0000051143ibm:CostOfRevenueMember2018-04-012018-06-30

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 ~~SEPTEMBER~~JUNE 30, ~~2017~~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~~914-499-1900

(Registrant’s telephone number)

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

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

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section l3 or l5(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x☒ No o☐

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

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

Large accelerated filer x☒		Accelerated filer o☐
Non-accelerated filer ☐		Smaller reporting company ☐
~~Non-accelerated filer~~ o		~~Smaller reporting company~~ o
~~(Do not check if a smaller reporting company)~~
		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 ~~925,791,378~~885,875,161 shares of common stock outstanding at ~~September~~June 30, ~~2017.~~2019.

Table of Contents

Index

~~Index~~


	Page
Part I - Financial ~~Information:~~Information:

Item 1. Consolidated Financial Statements (Unaudited):

Consolidated Statement of Earnings for the three and ~~nine~~six months ended ~~September~~June 30, ~~2017~~2019 and ~~2016~~2018	3

Consolidated Statement of Comprehensive Income for the three and ~~nine~~six months ended ~~September~~June 30, ~~2017~~2019 and ~~2016~~2018	4

Consolidated Statement of Financial Position at ~~September~~June 30, ~~2017~~2019 and December 31, ~~2016~~2018	5

Consolidated Statement of Cash Flows for the ~~nine~~six months ended ~~September~~June 30, ~~2017~~2019 and ~~2016~~2018	7

Consolidated Statement of Changes in Equity for the ~~nine~~three and six months ended ~~September~~June 30, ~~2017~~2019 and ~~2016~~2018	8

Notes to Consolidated Financial Statements	910

Item 2. Management’s Discussion and Analysis of Results of Operations and Financial Condition	5062

Item 4. Controls and Procedures	87100

Part II - Other ~~Information:~~Information:

Item 1. Legal Proceedings	87101

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds and Issuer Repurchases of Equity Securities	87101

Item 6. Exhibits	88102

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 September 30,

Nine Months Ended September 30,

(Dollars in millions except per share amounts)

2017

2016

2017

2016

Revenue:

Services

$
12,703

$
12,938

$
37,592

$
38,347

Sales

6,017

5,872

17,744

18,542

Financing

433

417

1,260

1,260

Total revenue

19,153

19,226

56,597

58,149

Cost:

Services

8,426

8,418

25,502

25,492

Sales

1,605

1,536

4,839

4,496

Financing

322

259

890

760

Total cost

10,353

10,213

31,232

30,748

Gross profit

8,800

9,013

25,365

27,401

Expense and other (income):

Selling, general and administrative

4,648

4,732

14,959

16,093

Research, development and engineering

1,342

1,397

4,360

4,320

Intellectual property and custom development income

(308
)
(528
)
(1,118
)
(1,110
)
Other (income) and expense

(114
)
(8
)
(218
)
281

Interest expense

168

158

451

473

Total expense and other (income)

5,735

5,751

18,434

20,056

Income from continuing operations before income taxes

3,065

3,263

6,931

7,345

Provision for/(benefit from) income taxes

339

409

120

(31
)
Income from continuing operations

$
2,726

$
2,854

$
6,811

$
7,375

Loss from discontinued operations, net of tax

0

(1
)
(3
)
(4
)
Net income

$
2,726

$
2,853

$
6,807

$
7,371

Earnings/(loss) per share of common stock:

Assuming dilution:

Continuing operations

$
2.92

$
2.98

$
7.24

$
7.67

Discontinued operations

0.00

0.00

0.00

0.00

Total

$
2.92

$
2.98

$
7.24

$
7.67

Basic:

Continuing operations

$
2.93

$
2.99

$
7.28

$
7.70

Discontinued operations

0.00

0.00

0.00

0.00

Total

$
2.93

$
2.99

$
7.28

$
7.70

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

Assuming dilution

933.2

957.3

940.2

960.7

Basic

929.4

954.0

935.6

957.7

Cash dividend per common share

$
1.50

$
1.40

$
4.40

$
4.10


	Three Months Ended June 30,				Six Months Ended June 30,
(Dollars in millions except per share amounts)	2019		2018		2019		2018
Revenue:
Services	$	12,352	$	12,886	$	24,775	$	25,848
Sales		6,458		6,721		11,812		12,421
Financing		351		396		756		806
Total revenue		19,161		20,003		37,342		39,075
Cost:
Services		8,272		8,645		16,631		17,479
Sales		1,651		1,869		3,167		3,591
Financing		228		290		492		559
Total cost		10,151		10,804		20,290		21,629
Gross profit		9,010		9,199		17,053		17,445
Expense and other (income):
Selling, general and administrative		5,456		4,857		10,147		10,302
Research, development and engineering		1,407		1,364		2,840		2,769
Intellectual property and custom development income		(222)		(250)		(323)		(567)
Other (income) and expense		(747)		280		(820)		692
Interest expense		348		173		558		338
Total expense and other (income)		6,242		6,423		12,402		13,534
Income from continuing operations before income taxes		2,768		2,776		4,651		3,911
Provision for/(benefit from) income taxes		269		373		558		(166)
Income from continuing operations	$	2,499	$	2,402	$	4,093	$	4,078
Income/(loss) from discontinued operations, net of tax		(1)		1		(4)		5
Net income	$	2,498	$	2,404	$	4,089	$	4,083

Earnings/(loss) per share of common stock:
Assuming dilution:
Continuing operations	$	2.81	$	2.61	$	4.58	$	4.42
Discontinued operations		0.00		0.00		0.00		0.01
Total	$	2.81	$	2.61	$	4.58	$	4.43
Basic:
Continuing operations	$	2.82	$	2.63	$	4.61	$	4.44
Discontinued operations		0.00		0.00		0.00		0.01
Total	$	2.82	$	2.63	$	4.61	$	4.45

Weighted-average number of common shares outstanding: (millions)
Assuming dilution		890.8		919.4		892.4		922.4
Basic		886.3		915.1		887.9		917.9

(Amounts may not add due to rounding.)

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

Table of Contents

INTERNATIONAL BUSINESS MACHINES CORPORATION

AND SUBSIDIARY COMPANIES

CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME

(UNAUDITED)


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

(Amounts may not add due to rounding.)

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

Table of Contents

INTERNATIONAL BUSINESS MACHINES CORPORATION

AND SUBSIDIARY COMPANIES

CONSOLIDATED STATEMENT OF ~~COMPREHENSIVE INCOME~~FINANCIAL POSITION

(UNAUDITED)

Three Months Ended September 30,

Nine Months Ended September 30,

(Dollars in millions)

2017

2016

2017

2016

Net income

$
2,726

$
2,853

$
6,807

$
7,371

Other comprehensive income/(loss), before tax:

Foreign currency translation adjustments

89

(99
)
213

(109
)
Net changes related to available-for-sale securities:

Unrealized gains/(losses) arising during the period

(1
)
(1
)
2

(36
)
Reclassification of (gains)/losses to net income

0

(1
)
1

36

Total net changes related to available-for-sale securities

(2
)
(2
)
2

0

Unrealized gains/(losses) on cash flow hedges:

Unrealized gains/(losses) arising during the period

(70
)
35

(198
)
(221
)
Reclassification of (gains)/losses to net income

(73
)
15

(347
)
26

Total unrealized gains/(losses) on cash flow hedges

(143
)
50

(545
)
(195
)
Retirement-related benefit plans:

Prior service costs/(credits)

0

—

0

—

Net (losses)/gains arising during the period

1

11

106

(57
)
Curtailments and settlements

2

4

3

19

Amortization of prior service (credits)/costs

(22
)
(28
)
(66
)
(81
)
Amortization of net (gains)/losses

733

696

2,156

2,079

Total retirement-related benefit plans

713

683

2,200

1,960

Other comprehensive income/(loss), before tax

658

632

1,869

1,656

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

11

(192
)
7

(213
)
Other comprehensive income/(loss)

669

440

1,877

1,442

Total comprehensive income/(loss)

$
3,394

$
3,293

$
8,684

$
8,813

ASSETS


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

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

(Amounts may not add due to rounding.)

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

Table of Contents

INTERNATIONAL BUSINESS MACHINES CORPORATION

AND SUBSIDIARY COMPANIES

CONSOLIDATED STATEMENT OF FINANCIAL POSITION – (CONTINUED)

(UNAUDITED)

LIABILITIES AND EQUITY


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

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

(Amounts may not add due to rounding.)

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

Table of Contents

INTERNATIONAL BUSINESS MACHINES CORPORATION

AND SUBSIDIARY COMPANIES

CONSOLIDATED STATEMENT OF ~~FINANCIAL POSITION~~CASH FLOWS

(UNAUDITED)


	Six Months Ended June 30,
(Dollars in millions)	2019		2018
Cash flows from operating activities:
Net income	$	4,089	$	4,083
Adjustments to reconcile net income to cash provided by operating activities
Depreciation		2,130		1,547
Amortization of intangibles		610		683
Stock-based compensation		248		242
Net (gain)/loss on asset sales and other		(787)		6
Changes in operating assets and liabilities, net of acquisitions/divestitures		1,410		336
Net cash provided by operating activities		7,700		6,896

Cash flows from investing activities:
Payments for property, plant and equipment		(1,122)		(1,801)
Proceeds from disposition of property, plant and equipment		383		180
Investment in software		(305)		(275)
Acquisition of businesses, net of cash acquired		(43)		(122)
Divestitures of businesses, net of cash transferred		888		—
Non-operating finance receivables — net		3,828		422
Purchases of marketable securities and other investments		(1,803)		(2,811)
Proceeds from disposition of marketable securities and other investments		1,483		2,009
Net cash provided by/(used in) investing activities		3,309		(2,399)

Cash flows from financing activities:
Proceeds from new debt		31,249		2,506
Payments to settle debt		(3,869)		(3,654)
Short-term borrowings/(repayments) less than 90 days — net		(307)		397
Common stock repurchases		(1,236)		(1,767)
Common stock repurchases for tax withholdings		(152)		(143)
Financing — other		41		52
Cash dividends paid		(2,833)		(2,819)
Net cash provided by/(used in) financing activities		22,894		(5,428)

Effect of exchange rate changes on cash, cash equivalents and restricted cash		27		(344)
Net change in cash, cash equivalents and restricted cash		33,930		(1,274)

Cash, cash equivalents and restricted cash at January 1		11,604		12,234
Cash, cash equivalents and restricted cash at June 30	$	45,534	$	10,960

(Amounts may not add due to rounding.)

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

Table of Contents

INTERNATIONAL BUSINESS MACHINES CORPORATION

~~ASSETS~~AND SUBSIDIARY COMPANIES

CONSOLIDATED STATEMENT OF CHANGES IN EQUITY

(UNAUDITED)

At September 30,

At December 31,

(Dollars in millions)

2017

2016

Assets:

Current assets:

Cash and cash equivalents

$
10,915

$
7,826

Marketable securities

600

701

Notes and accounts receivable - trade (net of allowances of $296 in 2017 and $290 in 2016)

8,150

9,182

Short-term financing receivables (net of allowances of $270 in 2017 and $337 in 2016)

18,050

19,006

Other accounts receivable (net of allowances of $39 in 2017 and $48 in 2016)

926

1,057

Inventories, at lower of average cost or market:

Finished goods

430

358

Work in process and raw materials

1,281

1,195

Total inventories

1,711

1,553

Prepaid expenses and other current assets

4,389

4,564

Total current assets

44,742

43,888

Property, plant and equipment

31,937

30,133

Less: Accumulated depreciation

20,880

19,303

Property, plant and equipment — net

11,057

10,830

Long-term financing receivables (net of allowances of $84 in 2017 and $101 in 2016)

8,459

9,021

Prepaid pension assets

4,521

3,034

Deferred taxes

7,289

5,224

Goodwill

36,782

36,199

Intangible assets — net

3,981

4,688

Investments and sundry assets

4,806

4,585

Total assets

$
121,636

$
117,470


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


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

(Amounts may not add due to rounding.)

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

Table of Contents

INTERNATIONAL BUSINESS MACHINES CORPORATION

AND SUBSIDIARY COMPANIES

CONSOLIDATED STATEMENT OF ~~FINANCIAL POSITION —~~CHANGES IN EQUITY – (CONTINUED)
~~(UNAUDITED)~~

~~LIABILITIES AND EQUITY~~(UNAUDITED)

At September 30,

At December 31,

(Dollars in millions)

2017

2016

Liabilities:

Current liabilities:

Taxes

$
3,038

$
3,235

Short-term debt

4,299

7,513

Accounts payable

5,442

6,209

Compensation and benefits

3,918

3,577

Deferred income

10,649

11,035

Other accrued expenses and liabilities

4,352

4,705

Total current liabilities

31,697

36,275

Long-term debt

41,327

34,655

Retirement and nonpension postretirement benefit obligations

17,554

17,070

Deferred income

3,579

3,600

Other liabilities

7,723

7,477

Total liabilities

101,879

99,078

Equity:

IBM stockholders’ equity:

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

54,395

53,935

Shares authorized: 4,687,500,000

Shares issued: 2017 - 2,228,489,401

2016 - 2,225,116,815

Retained earnings

155,565

152,759

Treasury stock - at cost

(162,812
)
(159,050
)
Shares: 2017 - 1,302,698,023

2016 - 1,279,249,412

Accumulated other comprehensive income/(loss)

(27,521
)
(29,398
)
Total IBM stockholders’ equity

19,627

18,246

Noncontrolling interests

130

146

Total equity

19,757

18,392

Total liabilities and equity

$
121,636

$
117,470


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


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

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

(Amounts may not add due to rounding.)

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

Table of Contents

~~INTERNATIONAL BUSINESS MACHINES CORPORATION~~
~~AND SUBSIDIARY COMPANIES~~

~~CONSOLIDATED STATEMENT OF CASH FLOWS~~

~~(UNAUDITED)~~

Nine Months Ended September 30,

(Dollars in millions)

2017

2016

Cash flows from operating activities:

Net income

$
6,807

$
7,371

Adjustments to reconcile net income to cash provided by operating activities

Depreciation

2,231

2,106

Amortization of intangibles

1,161

1,148

Stock-based compensation

388

403

Net (gain)/loss on asset sales and other

92

100

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

312

1,978
* **
Net cash provided by operating activities

10,991

13,105
* **

Cash flows from investing activities:

Payments for property, plant and equipment

(2,273
)
(2,594
)
Proceeds from disposition of property, plant and equipment

337

234

Investment in software

(411
)
(441
)
Acquisition of businesses, net of cash acquired

(442
)
(5,445
)
Divestitures of businesses, net of cash transferred

35

35

Non-operating finance receivables — net

469

1,441
*
Purchases of marketable securities and other investments

(3,770
)
(4,021
)
Proceeds from disposition of marketable securities and other investments

2,778

3,501

Net cash used in investing activities

(3,278
)
(7,289
)*

Cash flows from financing activities:

Proceeds from new debt

9,355

8,368

Payments to settle debt

(6,252
)
(5,616
)
Short-term borrowings/(repayments) less than 90 days — net

(794
)
(864
)
Common stock repurchases

(3,674
)
(2,632
)
Common stock repurchases for tax withholdings

(153
)
(115
)**
Common stock transactions — other

137

166

Cash dividends paid

(4,119
)
(3,927
)
Net cash used in financing activities

(5,499
)
(4,619
)**

Effect of exchange rate changes on cash and cash equivalents

875

155

Net change in cash and cash equivalents

3,089

1,352

Cash and cash equivalents at January 1

7,826

7,686

Cash and cash equivalents at September 30

$
10,915

$
9,039

* Revised classification of certain financing receivables.

** Reclassified to reflect adoption of the FASB guidance on share-based compensation.

~~(Amounts may not add due to rounding.)~~

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

~~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, 2017

$
53,935

$
152,759

$
(159,050
)
$
(29,398
)
$
18,246

$
146

$
18,392

Cumulative effect of change in accounting principle *

102

102

102

Net income

6,807

6,807

6,807

Other comprehensive income/(loss)

1,877

1,877

1,877

Total comprehensive income/(loss)

$
8,684

$
8,684

Cash dividends paid — common stock

(4,119
)

(4,119
)

(4,119
)
Common stock issued under employee plans (3,372,586 shares)

460

460

460

Purchases (960,186 shares) and sales (363,335 shares) of treasury stock under employee plans — net

15

(106
)

(91
)

(91
)
Other treasury shares purchased, not retired (22,851,760 shares)

(3,655
)

(3,655
)

(3,655
)
Changes in noncontrolling interests

(16
)
(16
)
Equity - September 30, 2017

$
54,395

$
155,565

$
(162,812
)
$
(27,521
)
$
19,627

$
130

$
19,757

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, 2016

$
53,262

$
146,124

$
(155,518
)
$
(29,607
)
$
14,262

$
162

$
14,424

Net income

7,371

7,371

7,371

Other comprehensive income/(loss)

1,442

1,442

1,442

Total comprehensive income/(loss)

$
8,813

$
8,813

Cash dividends paid — common stock

(3,927
)

(3,927
)

(3,927
)
Common stock issued under employee plans (3,370,992 shares)

513

513

513

Purchases (787,805 shares) and sales (336,480 shares) of treasury stock under employee plans — net

16

(72
)

(56
)

(56
)
Other treasury shares purchased, not retired (17,793,841 shares)

(2,579
)

(2,579
)

(2,579
)
Changes in other equity

(16
)
0

(17
)

(17
)
Changes in noncontrolling interests

(12
)
(12
)
Equity - September 30, 2016

$
53,759

$
149,585

$
(158,170
)
$
(28,164
)
$
17,010

$
149

$
17,159

* Reflects the adoption of the FASB guidance on intra-entity transfers of assets in the first-quarter 2017.

~~(Amounts may not add due to rounding.)~~

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

Notes to Consolidated Financial ~~Statements:~~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. ~~Refer to the company’s 2016 Annual Report on pages 71 to 74, for a discussion of the company’s critical accounting estimates.~~

The company revised the classification of certain financing receivables for the three and nine months ended September 30, 2016, decreasing net cash provided by operating activities and net cash used in investing activities in the amount of $99 million and $311 million, respectively, which the company concluded to be immaterial to the periods presented. The twelve-month revision for the period ended December 31, 2016 was provided in the company’s 2016 Annual Report on page 26. There was no impact to total GAAP cash flows or free cash flow.

In the first quarter of ~~2017,~~2019, the company ~~reported~~made a ~~benefit from income taxes~~number of ~~$329 million,~~changes to its organizational structure and ~~its effective tax rate was (23.1) percent. This was primarily driven by a discrete tax benefit of $582 million from a first-quarter 2017 transaction accounted for under~~management system. These changes impacted the ~~new~~company’s reportable segments, but did not impact the company’s Consolidated Financial Accounting Standards Board (FASB) guidance related to intra-entity transfers of assets. This benefit was partially offset by a discrete tax charge related to foreign audit activity of $99 million. The company had additional discrete tax benefits of $170 million in second-quarter 2017. For the nine months ended September 30, 2017, the company reported a provision for income taxes of $120 million and its effective tax rate was 1.7 percent, primarily as a result of the first and second quarter discrete items. For the nine months ended September 30, 2016, the company reported a benefit from income taxes of $31 million and its effective tax rate was (0.4) percent. The negative effective tax rate in the comparable period of 2016 was due to the resolution of a long-standing Japan tax matter in February 2016.Statements. Refer to note ~~2, “Accounting Changes,~~8, “Segments,” ~~and the Taxes section of the Management Discussion~~ for additional ~~information.~~

information on the changes in reportable segments. The periods presented in this Form 10-Q are reported on a comparable basis. The company provided recast historical segment information reflecting these changes in a Form 8-K dated April 4, 2019.

Noncontrolling interest amounts of ~~$4.4~~$4.9 million and ~~$3.1~~$3.8 million, net of tax, for the three months ended ~~September~~June 30, ~~2017~~2019 and ~~2016,~~2018, respectively, and ~~$11.5~~$11.9 million and ~~$7.5~~$11.7 million, net of tax, for the ~~nine~~six months ended ~~September~~June 30, ~~2017~~2019 and ~~2016,~~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 ~~2016~~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:

2. ~~Accounting Changes:~~

New Standards to be Implemented

In August ~~2017,~~2018, the ~~FASB~~Financial Accounting Standards Board (FASB) issued guidance ~~to simplify~~which changed the ~~application of current hedge accounting in certain areas, better portray the economic results of an entity’s risk management activities in its financial statements~~disclosure requirements for fair value measurements and ~~make targeted improvements to presentation and disclosure requirements.~~defined benefit plans. The guidance is effective for each of the topics on January 1, ~~2019~~2020 and December 31, 2020, respectively, with early adoption of certain provisions permitted. The company ~~plans to adopt~~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 ~~as of January 1, 2018. The~~is a change to disclosures only, the company does not expect the guidance ~~is not expected~~ to have a material impact in the consolidated financial results.

In ~~March~~January 2017, the FASB issued guidance that ~~impacts~~simplifies the ~~presentation of net periodic pension~~goodwill impairment test by removing Step 2. The guidance also changes the requirements for reporting units with zero or negative carrying amounts and postretirement benefit costs. Under the guidance, the service cost component of net benefit cost will continue to be presented in the same line items as other employee compensation costs, unless eligiblerequires additional disclosures for capitalization in the Consolidated Statement of Financial Position. The other components of net benefit costs will be presented separately from service cost as non-operating costs in the Consolidated Statement of Earnings or Notes to the Consolidated Financial Statements.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.

Table of Contents

Notes to Consolidated Financial Statements — (continued)

January 1, 2018 with early adoption permitted. The company will adopt the guidance as of the effective date. The guidance is primarily a change in financial statement presentation and is not expected to have a material impact in the consolidated financial results.

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

Standards Implemented

~~In February 2016, the~~The FASB issued guidance in February 2016, with amendments in 2018 and 2019, which ~~changes~~changed the accounting for leases. The guidance requires lessees to recognize right-of-use (ROU) assets and lease liabilities for most leases in the Consolidated Statement of Financial Position. The guidance ~~makes~~also made some changes to lessor accounting, including ~~the~~ elimination of the use of third-party residual value guarantee insurance in the ~~capital~~ lease classification test, and overall aligns with the new revenue recognition guidance. The guidance ~~also~~ requires qualitative and quantitative disclosures to assess the amount, timing and uncertainty of cash flows arising from leases. The company adopted the guidance is effective January 1, 2019, ~~and early adoption is permitted.~~using the transition option whereby prior comparative periods were not retrospectively presented in the Consolidated Financial Statements. The company ~~will adopt~~elected the ~~guidance as~~package of practical expedients not to reassess prior conclusions related to contracts containing leases, lease classification and initial direct costs and the ~~effective date. A cross-functional implementation team has been established which is evaluating the~~lessee practical expedient to combine lease ~~portfolio, system, process~~ and ~~policy change requirements.~~nonlease components for all asset classes. The company ~~is currently evaluating the impact of the new~~made a policy election to not recognize ROU assets and lease liabilities for short-term leases for all asset classes. The guidance ~~on its consolidated financial results and expects it will have~~had a material impact on the Consolidated Statement of Financial ~~Position.~~Position as of the effective date. As a lessee, at adoption, the company recognized operating and financing ROU assets of $4.8 billion and $0.2 billion, respectively, and operating and financing lease liabilities of $5.1 billion and $0.2 billion, respectively. The ~~company’s operating~~transition adjustment recognized in retained earnings on January 1, 2019 was not material. From a lessor perspective, the changes in lease ~~commitments were $6.9 billion at December 31, 2016. In 2016, the use~~termination guidance and removal of third-party residual value guarantee insurance ~~resulted~~ in the ~~company recognizing $220 million~~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 ~~sales-type lease revenue~~adoption.

In August 2018, the FASB issued guidance on a customer’s accounting for implementation costs incurred in cloud-computing arrangements that ~~would otherwise have been recognized~~are hosted by a vendor. Certain types of implementation costs should be capitalized and amortized over the ~~lease~~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 ~~operating lease revenue.~~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

Table of Contents

Notes to Consolidated Financial Statements — (continued)

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

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

In January 2016, the FASB issued guidance which addresses aspects of recognition, measurement, presentation and disclosure of financial instruments. ~~Certain~~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 ~~will~~to be measured at fair value with changes recognized in net income. The amendment also ~~simplifies~~simplified the impairment test of equity investments that lack readily determinable fair value. The guidance ~~is effective January 1, 2018 and early adoption is~~did not ~~permitted except for limited provisions. The guidance is not expected to~~ 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 ~~will depict~~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 ~~regarding the nature, amount, timing and uncertainty of~~relating to revenue and cash flows arising from contracts with customers. The guidance permits two methods of adoption: retrospectively to each prior reporting period presented, or retrospectively with the cumulative effect of initially applying the guidance recognized at the date of initial application (the cumulative catch-up transition method). The company will adopt the guidance on January 1, 2018 and apply the cumulative catch-up transition method. The transition adjustment to be recorded to stockholders’ equity upon adoption of the new standard is not expected to be material.

Given the scope of work required to implement the recognition and disclosure requirements under the new standard, the company began its assessment process in 2014 and has identified changes to policy, processes, systems and controls. This also includes the assessment of data availability and presentation necessary to meet the additional disclosure requirements of the guidance in the Notes to the Consolidated Financial Statements.

The company expects revenue recognition for its broad portfolio of hardware, software and services offerings to remain largely unchanged. However, the guidance is expected to change the timing of revenue recognition in certain areas, including accounting for certain software licenses. These impacts are not expected to be material. The company expects to continue to recognize revenue for term license (recurring license charge) software arrangements on a monthly basis over the period that the client is entitled to use the license due to the contractual terms in these arrangements.

Since the company currently expenses sales commissions as incurred, the requirement in the new standard to capitalize certain in-scope sales commissions will result in an accounting change for the company. However, the impact to the consolidated financial statements is not expected to be material, with no impact to cash flows.

~~The company continues to assess all potential impacts of the guidance and given normal ongoing business dynamics, preliminary conclusions are subject to change.~~

~~Notes to Consolidated Financial Statements — (continued)~~

~~Standards Implemented~~

In January 2017, the FASB issued guidance which clarifies the definition of a business. The guidance provides a more robust framework to use in determining when a set of assets and activities acquired or sold is a business. The guidance is effective January 1, 2018 and early adoption is permitted.recognition. The company adopted the guidance effective January 1, ~~2017, and it did not have a material impact in the consolidated financial results.~~

In October 2016, the FASB issued guidance which requires an entity to recognize the income tax consequences of intra-entity transfers of assets, other than inventory, at the time of transfer. Assets within the scope of the guidance include intellectual property and property, plant and equipment. The guidance is effective January 1, 2018 ~~and early adoption is permitted. The company adopted the guidance on January 1, 2017~~ using the ~~required~~ modified retrospective transition method. At adoption, ~~$95~~$557 million ~~and $47 million were~~was reclassified from ~~investments~~notes and ~~sundry assets~~accounts receivable-trade and deferred income-current to prepaid expenses and other current assets ~~respectively into retained earnings.~~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 ~~of $244~~were reduced by $184 million ~~were established in deferred taxes~~ in the Consolidated Statement of Financial Position, resulting in a cumulative-effect net ~~credit~~increase to retained earnings of ~~$102~~$524 million. In ~~January 2017,~~the fourth quarter of 2018, the company ~~had one transaction that generated~~recognized an additional impact to net deferred taxes and retained earnings of $56 million, resulting in a ~~$582 million benefit~~total net increase to ~~income tax expense, income from continuing operations and~~retained earnings of $580 million. The decrease to net ~~income and~~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 ~~benefit to both basic and diluted earnings per share of $0.62 per share for the nine months ended September 30, 2017. There was no~~material impact in the company’s consolidated financial ~~results~~results. Refer to note 3, “Revenue Recognition,” for ~~the three months ended September 30, 2017. The ongoing impact of this guidance will be dependent on any transaction that is within its scope.~~

additional information.

In March 2016, the FASB issued guidance which ~~changes~~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 inon 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. ~~See note 5, “Stock-Based Compensation,” for additional information.~~ 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. ~~Prior to adoption, the company reported this activity as an operating cash outflow and as a result, prior periods have been reclassified as required.~~ The FASB also issued guidance in May 2017 and June 2018, which relates to the accounting for modifications of share-based payment ~~awards.~~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.~~2017, and guidance for non-employees’ payments in the second quarter of 2018. The guidance had no impact in the consolidated financial results.

In September 2015, the FASB issued guidance eliminating the requirement that an acquirer in a business combination account for a measurement-period adjustment retrospectively. Instead, an acquirer will recognize a measurement-period adjustment during the period in which the amount

Table of the adjustment is determined. In addition, the portion of the amount recorded in current-period earnings by line item that would have been recorded in previous reporting periods if the adjustment to the provisional amounts had been recognized as of the acquisition date should be presented separately on the face of the income statement or disclosed in the notes. The guidance was effective January 1, 2016 on a prospective basis. The guidance did not have a material impact in the consolidated financial results.Contents

In May 2015, the FASB issued guidance which removed the requirement to categorize within the fair value hierarchy all investments for which fair value is measured using the net asset value per share practical expedient. The amendments also removed the requirement to make certain disclosures for all investments that are eligible to be measured at fair value using the net asset value per share practical expedient. Rather, those disclosures are limited to investments for which the entity has elected to measure the fair value using that practical expedient. The guidance was effective January 1, 2016. The guidance was a change in disclosure only and did not have an impact in the consolidated financial results.

In April 2015, the FASB issued guidance about whether a cloud computing arrangement includes a software license. If a cloud computing arrangement includes a software license, then the customer should account for the software license element of the arrangement consistent with the acquisition of other software licenses. If a cloud computing arrangement does not include a software license, the customer should account for the arrangement as a services contract. All software licenses recognized under this guidance will be accounted for consistent with other licenses of intangible assets. The guidance was effective January 1, 2016 and the company adopted it on a prospective basis. The guidance did not have a material impact in the consolidated financial results.

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.

