FOR THE THREE MONTHS ENDED MARCH 31, 2009



Snapshot



                                                                         Yr. To Yr.
                                                                          Percent/
(Dollars in millions except per share amounts)                             Margin
For the three months ended March 31:                2009       2008        Change
Revenue                                           $ 21,711   $ 24,502         (11.4 )%*
Gross profit margin                                   43.4 %     41.5 %         1.9 pts.
Total expense and other income                    $  6,309   $  6,968          (9.5 )%
Total expense and other income to revenue ratio       29.1 %     28.4 %         0.6 pts.
Provision for income taxes                        $    827   $    879          (5.9 )%
Net income                                        $  2,295   $  2,319          (1.0 )%
Net income margin                                     10.6 %      9.5 %         1.1 pts.
Earnings per share:
Assuming dilution                                 $   1.70   $   1.64 **        3.7 %
Basic                                             $   1.71   $   1.67 **        2.4 %
Weighted-average shares outstanding:
Assuming dilution                                  1,349.5    1,411.4 **       (4.4 )%
Basic                                              1,344.3    1,394.3 **       (3.6 )%




               3/31/09    12/31/08
Assets        $ 101,944   $ 109,524   (6.9 )%
Liabilities   $  88,252   $  95,939 + (8.0 )%
Equity        $  13,693   $  13,584 +  0.8 %

** Reflects the implementation of FSP EITF 03-6-1, "Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities." See Note 2 on pages 7 to 9 for additional information.

+ Reflects implementation of SFAS No. 160, "Noncontrolling Interests in Consolidated Financial Statements-an amendment of ARB No. 51." See Note 2 on pages 7 to 9 for additional information.

Within the Management Discussion, selected references to "adjusted for currency" or "at constant currency" are made so that the financial results and other performance metrics can be viewed without the impact of fluctuations in foreign currency exchange rates, thereby facilitating period-to-period comparisons of the company's business performance.

In the first quarter, in a challenging economic environment, the company delivered $1.70 in diluted earnings per share, an increase of 3.7 percent year to year. Total revenue decreased 11.4 percent as reported, 3.8 percent adjusted for currency. Pre-tax income of $3,122 million declined 2.4 percent, however, pre-tax margin increased 1.3 points due to improvements in gross margin and expense. Net income margin improved 1.1 points versus the first quarter of 2008, benefiting from an improved tax rate, and the company's ongoing common share repurchases drove a lower share balance contributing to the improvement in diluted earnings per share.

The company has been transforming its business over the last decade shifting to higher value areas, globalizing its operations and consistently focusing on cost reduction and operational efficiency. These changes have positioned the company to deliver this financial performance in the current environment.

With a focus on higher value offerings and strong services capabilities, the company has been able to adapt its offerings to deliver what clients are focusing on, which is primarily to save costs and conserve capital. The company's services signings reflect its ability to meet client's needs, with total signings in the quarter up 10 percent at constant currency, and longer-term outsourcing signings increasing at 27 percent, adjusted for currency.

The company has taken actions that have shifted the mix of its business, and the business model has become less dependent on hardware, which is more vulnerable to economic conditions. In the first quarter of 2009, effectively all of the company's pre-tax profit was generated by services, software and financing. The annuity nature of these businesses provides a solid base of revenue, profit and cash flow.

The company has been investing to capture the opportunity in the growth markets. The company's constant currency revenue growth in the first quarter (4 percent) in these markets remained about 8 points higher than in the major markets, consistent with full year and fourth-quarter 2008 results.

The company has had an ongoing focus on driving productivity in all parts of its business, including sales operations, supply chain management, services delivery and global support functions. These efforts have reduced the company's fixed cost base, improving the operational balance point.

As a result of these actions, the company has built a more resilient business model, one that generates more profit from each dollar of revenue.

The company's revenue performance was impacted by currency and the economic environment, but the results also reflect its broad business capabilities and the contribution of its annuity businesses. Services revenue was driven by the strong annuity base, though performance was impacted by a slowdown in small faster yielding projects and declines in longer-term signings in 2008. Software revenue growth, when adjusted for currency, was driven by continued demand for mission critical software. Systems and Technology performance reflects the challenges that transaction-based businesses are facing in the current economic environment. Within the segment, the company's UNIX servers performed well. Global Financing revenue, when adjusted for currency, resulted in financing and used equipment sales revenue flat versus the prior year.

