Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

 

FORM 10 - Q

 

QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

 

FOR THE QUARTER ENDED MARCH 31, 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)

 

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   x      No o

 

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  x          No  o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, 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 x

 

Accelerated filer o

Non-accelerated filer o

 

Smaller reporting company o

 

 

Emerging growth company o

 

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). o

 

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

 

The registrant had 886,642,873 shares of common stock outstanding at March 31, 2019.

 

z

 


Table of Contents

 

In dex

 

 

Page

Part I - Financial Information:

 

 

 

Item 1. Consolidated Financial Statements (Unaudited):

 

 

 

Consolidated Statement of Earnings for the three months ended March 31, 2019 and 2018

3

 

 

Consolidated Statement of Comprehensive Income for the three months ended March 31, 2019 and 2018

4

-

 

Consolidated Statement of Financial Position at March 31, 2019 and December 31, 2018

5

 

 

Consolidated Statement of Cash Flows for the three months ended March 31, 2019 and 2018

7

 

 

Consolidated Statement of Changes in Equity for the three months ended March 31, 2019 and 2018

8

 

 

Notes to Consolidated Financial Statements

10

 

 

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

50

 

 

Item 4. Controls and Procedures

75

 

 

Part II - Other Information:

 

 

 

Item 1. Legal Proceedings

75

 

 

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

75

 

 

Item 5. Other Information

76

 

 

Item 6. Exhibits

76

 

2


Table of Contents

 

Part I - Financial Information

 

Item 1. Consolidated Financial Statements:

 

INTERNATIONAL BUSINESS MACHINES CORPORATION

AND SUBSIDIARY COMPANIES

CONSOLIDATED STATEMENT OF EARNINGS

(UNAUDITED)

 

 

 

Three Months Ended March 31,

 

(Dollars in millions except per share amounts)

 

2019

 

2018

 

Revenue:

 

 

 

 

 

Services

 

$

12,423

 

$

12,961

 

Sales

 

5,354

 

5,700

 

Financing

 

404

 

410

 

Total revenue

 

18,182

 

19,072

 

Cost:

 

 

 

 

 

Services

 

8,359

 

8,835

 

Sales

 

1,516

 

1,722

 

Financing

 

264

 

269

 

Total cost

 

10,139

 

10,825

 

Gross profit

 

8,043

 

8,247

 

Expense and other (income):

 

 

 

 

 

Selling, general and administrative

 

4,691

 

5,445

 

Research, development and engineering

 

1,433

 

1,405

 

Intellectual property and custom development income

 

(101

)

(317

)

Other (income) and expense

 

(73

)

413

 

Interest expense

 

210

 

165

 

Total expense and other (income)

 

6,160

 

7,111

 

Income from continuing operations before income taxes

 

1,883

 

1,136

 

Provision for/(benefit from) income taxes

 

289

 

(540

)

Income from continuing operations

 

$

1,593

 

$

1,675

 

Income/(loss) from discontinued operations, net of tax

 

(2

)

4

 

Net income

 

$

1,591

 

$

1,679

 

 

 

 

 

 

 

Earnings/(loss) per share of common stock:

 

 

 

 

 

Assuming dilution:

 

 

 

 

 

Continuing operations

 

$

1.78

 

$

1.81

 

Discontinued operations

 

0.00

 

0.00

 

Total

 

$

1.78

 

$

1.81

 

Basic:

 

 

 

 

 

Continuing operations

 

$

1.79

 

$

1.82

 

Discontinued operations

 

0.00

 

0.00

 

Total

 

$

1.79

 

$

1.82

 

 

 

 

 

 

 

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

 

 

 

 

 

Assuming dilution

 

893.9

 

925.4

 

Basic

 

889.6

 

920.7

 

 

(Amounts may not add due to rounding.)

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

 

3


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INTERNATIONAL BUSINESS MACHINES CORPORATION

AND SUBSIDIARY COMPANIES

CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME

(UNAUDITED)

 

 

 

Three Months Ended March 31,

 

(Dollars in millions)

 

2019

 

2018

 

Net income

 

$

1,591

 

$

1,679

 

Other comprehensive income/(loss), before tax:

 

 

 

 

 

Foreign currency translation adjustments

 

171

 

(167

)

Net changes related to available-for-sale securities:

 

 

 

 

 

Unrealized gains/(losses) arising during the period

 

(1

)

(2

)

Reclassification of (gains)/losses to net income

 

 

0

 

Total net changes related to available-for-sale securities

 

(1

)

(3

)

Unrealized gains/(losses) on cash flow hedges:

 

 

 

 

 

Unrealized gains/(losses) arising during the period

 

(352

)

61

 

Reclassification of (gains)/losses to net income

 

98

 

(54

)

Total unrealized gains/(losses) on cash flow hedges

 

(254

)

7

 

Retirement-related benefit plans:

 

 

 

 

 

Prior service costs/(credits)

 

 

(1

)

Net (losses)/gains arising during the period

 

(4

)

2

 

Curtailments and settlements

 

1

 

0

 

Amortization of prior service (credits)/costs

 

(3

)

(19

)

Amortization of net (gains)/losses

 

464

 

753

 

Total retirement-related benefit plans

 

458

 

735

 

Other comprehensive income/(loss), before tax

 

375

 

573

 

Income tax (expense)/benefit related to items of other comprehensive income

 

(67

)

(143

)

Other comprehensive income/(loss), net of tax

 

308

 

430

 

Total comprehensive income/(loss)

 

$

1,899

 

$

2,109

 

 

(Amounts may not add due to rounding.)

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

 

4


Table of Contents

 

INTERNATIONAL BUSINESS MACHINES CORPORATION

AND SUBSIDIARY COMPANIES

CONSOLIDATED STATEMENT OF FINANCIAL POSITION

(UNAUDITED)

 

ASSETS

 

 

 

At March 31,

 

At December 31,

 

(Dollars in millions)

 

2019

 

2018

 

Assets:

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

17,134

 

$

11,379

 

Restricted cash

 

137

 

225

 

Marketable securities

 

872

 

618

 

Notes and accounts receivable — trade (net of allowances of $316 in 2019 and $309 in 2018)

 

6,987

 

7,432

 

Short-term financing receivables (net of allowances of $248 in 2019 and $244 in 2018)

 

20,287

 

22,388

 

Other accounts receivable (net of allowances of $33 in 2019 and $38 in 2018)

 

671

 

743

 

Inventories, at lower of average cost or net realizable value:

 

 

 

 

 

Finished goods

 

369

 

266

 

Work in process and raw materials

 

1,402

 

1,415

 

Total inventories

 

1,771

 

1,682

 

Deferred costs

 

2,368

 

2,300

 

Prepaid expenses and other current assets

 

2,478

 

2,378

 

Total current assets

 

52,705

 

49,146

 

Property, plant and equipment

 

32,692

 

32,460

 

Less: Accumulated depreciation

 

22,017

 

21,668

 

Property, plant and equipment — net

 

10,675

 

10,792

 

Operating right-of-use assets — net*

 

4,634

 

 

Long-term financing receivables (net of allowances of $38 in 2019 and $48 in 2018)

 

8,361

 

9,148

 

Prepaid pension assets

 

4,966

 

4,666

 

Deferred costs

 

2,663

 

2,676

 

Deferred taxes

 

5,284

 

5,216

 

Goodwill

 

36,281

 

36,265

 

Intangible assets — net

 

2,956

 

3,087

 

Investments and sundry assets

 

2,403

 

2,386

 

Total assets

 

$

130,926

 

$

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


Table of Contents

 

INTERNATIONAL BUSINESS MACHINES CORPORATION

AND SUBSIDIARY COMPANIES

CONSOLIDATED STATEMENT OF FINANCIAL POSITION — (CONTINUED)

(UNAUDITED)

 

LIABILITIES AND EQUITY

 

 

 

At March 31,

 

At December 31,

 

(Dollars in millions)

 

2019

 

2018

 

Liabilities:

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Taxes

 

$

2,484

 

$

3,046

 

Short-term debt

 

10,250

 

10,207

 

Accounts payable

 

5,711

 

6,558

 

Compensation and benefits

 

3,027

 

3,310

 

Deferred income

 

12,134

 

11,165

 

Operating lease liabilities*

 

1,313

 

 

Other accrued expenses and liabilities

 

3,952

 

3,941

 

Total current liabilities

 

38,871

 

38,227

 

Long-term debt

 

39,727

 

35,605

 

Retirement and nonpension postretirement benefit obligations

 

16,467

 

17,002

 

Deferred income

 

3,481

 

3,445

 

Operating lease liabilities*

 

3,590

 

 

Other liabilities

 

12,184

 

12,174

 

Total liabilities

 

114,320

 

106,452

 

Equity:

 

 

 

 

 

IBM stockholders’ equity:

 

 

 

 

 

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

 

55,287

 

55,151

 

Shares authorized: 4,687,500,000

 

 

 

 

 

Shares issued: 2019 - 2,234,819,047

 

 

 

 

 

2018 - 2,233,427,058

 

 

 

 

 

Retained earnings

 

159,396

 

159,206

 

Treasury stock - at cost

 

(169,021

)

(168,071

)

Shares: 2019 - 1,348,176,174

 

 

 

 

 

2018 - 1,340,947,648

 

 

 

 

 

Accumulated other comprehensive income/(loss)

 

(29,182

)

(29,490

)

Total IBM stockholders’ equity

 

16,481

 

16,796

 

Noncontrolling interests

 

126

 

134

 

Total equity

 

16,607

 

16,929

 

Total liabilities and equity

 

$

130,926

 

$

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


Table of Contents

 

INTERNATIONAL BUSINESS MACHINES CORPORATION

AND SUBSIDIARY COMPANIES

CONSOLIDATED STATEMENT OF CASH FLOWS

(UNAUDITED)

 

 

 

Three Months Ended March 31,

 

(Dollars in millions)

 

2019

 

2018

 

Cash flows from operating activities:

 

 

 

 

 

Net income

 

$

1,591

 

$

1,679

 

Adjustments to reconcile net income to cash provided by operating activities

 

 

 

 

 

Depreciation

 

1,143

 

774

 

Amortization of intangibles

 

303

 

340

 

Stock-based compensation

 

113

 

116

 

Net (gain)/loss on asset sales and other

 

(176

)

34

 

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

 

1,785

 

1,658

 

Net cash provided by operating activities

 

4,759

 

4,602

 

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

Payments for property, plant and equipment

 

(539

)

(870

)

Proceeds from disposition of property, plant and equipment

 

81

 

103

 

Investment in software

 

(156

)

(126

)

Acquisition of businesses, net of cash acquired

 

(1

)

(71

)

Divestitures of businesses, net of cash transferred

 

33

 

 

Non-operating finance receivables — net

 

193

 

(89

)

Purchases of marketable securities and other investments

 

(1,138

)

(1,521

)

Proceeds from disposition of marketable securities and other investments

 

674

 

810

 

Net cash used in investing activities

 

(853

)

(1,764

)

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

Proceeds from new debt

 

5,979

 

2,170

 

Payments to settle debt

 

(1,768

)

(3,295

)

Short-term borrowings/(repayments) less than 90 days — net

 

21

 

412

 

Common stock repurchases

 

(920

)

(777

)

Common stock repurchases for tax withholdings

 

(61

)

(53

)

Financing — other

 

9

 

16

 

Cash dividends paid

 

(1,397

)

(1,382

)

Net cash provided by/(used in) financing activities

 

1,863

 

(2,909

)

 

 

 

 

 

 

Effect of exchange rate changes on cash, cash equivalents and restricted cash

 

(102

)

100

 

Net change in cash, cash equivalents and restricted cash

 

5,668

 

28

 

 

 

 

 

 

 

Cash, cash equivalents and restricted cash at January 1

 

11,604

 

12,234

 

Cash, cash equivalents and restricted cash at March 31

 

$

17,272

 

$

12,262

 

 

(Amounts may not add due to rounding.)

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

 

7


Table of Contents

 

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 - 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

 

 

 

1,591

 

 

 

 

 

1,591

 

 

 

1,591

 

Other comprehensive income/(loss)

 

 

 

 

 

 

 

308

 

308

 

 

 

308

 

Total comprehensive income/(loss)

 

 

 

 

 

 

 

 

 

$

1,899

 

 

 

$

1,899

 

Cash dividends paid — common stock ($1.57 per share)

 

 

 

(1,397

)

 

 

 

 

(1,397

)

 

 

(1,397

)

Common stock issued under employee plans (1,391,989 shares)

 

137

 

 

 

 

 

 

 

137

 

 

 

137

 

Purchases (454,710 shares) and sales (82,862 shares) of treasury stock under employee plans — net

 

 

 

2

 

(50

)

 

 

(48

)

 

 

(48

)

Other treasury shares purchased, not retired (6,856,678 shares)

 

 

 

 

 

(900

)

 

 

(900

)

 

 

(900

)

Changes in other equity

 

 

 

(5

)

 

 

 

 

(5

)

 

 

(5

)

Changes in noncontrolling interests

 

 

 

 

 

 

 

 

 

 

 

(8

)

(8

)

Equity - March 31, 2019

 

$

55,287

 

$

159,396

 

$

(169,021

)

$

(29,182

)

$

16,481

 

$

126

 

$

16,607

 

 

(Amounts may not add due to rounding.)

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

 

8


Table of Contents

 

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, 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

 

 

 

1,679

 

 

 

 

 

1,679

 

 

 

1,679

 

Other comprehensive income/(loss)

 

 

 

 

 

 

 

430

 

430

 

 

 

430

 

Total comprehensive income/(loss)

 

 

 

 

 

 

 

 

 

$

2,109

 

 

 

$

2,109

 

Cash dividends paid — common stock ($1.50 per share)

 

 

 

(1,382

)

 

 

 

 

(1,382

)

 

 

(1,382

)

Common stock issued under employee plans (1,037,255 shares)

 

146

 

 

 

 

 

 

 

146

 

 

 

146

 

Purchases (325,635 shares) and sales (45,878 shares) of treasury stock under employee plans — net

 

 

 

1

 

(47

)

 

 

(45

)

 

 

(45

)

Other treasury shares purchased, not retired (4,968,417 shares)

 

 

 

 

 

(780

)

 

 

(780

)

 

 

(780

)

Changes in noncontrolling interests

 

 

 

 

 

 

 

 

 

 

 

(7

)

(7

)

Equity - March 31, 2018

 

$

54,712

 

$

156,371

 

$

(164,334

)

$

(28,583

)

$

18,166

 

$

124

 

$

18,290

 

 


* 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


Table of Contents

 

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.

 

For the three months ended March 31, 2019, the company recorded a provision for income taxes of $289 million and its effective tax rate was 15.4 percent. The rate was primarily driven by the geographical mix of income and foreign and domestic audit activity, partially offset by a discrete tax charge of $129 million related to the January 2019 additional tax reform guidance issued by the U.S. Treasury.  In the first quarter of 2018, the company reported a benefit from income taxes of $540 million and its effective tax rate was (47.5) percent.  This benefit was primarily driven by audit resolutions partially offset by a discrete provisional charge related to U.S. tax reform guidance.

 

Noncontrolling interest amounts of $7.0 million and $7.8 million, net of tax, for the three months ended March 31, 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.

 

In June 2016, with amendments in 2018, 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

 

10


Table of Contents

 

Notes to Consolidated Financial Statements — (continued)

 

credit losses. A cross-functional team was established that is evaluating the financial instruments portfolio and the system, process and policy change requirements and continues to make substantial progress. 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 and is continuing to evaluate the impact.

 

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 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 right-of-use 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 right-of-use (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 at 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 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.

 

11


Table of Contents

 

Notes to Consolidated Financial Statements — (continued)

 

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 in 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


Table of Contents

 

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 March 31, 2019:

 

Software

 

Services

 

Services

 

Systems

 

Financing

 

Other

 

Revenue

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cognitive Applications

 

$

1,308

 

$

 

$

 

$

 

$

 

$

 

$

1,308

 

Cloud & Data Platforms

 

1,917

 

 

 

 

 

 

1,917

 

Transaction Processing Platforms

 

1,812

 

 

 

 

 

 

1,812

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Consulting

 

 

1,964

 

 

 

 

 

1,964

 

Application Management

 

 

1,908

 

 

 

 

 

1,908

 

Global Process Services

 

 

247

 

 

 

 

 

247

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Infrastructure & Cloud Services

 

 

 

5,209

 

 

 

 

5,209

 

Technology Support Services

 

 

 

1,665

 

 

 

 

1,665

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Systems Hardware

 

 

 

 

914

 

 

 

914

 

Operating Systems Software

 

 

 

 

414

 

 

 

414

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Global Financing*

 

 

 

 

 

406

 

 

406

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other Revenue

 

 

 

 

 

 

417

 

417

 

Total

 

$

5,037

 

$

4,119

 

$

6,875

 

$

1,328

 

$

406

 

$

417

 

$

18,182

 

 


* 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)

 

 

 

For the three months

 

Total

 

ended March 31, 2019:

 

Revenue

 

 

 

 

 

Americas

 

$

8,493

 

Europe/Middle East/Africa

 

5,727

 

Asia Pacific

 

3,961

 

Total

 

$

18,182

 

 

13


Table of Contents

 

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 March 31, 2018:

 

Software*

 

Services*

 

Services*

 

Systems

 

Financing

 

Other*

 

Revenue

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cognitive Applications

 

$

1,286

 

$

 

$

 

$

 

$

 

$

 

$

1,286

 

Cloud & Data Platforms

 

1,950

 

 

 

 

 

 

1,950

 

Transaction Processing Platforms

 

1,880

 

 

 

 

 

 

1,880

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Consulting

 

 

1,867

 

 

 

 

 

1,867

 

Application Management

 

 

2,002

 

 

 

 

 

2,002

 

Global Process Services

 

 

246

 

 

 

 

 

246

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Infrastructure & Cloud Services

 

 

 

5,639

 

 

 

 

5,639

 

Technology Support Services

 

 

 

1,782

 

 

 

 

1,782

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Systems Hardware

 

 

 

 

1,093

 

 

 

1,093

 

Operating Systems Software

 

 

 

 

407

 

 

 

407

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Global Financing**

 

 

 

 

 

405

 

 

405

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other Revenue

 

 

 

 

 

 

515

 

515

 

Total

 

$

5,116

 

$

4,115

 

$

7,421

 

$

1,500

 

$

405

 

$

515

 

$

19,072

 

 


*   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)

 

 

 

For the three months

 

Total

 

ended March 31, 2018:

 

Revenue

 

 

 

 

 

Americas

 

$

8,707

 

Europe/Middle East/Africa

 

6,176

 

Asia Pacific

 

4,188

 

Total

 

$

19,072

 

 

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.

 

At March 31, 2019, the aggregate amount of the transaction price allocated to RPO related to customer contracts that are unsatisfied or partially unsatisfied was $118 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.

 

14


Table of Contents

 

Notes to Consolidated Financial Statements — (continued)

 

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 months ending March 31, 2019, the impact to revenue from performance obligations satisfied (or partially satisfied) in previous periods was immaterial. For the three months ending March 31, 2018, revenue was reduced by $22 million for performance obligations satisfied (or partially satisfied) in previous periods, mainly due to changes in estimates on percentage-of-completion based contracts. Refer to note A, “Significant Accounting Policies,” in the company’s 2018 Annual Report for additional information on percentage-of-completion contracts and estimates of costs to complete.

 

Reconciliation of Contract Balances

 

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

 

 

 

At March 31,

 

At December 31,

 

(Dollars in millions)

 

2019

 

2018

 

Notes and accounts receivable—trade (net of allowances of $316 and $309 at March 31, 2019 and December 31, 2018, respectively)

 

$

6,987

 

$

7,432

 

Contract assets (1)

 

528

 

470

 

Deferred income (current)

 

12,134

 

11,165

 

Deferred income (noncurrent)

 

3,481

 

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 months ended March 31, 2019 that was included within the deferred income balance at December 31, 2018 was $3.5 billion and primarily related to services and software. The amount of revenue recognized during the three months ended March 31, 2018 that was included within the deferred income balance at January 1, 2018 was $3.5 billion and was also 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;

 

·                   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.

 

15


Table of Contents

 

Notes to Consolidated Financial Statements — (continued)

 

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 three months ended March 31, 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.

 

Effective January 1, 2018, the company adopted the new FASB guidance on recognition, measurement, presentation and disclosure of financial instruments using the cumulative catch-up transition method. Since adoption, the company measures equity investments at fair value with changes recognized in net income. Refer to note 2, “Accounting Changes,” for further information.

 

The following tables present the company’s financial assets and financial liabilities that are measured at fair value on a recurring basis at March 31, 2019 and December 31, 2018.

 

16


Table of Contents

 

Notes to Consolidated Financial Statements — (continued)

 

(Dollars in millions)

 

 

 

 

 

 

 

 

 

At March 31, 2019

 

Level 1

 

Level 2

 

Level 3

 

Total

 

Assets:

 

 

 

 

 

 

 

 

 

Cash equivalents (1)

 

 

 

 

 

 

 

 

 

Time deposits and certificates of deposit

 

$

 

$

12,686

 

$

 

$

12,686

(6)

Money market funds

 

25

 

 

 

25

 

U.S. government securities

 

 

1,498

 

 

1,498

(6)

Total

 

$

25

 

$

14,184

 

$

 

$

14,209

 

Equity investments (2) 

 

0

 

 

 

0

 

Debt securities - current (3)

 

 

872

 

 

872

(6)

Derivative assets (4)

 

4

 

690

 

 

694

(7)

Total assets

 

$

29

 

$

15,747

 

$

 

$

15,776

 

Liabilities:

 

 

 

 

 

 

 

 

 

Derivative liabilities (5)

 

$

 

$

705

 

$

 

$

705

(7)

 


(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 March 31, 2019 were $346 million and $348 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 March 31, 2019 were $316 million and $389 million, respectively.

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

(7) If derivative exposures covered by a qualifying master netting agreement had been netted in the Consolidated Statement of Financial Position, the total derivative asset and liability positions each would have been reduced by $353 million.

 

(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

(7)

Total assets

 

$

26

 

$

9,028

 

$

 

$

9,053

 

Liabilities:

 

 

 

 

 

 

 

 

 

Derivative liabilities (5)

 

$

40

 

$

343

 

$

 

$

383

(7)

 


(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.

(7) If derivative exposures covered by a qualifying master netting agreement had been netted in the Consolidated Statement of Financial Position, the total derivative asset and liability positions each would have been reduced by $267 million.

 

17


Table of Contents

 

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 March 31, 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 $39,727 million and $35,605 million, and the estimated fair value was $41,675 million and $36,599 million at March 31, 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

 

G ross realized gains/losses from the sale of available-for-sale securities during the three month periods ended March 31, 2019 and 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 month periods ended March 31, 2019 and 2018 were immaterial.

 

The contractual maturities of substantially all available-for-sale debt securities are less than one year at March 31, 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 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

 

18


Table of Contents

 

Notes to Consolidated Financial Statements — (continued)

 

collateralized arrangements that were in a liability position at March 31, 2019 and December 31, 2018 was $359 million and $74 million, respectively, for which $14 million of collateral was posted and reduced the position at March 31, 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 March 31, 2019 and December 31, 2018 was $694 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 $353 million and $267 million at March 31, 2019 and December 31, 2018, respectively, of liabilities included in master netting arrangements with those counterparties. Additionally, at March 31, 2019 and December 31, 2018, this exposure was reduced by $20 million and $70 million of cash collateral, respectively. There were no non-cash collateral balances in U.S. Treasury securities at March 31, 2019 and December 31, 2018. At March 31, 2019 and December 31, 2018, the net exposure related to derivative assets recorded in the Consolidated Statement of Financial Position was $321 million and $395 million, respectively. At March 31, 2019 and December 31, 2018, the net position related to derivative liabilities recorded in the Consolidated Statement of Financial Position was $338 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 $14 million at March 31, 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 $20 million and $70 million at March 31, 2019 and December 31, 2018, respectively. 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. The company rehypothecated $14 million of cash collateral received at March 31, 2019 and no amount was rehypothecated at 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.

 

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 March 31, 2019 and December 31, 2018, the total notional amount of the company’s interest-rate swaps was $6.8 billion and $7.6 billion, respectively. The weighted-average remaining maturity of these instruments at March 31, 2019 and December 31, 2018 was approximately 3.6 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 March 31, 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. At March 31, 2019 and December 31, 2018, the total notional amount of forward starting interest-rate swaps

 

19


Table of Contents

 

Notes to Consolidated Financial Statements — (continued)

 

outstanding was $5.5 billion at both periods. These swaps are linked to future interest payments on anticipated U.S. dollar debt issuances forecasted to occur throughout 2019 and 2020. The maximum length of time over which the company has hedged its exposure to the variability in future cash flows is 30 years. These swaps are accounted for as cash flow hedges.

 

In connection with cash flow hedges of forecasted interest payments related to the company’s borrowings, the company recorded net losses of $206 million and net losses of $35 million (before taxes) at March 31, 2019 and December 31, 2018, respectively, in AOCI. The company estimates that $11 million (before taxes) of the deferred net losses on derivatives in AOCI at March 31, 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 March 31, 2019 and December 31, 2018, the total notional amount of derivative instruments designated as net investment hedges was $6.0 billion and $6.4 billion, respectively. At March 31, 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 March 31, 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 billion, respectively. At March 31, 2019 and December 31, 2018, the weighted-average remaining maturity of these instruments was approximately 0.8 years at both periods.

 

At March 31, 2019 and December 31, 2018, in connection with cash flow hedges of anticipated royalties and cost transactions, the company recorded net gains of $356 million and net gains of $342 million (before taxes), respectively, in AOCI. The company estimates that $256 million (before taxes) of deferred net gains on derivatives in AOCI at March 31, 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 March 31, 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 March 31, 2019 and December 31, 2018, in connection with cash flow hedges of foreign currency denominated borrowings, the company recorded net losses of $21 million and net gains of $75 million (before taxes), respectively, in AOCI. The company estimates that $346 million (before taxes) of deferred net gains on derivatives in AOCI at March 31, 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

 

20


Table of Contents

 

Notes to Consolidated Financial Statements — (continued)

 

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 March 31, 2019 and December 31, 2018, the total notional amount of derivative instruments in economic hedges of foreign currency exposure was $5.0 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 March 31, 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 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 March 31, 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 March 31, 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 March 31, 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 March 31, 2019 and December 31, 2018, as well as for the three months ended March 31, 2019 and 2018, respectively.

 

21


Table of Contents

 

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

 

3/31/2019

 

12/31/2018

 

Classification

 

3/31/2019

 

12/31/2018

 

Designated as hedging instruments:

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest rate contracts

 

Prepaid expenses and other current assets

 

$

12

 

$

9

 

Other accrued expenses and liabilities

 

$

211

 

$

4

 

 

 

Investments and sundry assets

 

245

 

212

 

Other liabilities

 

24

 

76

 

Foreign exchange contracts

 

Prepaid expenses and other current assets

 

301

 

348

 

Other accrued expenses and liabilities

 

99

 

110

 

 

 

Investments and sundry assets

 

104

 

135

 

Other liabilities

 

365

 

129

 

 

 

Fair value of derivative assets

 

$

662

 

$

704

 

Fair value of derivative liabilities

 

$

699

 

$

320

 

Not designated as hedging instruments:

 

 

 

 

 

 

 

 

 

 

 

 

 

Foreign exchange contracts

 

Prepaid expenses and other current assets

 

$

22

 

$

26

 

Other accrued expenses and liabilities

 

$

5

 

$

13

 

Equity contracts

 

Prepaid expenses and other current assets

 

10

 

2

 

Other accrued expenses and liabilities

 

0

 

51

 

 

 

Fair value of derivative assets

 

$

32

 

$

28

 

Fair value of derivative liabilities

 

$

6

 

$

63

 

Total derivatives

 

 

 

$

694

 

$

731

 

 

 

$

705

 

$

383

 

Total debt designated as hedging instruments(1):

 

 

 

 

 

 

 

 

 

 

 

 

 

Short-term debt

 

 

 

N/A

 

N/A

 

 

 

$

 

$

 

Long-term debt

 

 

 

N/A

 

N/A

 

 

 

6,175

 

6,261

 

 

 

 

 

N/A

 

N/A

 

 

 

$

6,175

 

$

6,261

 

Total

 

 

 

$

694

 

$

731

 

 

 

$

6,880

 

$

6,644

 

 


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

N/A - not applicable

 

22


Table of Contents

 

Notes to Consolidated Financial Statements — (continued)

 

At March 31, 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:

 

 

 

March 31,

 

December 31,

 

(Dollars in millions)

 

2019

 

2018

 

Short-term debt:

 

 

 

 

 

Carrying amount of the hedged item

 

$

(1,129

)

$

(1,878

)

Cumulative hedging adjustments included in the carrying amount - assets/(liabilities)

 

(4

)(1)

(4

)(1)

Long-term debt:

 

 

 

 

 

Carrying amount of the hedged item

 

$

(6,073

)

$

(6,004

)

Cumulative hedging adjustments included in the carrying amount - assets/(liabilities)

 

(402

)(2)

(333

)(2)

 


(1) Includes ($4) million and ($6) million of hedging adjustments on discontinued hedging relationships at March 31, 2019 and December 31, 2018, respectively.

(2) Includes ($209) million and ($213) million of hedging adjustments on discontinued hedging relationships at March 31, 2019 and December 31, 2018, respectively.

 

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 March 31:

 

2019

 

2018

 

2019

 

2018

 

Cost of services

 

$

8,359

 

$

8,835

 

$

10

 

$

19

 

Cost of sales

 

1,516

 

1,722

 

18

 

(17

)

Cost of financing

 

264

 

269

 

(18

)

4

*

SG&A expense

 

4,691

 

5,445

 

141

 

(33

)

Other (income) and expense

 

(73

)

413

 

(69

)

49

 

Interest expense

 

210

 

165

 

(20

)

4

*

 


* Reclassified to conform to 2019 presentation.

 

23


Table of Contents

 

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 March 31:

 

Earnings Line Item

 

2019

 

2018

 

2019

 

2018

 

Derivative instruments in fair value hedges(1):

 

 

 

 

 

 

 

 

 

 

 

Interest rate contracts

 

Cost of financing

 

$

36

 

$

(80

)

$

(33

)

$

96

 

 

 

Interest expense

 

39

 

(72

)

(36

)

87

 

Derivative instruments not designated as hedging instruments:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Foreign exchange contracts

 

Other (income) and expense

 

18

 

(55

)

N/A

 

N/A

 

Equity contracts

 

SG&A expense

 

119

 

(14

)

N/A

 

N/A

 

Total

 

 

 

$

212

 

$

(222

)

$

(69

)

$

182

 

 

 

 

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 March 31:

 

2019

 

2018

 

Earnings Line Item

 

2019

 

2018

 

2019

 

2018

 

Derivative instruments in cash flow hedges:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest rate contracts

 

$

(171

)

$

 

Cost of financing

 

$

 

$

 

$

 

$

 

 

 

 

 

 

 

Interest expense

 

 

 

 

 

Foreign exchange contracts

 

(181

)

61

 

Cost of services

 

10

 

19

 

 

 

 

 

 

 

 

 

Cost of sales

 

18

 

(17

)

 

 

 

 

 

 

 

 

Cost of financing

 

(29

)

(18

)*

 

 

 

 

 

 

 

 

 

 

SG&A expense

 

22

 

(18

)

 

 

 

 

 

 

 

 

Other (income) and expense

 

(87

)

104

 

 

 

 

 

 

 

 

 

Interest expense

 

(33

)

(16

)*

 

 

 

 

Instruments in net investment hedges(4):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Foreign exchange contracts

 

 

 

 

 

Cost of financing

 

 

 

8

 

6

*

 

 

19

 

(204

)

Interest expense

 

 

 

9

 

6

*

Total

 

$

(333

)

$

(143

)

 

 

$

(98

)

$

54

 

$

17

 

$

12

 

 


* 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 months ending March 31, 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.

 

24


Table of Contents

 

Notes to Consolidated Financial Statements — (continued)

 

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.

 

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 rights 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 right-of-use (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 minimum 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 March 31, 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 $149 million, $13 million, and $144 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.

 

25


Table of Contents

 

Notes to Consolidated Financial Statements — (continued)

 

The following table presents the various components of lease costs:

 

(Dollars in millions)

 

 

 

For the three months ended March 31:

 

2019

 

Finance lease cost:

 

 

 

Amortization of ROU assets

 

$

4

 

Interest on lease liabilities

 

1

 

Operating lease cost

 

386

 

Short-term lease cost

 

9

 

Variable lease cost

 

128

 

Sublease income

 

(2

)

Total lease cost

 

$

526

 

 

The following table presents 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 except for lease term and discount rate values)

 

 

 

For the three months ended March 31:

 

2019

 

(Gains) and losses on sale and leaseback transactions, net

 

$

(36

)

Cash paid for amounts included in the measurement of lease liabilities:

 

 

 

Operating cash outflows from finance leases

 

$

1

 

Financing cash outflows from finance leases

 

$

3

 

Operating cash outflows from operating leases

 

$

380

 

ROU assets obtained in exchange for new finance lease liabilities

 

$

153

*

ROU assets obtained in exchange for new operating lease liabilities

 

$

4,958

*

Weighted-average remaining lease term — finance leases

 

10.7

yrs.

