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, 2019

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)

Securities registered pursuant to Section 12(b) of the Act:

Title of each class	Trading symbol	Name of each exchange on which registered
Capital stock, par value $.20 per share	IBM	New York Stock Exchange
		Chicago Stock Exchange
1.375%  Notes due 2019	IBM 19B	New York Stock Exchange
2.750%  Notes due 2020	IBM 20B	New York Stock Exchange
1.875%  Notes due 2020	IBM 20A	New York Stock Exchange
0.500%  Notes due 2021	IBM 21B	New York Stock Exchange
2.625%  Notes due 2022	IBM 22A	New York Stock Exchange
1.25%    Notes due 2023	IBM 23A	New York Stock Exchange
0.375%  Notes due 2023	IBM 23B	New York Stock Exchange
1.125%  Notes due 2024	IBM 24A	New York Stock Exchange
2.875%  Notes due 2025	IBM 25A	New York Stock Exchange
0.950%  Notes due 2025	IBM 25B	New York Stock Exchange
0.875%  Notes due 2025	IBM 25C	New York Stock Exchange
0.300%  Notes due 2026	IBM 26B	New York Stock Exchange
1.250%  Notes due 2027	IBM 27B	New York Stock Exchange
1.750%  Notes due 2028	IBM 28A	New York Stock Exchange
1.500%  Notes due 2029	IBM 29	New York Stock Exchange
1.750%  Notes due 2031	IBM 31	New York Stock Exchange
8.375%  Debentures due 2019	IBM 19	New York Stock Exchange
7.00%    Debentures due 2025	IBM 25	New York Stock Exchange
6.22%    Debentures due 2027	IBM 27	New York Stock Exchange
6.50%    Debentures due 2028	IBM 28	New York Stock Exchange
7.00%    Debentures due 2045	IBM 45	New York Stock Exchange
7.125%  Debentures due 2096	IBM 96	New York Stock Exchange

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 12 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 ☒    No ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted 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 such files).    Yes ☒    No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer ☒	Accelerated filer ☐
Non-accelerated filer ☐	Smaller reporting company ☐
	Emerging growth company ☐

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act). ☐

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

The registrant had 885,875,161 shares of common stock outstanding at June 30, 2019.

Index

	Page
Part I - Financial Information:
Item 1. Consolidated Financial Statements (Unaudited):
Consolidated Statement of Earnings for the three and six months ended June 30, 2019 and 2018	3
Consolidated Statement of Comprehensive Income for the three and six months ended June 30, 2019 and 2018	4
Consolidated Statement of Financial Position at June 30, 2019 and December 31, 2018	5
Consolidated Statement of Cash Flows for the six months ended June 30, 2019 and 2018	7
Consolidated Statement of Changes in Equity for the three and six months ended June 30, 2019 and 2018	8
Notes to Consolidated Financial Statements	10
Item 2. Management’s Discussion and Analysis of Results of Operations and Financial Condition	62
Item 4. Controls and Procedures	100
Part II - Other Information:
Item 1. Legal Proceedings	101
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds and Issuer Repurchases of Equity Securities	101
Item 6. Exhibits	102

2

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)	2019		2018		2019		2018
Revenue:
Services	$	12,352	$	12,886	$	24,775	$	25,848
Sales		6,458		6,721		11,812		12,421
Financing		351		396		756		806
Total revenue		19,161		20,003		37,342		39,075
Cost:
Services		8,272		8,645		16,631		17,479
Sales		1,651		1,869		3,167		3,591
Financing		228		290		492		559
Total cost		10,151		10,804		20,290		21,629
Gross profit		9,010		9,199		17,053		17,445
Expense and other (income):
Selling, general and administrative		5,456		4,857		10,147		10,302
Research, development and engineering		1,407		1,364		2,840		2,769
Intellectual property and custom development income		(222)		(250)		(323)		(567)
Other (income) and expense		(747)		280		(820)		692
Interest expense		348		173		558		338
Total expense and other (income)		6,242		6,423		12,402		13,534
Income from continuing operations before income taxes		2,768		2,776		4,651		3,911
Provision for/(benefit from) income taxes		269		373		558		(166)
Income from continuing operations	$	2,499	$	2,402	$	4,093	$	4,078
Income/(loss) from discontinued operations, net of tax		(1)		1		(4)		5
Net income	$	2,498	$	2,404	$	4,089	$	4,083
Earnings/(loss) per share of common stock:
Assuming dilution:
Continuing operations	$	2.81	$	2.61	$	4.58	$	4.42
Discontinued operations		0.00		0.00		0.00		0.01
Total	$	2.81	$	2.61	$	4.58	$	4.43
Basic:
Continuing operations	$	2.82	$	2.63	$	4.61	$	4.44
Discontinued operations		0.00		0.00		0.00		0.01
Total	$	2.82	$	2.63	$	4.61	$	4.45
Weighted-average number of common shares outstanding: (millions)
Assuming dilution		890.8		919.4		892.4		922.4
Basic		886.3		915.1		887.9		917.9

(Amounts may not add due to rounding.)

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

3

INTERNATIONAL BUSINESS MACHINES CORPORATION

AND SUBSIDIARY COMPANIES

CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME

(UNAUDITED)

	Three Months Ended June 30,				Six Months Ended June 30,
(Dollars in millions)	2019		2018		2019		2018
Net income	$	2,498	$	2,404	$	4,089	$	4,083
Other comprehensive income/(loss), before tax:
Foreign currency translation adjustments		5		(347)		176		(513)
Net changes related to available-for-sale securities:
Unrealized gains/(losses) arising during the period		(2)		0		(3)		(2)
Reclassification of (gains)/losses to net income		—		—		—		0
Total net changes related to available-for-sale securities		(2)		0		(3)		(2)
Unrealized gains/(losses) on cash flow hedges:
Unrealized gains/(losses) arising during the period		(6)		(149)		(359)		(89)
Reclassification of (gains)/losses to net income		(168)		434		(70)		380
Total unrealized gains/(losses) on cash flow hedges		(175)		285		(429)		292
Retirement-related benefit plans:
Prior service costs/(credits)		—		0		—		(1)
Net (losses)/gains arising during the period		116		82		113		84
Curtailments and settlements		3		6		4		6
Amortization of prior service (credits)/costs		(3)		(19)		(6)		(37)
Amortization of net (gains)/losses		460		741		924		1,494
Total retirement-related benefit plans		576		810		1,035		1,545
Other comprehensive income/(loss), before tax		405		748		779		1,322
Income tax (expense)/benefit related to items of other comprehensive income		(64)		(455)		(131)		(598)
Other comprehensive income/(loss), net of tax		340		294		649		724
Total comprehensive income/(loss)	$	2,839	$	2,697	$	4,738	$	4,807

(Amounts may not add due to rounding.)

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

4

INTERNATIONAL BUSINESS MACHINES CORPORATION

AND SUBSIDIARY COMPANIES

CONSOLIDATED STATEMENT OF FINANCIAL POSITION

(UNAUDITED)

ASSETS

	At June 30,		At December 31,
(Dollars in millions)	2019		2018
Assets:
Current assets:
Cash and cash equivalents	$	45,399	$	11,379
Restricted cash		135		225
Marketable securities		874		618
Notes and accounts receivable — trade (net of allowances of $281 in 2019 and $309 in 2018)		7,414		7,432
Short-term financing receivables (net of allowances of $243 in 2019 and $244 in 2018)		15,543		22,388
Other accounts receivable (net of allowances of $39 in 2019 and $38 in 2018)		1,781		743
Inventories, at lower of average cost or net realizable value:
Finished goods		324		266
Work in process and raw materials		1,421		1,415
Total inventories		1,745		1,682
Deferred costs		2,217		2,300
Prepaid expenses and other current assets		2,409		2,378
Total current assets		77,517		49,146
Property, plant and equipment		31,843		32,460
Less: Accumulated depreciation		21,641		21,668
Property, plant and equipment — net		10,202		10,792
Operating right-of-use assets — net*		4,998		—
Long-term financing receivables (net of allowances of $35 in 2019 and $48 in 2018)		8,441		9,148
Prepaid pension assets		5,319		4,666
Deferred costs		2,662		2,676
Deferred taxes		5,274		5,216
Goodwill		35,284		36,265
Intangible assets — net		2,728		3,087
Investments and sundry assets		2,228		2,386
Total assets	$	154,652	$	123,382

* Reflects the adoption of the FASB guidance on leases. Refer to note 2, “Accounting Changes” and note 5, “Leases.”

(Amounts may not add due to rounding.)

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

5

INTERNATIONAL BUSINESS MACHINES CORPORATION

AND SUBSIDIARY COMPANIES

CONSOLIDATED STATEMENT OF FINANCIAL POSITION – (CONTINUED)

(UNAUDITED)

LIABILITIES AND EQUITY

	At June 30,		At December 31,
(Dollars in millions)	2019		2018
Liabilities:
Current liabilities:
Taxes	$	2,439	$	3,046
Short-term debt		14,594		10,207
Accounts payable		4,724		6,558
Compensation and benefits		3,556		3,310
Deferred income		11,261		11,165
Operating lease liabilities*		1,319		—
Other accrued expenses and liabilities		4,458		3,941
Total current liabilities		42,351		38,227
Long-term debt		58,445		35,605
Retirement and nonpension postretirement benefit obligations		16,471		17,002
Deferred income		3,474		3,445
Operating lease liabilities*		3,946		—
Other liabilities		12,190		12,174
Total liabilities		136,876		106,452
Equity:
IBM stockholders’ equity:
Common stock, par value $0.20 per share, and additional paid-in capital		55,404		55,151
Shares authorized: 4,687,500,000
Shares issued: 2019 - 2,236,702,273
2018 - 2,233,427,058
Retained earnings		160,467		159,206
Treasury stock - at cost		(169,385)		(168,071)
Shares: 2019 - 1,350,827,113
2018 - 1,340,947,648
Accumulated other comprehensive income/(loss)		(28,841)		(29,490)
Total IBM stockholders’ equity		17,645		16,796
Noncontrolling interests		131		134
Total equity		17,776		16,929
Total liabilities and equity	$	154,652	$	123,382

* Reflects the adoption of the FASB guidance on leases. Refer to note 2, “Accounting Changes” and note 5, “Leases.”

(Amounts may not add due to rounding.)

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

6

INTERNATIONAL BUSINESS MACHINES CORPORATION

AND SUBSIDIARY COMPANIES

CONSOLIDATED STATEMENT OF CASH FLOWS

(UNAUDITED)

	Six Months Ended June 30,
(Dollars in millions)	2019		2018
Cash flows from operating activities:
Net income	$	4,089	$	4,083
Adjustments to reconcile net income to cash provided by operating activities
Depreciation		2,130		1,547
Amortization of intangibles		610		683
Stock-based compensation		248		242
Net (gain)/loss on asset sales and other		(787)		6
Changes in operating assets and liabilities, net of acquisitions/divestitures		1,410		336
Net cash provided by operating activities		7,700		6,896
Cash flows from investing activities:
Payments for property, plant and equipment		(1,122)		(1,801)
Proceeds from disposition of property, plant and equipment		383		180
Investment in software		(305)		(275)
Acquisition of businesses, net of cash acquired		(43)		(122)
Divestitures of businesses, net of cash transferred		888		—
Non-operating finance receivables — net		3,828		422
Purchases of marketable securities and other investments		(1,803)		(2,811)
Proceeds from disposition of marketable securities and other investments		1,483		2,009
Net cash provided by/(used in) investing activities		3,309		(2,399)
Cash flows from financing activities:
Proceeds from new debt		31,249		2,506
Payments to settle debt		(3,869)		(3,654)
Short-term borrowings/(repayments) less than 90 days — net		(307)		397
Common stock repurchases		(1,236)		(1,767)
Common stock repurchases for tax withholdings		(152)		(143)
Financing — other		41		52
Cash dividends paid		(2,833)		(2,819)
Net cash provided by/(used in) financing activities		22,894		(5,428)
Effect of exchange rate changes on cash, cash equivalents and restricted cash		27		(344)
Net change in cash, cash equivalents and restricted cash		33,930		(1,274)
Cash, cash equivalents and restricted cash at January 1		11,604		12,234
Cash, cash equivalents and restricted cash at June 30	$	45,534	$	10,960

(Amounts may not add due to rounding.)

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

7

INTERNATIONAL BUSINESS MACHINES CORPORATION

AND SUBSIDIARY COMPANIES

CONSOLIDATED STATEMENT OF CHANGES IN EQUITY

(UNAUDITED)

	Common
	Stock and						Accumulated
	Additional						Other		Total IBM		Non-
	Paid-in		Retained		Treasury		Comprehensive		Stockholders’		Controlling		Total
(Dollars in millions)	Capital		Earnings		Stock		Income/(Loss)		Equity		Interests		Equity
Equity - April 1, 2019	$	55,287	$	159,396	$	(169,021)	$	(29,182)	$	16,481	$	126	$	16,607
Net income plus other comprehensive income/(loss):
Net income				2,498						2,498				2,498
Other comprehensive income/(loss)								340		340				340
Total comprehensive income/(loss)									$	2,839			$	2,839
Cash dividends paid — common stock ($1.62 per share)				(1,435)						(1,435)				(1,435)
Common stock issued under employee plans (1,883,226 shares)		117								117				117
Purchases (681,109 shares) and sales (330,849 shares) of treasury stock under employee plans — net				9		(49)				(40)				(40)
Other treasury shares purchased, not retired (2,300,679 shares)						(316)				(316)				(316)
Changes in noncontrolling interests												5		5
Equity – June 30, 2019	$	55,404	$	160,467	$	(169,385)	$	(28,841)	$	17,645	$	131	$	17,776

	Common
	Stock and						Accumulated
	Additional						Other		Total IBM		Non-
	Paid-in		Retained		Treasury		Comprehensive		Stockholders’		Controlling		Total
(Dollars in millions)	Capital		Earnings		Stock		Income/(Loss)		Equity		Interests		Equity
Equity - April 1, 2018	$	54,712	$	156,371	$	(164,334)	$	(28,583)	$	18,166	$	124	$	18,290
Net income plus other comprehensive income/(loss):
Net income				2,404						2,404				2,404
Other comprehensive income/(loss)								294		294				294
Total comprehensive income/(loss)									$	2,697			$	2,697
Cash dividends paid — common stock ($1.57 per share)				(1,437)						(1,437)				(1,437)
Common stock issued under employee plans (1,840,520 shares)		115								115				115
Purchases (620,961 shares) and sales (305,613 shares) of treasury stock under employee plans — net				10		(51)				(41)				(41)
Other treasury shares purchased, not retired (6,725,289 shares)						(980)				(980)				(980)
Changes in noncontrolling interests												3		3
Equity - June 30, 2018	$	54,827	$	157,349	$	(165,366)	$	(28,290)	$	18,520	$	128	$	18,648

(Amounts may not add due to rounding.)