The gross profit margin was 43.4 percent, an increase of 1.9 points, primarily due to improvements in Global Technology Services (1.0 point of the increase), Software (0.5 points of the increase) and Global Business Services (0.3 points of the increase), partially offset by a decrease in Systems and Technology (0.3 points of decline).

Total expense and other income decreased 9.5 percent for the first quarter of 2009 versus the first quarter of 2008. Overall, the decrease was driven by approximately 9 points due to the effects of currency, acquisitions drove approximately 3 points of growth and the company's operational expense improved 4 points year over year.

The company's effective tax rate for the first three months of 2009 was 26.5 percent versus 27.5 percent in the first three months of 2008.

Total assets decreased $7,579 million (decreased $5,382 million adjusted for currency) from December 31, 2008, primarily due to lower total receivables ($5,240 million), total deferred taxes ($880 million) and cash and cash equivalents ($447 million). The company had $12,295 million in cash and marketable securities at March 31, 2009.

Total liabilities decreased $7,687 million (decreased $5,915 million adjusted for currency) from December 31, 2008, primarily due to lower total debt ($2,949 million), compensation and benefits ($1,255 million), retirement and nonpension postretirement benefit obligations ($1,176 million), accounts payable ($1,136 million) and taxes payable ($711 million).

Stockholders' equity of $13,693 million increased $108 million from December 31, 2008, primarily due to higher retained earnings ($1,614 million), common stock ($301 million) and retirement-related items ($233 million), partially offset by increased treasury stock ($1,977 million).

The company generated $4,386 million in cash flow provided by operating activities, an increase of $185 million, compared to the first quarter of 2008. Net cash used in investing activities of $48 million was $5,730 million lower than the first quarter of 2008, primarily due to the Cognos acquisition in 2008 and the sale of core logistics operations to Geodis in the first quarter of 2009. Net cash used in financing activities of $4,583 million was $1,787 million higher, primarily due to increased net payments associated with debt ($1,605 million) and lower receipts of cash from other common stock transactions ($723 million), partially offset by lower payments to repurchase common stock ($662 million) in the first quarter of 2009 versus the first quarter of 2008.

Global Services signings were $12,535 million, a decrease of 0.6 percent year to year (increased 10 percent adjusted for currency). The estimated Global Services backlog, as reported, ended at $126 billion, down $4 billion (unchanged adjusted for currency) versus the December 31, 2008 balance.

Quarter in Review



Results of Operations



Segment Details



The following is an analysis of the first-quarter 2009 versus first-quarter 2008
reportable segment external revenue and gross margin results.



                                                                             Yr. to Yr.
                                                                               Percent
                                                                               Change
(Dollars in millions)                                      Yr. to Yr.         Adjusting
For the three months ended                               Percent/Margin          for
March 31:                        2009         2008           Change           Currency
Revenue:
Global Technology Services    $    8,754   $    9,677              (9.5 )%          (0.9 )%
Gross margin                        33.9 %       31.3 %             2.6 pts.
Global Business Services           4,397        4,911             (10.5 )%          (3.5 )%
Gross margin                        26.5 %       25.0 %             1.5 pts.
Software                           4,539        4,847              (6.3 )%           1.6 %
Gross margin                        84.2 %       83.9 %             0.3 pts.
Systems and Technology             3,228        4,219             (23.5 )%         (18.5 )%
Gross margin                        34.0 %       37.0 %           (3.0) pts.
Global Financing                     578          633              (8.5 )%           0.1 %
Gross margin                        45.9 %       50.8 %           (5.0) pts.
Other                                213          216              (0.9 )%           8.6 %
Gross margin                        52.7 %      (19.9 )%           72.6 pts.
Total revenue                 $   21,711   $   24,502             (11.4 )%          (3.8 )%
Gross profit                  $    9,431   $   10,166              (7.2 )%
Gross margin                        43.4 %       41.5 %             1.9 pts.

