Edgar Filing: INTERNATIONAL BUSINESS MACHINES CORP

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10 - Q

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

FOR THE QUARTER ENDED JUNE 30, 2006

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 x No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer x

Accelerated filer o

Non-accelerated filer o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x

The registrant has 1,521,839,006 shares of common stock outstanding at June 30, 2006.

Index

		Pages
Part I - Financial Information:

Item 1. Consolidated Financial Statements

Consolidated Statement of Earnings for the three and six months ended June 30, 2006 and 2005		1

Consolidated Statement of Financial Position at June 30, 2006 and December 31, 2005		3

Consolidated Statement of Cash Flows for the six months ended June 30, 2006 and 2005		5

Notes to Consolidated Financial Statements		6

Item 2. Management’s Discussion and Analysis of Results of Operations and Financial Condition		24

Item 4. Controls and Procedures		68

Part II - Other Information		69

Item 1. Legal Proceedings		69

Item 2. Unregistered Sales of Equity Securities, Use of Proceeds and Issuer Purchases of Equity Securities		69

Item 4. Submission of Matters to a Vote of Security Holders		70

Item 6. Exhibits		72

Part I - Financial Information

ITEM 1. Consolidated Financial Statements

INTERNATIONAL BUSINESS MACHINES CORPORATION
AND SUBSIDIARY COMPANIES
CONSOLIDATED STATEMENT OF EARNINGS
(UNAUDITED)

	Three Months Ended June 30,						Six Months Ended June 30,
(Dollars in millions except per share amounts)	2006			2005*			2006			2005*
Revenue:
Global Services	$	11,894		$	12,001		$	23,461		$	23,710
Hardware	5,148			5,562			9,722			12,315
Software	4,241			4,056			8,147			7,871
Global Financing	580			622			1,164			1,202
Other	26			29			54			80
Total revenue	21,890			22,270			42,549			45,178

Cost:
Global Services	8,604			8,868			17,092			17,734
Hardware	3,299			3,676			6,449			8,574
Software	668			634			1,285			1,252
Global Financing	284			295			558			561
Other	21			22			63			29
Total cost	12,876			13,495			25,447			28,149

Gross profit	9,014			8,775			17,102			17,029

Expense and other income:
Selling, general and administrative	4,916			6,497			9,518			11,430
Research, development and engineering	1,522			1,477			2,977			2,936
Intellectual property and custom development income	(188		)	(288		)	(418		)	(507		)
Other (income) and expense	(196		)	(1,711		)	(442		)	(1,689		)
Interest expense	72			67			138			116
Total expense and other income	6,125			6,042			11,774			12,286

Income from continuing operations before income taxes	2,889			2,733			5,328			4,743
Provision for income taxes	867			882			1,598			1,485
Income from continuing operations	2,022			1,851			3,730			3,258

* Reclassified to conform with 2006 presentation; see Note 1 on page 6 for additional information.

(Amounts may not add due to rounding.)

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

	Three Months Ended June 30,						Six Months Ended June 30,
(Dollars in millions except per share amounts)	2006			2005			2006			2005
Discontinued Operations
Loss from discontinued operations, net of tax	—			22			—			27
Net income	$	2,022		1,829			$	3,730		$	3,231

Earnings/(loss) per share of common stock:
Assuming dilution:
Continuing operations	$	1.30		$	1.14		$	2.37		$	1.98
Discontinued operations	(0.00		)	(0.01		)	(0.00		)	(0.02		)
Total	$	1.30		$	1.12		$	2.37		$	1.96

Basic:
Continuing operations	$	1.31		$	1.15		$	2.40		$	2.02
Discontinued operations	(0.00		)	(0.01		)	(0.00		)	(0.02		)
Total	$	1.31		$	1.14		$	2.40		$	2.00

Weighted-average number of common shares out-standing: (millions)

Assuming dilution	1,560.1			1,627.9			1,573.6			1,644.2

Basic	1,538.1			1,603.9			1,551.3			1,616.3

Cash dividends per common share	$	0.30		$	0.20		$	0.50		$	0.38

(Amounts may not add due to rounding.)

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

INTERNATIONAL BUSINESS MACHINES CORPORATION
AND SUBSIDIARY COMPANIES
CONSOLIDATED STATEMENT OF FINANCIAL POSITION
(UNAUDITED)
ASSETS

(Dollars in millions)	At June 30, 2006		At December 31, 2005
Assets
Current assets:
Cash and cash equivalents	$	7,100	$	12,568
Marketable securities	2,890		1,118
Notes and accounts receivable — trade (net of allowances of $241 in 2006 and $267 in 2005)	9,211		9,540
Short-term financing receivables (net of allowances of $365 in 2006 and $422 in 2005)	12,063		13,750
Other accounts receivable (net of allowances of $8 in 2006 and $7 in 2005)	1,062		1,138
Inventories, at lower of average cost or market:
Finished goods	873		902
Work in process and raw materials	2,238		1,939
Total inventories	3,111		2,841
Deferred taxes	1,640		1,765
Prepaid expenses and other current assets	2,514		2,941
Total current assets	39,591		45,661
Plant, rental machines and other property	35,237		34,261
Less: Accumulated depreciation	21,274		20,505
Plant, rental machines and other property — net	13,963		13,756
Long-term financing receivables	9,504		9,628
Prepaid pension assets	23,293		20,625
Intangible assets — net	1,657		1,663
Goodwill	10,324		9,441
Investments and sundry assets	5,046		4,974
Total assets	$	103,377	$	105,748

(Amounts may not add due to rounding.)

