Gross profit margin	36.9		%	36.3		%	0.6	pts.
Total expense and other income	$	6,115		$	5,263		16.2	%
Total expense and other income to revenue ratio	26.1		%	24.5		%	1.6 pts
Provision for income taxes	$	731		$	764		(4.4	)%
Income from continuing operations	$	1,800		$	1,785		0.9	%
Earnings per share from
continuing operations:
Assuming dilution	$	1.06		$	1.02		3.9	%
Basic	$	1.08		$	1.04		3.8	%
Weighted average shares outstanding:
Assuming dilution	1,700.4			1,756.4			(3.2	)%
Basic	1,669.6			1,722.6			(3.1	)%

* The following Results of Continuing Operations discussion does not include the HDD business that the company sold to Hitachi, Ltd. on December 31, 2002. The HDD business was accounted for as a discontinued operation under generally accepted accounting principles. There was no Loss from Discontinued Operations for the three-months ended September 30, 2004 and 2003. Loss from Discontinued Operations for the nine-months ended September 30, 2004 and 2003 were $3 million and $23 million, respectively.

The selected reference to “adjusting for currency” in the Management Discussion is made so that the financial results can be viewed without the impacts of changing foreign currency exchange rates and therefore facilitates a comparative view of business growth. In the third quarter of 2004 the U.S. dollar was generally weaker against other currencies compared to the third quarter of 2003, so growth rates that are adjusted for currency exchange rates were lower than growth at actual currency exchange rates.

** 4.9 percent adjusting for currency

(Dollars in millions except per share amounts)	2004			2003			Yr. To Yr. Percent/ Margin Change
Nine months ended September 30:
Revenue	$	68,832		$	63,218		8.9	%**
Gross profit margin	36.6		%	36.4		%	0.2	pts.
Total expense and other income	$	17,516		$	16,047		9.2	%
Total expense and other income to revenue ratio	25.4		%	25.4		%	0.0	pts.
Provision for income taxes	$	2,271		$	2,099		8.2	%
Income from continuing operations	$	5,393		$	4,897		10.1	%
Earnings per share from continuing operations:
Assuming dilution	$	3.14		$	2.78		12.9	%
Basic	$	3.21		$	2.84		13.0	%
Weighted average shares outstanding:
Assuming dilution	1,714.6			1,759.5			(2.6	)%
Basic	1,680.3			1,725.9			(2.6	)%

	9/30/04			12/31/03
Assets	$	100,676		$	104,457		(3.6	)%
Liabilities	$	70,974		$	76,593		(7.3	)%
Equity	$	29,702		$	27,864		6.6	%

** 3.9 percent adjusting for currency

The increase in IBM’s third quarter and first nine months of 2004 Income from continuing operations and diluted earnings per share from continuing operations compared to the third quarter and first nine months of 2003, respectively, was due to:

• Improving demand associated with the moderate expansion of the economy and continued market share gains for zSeries and xSeries server products

• Continued operational improvements in the Microeletronics Business

• Continued demand growth in emerging countries

• Favorable impact of currency translation

Partially offsetting these increases, in the third quarter and first nine months of 2004 was the one-time charge relating to the partial settlement of certain legal claims against the PPP.

The increase in IBM’s third quarter and first nine months of 2004 revenue compared to the third quarter and first nine months of 2003 was due to:

• Improved demand in Global Services and key industry sectors

• Improving demand associated with the moderate expansion of the economy and continued market share gains for zSeries and xSeries server products, and commercial personal computers

• Continued demand growth in emerging countries

• Favorable impact from currency translation

The third quarter of 2004 and, in part, the first nine months of 2004, business environment enabled the company’s on demand business model to deliver consistent strong performance and growth. The market presented the company with many strong opportunities, most notably in zSeries, xSeries, the Financial Services and Communications sectors, new and emerging areas, the Asia Pacific and Americas geography, and services. There were also challenges such as iSeries product transitions and in improving the operational performance in Microelectronics. The company’s ability to capitalize on these opportunities and respond to these challenges with flexible resources, variable cost structures, and forward-looking insight are reflected in the solid overall revenue results.

The gross profit margin was 36.9 percent in the third quarter of 2004 versus 36.3 percent in the third quarter of 2003. Global Services margin declined 0.1 points from the third quarter of 2003. Increases in Hardware margins were primarily due to improved yield and output performance in the Microelectronics business and margin improvements in personal computers, zSeries and xSeries servers and Storage products. The Software margin improved 1.5 points versus the third quarter of 2003 resulting from favorable currency translation and productivity improvements in distribution and support. The company’s total gross profit margin was 36.6 percent for the first nine months of 2004 versus 36.4 percent for the first nine months of 2003.