The following table presents each reportable segment's external revenue as a percentage of total external segment revenue and each reportable segment's pre-tax income as a percentage of total segment pre-tax income.

                                          Revenue       Pre-tax Income*
For the three months ended March 31:   2009    2008     2009       2008
Global Technology Services              40.7 %  39.8 %    33.0 %     29.3 %
Global Business Services                20.5    20.2      15.6       17.2
Total Global Services                   61.2    60.1      48.5       46.5
Software                                21.1    20.0      39.9       37.6
Systems and Technology                  15.0    17.4       0.8        4.3
Global Financing                         2.7     2.6      10.8       11.5
Total                                  100.0 % 100.0 %   100.0 %    100.0 %

Global Services

The Global Services segments, Global Technology Services (GTS) and Global Business Services (GBS), had combined revenue of $13,152 million, a decrease of 9.8 percent (2 percent adjusted for currency) in the first quarter of 2009 compared to the first quarter of 2008. Revenue was driven by the strong annuity base, though performance was impacted by a slowdown in small faster yielding projects and declines in long-term signings in 2008. In the first quarter of 2009, total Global Services signings decreased 1 percent (increased 10 percent adjusted for currency) to $12,535 million. Signings in the longer-term outsourcing businesses were $6,991 million, an increase of 14 percent (27 percent adjusted for currency). Shorter-term signings, which include Consulting and Systems Integration and Integrated Technology Services, were $5,544 million, a decrease of 14 percent (5 percent adjusted for currency). The company signed 16 deals larger than $100 million in the quarter. The estimated Global Services backlog, at actual currency rates was $126 billion at March 31, 2009, a decrease of $4 billion (unchanged adjusted for currency) from the December 31, 2008 level. The Global Services segments leveraged very strong margin performance and delivered combined pre-tax profit of $1,625 million in the first quarter of 2009, an improvement of 3.7 percent. Pre-tax margin increased 1.6 points to 11.8 percent. The Global Services business has continued to execute on cost and expense actions consistent with the transformation of its business model.

                                                             Yr. to Yr.
(Dollars in millions)                                         Percent
For the three months ended March 31:     2009       2008       Change
Global Services Revenue:               $ 13,152   $ 14,588         (9.8 )%
Global Technology Services:            $  8,754   $  9,677         (9.5 )%
Strategic Outsourcing                     4,539      5,011         (9.4 )
Integrated Technology Services            2,035      2,187         (7.0 )
Maintenance                               1,656      1,825         (9.2 )
Business Transformation Outsourcing         524        654        (19.8 )
Global Business Services               $  4,397   $  4,911        (10.5 )%

Global Technology Services revenue decreased 9.5 percent (1 percent adjusted for currency) versus the first quarter of 2008. Total signings in GTS increased 1 percent (13 percent adjusted for currency) led by longer-term outsourcing signings growth of 8 percent (22 percent adjusted for currency). Shorter-term signings decreased 16 percent (7 percent adjusted for currency).

Strategic Outsourcing (SO) revenue was down 9.4 percent (1 percent adjusted for currency) in the first quarter of 2009 versus the same period in 2008. SO signings in the first quarter of 2009 increased 8 percent (23 percent adjusted for currency), led by strength in North America, driven by Canada, and the growth markets. Strategic Outsourcing remains a compelling value proposition to clients as it provides a lower cost base and effective cost variability over the contract period.

Integrated Technology Services (ITS) revenue decreased 7.0 percent (increased 1 percent adjusted for currency) in the first quarter of 2009 versus the first quarter of 2008. ITS signings decreased 16 percent (7 percent adjusted for currency). In the first quarter, efficiency offerings such as Optimization and Managed Services continued to perform well, however, large end-user rollouts with high OEM capital content began to decline. The shift in the portfolio to higher value offerings and away from OEM content, although impacting revenue and signings in the quarter, contributed to better gross profit margin performance.

Business Transformation Outsourcing (BTO) revenue decreased 19.8 percent (9 percent adjusted for currency) year to year, driven primarily by lower client business volumes in North America and Europe. BTO signings increased 9 percent (19 percent adjusted for currency).