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

INTERNATIONAL BUSINESS MACHINES CORPORATION
AND SUBSIDIARY COMPANIES
CONSOLIDATED STATEMENT OF FINANCIAL POSITION
(UNAUDITED)
Liabilities and Stockholders’ Equity

	At June 30,			At December 31,
(Dollars in millions except per share amounts)	2006			2005
Liabilities and Stockholders’ Equity
Current liabilities:
Taxes	$	3,816		$	4,710
Short-term debt	7,907			7,216
Accounts payable and accruals	22,395			23,226
Total current liabilities	34,118			35,152

Long-term debt	13,872			15,425
Retirement and nonpension postretirement benefit obligations	13,049			13,779
Other liabilities	8,789			8,294
Total liabilities	69,828			72,650

Stockholders’ equity:

Common stock - par value $0.20 per share and additional paid-in capital	29,823			28,926
Shares authorized: 4,687,500,000
Shares issued: 2006 - 1,991,255,639 2005 - 1,981,259,104
Retained earnings	47,647			44,734

Treasury stock - at cost	(43,567		)	(38,546		)
Shares: 2006 - 469,416,633 2005 - 407,279,343

Accumulated gains and (losses) not affecting retained earnings	(354		)	(2,016		)


Total stockholders’ equity	33,549			33,098

Total liabilities and stockholders’ equity	$	103, 377		$	105,748

(Amounts may not add due to rounding.)

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

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

(Dollars in millions)	2006			2005*
Cash flow from operating activities from continuing operations:
Net Income	$	3,730		$	3,231
Loss from discontinued operations	—			$	27
Adjustments to reconcile income from continuing operations to cash provided from operating activities:
Depreciation	1,924			2,111
Amortization of intangibles	531			509
Stock-based compensation	409			545
Net gain on asset sales and other	(45		)	(1,164		)
Changes in operating assets and liabilities, net of acquisitions/divestitures	(871		)	(46		)

Net cash provided by operating activities from continuing operations	5,677			5,213


Cash flow from investing activities from continuing operations:
Payments for plant, rental machines and other property, net of proceeds from dispositions	(1,708		)	(1,623		)
Investment in software	(394		)	(403		)
Acquisition of businesses, net of cash acquired	(809		)	(1,122		)
Divestiture of businesses, net of cash transferred	—			486
Purchases of marketable securities and other investments	(13,651		)	(1,348		)
Proceeds from disposition of marketable securities and other investments	11,591			1,992

Net cash used in investing activities from continuing operations	(4,971		)	(2,018		)

Cash flow from financing activities from continuing operations:
Proceeds from new debt	214			3,984
Payments to settle debt	(1,288		)	(2,012		)
Short-term borrowings/(repayments) less than 90 days — net	105			(689		)
Common stock transactions — net	(4,501		)	(4,599		)
Cash dividends paid	(776		)	(615		)

Net cash used in financing activities from continuing operations	(6,246		)	(3,931		)

Effect of exchange rate changes on cash and cash equivalents	79			(662		)
Net cash used in discontinued operations - operating activities	(7		)	(7		)

Net change in cash and cash equivalents	(5,468		)	(1,405		)

Cash and cash equivalents at January 1	12,568			10,053

Cash and cash equivalents at June 30	$	7,100		$	8,648

* Reclassified to conform with 2006 presentation.

(Amounts may not add due to rounding.)

(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 six-month periods have been made.

In the first quarter of 2006, the company made changes to its management system. These changes impacted the company’s reportable segments and resulted in the reclassification of certain revenue and cost within its Consolidated Statement of Earnings. These changes did not impact the company’s total revenue, cost, expense, net income, earnings per share, Consolidated Statement of Financial Position or Consolidated Statement of Cash Flows. See Note 10 for additional information regarding the changes in reportable segments. The periods presented in this Form 10-Q are reported on a comparable basis. The company filed a Form 8-K with the Securities and Exchange Commission (SEC) on June 13, 2006 to reclassify its historical financial statements and related footnotes to reflect these management system changes.

Within the financial tables in this Form 10-Q, some columns and rows may not add due to the use of rounded numbers for disclosure purposes. Percentages presented are calculated from the underlying whole-dollar amounts.

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

	Three Months Ended June 30,						Six Months Ended June 30,
(Dollars in millions)	2006			2005			2006			2005
Net income	$	2,022		$	1,829		$	3,730		$	3,231
Gains and losses not affecting retained earnings (net of tax):
Foreign currency translation adjustments	499			(553		)	637			(1,025		)
Minimum pension liability adjustments	1,136			3			1,432			2
Net unrealized gains/(losses) on marketable securities	4			(29		)	(22		)	(17		)
Net unrealized (losses)/gains on cash flow hedge derivatives	(235		)	418			(386		)	777
Total gains and (losses) not affecting retained earnings	1,404			(161		)	1,662			(263		)
Net income plus gains and losses not affecting retained earnings	$	3,425		$	1,668		$	5,392		$	2,968

3. Effective January 1, 2005, the company adopted the provisions of Statement of Financial Accounting Standards (SFAS) No. 123(R), “Share-Based Payment.” Accordingly, stock-based compensation cost is measured at grant date, based on the fair value of the award, and is recognized as expense over the employee requisite service period. The following table shows total stock-based compensation expense included in the Consolidated Statement of Earnings:

	Three MonthsEnded June 30,						Six Months Ended June 30,
(Dollars in millions)	2006			2005			2006			2005
Cost	$	52		$	80		$	108		$	171
Selling, general and administrative*	136			153			258			318
Research, development and engineering	21			26			42			56
Other (income) and expense	—			(8		)	—			(8		)
Pre-tax stock-based compensation expense	209			251			409			537
Income tax benefits	(72		)	(87		)	(145		)	(182		)
Total stock-based compensation expense	$	137		$	164		$	264		$	355

* Includes $4 million of credits in the three-and six-month periods ended June 30, 2005, as a result of awards forfeited in connection with the company’s second-quarter 2005 workforce resource actions.

The reduction in pre-tax stock-based compensation expense for the three and six-month periods ended June 30, 2006, as compared to the corresponding periods in the prior year, was principally the result of: (1) a reduction in the level and fair value of stock option grants ($49 million and $137 million, respectively), (2) changes to the terms of the company’s employee stock purchase plan, which rendered it non-compensatory in the second quarter of 2005 in accordance with the provisions of SFAS 123(R) (no effect in three-month period and $18 million decrease in six-month period), offset by (3) increased expense for performance-based stock units ($7 million and $27 million, respectively) resulting from changes in the probabilities of achieving performance metrics. The effects on pre-tax stock-based compensation expense of the 2005 sale of the Personal Computing business were recorded in Other (income) and expense above and in the Consolidated Statement of Earnings for the three and six- month periods ended June 30, 2005.

As of June 30, 2006, $1,550 million of total unrecognized compensation costs related to non-vested awards is expected to be recognized over a weighted average period of approximately 2 years.