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

8

INTERNATIONAL BUSINESS MACHINES CORPORATION

AND SUBSIDIARY COMPANIES

CONSOLIDATED STATEMENT OF CHANGES IN EQUITY – (CONTINUED)

(UNAUDITED)

	Common
	Stock and						Accumulated
	Additional						Other		Total IBM		Non-
	Paid-in		Retained		Treasury		Comprehensive		Stockholders’		Controlling		Total
(Dollars in millions)	Capital		Earnings		Stock		Income/(Loss)		Equity		Interests		Equity
Equity - January 1, 2019	$	55,151	$	159,206	$	(168,071)	$	(29,490)	$	16,796	$	134	$	16,929
Net income plus other comprehensive income/(loss):
Net income				4,089						4,089				4,089
Other comprehensive income/(loss)								649		649				649
Total comprehensive income/(loss)									$	4,738			$	4,738
Cash dividends paid — common stock ($3.19 per share)				(2,833)						(2,833)				(2,833)
Common stock issued under employee plans (3,275,215 shares)		254								254				254
Purchases (1,135,819 shares) and sales (413,711 shares) of treasury stock under employee plans — net				11		(99)				(88)				(88)
Other treasury shares purchased, not retired (9,157,357 shares)						(1,216)				(1,216)				(1,216)
Changes in other equity				(5)						(5)				(5)
Changes in noncontrolling interests												(3)		(3)
Equity - June 30, 2019	$	55,404	$	160,467	$	(169,385)	$	(28,841)	$	17,645	$	131	$	17,776

	Common
	Stock and						Accumulated
	Additional						Other		Total IBM		Non-
	Paid-in		Retained		Treasury		Comprehensive		Stockholders’		Controlling		Total
(Dollars in millions)	Capital		Earnings		Stock		Income/(Loss)		Equity		Interests		Equity
Equity - January 1, 2018	$	54,566	$	153,126	$	(163,507)	$	(26,592)	$	17,594	$	131	$	17,725
Cumulative effect of change in accounting principle:
Revenue				524						524				524
Stranded tax effects/other *				2,422				(2,422)
Net income plus other comprehensive income/(loss):
Net income				4,083						4,083				4,083
Other comprehensive income/(loss)								724		724				724
Total comprehensive income/(loss)									$	4,807			$	4,807
Cash dividends paid — common stock ($3.07 per share)				(2,819)						(2,819)				(2,819)
Common stock issued under employee plans (2,877,775 shares)		261								261				261
Purchases (946,596 shares) and sales (351,491 shares) of treasury stock under employee plans — net				12		(98)				(86)				(86)
Other treasury shares purchased, not retired (11,693,706 shares)						(1,761)				(1,761)				(1,761)
Changes in noncontrolling interests												(3)		(3)
Equity - June 30, 2018	$	54,827	$	157,349	$	(165,366)	$	(28,290)	$	18,520	$	128	$	18,648

* Reflects the adoption of the FASB guidance on stranded tax effects, hedging and financial instruments. Refer to note 2, “Accounting Changes.”

(Amounts may not add due to rounding.)

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

9

Notes to Consolidated Financial Statements

1. Basis of Presentation:

The accompanying Consolidated Financial Statements and footnotes of the International Business Machines Corporation (IBM or the company) have been prepared in accordance with accounting principles generally accepted in the United States of America (GAAP). The financial statements and footnotes are unaudited. In the opinion of the company’s management, these statements include all adjustments, which are only 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 GAAP requires management to make estimates and assumptions that affect the amount of assets, liabilities, revenue, costs, expenses and other comprehensive income/(loss) that are reported in the Consolidated Financial Statements and accompanying disclosures. These estimates are based on management’s best knowledge of current events, historical experience, actions that the company may undertake in the future and on various other assumptions that are believed to be reasonable under the circumstances. As a result, actual results may be different from these estimates.

In the first quarter of 2019, the company made a number of changes to its organizational structure and management system. These changes impacted the company’s reportable segments, but did not impact the company’s Consolidated Financial Statements. Refer to note 8, “Segments,” for additional information on the changes in reportable segments. The periods presented in this Form 10-Q are reported on a comparable basis. The company provided recast historical segment information reflecting these changes in a Form 8-K dated April 4, 2019.

Noncontrolling interest amounts of $4.9 million and $3.8 million, net of tax, for the three months ended June 30, 2019 and 2018, respectively, and $11.9 million and $11.7 million, net of tax, for the six months ended June 30, 2019 and 2018, respectively, are included as a reduction within other (income) and expense in the Consolidated Statement of Earnings.

Interim results are not necessarily indicative of financial results for a full year. The information included in this Form 10-Q should be read in conjunction with the company’s 2018 Annual Report.

Within the financial statements and tables presented, 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. Certain prior year amounts have been reclassified to conform to the current year presentation. This is annotated where applicable.

2. Accounting Changes:

New Standards to be Implemented

In August 2018, the Financial Accounting Standards Board (FASB) issued guidance which changed the disclosure requirements for fair value measurements and defined benefit plans. The guidance is effective for each of the topics on January 1, 2020 and December 31, 2020, respectively, with early adoption of certain provisions permitted. The company early adopted the provision in the fair value guidance that removed the Level 1/Level 2 transfer disclosures. The company is evaluating the adoption date for the remaining changes. As the guidance is a change to disclosures only, the company does not expect the guidance to have a material impact in the consolidated financial results.

In January 2017, the FASB issued guidance that simplifies the goodwill impairment test by removing Step 2. The guidance also changes the requirements for reporting units with zero or negative carrying amounts and requires additional disclosures for these reporting units. The guidance is effective January 1, 2020 and early adoption is permitted. The company expects to adopt the guidance on a prospective basis on the effective date. The company is evaluating the impact of the guidance.

10

Notes to Consolidated Financial Statements — (continued)

In June 2016, with amendments in 2018 and 2019, the FASB issued guidance for credit impairment based on an expected loss model rather than an incurred loss model. The guidance requires the consideration of all available relevant information when estimating expected credit losses, including past events, current conditions and forecasts and their implications for expected credit losses. The new guidance expands the scope of financial instruments subject to impairment, including off-balance sheet commitments and residual value. The guidance is effective January 1, 2020 with one-year early adoption permitted. The company will adopt the guidance as of the effective date. A cross-functional team was established to evaluate the impact of the guidance on the financial instruments portfolio. All of the changes to systems, processes and policies are on track for completion before the effective date. The guidance is not expected to have a material impact in the consolidated financial results.

Standards Implemented

The FASB issued guidance in February 2016, with amendments in 2018 and 2019, which changed the accounting for leases. The guidance requires lessees to recognize right-of-use (ROU) assets and lease liabilities for most leases in the Consolidated Statement of Financial Position. The guidance also made some changes to lessor accounting, including elimination of the use of third-party residual value guarantee insurance in the lease classification test, and overall aligns with the new revenue recognition guidance. The guidance requires qualitative and quantitative disclosures to assess the amount, timing and uncertainty of cash flows arising from leases. The company adopted the guidance effective January 1, 2019, using the transition option whereby prior comparative periods were not retrospectively presented in the Consolidated Financial Statements. The company elected the package of practical expedients not to reassess prior conclusions related to contracts containing leases, lease classification and initial direct costs and the lessee practical expedient to combine lease and nonlease components for all asset classes. The company made a policy election to not recognize ROU assets and lease liabilities for short-term leases for all asset classes. The guidance had a material impact on the Consolidated Statement of Financial Position as of the effective date. As a lessee, at adoption, the company recognized operating and financing ROU assets of $4.8 billion and $0.2 billion, respectively, and operating and financing lease liabilities of $5.1 billion and $0.2 billion, respectively. The transition adjustment recognized in retained earnings on January 1, 2019 was not material. From a lessor perspective, the changes in lease termination guidance and removal of third-party residual value guarantee insurance in the lease classification test did not have a material impact in the consolidated financial results. Refer to note 5, “Leases,” for additional information, including further discussion on the impact of adoption.

In August 2018, the FASB issued guidance on a customer’s accounting for implementation costs incurred in cloud-computing arrangements that are hosted by a vendor. Certain types of implementation costs should be capitalized and amortized over the term of the hosting arrangement. The guidance is effective January 1, 2020 and early adoption is permitted. The company adopted the guidance on January 1, 2019 on a prospective basis. The guidance did not have a material impact in the consolidated financial results.

In February 2018, the FASB issued guidance that allows entities to elect an option to reclassify the stranded tax effects related to the application of U.S. tax reform from accumulated other comprehensive income/(loss) (AOCI) to retained earnings. The guidance was effective January 1, 2019 with early adoption permitted, and can be applied either in the period of adoption or retrospectively to all applicable periods. The company adopted the guidance effective January 1, 2018, and elected not to reclassify prior periods. In accordance with its accounting policy, the company releases income tax effects from AOCI once the reason the tax effects were established cease to exist (e.g., when available-for-sale debt securities are sold or if a pension plan is liquidated). This guidance allows for the reclassification of stranded tax effects as a result of the change in tax rates from U.S. tax reform to be recorded upon adoption of the guidance rather than at the actual cessation date. At adoption on January 1, 2018, $2.4 billion was reclassified from AOCI to retained earnings, primarily comprised of amounts relating to retirement-related benefit plans.

In August 2017, the FASB issued guidance to simplify the application of hedge accounting in certain areas, better portray the economic results of an entity’s risk management activities in its financial statements and make targeted improvements to presentation and disclosure requirements. The guidance was effective January 1, 2019 with early

11

Notes to Consolidated Financial Statements — (continued)

adoption permitted. The company adopted the guidance as of January 1, 2018, and it did not have a material impact in the consolidated financial results.

In March 2017, the FASB issued guidance that impacts the presentation of net periodic pension and postretirement benefit costs (net benefit cost). Under the guidance, the service cost component of net benefit cost continues to be presented within cost, SG&A expense and RD&E expense in the Consolidated Statement of Earnings, unless eligible for capitalization. The other components of net benefit cost are presented separately from service cost within other (income) and expense in the Consolidated Statement of Earnings. The guidance was effective January 1, 2018 with early adoption permitted. The company adopted the guidance as of the effective date. The guidance is primarily a change in financial statement presentation and did not have a material impact in the consolidated financial results. This presentation change was applied retrospectively upon adoption.

In January 2016, the FASB issued guidance which addresses aspects of recognition, measurement, presentation and disclosure of financial instruments. The guidance was effective January 1, 2018 and early adoption was not permitted except for limited provisions. The company adopted the guidance on the effective date. The guidance required certain equity investments to be measured at fair value with changes recognized in net income. The amendment also simplified the impairment test of equity investments that lack readily determinable fair value. The guidance did not have a material impact in the consolidated financial results.

The FASB issued guidance on the recognition of revenue from contracts with customers in May 2014 with amendments in 2015 and 2016. Revenue recognition depicts the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The guidance also requires specific disclosures relating to revenue recognition. The company adopted the guidance effective January 1, 2018 using the modified retrospective transition method. At adoption, $557 million was reclassified from notes and accounts receivable-trade and deferred income-current to prepaid expenses and other current assets to establish the opening balance for net contract assets. In-scope sales commission costs previously recorded in the Consolidated Statement of Earnings were capitalized in deferred costs in accordance with the transition guidance, in the amount of $737 million. Deferred income of $29 million was recorded for certain software licenses that will be recognized over time versus at point in time under previous guidance. Additionally, net deferred taxes were reduced by $184 million in the Consolidated Statement of Financial Position, resulting in a cumulative-effect net increase to retained earnings of $524 million. In the fourth quarter of 2018, the company recognized an additional impact to net deferred taxes and retained earnings of $56 million, resulting in a total net increase to retained earnings of $580 million. The decrease to net deferred taxes was the result of the company’s election to include Global Intangible Low-Taxed Income (GILTI) in measuring deferred taxes. The revenue guidance did not have a material impact in the company’s consolidated financial results. Refer to note 3, “Revenue Recognition,” for additional information.

In March 2016, the FASB issued guidance which changed the accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities and classification in the Consolidated Statement of Cash Flows. The guidance was effective and adopted by the company on January 1, 2017, and it did not have a material impact on the Consolidated Statement of Financial Position. The ongoing impact of the guidance could result in increased volatility in the provision for income taxes and earnings per share in the Consolidated Statement of Earnings, depending on the company’s share price at exercise or vesting of share-based awards compared to grant date, however these impacts are not expected to be material. These impacts are recorded on a prospective basis. The company continues to estimate forfeitures in conjunction with measuring stock-based compensation cost. The guidance also requires cash payments on behalf of employees for shares directly withheld for taxes to be presented as financing outflows in the Consolidated Statement of Cash Flows. The FASB also issued guidance in May 2017 and June 2018, which relates to the accounting for modifications of share-based payment awards and accounting for share-based payments issued to non-employees, respectively. The company adopted the guidance for modifications in the second quarter of 2017, and guidance for non-employees’ payments in the second quarter of 2018. The guidance had no impact in the consolidated financial results.

12

Notes to Consolidated Financial Statements — (continued)

3. Revenue Recognition:

Disaggregation of Revenue

The following tables provide details of revenue by major products/service offerings and by geography.

Revenue by Major Products/Service Offerings

(Dollars in millions)	Cloud &		Global		Global
For the three months	Cognitive		Business		Technology				Global				Total
ended June 30, 2019:	Software		Services		Services		Systems		Financing		Other		Revenue
Cognitive Applications	$	1,454	$	—	$	—	$	—	$	—	$	—	$	1,454
Cloud & Data Platforms		2,173		—		—		—		—		—		2,173
Transaction Processing Platforms		2,018		—		—		—		—		—		2,018
Consulting		—		1,978		—		—		—		—		1,978
Application Management		—		1,919		—		—		—		—		1,919
Global Process Services		—		258		—		—		—		—		258
Infrastructure & Cloud Services		—		—		5,174		—		—		—		5,174
Technology Support Services		—		—		1,663		—		—		—		1,663
Systems Hardware		—		—		—		1,328		—		—		1,328
Operating Systems Software		—		—		—		425		—		—		425
Global Financing*		—		—		—		—		351		—		351
Other Revenue		—		—		—		—		—		420		420
Total	$	5,645	$	4,155	$	6,837	$	1,753	$	351	$	420	$	19,161

* Contains lease and loan/working capital financing arrangements which are not subject to the guidance on revenue from contracts with customers.