Weighted-average remaining lease term — operating leases

 

5.1

yrs.

Weighted-average discount rate — finance leases

 

3.64

%

Weighted-average discount rate — operating leases

 

3.34

%

 


*  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 was $156 million for operating leases and immaterial for finance leases.

 

The following maturity analysis presents expected undiscounted cash out flows for operating and finance leases on an annual basis for the next five years, with the exception of 2019, which presents the expected undiscounted cash out flows for operating and finance leases for the remaining nine months of the year.

 

 

 

 

 

 

 

 

 

 

 

 

 

Beyond

 

Imputed

 

 

 

(Dollars in millions)

 

2019

 

2020

 

2021

 

2022

 

2023

 

2023

 

Interest *

 

Total

 

Finance leases

 

$

13

 

$

18

 

$

18

 

$

18

 

$

16

 

$

105

 

$

(33

)

$

156

 

Operating leases

 

$

1,192

 

$

1,258

 

$

937

 

$

655

 

$

435

 

$

829

 

$

(403

)

$

4,903

 

 


*  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.

 

26


Table of Contents

 

Notes to Consolidated Financial Statements — (continued)

 

 

 

 

 

 

 

 

 

 

 

 

 

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. Equipment generally consists of IBM Z, Power Systems and Storage Systems.

 

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.

 

The company’s payment terms for leases are typically unconditional. Therefore, while the client could terminate the lease prior to the end of the lease term, the client would 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 or renew the lease based on mutually agreed upon terms. With respect to a client purchase of leased assets, the lease agreement would include an option to purchase the equipment at either a stated price or at the then-current fair market value of the equipment at the end of the lease.

 

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 table presents amounts included in the Consolidated Statement of Earnings related to lessor activity:

 

(Dollars in millions)

 

 

 

For the three months ended March 31:

 

2019

 

Lease income — sales-type and direct financing leases

 

 

 

Sales-type lease selling price

 

$

149

 

Less: Carrying value of underlying assets, excluding unguaranteed residual value

 

55

 

Gross profit

 

94

 

Interest income on lease receivables

 

79

 

Total sales-type and direct financing lease income

 

$

172

 

Lease income — operating leases

 

90

 

Variable lease income

 

18

 

Total lease income

 

$

280

 

 

27


Table of Contents

 

Notes to Consolidated Financial Statements — (continued)

 

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, the estimated guaranteed and unguaranteed residual value of the equipment less unearned income and allowance for credit losses. At March 31, 2019, the unguaranteed residual value of sales-type and direct financing leases was $566 million. For further information on the company’s net investment in leases, including guaranteed and unguaranteed 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. The company recognizes finance income over the term of a sales-type lease on the net investment in the lease and any variable lease payments, which are not included in the net investment in the lease.

 

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 at lease inception. 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 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 months ended March 31, 2019, impairment of residual values was immaterial.

 

The following table provides a maturity analysis of the lease payments due to IBM on sales-type and direct financing leases over the next five years and thereafter, with the exception of 2019, which presents the expected undiscounted cash flows for the remaining nine months of the year, as well as a reconciliation of the undiscounted cash flows to the financing receivables recognized in the Consolidated Statement of Financial Position at March 31, 2019:

 

(Dollars in millions)

 

Total

 

2019

 

$

2,167

 

2020

 

2,173

 

2021

 

1,353

 

2022

 

616

 

2023

 

145

 

Thereafter

 

9

 

Total undiscounted cash flows

 

$

6,462

 

Present value of lease payments (recognized as financing receivables)

 

5,965

*

Difference between undiscounted cash flows and discounted cash flows

 

$

497

 

 


* 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.

 

28


Table of Contents

 

Notes to Consolidated Financial Statements — (continued)

 

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 March 31, 2019, the unguaranteed residual value of operating leases was $103 million.

 

At commencement of an operating lease, initial direct costs are deferred. As lease payments are made, the company records sales revenue over the lease term. Initial direct costs are expensed over the lease term on the same basis as lease income is recorded.

 

The following table provides a maturity analysis of the undiscounted lease payments due to IBM on operating leases over the next five years and thereafter, at March 31, 2019, with the exception of 2019, which presents the expected undiscounted cash flows for the remaining nine months of the year:

 

(Dollars in millions)

 

Total

 

2019

 

$

183

 

2020

 

136

 

2021

 

43

 

2022

 

2

 

2023

 

0

 

Thereafter

 

0

 

Total undiscounted cash flows

 

$

364

 

 

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 period for assets under operating leases.  These assets are included in “Property, plant and equipment net” in the Consolidated Statement of Financial Position.

 

29


Table of Contents

 

Notes to Consolidated Financial Statements — (continued)

 

6. Financing Receivables: Financing receivables primarily consist of investment in sales-type and direct financing leases, commercial financing receivables and client loan and installment payment receivables (loans). 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. 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.

 

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 March 31, 2019:

 

Leases

 

Receivables

 

(Loans)

 

Total

 

Financing receivables, gross

 

$

6,477

 

$

10,385

 

$

12,582

 

$

29,444

 

Unearned income

 

(497

)

(34

)

(617

)

(1,148

)

Recorded investment

 

$

5,980

 

$

10,351

 

$

11,965

 

$

28,296

 

Allowance for credit losses

 

(95

)

(18

)

(174

)

(287

)

Unguaranteed residual value

 

566

 

 

 

566

 

Guaranteed residual value

 

72

 

 

 

72

 

Total financing receivables, net

 

$

6,523

 

$

10,333

 

$

11,791

 

$

28,648

 

Current portion

 

$

2,712

 

$

10,333

 

$

7,241

 

$

20,287

 

Noncurrent portion

 

$

3,811

 

$

 

$

4,550

 

$

8,361

 

 

 

 

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 $868 million and $710 million at March 31, 2019 and December 31, 2018, respectively.

 

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

 

30


Table of Contents

 

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 March 31, 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 March 31, 2019:

 

Americas

 

EMEA

 

Asia Pacific

 

Total

 

Recorded investment

 

 

 

 

 

 

 

 

 

Lease receivables

 

$

3,617

 

$

1,230

 

$

1,133

 

$

5,980

 

Loan receivables

 

6,203

 

3,374

 

2,388

 

11,965

 

Ending balance

 

$

9,820

 

$

4,603

 

$

3,522

 

$

17,945

 

Recorded investment collectively evaluated for impairment

 

$

9,672

 

$

4,555

 

$

3,471

 

$

17,699

 

Recorded investment individually evaluated for impairment

 

$

148

 

$

48

 

$

50

 

$

247

 

 

 

 

 

 

 

 

 

 

 

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

 

$

(4

)

$

(1

)

$

(2

)

$

(8

)

Recoveries

 

0

 

0

 

0

 

0

 

Provision

 

3

 

(5

)

0

 

(1

)

Other *

 

(1

)

0

 

1

 

(1

)

Ending balance at March 31, 2019

 

$

155

 

$

59

 

$

55

 

$

269

 

Lease receivables

 

$

49

 

$

22

 

$

24

 

$

95

 

Loan receivables

 

$

106

 

$

37

 

$

31

 

$

174

 

 

 

 

 

 

 

 

 

 

 

Related allowance, collectively evaluated for impairment

 

$

33

 

$

14

 

$

5

 

$

52

 

Related allowance, individually evaluated for impairment

 

$

122

 

$

45

 

$

50

 

$

217

 

 


* Primarily represents translation adjustments.

 

Write-offs of lease receivables and loan receivables were $3 million and $5 million, respectively, for the three months ended March 31, 2019. Provisions for credit losses recorded for lease receivables and loan receivables were immaterial, for the three months ended March 31, 2019.

 

The average recorded investment of impaired leases and loans for Americas, EMEA and Asia Pacific was $147 million, $50 million and $51 million, respectively, for the three months ended March 31, 2019 and $130 million, $55 million and $81 million, respectively, for the three months ended March 31, 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 March 31, 2019 and 2018.

 

31


Table of Contents

 

Notes to Consolidated Financial Statements — (continued)

 

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

 

32


Table of Contents

 

Notes to Consolidated Financial Statements — (continued)

 

 

 

 

 

 

 

Recorded

 

Billed

 

Recorded

 

 

 

Total

 

Recorded

 

Investment

 

Invoices

 

Investment

 

(Dollars in millions)

 

Recorded

 

Investment

 

> 90 Days and

 

> 90 Days and

 

Not

 

At March 31, 2019:

 

Investment

 

> 90 Days (1)

 

Accruing (1)

 

Accruing

 

Accruing (2)

 

Americas

 

$

3,617

 

$

294

 

$

240

 

$

13

 

$

54

 

EMEA

 

1,230

 

40

 

22

 

3

 

17

 

Asia Pacific

 

1,133

 

37

 

13

 

2

 

23

 

Total lease receivables

 

$

5,980

 

$

370

 

$

276

 

$

18

 

$

94

 

 

 

 

 

 

 

 

 

 

 

 

 

Americas

 

$

6,203

 

$

232

 

$

131

 

$

23

 

$

101

 

EMEA

 

3,374

 

83

 

14

 

4

 

68

 

Asia Pacific

 

2,388

 

32

 

4

 

2

 

28

 

Total loan receivables

 

$

11,965

 

$

347

 

$

150

 

$

29

 

$

197

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

17,945

 

$

717

 

$

426

 

$

47

 

$

291

 

 


(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, $247 million is individually evaluated for impairment with a related allowance of $217 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 March 31, 2019 and December 31, 2018 . Receivables with a credit quality indicator ranging 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.

 

33


Table of Contents

 

Notes to Consolidated Financial Statements — (continued)

 

(Dollars in millions)

 

Lease Receivables

 

Loan Receivables

 

At March 31, 2019:

 

Americas

 

EMEA

 

Asia Pacific

 

Americas

 

EMEA

 

Asia Pacific

 

Credit ratings:

 

 

 

 

 

 

 

 

 

 

 

 

 

Aaa – Aa3

 

$

454

 

$

15

 

$

67

 

$

916

 

$

127

 

$

159

 

A1 – A3

 

804

 

136

 

540

 

892

 

238

 

792

 

Baa1 – Baa3

 

932

 

386

 

199

 

1,602

 

1,233

 

653

 

Ba1 – Ba2

 

679

 

437

 

135

 

1,459

 

944

 

535

 

Ba3 – B1

 

454

 

147

 

99

 

604

 

481

 

126

 

B2 – B3

 

198

 

69

 

54

 

521

 

284

 

75

 

Caa – D

 

47

 

18

 

15

 

104

 

31

 

19

 

Total

 

$

3,568

 

$

1,208

 

$

1,109

 

$

6,097

 

$

3,337

 

$

2,358

 

 

(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 three months ended March 31, 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.

 

(Dollars in millions)

 

 

 

 

 

For the three months ended March 31:

 

2019

 

2018

 

Cost

 

$

20

 

$

20

 

Selling, general and administrative

 

74

 

81

 

Research, development and engineering

 

19

 

16

 

Pre-tax stock-based compensation cost

 

$

113

 

$

116

 

Income tax benefits

 

(25

)

(35

)

Total net stock-based compensation cost

 

$

88

 

$

81

 

 

Pre-tax stock-based compensation cost for the three months ended March 31, 2019 decreased $3 million compared to the corresponding period in the prior year. This was due to decreases related to performance share units, the conversion of stock-based compensation previously issued by acquired entities and stock options, partially offset by an increase in restricted stock units.  All changes were immaterial.

 

As of March 31, 2019, the total unrecognized compensation cost of $671 million related to non-vested awards was expected to be recognized over a weighted-average period of approximately 2.5 years.

 

There was no significant capitalized stock-based compensation cost at March 31, 2019 and 2018.

 

34


Table of Contents

 

Notes to Consolidated Financial Statements — (continued)

 

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 pending 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
+ Security Services
- Divested Select Software*
+ Red Hat (post closing)

 

Cloud & Cognitive Software

 

 

 

 

 

Global Business Services

 

- Divested Mortgage Servicing**

 

Global Business Services

 

 

 

 

 

Technology Services & Cloud Platforms

 

- Security Services
- Integration Software

 

Global Technology Services

 

 

 

 

 

Systems

 

 

 

Systems

 

 

 

 

 

Global Financing

 

 

 

Global Financing

 

 

 

 

 

Other

 

+ Divested Mortgage Servicing**
+ Divested Select Software*

 

Other

 


*  IBM announced sales of select software assets expected to close mid-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.

 

35


Table of Contents

 

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 March 31, 2019:

 

 

 

 

 

 

 

 

 

 

 

 

 

External revenue

 

$

5,037

 

$

4,119

 

$

6,875

 

$

1,328

 

$

406

 

$

17,765

 

Internal revenue

 

841

 

74

 

290

 

163

 

300

 

1,668

 

Total revenue

 

$

5,879

 

$

4,193

 

$

7,164

 

$

1,491

 

$

706

 

$

19,433

 

Pre-tax income/(loss) from continuing operations

 

$

1,767

 

$

315

 

$

275

 

$

(202

)

$

288

 

$

2,444

 

Revenue year-to-year change

 

(2.8

)%

(0.3

)%

(5.3

)%

(9.8

)%

(15.4

)%

(4.3

)%

Pre-tax income year-to-year change

 

5.2

%

152.1

%

315.1

%

(0.4

)%

(23.4

)%

19.5

%

Pre-tax income/(loss) margin

 

30.1

%

7.5

%

3.8

%

(13.5

)%

40.8

%

12.6

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

For the three months ended March 31, 2018:

 

 

 

 

 

 

 

 

 

 

 

 

 

External revenue

 

$

5,116

*

$

4,115

*

$

7,421

*

$

1,500

 

$

405

 

$

18,557

*

Internal revenue

 

931

*

89

 

141

 

153

 

429

 

1,743

*

Total revenue

 

$

6,047

*

$

4,204

*

$

7,562

*

$

1,653

 

$

834

 

$

20,299

*

Pre-tax income/(loss) from continuing operations

 

$

1,680

*

$

125

*

$

66

*

$

(203

)

$

377

 

$

2,045

*

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Pre-tax income/(loss) margin

 

27.8

%*

3.0

%*

0.9

%*

(12.3

)%

45.1

%

10.1

%*

 


* Recast to conform to 2019 presentation.

 

Reconciliations to IBM as Reported:

 

(Dollars in millions)

 

 

 

 

 

For the three months ended March 31:

 

2019

 

2018

 

Revenue:

 

 

 

 

 

Total reportable segments

 

$

19,433

 

$

20,299

*

Other — divested businesses

 

343

 

446

*

Other revenue

 

74

 

69

 

Eliminations of internal transactions

 

(1,668

)

(1,743

)*

Total consolidated revenue

 

$

18,182

 

$

19,072

 

Pre-tax income from continuing operations:

 

 

 

 

 

Total reportable segments

 

$

2,444

 

$

2,045

*

Amortization of acquired intangible assets

 

(173

)

(203

)

Acquisition-related (charges)/income

 

(39

)

0

 

Non-operating retirement-related (costs)/income

 

(138

)

(402

)

Eliminations of internal transactions

 

(89

)

(190

)*

Other — divested businesses

 

(55

)

14

*

Unallocated corporate amounts

 

(67

)

(130

)

Total pre-tax income from continuing operations

 

$

1,883

 

$

1,136

 

 


* Recast to conform to 2019 presentation.

 

36


Table of Contents

 

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 March 31, 2019:

 

Amount

 

Benefit

 

Amount

 

Other comprehensive income/(loss):

 

 

 

 

 

 

 

Foreign currency translation adjustments

 

$

171

 

$

0

 

$

172

 

Net changes related to available-for-sale securities:

 

 

 

 

 

 

 

Unrealized gains/(losses) arising during the period

 

$

(1

)

$

0

 

$

(1

)

Reclassification of (gains)/losses to other (income) and expense

 

 

 

 

Total net changes related to available-for-sale securities

 

$

(1

)

$

0

 

$

(1

)

Unrealized gains/(losses) on cash flow hedges:

 

 

 

 

 

 

 

Unrealized gains/(losses) arising during the period

 

$

(352

)

$

84

 

$

(268

)

Reclassification of (gains)/losses to:

 

 

 

 

 

 

 

Cost of services

 

(10

)

3

 

(7

)

Cost of sales

 

(18

)

5

 

(13

)

Cost of financing

 

29

 

(7

)

22

 

SG&A expense

 

(22

)

6

 

(16

)

Other (income) and expense

 

87

 

(22

)

65

 

Interest expense

 

33

 

(8

)

24

 

Total unrealized gains/(losses) on cash flow hedges

 

$

(254

)

$

61

 

$

(193

)

Retirement-related benefit plans(1):

 

 

 

 

 

 

 

Net (losses)/gains arising during the period

 

$

(4

)

$

1

 

$

(2

)

Curtailments and settlements

 

1

 

0

 

1

 

Amortization of prior service (credits)/costs

 

(3

)

1

 

(2

)

Amortization of net (gains)/losses

 

464

 

(130

)

334

 

Total retirement-related benefit plans

 

$

458

 

$

(128

)

$

330

 

Other comprehensive income/(loss)

 

$

375

 

$

(67

)

$

308

 

 


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

 

37


Table of Contents

 

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 March 31, 2018:

 

Amount

 

Benefit

 

Amount

 

Other comprehensive income/(loss):

 

 

 

 

 

 

 

Foreign currency translation adjustments

 

$

(167

)

$

51

 

$

(115

)

Net changes related to available-for-sale securities:

 

 

 

 

 

 

 

Unrealized gains/(losses) arising during the period

 

$

(2

)

$

1

 

$

(2

)

Reclassification of (gains)/losses to other (income) and expense

 

0

 

0

 

0

 

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

 

$

61

 

$

(9

)

$

51

 

Reclassification of (gains)/losses to:

 

 

 

 

 

 

 

Cost of services

 

(19

)

5

 

(14

)

Cost of sales

 

17

 

(5

)

12

 

Cost of financing*

 

18

 

(4

)

13

 

SG&A expense

 

18

 

(5

)

13

 

Other (income) and expense

 

(104

)

26

 

(78

)

Interest expense*

 

16

 

(4

)

12

 

Total unrealized gains/(losses) on cash flow hedges

 

$

7

 

$

3

 

$

10

 

Retirement-related benefit plans(1):

 

 

 

 

 

 

 

Prior service costs/(credits)

 

$

(1

)

$

0

 

$

(1

)

Net (losses)/gains arising during the period

 

2

 

(1

)

1

 

Curtailments and settlements

 

0

 

0

 

0

 

Amortization of prior service (credits)/costs

 

(19

)

5

 

(14

)

Amortization of net (gains)/losses

 

753

 

(203

)

550

 

Total retirement-related benefit plans

 

$

735

 

$

(199

)

$

537

 

Other comprehensive income/(loss)

 

$

573

 

$

(143

)

$

430

 

 


*                  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.

 

38


Table of Contents

 

Notes to Consolidated Financial Statements — (continued)

 

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

 

(268

)

172

 

(2

)

(1

)

(99

)

Amount reclassified from accumulated other comprehensive income

 

75

 

 

333

 

 

407

 

Total change for the period

 

$

(193

)

$

172

 

$

330

 

$

(1

)

$

308

 

March 31, 2019

 

$

90

 

$

(3,519

)

$

(25,753

)

$

(1

)

$

(29,182

)

 


*                  Foreign currency translation adjustments are presented gross except for any associated hedges which are presented 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, 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

 

51

 

(115

)

0

 

(2

)

(65

)

Amount reclassified from accumulated other comprehensive income

 

(41

)

0

 

537

 

0

 

495

 

Total change for the period

 

$

10

 

$

(115

)

$

537

 

$

(2

)

$

430

 

March 31, 2018

 

$

50

 

$

(2,903

)

$

(25,730

)

$

(1

)

$

(28,583

)

 


*                  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.”

 

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 table provides the pre-tax cost for all retirement-related plans.

 

 

 

 

 

 

 

Yr. to Yr.

 

(Dollars in millions)

 

 

 

 

 

Percent

 

For the three months ended March 31:

 

2019

 

2018

 

Change

 

Retirement-related plans — cost

 

 

 

 

 

 

 

Defined benefit and contribution pension plans — cost

 

$

437

 

$

738

 

(40.8

)%

Nonpension postretirement plans — cost

 

54

 

51

 

6.4

 

Total

 

$

491

 

$

788

 

(37.7

)%

 

39


Table of Contents

 

Notes to Consolidated Financial Statements — (continued)

 

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

 

Cost/(Income) of Pension Plans

 

(Dollars in millions)

 

U.S. Plans

 

Non-U.S. Plans

 

For the three months ended March 31:

 

2019

 

2018

 

2019

 

2018

 

Service cost

 

$

 

$

 

$

93

 

$

104

 

Interest cost (1)

 

472

 

430

 

208

 

215

 

Expected return on plan assets (1)

 

(650

)

(676

)

(399

)

(348

)

Amortization of prior service costs/(credits) (1)

 

4

 

4

 

(6

)

(21

)

Recognized actuarial losses (1)

 

140

 

384

 

314

 

359

 

Curtailments and settlements (1)

 

 

 

1

 

0

 

Multi-employer plans

 

 

 

9

 

10

 

Other costs/(credits) (1)

 

 

 

5

 

7

 

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

 

$

(34

)

$

143

 

$

223

 

$

327

 

Cost of defined contribution plans

 

149

 

160

 

98

 

108

 

Total defined benefit and contribution pension plans cost recognized in the Consolidated Statement of Earnings

 

$

115

 

$

303

 

$

322

 

$

434

 

 


(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 for the three months ended March 31, 2019, compared to the corresponding period 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 three months of 2019 were $94 million, of which $33 million was in cash and $61 million in U.S. Treasury securities. Total contributions to the non-U.S. plans in the first three months of 2018 were $191 million, of which $44 million was in cash and $147 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.

 

The following table provides 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 March 31:

 

2019

 

2018

 

2019

 

2018

 

Service cost

 

$

3

 

$

3

 

$

1

 

$

1

 

Interest cost (1)

 

36

 

33

 

12

 

13

 

Expected return on plan assets (1)

 

 

 

(1

)

(1

)

Amortization of prior service costs/(credits) (1)

 

(1

)

(2

)

0

 

0

 

Recognized actuarial losses (1)

 

1

 

2

 

3

 

1

 

Curtailments and settlements (1)

 

 

 

0

 

0

 

Total nonpension postretirement plans cost recognized in Consolidated Statement of Earnings

 

$

39

 

$

37

 

$

15

 

$

14

 

 


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

 

The company contributed $194 million in U.S. Treasury securities to the U.S. nonpension postretirement benefit plan during the three months ended March 31, 2019, and $120 million in U.S. Treasury securities during the three months ended March 31, 2018. The contribution of U.S. Treasury securities is considered a non-cash transaction in the Consolidated Statement of Cash Flows.

 

40


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Notes to Consolidated Financial Statements — (continued)

 

11. Acquisitions/Divestitures:

 

Acquisitions: The company did not enter into any acquisition transactions during the three months ended March 31, 2019.

 

Red Hat On October 28, 2018, the company announced its intent to acquire all of the outstanding shares of Red Hat.  The combination of 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 capabilities required to address the next chapter of cloud implementations. Under the terms of the definitive agreement, Red Hat shareholders will receive $190 per share in cash, representing a total enterprise value of approximately $34 billion. On January 16, 2019, Red Hat stockholders voted to approve the merger with IBM. The transaction is subject to customary closing conditions, including regulatory reviews and is expected to close in the second half of 2019. The company intends to fund the transaction through a combination of cash and debt. Refer to note 13, “Borrowings”, for additional details on the commitment letter for a bridge term loan facility that IBM entered into in support of this transaction.

 

Divestitures:

 

Select IBM Software Products — On December 6, 2018, IBM and HCL Technologies Limited (HCL) announced a definitive agreement, in which HCL will acquire select standalone Cognitive Solutions software products for $1,775 million, inclusive of contingent consideration. The software products in-scope include AppScan, BigFix, Unica, Commerce, Portal, Notes, Domino and Connections. The transaction is expected to close in mid-2019, subject to the satisfaction of applicable regulatory requirements and customary closing conditions. IBM will receive cash consideration, with approximately half at closing and the remainder within 12 to 15 months of closing. At March 31, 2019, the company concluded that the business did not meet the held for sale classification.

 

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 will acquire select marketing platform and commerce offerings from IBM, including Customer Experience Analytics, Content Hub and Marketing Assistant, among others. The transaction is expected to close in mid-2019, subject to the satisfaction of applicable regulatory requirements and customary closing conditions. The financial terms related to this transaction are not expected to have a material impact to IBM’s consolidated financial statements. At March 31, 2019, the company concluded that the business did not meet the held for sale classification.

 

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.

 

Under the company’s new segment reporting structure, the above three divested businesses are reported in “Other divested businesses.” Refer to note 8, “Segments,” for additional information. Overall, the company expects to recognize a total pre-tax gain on these transactions in the range of $500 million to $700 million.

 

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.

 

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Notes to Consolidated Financial Statements — (continued)

 

12. Intangible Assets Including Goodwill:

 

Intangible Assets

 

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

 

 

 

At March 31, 2019

 

(Dollars in millions)

 

Gross Carrying

 

Accumulated

 

Net Carrying

 

Intangible asset class

 

Amount

 

Amortization

 

Amount

 

Capitalized software

 

$

1,665

 

$

(683

)

$

982

 

Client relationships

 

2,022

 

(1,150

)

872

 

Completed technology

 

2,032

 

(1,248

)

784

 

Patents/trademarks

 

635

 

(348

)

287

 

Other *

 

56

 

(25

)

30

 

Total

 

$

6,410

 

$

(3,454

)

$

2,956

 

 


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

 

 

 

At December 31, 2018

 

(Dollars in millions)

 

Gross Carrying

 

Accumulated

 

Net Carrying

 

Intangible asset class

 

Amount

 

Amortization

 

Amount

 

Capitalized software

 

$

1,568

 

$

(629

)

$

939

 

Client relationships

 

2,068

 

(1,123

)

945

 

Completed technology

 

2,156

 

(1,296

)

860

 

Patents/trademarks

 

641

 

(330

)

311

 

Other *

 

56

 

(23

)

32

 

Total

 

$

6,489

 

$

(3,402

)

$

3,087

 

 


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

 

The net carrying amount of intangible assets decreased $131 million during the first quarter of 2019, primarily due to intangible asset amortization, partially offset by additions resulting from capitalized software. The aggregate intangible amortization expense was $303 million and $340 million for the quarters ended March 31, 2019 and 2018, respectively. In addition, in the first three months of 2019, the company retired $273 million of fully amortized intangible assets, impacting both the gross carrying amount and accumulated amortization by this amount.

 

The amortization expense for each of the five succeeding years relating to intangible assets currently recorded in the Consolidated Statement of Financial Position is estimated to be the following at March 31, 2019:

 

 

 

Capitalized

 

Acquired

 

 

 

(Dollars in millions)

 

Software

 

Intangibles

 

Total

 

2019 (for Q2 - Q4)

 

$

383

 

$

501

 

$

885

 

2020

 

379

 

565

 

944

 

2021

 

209

 

450

 

659

 

2022

 

11

 

382

 

393

 

2023

 

 

64

 

64

 

 

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Table of Contents

 

Notes to Consolidated Financial Statements — (continued)

 

Goodwill

 

The change in the goodwill balances by segment, for the three months ended March 31, 2019 and for the year ended December 31, 2018 are as follows:

 

 

 

 

 

 

 

 

 

 

 

Foreign

 

 

 

 

 

 

 

 

 

 

 

 

 

Currency

 

 

 

 

 

 

 

 

 

Purchase

 

 

 

Translation

 

 

 

(Dollars in millions)

 

Balance

 

Goodwill

 

Price

 

 

 

And Other

 

Balance

 

Segment

 

1/1/2019

 

Additions

 

Adjustments

 

Divestitures

 

Adjustments*

 

3/31/2019

 

Cloud & Cognitive Software

 

$

24,594

 

$

 

$

0

 

$

 

$

31

 

$

24,625

 

Global Business Services

 

4,711

 

 

0

 

 

(3

)

4,708

 

Global Technology Services

 

3,988

 

 

 

 

16

 

4,003

 

Systems

 

1,847

 

 

 

 

3

 

1,851

 

Other — divested businesses

 

1,126

 

 

 

(32

)

 

1,094

 

Total

 

$

36,265

 

$

 

$

0

 

$

(32

)

$

47

 

$

36,281

 

 


*                  Primarily driven by foreign currency translation.

 

 

 

 

 

 

 

 

 

 

 

Foreign

 

 

 

 

 

 

 

 

 

 

 

 

 

Currency

 

 

 

 

 

 

 

 

 

Purchase

 

 

 

Translation

 

 

 

(Dollars in millions)

 

Balance

 

Goodwill

 

Price

 

 

 

And Other

 

Balance

 

Segment

 

1/1/2018

 

Additions

 

Adjustments

 

Divestitures

 

Adjustments**

 

12/31/2018

 

Cloud & Cognitive Software*

 

$

24,973

 

$

9

 

$

0

 

$

(1

)

$

(388

)

$

24,594

 

Global Business Services*

 

4,782

 

24

 

(3

)

 

(92

)

4,711

 

Global Technology Services*

 

4,044

 

 

0

 

 

(56

)

3,988

 

Systems

 

1,862

 

 

0

 

 

(15

)

1,847

 

Other — divested businesses*

 

1,127

 

1

 

0

 

0

 

(2

)

1,126

 

Total

 

$

36,788

 

$

34

 

$

(3

)

$

(1

)

$

(553

)

$

36,265

 

 


*                  Recast to conform to 2019 presentation.

**           Primarily driven by foreign currency translation.

 

In the first quarter of 2019, the company made a number of changes to its organizational structure and management system. With these changes, the company revised its reportable segments. Goodwill was reallocated to the new reporting segments, and as a result, an impairment assessment was performed. There were no goodwill impairment losses recorded during the first three months of 2019 or the full year of 2018 and the company has no accumulated impairment losses. For further information regarding the segment change, refer to note 8, “Segments.”

 

Purchase price adjustments recorded in the first three months of 2019 and full year 2018 were related to acquisitions that were still subject to the measurement period that ends at the earlier of 12 months from the acquisition date or when information becomes available. Net purchase price adjustments recorded during the first three months of 2019 and full year 2018 were not material.

 

13. Borrowings:

 

Short-Term Debt

 

 

 

At March 31,

 

At December 31,

 

(Dollars in millions)

 

2019

 

2018

 

Commercial paper

 

$

2,993

 

$

2,995

 

Short-term loans

 

150

 

161

 

Long-term debt — current maturities

 

7,106

 

7,051

 

Total

 

$

10,250

 

$

10,207

 

 

The weighted-average interest rate for commercial paper at March 31, 2019 and December 31, 2018 was 2.5 percent at both periods. The weighted-average interest rate for short-term loans was 5.8 percent and 4.3 percent at March 31, 2019 and December 31, 2018, respectively.

 

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Notes to Consolidated Financial Statements — (continued)

 

Long-Term Debt

 

Pre-Swap Borrowing

 

 

 

 

 

Balance

 

Balance

 

(Dollars in millions)

 

Maturities

 

3/31/2019

 

12/31/2018

 

U.S. dollar debt (weighted-average interest rate at March 31, 2019):*

 

 

 

 

 

 

 

3.2%

 

2019

 

$

3,959

 

$

5,465

 

2.6%

 

2020

 

4,338

 

4,344

 

2.9%

 

2021

 

5,531

 

5,529

 

2.5%

 

2022

 

3,529

 

3,536

 

3.2%

 

2023

 

2,413

 

2,428

 

3.6%

 

2024

 

2,046

 

2,037

 

7.0%

 

2025

 

600

 

600

 

3.5%

 

2026

 

1,350

 

1,350

 

4.7%

 

2027

 

969

 

969

 

6.5%

 

2028

 

313

 

313

 

3.7%

 

2030

 

149

 

32

 

5.9%

 

2032

 

600

 

600

 

8.0%

 

2038

 

83

 

83

 

5.6%

 

2039

 

745

 

745

 

4.0%

 

2042

 

1,107

 

1,107

 

7.0%

 

2045

 

27

 

27

 

4.7%

 

2046

 

650

 

650

 

7.1%

 

2096

 

316

 

316

 

 

 

 

 

$

28,726

 

$

30,131

 

Other currencies (weighted-average interest rate at March 31, 2019, in parentheses):*

 

 

 

 

 

 

 

Euros (1.3%)

 

2019–2031

 

$

15,438

 

$

10,011

 

Pound sterling (2.7%)

 

2020–2022

 

1,368

 

1,338

 

Japanese yen (0.3%)

 

2022–2026

 

1,314

 

1,325

 

Other (6.5%)

 

2019–2022

 

500

 

391

 

 

 

 

 

$

47,346

 

$

43,196

 

Less: net unamortized discount

 

 

 

831

 

802

 

Less: net unamortized debt issuance costs

 

 

 

88

 

76

 

Add: fair value adjustment**

 

 

 

406

 

337

 

 

 

 

 

$

46,833

 

$

42,656

 

Less: current maturities

 

 

 

7,106

 

7,051

 

Total

 

 

 

$

39,727

 

$

35,605

 

 


*                  Includes notes, debentures, bank loans, secured borrowings and finance lease obligations.