There were no significant capitalized stock-based compensation costs at June 30, 2006 and 2005.

Under IBM’s long-standing practices and policies, all stock option awards are approved prior to or on the date of grant. The exercise price of at-the-money stock options is the average of the high and low market price on the date of grant or, in the case of premium-priced stock options, 10 percent above such average. The options approval process specifies the individual receiving the grant, the number of options or the value of the award, the exercise price or formula for determining the exercise price, and the date of grant. All option awards for senior management are approved by the Executive Compensation and Management Resources Committee of the Board of Directors (the “Committee”). All option awards for employees other than senior management are approved by senior management pursuant to a series of delegations that were approved by the Committee, and the grants made pursuant to these delegations are reviewed periodically with the Committee. Options that are awarded as part of annual total compensation for senior management and other employees are made on specific cycle dates scheduled in advance. With respect to option awards given in connection with promotions or new hires, IBM’s policy requires approval of such awards prior to the grant date, which is typically the date

of the promotion or the date of hire. The exercise price of these options is the average of the high and low market price on the date of grant in the case of at-the-money stock options or, in the case of premium-priced stock options, 10 percent above such average. See IBM’s 2005 Annual Report, note U, “Stock-Based Compensation”, for additional information on the company’s stock-based incentive awards.

4. In July 2006, the Financial Accounting Standards Board (FASB) released FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109” (FIN 48). FIN 48 clarifies the accounting and reporting for uncertainties in income tax law. This Interpretation prescribes a comprehensive model for the financial statement recognition, measurement, presentation and disclosure of uncertain tax positions taken or expected to be taken in income tax returns. The company will adopt this Interpretation in the first quarter of 2007. The cumulative effects, if any, of applying this Interpretation will be recorded as an adjustment to retained earnings as of the beginning of the period of adoption. The company has commenced the process of evaluating the expected effect of FIN 48 on its Consolidated Financial Statements and is currently not yet in a position to determine such effects.

In March 2006, the FASB issued SFAS No. 156, “Accounting for Servicing of Financial Assets—an amendment of FASB Statement No. 140,” that provides guidance on accounting for separately recognized servicing assets and servicing liabilities. In accordance with the provisions of SFAS No. 156, separately recognized servicing assets and servicing liabilities must be initially measured at fair value, if practicable. Subsequent to initial recognition, the company may use either the amortization method or the fair value measurement method to account for servicing assets and servicing liabilities within the scope of this Statement. The company will adopt SFAS No. 156 in fiscal year 2007. The adoption of this Statement is not expected to have a material effect on the company’s Consolidated Financial Statements.

In February 2006, the FASB issued SFAS No. 155, “Accounting for Certain Hybrid Financial Instruments—an amendment of FASB Statements No. 133 and 140,” to permit fair value remeasurement for any hybrid financial instrument that contains an embedded derivative that otherwise would require bifurcation in accordance with the provisions of SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities.” The company will adopt SFAS No. 155 in fiscal year 2007. The adoption of this Statement is not expected to have a material effect on the company’s Consolidated Financial Statements.

In April 2006, the FASB issued FASB Staff Position (FSP) FIN 46(R)-6, “Determining the Variability to Be Considered in Applying FASB Interpretation No. 46(R)”, that will become effective beginning third quarter of 2006. FSP FIN No. 46(R)-6 clarifies that the variability to be considered in applying FASB Interpretation 46(R) shall be based on an analysis of the design of the variable interest entity. The adoption of this FSP is not expected to have a material effect on the company’s Consolidated Financial Statements.

5. In May 2005, the company implemented a series of restructuring actions designed to improve the company’s efficiencies, strengthen its client-facing operations and capture opportunities in high-growth markets. The company’s actions primarily included voluntary and involuntary workforce reductions, with the majority impacting the Global Services business, primarily in Europe, as well as the vacating of leased facilities. These actions were in addition to the company’s ongoing workforce reduction and rebalancing activities that occur each quarter.

The total charges expected to be incurred in connection with all second-quarter 2005 initiatives are approximately $1,776 million, of which $1,756 million has been recorded cumulatively through June 30, 2006. The remaining expected charges represent accretion/interest expense on the long-term portion of the company’s workforce and vacant space obligations. Approximately $1,634 million of the total charges require cash payments, of which approximately $1,308 million have been made as of June 30, 2006 and $67 million are expected to be made over the next 12 months.

Total pre-tax restructuring activity was as follows:

(Dollars in millions)	Pre-Tax Charges Recorded in 2Q 2005			Asset Impairments		Liability recorded in the 2^nd Qtr. 2005		Payments			Other(2)			Liability as of 12/31/05
Workforce reductions	$	1,574		$	—	$	1,574	$	(1,013	)	$	(107	)	$	454
Vacant space	141			—		141		(53		)	(5		)	83
Asset impairments	95			95		—		—			—			—
Total restructuring charges for 2Q 2005 actions	$	1,810	(1)	$	95	$	1,715	$	(1,066	)	$	(112	)	$	537	(3)

(1) $1.6 billion recorded in Selling, general and administrative expense and $0.2 billion recorded in Other (income) and expense in the Consolidated Statement of Earnings.

(2) Consists of foreign currency translation adjustments ($38 million), net reclassifications to other balance sheet categories ($41 million) and reversals of previously recorded liabilities ($34 million), offset by approximately $1 million of accretion expense. The reversals were recorded primarily in SG&A expense, for changes in the estimated cost of employee terminations and vacant space.

(3) $391 million recorded as a current liability in Accounts payable and accruals and $146 million as a non-current liability in Other liabilities in the Consolidated Statement of Financial Position.

	Liability as of December 31, 2005			Payments			Other(4)		Liability as of June 30, 2006
(Dollars in millions)
Workforce reductions	$	454		$	(215	)	$	9	$	248
Vacant space	83			(28		)	2		57
Total restructuring charges for 2Q 2005 actions	$	537	(3)	$	(242	)	$	11	$	306	(5)

(4) Consists of foreign currency translation adjustments ($30 million), net balance sheet reclassifications ($1 million) and accretion expense ($3 million), offset by reversals of previous recorded liabilities ($23 million) for changes in the estimated cost of employee terminations and vacant space. These reversals were primarily recorded in SG&A.

