Our view: IBM reported Sep-qtr results that were ahead of Street on EPS but below on revenues.

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1 EQUITY RESEARCH October 19, 2015 IBM Absence of Software Turn and GBS Weakness Dampen Outlook Our view: IBM reported Sep-qtr results that were ahead of Street on EPS but below on revenues. Key points: ALL YOU NEED TO KNOW: IBM reported Sep-qtr results from continuing operations that were above expectations on EPS but below the Street on revenues: $19.3B/$3.34 (vs. Street at $19.6B/$3.31). More importantly, IBM lowered its CY15 EPS guide to $ (from $ ) and lowered its FCF expectation to be flat y/y (vs. prior expectation for a modest increase). While strategic imperatives growth of +27% was a positive, we note that the software trajectory failed to improve and that the GBS transition to higher value is taking longer than originally anticipated. Within hardware, System-Z and Power continue to report growth while storage declined -14% y/y due to soft disk-based storage revenue. Based on the current trajectory of software, the slower than expected GBS transition, and Hardware nearing the tail end of the System- Z cycle, we estimate another y/y revenue decline for Maintaining Sector Perform and lowering price target to $150 from $155. Sep-15A Review: Revenue of $19.3B was below expectations (Street at $19.6B, IBM saw sales -13.9% y/y; -1% excluding FX and divestitures) while operating EPS of $3.34 was ahead of Street estimates of $3.31. From a margin perspective, the company generated 50.0% gross margin and 19.6% operating margin, which were slightly above our expectations. On a segment basis, Services revenues of $12.1B was down -11% y/y (GTS up +1% at constant currency ex-divestitures), while GBS was down 5%; S&T revenues of $1.5B were down -39% y/y (-2% at CC and adjusting for divestitures), and Software was down -10.0% y/y (-3% CC). On a geographic basis in constant currency: Americas was down -3%, EMEA was up +1%, and APAC was down -1%. Notably, BRIC was down -7% (Continued China, Russia, Brazil softness). Adjusting Estimates: Our Dec-qtr estimates now stand at $22.3B/$4.85 and our CY15 revenue estimate is lowered to $82.0B. We are are also lowering CY15 EPS to $14.94 to reflect the lower end of the new guidance range ($ ). Finally, our CY16 estimates now stand at $80.3B/ $ IBM also lowered its FCF guidance from up slightly y/y to flat y/y. RBC Capital Markets, LLC Amit Daryanani, CFA (Analyst) (415) amit.daryanani@rbccm.com Mitch Steves (Analyst) (415) mitch.steves@rbccm.com Sector: IT Hardware Sector Perform NYSE: IBM; USD Irvin Liu (Associate) (415) irvin.liu@rbccm.com Jeriel Ong (Associate) (415) jeriel.ong@rbccm.com Price Target USD WHAT'S INSIDE Rating/Risk Change Price Target Change In-Depth Report Est. Change Preview News Analysis Scenario Analysis* Downside Scenario % Current Price *Implied Total Returns Key Statistics Shares O/S (MM): Dividend: 5.20 Price Target % Upside Scenario % Market Cap (MM): 147,787 Yield: 3.5% Avg. Daily Volume: 3,751,420 RBC Estimates FY Dec 2014A 2015E 2016E 2017E Revenue Prev EPS, Ops Diluted Prev P/E 9.0x 10.0x 9.8x 9.5x Revenue Q1 Q2 Q3 Q A 24.0A 22.4A 24.1A A 20.8A 19.3A 22.3E Prev. 19.8E 23.0E E 20.1E 19.1E 22.3E Prev. 19.4E 20.8E 19.9E 23.2E EPS, Ops Diluted A 4.43A 3.68A 5.81A A 3.84A 3.34A 4.85E Prev. 3.25E 5.76E E 3.82E 3.36E 5.08E Prev. 3.05E 3.79E 3.66E 5.73E EPS, Ops Diluted: EPS historical results and estimates adjusted for acquisition and retirement-related items. Full year EPS may not sum to quarters given expectation for share buybacks throughout year. All values in USD unless otherwise noted. B/S and Cash Flow: Cash cycle days declined slightly on a y/y basis to 86 days due to shorter A/P days (52 days) and better inventory turnover offset by higher A/R days (122 days). The company generated $2.6 billion in free cash flow during the quarter, of which it returned $2.8 billion to shareholders via $1.3B in dividends and $1.5B in gross share repurchases. Priced as of prior trading day's market close, EST (unless otherwise noted). For Required Conflicts Disclosures, see Page 11.