3. Revenue by Major Products/Service Offerings


(Dollars in millions)	Cloud &		Global		Global
For the three months	Cognitive		Business		Technology				Global				Total
ended June 30, 2019:	Software		Services		Services		Systems		Financing		Other		Revenue

Cognitive Applications	$	1,454	$	—	$	—	$	—	$	—	$	—	$	1,454
Cloud & Data Platforms		2,173		—		—		—		—		—		2,173
Transaction Processing Platforms		2,018		—		—		—		—		—		2,018

Consulting		—		1,978		—		—		—		—		1,978
Application Management		—		1,919		—		—		—		—		1,919
Global Process Services		—		258		—		—		—		—		258

Infrastructure & Cloud Services		—		—		5,174		—		—		—		5,174
Technology Support Services		—		—		1,663		—		—		—		1,663

Systems Hardware		—		—		—		1,328		—		—		1,328
Operating Systems Software		—		—		—		425		—		—		425

Global Financing*		—		—		—		—		351		—		351

Other Revenue		—		—		—		—		—		420		420
Total	$	5,645	$	4,155	$	6,837	$	1,753	$	351	$	420	$	19,161

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

Revenue by Geography


(Dollars in millions)	Total
For the three months ended June 30, 2019:	Revenue

Americas	$	8,806
Europe/Middle East/Africa		6,149
Asia Pacific		4,205
Total	$	19,161

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 June 30, 2018:	Software*		Services*		Services*		Systems		Financing		Other*		Revenue

Cognitive Applications	$	1,413	$	—	$	—	$	—	$	—	$	—	$	1,413
Cloud & Data Platforms		2,079		—		—		—		—		—		2,079
Transaction Processing Platforms		1,978		—		—		—		—		—		1,978

Consulting		—		1,931		—		—		—		—		1,931
Application Management		—		1,946		—		—		—		—		1,946
Global Process Services		—		258		—		—		—		—		258

Infrastructure & Cloud Services		—		—		5,575		—		—		—		5,575
Technology Support Services		—		—		1,750		—		—		—		1,750

Systems Hardware		—		—		—		1,756		—		—		1,756
Operating Systems Software		—		—		—		421		—		—		421

Global Financing**		—		—		—		—		394		—		394

Other Revenue		—		—		—		—		—		503		503
Total	$	5,470	$	4,135	$	7,325	$	2,177	$	394	$	503	$	20,003

* Recast to conform to 2019 presentation.

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

Revenue by Geography


(Dollars in millions)	Total
For the three months ended June 30, 2018:	Revenue

Americas	$	9,212
Europe/Middle East/Africa		6,407
Asia Pacific		4,384
Total	$	20,003

Table of Contents

Notes to Consolidated Financial Statements — (continued)

Revenue by Major Products/Service Offerings


(Dollars in millions)	Cloud &		Global		Global
For the six months	Cognitive		Business		Technology				Global				Total
ended June 30, 2019:	Software		Services		Services		Systems		Financing		Other		Revenue

Cognitive Applications	$	2,762	$	—	$	—	$	—	$	—	$	—	$	2,762
Cloud & Data Platforms		4,090		—		—		—		—		—		4,090
Transaction Processing Platforms		3,830		—		—		—		—		—		3,830

Consulting		—		3,942		—		—		—		—		3,942
Application Management		—		3,827		—		—		—		—		3,827
Global Process Services		—		505		—		—		—		—		505

Infrastructure & Cloud Services		—		—		10,383		—		—		—		10,383
Technology Support Services		—		—		3,328		—		—		—		3,328

Systems Hardware		—		—		—		2,241		—		—		2,241
Operating Systems Software		—		—		—		840		—		—		840

Global Financing*		—		—		—		—		757		—		757

Other Revenue		—		—		—		—		—		837		837
Total	$	10,682	$	8,274	$	13,711	$	3,081	$	757	$	837	$	37,342

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

Revenue by Geography


(Dollars in millions)	Total
For the six months ended June 30, 2019:	Revenue

Americas	$	17,299
Europe/Middle East/Africa		11,876
Asia Pacific		8,167
Total	$	37,342

Table of Contents

Notes to Consolidated Financial Statements — (continued)

Revenue by Major Products/Service Offerings


(Dollars in millions)	Cloud &		Global		Global
For the six months	Cognitive		Business		Technology				Global				Total
ended June 30, 2018:	Software*		Services*		Services*		Systems		Financing		Other*		Revenue

Cognitive Applications	$	2,699	$	—	$	—	$	—	$	—	$	—	$	2,699
Cloud & Data Platforms		4,029		—		—		—		—		—		4,029
Transaction Processing Platforms		3,858		—		—		—		—		—		3,858

Consulting		—		3,798		—		—		—		—		3,798
Application Management		—		3,948		—		—		—		—		3,948
Global Process Services		—		504		—		—		—		—		504

Infrastructure & Cloud Services		—		—		11,214		—		—		—		11,214
Technology Support Services		—		—		3,531		—		—		—		3,531

Systems Hardware		—		—		—		2,848		—		—		2,848
Operating Systems Software		—		—		—		828		—		—		828

Global Financing**		—		—		—		—		799		—		799

Other Revenue		—		—		—		—		—		1,017		1,017
Total	$	10,586	$	8,250	$	14,746	$	3,676	$	799	$	1,017	$	39,075

* Recast to conform to 2019 presentation.

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

Revenue by Geography


(Dollars in millions)	Total
For the six months ended June 30, 2018:	Revenue

Americas	$	17,919
Europe/Middle East/Africa		12,583
Asia Pacific		8,573
Total	$	39,075

Remaining Performance Obligations

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

Table of Contents

Notes to Consolidated Financial Statements — (continued)

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

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

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

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

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

Reconciliation of Contract Balances

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


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

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

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

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

4. Financial Instruments:

Fair Value Measurements

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

●

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

Table of Contents

· ~~Level 1—Quoted prices (unadjusted) in active markets for identical assets or liabilities that can be accessed at the measurement date;~~Notes to Consolidated Financial Statements — (continued)

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

· ~~Level 3—Unobservable inputs for the asset or liability.~~

●

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

●

Level 3—Unobservable inputs for the asset or liability.

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

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

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

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

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

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

●

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

~~Non-financial~~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 ~~nonfinancial~~non-financial assets depend on the type of asset. ~~During the nine months ended September 30, 2016, a pre-tax impairment charge related to certain property, plant and equipment of $218 million was recorded.~~ There were no material impairments of non-financial assets for the ~~nine~~six months ended ~~September~~June 30, ~~2017.~~

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.

Table of Contents

Notes to Consolidated Financial Statements — (continued)

The following tables present the company’s financial assets and financial liabilities that are measured at fair value on a recurring basis at ~~September~~June 30, ~~2017~~2019 and December 31, ~~2016.~~2018.


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

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

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

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

(4)	The gross balances of derivative assets contained within prepaid expenses and other current assets, and investments and sundry assets in the Consolidated Statement of Financial Position at June 30, 2019 were $204 million and $215 million, respectively.

(5)	The gross balances of derivative liabilities contained within other accrued expenses and liabilities, and other liabilities in the Consolidated Statement of Financial Position at June 30, 2019 were $212 million and $377 million, respectively.

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


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

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

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

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

(4)	The gross balances of derivative assets contained within prepaid expenses and other current assets, and investments and sundry assets in the Consolidated Statement of Financial Position at December 31, 2018 were $385 million and $347 million, respectively.

(5)	The gross balances of derivative liabilities contained within other accrued expenses and liabilities, and other liabilities in the Consolidated Statement of Financial Position at December 31, 2018 were $177 million and $206 million, respectively.

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

Table of Contents

Notes to Consolidated Financial Statements — (continued)

(Dollars in millions)

At September 30, 2017

Level 1

Level 2

Level 3

Total

Assets:

Cash equivalents (1)

Time deposits and certificates of deposit

$
—

$
5,553

$
—

$
5,553

Money market funds

1,375

—

—

1,375

U.S. government securities

—

200

—

200

Canadian government securities

—

460

—

460

Total

1,375

6,214

—

7,589
(6)
Debt securities - current (2)

—

599

—

599
(6)
Debt securities - noncurrent (3)

4

7

—

11

Available-for-sale equity investments (3)

5

—

—

5

Derivative assets (4)

Interest rate contracts

—

517

—

517

Foreign exchange contracts

—

416

—

416

Equity contracts

—

23

—

23

Total

—

957

—

957
(7)
Total assets

$
1,384

$
7,775

$
—

$
9,159
(7)
Liabilities:

Derivative liabilities (5)

Foreign exchange contracts

$
—

$
333

$
—

$
333

Equity contracts

—

4

—

4

Interest rate contracts

—

15

—

15

Total liabilities

$
—

$
352

$
—

$
352
(7)

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

~~(2) U.S. government securities reported as marketable securities in the Consolidated Statement of Financial Position.~~

~~(3) Included within investments and sundry assets 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 September 30, 2017 were $269 million and $687 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 September 30, 2017 were $332 million and $20 million, respectively.~~

~~(6) Available-for-sale 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 $274 million.~~

~~Notes to Consolidated Financial Statements — (continued)~~

(Dollars in millions)

At December 31, 2016

Level 1

Level 2

Level 3

Total

Assets:

Cash equivalents (1)

Time deposits and certificates of deposit

$
—

$
3,629

$
—

$
3,629

Money market funds

1,204

—

—

1,204

Total

1,204

3,629

—

4,832
(6)
Debt securities - current (2)

—

699

—

699
(6)
Debt securities - noncurrent (3)

1

6

—

8

Available-for-sale equity investments (3)

7

—

—

7

Derivative assets (4)

Interest rate contracts

—

555

—

555

Foreign exchange contracts

—

560

—

560

Equity contracts

—

11

—

11

Total

—

1,126

—

1,126
(7)
Total assets

$
1,212

$
5,460

$
—

$
6,672
(7)
Liabilities:

Derivative liabilities (5)

Foreign exchange contracts

$
—

$
188

$
—

$
188

Equity contracts

—

10

—

10

Interest rate contracts

—

8

—

8

Total liabilities

$
—

$
206

$
—

$
206
(7)

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

~~(2) U.S government securities reported as marketable securities in the Consolidated Statement of Financial Position.~~

~~(3) Included within investments and sundry assets 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, 2016 were $532 million and $594 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, 2016 were $145 million and $61 million, respectively.~~

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

~~There were no transfers between Levels 1 and 2 for the nine months ended September 30, 2017 and the year ended December 31, 2016.~~

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)~~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~~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 ~~September~~June 30, ~~2017~~2019 and December 31, ~~2016,~~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.

~~Notes to Consolidated Financial Statements — (continued)~~

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 ~~$41,327~~$58,445 million and ~~$34,655~~$35,605 million, and the estimated fair value was ~~$43,623~~$62,018 million and ~~$36,838~~$36,599 million at ~~September~~June 30, ~~2017~~2019 and December 31, ~~2016,~~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.

~~Debt and Marketable Equity~~Available-for-Sale Securities

~~The company’s cash equivalents and current debt~~There were no gross realized gains/losses from the sale of available-for-sale securities ~~are considered available-for-sale and recorded at fair value, which is not materially different from carrying value, in the Consolidated Statement of Financial Position.~~

The following tables summarize the company’s noncurrent debt and marketable equity securities which are considered available-for-sale and recorded at fair value in the Consolidated Statement of Financial Position.

Gross

Gross

(Dollars in millions)

Adjusted

Unrealized

Unrealized

Fair

At September 30, 2017:

Cost

Gains

Losses

Value

Debt securities — noncurrent(1)

$
7

$
3

$
—

$
11

Available-for-sale equity investments(1)

$
1

$
4

$
0

$
5

~~(1) Included within investments and sundry assets in the Consolidated Statement of Financial Position.~~

Gross

Gross

(Dollars in millions)

Adjusted

Unrealized

Unrealized

Fair

At December 31, 2016:

Cost

Gains

Losses

Value

Debt securities — noncurrent(1)

$
5

$
3

$
—

$
8

Available-for-sale equity investments(1)

$
3

$
5

$
0

$
7

~~(1) Included within investments and sundry assets in the Consolidated Statement of Financial Position.~~

~~Sales of debt and available-for-sale equity investments~~ during the ~~period~~three and six month periods ended June 30, 2019 and gross realized gains/losses for the three and six months ended June 30, 2018 were ~~as follows:~~

(Dollars in millions)

For the three months ended September 30:

2017

2016

Proceeds

$
0

$
1

Gross realized gains (before taxes)

0

1

Gross realized losses (before taxes)

—

—

(Dollars in millions)

For the nine months ended September 30:

2017

2016

Proceeds

$
5

$
150

Gross realized gains (before taxes)

1

1

Gross realized losses (before taxes)

2

37

~~The after-tax~~immaterial. After-tax net unrealized holding gains/~~(losses)~~losses on available-for-sale ~~debt and equity~~ securities that have been included in other comprehensive income/~~(loss) for the period and after-tax net (gains)/losses reclassified from accumulated other comprehensive income/(loss) to net income were as follows:~~

~~Notes to Consolidated Financial Statements — (continued)~~

(Dollars in millions)

For the three months ended September 30:

2017

2016

Net unrealized gains/(losses) arising during the period

$
1

$
(1
)
Net unrealized (gains)/losses reclassified to net income*

0

(1
)

*There were no writedownsloss for the three ~~months~~and six month periods ended ~~September~~June 30, ~~2017~~2019 and ~~2016, respectively.~~

(Dollars in millions)

For the nine months ended September 30:

2017

2016

Net unrealized gains/(losses) arising during the period

$
1

$
(22
)
Net unrealized (gains)/losses reclassified to net income*

0

22

* There2018 were ~~no writedowns for the nine months ended September 30, 2017 and 2016, respectively.~~

immaterial.

The contractual maturities of substantially all available-for-sale debt securities are less than one year at ~~September~~June 30, ~~2017.~~

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

Table of Contents

Notes to Consolidated Financial Statements — (continued)

policy of only entering into contracts with carefully selected major financial institutions based upon their overall credit profile. The company’s established policies and procedures for mitigating credit risk on principal transactions include reviewing and establishing limits for credit exposure and continually assessing the creditworthiness of counterparties. The right of set-off that exists under certain of these arrangements enables the legal entities of the company subject to the arrangement to net amounts due to and from the counterparty reducing the maximum loss from credit risk in the event of counterparty default.

The company is also a party to collateral security arrangements with most of its major derivative counterparties. These arrangements require the company to hold or post collateral (cash or U.S. Treasury securities) when the derivative fair values exceed contractually established thresholds. Posting thresholds can be fixed or can vary based on credit default swap pricing or credit ratings received from the major credit agencies. The aggregate fair value of all derivative instruments under these collateralized arrangements that were in a liability position at ~~September~~June 30, ~~2017~~2019 and December 31, ~~2016~~2018 was ~~$45~~$325 million and ~~$11~~$74 million, respectively, for which $8 million of collateral was posted by the company and reduced the position at June 30, 2019 and no collateral was posted at ~~either date.~~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 ~~as of September~~at June 30, ~~2017~~2019 and December 31, ~~2016~~2018 was ~~$957~~$419 million and ~~$1,126~~$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 ~~$274~~$262 million and ~~$116~~$267 million at ~~September~~June 30, ~~2017~~2019 and December 31, ~~2016,~~2018, respectively, of liabilities included in master netting arrangements with those counterparties. Additionally, at ~~September 30, 2017 and~~ December 31, ~~2016,~~2018, this exposure was reduced by ~~$123 million and $141~~$70 million of cash collateral ~~respectively,~~received from counterparties, and ~~$35 million of non-cash~~no collateral ~~in U.S. Treasury securities~~was received at ~~December 31, 2016.~~June 30, 2019. There were no non-cash collateral balances received from counterparties in U.S. Treasury securities at ~~September~~June 30, ~~2017. At September 30, 2017~~2019 and December 31, ~~2016,~~2018. At June 30, 2019 and December 31, 2018, the net exposure related to derivative assets recorded in the Consolidated Statement of Financial Position was ~~$559~~$157 million and ~~$834~~$395 million, respectively. At ~~September~~June 30, ~~2017~~2019 and December 31, ~~2016,~~2018, the net position related to derivative liabilities recorded in the Consolidated Statement of Financial Position was ~~$78~~$320 million and ~~$90~~$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

~~Notes to Consolidated Financial Statements — (continued)~~

against the fair values of the related derivative instruments. The amount recognized in other receivables for the right to reclaim cash collateral was $8 million at June 30, 2019. No amount was recognized in other receivables at ~~September 30, 2017 or~~ December 31, ~~2016~~2018 for the right to reclaim cash collateral. The amount recognized in accounts payable for the obligation to return cash collateral was ~~$123 million and $141~~$70 million at ~~September 30, 2017 and~~ December 31, ~~2016, respectively.~~2018. No amount was recognized in accounts payable for the obligation to return cash collateral at June 30, 2019. The company restricts the use of cash collateral received to rehypothecation, and therefore reports it in ~~prepaid expenses and other current assets~~restricted cash in the Consolidated Statement of Financial Position. No amount was rehypothecated at ~~September~~June 30, ~~2017~~2019 and December 31, ~~2016.~~

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 ~~uses~~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.

Table of Contents

Notes to Consolidated Financial Statements — (continued)

Interest Rate Risk

Fixed and Variable Rate Borrowings

The company issues debt in the global capital markets to fund its operations and financing business. Access to cost-effective financing can result in interest rate mismatches with the underlying assets. To manage these mismatches and to reduce overall interest cost, the company ~~uses~~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 ~~September~~June 30, ~~2017~~2019 and December 31, ~~2016,~~2018, the total notional amount of the company’s ~~interest rate~~interest-rate swaps was ~~$9.1~~$5.5 billion and ~~$7.3~~$7.6 billion, respectively. The weighted-average remaining maturity of these instruments at ~~September~~June 30, ~~2017~~2019 and December 31, ~~2016~~2018 was approximately ~~5.0~~2.5 years and ~~6.2~~3.5 years, respectively.

These interest-rate contracts were accounted for as fair value hedges. The company did not have any cash flow hedges relating to this program outstanding at June 30, 2019 and December 31, 2018.

Forecasted Debt Issuance

The company is exposed to interest rate volatility on future debt issuances. To manage this risk, the company may use instruments such as forward starting interest-rate swaps to lock in the rate on the interest payments related to the forecasted debt ~~issuance.~~issuances. On May 15, 2019, the company issued an aggregate of $20 billion of indebtedness (see note 13, “Borrowings,” for additional information). Following the receipt of the net proceeds from this debt offering, the company terminated $5.5 billion of forward starting interest-rate swaps. These ~~swaps are~~instruments were designated and accounted for as cash flow ~~hedges. The company did not have any derivative~~hedges for a portion of this issuance and hedged exposure to the variability in future cash flows over a maximum of 30 years. These swaps were the only instruments ~~relating to~~outstanding under this program at December 31, 2018, and there were no instruments outstanding at ~~September~~June 30, ~~2017 and December 31, 2016.~~2019.

~~At December 31, 2016, net gains of less than $1 million (before taxes) were recorded in accumulated other comprehensive income/(loss) in~~In connection with cash flow hedges of forecasted interest payments related to the ~~company’s borrowings. During 2017, all gains~~company's borrowings, the company recorded net losses of $201 million and net losses ~~associated with this program~~of $35 million (before taxes) at June 30, 2019 and December 31, 2018, respectively, in AOCI. The company estimates that ~~were recorded~~$18 million (before taxes) of the deferred net losses on derivatives in ~~other comprehensive income/(loss) were~~AOCI at June 30, 2019 will be reclassified to net income ~~and there are no gains and losses remaining in accumulated other comprehensive income/(loss) at September 30, 2017.~~

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 ~~September~~June 30, ~~2017~~2019 and December 31, ~~2016,~~2018, the total notional amount of derivative instruments designated as net investment hedges was ~~$8.8~~$6.5 billion and ~~$6.7~~$6.4 billion, respectively. At ~~September~~June 30, ~~2017~~2019 and December 31, ~~2016,~~2018, the weighted-average remaining maturity of these instruments was approximately ~~0.1 years and~~ 0.2 years ~~respectively.~~

~~Notes to Consolidated Financial Statements — (continued)~~

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 ~~September~~June 30, ~~2017~~2019 and December 31, ~~2016,~~2018, the total notional amount of forward contracts designated as cash flow hedges of forecasted royalty and cost transactions was ~~$7.9~~$10.0 billion and ~~$8.3~~ $9.8

Table of Contents

Notes to Consolidated Financial Statements — (continued)

billion, respectively. ~~The~~At June 30, 2019 and December 31, 2018, the weighted-average remaining maturity of these instruments ~~at September 30, 2017 and December 31, 2016~~ was ~~0.7~~approximately 0.8 years at both periods.

At ~~September~~June 30, ~~2017~~2019 and December 31, ~~2016,~~2018, in connection with cash flow hedges of anticipated royalties and cost transactions, the company recorded net ~~losses~~gains of ~~$70~~$238 million and net gains of ~~$462~~$342 million (before taxes), respectively, in ~~accumulated other comprehensive income/(loss). Within these amounts, $161~~AOCI. The company estimates that $133 million (before taxes) of ~~losses and $397 million of~~deferred net gains ~~respectively, are expected to~~on derivatives in AOCI at June 30, 2019 will be reclassified to net income within the next 12 months, providing an offsetting economic impact against the underlying anticipated transactions.

Foreign Currency Denominated Borrowings

The company is exposed to exchange rate volatility on foreign currency denominated debt. To manage this risk, the company employs cross-currency swaps to convert fixed-rate foreign currency denominated debt to fixed-rate debt denominated in the functional currency of the borrowing entity. These swaps are accounted for as cash flow hedges. The maximum length of time over which the company has hedged its exposure to the variability in future cash flows is approximately ~~nine~~12 years. At ~~September~~June 30, ~~2017~~2019 and December 31, ~~2016,~~2018, the total notional amount of cross-currency swaps designated as cash flow hedges of foreign currency denominated debt was ~~$1.4~~$12.2 billion ~~at both periods.~~

and $6.5 billion, respectively.

At ~~September~~June 30, ~~2017~~2019 and December 31, ~~2016,~~2018, in connection with cash flow hedges of foreign currency denominated borrowings, the company recorded net ~~gains~~losses of ~~$16~~$84 million and net gains of ~~$29~~$75 million (before taxes), respectively, in ~~accumulated other comprehensive income/(loss). Within these amounts, $34~~AOCI. The company estimates that $305 million (before taxes) of deferred net gains ~~and $27 million of gains, respectively, are expected to~~on derivatives in AOCI at June 30, 2019 will be reclassified to net income within the next 12 months, providing an offsetting economic impact against the underlying exposure.

Subsidiary Cash and Foreign Currency Asset/Liability Management

The company uses its Global Treasury Centers to manage the cash of its subsidiaries. These centers principally use currency swaps to convert cash flows in a cost-effective manner. In addition, the company uses foreign exchange forward contracts to economically hedge, on a net basis, the foreign currency exposure of a portion of the company’s nonfunctional currency assets and liabilities. The terms of these forward and swap contracts are generally less than one year. The changes in the fair values of these contracts and of the underlying hedged exposures are generally offsetting and are recorded in other (income) and expense in the Consolidated Statement of Earnings. At ~~September~~June 30, ~~2017~~2019 and December 31, ~~2016,~~2018, the total notional amount of derivative instruments in economic hedges of foreign currency exposure was ~~$10.8~~$6.7 billion and ~~$12.7~~$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 ~~selling, general and administrative (SG&A)~~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 ~~September~~June 30, ~~2017~~2019 and December 31, ~~2016,~~2018, the total notional amount of derivative instruments in economic hedges of these compensation obligations was $1.2 billion at both periods.

~~Notes to Consolidated Financial Statements — (continued)~~

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

Table of Contents

Notes to Consolidated Financial Statements — (continued)

changes in the fair value of these warrants in other (income) and expense in the Consolidated Statement of Earnings. The company did not have any warrants qualifying as derivatives outstanding at ~~September~~June 30, ~~2017~~2019 and December 31, ~~2016.~~

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 ~~September~~June 30, ~~2017~~2019 and December 31, ~~2016.~~

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 ~~September~~June 30, ~~2017~~2019 and December 31, ~~2016,~~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 ~~as of September~~at June 30, ~~2017~~2019 and December 31, ~~2016,~~2018, as well as for the three and ~~nine~~six months ended ~~September~~June 30, ~~2017~~2019 and ~~2016,~~2018, respectively.

Table of Contents

Notes to Consolidated Financial Statements — (continued)

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

~~As of September 30, 2017 and December 31, 2016~~

Fair Value of Derivative Assets

Fair Value of Derivative Liabilities

Balance Sheet

Balance Sheet

(Dollars in millions)

Classification

9/30/2017

12/31/2016

Classification

9/30/2017

12/31/2016

Designated as hedging instruments:

Interest rate contracts:

Prepaid expenses and other current assets

$
—

$
—

Other accrued expenses and liabilities

$
1

$
—

Investments and sundry assets

517

555

Other liabilities

15

8

Foreign exchange contracts:

Prepaid expenses and other current assets

208

421

Other accrued expenses and liabilities

272

46

Investments and sundry assets

170

17

Other liabilities

5

35

Fair value of derivative assets

$
896

$
993

Fair value of derivative liabilities

$
292

$
89

Not designated as hedging instruments:

Foreign exchange contracts:

Prepaid expenses and other current assets

$
38

$
100

Other accrued expenses and liabilities

$
56

$
89

Investments and sundry assets

—

22

Other liabilities

—

18

Equity contracts:

Prepaid expenses and other current assets

23

11

Other accrued expenses and liabilities

4

10

Investments and sundry assets

—

—

Other liabilities

—

—

Fair value of derivative assets

$
61

$
133

Fair value of derivative liabilities

$
60

$
117

Total Derivatives

$
957

$
1,126

$
352

$
206

Total debt designated as hedging instruments(1):

Short-term debt

N/A

N/A

$
377

$
1,125

Long-term debt

N/A

N/A

11,469

7,844

N/A

N/A

$
11,846

$
8,969

Total

$
957

$
1,126

$
12,198

$
9,175


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

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

N/A - not applicable

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

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


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

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

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

Table of Contents

Notes to Consolidated Financial Statements — (continued)

The Effect of Derivative Instruments in the Consolidated Statement of Earnings

~~For~~The total amounts of income and expense line items presented in the ~~three months ended September 30, 2017~~Consolidated Statement of Earnings in which the effects of fair value hedges, cash flow hedges, net investment hedges and ~~2016~~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:

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 September 30:

Earnings Line Item

2017

2016

2017

2016

Derivative instruments in fair value hedges(1)(5):

Interest rate contracts

Cost of financing

$
(3
)
$
(20
)
$
20

$
40

Interest expense

(3
)
(21
)
20

43

Derivative instruments not designated as hedging instruments:

Foreign exchange contracts

Other (income) and expense

(35
)
30

N/A

N/A

Interest rate contracts

Other (income) and expense

—

0

N/A

N/A

Equity contracts

SG&A expense

31

45

N/A

N/A

Other (income) and expense

—

0

N/A

N/A

Total

$
(10
)
$
34

$
41

$
83

Gain (Loss) Recognized in Earnings and Other Comprehensive Income

Ineffectiveness and

(Dollars in millions)

Effective Portion

Consolidated

Effective Portion Reclassified

Amounts Excluded from

For the three months

Recognized in OCI

Statement of

from AOCI

Effectiveness Testing(3)

ended September 30:

2017

2016

Earnings Line Item

2017

2016

2017

2016

Derivative instruments in cash flow hedges:

Interest rate contracts

$
—

$
—

Interest expense

$
(7
)
$
(7
)
$
—

$
—

Foreign exchange contracts

(70
)
35

Other (income) and expense

64

(6
)
(1
)
(1
)

Cost of sales*

1

(7
)
—

—

Cost of services*

20

3

—

—

SG&A expense

(6
)
2

—

—

Instruments in net investment hedges(4):

Foreign exchange contracts

(507
)
(131
)
Cost of financing

—

—

0

—

Interest expense

—

—

8

25

Total

$
(577
)
$
(96
)

$
73

$
(15
)
$
7

$
24


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

* Reclassified to conform to ~~2017 presentation~~2019 presentation.

Table of Contents

~~N/A - not applicable~~

Note: OCI represents other comprehensive income/(loss) in the Consolidated Statement of Comprehensive Income and AOCI represents accumulated other comprehensive income/(loss) in the Consolidated Statement of Changes in Equity.

~~(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 amount of gain/(loss) recognized in income represents ineffectiveness on hedge relationships.~~

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

~~(5)~~ ~~For the three month periods ended September 30, 2017 and 2016, fair value hedges resulted in a loss of less than $1 million and a loss of $3 million in ineffectiveness, respectively.~~

Notes to Consolidated Financial Statements — (continued)


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

~~The Effect of Derivative Instruments in the Consolidated Statement of Earnings~~

~~For the nine months ended September 30, 2017 and 2016~~

Gain (Loss) Recognized in Earnings

Consolidated

Recognized on

Attributable to Risk

(Dollars in millions)

Statement of

Derivatives

Being Hedged(2)

For the nine months ended September 30:

Earnings Line Item

2017

2016

2017

2016

Derivative instruments in fair value hedges(1)(5):

Interest rate contracts

Cost of financing

$
37

$
195

$
22

$
(127
)

Interest expense

34

214

20

(140
)
Derivative instruments not designated as hedging instruments:

Foreign exchange contracts

Other (income) and expense

74

335

N/A

N/A

Interest rate contracts

Other (income) and expense

—

0

N/A

N/A

Equity contracts

SG&A expense

88

87

N/A

N/A

Other (income) and expense

—

(1
)
N/A

N/A

Total

$
233

$
830

$
42

$
(267
)

Gain (Loss) Recognized in Earnings and Other Comprehensive Income

Ineffectiveness and

(Dollars in millions)

Effective Portion

Consolidated

Effective Portion Reclassified

Amounts Excluded from

For the nine months

Recognized in OCI

Statement of

from AOCI

Effectiveness Testing(3)

ended September 30:

2017

2016

Earnings Line Item

2017

2016

2017

2016

Derivative instruments in cash flow hedges:

Interest rate contracts

$
—

$
—

Interest expense

$
(21
)
$
(17
)
$
—

$
—

Foreign exchange contracts

(198
)
(221
)
Other (income) and expense

275

6

2

(1
)

Cost of sales*

23

(5
)
—

—

Cost of services*

47

(9
)
—

—

SG&A expense

23

(1
)
—

—

Instruments in net investment hedges(4):

Foreign exchange contracts

(1,513
)
(1,071
)
Cost of financing

—

—

0

—

Interest expense

—

—

34

51

Total

$
(1,712
)
$
(1,292
)

$
347

$
(26
)
$
37

$
49


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

* Reclassified to conform to ~~2017~~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~~A - not applicable


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

* Reclassified to conform to 2019 presentation.

~~Note: OCI represents other comprehensive income/(loss) in the~~

Table of Contents

Notes to Consolidated ~~Statement of Comprehensive Income and AOCI represents accumulated other comprehensive income/(loss) in the Consolidated Statement of Changes in Equity.~~Financial Statements — (continued)


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


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

* Reclassified to conform to 2019 presentation.

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

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

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

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

N/A - not applicable

~~(3)~~ ~~The amount of gain/(loss) recognized in income represents ineffectiveness on hedge relationships.~~

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

~~(5)~~ ~~For the nine month periods ended September 30, 2017 and 2016, fair value hedges resulted in a loss of less than $1 million and a gain of less than $1 million in ineffectiveness, respectively.~~

For the three and ~~nine~~six months ending ~~September~~June 30, ~~2017~~2019 and ~~2016,~~2018, there were no ~~significant~~material gains or losses excluded from the assessment of hedge effectiveness (for fair value or cash flow hedges), or associated with an underlying exposure that did not or was not expected to occur (for cash flow hedges); nor are there any anticipated in the normal course of business.

