10-Q 1 a09-16493_110q.htm 10-Q

Table of Contents

 

 

 

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, 2009

 

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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes  x    No  o

 

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

 

Large accelerated filer x

 

Accelerated filer o

 

 

 

Non-accelerated filer o

 

Smaller reporting company o

(Do not check if a smaller reporting company)

 

 

 

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 1,310,883,577 shares of common stock outstanding at June 30, 2009.

 

 

 



Table of Contents

 

Index

 

 

Page

Part I - Financial Information:

 

 

 

Item 1. Consolidated Financial Statements:

 

 

 

Consolidated Statement of Earnings for the three and six months ended June 30, 2009 and 2008

3

 

 

Consolidated Statement of Financial Position at June 30, 2009 and December 31, 2008

4

 

 

Consolidated Statement of Cash Flows for the six months ended June 30, 2009 and 2008

6

 

 

Notes to Consolidated Financial Statements

7

 

 

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

28

 

 

Item 4. Controls and Procedures

63

 

 

Part II - Other Information:

63

 

 

Item 1. Legal Proceedings

63

 

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds and Issuer Repurchases of Equity Securities

63

 

 

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

64

 

 

Item 6. Exhibits

65

 

2



Table of Contents

 

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)

 

2009

 

2008

 

2009

 

2008

 

Revenue:

 

 

 

 

 

 

 

 

 

Services

 

$

13,479

 

$

15,203

 

$

26,656

 

$

29,777

 

Sales

 

9,198

 

10,976

 

17,147

 

20,263

 

Financing

 

574

 

642

 

1,158

 

1,282

 

Total revenue

 

23,250

 

26,820

 

44,962

 

51,322

 

 

 

 

 

 

 

 

 

 

 

Cost:

 

 

 

 

 

 

 

 

 

Services

 

9,145

 

10,709

 

18,208

 

21,057

 

Sales

 

3,221

 

4,225

 

6,123

 

7,899

 

Financing

 

303

 

286

 

618

 

600

 

Total cost

 

12,669

 

15,221

 

24,949

 

29,556

 

 

 

 

 

 

 

 

 

 

 

Gross profit

 

10,581

 

11,599

 

20,012

 

21,766

 

 

 

 

 

 

 

 

 

 

 

Expense and other income:

 

 

 

 

 

 

 

 

 

Selling, general and administrative

 

5,115

 

6,289

 

10,379

 

11,909

 

Research, development and engineering

 

1,434

 

1,660

 

2,914

 

3,229

 

Intellectual property and custom development income

 

(302

)

(285

)

(570

)

(559

)

Other (income) and expense

 

(28

)

(24

)

(331

)

(149

)

Interest expense

 

101

 

145

 

237

 

323

 

Total expense and other income

 

6,319

 

7,786

 

12,628

 

14,754

 

 

 

 

 

 

 

 

 

 

 

Income before income taxes

 

4,262

 

3,814

 

7,385

 

7,012

 

Provision for income taxes

 

1,159

 

1,049

 

1,986

 

1,928

 

Net income

 

$

3,103

 

$

2,765

 

$

5,398

 

$

5,084

 

 

 

 

 

 

 

 

 

 

 

Earnings per share of common stock:

 

 

 

 

 

 

 

 

 

Assuming dilution

 

$

2.32

 

$

1.97

*

$

4.02

 

$

3.61

*

Basic

 

$

2.34

 

$

2.01

*

$

4.04

 

$

3.67

*

 

 

 

 

 

 

 

 

 

 

Weighted-average number of common shares outstanding: (millions)

 

 

 

 

 

 

 

 

 

Assuming dilution

 

1,336.9

 

1,402.1

*

1,343.2

 

1,406.7

*

Basic

 

1,326.1

 

1,376.2

*

1,335.2

 

1,385.2

*

 

 

 

 

 

 

 

 

 

 

Cash dividend per common share

 

$

0.55

 

$

0.50

 

$

1.05

 

$

0.90

 


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

 

(Amounts may not add due to rounding.)

 

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

 

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Table of Contents

 

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

ASSETS

 

(Dollars in millions)

 

At June 30,
2009

 

At December 31,
2008

 

Assets:

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

11,678

 

$

12,741

 

Marketable securities

 

848

 

166

 

Notes and accounts receivable — trade (net of allowances of $241 in 2009 and $226 in 2008)

 

9,561

 

10,906

 

Short-term financing receivables (net of allowances of $400 in 2009 and $351 in 2008)

 

13,116

 

15,477

 

Other accounts receivable (net of allowances of $57 in 2009 and $55 in 2008)

 

1,179

 

1,172

 

Inventories, at lower of average cost or market:

 

 

 

 

 

Finished goods

 

565

 

524

 

Work in process and raw materials

 

2,126

 

2,176

 

Total inventories

 

2,691

 

2,701

 

Deferred taxes

 

1,652

 

1,542

 

Prepaid expenses and other current assets

 

3,709

 

4,299

 

Total current assets

 

44,435

 

49,004

 

 

 

 

 

 

 

Plant, rental machines and other property

 

38,669

 

38,445

 

Less: Accumulated depreciation

 

24,721

 

24,140

 

Plant, rental machines and other property — net

 

13,948

 

14,305

 

Long-term financing receivables (net of allowances of $132 in 2009 and $179 in 2008)

 

10,197

 

11,183

 

Prepaid pension assets

 

2,182

 

1,601

 

Deferred taxes

 

6,762

 

7,270

 

Goodwill

 

18,737

 

18,226

 

Intangible assets — net

 

2,580

 

2,878

 

Investments and sundry assets

 

4,813

 

5,058

 

Total assets

 

$

103,655

 

$

109,524

 

 

(Amounts may not add due to rounding.)

 

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

 

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Table of Contents

 

INTERNATIONAL BUSINESS MACHINES CORPORATION
AND SUBSIDIARY COMPANIES

CONSOLIDATED STATEMENT OF FINANCIAL POSITION — (CONTINUED)
(UNAUDITED)

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

(Dollars in millions)

 

At June 30,
2009

 

At December 31,
2008

 

Liabilities:

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Taxes

 

$

2,259

 

$

2,743

 

Short-term debt

 

8,504

 

11,236

 

Accounts payable

 

5,869

 

7,014

 

Compensation and benefits

 

3,901

 

4,623

 

Deferred income

 

10,335

 

10,239

 

Other accrued expenses and liabilities

 

5,562

 

6,580

 

Total current liabilities

 

36,430

 

42,435

 

Long-term debt

 

20,868

 

22,689

 

Retirement and nonpension postretirement benefit obligations

 

18,459

 

19,452

 

Deferred income

 

3,283

 

3,171

 

Other liabilities

 

9,141

 

8,192

*

Total liabilities

 

88,182

 

95,939

*

 

 

 

 

 

 

Stockholders’ equity:

 

 

 

 

 

 

 

 

 

 

 

IBM stockholders’ equity:

 

 

 

 

 

Common stock, par value $0.20 per share, and additional paid-in capital

 

39,774

 

39,129

 

Shares authorized: 4,687,500,000

 

 

 

 

 

Shares issued:

2009 – 2,105,119,767

 

 

 

 

 

 

2008 – 2,096,981,860

 

 

 

 

 

Retained earnings

 

74,328

 

70,353

 

Treasury stock - at cost

 

(77,679

)

(74,171

)

Shares:

2009 - 794,236,190

 

 

 

 

 

 

2008 - 757,885,937

 

 

 

 

 

Accumulated other comprehensive income/(loss)

 

(21,043

)

(21,845

)

Total IBM stockholders’ equity

 

15,380

 

13,465

*

Noncontrolling interests*

 

94

 

119

*

Total stockholders’ equity

 

15,473

 

13,584

*

Total liabilities and stockholders’ equity

 

$

103,655

 

$

109,524

 


*                 Reflects the adoption of SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements—an amendment of ARB No. 51.” See Note 2, “Accounting Changes,” on pages 7 to 9 for additional information.

 

(Amounts may not add due to rounding.)