(5) $67 million recorded as a current liability in Accounts payable and accruals and $239 million as a non-current liability in Other liabilities in the Consolidated Statement of Financial Position.

Charges incurred for the workforce reductions consisted of severance/termination benefits for approximately 16,000 employees (14,500 of which were for the incremental second-quarter 2005 actions). All separations were substantially completed by March 31, 2006. The non-current portion of the liability associated with the workforce reductions relates to terminated employees who were granted annual payments to supplement their income in certain countries. Depending on individual country legal requirements, these required payments will continue until the former employee begins receiving pension benefits or is deceased. Cash payments made through June 30, 2006 associated with the workforce reductions were $1,228 million.

The vacant space accruals are primarily for ongoing obligations to pay rent for vacant space, offset by estimated sublease income, over the respective lease term of the company’s lease agreements. The length of these obligations varies by lease with the longest extending through 2019.

In connection with the company’s restructuring activities initiated in the second quarter of 2005, the company recorded pre-tax impairment charges for certain real estate assets of approximately $95 million during the year ended December 31, 2005. The principal component of such impairment charges resulted from the sale of a facility in Yasu-City, Japan, which closed during the third quarter of 2005. In connection with this sale, the company recorded an impairment charge to write the asset down to its fair value in the second quarter of 2005.

These restructuring activities had the following effect on the company’s reportable segments:

At June 30, 2006:	Total Pre-Tax Charges Expected to be Incurred for 2Q 2005 Actions*		Cumulative Pre-Tax Charges Recorded for 2Q 2005 Actions*
(Dollars in millions)
Global Technology Services	$	730	$	721
Global Business Services	444		441
Systems & Technology Group	135		132
Software	98		97
Global Financing	16		16
Total reportable segments	1,423		1,407
Unallocated corporate amounts	354		349
Total	$	1,776	$	1,756

* Amounts reclassified from previously reported amounts to reflect the new management system structure implemented in the first quarter of 2006.

6. 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 from continuing operations before income taxes.

For the three months ended June 30:	2006		2005		Yr. to Yr. Percent Change
(Dollars in millions)
Retirement-related plans—cost:
Defined benefit and contribution pension plans—cost	$	521	$	491	6.1	%
Nonpension postretirement benefits-cost	93		91		2.2
Total	$	614	$	582	5.5	%

For the six months ended June 30:	2006		2005		Yr. to Yr. Percent Change
(Dollars in millions)
Retirement-related plans—cost:
Defined benefit and contribution pension plans—cost	$	1,044	$	947	10.2	%
Nonpension postretirement benefits—cost	193		184		4.9
Total	$	1,237	$	1,131	9.4	%

The following tables provides the components of the cost/(income) for the company’s pension plans:

Cost/(Income) of Pension Plans

	U.S. Plans						Non-U.S. Plans
For the three months ended June 30:	2006			2005			2006			2005
(Dollars in millions)
Service cost	$	202		$	166		$	159		$	173

Interest cost	611			617			391			413
Expected return on plan assets	(905		)	(918		)	(585		)	(567		)
Amortization of transition assets	—			—			(1		)	(2		)
Amortization of prior service cost	15			15			(25		)	2
Recognized actuarial losses	190			140			217			145
Net periodic pension cost—U.S. Plan and material non-U.S. Plans	113		*	20		*	156		**	164		**
Cost of other defined benefit plans	27			40			41			36
Cost of restructuring/divestiture actions	—			3			—			59
Total net periodic pension cost for all defined benefit plans	140			63			197			259
Cost of defined contribution plans	94			83			90			86
Total retirement plan cost recognized in the Consolidated Statement of Earnings	$	234		$	146		$	287		$	345

* 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
For the six months ended June 30:	2006			2005			2006			2005
(Dollars in millions)
Service cost	$	384		$	341		$	313		$	353
Interest cost	1,227			1,232			770			838
Expected return on plan assets	(1,806		)	(1,836		)	(1,143		)	(1,152		)
Amortization of transition assets	—			—			(2		)	(3		)
Amortization of prior service cost	30			30			(28		)	19
Recognized actuarial losses	393			284			403			278
Net periodic pension cost — U.S. Plan and material non-U.S. Plans	228		*	51		*	313		**	333		**
Cost of other defined benefit plans	55			72			78			71
Cost of restructuring/divestiture actions	—			3			—			59
Total net periodic pension cost for all defined benefit plans	283			126			391			463
Cost of defined contribution plans	192			186			178			172
Total retirement plan cost recognized in the Consolidated Statement of Earnings	$	475		$	312		$	569		$	635

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

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

In 2006, the company expects to contribute to its non-U.S. Defined Benefit Plans an amount of between $1.6 - 2 billion. The legally mandated minimum contribution included in the amount above for the company’s non-U.S. Plans is expected to be $842 million. In the first six months of 2006, the company contributed $1,550 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 June 30,						Six Months Ended June 30,
	2006			2005			2006			2005
(Dollars in millions)
Service cost	$	15		$	11		$	31		$	23
Interest cost	73			82			152			162
Amortization of prior service cost	(15		)	(15		)	(31		)	(31		)
Recognized actuarial losses	7			6			15			12
Net periodic post-retirement benefit cost — U.S. Plan	80			84			167			166
Cost of non-U.S. Plans	13			7			26			18
Total nonpension postretirement plan cost recognized in the Consolidated Statement of Earnings	$	93		$	91		$	193		$	184

The Medicare Prescription Drug Improvement and Modernization Act of 2003 did not have a material impact on the company’s Consolidated Financial Statements as of or for the periods ended June 30, 2006.

7. The changes in the carrying amount of goodwill, by reportable segment, for the six months ended June 30, 2006, are as follows:

Segment	Balance 12/31/05*		Goodwill Additions		Purchase Price Adjustments			Divestitures		Foreign Currency Translation Adjustments		Balance 6/30/06
(Dollars in millions)
Global Technology Services	$	1,530	$	5	$	(87	)	$	—	$	120	$	1,568
Global Business Services	3,588		—		(13		)	—		88		3,663
Systems and Technology Group	254		—		5			—		1		260
Software	4,069		791		(33		)	—		5		4,833
Global Financing	—		—		—			—		—		—
Total	$	9,441	$	796	$	(128	)	$	—	$	214	$	10,324

* Amounts reclassified from previously reported amounts reflect the new management system structure implemented in the first quarter of 2006.