5. Leases:

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

Table of Contents

Notes to Consolidated Financial Statements — (continued)

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

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

Accounting for leases as a lessee

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

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

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

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

Table of Contents

4. ~~Financing Receivables:~~Notes to Consolidated Financial Statements — (continued)

The following tables present the various components of lease costs:


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


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

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

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


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

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

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


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

Table of Contents

Notes to Consolidated Financial Statements — (continued)

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


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

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

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

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


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

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

Accounting for leases as a lessor

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

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

Table of Contents

Notes to Consolidated Financial Statements — (continued)

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

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

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


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


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

Sales-Type and Direct Financing Leases

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

Table of Contents

Notes to Consolidated Financial Statements — (continued)

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

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

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

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


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

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

At September 30,

At December 31,

(Dollars in millions)

2017

2016

Current:

Net investment in sales-type and direct financing leases

$
3,092

$
2,909

Commercial financing receivables

8,563

9,706

Client loan and installment payment receivables (loans)

6,395

6,390

Total

$
18,050

$
19,006

Noncurrent:

Net investment in sales-type and direct financing leases

$
3,579

$
3,950

Client loan and installment payment receivables (loans)

4,879

5,071

Total

$
8,459

$
9,021

Operating Leases

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

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

Table of Contents

Notes to Consolidated Financial Statements — (continued)

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


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

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

6. Financing Receivables:

Financing receivables primarily consist of client loan and installment payment receivables (loans), investment in sales-type and direct financing leases and commercial financing receivables. Client loan and installment payment receivables (loans) are provided primarily to clients to finance the purchase of hardware, software and services. Payment terms on these financing arrangements are generally for terms up to seven years. Client loans and installment payment financing contracts are priced independently at competitive market rates. Investment in sales-type and direct financing leases relates principally to the company’s Systems products and are for terms ranging generally from two to six years. Net investment in sales-type and direct financing leases includes unguaranteed residual values of $567 million and $585 million at September 30, 2017 and December 31, 2016, respectively, and is reflected net of unearned income of $459 million and $513 million, and net of allowance for credit losses of $118 million and $133 million at those dates, respectively.

Commercial financing receivables ~~net of allowance for credit losses of $21 million and $28 million at September 30, 2017 and December 31, 2016, respectively,~~ relate primarily to inventory and accounts receivable financing for dealers and remarketers of IBM and OEM products. Payment terms for inventory and accounts receivable financing generally range from 30 to 90 days. Beginning in the second quarter of 2019 and continuing throughout the year, the company is winding down the portion of its commercial financing operations which provides short-term working capital solutions for OEM information technology suppliers, distributors and resellers, which has resulted in a reduction of commercial financing receivables. This wind down is consistent with IBM’s capital allocation strategy and high-value focus. IBM Global Financing will continue to provide differentiated end-to-end financing solutions, including commercial financing in support of IBM partner relationships.

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

~~Client loan and installment payment receivables (loans), net~~


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

Table of ~~allowance for credit losses of $215 million and $276 million at September 30, 2017 and December 31, 2016, respectively, are loans that are provided primarily~~Contents

Notes 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.~~Consolidated Financial Statements — (continued)


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

~~Client loan and installment payment financing contracts are priced independently at competitive market rates. The company has a history of enforcing the terms of these financing agreements.~~

The company utilizes certain of its financing receivables as collateral for nonrecourse borrowings. Financing receivables pledged as collateral for borrowings were ~~$640~~$938 million and ~~$689~~$710 million at ~~September~~June 30, ~~2017~~2019 and December 31, ~~2016,~~2018, respectively.

The company did not have any financing receivables held for sale as of ~~September~~June 30, ~~2017~~2019 and December 31, ~~2016.~~2018.

Table of Contents

Notes to Consolidated Financial Statements — (continued)

Financing Receivables by Portfolio Segment

The following tables present ~~financing receivables on a gross basis, excluding~~ the ~~allowance for credit losses and residual value,~~recorded investment by portfolio segment and by class, excluding commercial financing receivables and other miscellaneous financing receivables at ~~September~~June 30, ~~2017~~2019 and December 31, ~~2016.~~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. ~~This portfolio segmentation was changed from growth markets~~


(Dollars in millions)
At June 30, 2019:	Americas		EMEA		Asia Pacific		Total
Recorded investment
Lease receivables	$	3,336	$	1,149	$	1,020	$	5,505
Loan receivables		6,208		3,443	$	2,538	$	12,189
Ending balance	$	9,544	$	4,592	$	3,558	$	17,694
Recorded investment collectively evaluated for impairment	$	9,400	$	4,544	$	3,509	$	17,453
Recorded investment individually evaluated for impairment	$	144	$	48	$	49	$	241

Allowance for credit losses
Beginning balance at January 1, 2019
Lease receivables	$	53	$	22	$	24	$	99
Loan receivables		105		43	$	32	$	179
Total	$	158	$	65	$	56	$	279
Write-offs	$	(11)	$	(2)	$	(3)	$	(16)
Recoveries		0		0	$	0	$	0
Provision / (benefit)		(1)		(6)	$	0	$	(7)
Other*		6		0	$	0	$	6
Ending balance at June 30, 2019	$	152	$	57	$	54	$	263
Lease receivables	$	48	$	17	$	24	$	89
Loan receivables	$	104	$	41	$	30	$	175

Related allowance, collectively evaluated for impairment	$	31	$	12	$	5	$	48
Related allowance, individually evaluated for impairment	$	122	$	45	$	49	$	215

* Primarily represents translation adjustments.

Write-offs of lease receivables and ~~major markets in 2017 as~~loan receivables were $8 million each, for the ~~company no longer manages~~six months ended June 30, 2019. Provisions for credit losses recorded for lease receivables were a release of $6 million for the ~~business under those market delineations. There was no impact to segment reporting or~~six months ended June 30, 2019, with the ~~company’s Consolidated Financial Statements.~~remainder of the current period benefit released for loan receivables.

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

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

Table of Contents

Notes to Consolidated Financial Statements — (continued)

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

(Dollars in millions)

At September 30, 2017

Americas

EMEA

Asia Pacific

Total

Financing receivables

Lease receivables

$
3,541

$
1,297

$
1,304

$
6,142

Loan receivables

6,180

3,120

2,189

11,489

Ending balance

$
9,721

$
4,417

$
3,493

$
17,631

Collectively evaluated for impairment

$
9,581

$
4,386

$
3,391

$
17,358

Individually evaluated for impairment

$
140

$
31

$
102

$
273

Allowance for credit losses

Beginning balance at January 1, 2017

Lease receivables

$
54

$
4

$
76

$
133

Loan receivables

169

18

89

276

Total

$
223

$
22

$
165

$
410

Write-offs

$
(49
)
$
0

$
(63
)
$
(112
)
Recoveries

0

0

0

0

Provision

11

9

(4
)
16

Other

12

5

2

19

Ending balance at September 30, 2017

$
197

$
36

$
100

$
333

Lease receivables

$
77

$
6

$
35

$
118

Loan receivables

$
120

$
29

$
65

$
215

Collectively evaluated for impairment

$
66

$
12

$
6

$
85

Individually evaluated for impairment

$
131

$
23

$
94

$
248

(Dollars in millions)

At December 31, 2016:*

Americas

EMEA

Asia Pacific

Total

Financing receivables:

Lease receivables

$
3,830

$
1,171

$
1,335

$
6,336

Loan receivables

6,185

3,309

2,243

11,737

Ending balance

$
10,015

$
4,480

$
3,578

$
18,073

Collectively evaluated for impairment

$
9,847

$
4,460

$
3,419

$
17,726

Individually evaluated for impairment

$
168

$
20

$
159

$
347

Allowance for credit losses

Beginning balance at January 1, 2016

Lease receivables

$
52

$
17

$
143

$
213

Loan receivables

122

55

200

377

Total

$
175

$
72

$
343

$
590

Write-offs

$
(36
)
$
(48
)
$
(154
)
$
(237
)
Recoveries

2

0

0

2

Provision

65

(1
)
(6
)
58

Other

17

(1
)
(18
)
(3
)
Ending balance at December 31, 2016

$
223

$
22

$
165

$
410

Lease receivables

$
54

$
4

$
76

$
133

Loan receivables

$
169

$
18

$
89

$
276

Collectively evaluated for impairment

$
62

$
13

$
15

$
90

Individually evaluated for impairment

$
161

$
9

$
150

$
320


(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

* ~~Reclassified to conform to 2017 presentation.~~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,

Table of Contents

Notes to Consolidated Financial Statements — (continued)

~~Financing Receivables on Non-Accrual Status~~

~~The following table presents the~~including recorded investments aged over 90 days and still accruing, billed invoices aged over 90 days and still accruing, and recorded investment ~~in financing receivables which were on non-accrual status at September 30, 2017 and December 31, 2016.~~not accruing.

At September 30,

At December 31,

(Dollars in millions)

2017

2016*

Americas

$
25

$
23

EMEA

0

2

Asia Pacific

4

14

Total lease receivables

$
30

$
40

Americas

$
79

$
128

EMEA

53

5

Asia Pacific

10

12

Total loan receivables

$
142

$
145

Total receivables

$
172

$
185


					Recorded		Billed		Recorded
	Total		Recorded		Investment		Invoices		Investment
(Dollars in millions)	Recorded		Investment		> 90 Days and		> 90 Days and		Not
At June 30, 2019:	Investment		> 90 Days⁽¹⁾		Accruing⁽¹⁾		Accruing		Accruing⁽²⁾
Americas	$	3,336	$	364	$	345	$	13	$	39
EMEA		1,149		31		12		4		19
Asia Pacific		1,020		25		13		2		13
Total lease receivables	$	5,505	$	421	$	370	$	19	$	71

Americas	$	6,208	$	204	$	105	$	17	$	120
EMEA		3,443		85		15		3		71
Asia Pacific		2,538		42		10		5		34
Total loan receivables	$	12,189	$	330	$	129	$	25	$	224

Total	$	17,694	$	751	$	499	$	44	$	295

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

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


					Recorded		Billed		Recorded
	Total		Recorded		Investment		Invoices		Investment
(Dollars in millions)	Recorded		Investment		> 90 Days and		> 90 Days and		Not
At December 31, 2018:	Investment		> 90 Days⁽¹⁾		Accruing⁽¹⁾		Accruing		Accruing⁽²⁾
Americas	$	3,827	$	310	$	256	$	19	$	57
EMEA		1,341		25		9		1		16
Asia Pacific		1,152		49		27		3		24
Total lease receivables	$	6,320	$	385	$	292	$	24	$	97

Americas	$	6,817	$	259	$	166	$	24	$	99
EMEA		3,675		98		25		3		73
Asia Pacific		2,489		40		11		1		31
Total loan receivables	$	12,981	$	397	$	202	$	29	$	203

Total	$	19,301	$	782	$	494	$	52	$	300

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

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

* Reclassified to conform to 2017 presentation.

~~Impaired Receivables~~

~~The company considers any receivable with an individually evaluated reserve as an impaired receivable. Depending on the level of impairment, receivables will also be placed on non-accrual status.~~

~~The following tables present impaired receivables. This presentation includes both loan and lease receivables.~~

At September 30, 2017

At December 31, 2016*

Recorded

Related

Recorded

Related

(Dollars in millions)

Investment

Allowance

Investment

Allowance

Americas

$
140

$
131

$
168

$
161

EMEA

31

23

20

9

Asia Pacific

102

94

159

150

Total

$
273

$
248

$
347

$
320

* Reclassified to conform to 2017 presentation.

Interest

Average

Interest

Income

(Dollars in millions)

Recorded

Income

Recognized on

For the three months ended September 30, 2017:

Investment

Recognized

Cash Basis

Americas

$
156

$
0

$
—

EMEA

31

0

—

Asia Pacific

101

0

—

Total

$
288

$
0

$
—

Interest

Average

Interest

Income

(Dollars in millions)

Recorded

Income

Recognized on

For the three months ended September 30, 2016:*

Investment

Recognized

Cash Basis

Americas

$
182

$
0

$
—

EMEA

61

0

—

Asia Pacific

302

0

—

Total

$
545

$
0

$
—

* Reclassified to conform to 2017 presentation.

~~Notes to Consolidated Financial Statements — (continued)~~

Interest

Average

Interest

Income

(Dollars in millions)

Recorded

Income

Recognized on

For the nine months ended September 30, 2017:

Investment

Recognized

Cash Basis

Americas

$
165

$
0

$
—

EMEA

27

0

—

Asia Pacific

131

0

—

Total

$
323

$
0

$
—

Interest

Average

Interest

Income

(Dollars in millions)

Recorded

Income

Recognized on

For the nine months ended September 30, 2016:*

Investment

Recognized

Cash Basis

Americas

$
158

$
0

$
—

EMEA

65

0

—

Asia Pacific

322

0

—

Total

$
545

$
0

$
—

* Reclassified to conform to 2017 presentation.

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 ~~net~~ recorded investment net of allowance for credit losses for each class of receivables, by credit quality indicator, at ~~September~~June 30, ~~2017~~2019 and December 31, ~~2016.~~2018. Receivables with a credit quality indicator ranging

Table of Contents

Notes to Consolidated Financial Statements — (continued)

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

	Lease Receivables						Loan Receivables

(Dollars in millions)					Asia						Asia		Lease Receivables						Loan Receivables
At September 30, 2017:	Americas		EMEA		Pacific		Americas		EMEA		Pacific
Credit Ratings:
At June 30, 2019:													Americas		EMEA		Asia Pacific		Americas		EMEA		Asia Pacific
Credit ratings:
Aaa – Aa3	$	358	$	52	$	56	$	626	$	124	$	94	$	428	$	12	$	60	$	998	$	160	$	185
A1 – A3	715		126		543		1,251		302		908			750		137		488		859		219		834
Baa1 – Baa3	807		404		329		1,412		968		550			780		365		170		1,615		1,271		718
Ba1 – Ba2	762		415		172		1,333		993		289			834		412		127		1,554		947		556
Ba3 – B1	421		197		86		736		473		143			229		136		96		461		542		130
B2 – B3	345		83		69		604		200		116			251		65		50		589		240		77
Caa – D	56		13		15		98		31		25			18		4		5		27		23		9
Total	$	3,465	$	1,290	$	1,269	$	6,059	$	3,091	$	2,124	$	3,288	$	1,132	$	996	$	6,103	$	3,402	$	2,508


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

At September 30, 2017, the industries which made up Global Financing’s receivables portfolio consisted of: Financial (33 percent), Government (14 percent), Manufacturing (14 percent), Services (13 percent), Retail (8 percent), Communications (7 percent), Healthcare (6 percent) and Other (5 percent).

~~Notes to Consolidated Financial Statements — (continued)~~

Lease Receivables

Loan Receivables

(Dollars in millions)

Asia

Asia

At December 31, 2016:*

Americas

EMEA

Pacific

Americas

EMEA

Pacific

Credit Ratings:

Aaa – Aa3

$
447

$
51

$
53

$
712

$
143

$
90

A1 – A3

782

113

486

1,246

318

832

Baa1 – Baa3

772

366

330

1,230

1,032

565

Ba1 – Ba2

822

350

185

1,309

987

316

Ba3 – B1

574

208

106

914

585

182

B2 – B3

297

71

84

472

201

143

Caa – D

83

9

15

133

25

25

Total

$
3,776

$
1,167

$
1,259

$
6,016

$
3,291

$
2,154

* Reclassified to conform to 2017 presentation.

At December 31, 2016, the industries which made up Global Financing’s receivables portfolio consisted of: Financial (34 percent), Government (14 percent), Manufacturing (13 percent), Services (12 percent), Retail (8 percent), Communications (7 percent), Healthcare (6 percent) and Other (6 percent).

~~Past Due Financing Receivables~~

Fully

<90 Days

Recorded

Total

Reserved

or Unbilled

Total

Investment

(Dollars in millions)

Past Due

Financing

Financing

Financing

> 90 Days and

At September 30, 2017:

> 90 days (1)

Receivables

Receivables

Receivables

Accruing (2)

Americas

$
28

$
51

$
3,463

$
3,541

$
255

EMEA

9

4

1,283

1,297

15

Asia Pacific

5

32

1,266

1,304

19

Total lease receivables

$
42

$
87

$
6,012

$
6,142

$
290

Americas

$
43

$
80

$
6,057

$
6,180

$
401

EMEA

26

19

3,076

3,120

46

Asia Pacific

6

61

2,122

2,189

9

Total loan receivables

$
75

$
160

$
11,255

$
11,489

$
456

Total

$
117

$
247

$
17,267

$
17,631

$
746

~~(1) Only the portion of a financing receivable which is greater than 90 days past due, excluding amounts that are fully reserved.~~

~~(2) At a contract level, which includes total billed and unbilled amounts for aged financing receivables greater than 90 days.~~

Fully

<90 Days

Recorded

Total

Reserved

or Unbilled

Total

Investment

(Dollars in millions)

Past Due

Financing

Financing

Financing

> 90 Days and

At December 31, 2016:*

> 90 days (1)

Receivables

Receivables

Receivables

Accruing (2)

Americas

$
17

$
20

$
3,793

$
3,830

$
66

EMEA

2

10

1,159

1,171

6

Asia Pacific

12

59

1,264

1,335

40

Total lease receivables

$
31

$
89

$
6,216

$
6,336

$
111

Americas

$
19

$
90

$
6,075

$
6,185

$
80

EMEA

5

5

3,299

3,309

15

Asia Pacific

6

87

2,150

2,243

46

Total loan receivables

$
31

$
182

$
11,524

$
11,737

$
141

Total

$
62

$
271

$
17,740

$
18,073

$
253

~~(1) Only the portion of a financing receivable which is greater than 90 days past due, excluding amounts that are fully reserved.~~

~~(2) At a contract level, which includes total billed and unbilled amounts for aged financing receivables greater than 90 days.~~

* Reclassified to conform to 2017 presentation.

~~Notes to Consolidated Financial Statements — (continued)~~

Troubled Debt Restructurings

The company did not have any significant troubled debt restructurings during the ~~nine~~six months ended ~~September~~June 30, ~~2017~~2019 or for the year ended December 31, ~~2016.~~2018 .

5. 7. Stock-Based Compensation:

Stock-based compensation cost is measured at grant date, based on the fair value of the award, and is recognized over the employee requisite service period. The following table presents total stock-based compensation cost included in income from continuing operations.

	Three Months Ended September 30,						Nine Months Ended September 30,



													Three Months Ended June 30,				Six Months Ended June 30,
(Dollars in millions)	2017			2016			2017			2016			2019		2018		2019		2018
Cost	$	22		$	23		$	68		$	67		$	22	$	21	$	42	$	41
Selling, general and administrative	88			105			277			295				93		88		167		169
Research, development and engineering	13			14			43			41				21		16		39		32
Pre-tax stock-based compensation cost	123			142			388			403			$	135	$	125	$	248	$	242
Income tax benefits	(41		)	(47		)	(128		)	(131		)		(29)		(24)		(54)		(59)
Total net stock-based compensation cost	$	82		$	95		$	260		$	272		$	106	$	102	$	194	$	183

Pre-tax stock-based compensation cost for the three months ended ~~September~~June 30, ~~2017 decreased $19~~2019 increased $10 million compared to the corresponding period in the prior year. This was due to ~~decreases~~an increase related to restricted stock units ($13 million), partially offset by decreases in performance share units ($111 million), stock options ($1 million) and the conversion of stock-based ~~awards~~compensation previously issued by acquired entities ($~~7 million) and restricted stock units ($2~~1 million).

Table of Contents

Notes to Consolidated Financial Statements — (continued)

Pre-tax stock-based compensation cost for the ~~nine~~six months ended ~~September~~June 30, ~~2017 decreased $15~~2019 increased $7 million compared to the corresponding period in the prior year. This was due to ~~decreases~~an increase related to restricted stock units ($16 million), partially offset by decreases in performance share units ($5 million), stock options ($2 million) and the conversion of stock-based ~~awards~~compensation previously issued by acquired entities ($202 million) ~~and performance share units ($17 million), partially offset by an increase in restricted stock units ($22 million)~~.

The implementation of the new FASB guidance for share-based payment transactions resulted in an immaterial impact to income tax benefits as of the three months and nine months ended September 30, 2017. Refer to note 2, “Accounting Changes,” for additional information.

As of ~~September~~June 30, ~~2017,~~2019, the total unrecognized compensation cost of ~~$905 million~~$1.0 billion related to non-vested awards was expected to be recognized over a weighted-average period of approximately ~~2.6~~2.8 years.

There was no significant capitalized stock-based compensation cost at ~~September~~June 30, ~~2017~~2019 and ~~2016.~~

2018.

6. 8.Segments: ~~The tables on pages 29~~

In the first quarter of 2019, the company made a number of changes to its organizational structure and ~~30 reflect~~management system that brought cloud and cognitive software under one organization to more effectively address evolving client needs and to prepare for the acquisition of Red Hat, Inc. (Red Hat). With these changes, the company has revised its reportable segments, but did not impact its Consolidated Financial Statements. In addition, the company is presenting the results of its announced divestitures in an “Other” segment, as the realignment of these businesses allows for a better representation of management’s view of the company, as well as the ongoing operational performance of the reportable segments. The company’s segments are as follows:


2018 Segments	Changes (+/-)	2019 Segments

Cognitive Solutions	+ Integration Software	Cloud & Cognitive Software
	+ Security Services
	- Divested Select Software*
	+ Red Hat (post closing)

Global Business Services	- Divested Mortgage Servicing**	Global Business Services

Technology Services & Cloud Platforms	- Security Services	Global Technology Services
	- Integration Software

Systems		Systems

Global Financing		Global Financing

Other	+ Divested Mortgage Servicing**	Other
	+ Divested Select Software*

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

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

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

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

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 June 30, 2019:
External revenue	$	5,645		$	4,155		$	6,837		$	1,753		$	351		$	18,741
Internal revenue		607			69			302			171			281			1,430
Total revenue	$	6,252		$	4,224		$	7,139		$	1,924		$	632		$	20,170
Pre-tax income/(loss) from continuing operations	$	2,001		$	300		$	235		$	61		$	239		$	2,836
Revenue year-to-year change		(0.5)	%		0.1	%		(4.7)	%		(20.5)	%		(27.1)	%		(5.2)	%
Pre-tax income year-to-year change		(1.4)	%		(19.4)	%		(47.9)	%		(82.3)	%		(33.1)	%		(20.2)	%
Pre-tax income/(loss) margin		32.0	%		7.1	%		3.3	%		3.2	%		37.8	%		14.1	%

For the three months ended June 30, 2018:
External revenue	$	5,470	*	$	4,135	*	$	7,325	*	$	2,177		$	394		$	19,500	*
Internal revenue		811	*		83			169			242			473			1,778	*
Total revenue	$	6,280	*	$	4,218	*	$	7,494	*	$	2,419		$	867		$	21,278	*
Pre-tax income/(loss) from continuing operations	$	2,029	*	$	372	*	$	451	*	$	346		$	357		$	3,556	*
Pre-tax income/(loss) margin		32.3	%*		8.8	%*		6.0	%*		14.3	%		41.2	%		16.7	%*

* Recast to conform to 2019 presentation.

~~SEGMENT INFORMATION~~

Cognitive Solutions &
Industry Services

Technology

Global

Services &

Cognitive

Business

Cloud

Global

Total

(Dollars in millions)

Solutions

Services

Platforms

Systems

Financing

Segments

For the three months ended September 30, 2017:

External revenue

$
4,400

$
4,093

$
8,457

$
1,721

$
427

$
19,098

Internal revenue

629

92

164

227

272

1,384

Total revenue

$
5,030

$
4,185

$
8,621

$
1,948

$
698

$
20,482

Pre-tax income from continuing operations

$
1,649

$
453

$
1,192

$
339

$
244

$
3,876

Revenue year-to-year change

2.6
%
(2.3
)%
(3.4
)%
12.3
%
(8.5
)%
(0.6
)%
Pre-tax income year-to-year change

4.8
%
(16.8
)%
(7.5
)%
149.7
%
(31.4
)%
(0.5
)%
Pre-tax income margin

32.8
%
10.8
%
13.8
%
17.4
%
34.9
%
18.9
%

For the three months ended September 30, 2016:

External revenue

$
4,235

$
4,191

$
8,748

$
1,558

$
412

$
19,145

Internal revenue

667

93

180

176

352

1,468

Total revenue

$
4,902

$
4,284

$
8,929

$
1,734

$
763

$
20,613

Pre-tax income from continuing operations

$
1,574

$
544

$
1,288

$
136

$
355

$
3,897

Pre-tax income margin

32.1
%
12.7
%
14.4
%
7.8
%
46.5
%
18.9
%

Reconciliations to IBM as Reported:


(Dollars in millions)
For the three months ended September 30:	2017			2016
For the three months ended June 30:							2019		2018
Revenue:
Total reportable segments	$	20,482		$	20,613		$	20,170	$	21,278	*
Other — divested businesses								363		457	*
Other revenue								57		45
Eliminations of internal transactions	(1,384		)	(1,468		)		(1,430)		(1,778)	*
Other revenue	56			81
Total consolidated revenue	$	19,153		$	19,226		$	19,161	$	20,003


Pre-tax income from continuing operations:
Total reportable segments	$	3,876		$	3,897		$	2,836	$	3,556	*
Amortization of acquired intangible assets	(238		)	(265		)		(169)		(203)
Acquisition-related (charges)/income	0			(4		)		(102)		(1)
Non-operating retirement-related (costs)/income	(306		)	(139		)		(136)		(394)
Eliminations of internal transactions	(126		)	(185		)		(60)		(308)	*
Other — divested businesses								557		188	*
Unallocated corporate amounts	(141		)	(42		)		(156)		(62)
Total pre-tax income from continuing operations	$	3,065		$	3,263		$	2,768	$	2,776

* Recast to conform to 2019 presentation.

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 six months ended June 30, 2019:
External revenue	$	10,682		$	8,274		$	13,711		$	3,081		$	757		$	36,506
Internal revenue		1,448			143			591			334			581			3,097
Total revenue	$	12,131		$	8,417		$	14,303		$	3,415		$	1,338		$	39,603
Pre-tax income/(loss) from continuing operations	$	3,768		$	615		$	510		$	(141)		$	527		$	5,280
Revenue year-to-year change		(1.6)	%		(0.1)	%		(5.0)	%		(16.1)	%		(21.3)	%		(4.7)	%
Pre-tax income year-to-year change		1.6	%		23.7	%		(1.4)	%		(198.1)	%		(28.1)	%		(5.7)	%
Pre-tax income/(loss) margin		31.1	%		7.3	%		3.6	%		(4.1)	%		39.4	%		13.3	%

For the six months ended June 30, 2018:
External revenue	$	10,586	*	$	8,250	*	$	14,746	*	$	3,676		$	799		$	38,057	*
Internal revenue		1,741	*		172			310			395			902			3,521	*
Total revenue	$	12,327	*	$	8,422	*	$	15,055	*	$	4,072		$	1,701		$	41,578	*
Pre-tax income/(loss) from continuing operations	$	3,709	*	$	497	*	$	517	*	$	143		$	734		$	5,601	*
Pre-tax income/(loss) margin		30.1	%*		5.9	%*		3.4	%*		3.5	%		43.1	%		13.5	%*

* Recast to conform to 2019 presentation.

~~SEGMENT INFORMATION~~

Cognitive Solutions &
Industry Services

Technology

Global

Services &

Cognitive

Business

Cloud

Global

Total

(Dollars in millions)

Solutions

Services

Platforms

Systems

Financing

Segments

For the nine months ended September 30, 2017:

External revenue

$
13,021

$
12,196

$
25,079

$
4,863

$
1,246

$
56,405

Internal revenue

2,001

271

497

571

925

4,265

Total revenue

$
15,022

$
12,467

$
25,576

$
5,434

$
2,171

$
60,670

Pre-tax income from continuing operations

$
4,539

$
1,065

$
2,888

$
227

$
836

$
9,555

Revenue year-to-year change

1.4
%
(3.3
)%
(3.6
)%
(6.0
)%
(16.0
)%
(3.1
)%
Pre-tax income year-to-year change

12.4
%
(12.0
)%
2.2
%
(35.9
)%
(30.7
)%
(0.8
)%
Pre-tax income margin

30.2
%
8.5
%
11.3
%
4.2
%
38.5
%
15.7
%

For the nine months ended September 30, 2016:

External revenue

$
12,889

$
12,578

$
26,029

$
5,184

$
1,245

$
57,926

Internal revenue

1,929

310

501

594

1,340

4,673

Total revenue

$
14,818

$
12,888

$
26,530

$
5,778

$
2,585

$
62,599

Pre-tax income from continuing operations

$
4,039

$
1,210

$
2,825

$
354

$
1,208

$
9,636

Pre-tax income margin

27.3
%
9.4
%
10.6
%
6.1
%
46.7
%
15.4
%

Reconciliations to IBM as Reported:


(Dollars in millions)
For the nine months ended September 30:	2017			2016
For the six months ended June 30:							2019		2018
Revenue:
Total reportable segments	$	60,670		$	62,599		$	39,603	$	41,578	*
Other — divested businesses								706		903	*
Other revenue								131		114
Eliminations of internal transactions	(4,265		)	(4,673		)		(3,097)		(3,521)	*
Other revenue	192			223
Total consolidated revenue	$	56,597		$	58,149		$	37,342	$	39,075


Pre-tax income from continuing operations:
Total reportable segments	$	9,555		$	9,636		$	5,280	$	5,601	*
Amortization of acquired intangible assets	(731		)	(742		)		(343)		(406)
Acquisition-related (charges)/income	(19		)	(1		)		(141)		(1)
Non-operating retirement-related (costs)/income	(1,065		)	(444		)		(274)		(796)
Eliminations of internal transactions	(515		)	(873		)		(149)		(497)	*
Other — divested businesses								502		202	*
Unallocated corporate amounts	(294		)	(230		)		(224)		(192)
Total pre-tax income from continuing operations	$	6,931		$	7,345		$	4,651	$	3,911

*Recast to conform to 2019 presentation.