 

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

 

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Table of Contents

 

INTERNATIONAL BUSINESS MACHINES CORPORATION
AND SUBSIDIARY COMPANIES

CONSOLIDATED STATEMENT OF CASH FLOWS
FOR THE SIX MONTHS ENDED JUNE 30,

(UNAUDITED)

 

(Dollars in millions)

 

2009

 

2008

 

Cash flow from operating activities:

 

 

 

 

 

Net income

 

$

5,398

 

$

5,084

 

Adjustments to reconcile net income to cash provided from operating activities:

 

 

 

 

 

Depreciation

 

1,853

 

2,096

 

Amortization of intangibles

 

618

 

654

 

Stock-based compensation

 

269

 

340

 

Net gain on asset sales and other

 

(340

)

(75

)

Changes in operating assets and liabilities, net of acquisitions/divestitures

 

1,330

 

353

 

Net cash provided by operating activities

 

9,127

 

8,453

 

 

 

 

 

 

 

Cash flow from investing activities:

 

 

 

 

 

Payments for plant, rental machines and other property, net of proceeds from dispositions

 

(1,304

)

(1,999

)

Investment in software

 

(319

)

(381

)

Acquisition of businesses, net of cash acquired

 

(100

)

(5,891

)

Divestiture of businesses, net of cash transferred

 

356

 

29

 

Non-operating finance receivables — net (1)

 

487

 

219

 

Purchases of marketable securities and other investments (1)

 

(2,330

)

(2,971

)

Proceeds from disposition of marketable securities and other investments (1)

 

1,314

 

4,084

 

Net cash used in investing activities

 

(1,897

)

(6,909

)

 

 

 

 

 

 

Cash flow from financing activities:

 

 

 

 

 

Proceeds from new debt

 

1,969

 

6,813

 

Payments to settle debt

 

(5,040

)

(5,924

)

Short-term repayments less than 90 days — net

 

(934

)

(2,273

)

Common stock repurchases

 

(3,436

)

(7,164

)

Common stock transactions — other

 

522

 

2,704

 

Cash dividends paid

 

(1,407

)

(1,239

)

Net cash used in financing activities

 

(8,326

)

(7,083

)

 

 

 

 

 

 

Effect of exchange rate changes on cash and cash equivalents

 

33

 

175

 

Net change in cash and cash equivalents

 

(1,063

)

(5,365

)

 

 

 

 

 

 

Cash and cash equivalents at January 1

 

12,741

 

14,991

 

Cash and cash equivalents at June 30

 

$

11,678

 

$

9,626

 


(1)          Non-operating finance receivables — net represents net cash flows from short-term commercial financing arrangements (terms generally 30 to  90 days) with dealers and remarketers of predominantly non-IBM products. Amounts previously presented gross within Purchases/Proceeds of marketable securities and other investments.

 

(Amounts may not add due to rounding.)

 

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

 

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Table of Contents

 

Notes to Consolidated Financial Statements:

 

1. Basis of Presentation:  The accompanying consolidated financial statements and footnotes thereto are unaudited.  In the opinion of the management of the International Business Machines Corporation (the company), these statements include all adjustments, which are of a normal recurring nature, necessary to present a fair statement of the company’s results of operations, financial position and cash flows.

 

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America (GAAP) requires management to make estimates and assumptions that affect the amounts of assets, liabilities, revenue, costs, expenses and accumulated other comprehensive income/(loss) that are reported in the Consolidated Financial Statements and accompanying disclosures. Actual results may be different. See the company’s 2008 Annual Report for a discussion of the company’s critical accounting estimates.

 

Interim results are not necessarily indicative of results for a full year. The information included in this Form 10-Q should be read in conjunction with the company’s 2008 Annual Report.

 

The company evaluated subsequent events through July 28, 2009, the date the company’s Board of Directors reviewed the financial statements to be issued. The company issued the financial statements on the same day.

 

Within the financial tables in this Form 10-Q, certain 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. Accounting Changes:  In June 2009, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 168, “The FASB Accounting Standards Codification TM and the Hierarchy of Generally Accepted Accounting Principles, a replacement of FASB Statement No. 162” (the Codification). The Codification, which was launched on July 1, 2009, became the single source of authoritative nongovernmental U.S. GAAP, superseding existing FASB, American Institute of Certified Public Accountants (AICPA), Emerging Issues Task Force (EITF) and related literature. The Codification eliminates the GAAP hierarchy contained in SFAS No. 162 and establishes one level of authoritative GAAP. All other literature is considered non-authoritative. This Statement is effective for financial statements issued for interim and annual periods ending after September 15, 2009. The company will adopt this Statement for its quarter ending September 30, 2009. There will be no change to the company’s Consolidated Financial Statements due to the implementation of this Statement.

 

In June 2009, the FASB issued SFAS No. 167, “Amendments to FASB Interpretation No. 46(R),” and SFAS No. 166, “ Accounting for Transfers of Financial Assets—an amendment of FASB Statement No. 140.” SFAS No. 167 amends FASB Interpretation 46(R) to eliminate the quantitative approach previously required for determining the primary beneficiary of a variable interest entity and requires ongoing qualitative reassessments of whether an enterprise is the primary beneficiary of a variable interest entity. SFAS No. 166 amends SFAS No. 140 by removing the exemption from consolidation for Qualifying Special Purpose Entities (QSPEs). This Statement also limits the circumstances in which a financial asset, or portion of a financial asset, should be derecognized when the transferor has not transferred the entire original financial asset to an entity that is not consolidated with the transferor in the financial statements being presented and/or when the transferor has continuing involvement with the transferred financial asset. The company will adopt these Statements for interim and annual reporting periods beginning on January 1, 2010. The company does not expect the adoption of these standards to have any material impact on the Consolidated Financial Statements.

 

In May 2009, the FASB issued SFAS No. 165, “Subsequent Events.”  This Statement sets forth: 1) the period after the balance sheet date during which management of a reporting entity should evaluate events or transactions that may occur for potential recognition or disclosure in the financial statements; 2) the circumstances under which an entity should recognize events or transactions occurring after the balance sheet date in its financial statements; and 3) the disclosures that an entity should make about events or transactions that occurred after the balance sheet date. This Statement is effective for interim and annual periods ending after June 15, 2009. The company adopted this Statement in the quarter ended June 30, 2009. This Statement did not impact the consolidated financial results.

 

In April 2009, the FASB issued FASB Staff Position (FSP) Financial Accounting Standard (FAS) 157-4, “Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly.” Based on the guidance, if an entity determines that the level of activity for an asset or liability has significantly decreased and that a transaction is not orderly, further analysis of transactions or quoted prices is needed, and a significant adjustment to the transaction or quoted prices may be necessary to estimate fair value in accordance with SFAS No. 157, “Fair Value Measurements.” This FSP is to be applied prospectively and is effective for interim and annual periods ending after June 15, 2009 with early adoption permitted for periods ending after March 15, 2009. The

 

 

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Table of Contents

 

Notes to Consolidated Financial Statements — (continued)

 

company adopted this FSP in the quarter ended June 30, 2009, and there was no material impact on the Consolidated Financial Statements.

 

In April 2009, the FASB issued FSP FAS 115-2 and FAS 124-2, “Recognition and Presentation of Other-Than-Temporary Impairments.” The guidance applies to investments in debt securities for which other-than-temporary impairments may be recorded. If an entity’s management asserts that it does not have the intent to sell a debt security and it is more likely than not that it will not have to sell the security before recovery of its cost basis, then an entity may separate other-than-temporary impairments into two components: 1) the amount related to credit losses (recorded in earnings), and 2) all other amounts (recorded in other comprehensive income). This FSP is to be applied prospectively and is effective for interim and annual periods ending after June 15, 2009 with early adoption permitted for periods ending after March 15, 2009. The company adopted this FSP for the quarter ended June 30, 2009, and there was no material impact on the Consolidated Financial Statements.

 

In April 2009, the FASB issued FSP FAS 107-1 and Accounting Principles Board (APB) 28-1, “Interim Disclosures about Fair Value of Financial Instruments.” The FSP amends SFAS No. 107, “Disclosures about Fair Value of Financial Instruments” to require an entity to provide disclosures about fair value of financial instruments in interim financial information. This FSP is to be applied prospectively and is effective for interim and annual periods ending after June 15, 2009 with early adoption permitted for periods ending after March 15, 2009. The company adopted this FSP in the quarter ended June 30, 2009. There was no impact on the Consolidated Financial Statements as it relates only to additional disclosures. The required disclosures are included in Note 4, “Fair Value of Financial Instruments,” on page 10.

 

In December 2007, the FASB issued SFAS No. 141(R), “Business Combinations,” which became effective January 1, 2009 via prospective application to business combinations. This Statement requires that the acquisition method of accounting be applied to a broader set of business combinations, amends the definition of a business combination, provides a definition of a business, requires an acquirer to recognize an acquired business at its fair value at the acquisition date and requires the assets and liabilities assumed in a business combination to be measured and recognized at their fair values as of the acquisition date (with limited exceptions). The company adopted this Statement on January 1, 2009. There was no impact upon adoption, and its effects on future periods will depend on the nature and significance of business combinations subject to this statement.