2 Target/Upside/Downside Scenarios Exhibit 1: 125 Weeks 28MAY13-19OCT UPSIDE m 60m 40m 20m 2013 M J J A S O N 2014 D J F M A M J J A S O N 2015 D J F M A M J J A S IBM Rel. S&P 500 COMPOSITE MA 40 weeks O TARGET CURRENT Source: Bloomberg and RBC Capital Markets estimates for Upside/Downside/Target DOWNSIDE Oct 2016 Target price/base case Even though we expect enterprise IT spending to grow 3% in 2015, we expect IBM's revenue to decline in the high single digits due to the continued shift to cloud-enabled products and services, which are not yet a strong suit for IBM. Given IBM s healthy services backlog, large annuity revenue streams (60%+ of profitability), enterprise productivity initiatives, and strong free cash flow generation capabilities allocated toward share buybacks, we believe IBM should generate a low-singledigit non-gaap EPS decline in Based on a ~10x FTM P/E multiple, we believe the stock should be valued at $150. Upside scenario In our upside scenario, we assume that revenue growth is flat in 2015, as IBM generates volume momentum across its growth initiatives (i.e., Growth Markets, Smarter Planet, Business Analytics, and Cloud). We also see IBM returning excess cash to shareholders and executing on its enterprise productivity initiatives. Assuming a ~13x FTM P/E multiple, we believe the stock could work toward $190. Investment summary In our view, IBM represents the best mix of technology businesses in the enterprise segment. However, top-line growth should remain limited near term, which could result in the firm focusing exclusively on share buybacks and margin mix to boost non-gaap EPS growth. Overall, we think investors should remain on the sidelines until better signs of positive revenue growth emerge. Leading technology business mix: With ~80% of its business in services and software, IBM has cultivated the preeminent technology portfolio. We estimate that approximately half of IBM s revenue comes from annuitylike businesses, such as services contracts and software licenses. The software and services businesses are highreturn, generating gross margins of ~80% and ~30%, respectively. The hardware business is dominated by IBM s server franchise in mainframes and UNIX. A solid defensive investment: We believe that prospects for an improving economy and enterprise IT sector suggest investors seek outperformance in hardware-centric opportunities in the near term. The need for a conservative investment, such as IBM, works best during periods of market dislocation. IBM outperformed the tech-heavy NASDAQ in both the tech downturn in 2001 and the financial crisis of IBM's success attracting competition: IBM's successful model is attracting competition from the likes of Hewlett- Packard, Cisco, EMC, Dell, and Oracle. A strong brand and competitive portfolio should help IBM to maintain a leading competitive position, but we believe it is unwise to discount increasing long-term competition. Downside scenario We could see revenue and non-gaap EPS declining in the low double digits as the macroeconomic environment negatively impacts enterprise IT spending on services, software, and server/storage demand. We would envision a more competitive landscape as lower utilization among competitors gives way to aggressively priced hardware and service contracts. Given the less-attractive growth profile, we believe the stock would receive a lower valuation multiple. Using a FTM P/E multiple of ~8x, we believe the stock could trade down to $120. October 19, 2015 Amit Daryanani, CFA (415) ; amit.daryanani@rbccm.com 2