Revenue by Geography

(Dollars in millions)	Total
For the three months ended June 30, 2019:	Revenue
Americas	$	8,806
Europe/Middle East/Africa		6,149
Asia Pacific		4,205
Total	$	19,161

13

Notes to Consolidated Financial Statements — (continued)

Revenue by Major Products/Service Offerings

(Dollars in millions)	Cloud &		Global		Global
For the three months	Cognitive		Business		Technology				Global				Total
ended June 30, 2018:	Software*		Services*		Services*		Systems		Financing		Other*		Revenue
Cognitive Applications	$	1,413	$	—	$	—	$	—	$	—	$	—	$	1,413
Cloud & Data Platforms		2,079		—		—		—		—		—		2,079
Transaction Processing Platforms		1,978		—		—		—		—		—		1,978
Consulting		—		1,931		—		—		—		—		1,931
Application Management		—		1,946		—		—		—		—		1,946
Global Process Services		—		258		—		—		—		—		258
Infrastructure & Cloud Services		—		—		5,575		—		—		—		5,575
Technology Support Services		—		—		1,750		—		—		—		1,750
Systems Hardware		—		—		—		1,756		—		—		1,756
Operating Systems Software		—		—		—		421		—		—		421
Global Financing**		—		—		—		—		394		—		394
Other Revenue		—		—		—		—		—		503		503
Total	$	5,470	$	4,135	$	7,325	$	2,177	$	394	$	503	$	20,003

*   Recast to conform to 2019 presentation.

** Contains lease and loan/working capital financing arrangements which are not subject to the guidance on revenue from contracts with customers.

Revenue by Geography

(Dollars in millions)	Total
For the three months ended June 30, 2018:	Revenue
Americas	$	9,212
Europe/Middle East/Africa		6,407
Asia Pacific		4,384
Total	$	20,003

14

Notes to Consolidated Financial Statements — (continued)

Revenue by Major Products/Service Offerings

(Dollars in millions)	Cloud &		Global		Global
For the six months	Cognitive		Business		Technology				Global				Total
ended June 30, 2019:	Software		Services		Services		Systems		Financing		Other		Revenue
Cognitive Applications	$	2,762	$	—	$	—	$	—	$	—	$	—	$	2,762
Cloud & Data Platforms		4,090		—		—		—		—		—		4,090
Transaction Processing Platforms		3,830		—		—		—		—		—		3,830
Consulting		—		3,942		—		—		—		—		3,942
Application Management		—		3,827		—		—		—		—		3,827
Global Process Services		—		505		—		—		—		—		505
Infrastructure & Cloud Services		—		—		10,383		—		—		—		10,383
Technology Support Services		—		—		3,328		—		—		—		3,328
Systems Hardware		—		—		—		2,241		—		—		2,241
Operating Systems Software		—		—		—		840		—		—		840
Global Financing*		—		—		—		—		757		—		757
Other Revenue		—		—		—		—		—		837		837
Total	$	10,682	$	8,274	$	13,711	$	3,081	$	757	$	837	$	37,342

* Contains lease and loan/working capital financing arrangements which are not subject to the guidance on revenue from contracts with customers.

Revenue by Geography

(Dollars in millions)	Total
For the six months ended June 30, 2019:	Revenue
Americas	$	17,299
Europe/Middle East/Africa		11,876
Asia Pacific		8,167
Total	$	37,342

15

Notes to Consolidated Financial Statements — (continued)

Revenue by Major Products/Service Offerings

(Dollars in millions)	Cloud &		Global		Global
For the six months	Cognitive		Business		Technology				Global				Total
ended June 30, 2018:	Software*		Services*		Services*		Systems		Financing		Other*		Revenue
Cognitive Applications	$	2,699	$	—	$	—	$	—	$	—	$	—	$	2,699
Cloud & Data Platforms		4,029		—		—		—		—		—		4,029
Transaction Processing Platforms		3,858		—		—		—		—		—		3,858
Consulting		—		3,798		—		—		—		—		3,798
Application Management		—		3,948		—		—		—		—		3,948
Global Process Services		—		504		—		—		—		—		504
Infrastructure & Cloud Services		—		—		11,214		—		—		—		11,214
Technology Support Services		—		—		3,531		—		—		—		3,531
Systems Hardware		—		—		—		2,848		—		—		2,848
Operating Systems Software		—		—		—		828		—		—		828
Global Financing**		—		—		—		—		799		—		799
Other Revenue		—		—		—		—		—		1,017		1,017
Total	$	10,586	$	8,250	$	14,746	$	3,676	$	799	$	1,017	$	39,075

*   Recast to conform to 2019 presentation.

** Contains lease and loan/working capital financing arrangements which are not subject to the guidance on revenue from contracts with customers.

Revenue by Geography

(Dollars in millions)	Total
For the six months ended June 30, 2018:	Revenue
Americas	$	17,919
Europe/Middle East/Africa		12,583
Asia Pacific		8,573
Total	$	39,075

Remaining Performance Obligations

The remaining performance obligation (RPO) disclosure provides the aggregate amount of the transaction price yet to be recognized as of the end of the reporting period and an explanation as to when the company expects to recognize these amounts in revenue. It is intended to be a statement of overall work under contract that has not yet been performed and does not include contracts in which the customer is not committed, such as certain as-a-Service, governmental, term software license and services offerings. The customer is not considered committed when they are able to terminate for convenience without payment of a substantive penalty. The disclosure includes estimates of variable consideration, except when the variable consideration is a sales-based or usage-based royalty promised in exchange for a license of intellectual property. Additionally, as a practical expedient, the company does not include contracts that have an original duration of one year or less. Remaining performance obligation estimates are subject to change and are affected by several factors, including terminations, changes in the scope of contracts, periodic revalidations, adjustment for revenue that has not materialized and adjustments for currency.

16

Notes to Consolidated Financial Statements — (continued)

At June 30, 2019, the aggregate amount of the transaction price allocated to RPO related to customer contracts that are unsatisfied or partially unsatisfied was $119 billion. Given the profile of contract terms, approximately 60 percent of this amount is expected to be recognized as revenue over the next two years, approximately 35 percent between three and five years and the balance (mostly Infrastructure & Cloud Services) thereafter.

At December 31, 2018, the aggregate amount of the transaction price allocated to RPO related to customer contracts that were unsatisfied or partially unsatisfied was $124 billion. Given the profile of contract terms, approximately 60 percent of this amount was expected to be recognized as revenue over the next two years, approximately 35 percent between three and five years and the balance (mostly Infrastructure & Cloud Services) thereafter.

Revenue Recognized for Performance Obligations Satisfied (or Partially Satisfied) in Prior Periods

For the three and six months ending June 30, 2019, revenue was reduced by $22 million and $35 million, respectively, for performance obligations satisfied (or partially satisfied) in previous periods mainly due to changes in estimates on percentage-of-completion based contracts.

For the three and six months ending June 30, 2018, the impact to revenue for performance obligations satisfied (or partially satisfied) in previous periods was immaterial.

Reconciliation of Contract Balances

The following table provides information about notes and accounts receivables — trade, contract assets and deferred income balances:

	At June 30,		At December 31,
(Dollars in millions)	2019		2018
Notes and accounts receivable—trade (net of allowances of $281 and $309 at June 30, 2019 and December 31, 2018, respectively)	$	7,414	$	7,432
Contract assets(1)		594		470
Deferred income (current)		11,261		11,165
Deferred income (noncurrent)		3,474		3,445

(1) Included within prepaid expenses and other current assets in the Consolidated Statement of Financial Position.

The amount of revenue recognized during the three and six months ended June 30, 2019 that was included within the deferred income balance at March 31, 2019 and December 31, 2018 was $3.8 billion and $5.7 billion, respectively, and primarily related to services and software.

The amount of revenue recognized during the three and six months ended June 30, 2018 that was included within the deferred income balance at March 31, 2018 and January 1, 2018 was $4.0 billion and $6.0 billion, respectively, and primarily related to services and software.

4. Financial Instruments:

Fair Value Measurements

Accounting guidance defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Under this guidance, the company is required to classify certain assets and liabilities based on the following fair value hierarchy:

● Level 1—Quoted prices (unadjusted) in active markets for identical assets or liabilities that can be accessed at the measurement date;

17

Notes to Consolidated Financial Statements — (continued)

● Level 2—Inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly; and

● Level 3—Unobservable inputs for the asset or liability.

The guidance requires the use of observable market data if such data is available without undue cost and effort.

When available, the company uses unadjusted quoted market prices in active markets to measure the fair value and classifies such items as Level 1. If quoted market prices are not available, fair value is based upon internally developed models that use current market-based or independently sourced market parameters such as interest rates and currency rates. Items valued using internally generated models are classified according to the lowest level input or value driver that is significant to the valuation.

The determination of fair value considers various factors including interest rate yield curves and time value underlying the financial instruments. For derivatives and debt securities, the company uses a discounted cash flow analysis using discount rates commensurate with the duration of the instrument.

In determining the fair value of financial instruments, the company considers certain market valuation adjustments to the “base valuations” calculated using the methodologies described below for several parameters that market participants would consider in determining fair value:

● Counterparty credit risk adjustments are applied to financial instruments, taking into account the actual credit risk of a counterparty as observed in the credit default swap market to determine the true fair value of such an instrument.

● Credit risk adjustments are applied to reflect the company’s own credit risk when valuing all liabilities measured at fair value. The methodology is consistent with that applied in developing counterparty credit risk adjustments, but incorporates the company’s own credit risk as observed in the credit default swap market.

As an example, the fair value of derivatives is derived utilizing a discounted cash flow model that uses observable market inputs such as known notional value amounts, yield curves, spot and forward exchange rates as well as discount rates. These inputs relate to liquid, heavily traded currencies with active markets which are available for the full term of the derivative.

Certain assets that are measured at fair value on a recurring basis can be subject to nonrecurring fair value measurements. These assets include available-for-sale debt securities that are deemed to be other-than-temporarily impaired. In the event of an other-than-temporary impairment of a debt security, fair value is measured using a model described above.

Certain non-financial assets such as property, plant and equipment, operating right-of-use assets, land, goodwill and intangible assets are also subject to nonrecurring fair value measurements if they are deemed to be impaired. The impairment models used for non-financial assets depend on the type of asset. There were no material impairments of non-financial assets for the six months ended June 30, 2019 and 2018, respectively.

Accounting guidance permits the measurement of eligible financial assets, financial liabilities and firm commitments at fair value, on an instrument-by-instrument basis, that are otherwise not permitted to be accounted for at fair value under other accounting standards. This election is irrevocable. The company has not applied the fair value option to any eligible assets or liabilities.

18

Notes to Consolidated Financial Statements — (continued)

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, 2019 and December 31, 2018.

(Dollars in millions)
At June 30, 2019	Level 1		Level 2		Level 3		Total
Assets:
Cash equivalents(1)
Time deposits and certificates of deposit	$	—	$	19,095	$	—	$	19,095	(6)
Money market funds		6,001		—		—		6,001
Total	$	6,001	$	19,095	$	—	$	25,096
Equity investments(2)		0		1		—		1
Debt securities - current(3)		—		873		—		873	(6)
Derivative assets(4)		4		415		—		419
Total assets	$	6,005	$	20,384	$	—	$	26,390
Liabilities:
Derivative liabilities(5)	$	—	$	589	$	—	$	589

(1) Included within cash and cash equivalents in the Consolidated Statement of Financial Position.

(2) Included within investments and sundry assets in the Consolidated Statement of Financial Position.

(3) Included within marketable securities in the Consolidated Statement of Financial Position.

(4) 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, 2019 were $204 million and $215 million, respectively.

(5) 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, 2019 were $212 million and $377 million, respectively.

(6) Available-for-sale debt securities with carrying values that approximate fair value.

(Dollars in millions)
At December 31, 2018	Level 1		Level 2		Level 3		Total
Assets:
Cash equivalents(1)
Time deposits and certificates of deposit	$	—	$	7,679	$	—	$	7,679	(6)
Money market funds		25		—		—		25
Total	$	25	$	7,679	$	—	$	7,704
Equity investments(2)		0		—		—		0
Debt securities - current(3)		—		618		—		618	(6)
Derivative assets(4)		1		731		—		731
Total assets	$	26	$	9,028	$	—	$	9,053
Liabilities:
Derivative liabilities(5)	$	40	$	343	$	—	$	383

(1) Included within cash and cash equivalents in the Consolidated Statement of Financial Position.

(2) Included within investments and sundry assets in the Consolidated Statement of Financial Position.

(3) Included within marketable securities in the Consolidated Statement of Financial Position.

(4) 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, 2018 were $385 million and $347 million, respectively.

(5) 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, 2018 were $177 million and $206 million, respectively.

(6) Available-for-sale debt securities with carrying values that approximate fair value.

19

Notes to Consolidated Financial Statements — (continued)

Financial Assets and Liabilities Not Measured at Fair Value

Short-Term Receivables and Payables

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 (excluding the current portion of long-term debt and including short-term finance lease liabilities) are financial liabilities with carrying values that approximate fair value. If measured at fair value in the financial statements, these financial instruments would be classified as Level 3 in the fair value hierarchy, except for short-term debt which would be classified as Level 2.

Loans and Long-Term Receivables

Fair values 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. At June 30, 2019 and December 31, 2018, the difference between the carrying amount and estimated fair value for loans and long-term receivables was immaterial. If measured at fair value in the financial statements, these financial instruments would be classified as Level 3 in the fair value hierarchy.

Long-Term Debt

Fair value of publicly-traded long-term debt is based on quoted market prices for the identical liability when traded as an asset in an active market. For other long-term debt (including long-term finance lease liabilities) for which a quoted market price is not available, an expected present value technique that uses rates currently available to the company for debt with similar terms and remaining maturities is used to estimate fair value. The carrying amount of long-term debt was $58,445 million and $35,605 million, and the estimated fair value was $62,018 million and $36,599 million at June 30, 2019 and December 31, 2018, respectively. If measured at fair value in the financial statements, long-term debt (including the current portion) would be classified as Level 2 in the fair value hierarchy.