 

In April 2009, the FASB issued FSP FAS 141(R)-1, “Accounting for Assets Acquired and Liabilities Assumed in a Business Combination That Arise from Contingencies.” This FSP requires that assets acquired and liabilities assumed in a business combination that arise from contingencies be recognized at fair value if fair value can be reasonably estimated. If fair value cannot be reasonably estimated, the asset or liability would generally be recognized in accordance with SFAS No. 5, “Accounting for Contingencies” and FASB Interpretation No. 14, “Reasonable Estimation of the Amount of a Loss.” Further, the FASB removed the subsequent accounting guidance for assets and liabilities arising from contingencies from SFAS No. 141(R). The requirements of this FSP carry forward without significant revision the guidance on contingencies of SFAS No. 141, “Business Combinations”, which was superseded by SFAS No. 141(R) (see previous paragraph). The FSP also eliminates the requirement to disclose an estimate of the range of possible outcomes of recognized contingencies at the acquisition date. For unrecognized contingencies, the FASB requires that entities include only the disclosures required by SFAS No. 5. This FSP was adopted effective January 1, 2009. There was no material impact upon adoption, and its effects on future periods will depend on the nature and significance of business combinations subject to this statement.

 

In April 2008, the FASB issued FSP FAS 142-3, “Determination of the Useful Life of Intangible Assets.” The FSP states that in developing assumptions about renewal or extension options used to determine the useful life of an intangible asset, an entity needs to consider its own historical experience adjusted for entity-specific factors. In the absence of that experience, an entity shall consider the assumptions that market participants would use about renewal or extension options. This FSP is  applied to intangible assets acquired after January 1, 2009. The adoption of this FSP did not have a material impact on the Consolidated Financial Statements.

 

In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements — an amendment of ARB No. 51.” This Statement requires that the noncontrolling interest in the equity of a subsidiary be accounted for and reported as equity, provides revised guidance on the treatment of net income and losses attributable to the noncontrolling interest and changes in ownership interests in a subsidiary and requires additional disclosures that identify and distinguish between the interests of the controlling and noncontrolling owners. Pursuant to the transition provisions of SFAS No. 160, the company adopted the Statement on January 1, 2009 via retrospective application of the presentation and

 

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Table of Contents

 

Notes to Consolidated Financial Statements — (continued)

 

disclosure requirements. Noncontrolling interests of $119 million at December 31, 2008 were reclassified from the Liabilities section to the Stockholders’ Equity section in the Consolidated Statement of Financial Position as of January 1, 2009.

 

Noncontrolling interest amounts of $0.4 million and $2 million, net of tax, for the three months ended June 30, 2009 and June 30, 2008, respectively, and $3 million and $14 million, net of tax, for the six months ended June 30, 2009 and June 30, 2008, respectively, are not presented separately in the Consolidated Statement of Earnings due to immateriality, but are reflected within the other (income) and expense line item.

 

In March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities — an amendment of FASB Statement No. 133.” SFAS No. 161 expands the current disclosure requirements of SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” such that entities must now provide enhanced disclosures on an interim and annual basis regarding how and why the entity uses derivatives; how derivatives and related hedged items are accounted for under SFAS No. 133 and how derivatives and related hedged items affect the entity’s financial position, financial results and cash flow. Pursuant to the transition provisions of the Statement, the company adopted SFAS No. 161 on January 1, 2009. The required disclosures are presented in Note 6, “Derivatives and Hedging Transactions,” on pages 12 to 18 on a prospective basis. This Statement does not impact the consolidated financial results as it is disclosure-only in nature.

 

In February 2008, the FASB issued FSP FAS 157-2, “Effective Date of FASB Statement No. 157.” FSP FAS 157-2 delayed the effective date of SFAS No. 157 “Fair Value Measurements” from 2008 to 2009 for all nonfinancial assets and nonfinancial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually). The adoption of the provisions of SFAS No. 157 related to nonfinancial assets and nonfinancial liabilities on January 1, 2009 did not have a material impact on the Consolidated Financial Statements. See Note 3, “Fair Value,” on pages 10 and 11 for SFAS No. 157 disclosures.

 

In June 2008, the FASB issued FSP EITF 03-6-1, “Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities,” which became effective in 2009 via retrospective application. Under the FSP, unvested share-based payment awards that contain non-forfeitable rights to dividends or dividend equivalents are participating securities and, therefore, are included in computing earnings per share (EPS) pursuant to the two-class method. The two-class method determines earnings per share for each class of common stock and participating securities according to dividends or dividend equivalents and their respective participation rights in undistributed earnings. Restricted Stock Units (RSUs) granted to employees prior to December 31, 2007 are considered participating securities as they receive non-forfeitable dividend equivalents at the same rate as common stock. RSUs granted after December 31, 2007 do not receive dividend equivalents and are not considered participating securities. The company retrospectively adopted the FSP on January 1, 2009. The impact of adopting the FSP decreased previously reported diluted EPS by $0.01 for the second-quarter 2008 and by $0.02 for the six months ended June 30, 2008. Previously reported basic EPS decreased by $0.01 for the second-quarter 2008 and by $0.02 for the six months ended June 30, 2008.

 

In November 2008, the FASB ratified EITF Issue 08-7, “Accounting for Defensive Intangible Assets.” A defensive intangible asset is an asset acquired in a business combination or in an asset acquisition that an entity does not intend to actively use. According to the guidance, defensive intangible assets are considered to be a separate unit of account and valued based on their highest and best use from the perspective of an external market participant. The company adopted EITF 08-7 on January 1, 2009. There was no material impact upon adoption, and its effects on future periods will depend on the nature and significance of the business combinations subject to this statement.

 

In December 2008, the FASB issued FSP FAS 132(R)-1, “Employers’ Disclosures about Postretirement Benefit Plan Assets.” This FSP amends SFAS No. 132(R), “Employers’ Disclosures about Pensions and Other Postretirement Benefits” to require more detailed disclosures about the fair value measurements of employers’ plan assets including: (a) investment policies and strategies; (b) major categories of plan assets; (c) information about valuation techniques and inputs to those techniques, including the fair value hierarchy classifications (as defined by SFAS No. 157) of the major categories of plan assets; (d) the effects of fair value measurements using significant unobservable inputs (Level 3) on changes in plan assets; and (e) significant concentrations of risk within plan assets. The disclosures required by the FSP will be included in the company’s year ending 2009 Consolidated Financial Statements. This Statement does not impact the consolidated financial results as it is disclosure-only in nature.

 

9



Table of Contents

 

Notes to Consolidated Financial Statements — (continued)

 

3. Fair Value:

 

Financial Assets and Financial Liabilities Measured at Fair Value on a Recurring Basis

 

The following tables present the company’s financial assets and financial liabilities that are measured at fair value on a recurring basis at June 30, 2009 and December 31, 2008 consistent with the fair value hierarchy provisions of SFAS No. 157.

 

(Dollars in millions)
At June 30, 2009

 

Level 1

 

Level 2

 

Level 3

 

Netting (1)

 

Total

 

Assets:

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

1,846

 

$

7,447

 

$

 

$

 

$

9,293

 

Marketable securities

 

 

848

 

 

 

848

 

Derivative assets (2)

 

 

879

 

 

(542

)

337

 

Investments and sundry assets

 

269

 

6

 

 

 

275

 

Total Assets

 

$

2,115

 

$

9,180

 

$

 

$

(542

)

$

10,753

 

 

 

 

 

 

 

 

 

 

 

 

 

Liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Derivative liabilities (3)

 

$

 

$

1,725

 

$

 

$

(542

)

$

1,183

 

Total Liabilities

 

$

 

$

1,725

 

$

 

$

(542

)

$

1,183

 


(1)   Represents netting of derivative exposures covered by a qualifying master netting agreement in accordance with FASB Interpretation No. 39, “Offsetting of Amounts Relating to Certain Contracts.”

(2)   The gross balances of derivative assets contained within prepaid expenses and other current assets, and investments and sundry assets in the Consolidated Statement of Financial Position at June 30, 2009 are $210 million and $669 million, respectively.

(3)   The gross balances of derivative liabilities contained within other accrued expenses and liabilities, and other liabilities in the Consolidated Statement of Financial Position at June 30, 2009 are $986 million and $739 million, respectively.