Maintenance revenue decreased 9.2 percent (2 percent adjusted for currency) in the first quarter of 2009 compared to the first quarter of 2008. Services provided to Ricoh InfoPrint Solutions in the first quarter of 2008, which in subsequent periods transitioned to Ricoh, drove the majority of the decline.

Global Business Services revenue decreased 10.5 percent (4 percent adjusted for currency) in the first quarter of 2009 compared with the prior year. While revenue in the growth markets accelerated from performance in the second half of 2008, the major markets were impacted by lower longer-term signings in 2008 and a deferral of some contracts. Total signings in GBS decreased 2 percent (increased 6 percent adjusted for currency) in the quarter. Longer-term application outsourcing signings increased 44 percent (49 percent adjusted for currency) with growth in both the major and growth markets. Within

the major markets, clients continue to be primarily motivated by cost savings opportunities, while in the growth markets, demand has been more balanced between cost savings and infrastructure build-out initiatives. Within the shorter-term category of Consulting and Systems Integration, signings decreased 13 percent (4 percent adjusted for currency) in the quarter, with declines in the smaller contracts that impact near-term revenue yield. Within total GBS signings, from a sector perspective, declines in Industrial and General Business were partially offset by growth in the Public and Communications sectors. Cost savings and efficiency offerings continue to drive the majority of the demand in GBS.

                                                           Yr. To Yr.
                                                            Percent/
(Dollars in millions)                                        Margin
For the three months ended March 31:    2009      2008       Change
Global Technology Services:
Gross profit                           $ 2,968   $ 3,032         (2.1 )%
Gross profit margin                       33.9 %    31.3 %        2.6 pts.
Global Business Services:
Gross profit                           $ 1,166   $ 1,228         (5.1 )%
Gross profit margin                       26.5 %    25.0 %        1.5 pts.

GTS gross profit decreased 2.1 percent compared to the first quarter of 2008, with gross profit margin improving 2.6 points. All lines of business delivered gross margin expansion in the quarter. Segment pre-tax profit increased 11.7 percent to $1,104 million with a pre-tax margin of 12.1 percent, an increase of 2.3 points versus the first quarter of 2008. This was the seventh consecutive quarter of double-digit pre-tax profit growth. These margin improvements were driven by a combination of greater mix to higher value offerings, particularly in Integrated Technology Services where the key plays are becoming a larger portion of the portfolio, and cost and expense management driven by initiatives in standardization, global integration and improved efficiency. The actions taken to improve efficiency provides the flexibility and capability needed to quickly address rapidly changing environments and positions GTS well for when the global economies start to improve.

GBS gross profit decreased 5.1 percent to $1,166 million while the gross profit margin improved 1.5 points to 26.5 percent. Segment pre-tax profit decreased 10.0 percent to $521 million with a pre-tax margin of 11.3 percent, an improvement of 0.1 points year over year. Within its services segments, the company expects to see the benefit from recent workforce rebalancing actions over the remainder of the year and has the management and delivery structure in place to continue to expand margins.

Global Services Signings



                                                                           Yr. to Yr.
                                                                             Percent
                                                            Yr. to Yr.       Change
(Dollars in millions)                                        Percent      Adjusting for
For the three months ended March 31:     2009      2008       Change        Currency
Global Technology Services Signings:
SO & BTO (Longer-term)                  $ 5,574   $ 5,162          8.0 %           22.2 %
ITS (Shorter-term)                        1,947     2,318        (16.0 )           (7.0 )
Total                                   $ 7,521   $ 7,480          0.5 %           13.2 %
Global Business Services Signings:
Application Outsourcing (Longer-term)   $ 1,416   $   984         44.0 %           49.5 %
C&SI (Shorter-term)                       3,597     4,147        (13.3 )           (4.2 )
Total                                   $ 5,014   $ 5,131         (2.3 )%           6.1 %

Global Services signings are management's initial estimate of the value of a client's commitment under a Global Services contract. Signings are used by management to assess period performance of Global Services management. There are no third-party standards or requirements governing the calculation of signings. The calculation used by management involves estimates and judgments to gauge the extent of a client's commitment, including the type and duration of the agreement, and the presence of termination charges or wind-down costs. For example, for long-term contracts that require significant up-front investment by the company, the portions of these contracts that are a signing are those periods in which there is a significant economic impact on the client if the commitment is not achieved, usually through a termination charge or the client incurring significant wind-down costs as a result of the termination. For short-term contracts that do not require

significant upfront investments, a signing is usually equal to the full contract value. Longer-term contracts represent SO and BTO outsourcing contracts as well as GBS contracts with the U.S. Federal government and its agencies and Application Management Services (AMS) for custom and legacy applications. Shorter-term contracts represent the remaining GBS offerings of Consulting and Systems Integration (C&SI), AMS for packaged applications and ITS contracts.

