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International Business Machines 10-Q 2008

Table of Contents

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

 

FORM 10 - Q

 

QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934

 

FOR THE QUARTER ENDED JUNE 30, 2008

 

1-2360

(Commission file number)

 

INTERNATIONAL BUSINESS MACHINES CORPORATION

(Exact name of registrant as specified in its charter)

 

New York

 

13-0871985

(State of incorporation)

 

(IRS employer identification number)

 

 

 

Armonk, New York

 

10504

(Address of principal executive offices)

 

(Zip Code)

 

914-499-1900

(Registrant’s telephone number)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section l3 or l5(d) of the Securities Exchange Act of 1934 during the preceding l2 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.      Yes  x        No   o

 

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

 

Large accelerated filer x

 

Accelerated filer o

 

 

 

Non-accelerated filer o

 

Smaller reporting company o

(Do not check if a smaller reporting company)

 

 

 

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

 

The registrant has 1,354,840,130 shares of common stock outstanding at June 30, 2008.

 

 

 



Table of Contents

 

Index

 

 

Page

Part I - Financial Information:

 

 

 

Item 1. Consolidated Financial Statements:

 

 

 

Consolidated Statement of Earnings for the three and six months ended June 30, 2008 and 2007

3

 

 

Consolidated Statement of Financial Position at June 30, 2008 and December 31, 2007

5

 

 

Consolidated Statement of Cash Flows for the six months ended June 30, 2008 and 2007

7

 

 

Notes to Consolidated Financial Statements

8

 

 

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

23

 

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk

55

 

 

Item 4. Controls and Procedures

56

 

 

Part II - Other Information:

56

 

 

Item 1. Legal Proceedings

56

 

 

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

56

 

 

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

57

 

 

 Item 5. Other Information

58

 

 

Item 6. Exhibits

58

 

2



Table of Contents

 

Part I - Financial Information

 

Item 1. Consolidated Financial Statements:

 

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

 

 

 

Three Months Ended June 30,

 

Six Months Ended June 30,

 

(Dollars in millions except per share amounts)

 

2008

 

2007

 

2008

 

2007

 

Revenue:

 

 

 

 

 

 

 

 

 

Services

 

$

15,203

 

$

13,072

 

$

29,777

 

$

25,495

 

Sales

 

10,976

 

10,097

 

20,263

 

19,083

 

Financing

 

642

 

602

 

1,282

 

1,223

 

Total revenue

 

26,820

 

23,772

 

51,322

 

45,801

 

 

 

 

 

 

 

 

 

 

 

Cost:

 

 

 

 

 

 

 

 

 

Services

 

10,709

 

9,450

 

21,057

 

18,501

 

Sales

 

4,225

 

4,059

 

7,899

 

7,867

 

Financing

 

286

 

325

 

600

 

629

 

Total cost

 

15,221

 

13,834

 

29,556

 

26,997

 

 

 

 

 

 

 

 

 

 

 

Gross profit

 

11,599

 

9,938

 

21,766

 

18,804

 

 

 

 

 

 

 

 

 

 

 

Expense and other income:

 

 

 

 

 

 

 

 

 

Selling, general and administrative

 

6,289

 

5,631

 

11,909

 

10,720

 

Research, development and engineering

 

1,660

 

1,534

 

3,229

 

3,044

 

Intellectual property and custom development income

 

(285

)

(246

)

(559

)

(451

)

Other (income) and expense

 

(24

)

(253

)

(149

)

(432

)

Interest expense

 

145

 

130

 

323

 

203

 

Total expense and other income

 

7,786

 

6,796

 

14,754

 

13,083

 

 

 

 

 

 

 

 

 

 

 

Income from continuing operations before income taxes

 

3,814

 

3,142

 

7,012

 

5,721

 

Provision for income taxes

 

1,049

 

881

 

1,928

 

1,616

 

Income from continuing operations

 

2,765

 

2,261

 

5,084

 

4,105

 

 

(Amounts may not add due to rounding.)

 

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

 

3



Table of Contents

 

INTERNATIONAL BUSINESS MACHINES CORPORATION
AND SUBSIDIARY COMPANIES
CONSOLIDATED STATEMENT OF EARNINGS – (continued)
(UNAUDITED)

 

 

 

Three Months Ended June 30,

 

Six Months Ended June 30,

 

(Dollars in millions except per share amounts)

 

2008

 

2007

 

2008

 

2007

 

Discontinued Operations

 

 

 

 

 

 

 

 

 

Loss from discontinued operations, net of tax

 

 

(1

)

 

(0

)

Net income

 

$

2,765

 

$

2,260

 

$

5,084

 

$

4,105

 

 

 

 

 

 

 

 

 

 

 

Earnings/(loss) per share of common stock:

 

 

 

 

 

 

 

 

 

Assuming dilution:

 

 

 

 

 

 

 

 

 

Continuing operations

 

$

1.98

 

$

1.55

 

$

3.63

 

$

2.75

 

Discontinued operations

 

 

(0.00

)

 

(0.00

)

Total

 

$

1.98

 

$

1.55

 

$

3.63

 

$

2.75

 

 

 

 

 

 

 

 

 

 

 

Basic:

 

 

 

 

 

 

 

 

 

Continuing operations

 

$

2.02

 

$

1.57

 

$

3.70

 

$

2.80

 

Discontinued operations

 

 

(0.00

)

 

(0.00

)

Total

 

$

2.02

 

$

1.57

 

$

3.70

 