**           The portion of the company’s fixed-rate debt obligations that is hedged is reflected in the Consolidated Statement of Financial Position as an amount equal to the sum of the debt’s carrying value and a fair value adjustment representing changes in the fair value of the hedged debt obligations attributable to movements in benchmark interest rates.

 

There are no debt securities issued and outstanding by IBM International Group Capital LLC, which is an indirect, 100 percent owned finance subsidiary of IBM, the parent. Any debt securities issued by IBM International Group Capital LLC, would be fully and unconditionally guaranteed by the parent.

 

The company’s indenture governing its debt securities and its various credit facilities each contain significant covenants which obligate the company to promptly pay principal and interest, limit the aggregate amount of secured indebtedness and sale and leaseback transactions to 10 percent of the company’s consolidated net tangible assets, and restrict the company’s ability to merge or consolidate unless certain conditions are met. The credit facilities also include a covenant on the company’s consolidated net interest expense ratio, which cannot be less than 2.20 to 1.0, as well as a cross default provision with respect to other defaulted indebtedness of at least $500 million.

 

The company is in compliance with all of its significant debt covenants and provides periodic certifications to its lenders. The failure to comply with its debt covenants could constitute an event of default with respect to the debt to which such provisions apply. If certain events of default were to occur, the principal and interest on the debt to which such event of default applied would become immediately due and payable.

 

44


Table of Contents

 

Notes to Consolidated Financial Statements — (continued)

 

Pre-swap annual contractual obligations of long-term debt outstanding at March 31, 2019, are as follows:

 

(Dollars in millions)

 

Total

 

2019 (for Q2 - Q4)

 

$

5,459

 

2020

 

7,374

 

2021

 

6,700

 

2022

 

4,354

 

2023

 

5,358

 

2024 and beyond

 

18,102

 

Total

 

$

47,346

 

 

Interest on Debt

 

(Dollars in millions)

 

 

 

 

 

For the three months ended March 31:

 

2019

 

2018

 

Cost of financing

 

$

179

 

$

182

 

Interest expense

 

210

 

165

 

Interest capitalized

 

2

 

3

 

Total interest paid and accrued

 

$

391

 

$

349

 

 

Lines of Credit

 

On October 28, 2018, the company announced its intent to acquire all of the outstanding shares of Red Hat. In connection with this acquisition, IBM entered into a commitment letter under which certain banks committed to provide the company with a 364-day unsecured bridge term loan facility in an aggregate principal amount of up to $20 billion to fund the acquisition. The company also entered into a fee letter in connection with the 364-day bridge facility, under which the company incurred $60 million in fees. These fees were capitalized and are being amortized to SG&A in the Consolidated Statement of Earnings over the expected term of the bridge term loan facility. For additional information on this transaction, see note 11, “Acquisitions/Divestitures.”

 

14. Contingencies:  As a company with a substantial employee population and with clients in more than 175 countries, IBM is involved, either as plaintiff or defendant, in a variety of ongoing claims, demands, suits, investigations, tax matters and proceedings that arise from time to time in the ordinary course of its business. The company is a leader in the information technology industry and, as such, has been and will continue to be subject to claims challenging its IP rights and associated products and offerings, including claims of copyright and patent infringement and violations of trade secrets and other IP rights. In addition, the company enforces its own IP against infringement, through license negotiations, lawsuits or otherwise. Also, as is typical for companies of IBM’s scope and scale, the company is party to actions and proceedings in various jurisdictions involving a wide range of labor and employment issues (including matters related to contested employment decisions, country-specific labor and employment laws, and the company’s pension, retirement and other benefit plans), as well as actions with respect to contracts, product liability, securities, foreign operations, competition law and environmental matters. These actions may be commenced by a number of different parties, including competitors, clients, current or former employees, government and regulatory agencies, stockholders and representatives of the locations in which the company does business. Some of the actions to which the company is party may involve particularly complex technical issues, and some actions may raise novel questions under the laws of the various jurisdictions in which these matters arise.

 

The company records a provision with respect to a claim, suit, investigation or proceeding when it is probable that a liability has been incurred and the amount of the loss can be reasonably estimated. Any recorded liabilities, including any changes to such liabilities for the quarter ended March 31, 2019 were not material to the Consolidated Financial Statements.

 

In accordance with the relevant accounting guidance, the company provides disclosures of matters for which the likelihood of material loss is at least reasonably possible. In addition, the company also discloses matters based on its consideration of other matters and qualitative factors, including the experience of other companies in the industry, and investor, customer and employee relations considerations.

 

With respect to certain of the claims, suits, investigations and proceedings discussed herein, the company believes at this time that the likelihood of any material loss is remote, given, for example, the procedural status, court rulings, and/or the strength of the company’s defenses in those matters. With respect to the remaining claims, suits, investigations and

 

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Notes to Consolidated Financial Statements — (continued)

 

proceedings discussed in this note, except as specifically discussed herein, the company is unable to provide estimates of reasonably possible losses or range of losses, including losses in excess of amounts accrued, if any, for the following reasons.

 

Claims, suits, investigations and proceedings are inherently uncertain, and it is not possible to predict the ultimate outcome of these matters. It is the company’s experience that damage amounts claimed in litigation against it are unreliable and unrelated to possible outcomes, and as such are not meaningful indicators of the company’s potential liability. Further, the company is unable to provide such an estimate due to a number of other factors with respect to these claims, suits, investigations and proceedings, including considerations of the procedural status of the matter in question, the presence of complex or novel legal theories, and/or the ongoing discovery and development of information important to the matters. The company reviews claims, suits, investigations and proceedings at least quarterly, and decisions are made with respect to recording or adjusting provisions and disclosing reasonably possible losses or range of losses (individually or in the aggregate), to reflect the impact and status of settlement discussions, discovery, procedural and substantive rulings, reviews by counsel and other information pertinent to a particular matter.

 

Whether any losses, damages or remedies finally determined in any claim, suit, investigation or proceeding could reasonably have a material effect on the company’s business, financial condition, results of operations or cash flows will depend on a number of variables, including: the timing and amount of such losses or damages; the structure and type of any such remedies; the significance of the impact any such losses, damages or remedies may have in the Consolidated Financial Statements; and the unique facts and circumstances of the particular matter that may give rise to additional factors. While the company will continue to defend itself vigorously, it is possible that the company’s business, financial condition, results of operations or cash flows could be affected in any particular period by the resolution of one or more of these matters.

 

The following is a summary of the more significant legal matters involving the company.

 

The company is a defendant in an action filed on March 6, 2003 in state court in Salt Lake City, Utah by the SCO Group (SCO v. IBM). The company removed the case to Federal Court in Utah. Plaintiff is an alleged successor in interest to some of AT&T’s UNIX IP rights, and alleges copyright infringement, unfair competition, interference with contract and breach of contract with regard to the company’s distribution of AIX and Dynix and contribution of code to Linux and the company has asserted counterclaims. On September 14, 2007, plaintiff filed for bankruptcy protection, and all proceedings in this case were stayed. The court in another suit, the SCO Group, Inc. v. Novell, Inc., held a trial in March 2010. The jury found that Novell is the owner of UNIX and UnixWare copyrights; the judge subsequently ruled that SCO is obligated to recognize Novell’s waiver of SCO’s claims against IBM and Sequent for breach of UNIX license agreements. On August 30, 2011, the Tenth Circuit Court of Appeals affirmed the district court’s ruling and denied SCO’s appeal of this matter. In June 2013, the Federal Court in Utah granted SCO’s motion to reopen the SCO v. IBM case. In February 2016, the Federal Court ruled in favor of IBM on all of SCO’s remaining claims, and SCO appealed. On October 30, 2017, the Tenth Circuit Court of Appeals affirmed the dismissal of all but one of SCO’s remaining claims, which was remanded to the Federal Court in Utah.

 

On May 13, 2010, IBM and the State of Indiana (acting on behalf of the Indiana Family and Social Services Administration) sued one another in a dispute over a 2006 contract regarding the modernization of social service program processing in Indiana. After six weeks of trial, on July 18, 2012, the Indiana Superior Court in Marion County rejected the State’s claims in their entirety and awarded IBM $52 million plus interest and costs. On February 13, 2014, the Indiana Court of Appeals reversed portions of the trial judge’s findings, found IBM in material breach, and ordered the case remanded to the trial judge to determine the State’s damages, if any. The Indiana Court of Appeals also affirmed approximately $50 million of the trial court’s award of damages to IBM. On March 22, 2016, the Indiana Supreme Court affirmed the outcome of the Indiana Court of Appeals and remanded the case to the Indiana Superior Court. On August 7, 2017, the Indiana Superior Court awarded the State $128 million, which it then offset against IBM’s previously affirmed award of $50 million, resulting in a $78 million award to the State, plus interest. On September 28, 2018, the Indiana Court of Appeals affirmed the Superior Court’s $78 million award to the State, but reversed the Superior Court by awarding IBM prejudgment interest on its previously affirmed $50 million award. In February 2019, the Indiana Supreme Court heard both parties’ appeals. The matter remains pending.

 

On March 9, 2017, the Commonwealth of Pennsylvania’s Department of Labor and Industry sued IBM in Pennsylvania state court regarding a 2006 contract for the development of a custom software system to manage the Commonwealth’s unemployment insurance benefits programs. The matter is pending in a Pennsylvania court.

 

Following the 2017 final judgment of the Appeal Court in London holding that IBM UK acted lawfully in 2010 in closing its UK defined benefit plans to future accruals for most participants and in implementing a new retirement policy, the Employment Tribunal in Southampton UK is expected to address approximately 290 individual actions alleging constructive

 

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Table of Contents

 

Notes to Consolidated Financial Statements — (continued)

 

dismissal and age discrimination brought against IBM UK in 2010 by employees who left the company at that time. The individual actions were previously stayed.

 

In May 2015, a putative class action was commenced in the United States District Court for the Southern District of New York related to the company’s October 2014 announcement that it was divesting its global commercial semiconductor technology business, alleging violations of the Employee Retirement Income Security Act (ERISA). Management’s Retirement Plans Committee and three current or former IBM executives are named as defendants. On September 29, 2017, the Court granted the defendants’ motion to dismiss the first amended complaint. On December 10, 2018, the Second Circuit Court of Appeals reversed the District Court order and the matter remains pending.

 

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

 

The company is also subject to ongoing tax examinations and governmental assessments in various jurisdictions. Along with many other U.S. companies doing business in Brazil, the company is involved in various challenges with Brazilian tax authorities regarding non-income tax assessments and non-income tax litigation matters. The total potential amount related to all these matters for all applicable years is approximately $900 million. The company believes it will prevail on these matters and that this amount is not a meaningful indicator of liability.

 

15. Commitments: The company’s extended lines of credit to third-party entities include unused amounts of $7,902 million and $7,368 million at March 31, 2019 and December 31, 2018, respectively. A portion of these amounts was available to the company’s business partners to support their working capital needs. In addition, the company has committed to provide future financing to its clients in connection with client purchase agreements for approximately $4,165 million and $4,432 million at March 31, 2019 and December 31, 2018, respectively.

 

The company has applied the guidance requiring a guarantor to disclose certain types of guarantees, even if the likelihood of requiring the guarantor’s performance is remote. The following is a description of arrangements in which the company is the guarantor.

 

The company is a party to a variety of agreements pursuant to which it may be obligated to indemnify the other party with respect to certain matters. Typically, these obligations arise in the context of contracts entered into by the company, under which the company customarily agrees to hold the party harmless against losses arising from a breach of representations and covenants related to such matters as title to the assets sold, certain intellectual property (IP) rights, specified environmental matters, third-party performance of nonfinancial contractual obligations and certain income taxes. In each of these circumstances, payment by the company is conditioned on the other party making a claim pursuant to the procedures specified in the particular contract, the procedures of which typically allow the company to challenge the other party’s claims. While typically indemnification provisions do not include a contractual maximum on the company’s payment, the company’s obligations under these agreements may be limited in terms of time and/or nature of claim, and in some instances, the company may have recourse against third parties for certain payments made by the company.

 

It is not possible to predict the maximum potential amount of future payments under these or similar agreements due to the conditional nature of the company’s obligations and the unique facts and circumstances involved in each particular agreement. Historically, payments made by the company under these agreements have not had a material effect on the company’s business, financial condition or results of operations.

 

In addition, the company guarantees certain loans and financial commitments. The maximum potential future payment under these financial guarantees was $24 million and $26 million at March 31, 2019 and December 31, 2018, respectively. The fair value of the guarantees recognized in the Consolidated Statement of Financial Position is not material.

 

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Table of Contents

 

Notes to Consolidated Financial Statements — (continued)

 

Changes in the company’s warranty liability for standard warranties and deferred income for extended warranty are

presented in the following tables.

 

Standard Warranty Liability

 

(Dollars in millions)

 

2019

 

2018

 

Balance at January 1

 

$

118

 

$

152

 

Current period accruals

 

110

 

25

 

Accrual adjustments to reflect actual experience

 

(9

)

(14

)

Charges incurred

 

(111

)

(32

)

Balance at March 31

 

$

107

 

$

130

 

 

Extended Warranty Liability

 

(Dollars in millions)

 

2019

 

2018

 

Aggregate deferred revenue at January 1

 

$

533

 

$

566

 

Revenue deferred for new extended warranty contracts

 

36

 

46

 

Amortization of deferred revenue

 

(64

)

(69

)

Other*

 

(3

)

5

 

Aggregate deferred revenue at March 31

 

$

503

 

$

548

 

Current portion

 

$

242

 

$

260

 

Noncurrent portion

 

$

261

 

$

288

 

 


* Other primarily consists of foreign currency translation adjustments.

 

48


Table of Contents

 

Notes to Consolidated Financial Statements — (continued)

 

16. Earnings Per Share of Common Stock: The following tables provide the computation of basic and diluted earnings per share of common stock for the three months ended March 31, 2019 and 2018.

 

 

 

For the Three Months Ended

 

 

 

March 31, 2019

 

March 31, 2018

 

Number of shares on which basic earnings per share is calculated:

 

 

 

 

 

Weighted-average shares outstanding during period

 

889,581,542

 

920,680,222

 

Add — Incremental shares under stock-based compensation plans

 

3,372,460

 

3,553,104

 

Add — Incremental shares associated with contingently issuable shares

 

956,524

 

1,176,108

 

Number of shares on which diluted earnings per share is calculated

 

893,910,526

 

925,409,434

 

 

 

 

 

 

 

Income from continuing operations (millions)

 

$

1,593

 

$

1,675

 

Income/(loss) from discontinued operations, net of tax (millions)

 

(2

)

4

 

Net income on which basic earnings per share is calculated (millions)

 

$

1,591

 

$

1,679

 

 

 

 

 

 

 

Income from continuing operations (millions)

 

$

1,593

 

$

1,675

 

Net income applicable to contingently issuable shares (millions)

 

 

 

Income from continuing operations on which diluted earnings per share is calculated (millions)

 

$

1,593

 

$

1,675

 

Income/(loss) from discontinued operations, net of tax, on which basic and diluted earnings per share is calculated (millions)

 

(2

)

4

 

Net income on which diluted earnings per share is calculated (millions)

 

$

1,591

 

$

1,679

 

 

 

 

 

 

 

Earnings/(loss) per share of common stock:

 

 

 

 

 

Assuming dilution

 

 

 

 

 

Continuing operations

 

$

1.78

 

$

1.81

 

Discontinued operations

 

0.00

 

0.00

 

Total

 

$

1.78

 

$

1.81

 

Basic

 

 

 

 

 

Continuing operations

 

$

1.79

 

$

1.82

 

Discontinued operations

 

0.00

 

0.00

 

Total

 

$

1.79

 

$

1.82

 

 

Stock options to purchase 1,137,019 shares and 16,869 shares were outstanding as of March 31, 2019 and 2018, respectively, but were not included in the computation of diluted earnings per share because the options’ exercise price during the respective period was greater than the average market price of the common shares, and, therefore, the effect would have been antidilutive.

 

17. Subsequent Events : On April 30, 2019, the company announced that the Board of Directors approved a quarterly dividend of $1.62 per common share. The dividend is payable June 10, 2019 to shareholders of record on May 10, 2019. The dividend declaration represents an increase of $0.05 per common share, which is 3 percent higher than the prior quarterly dividend of $1.57 per common share.

 

49


Table of Contents

 

Item 2.

 

MANAGEMENT’S DISCUSSION AND ANALYSIS
OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION
FOR THE THREE MONTHS ENDED MARCH 31, 2019

 

Snapshot

 

Financial Results Summary — Three Months Ended March 31:

 

 

 

 

 

 

 

Yr. to Yr.

 

 

 

 

 

 

 

Percent/

 

(Dollars and shares in millions except per share amounts)

 

 

 

 

 

Margin

 

For the three months ended March 31:

 

2019

 

2018

 

Change

 

Revenue

 

$

18,182

 

$

19,072

 

(4.7

)%*

Gross profit margin

 

44.2

%

43.2

%

1.0

pts.

Total expense and other (income)

 

$

6,160

 

$

7,111

 

(13.4

)%

Income from continuing operations before income taxes

 

$

1,883

 

$

1,136

 

65.8

%

Provision for income taxes from continuing operations

 

$

289

 

$

(540

)

nm

 

Income from continuing operations

 

$

1,593

 

$

1,675

 

(4.9

)%

Income from continuing operations margin

 

8.8

%

8.8

%

0.0

pts.

Net income

 

$

1,591

 

$

1,679

 

(5.2

)%

Earnings per share from continuing operations - assuming dilution

 

$

1.78

 

$

1.81

 

(1.7

)%

Weighted-average shares outstanding - assuming dilution

 

893.9

 

925.4

 

(3.4

)%

 

 

 

 

 

 

 

 

 

 

At 3/31/2019

 

At 12/31/2018

 

 

 

Assets

 

$

130,926

 

$

123,382

 

6.1

%

Liabilities

 

$

114,320

 

$

106,452

 

7.4

%

Equity

 

$

16,607

 

$

16,929

 

(1.9

)%

 


* (0.9) percent adjusted for currency.

nm - not meaningful

 

Organization of Information:

 

Effective with the first quarter of 2019, the company made a number of changes to its organizational structure and management system. As a result of these changes, the company revised its reportable segments. There is no change to the company’s Consolidated Financial Statements. Refer to note 8, “Segments” on pages 35 to 36 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.

 

Currency:

 

The references to “adjusted for currency” or “at constant currency” in the Management Discussion do not include operational impacts that could result from fluctuations in foreign currency rates. When the company refers to growth rates at constant currency or adjusts such growth rates for currency, it is done so that certain financial results can be viewed without the impact of fluctuations in foreign currency exchange rates, thereby facilitating period-to-period comparisons of its business performance. Financial results adjusted for currency are calculated by translating current period activity in local currency using the comparable prior year period’s currency conversion rate. This approach is used for countries where the functional currency is the local currency. Generally, when the dollar either strengthens or weakens against other currencies, the growth at constant currency rates or adjusting for currency will be higher or lower than growth reported at actual exchange rates. Refer to “Currency Rate Fluctuations” on page 71 for additional information.

 

50


Table of Contents

 

Management Discussion — (continued)

 

Operating (non-GAAP) Earnings:

 

In an effort to provide better transparency into the operational results of the business, the company separates business results into operating and non-operating categories. Operating earnings from continuing operations is a non-GAAP measure that excludes the effects of certain acquisition-related charges, intangible asset amortization expense resulting from basis differences on equity method investments, retirement-related costs and discontinued operations and their related tax impacts. Due to the unique, non-recurring nature of the enactment of the U.S. Tax Cuts and Jobs Act (“U.S. tax reform”), the company characterizes the one-time provisional charge recorded in the fourth quarter of 2017 and subsequent adjustments to that charge as non-operating. Adjustments include true-ups, accounting elections, any changes to regulations, laws, audit adjustments, etc. that affect the recorded one-time charge. For acquisitions, operating (non-GAAP) earnings exclude the amortization of purchased intangible assets and acquisition-related charges such as in-process research and development, transaction costs, applicable restructuring and related expenses, tax charges related to acquisition integration and pre-closing charges, such as financing costs. These charges are excluded as they may be inconsistent in amount and timing from period to period and are dependent on the size, type and frequency of the company’s acquisitions. All other spending for acquired companies is included in both earnings from continuing operations and in operating (non-GAAP) earnings. Throughout the Management Discussion, the impact of acquisitions over the prior 12-month period may be a driver of higher expense year to year. For retirement-related costs, the company characterizes certain items as operating and others as non-operating, consistent with GAAP. The company includes defined benefit plan and nonpension postretirement benefit plan service costs, multi-employer plan costs and the cost of defined contribution plans in operating earnings. Non-operating retirement-related costs include defined benefit plan and nonpension postretirement benefit plan amortization of prior service costs, interest cost, expected return on plan assets, amortized actuarial gains/losses, the impacts of any plan curtailments/settlements and pension insolvency costs and other costs. Non-operating retirement-related costs are primarily related to changes in pension plan assets and liabilities which are tied to financial market performance, and the company considers these costs to be outside of the operational performance of the business.

 

Overall, the company believes that providing investors with a view of operating earnings as described above provides increased transparency and clarity into both the operational results of the business and the performance of the company’s pension plans; improves visibility to management decisions and their impacts on operational performance; enables better comparison to peer companies; and allows the company to provide a long-term strategic view of the business going forward. The company’s reportable segment financial results reflect pre-tax operating earnings from continuing operations, consistent with the company’s management and measurement system.

 

The following table provides the company’s operating (non-GAAP) earnings for the first quarter of 2019 and 2018.

 

 

 

 

 

 

 

Yr. to Yr.

 

(Dollars in millions except per share amounts)

 

 

 

 

 

Percent

 

For the three months ended March 31:

 

2019

 

2018

 

Change

 

Net income as reported

 

$

1,591

 

$

1,679

 

(5.2

)%

Income/(loss) from discontinued operations, net of tax

 

(2

)

4

 

nm

 

Income from continuing operations

 

$

1,593

 

$

1,675

 

(4.9

)%

Non-operating adjustments (net of tax):

 

 

 

 

 

 

 

Acquisition-related charges

 

164

 

164

 

(0.2

)

Non-operating retirement-related costs/(income)

 

111

 

325

 

(65.8

)

U.S. tax reform charges

 

141

 

107

 

31.3

 

Operating (non-GAAP) earnings*

 

$

2,009

 

$

2,272

 

(11.6

)%

Diluted operating (non-GAAP) earnings per share

 

$

2.25

 

$

2.45

 

(8.2

)%

 


*   Refer to page 74 for a more detailed reconciliation of net income to operating earnings.

nm - not meaningful

 

Financial Performance Summary — Three Months Ended March 31:

 

In the first quarter of 2019, the company reported $18.2 billion in revenue, $1.6 billion in income from continuing operations and operating (non-GAAP) earnings of $2.0 billion, resulting in diluted earnings per share from continuing operations of $1.78 as reported and $2.25 on an operating (non-GAAP) basis. The company also generated $4.8 billion in cash from operations, $1.7 billion in free cash flow and delivered shareholder returns of $2.3 billion in gross common stock repurchases and dividends. As the company continued to optimize its portfolio and invest in emerging, high-value areas of the IT industry, there was strong performance in offerings that help clients with their digital transformation and shift of mission-critical work to the cloud.

 

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Table of Contents

 

Management Discussion — (continued)

 

Total consolidated revenue decreased 4.7 percent as reported and 1 percent adjusted for currency compared to the prior year. Cloud & Cognitive Software decreased 1.5 percent as reported, but increased 2 percent adjusted for currency. Within that segment, Cognitive Applications grew 1.7 percent as reported and 4 percent adjusted for currency, Cloud & Data Platforms decreased 1.7 percent as reported, but increased 2 percent adjusted for currency and Transaction Processing Platforms declined 3.6 percent as reported, but was flat adjusted for currency. Global Business Services (GBS) was flat as reported and increased 4 percent adjusted for currency led by Consulting which grew 5.2 percent (9 percent adjusted for currency). Global Technology Services (GTS) decreased 7.4 percent as reported (3 percent adjusted for currency), with declines in Infrastructure & Cloud Services and Technology Support Services. Within GTS, there was continued growth in cloud revenue which increased 8 percent year to year as reported and 13 percent adjusted for currency as the company continued to shift clients to hybrid cloud. Systems decreased 11.4 percent as reported (9 percent adjusted for currency), with IBM Z declining year to year reflecting the product cycle dynamics. Storage Systems declined driven by competitive dynamics and pricing pressures, while Power Systems grew as reported and adjusted for currency, driven by Linux and the full rollout of the POWER9-based architecture.

 

Total cloud revenue of $4.5 billion in the first quarter of 2019 grew 7 percent as reported and 12 percent adjusted for currency. The annual exit run rate for as-a-Service revenue was $11.7 billion, an increase of 10 percent as reported and 15 percent adjusted for currency.

 

From a geographic perspective, Americas revenue declined 2.5 percent year to year as reported (1 percent adjusted for currency). Europe/Middle East/Africa (EMEA) decreased 7.3 percent, but was flat adjusted for currency. Asia Pacific declined 5.4 percent year to year as reported (2 percent adjusted for currency).

 

The consolidated gross margin of 44.2 percent increased 1.0 points year to year, and the operating (non-GAAP) gross margin of 44.7 percent increased 0.9 points versus the prior year. The company has been focused on improving margins and the results in the first quarter reflect the actions that have been taken to focus on higher value and portfolio optimization, and also in driving productivity and operational efficiency — especially in the services businesses.

 

Total expense and other (income) decreased 13.4 percent in the first quarter of 2019 compared to the prior year. The year-to-year performance was driven by a lower level of workforce rebalancing charges (7 points), the impact of currency (5 points) and lower non-operating retirement-related costs (4 points), partially offset by a decrease in intellectual property (IP) income (3 points). Total operating (non-GAAP) expense and other (income) decreased 10.8 percent year to year, driven primarily by the same factors excluding the non-operating retirement-related costs.

 

Pre-tax income from continuing operations of $1.9 billion increased 65.8 percent and the pre-tax margin was 10.4 percent, an increase of 4.4 points versus 2018. The continuing operations effective tax rate for the first quarter of 2019 was 15.4 percent, an increase of 62.9 points compared to the first quarter of 2018. The year-to-year change was primarily driven by a reduced benefit from audit resolutions (65.8 points), offset by a lower impact from U.S. tax reform (2.5 points) and a more favorable mix of earnings. Net income of $1.6 billion decreased 5.2 percent and the net income margin was 8.8 percent, flat year to year. Operating (non-GAAP) pre-tax income from continuing operations of $2.2 billion grew 28.3 percent year to year and the operating (non-GAAP) pre-tax margin from continuing operations increased 3.2 points to 12.3 percent. The operating (non-GAAP) tax rate for the first quarter of 2019 was 10.0 percent, an increase of 40.6 points compared to the first quarter of 2018. The change in the operating (non-GAAP) tax rate was primarily driven by the same factors mentioned above, excluding the impacts of U.S. tax reform related activity. Operating (non-GAAP) income from continuing operations of $2.0 billion decreased 11.6 percent with an operating (non-GAAP) income margin from continuing operations of 11.0 percent, down 0.9 points year to year.

 

Diluted earnings per share from continuing operations of $1.78 in the first quarter of 2019 decreased 1.7 percent and operating (non-GAAP) diluted earnings per share of $2.25 decreased 8.2 percent versus the first quarter of 2018. In the first quarter of 2019, the company repurchased 6.9 million shares of its common stock at a cost of $0.9 billion and had $2.4 billion remaining in the current share repurchase authorization at March 31, 2019.

 

At March 31, 2019, the balance sheet remains strong and the company continues to be committed to maintaining a strong investment grade rating. Cash, restricted cash and marketable securities at quarter end were $18.1 billion, an increase of $5.9 billion from December 31, 2018. Cash and debt balances increased since year-end 2018, as the company prepares for the acquisition of Red Hat. Key drivers in the balance sheet and total cash flows were:

 

Total assets increased $7.5 billion ($7.7 billion adjusted for currency) from December 31, 2018 driven by:

 

52


Table of Contents

 

Management Discussion — (continued)

 

·                   An increase of $5.9 billion in cash, restricted cash and marketable securities;

 

·                   An increase in operating right-of-use assets of $4.6 billion resulting from the adoption of the new leasing standard; partially offset by

 

·                   A decrease in total receivables of $3.4 billion due to collections of higher year-end balances.

 

Total liabilities increased $7.9 billion ($8.2 billion adjusted for currency) from December 31, 2018 driven by:

 

·                   An increase in operating lease liabilities of $4.9 billion resulting from the adoption of the new leasing standard; and

 

·                   An increase in total debt of $4.2 billion driven by new issuances.

 

Total equity of $16.6 billion decreased $0.3 billion from December 31, 2018 as a result of:

 

·              Decreases from dividends ($1.4 billion) and treasury stock ($1.0 billion) primarily due to share repurchases; partially offset by

 

·                   Increases from net income ($1.6 billion) and retirement related plans ($0.3 billion).

 

The company generated $4.8 billion in cash flow provided by operating activities, an increase of $0.2 billion compared to the first quarter of 2018, driven primarily by an increase in cash provided by financing receivables ($0.1 billion). Net cash used in investing activities of $0.9 billion was $0.9 billion lower than the prior year, primarily driven by an increase in cash provided by non-operating finance receivables ($0.3 billion), a decrease in net capital expenditures ($0.3 billion), and lower net purchases of marketable securities and other investments ($0.2 billion). In the first quarter of 2019, financing activities were a source of cash of $1.9 billion compared to a $2.9 billion use of cash in the first quarter of 2018. The $4.8 billion increase in cash flow year to year was driven by an increase in net cash sourced from debt transactions ($4.9 billion), with a higher level of issuances and a lower level of maturities in the current year.

 

The company continues to expect GAAP diluted earnings per share from continuing operations of at least $12.45 and operating (non-GAAP) earnings of at least $13.90 per diluted share for 2019. The company continues to expect free cash flow to be approximately $12 billion in 2019, with free cash flow realization expected to be approximately 100 percent of GAAP net income. Refer to page 72 in the Liquidity and Capital Resources section for additional information on this non-GAAP measure. Refer to the Looking Forward section on pages 69 to 71 for additional information on the company’s expectations.

 

53


Table of Contents

 

Management Discussion — (continued)

 

First Quarter in Review

 

Results of Continuing Operations

 

Segment Details

 

The following is an analysis of the first quarter of 2019 versus the first quarter of 2018 reportable segment external revenue and gross margin results. Segment pre-tax income includes transactions between segments that are intended to reflect an arm’s-length transfer price and excludes certain unallocated corporate items.

 

 

 

 

 

 

 

 

 

Yr. to Yr.

 

 

 

 

 

 

 

 

 

Percent

 

 

 

 

 

 

 

Yr. to Yr.

 

Change

 

(Dollars in millions)

 

 

 

 

 

Percent/Margin

 

Adjusted For

 

For the three months ended March 31:

 

2019

 

2018

 

Change

 

Currency

 

Revenue:

 

 

 

 

 

 

 

 

 

Cloud & Cognitive Software

 

$

5,037

 

$

5,116

*

(1.5

)%

1.5

%

Gross margin

 

75.1

%

76.3

%*

(1.3

)pts.

 

 

Global Business Services

 

4,119

 

4,115

*

0.1

%

4.3

%

Gross margin

 

26.2

%

23.4

%*

2.8

pts.

 

 

Global Technology Services

 

6,875

 

7,421

*

(7.4

)%

(3.0

)%

Gross margin

 

33.7

%

32.6

%*

1.1

pts.

 

 

Systems

 

1,328

 

1,500

 

(11.4

)%

(8.8

)%

Gross margin

 

46.2

%

43.7

%

2.5

pts.

 

 

Global Financing

 

406

 

405

 

0.2

%

3.9

%

Gross margin

 

34.9

%

34.4

%

0.6

pts.

 

 

Other

 

417

 

515

*

(19.0

)%

(16.3

)%

Gross margin

 

26.8

%

31.8

%*

(5.0

)pts.

 

 

Total consolidated revenue

 

$

18,182

 

$

19,072

 

(4.7

)%

(0.9

)%

Total consolidated gross profit

 

$

8,043

 

$

8,247

 

(2.5

)%

 

 

Total consolidated gross margin

 

44.2

%

43.2

%

1.0

pts.

 

 

Non-operating adjustments:

 

 

 

 

 

 

 

 

 

Amortization of acquired intangible assets

 

76

 

93

 

(18.7

)%

 

 

Operating (non-GAAP) gross profit

 

$

8,119

 

$

8,340

 

(2.7

)%

 

 

Operating (non-GAAP) gross margin

 

44.7

%

43.7

%

0.9

pts.

 

 

 


* Recast to reflect segment changes.

 

Cloud & Cognitive Software

 

 

 

 

 

 

 

 

 

Yr. to Yr.

 

 

 

 

 

 

 

 

 

Percent

 

 

 

 

 

 

 

Yr. to Yr.