Table of Contents

Notes to Consolidated Financial Statements — (continued)

9. Equity Activity:

7. ~~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 September 30, 2017:

Amount

Benefit

Amount

Other comprehensive income/(loss):

Foreign currency translation adjustments

$
89

$
195

$
284

Net changes related to available-for-sale securities:

Unrealized gains/(losses) arising during the period

$
(1
)
$
1

$
0

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

0

0

0

Total net changes related to available-for-sale securities

$
(2
)
$
1

$
(1
)
Unrealized gains/(losses) on cash flow hedges:

Unrealized gains/(losses) arising during the period

$
(70
)
$
20

$
(50
)
Reclassification of (gains)/losses to:

Cost of sales

(1
)
1

(1
)
Cost of services

(20
)
8

(12
)
SG&A expense

6

(1
)
4

Other (income) and expense

(64
)
25

(39
)
Interest expense

7

(3
)
4

Total unrealized gains/(losses) on cash flow hedges

$
(143
)
$
49

$
(94
)
Retirement-related benefit plans(1):

Prior service costs/(credits)

$
0

$
0

$
0

Net (losses)/gains arising during the period

1

0

1

Curtailments and settlements

2

(1
)
1

Amortization of prior service (credits)/costs

(22
)
7

(15
)
Amortization of net (gains)/losses

733

(242
)
491

Total retirement-related benefit plans

$
713

$
(235
)
$
479

Other comprehensive income/(loss)

$
658

$
11

$
669


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

~~(1)~~

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

Table of ~~net periodic pension cost. (See note 8, “Retirement-Related Benefits,” for additional information.)~~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 September 30, 2016:

Amount

Benefit

Amount

Other comprehensive income/(loss):

Foreign currency translation adjustments

$
(99
)
$
50

$
(49
)
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

(1
)
0

(1
)
Total net changes related to available-for-sale securities

$
(2
)
$
1

$
(1
)
Unrealized gains/(losses) on cash flow hedges:

Unrealized gains/(losses) arising during the period

$
35

$
(14
)
$
21

Reclassification of (gains)/losses to:

Cost of sales*

7

(3
)
4

Cost of services*

(3
)
1

(2
)
SG&A expense

(2
)
(1
)
(3
)
Other (income) and expense

6

(2
)
4

Interest expense

7

(3
)
4

Total unrealized gains/(losses) on cash flow hedges

$
50

$
(22
)
$
29

Retirement-related benefit plans(1):

Net (losses)/gains arising during the period

$
11

$
(5
)
$
6

Curtailments and settlements

4

(1
)
3

Amortization of prior service (credits)/costs

(28
)
9

(19
)
Amortization of net (gains)/losses

696

(225
)
471

Total retirement-related benefit plans

$
683

$
(222
)
$
461

Other comprehensive income/(loss)

$
632

$
(192
)
$
440


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

* Reclassified to conform to ~~2017~~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.

Table of Contents

~~(1)~~ ~~These AOCI components are included in the computation of net periodic pension cost. (See note 8, “Retirement-Related Benefits,” for additional information.)~~

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 nine months ended September 30, 2017:

Amount

Benefit

Amount

Other comprehensive income/(loss):

Foreign currency translation adjustments

$
213

$
581

$
794

Net changes related to available-for-sale securities:

Unrealized gains/(losses) arising during the period

$
2

$
0

$
1

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

1

0

0

Total net changes related to available-for-sale securities

$
2

$
0

$
2

Unrealized gains/(losses) on cash flow hedges:

Unrealized gains/(losses) arising during the period

$
(198
)
$
53

$
(146
)
Reclassification of (gains)/losses to:

Cost of sales

(23
)
6

(17
)
Cost of services

(47
)
18

(29
)
SG&A expense

(23
)
6

(17
)
Other (income) and expense

(275
)
106

(169
)
Interest expense

21

(8
)
13

Total unrealized gains/(losses) on cash flow hedges

$
(545
)
$
180

$
(365
)
Retirement-related benefit plans(1):

Prior service costs/(credits)

$
0

$
0

$
0

Net (losses)/gains arising during the period

106

(36
)
70

Curtailments and settlements

3

(1
)
2

Amortization of prior service (credits)/costs

(66
)
23

(43
)
Amortization of net (gains)/losses

2,156

(739
)
1,417

Total retirement-related benefit plans

$
2,200

$
(754
)
$
1,446

Other comprehensive income/(loss)

$
1,869

$
7

$
1,877


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

~~(1)~~

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

Table of ~~net periodic pension cost. (See note 8, “Retirement-Related Benefits,” for additional information.)~~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 nine months ended September 30, 2016:

Amount

Benefit

Amount

Other comprehensive income/(loss):

Foreign currency translation adjustments

$
(109
)
$
411

$
303

Net changes related to available-for-sale securities:

Unrealized gains/(losses) arising during the period

$
(36
)
$
14

$
(22
)
Reclassification of (gains)/losses to other (income) and expense

36

(14
)
22

Total net changes related to available-for-sale securities

$
0

$
0

$
0

Unrealized gains/(losses) on cash flow hedges:

Unrealized gains/(losses) arising during the period

$
(221
)
$
82

$
(139
)
Reclassification of (gains)/losses to:

Cost of sales*

5

(4
)
2

Cost of services*

9

(3
)
5

SG&A expense

1

(3
)
(1
)
Other (income) and expense

(6
)
2

(4
)
Interest expense

17

(6
)
10

Total unrealized gains/(losses) on cash flow hedges

$
(195
)
$
68

$
(127
)
Retirement-related benefit plans(1):

Net (losses)/gains arising during the period

$
(57
)
$
20

$
(37
)
Curtailments and settlements

19

(7
)
12

Amortization of prior service (credits)/costs

(81
)
29

(52
)
Amortization of net (gains)/losses

2,079

(735
)
1,344

Total retirement-related benefit plans

$
1,960

$
(693
)
$
1,267

Other comprehensive income/(loss)

$
1,656

$
(213
)
$
1,442


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

* Reclassified to conform to ~~2017~~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.

~~(1)~~ ~~These AOCI components are included in the computation of net periodic pension cost. (See note 8, “Retirement-Related Benefits,” for additional information.)~~

~~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, 2017

$
319

$
(3,603
)
$
(26,116
)
$
2

$
(29,398
)
Other comprehensive income before reclassifications

(146
)
794

72

1

721

Amount reclassified from accumulated other comprehensive income

(219
)
0

1,374

0

1,155

Total change for the period

(365
)
794

1,446

2

1,877

September 30, 2017

$
(46
)
$
(2,809
)
$
(24,670
)
$
4

$
(27,521
)


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

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

Table of Contents

Notes to Consolidated Financial Statements — (continued)

Net Change

Net Unrealized

Net Unrealized

Foreign

Retirement-

Gains/(Losses)

Accumulated

Gains/(Losses)

Currency

Related

on Available-

Other

on Cash Flow

Translation

Benefit

For-Sale

Comprehensive

(Dollars in millions)

Hedges

Adjustments*

Plans

Securities

Income/(Loss)

January 1, 2016

$
100

$
(3,463
)
$
(26,248
)
$
5

$
(29,607
)
Other comprehensive income before reclassifications

(139
)
303

(25
)
(22
)
117

Amount reclassified from accumulated other comprehensive income

12

0

1,292

22

1,326

Total change for the period

(127
)
303

1,267

0

1,442

September 30, 2016

$
(28
)
$
(3,161
)
$
(24,981
)
$
4

$
(28,164
)


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

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

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

8. Stock Repurchases

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

10. Retirement-Related Benefits:

The company offers defined benefit pension plans, defined contribution pension plans, as well as nonpension postretirement plans primarily consisting of retiree medical benefits. The following tables provide the pre-tax cost for all retirement-related plans.

					Yr. to Yr.

											Yr. to Yr.
(Dollars in millions)					Percent						Percent
For the three months ended September 30:	2017		2016		Change
For the three months ended June 30:							2019		2018		Change
Retirement-related plans — cost
Defined benefit and contribution pension plans — cost	$	592	$	421	40.6	%	$	441	$	709	(37.7)	%
Nonpension postretirement plans — cost	61		64		(5.9	)		53		49	7.3
Total	$	653	$	486	34.4	%	$	494	$	758	(34.8)	%

Yr. to Yr.

(Dollars in millions)

Percent

For the nine months ended September 30:

2017

2016

Change

Retirement-related plans — cost

Defined benefit and contribution pension plans — cost

$
1,915

$
1,315

45.6
%
Nonpension postretirement plans — cost

182

185

(1.6
)
Total

$
2,097

$
1,500

39.8
%


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

~~Notes to Consolidated Financial Statements — (continued)~~

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

Table of Contents

~~Cost/(Income) of Pension Plans~~

(Dollars in millions)

U.S. Plans

Non-U.S. Plans

For the three months ended September 30:

2017

2016

2017

2016

Service cost

$
—

$
—

$
106

$
108

Interest cost

478

512

215

257

Expected return on plan assets

(753
)
(922
)
(340
)
(468
)
Amortization of prior service costs/(credits)

4

3

(25
)
(28
)
Recognized actuarial losses

334

328

387

357

Curtailments and settlements

—

—

2

4

Multi-employer plans/other

—

—

(74
)
8

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

63

(79
)
271

239

Cost of defined contribution plans

156

159

102

103

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

$
219

$
79

$
373

$
342

(Dollars in millions)

U.S. Plans

Non-U.S. Plans

For the nine months ended September 30:

2017

2016

2017

2016

Service cost

$
—

$
—

$
308

$
318

Interest cost

1,435

1,536

622

787

Expected return on plan assets

(2,260
)
(2,767
)
(985
)
(1,419
)
Amortization of prior service costs/(credits)

12

8

(73
)
(79
)
Recognized actuarial losses

1,003

985

1,120

1,062

Curtailments and settlements

—

—

3

19

Multi-employer plan/other

—

—

(46
)
64

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

190

(238
)
950

751

Cost of defined contribution plans

475

484

301

318

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

$
665

$
246

$
1,250

$
1,069

On October 12, 2012, the High Court in London issued a ruling against IBM United Kingdom Limited and IBM United Kingdom Holdings Limited, both wholly-owned subsidiaries of the company, in litigation involving one of IBM UK’s defined benefit plans. As a result of the ruling, the company recorded a pre-tax retirement-related obligation of $162 million in the fourth quarter of 2012 in selling, general and administrative expense in the Consolidated Statement of Earnings. As a result of the final Court of Appeal ruling received in August 2017, the company adjusted its obligation under the plan. This adjustment resulted in a gain of $91 million recorded in selling, general and administrative expense in the Consolidated Statement of Earnings for the three and nine months ended September 30, 2017. This gain is reflected in “Non-U.S. Plans - Multi-employer plans/other” in the tables above. See note 12, “Contingencies” for additional information.

In March 2017, the company initiated a change to the investment strategy of its U.S. defined benefit plan. The 2017 target asset allocation was modified by reducing equity securities from 20 percent to 12 percent, increasing debt securities from 70 percent to 79 percent and other investments largely remained unchanged at 10 percent of total plan assets. This change was designed to reduce the risk associated with the potential negative impact that equity markets might have on the funded status of the U.S. defined benefit plan. The change is expected to reduce the 2018 expected long-term rate of return on assets from 5.75 percent to approximately 5.25 percent. See note S, “Retirement-Related Benefits,” on page 144 in the company’s 2016 Annual Report for additional information regarding the company’s investment strategy.

Notes to Consolidated Financial Statements — (continued)

Cost/(Income) of Pension Plans


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

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


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

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

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

In ~~2017,~~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 ~~the UK.~~Belgium. This amount generally represents the legally mandated minimum contribution. Total ~~contributions to the non-U.S. plans in the first nine months of 2017 were $301 million, of which $124 million was in cash and $176 million in U.S. Treasury securities. Total~~ net contributions to the non-U.S. plans in the first ~~nine~~six months of ~~2016~~2019 were ~~$261~~$128 million, of which ~~$97~~$63 million was in cash and ~~$164~~$65 million in U.S. Treasury securities. Total contributions to the non-U.S. plans in the first six months of 2018 were $237 million, of which $80 million was in cash and $157 million in U.S. Treasury securities. The contribution of U.S. Treasury securities is considered a non-cash transaction in the Consolidated Statement of Cash Flows.

Table of Contents

Notes to Consolidated Financial Statements — (continued)

The following tables provide the components of the ~~cost/(income)~~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 September 30:

2017

2016

2017

2016

Service cost

$
4

$
4

$
1

$
1

Interest cost

38

41

14

15

Expected return on plan assets

—

—

(2
)
(2
)
Amortization of prior service costs/(credits)

(2
)
(2
)
0

(1
)
Recognized actuarial losses

5

5

2

2

Curtailments and settlements

—

—

0

0

Total nonpension postretirement plan cost recognized in Consolidated Statement of Earnings

$
45

$
49

$
16

$
16

(Dollars in millions)

U.S. Plan

Non-U.S. Plans

For the nine months ended September 30:

2017

2016

2017

2016

Service cost

$
11

$
13

$
4

$
4

Interest cost

115

124

43

37

Expected return on plan assets

—

—

(6
)
(5
)
Amortization of prior service costs/(credits)

(6
)
(6
)
0

(4
)
Recognized actuarial losses

15

15

5

7

Curtailments and settlements

—

—

0

0

Total nonpension postretirement plan cost recognized in Consolidated Statement of Earnings

$
135

$
146

$
47

$
39


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

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


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

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

The company contributed ~~$259~~$292 million in U.S. Treasury securities to the U.S. nonpension postretirement benefit ~~plan~~and active employee medical trusts during the ~~nine~~six months ended ~~September~~June 30, ~~2017,~~2019, and ~~$200~~$215 million in U.S. Treasury securities ~~and $40 million in cash~~ during the ~~nine~~six months ended ~~September~~June 30, ~~2016.~~2018. The contribution of U.S. Treasury securities is considered a non-cash transaction in the Consolidated Statement of Cash Flows.

Table of Contents

9. ~~Acquisitions/Divestitures:~~

~~Acquisitions:~~ ~~During the nine months ended September 30, 2017, the company completed four acquisitions at an aggregate cost of $128 million.~~

The Technology Services & Cloud Platforms segment completed acquisitions of three businesses: in the first quarter, Agile 3 Solutions, LLC (Agile 3 Solutions), a privately held business; in the third quarter, the cloud and managed hosting services business from a large U.S. telecommunications company, and Cloudigo Ltd. (Cloudigo), a privately held business. The Cognitive Solutions segment completed the acquisition of one privately held business: in the second quarter, XCC Web Content & Custom Apps Extension (XCC) from TIMETOACT Software & Consulting GmbH.

Each acquisition is expected to enhance the company’s portfolio of product and services capabilities. Agile 3 Solutions is a developer of software used by C-Suite and senior executives to better visualize, understand and manage risks associated with the protection of sensitive data and adds capabilities to the company’s security portfolio. The acquisition of the cloud and managed hosting services business strengthens the company’s services portfolio and aligns with its cloud strategy. Cloudigo brings talent and technology that aligns closely with the company’s cloud platform investments in advanced

Notes to Consolidated Financial Statements — (continued)

11. Acquisitions/Divestitures:

~~network processing. XCC’s technology enhances IBM’s Connections Cloud platform by providing a single, accessible engagement center for sharing content.~~

Purchase price consideration for all acquisitions as reflected in the following table, was paid in cash. All acquisitions are reported in the Consolidated Statement of Cash Flows net of acquired cash and cash equivalents.

Acquisitions

The ~~following table reflects~~company did not enter into any acquisition transactions during the ~~purchase price related to these acquisitions and~~six months ended June 30, 2019.

Red Hat - On July 9, 2019, the ~~resulting purchase price allocations as of September 30, 2017.~~

Amortization

Total

(Dollars in millions)

Life (in yrs.)

Acquisitions

Current assets

$
18

Fixed assets/noncurrent assets

69

Intangible assets:

Goodwill

N/A

16

Completed technology

5

9

Client relationships

7

62

Patents/trademarks

1-5

1

Total assets acquired

175

Current liabilities

(47
)
Total liabilities assumed

(47
)
Total purchase price

$
128

~~N/A - not applicable~~

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

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

Divestitures

Select IBM Software Products – On December 6, 2018, IBM and ~~the acquired assembled workforce, neither of which qualify as an amortizable intangible asset.~~

The overall weighted-average life of the identified amortizable intangible assets acquired is 6.6 years. These identified intangible assets will be amortized on a straight-line basis over their useful lives. Goodwill of $13 million has been assigned to the Technology Services & Cloud Platforms segment and goodwill of $3 million has been assigned to the Cognitive Solutions segment. It is expected that approximately 50 percent of the goodwill will be deductible for tax purposes. Each of the acquisitions was for 100 percent of the acquired businesses.

On October 4, 2017, the company announced its intent to acquire Vivant Digital (Vivant), a boutique digital and innovation agency. The acquisition extends the strategy and design expertise of IBM Interactive Experience (IBM iX) and will help accelerate clients’ digital transformations. The transaction is expected to close in the fourth quarter of 2017 and the business will be integrated within the GBS segment.

~~Divestitures:~~

~~Microelectronics —~~ ~~On October 20, 2014, IBM and GLOBALFOUNDRIES~~HCL Technologies Limited (HCL) announced a definitive agreement, in which ~~GLOBALFOUNDRIES~~HCL would acquire select standalone Cloud and Cognitive Software products for $1,775 million, inclusive of $150 million of contingent consideration. The software products in-scope include AppScan, BigFix, Unica, Commerce, Portal, Notes, Domino and Connections. The transaction included commercial software, intellectual property and services offerings. In addition, the ~~company’s Microelectronics business, including existing semiconductor manufacturing assets~~transaction includes transition services for IT and ~~operations in East Fishkill, NY and Essex Junction, VT.~~other services. The ~~commercial OEM business acquired by GLOBALFOUNDRIES includes custom logic and specialty foundry, manufacturing and related operations.~~ initial terms of the transition services are generally less than one year, however, HCL can renew certain services up to an additional year.

The transaction closed on ~~July 1, 2015.~~June 30, 2019. The company received cash of $812 million at closing and expects to receive an additional $813 million within 12 months of closing. The company recognized a pre-tax gain on the sale of $556 million on June 30, 2019 which was recorded in other (income) and expense in the Consolidated Statement of Earnings. The total gain on sale may change in the future due to contingent consideration or changes in other transaction estimates, however, material changes are not expected.

~~At September 30, 2014,~~Select IBM Marketing Platform and Commerce Offerings – On April 4, 2019, IBM and Centerbridge Partners, L.P. (Centerbridge) announced a definitive agreement, in which Centerbridge would acquire select marketing platform and commerce offerings from IBM, including Customer Experience Analytics, Content Hub and Marketing Assistant, among others.The transaction included commercial software and services offerings. In addition, the company ~~concluded~~will provide Centerbridge with transition services including IT, supply chain management, and other services, with initial terms generally of nine months, with renewal options up to nine months. Upon closing, Centerbridge announced that this business would be re-branded under the ~~Microelectronics business met~~name Acoustic. The closing completed for the ~~criteria~~U.S. on June 30, 2019. The company expects a subsequent closing for ~~discontinued operations reporting.~~the remaining countries to occur within 12 months. The ~~disposal group constituted~~timing of the subsequent closing is subject to change as more information becomes available. The company received a ~~component under accounting guidance. The continuing~~net cash ~~inflows~~payment of $240 million at the U.S. closing and ~~outflows with the discontinued component are related~~expects to the manufacturing sourcing arrangement and the transition, packaging and test services. These cash flows are not direct cash flows as they are not significant and the company has no significant continuing involvement.receive an additional $150 million within 36 months.

Table of Contents

Notes to Consolidated Financial Statements — (continued)

~~All assets and liabilities~~The company recognized an immaterial pre-tax gain on the sale on June 30, 2019. The amount of the ~~business, classified as held~~pre-tax gain for ~~sale at June 30, 2015, were~~the remaining countries will not be determinable until the valuation of the final balance sheet transferred at closing. The company transferred $515 million of net cash to GLOBALFOUNDRIES in the third quarter of 2015. This amount included $750 million of cash consideration, adjusted by the amount of working capital due from GLOBALFOUNDRIES and other miscellaneous items. A second cash payment in the amount of $500 million was transferred in December 2016. The remaining cash consideration of $250 million is completed, however, it is not expected to be ~~transferred in December 2017.~~material.

~~Summarized financial information for discontinued operations is immaterial.~~

~~Industry Standard Server —~~ Seterus – On January ~~23, 2014,~~3, 2019, IBM and ~~Lenovo~~Mr. Cooper Group ~~Limited (Lenovo)~~ announced a definitive agreement, in which ~~Lenovo would acquire the company’s industry standard server portfolio (System x) for an adjusted purchase price of $2.1 billion, consisting of approximately $1.8 billion~~Mr. Cooper Group acquired IBM’s Seterus home mortgage servicing platform business. The transaction closed in cash, with the balance in Lenovo common stock. The stock represented less than 5 percent equity ownership in Lenovo. The company sold to Lenovo its System x, BladeCenter and Flex System blade servers and switches, x86-based Flex integrated systems, NeXtScale and iDataPlex servers and associated software, blade networking and maintenance operations. As of March 31, 2016, all Lenovo common stock was sold.

~~The initial closing was completed on October 1, 2014. A subsequent closing occurred in most other countries in which there was a large business footprint on December 31, 2014. T~~he remaining countries closed on March 31, 2015. An assessment of the ongoing contractual terms of the transaction resulted in the recognition of pre-tax gains of $63 million, $57 million and $13 million in 2015, 2016 and the first nine months of 2017, respectively.

~~Overall, the company expects to recognize a total pre-tax gain on the sale of approximately $1.6 billion~~, which does not include associated costs related to transition and performance-based costs. Net of these charges, the pre-tax gain was approximately $1.3 billion, of which the cumulative gain recorded as of September 30, 2017 is $1.2 billion. The balance of the gain is expected to be recognized in 2019 upon conclusion of the maintenance agreement.

~~Others –~~ In the first quarter of 2017, the company completed one research-related divestiture. The company completed two Cognitive Solutions divestitures in the second quarter of 2017 and one Cognitive Solutions divestiture in the third quarter of 2017.2019. The financial terms related to ~~these transactions~~this transaction were not material. ~~Overall,~~

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

Other – In the ~~company recognized~~fourth quarter of 2018, the Global Financing segment entered into a ~~pre-tax gain~~definitive agreement to sell certain commercial financing capabilities and assign a number of ~~$25 million~~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 ~~these transactions in 2017.~~this transaction were not material.

~~Notes to Consolidated Financial Statements — (continued)~~12.

~~10.~~ Intangible Assets Including Goodwill:

Intangible Assets

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

At September 30, 2017

(Dollars in millions)

Gross Carrying

Accumulated

Net Carrying

Intangible asset class

Amount

Amortization

Amount

Capitalized software

$
1,586

$
(750
)
$
835

Client relationships

2,416

(1,054
)
1,363

Completed technology

2,872

(1,562
)
1,310

Patents/trademarks

707

(267
)
440

Other*

52

(19
)
32

Total

$
7,633

$
(3,652
)
$
3,981


	At June 30, 2019
(Dollars in millions)	Gross Carrying		Accumulated		Net Carrying
Intangible asset class	Amount		Amortization		Amount
Capitalized software	$	1,621	$	(668)	$	953
Client relationships		1,876		(1,094)		782
Completed technology		1,903		(1,201)		701
Patents/trademarks		622		(358)		263
Other*		56		(27)		28
Total	$	6,077	$	(3,349)	$	2,728

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

At December 31, 2016

(Dollars in millions)

Gross Carrying

Accumulated

Net Carrying

Intangible asset class

Amount

Amortization

Amount

Capitalized software

$
1,537

$
(661
)
$
876

Client relationships

2,831

(1,228
)
1,602

Completed technology

3,322

(1,668
)
1,654

Patents/trademarks

730

(205
)
525

Other*

46

(15
)
31

Total

$
8,466

$
(3,778
)
$
4,688


	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.~~

systems.

The net carrying amount of intangible assets decreased ~~$707~~$360 million during the first ~~nine~~six months of ~~2017,~~2019, primarily due to intangible asset amortization, partially offset by additions resulting from capitalized software. The aggregate intangible amortization expense was ~~$383~~$307 million and ~~$1,161~~$610 million for the ~~third~~second quarter and first ~~nine~~six months of ~~2017,~~2019, respectively, versus ~~$403~~$342 million and ~~$1,148~~$683 million for the ~~third~~second quarter and first ~~nine~~six months of ~~2016,~~2018, respectively. In

Table of Contents

Notes to Consolidated Financial Statements — (continued)

addition, in the first ~~nine~~six months of ~~2017,~~2019, the company retired ~~$1,255~~$433 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 ~~September~~June 30, ~~2017:~~2019:

	Capitalized		Acquired

							Capitalized		Acquired
(Dollars in millions)	Software		Intangibles		Total		Software		Intangibles		Total
2017 (for Q4)	$	144	$	216	$	359
2018	441		811		1,252
2019	202		671		873
2019 (for Q3-Q4)							$	261	$	323	$	584
2020	48		559		607			410		550		961
2021	—		446		446			248		445		693

2022								33		382		415
2023								—		64		64

Goodwill

The change in the goodwill balances by ~~reportable~~ segment, for the ~~nine~~six months ended ~~September~~June 30, ~~2017~~2019 and for the year ended December 31, ~~2016~~2018 are as follows:

~~Notes to Consolidated Financial Statements — (continued)~~

Foreign

Currency

Purchase

Translation

(Dollars in millions)

Balance

Goodwill

Price

And Other

Balance

Segment

01/01/17

Additions

Adjustments

Divestitures

Adjustments*

9/30/17

Cognitive Solutions

$
19,484

$
3

$
(36
)
$
(15
)
$
243

$
19,679

Global Business Services

4,607

—

4

—

186

4,797

Technology Services & Cloud Platforms

10,258

13

(3
)
—

175

10,444

Systems

1,850

—

—

—

13

1,863

Total

$
36,199

$
16

$
(36
)
$
(15
)
$
618

$
36,782


									Foreign
									Currency
					Purchase				Translation
(Dollars in millions)	Balance		Goodwill		Price				And Other		Balance
Segment	1/1/2019		Additions		Adjustments		Divestitures		Adjustments*		6/30/2019
Cloud & Cognitive Software	$	24,594	$	—	$	0	$	—	$	89	$	24,683
Global Business Services		4,711		—		1		—		7		4,718
Global Technology Services		3,988		—		—		—		40		4,027
Systems		1,847		—		—		—		7		1,855
Other — divested businesses		1,126		—		—		(1,126)		—		—
Total	$	36,265	$	—	$	1	$	(1,126)	$	143	$	35,284

* Primarily driven by foreign currency ~~translation.~~translation.

Foreign

Currency

Purchase

Translation

(Dollars in millions)

Balance

Goodwill

Price

And Other

Balance

Segment

01/01/16

Additions

Adjustments

Divestitures

Adjustments*

12/31/16

Cognitive Solutions

$
15,621

$
3,821

$
5

$
(12
)
$
48

$
19,484

Global Business Services

4,396

303

4

(1
)
(95
)
4,607

Technology Services & Cloud Platforms

10,156

119

(12
)
(5
)
(1
)
10,258

Systems

1,848

—

(4
)
—

5

1,850

Total

$
32,021

$
4,244

$
(7
)
$
(18
)
$
(42
)
$
36,199


									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.

There were no goodwill impairment losses recorded during the first ~~nine~~six months of ~~2017~~2019 or the full year of ~~2016~~2018 and the company has no accumulated impairment losses.

Purchase price adjustments recorded in the first ~~nine~~six months of ~~2017~~2019 and full year ~~2016~~2018 were related to acquisitions ~~completed on or prior to June 30, 2017 or September 30, 2016, respectively, and~~that were still subject to the measurement period that ends at the earlier of 12 months from the acquisition date or when

Table of Contents

Notes to Consolidated Financial Statements — (continued)

information becomes available. Net purchase price adjustments ~~of $36 million were~~ recorded during the first ~~nine~~six months of ~~2017, with~~2019 and full year 2018 were not material.

13. Borrowings:

Short-Term Debt


	At June 30,		At December 31,
(Dollars in millions)	2019		2018
Commercial paper	$	7,871	$	2,995
Short-term loans		192		161
Long-term debt — current maturities		6,530		7,051
Total	$	14,594	$	10,207

The commercial paper increase of $4.9 billion from December 31, 2018 was primarily driven by new issuances used to partially fund the ~~primary drivers being deferred tax assets, other taxes payable and other current liabilities associated with~~Red Hat acquisition. For further information on the ~~Truven Health Analytics, Inc. and The Weather Company acquisitions. Net purchase price adjustments~~financing of ~~$7 million were recorded during 2016, with~~ the ~~primary drivers being deferred tax assets, accounts receivable, deferred income, inventory and other current liabilities.~~

~~11.~~ ~~Borrowings:~~

~~Short-Term Debt~~

At September 30,

At December 31,

(Dollars in millions)

2017

2016

Commercial paper

$
—

$
899

Short-term loans

407

375

Long-term debt — current maturities

3,892

6,239

Total

$
4,299

$
7,513

Red Hat acquisition, see the long-term debt section below.

The weighted-average interest rate for commercial paper at June 30, 2019 and December 31, ~~2016~~2018 was ~~0.7 percent.~~2.5 percent at both periods. The weighted-average interest rate for short-term loans was ~~5.4~~5.0 percent and ~~9.5~~4.3 percent at ~~September~~June 30, ~~2017~~2019 and December 31, ~~2016,~~2018, respectively.

Table of Contents

Notes to Consolidated Financial Statements — (continued)

Long-Term Debt

Pre-Swap Borrowing

Balance

Balance

(Dollars in millions)

Maturities

9/30/2017

12/31/2016

U.S. dollar debt (average interest rate at September 30, 2017):*

2.7%

2017

$
2

$
5,104

3.0%

2018–2019

10,208

8,856

2.0%

2020–2021

7,416

4,941

2.4%

2022

3,492

1,901

3.4%

2023

1,529

1,500

3.6%

2024

2,000

2,000

7.0%

2025

600

600

3.5%

2026

1,350

1,350

4.7%

2027

969

469

6.5%

2028

313

313

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

$
31,408

$
30,563

Other currencies (average interest rate at September 30, 2017, in parentheses):*

Euros (1.5%)

2019–2029

$
10,342

$
7,122

Pound sterling (2.7%)

2020–2022

1,409

1,296

Japanese yen (0.9%)

2017–2026

1,669

1,576

Canadian (2.2%)

2017

—

373

Other (7.4%)

2018–2020

694

215

$
45,522

$
41,145

Less: net unamortized discount

833

839

Less: net unamortized debt issuance costs

99

82

Add: fair value adjustment**

627

669

$
45,218

$
40,893

Less: current maturities

3,892

6,239

Total

$
41,327

$
34,655


		Balance		Balance
(Dollars in millions)	Maturities	6/30/2019		12/31/2018
U.S. dollar debt (weighted-average interest rate at June 30, 2019):*
4.3%	2019	$	2,155	$	5,465
2.5%	2020		4,331		4,344
2.9%	2021		8,537		5,529
2.7%	2022		6,273		3,536
3.2%	2023		2,399		2,428
3.2%	2024		5,059		2,037
6.9%	2025		611		600
3.3%	2026		4,350		1,350
4.7%	2027		969		969
6.5%	2028		313		313
3.5%	2029		3,250		—
3.7%	2030		33		32
5.9%	2032		600		600
8.0%	2038		83		83
4.5%	2039		2,745		745
4.0%	2042		1,107		1,107
7.0%	2045		27		27
4.7%	2046		650		650
4.3%	2049		3,000		—
7.1%	2096		316		316
		$	46,808	$	30,131
Other currencies (weighted-average interest rate at June 30, 2019, in parentheses):*
Euros (1.3%)	2019–2031	$	15,669	$	10,011
Pound sterling (2.7%)	2020–2022		1,336		1,338
Japanese yen (0.2%)	2022–2026		1,349		1,325
Other (6.3%)	2020–2022		407		391
		$	65,569	$	43,196
Less: net unamortized discount			903		802
Less: net unamortized debt issuance costs			156		76
Add: fair value adjustment**			465		337
		$	64,975	$	42,656
Less: current maturities			6,530		7,051
Total		$	58,445	$	35,605

*Includes notes, debentures, bank loans, secured borrowings and ~~capital~~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 ~~International Business Machines Corporation,~~IBM, the parent. Any debt securities issued by IBM International Group Capital LLC would be fully and unconditionally guaranteed by the parent.