Available-for-Sale Securities

There were no gross realized gains/losses from the sale of available-for-sale securities during the three and six month periods ended June 30, 2019 and gross realized gains/losses for the three and six months ended June 30, 2018 were immaterial. After-tax net unrealized holding gains/losses on available-for-sale securities that have been included in other comprehensive income/loss for the three and six month periods ended June 30, 2019 and 2018 were immaterial.

The contractual maturities of substantially all available-for-sale debt securities are less than one year at June 30, 2019.

Derivative Financial Instruments

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

20

Notes to Consolidated Financial Statements — (continued)

policy of only entering into contracts with carefully selected major financial institutions based upon their overall credit profile. 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 most of its major derivative 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 under these collateralized arrangements that were in a liability position at June 30, 2019 and December 31, 2018 was $325 million and $74 million, respectively, for which $8 million of collateral was posted by the company and reduced the position at June 30, 2019 and no collateral was posted at December 31, 2018. Full 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 asset positions at June 30, 2019 and December 31, 2018 was $419 million and $731 million, respectively. This amount represents the maximum exposure to loss at the reporting date if the counterparties failed to perform as contracted. This exposure was reduced by $262 million and $267 million at June 30, 2019 and December 31, 2018, respectively, of liabilities included in master netting arrangements with those counterparties. Additionally, at December 31, 2018, this exposure was reduced by $70 million of cash collateral received from counterparties, and no collateral was received at June 30, 2019. There were no non-cash collateral balances received from counterparties in U.S. Treasury securities at June 30, 2019 and December 31, 2018. At June 30, 2019 and December 31, 2018, the net exposure related to derivative assets recorded in the Consolidated Statement of Financial Position was $157 million and $395 million, respectively.  At June 30, 2019 and December 31, 2018, the net position related to derivative liabilities recorded in the Consolidated Statement of Financial Position was $320 million and $116 million, respectively.

In the Consolidated Statement of Financial Position, 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. The amount recognized in other receivables for the right to reclaim cash collateral was $8 million at June 30, 2019. No amount was recognized in other receivables at December 31, 2018 for the right to reclaim cash collateral. The amount recognized in accounts payable for the obligation to return cash collateral was $70 million at December 31, 2018. No amount was recognized in accounts payable for the obligation to return cash collateral at June 30, 2019. The company restricts the use of cash collateral received to rehypothecation, and therefore reports it in restricted cash in the Consolidated Statement of Financial Position. No amount was rehypothecated at June 30, 2019 and December 31, 2018.  

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, expose the company to liquidity risk as the derivatives have an immediate cash flow impact upon maturity which is not offset by a cash flow from the translation of the underlying hedged equity. The company monitors this cash loss potential on an ongoing basis and may discontinue some of these hedging relationships by de-designating or terminating the derivative instrument in order to manage the liquidity risk. Although not designated as accounting hedges, the company may utilize derivatives to offset the changes in the fair value of the de-designated instruments from the date of de-designation until maturity.

In its hedging programs, the company may use forward contracts, futures contracts, interest-rate swaps, cross-currency swaps, equity swaps, and options 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.

21

Notes to Consolidated Financial Statements — (continued)

Interest Rate Risk

Fixed and Variable Rate Borrowings

The company issues debt in the global capital markets to fund its operations and financing business. 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 may use 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, 2019 and December 31, 2018, the total notional amount of the company’s interest-rate swaps was $5.5 billion and $7.6 billion, respectively. The weighted-average remaining maturity of these instruments at June 30, 2019 and December 31, 2018 was approximately 2.5 years and 3.5 years, respectively. These interest-rate contracts were accounted for as fair value hedges. The company did not have any cash flow hedges relating to this program outstanding at June 30, 2019 and December 31, 2018.

Forecasted Debt Issuance

The company is exposed to interest rate volatility on future debt issuances. To manage this risk, the company may use instruments such as forward starting interest-rate swaps to lock in the rate on the interest payments related to the forecasted debt issuances. On May 15, 2019, the company issued an aggregate of $20 billion of indebtedness (see note 13, “Borrowings,” for additional information). Following the receipt of the net proceeds from this debt offering, the company terminated $5.5 billion of forward starting interest-rate swaps. These instruments were designated and accounted for as cash flow hedges for a portion of this issuance and hedged exposure to the variability in future cash flows over a maximum of 30 years. These swaps were the only instruments outstanding under this program at December 31, 2018, and there were no instruments outstanding at June 30, 2019.

In connection with cash flow hedges of forecasted interest payments related to the company's borrowings, the company recorded net losses of $201 million and net losses of $35 million (before taxes) at June 30, 2019 and December 31, 2018, respectively, in AOCI. The company estimates that $18 million (before taxes) of the deferred net losses on derivatives in AOCI at June 30, 2019 will be reclassified to net income within the next 12 months, providing an offsetting economic impact against the underlying anticipated transactions.

Foreign Exchange Risk

Long-Term Investments in Foreign Subsidiaries (Net Investment)

A large portion of the company’s foreign currency denominated debt portfolio is designated as a hedge of net investment in foreign subsidiaries 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, 2019 and December 31, 2018, the total notional amount of derivative instruments designated as net investment hedges was $6.5 billion and $6.4 billion, respectively. At June 30, 2019 and December 31, 2018, the weighted-average remaining maturity of these instruments was approximately 0.2 years at both periods.

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 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 has hedged its exposure to the variability in future cash flows is four years. At June 30, 2019 and December 31, 2018, the total notional amount of forward contracts designated as cash flow hedges of forecasted royalty and cost transactions was $10.0 billion and $9.8

22

Notes to Consolidated Financial Statements — (continued)

billion, respectively. At June 30, 2019 and December 31, 2018, the weighted-average remaining maturity of these instruments was approximately 0.8 years at both periods.

At June 30, 2019 and December 31, 2018, in connection with cash flow hedges of anticipated royalties and cost transactions, the company recorded net gains of $238 million and net gains of $342 million (before taxes), respectively, in AOCI. The company estimates that $133 million (before taxes) of deferred net gains on derivatives in AOCI at June 30, 2019 will be reclassified to net income within the next 12 months, providing an offsetting economic impact against the underlying anticipated transactions.

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. The maximum length of time over which the company has hedged its exposure to the variability in future cash flows is approximately 12 years. At June 30, 2019 and December 31, 2018, the total notional amount of cross-currency swaps designated as cash flow hedges of foreign currency denominated debt was $12.2 billion and $6.5 billion, respectively.

At June 30, 2019 and December 31, 2018, in connection with cash flow hedges of foreign currency denominated borrowings, the company recorded net losses of $84 million and net gains of $75 million (before taxes), respectively, in AOCI. The company estimates that $305 million (before taxes) of deferred net gains on derivatives in AOCI at June 30, 2019 will be reclassified to net income within the next 12 months, providing an offsetting economic impact against the underlying exposure.

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 one year. 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, 2019 and December 31, 2018, the total notional amount of derivative instruments in economic hedges of foreign currency exposure was $6.7 billion and $5.2 billion, respectively.

Equity Risk Management

The company is exposed to market price changes in certain broad market indices and in the company’s own stock primarily related to certain obligations to employees. Changes in the overall value of these employee compensation obligations are recorded in SG&A expense in the Consolidated Statement of Earnings. Although not designated as accounting hedges, the company utilizes 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 market indices or the total return on the company’s common stock, and are recorded at fair value with gains or losses also reported in SG&A expense in the Consolidated Statement of Earnings. At June 30, 2019 and December 31, 2018, the total notional amount of derivative instruments in economic hedges of these compensation obligations was $1.2 billion at both periods.

Other Risks

The company may hold warrants to purchase 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

23

Notes to Consolidated Financial Statements — (continued)

changes in the fair value of these warrants in other (income) and expense in the Consolidated Statement of Earnings. The company did not have any warrants qualifying as derivatives outstanding at June 30, 2019 and December 31, 2018.

The company is exposed to a potential loss if a client fails to pay amounts due under contractual terms. The company may utilize credit default swaps to economically hedge its credit exposures. 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 did not have any derivative instruments relating to this program outstanding at June 30, 2019 and December 31, 2018.

The company is exposed to market volatility on certain investment securities. The company may utilize options or forwards to economically hedge its market exposure. The derivatives are recorded at fair value with gains and losses reported in other (income) and expense in the Consolidated Statement of Earnings. At June 30, 2019 and December 31, 2018, the company did not have any derivative instruments relating to this program outstanding.

The following tables provide a quantitative summary of the derivative and non-derivative instrument-related risk management activity at June 30, 2019 and December 31, 2018, as well as for the three and six months ended June 30, 2019 and 2018, respectively.

24

Notes to Consolidated Financial Statements — (continued)

Fair Values of Derivative Instruments in the Consolidated Statement of Financial Position

	Fair Value of Derivative Assets					Fair Value of Derivative Liabilities
	Balance Sheet					Balance Sheet
(Dollars in millions)	Classification	6/30/2019		12/31/2018		Classification	6/30/2019		12/31/2018
Designated as hedging instruments:
Interest rate contracts	Prepaid expenses and other current assets	$	5	$	9	Other accrued expenses and liabilities	$	—	$	4
	Investments and sundry assets		107		212	Other liabilities		1		76
Foreign exchange contracts	Prepaid expenses and other current assets		177		348	Other accrued expenses and liabilities		199		110
	Investments and sundry assets		108		135	Other liabilities		376		129
	Fair value of derivative assets	$	397	$	704	Fair value of derivative liabilities	$	576	$	320
Not designated as hedging instruments:
Foreign exchange contracts	Prepaid expenses and other current assets	$	14	$	26	Other accrued expenses and liabilities	$	12	$	13
Equity contracts	Prepaid expenses and other current assets		8		2	Other accrued expenses and liabilities		1		51
	Fair value of derivative assets	$	22	$	28	Fair value of derivative liabilities	$	13	$	63
Total derivatives		$	419	$	731		$	589	$	383
Total debt designated as hedging instruments(1):
Short-term debt			N/A		N/A		$	—	$	—
Long-term debt			N/A		N/A			6,265		6,261
			N/A		N/A		$	6,265	$	6,261
Total		$	419	$	731		$	6,854	$	6,644

(1) Debt designated as hedging instruments are reported at carrying value.

N/A - not applicable

At June 30, 2019 and December 31, 2018, the following amounts were recorded in the Consolidated Statement of Financial Position related to cumulative basis adjustments for fair value hedges:

	June 30,			December 31,
(Dollars in millions)	2019			2018
Short-term debt:
Carrying amount of the hedged item	$	(1,128)		$	(1,878)
Cumulative hedging adjustments included in the carrying amount - assets/(liabilities)		(3)	(1)		(4)	(1)
Long-term debt:
Carrying amount of the hedged item	$	(4,826)		$	(6,004)
Cumulative hedging adjustments included in the carrying amount - assets/(liabilities)		(461)	(2)		(333)	(2)

(1) Includes ($2) million and ($6) million of hedging adjustments on discontinued hedging relationships at June 30, 2019 and December 31, 2018, respectively.

(2) Includes ($388) million and ($213) million of hedging adjustments on discontinued hedging relationships at June 30, 2019 and December 31, 2018, respectively.

25

Notes to Consolidated Financial Statements — (continued)

The Effect of Derivative Instruments in the Consolidated Statement of Earnings

The total amounts of income and expense line items presented in the Consolidated Statement of Earnings in which the effects of fair value hedges, cash flow hedges, net investment hedges and derivatives not designated as hedging instruments are recorded and the total effect of hedge activity on these income and expense line items are as follows:

					Gains/(Losses) of
(Dollars in millions)	Total				Total Hedge Activity
For the three months ended June 30:	2019		2018		2019		2018
Cost of services	$	8,272	$	8,645	$	20	$	9
Cost of sales		1,651		1,869		11		(6)
Cost of financing		228		290		(18)		0	*
SG&A expense		5,456		4,857		38		10
Other (income) and expense		(747)		280		271		(435)
Interest expense		348		173		(39)		0	*

* Reclassified to conform to 2019 presentation.

26

Notes to Consolidated Financial Statements — (continued)

	Gain (Loss) Recognized in Earnings
	Consolidated	Recognized on				Attributable to Risk
(Dollars in millions)	Statement of	Derivatives				Being Hedged(2)
For the three months ended June 30:	Earnings Line Item	2019		2018		2019		2018
Derivative instruments in fair value hedges(1):
Interest rate contracts	Cost of financing	$	23	$	(32)	$	(20)	$	42
	Interest expense		48		(28)		(43)		37
Derivative instruments not designated as hedging instruments:
Foreign exchange contracts	Other (income) and expense		69		(38)		N/A		N/A
Equity contracts	SG&A expense		26		12		N/A		N/A
Total		$	165	$	(86)	$	(64)	$	79

	Gain (Loss) Recognized in Earnings and Other Comprehensive Income
(Dollars in millions)					Consolidated	Reclassified					Amounts Excluded from
For the three months	Recognized in OCI				Statement of	from AOCI					Effectiveness Testing(3)
ended June 30:	2019		2018		Earnings Line Item	2019		2018			2019		2018
Derivative instruments in cash flow hedges:
Interest rate contracts	$	3	$	—	Cost of financing	$	(1)	$	—		$	—	$	—
					Interest expense		(2)		—			—		—
Foreign exchange contracts		(10)		(149)	Cost of services		20		9			—		—
					Cost of sales		11		(6)			—		—
					Cost of financing		(24)		(20)	*		—		—
					SG&A expense		12		(3)			—		—
					Other (income) and expense		202		(397)			—		—
					Interest expense		(51)		(18)	*		—		—
Instruments in net investment hedges(4):
Foreign exchange contracts		(148)		627	Cost of financing		—		—			4		11	*
					Interest expense		—		—			9		9	*
Total	$	(154)	$	477		$	168	$	(434)		$	13	$	20

* Reclassified to conform to 2019 presentation.

(1) 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.

(2) 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.

(3) The company’s policy is to recognize all fair value changes in amounts excluded from effectiveness testing in net income each period.

(4) Instruments in net investment hedges include derivative and non-derivative instruments.

N/A - not applicable

					Gains/(Losses) of
(Dollars in millions)	Total				Total Hedge Activity
For the six months ended June 30:	2019		2018		2019		2018
Cost of services	$	16,631	$	17,479	$	29	$	28
Cost of sales		3,167		3,591		30		(23)
Cost of financing		492		559		(36)		4	*
SG&A expense		10,147		10,302		179		(23)
Other (income) and expense		(820)		692		202		(386)
Interest expense		558		338		(59)		4	*

* Reclassified to conform to 2019 presentation.