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 June 30, 2006
Intangible asset class	Gross Carrying Amount		Accumulated Amortization			Net Carrying Amount
(Dollars in millions)
Capitalized software	$	1,862	$	(847	)	$	1,015
Client-related	731		(350		)	381
Completed technology	210		(81		)	129
Strategic alliances	104		(78		)	26
Patents/Trademarks	37		(21		)	16
Other(a)	254		(164		)	90
Total	$	3,198	$	(1,542	)	$	1,657

	At December 31, 2005
Intangible asset class	Gross Carrying Amount		Accumulated Amortization			Net Carrying Amount
(Dollars in millions)
Capitalized software	$	1,805	$	(802	)	$	1,003
Client-related	910		(490		)	420
Completed technology	383		(270		)	113
Strategic alliances	104		(68		)	36
Patents/Trademarks	32		(17		)	15
Other(a)	218		(142		)	76
Total	$	3,452	$	(1,789	)	$	1,663

(a)

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

The net carrying amount of intangible assets decreased $6 million during the first six months of 2006 due to amortization of existing intangible asset balances partially offset by acquisitions. The aggregate intangible asset amortization expense was $266 million and $531 million for the second quarter and first six months of 2006, respectively, versus $259 million and $509 million for the second quarter and first six months of 2005, respectively. In addition, in the first six months of 2006, the company retired $782 million of fully amortized intangible assets, impacting both the gross carrying amount and accumulated amortization for this amount.

The amortization expense for each of the five succeeding years relating to intangible assets currently recorded in the Consolidated Statement of Financial Position is estimated to be the following at June 30, 2006:

2006 (for Q3-Q4)		$491 million
2007		$695 million
2008		$298 million
2009		$112 million
2010		$33 million

8. During the six months ended June 30, 2006, the company completed 7 acquisitions at an aggregate cost of $969 million.

The Software segment completed six acquisitions in the first half: in the first quarter, Micromuse, a publicly traded company; Cims Lab, a privately held company; and Language Analysis Systems, Inc., a privately held company; and, in the second quarter, Buildforge, a privately held company; Unicorn Solutions, Inc., a privately held company; and Rembo Technology, a privately held company. Each acquisition further complemented and enhanced the company’s portfolio of software product offerings.

Global Technology Services (GTS) completed one acquisition in the first quarter: Viacore, Inc., a privately held company. This acquisition augments GTS’s supply chain optimization practice within its Business Transformation Outsourcing offerings.

Purchase price consideration was paid all in cash. These acquisitions are reported in the Consolidated Statement of Cash Flows net of acquired cash and cash equivalents.

The table below reflects the purchase price related to these acquisitions and the resulting purchase price allocations as of June 30, 2006. The Micromuse acquisition is shown separately given its significant purchase price.

		Micromuse
	Amortization Life (yrs.)	Original Amount Disclosed in First Qtr. 2006			Purchase Adjustments			Total Allocation			Other Acquisitions
(Dollars in millions)
Current assets		$	201		$	—		$	201		$	14
Fixed assets/non-current		8			—			8			2
Intangible assets:
Goodwill	N/A	694			6			700			96
Completed technology	3	46			—			46			3
Client relationships	3 - 5	46			—			46			14
Other identifiable assets		4			—			4			—
In-process research and development		1			—			1			—
Total assets acquired		1,000			6			1,006			129
Current liabilities		(89		)	(6		)	(95		)	(13		)
Non-current liabilities		(49		)	—			(49		)	(9		)
Total liabilities assumed		(138		)	(6		)	(144		)	(22		)
Total purchase price		$	862		$	—		$	862		$	107

The acquisitions were accounted for as purchase transactions, and accordingly, the assets and liabilities of the acquired entities were recorded at their estimated fair values at the date of acquisition. The primary items that generated the goodwill are the value of the synergies between the acquired companies and IBM and the acquired assembled workforce, neither of which qualify as an amortizable intangible asset. The company is currently analyzing the amount of goodwill that is deductible for tax purposes. The overall weighted-average life of the identified amortizable intangible assets acquired is 4.2 years. With the exception of goodwill, these identified intangible assets will be amortized on a straight-line basis over their useful lives.

Goodwill of $796 million has been assigned to the Software ($791 million) and Global Technology Services ($5 million) segments.

9. On April 30, 2005 (“closing date”), the company completed the divestiture of its Personal

Computing Division (“PCD”) business to Lenovo Group Limited (“Lenovo”), a publicly traded company on the Hong Kong Stock Exchange. For the year ended December 31, 2005, the company recorded a total pre-tax gain of $1,108 million of which $1,097 million was recorded in the second quarter of 2005.

As part of the total consideration received at the closing date, the company received equity in Lenovo. The equity is subject to specific lock-up provisions that restrict the company from divesting the securities. The restrictions, agreed to at the closing date, apply to specific equity tranches and expire over a three-year period from the closing date. In the second quarter of 2006, the company and Lenovo agreed to revise these restrictions such that the company can now fully divest its shares in Lenovo by November 1, 2007 versus the prior expiration date of May 1, 2008.

See IBM’s 2005 Annual Report, note C, “Acquisitions/Divestitures”, for additional information.

10. The tables on pages 79 through 82 of this Form 10-Q reflect the results of the company’s reportable 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.

As discussed in Note 1, in the first quarter of 2006, the company made changes to its management system that impacted the company’s reportable segments. The Enterprise Investment segment was dissolved and the Product Lifecycle Management software business was transferred to the Software segment. Certain other investments and products previously managed as Enterprise Investments are now included in the Software, Systems and Technology Group and Global Services segments.

In addition, the company made changes in the management system of its Global Services business. These changes include the separation of the Global Services segment into two new reportable segments: Global Technology Services and Global Business Services.

The two new Global Services segments consist of the following:

The Global Technology Services (GTS) segment primarily reflects infrastructure services, delivering value through the company’s global scale, standardization and automation. It includes outsourcing, both Strategic Outsourcing and Business Transformation Outsourcing, Integrated Technology Services and Maintenance.