$

2.80

 

 

 

 

 

 

 

 

 

 

 

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

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Assuming dilution

 

1,395.8

 

1,460.8

 

1,400.1

 

1,491.8

 

 

 

 

 

 

 

 

 

 

 

Basic

 

1,366.3

 

1,437.2

 

1,374.6

 

1,468.3

 

 

 

 

 

 

 

 

 

 

 

Cash dividends per common share

 

$

0.50

 

$

0.40

 

$

0.90

 

$

0.70

 

 

(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

 

(Dollars in millions)

 

At June 30, 
2008

 

At December 31,
 2007

 

Assets:

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

9,626

 

$

14,991

 

Marketable securities

 

221

 

1,155

 

Notes and accounts receivable — trade (net of allowances of $254 in 2008 and $241 in 2007)

 

10,952

 

11,428

 

Short-term financing receivables (net of allowances of $323 in 2008 and $296 in 2007)

 

15,242

 

16,289

 

Other accounts receivable (net of allowances of $15 in 2008 and $13 in 2007)

 

1,034

 

1,072

 

Inventories, at lower of average cost or market:

 

 

 

 

 

Finished goods

 

667

 

668

 

Work in process and raw materials

 

2,248

 

1,996

 

Total inventories

 

2,916

 

2,664

 

Deferred taxes

 

1,949

 

1,687

 

Prepaid expenses and other current assets

 

4,371

 

3,891

 

Total current assets

 

46,312

 

53,177

 

 

 

 

 

 

 

Plant, rental machines and other property

 

40,320

 

38,584

 

Less: Accumulated depreciation

 

24,934

 

23,503

 

Plant, rental machines and other property — net

 

15,386

 

15,081

 

Long-term financing receivables (net of allowances of $65 in 2008 and $58 in 2007)

 

11,473

 

11,603

 

Prepaid pension assets

 

19,027

 

17,417

 

Intangible assets — net

 

3,277

 

2,107

 

Goodwill

 

19,624

 

14,285

 

Investments and sundry assets

 

5,829

 

6,761

 

Total assets

 

$

120,928

 

$

120,431

 

 

 (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
(UNAUDITED)

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

At June 30,

 

At December 31,

 

(Dollars in millions except per share amounts)

 

2008

 

2007

 

Liabilities and Stockholders’ Equity:

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Taxes

 

$

2,831

 

$

3,673

 

Short-term debt

 

12,710

 

12,235

 

Accounts payable

 

7,531

 

8,054

 

Compensation and benefits

 

4,288

 

4,645

 

Deferred income

 

10,815

 

9,802

 

Other accrued expenses and liabilities

 

6,508

 

5,901

 

Total current liabilities

 

44,683

 

44,310

 

 

 

 

 

 

 

Long-term debt

 

21,522

 

23,039

 

Retirement and nonpension postretirement benefit obligations

 

14,243

 

13,582

 

Deferred income

 

3,171

 

3,060

 

Other liabilities

 

9,044

 

7,970

 

Total liabilities

 

92,663

 

91,962

 

 

 

 

 

 

 

Stockholders’ equity:

 

 

 

 

 

 

 

 

 

 

 

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

 

37,882

 

35,188

 

Shares authorized: 4,687,500,000

 

 

 

 

 

Shares issued: 2008 - 2,086,162,676
2007 - 2,057,607,421

 

 

 

 

 

Retained earnings

 

64,456

 

60,640

 

 

 

 

 

 

 

Treasury stock - at cost

 

(71,068

)

(63,945

)

Shares: 2008 - 731,322,546
2007 - 672,373,283

 

 

 

 

 

 

 

 

 

 

 

Accumulated gains and (losses) not affecting retained earnings

 

(3,006

)

(3,414

)

 

 

 

 

 

 

Total stockholders’ equity

 

28,264

 

28,470

 

 

 

 

 

 

 

Total liabilities and stockholders’ equity

 

$

120,928

 

$

120,431

 

 

 (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
FOR THE SIX MONTHS ENDED JUNE 30,
(UNAUDITED)

 

(Dollars in millions)

 

2008

 

2007

 

Cash flow from operating activities from continuing operations:

 

 

 

 

 

Net Income

 

$

5,084

 

$

4,105

 

Loss from discontinued operations

 

 

(0

)

Adjustments to reconcile income from continuing operations to cash provided from operating activities:

 

 

 

 

 

Depreciation

 

2,096

 

1,943

 

Amortization of intangibles

 

654

 

581

 

Stock-based compensation

 

340

 

361

 

Net gain on asset sales and other

 

(75

)

(257

)

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

 

353

 

(274

)

 

 

 

 

 

 

Net cash provided by operating activities from continuing operations

 

8,453

 

6,459

 

 

 

 

 

 

 

Cash flow from investing activities from continuing operations:

 

 

 

 

 

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

 

(1,999

)

(1,803

)

Investment in software

 

(381

)

(439

)

Acquisition of businesses, net of cash acquired

 

(5,891

)

(241

)

Divestiture of businesses, net of cash transferred

 

29

 

310

 

Purchases of marketable securities and other investments

 

(8,284

)

(16,998

)

Proceeds from sale of marketable securities and other investments

 

9,617

 

16,602

 

 

 

 

 

 

 

Net cash used in investing activities from continuing operations

 

(6,909

)

(2,569

)

 

 

 

 

 

 

Cash flow from financing activities from continuing operations:

 

 

 

 

 