 

Change

 

(Dollars in millions)

 

 

 

 

 

Percent

 

Adjusted For

 

For the three months ended March 31:

 

2019

 

2018*

 

Change

 

Currency

 

Cloud & Cognitive Software external revenue:

 

$

5,037

 

$

5,116

 

(1.5

)%

1.5

%

Cognitive Applications

 

$

1,308

 

$

1,286

 

1.7

%

4.3

%

Cloud & Data Platforms

 

1,917

 

1,950

 

(1.7

)

1.6

 

Transaction Processing Platforms

 

1,812

 

1,880

 

(3.6

)

(0.4

)

 


* Recast to reflect segment changes.

 

Cloud & Cognitive Software revenue of $5,037 million decreased 1.5 percent as reported, but grew 2 percent adjusted for currency in the first quarter of 2019 compared to the prior year. There was year-to-year growth in Cognitive Applications as reported and adjusted for currency. Cloud & Data Platforms declined as reported, but grew adjusted for currency. Transaction Processing Platforms decreased as reported, but was flat on a constant currency basis.

 

54


Table of Contents

 

Management Discussion — (continued)

 

Cognitive Applications includes software that addresses vertical and domain-specific solutions, increasingly infused with AI. This includes areas such as health, financial services, IOT solutions, The Weather Company and security software and services. This content was previously reported in Solutions Software, with the exception of security services, which was reported in Infrastructure Services. Cognitive Applications revenue of $1,308 million grew 1.7 percent as reported (4 percent adjusted for currency) compared to the prior year, led by offerings in security, and solution areas such as health, supply chain and weather. Security offerings generated double-digit revenue growth driven by the company’s integrated software and services value proposition. Watson Health offerings had broad-based growth this quarter and Weather offerings had double-digit growth and reached an all-time high in the number of active users.

 

Cloud & Data Platforms includes the distributed middleware and data platform software critical for orchestration and integration of multi-cloud environments, inclusive of public and private clouds. This includes product areas such as WebSphere distributed, IBM Cloud Private, analytics platform software (e.g., DB2 distributed, information integration, and enterprise content management) and IOT, Blockchain and AI platforms. Cloud & Data Platforms revenue of $1,917 million decreased 1.7 percent as reported, but grew 2 percent adjusted for currency compared to the prior year. Offerings that are helping clients modernize and integrate applications as well as collect and manage data, grew in the first quarter as clients transition to hybrid and open multicloud environments.

 

Transaction Processing Platforms includes software that supports client mission critical on-premise workloads, including transaction processing software as well as analytics and integration software running on IBM operating systems. Transaction Processing Platforms revenue of $1,812 million decreased 3.6 percent as reported, but was flat adjusted for currency in the first quarter of 2019 compared to the prior year. Clients continued to commit to IBM’s platform for the long term given the value provided by these platforms while offering predictability in spending.

 

Within Cloud & Cognitive Software, cloud revenue of $0.7 billion grew 7 percent as reported (10 percent adjusted for currency), with an as-a-Service exit run rate of $2.1 billion.

 

 

 

 

 

 

 

Yr. to Yr.

 

 

 

 

 

 

 

Percent/

 

(Dollars in millions)

 

 

 

 

 

Margin

 

For the three months ended March 31:

 

2019

 

2018*

 

Change

 

Cloud & Cognitive Software:

 

 

 

 

 

 

 

External gross profit

 

$

3,782

 

$

3,906

 

(3.2

)%

External gross profit margin

 

75.1

%

76.3

%

(1.3

)pts.

Pre-tax income

 

$

1,767

 

$

1,680

 

5.2

%

Pre-tax margin

 

30.1

%

27.8

%

2.3

pts.

 


* Recast to reflect segment changes.

 

Cloud & Cognitive Software gross profit margin decreased 1.3 points to 75.1 percent in the first quarter of 2019 compared to the prior year, driven by a higher mix of services and higher royalty costs in the current year.

 

Pre-tax income of $1,767 million increased 5.2 percent in the first quarter of 2019 compared to the prior year. The pre-tax margin increased 2.3 points to 30.1 percent, driven by a lower level of workforce rebalancing charges in the current year, partially offset by lower IP income and continued investment in key strategic areas.

 

55


Table of Contents

 

Management Discussion — (continued)

 

Global Business Services

 

 

 

 

 

 

 

 

 

Yr. to Yr.

 

 

 

 

 

 

 

 

 

Percent

 

 

 

 

 

 

 

Yr. to Yr.

 

Change

 

(Dollars in millions)

 

 

 

 

 

Percent

 

Adjusted For

 

For the three months ended March 31:

 

2019

 

2018

 

Change

 

Currency

 

Global Business Services external revenue:

 

$

4,119

 

$

4,115

*

0.1

%

4.3

%

Consulting

 

$

1,964

 

$

1,867

 

5.2

%

9.1

%

Global Process Services

 

247

 

246

*

0.3

 

5.3

 

Application Management

 

1,908

 

2,002

 

(4.7

)

(0.3

)

 


* Recast to reflect segment changes.

 

Global Business Services revenue of $4,119 million was flat as reported, but increased 4 percent adjusted for currency in the first quarter of 2019 compared to the prior year. There was strong growth in Consulting, as clients turn to GBS, with its industry specific expertise and innovative technology portfolio, to help them on their digital journey to a Cognitive Enterprise.

 

Consulting revenue of $1,964 million grew 5.2 percent as reported and 9 percent adjusted for currency. This growth was led by Digital Strategy and iX, consulting for cloud application migrations and the Next Generation Enterprise Application practice.

 

Global Process Services revenue of $247 million was flat as reported, but grew 5 percent adjusted for currency, driven by strong performance in risk and compliance.

 

Application Management revenue of $1,908 million declined 4.7 percent as reported, but was flat adjusted for currency. As the business shifts to cloud-based offerings, there was continued growth in Cloud Migration Factory and cloud application development. This growth was offset by ongoing declines in traditional application management engagements.

 

Within GBS, cloud revenue of $1.2 billion grew 20 percent as reported (25 percent adjusted for currency), with an as-a-Service exit run rate of $1.8 billion.

 

 

 

 

 

 

 

Yr. to Yr.

 

 

 

 

 

 

 

Percent/

 

(Dollars in millions)

 

 

 

 

 

Margin

 

For the three months ended March 31:

 

2019

 

2018*

 

Change

 

Global Business Services:

 

 

 

 

 

 

 

External gross profit

 

$

1,078

 

$

962

 

12.0

%

External gross profit margin

 

26.2

%

23.4

%

2.8

pts.

Pre-tax income

 

$

315

 

$

125

 

152.1

%

Pre-tax margin

 

7.5

%

3.0

%

4.5

pts.

 


* Recast to reflect segment changes.

 

GBS gross profit margin increased 2.8 points year to year to 26.2 percent, driven by a mix to higher-value offerings, continued yield from productivity and utilization initiatives and benefits from currency due to the global delivery model. Pre-tax income increased to $315 million in the first quarter of 2019 and pre-tax margin increased 4.5 points to 7.5 percent, reflecting the improvements in gross margin and a lower level of workforce rebalancing charges in the current year.

 

56


Table of Contents

 

Management Discussion — (continued)

 

Global Technology Services

 

 

 

 

 

 

 

 

 

Yr. to Yr.

 

 

 

 

 

 

 

 

 

Percent

 

 

 

 

 

 

 

Yr. to Yr.

 

Change

 

(Dollars in millions)

 

 

 

 

 

Percent

 

Adjusted For

 

For the three months ended March 31:

 

2019

 

2018

 

Change

 

Currency

 

Global Technology Services external revenue:

 

$

6,875

 

$

7,421

*

(7.4

)%

(3.0

)%

Infrastructure & Cloud Services

 

$

5,209

 

$

5,639

*

(7.6

)%

(3.3

)%

Technology Support Services

 

1,665

 

1,782

 

(6.5

)

(2.1

)

 


* Recast to reflect segment changes.

 

Global Technology Services revenue of $6,875 million declined 7.4 percent as reported (3 percent adjusted for currency) in the first quarter of 2019 compared to the prior year. The company is continuing to take actions to optimize the portfolio by de-emphasizing lower-value services content to increase margin, profit and cash contribution and better position the business for the longer term.

 

Infrastructure & Cloud Services revenue of $5,209 million decreased 7.6 percent as reported (3 percent adjusted for currency) compared to the first quarter of the prior year. There was continuing solid growth in cloud revenue as the company continues to migrate client’s mission-critical workloads to a hybrid multi-cloud environment.

 

Technology Support Services revenue of $1,665 million decreased 6.5 percent as reported (2 percent adjusted for currency) due primarily to hardware cycle dynamics.

 

Within GTS, cloud revenue of $2.1 billion grew 8 percent as reported (13 percent adjusted for currency), with an as-a-Service exit run rate of $7.5 billion.

 

 

 

 

 

 

 

Yr. to Yr.

 

 

 

 

 

 

 

Percent/

 

(Dollars in millions)

 

 

 

 

 

Margin

 

For the three months ended March 31:

 

2019

 

2018*

 

Change

 

Global Technology Services:

 

 

 

 

 

 

 

External gross profit

 

$

2,316

 

$

2,421

 

(4.3

)%

External gross profit margin

 

33.7

%

32.6

%

1.1

pts.

Pre-tax income

 

$

275

 

$

66

 

315.1

%

Pre-tax margin

 

3.8

%

0.9

%

3.0

pts.

 


* Recast to reflect segment changes.

 

Global Technology Services gross profit margin increased 1.1 points to 33.7 percent, driven primarily by the mix shift to higher-value, benefits from cloud scale efficiencies and productivity improvements. Pre-tax income increased to $275 million and pre-tax margin increased 3.0 points year to year to 3.8 percent, reflecting the improvements in gross margin and a lower level of workforce rebalancing charges in the current year.

 

Services Backlog and Signings

 

 

 

 

 

 

 

 

 

Yr. to Yr.

 

 

 

 

 

 

 

 

 

Percent

 

 

 

 

 

 

 

Yr. to Yr.

 

Change

 

 

 

At March 31,

 

At March 31,

 

Percent

 

Adjusted For

 

(Dollars in billions)

 

2019

 

2018

 

Change

 

Currency

 

Total backlog

 

$

111.6

 

$

121.3

 

(8.0

)%

(2.3

)%

 

The estimated total services backlog at March 31, 2019 was $112 billion, a decrease of 8.0 percent as reported (2 percent adjusted for currency).

 

Total services backlog includes Infrastructure & Cloud Services, Security Services, Consulting, Global Process Services, Application Management and Technology Support Services. Total backlog is intended to be a statement of overall work

 

57


Table of Contents

 

Management Discussion — (continued)

 

under contract which is either non-cancellable, or which historically has very low likelihood of termination, given the criticality of certain services to the company’s clients. Total backlog does not include as-a-Service arrangements that allow for termination under contractual commitment terms. Backlog estimates are subject to change and are affected by several factors, including terminations, changes in the scope of contracts, periodic revalidations, adjustments for revenue not materialized and adjustments for currency.

 

Services signings are management’s initial estimate of the value of a client’s commitment under a services contract. There are no third-party standards or requirements governing the calculation of signings. The calculation used by management involves estimates and judgments to gauge the extent of a client’s commitment, including the type and duration of the agreement, and the presence of termination charges or wind-down costs.

 

Signings include Infrastructure & Cloud Services, Security Services, Consulting, Global Process Services and Application Management contracts. Contract extensions and increases in scope are treated as signings only to the extent of the incremental new value. Technology Support Services (TSS) are generally not included in signings as the maintenance contracts tend to be more steady state, where revenues equal renewals. Certain longer-term TSS contracts that have characteristics similar to outsourcing contracts are included in signings.

 

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

 

 

 

 

 

 

 

 

 

Yr. to Yr.

 

 

 

 

 

 

 

 

 

Percent

 

 

 

 

 

 

 

Yr. to Yr.

 

Change

 

(Dollars in millions)

 

 

 

 

 

Percent

 

Adjusted For

 

For the three months ended March 31:

 

2019

 

2018

 

Change

 

Currency

 

Total signings

 

$

7,637

 

$

9,308

 

(18.0

)%

(13.8

)%

 

Systems

 

 

 

 

 

 

 

 

 

Yr. to Yr.

 

 

 

 

 

 

 

 

 

Percent

 

 

 

 

 

 

 

Yr. to Yr.

 

Change

 

(Dollars in millions)

 

 

 

 

 

Percent

 

Adjusted For

 

For the three months ended March 31:

 

2019

 

2018

 

Change

 

Currency

 

Systems external revenue:

 

$

1,328

 

$

1,500

 

(11.4

)%

(8.8

)%

Systems Hardware

 

$

914

 

$

1,093

 

(16.4

)%

(14.0

)%

IBM Z

 

 

 

 

 

(38.8

)

(37.6

)

Power Systems

 

 

 

 

 

5.9

 

9.4

 

Storage Systems

 

 

 

 

 

(13.4

)

(10.8

)

Operating Systems Software

 

414

 

407

 

1.8

 

5.1

 

 

Systems revenue of $1,328 million decreased 11.4 percent as reported (9 percent adjusted for currency) in the first quarter of 2019 compared to the prior year. Systems Hardware revenue of $914 million declined 16.4 percent as reported (14 percent adjusted for currency). These declines were driven by IBM Z and Storage Systems, partially offset by growth in Power Systems. Operating Systems Software revenue of $414 million grew 1.8 percent as reported (5 percent adjusted for currency) compared to the prior year.

 

IBM Z revenue declined 38.8 percent as reported (38 percent adjusted for currency) year to year reflecting the product cycle dynamics. The z14 continues to track ahead of the prior program with strong growth in MIPS shipped during the quarter led by Linux. The single-frame z14 designed specifically for cloud data centers was also a growth driver.

 

Power Systems revenue grew 5.9 percent as reported (9 percent adjusted for currency) year to year. This was the sixth consecutive quarter of growth, driven by Linux and the full rollout of the POWER9-based architecture. The POWER9-based systems are designed to handle more data intensive workloads in AI, HANA and UNIX, as well as manage advanced analytics and cloud environments. There was double-digit growth in the high-end and entry-level systems, partially offset by declines in the midrange systems, as reported and adjusted for currency.

 

58


Table of Contents

 

Management Discussion — (continued)

 

Storage Systems revenue decreased 13.4 percent as reported (11 percent adjusted for currency), driven by declines in high-end and midrange products, partially offset by double-digit growth in all-flash array offerings. The storage market remains competitive with continued pricing pressures. The company continued to introduce new innovations and functionality to differentiate and manage the portfolio for the market shift to flash.

 

Within Systems, cloud revenue of $0.4 billion declined 18 percent as reported (15 percent adjusted for currency).

 

 

 

 

 

 

 

Yr. to Yr.

 

 

 

 

 

 

 

Percent/

 

(Dollars in millions)

 

 

 

 

 

Margin

 

For the three months ended March 31:

 

2019

 

2018

 

Change

 

Systems:

 

 

 

 

 

 

 

External Systems Hardware gross profit

 

$

264

 

$

312

 

(15.3

)%

External Systems Hardware gross profit margin

 

28.9

%

28.5

%

0.4

pts.

External Operating Systems Software gross profit

 

$

349

 

$

343

 

1.7

%

External Operating Systems Software gross profit margin

 

84.2

%

84.3

%

(0.1

)pts.

External total gross profit

 

$

613

 

$

655

 

(6.4

)%

External total gross profit margin

 

46.2

%

43.7

%

2.5

pts.

Pre-tax income

 

$

(202

)

$

(203

)

(0.4

)%

Pre-tax margin

 

(13.5

)%

(12.3

)%

(1.3

)pts.

 

The Systems gross profit margin increased 2.5 points to 46.2 percent in the first quarter of 2019 compared to the prior year. The year-to-year increase was driven by actions taken in the prior year to better position the systems cost structure over the longer term, and a current year benefit from mix to operating systems software.

 

The pre-tax loss in the first quarter of 2019 was flat compared to the prior year. The pre-tax margin decreased 1.3 points year to year, driven by mix due to the z14 product cycle.

 

Global Financing

 

Global Financing is a reportable segment that is measured as a stand-alone entity. Global Financing facilitates IBM clients’ acquisition of information technology systems, software and services by providing financing solutions in the areas where the company has the expertise, while generating strong returns on equity. Global Financing also optimizes the recovery of residual values by selling assets sourced from end of lease, leasing used equipment to new clients, or extending lease arrangements with current clients. Sales of equipment include equipment returned at the end of a lease, surplus internal equipment and used equipment purchased externally. Residual value is a risk unique to the financing business and management of this risk is dependent upon the ability to accurately project future equipment values at lease inception. Global Financing has insight into product plans and cycles for the IBM products under lease. Based upon this product information, Global Financing continually monitors projections of future equipment values and compares them with the residual values reflected in the portfolio.

 

Results of Operations

 

 

 

 

 

 

 

Yr. to Yr.

 

 

 

 

 

 

 

Percent/

 

(Dollars in millions)

 

 

 

 

 

Margin

 

For the three months ended March 31:

 

2019

 

2018

 

Change

 

External revenue

 

$

406

 

$

405

 

0.2

%

Internal revenue

 

300

 

429

 

(30.0

)

Total revenue

 

$

706

 

$

834

 

(15.4

)%

Pre-tax income

 

$

288

 

$

377

 

(23.4

)%

 

In the first quarter, Global Financing total revenue of $706 million declined 15.4 percent compared to the prior year. External revenue was flat as reported and increased 4 percent adjusted for currency due to an increase in financing (increased 7.4 percent to $336 million), partially offset by a decrease in used equipment sales (down 24.2 percent to $70 million). Internal revenue decreased 30.0 percent, driven by a decrease in used equipment sales (down 42.2 percent to $188 million), partially offset by an increase in financing (up 8.1 percent to $113 million).

 

59


Table of Contents

 

Management Discussion — (continued)

 

The increases in internal and external financing revenue in the first quarter of 2019 compared to the same period in 2018 were primarily due to higher asset yields.

 

Sales of used equipment declined to 36.5 percent of Global Financing’s revenue in the first quarter of 2019 compared to 50.0 percent in the first quarter of 2018 due to lower volumes of internal and external used equipment sales. The gross profit margin on used sales was 52.3 percent and 59.0 percent in the first quarter of 2019 and 2018, respectively. The decrease in gross profit margin was driven by lower margin on external equipment sales and a shift away from higher margin internal equipment sales.

 

Global Financing pre-tax income decreased 23.4 percent to $288 million in the first quarter of 2019 compared to the same period in 2018, due to lower gross profit of $134 million, offset by a decrease in expense of $46 million, which included the gain from the sale of certain commercial financing capabilities, which closed in the first-quarter 2019.

 

Global Financing return on equity was 13.7 percent for the three months ended March 31, 2019 compared to 32.5 percent for the three months ended March 31, 2018. The decrease in return on equity was driven by a decline in net income. Net income included higher tax expense in the first quarter of 2019 due to additional guidance issued by the U.S. Treasury regarding the U.S. tax reform repatriation tax. Refer to page 73 for the details of the after-tax income and return on equity calculation.

 

Geographic Revenue

 

In addition to the revenue presentation by reportable segment, the company also measures revenue performance on a geographic basis.

 

 

 

 

 

 

 

 

 

Yr. to Yr.

 

 

 

 

 

 

 

 

 

Percent

 

 

 

 

 

 

 

Yr. to Yr.

 

Change

 

(Dollars in millions)

 

 

 

 

 

Percent

 

Adjusted For

 

For the three months ended March 31:

 

2019

 

2018

 

Change

 

Currency

 

Total Revenue

 

$

18,182

 

$

19,072

 

(4.7

)%

(0.9

)%

Americas

 

$

8,493

 

$

8,707

 

(2.5

)%

(0.9

)%

Europe/Middle East/Africa (EMEA)

 

5,727

 

6,176

 

(7.3

)

(0.2

)

Asia Pacific

 

3,961

 

4,188

 

(5.4

)

(1.8

)

 

In the first quarter, total revenue of $18,182 million decreased 4.7 percent as reported and 1 percent adjusted for currency compared to the prior year. Americas revenue of $8,493 million decreased 2.5 percent as reported and 1 percent adjusted for currency. EMEA revenue of $5,727 million decreased 7.3 percent as reported, but was flat adjusted for currency. Asia Pacific revenue of $3,961 million decreased 5.4 percent as reported and 2 percent adjusted for currency.

 

Within Americas, U.S. revenue decreased 2.8 percent compared to the prior year. Canada revenue was flat as reported, but grew 5 percent adjusted for currency. Latin America decreased 3.9 percent as reported, but increased 5 percent adjusted for currency. Within Latin America, Brazil decreased 6.4 percent as reported, but increased 4 percent adjusted for currency.

 

In EMEA, France declined 9.3 percent as reported and 2 percent adjusted for currency. Germany decreased 7.6 percent as reported, but was flat adjusted for currency. Italy decreased 6.4 percent as reported, but increased 1 percent adjusted for currency. The UK decreased 1.7 percent as reported, but grew 5 percent adjusted for currency. The Middle East and Africa region decreased 8.3 percent as reported and 5 percent adjusted for currency.

 

Within Asia Pacific, Japan revenue increased 1.8 percent as reported (4 percent adjusted for currency) compared to the prior year. China decreased 16.5 percent as reported (13 percent adjusted for currency), India decreased 17.1 percent as reported (10 percent adjusted for currency) and Australia decreased 12.7 percent as reported (4 percent adjusted for currency).

 

60


Table of Contents

 

Management Discussion — (continued)

 

Expense

 

Total Expense and Other (Income)

 

 

 

 

 

 

 

Yr. to Yr.

 

(Dollars in millions)

 

 

 

 

 

Percent

 

For the three months ended March 31:

 

2019

 

2018

 

Change

 

Total consolidated expense and other (income)

 

$

6,160

 

$

7,111

 

(13.4

)%

Non-operating adjustments:

 

 

 

 

 

 

 

Amortization of acquired intangible assets

 

$

(98

)

$

(110

)

(11.0

)%

Acquisition-related charges

 

(39

)

0

 

nm

 

Non-operating retirement-related (costs)/income

 

(138

)

(402

)

(65.7

)

Operating (non-GAAP) expense and other (income)

 

$

5,886

 

$

6,600

 

(10.8

)%

Total consolidated expense-to-revenue ratio

 

33.9

%

37.3

%

(3.4

)pts.

Operating (non-GAAP) expense-to-revenue ratio

 

32.4

%

34.6

%

(2.2

)pts.

 


nm - not meaningful

 

For additional information regarding total expense and other (income) for both expense presentations, see the following analyses by category.

 

Selling, General and Administrative Expense

 

 

 

 

 

 

 

Yr. to Yr.

 

(Dollars in millions)

 

 

 

 

 

Percent

 

For the three months ended March 31:

 

2019

 

2018

 

Change

 

Selling, general and administrative expense:

 

 

 

 

 

 

 

Selling, general and administrative — other

 

$

4,048

 

$

4,300

 

(5.9

)%

Advertising and promotional expense

 

432

 

401

 

7.7

 

Workforce rebalancing charges

 

19

 

540

 

(96.4

)

Amortization of acquired intangible assets

 

97

 

110

 

(11.6

)

Stock-based compensation

 

74

 

81

 

(8.4

)

Bad debt expense

 

20

 

13

 

51.1

 

Total consolidated selling, general and administrative expense

 

$

4,691

 

$

5,445

 

(13.9

)%

Non-operating adjustments:

 

 

 

 

 

 

 

Amortization of acquired intangible assets

 

$

(97

)

$

(110

)

(11.6

)%

Acquisition-related charges

 

(27

)

0

 

nm

 

Operating (non-GAAP) selling, general and administrative expense

 

$

4,566

 

$

5,335

 

(14.4

)%

 


nm — not meaningful

 

Total selling, general and administrative (SG&A) expense decreased 13.9 percent in the first quarter of 2019 versus the prior year driven primarily by the following factors:

 

·                   Lower workforce rebalancing charges (10 points);

 

·                   The effects of currency (3 points); and

 

·                   Lower spending (2 points).

 

Operating (non-GAAP) expense decreased 14.4 percent year to year driven by primarily the same factors.

 

Bad debt expense decreased $7 million year to year. The receivables provision coverage was 1.7 percent at March 31, 2019, an increase of 10 basis points from December 31, 2018 and unchanged from March 31, 2018.

 

61


Table of Contents

 

Management Discussion — (continued)

 

Research, Development and Engineering

 

 

 

 

 

 

 

Yr. to Yr.

 

(Dollars in millions)

 

 

 

 

 

Percent

 

For the three months ended March 31:

 

2019

 

2018

 

Change

 

Research, development and engineering expense

 

$

1,433

 

$

1,405

 

2.0

%

 

Research, development and engineering (RD&E) expense was 7.9 percent of revenue in the first quarter of 2019 compared to 7.4 percent of revenue in the first quarter of 2018.

 

RD&E expense in the first quarter of 2019 increased 2.0 percent year to year primarily driven by:

·                   Higher spending (4 points); partially offset by

 

·                   The effects of currency (2 points).

 

Intellectual Property and Custom Development Income

 

 

 

 

 

 

 

Yr. to Yr.

 

(Dollars in millions)

 

 

 

 

 

Percent

 

For the three months ended March 31:

 

2019

 

2018

 

Change

 

Intellectual Property and Custom Development Income:

 

 

 

 

 

 

 

Licensing of intellectual property including royalty-based fees

 

$

50

 

$

249

 

(79.8

)%

Custom development income

 

51

 

67

 

(24.5

)

Sales/other transfers of intellectual property

 

0

 

0

 

212.5

 

Total

 

$

101

 

$

317

 

(68.0

)%

 

Licensing of intellectual property including royalty-based fees decreased 79.8 percent year to year in the first quarter of 2019. This was primarily due to a decline in new partnership agreements compared with the first quarter of 2018. The timing and amount of licensing, sales or other transfers of IP may vary significantly from period to period depending upon the timing of licensing agreements, economic conditions, industry consolidation and the timing of new patents and know-how development.

 

Other (Income) and Expense

 

 

 

 

 

 

 

Yr. to Yr.

 

(Dollars in millions)

 

 

 

 

 

Percent

 

For the three months ended March 31:

 

2019

 

2018

 

Change

 

Other (income) and expense:

 

 

 

 

 

 

 

Foreign currency transaction losses/(gains)

 

$

(172

)

$

141

 

nm

 

(Gains)/losses on derivative instruments

 

69

 

(49

)

nm

 

Interest income

 

(70

)

(71

)

(0.2

)%

Net (gains)/losses from securities and investment assets

 

(4

)

(22

)

(80.8

)

Retirement-related costs/(income)

 

138

 

402

 

(65.7

)

Other

 

(32

)

11

 

nm

 

Total consolidated other (income) and expense

 

$

(73

)

$

413

 

nm

 

Non-operating adjustments:

 

 

 

 

 

 

 

Amortization of acquired intangible assets

 

$

(1

)

$

 

nm

 

Acquisition-related charges

 

24

 

0

 

nm

 

Non-operating retirement-related (costs)/income

 

(138

)

(402

)

(65.7

)%

Operating (non-GAAP) other (income) and expense

 

$

(187

)

$

11

 

nm

 

 


nm - not meaningful

 

Total consolidated other (income) and expense was income of $73 million in the first quarter of 2019 compared to expense of $413 million in the prior year. The $485 million year-to-year change was primarily driven by:

 

·                   Net exchange gains in the current year versus net exchange losses in the prior year ($196 million); and

 

62


Table of Contents

 

Management Discussion — (continued)

 

·                   Lower non-operating retirement-related costs ($264 million). Refer to “Retirement-Related Plans” for additional information.

 

Operating (non-GAAP) other (income) and expense was $187 million of income in the first quarter of 2019 compared to expense of $11 million in the prior year. The year-to-year change was driven primarily by the net exchange dynamics described above.

 

Interest Expense

 

 

 

 

 

 

 

Yr. to Yr.

 

(Dollars in millions)

 

 

 

 

 

Percent

 

For the three months ended March 31:

 

2019

 

2018

 

Change

 

Interest expense

 

$

210

 

$

165

 

27.4

%

Non-operating adjustment:

 

 

 

 

 

 

 

Acquisition-related charges

 

$

(36

)

$

 

nm

 

Operating (non-GAAP) interest expense

 

$

174

 

$

165

 

5.6

%

 


nm - not meaningful

 

Interest expense increased $45 million year to year in the first quarter of 2019. Interest expense is presented in cost of financing in the Consolidated Statement of Earnings if the related external borrowings are to support the Global Financing external business. Overall interest expense (excluding capitalized interest) for the first quarter of 2019 was $389 million, an increase of $42 million versus the comparable prior-year period, primarily driven by a higher average debt balance and higher average interest rates.

 

Retirement-Related Plans

 

The following table provides the total pre-tax cost for all retirement-related plans. The operating cost amounts are included in the Consolidated Statement of Earnings within the caption (e.g., Cost, SG&A, RD&E) relating to the job function of the plan participants. The non-operating cost amounts are included in other (income) and expense.

 

 

 

 

 

 

 

Yr. to Yr.

 

(Dollars in millions)

 

 

 

 

 

Percent

 

For the three months ended March 31:

 

2019

 

2018

 

Change

 

Retirement-related plans — cost:

 

 

 

 

 

 

 

Service cost

 

$

97

 

$

109

 

(10.9

)%

Multi-employer plans

 

9

 

10

 

(17.4

)

Cost of defined contribution plans

 

248

 

268

 

(7.5

)

Total operating costs/(income)

 

$

353

 

$

387

 

(8.7

)%

Interest cost

 

$

728

 

$

692

 

5.2

%

Expected return on plan assets

 

(1,051

)

(1,025

)

2.5

 

Recognized actuarial losses

 

458

 

747

 

(38.7

)

Amortization of prior service costs/(credits)

 

(3

)

(19

)

(84.5

)

Curtailments/settlements

 

1

 

0

 

nm

 

Other costs

 

5

 

7

 

(26.9

)

Total non-operating costs/(income)

 

$

138

 

$

402

 

(65.7

)%

Total retirement-related plans — cost

 

$

491

 

$

788

 

(37.7

)%

 


nm - not meaningful

 

Total pre-tax retirement-related plan cost decreased by $297 million compared to the first quarter of 2018, primarily driven by a decrease in recognized actuarial losses ($289 million), primarily due to the change in the amortization period in the U.S. Qualified Personal Pension Plan, higher expected return on plan assets ($26 million) and a decrease in defined contribution plans cost ($20 million), partially offset by higher interest costs ($36 million).

 

63


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Management Discussion — (continued)

 

As discussed in the “Operating (non-GAAP) Earnings” section on page 51, the company characterizes certain retirement-related costs as operating and others as non-operating. Utilizing this characterization, operating retirement-related costs in the first quarter of 2019 were $353 million, a decrease of $34 million compared to the first quarter of 2018, primarily driven by lower defined contribution plans cost ($20 million) and lower service cost ($12 million). Non-operating costs of $138 million in the first quarter of 2019 decreased $264 million year to year, driven primarily by lower recognized actuarial losses ($289 million) and a higher expected return on plan assets ($26 million), partially offset by higher interest costs ($36 million).

 

Taxes

 

The continuing operations effective tax rate for the first quarter of 2019 was 15.4 percent, an increase of 62.9 points compared to the first quarter of 2018. The operating (non-GAAP) tax rate for the first quarter of 2019 was 10.0 percent, an increase of 40.6 points compared to the first quarter of 2018.

 

The year-to-year change in the continuing operations effective tax rate was primarily driven by a reduced benefit from audit resolutions (65.8 points), offset by a lower impact from U.S. tax reform (2.5 points) and a more favorable mix of earnings. The change in the operating (non-GAAP) tax rate was primarily driven by the same factors, except for the impacts of U.S. tax reform related activity.

 

In January 2019, the U.S. Treasury issued additional U.S. tax reform guidelines. The impact is included in the company’s first quarter 2019 provision for income taxes (GAAP only).

 

The company is no longer subject to income tax examination of its U.S. federal tax returns for years prior to 2013. The company’s U.S. income tax returns for 2013 and 2014 continue to be examined by the IRS with specific focus on certain cross-border transactions in 2013. With respect to major U.S. state and foreign taxing jurisdictions, the company is generally no longer subject to tax examinations for years prior to 2014. The company is involved in a number of income tax-related matters in India challenging tax assessments issued by the India Tax Authorities. As of March 31, 2019, the company has recorded $759 million as prepaid income taxes representing cash tax deposits paid over time to protect the company’s right to appeal various income tax assessments made by the Indian Tax Authorities. Tax years still subject to examination contain matters that could be subject to differing interpretations of applicable tax laws and regulations as it relates to the amount and/or timing of income, deductions and tax credits. Although the outcome of tax audits is always uncertain, the company believes that adequate amounts of tax, interest and penalties have been provided for any adjustments that are expected to result for these years.

 

The amount of unrecognized tax benefits at March 31, 2019 is $6,561 million which can be reduced by $657 million of offsetting tax benefits associated with timing adjustments, U.S. tax credits, potential transfer pricing adjustments, and state income taxes. The net amount of $5,904 million, if recognized, would favorably affect the company’s effective tax rate.