 

(Dollars in millions)
At December 31, 2008

 

Level 1

 

Level 2

 

Level 3

 

Netting (1)

 

Total

 

Assets:

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

1,950

 

$

8,059

 

$

 

$

 

$

10,009

 

Marketable securities

 

 

166

 

 

 

166

 

Derivative assets (2)

 

56

 

1,834

 

 

(875

)

1,015

 

Investments and sundry assets

 

165

 

6

 

 

 

171

 

Total Assets

 

$

2,171

 

$

10,065

 

$

 

$

(875

)

$

11,361

 

 

 

 

 

 

 

 

 

 

 

 

 

Liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Derivative liabilities (3)

 

$

 

$

2,116

 

$

 

$

(875

)

$

1,241

 

Total Liabilities

 

$

 

$

2,116

 

$

 

$

(875

)

$

1,241

 


(1)   Represents netting of derivative exposures covered by a qualifying master netting agreement in accordance with FASB Interpretation No. 39, “Offsetting of Amounts Relating to Certain Contracts.”

(2)   The gross balances of derivative assets contained within prepaid expenses and other current assets, and investments and sundry assets in the Consolidated Statement of Financial Position at December 31, 2008 are $773 million and $1,117 million, respectively.

(3)   The gross balances of derivative liabilities contained within other accrued expenses and liabilities, and other liabilities in the Consolidated Statement of Financial Position at December 31, 2008 are $1,414 million and $702 million, respectively.

 

At June 30, 2009 and December 31, 2008, the company did not have any financial assets or financial liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) in the Consolidated Statement of Financial Position.

 

10



Table of Contents

 

Notes to Consolidated Financial Statements — (continued)

 

Items Measured at Fair Value on a Nonrecurring Basis

 

In the fourth quarter of 2008, the company recorded an other-than-temporary impairment of $81 million for an equity method investment. The resulting investment which was classified as Level 3 in the fair value hierarchy was valued using a discounted cash flow model. The valuation inputs included an estimate of future cash flows, expectations about possible variations in the amount and timing of cash flows and a discount rate based on the risk-adjusted cost of capital. Potential results were assigned probabilities that resulted in a weighted average or most-likely discounted cash flow fair value as of December 31, 2008. The fair value of the investment after impairment was $7 million at December 31, 2008. In the first half of 2009, the balance of this investment was further reduced by an additional impairment of $5 million and other adjustments primarily related to dividends. The balance of this investment was zero at June 30, 2009.

 

4. Fair Value of Financial Instruments: Cash and cash equivalents, debt and marketable equity securities and derivative financial instruments are recognized and measured at fair value in the company’s financial statements. Notes and other accounts receivable and other investments are financial assets with carrying values that approximate fair value. Accounts payable, other accrued expenses and short-term debt are financial liabilities with carrying values that approximate fair value. In the absence of quoted prices in active markets, considerable judgment is required in developing estimates of fair value. Estimates are not necessarily indicative of the amounts the company could realize in a current market transaction. The following methods and assumptions are used to estimate fair values:

 

Loans and Long-term Receivables

 

Estimates of fair value are based on discounted future cash flows using current interest rates offered for similar loans to clients with similar credit ratings for the same remaining maturities.

 

Long-term Debt

 

For publicly-traded debt, estimates of fair value are based on market prices. For other debt, fair value is estimated based on rates currently available to the company for debt with similar terms and remaining maturities. The carrying amount of long-term debt is $20,868 million and $22,689 million and the estimated fair value is $22,999 million and $23,351 million at June 30, 2009 and December 31, 2008, respectively.

 

5. Financing Receivables: The following table presents financing receivables, net of allowances for doubtful accounts, including residual values.

 

 

 

At June 30,

 

At December 31,

 

(Dollars in millions)

 

2009

 

2008

 

Current:

 

 

 

 

 

Net investment in sales-type and direct financing leases

 

$

4,064

 

$

4,226

 

Commercial financing receivables

 

3,904

 

5,781

 

Client loan receivables

 

4,492

 

4,861

 

Installment payment receivables

 

656

 

608

 

Total

 

$

13,116

 

$

15,477

 

Noncurrent:

 

 

 

 

 

Net investment in sales-type and direct financing leases

 

$

5,396

 

$

5,938

 

Commercial financing receivables

 

72

 

94

 

Client loan receivables

 

4,323

 

4,718

 

Installment payment receivables

 

405

 

433

 

Total

 

$

10,197

 

$

11,183

 

 

Net investment in sales-type and direct financing leases is for leases that relate principally to the company’s equipment and are for terms ranging from two to seven years. Net investment in sales-type and direct financing leases includes unguaranteed residual values of $881 million and $916 million at June 30, 2009 and December 31, 2008, respectively, and is reflected net of unearned income of $987 million and $1,049 million and of allowance for doubtful accounts of $201 million and $217 million at those dates, respectively.

 

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Table of Contents

 

Notes to Consolidated Financial Statements — (continued)

 

Commercial financing receivables relate primarily to inventory and accounts receivable financing for dealers and remarketers of IBM and non-IBM products. Payment terms for inventory and accounts receivable financing generally range from 30 to 90 days.

 

Client loan receivables relate to loans that are provided by Global Financing primarily to the company’s clients to finance the purchase of the company’s software and services. Separate contractual relationships on these financing arrangements are for terms ranging from two to seven years. Each financing contract is priced independently at competitive market rates. The company has a history of enforcing the terms of these separate financing agreements.

 

The company utilizes certain of its financing receivables as collateral for non-recourse borrowings. Financing receivables pledged as collateral for borrowings were $238 million and $373 million at June 30, 2009 and December 31, 2008, respectively.

 

The company did not have any financing receivables held for sale as of June 30, 2009 and December 31, 2008.

 

6. Derivatives and Hedging Transactions: The company operates in multiple functional currencies and is a significant lender and borrower in the global markets. In the normal course of business, the company is exposed to the impact of interest rate changes and foreign currency fluctuations, and to a lesser extent equity and commodity price changes and client credit risk. The company limits these risks by following established risk management policies and procedures, including the use of derivatives, and, where cost effective, financing with debt in the currencies in which assets are denominated. For interest rate exposures, derivatives are used to better align rate movements between the interest rates associated with the company’s lease and other financial assets and the interest rates associated with its financing debt. Derivatives are also used to manage the related cost of debt. For foreign currency exposures, derivatives are used to better manage the cash flow volatility arising from foreign exchange rate fluctuations.

 

As a result of the use of derivative instruments, the company is exposed to the risk that counterparties to derivative contracts will fail to meet their contractual obligations. To mitigate the counterparty credit risk, the company has a policy of only entering into contracts with carefully selected major financial institutions based upon their credit ratings and other factors. The company’s established policies and procedures for mitigating credit risk on principal transactions include reviewing and establishing limits for credit exposure and continually assessing the creditworthiness of counterparties. The right of set-off that exists under certain of these arrangements enables the legal entities of the company subject to the arrangement to net amounts due to and from the counterparty reducing the maximum loss from credit risk in the event of counterparty default. The company is also a party to collateral security arrangements with certain counterparties.  These arrangements require the company to hold or post collateral (cash or U.S. Treasury securities) when the derivative fair values exceed contractually established thresholds. Posting thresholds can be fixed or can vary based on credit default swap pricing or credit ratings received from the major credit agencies. The aggregate fair value of all derivative instruments with credit-risk related contingent features that were in a liability position at June 30, 2009 was $494 million for which the company has posted collateral of $37 million. Full overnight collateralization of these agreements would be required in the event that the company’s credit rating falls below investment grade or if its credit default swap spread exceeds 250 basis points, as applicable, pursuant to the terms of the collateral security arrangements. The aggregate fair value of derivative instruments in net asset positions as of June 30, 2009 was $879 million. This amount represents the maximum exposure to loss at the reporting date as a result of the counterparties failing to perform as contracted. This exposure is reduced by $542 million of liabilities included in master netting arrangements with those counterparties.  The company does not offset derivative assets against liabilities in master netting arrangements nor does it offset receivables or payables recognized upon payment or receipt of cash collateral against the fair values of the related derivative instruments.  At June 30, 2009, the company recorded $42 million in cash collateral related to all applicable derivative instruments in prepaid expenses and other current assets in the Consolidated Statement of Financial Position.

 

The company may employ derivative instruments to hedge the volatility in stockholders’ equity resulting from changes in currency exchange rates of significant foreign subsidiaries of the company with respect to the U.S. dollar. These instruments, designated as net investment hedges in accordance with SFAS No. 133, expose the company to liquidity risk as the derivatives have an immediate cash flow impact upon maturity which is not offset by the translation of the underlying hedged equity. The company monitors the cash loss potential on an ongoing basis and may discontinue some of these hedging relationships by de-designating the derivative instrument to manage this liquidity risk. Although not designated as

 

12



Table of Contents

 

Notes to Consolidated Financial Statements — (continued)

 

accounting hedges, the company may utilize derivatives to offset the changes in fair value of the de-designated instruments from the date of de-designation until maturity. The company expended $158 million and $303 million related to maturities of derivative instruments that existed in qualifying net investment hedge relationships in the three months and six months ending June 30, 2009, respectively. At June 30, 2009, the company had net assets of $105 million, representing the fair value of derivative instruments in qualifying net investment hedge relationships. The weighted-average remaining maturity of these instruments at June 30, 2009 was approximately 2 years. In addition, at June 30, 2009, the company had net liabilities of $544 million representing the fair value of derivative instruments that were previously designated in qualifying net investment hedging relationships but were de-designated prior to June 30, 2009; of this amount $251 million is expected to mature over the next twelve months. The notional amount of these instruments at June 30, 2009 was $5,600 million including original and offsetting transactions.