Proceeds from new debt

 

6,813

 

14,066

 

Payments to settle debt

 

(5,924

)

(1,962

)

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

 

(2,273

)

171

 

Common stock repurchases

 

(7,164

)

(18,205

)

Common stock transactions — other

 

2,704

 

1,967

 

Cash dividends paid

 

(1,239

)

(1,044

)

 

 

 

 

 

 

Net cash used in financing activities from continuing operations

 

(7,083

)

(5,008

)

 

 

 

 

 

 

Effect of exchange rate changes on cash and cash equivalents

 

175

 

112

 

Net cash used in discontinued operations - operating activities

 

 

(6

)

 

 

 

 

 

 

Net change in cash and cash equivalents

 

(5,365

)

(1,012

)

 

 

 

 

 

 

Cash and cash equivalents at January 1

 

14,991

 

8,022

 

 

 

 

 

 

 

Cash and cash equivalents at June 30

 

$

9,626

 

$

7,010

 

 

(Amounts may not add due to rounding.)

 

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

 

7



Table of Contents

 

Notes to Consolidated Financial Statements:

 

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

 

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America (GAAP) requires management to make estimates and assumptions that affect the amounts of assets, liabilities, revenue, costs, expenses and gains and losses not affecting retained earnings that are reported in the Consolidated Financial Statements and accompanying disclosures.  Actual results may be different.  See the company’s 2007 Annual Report for a discussion of the company’s critical accounting estimates.

 

Interim results are not necessarily indicative of results for a full year.  The information included in this Form 10-Q should be read in conjunction with the company’s 2007 Annual Report.

 

Within the financial tables in this Form 10-Q, certain columns and rows may not add due to the use of rounded numbers for disclosure purposes. Percentages presented are calculated from the underlying whole-dollar amounts.

 

2. Accounting Changes:  In June 2008, the Financial Accounting Standards Board (FASB) issued FASB Staff Position (FSP) Emerging Issues Task Force 03-6-1, “Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities,” which will become effective in 2009 via retrospective application. Under the FSP, unvested share-based payment awards that contain non-forfeitable rights to dividends or dividend equivalents are participating securities and, therefore, are included in computing earnings per share (EPS) pursuant to the two-class method. The two-class method determines earnings per share for each class of common stock and participating securities according to dividends or dividend equivalents and their respective participation rights in undistributed earnings. Restricted Stock Units (RSUs) granted to employees prior to December 31, 2007 are considered participating securities as they receive non-forfeitable dividend equivalents at the same rate as common stock. RSUs granted after December 31, 2007 do not receive dividend equivalents and are not considered participating securities. The company will adopt the FSP in fiscal year 2009. Upon implementation, the company does not expect a material impact on diluted and basic EPS. The implementation of the FSP is expected to decrease diluted EPS by $0.01 for the first and second quarters of 2008, by $0.02 for the six months ended June 30, 2008, and by $0.03 for the year ended December 31, 2007. Basic EPS is expected to decrease by $0.01 in each of the first and second quarters of 2008, by $0.02 for the six months ended June 30, 2008 and by $0.05 for the year ended December 31, 2007.

 

In March 2008, the FASB issued Statement of Financial Accounting Standards (SFAS) No. 161, “Disclosures about Derivative Instruments and Hedging Activities-an amendment of FASB Statement No. 133.” SFAS No. 161 expands the current disclosure requirements of SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” such that entities must now provide enhanced disclosures on a quarterly basis regarding how and why the entity uses derivatives; how derivatives and related hedged items are accounted for under SFAS No. 133 and how derivatives and related hedged items affect the entity’s financial position, performance and cash flow. Pursuant to the transition provisions of the Statement, the company will adopt SFAS No. 161 in fiscal year 2009 and will present the required disclosures in the prescribed format on a prospective basis. This Statement will not impact the consolidated financial results as it is disclosure-only in nature.

 

In February 2008, the FASB issued FSP Financial Accounting Standard (FAS) 157-1, “Application of FASB Statement No. 157 to FASB Statement No. 13 and Other Accounting Pronouncements That Address Fair Value Measurements for Purposes of Lease Classification or Measurement under Statement 13,” and FSP FAS 157-2, “Effective Date of FASB Statement No. 157.” FSP FAS 157-1 removes leasing from the scope of SFAS No. 157, “Fair Value Measurements.” FSP FAS 157-2 delays the effective date of SFAS No. 157 from 2008 to 2009 for all nonfinancial assets and nonfinancial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually). See SFAS No. 157 discussion on page 9.

 

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

 

8



Table of Contents

 

Notes to Consolidated Financial Statements – (continued)

 

In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements — an amendment of ARB No. 51.” This Statement requires that the noncontrolling interest in the equity of a subsidiary be accounted for and reported as equity, provides revised guidance on the treatment of net income and losses attributable to the noncontrolling interest and changes in ownership interests in a subsidiary and requires additional disclosures that identify and distinguish between the interests of the controlling and noncontrolling owners. Pursuant to the transition provisions of SFAS No. 160, the company will adopt the Statement in fiscal year 2009 via retrospective application of the presentation and disclosure requirements. The company does not expect the adoption of this Statement to have a material effect on the Consolidated Financial Statements.

 

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities, Including an amendment of FASB Statement No. 115,” which became effective January 1, 2008. SFAS No. 159 permits entities to measure 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 generally accepted accounting principles. The fair value measurement election is irrevocable and subsequent changes in fair value must be recorded in earnings. The company adopted this Statement as of January 1, 2008 and the adoption of this Statement did not have a material effect on the Consolidated Financial Statements.