The Global Business Services (GBS) segment primarily reflects professional services, delivering business value and innovation to clients through solutions which leverage industry and

business process expertise. It includes consulting, systems integration and application management services (AMS).

In the second quarter of 2005, the company divested its Personal Computing business which was previously a part of the Personal Systems Group. The two remaining units of the former Personal Systems Group, Retail Store Solutions and Printing Systems, were combined with the Systems and Technology Group. The Personal Computing business financial results are displayed as part of the segment disclosures, for applicable periods presented, in a manner consistent with the segment disclosures.

Previously reported segment information on pages 79 through 82 has been reclassified for all periods presented to reflect these changes in the company’s reportable segments.

11. The following table provides a rollforward of the liability balances for actions taken in the following periods: (1) the second quarter of 2005, discussed in Note 5; (2) the second-quarter of 2002 associated with the Microelectronics Division and rebalancing of both the company’s workforce and leased space resources; (3) the fourth-quarter 2002 actions associated with the acquisition of the PricewaterhouseCoopers consulting business; (4) the 2002 actions associated with the hard disk drive (HDD) business for reductions in workforce, manufacturing capacity and space; (5) the actions taken in 1999; and (6) actions that took place prior to 1994.

	Liability as of 12/31/2005		Payments			Other adjustments*			Liability as of 6/30/2006
(Dollars in millions)
Current:
Workforce	$	461	$	(267	)	$	(67	)	$	127
Space	62		(62		)	61			61
Other	6		—			—			6
Total Current	$	529	$	(329	)	$	(6	)	$	194

Non-current:
Workforce	$	497	$	—		$	134		$	631
Space	236		—			(75		)	161
Total Non-current	$	733	$	—		$	59		$	792

* The other adjustments column in the table above principally includes the reclassification of non-current to current and foreign currency translation adjustments. In addition, during the six-month period ended June 30, 2006, net adjustments to decrease previously recorded liabilities for changes in the estimated cost of employee terminations and vacant space were recorded for the 2002 actions ($17 million) and the 2Q 2005 actions ($23 million), offset by increases for the actions taken prior to 1999 ($5 million). Of the $35 million of net reductions recorded during the six months ended June 30, 2006 in the Consolidated Statement of Earnings, $14 million was included in Selling, General and Administrative expense and $3 million was recorded Other (income) and expense. Additionally, adjustments of $18 million for the six-month period ended June 30, 2006, were recorded to Goodwill for changes to estimated vacant space and workforce reserves associated with the 2002 actions.

12. 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, benefits, securities, and environmental matters. These actions may be commenced by a number of different constituents,

including competitors, partners, clients, current or former employees, government and regulatory agencies, stockholders, and representatives of the locations in which the company does business. 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. v. The IBM Personal Pension Plan (PPP) and IBM Corporation, held that the company’s pension plan violated the age discrimination provisions of the Employee Retirement Income Security Act of 1974 (ERISA). On September 29, 2004, the company announced that IBM and plaintiffs agreed in principle to resolve certain claims in the litigation. That agreement was finalized by the parties in May 2005, and received final approval from the District Court on August 16, 2005. 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. This settlement, together with a previous settlement of a claim referred to as the partial plan termination claim resulted in the company taking a one-time charge of $320 million in the third quarter of 2004.

This agreement ends the litigation on all claims except the two claims associated with IBM’s cash balance formula. The company 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 the company’s shareholders, and to allow for a review of its cash balance formula by the Court of Appeals. The company continues to believe it is likely to be successful on appeal.

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

On August 30, 2005, the company filed its Notice of Appeal of the liability rulings on the cash balance claims with the Seventh Circuit Court of Appeals and the matter was subsequently fully briefed. On February 16, 2006 oral arguments on the appeal were heard by the Court of Appeals, and the company estimates that the appeals process should conclude in 2006.

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 an alleged successor in interest to some of AT&T’s Unix IP rights, and alleges copyright infringement, unfair competition, interference with contract and breach of contract with regard to the company’s distribution of AIX and Dynix and contribution of code to Linux. 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, promissory estoppel and copyright infringement. In October 2005, the company withdrew its patent counterclaims in an effort to simplify and focus the issues in the case and to expedite their resolution. Trial is currently scheduled for February 2007.

In May 2005, the Louisiana Supreme Court denied the company’s motion to review and reverse a Louisiana state court’s certification of a nationwide class in a case filed against the company in 1995. The class consists of certain former employees who left the company in 1992, and their spouses. They claim damages based on the company’s termination of an education assistance program. On April 4, 2006, the trial court denied the company’s motion for summary judgment. On June 26, 2006, the Louisiana Court of Appeals denied IBM’s writ seeking an interlocutory appeal of the trial court’s decision to deny summary judgment. IBM intends to file a writ seeking a discretionary appeal with the Louisiana Supreme Court. No date has been set for trial.

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

On January 8, 2004, the company 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 the company’s Retail Stores Solutions unit. It is the company’s understanding that an employee in the company’s Sales & Distribution unit also received a Wells Notice from the SEC in connection with this matter. The Wells Notice notifies the company that the SEC staff is considering recommending that the SEC bring a civil action against the company 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, the company 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, the company responded to the SEC staff regarding whether any action should be brought against the company by the SEC. The separate SEC investigation noted above, relating to the recognition of revenue by the company in 2000 and 2001 primarily concerning certain types of client transactions, is not the subject of this Wells Notice.

On June 27, 2005, the company announced that it had received a request to voluntarily comply with an informal investigation by the staff of the SEC concerning the company’s disclosures relating to the company’s first quarter 2005 earnings and expensing of equity compensation. On January 12, 2006, the company announced that it received notice of a formal, nonpublic investigation by the SEC of this matter. The company has been cooperating with the SEC, and will continue to do so. The SEC has informed the company that the investigation should not be construed as an indication that any violations of law have occurred.