3 IBM Earnings Overview Sep-15A Review: Revenue of $19.3B was below expectations (Street at $19.6B, IBM saw sales -13.9% y/y; -1% excluding FX and divestitures) while operating EPS of $3.34 was ahead of Street estimates of $3.31. From a margin perspective, the company generated 50.0% gross margin and 19.6% operating margin, which were slightly above our expectations. On a segment basis, Services revenues of $12.1B was down -11% y/y (GTS up +1% at constant currency ex-divestitures) while GBS was down 5%; S&T revenues of $1.5B were down -39% y/y (-2% at CC and adjusting for divestitures), and Software was down -10.0% y/y (-3% CC). On a geographic basis in constant currency, Americas was down -3%, EMEA was up +1%, and APAC was down -1%. Notably, BRIC was down -7% (Continued China, Russia, Brazil softness). Exhibit 2: IBM Earnings Analysis ($ in millions, except for percentages and per share data) Quarterly Comparison Sept-15A Sept-14A Jun-15A RBC Est. Y/Y Q/Q vs. Est. Comments Total Revenue $19,278 $22,397 $20,814 $19, % (7.4%) (2.7%) Below our expectations and Street COGS 9,635 11,374 10,224 9, % (5.8%) (3.2%) % Of Sales 50.0% 50.8% 49.1% 50.3% Gross Profit $9,643 $11,023 $10,590 $9, % -8.9% -2.1% Gross Margin % 50.0% 49.2% 50.9% 49.7% +80 bps (90 bps) +30 bps Slightly above our estimate SG&A 4,581 5,137 5,042 4, % -9.1% -6.1% Below our estimate % Of Sales 23.8% 22.9% 24.2% 24.6% + 80 bps (50 bps) (90 bps) R&D 1,275 1,374 1,289 1, % -1.1% 2.0% % Of Sales 6.6% 6.1% 6.2% 6.3% + 50 bps + 40 bps + 30 bps Operating Income $3,787 $4,512 $4,259 $3, % -11.1% 1.8% Operating Margin % 19.6% 20.1% 20.5% 18.8% (50 bps) (80 bps) +90 bps IP&CD (Income)/Expense (188) (145) (128) (150) 29.7% 46.9% 25.3% Interest (Income)/Expense % 1.7% 56.0% Misc. (Inc.)/Loss (133) (103) (306) (180) 29.1% NM (26.1%) Pretax Income 3,991 4,634 4,578 3, % (12.8%) 0.4% Pre-Tax Margin % 20.7% 20.7% 22.0% 20.1% + 0 bps (130 bps) + 60 bps Provision for Taxes Tax Rate % 18.0% 20.8% 17.2% 20.0% (280 bps) + 80 bps (200 bps) Below ~20% guidance Non-GAAP Net Income 3,273 3,671 3,790 3, % (13.6%) 2.9% Non-GAAP Net Income Margin % 17.0% 16.4% 18.2% 16.1% + 60 bps (120 bps) + 90 bps Shares - Diluted % -0.7% 0.1% Non-GAAP Diluted EPS $3.34 $3.61 $3.84 $ % -13.0% 2.9% Modest beat relative to street but aided by 8c from tax rate Source: RBC Capital Markets and Company reports October 19, 2015 Amit Daryanani, CFA (415) ; amit.daryanani@rbccm.com 3

4 Dec-Qtr and Guidance Guidance: For Dec-qtr, our estimates move to $22.3B/$4.85 to reflect continued weakness in software and GBS. For FY15, the company lowered its operating EPS target from $ to $ to reflect incremental weakness in GBS and indicated that the low end of EPS guidance assumes no improvement in the current software trajectory. Our model takes a more conservative stance and assumes the software business does not improve; our estimates are therefore at the lower end of EPS guidance ($82.0B/$14.94). Separately, management indicated that free cash flow for 2015 will be flattish y/y, down from up slightly. Revenue and Mix From a long-term perspective, the company intends to: 1) continue with strategic imperative growth; 2) expand margins by shifting to higher-value products; 3) generate low-single-digit