 

In September 2006, the FASB finalized SFAS No. 157 which became effective January 1, 2008 except as amended by FSP FAS 157-1 and FSP FAS 157-2 as previously described. This Statement defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements; however, it does not require any new fair value measurements. The provisions of SFAS No. 157 were applied prospectively to fair value measurements and disclosures for financial assets and financial liabilities and nonfinancial assets and nonfinancial liabilities recognized or disclosed at fair value in the financial statements on at least an annual basis beginning in the first quarter of 2008. The adoption of this Statement did not have a material effect on the Consolidated Financial Statements for fair value measurements made during the six months ended June 30, 2008. While the company does not expect the adoption of this Statement to have a material impact on its Consolidated Financial Statements in subsequent reporting periods, the company continues to monitor any additional implementation guidance that is issued that addresses the fair value measurements for certain financial assets, such as private market pension plan assets, and nonfinancial assets and nonfinancial liabilities not disclosed at fair value in the financial statements on at least an annual basis. See Note 6 on pages 12 to 14 for additional information regarding the adoption of this Statement.

 

3. Stockholders’ Equity: The following table summarizes Net income plus gains and (losses) not affecting retained earnings (net of tax), a component of Stockholders’ equity in the Consolidated Statement of Financial Position:

 

 

 

Three Months Ended June 30,

 

Six Months Ended June 30,

 

(Dollars in millions)

 

2008

 

2007

 

2008

 

2007

 

Net income

 

$

2,765

 

$

2,260

 

$

5,084

 

$

4,105

 

Gains and (losses) not affecting retained earnings (net of tax):

 

 

 

 

 

 

 

 

 

Foreign currency translation adjustments

 

(2

)

259

 

457

 

349

 

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

 

151

 

262

 

277

 

470

 

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

 

(19

)

65

 

(176

)

47

 

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

 

147

 

23

 

(149

)

38

 

Total net gains and (losses) not affecting retained earnings

 

276

 

609

 

408

 

904

 

Net income plus gains and (losses) not affecting retained earnings

 

$

3,041

 

$

2,869

 

$

5,492

 

$

5,009

 

 


(1) Sale of Lenovo stock and mark-to-market adjustments of remaining Lenovo stock accounted for a $18 million loss and a $89 million gain for second quarter of 2008 and 2007, and a loss of $169 million and a gain of $52 million in the first six months of 2008 and 2007, respectively.

 

9



Table of Contents

 

Notes to Consolidated Financial Statements – (continued)

 

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

 

 

 

Three Months Ended June 30,

 

Six Months Ended June 30,

 

(Dollars in millions)

 

2008

 

2007

 

2008

 

2007

 

Cost

 

$

30

 

$

45

 

$

59

 

$

91

 

Selling, general and administrative

 

125

 

123

 

252

 

235

 

Research, development and engineering

 

15

 

17

 

29

 

37

 

Other (income) and expense

 

 

(1

)

 

(1

)

Pre-tax stock-based compensation cost

 

170

 

184

 

340

 

361

 

Income tax benefits

 

(63

)

(76

)

(110

)

(143

)

Total stock-based compensation cost

 

$

106

 

$

107

 

$

230

 

$

219

 

 

The reduction in pre-tax stock-based compensation cost for the three months ended June 30, 2008, as compared to the corresponding period in the prior year, was principally the result of a reduction in the level of stock option grants ($55 million), partially offset by an increase related to restricted and performance-based stock units ($36 million).  The reduction in pre-tax stock-based compensation cost for the six months ended June 30, 2008, as compared to the corresponding period in the prior year, was principally the result of a reduction in the level of stock option grants ($119 million), partially offset by an increase related to restricted and performance-based stock units ($93 million). The effects on pre-tax stock-based compensation cost related to the formation of a joint venture based on the company’s Printing Systems Division are included in Other (income) and expense above and in the Consolidated Statement of Earnings for the three and six-month periods ended June 30, 2007.

 

As of June 30, 2008, the total unrecognized compensation cost of $1,342 million related to non-vested awards is expected to be recognized over a weighted-average period of approximately three years.

 

There were no significant capitalized stock-based compensation costs at June 30, 2008 and 2007.

 

For Restricted Stock Units (RSUs) awarded after December 31, 2007, dividend equivalents will not be paid. The fair value of such RSUs is determined and fixed on the grant date based on the company’s stock price adjusted for the exclusion of dividend equivalents.

 

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

 

For the three months ended June 30:

 

2008

 

2007

 

Yr. to Yr.
Percent 
Change

 

(Dollars in millions)

 

 

 

 

 

 

 

Retirement-related plans cost:

 

 

 

 

 

 

 

Defined benefit and contribution pension plans cost

 

$

290

 

$

534

 

(45.8

)%

Nonpension postretirement plans cost

 

91

 

94

 

(3.6

)

Total

 

$

381

 

$

628

 

(39.4

)%

 

For the six months ended June 30:

 

2008

 

2007

 

Yr. to Yr. 
Percent 
Change

 

(Dollars in millions)

 

 

 

 

 

 

 

Retirement-related plans cost:

 

 

 

 

 

 

 

Defined benefit and contribution pension plans cost

 

$

651

 

$

1,074

 

(39.4

)%

Nonpension postretirement plans cost

 

185

 

197

 

(6.1

)

Total

 