 

Earnings Per Share

 

Basic earnings per share is computed on the basis of the weighted-average number of shares of common stock outstanding during the period. Diluted earnings per share is computed on the basis of the weighted-average number of shares of common stock outstanding plus the effect of dilutive potential common shares outstanding during the period using the treasury stock method. Dilutive potential common shares include outstanding stock options and stock awards.

 

 

 

 

 

 

 

Yr. to Yr.

 

 

 

 

 

 

 

Percent

 

For the three months ended March 31:

 

2019

 

2018

 

Change

 

Earnings per share of common stock from continuing operations:

 

 

 

 

 

 

 

Assuming dilution

 

$

1.78

 

$

1.81

 

(1.7

)%

Basic

 

$

1.79

 

$

1.82

 

(1.6

)%

Diluted operating (non-GAAP)

 

$

2.25

 

$

2.45

 

(8.2

)%

Weighted-average shares outstanding: (in millions)

 

 

 

 

 

 

 

Assuming dilution

 

893.9

 

925.4

 

(3.4

)%

Basic

 

889.6

 

920.7

 

(3.4

)%

 

64


Table of Contents

 

Management Discussion — (continued)

 

Actual shares outstanding at March 31, 2019 were 886.6 million. The weighted-average number of common shares outstanding assuming dilution during the first quarter of 2019 was 31.5 million shares (3.4 percent) lower than the same period of 2018. The decrease was primarily the result of the common stock repurchase program.

 

Financial Position

 

Dynamics

 

At March 31, 2019, the balance sheet remained strong and the company is well positioned for the long term. Cash, restricted cash and marketable securities at quarter end were $18,144 million compared to $12,222 million at December 31, 2018, with a corresponding increase in debt as the company begins to prepare for the pending Red Hat acquisition. The company continues to manage the investment portfolio to meet its capital preservation and liquidity objectives. Total debt of $49,976 million increased $4,165 million from December 31, 2018, driven by new debt issuances of $5,962 million; partially offset by debt maturities of $1,751 million. Within total debt, $29,522 million is in support of the Global Financing business. In the first quarter of 2019, the company adopted the new leasing standard, which increased assets and corresponding lease liabilities by $4,634 million and $4,903 million, respectively, as of March 31, 2019. In the first three months of 2019, the company generated $4,759 million in cash from operations, compared to $4,602 million in the first three months of 2018. The company has consistently generated strong cash flows from operations and continues to have access to additional sources of liquidity through the capital markets and its credit facilities.

 

The assets and debt associated with the Global Financing business are a significant part of the company’s financial position. Debt for Global Financing is expected to decline during 2019 as the company winds down its OEM Commercial Financing content. The financial position amounts appearing on pages 5 and 6 are the consolidated amounts including Global Financing.

 

Global Financing Financial Position Key Metrics:

 

 

 

At March 31,

 

At December 31,

 

(Dollars in millions)

 

2019

 

2018

 

Cash and cash equivalents

 

$

1,582

 

$

1,833

 

Net investment in sales-type and direct financing leases (1)

 

6,548

 

6,924

 

Equipment under operating leases — external clients (2)

 

394

 

444

 

Client loans

 

11,791

 

12,802

 

Total client financing assets

 

18,733

 

20,170

 

Commercial financing receivables

 

10,333

 

11,838

 

Intercompany financing receivables (3) (4)

 

5,168

 

4,873

 

Total assets

 

$

36,750

 

$

41,320

 

Debt

 

$

29,522

 

$

31,227

 

Total equity

 

$

3,276

 

$

3,470

 

 


( 1) Includes deferred initial direct costs which are eliminated in IBM’s consolidated results.

( 2) Includes intercompany mark-up, priced on an arm’s-length basis, on products purchased from the company’s product divisions

which is eliminated in IBM’s consolidated results.

(3) Entire amount eliminated for purposes of IBM’s consolidated results and therefore does not appear on pages 5 and 6.

(4) These assets, along with all other financing assets in this table, are leveraged at the value in the table using Global Financing debt.

 

At March 31, 2019, substantially all client and commercial financing assets were IT related assets, and approximately 55 percent of the total external portfolio was with investment grade clients with no direct exposure to consumers. This investment grade percentage is based on the credit ratings of the companies in the portfolio.

 

The company has a long-standing practice of taking mitigating actions, in certain circumstances, to transfer credit risk to third parties, including credit insurance, financial guarantees, non-recourse borrowings, transfers of receivables recorded as true sales in accordance with accounting guidance or sales of equipment under operating lease. Adjusting for the mitigation actions, the investment grade content would increase by 16 points to 71 percent, an increase of 1 point year to year.

 

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Table of Contents

 

Management Discussion — (continued)

 

IBM Working Capital

 

 

 

 

At March 31,

 

At December 31,

 

(Dollars in millions)

 

2019

 

2018

 

Current assets

 

$

52,705

 

$

49,146

 

Current liabilities

 

38,871

 

38,227

 

Working capital

 

$

13,834

 

$

10,918

 

Current ratio

 

1.36:1

 

1.29:1

 

 

Working capital increased $2,916 million from the year-end 2018 position. The key changes are described below:

 

Current assets increased $3,560 million ($3,725 million adjusted for currency) due to:

 

·                   An increase of $5,922 million ($6,022 million adjusted for currency) in cash, restricted cash, and marketable securities; partially offset by

 

·                   A decline in receivables of $2,619 million ($2,561 million adjusted for currency) primarily driven by declines in financing receivables of $2,101 million as a result of collections of higher year-end balances.

 

Current liabilities increased $644 million ($732 million adjusted for currency) as a result of:

 

·                   An increase in operating lease liabilities of $1,313 million ($1,315 million adjusted for currency) as a result of the adoption of the new leasing standard; and

 

·                   An increase in deferred income of $969 million ($1,011 million adjusted for currency) primarily due to the cyclical increase from annual billings; partially offset by

 

·                   A decrease in accounts payable of $847 million ($843 million adjusted for currency) reflecting declines from typically higher year-end balances; and

 

·                   A decrease in taxes payable of $562 million ($538 million adjusted for currency).

 

Receivables and Allowances

 

Roll Forward of Total IBM Receivables Allowance for Credit Losses (included in Total IBM)

 

(Dollars in millions)

 

 

 

 

 

 

 

 

 

January 1, 2019

 

Additions *

 

Write-offs **

 

Other ***

 

March 31, 2019

 

$

639

 

$

20

 

$

(21

)

$

(2

)

$

636

 

 


*                            Additions for Allowance for Credit Losses are charged to expense.

**                     Refer to note A, “Significant Accounting Policies,” in the company’s 2018 Annual Report on pages 87 and 88 for additional information regarding Allowance for Credit Loss write-offs.

***              Primarily represents translation adjustments.

 

The total IBM receivables provision coverage was 1.7 percent at March 31, 2019, an increase of 10 basis points compared to December 31, 2018. The increase was driven by the overall decline in gross receivables.

 

Global Financing Receivables and Allowances

 

The following table presents external Global Financing receivables excluding residual values, the allowance for credit losses and immaterial miscellaneous receivables.

 

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Table of Contents

 

Management Discussion — (continued)

 

 

 

At March 31,

 

At December 31,

 

(Dollars in millions)

 

2019

 

2018

 

Recorded investment (1)

 

$

28,321

 

$

31,182

 

Specific allowance for credit losses

 

221

 

220

 

Unallocated allowance for credit losses

 

66

 

72

 

Total allowance for credit losses

 

287

 

292

 

Net financing receivables

 

$

28,034

 

$

30,890

 

Allowance for credit losses coverage

 

1.0

%

0.9

%

 


(1) Includes deferred initial direct costs which are eliminated in IBM’s consolidated results.

 

The percentage of Global Financing receivables reserved increased from 0.9 percent at December 31, 2018, to 1.0 percent at March 31, 2019. The increase was primarily driven by the overall decline in gross receivables. Specific reserves were flat at March 31, 2019 compared to year-end 2018. Unallocated reserves decreased 7.7 percent from $72 million at December 31, 2018, to $66 million at March 31, 2019.

 

Roll Forward of Global Financing Receivables Allowance for Credit Losses

 

(Dollars in millions)

 

 

 

 

 

 

 

 

 

January 1, 2019

 

Additions *

 

Write-offs **

 

Other ***

 

March 31, 2019

 

$

292

 

$

3

 

$

(8

)

$

(1

)

$

287

 

 


*                            Additions for Allowance for Credit Losses are charged to expense.

**                     Refer to note A, “Significant Accounting Policies,” in the company’s 2018 Annual Report on pages 87 and 88 for additional information regarding allowance for credit loss write-offs.

***              Primarily represents translation adjustments.

 

Global Financing’s bad debt expense was $3 million for the three months ended March 31, 2019, compared to $4 million for the same period in 2018.

 

Noncurrent Assets and Liabilities

 

 

 

At March 31,

 

At December 31,

 

(Dollars in millions)

 

2019

 

2018

 

Noncurrent assets

 

$

78,221

 

$

74,236

 

Long-term debt

 

$

39,727

 

$

35,605

 

Noncurrent liabilities (excluding debt)

 

$

35,722

 

$

32,621

 

 

Noncurrent assets increased $3,985 million ($4,012 million adjusted for currency) due to:

 

·                   An increase in operating right-of-use assets of $4,634 million ($4,658 million adjusted for currency) as a result of the adoption of the new leasing standard; partially offset by

 

·                   A decrease in long-term financing receivables of $787 million ($773 million adjusted for currency) as a result of seasonal reductions of higher year-end balances.

 

Long-term debt increased $4,122 million ($4,213 million adjusted for currency) due to:

 

·                   Issuances of $5,922 million; partially offset by

 

·                   Reclassifications to short-term debt of $1,749 million to reflect upcoming maturities.

 

Noncurrent liabilities (excluding debt) increased $3,101 million ($3,255 million adjusted for currency) due to:

 

·                   An increase in long-term operating lease liabilities of $3,590 million as a result of the adoption of the new leasing standard.

 

67


Table of Contents

 

Management Discussion — (continued)

 

Debt

 

The company’s funding requirements are continually monitored and strategies are executed to manage the overall asset and liability profile. Additionally, the company maintains sufficient flexibility to access global funding sources as needed.

 

 

 

At March 31,

 

At December 31,

 

(Dollars in millions)

 

2019

 

2018

 

Total company debt

 

$

49,976

 

$

45,812

 

Total Global Financing segment debt

 

$

29,522

 

$

31,227

 

Debt to support external clients

 

25,366

 

27,536

 

Debt to support internal clients

 

4,156

 

3,690

 

Non-Global Financing debt

 

$

20,455

 

$

14,585

 

 

Total debt of $49,976 million increased $4,165 million from December 31, 2018, driven by new debt issuances of $5,962 million; partially offset by debt maturities of $1,751 million.

 

Non-Global Financing debt of $20,455 million was up $5,870 million from December 31, 2018 in preparation for the pending acquisition of Red Hat.

 

Global Financing provides financing predominantly for the company’s external client assets, as well as for assets under contract by other IBM units. These assets, primarily for Global Technology Services, generate long-term, stable revenue streams similar to the Global Financing asset portfolio. Based on their attributes, these Global Technology Services assets are leveraged with the balance of the Global Financing asset base.

 

The debt used to fund Global Financing assets is composed of intercompany loans and external debt. Total debt changes generally correspond with the level of client and commercial financing receivables, the level of cash and cash equivalents, the change in intercompany and external payables and the change in intercompany investment from IBM. The terms of the intercompany loans are set by the company to substantially match the term, currency and interest rate variability underlying the financing receivable and are based on arm’s-length pricing. The Global Financing debt-to-equity ratio remained at 9.0 to 1 at March 31, 2019.

 

Global Financing provides financing predominantly for the company’s external client assets, as well as for assets under contract by other IBM units. As previously stated , the company measures Global Financing as a stand-alone entity, and accordingly, interest expense relating to debt supporting Global Financing’s external client and internal business is included in the “Global Financing Results of Operations” on page 59 and in note 8, “Segments,” on pages 35 and 36. In the company’s Consolidated Statement of Earnings, the external debt-related interest expense supporting Global Financing’s internal financing to the company is reclassified from cost of financing to interest expense.

 

Equity

 

Total equity decreased $323 million from December 31, 2018, primarily due to decreases from dividends paid ($1,397 million) and an increase in treasury stock ($950 million) primarily due to share repurchases; partially offset by increases from net income ($1,591 million) and retirement-related plans ($330 million).

 

Cash Flow

 

The company’s cash flows from operating, investing and financing activities, as reflected in the Consolidated Statement of Cash Flows on page 7, are summarized in the following table. These amounts include the cash flows associated with the Global Financing business.

 

68


Table of Contents

 

Management Discussion — (continued)

 

(Dollars in millions)

 

 

 

 

 

For the three months ended March 31:

 

2019

 

2018

 

Net cash provided by/(used in) continuing operations:

 

 

 

 

 

Operating activities

 

$

4,759

 

$

4,602

 

Investing activities

 

(853

)

(1,764

)

Financing activities

 

1,863

 

(2,909

)

Effect of exchange rate changes on cash, cash equivalents and restricted cash

 

(102

)

100

 

Net change in cash, cash equivalents and restricted cash

 

$

5,668

 

$

28

 

 

Net cash provided by operating activities increased $158 million as compared to the first three months of 2018 driven primarily by:

 

·                   An increase of $98 million in cash provided by financing receivables.

 

Net cash used in investing activities decreased $912 million driven by:

 

·                   An increase of $281 million in cash provided by non-operating finance receivables;

 

·                   A decrease in cash used for net capital expenditures of $279 million; and

 

·                   A decrease in net purchases of marketable securities and other investments of $248 million.

 

Financing activities were a net source of cash of $1,863 million in the first quarter of 2019 compared to a net use of cash of $2,909 million in the first quarter of 2018.  The year-to-year increase in cash flow of $4,772 million was driven by:

 

·                   An increase in net cash sourced from debt transactions of $4,945 million primarily driven by a higher level of issuances and a lower level of maturities in the current year.

 

Looking Forward

 

The company’s strategies, investments and actions are all made with an objective of optimizing long-term performance. A long-term perspective ensures that the company is well-positioned to take advantage of the major shifts in technology, business and the global economy.

 

As part of its long-term strategic model, the company expects to continue to allocate capital efficiently and effectively to investments, and to return value to shareholders through a combination of dividends and share repurchases. Over the long term, in consideration of the opportunities it will continue to develop, the company continues to expect to have the ability to generate low single-digit revenue growth, and with a higher-value business mix, mid single-digit profit growth, high single-digit operating (non-GAAP) earnings per share growth, with free cash flow realization of GAAP net income over 90 percent.

 

Over the last several years, the company has been making investments and shifting resources, embedding AI and cloud into its offerings while building new solutions and modernizing its existing platforms. These investments not only drive current performance, but will extend the company’s innovation leadership into the future. The company’s key differentiators are built around three pillars — innovative technology, industry expertise and trust and security, uniquely delivered through an integrated model.

 

The company is focused on the next chapter of cloud, which will shift mission-critical work to the cloud and optimize everything from supply chains to core banking systems.  To address this opportunity, enterprises need to be able to move and manage data, services, and workflows across multiple clouds and on-premises. They also need to be able to address security concerns, data protection and protocols, availability, and cloud management.  This requires a hybrid, multi-cloud, open approach.  As a result, the company has been reshaping its business to address this opportunity, investing heavily to build capabilities.  Going forward, the company will continue providing growth rates for cloud and as-a service — the signposts of key emerging high value areas of the IT industry. The company eliminated its strategic imperatives reporting, established in 2015, with a goal of achieving approximately $40B of revenue across its strategic imperatives, which was achieved in 2018.

 

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Table of Contents

 

Management Discussion — (continued)

 

IBM’s pending acquisition of Red Hat will bring together the best-in-class hybrid cloud providers and will enable companies to securely unlock the full value of cloud for their businesses. IBM and Red Hat will be strongly positioned to address this opportunity and accelerate hybrid cloud adoption. The company is proceeding through the regulatory process and continues to expect to close the transaction in the second half of 2019. The acquisition of Red Hat reinforces IBM’s high-value model. It is expected to accelerate IBM’s revenue growth, gross margin and be accretive to free cash flow within 12 months of closing. The company will continue with a disciplined financial policy and is committed to maintaining strong investment grade credit ratings and supporting a solid and growing dividend. The company will target a leverage profile consistent with a mid to high single A credit rating. During the first quarter of 2019, the company began the issuance of additional debt in preparation of the pending acquisition.  In order to reduce debt, the company intends to suspend its share repurchase program in 2020 and 2021.

 

At mid-April 2019 spot rates, the company expects a currency headwind of approximately 2.5 points to second quarter 2019 revenue growth and a headwind of approximately 2.0 points to full year 2019 revenue growth. The company expects revenue dynamics from the first quarter to the second quarter of 2019 to be similar to the last two years, which is a sequential increase of approximately $900 million to $1 billion. For full-year 2019, the company expects to expand gross and pre-tax margins.

 

Overall, the company continues to expect GAAP earnings per share from continuing operations for 2019 to be at least $12.45. Excluding acquisition-related charges of $0.76 per share, non-operating retirement-related items of $0.45 per share and tax reform enactment impacts of $0.24 per share, operating (non-GAAP) earnings per share is expected to be at least $13.90. Earnings per share expectations do not include Red Hat, as financial implications for 2019 are heavily dependent on the timing of the closing. Expectations will be updated after the transaction closes.  The two announced divestitures of software products are expected to close in the second quarter and have been included in the full-year earnings per share expectations.

 

For the second quarter of 2019, the company expects GAAP earnings per share from continuing operations and operating (non-GAAP) earnings per share to be approximately 22 percent of the respective full-year expectations.  Looking forward to the second half of 2019, the company expects growth in earnings per share to be skewed to the fourth quarter.  The company expects the gains on the previously announced divestitures to be between $500 million and $700 million and the company’s earnings per share expectations for the second quarter of 2019 assume the low-end of this range. For the full year and second quarter of 2019, the company’s expectations assume minimal to no impact to profit and earnings per share overall, with the majority of any gains offset by foregone profit and stranded costs from the divestitures, as well as actions taken to address structure and stranded costs.

 

The company continues to expect free cash flow to be approximately $12 billion in 2019. Free cash flow expectations for the year reflect expected operational profit performance and continued balance sheet efficiency including capital management, partially offset by a cash tax headwind. Free cash flow realization, which is defined as free cash flow to income from continuing operations (GAAP), is expected to be approximately 100 percent for the year. These expectations also take into account the estimated impact of the announced and closed divestitures, however do not include estimated impacts from the pending acquisition of Red Hat, other than an estimate of pre-closing financing costs.

 

For full-year 2019, the company expects the GAAP effective tax rate to be approximately 12 to 13 percent, including an estimate for potential discrete tax events (discretes). Discretes by their nature are difficult to estimate and the actual impacts will be recorded as the discrete events occur.  The company expects its operating (non-GAAP) tax rate for 2019 to be approximately 11 to 12 percent (which is a 3 to 4 points headwind year to year), including an estimate of potential discretes. The rates will change year to year based on discrete tax events, such as the settlement of income tax audits and changes in tax laws, as well as recurring factors including the geographic mix of income before taxes, state and local taxes and the effects of various global income tax strategies. The GAAP effective tax rate could also be affected by adjustments to the previously recorded charges for U.S. tax reform attributable to any changes in law, new regulations and guidance, audit adjustments, among others.

 

Beginning in the second quarter of 2019 and continuing throughout the year, IBM’s Global Financing business will wind down the portion of its commercial financing operations, which provides short-term working capital solutions for OEM information technology suppliers, distributors and resellers. IBM Global Financing will continue to provide differentiated end-to-end financing solutions, including commercial financing in support of IBM partner relationships. The wind down of this activity is expected to reduce IBM’s revenue, with a nominal impact to profit, however it does not change the company’s earnings per share and free cash flow expectations for 2019.

 

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Management Discussion — (continued)

 

Beginning in 2019, within the IBM U.S. Qualified Personal Pension Plan, substantially all the plan participants are now considered inactive, which, as required by U.S. GAAP, resulted in a change in the amortization period of unrecognized actuarial losses, from the average remaining service period of active plan participants to the average remaining life expectancy of inactive plan participants. These periods are approximately 6 years and 18 years, respectively. As a result of this change, there will be a reduction to 2019 amortization expense of approximately $900 million. Actuarial loss amortization is reported within non-operating pension costs. There will be no impact to 2019 operating (non-GAAP) retirement-related costs, funded status, retiree benefit payments or funding requirements of the U.S. Qualified Personal Pension Plan. However, there will be an impact to free cash flow realization.

 

The company expects 2019 pre-tax retirement-related plan cost to be approximately $2.0 billion, a decrease of approximately $1 billion compared to 2018. This estimate reflects current pension plan assumptions at December 31, 2018. Within total retirement-related plan cost, operating retirement-related plan cost is expected to be approximately $1.5 billion, approximately flat versus 2018. Non-operating retirement-related plan cost is expected to be approximately $0.6 billion, a decrease of approximately $1 billion compared to 2018, primarily driven by lower actuarial loss amortization resulting from the change in amortization period for the U.S. plan. Contributions for all retirement-related plans are expected to be approximately $2.4 billion in 2019, an increase of approximately $100 million compared to 2018.

 

Currency Rate Fluctuations

 

Changes in the relative values of non-U.S. currencies to the U.S. dollar (USD) affect the company’s financial results and financial position. At March 31, 2019, currency changes resulted in assets and liabilities denominated in local currencies being translated into fewer dollars than at year-end 2018. The company uses financial hedging instruments to limit specific currency risks related to financing transactions and other foreign currency-based transactions.

 

During periods of sustained movements in currency, the marketplace and competition adjust to the changing rates. For example, when pricing offerings in the marketplace, the company may use some of the advantage from a weakening U.S. dollar to improve its position competitively, and price more aggressively to win the business, essentially passing on a portion of the currency advantage to its customers. Competition will frequently take the same action. Consequently, the company believes that some of the currency-based changes in cost impact the prices charged to clients. The company also maintains currency hedging programs for cash management purposes which temporarily mitigate, but do not eliminate, the volatility of currency impacts on the company’s financial results.

 

The company translates revenue, cost and expense in its non-U.S. operations at current exchange rates in the reported period. References to “adjusted for currency” or “constant currency” reflect adjustments based upon a simple mathematical formula. However, this constant currency methodology that the company utilizes to disclose this information does not incorporate any operational actions that management could take to mitigate fluctuating currency rates. Currency movements impacted the company’s year-to-year revenue and earnings per share growth in the first three months of 2019. Based on the currency rate movements in the first three months of 2019, total revenue decreased 4.7 percent as reported and 0.9 percent at constant currency versus the first three months of 2018. On an income from continuing operations before income tax basis, these translation impacts offset by the net impact of hedging activities resulted in a theoretical maximum (assuming no pricing or sourcing actions) increase of approximately $60 million in the first three months of 2019 on an as-reported basis and an increase of approximately $50 million on an operating (non-GAAP) basis. The same mathematical exercise resulted in an increase of approximately $70 million in the first three months of 2018 on an as-reported basis and an increase of approximately $90 million on an operating (non-GAAP) basis. The company views these amounts as a theoretical maximum impact to its as-reported financial results. Considering the operational responses mentioned above, movements of exchange rates, and the nature and timing of hedging instruments, it is difficult to predict future currency impacts on any particular period, but the company believes it could be substantially less than the theoretical maximum given the competitive pressure in the marketplace.

 

For non-U.S. subsidiaries and branches that operate in U.S. dollars or whose economic environment is highly inflationary, translation adjustments are reflected in results of operations. Generally, the company manages currency risk in these entities by linking prices and contracts to U.S. dollars.

 

Liquidity and Capital Resources

 

In the company’s 2018 Annual Report, on pages 60 to 62, there is a discussion of the company’s liquidity including two tables that present three years of data. The table presented on page 60 includes net cash from operating activities, cash, restricted cash and short-term marketable securities, and the size of the company’s global credit facilities for each of the past

 

71


Table of Contents

 

Management Discussion — (continued)

 

three years. For the three months ended, or as of, as applicable, March 31, 2019, those amounts are $4.8 billion of net cash from operating activities, $18.1 billion of cash, restricted cash and short-term marketable securities and $15.3 billion in global credit facilities, respectively.

 

On October 28, 2018, IBM announced its intent to acquire all the outstanding shares of Red Hat. The transaction is subject to customary closing conditions, including regulatory clearance. The company intends to fund this transaction through a combination of cash and debt. In connection with this acquisition, IBM entered into a commitment letter under which certain banks committed to provide the company with a 364-day unsecured bridge term loan facility in an aggregate principal amount of up to $20 billion to fund the acquisition.

 

The major rating agencies’ ratings on the company’s debt securities at March 31, 2019 appear in the following table and remain unchanged from December 31, 2018. IBM will continue with a disciplined financial policy and is committed to maintaining strong investment grade credit ratings. The company does not have “ratings trigger” provisions in its debt covenants or documentation, which would allow the holders to declare an event of default and seek to accelerate payments thereunder in the event of a change in credit rating. The company’s contractual agreements governing derivative instruments contain standard market clauses which can trigger the termination of the agreement if the company’s credit rating were to fall below investment grade. At March 31, 2019, the fair value of those instruments that were in a liability position was $705 million, before any applicable netting, and this position is subject to fluctuations in fair value period to period based on the level of the company’s outstanding instruments and market conditions. The company has no other contractual arrangements that, in the event of a change in credit rating, would result in a material adverse effect on its financial position or liquidity.

 

 

 

STANDARD

 

MOODY’S

 

 

 

 

 

AND

 

INVESTORS

 

FITCH

 

IBM and IBM Credit LLC ratings:

 

POOR’S

 

SERVICE

 

RATINGS

 

Senior long-term debt

 

A

 

A1

 

A

 

Commercial paper

 

A-1

 

Prime-1

 

F1

 

 

The company prepares its Consolidated Statement of Cash Flows in accordance with applicable accounting standards for cash flow presentation on page 7 of this Form 10-Q and highlights causes and events underlying sources and uses of cash in that format on page 69. For the purpose of running its business, the company manages, monitors and analyzes cash flows in a different manner.

 

Management uses free cash flow as a measure to evaluate its operating results, plan share repurchase levels, strategic investments and assess its ability and need to incur and service debt. The entire free cash flow amount is not necessarily available for discretionary expenditures. The company defines free cash flow as net cash from operating activities less the change in Global Financing receivables and net capital expenditures, including the investment in software. A key objective of the Global Financing business is to generate strong returns on equity, and increasing receivables is the basis for growth. Accordingly, management considers Global Financing receivables as a profit-generating investment, not as working capital that should be minimized for efficiency. Therefore, management includes presentations of both free cash flow and net cash from operating activities that exclude the effect of Global Financing receivables. F ree cash flow guidance is derived using an estimate of profit, working capital and operational cash outflows. As previously noted, the company views Global Financing receivables as a profit-generating investment which it seeks to maximize and therefore it is not considered when formulating guidance for free cash flow. As a result the company does not estimate a GAAP Net Cash from Operations expectation metric.

 

The following is management’s view of cash flows for the first three months of 2019 and 2018 prepared in a manner consistent with the description above.

 

72


Table of Contents

 

Management Discussion — (continued)

 

(Dollars in millions)

 

 

 

 

 

For the three months ended March 31:

 

2019

 

2018

 

Net cash from operating activities per GAAP

 

$

4,759

 

$

4,602

 

Less: change in Global Financing receivables

 

2,458

 

2,360

 

Net cash from operating activities, excluding Global Financing receivables

 

$

2,302

 

$

2,242

 

Capital expenditures, net

 

(614

)

(893

)

Free cash flow (FCF)

 

$

1,688

 

$

1,349

 

Acquisitions

 

(1

)

(71

)

Divestitures

 

33

 

 

Share repurchase

 

(920

)

(777

)

Common stock repurchases for tax withholdings

 

(61

)

(53

)

Dividends

 

(1,397

)

(1,382

)

Non-Global Financing debt

 

5,890

 

(547

)

Other (includes Global Financing net receivables and Global Financing debt)

 

690

 

1,794

 

Change in cash, cash equivalents, restricted cash and short-term marketable securities

 

$

5,922

 

$

313

 

 

In the first three months of 2019, the company generated free cash flow of $1.7 billion, an increase of $0.3 billion versus the prior year. In the first quarter, the company continued to focus its cash utilization on returning value to shareholders including $1.4 billion in dividends and $0.9 billion in gross common stock repurchases (6.9 million shares).

 

Events that could temporarily change the historical cash flow dynamics discussed previously and in the company’s 2018 Annual Report include significant changes in operating results, material changes in geographic sources of cash, unexpected adverse impacts from litigation, future pension funding requirements during periods of severe downturn in the capital markets or the timing of tax payments. Whether any litigation has such an adverse impact will depend on a number of variables, which are more completely described in note 14, “Contingencies,” in this Form 10-Q. With respect to pension funding, the company expects to make legally mandated pension plan contributions to certain non-U.S. defined benefit plans of approximately $400 million in 2019. Contributions related to all retirement-related plans are expected to be approximately $2.4 billion in 2019. Financial market performance could increase the legally mandated minimum contributions in certain non-U.S. countries that require more frequent remeasurement of the funded status. The company is not quantifying any further impact from pension funding because it is not possible to predict future movements in the capital markets or pension plan funding regulations.

 

In 2019, the company is not legally required to make any contributions to the U.S. defined benefit pension plans.

 

The company’s cash flows are sufficient to fund its current operations and obligations, including investing and financing activities such as dividends and debt service. When additional requirements arise, the company has several liquidity options available. These options may include the ability to borrow additional funds at reasonable interest rates and utilizing its committed global credit facilities.

 

Global Financing Return on Equity Calculation

 

(Dollars in millions)

 

 

 

 

 

For the three months ended March 31:

 

2019

 

2018

 

Numerator

 

 

 

 

 

Global Financing after-tax income*

 

$

116

 

$

284

 

Annualized after-tax income (1)

 

$

463

 

$

1,137

 

Denominator

 

 

 

 

 

Average Global Financing equity (2)**

 

$

3,372

 

$

3,501

 

Global Financing return on equity (1)/(2)

 

13.7

%

32.5

%

 


*   Calculated based upon an estimated tax rate principally based on Global Financing’s geographic mix of earnings as IBM’s provision for income taxes is determined on a consolidated basis.

** Average of the ending equity for Global Financing for the last two quarters.

 

73


Table of Contents

 

Management Discussion — (continued)

 

GAAP Reconciliation

 

The tables below provide a reconciliation of the company’s income statement results as reported under GAAP to its operating earnings presentation which is a non-GAAP measure. The company’s calculation of operating (non-GAAP) earnings, as presented, may differ from similarly titled measures reported by other companies. Refer to the “Operating (non-GAAP) Earnings” section on page 51 for the company’s rationale for presenting operating earnings information.

 

 

 

 

 

Acquisition-

 

Retirement-

 

U.S.

 

 

 

(Dollars in millions except per share amounts)

 

 

 

Related

 

Related

 

Tax Reform

 

Operating

 

For the three months ended March 31, 2019:

 

GAAP

 

Adjustments

 

Adjustments

 

Charges**

 

(non-GAAP)

 

Gross profit

 

$

8,043

 

$

76

 

$

 

$

 

$

8,119

 

Gross profit margin

 

44.2

%

0.4

pts.

pts.

pts.

44.7

%

S,G&A

 

$

4,691

 

$

(124

)

$

 

$

 

$

4,566

 

R,D&E

 

1,433

 

 

 

 

1,433

 

Other (income) and expense

 

(73

)

23

 

(138

)

 

(187

)

Interest expense

 

210

 

(36

)

 

 

 

174

 

Total expense and other (income)

 

6,160

 

(137

)

(138

)

 

5,886

 

Pre-tax income from continuing operations

 

1,883

 

212

 

138

 

 

2,233

 

Pre-tax margin from continuing operations

 

10.4

%

1.2

pts.

0.8

pts.

pts.

12.3

%

Provision for income taxes*

 

$

289

 

$

49

 

$

26

 

$

(141

)

$

224

 

Effective tax rate

 

15.4

%

0.7

pts.

0.2

pts.

(6.3

) pts.

10.0

%

Income from continuing operations

 

$

1,593

 

$

164

 

$

111

 

$

141

 

$

2,009

 

Income margin from continuing operations

 

8.8

%

0.9

pts.

0.6

pts.

0.8

pts.

11.0

%

Diluted earnings per share from continuing operations

 

$

1.78

 

$

0.18

 

$

0.13

 

$

0.16

 

$

2.25

 

 


*    The tax impact on operating (non-GAAP) pre-tax income from continuing operations is calculated under the same accounting principles applied to the GAAP pre-tax income which employs an annual effective tax rate method to the results.

** Operating (non-GAAP) earnings exclude charges associated with the enactment of U.S. tax reform due to their unique non-recurring nature.

 

 

 

 

 

Acquisition-

 

Retirement-

 

U.S.