During the third quarter of 2017, IBM Credit LLC, a wholly owned subsidiary of the company, filed a shelf registration statement with the Securities and Exchange Commission (SEC) allowing it to offer for sale public debt securities. IBM Credit LLC issued fixed and floating rate debt securities in the aggregate amount of $3.0 billion with maturity dates ranging from 2019 to 2022. This debt is included in the long-term debt table above.

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

Table of Contents

Notes to Consolidated Financial Statements — (continued)

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.

~~Notes to Consolidated Financial Statements — (continued)~~

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.

In the fourth quarter of 2018, upon the company’s announcement of its intent to acquire Red Hat, 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 were fully amortized to SG&A in the Consolidated Statement of Earnings as of June 30, 2019.

On May 15, 2019, the company issued an aggregate of $20 billion of indebtedness in the following eight tranches: $1.5 billion of 2-year floating rate notes priced at 3 month LIBOR plus 40 basis points, $1.5 billion of 2-year fixed rate notes with a 2.8 percent coupon, $2.75 billion of 3-year fixed rate notes with a 2.85 percent coupon, $3.0 billion of 5-year fixed rate notes with a 3.0 percent coupon, $3.0 billion of 7-year fixed rate notes with a 3.3 percent coupon, $3.25 billion of 10-year fixed rate notes with a 3.5 percent coupon, $2.0 billion of 20-year fixed rate notes with a 4.15 percent coupon and $3.0 billion of 30-year fixed rate notes with a 4.25 percent coupon. Following receipt of the net proceeds from this multi-tranche debt offering, on May 15, 2019, and in accordance with the terms of the commitment letter, IBM notified the banks of IBM’s termination of all commitments under the commitment letter. There were no early termination penalties. The proceeds from these debt issuances were primarily used for the acquisition of Red Hat. For additional information on this transaction, see note 11, “Acquisitions/Divestitures.”

Additionally, the long-term debt table above includes Euro bonds that were issued in the first quarter of 2019 to partially finance the acquisition of Red Hat upon closing.

Pre-swap annual contractual ~~maturities~~obligations of long-term debt outstanding at ~~September~~June 30, ~~2017,~~2019, are as follows:


(Dollars in millions)	Total		Total
2017 (for Q4)	$	468
2018	5,140
2019	7,034
2019 (for Q3-Q4)			$	3,486
2020	6,155			7,413
2021	5,155			9,742
2022 and beyond	21,569
2022				7,104
2023				5,395
2024 and beyond				32,429
Total	$	45,522	$	65,569

Interest on Debt


(Dollars in millions)
For the nine months ended September 30:	2017			2016
For the six months ended June 30:							2019		2018
Cost of financing	$	496		$	432		$	343	$	375
Interest expense	485			523				558		338
Net investment derivative activity	(34		)	(51		)
Interest capitalized	(1		)	3				3		3
Total interest paid and accrued	$	947		$	907		$	904	$	717

Table of Contents

Notes to Consolidated Financial Statements — (continued)

Lines of Credit

~~In 2016,~~On July 18, 2019, the company ~~increased~~extended the ~~size~~maturity date of its ~~five-year Credit Agreement (the “Credit Agreement”) from $10 billion to~~existing $10.25 billion ~~and extended the term by one year to November 10, 2021. The~~Five-Year Credit ~~Agreement permits~~Agreement. In addition, the company and ~~its Subsidiary Borrowers~~IBM Credit LLC entered into a new $2.5 billion 364-day Credit Agreement to ~~borrow up to $10.25~~replace the existing $2.5 billion ~~on a revolving basis. Borrowings~~364-day Credit Agreement, and also extended the maturity date of the ~~Subsidiary Borrowers will be unconditionally backed by the company. The company may also, upon the agreement of either~~ existing lenders, or of the additional banks not currently party to the Credit Agreement, increase the commitments under the Credit Agreement up to an additional $1.75 billion. Subject to certain terms of the Credit Agreement, the company and Subsidiary Borrowers may borrow, prepay and reborrow amounts under the Credit Agreement at any time during the Credit Agreement term. Interest rates on borrowings under the Credit Agreement will be based on prevailing market interest rates, as further described in the$2.5 billion Three-Year Credit Agreement. The new maturity dates for the Three-Year and Five-Year Credit ~~Agreement contains customary representations~~Agreements are July 20, 2022 and ~~warranties, covenants, events~~July 20, 2024, respectively. Each of ~~default, and indemnification provisions. The company believes that circumstances that might give rise to breach of these covenants or an event of default, as specified in~~ the ~~Credit Agreement, are remote.~~ facility sizes remain unchanged. As of ~~September~~June 30, ~~2017,~~2019, there were no borrowings by the company, or its subsidiaries, under the Credit ~~Agreement.~~Facilities.

The company also has other committed lines of credit in some of the geographies which are not significant in the aggregate. Interest rates and other terms of borrowing under these lines of credit vary from country to country, depending on local market conditions.

On July 20, 2017, the company and IBM Credit LLC, (the Borrowers), entered into a $2.5 billion 364-Day Credit Agreement, and a $2.5 billion Three-Year Credit Agreement (the New Credit Agreements, and together with the Credit Agreement, the Credit Facilities). IBM also entered into the Third Amendment to its Credit Agreement. The New Credit Agreements permit the Borrowers to borrow up to an aggregate of $5 billion on a revolving basis. Neither Borrower is a guarantor or co-obligor of the other Borrower under the New Credit Agreements. Subject to certain conditions stated in the New Credit Agreements, the Borrowers may borrow, prepay and re-borrow amounts under the New Credit Agreements at any time during the term of the New Credit Agreements. Funds borrowed may be used for the general corporate purposes of the Borrowers. Interest rates on borrowings under the New Credit Agreements will be based on prevailing market interest rates, as further described in the New Credit Agreements. The New Credit Agreements contain customary representations and warranties, covenants, events of default, and indemnification provisions. The Amendment to the Credit Agreement adds and restates various provisions in order to provide the company with the opportunity in 2018 to request that the lenders extend the termination date of the Credit Agreement to July 20, 2023.

~~Notes to Consolidated Financial Statements — (continued)~~14.Contingencies:

~~12.~~ ~~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 ~~September~~June 30, ~~2017~~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 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.

Table of Contents

Notes to Consolidated Financial Statements — (continued)

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

~~Notes to Consolidated Financial Statements — (continued)~~

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. ~~IBM appealed to~~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 interest on its previously affirmed $50 million award. On June 26, 2019, the Indiana Supreme Court reversed the Indiana Court of Appeals’ award of interest to IBM, but otherwise affirmed the Superior Court’s and the Court of Appeals’ awards. IBM has petitioned the Indiana Supreme Court for rehearing. 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.

~~On October 29, 2013, Bridgestone Americas, Inc. (Bridgestone) sued IBM regarding a 2009 contract for~~Following the implementation of an SAP-based, enterprise-wide order management system. IBM counterclaimed against Bridgestone and its parent, Bridgestone Corp. The case is pending in the Middle District of Tennessee.

On April 16, 2014, Iusacell SA de C.V. (Iusacell) sued IBM, claiming that IBM made fraudulent misrepresentations that induced Iusacell to enter into an agreement with IBM Mexico. Iusacell claimed damages for lost profits. Iusacell’s complaint related to a contractual dispute in Mexico, which was the subject of a pending arbitration proceeding in Mexico initiated by IBM Mexico against Iusacell for breach2017 final judgment of the ~~underlying agreement. On August 31, 2017, the parties entered into an agreement releasing all claims against each other, resolving both the lawsuit and the arbitration proceeding.~~

~~IBM United Kingdom Limited (IBM UK) initiated legal proceedings in May 2010 before the High~~Appeal Court in London ~~against the~~holding that IBM UK ~~Pensions Trust (the UK Trust) and two representative beneficiaries of the UK Trust membership. IBM UK sought a declaration that it~~ acted lawfully ~~both~~ in ~~notifying the Trustee of the UK Trust that it was~~2010 in closing its UK defined benefit plans to future accruals for most participants and in implementing ~~the company’s~~a new retirement ~~policy. In April 2014,~~policy, the ~~High Court acknowledged that the changes made to its UK defined benefit plans were within IBM’s discretion, but ruled that IBM breached its implied duty of good faith both~~Employment Tribunal in implementing these changes and in the manner in which it consulted with employees. Proceedings to determine remedies were held in July 2014, and in February 2015 the High Court held that for IBM to make changes to accruals under the plan would require a new consultation of the participants, but other changes (including to early retirement policy) would not require such consultation. IBM UK appealed both the breach and remedies judgments. In August 2017, the Appeal Court reversed the High Court, holding that IBM UK was not in breach of its implied duties of good faith and that the changes made to the plans were lawful. The time to appeal has expired and the Appeal Court judgment is final. In addition, IBMSouthampton UK is ~~a defendant in~~expected to address approximately 290 individual actions ~~brought since early 2010 by participants of the defined benefits plans who left IBM UK. These actions, which allege~~alleging constructive dismissal and age discrimination ~~are pending before~~brought against IBM UK in 2010 by employees who left the ~~Employment Tribunal in Southampton UK.~~

In early 2012, IBM notified the SEC of an investigation by the Polish Central Anti-Corruption Bureau involving allegations of illegal activity by a former IBM Poland employee in connection with sales to the Polish government. IBM cooperated with the SEC and Polish authorities in this matter. In April 2013, IBM learnedcompany at that ~~the U.S. Department of Justice (DOJ) was also investigating allegations related to the Poland matter, as well as allegations relating to transactions in Argentina, Bangladesh and Ukraine.~~time. The DOJ was seeking information regarding the company’s global FCPA compliance program and its public sector business. The company cooperated with the DOJ in this matter. In June 2017, the DOJ and the SEC each informed IBM that based on the information to date, they closed their respective investigations into these matters without pursuing any enforcement action against the company.

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

Table of Contents

Notes to Consolidated Financial Statements — (continued)

semiconductor technology business, alleging violations of the Employee Retirement Income Security Act ~~(“ERISA”)~~(ERISA). ~~The company,~~

~~Notes to Consolidated Financial Statements — (continued)~~

~~management’s~~Management’s Retirement Plans Committee and three current or former IBM executives ~~were~~are named as defendants. On September 7, 2016, the Court granted the company’s motion to dismiss the plaintiffs’ claims. On October 21, 2016, the plaintiffs filed an amended complaint, dropping the company as a defendant. On September 29, 2017, the Court granted the defendants’ motion to ~~dismiss. Plaintiffs have filed a notice of appeal to~~dismiss the first amended complaint. On December 10, 2018, the Second Circuit Court of Appeals ~~and~~reversed the ~~matter remains pending.~~

~~In August 2015, IBM learned that~~District Court order. On June 3, 2019, the ~~SEC is conducting an investigation relating~~Supreme Court of the United States granted defendants’ request to ~~revenue recognition with respect to~~hear the ~~accounting treatment of certain transactions in the U.S., UK and Ireland. The company is cooperating with the SEC in this matter.~~

case.

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 ~~$1.1 billion.~~$950 million. The company believes it will prevail on these matters and that this amount is not a meaningful indicator of liability.

15. Commitments:

~~13.~~ ~~Commitments:~~The company’s extended lines of credit to third-party entities include unused amounts of ~~$8,016~~$4,783 million and ~~$6,542~~$7,368 million at ~~September~~June 30, ~~2017~~2019 and December 31, ~~2016,~~2018, respectively. A portion of these amounts was available to the company’s business partners to support their working capital needs. The decrease reflects the company’s wind down of its OEM IT commercial financing operations. In addition, the company has committed to provide future financing to its clients in connection with client purchase agreements for approximately ~~$3,063~~$5,033 million and ~~$2,463~~$4,432 million at ~~September~~June 30, ~~2017~~2019 and December 31, ~~2016,~~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 ~~$21~~$25 million and ~~$34~~$26 million at ~~September~~June 30, ~~2017~~2019 and December 31, ~~2016,~~ 2018,

Table of Contents

Notes to Consolidated Financial Statements — (continued)

respectively. The fair value of the guarantees recognized in the Consolidated Statement of Financial Position is not material.

~~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
Accruals recorded in first quarter		19	*		25
Accrual adjustments to reflect actual experience		(1)	*		(14)
Charges incurred in first quarter		(29)	*		(32)
Balance at March 31		107			130
Current period accruals		26			37
Accrual adjustments to reflect actual experience		0			(9)
Charges incurred in current period		(30)			(31)
Balance at June 30	$	103		$	126

* Revised grossed-up amounts to conform to current presentation.

(Dollars in millions)

2017

2016

Balance at January 1

$
156

$
181

Current period accruals

107

107

Accrual adjustments to reflect actual experience

(3
)
4

Charges incurred

(126
)
(132
)
Balance at September 30

$
134

$
160

Extended Warranty Liability

(Dollars in millions)

2017

2016

Aggregate deferred revenue at January 1

$
531

$
538

Revenue deferred for new extended warranty contracts

175

176

Amortization of deferred revenue

(198
)
(198
)
Other*

24

12

Aggregate deferred revenue at September 30

$
533

$
528

Current portion

$
258

$
287

Noncurrent portion

$
275

$
241


(Dollars in millions)	2019		2018
Aggregate deferred revenue at January 1	$	533	$	566
Revenue deferred for new extended warranty contracts		81		111
Amortization of deferred revenue		(128)		(134)
Other*		0		(9)
Aggregate deferred revenue at June 30	$	486	$	534
Current portion	$	225	$	254
Noncurrent portion	$	260	$	280

* Other primarily consists of foreign currency translation adjustments.

Table of Contents

Notes to Consolidated Financial Statements — (continued)

~~14.~~ 16. Earnings Per Share of Common ~~Stock:~~Stock:

The following tables provide the computation of basic and diluted earnings per share of common stock for the three and ~~nine~~six months ended ~~September~~June 30, ~~2017~~2019 and ~~2016.~~2018.

	For the Three Months Ended
	September 30, 2017		September 30, 2016

						For the Three Months Ended
						June 30, 2019		June 30, 2018
Number of shares on which basic earnings per share is calculated:
Weighted-average shares outstanding during period	929,437,441		953,995,828				886,273,682		915,064,434
Add — Incremental shares under stock-based compensation plans	2,236,234		2,357,365				3,281,570		2,882,043
Add — Incremental shares associated with contingently issuable shares	1,553,754		964,091				1,276,549		1,452,129
Number of shares on which diluted earnings per share is calculated	933,227,429		957,317,284				890,831,801		919,398,606


Income from continuing operations (millions)	$	2,726	$	2,854		$	2,499	$	2,402
Loss from discontinued operations, net of tax (millions)	0		(1		)
Income/(loss) from discontinued operations, net of tax (millions)							(1)		1
Net income on which basic earnings per share is calculated (millions)	$	2,726	$	2,853		$	2,498	$	2,404

Income from continuing operations (millions)	$	2,726	$	2,854		$	2,499	$	2,402
Net income applicable to contingently issuable shares (millions)	0		—				0		(1)
Income from continuing operations on which diluted earnings per share is calculated (millions)	$	2,726	$	2,854		$	2,500	$	2,401
Loss from discontinued operations, net of tax, on which basic and diluted earnings per share is calculated (millions)	0		(1		)
Income/(loss) from discontinued operations, net of tax, on which basic and diluted earnings per share is calculated (millions)							(1)		1
Net income on which diluted earnings per share is calculated (millions)	$	2,726	$	2,853		$	2,499	$	2,403


Earnings/(loss) per share of common stock:
Assuming dilution
Continuing operations	$	2.92	$	2.98		$	2.81	$	2.61
Discontinued operations	0.00		0.00				0.00		0.00
Total	$	2.92	$	2.98		$	2.81	$	2.61
Basic
Continuing operations	$	2.93	$	2.99		$	2.82	$	2.63
Discontinued operations	0.00		0.00				0.00		0.00
Total	$	2.93	$	2.99		$	2.82	$	2.63

Stock options to purchase ~~399,844~~762,019 shares and ~~29,033~~388,681 shares were outstanding as of ~~September~~June 30, ~~2017~~2019 and ~~2016,~~2018, respectively, but were not included in the computation of diluted earnings per share because the ~~options’~~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.

Table of Contents

Notes to Consolidated Financial Statements — (continued)


	For the Six Months Ended
	June 30, 2019		June 30, 2018
Number of shares on which basic earnings per share is calculated:
Weighted-average shares outstanding during period		887,927,612		917,872,328
Add — Incremental shares under stock-based compensation plans		3,327,015		3,217,574
Add — Incremental shares associated with contingently issuable shares		1,116,537		1,314,118
Number of shares on which diluted earnings per share is calculated		892,371,164		922,404,020

Income from continuing operations (millions)	$	4,093	$	4,078
Income/(loss) from discontinued operations, net of tax (millions)		(4)		5
Net income on which basic earnings per share is calculated (millions)	$	4,089	$	4,083

Income from continuing operations (millions)	$	4,093	$	4,078
Net income applicable to contingently issuable shares (millions)		0		(1)
Income from continuing operations on which diluted earnings per share is calculated (millions)	$	4,093	$	4,077
Income/(loss) from discontinued operations, net of tax, on which basic and diluted earnings per share is calculated (millions)		(4)		5
Net income on which diluted earnings per share is calculated (millions)	$	4,090	$	4,082

Earnings/(loss) per share of common stock:
Assuming dilution
Continuing operations	$	4.58	$	4.42
Discontinued operations		0.00		0.01
Total	$	4.58	$	4.43
Basic
Continuing operations	$	4.61	$	4.44
Discontinued operations		0.00		0.01
Total	$	4.61	$	4.45

For the Nine Months Ended

September 30, 2017

September 30, 2016

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

Weighted-average shares outstanding during period

935,600,777

957,693,385

Add — Incremental shares under stock compensation plans

3,213,758

2,258,854

Add — Incremental shares associated with contingently issuable shares

1,394,930

771,943

Number of shares on which diluted earnings per share is calculated

940,209,466

960,724,182

Income from continuing operations (millions)

$
6,811

$
7,375

Loss from discontinued operations, net of tax (millions)

(3
)
(4
)
Net income on which basic earnings per share is calculated (millions)

$
6,807

$
7,371

Income from continuing operations (millions)

$
6,811

$
7,375

Net income applicable to contingently issuable shares (millions)

(2
)
—

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

$
6,809

$
7,375

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

(3
)
(4
)
Net income on which diluted earnings per share is calculated (millions)

$
6,806

$
7,371

Earnings/(loss) per share of common stock:

Assuming dilution

Continuing operations

$
7.24

$
7.67

Discontinued operations

0.00

0.00

Total

$
7.24

$
7.67

Basic

Continuing operations

$
7.28

$
7.70

Discontinued operations

0.00

0.00

Total

$
7.28

$
7.70

Stock options to purchase ~~146,795~~949,519 shares and ~~533,089~~202,775 shares (average of first ~~second~~ and ~~third~~second quarter share amounts) were outstanding as of ~~September~~June 30, ~~2017~~2019 and ~~2016,~~2018, respectively, but were not included in the computation of diluted earnings per share because the ~~options’~~options' exercise price during the respective ~~periods~~period was greater than the average market price of the common shares, and, therefore, the effect would have been antidilutive.

~~15.~~ 17. Subsequent Events:

On ~~October 31, 2017,~~July 30, 2019, the company announced that the Board of Directors approved a quarterly dividend of ~~$1.50~~$1.62 per common share. The dividend is payable ~~December 9, 2017~~September 10, 2019 to shareholders of record on ~~November 10, 2017.~~August 9, 2019.

~~On October 31, 2017, the company announced that the Board~~

Table of ~~Directors authorized $3.0 billion in additional funds for use in the company’s stock repurchase program.~~Contents

Item 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS

OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION

FOR THE THREE ~~AND NINE~~ MONTHS ENDED ~~SEPTEMBER~~JUNE 30, ~~2017~~2019

Snapshot

~~Snapshot~~

Financial Results Summary — Three Months Ended ~~September~~June 30:

Yr. to Yr.

Percent/

(Dollars and shares in millions except per share amounts)

Margin

For the three months ended September 30:

2017

2016

Change

Revenue

$
19,153

$
19,226

(0.4
)%*
Gross profit margin

45.9
%
46.9
%
(0.9
)pts.
Total expense and other (income)

$
5,735

$
5,751

(0.3
)%
Total expense and other (income)-to-revenue ratio

29.9
%
29.9
%
0.0
pts.
Income from continuing operations, before income taxes

$
3,065

$
3,263

(6.1
)%
Provision for income taxes from continuing operations

$
339

$
409

(17.1
)%
Income from continuing operations

$
2,726

$
2,854

(4.5
)%
Income from continuing operations margin

14.2
%
14.8
%
(0.6
)pts.
Loss from discontinued operations, net of tax

$
0

$
(1
)
(79.3
)%
Net income

$
2,726

$
2,853

(4.5
)%
Earnings per share from continuing operations:

Assuming dilution

$
2.92

$
2.98

(2.0
)%
Basic

$
2.93

$
2.99

(2.0
)%
Consolidated earnings per share - assuming dilution

$
2.92

$
2.98

(2.0
)%
Weighted-average shares outstanding:

Assuming dilution

933.2

957.3

(2.5
)%
Basic

929.4

954.0

(2.6
)%


							Yr. to Yr.
							Percent/
(Dollars and shares in millions except per share amounts)							Margin
For the three months ended June 30:	2019			2018			Change
Revenue	$	19,161		$	20,003		(4.2)	%*
Gross profit margin		47.0	%		46.0	%	1.0	pts.
Total expense and other (income)	$	6,242		$	6,423		(2.8)	%
Income from continuing operations before income taxes	$	2,768		$	2,776		(0.3)	%
Provision for income taxes from continuing operations	$	269		$	373		(28.0)	%
Income from continuing operations	$	2,499		$	2,402		4.0	%
Income from continuing operations margin		13.0	%		12.0	%	1.0	pts.
Net income	$	2,498		$	2,404		3.9	%
Earnings per share from continuing operations - assuming dilution	$	2.81		$	2.61		7.7	%
Weighted-average shares outstanding - assuming dilution		890.8			919.4		(3.1)	%

* ~~(1.0)~~(1.6) percent adjusted for currency.

Organization of Information:

~~In October 2014,~~Effective with the first quarter of 2019, the company ~~announced~~made a ~~definitive agreement~~number of changes to ~~divest~~ its ~~Microelectronics business~~organizational structure and ~~manufacturing operations.~~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” for additional information on the changes in reportable segments. The ~~operating results of the Microelectronics business~~periods presented in this Form 10-Q are reported ~~as discontinued operations.~~on a comparable basis. The ~~transaction closed on July 1, 2015.~~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. ~~See~~Refer to “Currency Rate Fluctuations” ~~on page 81~~ for additional information.

~~Management Discussion — (continued)~~

Operating (non-GAAP) Earnings:

In an effort to provide better transparency into the operational results of the business, supplementally, 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

Table of Contents

Management Discussion – (continued)

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 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, ~~and~~ tax charges related to acquisition ~~integration.~~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~~significantly impacted by 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, ~~& Analysis,~~ the impact of acquisitions over the prior 12-month period may be a driver of higher ~~expenses~~expense year to year. For retirement-related costs, the company characterizes certain items as operating and others as ~~non-operating.~~non-operating, consistent with GAAP. The company includes defined benefit plan and nonpension postretirement benefit plan service ~~cost, amortization of prior service cost~~costs, multi-employer plan costs and the cost of defined contribution plans in operating earnings. Non-operating retirement-related ~~cost includes~~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 ~~multi-employer plan costs,~~ 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 supplementally 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 ~~comparisons~~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.

In addition, these non-GAAP measures provide a perspective consistent with areas of interest the company routinely receives from investors and analysts.

The following table provides the company’s operating (non-GAAP) ~~operating~~ earnings for the ~~third~~second quarter of ~~2017~~2019 and ~~2016.~~2018.

Yr. to Yr.

(Dollars in millions except per share amounts)

Percent

For the three months ended September 30:

2017

2016

Change

Net income as reported

$
2,726

$
2,853

(4.5
)%
Loss from discontinued operations, net of tax

0

(1
)
(79.3
)
Income from continuing operations

$
2,726

$
2,854

(4.5
)%
Non-operating adjustments (net of tax):

Acquisition-related charges

159

197

(19.1
)
Non-operating retirement-related costs/(income)

193

99

96.1

Operating (non-GAAP) earnings*

$
3,079

$
3,149

(2.2
)%
Diluted operating (non-GAAP) earnings per share

$
3.30

$
3.29

0.3
%


					Yr. to Yr.
(Dollars in millions except per share amounts)					Percent
For the three months ended June 30:	2019		2018		Change
Net income as reported	$	2,498	$	2,404	3.9	%
Income/(loss) from discontinued operations, net of tax		(1)		1	nm
Income from continuing operations	$	2,499	$	2,402	4.0	%
Non-operating adjustments (net of tax):
Acquisition-related charges		217		160	35.6
Non-operating retirement-related costs/(income)		97		286	(66.2)
U.S. tax reform charges		14		(14)	nm
Operating (non-GAAP) earnings*	$	2,827	$	2,834	(0.3)	%
Diluted operating (non-GAAP) earnings per share	$	3.17	$	3.08	2.9	%

* ~~See~~Refer to page 8598 for a more detailed reconciliation of net income to operating earnings.

nm - not meaningful

Financial Performance Summary — Three Months Ended ~~September~~June 30:

In the ~~third~~second quarter of ~~2017,~~2019, the company reported $19.2 billion in revenue, ~~$2.7~~$2.5 billion in income from continuing operations and ~~$3.1 billion in~~ operating (non-GAAP) earnings of $2.8 billion, resulting in diluted earnings per share from continuing operations of ~~$2.92~~$2.81 as reported and ~~$3.30~~$3.17 on an operating (non-GAAP) basis. The company also generated ~~$3.6~~

Table of Contents

Management Discussion – (continued)

$2.9 billion in cash from operations, ~~and $2.5~~$2.4 billion in free cash flow ~~in the third quarter of 2017~~ and delivered shareholder returns of ~~$2.3~~$1.8 billion in gross common stock repurchases and dividends. This performance reflects improving fundamentals as the company continues to focus on investment prioritization shifting to higher value areas and the value the company provides to clients in their digital transformations and journey to the cloud. The company has taken significant actions to improve its position over time including the completion of the two software asset divestitures and workforce actions in the second quarter as well as the acquisition of Red Hat on July 9, 2019. This acquisition is an important milestone for the company, and one that will significantly impact the cloud landscape. It is clear that the next chapter of cloud will be about shifting mission-critical work to the cloud and optimizing everything from supply chains to core banking systems. This requires a hybrid, multicloud, open approach, to provide portability, management consistency and security for enterprise workloads.

Total consolidated revenue decreased ~~0.4~~4.2 percent ~~year to year~~ as reported and ~~1.0~~2 percent adjusted for currency incompared to the ~~third quarter of 2017, with sequential improvement of 4.3 points as reported and 2.3 points adjusted for currency from the second-quarter year-to-year rates. The~~prior year. Cloud & Cognitive Solutions segment and the Systems segment both had revenue growth year to year in the third quarter as reported and adjusted for currency. The year-to-year effect of currency in the third quarter (0.6 points help) improved from the second quarter impact (1.4 points hurt).

~~Management Discussion — (continued)~~

The company is embedding cloud and cognitive capabilities across the business and the strategic imperatives are a signpost of the progress being made in helping enterprise clients extract value from data and become digital businesses. In the third quarter of 2017, the company continued to deliver solid revenue growth in its strategic imperatives - cloud, analytics, mobile, security and social, which together generated $8.8 billion of revenue and grew 11Software increased 3.2 percent as reported and 105 percent adjusted for currency with ~~double-digit~~ growth ~~in cloud and security. Strategic imperatives growth in~~across all three business lines of the ~~third quarter largely represented organic growth as the acquisitive content has leveled on a year-to-year basis. Total Cloud revenue of $4.1 billion increased 20~~segment. Cognitive Applications grew 2.9 percent as reported and 5 percent adjusted for currency, ~~with as-a-Service revenue up 25 percent (24 percent adjusted for currency). The annual exit run rate for as-a-Service revenue~~Cloud & Data Platforms increased to $9.4 billion in the third quarter of 2017 compared to $7.5 billion in the third quarter of 2016. Analytics revenue of $5.0 billion increased 5 percent both as reported and adjusted for currency. Mobile revenue increased 74.5 percent as reported and 7 percent adjusted for currency and ~~Security revenue increased 51~~Transaction Processing Platforms grew 2.0 percent ~~(49~~as reported and 4 percent adjusted for ~~currency), driven by security software solutions and strong demand for the pervasive encryption capabilities in the new z14 mainframe.~~

~~From a segment perspective, in the third quarter, Cognitive Solutions revenue~~currency. Global Business Services (GBS) increased ~~3.9~~0.5 percent as reported and 3 percent adjusted for currency led by Consulting which grew 2.4 percent (5 percent adjusted for currency). Global Technology Services (GTS) decreased 6.7 percent as reported (4 percent adjusted for currency), with ~~growth~~declines in ~~Solutions Software~~Infrastructure & Cloud Services and ~~Transaction Processing Software~~Technology Support Services reflecting actions taken to deemphasize lower-value contracts and third-party content. Systems decreased 19.5 percent as reported (18 percent adjusted for currency), with IBM Z declining 41.8 percent (41 percent adjusted for currency) year to year reflecting the product cycle dynamics. Storage Systems decreased year to year with declines in high-end product sales which is tied to the mainframe cycle and the ongoing competitive dynamics and pricing pressures in the mid-range. Power Systems grew as reported and adjusted for ~~currency. Performance~~currency with the continued strong performance of POWER9.