$

836

 

$

1,271

 

(34.2

)%

 

10



Table of Contents

 

Notes to Consolidated Financial Statements – (continued)

 

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

 

Cost/(Income) of Pension Plans

 

 

 

U.S. Plans

 

Non-U.S. Plans

 

For the three months ended June 30:

 

2008

 

2007

 

2008

 

2007

 

(Dollars in millions)

 

 

 

 

 

 

 

 

 

Service cost

 

$

 

$

185

 

$

138

 

$

145

 

Interest cost

 

666

 

647

 

518

 

433

 

Expected return on plan assets

 

(994

)

(926

)

(705

)

(613

)

Amortization of transition assets

 

 

 

 

 

Amortization of prior service cost

 

 

15

 

(34

)

(31

)

Recognized actuarial losses

 

63

 

171

 

156

 

222

 

Net periodic pension (income)/cost—U.S. Plan and material
non-U.S. Plans

 

(265

)*

92

*

73

**

156

**

Cost of other defined benefit plans

 

27

 

32

 

59

 

42

 

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

 

(238

)

124

 

132

 

198

 

Cost of defined contribution plans

 

252

 

97

 

143

 

115

 

Total retirement plan cost recognized in the Consolidated Statement of Earnings

 

$

15

 

$

221

 

$

275

 

$

313

 

 


*   Represents the qualified portion of the IBM Personal Pension Plan.

** Represents the qualified and non-qualified portion of material non-U.S. Plans.

 

 

 

U.S. Plans

 

Non-U.S. Plans

 

For the six months ended June 30:

 

2008

 

2007

 

2008

 

2007+

 

(Dollars in millions)

 

 

 

 

 

 

 

 

 

Service cost

 

$

 

$

373

 

$

276

 

$

291

 

Interest cost

 

1,337

 

1,293

 

1,024

 

857

 

Expected return on plan assets

 

(1,989

)

(1,852

)

(1,395

)

(1,217

)

Amortization of transition assets

 

 

 

 

(1

)

Amortization of prior service cost

 

 

30

 

(68

)

(62

)

Recognized actuarial losses

 

133

 

340

 

310

 

442

 

Net periodic pension (income)/cost—U.S. Plan and material non-U.S. Plans

 

(519

)*

184

147

**

310

**

Cost of other defined benefit plans

 

50

 

62

 

116

 

79

 

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

 

(469

)

246

 

263

 

389

 

Cost of defined contribution plans

 

573

 

213

 

283

 

226

 

Total retirement plan cost recognized in the Consolidated Statement of Earnings

 

$

105

 

$

459

 

$

546

 

$

615

 

 


+   Reclassified to conform with 2008 presentation.

*   Represents the qualified portion of the IBM Personal Pension Plan.

** Represents the qualified and non-qualified portion of material non-U.S. Plans.

 

In 2008, the company expects to contribute to its non-U.S. defined benefit plans approximately $660 million, which is the legally mandated minimum contribution for its non-U.S. plans. Total contributions to the non-U.S. plans in the first half of 2008 were $295 million.

 

On April 29, 2008, the IBM Board of Directors approved a pension adjustment for certain U.S. retirees and beneficiaries. Effective September 1, 2008, this adjustment provides a pension increase to approximately 42,000 IBM retirees who retired before January 1, 1997. The impact of this adjustment will be included in the IBM Personal Pension Plan remeasurement at December 31, 2008, therefore, there will be no impact to 2008 net periodic pension cost.

 

11



Table of Contents

 

Notes to Consolidated Financial Statements – (continued)

 

The following table provides the components of the cost for the company’s nonpension postretirement plans.

 

Cost of Nonpension Postretirement Plans

 

 

 

Three Months Ended June 30,

 

Six Months Ended June 30,

 

(Dollars in millions)

 

2008

 

2007

 

2008

 

2007

 

Service cost

 

$

13

 

$

17

 

$

28

 

$

34

 

Interest cost

 

77

 

76

 

156

 

155

 

Amortization of prior service cost

 

(15

)

(15

)

(31

)

(30

)

Expected return on plan assets

 

 

 

(4

)

 

Recognized actuarial losses

 

2

 

4

 

5

 

12

 

Net periodic post retirement plan cost — U.S. Plan

 

77

 

82

 

153

 

171

 

Cost of non-U.S. Plans

 

14

 

12

 

32

 

26

 

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

 

$

91

 

$

94

 

$

185

 

$

197

 

 

The company received a $17.1 million subsidy in the second quarter and $20.2 million for the first half of 2008 in connection with the Medicare Prescription Drug Improvement and Modernization Act of 2003. A portion of this amount is used by the company to reduce its obligation and expense related to the plan, and the remainder is contributed to the plan to reduce contributions required by the participants. For further information related to the Medicare Prescription Drug Act, see page 115 in the company’s 2007 Annual Report.

 

6. Fair Value:  As highlighted in Note 2 on page 8, the company adopted the provisions of SFAS No. 157 as amended by FSP FAS 157-1 and FSP FAS 157-2 on January 1, 2008. Pursuant to the provisions of FSP FAS 157-2, the company will not apply the provisions of SFAS No. 157 until January 1, 2009 for the following major categories of nonfinancial assets and liabilities from the Consolidated Statement of Financial Position: Plant, rental machines and other property-net; Goodwill; Intangible assets-net; and, the Asset retirement obligation liabilities within Other accrued expenses and liabilities and Other liabilities.  The company recorded no change to its opening balance of Retained earnings as of January 1, 2008 as it did not have any financial instruments requiring retrospective application per the provisions of SFAS No. 157.