27

Notes to Consolidated Financial Statements — (continued)

	Gain (Loss) Recognized in Earnings
	Consolidated	Recognized on				Attributable to Risk
(Dollars in millions)	Statement of	Derivatives				Being Hedged(2)
For the six months ended June 30:	Earnings Line Item	2019		2018		2019		2018
Derivative instruments in fair value hedges(1):
Interest rate contracts	Cost of financing	$	55	$	(112)	$	(50)	$	138
	Interest expense		90		(101)		(82)		124
Derivative instruments not designated as hedging instruments:
Foreign exchange contracts	Other (income) and expense		87		(93)		N/A		N/A
Equity contracts	SG&A expense		145		(2)		N/A		N/A
Total		$	377	$	(308)	$	(132)	$	262

	Gain (Loss) Recognized in Earnings and Other Comprehensive Income
(Dollars in millions)					Consolidated	Reclassified					Amounts Excluded from
For the six months	Recognized in OCI				Statement of	from AOCI					Effectiveness Testing(3)
ended June 30:	2019		2018		Earnings Line Item	2019		2018			2019		2018
Derivative instruments in cash flow hedges:
Interest rate contracts	$	(168)	$	—	Cost of financing	$	(1)	$	—		$	—	$	—
					Interest expense		(1)		—			—		—
Foreign exchange contracts		(191)		(89)	Cost of services		29		28			—		—
					Cost of sales		30		(23)			—		—
					Cost of financing		(52)		(38)	*		—		—
					SG&A expense		34		(21)			—		—
					Other (income) and expense		115		(293)			—		—
					Interest expense		(85)		(34)	*		—		—
Instruments in net investment hedges(4):
Foreign exchange contracts		(128)		423	Cost of financing		—		—			12		17	*
					Interest expense		—		—			19		15	*
Total	$	(487)	$	334		$	70	$	(380)		$	30	$	31

* Reclassified to conform to 2019 presentation.

(1) 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.

(2) 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.

(3) The company’s policy is to recognize all fair value changes in amounts excluded from effectiveness testing in net income each period.

(4) Instruments in net investment hedges include derivative and non-derivative instruments.

N/A - not applicable

For the three and six months ending June 30, 2019 and 2018, there were no material gains or losses excluded from the assessment of hedge effectiveness (for fair value or cash flow 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.

5. Leases:

The company conducts business as both a lessee and a lessor. In its ordinary course of business, the company enters into leases as a lessee for property, plant and equipment. The company is also the lessor of certain equipment, mainly through its Global Financing segment.

28

Notes to Consolidated Financial Statements — (continued)

When procuring goods or services, or upon entering into a contract with its clients, the company determines whether an arrangement contains a lease at its inception. As part of that evaluation, the company considers whether there is an implicitly or explicitly identified asset in the arrangement and whether the company, as the lessee, or the client, if the company is the lessor, has the right to control that asset.

The company determines whether there is a right to control the use of the asset by assessing its rights, as the lessee, or the client’s rights, if the company is the lessor, to obtain substantially all of the economic benefits from the use of the identified asset and the right to direct the use of the identified asset. If there is either an explicit or embedded lease within a contract, the company determines the classification of the lease (e.g., finance, operating, sales-type lease) at the lease commencement date.

Accounting for leases as a lessee

Effective January 1, 2019, when the company is the lessee, all leases with a term of more than 12 months are recognized as ROU assets and associated lease liabilities in the Consolidated Statement of Financial Position. The lease liabilities are measured at the lease commencement date and determined using the present value of the lease payments not yet paid and the company's incremental borrowing rate, which approximates the rate at which the company would borrow, on a secured basis, in the country where the lease was executed. The interest rate implicit in the lease is generally not determinable in transactions where the company is the lessee. The ROU asset equals the lease liability adjusted for any initial direct costs (IDCs), prepaid rent and lease incentives. Fixed and in-substance fixed payments are included in the recognition of ROU assets and lease liabilities, however, variable lease payments, other than those based on a rate or index, are recognized in the Consolidated Statement of Earnings in the period in which the obligation for those payments is incurred. The company’s variable lease payments generally relate to payments tied to various indexes, non-lease components and payments above a contractual minimum fixed payment.

ROU assets represent the company’s right to control the underlying assets under lease, and the lease liability is the obligation to make the lease payments related to the underlying assets under lease. Operating leases are included in operating right-of-use assets – net, current operating lease liabilities and operating lease liabilities in the Consolidated Statement of Financial Position. Finance leases are included in property, plant and equipment, short-term debt and long-term debt in the Consolidated Statement of Financial Position. At June 30, 2019, the total amount of ROU assets and lease liabilities for finance leases recognized in the Consolidated Statement of Financial Position in property, plant and equipment, short-term debt and long-term debt was $63 million, $7 million and $65 million, respectively.

Finance lease ROU assets are generally amortized on a straight-line basis over the lease term with the interest expense on the lease liability recorded using the interest method. The amortization and interest expense are recorded separately in the Consolidated Statement of Earnings. For operating leases, the amortization of the ROU asset and the interest expense on the lease liability are not separately recorded; rather, the lease cost is recognized on a straight-line basis over the lease term as a single-line item in the Consolidated Statement of Earnings, unless the ROU asset is impaired. The company has elected to not recognize leases with a lease term of less than 12 months in the Consolidated Statement of Financial Position, including those acquired in a business combination, and lease costs for those short-term leases are recognized on a straight-line basis over the lease term in the Consolidated Statement of Earnings.

For all asset classes, the company has elected the lessee practical expedient to combine lease and non-lease components (e.g., maintenance services) and account for the combined unit as a single lease component. A significant portion of the company’s lease portfolio is real estate, which are mainly accounted for as operating leases, and are primarily used for corporate offices and data centers. The average term of the real estate leases is approximately five years. Certain real estate leases have renewal and/or termination options, which are assessed to determine if those options would affect the duration of the lease term. The company also has equipment leases, such as IT equipment and vehicles, which have lease terms that range from two to five years. For certain equipment leases, the company applies a portfolio approach to account for the operating lease ROU assets and lease liabilities.

29

Notes to Consolidated Financial Statements — (continued)

The following tables present the various components of lease costs:

(Dollars in millions)
For the three months ended June 30:	2019
Finance lease cost	$	2
Operating lease cost		434
Short-term lease cost		7
Variable lease cost		128
Sublease income		(6)
Total lease cost	$	565

(Dollars in millions)
For the six months ended June 30:	2019
Finance lease cost	$	7
Operating lease cost		820
Short-term lease cost		16
Variable lease cost		256
Sublease income		(8)
Total lease cost	$	1,090

The company recorded net gains on sale and leaseback transactions of $5 million and $41 million for the three and six months ended June 30, 2019, respectively.

The following tables present supplemental information relating to the cash flows arising from lease transactions. Cash payments made from variable lease costs and short-term leases are not included in the measurement of operating and finance lease liabilities, and, as such, are excluded from the amounts below:

(Dollars in millions)
For the six months ended June 30:	2019
Cash paid for amounts included in the measurement of lease liabilities:
Operating cash outflows from finance leases	$	4
Financing cash outflows from finance leases	$	2
Operating cash outflows from operating leases	$	762
ROU assets obtained in exchange for new finance lease liabilities	$	77	*
ROU assets obtained in exchange for new operating lease liabilities	$	5,771	*

*  Includes opening balance additions as a result of the adoption of the new lease guidance effective January 1, 2019. The post adoption addition of leases for the six months ended June 30, 2019 was $927 million for operating leases and immaterial for finance leases.

The following table presents the weighted-average lease terms and discount rates for both finance and operating leases:

At June 30:	2019
Weighted-average remaining lease term — finance leases		7.2	yrs.
Weighted-average remaining lease term — operating leases		5.2	yrs.
Weighted-average discount rate — finance leases		2.46	%
Weighted-average discount rate — operating leases		3.13	%

30

Notes to Consolidated Financial Statements — (continued)

The following table presents a maturity analysis of the expected undiscounted cash out flows for operating and finance leases on an annual basis for the next five years and thereafter, at June 30, 2019:

	Remainder of										Beyond		Imputed
(Dollars in millions)	2019		2020		2021		2022		2023		2023		Interest*		Total
Finance leases	$	8	$	17	$	17	$	16	$	12	$	53	$	(53)	$	71
Operating leases	$	819	$	1,372	$	1,054	$	777	$	551	$	1,064	$	(371)	$	5,265

* Imputed interest represents the difference between undiscounted cash flows and discounted cash flows.

Prior to the adoption of the new lease guidance on January 1, 2019, ROU assets and lease liabilities for operating leases were not recognized in the Consolidated Statement of Financial Position. The company has elected the practical expedient to not provide comparable presentation in the Consolidated Statement of Financial Position for periods prior to adoption. Rental expense, including amounts charged to inventories and fixed assets, and excluding amounts previously reserved, was $1,944 million for the year ended December 31, 2018. Rental expense in agreements with rent holidays and scheduled rent increases was previously recognized on a straight-line basis over the lease term. Contingent rentals were included in the determination of rental expense as accruable.

The following table, which was included in the company’s 2018 Annual Report, depicts gross minimum rental commitments under noncancelable leases, amounts related to vacant space associated with workforce transformation, sublease income commitments and capital lease commitments at December 31, 2018.

											Beyond
(Dollars in millions)	2019		2020		2021		2022		2023		2023
Operating lease commitments
Gross minimum rental commitments
(including vacant space below)	$	1,581	$	1,233	$	914	$	640	$	445	$	815
Vacant space	$	29	$	23	$	14	$	9	$	5	$	8
Sublease income commitments	$	11	$	7	$	5	$	4	$	4	$	2
Capital lease commitments	$	3	$	3	$	3	$	3	$	2	$	28

The difference between the company’s total lease commitments as reported at December 31, 2018 compared to the January 1, 2019 ROU asset balance in the Consolidated Statement of Financial Position is primarily due to the required use of a discount factor (imputed interest) under the new lease guidance and certain amounts that are not included in the ROU asset under the new lease guidance (e.g., tenant incentives and vacant space).

Accounting for leases as a lessor

The company typically enters into leases as an alternative means of realizing value from equipment that it would otherwise sell. Assets under lease include new and used IBM equipment and certain OEM products. IBM equipment generally consists of IBM Z, Power Systems and Storage Systems products.

Lease payments due to IBM are typically fixed and paid in equal installments over the lease term. The majority of the company’s leases do not contain variable payments that are dependent on an index or a rate. Variable lease payments that do not depend on an index or a rate (e.g., property taxes), that are paid directly by the company and are reimbursed by the client, are recorded as revenue, along with the related cost, in the period in which collection of these payments is probable. Payments that are made directly by the client to a third party, including certain property taxes and insurance, are not considered part of variable payments and therefore are not recorded by the company. The company has made a policy election to exclude from consideration in contracts all collections from sales and other similar taxes.

31

Notes to Consolidated Financial Statements — (continued)

The company’s payment terms for leases are typically unconditional. Therefore, in an instance when the client requests to terminate the lease prior to the end of the lease term, the client would typically be required to pay the remaining lease payments in full. At the end of the lease term, the company allows the client to either return the equipment, purchase the equipment at the then-current fair market value or at a pre-stated purchase price or renew the lease based on mutually agreed upon terms.

When lease arrangements include multiple performance obligations, the company allocates the consideration in the contract between the lease components and the non-lease components on a relative standalone selling price basis.

The following tables present amounts included in the Consolidated Statement of Earnings related to lessor activity:

(Dollars in millions)
For the three months ended June 30:	2019
Lease income — sales-type and direct financing leases
Sales-type lease selling price	$	179
Less: Carrying value of underlying assets, excluding unguaranteed residual value		74
Gross profit		105
Interest income on lease receivables		73
Total sales-type and direct financing lease income	$	178
Lease income — operating leases		82
Variable lease income		9
Total lease income	$	269

(Dollars in millions)
For the six months ended June 30:	2019
Lease income — sales-type and direct financing leases
Sales-type lease selling price	$	328
Less: Carrying value of underlying assets, excluding unguaranteed residual value		129
Gross profit		199
Interest income on lease receivables		151
Total sales-type and direct financing lease income	$	350
Lease income — operating leases		172
Variable lease income		27
Total lease income	$	548

Sales-Type and Direct Financing Leases

If a lease is classified as a sales-type or direct financing lease, the carrying amount of the asset is derecognized from inventory and a net investment in the lease is recorded. For a sales-type lease, the net investment in the lease is measured at commencement date as the sum of the lease receivable and the estimated residual value of the equipment less unearned income and allowance for credit losses. At June 30, 2019, the unguaranteed residual value of sales-type and direct financing leases was $582 million. For further information on the company’s net investment in leases, including residual values, refer to note 6, “Financing Receivables.” Any selling profit or loss arising from a sales-type lease is recorded at lease commencement. Selling profit or loss is presented on a gross basis when the company enters into a lease to realize value from a product that it would otherwise sell in its ordinary course of business, whereas in transactions where the company enters into a lease for the purpose of generating revenue by providing financing, the selling profit or loss is presented on a net basis. Under a sales-type lease, initial direct costs are expensed at lease commencement. Over the term of the lease, the company recognizes finance income on the net investment in the lease and any variable lease payments, which are not included in the net investment in the lease.

32

Notes to Consolidated Financial Statements — (continued)

For a direct financing lease, the investment in the lease is measured similarly to a sales-type lease, however, the net investment in the lease is reduced by any selling profit. In a direct financing lease, the selling profit and initial direct costs are deferred at commencement and recognized over the lease term. The company rarely enters into direct financing leases.

The estimated residual value represents the estimated fair value of the equipment under lease at the end of the lease. Estimating residual value is a risk unique to financing activities, and management of this risk is dependent upon the ability to accurately project future equipment values. The company has insight into product plans and cycles for the IBM products under lease. The company estimates the future fair value of leased equipment by using historical models, analyzing the current market for new and used equipment and obtaining forward-looking product information such as marketing plans and technology innovations.

The company optimizes the recovery of residual values by extending lease arrangements with, or selling leased equipment to existing clients. The company has historically managed residual value risk both through insight into its own product cycles and monitoring of OEM IT product announcements. The company periodically reassesses the realizable value of its lease residual values. Anticipated decreases in specific future residual values that are considered to be other-than-temporary are recognized immediately upon identification and are recorded as an adjustment to the residual value estimate. For sales-type and direct financing leases, this reduction lowers the recorded net investment and is recognized as a loss charged to finance income in the period in which the estimate is changed, as well as an adjustment to unearned income to reduce future-period financing activities. For the three and six months ended June 30, 2019 and June 30, 2018, respectively, impairment of residual values was immaterial.