In July 2005, two lawsuits were filed in the United States District Court for the Southern District of New York related to the company’s disclosures concerning first-quarter 2005 earnings and the expensing of equity compensation. One lawsuit named as defendants IBM and IBM’s Senior Vice President and Chief Financial Officer. The other lawsuit named as defendants IBM, IBM’s Senior Vice President and Chief Financial Officer, and IBM’s Chairman and Chief Executive Officer. Both complaints alleged that defendants made certain misrepresentations in violation of Section 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5

promulgated thereunder. On September 6, 2005, counsel in one of these lawsuits filed a motion seeking to have the lawsuits consolidated, and for the appointment of lead plaintiff and lead counsel. Pursuant to an Order from the Court dated March 28, 2006, the two lawsuits were consolidated into a single action captioned “In re International Business Machines Corp. Securities Litigation.” Pursuant to a schedule set by the Court, Plaintiffs served on the company an Amended Consolidated Complaint on May 19, 2006. IBM filed a Motion to Dismiss the Amended Consolidated Complaint on June 23, 2006. Plaintiffs filed their response to IBM’s Motion on July 21, 2006; and IBM has until August 2, 2006 to file a final brief in support of its Motion.

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, which has since been dissolved, effective January, 2005) 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 IBM 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. Debarment orders were imposed at different times, covering a period of no more than a year from the date of issuance, which barred IBM Korea from doing business directly with certain government controlled entities in Korea. All debarment orders have since expired and when they were in force did not prohibit IBM Korea from selling products and services to business partners who sold to government-controlled entities in Korea. In addition, the U.S. Department of Justice and the SEC have both contacted the company in connection with this matter.

On January 24, 2006, a putative class action lawsuit was filed against IBM in federal court in San Francisco on behalf of technical support workers whose primary responsibilities are or were to install and maintain computer software and hardware. The complaint was subsequently amended on March 13, 2006. The First Amended Complaint, among other things, adds four additional named plaintiffs and modifies the definition of the workers purportedly included in the class. The suit, Rosenburg, et. al., v. IBM, alleges the company failed to pay overtime wages pursuant to the Fair Labor Standards Act and state law, and asserts violations of various state wage requirements, including recordkeeping and meal-break provisions. The suit also asserts certain violations of ERISA. Relief sought includes back wages, corresponding 401K and pension plan credits, interest, and attorneys’ fees.

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

In accordance with SFAS No. 5, “Accounting for Contingencies,” the company records a provision with respect to a claim, suit, investigation or proceeding when it is probable that a liability has been incurred and the amount of the loss can be reasonably estimated. Any

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 quarter ended June 30, 2006, were not material to the Consolidated Financial Statements. 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. Claims, suits, investigations and proceedings are inherently uncertain and it is not possible to predict the ultimate outcome of the matters previously discussed. 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 the company’s Consolidated Financial Statements; and the unique facts and circumstances of the particular matter which may give rise to additional factors.

13. The company’s extended lines of credit include unused amounts of $2,990 million and $3,019 million at June 30, 2006 and December 31, 2005, 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 $2,157 million and $2,155 million at June 30, 2006 and December 31, 2005, 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 would 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 $32 million and $39 million at June 30, 2006 and December 31, 2005, respectively.

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

(Dollars in millions)	2006			2005
Balance at January 1	$	754		$	944
Current period accruals	220			376
Accrual adjustments to reflect actual experience	56			(27		)
Charges incurred	(386		)	(409		)
Balance at June 30	$	645		$	884

The decrease in the warranty liability balance was primarily driven by the divestiture of the company’s Personal Computing business in April 2005.

14. Subsequent Event On July 25, 2006, the company announced that the Board of Directors approved a quarterly dividend of $0.30 per common share. The dividend is payable September 9, 2006 to shareholders of record on August 10, 2006.

ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS
OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2006*

Snapshot

(Dollars in millions except per share amounts)							Yr. To Yr.
							Percent/
							Margin
Three months ended June 30:	2006			2005			Change
Revenue	$	21,890		$	22,270		(1.7	)%**
Gross profit margin	41.2		%	39.4		%	1.8	pts.
Total expense and other income	$	6,125		$	6,042		1.4	%
Total expense and other income to revenue ratio	28.0		%	27.1		%	0.9	pts.
Provision for income taxes	$	867		$	882		(1.7	)%
Income from continuing operations	$	2,022		$	1,851		9.2	%
Earnings per share from continuing operations:
Assuming dilution	$	1.30		$	1.14		14.0	%
Basic	$	1.31		$	1.15		13.9	%
Weighted average shares outstanding:
Assuming dilution	1,560.1			1,627.9			(4.2	)%
Basic	1,538.1			1,603.9			(4.1	)%

*		The following Results of Continuing Operations discussion does not include the Hard Disk Drive (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 in the second quarter and first six months of 2006, respectively, versus $22 million and $27 million in the second quarter and first six months of 2005. The 2005 charges were for additional costs associated with parts warranty as agreed upon by the company and Hitachi Ltd., under the terms of the agreement for the sale of the HDD business to Hitachi Ltd.

**		(1.6) percent adjusted for currency

The selected reference to “adjusted 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.

								Yr. To Yr.
(Dollars in millions except per share amounts)								Percent/
								Margin
Six months ended June 30:	2006			2005				Change
Revenue	$	42,549		$		45,178		(5.8	)%**
Gross profit margin	40.2		%	37.7			%	2.5	pts.
Total expense and other income	$	11,774		$	12,286			(4.2	)%
Total expense and other income to revenue ratio	27.7		%	27.2			%	0.5	pts.
Provision for income taxes	$	1,598		$	1,485			7.7	%
Income from continuing operations	$	3,730		$	3,258			14.5	%
Earnings per share from continuing operations:
Assuming dilution	$	2.37		$	1.98			19.7	%
Basic	$	2.40		$	2.02			18.8	%
Weighted average shares outstanding:
Assuming dilution	1,573.6			1,644.2				(4.3	)%
Basic	1,551.3			1,616.3				(4.0	)%

							Yr. To Yr.
	6/30/06			12/31/05			Percent Change
Assets	$	103,377		$		105,748	(2.2	)%
Liabilities	$	69,828		$	72,650		(3.9	)%
Equity	$		33,549	$	33,098		1.4	%

(4.1) percent adjusted for currency

The company’s second-quarter 2006 diluted earnings per common share from continuing operations of $1.30 increased 14 percent versus $1.14 in the second quarter of 2005. Continuing operations for the second quarter of 2005 included a $0.72 per share charge for incremental restructuring, a $0.45 per share gain on the sale of the Personal Computing business and $0.29 per share of other income due to a legal settlement with Microsoft.