In the third quarter and first nine months of 2004, total expense and other income increased over the year-earlier period, primarily due to increased expense for retirement-related plans (including the $320 million charge due to the partial settlement of certain legal claims against the company’s PPP), research, development and engineering, lower IP income and unfavorable currency translation. Overall, the Total expense and other income-to-revenue ratio increased for the third quarter of 2004 versus the same period in 2003 and was flat for the first nine months of 2004 versus the first nine months of 2003.

The effective tax rate for the third quarter of 2004 was 28.9 percent versus 30.0 percent for the third quarter of 2003. The effective tax rate for the first nine months of 2004 was 29.6 percent versus 30.0 percent for the first nine months of 2003. The decreases in the effective tax rates in 2004 were the result of the tax impact of the charge taken in the third quarter of 2004 for the partial settlement of certain legal claims against the PPP.

With regard to total Assets, the decline of approximately $3.8 billion from December 31, 2003 to September 30, 2004 was primarily due to the decrease in short-term and long-term financing receivables and deferred taxes partially offset by increases in cash, goodwill and pension assets.

Global Services signings were $9.8 billion in the third quarter of 2004 as compared to $15.4 billion for the three months ended September 30, 2003. The estimated Global Services backlog including SO, Business Consulting Services (BCS), Integrated Technology Services (ITS) and Maintenance was estimated at $110 billion at September 30, 2004.

Quarter and First-Nine Months in Review

Results of Continuing Operations

Revenue

(Dollars in millions) For the three months ended September 30:	2004		2003		Yr. to Yr. Percent Change		Yr. to Yr. Percent Change Adjusting for Currency
Statement of Earnings Revenue Presentation:
Global Services	$	11,392	$	10,383	9.7	%	5.1	%
Hardware	7,501		6,697		12.0		8.9
Software	3,621		3,461		4.6		0.5
Global Financing	638		715		(10.9	)	(14.1	)
Enterprise Investments/Other	277		266		4.3		2.2
Total	$	23,429	$	21,522	8.9	%	4.9	%

(Dollars in millions) For the nine months ended September 30:	2004		2003		Yr. to Yr. Percent Change		Yr. to Yr. Percent Change Adjusting for Currency
Statement of Earnings Revenue Presentation:
Global Services	$	33,818	$	31,187	8.4	%	2.8	%
Hardware	21,659		19,118		13.3		9.4
Software	10,545		10,061		4.8		(0.4	)
Global Financing	1,951		2,092		(6.8	)	(10.8	)
Enterprise Investments/Other	859		760		13.1		8.7
Total	$	68,832	$	63,218	8.9	%	3.9	%

(Dollars in millions) For the three months ended September 30:	2004		2003*		Yr. to Yr. Percent Change		Yr. to Yr. Percent Change Adjusting for Currency
Industry Sector**:
Financial Services	$	5,899	$	5,428	8.7	%	4.2	%
Public	3,776		3,396		11.2		7.8
Industrial	2,997		2,886		3.8		(0.4	)
Distribution	2,138		1,923		11.1		7.4
Communications	2,174		1,881		15.5		11.6
Small & Medium	4,999		4,742		5.4		1.1
OEM	726		642		12.9		12.7
Other	720		624		15.5		15.5
Total	$	23,429	$	21,522	8.9	%	4.9	%

(Dollars in millions) For the nine months ended September 30:	2004		2003*		Yr. To Yr. Percent Change		Yr. To Yr. Percent Change Adjusting for Currency
Industry Sector**:
Financial Services	$	17,367	$	15,608	11.3	%	5.6	%
Public	10,460		9,911		5.5		1.4
Industrial	9,073		8,379		8.3		2.8
Distribution	6,289		5,810		8.2		3.7
Communications	6,355		5,743		10.7		5.9
Small & Medium	15,015		13,803		8.8		3.3
OEM	2,098		1,920		9.3		9.0
Other	2,175		2,044		6.4		6.4
Total	$	68,832	$	63,218	8.9	%	3.9	%

* Reclassified to conform with 2004 presentation.

** The majority of the company’s enterprise business, which excludes the company’s original equipment manufacturer (OEM) technology business, occurs in industries that are broadly grouped into six sectors around which the company’s sales and distribution activities, as well as an increasing number of its services and products businesses are organized. The majority of the businesses in the Small & Medium category have fewer than 1,000 employees.