 

Fair Value Hierarchy

 

SFAS No. 157 specifies a hierarchy of valuation techniques based upon whether the inputs to those valuation techniques reflect assumptions other market participants would use based upon market data obtained from independent sources (observable inputs) or reflect the company’s own assumptions of market participant valuation (unobservable inputs). In accordance with SFAS No. 157, these two types of inputs have created the following fair value hierarchy:

 

· Level 1 –

Quoted prices in active markets that are unadjusted and accessible at the measurement date for identical, unrestricted assets or liabilities;

· Level 2 –

Quoted prices for identical assets and liabilities in markets that are not active, quoted prices for similar assets and liabilities in active markets or financial instruments for which significant inputs are observable, either directly or indirectly;

· Level 3 –

Prices or valuations that require inputs that are both significant to the fair value measurement and unobservable.

 

12



Table of Contents

 

Notes to Consolidated Financial Statements – (continued)

 

SFAS No. 157 requires the use of observable market data if such data is available without undue cost and effort.

 

Measurement of Fair Value

 

The company measures fair value as an exit price using the procedures described below for all assets and liabilities measured at fair value. When available, the company uses unadjusted quoted market prices to measure fair value and classifies such items within Level 1. If quoted market prices are not available, fair value is based upon internally developed models that use, where possible, 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. Thus, an item may be classified in Level 3 even though there may be inputs that are readily observable. If quoted market prices are not available, the valuation model used generally depends on the specific asset or liability being valued. The determination of fair value considers various factors including interest rate yield curves and time value underlying the financial instruments. For derivatives and marketable debt securities, the company uses a discounted cash flow analysis using discount rates commensurate with the duration of the instrument. In the event of an other-than-temporary impairment of a nonpublic equity method investment, the company uses the net asset value of its investment in the investee adjusted using discounted cash flows for the company’s estimate of the price that it would receive to sell the investment to a market participant that would consider all factors that would impact the investment’s fair value. In determining the fair value of financial instruments, the company considers ‘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, where the base valuation uses market parameters based on an AA (or equivalent) credit rating. Due to the fact that not all counterparties have a AA (or equivalent) credit rating, it is necessary to take into account the actual credit rating of a counterparty 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.

 

Items Measured at Fair Value on a Recurring Basis

 

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

 

(Dollars in millions)

 

Level 1

 

Level 2

 

Level 3

 

Netting (1)

 

Total

 

Assets:

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

2,919

 

$

4,044

 

$

 

$

 

$

6,964

 

Marketable securities

 

 

120

 

 

 

120

 

Derivative assets (2)

 

31

 

1,009

 

 

(541

)

499

 

Investments and sundry assets

 

437

 

1

 

 

 

438

 

Total Assets

 

$

3,387

 

$

5,175

 

$

 

$

(541

)

$

8,021

 

 

 

 

 

 

 

 

 

 

 

 

 

Liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Derivative liabilities (3)

 

$

 

$

1,782

 

$

 

$

(541

)

$

1,241

 

Total Liabilities

 

$

 

$

1,782

 

$

 

$

(541

)

$

1,241

 

 


(1)

Represents netting of derivative exposures covered by a qualifying master netting agreement in accordance with FASB Interpretation No. 39, “Offsetting of Amounts Relating to Certain Contracts,” and credit risk adjustments, if material.

(2)

The gross balances of derivative assets contained within prepaid expenses and other current assets, and investments and sundry assets in the Consolidated Statement of Financial Position at June 30, 2008 are $793 million and $247 million, respectively.

(3)

The gross balances of derivative liabilities contained within other accrued expenses and liabilities, and other liabilities in the Consolidated Statement of Financial Position at June 30, 2008 are $1,300 million and $481 million, respectively.

 

 

At June 30, 2008, the company did not have any assets or liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3).

 

13



Table of Contents

 

Notes to Consolidated Financial Statements – (continued)

 

Items Measured at Fair Value on a Nonrecurring Basis

 

Certain assets are measured at fair value on a nonrecurring basis and therefore are not included in the table above. These assets include equity method investments that are recognized at fair value at the end of the period to the extent that they are deemed to be other-than-temporarily impaired. Certain assets that are measured at fair value on a recurring basis and are included in the table above can also be subject to nonrecurring fair value measurements. These assets include public cost method investments that are deemed to be other-than-temporarily impaired. The company did not record any other-than-temporary impairment charges for these assets during the first six months of 2008.

 

7. Accelerated Share Repurchase:  In May 2007, IBM International Group (IIG), a wholly-owned foreign subsidiary of the company repurchased 118.8 million shares of common stock for $12.5 billion under accelerated share repurchase (ASR) agreements with three banks.