 

In its hedging programs, the company uses forward contracts, futures contracts, interest-rate swaps and cross-currency swaps, depending upon the underlying exposure. The company is not a party to leveraged derivative instruments.

 

A brief description of the major hedging programs, categorized by underlying risk, follows.

 

Interest Rate Risk

 

Fixed and Variable Rate Borrowings

 

The company issues debt in the global capital markets, principally to fund its financing lease and loan portfolio. Access to cost-effective financing can result in interest rate mismatches with the underlying assets. To manage these mismatches and to reduce overall interest cost, the company uses interest-rate swaps to convert specific fixed-rate debt issuances into variable-rate debt (i.e., fair value hedges) and to convert specific variable-rate debt issuances into fixed-rate debt (i.e., cash flow hedges). At June 30, 2009, the total notional amount of the company’s interest rate swaps was $8,361 million.

 

Forecasted Debt Issuance

 

The company is exposed to interest rate volatility on forecasted debt issuances. To manage this risk, the company may use forward starting interest-rate swaps to lock in the rate on the interest payments related to the forecasted debt issuance. These swaps are accounted for as cash flow hedges. The company did not have any derivative instruments relating to this program outstanding at June 30, 2009.

 

Foreign Exchange Risk

 

Long-Term Investments in Foreign Subsidiaries (Net Investment)

 

A significant portion of the company’s foreign currency denominated debt portfolio is designated as a hedge of net investment to reduce the volatility in stockholders’ equity caused by changes in foreign currency exchange rates in the functional currency of major foreign subsidiaries with respect to the U.S. dollar. The company also uses cross-currency swaps and foreign exchange forward contracts for this risk management purpose. At June 30, 2009, the total notional amount of derivative instruments designated as net investment hedges was $1,000 million.

 

Anticipated Royalties and Cost Transactions

 

The company’s operations generate significant nonfunctional currency, third-party vendor payments and intercompany payments for royalties and goods and services among the company’s non-U.S. subsidiaries and with the parent company. In anticipation of these foreign currency cash flows and in view of the volatility of the currency markets, the company selectively employs foreign exchange forward contracts to manage its currency risk. These forward contracts are accounted for as cash flow hedges. The maximum length of time over which the company is hedging its exposure to the variability in future cash flows is approximately four years. At June 30, 2009, the total notional amount of forward contracts designated as cash flow hedges of forecasted royalty and cost transactions was $21,261 million with a weighted-average remaining maturity of 1.4 years.

 

13



Table of Contents

 

Notes to Consolidated Financial Statements — (continued)

 

Foreign Currency Denominated Borrowings

 

The company is exposed to exchange rate volatility on foreign currency denominated debt. To manage this risk, the company employs cross-currency swaps to convert fixed-rate foreign currency denominated debt to fixed-rate debt denominated in the functional currency of the borrowing entity. These swaps are accounted for as cash flow hedges. At June 30, 2009, the total notional amount of cross-currency swaps designated as cash flow hedges of foreign currency denominated debt was $300 million.

 

Subsidiary Cash and Foreign Currency Asset/Liability Management

 

The company uses its Global Treasury Centers to manage the cash of its subsidiaries. These centers principally use currency swaps to convert cash flows in a cost-effective manner. In addition, the company uses foreign exchange forward contracts to economically hedge, on a net basis, the foreign currency exposure of a portion of the company’s nonfunctional currency assets and liabilities. The terms of these forward and swap contracts are generally less than two years. The changes in the fair values of these contracts and of the underlying hedged exposures are generally offsetting and are recorded in other (income) and expense in the Consolidated Statement of Earnings. At June 30, 2009, the total notional amount of derivative instruments in economic hedges of foreign currency exposure was $8,773 million.

 

Equity Risk Management

 

The company is exposed to equity price changes related to certain obligations to employees. These equity exposures are primarily related to market price movements in certain broad equity market indices and in the company’s own stock. Changes in the overall value of these employee compensation obligations are recorded in selling, general and administrative (SG&A) expense in the Consolidated Statement of Earnings. Although not designated as accounting hedges, the company utilizes equity derivatives, including equity swaps and futures, to economically hedge the exposures related to its employee compensation obligations. The derivatives are linked to the total return on certain broad equity market indices or the total return on the company’s common stock. They are recorded at fair value with gains or losses also reported in SG&A expense in the Consolidated Statement of Earnings. At June 30, 2009, the total notional amount of derivative instruments in economic hedges of equity risk was $662 million.

 

Other Risks

 

The company holds warrants to purchase approximately 0.25 million shares of common stock in connection with various investments that are deemed derivatives because they contain net share or net cash settlement provisions. The company records the changes in the fair value of these warrants in other (income) and expense in the Consolidated Statement of Earnings.

 

The company is exposed to a potential loss if a client fails to pay amounts due under contractual terms. The company utilizes credit default swaps to economically hedge its credit exposures. These derivatives have terms of one year or less. The swaps are recorded at fair value with gains and losses reported in other (income) and expense in the Consolidated Statement of Earnings. The company does not have any derivative instruments relating to this program outstanding at June 30, 2009.

 

The following tables provide a quantitative summary of the derivative and non-derivative instrument related risk management activity as of and for the three months and six months ended June 30, 2009:

 

14



Table of Contents

 

Notes to Consolidated Financial Statements — (continued)

 

Fair Values of Derivative Instruments

As of June 30, 2009

 

 

 

Derivative Assets

 

Derivative Liabilities

 

(Dollars in millions)

 

Location in the Consolidated Statement of Financial Position

 

Fair Value

 

Location in the Consolidated Statement of Financial Position

 

Fair Value

 

Derivative Instruments Designated as Hedging Instruments under SFAS No.133

 

 

 

 

 

 

 

 

 

Interest Rate Contracts

 

Prepaid expenses and other current assets

 

$

35

 

Other accrued expenses and liabilities

 

$

 

 

 

Investments and sundry assets

 

460

 

Other liabilities

 

6

 

Foreign Exchange Contracts

 

Prepaid expenses and other current assets

 

138

 

Other accrued expenses and liabilities

 

636

 

 

 

Investments and sundry assets

 

199

 

Other liabilities

 

389

 

Total Derivative Instruments Designated as Hedging Instruments under SFAS No. 133

 

 

 

$

832

 

 

 

$

1,031

 

Derivative Instruments Not Designated as Hedging Instruments under SFAS No. 133 (1)

 

 

 

 

 

 

 

 

 

Foreign Exchange Contracts

 

Prepaid expenses and other current assets

 

$

33

 

Other accrued expenses and liabilities

 

$

350

 

 

 

Investments and sundry assets

 

10

 

Other liabilities

 

344

 

Equity Contracts

 

Prepaid expenses and other current assets

 

4

 

Other accrued expenses and liabilities

 

 

 

 

Investments and sundry assets

 

 

Other liabilities

 

 

Total Derivative Instruments Not Designated as Hedging Instruments under SFAS No. 133

 

 

 

$

47

 

 

 

$

694

 

Total Derivative Instruments

 

 

 

$

879

 

 

 

$

1,725

 

Total Debt Designated as Hedging

 

 

 

$

 

Short—term debt

 

$

1,426

 

Instruments under SFAS No. 133

 

 

 

 

Long—term debt

 

2,557

 

Total

 

 

 

$

879

 

 

 

$

5,708

 

 

15



Table of Contents

 

Notes to Consolidated Financial Statements — (continued)

 

The Effect of Derivative Instruments on the Consolidated Statement of Earnings

For the three months ended June 30, 2009

 

(Dollars in millions)

Derivative Instruments in SFAS No. 133 Fair Value Hedging Relationships

 

Location of Gain (Loss) Recognized in Income on Derivatives

 

Amount of Gain (Loss) Recognized in Income on Derivatives (2)

 

Location of Gain (Loss) on Hedged Item

 

Amount of Gain (Loss) on Hedged Item Recognized in Income Attributable to Risk Being Hedged (3)

 

 

Interest Rate Contracts

 

Cost of financing

 

$

(138

)