revenue growth; 4) continue using capital allocation to support shareholder returns; and 5) achieve mid- to high-single-digit EPS growth. Revenue: Revenue of $19.3B (-13.9% y/y and -7.4% q/q) was slightly below consensus expectations of $19.6B. GTS generated $7.9B (-14% y/y), GBS $4.2B (-6% y/y), Software $5.1B (-10% y/y), and Systems & Technology $1.5B (-39% y/y). Exhibit 3: IBM Revenue ($M) $30,000 $25,000 $20,000 $15,000 $10,000 $5,000 $0 Mar-14A Jun-14A Sept-14A Dec-14A Mar-15A Jun-15A Sept-15A Dec-15E Mar-16E Jun-16E Sept-16E Dec-16E 2% 0% -2% -4% -6% -8% -10% -12% -14% -16% Total Revenue Y/Y Change Source: RBC Capital Markets estimates and Company reports October 19, 2015 Amit Daryanani, CFA (415) ; amit.daryanani@rbccm.com 4

5 Exhibit 4: IBM Revenue Mix by Segment and Geography By Segment 7.7% 2.3% 0.0% By Geography 21.2% 41.2% 26.6% 47.2% 31.6% 21.8% Global Technology Services Software Global Financing Global Business Services Systems & Technology Other Americas Europe/Middle East/Africa Asia Pacific Source: RBC Capital Markets and Company reports Performance by Segment IBM Services: (63% of sales; 44% of PTI) Total services revenue came in at $12.1B, down -11% y/y, while total backlog came in at $118B. Excluding FX impact and divestitures, Global Technology Services revenue of $7.9B was up +1% y/y while GTS outsourcing revenue was flat y/y, integrated technology services was up +4% y/y, and maintenance revenue was up +1% y/y. Global Business Services revenues of $4.2B was down -5% y/y, with GBS Outsourcing growing +1% y/y while Consulting and Systems Integration was down -7% y/y. Global Technology Services pre-tax margins of 15.7% fell -220 bps on a y/y basis. Global Business Services pre-tax margins of 15.6% also fell -170 bps on a y/y basis. Total signings of $9.3B were down -7% y/y, with Outsourcing signings of $3.9B declining -15% year-over-year while Transactional signings of $5.4B were down -1% year-over-year. October 19, 2015 Amit Daryanani, CFA (415) ; amit.daryanani@rbccm.com 5

6 Exhibit 5: IBM Services: GTS ($ in millions) GTS Detail Global Technology Services (GTS) GTS Outsourcing 0% Integrated Technology Services 4% Maintenance 1% Total GTS 1% Commentary Y/Y growth driven by 27% growth in strategic imperatives GTS Revenue & Pretax Margin Y/Y% ex. FX, Divestitures $11,000.0 $10,000.0 $9,000.0 $8,000.0 $7, % 20% 18% 16% 14% 12% 10% 8% Total Revenue Pretax Margin Source: RBC Capital Markets and Company reports Exhibit 6: IBM Services: GBS ($ in millions) GBS Detail Global Business Services (GBS) GBS Outsourcing 1% Consulting & Systems Integration (7%) Total GBS (5%) Commentary Transitioning to strategic imperatives; ERP weakness continues GBS Revenue & Pretax Margin Y/Y% ex. FX, Divestitures $5,000.0 $4,750.0 $4,500.0 $4, % 20% 18% 16% 14% 12% 10% $4, % Revenue Pretax Margin Source: RBC Capital Markets and Company reports Exhibit 7: IBM Systems & Technology ($ in millions) IBM Systems and Technology (8% of sales) Systems and Technology revenue of $1.5B was down -2% y/y (adjusting for FX and divestitures). System-Z and Power growth continued in the Sep-qtr; however, soft sales in disk-based storage contributed to weakness within Storage. Notably, pre-tax income was negative for Hardware. S&T Detail S&T Revenue & Pretax Margin System Y/Y% ex. FX, Divestitures $6,250.0 System z 20% $5,500.0 Power Systems 2% $4,750.0 $4,000.0 Storage (14%) 20% 10% 0% Total Systems & Technology (2%) Commentary System Z & Power remain positve offset by weak disk-based storage $3,250.0 $2,500.0 $1,750.0 $1,000.0 (10%) (20%) (30%) Revenue Pretax Margin Source: RBC Capital Markets and Company reports October 19, 2015 Amit Daryanani, CFA (415) ; amit.daryanani@rbccm.com 6