 

 

 

(Dollars in millions except per share amounts)

 

 

 

Related

 

Related

 

Tax Reform

 

Operating

 

For the three months ended March 31, 2018:

 

GAAP

 

Adjustments

 

Adjustments

 

Charges**

 

(non-GAAP)

 

Gross profit

 

$

8,247

 

$

93

 

$

 

$

 

$

8,340

 

Gross profit margin

 

43.2

%

0.5

pts.

pts.

pts.

43.7

%

S,G&A

 

$

5,445

 

$

(110

)

$

 

$

 

$

5,335

 

R,D&E

 

1,405

 

 

 

 

1,405

 

Other (income) and expense

 

413

 

 

(402

)

 

11

 

Interest expense

 

165

 

 

 

 

 

165

 

Total expense and other (income)

 

7,111

 

(110

)

(402

)

 

6,600

 

Pre-tax income from continuing operations

 

1,136

 

203

 

402

 

 

1,740

 

Pre-tax margin from continuing operations

 

6.0

%

1.1

pts.

2.1

pts.

pts.

9.1

%

Provision for income taxes*

 

$

(540

)

$

39

 

$

76

 

$

(107

)

$

(532

)

Effective tax rate

 

(47.5

)%

7.8

pts.

15.4

pts.

(6.1

) pts.

(30.5

)%

Income from continuing operations

 

$

1,675

 

$

164

 

$

325

 

$

107

 

$

2,272

 

Income margin from continuing operations

 

8.8

%

0.9

pts.

1.7

pts.

0.6

pts.

11.9

%

Diluted earnings per share from continuing operations

 

$

1.81

 

$

0.17

 

$

0.35

 

$

0.12

 

$

2.45

 

 


*   The tax impact on operating (non-GAAP) pre-tax income from continuing operations is calculated under the same accounting principles applied to the GAAP pre-tax income which employs an annual effective tax rate method to the results.

** Operating (non-GAAP) earnings exclude charges associated with the enactment of U.S. tax reform due to their unique non-recurring nature.

 

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Table of Contents

 

Management Discussion — (continued)

 

Forward-Looking and Cautionary Statements

 

Except for the historical information and discussions contained herein, statements contained in this Form 10-Q may constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are based on the company’s current assumptions regarding future business and financial performance.  These statements involve a number of risks, uncertainties and other factors that could cause actual results to differ materially, including, but not limited to, the following: a downturn in economic environment and client spending budgets; the company’s failure to meet growth and productivity objectives; a failure of the company’s innovation initiatives; damage to the company’s reputation; risks from investing in growth opportunities; failure of the company’s intellectual property portfolio to prevent competitive offerings and the failure of the company to obtain necessary licenses; cybersecurity and data privacy considerations; fluctuations in financial results; impact of local legal, economic, political and health conditions; adverse effects from environmental matters, tax matters and the company’s pension plans; ineffective internal controls; the company’s use of accounting estimates; the company’s ability to attract and retain key employees and its reliance on critical skills; impacts of relationships with critical suppliers; product quality issues; impacts of business with government clients; currency fluctuations and customer financing risks; impact of changes in market liquidity conditions and customer credit risk on receivables; reliance on third party distribution channels and ecosystems; the company’s ability to successfully manage acquisitions, alliances and dispositions, including integration challenges, failure to achieve objectives, the assumption of liabilities, and higher debt levels; legal proceedings and investigatory risks; risk factors related to IBM securities; and other risks, uncertainties and factors discussed in the company’s Form 10-Qs, Form 10-K and in the company’s other filings with the U.S. Securities and Exchange Commission (SEC) or in materials incorporated therein by reference. The company assumes no obligation to update or revise any forward-looking statements.

 

Item 4. Controls and Procedures

 

The company’s management evaluated, with the participation of the Chief Executive Officer and Chief Financial Officer, the effectiveness of the company’s disclosure controls and procedures as of the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that the company’s disclosure controls and procedures were effective as of the end of the period covered by this report. There has been no change in the company’s internal control over financial reporting that occurred during the quarter covered by this report that has materially affected, or is reasonably likely to materially affect, the company’s internal control over financial reporting.

 

Part II — Other Information

 

Item 1.  Legal Proceedings

 

Refer to note 14, “Contingencies,” on pages 45 to 47 of this Form 10-Q.

 

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

 

The following table provides information relating to the company’s repurchase of common stock for the first quarter of 2019.

 

 

 

 

 

 

 

Total Number

 

Approximate

 

 

 

 

 

 

 

of Shares

 

Dollar Value

 

 

 

 

 

 

 

Purchased as

 

of Shares that

 

 

 

Total Number

 

Average

 

Part of Publicly

 

May Yet Be

 

 

 

of Shares

 

Price Paid

 

Announced

 

Purchased Under

 

Period

 

Purchased

 

per Share

 

Program

 

The Program*

 

January 1, 2019 - January 31, 2019

 

2,961,581

 

$

122.91

 

2,961,581

 

$

2,974,850,211

 

 

 

 

 

 

 

 

 

 

 

February 1, 2019 - February 28, 2019

 

2,084,642

 

$

136.72

 

2,084,642

 

$

2,689,832,120

 

 

 

 

 

 

 

 

 

 

 

March 1, 2019 - March 31, 2019

 

1,810,455

 

$

138.63

 

1,810,455

 

$

2,438,843,554

 

 

 

 

 

 

 

 

 

 

 

Total

 

6,856,678

 

$

131.26

 

6,856,678

 

 

 

 


* On October 30, 2018, the Board of Directors authorized $4.0 billion in funds for use in the company’s common stock repurchase program. The company stated that it would repurchase shares on the open market or in private transactions depending on market conditions. The common stock repurchase program does not have an expiration date. This table does not include shares tendered to satisfy the exercise price in connection with cashless exercises of employee stock options or shares tendered to satisfy tax withholding obligations in connection with employee equity awards.

 

75


Table of Contents

 

Item 5. Other Information

 

As disclosed in the company’s 2019 Proxy Statement filed on March 11, 2019, Hutham S. Olayan and James W. Owens were not nominees for election at the company’s annual meeting of stockholders held on April 30, 2019, and their terms on the Board ended.  As a result, Article III, Section 2 of the company’s By-Laws was amended to decrease the number of directors to twelve, effective April 30, 2019.  The full text of IBM’s By-Laws, as amended effective April 30, 2019, is included as Exhibit 3.2 of this report.

 

On April 30, 2019, the company entered into a consulting arrangement with Erich Clementi, who retired as Senior Vice President on March 31, 2019.  For a period of one year, Mr. Clementi may be asked, from time to time, to provide consulting services to the company as an independent contractor.  The fee for such services would be $7,000 per day for each day he provides four or more hours of services and $3,500 per day for each day that he provides less than four hours.

 

The consulting arrangement is set forth in the Letter Agreement attached as Exhibit 10.1.

 

Item 6. Exhibits

 

Exhibit Number

 

 

 

 

 

3.2

 

The By-Laws of IBM, as amended through April 30, 2019.

 

 

 

10.1

 

Letter Agreement, signed by Erich Clementi and IBM, effective as of April 30, 2019.

 

 

 

10.2

 

Terms and Conditions of IBM LTPP Equity Awards, effective June 1, 2019.

 

 

 

31.1

 

Certification by principal executive officer pursuant to Rule 13A-14(a) or 15D-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

 

 

 

31.2

 

Certification by principal financial officer pursuant to Rule 13A-14(a) or 15D-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

 

 

 

32.1

 

Certification by principal executive officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

 

 

32.2

 

Certification by principal financial officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

 

 

101.INS

 

XBRL Instance Document

 

 

 

101.SCH

 

XBRL Taxonomy Extension Schema Document

 

 

 

101.CAL

 

XBRL Taxonomy Extension Calculation Linkbase Document

 

 

 

101.DEF

 

XBRL Taxonomy Extension Definition Linkbase Document

 

 

 

101.LAB

 

XBRL Taxonomy Extension Label Linkbase Document

 

 

 

101.PRE

 

XBRL Taxonomy Extension Presentation Linkbase Document

 

76


Table of Contents

 

SIGNATURE

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

 

International Business Machines Corporation

 

(Registrant)

 

 

Date:

April 30, 2019

 

 

 

By:

/s/ Robert F. Del Bene

 

 

     Robert F. Del Bene

 

 

Vice President and Controller

 

77


Exhibit 3.2

 

BY-LAWS

 

of

 

INTERNATIONAL BUSINESS MACHINES CORPORATION

 

Adopted April 29, 1958

 

As Amended Through

 

April 30, 2019

 


 

TABLE OF CONTENTS

 

ARTICLE I — Definitions

1

 

 

 

ARTICLE II — MEETINGS OF STOCKHOLDERS

 

 

 

 

SECTION  1.

Place of Meetings

1

SECTION  2.

Annual Meetings

1

SECTION  3.

Special Meetings

2

SECTION  4.

Notice of Meetings

2

SECTION  5.

Quorum

2

SECTION  6.

Organization

3

SECTION  7.

Items of Business

3

SECTION  8.

Voting

5

SECTION  9.

List of Stockholders

5

SECTION 10.

Inspectors of Election

6

SECTION 11.

Proxy Access

6

 

 

 

ARTICLE III — BOARD OF DIRECTORS

 

 

 

 

SECTION  1.

General Powers

13

SECTION  2.

Number; Qualifications; Election; Term of Office

13

SECTION  3.

Place of Meetings

13

SECTION  4.

First Meeting

14

SECTION  5.

Regular Meetings

14

SECTION  6.

Special Meetings

14

SECTION  7.

Notice of Meetings

14

SECTION  8.

Quorum and Manner of Acting

14

SECTION  9.

Organization

14

SECTION 10.

Resignations

15

SECTION 11.

Vacancies

15

SECTION 12.

Retirement of Directors

15

 

 

 

ARTICLE IV — EXECUTIVE AND OTHER COMMITTEES

 

 

 

 

SECTION  1.

Executive Committee

15

SECTION  2.

Powers of the Executive Committee

16

SECTION  3.

Meetings of the Executive Committee

16

SECTION  4.

Quorum and Manner of Acting of the Executive Committee

16

SECTION  5.

Other Committees

17

SECTION  6.

Changes in Committees; Resignations; Removals; Vacancies

17

 

i


 

ARTICLE V — OFFICERS

 

 

 

 

SECTION  1.

Number and Qualifications

18

SECTION  2.

Resignations

18

SECTION  3.

Removal

18

SECTION  4.

Vacancies

18

SECTION  5.

Chairman of the Board

18

SECTION  6.

Vice Chairman of the Board

18

SECTION  7.

President

19

SECTION  8.

Designated Officers

19

SECTION  9.

Executive Vice Presidents, Senior Vice Presidents and Vice Presidents

19

SECTION 10.

Treasurer

20

SECTION 11.

Secretary

20

SECTION 12.

Controller

21

SECTION 13.

Compensation

21

 

 

 

ARTICLE VI — CONTRACTS, CHECKS, DRAFTS, BANK ACCOUNTS, ETC.

 

 

 

 

SECTION  1.

Execution of Contracts

21

SECTION  2.

Loans

22

SECTION  3.

Checks, Drafts, etc.

22

SECTION  4.

Deposits

22

SECTION  5.

General and Special Bank Accounts

22

SECTION  6.

Indemnification

22

 

 

 

ARTICLE VII — SHARES

 

 

 

 

SECTION  1.

Stock Certificates

23

SECTION  2.

Books of Account and Record of Stockholders

23

SECTION  3.

Transfers of Stock

24

SECTION  4.

Regulations

24

SECTION  5.

Fixing of Record Date

24

SECTION  6.

Lost, Destroyed or Mutilated Certificates

24

SECTION  7.

Inspection of Records

25

SECTION  8.

Auditors

25

 

 

 

ARTICLE VIII — OFFICES

 

 

 

 

SECTION  1.

Principal Office

25

SECTION  2.

Other Offices

25

 

 

 

ARTICLE IX — Waiver of Notice

25

 

 

 

ARTICLE X — Fiscal Year

26

 

 

 

ARTICLE XI — Seal

26

 

 

 

ARTICLE XII — Amendments

26

 

ii


 

BY-LAWS

 

OF

 

INTERNATIONAL BUSINESS MACHINES CORPORATION

 

ARTICLE I

 

DEFINITIONS

 

In these By-laws, and for all purposes hereof, unless there be something in the subject or context inconsistent therewith:

 

(a)  ‘Board’ shall mean the Board of Directors of the Corporation.

 

(b) ‘Certificate of Incorporation’ shall mean the restated Certificate of Incorporation as filed on May 27, 1992, together with any and all amendments and subsequent restatements thereto.

 

(c) ‘Chairman of the Board’, ‘Vice Chairman of the Board’, ‘Chairman of the Executive Committee’, ‘Chief Executive Officer,’ ‘Chief Financial Officer’, ‘Chief Accounting Officer’, ‘President’, ‘Executive Vice President’, ‘Senior Vice President’, ‘Vice President’, ‘Treasurer’, ‘Secretary’, or ‘Controller’, as the case may be, shall mean the person at any given time occupying the particular office with the Corporation.

 

(d) ‘Corporation’ shall mean International Business Machines Corporation.

 

(e) ‘Exchange Act’ shall mean the Securities Exchange Act of 1934, as amended.

 

(f) ‘Lead Director’ shall mean, at any given time, the lead, independent member of the Board of Directors of the Corporation occupying such position.

 

(g) ‘stockholders’ shall mean the stockholders of the Corporation.

 

ARTICLE II

 

MEETINGS OF STOCKHOLDERS

 

SECTION 1.  Place of Meetings.  Meetings of the stockholders of the Corporation shall be held at such place either within or outside the State of New York as may from time to time be fixed by the Board or specified or fixed in the notice of any such meeting.

 

SECTION 2.  Annual Meetings.  The annual meeting of the stockholders of the Corporation for the election of directors and for the transaction of such other business as may properly come before the meeting shall be held on the last Tuesday of April of

 

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each year, if not a legal holiday, or, if such day shall be a legal holiday, then on the next succeeding day not a legal holiday, or any other day as determined by the Board. If the directors to be elected at such annual meeting shall not have been elected thereat or at any adjournment thereof, the Board shall forthwith call a special meeting of the stockholders for the election of directors to be held as soon thereafter as convenient and give notice thereof as provided in these By-laws in respect of the notice of an annual meeting of the stockholders. At such special meeting the stockholders may elect the directors and transact other business with the same force and effect as at an annual meeting of the stockholders duly called and held.

 

SECTION 3.  Special Meetings.  Special meetings of the stockholders, unless otherwise provided by law, may be called at any time by the Chairman of the Board or by the Board, and shall be called by the Board upon written request delivered to the Secretary of the Corporation by the holder(s) with the power to vote and dispose of at least 25% of the outstanding shares of the Corporation.  Such request shall be signed by each such holder, stating the number of shares owned by each holder, and shall indicate the purpose of the requested meeting and provide the other information required for the submission of business at an annual meeting pursuant to Section 7 of this Article II.  In addition, any stockholder(s) requesting a special meeting shall promptly provide any other information reasonably requested by the Corporation.  Business conducted at a special meeting shall be limited to that specified in the notice of meeting.

 

SECTION 4.  Notice of Meetings.  Notice of each meeting of the stockholders, annual or special, shall be given in the name of the Chairman of the Board, a Vice Chairman of the Board or the President or a Vice President or the Secretary.  Such notice shall state the purpose or purposes for which the meeting is called and the date and hour when and the place where it is to be held. A copy thereof shall be duly delivered or transmitted to all stockholders of record entitled to vote at such meeting, and all stockholders of record who, by reason of any action proposed to be taken at such meeting, would be entitled to have their stock appraised if such action were taken, not less than ten or more than sixty days before the day on which the meeting is called to be held. If mailed, such copy shall be directed to each stockholder at the address listed on the record of stockholders of the Corporation, or if the stockholder shall have filed with the Secretary a written request that notices be mailed to some other address, it shall be mailed to the address designated in such request. Nevertheless, notice of any meeting of the stockholders shall not be required to be given to any stockholder who shall waive notice thereof as hereinafter provided in Article IX of these By-laws. Except when expressly required by law, notice of any adjourned meeting of the stockholders need not be given nor shall publication of notice of any annual or special meeting thereof be required.

 

SECTION 5.  Quorum.  Except as otherwise provided by law, at all meetings of the stockholders, the presence of holders of record of a majority of the outstanding shares of stock of the Corporation having voting power, in person or represented by proxy and entitled to vote thereat, shall be necessary to constitute a quorum for the transaction of business. In the absence of a quorum at any such meeting or any

 

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adjournment or adjournments thereof, a majority in voting interest of those present in person or represented by proxy and entitled to vote thereat, or, in the absence of all the stockholders, any officer entitled to preside at, or to act as secretary of, such meeting, may adjourn such meeting from time to time without further notice, other than by announcement at the meeting at which such adjournment shall be taken, until a quorum shall be present thereat. At any adjourned meeting at which a quorum shall be present any business may be transacted which might have been transacted at the meeting as originally called.

 

SECTION  6.  Organization.  At each meeting of the stockholders, the Chairman of the Board, or in the absence of the Chairman of the Board, the President, or in the absence of the Chairman of the Board and the President, a Vice Chairman of the Board, or if the Chairman of the Board, the President, and all Vice Chairmen of the Board shall be absent therefrom, an Executive Vice President, or if the Chairman of the Board, the President, all Vice Chairmen of the Board and all Executive Vice Presidents shall be absent therefrom, a Senior Vice President shall act as chairman. The Secretary, or, if the Secretary shall be absent from such meeting or unable to act, the person whom the Chairman of such meeting shall appoint secretary of such meeting shall act as secretary of such meeting and keep the minutes thereof.

 

SECTION  7.   Items of Business.  The items of business at all meetings of the stockholders shall be, insofar as applicable, as follows:

 

— Call to order.

 

— Proof of notice of meeting or of waiver thereof.

 

— Appointment of inspectors of election, if necessary.

 

— A quorum being present.

 

— Reports.

 

— Election of directors.

 

— Other business specified in the notice of the meeting.

 

— Adjournment.

 

Any items of business not referred to in the foregoing may be taken up at the meeting as the chairman of the meeting shall determine.

 

No business shall be transacted at any annual meeting of stockholders, except business as may be: (i) specified in the notice of meeting (including stockholder proposals included in the Corporation’s proxy materials under Rule 14a-8 of Regulation 14A under the Exchange Act), (ii) otherwise brought before the meeting by or at the

 

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direction of the Board of Directors, (iii) a proper subject for the meeting which is timely submitted by a stockholder of the Corporation entitled to vote at such meeting who complies fully with the notice requirements set forth below or (iv) a director nomination submitted by a stockholder in accordance with Section 11 of this Article II.

 

For (a) business to be properly submitted by a stockholder before any annual meeting under subparagraph (iii) above, or (b) any stockholder to properly nominate any person for election as a director of the Corporation (other than director nominations submitted in accordance with Section 11 of this Article II), a stockholder must give timely notice in writing of such business or nomination to the Secretary of the Corporation in accordance with this Section 7.  To be considered timely, a stockholder’s notice must be received by the Secretary at the principal executive offices of the Corporation not less than 120 calendar days nor more than 150 calendar days before the anniversary date of the Corporation’s proxy statement released to stockholders in connection with the prior year’s annual meeting.

 

However, if no annual meeting was held in the previous year, or if the date of the applicable annual meeting has been changed by more than 30 days from the anniversary date of the prior year’s annual meeting, a stockholder’s notice must be received by the Secretary not later than the 10th calendar day following the date on which the Corporation publicly announces the date of the applicable annual meeting.

 

A stockholder’s notice to the Secretary to submit business or nominate directors (other than director nominations submitted in accordance with Section 11 of this Article II) at an annual meeting of stockholders shall set forth: (i) the name and address of the stockholder, (ii) the number of shares of stock held of record and beneficially by such stockholder, (iii) the name in which all such shares of stock are registered on the stock transfer books of the Corporation, (iv) a representation that the stockholder intends to appear at the meeting in person or by proxy to submit the business specified in such notice, (v) a brief description of the business desired to be submitted to the annual meeting, including the complete text of any resolutions intended to be presented at the annual meeting, and the reasons for conducting such nomination or business at the annual meeting, (vi) any personal or other material interest of the stockholder in the nomination or business to be submitted, and (vii) all other information which may be required to be disclosed under applicable law, including in connection with a solicitation of proxies, with respect to such nomination or business. Such notice shall include a true, complete and signed questionnaire with respect to such stockholder and, if applicable, with respect to each nominee of such stockholder for election as a director of the Corporation, in a form which shall be provided by the Secretary of the Corporation upon written request.   In addition, a stockholder submitting such notice shall promptly provide any other information reasonably requested by the Corporation.

 

The stockholder submitting such notice shall, no later than five (5) business days following the record date for the applicable meeting, deliver to the Secretary at the principal executive offices of the Corporation, a written notice disclosing any changes to the information so submitted, as of such record date.

 

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The chairman of the meeting shall determine all matters relating to the efficient conduct of the meeting, including, but not limited to, the items of business, as well as the maintenance of order and decorum. The chairman shall, if the facts warrant, determine and declare that any putative nomination or business was not properly brought before the meeting in accordance with the procedures prescribed by this Section 7, in which case such nomination shall not be considered or such business shall not be transacted.  The order in which items of business will be considered will be determined by the chairman.

 

Notwithstanding the foregoing provisions of this Section 7, a stockholder who seeks to have any proposal included in the Corporation’s proxy materials shall comply with the requirements of Rule 14a-8 under Regulation 14A of the Exchange Act.

 

SECTION 8.  Voting.  Except as otherwise provided by law, each holder of record of shares of stock of the Corporation having voting power shall be entitled at each meeting of the stockholders to one vote for every share of such stock standing in the stockholder’s name on the record of stockholders of the Corporation:

 

(a) on the date fixed pursuant to the provisions of Section 5 of Article VII of these By-laws as the record date for the determination of the stockholders who shall be entitled to vote at such meeting, or

 

(b) if such record date shall not have been so fixed, then at the close of business on the day next preceding the day on which notice of such meeting shall have been given, or

 

(c) if such record date shall not have been so fixed and if no notice of such meeting shall have been given, then at the time of the call to order of such meeting.

 

Any vote on stock of the Corporation at any meeting of the stockholders may be given by the stockholder of record entitled thereto in person or by proxy appointed by such stockholder or by the stockholder’s attorney thereunto duly authorized and delivered or transmitted to the secretary of such meeting at or prior to the time designated in the order of business for turning in proxies. At all meetings of the stockholders at which a quorum shall be present, all matters (except where otherwise provided by law, the Certificate of Incorporation or these By-laws) shall be decided by the vote of a majority in voting interest of the stockholders present in person or represented by proxy and entitled to vote thereat.  Unless required by law, or determined by the chairman of the meeting to be advisable, the vote on any question need not be by ballot. On a vote by ballot, each ballot shall be signed by the stockholder voting, or by the stockholder’s proxy as such, if there be such proxy.

 

SECTION 9.  List of Stockholders.  A list, certified by the Secretary, of the stockholders of the Corporation entitled to vote shall be produced at any meeting of the stockholders upon the request of any stockholder of the Corporation pursuant to the provisions of applicable law, the Certificate of Incorporation or these By-laws.

 

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SECTION  10.   Inspectors of Election.   Prior to the holding of each annual or special meeting of the stockholders, two inspectors of election to serve thereat shall be appointed by the Board, or, if the Board shall not have made such appointment, by the Chairman of the Board. If there shall be a failure to appoint inspectors, or if, at any such meeting, any inspector so appointed shall be absent or shall fail to act or the office shall become vacant, the chairman of the meeting may, and at the request of a stockholder present in person and entitled to vote at such meeting shall, appoint such inspector or inspectors of election, as the case may be, to act thereat. The inspectors of election so appointed to act at any meeting of the stockholders, before entering upon the discharge of their duties, shall be sworn faithfully to execute the duties of inspectors at such meeting, with strict impartiality and according to the best of their ability, and the oath so taken shall be subscribed by them. Such inspectors of election shall take charge of the polls, and, after the voting on any question, shall make a certificate of the results of the vote taken. No director or candidate for the office of director shall act as an inspector of an election of directors. Inspectors need not be stockholders.

 

SECTION  11.   Proxy Access.

 

(a)                                  The Corporation shall include in its proxy statement for an annual meeting of the stockholders, the name, together with the required information specified below, of any person nominated for election to the Board by a stockholder that satisfies, or by a group of no more than 20 stockholders that satisfy, the requirements of this Section 11, and who expressly elects at the time of providing the notice required by this Section 11 to have its nominee included in the Corporation’s proxy materials pursuant to this Section 11. The number of stockholders to be counted towards the 20-stockholder limit in the foregoing sentence shall be the aggregate number of record stockholders and beneficial owners whose ownership is counted for the purposes of satisfying the ownership requirements set forth in paragraph (e) of this Section 11. Two or more funds that are (i) under common management and investment control or (ii) under common management and funded primarily by the same employer or (iii) a “group of investment companies,” as such term is defined in Section 12(d)(1)(G)(ii) of the Investment Company Act of 1940, as amended, shall be treated as one stockholder for purposes of determining the aggregate number of stockholders in this paragraph and shall be treated as one person for the purpose of determining “ownership” as defined in paragraph (d) of this Section 11; provided that the funds provide documentation reasonably satisfactory to the Corporation to demonstrate that such funds satisfy the requirements of clause (i), (ii) or (iii) above. No stockholder may be a member of more than one group using the proxy access procedures set forth in this Section 11, and no shares of stock may be attributed to more than one stockholder or group of stockholders.  If any person purports to be a member of more than one group of stockholders, such person shall only be deemed to be a member of the group that has the largest ownership position (as reflected in the notice provided pursuant to this Section 11).

 

For purposes of this Section 11, the information that the Corporation will be required to include in its proxy statement is: (i) the information concerning the nominee

 

6


 

and the stockholder or group of stockholders who nominated such nominee that is required to be disclosed in the Corporation’s proxy statement by the regulations promulgated under the Exchange Act; and (ii) if such stockholder or group of stockholders so elects, a statement pursuant to paragraph (j) of this Section 11. To be timely, this required information must be included in the notice required to be submitted to the Secretary of the Corporation pursuant to paragraph (b) of this Section 11. Nothing in this Section 11 shall limit the Corporation’s ability to solicit against or for, and include in its proxy materials its own statements relating to, any nominee or any nominating stockholder or group of stockholders.

 

(b)                                  For nominations pursuant to this Section 11 to be properly submitted, the submitting stockholder or group of stockholders must give timely notice in writing of such nominations to the Secretary of the Corporation. To be considered timely, such notice and any other information required by this Section 11 must be received by the Secretary at the principal executive offices of the Corporation not less than 120 calendar days nor more than 150 calendar days before the anniversary date of the Corporation’s proxy statement released to stockholders in connection with the prior year’s annual meeting.  However, if no annual meeting was held in the previous year, or if the date of the applicable annual meeting has been changed by more than 30 days from the anniversary date of the prior year’s annual meeting, a stockholder’s notice must be received by the Secretary not later than the 10th calendar day following the date on which the Corporation publicly announces the date of the applicable annual meeting.

 

(c)                                   The number of stockholder nominees nominated pursuant to this Section 11 (including any nominees that were submitted by a stockholder or group of stockholders for inclusion in the Corporation’s proxy materials pursuant to this Section 11, but either are subsequently withdrawn or that the Board decides to nominate as Board nominees) appearing in the Corporation’s proxy materials with respect to an annual meeting of stockholders, together with any nominees who were previously elected to the Board, after being nominated pursuant to this Section 11, at any of the preceding two annual meetings and who are re-nominated for election at such annual meeting by the Board, shall not exceed the greater of two or 20% of the number of directors in office as of the last day on which notice of a nomination in accordance with the procedures set forth in this Section 11 may be received by the Secretary of the Corporation pursuant to this Section 11, or if such amount is not a whole number, the closest whole number below 20%. In the event that one or more vacancies for any reason occurs on the Board after the last day on which notice of a nomination in accordance with the procedures set forth in this Section 11 may be received by the Secretary of the Corporation pursuant to Section 11, but before the date of the annual meeting of stockholders and the Board resolves to reduce the size of the Board in connection therewith, the maximum number of stockholder nominees nominated pursuant to this Section 11 included in the Corporation’s proxy materials shall be calculated based on the number of directors in office as so reduced. Any stockholder or group of stockholders submitting more than one nominee for inclusion in the Corporation’s proxy materials pursuant to this Section 11 shall rank its nominees based

 

7


 

on the order that such stockholder or group of stockholders desires such nominees to be selected for inclusion in the Corporation’s proxy materials in the event that the total number of stockholder nominees submitted by stockholders or groups of stockholders pursuant to this Section 11 exceeds the maximum number of stockholder nominees provided for in this Section 11. In the event that the number of stockholder nominees submitted by stockholders or groups of stockholders pursuant to this Section 11 exceeds the maximum number of stockholder nominees provided for in this Section 11, the highest ranking stockholder nominee who meets the requirements of this Section 11 from each stockholder or group of stockholders will be selected for inclusion in the Corporation’s proxy materials until the maximum number is reached, going in order of the amount (largest to smallest) of shares of common stock of the Corporation each stockholder or group of stockholders disclosed as owned in its respective notice of a nomination submitted to the Corporation in accordance with the procedures set forth in this Section 11. If the maximum number is not reached after the highest ranking stockholder nominee who meets the requirements of this Section 11 from each stockholder or group of stockholders has been selected, this process will continue as many times as necessary, following the same order each time, until the maximum number is reached.

 

(d)                                  For purposes of this Section 11, a stockholder or group of stockholders shall be deemed to “own” only those outstanding shares of common stock of the Corporation as to which the stockholder or any member of a group of stockholders possesses both (i) the full voting and investment rights pertaining to the shares and (ii) the full economic interest in (including the opportunity for profit and risk of loss on) such shares; provided that the number of shares calculated in accordance with clauses (i) and (ii) shall not include any shares (x) sold by such stockholder or any of its affiliates in any transaction that has not been settled or closed, (y) borrowed by such stockholder or any of its affiliates for any purposes or purchased by such stockholder or any of its affiliates pursuant to an agreement to resell or (z) subject to any option, warrant, forward contract, swap, contract of sale, other derivative or similar agreement entered into by such stockholder or any of its affiliates, whether any such instrument or agreement is to be settled with shares or with cash based on the notional amount or value of shares of outstanding common stock of the Corporation, in any such case which instrument or agreement has, or is intended to have, the purpose or effect of (1) reducing in any manner, to any extent or at any time in the future, such stockholder’s or affiliates’ full right to vote or direct the voting of any such shares, and/or (2) hedging, offsetting or altering to any degree gain or loss arising from the full economic ownership of such shares by such stockholder or affiliate. A person’s ownership of shares shall be deemed to continue during any period in which (i) the person has loaned such shares, provided that the person has the power to recall such loaned shares on five business days’ notice and has recalled such shares within five business days of being notified that any of their nominees will be included in the Corporation’s proxy materials; or (ii) the person has delegated any voting power by means of a proxy, power of attorney or other instrument or arrangement which is revocable at any time by the person. Whether outstanding shares of the common stock of the Corporation are “owned” for these purposes shall be determined by the Board. For purposes of this Section 11, the term

 

8


 

“affiliate” or “affiliates” shall have the meaning ascribed thereto under the General Rules and Regulations under the Exchange Act.

 

(e)                                   In order to make a nomination pursuant to this Section 11, a stockholder or group of stockholders must have owned (as defined above) 3% or more of the Corporation’s outstanding common stock continuously for at least three years as of both the date the written notice of the nomination is delivered to or mailed and received by the Corporation in accordance with this Section 11 and the record date for determining stockholders entitled to vote at the annual meeting of stockholders, and must continue to hold at least 3% of the Corporation’s outstanding common stock through the meeting date. Within the time period specified in this Section 11 for providing notice of a nomination in accordance with the procedures set forth in this Section 11, a stockholder or group of stockholders must provide the following information in writing to the Secretary of the Corporation: (i) one or more written statements from the record holder of the shares (or for beneficial owners, proof of ownership from each intermediary through which the shares are or have been held during the requisite three-year holding period in a form that would be deemed by the Corporation to be acceptable pursuant to Rule 14a-8(b)(2) under the Exchange Act for purposes of a shareholder proposal) verifying that, as of the date the written notice of the nomination is delivered to or mailed and received by the Secretary of the Corporation, the stockholder or group of stockholders owns, and has owned continuously for the preceding three years, at least 3% of the Corporation’s outstanding common stock, and the stockholder or group of stockholders’ agreement to provide, within five business days after the record date for the annual meeting of stockholders, written statements from the record holder and intermediaries verifying such stockholder or group of stockholders’ continuous ownership of at least 3% of the Corporation’s outstanding common stock through the record date; (ii) the written consent of each stockholder nominee to being named in the proxy statement as a nominee and to serve as a director if elected and (iii) a copy of the Schedule 14N that has been filed with the Securities and Exchange Commission as required by Rule 14a-18 under the Exchange Act.