 

Pursuant to the ASR agreements, executed on May 25, 2007, IIG paid an initial purchase price of $105.18 per share for the repurchase. The initial purchase price was subject to adjustment based on the volume weighted average price of IBM common stock over a settlement period of three months for each of the banks. The adjustment also reflected certain other amounts including the banks’ carrying costs, compensation for ordinary dividends declared by the company during the settlement period and interest benefits for receiving the $12.5 billion payment in advance of the anticipated purchases by each bank of shares in the open market during its settlement period.  The adjustment amount could be settled in cash, registered shares or unregistered shares at IIG’s option. Under the ASR, IIG had a separate settlement with each of the three banks. The first settlement occurred on September 6, 2007, resulting in a settlement payment to the bank of $151.8 million. The second settlement occurred on December 5, 2007, resulting in a settlement payment to the bank of $253.1 million. The third settlement occurred on March 4, 2008, resulting in a settlement payment to the company of $54.2 million. The settlement amounts were paid in cash at the election of IIG in accordance with the provisions of the ASR and were recorded as adjustments to Stockholders’ equity in the Consolidated Statement of Financial Position on the settlement dates. The adjusted average price paid per share during the ASR period was $108.13, resulting in a total purchase price of $12,851 million versus the original $12,500 million. The $351 million difference was settled in cash.

 

8. Acquisitions: During the six months ended June 30, 2008, the company completed 13 acquisitions at an aggregate cost of $6,447 million. The Cognos, Inc. and Telelogic AB acquisitions are shown separately given their significant purchase prices.

 

Cognos, Inc. (Cognos) – On January 31, 2008, the company acquired 100 percent of the outstanding common shares of Cognos for consideration of $5,021 million consisting of $4,998 million of cash and $24 million of equity instruments. Through this acquisition, IBM and Cognos will become a leading provider of technology and services for business intelligence and performance management, delivering the industry’s most complete, open standards-based platform with the broadest range of expertise to help companies expand the value of their information, optimize their business processes and maximize performance across their enterprises. The company acquired Cognos to accelerate its Information on Demand strategy, a cross-company initiative that combines the company’s strength in information integration, content and data management and business consulting services to unlock the business value of information. Cognos was integrated into the Software segment upon acquisition, and goodwill, as reflected in the table on page 15 has been entirely assigned to the Software segment. It is expected that 20-30 percent of the goodwill will be deductible for tax purposes. The overall weighted average useful life of the intangible assets acquired, excluding goodwill, is 6.5 years.

 

Telelogic, AB (Telelogic) – On April 3, 2008, IBM acquired 100 percent of the outstanding common shares of Telelogic for cash consideration of $885 million. Telelogic is a leading global provider of solutions for automating and supporting best practices across the enterprise  from powerful modeling of business processes and enterprise architectures to requirements-driven development of advanced systems and software. Telelogic’s solutions enable organizations to align product, systems and software development lifecycles with business objectives and customer needs to dramatically improve quality and predictability, while significantly reducing time-to-market and overall costs. Clients will benefit from the combined technologies and services of both companies, providing them a wider range of software and system development capabilities used to build complex systems. Telelogic was integrated into the Software segment upon acquisition, and goodwill, as reflected in the table on page 15 has been entirely assigned to the Software segment. None of the goodwill will be deductible for tax purposes. The overall weighted average useful life of the intangible assets acquired, excluding goodwill, is 7.0 years.

 

14



Table of Contents

 

Notes to Consolidated Financial Statements – (continued)

 

Other Acquisitions – The company acquired 11 additional companies at an aggregate cost of $541 million that are presented in the table below as “Other Acquisitions.”

 

The Software segment completed seven other acquisitions, all privately held companies: in the first quarter; AptSoft Corporation, Solid Information Technology, Net Integration Technologies Inc., and Encentuate, Inc; in the second quarter;  Infodyne, Beijing Super Info and FilesX.

 

Global Technology Services (GTS) completed one acquisition in the first quarter: Arsenal Digital Solutions, a privately held company. Arsenal provides global clients with security rich information protection services designed to handle increasing data retention requirements.

 

Global Business Services (GBS) completed one acquisition in the first quarter: u9consult, a privately held company. u9consult complements the company’s existing capabilities in value chain consulting.

 

Systems and Technology completed two acquisitions in the second quarter: Diligent Technologies Corporation and Platform Solutions, Inc (PSI), both privately held companies. Diligent will be an important component of IBM’s New Enterprise Data Center model, which helps clients improve IT efficiency and facilitates the rapid deployment of new IT services for future business growth. PSI’s technologies and skills, along with its intellectual capital, will be integrated into the company’s mainframe product engineering cycles and future product plans. In the second quarter, $24 million of the purchase price of PSI was attributed to the settlement of a preexisting lawsuit between IBM and PSI and recorded in SG&A expense. See note 14 on page 18 for additional information regarding this litigation. Also, the company recorded a $24 million In-Process Research and Development (IPR&D) charge related to this acquisition in the second quarter.

 

Purchase price consideration for the “Other Acquisitions” was paid all in cash. All acquisitions are reported in the Consolidated Statement of Cash Flows net of acquired cash and cash equivalents.

 

The table below reflects the purchase price related to these acquisitions and the resulting purchase price allocations as of June 30, 2008.

 

(Dollars in millions)

 

Amortization 
Life (yrs.)

 

Cognos*

 

Telelogic

 

Other 

Acquisitions

 

Current assets

 

 

 

$

507

 

$

238

 

$

26

 

Fixed assets/non current

 

 

 

126

 

7

 

17

 

Intangible assets:

 

 

 

 

 

 

 

 

 

Goodwill

 

N/A

 

4,177

 

658

 

433

 

Completed technology

 

3 – 7

 

534

 

108

 

47

 

Client relationships

 

3 – 7

 

47

 

127

 

11

 

IPR&D

 

N/A

 

 

 

24

 

Other

 

3 – 7

 

543

 

15

 

18

 

Total assets acquired

 

 

 

5,934

 

1,153

 

575

 

Current liabilities

 

 

 

(784

)

(213

)

(47

)

Non current liabilities

 

 

 

(128

)

(54

)

(12

Total liabilities assumed

 

 

 

(912

)

(267

)

(59

Settlement of preexisting litigation

 

 

 

 

 

24

 

Total purchase price

 

 

 

$

5,021

 

$

885

 

$

541

 

 


* Purchase price allocation at June 30, 2008 reflects immaterial adjustments from the March 31, 2008 balances.