Cost of financing

 

$

177

 

 

 

 

Interest expense

 

(84

)

Interest expense

 

108

 

 

Total

 

 

 

$

(222

)

 

 

$

285

 

 

 

Derivative Instruments  in SFAS No. 133 Cash Flow Hedging Relationships

 

Amount of Gain (Loss) Recognized in Accumulated Other Comprehensive Income/(Loss) on Derivatives (Effective Portion)

 

Location of Gain (Loss) Reclassified from Accumulated Other Comprehensive Income/(Loss) into Income

 

Amount of Gain (Loss) Reclassified from Accumulated Other Comprehensive Income/(Loss) to Income (Effective Portion)

 

Location of Gain (Loss) on Derivative (Ineffectiveness) and Amounts Excluded from Effectiveness Testing

 

Amount of Gain (Loss) Recognized in Income on Derivatives (Ineffectiveness) and Amounts Excluded from Effectiveness Testing  (4)

Interest Rate Contracts

 

$

 

Interest expense

 

$

(2

)

Other (income) and expense

 

$

 

 

 

 

Other (income) and expense

 

80

 

 

 

 

 

 

 

 

Cost of sales

 

43

 

 

 

 

Foreign Exchange Contracts

 

(909

)

 

 

 

 

Other (income) and expense

 

2

 

 

 

 

Selling, general and administrative expense

 

32

 

 

 

 

Total

 

$

(909

)

 

 

$

153

 

 

 

$

2

 

Derivative Instruments and Debt in SFAS No. 133 Net Investment Hedging Relationships

 

Amount of Gain (Loss) Recognized in Accumulated Other Comprehensive Income/(Loss) on Derivatives (Effective   Portion)

 

Location of Gain (Loss) Reclassified from Accumulated Other Comprehensive Income/(Loss) into Income

 

Amount of Gain (Loss) Reclassified from Accumulated Other Comprehensive Income/(Loss) into Income (Effective Portion)

 

Location of Gain (Loss) on Derivatives (Ineffectiveness) and Amounts Excluded from Effectiveness Testing

 

Amount of Gain (Loss) Recognized in Income on Derivatives (Ineffectiveness) and Amounts Excluded from Effectiveness Testing (5)

Foreign Exchange Contracts

 

$

(239)

 

Other (income) and expense

 

$

 

Interest expense

 

$

3

 

Derivative Instruments Not Designated as Hedging Instruments under SFAS No. 133 (1)

 

Location of Gain (Loss) on Derivatives

 

Amount of Gain (Loss) Recognized in Income on Derivatives

 

 

 

 

 

 

Foreign Exchange Contracts

 

Other (income) and expense

 

$

(69

)

 

 

 

 

 

Equity Contracts

 

Selling, general and administrative expense

 

74

 

 

 

 

 

 

Total

 

 

 

$

5

 

 

 

 

 

 


(1)          See Note 6 for additional information on the company’s purpose for entering into derivatives not designated as hedging instruments and its overall risk management strategies.

(2)          The amount includes changes in clean fair values of the derivative instruments in fair value hedging relationships and the periodic accrual for coupon payments required under these derivative contracts.

(3)          The amount includes basis adjustments to the carrying value of the hedged item recorded during the period and amortization of basis adjustments recorded on de-designated hedging relationships during the period.

(4)          The amount of gain (loss) recognized in income represents ineffectiveness on hedge relationships.

(5)          The amount of gain (loss) recognized in income represents amounts excluded from effectiveness assessment.

 

16


 


Table of Contents

 

Notes to Consolidated Financial Statements — (continued)

 

The Effect of Derivative Instruments on the Consolidated Statement of Earnings

For the six months ended June 30, 2009

 

(Dollars in millions)

Derivative Instruments in SFAS No. 133 Fair Value Hedging Relationships

 

Location of Gain (Loss) Recognized in Income on Derivatives

 

Amount of Gain (Loss) Recognized in Income on Derivatives (2)

 

Location of Gain (Loss) on Hedged Item

 

Amount of Gain (Loss) on Hedged Item Recognized in Income Attributable to Risk Being Hedged (3)

 

 

Interest Rate Contracts

 

Cost of financing

 

$

(184

)

Cost of financing

 

$

250

 

 

 

 

Interest expense

 

(117

)

Interest expense

 

159

 

 

Total

 

 

 

$

(301

)

 

 

$

409

 

 

 

Derivative Instruments  in SFAS No. 133 Cash Flow Hedging Relationships

 

Amount of Gain (Loss) Recognized in Accumulated Other Comprehensive Income/(Loss)on Derivatives (Effective Portion)

 

Location of Gain (Loss) Reclassified from Accumulated Other Comprehensive Income/(Loss) into Income

 

Amount of Gain (Loss) Reclassified from Accumulated Other Comprehensive Income/(Loss) into Income (Effective Portion)

 

Location of Gain (Loss) on Derivatives (Ineffectiveness) and Amounts Excluded from Effectiveness Testing

 

Amount of Gain (Loss) Recognized in Income on Derivatives (Ineffectiveness) and Amounts Excluded from Effectiveness Testing  (4)

Interest Rate Contracts

 

$

(0

)

Interest expense

 

$

(11

)

Other (income) and expense

 

$

 

 

 

 

Other (income) and expense

 

204

 

 

 

 

 

 

 

 

Cost of sales

 

102

 

 

 

 

Foreign Exchange Contracts

 

(130

)

 

 

 

 

Other (income) and expense

 

2

 

 

 

 

Selling, general and administrative expense

 

68

 

 

 

 

Total

 

$

(130

)

 

 

$

363

 

 

 

$

2

 

Derivative Instruments and Debt in SFAS No. 133 Net Investment Hedging Relationships

 

Amount of Gain (Loss) Recognized in Accumulated Other Comprehensive Income/(Loss) on Derivatives (Effective   Portion)

 

Location of Gain (Loss) Reclassified from Accumulated Other Comprehensive Income/(Loss) into Income

 

Amount of Gain (Loss) Reclassified from Accumulated Other Comprehensive Income/(Loss) into Income (Effective Portion)

 

Location of Gain (Loss) on Derivatives (Ineffectiveness) and Amounts Excluded from Effectiveness Testing

 

Amount of Gain (Loss) Recognized in Income on Derivatives (Ineffectiveness) and Amounts Excluded from Effectiveness Testing (5)

Foreign Exchange Contracts

 

$

(44

)

Other (income) and expense

 

$

 

Interest expense

 

$

2

 

Derivative Instruments Not Designated as Hedging Instruments under SFAS No. 133 (1)

 

Location of Gain (Loss) on Derivatives

 

Amount of Gain (Loss) Recognized in Income on Derivatives

 

 

 

 

 

 

Foreign Exchange Contracts

 

Other (income) and expense

 

$

(242

)

 

 

 

 

 

Equity Contracts

 

Selling, general and administrative expense

 

47

 

 

 

 

 

 

Total

 

 

 

$

(195

)

 

 

 

 

 


(1)   See Note 6 for additional information on the company’s purpose for entering into derivatives not designated as hedging instruments and its overall risk management strategies.

(2)   The amount includes changes in clean fair values of the derivative instruments in fair value hedging relationships and the periodic accrual for coupon payments required under these derivative contracts.

(3)   The amount includes basis adjustments to the carrying value of the hedged item recorded during the period and amortization of basis adjustments recorded on de-designated hedging relationships during the period.

(4)   The amount of gain (loss) recognized in income represents ineffectiveness on hedge relationships.

(5)   The amount of gain (loss) recognized in income represents amounts excluded from effectiveness assessment.

 

17



Table of Contents

 

Notes to Consolidated Financial Statements — (continued)

 

At June 30, 2009, in connection with cash flow hedges of anticipated royalties and cost transactions, the company recorded net losses of $402 million (before taxes), in accumulated other comprehensive income/(loss). Of this amount, $182 million of losses are expected to be reclassified to net income within the next twelve months, providing an offsetting economic impact against the underlying anticipated transactions. At June 30, 2009, net losses of approximately $16 million (before taxes), were recorded in accumulated other comprehensive income/(loss) in connection with cash flow hedges of the company’s borrowings. Of this amount, $6 million of losses are expected to be reclassified to net income within the next twelve months, providing an offsetting economic impact against the underlying transactions.

 

For the six months ending June 30, 2009, there were no significant gains or losses recognized in earnings representing hedge ineffectiveness or excluded from the assessment of hedge effectiveness (for fair value hedges), or associated with an underlying exposure that did not or was not expected to occur (for cash flow hedges); nor are there any anticipated in the normal course of business.