The following table presents a maturity analysis of the lease payments due to IBM on sales-type and direct financing leases over the next five years and thereafter, as well as a reconciliation of the undiscounted cash flows to the financing receivables recognized in the Consolidated Statement of Financial Position at June 30, 2019:

(Dollars in millions)	Total
Remainder of 2019	$	1,496
2020		2,199
2021		1,426
2022		654
2023		166
Thereafter		25
Total undiscounted cash flows	$	5,967
Present value of lease payments (recognized as financing receivables)		5,494	*
Difference between undiscounted cash flows and discounted cash flows	$	473

*  The present value of the lease payments will not equal the financing receivables balances in the Statement of Financial Position, due to certain items including IDC's, allowance for credit losses and residual values, which are included in the financing receivables balance, but are not included in the future lease payments.

Operating Leases

Equipment provided to clients under an operating lease is carried at cost within property, plant and equipment in the Consolidated Statement of Financial Position and depreciated over the lease term using the straight-line method, generally ranging from one to six years. The depreciable basis is the original cost of the equipment less the estimated residual value of the equipment at the end of the lease term. At June 30, 2019, the unguaranteed residual value of operating leases was $97 million.

At commencement of an operating lease, IDCs are deferred. As lease payments are made, the company records sales revenue over the lease term. IDCs are amortized over the lease term on the same basis as lease income is recorded.

33

Notes to Consolidated Financial Statements — (continued)

The following table presents a maturity analysis of the undiscounted lease payments due to IBM on operating leases over the next five years and thereafter, at June 30, 2019:

(Dollars in millions)	Total
Remainder of 2019	$	153
2020		115
2021		31
2022		2
2023		0
Thereafter		0
Total undiscounted cash flows	$	301

Assets under operating leases are tested for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. The impairment test is based on undiscounted cash flows, and, if impaired, the asset is written down to fair value based on either discounted cash flows or appraised values. There were no material impairment losses incurred during the three and six months ended June 30, 2019 for assets under operating leases. These assets are included in “Property, plant and equipment — net” in the Consolidated Statement of Financial Position.

6. Financing Receivables:

Financing receivables primarily consist of client loan and installment payment receivables (loans), investment in sales-type and direct financing leases and commercial financing receivables. Client loan and installment payment receivables (loans) are provided primarily to clients to finance the purchase of hardware, software and services. Payment terms on these financing arrangements are generally for terms up to seven years. Client loans and installment payment financing contracts are priced independently at competitive market rates. Investment in sales-type and direct financing leases relates principally to the company’s Systems products and are for terms ranging generally from two to six years. Commercial financing receivables relate primarily to inventory and accounts receivable financing for dealers and remarketers of IBM and OEM products. Payment terms for inventory and accounts receivable financing generally range from 30 to 90 days. Beginning in the second quarter of 2019 and continuing throughout the year, the company is winding down the portion of its commercial financing operations which provides short-term working capital solutions for OEM information technology suppliers, distributors and resellers, which has resulted in a reduction of commercial financing receivables. This wind down is consistent with IBM’s capital allocation strategy and high-value focus. IBM Global Financing will continue to provide differentiated end-to-end financing solutions, including commercial financing in support of IBM partner relationships.

A summary of the components of the company’s financing receivables is presented as follows:

	Investment in				Client Loan and
	Sales-Type and		Commercial		Installment Payment
(Dollars in millions)	Direct Financing		Financing		Receivables/
At June 30, 2019:	Leases		Receivables		(Loans)		Total
Financing receivables, gross	$	5,978	$	5,936	$	12,800	$	24,714
Unearned income		(473)		(18)		(611)		(1,102)
Recorded investment	$	5,505	$	5,918	$	12,189	$	23,612
Allowance for credit losses		(89)		(15)		(175)		(278)
Unguaranteed residual value		582		—		—		582
Guaranteed residual value		68		—		—		68
Total financing receivables, net	$	6,066	$	5,903	$	12,014	$	23,984
Current portion	$	2,338	$	5,903	$	7,302	$	15,543
Noncurrent portion	$	3,728	$	—	$	4,713	$	8,441

34

Notes to Consolidated Financial Statements — (continued)

	Investment in				Client Loan and
	Sales-Type and		Commercial		Installment Payment
(Dollars in millions)	Direct Financing		Financing		Receivables/
At December 31, 2018:	Leases		Receivables		(Loans)		Total
Financing receivables, gross	$	6,846	$	11,889	$	13,614	$	32,348
Unearned income		(526)		(37)		(632)		(1,195)
Recorded investment	$	6,320	$	11,852	$	12,981	$	31,153
Allowance for credit losses		(99)		(13)		(179)		(292)
Unguaranteed residual value		589		—		—		589
Guaranteed residual value		85		—		—		85
Total financing receivables, net	$	6,895	$	11,838	$	12,802	$	31,536
Current portion	$	2,834	$	11,838	$	7,716	$	22,388
Noncurrent portion	$	4,061	$	—	$	5,086	$	9,148

The company utilizes certain of its financing receivables as collateral for nonrecourse borrowings. Financing receivables pledged as collateral for borrowings were $938 million and $710 million at June 30, 2019 and December 31, 2018, respectively.

The company did not have any financing receivables held for sale as of June 30, 2019 and December 31, 2018.

35

Notes to Consolidated Financial Statements — (continued)

Financing Receivables by Portfolio Segment

The following tables present the recorded investment by portfolio segment and by class, excluding commercial financing receivables and other miscellaneous financing receivables at June 30, 2019 and December 31, 2018. Commercial financing receivables are excluded from the presentation of financing receivables by portfolio segment, as they are short term in nature and the current estimated risk of loss and resulting impact to the company’s financing results are not material. The company determines its allowance for credit losses based on two portfolio segments: lease receivables and loan receivables, and further segments the portfolio into three classes: Americas, Europe/Middle East/Africa (EMEA) and Asia Pacific.

(Dollars in millions)
At June 30, 2019:	Americas		EMEA		Asia Pacific		Total
Recorded investment
Lease receivables	$	3,336	$	1,149	$	1,020	$	5,505
Loan receivables		6,208		3,443	$	2,538	$	12,189
Ending balance	$	9,544	$	4,592	$	3,558	$	17,694
Recorded investment collectively evaluated for impairment	$	9,400	$	4,544	$	3,509	$	17,453
Recorded investment individually evaluated for impairment	$	144	$	48	$	49	$	241
Allowance for credit losses
Beginning balance at January 1, 2019
Lease receivables	$	53	$	22	$	24	$	99
Loan receivables		105		43	$	32	$	179
Total	$	158	$	65	$	56	$	279
Write-offs	$	(11)	$	(2)	$	(3)	$	(16)
Recoveries		0		0	$	0	$	0
Provision / (benefit)		(1)		(6)	$	0	$	(7)
Other*		6		0	$	0	$	6
Ending balance at June 30, 2019	$	152	$	57	$	54	$	263
Lease receivables	$	48	$	17	$	24	$	89
Loan receivables	$	104	$	41	$	30	$	175
Related allowance, collectively evaluated for impairment	$	31	$	12	$	5	$	48
Related allowance, individually evaluated for impairment	$	122	$	45	$	49	$	215

* Primarily represents translation adjustments.

Write-offs of lease receivables and loan receivables were $8 million each, for the six months ended June 30, 2019. Provisions for credit losses recorded for lease receivables were a release of $6 million for the six months ended June 30, 2019, with the remainder of the current period benefit released for loan receivables.

The average recorded investment of impaired leases and loans for Americas, EMEA and Asia Pacific were $146 million, $48 million and $50 million, respectively, for the three months ended June 30, 2019 and $128 million, $55 million and $78 million, respectively, for the three months ended June 30, 2018. Both interest income recognized and interest income recognized on a cash basis on impaired leases and loans were immaterial for the three months ended June 30, 2019 and 2018.

The average recorded investment of impaired leases and loans for Americas, EMEA and Asia Pacific were $146 million, $50 million and $50 million, respectively, for the six months ended June 30, 2019 and $128 million, $56 million and $80 million, respectively, for the six months ended June 30, 2018. Both interest income recognized and interest

36

Notes to Consolidated Financial Statements — (continued)

income recognized on a cash basis on impaired leases and loans were immaterial for the six months ended June 30, 2019 and 2018.

(Dollars in millions)
At December 31, 2018:	Americas		EMEA		Asia Pacific		Total
Recorded investment
Lease receivables	$	3,827	$	1,341	$	1,152	$	6,320
Loan receivables		6,817		3,675	$	2,489	$	12,981
Ending balance	$	10,644	$	5,016	$	3,641	$	19,301
Recorded investment collectively evaluated for impairment	$	10,498	$	4,964	$	3,590	$	19,052
Recorded investment individually evaluated for impairment	$	146	$	52	$	51	$	249
Allowance for credit losses
Beginning balance at January 1, 2018
Lease receivables	$	63	$	9	$	31	$	103
Loan receivables		108		52	$	51	$	211
Total	$	172	$	61	$	82	$	314
Write-offs	$	(10)	$	(2)	$	(23)	$	(35)
Recoveries		0		0	$	2	$	2
Provision		7		9	$	0	$	16
Other*		(11)		(3)	$	(4)	$	(19)
Ending balance at December 31, 2018	$	158	$	65	$	56	$	279
Lease receivables	$	53	$	22	$	24	$	99
Loan receivables	$	105	$	43	$	32	$	179
Related allowance, collectively evaluated for impairment	$	39	$	16	$	5	$	59
Related allowance, individually evaluated for impairment	$	119	$	49	$	51	$	219

* Primarily represents translation adjustments.

Write-offs of lease receivables and loan receivables were $15 million and $20 million, respectively, for the year ended December 31, 2018. Provisions for credit losses recorded for lease receivables and loan receivables were $14 million and $2 million, respectively, for the year ended December 31, 2018.

When determining the allowances, financing receivables are evaluated either on an individual or a collective basis. For individually evaluated receivables, the company determines the expected cash flow for the receivable and calculates an estimate of the potential loss and the probability of loss. For those accounts in which the loss is probable, the company records a specific reserve. The company considers any receivable with an individually evaluated reserve as an impaired receivable.

In addition, the company records an unallocated reserve that is determined by applying a reserve rate to its different portfolios, excluding accounts that have been specifically reserved. This reserve rate is based upon credit rating, probability of default, term, characteristics (lease/loan) and loss history.

Past Due Financing Receivables

The company considers a client’s financing receivable balance past due when any installment is aged over 90 days. The following table summarizes information about the recorded investment in lease and loan financing receivables,

37

Notes to Consolidated Financial Statements — (continued)

including recorded investments aged over 90 days and still accruing, billed invoices aged over 90 days and still accruing, and recorded investment not accruing.

					Recorded		Billed		Recorded
	Total		Recorded		Investment		Invoices		Investment
(Dollars in millions)	Recorded		Investment		> 90 Days and		> 90 Days and		Not
At June 30, 2019:	Investment		> 90 Days(1)		Accruing(1)		Accruing		Accruing(2)
Americas	$	3,336	$	364	$	345	$	13	$	39
EMEA		1,149		31		12		4		19
Asia Pacific		1,020		25		13		2		13
Total lease receivables	$	5,505	$	421	$	370	$	19	$	71
Americas	$	6,208	$	204	$	105	$	17	$	120
EMEA		3,443		85		15		3		71
Asia Pacific		2,538		42		10		5		34
Total loan receivables	$	12,189	$	330	$	129	$	25	$	224
Total	$	17,694	$	751	$	499	$	44	$	295

(1) At a contract level, which includes total billed and unbilled amounts for financing receivables aged greater than 90 days.

(2) Of the recorded investment not accruing, $241 million is individually evaluated for impairment with a related allowance of $215 million.

					Recorded		Billed		Recorded
	Total		Recorded		Investment		Invoices		Investment
(Dollars in millions)	Recorded		Investment		> 90 Days and		> 90 Days and		Not
At December 31, 2018:	Investment		> 90 Days(1)		Accruing(1)		Accruing		Accruing(2)
Americas	$	3,827	$	310	$	256	$	19	$	57
EMEA		1,341		25		9		1		16
Asia Pacific		1,152		49		27		3		24
Total lease receivables	$	6,320	$	385	$	292	$	24	$	97
Americas	$	6,817	$	259	$	166	$	24	$	99
EMEA		3,675		98		25		3		73
Asia Pacific		2,489		40		11		1		31
Total loan receivables	$	12,981	$	397	$	202	$	29	$	203
Total	$	19,301	$	782	$	494	$	52	$	300

(1) At a contract level, which includes total billed and unbilled amounts for financing receivables aged greater than 90 days.

(2) Of the recorded investment not accruing, $249 million is individually evaluated for impairment with a related allowance of $219 million.

Credit Quality Indicators

The company’s credit quality indicators, which are based on rating agency data, publicly available information and information provided by customers, are reviewed periodically based on the relative level of risk. The resulting indicators are a numerical rating system that maps to Moody’s Investors Service credit ratings as shown below. The company uses information provided by Moody’s, where available, as one of many inputs in its determination of customer credit ratings.

The following tables present the recorded investment net of allowance for credit losses for each class of receivables, by credit quality indicator, at June 30, 2019 and December 31, 2018. Receivables with a credit quality indicator ranging

38

Notes to Consolidated Financial Statements — (continued)

from Aaa to Baa3 are considered investment grade. All others are considered non-investment grade. The credit quality indicators do not reflect mitigation actions that the company takes to transfer credit risk to third parties.