(Dollars in millions) For the three months ended September 30:	2004		2003		Yr. to Yr. Percent Change		Yr. To Yr. Percent Change Adjusting for Currency
Geographies:
Americas	$	10,098	$	9,364	7.9	%	7.4	%
Europe/Middle East/Africa	7,320		6,757		8.3		(0.4	)
Asia Pacific	5,285		4,759		11.0		6.3
OEM	726		642		12.9		12.7
Total	$	23,429	$	21,522	8.9	%	4.9	%

(Dollars in millions) For the nine months ended September 30:	2004		2003		Yr. to Yr. Percent Change		Yr. To Yr. Percent Change Adjusting for Currency
Geographies:
Americas	$	28,923	$	27,464	5.3	%	4.6	%
Europe/Middle East/Africa	22,094		19,965		10.7		0.8
Asia Pacific	15,717		13,869		13.3		6.3
OEM	2,098		1,920		9.3		9.0
Total	$	68,832	$	63,218	8.9	%	3.9	%

Revenue from all industry sectors in the third quarter and first nine months of 2004 increased when compared to the same periods of 2003 on an as-reported basis, reflecting the company’s broad capabilities and industry-specific solutions which combine technology and high value services to solve a clients’ business or IT problems. These solutions also provide for a longer-term relationship with the client, rather than a transaction-oriented sale. The Financial Services sector revenue growth was led by banking and financial markets. The Industrial sector was mixed, led by growth in Electronics, while spending in the Small & Medium businesses increased as the company continues to roll out new products under the Express label that are designed and priced specifically for customers in the 100 to 1000 employee segment. The Communications sector had revenue growth in all industries driven by strong growth in Telecom. The Public sector revenue growth was led by increases in Education and U.S. Federal performance while the Distribution sector was led by the retail industry.

Revenue for the third quarter and first nine months of 2004 increased across all geographies when compared to the third quarter and first nine months of 2003 on an as-reported basis. Revenue increases in the Americas in the third quarter of 2004 were across all three of the major regions, with the U.S. having its strongest growth in years. Asia Pacific had the strongest revenue growth in the third quarter of 2004, led by China and the Asean region, while Japan, which is about 60 percent of Asia Pacific’s revenue, also achieved modest growth. Europe had revenue growth in the third quarter of 2004, but it was primarily driven by favorable impacts of currency movements. Eastern Europe, the Nordic countries and Spain had revenue growth

while UK, France, Italy and Germany declined after adjusting for currency. Collectively and as a result of the company’s targeted investments, the emerging countries of China, Russia, India and Brazil had revenue growth over 30 percent to generate approximately $3.0 billion of revenue in the first nine months of 2004.

OEM revenue increased in the third quarter and first nine months of 2004 versus the same periods in 2003 due primarily to improved operational performance in the Microelectronics business. Continued strong growth in the company’s Engineering and Technology Services and Storage OEM businesses also contributed to OEM revenue growth.

Global Services revenue increased in the third quarter and first nine months of 2004 versus the comparable periods of 2003, as SO continued its steady growth and BCS and ITS revenue also increased. Maintenance revenue increased due to the favorable impact of currency movements. In addition, continued progress was made in the company’s relatively new Business Performance Transformation Services area (see page 43).

Revenue was strong for Hardware in the third quarter and first nine months of 2004 compared to the same periods in 2003. Systems and Technology Group continued the strong performance in zSeries servers driven by new workloads to the mainframes as clients build their on-demand infrastructures, and xSeries sustained its strong performance , driven by leadership in Blades. pSeries server revenue increased as the company continued to transition to Power5 technology in 2004. There was strong demand in the Americas and Asia Pacific while revenue declined in Europe driven by a longer transition cycle. iSeries revenue declined in both periods as the transition to Power5 technology is taking longer than previous cycles, as existing clients must transition their operating environment to the new level required. Storage Systems revenue increased due to greater demand for external midrange disk and tape products. Microelectronics revenue increased in the third quarter of 2004 versus the third quarter of 2003 due primarily to improved yields and increased output in the 300 millimeter factory. Demand for the company’s Engineering and Technology business continues to be strong.

Personal Systems Group revenue increased in the third quarter and first nine months of 2004 versus the same periods last year, driven by strong performance world wide by the company’s ThinkPad mobile computers and increased desktop revenue. Retail Stores Solutions also delivered strong revenue growth in the third quarter and first nine months of 2004 due to continued demand for its products as well as the acquisition of Productivity Solutions Inc. in November 2003.

Software revenue increased in the third quarter and first nine months of 2004 versus the same periods of 2003, as Middleware revenue increased driven by strong performance in strategic products, while Operating Systems revenue declined in the three month period, however was up during the first nine months of 2004, primarily due to favorable currency translation.

Global Financing revenue declined in the third quarter and first nine months of 2004 versus the same periods in 2003. The decline in the third quarter was primarily driven by lower external used equipment sales due to lower sales from inventory, offset by an increase in financing income, which was largely the result of the favorable impact of currency. The decrease in revenue for the first nine months was driven by a decline in external equipment sales and

lower external financing revenue due to a lower average asset balance. See pages 48 to 55 for additional information regarding Global Financing results.

The following table presents each segment’s revenue as a percentage of the company’s total:

	Three Months Ended September 30,				Nine Months Ended September 30,
	2004		2003		2004		2003

Global Services	48.6	%	48.3	%	49.1	%	49.3	%
Hardware	32.0