 

Refer to the 2008 IBM Annual Report, Note A, “Significant Accounting Policies” on pages 73 and 74 for additional information on the company’s use of derivative instruments.

 

7. Stock-Based Compensation: Stock-based compensation cost is measured at grant date, based on the fair value of the award, and is recognized over the employee requisite service period.  The following table presents total stock-based compensation cost included in the Consolidated Statement of Earnings:

 

 

 

Three Months Ended June 30,

 

Six Months Ended June 30,

 

(Dollars in millions)

 

2009

 

2008

 

2009

 

2008

 

Cost

 

$

22

 

$

30

 

$

46

 

$

59

 

Selling, general and administrative

 

99

 

125

 

199

 

252

 

Research, development and engineering

 

11

 

15

 

23

 

29

 

Pre-tax stock-based compensation cost

 

132

 

170

 

269

 

340

 

Income tax benefits

 

(46

)

(63

)

(94

)

(110

)

Total stock-based compensation cost

 

$

86

 

$

106

 

$

175

 

$

230

 

 

The reduction in pre-tax stock-based compensation cost for the three months ended June 30, 2009, as compared to the corresponding period in the prior year, was principally the result of a reduction in the level of stock option grants ($46 million), partially offset by an increase related to restricted and performance-based stock units ($9 million).  The reduction in pre-tax stock-based compensation cost for the six months ended June 30, 2009, as compared to the corresponding period in the prior year, was principally the result of a reduction in the level of stock option grants ($89 million), partially offset by an increase related to restricted and performance-based stock units ($18 million).

 

As of June 30, 2009, the total unrecognized compensation cost of $1,315 million related to non-vested awards is expected to be recognized over a weighted-average period of approximately three years.

 

There were no significant capitalized stock-based compensation costs at June 30, 2009 and 2008.

 

8. Segments:  The table on pages 70 and 71 of this Form 10-Q reflects 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 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.  Different results could occur if actuarial assumptions that are unique to the segments 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.

 

18



Table of Contents

 

Notes to Consolidated Financial Statements — (continued)

 

9.  Stockholders’ Equity:

 

(Dollars in millions)

 

Common
Stock and Additional Paid-in
Capital

 

Retained Earnings

 

Treasury
Stock

 

Accumulated Other Comprehensive Income/(Loss)

 

Total IBM Corporation Stockholders’ Equity

 

Noncontrolling Interests*

 

Total Stockholders’ Equity

 

Stockholders’ equity, January 1, 2009

 

$

39,129

 

$

70,353

 

$

(74,171

)

$

(21,845

)

$

13,465

 

$

119

 

$

13,584

 

Net income

 

 

 

5,398

 

 

 

 

 

5,398

 

 

 

5,398

 

Other comprehensive income, net of tax (total)

 

 

 

 

 

 

 

802

 

802

 

 

 

802

 

Cash dividends declared – common stock

 

 

 

(1,407

)

 

 

 

 

(1,407

)

 

 

(1,407

)

Stock transactions related to employee plans – net

 

645

 

(16

)

2

 

 

 

631

 

 

 

631

 

Other treasury shares purchased – not retired

 

 

 

 

 

(3,510

)

 

 

(3,510

)

 

 

(3,510

)

Changes in noncontrolling interests

 

 

 

 

 

 

 

 

 

 

 

(25

)

(25

)

Stockholders’ equity June 30, 2009

 

$

39,774

 

$

74,328

 

$

(77,679

)

$

(21,043

)

$

15,380

 

$

94

 

$

15,473

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(Dollars in millions)

 

Common
Stock and Additional Paid-in
Capital

 

Retained Earnings

 

Treasury
Stock

 

Accumulated Other Comprehensive Income/(Loss)

 

Total IBM Corporation Stockholders’ Equity

 

Noncontrolling Interests*

 

Total Stockholders’ Equity

 

Stockholders’ equity, January 1, 2008

 

$

35,188

 

$

60,640

 

$

(63,945

)

$

(3,414

)

$

28,470

 

$

145

 

$

28,615

 

Net income

 

 

 

5,084

 

 

 

 

 

5,084

 

 

 

5,084

 

Other comprehensive income, net of tax (total)

 

 

 

 

 

 

 

408

 

408

 

 

 

408

 

Cash dividends declared – common stock

 

 

 

(1,239

)

 

 

 

 

(1,239

)

 

 

(1,239

)

Stock transactions related to employee plans – net

 

2,693

 

(28

)

287

 

 

 

2,952

 

 

 

2,952

 

Other treasury shares purchased – not retired

 

 

 

 

 

(7,410

)

 

 

(7,410

)

 

 

(7,410

)

Changes in noncontrolling interests

 

 

 

 

 

 

 

 

 

 

 

1

 

1

 

Stockholders’ equity June 30, 2008

 

$

37,882

 

$

64,456

 

$

(71,068

)

$

(3,006

)

$

28,264

 

$

146

 

$

28,410

 


*            Reflects the adoption of SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements — an amendment of ARB No. 51.” See Note 2, “Accounting Changes,” on pages 7 to 9 for additional information.

 

19



Table of Contents

 

Notes to Consolidated Financial Statements — (continued)

 

The following table summarizes Net income plus other comprehensive income/(loss), a component of Stockholders’ equity in the Consolidated Statement of Financial Position:

 

 

 

Three Months Ended June 30,

 

Six Months Ended June 30,

 

(Dollars in millions)

 

2009

 

2008

 

2009

 

2008

 

Net income

 

$

3,103

 

$

2,765

 

$

5,398

 

$

5,084

 

Other comprehensive income/(loss) – net of tax:

 

 

 

 

 

 

 

 

 

Foreign currency translation adjustments

 

1,150

 

(2

)

766

 

457

 

Prior service costs, net gains/(losses) and transition assets/(obligations)

 

118

 

151

 

351

 

277

 

Net unrealized (losses)/gains on marketable securities (1)

 

42

 

(19

)

36

 

(176

)

Net unrealized gains/(losses) on cash flow hedge derivatives

 

(704

)

147

 

(351

)

(149

)

Total other comprehensive income/(loss)

 

605

 

276

 

802

 

408

 

Net income plus other comprehensive income/(loss)

 

$

3,709

 

$

3,041

 

$

6,200

 

$

5,492

 


(1)          Mark-to-market adjustments of Lenovo stock accounted for a gain of $39 million and $28 million in the second quarter and the first  six months of 2009, respectively. Sale of Lenovo stock and mark-to-market adjustments of Lenovo stock accounted for a loss of $18 million and $169 million in the second quarter and the first six months of 2008, respectively.

 

10. Retirement-Related Benefits: The company offers defined benefit pension plans, defined contribution pension plans, as well as nonpension postretirement plans primarily consisting of retiree medical benefits.  The following tables provide the total retirement-related benefit plans’ impact on income before income taxes:

 

For the three months ended June 30:

 

2009

 

2008

 

Yr. to Yr.
Percent
Change

 

(Dollars in millions)

 

 

 

 

 

 

 

Retirement-related plans cost:

 

 

 

 

 

 

 

Defined benefit and contribution pension plans cost

 

$

220

 

$

290

 

(24.2

)%

Nonpension postretirement plans cost

 

88

 

91

 

(3.1

)

Total

 

$

307

 

$

381

 

(19.3

)%

 

For the six months ended June 30:

 

2009

 

2008

 

Yr. to Yr.
Percent
Change

 

(Dollars in millions)

 

 

 

 

 

 

 

Retirement-related plans cost:

 

 

 

 

 

 

 

Defined benefit and contribution pension plans cost

 

$

561

 

$

651

 

(13.8

)%

Nonpension postretirement plans cost

 

173

 

185

 

(6.6

)

Total

 

$

734

 

$

836

 

(12.2

)%

 

20



Table of Contents

 

Notes to Consolidated Financial Statements — (continued)

 

The following tables provide 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:

 

2009

 

2008*

 

2009

 

2008*

 

(Dollars in millions)

 

 

 

 

 

 

 

 

 

Service cost

 

$

 

$

 

$

145

 

$

171

 

Interest cost

 

666

 

687

 

464

 

534

 

Expected return on plan assets

 

(1,002

)

(994

)

(620

)

(714

)

Amortization of prior service cost/(credits)

 

3

 

(2

)

(31

)

(33

)

Recognized actuarial losses

 

97

 

70

 

143

 

159

 

Plan amendments/curtailments/settlements

 

 

 

(1

)

 

Multiemployer plan/other costs

 

 

 

12

 

16

 

Total net periodic pension (income)/cost of defined benefit plans

 

(236

)

(238

)

112

 

132

 

Cost of defined contribution plans

 

228

 

252

 

116

 

143

 

Total pension plan cost recognized in the Consolidated Statement of Earnings

 

$

(8

)

$

15

 

$

228

 

$

275

 


*Reclassified to conform with 2009 presentation.