Signings include SO, BTO, ITS and GBS contracts. Contract extensions and increases in scope are treated as signings only to the extent of the incremental new value. Maintenance is not included in signings as maintenance contracts tend to be more steady state, where revenues equal renewals.

Backlog includes SO, BTO, ITS, GBS and Maintenance. Backlog is intended to be a statement of overall work under contract and therefore does include Maintenance. Backlog estimates are subject to change and are affected by several factors, including terminations, changes in the scope of contracts, periodic revalidations, adjustments for revenue not materialized and currency assumptions used to approximate constant currency.

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

Software



                                                           Yr. to Yr.
(Dollars in millions)                                       Percent
For the three months ended March 31:    2009      2008       Change
Software Revenue:                      $ 4,539   $ 4,847         (6.3 )%
Middleware:                            $ 3,577   $ 3,751         (4.6 )%
Key Branded Middleware:                  2,484     2,586         (3.9 )
WebSphere Family                                                  4.9
Information Management                                           (7.6 )
Lotus                                                           (11.6 )
Tivoli                                                           (1.3 )
Rational                                                          9.2
Other middleware                         1,093     1,164         (6.2 )
Operating systems                          492       529         (7.1 )
Product Lifecycle Management               169       248        (32.1 )
Other                                      302       318         (5.2 )

Software segment revenue of $4,539 million decreased 6.3 percent (increased 2 percent adjusted for currency) in the first quarter of 2009 compared to the first quarter of 2008. In a tough economic environment, customers continued to purchase mission critical software to run their businesses. In addition, demand was strong for software that delivers clients a fast return on their investment, while acquisition of software for transformational projects slowed, and any non-essential purchases were heavily scrutinized.

Key Branded Middleware revenue decreased 3.9 percent (increased 5 percent adjusted for currency) and represented 55 percent of total Software segment revenue, an increase of 1 point compared to first-quarter 2008. Adjusted for currency, growth was led by WebSphere, Rational and Tivoli.

WebSphere Family revenue increased 4.9 percent (14 percent adjusted for currency) in the first quarter of 2009. Application Servers, which allow customers to build, run and integrate their mission-critical business applications, was up 10 percent, adjusted for currency, in the quarter. ILOG, which was acquired in December 2008, performed well in the quarter and contributed to the double-digit revenue growth in WebSphere Business Integration software.

Information Management revenue decreased 7.6 percent (increased 1 percent adjusted for currency) in the first quarter of 2009 compared to the first quarter of 2008. Distributed Relational Database software continued to perform well and had double-digit revenue growth, adjusted for currency, in the quarter.

Lotus revenue decreased 11.6 percent (3 percent adjusted for currency) in the first quarter of 2009 driven by customer consolidation.

Tivoli revenue decreased 1.3 percent (increased 8 percent adjusted for currency) in the quarter. Adjusting for currency, there was strong growth in all product lines: security, systems management and storage software. Customers continue to utilize Tivoli software to improve control and automation in their infrastructure to drive lower cost and improved efficiency. Storage management software grew 13 percent, adjusted for currency, as customers optimized their storage infrastructure.

Rational revenue increased 9.2 percent (19 percent adjusted for currency) in the first quarter of 2009, driven by strength in performance and security testing offerings.

Revenue from Other middleware and Operating systems products decreased 6.2 percent (increased 2 percent adjusted for currency) and 7.1 percent (flat adjusted for currency), respectively, in the first quarter of 2009 compared to the first quarter of 2008.

Other software segment revenue decreased 5.2 percent (increased 3 percent adjusted for currency) in the first quarter of 2009 reflecting continued growth, adjusted for currency, in software-related services.

. . .