7 IBM Software (27% of sales; 43% of PTI) Software revenues of $5.1B were down -3% y/y (at CC). Segment revenue continues to shift toward faster-growing and higher-value branded middleware, which now account for ~70% of total software revenue. Looking at the segments, we note that Websphere (+1% y/y) and Information Management (+1 y/y) were the strongest performers during the quarter while Operating Systems (-7%) were weak. Pre-tax margins of 32.1% were solid as IBM continues to transition to a SaaS model and will accelerate investments to enhance its current software position. Exhibit 8: IBM Software ($ in millions) Software Detail Software Revenue & Pretax Margin $8,500.0 Middleware Y/Y% ex. FX, Divestitures $8,000.0 WebSphere Family 1% $7,500.0 Information Management 1% $7,000.0 Tivoli (2%) $6,500.0 Social Workforce Solutions (3%) $6,000.0 Rational (11%) $5,500.0 Key Branded Middleware (1%) $5,000.0 Total Software (3%) 49% 46% 43% 40% 37% 34% 31% 28% Commentary Growth trajectory did not improve from Mar/Jun-qtr levels Source: RBC Capital Markets and Company reports Revenue Pretax Margin October 19, 2015 Amit Daryanani, CFA (415) ; amit.daryanani@rbccm.com 7

8 Balance Sheet and Cash Flow Cash cycle days declined slightly on a y/y basis to 86 days due to shorter A/P days (52 days) and better inventory turnover offset by higher A/R days (122 days). The company generated $2.6 billion in free cash flow during the quarter, of which it returned $2.8 billion to shareholders via $1.3B in dividends and $1.5B in gross share repurchases. Exhibit 9: Key Balance Sheet and Cash Flow Metrics ($ in millions) Working Capital & Cash Metrics Sept-15A Sept-14A Jun-15A Inv T/O (2Q Avg Inv) Remains stable in high teens low 20s range A/R Days (2Q Avg A/R) A/P Days (2Q Avg A/P) Continues to report in the low 50s Cash Cycle Days Comments Free Cash Flow Excluding GF Receivables 2, , ,369.0 FCF should remain flat in FY15E compared to FY14 Source: Company reports and RBC Capital Markets estimates October 19, 2015 Amit Daryanani, CFA (415) ; amit.daryanani@rbccm.com 8

9 Valuation Our price target of $150 is based on a FTM P/E multiple of ~10x. Examining multiples over the last cycle, we believe IBM should trade at the low end of the 10 14x FTM P/E range due to the ongoing challenges of revenue, non-gaap EPS, and FCF. Price target impediments Company description 1. Tech spending downturn: The biggest challenge to IBM would be a contraction in enterprise IT spending. We think the chances of this occurring are becoming less likely. We believe a rebound in core enterprise IT spending should help IBM re-accelerate in key verticals. Our overall expectation is +3% enterprise IT spending growth in 2015, with strong growth in hardware and software. 