Total cloud revenue of $4.8 billion in the ~~third~~second quarter ~~included growth in annuity revenue, including as-a-Service solutions, as well as growth in software transactional performance. Global Business Services (GBS) revenue decreased 2.3~~of 2019 grew 2 percent as reported and 25 percent adjusted for ~~currency, primarily driven by declines in both Application Management and Global Process Services, partially offset by growth in Consulting. The GBS business continued to shift resources and move into~~currency. Over the ~~high-value strategic areas of digital,~~trailing 12 months, total cloud ~~and analytics. GBS strategic imperatives~~ revenue ~~increased 10~~was $19.5 billion, up 5 percent ~~(11~~(8 percent adjusted for currency) year to year. ~~Technology Services & Cloud Platforms~~As-a-Service revenue increased 4 percent as reported and 7 percent adjusted for currency in the second quarter of 2019 compared to the prior-year period and grew 13 percent (16 percent adjusted for currency) over the trailing 12 months. The annual exit run rate for as-a-Service revenue was $11.5 billion.

From a geographic perspective, Americas revenue declined 4.4 percent year to year as reported (3 percent adjusted for currency). Europe/Middle East/Africa (EMEA) decreased 4.0 percent, but grew 1 percent adjusted for currency. Asia Pacific declined 4.1 percent year to year as reported (2 percent adjusted for currency).

The consolidated gross margin of 47.0 percent increased 1.0 points year to year, and the operating (non-GAAP) gross margin of 47.4 percent increased 1.0 points versus the prior year, reflecting strong software growth, services productivity and cloud scale efficiencies.

Total expense and other (income) decreased 2.8 percent in the second quarter of 2019 compared to the prior year. The year-to-year performance was driven by gains from the divestitures (9 points), the impact of currency (4 points) and lower non-operating retirement-related costs (4 points), partially offset by a higher level of workforce rebalancing charges (7 points) and higher spending and litigation matters (5 points). Total operating (non-GAAP) expense and other (income) decreased 0.2 percent year to year, driven primarily by the same factors, excluding the non-operating retirement-related costs.

Pre-tax income from continuing operations of $2.8 billion decreased 0.3 percent and the pre-tax margin was 14.4 percent, an increase of 0.6 points versus the prior-year period. The continuing operations effective tax rate for the second quarter of 2019 was 9.7 percent, a decrease of 3.7 points compared to the second quarter of 2018. The year-to-year change was primarily driven by an increase in tax benefits attributable to foreign audit activity (3.7 points). Net income of $2.5 billion increased 3.9 percent and the net income margin was 13.0 percent, an increase of 1.0 points year to year.

Table of Contents

Management Discussion – (continued)

Operating (non-GAAP) pre-tax income from continuing operations of $3.2 billion decreased 5.9 percent year to year and the operating (non-GAAP) pre-tax margin from continuing operations decreased 0.3 points to 16.6 percent. The operating (non-GAAP) tax rate for the second quarter of 2019 was 11.0 percent, a decrease of 5.0 points compared to the second quarter of 2018. The change in the operating (non-GAAP) tax rate was primarily driven by the same factor mentioned above. Operating (non-GAAP) income from continuing operations of $2.8 billion decreased 0.3 percent with an operating (non-GAAP) income margin from continuing operations of 14.8 percent, up 0.6 points year to year.

Diluted earnings per share from continuing operations of $2.81 in the second quarter of 2019 increased 7.7 percent and operating (non-GAAP) diluted earnings per share of $3.17 increased 2.9 percent versus the second quarter of 2018. In the second quarter of 2019, the company repurchased 2.3 million shares of its common stock at a cost of $0.3 billion and had $2.1 billion remaining in the current share repurchase authorization at June 30, 2019.

The company generated $2.9 billion in cash flow provided by operating activities, an increase of $0.6 billion compared to the second quarter of 2018, driven primarily by an increase in cash provided by financing receivables ($0.7 billion). In the second quarter of 2019, investing activities were a net source of cash of $4.2 billion compared to a net use of cash of $0.6 billion in the prior year, primarily driven by an increase in cash provided by non-operating finance receivables ($3.1 billion), an increase in cash provided by current year divestitures ($0.9 billion) and a decrease in net capital expenditures ($0.6 billion). In the second quarter of 2019, financing activities were a source of cash of $21.0 billion compared to a use of cash of $2.5 billion in the second quarter of 2018. The $23.5 billion increase in financing cash flows year to year was driven by an increase in net cash sourced from debt transactions ($22.9 billion) to fund the acquisition of Red Hat.

Refer to the Looking Forward section for information on the company’s expectations.

Financial Results Summary — Six Months Ended June 30:


							Yr. to Yr.
							Percent/
(Dollars and shares in millions except per share amounts)							Margin
For the six months ended June 30:	2019			2018			Change
Revenue	$	37,342		$	39,075		(4.4)	%*
Gross profit margin		45.7	%		44.6	%	1.0	pts.
Total expense and other (income)	$	12,402		$	13,534		(8.4)	%
Income from continuing operations before income taxes	$	4,651		$	3,911		18.9	%
Provision for/(benefit from) income taxes from continuing operations	$	558		$	(166)		nm
Income from continuing operations	$	4,093		$	4,078		0.4	%
Income from continuing operations margin		11.0	%		10.4	%	0.5	pts.
Net income	$	4,089		$	4,083		0.2	%
Earnings per share from continuing operations - assuming dilution	$	4.58		$	4.42		3.6	%
Weighted-average shares outstanding - assuming dilution		892.4			922.4		(3.3)	%

	At 6/30/2019			At 12/31/2018
Assets	$	154,652		$	123,382		25.3	%
Liabilities	$	136,876		$	106,452		28.6	%
Equity	$	17,776		$	16,929		5.0	%

* (1.2) percent adjusted for currency.

nm - not meaningful

Table of Contents

Management Discussion – (continued)

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


					Yr. to Yr.
(Dollars in millions except per share amounts)					Percent
For the six months ended June 30:	2019		2018		Change
Net income as reported	$	4,089	$	4,083	0.2	%
Income/(loss) from discontinued operations, net of tax		(4)		5	nm
Income from continuing operations	$	4,093	$	4,078	0.4	%
Non-operating adjustments (net of tax):
Acquisition-related charges		381		324	17.5
Non-operating retirement-related costs/(income)		208		611	(66.0)
U.S. tax reform charges		155		93	66.1
Operating (non-GAAP) earnings*	$	4,836	$	5,106	(5.3)	%
Diluted operating (non-GAAP) earnings per share	$	5.42	$	5.53	(2.0)	%

* Refer to page 99 for a more detailed reconciliation of net income to operating earnings.

nm - not meaningful

Financial Performance Summary — Six Months Ended June 30:

In the first six months of 2019, the company reported $37.3 billion in revenue, $4.1 billion in income from continuing operations and operating (non-GAAP) earnings of $4.8 billion, resulting in diluted earnings per share from continuing operations of $4.58 as reported and $5.42 on an operating (non-GAAP) basis. The company also generated $7.7 billion in cash from operations, $4.1 billion in free cash flow and delivered shareholder returns of $4.1 billion in gross common stock repurchases and dividends.

Total consolidated revenue decreased ~~3.3~~4.4 percent as reported and 1 percent adjusted for currency compared to the prior year. Cloud & Cognitive Software increased 0.9 percent as reported and 4 percent adjusted for currency. Cognitive Applications grew 2.3 percent as reported and 5 percent adjusted for currency, Cloud & Data Platforms increased 1.5 percent as reported and 4 percent adjusted for currency ~~primarily driven by a decline in Infrastructure Services. However, within Technology Services & Cloud~~and Transaction Processing Platforms ~~strategic imperatives revenue was up 12~~declined 0.7 percent as reported, but grew 2 percent adjusted for currency. GBS grew 0.3 percent as reported and ~~adjusted for currency year to year, driven by hybrid cloud services, security and mobile. Systems revenue increased 10.4 percent as reported and 10~~4 percent adjusted for currency ~~driven~~led by ~~strong contribution from the new z14 mainframe~~Consulting which grew 3.8 percent (7 percent adjusted for currency). GTS decreased 7.0 percent as reported (3 percent adjusted for currency), with declines in Infrastructure & Cloud Services and ~~continued growth in Storage Systems.~~

~~From a geographic perspective, Americas revenue~~Technology Support Services. Systems decreased ~~2.0~~16.2 percent (2as reported (14 percent adjusted for currency), with IBM Z declining 40.8 percent (40 percent adjusted for currency) year to year reflecting the product cycle dynamics. Storage Systems declined with continued competitive dynamics and pricing pressures, while Power Systems grew as reported and adjusted for currency. Total cloud revenue of $9.3 billion in the ~~U.S. down 2.6~~first six months of 2019 grew 4 percent as reported and ~~Latin America down 1.5~~8 percent adjusted for currency.

From a geographic perspective, Americas revenue declined 3.5 percent year to year as reported (2 percent adjusted for currency). ~~Canada was up 2.1 percent as reported, but down 2 percent adjusted for currency.~~ Europe/Middle East/Africa (EMEA) ~~revenue increased 2.4~~decreased 5.6 percent, ~~as reported,~~ but ~~decreased 1 percent adjusted for currency, with growth in France, Germany and Spain and a decline in the UK. Asia Pacific revenue decreased 1.2 percent as reported, but increased 2 percent~~was flat adjusted for currency. ~~Within~~ Asia Pacific ~~Japan decreased 4.0~~declined 4.7 percent year to year as reported ~~but increased 4 percent adjusted for currency, and China increased 3.9 percent (4~~(2 percent adjusted for currency).

The consolidated gross ~~profit~~ margin of ~~45.9~~45.7 percent ~~decreased 0.9~~increased 1.0 points year to year, ~~driven by continued investments, mix~~ and ~~higher retirement-related costs, partially offset by benefits from productivity. The~~the operating (non-GAAP) gross margin of ~~47.6~~46.1 percent increased 0.9 points versus the prior year. The improved margins in the first six months of 2019 reflect the actions the company has taken to focus on higher value and portfolio optimization while also driving productivity and operational efficiency.

Total expense and other (income) decreased ~~0.4 points~~8.4 percent in the first six months of 2019 compared to the prior year. The year-to-year performance was driven by the impact of currency (5 points), gains from divestitures (4 points) and lower non-operating retirement-related costs (4 points), partially offset by a decrease in intellectual property (IP) income

Table of Contents

Management Discussion – (continued)

(2 points) and higher spending (2 points). Total operating (non-GAAP) expense and other (income) decreased 5.8 percent year to year, driven primarily by the same factors excluding the ~~impact of higher~~ non-operating retirement-related costs. ~~The consolidated gross margin and the operating (non-GAAP) gross margin both improved 0.4 points compared to the second-quarter 2017 gross margins.~~

Total expense and other (income) decreased 0.3 percent in the third quarter of 2017 compared to the prior year. The year-to-year decrease was primarily the result of lower operational spending (4 points), largely offset by lower intellectual property income (4 points) and spending related to acquisitions completed in the prior 12 months. The expense dynamics reflect continued efficiency in the underlying spending offset by continued investment to build and reinvent new solutions and platforms. Total operating (non-GAAP) expense and other (income) decreased 0.8 percent year to year driven primarily by the same factors.

Pre-tax income from continuing operations of ~~$3.1~~$4.7 billion ~~in the third quarter of 2017 decreased 6.1~~increased 18.9 percent ~~year to year~~ and the pre-tax margin was ~~16.0~~12.5 percent, ~~a decrease~~an increase of ~~1.0~~2.4 points ~~compared to the third quarter of 2016.~~versus 2018. The continuing operations effective tax rate for the ~~third quarter~~first six months of ~~2017~~2019 was ~~11.0~~12.0 percent, ~~a decrease~~an increase of ~~1.5~~16.3 points compared to the ~~third quarter~~first six months of ~~2016,~~2018. The year-to-year change was primarily driven by ~~an increase in foreign tax credits, partially offset by a benefit related~~reduced audit resolution benefits compared to ~~tax audit activity in~~ the prior ~~year period. Income from continuing operations~~year. Net income of ~~$2.7~~$4.1 billion ~~decreased 4.5~~increased 0.2 percent and the net income margin was ~~14.2~~11.0 percent, a decrease of 0.6 points. Losses from discontinued operations, net of tax, were $0.2 million in the third quarter of 2017 and $1.0 million in the third quarter of 2016. Net income of $2.7 billion decreased 4.5 percentup 0.5 points year to year. Operating (non-GAAP) pre-tax income from continuing operations of ~~$3.6~~$5.4 billion decreased 1.7 percent year to year. Operating (non-GAAP) pre-tax margin from continuing operations decreased 0.2 points to 18.8 percent. Operating (non-GAAP) income from continuing operations of $3.1 billion decreased 2.2 percent and the operating (non-GAAP) income

~~Management Discussion — (continued)~~

margin from continuing operations of 16.1 percent decreased 0.3 points. The operating (non-GAAP) effective tax rate from continuing operations in the third quarter of 2017 was 14.7 percent versus 14.2 percent in the prior year.

Diluted earnings per share from continuing operations of $2.92 in the third quarter of 2017 decreased 2.0 percent year to year. In the third quarter of 2017, the company repurchased 6.6 million shares of its common stock at a cost of $0.9 billion and had $1.5 billion remaining in the share repurchase authorization at September 30, 2017. Operating (non-GAAP) diluted earnings per share of $3.30 increased 0.3 percent versus the third quarter of 2016.

The company generated $3.6 billion in cash flow from operating activities in the third quarter of 2017, a decrease of $0.5 billion compared to the third quarter of 2016. Net cash used in investing activities of $1.9 billion was $1.0 billion higher than the prior year, primarily driven by a reduction in cash sourced from non-operating finance receivables ($0.4 billion) and an increase in cash used from net purchases of marketable securities and other investments ($0.4 billion). Net cash used in financing activities of $2.8 billion decreased $1.4 billion compared to the prior year, primarily driven by higher net debt issuances ($1.6 billion).

In January 2017, the company disclosed that it expected GAAP earnings per share from continuing operations of at least $11.95 and operating (non-GAAP) earnings of at least $13.80 per diluted share for 2017. The company also disclosed that it expected 2017 free cash flow to be consistent with 2016. Refer to page 82 in the Liquidity and Capital Resources section for additional information on this non-GAAP measure. In October 2017, the company disclosed that it continues to maintain these expectations. Refer to the Looking Forward section on pages 80 and 81 for additional information on the company’s expectations.

~~Financial Results Summary - Nine Months Ended September 30:~~

Yr. to Yr.

Percent/

(Dollars and shares in millions except per share amounts)

Margin

For the nine months ended September 30:

2017

2016

Change

Revenue

$
56,597

$
58,149

(2.7
)%*
Gross profit margin

44.8
%
47.1
%
(2.3
)pts.
Total expense and other (income)

$
18,434

$
20,056

(8.1
)%
Total expense and other (income)-to-revenue ratio

32.6
%
34.5
%
(1.9
)pts.
Income from continuing operations, before income taxes

$
6,931

$
7,345

(5.6
)%
Provision for/(benefit from) income taxes from continuing operations

$
120

$
(31
)
nm
%
Income from continuing operations

$
6,811

$
7,375

(7.7
)%
Income from continuing operations margin

12.0
%
12.7
%
(0.6
)pts.
Loss from discontinued operations, net of tax

$
(3
)
$
(4
)
(17.5
)%
Net income

$
6,807

$
7,371

(7.6
)%
Earnings per share from continuing operations:

Assuming dilution

$
7.24

$
7.67

(5.6
)%
Basic

$
7.28

$
7.70

(5.5
)%
Consolidated earnings per share - assuming dilution

$
7.24

$
7.67

(5.6
)%
Weighted-average shares outstanding:

Assuming dilution

940.2

960.7

(2.1
)%
Basic

935.6

957.7

(2.3
)%

9/30/17

12/31/16

Assets

$
121,636

$
117,470

3.5
%
Liabilities

$
101,879

$
99,078

2.8
%
Equity

$
19,757

$
18,392

7.4
%

* (2.2) percent adjusted for currency

~~nm - not meaningful~~

~~The following table provides the company’s (non-GAAP) operating earnings for the first nine months of 2017 and 2016.~~

~~Management Discussion — (continued)~~

Yr. to Yr.

(Dollars in millions except per share amounts)

Percent

For the nine months ended September 30:

2017

2016

Change

Net income as reported

$
6,807

$
7,371

(7.6
)%
Loss from discontinued operations, net of tax

(3
)
(4
)
(17.5
)
Income from continuing operations

$
6,811

$
7,375

(7.7
)%
Non-operating adjustments (net of tax):

Acquisition-related charges

537

542

(0.7
)
Non-operating retirement-related costs/(income)

777

338

129.9

Operating (non-GAAP) earnings*

$
8,125

$
8,255

(1.6
)%
Diluted operating (non-GAAP) earnings per share

$
8.64

$
8.59

0.6
%

* See page 86 for a more detailed reconciliation of net income to operating earnings.

~~Financial Performance Summary — Nine Months Ended September 30:~~

In the first nine months of 2017, the company reported $56.6 billion in revenue, and delivered $6.8 billion in income from continuing operations, resulting in diluted earnings per share from continuing operations of $7.24 as reported and $8.64 on an operating (non-GAAP) basis. The company generated $11.0 billion in cash from operations and $6.2 billion in free cash flow in the first nine months of 2017 and shareholder returns of $7.8 billion in gross common stock repurchases and dividends.

~~Total consolidated revenue decreased 2.7 percent year to year as reported and 2.2 percent adjusted for currency in the first nine months of 2017.~~

~~In the first nine months of 2017, the company’s strategic imperatives revenue~~ grew 9 percent year to year as reported and 10 percent adjusted for currency. Total Cloud revenue of $11.6 billion was up 22 percent year to year as reported and 23 percent adjusted for currency, with as-a-Service revenue up 36 percent (37 percent adjusted for currency). Analytics revenue of $14.5 billion increased 5 percent as reported and 6 percent adjusted for currency. Mobile revenue was up 17 percent year to year (19 percent adjusted for currency) and Security revenue increased 21 percent as reported and adjusted for currency.

From a segment perspective, for the first nine months, Cognitive Solutions revenue increased 1.0 percent as reported and 1 percent adjusted for currency. On an as reported and adjusted for currency basis, Solutions Software increased year to year, while Transaction Processing Software declined. GBS revenue decreased 3.0 percent as reported and 2 percent adjusted for currency with declines in Application Management , Consulting and Global Process Services. GBS strategic imperatives revenue increased 10 percent (11 percent adjusted for currency) year to year. Technology Services & Cloud Platforms revenue decreased 3.7 percent as reported and 3 percent adjusted for currency, primarily driven by Infrastructure Services which declined 4.4 percent (4 percent adjusted for currency). Technology Services & Cloud Platforms strategic imperatives revenue was up 20 percent (21 percent adjusted for currency) year to year, led by hybrid cloud services. Systems revenue decreased 6.2 percent as reported (6 percent adjusted for currency) with declines in z Systems and Power Systems, both due to product refresh cycle dynamics, partially offset by growth in Storage Systems.

From a geographic perspective, Americas revenue decreased 1.8 percent (2 percent adjusted for currency) year to year with the U.S. down 3.0 percent, partially offset by growth in Latin America (4.5 percent as reported, 1 percent adjusted for currency). EMEA revenue decreased 4.7 percent (3 percent adjusted for currency) driven primarily by declines in the UK and Germany. Asia Pacific revenue decreased 1.9 percent (1 percent adjusted for currency), with Japan down 1.8 percent as reported, but up 2 percent adjusted for currency.

The consolidated gross margin of 44.8 percent decreased 2.3 points year to year and reflects investments, mix and higher retirement-related costs, partially offset by benefits from productivity. The operating (non-GAAP) gross margin of 46.5 percent decreased 1.7 points versus the prior year primarily driven by the same factors, excluding the impact of higher non-operational retirement-related costs.

Total expense and other (income) decreased $1.6 billion or 8.1 percent in the first nine months of 2017 compared to the prior year. The year-to-year decrease was primarily the result of continued focus on efficiency in spending and reduced expenses for workforce transformation. This included a lower level of workforce rebalancing charges (4 points), a prior-year charge for real estate actions (2 points) and lower operational spending (2 points). In addition, the effects of currency (1 point) contributed to the year-to-year decline. The year-to-year decrease in expense and other (income) was partially offset by

~~Management Discussion — (continued)~~

spending related to acquisitions (2 points) completed in the prior 12 months. Total operating (non-GAAP) expense and other (income) decreased 9.9 percent year to year, driven primarily by the same factors.

Pre-tax income from continuing operations of $6.9 billion decreased 5.6 percent and the pre-tax margin was 12.2 percent, a decrease of 0.4 points versus the first nine months of 2016. The continuing operations effective tax rate for the first nine months of 2017 was 1.7 percent compared to (0.4) percent in the prior year. The tax rate in the first nine months of 2017 benefitted from discrete tax items, including the first-quarter intra-entity transfer of assets ($0.6 billion) and certain second-quarter discrete items. The prior year negative tax rate was primarily the result of a refund ($1.2 billion) of previously paid non-U.S. taxes plus interest in the first quarter of 2016. Income from continuing operations of $6.8 billion decreased 7.7 percent and the net income margin was 12.0 percent, a decrease of 0.6 points compared to the first nine months of 2016. Losses from discontinued operations, net of tax, were $3.5 million in the first nine months of 2017 and $4.2 million in the prior-year period. Net income of $6.8 billion decreased 7.6 percent year to year. Operating (non-GAAP) pre-tax income from continuing operations of $8.7 billion increased 2.55.8 percent year to year and the operating (non-GAAP) pre-tax margin from continuing operations increased ~~0.8~~1.4 points to ~~15.5~~14.5 percent. The operating (non-GAAP) tax rate for the first six months of 2019 was 10.6 percent, an increase of 10.4 points compared to the first six months of 2018. The change in the operating (non-GAAP) tax rate was primarily driven by the same factor mentioned above. Operating (non-GAAP) income from continuing operations of ~~$8.1~~$4.8 billion decreased ~~1.6~~5.3 percent ~~and the~~with an operating (non-GAAP) income margin from continuing operations of ~~14.4~~13.0 percent, ~~increased 0.2 points. The operating (non-GAAP) effective tax rate from continuing operations in the first nine months of 2017 was 7.1 percent versus 3.2 percent in the first nine months of 2016.~~down 0.1 points year to year.

Diluted earnings per share from continuing operations of ~~$7.24~~$4.58 in the first six months of 2019 increased 3.6 percent and operating (non-GAAP) diluted earnings per share of $5.42 decreased ~~5.6~~2.0 percent ~~year to year.~~versus the first six months of 2018. In the first ~~nine~~six months of ~~2017,~~2019, the company repurchased ~~22.9~~9.2 million shares of its common stock ~~and had $1.5 billion remaining in the current share repurchase authorization~~ at ~~September 30, 2017. Operating (non-GAAP) diluted earnings per share~~a cost of ~~$8.64 increased 0.6 percent versus the prior year.~~$1.2 billion.

At ~~September~~June 30, ~~2017,~~2019, the balance sheet remains strong and ~~with the newly reorganized financing entity, IBM Credit LLC,~~ the company ~~is better positioned~~continues to ~~support the business over the long term.~~be committed to maintaining a strong investment grade rating. Cash, restricted cash and marketable securities at quarter end were ~~$11.5~~$46.4 billion, an increase of ~~$3.0~~$34.2 billion from December 31, ~~2016.~~2018. Cash and debt balances increased since year-end 2018, as the company prepared for the acquisition of Red Hat. Key drivers in the balance sheet and total cash flows were:

Total assets increased ~~$4.2~~$31.3 billion ~~(decreased $0.4~~($30.9 billion adjusted for currency) from December 31, ~~2016~~2018 driven by:

●

An increase of $34.2 billion in cash, restricted cash and marketable securities, which was subsequently used to fund the Red Hat acquisition on July 9, 2019; and

●

An increase in operating right-of-use assets of $5.0 billion resulting from the adoption of the new leasing standard on January 1, 2019; partially offset by

●

A decrease in total receivables of $6.6 billion primarily driven by a decline in financing receivables due to the wind down of OEM IT commercial financing operations.

· ~~Increases in cash and marketable securities ($3.0 billion), deferred taxes ($2.1 billion), retirement plan assets ($1.5 billion) and goodwill ($0.6 billion); partially offset by~~

· ~~Decreases in total receivables ($2.7 billion) and intangible assets ($0.7 billion).~~

Total liabilities increased ~~$2.8~~$30.4 billion ~~(decreased $1.5~~($30.2 billion adjusted for currency) from December 31, ~~2016~~2018 driven by:

●

An increase in total debt of $27.2 billion primarily driven by new issuances; and

●

An increase in operating lease liabilities of $5.3 billion resulting from the adoption of the new leasing standard.

· ~~Increases in total debt ($3.5 billion); partially offset by~~

· ~~Decreases in accounts payable ($0.8 billion).~~

Total equity of ~~$19.8~~$17.8 billion increased ~~$1.4~~$0.8 billion from December 31, ~~2016~~2018 as a result of:

●

Increases from net income of $4.1 billion and retirement related plans of $0.8 billion; partially offset by

●

Decreases from dividends of $2.8 billion and gross share repurchases of $1.2 billion.

· ~~Increases from net income ($6.8 billion), retirement-related ($1.4 billion) and equity translation adjustments ($0.8 billion); partially offset by~~

· ~~Decreases from dividends ($4.1 billion) and share repurchases ($3.7 billion).~~

The company generated ~~$11.0~~$7.7 billion in cash flow provided by operating activities, ~~a decrease~~an increase of ~~$2.1~~$0.8 billion compared to the first ~~nine~~six months of ~~2016,~~2018, driven primarily by ~~the prior-year tax refund and a decrease~~an increase in cash provided by financing ~~receivables. Net cash used in~~receivables ($0.8 billion). In the first six months of 2019, investing activities were a net source of cash of $3.3 billion ~~was $4.0~~compared to a net use of cash of $2.4 billion ~~lower than~~in the prior year. The year-to-year increase in investing cash flows was driven by an increase in cash provided by non-operating finance receivables ($3.4 billion), cash provided by current year divestitures ($0.9

Table of Contents

Management Discussion – (continued)

billion) and a decrease in net capital expenditures ($0.9 billion). In the first six months of 2019, financing activities were a source of cash of $22.9 billion compared to a use of cash of $5.4 billion in the first six months of 2018. The $28.3 billion increase in financing cash flows year to year was driven by an increase in net cash sourced from debt transactions ($27.8 billion) primarily driven by a ~~decrease in cash used for acquisitions ($5.0 billion). Net cash used in financing activities~~higher level of ~~$5.5 billion increased $0.9 billion compared~~issuances to fund the ~~first nine months~~acquisition of ~~2016, driven primarily by increased gross common share repurchases ($1.0 billion).~~

~~Management Discussion — (continued)~~

Red Hat.

~~Third~~Second Quarter and First ~~Nine~~Six Months in Review

Results of Continuing Operations

Segment Details

The following is an analysis of the ~~third~~second quarter and first ~~nine~~six months of ~~2017~~2019 versus the ~~third~~second quarter and first ~~nine~~six months of ~~2016~~2018 reportable segment external revenue and gross margin results. Segment pre-tax income includes transactions between ~~the~~ 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 June 30:	2019			2018			Change		Currency
Revenue:
Cloud & Cognitive Software	$	5,645		$	5,470	*	3.2	%	5.4	%
Gross margin		77.3	%		77.7	%*	(0.4)	pts.
Global Business Services		4,155			4,135	*	0.5	%	3.4	%
Gross margin		26.0	%		26.0	%*	(0.1)	pts.
Global Technology Services		6,837			7,325	*	(6.7)	%	(3.5)	%
Gross margin		34.4	%		33.2	%*	1.2	pts.
Systems		1,753			2,177		(19.5)	%	(18.0)	%
Gross margin		53.5	%		50.6	%	2.9	pts.
Global Financing		351			394		(11.0)	%	(8.5)	%
Gross margin		35.0	%		26.6	%	8.3	pts.
Other		420			503	*	(16.4)	%	(14.2)	%
Gross margin		36.5	%		45.7	%*	(9.2)	pts.
Total consolidated revenue	$	19,161		$	20,003		(4.2)	%	(1.6)	%
Total consolidated gross profit	$	9,010		$	9,199		(2.1)	%
Total consolidated gross margin		47.0	%		46.0	%	1.0	pts.
Non-operating adjustments:
Amortization of acquired intangible assets		73			94		(21.7)	%
Operating (non-GAAP) gross profit	$	9,083		$	9,292		(2.3)	%
Operating (non-GAAP) gross margin		47.4	%		46.5	%	1.0	pts.

* Recast to reflect segment changes.

Yr. to Yr.

Percent

Yr. to Yr.

Change

(Dollars in millions)

Percent/Margin

Adjusted For

For the three months ended September 30:

2017

2016

Change

Currency

Revenue:

Cognitive Solutions

$
4,400

$
4,235

3.9
%
3.0
%
Gross margin

78.7
%
80.4
%
(1.7
)pts.

Global Business Services

4,093

4,191

(2.3
)%
(2.2
)%
Gross margin

27.3
%
28.8
%
(1.5
)pts.

Technology Services & Cloud Platforms

8,457

8,748

(3.3
)%
(4.1
)%
Gross margin

41.1
%
42.0
%
(1.0
)pts.

Systems

1,721

1,558

10.4
%
9.6
%
Gross margin

53.6
%
51.1
%
2.6
pts.

Global Financing

427

412

3.7
%
2.8
%
Gross margin

25.2
%
37.8
%
(12.6
)pts.

Other

56

81

(31.8
)%
(32.8
)%
Gross margin

(511.4
)%
(279.2
)%
(232.2
)pts.

Total consolidated revenue

$
19,153

$
19,226

(0.4
)%
(1.0
)%
Total consolidated gross profit

$
8,800

$
9,013

(2.4
)%

Total consolidated gross margin

45.9
%
46.9
%
(0.9
)pts.

Non-operating adjustments:

Amortization of acquired intangible assets

114

129

(12.2
)%

Retirement-related costs/(income)

203

79

158.7
%

Operating (non-GAAP) gross profit

$
9,116

$
9,221

(1.1
)%

Operating (non-GAAP) gross margin

47.6
%
48.0
%
(0.4
)pts.