 

(f)                                    Within the time period specified in this Section 11 for providing notice of a nomination in accordance with the procedures set forth in this Section 11, a stockholder or group of stockholders must provide a representation and agreement that such stockholder or group of stockholders: (i) acquired at least 3% of the Corporation’s outstanding common stock in the ordinary course of business and not with the intent to change or influence control at the Corporation, and does not presently have such intent, (ii) presently intends to maintain qualifying ownership of at least 3% of the Corporation’s outstanding common stock through the date of the annual meeting and to vote such shares at the annual meeting, (iii) has not nominated and will not nominate for election to the Board at the annual meeting of stockholders any person other than the nominee or nominees being nominated pursuant to this Section 11, (iv) has not engaged and will not engage in, and has not and will not be a “participant” in another person’s, “solicitation” within the meaning of Rule 14a-1(l) under the Exchange Act, in support of the election of any individual as a director at the annual meeting of stockholders other than its nominee or a nominee of the Board, (v) will not distribute to any stockholder any

 

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form of proxy for the annual meeting of stockholders other than the form distributed by the Corporation, and (vi) will provide facts, statements and other information in all communications with the Corporation and stockholders of the Corporation that are or will be true and correct in all material respects and do not and will not omit to state a material fact necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading.

 

(g)                                   Within the time period specified in this Section 11 for providing notice of a nomination in accordance with the procedures set forth in this Section 11, a stockholder or group of stockholders must provide an undertaking that the stockholder or group of stockholders agrees to: (i) assume all liability stemming from any legal or regulatory violation arising out of the stockholder or group of stockholders’ communications with the stockholders of the Corporation or out of the information that the such stockholder or group of stockholders provided to the Corporation, (ii) comply with all other laws and regulations applicable to any solicitation in connection with the annual meeting of stockholders, and (iii) indemnify and hold harmless the Corporation and each of its directors, officers and employees individually against any liability, loss or damages in connection with any threatened or pending action, suit or proceeding, whether legal, administrative or investigative, against the Corporation or any of its directors, officers or employees arising out of any nomination submitted by the stockholder or group of stockholders pursuant to this Section 11. In the case of a nomination by a group of stockholders, the stockholder group shall, in the notice required by this Section 11, designate one member of the group that is authorized to receive communications, notices and inquiries from the Corporation and to act on behalf of all members of the group with respect to all matters relating to the nomination under this Section 11 (including withdrawal of the nomination).

 

The inspector of elections shall not give effect to the stockholder or group of stockholders’ votes with respect to the election of directors if such stockholder or group of stockholders does not comply with the undertaking) above.

 

(h)                                  Within the time period specified in this Section 11 for providing notice of a nomination in accordance with the procedures set forth in this Section 11, the applicable stockholder or group of stockholders must deliver to the Secretary of the Corporation, at the principal executive offices of the Corporation, (i) all information and materials required by Section 7 of this Article II in connection with the nomination of any person for election as a director of the Corporation and (ii) a written representation and agreement that such person (x) is not and will not become a party to any agreement, arrangement or understanding with, and has not given any commitment or assurance to, any person or entity as to how such person, if elected as a director of the Corporation, will act or vote on any issue or question that has not been disclosed to the Corporation, (y) may not be, and may not become, a party to any compensatory, payment, indemnification or other financial agreement, arrangement or understanding with any person or entity other than the Corporation in connection with service or action as a director that has not been disclosed to the Corporation, and (z) will comply with all of the Corporation’s corporate governance, conflict of interest, confidentiality and stock

 

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ownership and trading policies and guidelines, and any other Corporation policies and guidelines applicable to directors. At the request of the Corporation, the stockholder nominee must submit all completed and signed questionnaires required of directors of the Corporation. In addition, such stockholder or group of stockholders shall provide the Secretary of the Corporation with notice of changes to such information, in the manner provided in Section 7 of this Article II, and shall promptly provide any other information reasonably requested by the Corporation.

 

The Corporation may request such additional information as necessary to permit the Board to determine if each stockholder nominee is independent under the listing standards of the principal U.S. securities exchange upon which the common stock of the Corporation is listed (including any additional independence standards that are applicable to audit, compensation or other board committees), any applicable rules of the Securities and Exchange Commission (including under the definition of a “non-employee director” under Exchange Act Rule 16b-3), the definition of “outside director” under Section 162(m) of the Internal Revenue Code of 1986, as amended (or any successor provision) and any publicly disclosed standards used by the Board in determining and disclosing the independence of the Corporation’s directors. If the Board determines that a stockholder nominee is not independent under any of the foregoing standards, the stockholder nominee will be ineligible for inclusion in the Corporation’s proxy materials.

 

(i)                                      In the event that any information or communications provided by the stockholder or group of stockholders or the stockholder nominee to the Corporation or its stockholders ceases to be true and correct in all material respects or omits a material fact necessary to make the statements made, in light of the circumstances under which they were made, not misleading, each stockholder or group of stockholders or stockholder nominee, as the case may be, shall promptly notify the Secretary of the Corporation of any defect in such previously provided information and of the information that is required to correct any such defect.

 

(j)                                     The stockholder or group of stockholders may provide to the Secretary of the Corporation, at the time the information required by this Section 11 is provided, a written statement for inclusion in the Corporation’s proxy statement for the annual meeting of stockholders, not to exceed 500 words, in support of the stockholder nominee’s candidacy. Only one such statement may be submitted by a stockholder or group of stockholders for each of their director nominees. Notwithstanding anything to the contrary contained in this Section 11, the Corporation may omit from its proxy materials any information or statement that it, in good faith, believes would violate any applicable law or regulation.

 

(k)                                  The Corporation shall not be required to include, pursuant to this Section 11, any stockholder nominee in its proxy materials for any meeting of stockholders: (i) for which the Secretary of the Corporation receives a notice that a stockholder or group of stockholders has nominated a person for election to the Board pursuant to the advance notice requirements for stockholder nominees for director, (ii) if the stockholder nominee is, or has been within the three years preceding the date the Corporation first

 

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mails to the stockholders its notice of meeting that includes the name of the stockholder nominee, an officer or director of a company that is a competitor, as defined in Section 8 of the Clayton Antitrust Act of 1914, of the Corporation, (iii) who is not independent under any of the independence standards referred to in paragraph (h) of this Section 11, (iv) if the stockholder nominee serves as a director at more than four other public companies, or at more than two other public companies if the stockholder nominee also serves as an executive officer of another public company, as of the date the Corporation first mails to the stockholders its notice of meeting that includes the name of the stockholder nominee, (v) if the stockholder nominee or the stockholder or group of stockholders who has nominated such stockholder nominee has engaged in or is currently engaged in, or has been or is a “participant” in another person’s, “solicitation” within the meaning of Rule 14a-1(l) under the Exchange Act, in support of the election of any individual as a director at the meeting other than such stockholder nominee or a nominee of the Board, (vi) who is or becomes a party to any compensatory, payment or other financial agreement, arrangement or understanding with any person other than the Corporation that has not been disclosed to the Corporation, (vii) who is a named subject of a criminal proceeding (excluding traffic violations and other minor offenses) pending as of the date the Corporation first mails to the stockholders its notice of meeting that includes the name of the stockholder nominee, or who, within the ten years preceding such date, was convicted in such a criminal proceeding, (viii) who upon becoming a member of the Board, would cause the Corporation to be in violation of these By-Laws, the Certificate of Incorporation, the rules and listing standards of the principal U.S. exchange upon which the common stock of the Corporation is listed, or any applicable state or federal law, rule or regulation, (ix) if such stockholder nominee or the applicable stockholder or group of stockholders shall have provided information to the Corporation in respect to such nomination that was untrue in any material respect or omitted to state a material fact necessary in order to make the statement made, in light of the circumstances under which it was made, not misleading, as determined by the Board, or (x) if the stockholder or group of stockholders or applicable stockholder nominee otherwise contravenes any of the agreements, representations or undertakings made by such stockholder or group of stockholders or stockholder nominee or fails to comply with its obligations pursuant to this Section 11. For purposes of clause (ii) above, a “competitor” of the Corporation is any company engaged in any business or other activities that are competitive with any aspect of the Corporation’s business to an extent that is more than de minimis, as determined by the Board.

 

(l)                                      Notwithstanding anything to the contrary set forth in this Section 11, the Board or the chairman of the annual meeting of stockholders shall declare a nomination by a stockholder or group of stockholders to be invalid, and such nomination shall be disregarded notwithstanding that proxies in respect of such vote may have been received by the Corporation, if: (i) the stockholder nominee(s) and/or the applicable stockholder (or any member of any group of stockholders) shall have failed to comply or breached its or their obligations under this Section 11, including, but not limited to, a breach of any representations, agreements or undertakings required under this Section 11, or if any of the events or conditions referred to in paragraph (k) of this Section 11 has occurred, in each case as determined by the Board or the chairman of the annual

 

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meeting of stockholders or (ii) the stockholder or group of stockholders (or a qualified representative thereof) does not appear at the annual meeting of stockholders to present any nomination pursuant to this Section 11.

 

(m)                              Any stockholder nominee who is included in the Corporation’s proxy materials for a particular annual meeting of stockholders but either: (i) withdraws from or becomes ineligible or unavailable for election at the annual meeting of stockholders, or (ii) does not receive at least 25% of the votes cast in favor of the stockholder nominee’s election, will be ineligible to be a stockholder nominee pursuant to this Section 11 for the next two annual meetings of stockholders.

 

(n)                                  The Board (or any other person or body duly authorized by the Board), at all times acting in good faith, shall have the power and authority to interpret this Section 11 and to make any and all determinations necessary or advisable pursuant to this Section 11.

 

ARTICLE III

 

BOARD OF DIRECTORS

 

SECTION 1.  General Powers.  The business and affairs of the Corporation shall be managed by the Board. The Board may exercise all such authority and powers of the Corporation and do all such lawful acts and things as are not by law, the Certificate of Incorporation or these By-laws, directed or required to be exercised or done by the stockholders.

 

SECTION 2.  Number; Qualifications; Election; Term of Office.  The number of directors of the Corporation shall be twelve, but the number thereof may be increased to not more than twenty-five, or decreased to not less than nine, by amendment of these By-laws. The directors shall be elected at the annual meeting of the stockholders. At each meeting of the stockholders for the election of directors at which a quorum is present, the vote required for election of a director shall, except in a contested election, be the affirmative vote of a majority of the votes cast in favor of or against such nominee.  In a contested election, a nominee receiving a plurality of the votes cast at such election shall be elected.  An election shall be considered to be contested if, as of the record date for such meeting, there are more nominees for election than positions on the Board to be filled by election at the meeting.  Each director shall hold office until the annual meeting of the stockholders which shall be held next after the election of such director and until a successor shall have been duly elected and qualified, or until death, or until the director shall have resigned as hereinafter provided in Section 10 of this Article III.

 

SECTION 3.  Place of Meetings.  Meetings of the Board shall be held at such place either within or outside State of New York as may from time to time be fixed by the Board or specified or fixed in the notice of any such meeting.

 

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SECTION 4.  First Meeting.  The Board shall meet for the purpose of organization and the transaction of other business following each annual meeting of stockholders at such time and place as shall be specified in a notice thereof given as hereinafter provided in Section 7 of this Article III.

 

SECTION 5.  Regular Meetings.  Regular meetings of the Board shall be held at times and dates fixed by the Board or at such other times and dates as the Chairman of the Board shall determine and as shall be specified in the notice of such meetings. Notice of regular meetings of the Board need not be given except as otherwise required by law or these By-laws.

 

SECTION 6.  Special Meetings.  Special meetings of the Board may be called by the Chairman of the Board, provided, however, that if the Chairman of the Board is unavailable, a special meeting of the Board may be called by agreement of each of the remaining members of the Executive Committee.

 

SECTION 7.  Notice of Meetings.  Notice of each special meeting of the Board (and of each regular meeting for which notice shall be required) shall be given by the Secretary as hereinafter provided in this Section 7, in which notice shall be stated the time, place and, if required by law or these By-laws, the purposes of such meeting. Notice of each such meeting shall be mailed, postage prepaid, to each director, by first-class mail, at least four days before the day on which such meeting is to be held, or shall be sent by facsimile transmission or comparable medium, or be delivered personally or by telephone, before the time at which such meeting is to be held. Notice of any such meeting need not be given to any director who shall waive notice thereof as provided in Article IX of these By-laws. Any meeting of the Board shall be a legal meeting without notice thereof having been given, if all the directors of the Corporation then holding office shall be present thereat.

 

SECTION 8.  Quorum and Manner of Acting.  A majority of the Board shall be present in person at any meeting of the Board in order to constitute a quorum for the transaction of business at such meeting. Participation in a meeting by means of a conference telephone or similar communications equipment allowing all persons participating in the meeting to hear each other shall constitute presence in person at a meeting. Except as otherwise expressly required by law or the Certificate of Incorporation and except also as specified in Section 1, Section 5, and Section 6 of Article IV, in Section 3 of Article V and in Article XII of these By-laws, the act of a majority of the directors present at any meeting at which a quorum is present shall be the act of the Board. In the absence of a quorum at any meeting of the Board, a majority of the directors present thereat may adjourn such meeting from time to time until a quorum shall be present thereat. Notice of any adjourned meeting need not be given. At any adjourned meeting at which a quorum is present, any business may be transacted which might have been transacted at the meeting as originally called. The directors shall act only as a Board and the individual directors shall have no power as such.

 

SECTION  9.   Organization.   At each meeting of the Board, the Chairman of the Board, or in the case of the Chairman’s absence therefrom, the Lead Director, or in the

 

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case of the Lead Director’s absence therefrom, the President, or in the case of the President’s absence therefrom, a Vice Chairman, or in the case of the absence of all such persons, another director chosen by a majority of directors present, shall act as chairman of the meeting and preside thereat. The Secretary, or if the Secretary shall be absent from such meeting, any person appointed by the chairman, shall act as secretary of the meeting and keep the minutes thereof.

 

SECTION 10.  Resignations.

 

(a) Any director of the Corporation may resign at any time by giving written notice of resignation to the Board or the Chairman of the Board or the Secretary. Subject to Section 10(b), any such resignation shall take effect at the time specified therein, or if the time when it shall become effective shall not be specified therein, then it shall take effect immediately upon its receipt; and unless otherwise specified therein, the acceptance of such resignation shall not be necessary to make it effective.

 

(b) In an uncontested election, any incumbent nominee for director who does not receive an affirmative vote of a majority of the votes cast in favor of or against such nominee shall promptly tender his or her resignation after such election.  The independent directors of the Board, giving due consideration to the best interests of the Corporation and its stockholders, shall evaluate the relevant facts and circumstances, and shall make a decision, within 90 days after the election, on whether to accept the tendered resignation.  Any director who tenders a resignation pursuant to this provision shall not participate in the Board’s decision. The Board will promptly disclose publicly its decision and, if applicable, the reasons for rejecting the tendered resignation.

 

SECTION 11.  Vacancies.  Any vacancy in the Board, whether arising from death, resignation, an increase in the number of directors or any other cause, may be filled by the Board.

 

SECTION 12.  Retirement of Directors. The Board may prescribe a retirement policy for directors on or after reaching a certain age, provided, however, that such retirement shall not cut short the annual term for which any director shall have been elected by the stockholders.

 

ARTICLE IV

 

EXECUTIVE AND OTHER COMMITTEES

 

SECTION 1.  Executive Committee.  The Executive Committee shall be comprised of the Chairman of the Board, and each of the respective chairs of the (i) Audit Committee, (ii) Executive Compensation and Management Resources Committee, (iii) Directors and Corporate Governance Committee, in each case including any successor committee, and (iv) the Lead Director, if such person is does not fall within one of the roles set forth in clause (i), (ii) or (iii) above. The Chairman of the Board shall serve as the Chairman of the Executive Committee to preside at all meetings of such Committee.  The Secretary, or if the Secretary shall be absent from such meeting, any

 

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person appointed by the chairman, shall act as secretary of the meeting and keep the minutes thereof.

 

SECTION 2.  Powers of the Executive Committee.  To the extent permitted by law, the Executive Committee may exercise all the powers of the Board in the management of specified matters where such authority is delegated to it by the Board, and also, to the extent permitted by law, the Executive Committee shall have, and may exercise, all the powers of the Board in the management of the business and affairs of the Corporation (including the power to authorize the seal of the Corporation to be affixed to all papers which may require it; but excluding the power to appoint a member of the Executive Committee) in such manner as the Executive Committee shall deem to be in the best interests of the Corporation and not inconsistent with any prior specific action of the Board. An act of the Executive Committee taken within the scope of its authority shall be an act of the Board. The Executive Committee shall render in the form of minutes a report of its several acts at each regular meeting of the Board and at any other time when so directed by the Board.

 

SECTION 3.  Meetings of the Executive Committee.  Regular meetings of the Executive Committee shall be held at such times, on such dates and at such places as shall be fixed by resolution adopted by a majority of the Executive Committee, of which regular meetings notice need not be given, or as shall be fixed by the Chairman of the Executive Committee or in the absence of the Chairman of the Executive Committee the Chief Executive Officer and specified in the notice of such meeting. Special meetings of the Executive Committee may be called by the Chairman of the Executive Committee or by the Chief Executive Officer. Notice of each such special meeting of the Executive Committee (and of each regular meeting for which notice shall be required), stating the time and place thereof shall be mailed, postage prepaid, to each member of the Executive Committee, by first-class mail, at least four days before the day on which such meeting is to be held, or shall be sent by facsimile transmission or comparable medium, or be delivered personally or by telephone, at least twenty-four hours before the time at which such meeting is to be held; but notice need not be given to a member of the Executive Committee who shall waive notice thereof as provided in Article IX of these By-laws, and any meeting of the Executive Committee shall be a legal meeting without any notice thereof having been given, if all the members of such Committee shall be present thereat.

 

SECTION 4.  Quorum and Manner of Acting of the Executive Committee.  Four members of the Executive Committee or, if the Lead Director does not fall within one of the roles set forth in clause (i), (ii) or (iii) of Section 1 of this Article V, five members of the Executive Committee, shall constitute a quorum for the transaction of business, and the act of a majority of the members of the Executive Committee present at a meeting at which a quorum shall be present shall be the act of the Executive Committee. Participating in a meeting by means of a conference telephone or similar communications equipment allowing all persons participating in the meeting to hear each other shall constitute presence at a meeting of the Executive Committee. The members of the Executive Committee shall act only as a committee and individual members shall have no power as such.

 

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SECTION 5.  Other Committees.  The Board may, by resolution adopted by a majority of the Board, designate members of the Board to constitute other committees, which shall have, and may exercise, such powers as the Board may by resolution delegate to them, and shall in each case consist of such number of directors as the Board may determine; provided, however, that each such committee shall have at least three directors as members thereof. Such a committee may either be constituted for a specified term or may be constituted as a standing committee which does not require annual or periodic reconstitution. A majority of all the members of any such committee may determine its action and its quorum requirements and may fix the time and place of its meetings, unless the Board shall otherwise provide. Participating in a meeting by means of a conference telephone or similar communications equipment allowing all persons participating in the meeting to hear each other shall constitute presence at a meeting of such other committees.

 

In addition to the foregoing, the Board may, by resolution adopted by a majority of the Board, create a committee of indeterminate membership and duration and not subject to the limitations as to the membership, quorum and manner of meeting and acting prescribed in these By-laws, which committee, in the event of a major disaster or catastrophe or national emergency which renders the Board incapable of action by reason of the death, physical incapacity or inability to meet of some or all of its members, shall have, and may exercise all the powers of the Board in the management of the business and affairs of the Corporation (including, without limitation, the power to authorize the seal of the Corporation to be affixed to all papers which may require it and the power to fill vacancies in the Board). An act of such committee taken within the scope of its authority shall be an act of the Board.

 

SECTION 6.  Changes in Committees; Resignations; Removals; Vacancies.  The Board shall have power, by resolution adopted by a majority of the Board, at any time to change or remove the members of, to fill vacancies in, and to discharge any committee created pursuant to these By-laws, either with or without cause. Any member of any such committee may resign at any time by giving written notice to the Board or the Chairman of the Board or the Secretary. Such resignation shall take effect upon receipt of such notice or at any later time specified therein; and, unless otherwise specified therein, acceptance of such resignation shall not be necessary to make it effective. Any vacancy in any committee, whether arising from death, resignation, an increase in the number of committee members or any other cause, shall be filled by the Board in the manner prescribed in these By-laws for the original appointment of the members of such committee.

 

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ARTICLE V

 

OFFICERS

 

SECTION 1.  Number and Qualifications. The officers of the Corporation shall include the Chairman of the Board, and may include one or more Vice Chairmen of the Board, the President, one or more Vice Presidents (one or more of whom may be designated as Executive Vice Presidents or as Senior Vice Presidents or by other designations), the Treasurer, the Secretary and the Controller.  Officers shall be elected from time to time by the Board, each to hold office until a successor shall have been duly elected and shall have qualified, or until death, or until resignation as hereinafter provided in Section 2 of this Article V, or until removed as hereinafter provided in Section 3 of this Article V.

 

SECTION  2.   Resignations.   Any officer of the Corporation may resign at any time by giving written notice of resignation to the Board, the Chairman of the Board, the Chief Executive Officer or the Secretary. Any such resignation shall take effect at the time specified therein, or, if the time when it shall become effective shall not be specified therein, then it shall become effective upon its receipt; and, unless otherwise specified therein, the acceptance of such resignation shall not be necessary to make it effective.

 

SECTION  3.  Removal.  Any officer of the Corporation may be removed, either with or without cause, at any time, by a resolution adopted by a majority of the Board at any meeting of the Board.

 

SECTION  4.  Vacancies.  A vacancy in any office, whether arising from death, resignation, removal or any other cause, may be filled for the unexpired portion of the term of office which shall be vacant, in the manner prescribed in these By-laws for the regular election or appointment to such office.

 

SECTION  5.  Chairman of the Board.  The Chairman of the Board shall, if present, preside at each meeting of the stockholders and of the Board and shall perform such other duties as may from time to time be assigned by the Board. The Chairman may sign certificates representing shares of the stock of the Corporation pursuant to the provisions of Section 1 of Article VII of these By-laws; sign, execute and deliver in the name of the Corporation all deeds, mortgages, bonds, contracts or other instruments authorized by the Board, except in cases where the signing, execution or delivery thereof shall be expressly delegated by the Board or these By-laws to some other officer or agent of the Corporation or where they shall be required by law otherwise to be signed, executed and delivered; and affix the seal of the Corporation to any instrument which shall require it. The Chairman of the Board, when there is no President or in the absence or incapacity of the President, shall perform all the duties and functions and exercise all the powers of the President.

 

SECTION 6.  Vice Chairman of the Board. Each Vice Chairman of the Board shall assist the Chairman of the Board and have such other duties as may be assigned

 

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by the Board or the Chairman of the Board. The Vice Chairman may sign certificates representing shares of the stock of the Corporation pursuant to the provisions of Section 1 of Article VII of these By-laws; sign, execute and deliver in the name of the Corporation all deeds, mortgages, bonds, contracts or other instruments authorized by the Board, except in cases where the signing, execution or delivery thereof shall be expressly delegated by the Board or these By-laws to some officer or agent of the Corporation or where they shall be required by law otherwise to be signed, executed and delivered; and affix the seal of the Corporation to any instrument which shall require it.

 

SECTION  7.  President.  The President shall perform all such duties as from time to time may be assigned by the Board or the Chairman of the Board. The President may sign certificates representing shares of the stock of the Corporation pursuant to the provisions of Section 1 of Article VII of these By-laws; sign, execute and deliver in the name of the Corporation all deeds mortgages, bonds, contracts or other instruments authorized by the Board, except in cases where the signing, execution or delivery thereof shall be expressly delegated by the Board or these By-laws to some other officer or agent of the Corporation or where they shall be required by law otherwise to be signed, executed and delivered, and affix the seal of the Corporation to any instrument which shall require it; and, in general, perform all duties incident to the office of President. The President shall in the absence or incapacity of the Chairman of the Board and the Lead Director, perform all the duties and functions and exercise all the powers of the Chairman of the Board.

 

SECTION  8.   Designated Officers.   (a)  Chief Executive Officer.  Either the Chairman of the Board, or the President, as the Board of Directors may designate, shall be the Chief Executive Officer of the Corporation. The officer so designated shall have, in addition to the powers and duties applicable to the office set forth in Section 5 or 7 of this Article V, general and active supervision over the business and affairs of the Corporation and over its several officers, agents, and employees, subject, however, to the control of the Board. The Chief Executive Officer shall see that all orders and resolutions of the Board are carried into effect, be an ex officio member of all committees of the Board (except the Audit Committee, the Directors and Corporate Governance Committee, and committees specifically empowered to fix or approve the Chief Executive Officer’s compensation or to grant or administer bonus, option or other similar plans in which the Chief Executive Officer is eligible to participate), and, in general, shall perform all duties incident to the position of Chief Executive Officer and such other duties as may from time to time be assigned by the Board.    (b) Other Designated Officers.  The Board of Directors may designate officers to serve as Chief Financial Officer, Chief Accounting Officer and other such designated positions and to fulfill the responsibilities of such designated positions in addition to their duties as officers as set forth in this Article V.

 

SECTION 9.  Executive Vice Presidents, Senior Vice Presidents and Vice Presidents. Each Executive and Senior Vice President shall perform all such duties as from time to time may be assigned by the Board or the Chairman of the Board or a Vice Chairman of the Board or the President. Each Vice President shall perform all such

 

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duties as from time to time may be assigned by the Board or the Chairman of the Board or a Vice Chairman of the Board or the President or an Executive or a Senior Vice President. Any Vice President may sign certificates representing shares of stock of the Corporation pursuant to the provisions of Section 1 of Article VII of these By-laws.

 

SECTION 10.  Treasurer.  The Treasurer shall:

 

(a) have charge and custody of, and be responsible for, all the funds and securities of the Corporation, and may invest the same in any securities, may open, maintain and close accounts for effecting any and all purchase, sale, investment and lending transactions in securities of any and all kinds for and on behalf of the Corporation or any employee pension or benefit plan fund or other fund established by the Corporation, as may be permitted by law;

 

(b) keep full and accurate accounts of receipts and disbursements in books belonging to the Corporation;

 

(c) deposit all moneys and other valuables to the credit of the Corporation in such depositaries as may be designated by the Board or the Executive Committee;

 

(d) receive, and give receipts for, moneys due and payable to the Corporation from any source whatsoever;

 

(e) disburse the funds of the Corporation and supervise the investment of its funds, taking proper vouchers therefor;

 

(f) render to the Board, whenever the Board may require, an account of all transactions as Treasurer; and

 

(g) in general, perform all the duties incident to the office of Treasurer and such other duties as from time to time may be assigned by the Board or the Chairman of the Board or a Vice Chairman of the Board or the President or an Executive or Senior Vice President.

 

SECTION 11.  Secretary.  The Secretary shall:

 

(a) keep or cause to be kept in one or more books provided for the purpose, the minutes of all meetings of the Board, the Executive Committee and other committees of the Board and the stockholders;

 

(b) see that all notices are duly given in accordance with the provisions of these By-laws and as required by law;

 

(c) be custodian of the records and the seal of the Corporation and affix and attest the seal to all stock certificates of the Corporation and affix and attest the seal to all other documents to be executed on behalf of the Corporation under its seal;

 

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(d) see that the books, reports, statements, certificates and other documents and records required by law to be kept and filed are properly kept and filed; and

 

(e) in general, perform all the duties incident to the office of Secretary and such other duties as from time to time may be assigned by the Board or the Chairman of the Board or a Vice Chairman of the Board or the President or an Executive or Senior Vice President.

 

SECTION  12.  Controller.  The Controller shall:

 

(a) have control of all the books of account of the Corporation;

 

(b) keep a true and accurate record of all property owned by it, of its debts and of its revenues and expenses;

 

(c) keep all accounting records of the Corporation (other than the accounts of receipts and disbursements and those relating to the deposits of money and other valuables of the Corporation, which shall be kept by the Treasurer);

 

(d) render to the Board, whenever the Board may require, an account of the financial condition of the Corporation; and

 

(e) in general, perform all the duties incident to the office of Controller and such other duties as from time to time may be assigned by the Board or the Chairman of the Board or a Vice Chairman of the Board or the President or an Executive or Senior Vice President.

 

SECTION 13.  Compensation.  The compensation of the officers of the Corporation shall be fixed from time to time by the Board; provided, however, that the Board may delegate to a committee the power to fix or approve the compensation of any officers. An officer of the Corporation shall not be prevented from receiving compensation by reason of being also a director of the Corporation; but any such officer who shall also be a director shall not have any vote in the determination of the amount of compensation paid to such officer.

 

ARTICLE VI

 

CONTRACTS, CHECKS, DRAFTS, BANK ACCOUNTS, ETC.

 

SECTION 1.  Execution of Contracts.  Except as otherwise required by law or these By-laws, any contract or other instrument may be executed and delivered in the name and on behalf of the Corporation by any officer (including any assistant officer) of the Corporation. The Board or the Executive Committee may authorize any agent or employee to execute and deliver any contract or other instrument in the name and on behalf of the Corporation, and such authority may be general or confined to specific

 

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instances as the Board or such Committee, as the case may be, may by resolution determine.

 

SECTION 2.  Loans.  Unless the Board shall otherwise determine, the Chairman of the Board or a Vice Chairman of the Board or the President or any Vice President, acting together with the Treasurer or the Secretary, may effect loans and advances at any time for the Corporation from any bank, trust company or other institution, or from any firm, corporation or individual, and for such loans and advances may make, execute and deliver promissory notes, bonds or other certificates or evidences of indebtedness of the Corporation, but in making such loans or advances no officer or officers shall mortgage, pledge, hypothecate or transfer any securities or other property of the Corporation, except when authorized by resolution adopted by the Board.

 

SECTION 3.  Checks, Drafts, etc.  All checks, drafts, bills of exchange or other orders for the payment of money out of the funds of the Corporation, and all notes or other evidences of indebtedness of the Corporation, shall be signed in the name and on behalf of the Corporation by such persons and in such manner as shall from time to time be authorized by the Board or the Executive Committee or authorized by the Treasurer  acting together with either the General Manager of an operating unit or a nonfinancial Vice President of the Corporation, which authorization may be general or confined to specific instances.

 

SECTION 4.  Deposits.  All funds of the Corporation not otherwise employed shall be deposited from time to time to the credit of the Corporation in such banks, trust companies or other depositaries as the Board or the Executive Committee may from time to time designate or as may be designated by any officer or officers of the Corporation to whom such power of designation may from time to time be delegated by the Board or the Executive Committee. For the purpose of deposit and for the purpose of collection for the account of the Corporation, checks, drafts and other orders for the payment of money which are payable to the order of the Corporation may be endorsed, assigned and delivered by any officer, employee or agent of the Corporation.

 

SECTION 5.  General and Special Bank Accounts.  The Board or the Executive Committee may from time to time authorize the opening and keeping of general and special bank accounts with such banks, trust companies or other depositaries as the Board or the Executive Committee may designate or as may be designated by any officer or officers of the Corporation to whom such power of designation may from time to time be delegated by the Board or the Executive Committee. The Board or the Executive Committee may make such special rules and regulations with respect to such bank accounts, not inconsistent with the provisions of these By-laws, as it may deem expedient.

 

SECTION 6.  Indemnification.  The Corporation shall, to the fullest extent permitted by applicable law as in effect at any time, indemnify any person made, or threatened to be made, a party to an action or proceeding whether civil or criminal (including an action or proceeding by or in the right of the Corporation) by reason of the fact that such person is (i) an officer or director of the Corporation or (ii) an officer or

 

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director of the Corporation who is asked to serve in any capacity at the request of the Corporation in any corporation, partnership, joint venture, trust, employee benefit plan or other enterprise, against, in each case, judgments, fines, amounts paid in settlement and reasonable expenses, including attorneys’ fees actually and necessarily incurred as a result of such action or proceeding, or any appeal therein. Such indemnification shall be a contract right that vests upon the occurrence or alleged occurrence of any act or omission to act that forms the basis for or is related to the claim for which indemnification is sought and shall include the right to be paid advances of any expenses incurred by such person in connection with such action, suit or proceeding, and the right to be indemnified for expenses incurred by such person in connection with successfully establishing a right to indemnification, in each case consistent with the provisions of applicable law in effect at any time. Indemnification shall be deemed to be ‘permitted’ within the meaning of the first sentence hereof if it is not expressly prohibited by applicable law as in effect at the time.  The indemnification rights hereunder shall continue as to any such person who has ceased to be an officer or director of the Corporation and shall inure to the benefit of the heirs, executors and administrators of any such person.  If the right of indemnification provided for in this Section 6 is amended or repealed, such amendment or repeal will not limit the indemnification provided for herein with respect to any acts or omissions to act occurring prior to any such amendment or repeal.