 

The acquisitions were accounted for as purchase transactions, and accordingly, the assets and liabilities of the acquired entities were recorded at their estimated fair values at the date of acquisition. The primary items that generated the goodwill are the value of the synergies between the acquired companies and IBM and the acquired assembled workforce, neither of which qualify as an amortizable intangible asset. For the “Other Acquisitions,” the overall weighted-average life of the identified amortizable intangible assets acquired is 5.0 years. With the exception of goodwill, these identified intangible assets will be amortized on a straight-line basis over their useful lives. Goodwill of $433 million has been assigned to the Software ($119 million), Global Technology Services ($84 million) and Systems and Technology ($231 million) segments. Substantially, all of the goodwill related to “Other Acquisitions” is not deductible for tax purposes.

 

15



Table of Contents

 

Notes to Consolidated Financial Statements – (continued)

 

9. Printing Systems Divestiture:  In January 2007, the company announced an agreement with Ricoh Company Limited (Ricoh), a publicly traded company, to form a joint venture company based on IBM’s Printing System Division (a division of the Systems and Technology segment). The company initially created a wholly-owned subsidiary, InfoPrint Solutions Company, LLC (InfoPrint), by contributing specific assets and liabilities from its printer business. The Printing System Division generated approximately $1 billion of revenue in 2006. The InfoPrint portfolio includes solutions for production printing for enterprises and commercial printers as well as solutions for office workgroup environments and industrial segments. On June 1, 2007 (closing date), the company divested 51 percent of its interest in InfoPrint to Ricoh.  The company will divest its remaining ownership to Ricoh quarterly over a three year period from the closing date. At June 30, 2008, the company’s ownership in InfoPrint was 32.6 percent. See IBM’s 2007 Annual Report, Note C, “Acquisitions/Divestitures”, for additional information.

 

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

 

 

 

At June 30, 2008

 

(Dollars in millions)

 

Gross Carrying

 

Accumulated

 

Net Carrying

 

Intangible asset class

 

Amount

 

Amortization

 

Amount

 

Capitalized software

 

$

1,920

 

$

(841

)

$

1,079

 

Client-related

 

1,664

 

(573

)

1,091

 

Completed technology

 

1,161

 

(239

)

922

 

Patents/Trademarks

 

195

 

(55

)

140

 

Other(1)

 

176

 

(129

)

46

 

Total

 

$

5,115

 

$

(1,837

)

$

3,277

 

 

 

 

At December 31, 2007

 

(Dollars in millions)

 

Gross Carrying

 

Accumulated

 

Net Carrying

 

Intangible asset class

 

Amount

 

Amortization

 

Amount

 

Capitalized software

 

$

1,926

 

$

(826

)

$

1,100

 

Client-related

 

1,054

 

(495

)

559

 

Completed technology

 

536

 

(194

)

342

 

Strategic alliances

 

103

 

(103

)

 

Patents/Trademarks

 

128

 

(61

)

67

 

Other(1)

 

154

 

(115

)

39

 

Total

 

$

3,901

 

$

(1,794

)

$

2,107

 

 


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

 

The net carrying amount of intangible assets increased $1,170 million during the first half of 2008, primarily due to acquired intangible assets and capitalized software additions, partially offset by amortization. The aggregate intangible amortization expense was $337 million and $654 million for the second quarter and first six months of 2008, respectively, versus $289 million and $580 million for the second quarter and first six months ended June 30, 2007, respectively. In addition, in the first half of 2008, the company retired $619 million of fully amortized intangible assets, impacting both the gross carrying amount and accumulated amortization by this amount.

 

The amortization expense for each of the five succeeding years relating to intangible assets currently recorded in the Consolidated Statement of Financial Position is estimated to be the following at June 30, 2008:

 

 

 

Capitalized

 

Acquired

 

 

 

(Dollars in millions)

 

Software

 

Intangibles

 

Total

 

2008 (for Q3-Q4)

 

$

373

 

$

316

 

$

689

 

2009

 

497

 

498

 

994

 

2010

 

186

 

402

 

588

 

2011

 

22

 

353

 

375

 

2012

 

 

271

 

271

 

 

16



Table of Contents

 

Notes to Consolidated Financial Statements – (continued)

 

The changes in the goodwill balances by reportable segment, for the six months ended June 30, 2008, are as follows:

 

 

 

 

 

 

 

 

 

 

 

Foreign

 

 

 

 

 

 

 

 

 

 

 

 

 

Currency

 

 

 

 

 

 

 

 

 

Purchase

 

 

 

Translation

 

 

 

(Dollars in millions)

 

Balance

 

Goodwill

 

Price

 

 

 

And Other

 

Balance

 

Segment

 

12/31/07

 

Additions

 

Adjustments

 

Divestitures

 

Adjustments

 

6/30/08

 

Global Business Services

 

$

4,041

 

$

 

$

(1

)

$

 

$

29

 

$

4,069

 

Global Technology Services

 

2,914

 

84

 

(2

)

 

166

 

3,161

 

Systems and Technology

 

484

 

231