Table of Contents

Management Discussion —– (continued)


									Yr. to Yr.
									Percent
							Yr. to Yr.		Change
(Dollars in millions)							Percent/Margin		Adjusted For
For the six months ended June 30:	2019			2018			Change		Currency
Revenue:
Cloud & Cognitive Software	$	10,682		$	10,586	*	0.9	%	3.6	%
Gross margin		76.3	%		77.1	%*	(0.8)	pts.
Global Business Services		8,274			8,250	*	0.3	%	3.9	%
Gross margin		26.1	%		24.7	%*	1.4	pts.
Global Technology Services		13,711			14,746	*	(7.0)	%	(3.3)	%
Gross margin		34.1	%		32.9	%*	1.1	pts.
Systems		3,081			3,676		(16.2)	%	(14.2)	%
Gross margin		50.3	%		47.8	%	2.6	pts.
Global Financing		757			799		(5.3)	%	(2.2)	%
Gross margin		34.9	%		30.6	%	4.4	pts.
Other		837			1,017	*	(17.8)	%	(15.3)	%
Gross margin		31.7	%		38.7	%*	(7.0)	pts.
Total consolidated revenue	$	37,342		$	39,075		(4.4)	%	(1.2)	%
Total consolidated gross profit	$	17,053		$	17,445		(2.3)	%
Total consolidated gross margin		45.7	%		44.6	%	1.0	pts.
Non-operating adjustments:
Amortization of acquired intangible assets		149			187		(20.2)	%
Operating (non-GAAP) gross profit	$	17,202		$	17,633		(2.4)	%
Operating (non-GAAP) gross margin		46.1	%		45.1	%	0.9	pts.

* Recast to reflect segment changes.

Yr. to Yr.

Percent

Yr. to Yr.

Change

(Dollars in millions)

Percent/Margin

Adjusted For

For the nine months ended September 30:

2017

2016

Change

Currency

Revenue:

Cognitive Solutions

$
13,021

$
12,889

1.0
%
1.3
%
Gross margin

78.4
%
81.5
%
(3.1
)pts.

Global Business Services

12,196

12,578

(3.0
)%
(1.9
)%
Gross margin

25.3
%
27.0
%
(1.7
)pts.

Technology Services & Cloud Platforms

25,079

26,029

(3.7
)%
(3.3
)%
Gross margin

40.2
%
41.5
%
(1.3
)pts.

Systems

4,863

5,184

(6.2
)%
(5.9
)%
Gross margin

51.5
%
55.1
%
(3.6
)pts.

Global Financing

1,246

1,245

0.1
%
(0.4
)%
Gross margin

29.2
%
39.6
%
(10.4
)pts.

Other

192

223

(14.2
)%
(14.3
)%
Gross margin

(456.0
)%
(295.2
)%
(160.8
)pts.

Total consolidated revenue

$
56,597

$
58,149

(2.7
)%
(2.2
)%
Total consolidated gross profit

$
25,365

$
27,401

(7.4
)%

Total consolidated gross margin

44.8
%
47.1
%
(2.3
)pts.

Non-operating adjustments:

Amortization of acquired intangible assets

349

371

(5.7
)%

Retirement-related costs/(income)

591

238

148.2
%

Operating (non-GAAP) gross profit

$
26,305

$
28,010

(6.1
)%

Operating (non-GAAP) gross margin

46.5
%
48.2
%
(1.7
)pts.

Cloud & Cognitive Software


							Yr. to Yr.
							Percent
					Yr. to Yr.		Change
(Dollars in millions)					Percent		Adjusted For
For the three months ended June 30:	2019		2018*		Change		Currency
Cloud & Cognitive Software external revenue:	$	5,645	$	5,470	3.2	%	5.4	%
Cognitive Applications	$	1,454	$	1,413	2.9	%	4.9	%
Cloud & Data Platforms		2,173		2,079	4.5		6.8
Transaction Processing Platforms		2,018		1,978	2.0		4.5

* Recast to reflect segment changes.


							Yr. to Yr.
							Percent
					Yr. to Yr.		Change
(Dollars in millions)					Percent		Adjusted For
For the six months ended June 30:	2019		2018*		Change		Currency
Cloud & Cognitive Software external revenue:	$	10,682	$	10,586	0.9	%	3.6	%
Cognitive Applications	$	2,762	$	2,699	2.3	%	4.6	%
Cloud & Data Platforms		4,090		4,029	1.5		4.3
Transaction Processing Platforms		3,830		3,858	(0.7)		2.1

* Recast to reflect segment changes.

Table of Contents

Management Discussion – (continued)

Cloud & Cognitive ~~Solutions~~

Yr. to Yr.

Percent

Yr. to Yr.

Change

(Dollars in millions)

Percent

Adjusted For

For the three months ended September 30:

2017

2016

Change

Currency

Cognitive Solutions external revenue:

$
4,400

$
4,235

3.9
%
3.0
%
Solutions Software

$
3,029

$
2,919

3.8
%
2.9
%
Transaction Processing Software

1,371

1,316

4.2

3.2

Yr. to Yr.

Percent

Yr. to Yr.

Change

(Dollars in millions)

Percent

Adjusted For

For the nine months ended September 30:

2017

2016

Change

Currency

Cognitive Solutions external revenue:

$
13,021

$
12,889

1.0
%
1.3
%
Solutions Software

$
9,015

$
8,842

2.0
%
2.3
%
Transaction Processing Software

4,006

4,048

(1.0
)
(0.8
)

~~Cognitive Solutions~~Software revenue of ~~$4,400~~$5,645 million ~~grew 3.9~~increased 3.2 percent as reported and 35 percent adjusted for currency in the ~~third~~second quarter of ~~2017~~2019 compared to the prior ~~year with~~year. There was year-to-year growth in both Solutions Software and Transaction Processing Software. For the first nine months of the year, Cognitive Solutions revenue of $13,021 million grew 1.0 percent as reported and 1 percent adjusted for currency with growth in Solutions Software, partially offset by declines in Transaction Processing Software bothacross all three business lines as reported and adjusted for currency.

~~Cognitive Solutions third-quarter annuity revenue grew~~ The company’s portfolio of software offerings help clients securely deploy, run and manage data and applications on private and public clouds as ~~reported and adjusted for currency including strong Software-as-a-Service (SaaS) performance with continued double-digit revenue growth~~well as reported and adjusted for currency. There was growth, as reported and adjusted for currency, in software services which support solutions offerings through industry and product expertise. Transactional revenue also grew this quarter as reported and adjusted for currency compared to the

~~Management Discussion — (continued)~~

~~prior year as clients commit to the platform long term. Within the segment, third-quarter revenue growth was driven by organic performance as acquisitive content has leveled on a year-to-year basis.~~

In the third quarter, Solutions Software revenue of $3,029 million grew 3.8 percent as reported (3 percent adjusted for currency) compared to the prior year. Transaction Processing Software revenue of $1,371 million grew 4.2 percent as reported (3 percent adjusted for currency) compared to the third quarter of 2016. Within Solutions Software, third quarter year-to-year growth was led by offerings in security and analytics. Security software grew double digits as reported and adjusted for currency year to year in the third quarter with strong performance across the portfolio as cognitive capabilities continue to be embedded into these offerings. Analytics revenue growth was broad-based as the company continues to reinvent these offerings. With new offerings and new clients added to the platform this quarter, Internet of Things (IoT) revenue grew double digits in the third quarter both as reported and adjusted for currency. Within Transaction Processing Software, the year-to-year growth reflects clients’ ongoing long-term commitment and the value the company’s platform provides to them. This portfolio predominately runs on-premise mission critical workloads running on z Systems in industries such as banking, airlines and retail.

Cognitive Solutions total third-quarter strategic imperatives revenue of $2.9 billion grew 5 percent year to year as reported and adjusted for currency. Cloud revenue of $0.6 billion grew 10 percent as reported and adjusted for currency, with an as-a-Service exit run rate of $2.0 billion.on-premises. For the first ~~nine~~six months of the year, ~~total strategic imperatives~~Cloud & Cognitive Software revenue of ~~$8.5 billion~~$10,682 million grew ~~4 percent as reported and adjusted for currency year to year. Cloud revenue of $1.8 billion grew 24 percent as reported and adjusted for currency.~~

Yr. to Yr.

Percent/

(Dollars in millions)

Margin

For the three months ended September 30:

2017

2016

Change

Cognitive Solutions:

External gross profit

$
3,465

$
3,407

1.7
%
External gross profit margin

78.7
%
80.4
%
(1.7
)pts.
Pre-tax income

$
1,649

$
1,574

4.8
%
Pre-tax margin

32.8
%
32.1
%
0.7
pts.

Yr. to Yr.

Percent/

(Dollars in millions)

Margin

For the nine months ended September 30:

2017

2016

Change

Cognitive Solutions:

External gross profit

$
10,207

$
10,509

(2.9
)%
External gross profit margin

78.4
%
81.5
%
(3.1
)pts.
Pre-tax income

$
4,539

$
4,039

12.4
%
Pre-tax margin

30.2
%
27.3
%
3.0
pts.

Cognitive Solutions gross profit margin decreased 1.7 points to 78.7 percent in the third quarter of 2017 compared to the prior year. For the first nine months of the year, gross profit margin decreased 3.1 points to 78.4 percent. The gross profit margin decline year to year is driven by continued investment and an increasing mix toward SaaS.

In the third quarter, pre-tax income of $1,649 million increased 4.8 percent compared to the prior year with a pre-tax margin improvement of 0.7 points to 32.8 percent. For the first nine months of the year, pre-tax income of $4,539 million increased 12.4 percent compared to the prior year with a pre-tax margin improvement of 3.0 points to 30.2 percent. The company continues to embed cognitive into offerings, scale platforms and build high value vertical solutions. The year-to-year benefit in the nine-month period also reflects a lower level of charges related to workforce rebalancing and real estate actions year to year.

~~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 September 30:

2017

2016

Change

Currency

Global Business Services external revenue:

$
4,093

$
4,191

(2.3
)%
(2.2
)%
Consulting

$
1,803

$
1,799

0.2
%
0.9
%
Global Process Services

314

354

(11.3
)
(11.9
)
Application Management

1,976

2,038

(3.0
)
(3.2
)

Yr. to Yr.

Percent

Yr. to Yr.

Change

(Dollars in millions)

Percent

Adjusted For

For the nine months ended September 30:

2017

2016

Change

Currency

Global Business Services external revenue:

$
12,196

$
12,578

(3.0
)%
(1.9
)%
Consulting

$
5,394

$
5,520

(2.3
)%
(0.9
)%
Global Process Services

948

1,048

(9.6
)
(9.2
)
Application Management

5,855

6,011

(2.6
)
(1.6
)

Global Business Services revenue of $4,093 million decreased 2.3 percent as reported and 2 percent adjusted for currency in the third quarter of 2017 compared to the prior year. The company continues to transform this business and shift its practices to where there is opportunity, which is around digital, cognitive, cloud and automation. GBS signings grew for the third consecutive quarter as reported and adjusted for currency, and strategic imperatives revenue grew double digits year to year as reported and adjusted for currency. However, this growth continues to be more than offset by declines in the more traditional areas that the company is shifting away from. For the first nine months of the year, Global Business Services revenue of $12,196 million decreased 3.0 percent as reported and 2 percent adjusted for currency.

In the third quarter, Consulting revenue of $1,803 million increased 0.2 percent as reported (1 percent adjusted for currency) with continued improvement on a sequential basis led by the company’s digital strategy and iX platform. The Consulting backlog returned to growth as reported and adjusted for currency in the third quarter versus the prior year. Global Process Services (GPS) revenue of $314 million decreased 11.3 percent as reported (12 percent adjusted for currency) compared to the prior year. Application Management revenue of $1,976 million decreased 3.0 percent as reported (3 percent adjusted for currency). The company continues to help clients implement new cloud-centric architectures in their critical applications. Overall performance was impacted by areas of this business that are not as differentiated and are experiencing pricing pressure.

Third-quarter 2017 GBS strategic imperatives revenue of $2.5 billion grew 10 percent as reported (11 percent adjusted for currency) year to year. Cloud revenue of $1.0 billion grew 35 percent as reported and adjusted for currency, with an as-a-Service exit run rate of $1.2 billion. For the first nine months of the year, total strategic imperatives revenue of $7.2 billion grew 10 percent as reported (11 percent adjusted for currency) year to year. Cloud revenue of $2.9 billion grew 41 percent as reported (43 percent adjusted for currency).

~~Management Discussion — (continued)~~

Yr. to Yr.

Percent/

(Dollars in millions)

Margin

For the three months ended September 30:

2017

2016

Change

Global Business Services:

External gross profit

$
1,117

$
1,206

(7.4
)%
External gross profit margin

27.3
%
28.8
%
(1.5
)pts.
Pre-tax income

$
453

$
544

(16.8
)%
Pre-tax margin

10.8
%
12.7
%
(1.9
)pts.

Yr. to Yr.

Percent/

(Dollars in millions)

Margin

For the nine months ended September 30:

2017

2016

Change

Global Business Services:

External gross profit

$
3,083

$
3,393

(9.2
)%
External gross profit margin

25.3
%
27.0
%
(1.7
)pts.
Pre-tax income

$
1,065

$
1,210

(12.0
)%
Pre-tax margin

8.5
%
9.4
%
(0.8
)pts.

GBS third quarter gross profit margin decreased 1.5 points to 27.3 percent year to year with a decline similar to the second quarter 2017. In the third quarter of 2017, pre-tax income of $453 million decreased 16.8 percent year to year. The pre-tax margin declined 1.9 points to 10.8 percent, however it improved more than 3 points sequentially compared to the second quarter 2017. For the first nine months of the year, pre-tax income of $1,065 million decreased 12.0 percent and the pre-tax margin declined 0.8 points to 8.5 percent. Pre-tax income performance for the first nine months of 2017 includes a lower level of charges related to workforce rebalancing and real estate actions as compared to the prior year.

~~The GBS margin has been impacted by investments to drive transformation and reflects pricing and profit pressure in the more traditional IT services.~~ The company will continue to focus on improving productivity with a streamlined practice model and new project management approaches. As it grows its practices around cloud, analytics and mobility services, the company will continue to invest in skills necessary to drive this transformation.

~~Technology Services & Cloud Platforms~~

Yr. to Yr.

Percent

Yr. to Yr.

Change

(Dollars in millions)

Percent

Adjusted For

For the three months ended September 30:

2017

2016

Change

Currency

Technology Services & Cloud Platforms external revenue:

$
8,457

$
8,748

(3.3
)%
(4.1
)%
Infrastructure Services

$
5,665

$
5,901

(4.0
)%
(4.8
)%
Technical Support Services

1,801

1,831

(1.6
)
(2.1
)
Integration Software

990

1,016

(2.6
)
(3.4
)

Yr. to Yr.

Percent

Yr. to Yr.

Change

(Dollars in millions)

Percent

Adjusted For

For the nine months ended September 30:

2017

2016

Change

Currency

Technology Services & Cloud Platforms external revenue:

$
25,079

$
26,029

(3.7
)%
(3.3
)%
Infrastructure Services

$
16,695

$
17,458

(4.4
)%
(3.9
)%
Technical Support Services

5,357

5,446

(1.6
)
(1.5
)
Integration Software

3,027

3,126

(3.2
)
(2.7
)

~~Technology Services & Cloud Platforms revenue of $8,457 million decreased 3.3~~0.9 percent as reported and 4 percent adjusted for ~~currency~~currency. There was year-to-year growth in ~~the third quarter of 2017 compared to the prior year. In the third quarter, there were declines across~~

~~Management Discussion — (continued)~~

~~all lines of business, however there was double-digit growth~~Cognitive Applications and Cloud & Data Platforms as reported and adjusted for ~~currency in strategic imperatives revenue. Global Technology Services (GTS) signings also grew more than 25 percent year to year. For the first nine months of the year, Technology Services and Cloud~~currency. Transaction Processing Platforms ~~revenue of $25,079 million~~ decreased ~~3.7 percent~~ as reported, ~~and 3~~but grew 2 percent adjusted for currency.

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. In the ~~third~~second quarter, ~~Infrastructure Services~~Cognitive Applications revenue of ~~$5,665~~$1,454 million ~~declined 4.0~~grew 2.9 percent as reported (5 percent adjusted for currency) compared to the prior year. This decline reflects the continued impact associated with contract conclusions at the end of 2016 and the shift away from certain lower value work within this business. The full year-to-year benefit from certain larger contracts signed in second-quarter 2017 are not yet providing offsetting growth. However,year, led by strong performance in the ~~third quarter, there was~~integrated security software and services portfolio and growth across many industry vertical solutions. The performance in Security included continued strong ~~signings performance both~~results in threat management software and services offerings, as well as managed security intelligence and data security solutions.

Cloud & Data Platforms includes the distributed middleware and data platform software critical for orchestration and integration of multicloud 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 second-quarter revenue of $2,173 million increased 4.5 percent as reported and 7 percent adjusted for currency compared to the prior year. This growth was broad-based throughout the portfolio, including from several new offerings that help clients modernize their applications for hybrid cloud environments and their data for AI. Year-to-year growth in hybrid cloud continued as clients ~~contract~~leverage the reliability and scalability of IBM Cloud Private, built on open source. IBM Cloud Private for Data, launched in 2018, continued to ~~implement~~have strong client adoption and grew its install base nearly 40 percent since the first quarter of 2019.

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. In the second quarter, Transaction Processing Platforms revenue of $2,018 million increased 2.0 percent as reported and 4 percent adjusted for currency compared to the prior year. This growth was driven by strong performance in IBM Z middleware as clients continue to rely on this platform to predictably manage IT spending for their growing IBM Z mission critical workloads.

Within Cloud & Cognitive Software, cloud revenue of $0.8 billion grew 6 percent as reported and 8 percent adjusted for currency in the second quarter of 2019, with an as-a-Service exit run rate of $2.1 billion. For the first six months of 2019, cloud revenue of $1.5 billion grew 7 percent as reported and 9 percent adjusted for currency.


							Yr. to Yr.
							Percent/
(Dollars in millions)							Margin
For the three months ended June 30:	2019			2018*			Change
Cloud & Cognitive Software:
External gross profit	$	4,364		$	4,252		2.6	%
External gross profit margin		77.3	%		77.7	%	(0.4)	pts.
Pre-tax income	$	2,001		$	2,029		(1.4)	%
Pre-tax margin		32.0	%		32.3	%	(0.3)	pts.

* Recast to reflect segment changes.

Table of Contents

Management Discussion – (continued)


							Yr. to Yr.
							Percent/
(Dollars in millions)							Margin
For the six months ended June 30:	2019			2018*			Change
Cloud & Cognitive Software:
External gross profit	$	8,146		$	8,158		(0.1)	%
External gross profit margin		76.3	%		77.1	%	(0.8)	pts.
Pre-tax income	$	3,768		$	3,709		1.6	%
Pre-tax margin		31.1	%		30.1	%	1.0	pts.

* Recast to reflect segment changes.

Cloud & Cognitive Software gross profit margin decreased 0.4 points to 77.3 percent in the second quarter of 2019 compared to the prior year, driven by portfolio mix. For the first six months of 2019, gross profit margin decreased 0.8 points to 76.3 percent, driven by the same factor.

In the second quarter, pre-tax income of $2,001 million decreased 1.4 percent compared to the prior year. The pre-tax margin decreased 0.3 points to 32.0 percent in the second quarter, which included an impact of 2.1 points from workforce rebalancing actions in the second quarter of 2019. For the first six months of the year, pre-tax income of $3,768 million increased 1.6 percent compared to the prior year and the pre-tax margin improved 1.0 points to 31.1 percent. The year-to-year improvement in the six-month period reflects strong transactional performance in high-value areas and a lower level of workforce actions year to year, partially offset by lower IP income and ongoing investments in key strategic areas in the first six months of 2019 as compared to the same period in 2018.

Global Business Services


								Yr. to Yr.
								Percent
						Yr. to Yr.		Change
(Dollars in millions)						Percent		Adjusted For
For the three months ended June 30:	2019		2018			Change		Currency
Global Business Services external revenue:	$	4,155	$	4,135	*	0.5	%	3.4	%
Consulting	$	1,978	$	1,931		2.4	%	5.1	%
Global Process Services		258		258	*	(0.1)		3.3
Application Management		1,919		1,946		(1.4)		1.8

* Recast to reflect segment changes.


								Yr. to Yr.
								Percent
						Yr. to Yr.		Change
(Dollars in millions)						Percent		Adjusted For
For the six months ended June 30:	2019		2018			Change		Currency
Global Business Services external revenue:	$	8,274	$	8,250	*	0.3	%	3.9	%
Consulting	$	3,942	$	3,798		3.8	%	7.1	%
Global Process Services		505		504	*	0.1		4.3
Application Management		3,827		3,948		(3.1)		0.7

* Recast to reflect segment changes.

Global Business Services revenue of $4,155 million increased 0.5 percent as reported and 3 percent adjusted for currency in the second quarter of 2019 compared to the prior year. Growth was driven by engagement with clients on their digital reinvention journeys to become cloud and cognitive enterprises. GBS brings deep industry expertise, IBM’s

Table of Contents

Management Discussion – (continued)

innovative technology portfolio and third-party IT architectures together to deliver differentiated value to enterprises. For the first six months of the year, Global Business Services revenue of $8,274 million increased 0.3 percent as reported and 4 percent adjusted for currency.

In the second quarter, Consulting revenue of $1,978 million grew 2.4 percent as reported and 5 percent adjusted for currency, led by growth in the next generation enterprise applications, such as S4/Hana, and in Digital Strategy and iX offerings. Clients are also leveraging IBM Garage to help power their digital reinventions with AI and hybrid cloud.

Global Process Services second-quarter revenue of $258 million was flat as reported, but grew 3 percent adjusted for currency.

Application Management revenue of $1,919 million declined 1.4 percent as reported, but grew 2 percent adjusted for currency compared to the second-quarter 2018. Cloud Migration Factory continued to contribute to growth, offset by continued declines in traditional application management engagements.

Within GBS, cloud revenue of $1.2 billion grew 14 percent as reported (17 percent adjusted for currency) in the second quarter of 2019, with an as-a-Service exit run rate of $1.7 billion. For the first six months of the year, cloud revenue of $2.5 billion grew 17 percent as reported (21 percent adjusted for currency).


							Yr. to Yr.
							Percent/
(Dollars in millions)							Margin
For the three months ended June 30:	2019			2018*			Change
Global Business Services:
External gross profit	$	1,079		$	1,077		0.2	%
External gross profit margin		26.0	%		26.0	%	(0.1)	pts.
Pre-tax income	$	300		$	372		(19.4)	%
Pre-tax margin		7.1	%		8.8	%	(1.7)	pts.

* Recast to reflect segment changes.


							Yr. to Yr.
							Percent/
(Dollars in millions)							Margin
For the six months ended June 30:	2019			2018*			Change
Global Business Services:
External gross profit	$	2,157		$	2,039		5.8	%
External gross profit margin		26.1	%		24.7	%	1.4	pts.
Pre-tax income	$	615		$	497		23.7	%
Pre-tax margin		7.3	%		5.9	%	1.4	pts.

* Recast to reflect segment changes.

GBS second-quarter gross profit margin of 26.0 percent was flat on a year-to-year basis, with contribution from continued mix shift to higher-value offerings and from currency given the global delivery model. This was offset by a higher level of skill capacity investments to capture the market opportunity around Red Hat and digital reinvention. Pre-tax income decreased to $300 million and pre-tax margin decreased 1.7 points to 7.1 percent in the second quarter of 2019 compared to the prior year. Pre-tax margin for the second quarter of 2019 included a 1.5 point impact from workforce rebalancing actions in the second quarter of 2019. For the first six months of the year, pre-tax income of $615 million increased 23.7 percent and the pre-tax margin increased 1.4 points to 7.3 percent. The pre-tax margin for the first six months of 2019 included a lower level of workforce rebalancing charges year to year.

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 June 30:	2019		2018			Change		Currency
Global Technology Services external revenue:	$	6,837	$	7,325	*	(6.7)	%	(3.5)	%
Infrastructure & Cloud Services	$	5,174	$	5,575	*	(7.2)	%	(4.2)	%
Technology Support Services		1,663		1,750		(4.9)		(1.5)

* Recast to reflect segment changes.


								Yr. to Yr.
								Percent
						Yr. to Yr.		Change
(Dollars in millions)						Percent		Adjusted For
For the six months ended June 30:	2019		2018			Change		Currency
Global Technology Services external revenue:	$	13,711	$	14,746	*	(7.0)	%	(3.3)	%
Infrastructure & Cloud Services	$	10,383	$	11,214	*	(7.4)	%	(3.7)	%
Technology Support Services		3,328		3,531		(5.7)		(1.8)

* Recast to reflect segment changes.

Global Technology Services revenue of $6,837 million declined 6.7 percent as reported (4 percent adjusted for currency) in the second quarter of 2019 compared to the prior year. This performance reflects the actions the company has been taking to deemphasize lower-value contracts and third-party content, and to focus investments on higher-value segments of the IT market, such as hybrid cloud, ~~environments.~~to manage the business for increased margin, profit and cash contribution for the longer term. For the first six months of the year, Global Technology Services revenue of $13,711 million declined 7.0 percent as reported (3 percent adjusted for currency).

~~Technical~~In the second quarter, Infrastructure & Cloud Services revenue of $5,174 million decreased 7.2 percent as reported (4 percent adjusted for currency) compared to the prior-year period, driven by declines across the portfolio. As this business is repositioned for the long term, the actions contribute to lower revenue in the short term, but are expected to enable the business to deliver sustained margin improvement. Technology Support Services ~~third-quarter~~second-quarter revenue of ~~$1,801~~$1,663 million decreased ~~1.6~~4.9 percent as reported (2 percent adjusted for currency) ~~year~~due primarily to ~~year.~~ hardware cycle dynamics.

Within this line of business, the company is focused on growing its multi-vendor support services which provide clients with a single source of expertise and visibility across different vendor solutions. Integration Software third quarterGTS, cloud revenue of ~~$990 million decreased 2.6~~$2.0 billion grew 2 percent as reported (3(5 percent adjusted for currency) ~~compared to~~in the prior year. There was continued growth in SaaS across the portfolio as the company helps clients implement hybrid cloud environments. This growth was offset by declines in areas such as on premise DevOps and IT service management.

~~Technology Services & Cloud Platforms third-quarter 2017 strategic imperatives revenue~~second quarter of ~~$2.6 billion grew 12 percent year to year as reported and adjusted for currency. Cloud revenue of $1.8 billion grew 16 percent as reported and adjusted for currency,~~2019, with an as-a-Service exit run rate of ~~$6.2~~$7.4 billion. For the first ~~nine~~six months of the year, ~~total strategic imperatives~~cloud revenue of ~~$7.4~~$4.1 billion grew 205 percent as reported ~~(21 percent adjusted for currency) year to year. Cloud revenue of $5.1 billion grew 24 percent as reported (25~~(9 percent adjusted for currency).


							Yr. to Yr.
							Percent/
(Dollars in millions)							Margin
For the three months ended June 30:	2019			2018*			Change
Global Technology Services:
External gross profit	$	2,353		$	2,435		(3.3)	%
External gross profit margin		34.4	%		33.2	%	1.2	pts.
Pre-tax income	$	235		$	451		(47.9)	%
Pre-tax margin		3.3	%		6.0	%	(2.7)	pts.

* Recast to reflect segment changes.

Table of Contents

Management Discussion – (continued)

Yr. to Yr.

Percent/

(Dollars in millions)

Margin

For the three months ended September 30:

2017

2016

Change

Technology Services & Cloud Platforms:

External Technology Services gross profit

$
2,667

$
2,825

(5.6
)%
External Technology Services gross profit margin

35.7
%
36.5
%
(0.8
)pts.
External Integration Software gross profit

$
805

$
851

(5.4
)%
External Integration Software gross profit margin

81.3
%
83.8
%
(2.4
)pts.
External total gross profit

$
3,473

$
3,676

(5.5
)%
External total gross profit margin

41.1
%
42.0
%
(1.0
)pts.
Pre-tax income

$
1,192

$
1,288

(7.5
)%
Pre-tax margin

13.8
%
14.4
%
(0.6
)pts.


							Yr. to Yr.
							Percent/
(Dollars in millions)							Margin
For the six months ended June 30:	2019			2018*			Change
Global Technology Services:
External gross profit	$	4,670		$	4,855		(3.8)	%
External gross profit margin		34.1	%		32.9	%	1.1	pts.
Pre-tax income	$	510		$	517		(1.4)	%
Pre-tax margin		3.6	%		3.4	%	0.1	pts.

Yr. to Yr.

Percent/

(Dollars in millions)

Margin

For the nine months ended September 30:

2017

2016

Change

Technology Services & Cloud Platforms:

External Technology Services gross profit

$
7,630

$
8,176

(6.7
)%
External Technology Services gross profit margin

34.6
%
35.7
%
(1.1
)pts.
External Integration Software gross profit

$
2,450

$
2,630

(6.9
)%
External Integration Software gross profit margin

80.9
%
84.2
%
(3.2
)pts.
External total gross profit

$
10,080

$
10,806

(6.7
)%
External total gross profit margin

40.2
%
41.5
%
(1.3
)pts.
Pre-tax income

$
2,888

$
2,825

2.2
%
Pre-tax margin

11.3
%
10.6
%
0.6
pts.

* Recast to reflect segment changes.

Global Technology Services ~~& Cloud Platforms~~ gross profit margin ~~decreased 1.0~~increased 1.2 points ~~year~~ to ~~year~~34.4 percent in the third quarter to 41.1 percent and pre-tax income of $1,192 million decreased 7.5 percent. The pre-tax margin declined 0.6 points year to year to 13.8 percent, but improved sequentially by 2 points compared to the second quarter of ~~2017.~~2019, primarily driven by scale efficiencies in the cloud, productivity improvements from infusion of AI and automation into service delivery models and the shift to higher-value areas. Second-quarter pre-tax income decreased to $235 million and pre-tax margin decreased 2.7 points to 3.3 percent. Pre-tax margin in the second quarter of 2019 included a 3.1 point impact from workforce rebalancing actions in the second-quarter 2019. For the first ~~nine~~six months of the year, pre-tax income of ~~$2,888~~$510 million ~~increased 2.2~~decreased 1.4 percent and ~~the~~ pre-tax margin of 3.6 percent improved ~~0.6 points~~modestly year to ~~11.3 percent. The~~

~~Management Discussion — (continued)~~

~~year-to-year performance~~year, reflecting the improvements in ~~the nine months of 2017 compared to the prior year includes a lower level of charges related to workforce and real estate actions.~~gross profit margin.

The company continues to yield savings from prior-year workforce transformation, is focused on delivering productivity to clients, and continues to invest to expand its cloud infrastructure which is currently impacting margin. With over sixty cloud centers across nineteen countries, the IBM Cloud provides clients with flexibility in how and where they store their data.

Services Backlog and Signings


							Yr. to Yr.
							Percent
					Yr. to Yr.		Change
	At June 30,		At June 30,		Percent		Adjusted For
(Dollars in billions)	2019		2018		Change		Currency
Total backlog	$	111.2	$	116.5	(4.5)	%	(3.5)	%

Yr. to Yr.