(Dollars in millions)	Lease Receivables						Loan Receivables
At June 30, 2019:	Americas		EMEA		Asia Pacific		Americas		EMEA		Asia Pacific
Credit ratings:
Aaa – Aa3	$	428	$	12	$	60	$	998	$	160	$	185
A1 – A3		750		137		488		859		219		834
Baa1 – Baa3		780		365		170		1,615		1,271		718
Ba1 – Ba2		834		412		127		1,554		947		556
Ba3 – B1		229		136		96		461		542		130
B2 – B3		251		65		50		589		240		77
Caa – D		18		4		5		27		23		9
Total	$	3,288	$	1,132	$	996	$	6,103	$	3,402	$	2,508

(Dollars in millions)	Lease Receivables						Loan Receivables
At December 31, 2018:	Americas		EMEA		Asia Pacific		Americas		EMEA		Asia Pacific
Credit ratings:
Aaa – Aa3	$	593	$	45	$	85	$	1,055	$	125	$	185
A1 – A3		678		158		413		1,206		436		901
Baa1 – Baa3		892		417		297		1,587		1,148		648
Ba1 – Ba2		852		426		191		1,516		1,175		417
Ba3 – B1		433		171		84		770		472		184
B2 – B3		299		90		50		531		249		109
Caa – D		26		10		7		47		28		15
Total	$	3,774	$	1,319	$	1,128	$	6,712	$	3,633	$	2,457

Troubled Debt Restructurings

The company did not have any significant troubled debt restructurings during the six months ended June 30, 2019 or for the year ended December 31, 2018 .

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 income from continuing operations.

	Three Months Ended June 30,				Six Months Ended June 30,
(Dollars in millions)	2019		2018		2019		2018
Cost	$	22	$	21	$	42	$	41
Selling, general and administrative		93		88		167		169
Research, development and engineering		21		16		39		32
Pre-tax stock-based compensation cost	$	135	$	125	$	248	$	242
Income tax benefits		(29)		(24)		(54)		(59)
Total net stock-based compensation cost	$	106	$	102	$	194	$	183

Pre-tax stock-based compensation cost for the three months ended June 30, 2019 increased $10 million compared to the corresponding period in the prior year. This was due to an increase related to restricted stock units ($13 million), partially offset by decreases in performance share units ($1 million), stock options ($1 million) and the conversion of stock-based compensation previously issued by acquired entities ($1 million).

39

Notes to Consolidated Financial Statements — (continued)

Pre-tax stock-based compensation cost for the six months ended June 30, 2019 increased $7 million compared to the corresponding period in the prior year. This was due to an increase related to restricted stock units ($16 million), partially offset by decreases in performance share units ($5 million), stock options ($2 million) and the conversion of stock-based compensation previously issued by acquired entities ($2 million).

As of June 30, 2019, the total unrecognized compensation cost of $1.0 billion related to non-vested awards was expected to be recognized over a weighted-average period of approximately 2.8 years.

There was no significant capitalized stock-based compensation cost at June 30, 2019 and 2018.

8. Segments:

In the first quarter of 2019, the company made a number of changes to its organizational structure and management system that brought cloud and cognitive software under one organization to more effectively address evolving client needs and to prepare for the acquisition of Red Hat, Inc. (Red Hat). With these changes, the company has revised its reportable segments, but did not impact its Consolidated Financial Statements. In addition, the company is presenting the results of its announced divestitures in an “Other” segment, as the realignment of these businesses allows for a better representation of management’s view of the company, as well as the ongoing operational performance of the reportable segments. The company’s segments are as follows:

2018 Segments	Changes (+/-)	2019 Segments
Cognitive Solutions	+ Integration Software	Cloud & Cognitive Software
	+ Security Services
	- Divested Select Software*
	+ Red Hat (post closing)
Global Business Services	- Divested Mortgage Servicing**	Global Business Services
Technology Services & Cloud Platforms	- Security Services	Global Technology Services
	- Integration Software
Systems		Systems
Global Financing		Global Financing
Other	+ Divested Mortgage Servicing**	Other
	+ Divested Select Software*

*  IBM completed the sales of select software products and marketing and platform commerce offerings (in the U.S.) on June 30, 2019. Refer to

note 11, “Acquisitions/Divestitures,” for additional information.

** IBM completed the sale of the mortgage servicing business on February 28, 2019.

The tables below reflect the continuing operations results of the company’s segments consistent with the management and measurement system utilized within the company. Performance measurement is based on operating pre-tax income from continuing operations. The segments represent components of the company for which separate financial information is available that is utilized on a regular basis by the chief operating decision maker (the chief executive officer) in determining how to allocate resources and evaluate performance. The tables reflect the segment recast for the prior-year period.

40

Notes to Consolidated Financial Statements — (continued)

SEGMENT INFORMATION

	Cloud &			Global			Global
	Cognitive			Business			Technology						Global			Total
(Dollars in millions)	Software			Services			Services			Systems			Financing			Segments
For the three months ended June 30, 2019:
External revenue	$	5,645		$	4,155		$	6,837		$	1,753		$	351		$	18,741
Internal revenue		607			69			302			171			281			1,430
Total revenue	$	6,252		$	4,224		$	7,139		$	1,924		$	632		$	20,170
Pre-tax income/(loss) from continuing operations	$	2,001		$	300		$	235		$	61		$	239		$	2,836
Revenue year-to-year change		(0.5)	%		0.1	%		(4.7)	%		(20.5)	%		(27.1)	%		(5.2)	%
Pre-tax income year-to-year change		(1.4)	%		(19.4)	%		(47.9)	%		(82.3)	%		(33.1)	%		(20.2)	%
Pre-tax income/(loss) margin		32.0	%		7.1	%		3.3	%		3.2	%		37.8	%		14.1	%
For the three months ended June 30, 2018:
External revenue	$	5,470	*	$	4,135	*	$	7,325	*	$	2,177		$	394		$	19,500	*
Internal revenue		811	*		83			169			242			473			1,778	*
Total revenue	$	6,280	*	$	4,218	*	$	7,494	*	$	2,419		$	867		$	21,278	*
Pre-tax income/(loss) from continuing operations	$	2,029	*	$	372	*	$	451	*	$	346		$	357		$	3,556	*
Pre-tax income/(loss) margin		32.3	%*		8.8	%*		6.0	%*		14.3	%		41.2	%		16.7	%*

* Recast to conform to 2019 presentation.

Reconciliations to IBM as Reported:

(Dollars in millions)
For the three months ended June 30:	2019		2018
Revenue:
Total reportable segments	$	20,170	$	21,278	*
Other — divested businesses		363		457	*
Other revenue		57		45
Eliminations of internal transactions		(1,430)		(1,778)	*
Total consolidated revenue	$	19,161	$	20,003
Pre-tax income from continuing operations:
Total reportable segments	$	2,836	$	3,556	*
Amortization of acquired intangible assets		(169)		(203)
Acquisition-related (charges)/income		(102)		(1)
Non-operating retirement-related (costs)/income		(136)		(394)
Eliminations of internal transactions		(60)		(308)	*
Other — divested businesses		557		188	*
Unallocated corporate amounts		(156)		(62)
Total pre-tax income from continuing operations	$	2,768	$	2,776

* Recast to conform to 2019 presentation.

41

Notes to Consolidated Financial Statements — (continued)

SEGMENT INFORMATION

	Cloud &			Global			Global
	Cognitive			Business			Technology						Global			Total
(Dollars in millions)	Software			Services			Services			Systems			Financing			Segments
For the six months ended June 30, 2019:
External revenue	$	10,682		$	8,274		$	13,711		$	3,081		$	757		$	36,506
Internal revenue		1,448			143			591			334			581			3,097
Total revenue	$	12,131		$	8,417		$	14,303		$	3,415		$	1,338		$	39,603
Pre-tax income/(loss) from continuing operations	$	3,768		$	615		$	510		$	(141)		$	527		$	5,280
Revenue year-to-year change		(1.6)	%		(0.1)	%		(5.0)	%		(16.1)	%		(21.3)	%		(4.7)	%
Pre-tax income year-to-year change		1.6	%		23.7	%		(1.4)	%		(198.1)	%		(28.1)	%		(5.7)	%
Pre-tax income/(loss) margin		31.1	%		7.3	%		3.6	%		(4.1)	%		39.4	%		13.3	%
For the six months ended June 30, 2018:
External revenue	$	10,586	*	$	8,250	*	$	14,746	*	$	3,676		$	799		$	38,057	*
Internal revenue		1,741	*		172			310			395			902			3,521	*
Total revenue	$	12,327	*	$	8,422	*	$	15,055	*	$	4,072		$	1,701		$	41,578	*
Pre-tax income/(loss) from continuing operations	$	3,709	*	$	497	*	$	517	*	$	143		$	734		$	5,601	*
Pre-tax income/(loss) margin		30.1	%*		5.9	%*		3.4	%*		3.5	%		43.1	%		13.5	%*

* Recast to conform to 2019 presentation.

Reconciliations to IBM as Reported:

(Dollars in millions)
For the six months ended June 30:	2019		2018
Revenue:
Total reportable segments	$	39,603	$	41,578	*
Other — divested businesses		706		903	*
Other revenue		131		114
Eliminations of internal transactions		(3,097)		(3,521)	*
Total consolidated revenue	$	37,342	$	39,075
Pre-tax income from continuing operations:
Total reportable segments	$	5,280	$	5,601	*
Amortization of acquired intangible assets		(343)		(406)
Acquisition-related (charges)/income		(141)		(1)
Non-operating retirement-related (costs)/income		(274)		(796)
Eliminations of internal transactions		(149)		(497)	*
Other — divested businesses		502		202	*
Unallocated corporate amounts		(224)		(192)
Total pre-tax income from continuing operations	$	4,651	$	3,911

* Recast to conform to 2019 presentation.

42

Notes to Consolidated Financial Statements — (continued)

9. Equity Activity:

Reclassifications and Taxes Related to Items of Other Comprehensive Income

(Dollars in millions)	Before Tax		Tax (Expense)/		Net of Tax
For the three months ended June 30, 2019:	Amount		Benefit		Amount
Other comprehensive income/(loss):
Foreign currency translation adjustments	$	5	$	37	$	42
Net changes related to available-for-sale securities:
Unrealized gains/(losses) arising during the period	$	(2)	$	0	$	(1)
Reclassification of (gains)/losses to other (income) and expense		—		—		—
Total net changes related to available-for-sale securities	$	(2)	$	0	$	(1)
Unrealized gains/(losses) on cash flow hedges:
Unrealized gains/(losses) arising during the period	$	(6)	$	2	$	(4)
Reclassification of (gains)/losses to:
Cost of services		(20)		5		(15)
Cost of sales		(11)		3		(8)
Cost of financing		25		(6)		18
SG&A expense		(12)		3		(9)
Other (income) and expense		(202)		51		(151)
Interest expense		52		(13)		39
Total unrealized gains/(losses) on cash flow hedges	$	(175)	$	45	$	(129)
Retirement-related benefit plans(1):
Net (losses)/gains arising during the period	$	116	$	(25)	$	92
Curtailments and settlements		3		0		3
Amortization of prior service (credits)/costs		(3)		0		(3)
Amortization of net (gains)/losses		460		(123)		337
Total retirement-related benefit plans	$	576	$	(147)	$	430
Other comprehensive income/(loss)	$	405	$	(64)	$	340

(1) These AOCI components are included in the computation of net periodic pension cost. Refer to note 10, “Retirement-Related Benefits,” for additional information.

43

Notes to Consolidated Financial Statements — (continued)

Reclassifications and Taxes Related to Items of Other Comprehensive Income

(Dollars in millions)	Before Tax		Tax (Expense)/		Net of Tax
For the three months ended June 30, 2018:	Amount		Benefit		Amount
Other comprehensive income/(loss):
Foreign currency translation adjustments	$	(347)	$	(158)	$	(505)
Net changes related to available-for-sale securities:
Unrealized gains/(losses) arising during the period	$	0	$	0	$	0
Reclassification of (gains)/losses to other (income) and expense		—		—		—
Total net changes related to available-for-sale securities	$	0	$	0	$	0
Unrealized gains/(losses) on cash flow hedges:
Unrealized gains/(losses) arising during the period	$	(149)	$	38	$	(111)
Reclassification of (gains)/losses to:
Cost of services		(9)		2		(7)
Cost of sales		6		(2)		5
Cost of financing*		20		(5)		15
SG&A expense		3		(1)		2
Other (income) and expense		397		(100)		297
Interest expense*		18		(4)		13
Total unrealized gains/(losses) on cash flow hedges	$	285	$	(71)	$	214
Retirement-related benefit plans(1):
Prior service costs/(credits)	$	0	$	0	$	0
Net (losses)/gains arising during the period		82		(23)		59
Curtailments and settlements		6		(2)		4
Amortization of prior service (credits)/costs		(19)		5		(13)
Amortization of net (gains)/losses		741		(207)		534
Total retirement-related benefit plans	$	810	$	(226)	$	584
Other comprehensive income/(loss)	$	748	$	(455)	$	294

*     Reclassified to conform to current period presentation.

(1) These AOCI components are included in the computation of net periodic pension cost. Refer to note 10, “Retirement-Related Benefits,” for additional information.

44

Notes to Consolidated Financial Statements — (continued)

Reclassifications and Taxes Related to Items of Other Comprehensive Income

(Dollars in millions)	Before Tax		Tax (Expense)/		Net of Tax
For the six months ended June 30, 2019:	Amount		Benefit		Amount
Other comprehensive income/(loss):
Foreign currency translation adjustments	$	176	$	38	$	214
Net changes related to available-for-sale securities:
Unrealized gains/(losses) arising during the period	$	(3)	$	1	$	(2)
Reclassification of (gains)/losses to other (income) and expense		—		—		—
Total net changes related to available-for-sale securities	$	(3)	$	1	$	(2)
Unrealized gains/(losses) on cash flow hedges:
Unrealized gains/(losses) arising during the period	$	(359)	$	87	$	(272)
Reclassification of (gains)/losses to:
Cost of services		(29)		8		(22)
Cost of sales		(30)		8		(21)
Cost of financing		53		(13)		40
SG&A expense		(34)		9		(25)
Other (income) and expense		(115)		29		(86)
Interest expense		86		(22)		64
Total unrealized gains/(losses) on cash flow hedges	$	(429)	$	106	$	(323)
Retirement-related benefit plans(1):
Net (losses)/gains arising during the period	$	113	$	(24)	$	89
Curtailments and settlements		4		0		4
Amortization of prior service (credits)/costs		(6)		1		(5)
Amortization of net (gains)/losses		924		(252)		671
Total retirement-related benefit plans	$	1,035	$	(275)	$	760
Other comprehensive income/(loss)	$	779	$	(131)	$	649

(1) These AOCI components are included in the computation of net periodic pension cost. Refer to note 10, “Retirement-Related Benefits,” for additional information.