2. Increasing competition: We believe the competitive challenges are emerging from companies seeking to build a business model similar to IBM's, notably Hewlett-Packard, Cisco, Oracle, EMC, and Dell. Of these competitors, we believe Hewlett-Packard is the closest, with its EDS, 3Com, and 3PAR acquisitions. We also would not be surprised to see Cisco become the next major OEM to move toward this model given the push into the x86 server market (UCS). Beyond Hewlett-Packard and Cisco, there are also others attempting to recreate the IBM model. Oracle's purchase of Sun Microsystems is transforming the software vendor into a systems player. Dell's acquisition of Perot Systems and Xerox's acquisition of ACS were also likely done in that vein. As an increasing number of competitors move toward the model of integrating services, hardware, and software, we believe the competitive advantage IBM has long enjoyed from a broad product portfolio and services could erode. International Business Machines (IBM) is one of the world's largest enterprise IT companies. Main offerings include IT services, enterprise software, servers, and storage. The company is based in Armonk, New York. October 19, 2015 Amit Daryanani, CFA (415) ; amit.daryanani@rbccm.com 9

10 Amit Daryanani, CFA (415) ; Two Embarcadero Center, Suite 2350, San Francisco, CA International Business Machines (NYSE: IBM), FY End December Income Statement ($M) Mar-15A Jun-15A Sept-15A Dec-15E Mar-16E Jun-16E Sept-16E Dec-16E Mar-17E Jun-17E Sept-17E Dec-17E CY15E CY16E CY17E Total Revenue $19,590 $20,814 $19,278 $22,279 $18,845 $20,106 $19,106 $22,325 $18,793 $20,015 $19,226 $22,324 $81,961 $80,382 $80,358 Q/Q Change -11.9% 6.2% -7.4% 15.6% -15.4% 6.7% -5.0% 16.8% -15.8% 6.5% -3.9% 16.1% NA NA NA Y/Y Change -11.9% -13.4% -13.9% -7.6% -3.8% -3.4% -0.9% 0.2% -0.3% -0.5% 0.6% 0.0% -11.7% -1.9% 0.0% COGS 9,926 10,224 9,635 10,539 9,426 9,801 9,581 10,406 9,475 9,810 9,602 10,326 40,324 39,214 39,212 % Of Sales 50.7% 49.1% 50.0% 47.3% 50.0% 48.7% 50.1% 46.6% 50.4% 49.0% 49.9% 46.3% 49.2% 48.8% 48.8% Gross Profit (Non-GAAP after 2008) $9,664 $10,590 $9,643 $11,740 $9,419 $10,306 $9,525 $11,919 $9,318 $10,205 $9,624 $11,999 $41,637 $41,169 $41,146 Gross Margin % 49.3% 50.9% 50.0% 52.7% 50.0% 51.3% 49.9% 53.4% 49.6% 51.0% 50.1% 53.7% 50.8% 51.2% 51.2% q/q Change -9.6% 9.6% -8.9% 21.8% -19.8% 9.4% -7.6% 25.1% -21.8% 9.5% -5.7% 24.7% NA NA NA Y/Y Change -9.6% -12.0% -12.5% -9.7% -2.5% -2.7% -1.2% 1.5% -1.1% -1.0% 1.0% 0.7% -10.9% -1.1% -0.1% Incr. Margin 38.8% 44.5% 44.2% 68.5% 32.9% 40.2% 68.7% 390.9% 195.8% 110.4% 82.9% % 47.1% 29.7% 94.7% QTQ Incr. Margin 38.8% 75.7% 61.7% 69.9% 67.6% 70.3% 78.0% 74.4% 73.6% 72.6% 73.6% 76.6% NA NA NA Selling Expense (Non-GAAP after 2008) 4,975 5,042 4,581 5,060 4,800 4,700 4,500 5,050 4,775 4,825 4,475 4,875 19,658 19,050 18,950 % Of Sales 25.4% 24.2% 23.8% 22.7% 25.5% 23.4% 23.6% 22.6% 25.4% 24.1% 23.3% 21.8% 24.0% 23.7% 23.6% Research and Development (Non-GAAP after 2008) 1,285 1,289 1,275 1,220 1,275 1,200 1,260 1,300 1,250 1,200 1,245 1,275 5,069 5,035 4,970 % Of Sales 6.6% 6.2% 6.6% 5.5% 6.8% 6.0% 6.6% 5.8% 6.7% 6.0% 6.5% 5.7% 6.2% 6.3% 6.2% Operating Income $3,404 $4,259 $3,787 $5,460 $3,344 $4,406 $3,765 $5,569 $3,293 $4,180 $3,904 $5,849 $16,910 $17,084 $17,226 Operating Margin % 17.4% 20.5% 19.6% 24.5% 17.7% 21.9% 19.7% 24.9% 17.5% 20.9% 20.3% 26.2% 20.6% 21.3% 21.4% q/q Change 3.8% 25.1% -11.1% 44.2% -38.8% 31.7% -14.5% 47.9% -40.9% 26.9% -6.6% 49.8% NA NA NA Y/Y Change 3.8% -20.3% -16.1% -6.0% -1.8% 3.4% -0.6% 2.0% -1.5% -5.1% 3.7% 5.0% -10.8% 1.0% 0.8% Incr. Margin -4.7% 33.7% 23.2% 19.1% 8.1% -20.7% 12.8% 237.8% 98.6% 247.1% 116.4% % 18.8% -11.0% % QTQ Incr. Margin -4.7% 69.9% 30.7% 55.8% 61.6% 84.1% 64.1% 56.0% 64.4% 72.6% 34.9% 62.8% NA NA NA IP&CD (Income)/Expense (173) (128) (188) (190) (150) (150) (200) (190) (150) (150) (175) (190) (679) (690) (665) Interest (Income)/Expense Misc. (Inc.)