 

ARTICLE VII

 

SHARES

 

SECTION 1.  Stock Certificates.  The shares of the Corporation shall be represented by certificates, or shall be uncertificated shares.  Each owner of stock of the Corporation shall be entitled to have a certificate, in such form as shall be approved by the Board, certifying the number of shares of stock of the Corporation owned.  To the extent that shares are represented by certificates, such certificates of stock shall be signed in the name of the Corporation by the Chairman of the Board or a Vice Chairman of the Board or the President or a Vice President and by the Secretary and sealed with the seal of the Corporation (which seal may be a facsimile, engraved or printed); provided, however, that where any such certificate is signed by a registrar, other than the Corporation or its employee, the signatures of the Chairman of the Board, a Vice Chairman of the Board, the President, the Secretary, and transfer agent or a transfer clerk acting on behalf of the Corporation upon such certificates may be facsimiles, engraved or printed. In case any officer, transfer agent or transfer clerk acting on behalf of the Corporation ceases to be such officer, transfer agent, or transfer clerk before such certificates shall be issued, they may nevertheless be issued by the Corporation with the same effect as if they were still such officer, transfer agent or transfer clerk at the date of their issue.

 

SECTION 2.  Books of Account and Record of Stockholders.  There shall be kept at the office of the Corporation correct books of account of all its business and transactions, minutes of the proceedings of stockholders, Board, and Executive

 

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Committee, and a book to be known as the record of stockholders, containing the names and addresses of all persons who are stockholders, the number of shares of stock held, and the date when the stockholder became the owner of record thereof.

 

SECTION 3.  Transfers of Stock.  Transfers of shares of stock of the Corporation shall be made on the record of stockholders of the Corporation only upon authorization by the registered holder thereof, or by an attorney thereunto authorized by power of attorney duly executed and filed with the Secretary or with a transfer agent or transfer clerk, and on surrender of the certificate or certificates for such shares properly endorsed, provided such shares are represented by a certificate, or accompanied by a duly executed stock transfer power and the payment of all taxes thereon.  The person in whose names shares of stock shall stand on the record of stockholders of the Corporation shall be deemed the owner thereof for all purposes as regards the Corporation. Whenever any transfers of shares shall be made for collateral security and not absolutely and written notice thereof shall be given to the Secretary or to such transfer agent or transfer clerk, such fact shall be stated in the entry of the transfer.

 

SECTION 4.  Regulations.  The Board may make such additional rules and regulations as it may deem expedient, not inconsistent with these By-laws, concerning the issue, transfer and registration of certificated or uncertificated shares of stock of the Corporation.  It may appoint, or authorize any officer or officers to appoint, one or more transfer agents or one or more transfer clerks and one or more registrars and may require all certificates of stock to bear the signature or signatures of any of them.

 

SECTION 5.  Fixing of Record Date.  The Board shall fix a time not exceeding sixty nor less than ten days prior to the date then fixed for the holding of any meeting of the stockholders or prior to the last day on which the consent or dissent of the stockholders may be effectively expressed for any purpose without a meeting, as the time as of which the stockholders entitled to notice of and to vote at such meeting or whose consent or dissent is required or may be expressed for any purpose, as the case may be, shall be determined, and all persons who were holders of record of voting stock at such time, and no others, shall be entitled to notice of and to vote at such meeting or to express their consent or dissent, as the case may be.  The Board may fix a time not exceeding sixty days preceding the date fixed for the payment of any dividend or the making of any distribution or the allotment of rights to subscribe for securities of the Corporation, or for the delivery of evidences of rights or evidences of interests arising out of any change, conversion or exchange of capital stock or other securities, as the record date for the determination of the stockholders entitled to receive any such dividend, distribution, allotment, rights or interests, and in such case only the stockholders of record at the time so fixed shall be entitled to receive such dividend, distribution, allotment, rights or interests.

 

SECTION 6.  Lost, Destroyed or Mutilated Certificates.  The holder of any certificate representing shares of stock of the Corporation shall immediately notify the Corporation of any loss, destruction or mutilation of such certificate, and the Corporation may issue a new certificate of stock in the place of any certificate theretofore issued by it which the owner thereof shall allege to have been lost or destroyed or which shall

 

24


 

have been mutilated, and the Corporation may, in its discretion, require such owner or the owner’s legal representatives to give to the Corporation a bond in such sum, limited or unlimited, and in such form and with such surety or sureties as the Board in its absolute discretion shall determine, to indemnify the Corporation against any claim that may be made against it on account of the alleged loss or destruction of any such certificate, or the issuance of such new certificate. Anything to the contrary notwithstanding, the Corporation, in its absolute discretion, may refuse to issue any such new certificate, except pursuant to legal proceedings under the laws of the State of New York.

 

SECTION 7.  Inspection of Records.  The record of stockholders and minutes of the proceedings of stockholders shall be available for inspection, within the limits and subject to the conditions and restrictions prescribed by applicable law.   

 

SECTION 8.  Auditors.  The Board shall employ an independent public or certified public accountant or firm of such accountants who shall act as auditors in making examinations of the consolidated financial statements of the Corporation and its subsidiaries in accordance with generally accepted auditing standards. The auditors shall certify that the annual financial statements are prepared in accordance with generally accepted accounting principles, and shall report on such financial statements to the stockholders and directors of the Corporation. The Board’s selection of auditors shall be presented for ratification by the stockholders at the annual meeting. Directors and officers, when acting in good faith, may rely upon financial statements of the Corporation represented to them to be correct by the officer of the Corporation having charge of its books of account, or stated in a written report by the auditors fairly to reflect the financial condition of the Corporation.

 

ARTICLE VIII

 

OFFICES

 

SECTION 1.  Principal Office.  The principal office of the Corporation shall be at such place in the Town of North Castle, County of Westchester and State of New York as the Board shall from time to time determine.

 

SECTION 2.  Other Offices.  The Corporation may also have an office or offices other than said principal office at such place or places as the Board shall from time to time determine or the business of the Corporation may require.

 

ARTICLE IX

 

WAIVER OF NOTICE

 

Whenever under the provisions of any law of the State of New York, the Certificate of Incorporation or these By-laws or any resolution of the Board or any committee thereof, the Corporation or the Board or any committee thereof is authorized to take any action after notice to the stockholders, directors or members of any such

 

25


 

committee, or after the lapse of a prescribed period of time, such action may be taken without notice and without the lapse of any period of time, if, at any time before or after such action shall be completed, such notice or lapse of time shall be waived by the person or persons entitled to said notice or entitled to participate in the action to be taken, or, in the case of a stockholder, by an attorney thereunto authorized. Attendance at a meeting requiring notice by any person or, in the case of a stockholder, by the stockholder’s attorney, agent or proxy, shall constitute a waiver of such notice on the part of the person so attending, or by such stockholder, as the case may be.

 

ARTICLE X

 

FISCAL YEAR

 

The fiscal year of the Corporation shall end on the thirty-first day of December in each year.

 

ARTICLE XI

 

SEAL

 

The Seal of the Corporation shall consist of two concentric circles with the IBM logotype appearing in bold face type within the inner circle and the words ‘International Business Machines Corporation’ appearing within the outer circle.

 

ARTICLE XII

 

AMENDMENTS

 

These By-laws may be amended or repealed or new By-laws may be adopted by the stockholders at any annual or special meeting, if the notice thereof mentions that amendment or repeal or the adoption of new By-laws is one of the purposes of such meeting. These By-laws, subject to the laws of the State of New York, may also be amended or repealed or new By-laws may be adopted by the affirmative vote of a majority of the Board given at any meeting, if the notice thereof mentions that amendment or repeal or the adoption of new By-laws is one of the purposes of such meeting.

 

26


Exhibit 10.1

 

April 30, 2019

 

Mr. Erich Clementi

c/o IBM Corporation

New Orchard Road

Armonk, NY 10576

 

Dear Erich:

 

This letter agreement shall constitute the agreement between you and International Business Machines Corporation (“IBM” or “Company”) (the “Agreement”), as to the terms of providing consulting services to IBM.

 

Consulting Services

 

For a period of one year from the date that you sign this Agreement, the Company may request, from time to time, that you provide consulting services to the Company, which services must be approved in advance by the Company’s Chairman, President and Chief Executive Officer (“Services”).  Any Services you provide will be as an independent contractor.

 

If you provide Services, the following terms shall govern:

 

·                   The fee for such Services will be $7,000 per day for each day on which you provide four or more hours of Services and $3,500 per day for each day that you provide less than four hours of Services;

 

·                   The Company shall reimburse you for any reasonable actual travel and other expenses incurred in connection with providing the Services; and

 

·                   The provision of Services by you shall not exceed 20% of the average level of services performed by you over the 36-month period immediately prior to your Retirement Date.  Further, it is intended by the parties that the provision of Services shall not further delay any payment to which you are entitled under an IBM employee benefit plan or agreement.

 

1


 

Nonpublic information you receive from IBM is confidential and proprietary to IBM and may not be divulged in whole or in part, in any form, to anyone outside the scope and needs of the Services. Failure to comply with the confidentiality obligations may result in action taken by IBM, including termination of your consulting services.

 

* * * * *

 

If you agree with the foregoing, please sign and date the enclosed copy of this letter in the space indicated below.

 

 

Sincerely,

 

 

 

 

 

/s/ Diane J. Gherson

 

Diane J. Gherson

 

Senior Vice President, Human Resources

 

 

Accepted by and Agreed to:

 

 

 

 

 

 

 

 

/s/ Erich Clementi

 

 

Erich Clementi

 

 

 

 

 

 

 

 

April 30, 2019

 

 

Date

 

 

 

2


Exhibit 10.2

 

IBM

 

TERMS AND CONDITIONS OF YOUR EQUITY AWARD:

EFFECTIVE June 1, 2019

 


 

Terms and Conditions of Your Equity Award

 

Table of Contents

 

Introduction

3

How to Use This Document

3

Definition of Terms

4

Provisions that apply to all Award types and all countries

6

Provisions that apply to all Award types but not all countries

8

Provisions that apply to specific Award types for all countries

9

a. Restricted Stock Units (“RSUs”) including Cash-Settled RSUs and Retention RSUs (“RRSUs”)

9

i. All RSUs

9

ii. RSUs Other Than Cash-Settled RSUs and Cash-Settled RRSUs

11

iii. Cash-Settled RSUs including Cash-Settled RRSUs

11

b. Restricted Stock

11

c. Stock Options (“Options”) and Stock Appreciation Rights (“SARs”)

13

i. All Option and SAR Awards

13

ii. All SAR Awards

14

d. Performance Share Units (“PSUs”)

15

Provisions that apply to specific countries

16

a. Denmark

16

b. Israel

16

c. United States

16

 

2


 

Terms and Conditions of Your Equity Award

 

Introduction

 

This document provides you with the terms and conditions of your Award that are in addition to the terms and conditions contained in your Equity Award Agreement for your specific Award. Also, your Award is subject to the terms and conditions in the governing plan document; the applicable document is indicated in your Equity Award Agreement and can be found at http://w3.ibm.com/hr/exec/comp/eq_prospectus.shtml.

 

As an Award recipient, you can see a personalized summary of all your outstanding equity grants in the “Personal statement” section of the IBM executive compensation web site (http://w3.ibm.com/hr/exec/comp). This site also contains other information about long-term incentive awards, including copies of the prospectus (the governing plan document).  If you have additional questions and you are based in the U.S., you can call the IBM Benefits Center at 866-937-0720, weekdays from 8:00 a.m. to 8:00 p.m. Eastern time (TTY available at 800-426-6537). Outside of the U.S. dial your country’s toll-free AT&T Direct® access number, and then enter 866-937-0720. In the U.S., call 800-331-1140 to obtain AT&T Direct access numbers. Access numbers are also available online at www.att.com/traveler or from your local operator.

 

How to Use This Document

 

Terms and conditions that apply to all awards in all countries can be found on page 6. Review these in addition to any award- or country-specific terms and conditions that may be listed. Once you have reviewed these general terms, check in your Equity Award Agreement for any award-specific and/or country-specific terms that apply to your Award.

 

3


 

Terms and Conditions of Your Equity Award:

 

Definition of Terms

 

The following are defined terms from the Long-Term Performance Plan, your Equity Award Agreement, or this Terms and Conditions document. These are provided for your information. In addition to this document, see the Plan prospectus and your Equity Award Agreement for more details.

 

“Awards” — The grant of any form of stock option, stock appreciation right, stock or cash award, whether granted singly, in combination or in tandem, to a Participant pursuant to such terms, conditions, performance requirements, limitations and restrictions as the Committee may establish in order to fulfill the objectives of the Plan.

 

“Board” — The Board of Directors of International Business Machines Corporation (“IBM”).

 

“Capital Stock” — Authorized and issued or unissued Capital Stock of IBM, at such par value as may be established from time to time.

 

“Committee” — The committee designated by the Board to administer the Plan.

 

“Company” — IBM and its affiliates and subsidiaries including subsidiaries of subsidiaries and partnerships and other business ventures in which IBM has an equity interest.

 

“Engage in or Associate with” includes, without limitation, engagement or association as a sole proprietor, owner, employer, director, partner, principal, joint venture, associate, employee, member, consultant, or contractor.  This also includes engagement or association as a shareholder or investor during the course of your employment with the Company, and includes beneficial ownership of five percent (5%) or more of any class of outstanding stock of a competitor of the Company following the termination of your employment with the Company.

 

“Equity Award Agreement” — The document provided to the Participant which provides the grant details.

 

“Fair Market Value” — The average of the high and low prices of Capital Stock on the New York Stock Exchange for the date in question, provided that, if no sales of Capital Stock were made on said exchange on that date, the average of the high and low prices of Capital Stock as reported for the most recent preceding day on which sales of Capital Stock were made on said exchange.

 

“Participant” — An individual to whom an Award has been made under the Plan. Awards may be made to any employee of, or any other individual providing services to, the Company. However, incentive stock options may be granted only to individuals who are

 

4


 

employed by IBM or by a subsidiary corporation (within the meaning of section 424(f) of the Code) of IBM, including a subsidiary that becomes such after the adoption of the Plan.

 

“Plan” — Any IBM Long-Term Performance Plan.

 

“Termination of Employment” — For the purposes of determining when you cease to be an employee for the cancellation of any Award, a Participant will be deemed to be terminated if the Participant is no longer employed by IBM or a subsidiary corporation that employed the Participant when the Award was granted unless approved by a method designated by those administering the Plan.

 

5


 

Terms and Conditions of Your Equity Award:

 

Provisions that apply to all Award types and all countries

 

The following terms apply to all countries and for all Award types (Restricted Stock Units, Cash-Settled Restricted Stock Units, Restricted Stock, Stock Options, Stock Appreciation Rights and Performance Share Units).

 

Cancellation and Rescission

 

All determinations regarding enforcement, waiver or modification of the cancellation and rescission and other provisions of the Plan and your Equity Award Agreement (including the provisions relating to termination of employment, death and disability) shall be made in IBM’s sole discretion. Determinations made under your Equity Award Agreement and the Plan need not be uniform and may be made selectively among individuals, whether or not such individuals are similarly situated.

 

You agree that the cancellation and rescission provisions of the Plan and your Equity Award Agreement are reasonable and agree not to challenge the reasonableness of such provisions, even where forfeiture of your Award is the penalty for violation.  Engaging in Detrimental Activity as defined in the Plan may result in cancellation or rescission of your Award.  Detrimental Activity includes your acceptance of an offer to Engage in or Associate with any business which is or becomes competitive with the Company.

 

Jurisdiction, Governing Law, Expenses, Taxes and Administration

 

Your Equity Award Agreement shall be governed by, and construed in accordance with, the laws of the State of New York, without regard to its conflict of law rules. You agree that any action or proceeding with respect to your Equity Award Agreement shall be brought exclusively in the state and federal courts sitting in New York County or, Westchester County, New York.  You agree to the personal jurisdiction thereof, and irrevocably waive any objection to the venue of such action, including any objection that the action has been brought in an inconvenient forum.

 

If any court of competent jurisdiction finds any provision of your Equity Award Agreement, or portion thereof, to be unenforceable, that provision shall be enforced to the maximum extent permissible so as to effect the intent of the parties, and the remainder of your Equity Award Agreement shall continue in full force and effect.

 

If you or the Company brings an action to enforce your Equity Award Agreement and the Company prevails, you will pay all costs and expenses incurred by the Company in connection with that action and in connection with collection, including reasonable attorneys’ fees.

 

If the Company, in its sole discretion, determines that it has incurred or will incur any obligation to withhold taxes as a result of your Award, without limiting the Company’s rights under Section 9 of the Plan, the Company may withhold the number of shares

 

6


 

that it determines is required to satisfy such liability and/or the Company may withhold amounts from other compensation to the extent required to satisfy such liability under federal, state, provincial, local, foreign or other tax laws. To the extent that such amounts are not withheld, the Company may require you to pay to the Company any amount demanded by the Company for the purpose of satisfying such liability.

 

If the Company changes the vendor engaged to administer the Plan, you consent to moving all of the shares you have received under the Plan that is in an account with such vendor (including unvested and previously vested shares), to the new vendor that the Company engages to administer the Plan. Such consent will remain in effect unless and until revoked in writing by you.

 

7


 

Terms and Conditions of Your Equity Award:

 

Provisions that apply to all Award types but not all countries

 

The following provision applies to all Award types (Restricted Stock Units, Cash-Settled Restricted Stock Units, Restricted Stock, Stock Options, Stock Appreciation Rights and Performance Share Units) granted to all individuals in all countries except those with a home country of Latin America, specifically: Argentina, Bolivia, Brazil, Chile, Columbia, Costa Rica, Ecuador, Mexico, Paraguay, Peru, Uruguay, and Venezuela.

 

Non-Solicitation

 

In consideration of your Award, you agree that during your employment with the Company and for two years following the termination of your employment for any reason, you will not directly or indirectly hire, solicit or make an offer to any employee of the Company to be employed or perform services outside of the Company. Also, you agree that during your employment with the Company and for one year following the termination of your employment for any reason, you will not directly or indirectly, solicit, for competitive business purposes, any customer of the Company with which you were involved as part of your job responsibilities during the last year of your employment with the Company. By accepting your Award, you acknowledge that the Company would suffer irreparable harm if you fail to comply with the foregoing, and that the Company would be entitled to any appropriate relief, including money damages, equitable relief and attorneys’ fees.

 

8


 

Terms and Conditions of Your Equity Award:

 

Provisions that apply to specific Award types for all countries

 

a. Restricted Stock Units (“RSUs”) including Cash-Settled RSUs and Retention RSUs (“RRSUs”)

 

All references in this document to RSUs include RRSUs, unless explicitly stated otherwise

 

i. All RSUs

 

Termination of Employment including Death, Disability and Leave of Absence

 

Termination of Employment

 

In the event you cease to be an employee (other than on account of death or are disabled as described in Section 12 of the Plan) prior to the Vesting Date(s) set in your Equity Award Agreement, all then unvested RSUs, including RRSUs, under your Award shall be canceled.

 

However, your unvested and/or outstanding RSUs, but not RRSUs, will continue to vest upon the termination of employment if all of the following criteria are met:

 

·                   You are on the performance team, or any successor team thereto, at the time of termination of employment;

·                   You have completed at least one year of active service since the award date of grant;

·                   You have reached age 55 with 15 years of service at the time of termination of employment (age 60 with 15 years of service for the Chairman and CEO); and

·                   Appropriate senior management, the Committee or the Board, as appropriate, do not exercise their discretion to cancel or otherwise limit the vesting of the RSUs.

 

For purposes of the Plan the performance team refers to the team of IBM’s senior leaders who run IBM Business Units or geographies, including the chairman and CEO.

 

Death or Disability

 

Upon your death all RSUs covered by this Agreement shall vest immediately and your Vesting Date shall be your date of death. If you are disabled as described in Section 12 of the Plan, your RSUs shall continue to vest according to the terms of your Award.

 

Leave of Absence

 

In the event of a management approved leave of absence, any unvested RSUs shall continue to vest as if you were an active employee of the Company, subject to the terms in this document and your Equity Award Agreement. If you return to active

 

9


 

status, your unvested RSUs will continue to vest in accordance with the terms in this document and your Equity Award Agreement.

 

Dividend Equivalents

 

IBM shall not pay dividend equivalents on cash-settled or stock-settled unvested RSU awards.

 

10


 

Terms and Conditions of Your Equity Award:

Provisions that apply to specific Award types for all countries

 

ii. RSUs Other Than Cash-Settled RSUs and Cash-Settled RRSUs

 

Settlement of Award

 

Subject to Sections 12 and 13 of the Plan and the section “Termination of Employment including Death, Disability and Leave of Absence” above, upon the Vesting Date(s), or as soon thereafter as may be practicable but in no event later than March 15 of the following calendar year, IBM shall make a payment to Participant in shares of Capital Stock equal to the number of vested RSUs, subject to any applicable tax withholding requirements as described in Section 9 of the Plan, and the respective RSUs shall thereupon be canceled. RSUs are not shares of Capital Stock and do not convey any stockholder rights.

 

iii. Cash-Settled RSUs including Cash-Settled RRSUs

 

Settlement of Award

 

Subject to Sections 12 and 13 of the Plan and the section entitled “Termination of Employment including Death, Disability and Leave of Absence” above, upon the Vesting Date(s), or as soon thereafter as may be practicable but in no event later than March 15 of the following calendar year, the Company shall make a payment to Participant in cash equal to the Fair Market Value of the vested RSUs, subject to any applicable tax withholding requirements as described in Section 9 of the Plan, and the respective RSUs shall thereupon be canceled. Fair Market Value will be calculated in your home country currency at the exchange rate on the applicable Vesting Date using a commercially reasonable measure of exchange rate. RSUs are not shares of Capital Stock and do not convey any stockholder rights.

 

b. Restricted Stock

 

Settlement of Award

 

Subject to Sections 12 and 13 of the Plan and the paragraph entitled “Termination of Employment including Death, Disability or Leave of Absence” below, upon the Vesting Date(s), or as soon thereafter as may be practicable but in no event later than March 15 of the following calendar year, the shares of Restricted Stock awarded under your Equity Award Agreement will be deliverable to you, subject to any applicable tax withholding requirements as described in Section 9 of the Plan.

 

11


 

Terms and Conditions of Your Equity Award:

Provisions that apply to specific Award types for all countries

 

Termination of Employment including Death, Disability and Leave of Absence

 

Termination of Employment

 

In the event you cease to be an employee (other than on account of death or are disabled as described in Section 12 of the Plan) prior to the Vesting Date(s) in your Equity Award Agreement, all then unvested shares of Restricted Stock under your Award shall be canceled (unless your Equity Award Agreement provides otherwise).

 

Death or Disability

 

Upon your death all unvested shares of Restricted Stock covered by your Equity Award Agreement shall vest immediately and your Vesting Date shall be your date of death. If you are disabled as described in Section 12 of the Plan, your unvested shares of Restricted Stock shall continue to vest according to the terms of your Equity Award Agreement.

 

Leave of Absence

 

In the event of a management approved leave of absence, any unvested shares of Restricted Stock shall continue to vest as if you were an active employee of the Company, subject to the terms in this document and your Equity Award Agreement. If you return to active status, your unvested shares of Restricted Stock will continue to vest in accordance with the terms in this document and your Equity Award Agreement.

 

Dividends and Other Rights

 

During the period that the Restricted Stock is held by IBM hereunder, such stock will remain on the books of IBM in your name, may be voted by you, and any applicable dividends shall be paid to you. Shares issued in stock splits or similar events which relate to Restricted Stock then held by IBM in your name shall be issued in your name but shall be held by IBM under the terms hereof.

 

Transferability

 

Shares of Restricted Stock awarded under your Equity Award Agreement cannot be sold, assigned, transferred, pledged or otherwise encumbered prior to the vesting of your Award as set forth in your Equity Award Agreement and any such sale, assignment, transfer, pledge or encumbrance, or any attempt thereof, shall be void.

 

12


 

Terms and Conditions of Your Equity Award:

Provisions that apply to specific Award types for all countries

 

c. Stock Options (“Options”) and Stock Appreciation Rights (“SARs”)

 

i. All Option and SAR Awards

 

Termination of Employment including Death, Disability and Leave of Absence

 

Termination of Employment

 

In the event you cease to be an employee (other than on account of death or are disabled as described in Section 12 of the Plan):

 

·                   Any Options or SARs that are not exercisable as of the date your employment terminates shall be canceled immediately (unless your Equity Award Agreement provides otherwise), and

 

·                   Any Options or SARs that are exercisable as of the date your employment terminates (other than for cause) will remain exercisable for 90 days (not three months) after the date of termination, after which any unexercised Options or SARs are canceled; provided, however, if you are a banded executive when your employment with the Company terminates (other than for cause) after you have attained age 55 and completed at least 15 years of service with the Company at the time of termination, any Options or SARs that are exercisable as of the date your employment terminates shall remain exercisable for the full term as in your Equity Award Agreement (unless your Equity Award Agreement provides otherwise).

 

Death or Disability

 

In the event of your death, all Options or SARs shall become fully exercisable and remain exercisable for their full term.

 

In the event you are disabled (as described in Section 12 of the Plan), any unvested Options or SARs shall continue to vest and be exercisable.

 

13


 

Terms and Conditions of Your Equity Award:

Provisions that apply to specific Award types for all countries

 

Leave of Absence

 

In the event of a management approved leave of absence, any unvested Options or SARs shall continue to vest and be exercisable as if you were an active employee of the Company, subject to the terms in this document and your Equity Award Agreement. If you return to active status, your Options or SARs will continue to vest and be exercisable in accordance with their terms. If you do not return to active status,

 

·                        Your unvested Options or SARs will be canceled immediately; and

 

·                        Your vested Options or SARs will be canceled on the later of the 91 st  day following your last day of active employment or the date of the termination of your leave of absence; provided, however, if you are a banded executive when your employment terminates (other than for cause) after you have attained age 55 and completed at least 15 years of service with the Company at the time of termination, any Options or SARs that are exercisable as of the date your employment terminates shall remain exercisable for the full term as in your Equity Award Agreement.

 

Termination of Employment for Cause

 

If your employment terminates for cause, all exercisable and not exercisable Options or SARs are canceled immediately.

 

ii. All SAR Awards

 

Settlement of Award

 

Upon exercise, the Company shall deliver an aggregate amount, in cash, equal to the excess of the Fair Market Value of a share of Capital Stock on the date of exercise over the Exercise Price set forth in your Equity Award Agreement multiplied by the number of SARs exercised, subject to any applicable tax withholding requirements as described in Section 9 of the Plan. The value of the Award will be calculated in your home country currency at the exchange rate on the date the Award becomes fully vested using a commercially reasonable measure of exchange rate.

 

14


 

Terms and Conditions of Your Equity Award:

Provisions that apply to specific Award types for all countries

 

d. Performance Share Units (“PSUs”)

 

Termination of Employment, including Death and Disability, and Leave of Absence

 

Termination of Employment and Leave of Absence

 

If you cease to be an active, full-time employee for any reason (other than on account of death or are disabled as described in Section 12 of the Plan) before the Date of Payout (in the case of a recipient in the United States, at year end of the applicable PSU Performance Period), all PSUs are canceled immediately provided, however, if you are a banded executive when you cease to be an active, full-time employee (other than for cause) after you have attained age 55, completed at least 15 years of service with the Company at such time, and completed at least one year of active service during the PSU Performance Period (as set forth in your Equity Award Agreement), the PSUs granted hereunder shall be paid out on the Date of Payout (as set forth in your Equity Award Agreement) based on IBM performance over the entire applicable Performance Period(s), in an amount that will be prorated for the number of months completed as an active, full-time executive during the PSU Performance Period, adjusted for the performance score.

 

However, your unvested PSUs will continue to vest upon termination of employment or the time you cease to be an active, full-time employee if all of the following criteria are met:

 

·                   You are on the performance team, or any successor team thereto, at the time of termination of employment or the time you cease to be an active, full-time employee;

·                   You have completed at least one year of active service during the PSU Performance Period (as set forth in your Equity Award Agreement);

·                   You have reached age 55 with 15 years of service at the time of termination of employment or the time you cease to be an active, full-time employee (age 60 with 15 years of service for the Chairman and CEO);

·                   The Committee has certified that all performance conditions have been met; and

·                   Appropriate senior management, the Committee or the Board, as appropriate, do not exercise their discretion to cancel or otherwise limit the payout.

 

Death or Disability

 

Prior to the Date of Payout, (i) in the event of your death or (ii) if you are disabled (as described in Section 12 of the Plan), all PSUs shall continue to vest according to the terms of your Equity Award Agreement and the PSUs will be paid out at the end of the Performance Period based on IBM performance over the entire applicable Performance Period(s).

 

15


 

Terms and Conditions of Your Equity Award:

Provisions that apply to specific countries

 

a. Denmark

 

i. All Awards

 

Non-Solicitation

 

The following part of the above non-solicitation provision does not apply to those individuals with the home country of Denmark: “In consideration of your Award, you agree that during your employment with the Company and for two years following the termination of your employment for any reason, you will not directly or indirectly hire, solicit or make an offer to any employee of the Company to be employed or perform services outside of the Company.”

 

b. Israel

 

i. All Awards

 

Data Privacy

 

In addition to the data privacy provisions in your Equity Award Agreement, you agree that data, including your personal data, necessary to administer this Award may be exchanged among IBM and its subsidiaries and affiliates as necessary (including transferring such data out of the country of origin both in and out of the EEA), and with any vendor engaged by IBM to administer this Award.

 

c. United States

 

i. All Awards

 

Nothing in the Plan prospectus, your Equity Award Agreement or this Document affects your rights, immunities, or obligations under any federal, state, or local law, including under the Defend Trade Secrets Act of 2016, as described in Company policies, or prohibits you from reporting possible violations of law or regulation to a government agency, as protected by law.

 

If you are, and have been for at least 30 days immediately preceding, a resident of, or an employee in Massachusetts at the time of the termination of your employment with IBM, cancellation and rescission provisions of the Plan will not apply if you engage in competitive activities after your employment relationship has ended with IBM. For the avoidance of doubt, cancellation and rescission provisions of the Plan will apply if you engage in (1) any Detrimental Activity prior to your employment relationship ending with IBM or (2) any Detrimental Activity described in Section 13(a) of the Plan other than engaging in competitive activities after your employment relationship has ended with IBM.

 

16


Exhibit 31.1

 

CERTIFICATION PURSUANT TO RULE 13A-14(a) OR 15D-14(a) OF THE SECURITIES
EXCHANGE ACT OF 1934, AS ADOPTED PURSUANT TO SECTION 302 OF THE
SARBANES-OXLEY ACT OF 2002

 

I, Virginia M. Rometty, certify that:

 

1.               I have reviewed this quarterly report on Form 10-Q of International Business Machines Corporation;

 

2.               Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

 

3.               Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

 

4.               The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

 

a.               designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

 

b.               designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

 

c.                evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

 

d.               disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

 

5.               The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent functions):

 

a.               all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

 

b.               any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

 

Date: April 30, 2019

 

 

 

/s/ Virginia M. Rometty

 

 

 

Virginia M. Rometty

 

Chairman, President and Chief Executive Officer

 

 


Exhibit 31.2

 

CERTIFICATION PURSUANT TO RULE 13A-14(a) OR 15D-14(a) OF THE SECURITIES
EXCHANGE ACT OF 1934, AS ADOPTED PURSUANT TO SECTION 302 OF THE
SARBANES-OXLEY ACT OF 2002

 

I, James J. Kavanaugh, certify that:

 

1.               I have reviewed this quarterly report on Form 10-Q of International Business Machines Corporation;

 

2.               Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

 

3.               Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

 

4.               The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

 

a.               designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

 

b.               designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

 

c.                evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

 

d.               disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

 

5.               The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent functions):

 

a.               all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

 

b.               any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

 

Date: April 30, 2019

 

 

 

/s/ James J. Kavanaugh

 

 

 

James J. Kavanaugh

 

Senior Vice President and Chief Financial Officer

 

 


Exhibit 32.1

 

INTERNATIONAL BUSINESS MACHINES CORPORATION

 

CERTIFICATION PURSUANT TO

18 U.S.C. SECTION 1350,

AS ADOPTED PURSUANT TO

SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

 

In connection with the Quarterly Report of International Business Machines Corporation (the “Company”) on Form 10-Q for the period ending March 31, 2019, as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Virginia M. Rometty, Chairman, President and Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. ss. 1350, as adopted pursuant to ss. 906 of the Sarbanes-Oxley Act of 2002, that:

 

(1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

 

(2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

 

/s/ Virginia M. Rometty

 

 

 

Virginia M. Rometty

 

Chairman, President and Chief Executive Officer

 

April 30, 2019

 

 

A signed original of this written statement required by Section 906 has been provided to IBM and will be retained by IBM and furnished to the Securities and Exchange Commission or its staff upon request.

 


Exhibit 32.2

 

INTERNATIONAL BUSINESS MACHINES CORPORATION

 

CERTIFICATION PURSUANT TO

18 U.S.C. SECTION 1350,

AS ADOPTED PURSUANT TO

SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

 

In connection with the Quarterly Report of International Business Machines Corporation (the “Company”) on Form 10-Q for the period ending March 31, 2019, as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, James  J. Kavanaugh, Senior Vice President and Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. ss. 1350, as adopted pursuant to ss. 906 of the Sarbanes-Oxley Act of 2002, that:

 

(1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

 

(2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

 

/s/ James J. Kavanaugh

 

 

 

James J. Kavanaugh

 

Senior Vice President and Chief Financial Officer

 

April 30, 2019

 

 

A signed original of this written statement required by Section 906 has been provided to IBM and will be retained by IBM and furnished to the Securities and Exchange Commission or its staff upon request.