45

Notes to Consolidated Financial Statements — (continued)

Reclassifications and Taxes Related to Items of Other Comprehensive Income

(Dollars in millions)	Before Tax		Tax (Expense)/		Net of Tax
For the six months ended June 30, 2018:	Amount		Benefit		Amount
Other comprehensive income/(loss):
Foreign currency translation adjustments	$	(513)	$	(106)	$	(620)
Net changes related to available-for-sale securities:
Unrealized gains/(losses) arising during the period	$	(2)	$	0	$	(1)
Reclassification of (gains)/losses to other (income) and expense		0		0		0
Total net changes related to available-for-sale securities	$	(2)	$	0	$	(1)
Unrealized gains/(losses) on cash flow hedges:
Unrealized gains/(losses) arising during the period	$	(89)	$	29	$	(60)
Reclassification of (gains)/losses to:
Cost of services		(28)		7		(21)
Cost of sales		23		(6)		17
Cost of financing*		38		(9)		28
SG&A expense		21		(6)		15
Other (income) and expense		293		(74)		219
Interest expense*		34		(9)		25
Total unrealized gains/(losses) on cash flow hedges	$	292	$	(68)	$	224
Retirement-related benefit plans(1):
Prior service costs/(credits)	$	(1)	$	0	$	(1)
Net (losses)/gains arising during the period		84		(23)		61
Curtailments and settlements		6		(2)		4
Amortization of prior service (credits)/costs		(37)		10		(27)
Amortization of net (gains)/losses		1,494		(410)		1,084
Total retirement-related benefit plans	$	1,545	$	(424)	$	1,121
Other comprehensive income/(loss)	$	1,322	$	(598)	$	724

*     Reclassified to conform to current period presentation.

(1) These AOCI components are included in the computation of net periodic pension cost. Refer to note 10, “Retirement-Related Benefits,” for additional information.

Accumulated Other Comprehensive Income/(Loss) (net of tax)

					Net Change		Net Unrealized
	Net Unrealized		Foreign		Retirement-		Gains/(Losses)		Accumulated
	Gains/(Losses)		Currency		Related		on Available-		Other
	on Cash Flow		Translation		Benefit		For-Sale		Comprehensive
(Dollars in millions)	Hedges		Adjustments*		Plans		Securities		Income/(Loss)
January 1, 2019	$	284	$	(3,690)	$	(26,083)	$	0	$	(29,490)
Other comprehensive income before reclassifications		(272)		214		89		(2)		29
Amount reclassified from accumulated other comprehensive income		(51)		—		671		—		620
Total change for the period	$	(323)	$	214	$	760	$	(2)	$	649
June 30, 2019	$	(39)	$	(3,477)	$	(25,323)	$	(2)	$	(28,841)

*  Foreign currency translation adjustments are presented gross except for any associated hedges which are presented net of tax.

46

Notes to Consolidated Financial Statements — (continued)

					Net Change		Net Unrealized
	Net Unrealized		Foreign		Retirement-		Gains/(Losses)		Accumulated
	Gains/(Losses)		Currency		Related		on Available-		Other
	on Cash Flow		Translation		Benefit		For-Sale		Comprehensive
(Dollars in millions)	Hedges		Adjustments*		Plans		Securities		Income/(Loss)
January 1, 2018	$	35	$	(2,834)	$	(23,796)	$	3	$	(26,592)
Cumulative effect of a change in accounting principle**		5		46		(2,471)		(2)		(2,422)
Other comprehensive income before reclassifications		(60)		(620)		64		(1)		(617)
Amount reclassified from accumulated other comprehensive income		284		—		1,057		—		1,340
Total change for the period	$	224	$	(620)	$	1,121	$	(1)	$	724
June 30, 2018	$	264	$	(3,408)	$	(25,146)	$	0	$	(28,290)

*   Foreign currency translation adjustments are presented gross except for any associated hedges which are presented net of tax.

**  Reflects the adoption of the FASB guidance on stranded tax effects, hedging and financial instruments. Refer to note 2, “Accounting Changes.”

Stock Repurchases

The Board of Directors authorizes the company to repurchase IBM common stock. At June 30, 2019, $2,123 million of Board common stock repurchase authorization was available. The company had previously announced its intent to suspend its share repurchase program in 2020 and 2021 in order to reduce debt that it had issued to finance the Red Hat acquisition. The share repurchase program was suspended on July 9, 2019, which was earlier than the company previously stated.

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 pre-tax cost for all retirement-related plans.

					Yr. to Yr.
(Dollars in millions)					Percent
For the three months ended June 30:	2019		2018		Change
Retirement-related plans — cost
Defined benefit and contribution pension plans — cost	$	441	$	709	(37.7)	%
Nonpension postretirement plans — cost		53		49	7.3
Total	$	494	$	758	(34.8)	%

					Yr. to Yr.
(Dollars in millions)					Percent
For the six months ended June 30:	2019		2018		Change
Retirement-related plans — cost
Defined benefit and contribution pension plans — cost	$	878	$	1,447	(39.3)	%
Nonpension postretirement plans — cost		107		100	6.9
Total	$	985	$	1,546	(36.3)	%

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

47

Notes to Consolidated Financial Statements — (continued)

Cost/(Income) of Pension Plans

(Dollars in millions)	U.S. Plans				Non-U.S. Plans
For the three months ended June 30:	2019		2018		2019		2018
Service cost	$	—	$	—	$	93	$	101
Interest cost(1)		469		429		206		211
Expected return on plan assets(1)		(650)		(675)		(396)		(339)
Amortization of prior service costs/(credits)(1)		4		4		(7)		(21)
Recognized actuarial losses(1)		139		378		312		353
Curtailments and settlements(1)		—		—		3		6
Multi-employer plans		—		—		8		10
Other costs/(credits)(1)		—		—		6		4
Total net periodic pension (income)/cost of defined benefit plans	$	(37)	$	136	$	225	$	325
Cost of defined contribution plans		140		145		114		103
Total defined benefit and contribution pension plans cost recognized in the Consolidated Statement of Earnings	$	103	$	281	$	339	$	428

(1) These components of net periodic pension cost are included in other (income) and expense in the Consolidated Statement of Earnings.

(Dollars in millions)	U.S. Plans				Non-U.S. Plans
For the six months ended June 30:	2019		2018		2019		2018
Service cost	$	—	$	—	$	185	$	205
Interest cost(1)		941		859		413		426
Expected return on plan assets(1)		(1,300)		(1,351)		(795)		(687)
Amortization of prior service costs/(credits)(1)		8		8		(13)		(42)
Recognized actuarial losses(1)		279		763		626		712
Curtailments and settlements(1)		—		—		4		6
Multi-employer plans		—		—		17		20
Other costs/(credits)(1)		—		—		11		11
Total net periodic pension (income)/cost of defined benefit plans	$	(71)	$	279	$	449	$	651
Cost of defined contribution plans		289		305		212		211
Total defined benefit and contribution pension plans cost recognized in the Consolidated Statement of Earnings	$	218	$	584	$	661	$	863

(1) These components of net periodic pension cost are included in other (income) and expense in the Consolidated Statement of Earnings.

As of 2019, substantially all the plan participants in the U.S. Qualified IBM Personal Pension Plan (PPP) are considered inactive. As required by U.S. GAAP, this resulted in a change in the amortization period of unrecognized actuarial losses to the average remaining life expectancy of inactive plan participants, which was 18 years as of December 31, 2018. Recognized actuarial losses decreased by approximately $240 million and $480 million for the three and six months ended June 30, 2019, respectively, compared to the corresponding periods in the prior year, primarily driven by the change in amortization period. There was no impact to funded status, retiree benefit payments or funding requirements of the U.S. Qualified PPP as a result of this change.

In 2019, the company expects to contribute approximately $400 million to its non-U.S. defined benefit and multi-employer plans, the largest of which will be contributed to the defined benefit pension plans in Japan, Spain and Belgium. This amount generally represents the legally mandated minimum contribution. Total net contributions to the non-U.S. plans in the first six months of 2019 were $128 million, of which $63 million was in cash and $65 million in U.S. Treasury securities. Total contributions to the non-U.S. plans in the first six months of 2018 were $237 million, of which $80 million was in cash and $157 million in U.S. Treasury securities. The contribution of U.S. Treasury securities is considered a non-cash transaction in the Consolidated Statement of Cash Flows.

48

Notes to Consolidated Financial Statements — (continued)

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

Cost of Nonpension Postretirement Plans

(Dollars in millions)	U.S. Plan				Non-U.S. Plans
For the three months ended June 30:	2019		2018		2019		2018
Service cost	$	3	$	3	$	1	$	1
Interest cost(1)		36		33		12		11
Expected return on plan assets(1)		—		—		(1)		(1)
Amortization of prior service costs/(credits)(1)		(1)		(2)		0		0
Recognized actuarial losses(1)		0		2		3		1
Curtailments and settlements(1)		—		—		—		0
Total nonpension postretirement plans cost recognized in Consolidated Statement of Earnings	$	38	$	37	$	15	$	12

(1) These components of net periodic pension cost are included in other (income) and expense in the Consolidated Statement of Earnings.

(Dollars in millions)	U.S. Plan				Non-U.S. Plans
For the six months ended June 30:	2019		2018		2019		2018
Service cost	$	5	$	6	$	3	$	3
Interest cost(1)		73		66		25		24
Expected return on plan assets(1)		—		—		(3)		(3)
Amortization of prior service costs/(credits)(1)		(1)		(4)		0		0
Recognized actuarial losses(1)		0		5		5		3
Curtailments and settlements(1)		—		—		0		0
Total nonpension postretirement plans cost recognized in Consolidated Statement of Earnings	$	77	$	74	$	30	$	26

(1) These components of net periodic pension cost are included in other (income) and expense in the Consolidated Statement of Earnings.

The company contributed $292 million in U.S. Treasury securities to the U.S. nonpension postretirement benefit and active employee medical trusts during the six months ended June 30, 2019, and $215 million in U.S. Treasury securities during the six months ended June 30, 2018. The contribution of U.S. Treasury securities is considered a non-cash transaction in the Consolidated Statement of Cash Flows.

49

Notes to Consolidated Financial Statements — (continued)

11. Acquisitions/Divestitures:

Acquisitions

The company did not enter into any acquisition transactions during the six months ended June 30, 2019.

Red Hat - On July 9, 2019, the company completed the acquisition of all of the outstanding shares of Red Hat. Red Hat’s vast portfolio of open-source technologies, innovative cloud development platform and developer community, combined with IBM’s innovative hybrid cloud technology, industry expertise, and commitment to data, trust and security, will deliver the hybrid multicloud capabilities required to address the next chapter of cloud implementations as well as accelerate the company’s growth. Red Hat’s business model is based upon open-source software, which is an alternative to proprietary software in relation to the development and licensing of the commercial software code. For Red Hat’s open-source software subscriptions, no revenue is recognized upfront from the licensing of the code itself, but rather, is recognized over time throughout the contract term as control of the promised product or service is transferred to the customer.

On the acquisition date, Red Hat shareholders were entitled to receive $190 per share in cash, which represented a total equity value of approximately $34 billion and was remitted to the paying agent. The company funded the transaction through a combination of cash on hand and proceeds from debt issuances. Refer to note 13, “Borrowings,” for additional details on the financing of the transaction. The initial accounting for the Red Hat acquisition is not complete due to the limited amount of time since the acquisition date. In an acquisition, U.S. GAAP requires the company to record all assets acquired and liabilities assumed at the acquisition date fair value. This includes the acquired deferred revenue balance. This will result in a non-cash adjustment to the acquired deferred revenue balance and a reduction to reported revenue post-closing. The level of adjustment will reflect the high margin profile of Red Hat’s business.

Divestitures

Select IBM Software Products – On December 6, 2018, IBM and HCL Technologies Limited (HCL) announced a definitive agreement, in which HCL would acquire select standalone Cloud and Cognitive Software products for $1,775 million, inclusive of $150 million of contingent consideration. The software products in-scope include AppScan, BigFix, Unica, Commerce, Portal, Notes, Domino and Connections. The transaction included commercial software, intellectual property and services offerings. In addition, the transaction includes transition services for IT and other services. The initial terms of the transition services are generally less than one year, however, HCL can renew certain services up to an additional year.

The transaction closed on June 30, 2019. The company received cash of $812 million at closing and expects to receive an additional $813 million within 12 months of closing. The company recognized a pre-tax gain on the sale of $556 million on June 30, 2019 which was recorded in other (income) and expense in the Consolidated Statement of Earnings. The total gain on sale may change in the future due to contingent consideration or changes in other transaction estimates, however, material changes are not expected.

Select IBM Marketing Platform and Commerce Offerings – On April 4, 2019, IBM and Centerbridge Partners, L.P. (Centerbridge) announced a definitive agreement, in which Centerbridge would acquire select marketing platform and commerce offerings from IBM, including Customer Experience Analytics, Content Hub and Marketing Assistant, among others. The transaction included commercial software and services offerings. In addition, the company will provide Centerbridge with transition services including IT, supply chain management, and other services, with initial terms generally of nine months, with renewal options up to nine months. Upon closing, Centerbridge announced that this business would be re-branded under the name Acoustic. The closing completed for the U.S. on June 30, 2019. The company expects a subsequent closing for the remaining countries to occur within 12 months. The timing of the subsequent closing is subject to change as more information becomes available. The company received a net cash payment of $240 million at the U.S. closing and expects to receive an additional $150 million within 36 months.

50

Notes to Consolidated Financial Statements — (continued)

The company recognized an immaterial pre-tax gain on the sale on June 30, 2019. The amount of the pre-tax gain for the remaining countries will not be determinable until the valuation of the final balance sheet transferred is completed, however, it is not expected to be material.

Seterus – On January 3, 2019, IBM and Mr. Cooper Group announced a definitive agreement, in which Mr. Cooper Group acquired IBM’s Seterus home mortgage servicing platform business. The transaction closed in the first quarter of 2019. The financial terms related to this transaction were not material.

The above three divested businesses are reported in other – divested businesses. Refer to note 8, “Segments,” for additional information.

Other – In the fourth quarter of 2018, the Global Financing segment entered into a definitive agreement to sell certain commercial financing capabilities and assign a number of its commercial financing contracts, excluding related receivables which will be collected as they become due in the normal course of business. These commercial financing capabilities and contracts have been reported within IBM’s Global Financing segment. The transaction closed in the first quarter of 2019. The financial terms related to this transaction were not material.

12. Intangible Assets Including Goodwill: 

Intangible Assets

The following table details the company's intangible asset balances by major asset class.

	At June 30, 2019
(Dollars in millions)	Gross Carrying	Accumulated	Net Carrying
Intangible asset class	Amount