/Loss (143) (306) (133) (325) (130) (130) (130) (325) (105) (105) (110) (325) (907) (715) (645) Pretax Income $3,612 $4,578 $3,991 $5,855 $3,509 $4,571 $3,980 $5,969 $3,433 $4,320 $4,074 $6,249 $18,036 $18,029 $18,076 Pre-Tax Margin % 18.4% 22.0% 20.7% 26.3% 18.6% 22.7% 20.8% 26.7% 18.3% 21.6% 21.2% 28.0% 22.0% 22.4% 22.5% Prov. For Tax , , ,250 3,370 3,606 3,615 Tax Rate 20% 17% 18% 20% 20% 20% 20% 20% 20% 20% 20% 20% 19% 20% 20% Non-GAAP Net Income $2,890 $3,790 $3,273 $4,714 $2,807 $3,656 $3,184 $4,775 $2,747 $3,456 $3,259 $4,999 $14,667 $14,423 $14,460 Non-GAAP Net Income % 14.8% 18.2% 17.0% 21.2% 14.9% 18.2% 16.7% 21.4% 14.6% 17.3% 17.0% 22.4% 17.9% 17.9% 18.0% Adjustments to Net Income Shares - Basic Shares - Diluted Non-GAAP Diluted EPS $2.91 $3.84 $3.34 $4.85 $2.91 $3.82 $3.36 $5.08 $2.95 $3.74 $3.56 $5.50 $14.94 $15.15 $15.72 Dividends Per Share $1.10 $1.30 $1.30 $1.30 $1.30 $1.30 $1.30 $1.30 $1.30 $1.30 $1.30 $1.30 $5.00 $5.20 $5.20 Source: Company Reports and RBC Capital Markets Estimates. October 19, 2015 Amit Daryanani, CFA (415) ; amit.daryanani@rbccm.com 10

11 Required disclosures Conflicts disclosures The analyst(s) responsible for preparing this research report received compensation that is based upon various factors, including total revenues of the member companies of RBC Capital Markets and its affiliates, a portion of which are or have been generated by investment banking activities of the member companies of RBC Capital Markets and its affiliates. Please note that current conflicts disclosures may differ from those as of the publication date on, and as set forth in, this report. To access current conflicts disclosures, clients should refer to DisclosureLookup.aspx?entityId=1 or send a request to RBC CM Research Publishing, P.O. Box 50, 200 Bay Street, Royal Bank Plaza, 29th Floor, South Tower, Toronto, Ontario M5J 2W7. A member company of RBC Capital Markets or one of its affiliates received compensation for investment banking services from in the past 12 months. RBC Capital Markets, LLC makes a market in the securities of. RBC Capital Markets is currently providing with non-securities services. RBC Capital Markets has provided with investment banking services in the past 12 months. Bridget van Kralingen, a member of the Board of Directors of Royal Bank of Canada, is Senior Vice-President of International Business Machines Corporation. RBC Capital Markets LLC is advising IBM (NYSE: IBM) in connection with the acquisition of Merge Healthcare Incorporated (NASDAQ: MRGE) as announced on August 6, The transaction is subject to customary closing conditions. This research report and the information herein is not intended to provide voting advice, serve as an endorsement of the announced transaction or result in procurement, withholding or revocation of a potential proxy or any other action by a security holder. Explanation of RBC Capital Markets Equity rating system An analyst's 'sector' is the universe of companies for which the analyst provides research coverage. Accordingly, the rating assigned to a particular stock represents solely the analyst's view of how that stock will perform over the next 12 months relative to the analyst's