 

 

 

U.S. Plans

 

Non-U.S. Plans

 

For the six months ended June 30:

 

2009

 

2008*

 

2009

 

2008*

 

(Dollars in millions)

 

 

 

 

 

 

 

 

 

Service cost

 

$

 

$

 

$

284

 

$

336

 

Interest cost

 

1,341

 

1,378

 

907

 

1,065

 

Expected return on plan assets

 

(2,004

)

(1,989

)

(1,213

)

(1,418

)

Amortization of prior service cost/(credits)

 

5

 

(3

)

(61

)

(66

)

Recognized actuarial losses

 

205

 

145

 

303

 

315

 

Plan amendments/curtailments/settlements

 

 

 

8

 

 

Multiemployer plan/other costs

 

 

 

25

 

31

 

Total net periodic pension (income)/cost of defined benefit plans

 

(453

)

(469

)

252

 

263

 

Cost of defined contribution plans

 

534

 

573

 

228

 

283

 

Total pension plan cost recognized in the Consolidated Statement of Earnings

 

$

81

 

$

105

 

$

480

 

$

546

 


*Reclassified to conform with 2009 presentation.

 

In 2009, the company expects to contribute to its non-U.S. defined benefit plans approximately $1,100 million, which is the legally mandated minimum contribution for its non-U.S. plans. Total contributions to the non-U.S. plans in the first half of 2009 were $546 million.

 

The following tables provide the components of the cost for the company’s nonpension postretirement plans:

 

Cost of Nonpension Postretirement Plans

 

 

 

U.S. Plans

 

Non-U.S. Plans

 

For the three months ended June 30:

 

2009

 

2008*

 

2009

 

2008*

 

(Dollars in millions)

 

 

 

 

 

 

 

 

 

Service cost

 

$

10

 

$

13

 

$

2

 

$

3

 

Interest cost

 

73

 

77

 

13

 

12

 

Expected return on plan assets

 

 

 

(2

)

(4

)

Amortization of prior service credits

 

(10

)

(15

)

(2

)

(2

)

Recognized actuarial losses

 

 

2

 

3

 

4

 

Total nonpension postretirement plan cost recognized in the Consolidated Statement of Earnings

 

$

74

 

$

77

 

$

14

 

$

14

 


*Reclassified to conform with 2009 presentation.

 

21



Table of Contents

 

Notes to Consolidated Financial Statements — (continued)

 

 

 

U.S. Plans

 

Non-U.S. Plans

 

For the six months ended June 30:

 

2009

 

2008*

 

2009

 

2008*

 

(Dollars in millions)

 

 

 

 

 

 

 

 

 

Service cost

 

$

21

 

$

28

 

$

5

 

$

6

 

Interest cost

 

145

 

156

 

24

 

28

 

Expected return on plan assets

 

 

(4

)

(4

)

(6

)

Amortization of prior service credits

 

(20

)

(31

)

(3

)

(4

)

Recognized actuarial losses

 

 

5

 

5

 

7

 

Total nonpension postretirement plan cost recognized in the Consolidated Statement of Earnings

 

$

146

 

$

153

 

$

27

 

$

32

 


*Reclassified to conform with 2009 presentation.

 

The company received a $6.3 million subsidy in the second quarter and $19.5 million for the first half of 2009 in connection with the Medicare Prescription Drug Improvement and Modernization Act of 2003. A portion of this amount is used by the company to reduce its obligation and expense related to the plan, and the remainder is contributed to the plan to reduce contributions required by the participants. For further information related to the Medicare Prescription Drug Act, see pages 115 and 116 in the company’s 2008 Annual Report.

 

11. Acquisitions/Divestitures:

 

Acquisitions: During the six months ended June 30, 2009, the company completed two acquisitions at an aggregate cost of $40 million.

 

The Software segment completed two acquisitions in the second quarter: Outblaze Limited and Exeros, Inc., both privately held companies. Each acquisition further complemented and enhanced the company’s portfolio of product 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, 2009:

 

(Dollars in millions)

 

Amortization
Life (yrs.)

 

Total
Acquisitions

 

Current assets

 

 

 

$

1

 

Fixed assets/noncurrent

 

 

 

0

 

Intangible assets:

 

 

 

 

 

Goodwill

 

N/A

 

33

 

Completed technology

 

5

 

5

 

Client relationships

 

5

 

1

 

IPR&D

 

N/A

 

 

Other

 

5

 

0

 

Total assets acquired

 

 

 

40

 

Current liabilities

 

 

 

(0

)

Noncurrent liabilities

 

 

 

 

Total liabilities assumed

 

 

 

(0

)

Total purchase price

 

 

 

$

40

 

 

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 overall weighted-average life of the identified amortizable intangible assets acquired is 5.0 years. With the exception of goodwill, these identified intangible assets will be amortized on a straight-line basis over their useful lives. Goodwill of $33 million has been assigned to the Software segment. Substantially all of the goodwill is not deductible for tax purposes.

 

22



Table of Contents

 

Notes to Consolidated Financial Statements — (continued)

 

Divestitures: On March 16, 2009, the company completed the sale of certain processes, resources, assets and third-party contracts related to its core logistics operations to Geodis. The company received proceeds of $365 million and recognized a net gain of $298 million on the transaction in the first quarter of 2009. The gain was net of the fair value of certain contractual terms, certain transaction costs and related real estate charges. As part of this transaction, the company outsourced its logistics operations to Geodis which enables the company to leverage industry-leading skills and scale and improve the productivity of the company’s supply chain.

 

In 2007, the company divested 51 percent of its printing business (InfoPrint) to Ricoh. The company also stated that it would divest its remaining ownership to Ricoh quarterly over a three year period from the closing date. At June 30, 2009, the company’s ownership in InfoPrint was 16.2 percent. See the company’s 2008 Annual Report on page 83 for additional information.

 

12. Intangible Assets Including Goodwill:  The following table details the company’s intangible asset balances by major asset class:

 

 

 

At June 30, 2009

 

(Dollars in millions)

 

Gross Carrying

 

Accumulated

 

Net Carrying

 

Intangible asset class

 

Amount

 

Amortization

 

Amount

 

Capitalized software

 

$

1,829

 

$

(859

)

$

970

 

Client-related

 

1,521

 

(768

)

753

 

Completed technology

 

1,103

 

(370

)

733

 

Patents/trademarks

 

181

 

(84

)

97

 

Other(a)

 

111

 

(85

)

26

 

Total

 

$

4,746

 

$

(2,166

)

$

2,580

 

 

 

 

 

 

 

 

 

 

 

At December 31, 2008

 

(Dollars in millions)

 

Gross Carrying

 

Accumulated

 

Net Carrying

 

Intangible asset class

 

Amount

 

Amortization

 

Amount

 

Capitalized software

 

$

1,861

 

$

(839

)

$

1,022

 

Client-related

 

1,532

 

(663

)

869

 

Completed technology

 

1,167

 

(327

)

840

 

Patents/trademarks

 

188

 

(76

)

112

 

Other(a)

 

154

 

(121

)

35

 

Total

 

$

4,901

 

$

(2,023

)

$

2,878

 


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

 

The net carrying amount of intangible assets decreased $299 million during the first half of 2009, primarily due to amortization of acquired intangibles. The aggregate intangible amortization expense was $307 million and $618 million for the second quarter and first six months of 2009, respectively, versus $337 million and $654 million for the second quarter and first six months ended June 30, 2008, respectively. In addition, in the first half of 2009, the company retired $478 million of fully amortized intangible assets, impacting both the gross carrying amount and accumulated amortization by 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, 2009:

 

 

 

Capitalized

 

Acquired

 

 

 

(Dollars in millions)

 

Software

 

Intangibles

 

Total

 

2009 (for Q3-Q4)

 

$

345

 

$

235

 

$

580

 

2010

 

444

 

394

 

838

 

2011

 

160

 

346

 

505

 

2012

 

22

 

278

 

300

 

2013

 

 

198

 

198

 

 

23



Table of Contents

 

Notes to Consolidated Financial Statements — (continued)

 

The changes in the goodwill balances by reportable segment, for the quarter ended June 30, 2009, are as follows:

 

 

 

 

 

 

 

 

 

 

 

Foreign

 

 

 

 

 

 

 

 

 

 

 

 

 

Currency

 

 

 

 

 

 

 

 

 

Purchase

 

 

 

Translation

 

 

 

(Dollars in millions)

 

Balance

 

Goodwill

 

Price

 

 

 

And Other

 

Balance