Second quarter and first six months of 2006 income from continuing operations was $2,022 million and $3,730 million versus $1,851 million and $3,258 million for the comparable periods in 2005, respectively. The 2005 results included the pretax charge for the incremental restructuring of $1,740 million, offset by a $1,097 million gain on the sale of the Personal Computing business and a $775 million legal settlement received from Microsoft.

Total revenue decreased 1.7 percent and 5.8 percent (1.6 percent and 4.1 percent adjusted for currency) for the second quarter and first six months of 2006 versus the same periods in 2005, primarily due to the divestiture of the Personal Computing business on April 30, 2005. The second quarter 2005 results include one month of Personal Computing revenue versus no activity in 2006 and the six months of 2005 results have four months of Personal Computing revenue versus no activity in 2006. Excluding revenue from the divested Personal Computing business, second quarter and first six months revenue of 2006 increased 0.8 percent and 0.6 percent, respectively.

In the second quarter, the company experienced longer sales and contracting cycles during June 2006. In that environment, the company delivered double-digit earnings per share growth through solid performance in certain areas of its broad portfolio of businesses. Software leveraged its Services Oriented Architecture (SOA) capabilities and the strength of its product portfolio to post solid growth in revenue and pre-tax profit. Microelectronics revenue continued to benefit from good demand for game processors and Systems z revenue returned to growth. Strategic Outsourcing revenue growth improved reflecting the growth in signings in 2005 and the first quarter of 2006, and productivity initiatives continued to drive improved profit margins. Offsetting this performance were execution issues in the company’s supply chain for servers, as some customer orders were left unfilled, and the company continued to work through product transitions in midrange servers. In Global Services, short-term businesses were weak. The Integrated Technology Services business has been in transition and this transition is taking longer to deliver results than anticipated. In Global Business Services, the company’s business grew in the Americas, but under-performed in some key countries in Europe and Asia. Overall, the company’s performance once again reflects the ability to leverage its portfolio and its productivity initiatives to generate solid earnings per share and cash growth.

The gross profit margin was 41.2 percent and 40.2 percent in the second quarter and first six months of 2006 versus 39.4 percent and 37.7 percent in the second quarter and first six months of 2005. The increases in the gross profit margins were primarily driven by the divestiture of the Personal Computing business (1.2 points and 2.0 points, respectively) and benefits from the productivity initiatives implemented in the second quarter of 2005.

In the second quarter of 2006, total expense and other income increased over the year-earlier period, primarily due to lower Intellectual Property income and increased expense associated with retirement-related plans. In the first six months of 2006, total expense and other income declined versus the same period in 2005, primarily due to the divestiture of the Personal Computing business and benefits from the productivity initiatives initiated in the second quarter of 2005. The ratio of Total expense to revenue increased 0.9 points and 0.5 points to 28.0 percent and 27.7 percent, for the second quarter and first six months of 2006 versus the comparable periods of 2005, respectively.

The effective tax rates for the second quarter of 2006 and 2005 were 30.0 percent and 32.3 percent, respectively. The corresponding effective tax rates for the first six months of 2006 and 2005 were 30.0 percent and 31.3 percent, respectively. The decrease in the 2006 quarterly and six months’ tax rate was attributable to the absence of the tax effects related to the restructuring actions, Personal Computing divestiture and the Microsoft settlement in the second quarter of 2005.

Assets declined approximately $2.4 billion from December 31, 2005 to June 30, 2006 primarily due to lower cash and cash equivalents and marketable securities of $3.7 billion due to pension funding ($1.5 billion), acquisitions ($0.8 billion), tax payments ($1.3 billion), restructuring payments ($0.3 billion) and share repurchases ($5.1 billion) in the first half of 2006. In addition, financing receivables declined by $1.8 billion during the first six months of 2006. These decreases were partially offset by an increase in pension assets of $2.7 billion and goodwill of approximately $0.9 billion.

Total Global Services signings were $9.6 billion in the second quarter of 2006 as compared to $14.6 billion for the three months ended June 30, 2005. The estimated total Global Services backlog was $109 billion at June 30, 2006.

Second Quarter and First Six Months in Review

Results of Continuing Operations

								Yr. to Yr.
Revenue								Percent
								Adjusted
(Dollars in millions)						Yr. to Yr.		for
						Percent		Change
For the three months ended June 30:	2006		2005*			Change		Currency
Statement of Earnings Revenue Presentation:
Global Services	$	11,894	$		12,001	(0.9	)%	(0.5	)%
Hardware	5,148		5,562			(7.4	)	(7.8	)
Software	4,241		4,056			4.5		4.9
Global Financing	580		622			(6.8	)	(7.0	)
Other	26		29			(11.0	)	(9.8	)
Total	$	21,890	$	22,270		(1.7	)%	(1.6	)%

							Yr. toYr.
							Percent
							Change
(Dollars in millions)					Yr. to Yr.		Adjusted
					Percent		for
For the six months ended June 30:	2006		2005*		Change		Currency
Statement of Earnings Revenue Presentation:
Global Services	$	23,461	$	23,710	(1.0	)%	1.2	%
Hardware	9,722		12,315		(21.1	)	(20.3	)
Software	8,147		7,871		3.5		5.4
Global Financing	1,164		1,202		(3.2	)	(1.9	)
Other	54		80		(31.8	)	(31.4	)
Total	$	42,549	$	45,178	(5.8	)%	(4.1	)%

Reclassified to conform with current presentation.

							Yr. to Yr.
							Percent
							Change
(Dollars in millions)					Yr. to Yr.		Adjusted
					Percent		for
For the three months ended June 30:	2006		2005*		Change		Currency
Industry Sector**:
Financial Services	$	5,928	$	5,869	1.0	%	1.3	%
Public	3,195		3,533		(9.5	)	(9.8	)
Industrial	2,855		2,912		(2.0	)	(1.5	)
Distribution	2,243		2,239		0.1		0.1
	2,071
Communications	2,029		2,123		(4.4	)	(4.4	)
Small & Medium	4,086		4,220		(3.2	)	(2.9	)
OEM	939		702		33.7		33.7