sector average. Although RBC Capital Markets' ratings of Top Pick (TP)/Outperform (O), Sector Perform (SP), and Underperform (U) most closely correspond to Buy, Hold/Neutral and Sell, respectively, the meanings are not the same because our ratings are determined on a relative basis. Ratings Top Pick (TP): Represents analyst's best idea in the sector; expected to provide significant absolute total return over 12 months with a favorable risk-reward ratio. Outperform (O): Expected to materially outperform sector average over 12 months. Sector Perform (SP): Returns expected to be in line with sector average over 12 months. Underperform (U): Returns expected to be materially below sector average over 12 months. Risk Rating As of March 31, 2013, RBC Capital Markets suspends its Average and Above Average risk ratings. The Speculative risk rating reflects a security's lower level of financial or operating predictability, illiquid share trading volumes, high balance sheet leverage, or limited operating history that result in a higher expectation of financial and/or stock price volatility. October 19, 2015 Amit Daryanani, CFA (415) ; amit.daryanani@rbccm.com 11

12 Distribution of ratings For the purpose of ratings distributions, regulatory rules require member firms to assign ratings to one of three rating categories - Buy, Hold/Neutral, or Sell - regardless of a firm's own rating categories. Although RBC Capital Markets' ratings of Top Pick(TP)/ Outperform (O), Sector Perform (SP), and Underperform (U) most closely correspond to Buy, Hold/Neutral and Sell, respectively, the meanings are not the same because our ratings are determined on a relative basis (as described below). Distribution of ratings RBC Capital Markets, Equity Research As of 30-Sep-2015 Investment Banking Serv./Past 12 Mos. Rating Count Percent Count Percent BUY [Top Pick & Outperform] HOLD [Sector Perform] SELL [Underperform] References to a Recommended List in the recommendation history chart may include one or more recommended lists or model portfolios maintained by RBC Wealth Management or one of its affiliates. RBC Wealth Management recommended lists include the Guided Portfolio: Prime Income (RL 6), the Guided Portfolio: Large Cap (RL 7), the Guided Portfolio: Dividend Growth (RL 8), the Guided Portfolio: Midcap 111 (RL 9), the Guided Portfolio: ADR (RL 10), and the Guided Portfolio: Global Equity (U.S.) (RL 11). RBC Capital Markets recommended lists include the Strategy Focus List and the Fundamental Equity Weightings (FEW) portfolios. The abbreviation 'RL On' means the date a security was placed on a Recommended List. The abbreviation 'RL Off' means the date a security was removed from a Recommended List. Equity valuation and risks For valuation methods used to determine, and risks that may impede achievement of, price targets for covered companies, please see the most recent company-specific research report at or send a request to RBC Capital Markets Research Publishing, P.O. Box 50, 200 Bay Street, Royal Bank Plaza, 29th Floor, South Tower, Toronto, Ontario M5J 2W7. Conflicts policy RBC Capital Markets Policy for Managing Conflicts of Interest in Relation to Investment Research is available from us on request. To access our current policy, clients should refer to October 19, 2015 Amit Daryanani, CFA (415) ; amit.daryanani@rbccm.com 12

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