Percent

Yr. to Yr.

Change

At September 30,

At September 30,

Percent

Adjusted For

(Dollars in billions)

2017

2016

Change

Currency

Total backlog

$
119.3

$
121.3

(1.6
)%
(2.1
)%

The estimated total services backlog at ~~September~~June 30, ~~2017~~2019 was ~~$119~~$111 billion, a decrease of ~~1.6~~4.5 percent as reported ~~and 2~~(4 percent adjusted for ~~currency with modest growth in GTS as reported (essentially flat adjusted for~~ currency) ~~and a decrease in GBS year to year as reported and adjusted for currency.~~

Total services backlog includes Infrastructure & Cloud Services, Security Services, Consulting, Global Process Services, Application Management and ~~Technical~~Technology Support Services. Total backlog is intended to be a statement of overall work under contract ~~for these businesses and therefore includes Technical Support Services. It~~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 ~~offerings~~arrangements that ~~have flexibility in~~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. ~~Technical~~Technology Support Services is(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.

Table of Contents

Management Discussion – (continued)

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 June 30:	2019		2018		Change		Currency
Total signings	$	9,687	$	11,528	(16.0)	%	(14.2)	%

							Yr. to Yr.
							Percent
					Yr. to Yr.		Change

															Yr. to Yr.
															Percent
													Yr. to Yr.		Change
(Dollars in millions)					Percent		Adjusted For						Percent		Adjusted For
For the three months ended September 30:	2017		2016		Change		Currency
For the six months ended June 30:									2019		2018		Change		Currency
Total signings	$	10,385	$	8,955	16.0	%	14.8	%	$	17,324	$	20,836	(16.9)	%	(14.0)	%

~~Management Discussion — (continued)~~

Systems


							Yr. to Yr.
							Percent
					Yr. to Yr.		Change
(Dollars in millions)					Percent		Adjusted For
For the three months ended June 30:	2019		2018		Change		Currency
Systems external revenue:	$	1,753	$	2,177	(19.5)	%	(18.0)	%
Systems Hardware	$	1,328	$	1,756	(24.4)	%	(23.1)	%
IBM Z					(41.8)		(40.9)
Power Systems					1.0		2.9
Storage Systems					(22.0)		(20.7)
Operating Systems Software		425		421	1.0		3.3

~~Systems~~


							Yr. to Yr.
							Percent
					Yr. to Yr.		Change
(Dollars in millions)					Percent		Adjusted For
For the six months ended June 30:	2019		2018		Change		Currency
Systems external revenue:	$	3,081	$	3,676	(16.2)	%	(14.2)	%
Systems Hardware	$	2,241	$	2,848	(21.3)	%	(19.6)	%
IBM Z					(40.8)		(39.8)
Power Systems					3.1		5.7
Storage Systems					(18.6)		(16.7)
Operating Systems Software		840		828	1.4		4.2

Yr. to Yr.

Percent

Yr. to Yr.

Change

(Dollars in millions)

Percent

Adjusted For

For the three months ended September 30:

2017

2016

Change

Currency

Systems external revenue:

$
1,721

$
1,558

10.4
%
9.6
%
Systems Hardware

$
1,301

$
1,128

15.3
%
14.4
%
z Systems

63.8

61.9

Power Systems

(7.2
)
(7.8
)
Storage Systems

4.9

4.3

Operating Systems Software

420

430

(2.3
)
(2.9
)

Yr. to Yr.

Percent

Yr. to Yr.

Change

(Dollars in millions)

Percent

Adjusted For

For the nine months ended September 30:

2017

2016

Change

Currency

Systems external revenue:

$
4,863

$
5,184

(6.2
)%
(5.9
)%
Systems Hardware

$
3,629

$
3,852

(5.8
)%
(5.5
)%
z Systems

(13.4
)
(13.3
)
Power Systems

(12.7
)
(12.6
)
Storage Systems

6.1

6.6

Operating Systems Software

1,234

1,332

(7.4
)
(7.1
)

Systems revenue of ~~$1,721~~$1,753 million ~~grew 10.4~~decreased 19.5 percent ~~year to year~~ as reported ~~(10~~(18 percent adjusted for currency) in the ~~third~~second quarter of ~~2017 driven by a combination of strong z14 market acceptance and~~2019 compared to the ~~third consecutive quarter of growth as reported and adjusted for currency in Storage Systems.~~prior year. Systems Hardware revenue of ~~$1,301~~$1,328 million ~~grew 15.3~~decreased 24.4 percent as reported ~~(14~~(23 percent adjusted for currency) ~~with~~. These declines were driven by IBM Z and Storage Systems, reflecting the ~~growth in z Systems and Storage~~late stage of the z14 product cycle, partially offset by ~~a decrease~~growth in Power ~~Systems as reported and adjusted for currency.~~Systems. Operating Systems Software revenue of ~~$420~~$425 million ~~decreased 2.3~~grew 1.0 percent as reported (3 percent adjusted for currency) compared to the prior year. For the first ~~nine~~six months of ~~2017,~~2019, Systems revenue of ~~$4,863~~$3,081 million decreased ~~6.2~~16.2 percent as reported (6(14 percent adjusted for currency) ~~with declines in both Systems Hardware and~~compared to the first six months of 2018, driven by the same factors as the quarter. Operating Systems Software ~~both~~revenue increased 1.4 percent as reported and 4 percent adjusted for currency.

IBM Z revenue declined 41.8 percent as reported (41 percent adjusted for currency) year to year reflecting the product cycle dynamics. The z14, announced two years ago, continued to track ahead of the prior program. Clients

Table of Contents

Management Discussion – (continued)

continued to take advantage of the value of z14, such as pervasive encryption and connectivity to the cloud, and there is continued demand for technology underpinned by data protection and resiliency, with the ability to integrate across cloud environments.

Power Systems revenue grew 1.0 percent as reported (3 percent adjusted for currency) year to year. There was continued growth in high-end offerings and in Linux with HANA on Power, leveraging the performance of the POWER9-based systems. In the second quarter, the company announced IBM Power Systems Virtual Servers available in the IBM Cloud which provide clients with hybrid cloud scaleup compute for AIX and IBM i workloads. There was continued double-digit growth in the high-end Power systems, partially offset by declines in the low-end and midrange systems, as reported and adjusted for currency.

~~Within Systems Hardware, third quarter z~~Storage Systems revenue ~~grew 63.8~~decreased 22.0 percent as reported ~~(62~~(21 percent adjusted for currency) ~~year~~, reflecting a decline in high-end storage, which is tied to ~~year driven by~~ the ~~successful launch of the z14~~ mainframe ~~in mid-September 2017. This success is due to strong demand for technology that helps address the growing threat of global data breaches~~cycle and the ~~need for clients to operate within regulated environments. The z14 mainframe has unprecedented encryption capabilities that are widely appealing~~ongoing competitive dynamics and ~~the company has already experienced good traction across a broad mix of industries and geographies~~pricing pressures in the ~~quarter.~~mid-range products.

~~Power~~In the second quarter, Operating Systems ~~third quarter~~Software revenue ~~decreased 7.2~~of $425 million increased 1.0 percent as reported (8and 3 percent adjusted for currency compared to the prior year. This growth was driven by strong performance in IBM Z operating system software as clients continue to rely on the IBM Z platform to manage predictable IT spending for mission critical workloads, partially offset by a decline in Power operating system software.

Within Systems, cloud revenue of $0.7 billion declined 17 percent as reported (16 percent adjusted for currency) year to year. This reflects the company’s continued shift to a growing Linux market while continuing to serve a high value, but declining UNIX market. Linux had continued revenue growth as reported and adjusted for currency in the ~~third quarter. Although there was growth in UNIX high-end systems this~~second quarter ~~overall UNIX~~of 2019. For the first six months of the year, cloud revenue of $1.1 billion declined ~~as reported and adjusted for currency.~~

~~Storage Systems third quarter revenue increased by 4.9~~18 percent as reported (4(16 percent adjusted for currency).


							Yr. to Yr.
							Percent/
(Dollars in millions)							Margin
For the three months ended June 30:	2019			2018			Change
Systems:
External Systems Hardware gross profit	$	579		$	754		(23.2)	%
External Systems Hardware gross profit margin		43.6	%		42.9	%	0.7	pts.
External Operating Systems Software gross profit	$	359		$	347		3.3	%
External Operating Systems Software gross profit margin		84.3	%		82.4	%	1.9	pts.
External total gross profit	$	937		$	1,101		(14.8)	%
External total gross profit margin		53.5	%		50.6	%	2.9	pts.
Pre-tax income	$	61		$	346		(82.3)	%
Pre-tax margin		3.2	%		14.3	%	(11.1)	pts.


							Yr. to Yr.
							Percent/
(Dollars in millions)							Margin
For the six months ended June 30:	2019			2018			Change
Systems:
External Systems Hardware gross profit	$	843		$	1,066		(20.9)	%
External Systems Hardware gross profit margin		37.6	%		37.4	%	0.2	pts.
External Operating Systems Software gross profit	$	707		$	690		2.5	%
External Operating Systems Software gross profit margin		84.2	%		83.3	%	0.9	pts.
External total gross profit	$	1,551		$	1,756		(11.7)	%
External total gross profit margin		50.3	%		47.8	%	2.6	pts.
Pre-tax income	$	(141)		$	143		(198.1)	%
Pre-tax margin		(4.1)	%		3.5	%	(7.6)	pts.

Table of Contents

Management Discussion – (continued)

Systems gross profit margin increased 2.9 points to 53.5 percent in the second quarter of 2019 compared to the prior year, reflecting margin expansion across the hardware brands and the IBM Z product cycle. Systems Hardware margin increased 0.7 points to 43.6 points year to year, with ~~growth as reported and adjusted for currency~~margin expansion across the ~~major hardware product areas. There was continued growth as reported and adjusted for currency in all-flash array offerings in line with this high-growth market.~~

Third-quarter Systems strategic imperatives revenue of $0.9 billion grew 26 percent year to year as reported (25 percent adjusted for currency). Cloud revenue of $0.7 billion grew 24 percent as reported (23 percent adjusted for currency).portfolio. For the first ~~nine~~six months of the year, total strategic imperatives revenue of $2.2 billion decreased 3 percent as reported and adjusted for currency year to year, primarily a reflection of product cycle dynamics. Cloud revenue of $1.7 billion decreased 5 percent as reported and adjusted for currency.

~~Management Discussion — (continued)~~

Yr. to Yr.

Percent/

(Dollars in millions)

Margin

For the three months ended September 30:

2017

2016

Change

Systems:

External Systems Hardware gross profit

$
557

$
416

33.8
%
External Systems Hardware gross profit margin

42.9
%
36.9
%
5.9
pts.
External Operating Systems Software gross profit

$
366

$
380

(3.7
)%
External Operating Systems Software gross profit margin

87.0
%
88.3
%
(1.2
)pts.
External total gross profit

$
923

$
796

16.0
%
External total gross profit margin

53.6
%
51.1
%
2.6
pts.
Pre-tax income/(loss)

$
339

$
136

149.7
%
Pre-tax margin

17.4
%
7.8
%
9.6
pts.

Yr. to Yr.

Percent/

(Dollars in millions)

Margin

For the nine months ended September 30:

2017

2016

Change

Systems:

External Systems Hardware gross profit

$
1,432

$
1,676

(14.6
)%
External Systems Hardware gross profit margin

39.5
%
43.5
%
(4.0
)pts.
External Operating Systems Software gross profit

$
1,074

$
1,182

(9.2
)%
External Operating Systems Software gross profit margin

87.0
%
88.7
%
(1.7
)pts.
External total gross profit

$
2,506

$
2,858

(12.3
)%
External total gross profit margin

51.5
%
55.1
%
(3.6
)pts.
Pre-tax income/(loss)

$
227

$
354

(35.9
)%
Pre-tax margin

4.2
%
6.1
%
(1.9
)pts.

~~The~~2019, Systems gross profit margin increased 2.6 points to 53.6 percent in the third quarter of 2017 compared to the prior year, with sequential improvement compared to the second quarter of 2017. The overall increase year-to-year was driven by product mix primarily toward the high-margin z Systems. There was also margin improvement in z Systems and Storage Systems, with Power Systems essentially flat year to year. For the first nine months of the year, the Systems gross profit margin decreased 3.6 points to 51.550.3 percent compared to the prior year, driven by actions taken in 2018 to better position the systems cost structure over the longer term. Systems Hardware gross profit margin was flat year to year, with margin declines ~~across all hardware brands and Operating~~in Power Systems, ~~Software, as well as an impact from mix.~~

partially offset by margin improvement in Storage Systems.

In the ~~third~~second quarter of ~~2017,~~2019, pre-tax income of ~~$339~~$61 million ~~grew 149.7~~declined 82.3 percent and pre-tax margin ~~increased 9.6~~decreased 11.1 points year to year to ~~17.4 percent driven~~3.2 percent. The pre-tax margin is impacted by the ~~strong performance~~IBM Z product cycle, and also included an impact of 1.5 points from workforce rebalancing actions in ~~z Systems.~~the second quarter of 2019. For the first ~~nine~~six months of 2019, Systems had a pre-tax loss of $141 million compared to pre-tax income of $143 million in the first six months of the prior year. Pre-tax margin decreased 7.6 points year ~~pre-tax income of $227 million decreased 35.9~~to year to (4.1) percent, ~~compared~~primarily due to the prior year which also included a higher level of charges related to workforce rebalancing and real estate actions. The company remains focused on continually reinventing this portfolio to address new workloads.IBM Z 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.

~~Management Discussion — (continued)~~

Results of Operations


					Yr. to Yr.
					Percent/
(Dollars in millions)					Margin
For the three months ended June 30:	2019		2018		Change
External revenue	$	351	$	394	(11.0)	%
Internal revenue		281		473	(40.6)
Total revenue	$	632	$	867	(27.1)	%
Pre-tax income	$	239	$	357	(33.1)	%

	Three Months Ended				Nine Months Ended
	September 30,				September 30,

													Yr. to Yr.
													Percent/
(Dollars in millions)	2017		2016		2017		2016						Margin
For the six months ended June 30:									2019		2018		Change
External revenue	$	427	$	412	$	1,246	$	1,245	$	757	$	799	(5.3)	%
Internal revenue	272		352		925		1,340			581		902	(35.6)
Total revenue	$	698	$	763	$	2,171	$	2,585	$	1,338	$	1,701	(21.3)	%
Pre-tax income	$	244	$	355	$	836	$	1,208	$	527	$	734	(28.1)	%

In the ~~third~~second quarter, ~~of 2017,~~ Global Financing total revenue of ~~$698~~$632 million ~~decreased 8.5~~declined 27.1 percent compared to the prior year. ~~This was due to a decline in internal~~Internal revenue ~~of 22.8~~decreased 40.6 percent, driven by a decrease in internal used equipment sales (down ~~31.2~~49.4 percent to ~~$184~~$189 million), and internal financing (down 7.8 percent to $92 million). External revenue decreased 11.0 percent (9 percent adjusted for currency), due to a decrease in external used equipment sales (down 32.1 percent to $65 million), and a decrease in external financing (down 4.2 percent to $286 million).

Table of Contents

Management Discussion – (continued)

The decrease in total revenue of $363 million in the first six months of 2019 compared to the same period of 2018 was due to a decrease in internal revenue of 35.6 percent, driven by a decrease in internal used equipment sales (down 46.0 percent to $377 million), partially offset by an increase in internal financing (up ~~4.4~~0.3 percent to ~~$88~~$205 million). External revenue ~~increased 3.7~~decreased 5.3 percent ~~as reported (2.8~~(2 percent adjusted for currency), ~~due to an increase~~driven by a decline in external used equipment sales ~~(up 31.6~~(down 28.2 percent to ~~$141 million), partially offset by a decrease in external financing (down 6.1 percent to $286 million).~~

The decrease in total revenue in the first nine months of 2017 compared to the same period in 2016 was due to a decline in internal revenue of 30.9 percent, driven by a decrease in internal used equipment sales (down 39.9 percent to $662 million), partially offset by an increase in internal financing (up 10.1 percent to $263 million). External revenue was flat (down 0.4 percent adjusted for currency), with a decline in financing (down 6.3 percent to $877$134 million), partially offset by an increase in external ~~used equipment sales~~financing (up ~~19.3~~1.7 percent to ~~$370~~$623 million).

The ~~year-to-year increase~~decrease in internal and external financing revenue in the ~~third~~second quarter of ~~2017~~2019 compared to the same period in 2018 was primarily due to ~~higher~~lower average asset balances, partially offset by ~~lower asset yields. The year-to-year increase in internal financing revenue in the first nine months of 2017 was due to higher average asset balances and~~ higher asset yields. The ~~decrease~~increase in internal and external financing revenue infor the ~~third quarter~~first six months of ~~2017,~~2019 compared to the same period in ~~2016,~~2018 was primarily due to ~~lower~~higher asset yields, partially offset by ~~higher~~lower average asset balances. ~~The decrease in external financing revenue in the first nine months of 2017, compared to the same period in 2016 was due to lower asset yields.~~

Total sales of used equipment represented ~~46.5~~40.1 percent and ~~47.5~~38.2 percent of Global Financing’s revenue in the ~~third~~second quarter and first ~~nine~~six months of ~~2017,~~2019, respectively, ~~and 49.1~~compared to 54.0 percent and ~~54.6~~52.0 percent in the ~~third~~second quarter and first ~~nine~~six months of ~~2016,~~2018, respectively. The ~~decreases~~decrease in both periods ~~were~~was due to a lower ~~volume~~volumes of both internal and external used equipment ~~sales for internal transactions.~~sales. The gross profit margin on used sales was ~~33.2~~53.7 percent and ~~54.6~~58.3 percent in the ~~third~~second quarter of ~~2017~~2019 and ~~2016,~~2018, respectively, and ~~45.4~~53.0 percent and ~~60.8~~58.6 percent in the first ~~nine~~six months of ~~2017~~2019 and ~~2016,~~2018, respectively. ~~The decrease in the gross profit margin was driven by a shift in mix away from higher margin internal equipment sales and declines in internal sales margins.~~

Global Financing pre-tax income decreased ~~31.4~~33.1 percent to ~~$244~~$239 million in the ~~third~~second quarter of ~~2017,~~2019 compared to the same period in ~~2016,~~2018, due to lower gross profit ~~($118 million),~~of $165 million, partially offset by a decrease in ~~total expenses ($6 million).~~expense of $47 million. The decline in expense was primarily due to a decrease in the provision for credit losses driven by lower reserve requirements in the current year. Pre-tax income decreased ~~30.8~~28.1 percent to ~~$836~~$527 million in the first ~~nine~~six months of ~~2017,~~2019, compared to the same period in ~~2016,~~2018, due to lower gross profit ~~($426 million),~~of $299 million, partially offset by a decrease in ~~total~~ expense ~~($55 million), including~~of $92 million, which included a ~~decrease in~~lower provision for credit losses and the gain from the sale of certain commercial financing ~~receivables provisions ($61 million), primarily due to higher Brazil reserve requirements~~capabilities in the ~~prior year.~~

first quarter of 2019.

Global Financing return on equity was ~~23.8~~24.9 percent and ~~24.6~~19.2 percent for the three and ~~nine~~six months ended ~~September~~June 30, ~~2017, respectively,~~2019 compared to ~~27.2~~31.2 percent and ~~30.3~~31.9 percent for the three and ~~nine~~six months ended ~~September~~June 30, ~~2016, respectively.~~2018. The decrease in return on equity in both periods was driven by a decline in net income. Net income included higher tax expense in the ~~third~~first quarter ~~and first nine months~~ of ~~2017 compared to the same periods of 2016, was~~2019 due to additional guidance issued by the ~~decrease in net income, partially offset by a decrease in equity. See~~U.S. Treasury regarding the U.S. tax reform repatriation tax. Refer to page 8497 for the details of the after-tax income and return on equity calculation.

Total unguaranteed residual value of leases was $668 million as of September 30, 2017. In addition to the unguaranteed residual value, on a limited basis, Global Financing will obtain guarantees of the future value of the equipment to be returned at end of lease. Third-party residual value guarantees increase the minimum lease payments as provided for by accounting standards that are utilized in determining the classification of a lease as a sales-type lease, direct financing lease or operating lease and provide protection against risk of loss arising from declines in equipment values for these assets. The aggregate asset values associated with the guarantees of sales-type leases were $79 million and $43 million for the financing

~~Management Discussion — (continued)~~

~~transactions originated during the quarters ended September 30, 2017 and 2016, respectively and $186 million and $201 million for the nine months ended September 30, 2017 and 2016, respectively.~~

Geographic Revenue

In addition to the revenue presentation by reportable segment, the company also measures revenue performance on a geographic basis. ~~The following geographic, regional and country-specific revenue performance excludes OEM revenue.~~


							Yr. to Yr.
							Percent
					Yr. to Yr.		Change
(Dollars in millions)					Percent		Adjusted For
For the three months ended June 30:	2019		2018		Change		Currency
Total Revenue	$	19,161	$	20,003	(4.2)	%	(1.6)	%
Americas	$	8,806	$	9,212	(4.4)	%	(3.4)	%
Europe/Middle East/Africa (EMEA)		6,149		6,407	(4.0)		1.0
Asia Pacific		4,205		4,384	(4.1)		(1.7)

Table of Contents

Management Discussion – (continued)

Yr. to Yr.

Percent

Yr. to Yr.

Change

(Dollars in millions)

Percent

Adjusted For

For the three months ended September 30:

2017

2016

Change

Currency

Total Revenue

$
19,153

$
19,226

(0.4
)%
(1.0
)%
Geographies:

$
19,063

$
19,159

(0.5
)%
(1.1
)%
Americas

8,887

9,070

(2.0
)
(2.5
)
Europe/Middle East/Africa (EMEA)

5,989

5,851

2.4

(1.4
)
Asia Pacific

4,187

4,238

(1.2
)
2.2


							Yr. to Yr.
							Percent
					Yr. to Yr.		Change
(Dollars in millions)					Percent		Adjusted For
For the six months ended June 30:	2019		2018		Change		Currency
Total Revenue	$	37,342	$	39,075	(4.4)	%	(1.2)	%
Americas	$	17,299	$	17,919	(3.5)	%	(2.2)	%
Europe/Middle East/Africa (EMEA)		11,876		12,583	(5.6)		0.4
Asia Pacific		8,167		8,573	(4.7)		(1.7)

Yr. to Yr.

Percent

Yr. to Yr.

Change

(Dollars in millions)

Percent

Adjusted For

For the nine months ended September 30:

2017

2016

Change

Currency

Total Revenue

$
56,597

$
58,149

(2.7
)%
(2.2
)%
Geographies:

$
56,343

$
57,932

(2.7
)%
(2.2
)%
Americas

26,727

27,229

(1.8
)
(2.3
)
Europe/Middle East/Africa (EMEA)

17,186

18,032

(4.7
)
(3.3
)
Asia Pacific

12,430

12,671

(1.9
)
(0.6
)

Total ~~geographic~~ revenue of ~~$19,063~~$19,161 million decreased ~~0.5~~4.2 percent as reported and 2 percent adjusted for currency in the second quarter compared to the prior year. Americas revenue of $8,806 million decreased 4.4 percent as reported and 3 percent adjusted for currency. EMEA revenue of $6,149 million decreased 4.0 percent as reported, but increased 1 percent adjusted for currency. Asia Pacific revenue of $4,205 million decreased 4.1 percent as reported and 2 percent adjusted for currency.

Within Americas, the U.S. decreased 4.7 percent compared to the prior year. Canada increased 4.4 percent as reported and 8 percent adjusted for currency. Latin America decreased 9.1 percent as reported and 3 percent adjusted for currency, with Brazil down 22.2 percent as reported and 17 percent adjusted for currency.

In EMEA, Germany declined 9.4 percent as reported (4 percent adjusted for currency) and France declined 9.4 percent as reported (4 percent adjusted for currency). The UK increased 0.9 percent (7 percent adjusted for currency) and Italy increased 1.1 percent (7 percent adjusted for currency). The Middle East and Africa region decreased 2.3 percent as reported and was flat adjusted for currency.

Within Asia Pacific, Japan increased 2.1 percent as reported (3 percent adjusted for currency) compared to the prior year. Australia decreased 19.3 percent as reported (13 percent adjusted for currency), China decreased 9.4 percent as reported (6 percent adjusted for currency) and India decreased 6.0 percent as reported (3 percent adjusted for currency).

Total revenue of $37,342 million decreased 4.4 percent as reported and 1 percent adjusted for currency in the ~~third quarter~~first six months of ~~2017~~2019 compared to the prior year. Americas revenue of ~~$8,887~~$17,299 million decreased ~~2.0~~3.5 percent as reported and 2 percent adjusted for currency. EMEA revenue of ~~$5,989~~$11,876 million ~~increased 2.4~~decreased 5.6 percent as reported ~~but declined 1 percent~~and was flat adjusted for currency. Asia Pacific revenue of ~~$4,187~~$8,167 million declined 1.2 percent as reported, but grew 2 percent adjusted for currency in the third quarter versus the prior year. Each of the three geographies had year-to-year revenue performance improvement (as reported and at constant currency) compared to the second-quarter 2017 year-to-year performance.

~~Within Americas, third-quarter revenue in the U.S.~~ decreased 2.6 percent compared to the prior year. Canada increased 2.1 percent as reported but declined 2 percent year to year adjusted for currency. Latin America decreased 1.5 percent as reported and 2 percent adjusted for currency. Within Latin America, Brazil decreased 11.3 percent as reported and 13 percent adjusted for currency while Mexico increased 31.0 percent as reported and 27 percent adjusted for currency.

In the third quarter, within EMEA, the UK declined 9.3 percent (9 percent adjusted for currency). France increased 14.2 percent (8 percent adjusted for currency), Germany increased 8.4 percent (3 percent adjusted for currency), Spain increased 10.9 percent (5 percent adjusted for currency), Norway increased 30.0 percent (24 percent adjusted for currency) and Italy increased 7.3 percent (2 percent adjusted for currency) compared to the same period in the prior year. The Middle East and Africa region increased 3.14.7 percent as reported and 2 percent adjusted for currency.

Within ~~Asia Pacific, Japan revenue~~Americas, the U.S. decreased ~~4.0~~3.8 percent as reported, but grew 4 percent adjusted for currency compared to the same period in the prior year. India grew 14.1 percent as reported (10 percent adjusted for currency) while Australia declined 7.8 percent (11 percent adjusted for currency). China revenue grew 3.9 percent as reported (4 percent adjusted for currency) and Taiwan grew 19.2 percent as reported (14 percent adjusted for currency).

~~Total geographic revenue of $56,343 million decreased 2.7 percent as reported and 2 percent adjusted for currency in the first nine months of 2017~~ compared to the prior year. Americas revenue of $26,727 million decreased 1.8 percent as reported and 2 percent adjusted for currency. EMEA revenue of $17,186 million decreased 4.7 percent as reported and 3 percent adjusted for currency. Asia Pacific revenue of $12,430 million decreased 1.9 percent as reported and 1 percent adjusted for currency.

~~Management Discussion — (continued)~~

~~Within Americas, U.S. revenue decreased 3.0 percent compared to the first nine months of the prior year.~~ Canada increased 0.9 percent as reported, which was essentially flat year to year on an adjusted for currency basis. Latin America increased 4.5 percent as reported and 1 percent adjusted for currency. Within Latin America, Brazil increased 5.7 percent as reported, but declined 2 percent adjusted for currency while Mexico increased 11.3 percent as reported and 13 percent adjusted for currency.

Within EMEA, the UK decreased 15.6 percent as reported and 8 percent adjusted for currency compared to the first nine months of the prior year. Germany decreased 4.7 percent as reported and 5 percent adjusted for currency. Switzerland decreased 12.3 percent as reported and 12 percent adjusted for currency. Spain increased 4.4 percent (5 percent adjusted for currency). The Central and Eastern European region declined 1.7 percent (2 percent adjusted for currency) and the Middle East and Africa region was essentially flat as reported, but down 2 percent adjusted for currency.

Within Asia Pacific, Japan declined 1.8 percent as reported, but grew 2 percent adjusted for currency compared to the first nine months of the prior year. Australia decreased 6.6 percent as reported and 9 percent adjusted for currency. China decreased 7.82.2 percent as reported and 6 percent adjusted for currency. ~~India increased 8.9~~Latin America decreased 6.6 percent as reported, but increased 1 percent adjusted for currency, with Brazil down 14.6 percent as reported and 7 percent adjusted for currency.

In EMEA, Germany declined 8.5 percent as reported (2 percent adjusted for currency) and France declined 9.3 percent as reported (3 percent adjusted for currency). Italy decreased 2.7 percent as reported, but increased 4 percent adjusted for currency. The UK was flat as reported and increased 6 percent adjusted for currency. ~~South Korea increased 5.4~~The Middle East and Africa region decreased 5.2 percent as reported and 32 percent adjusted for currency.

Within Asia Pacific, Japan increased 1.9 percent as reported (3 percent adjusted for currency) compared to the prior year. Australia decreased 16.4 percent as reported (9 percent adjusted for currency), China decreased 12.8 percent as reported (9 percent adjusted for currency) and India decreased 11.9 percent as reported (6 percent adjusted for currency).

Table of Contents

Management Discussion – (continued)

Expense

Total Expense and Other (Income)


							Yr. to Yr.
(Dollars in millions)							Percent
For the three months ended June 30:	2019			2018			Change
Total consolidated expense and other (income)	$	6,242		$	6,423		(2.8)	%
Non-operating adjustments:
Amortization of acquired intangible assets	$	(96)		$	(109)		(12.2)	%
Acquisition-related charges		(102)			(1)		nm
Non-operating retirement-related (costs)/income		(136)			(394)		(65.4)
Operating (non-GAAP) expense and other (income)	$	5,907		$	5,918		(0.2)	%
Total consolidated expense-to-revenue ratio		32.6	%		32.1	%	0.5	pts.
Operating (non-GAAP) expense-to-revenue ratio		30.8	%		29.6	%	1.2	pts.

nm - not meaningful

Yr. to Yr.

(Dollars in millions)

Percent

For the three months ended September 30:

2017

2016

Change

Total consolidated expense and other (income)

$
5,735

$
5,751

(0.3
)%
Non-operating adjustments:

Amortization of acquired intangible assets

$
(125
)
$
(136
)
(8.1
)%
Acquisition-related charges

0

(4
)
(101.8
)
Non-operating retirement-related (costs)/income

(103
)
(60
)
71.9

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

$
5,507

$
5,550

(0.8
)%
Total consolidated expense-to-revenue ratio

29.9
%
29.9
%
0.0
pts.
Operating (non-GAAP) expense-to-revenue ratio

28.8
%
28.9
%
(0.1
)pts.

Yr. to Yr.

(Dollars in millions)

Percent

For the nine months ended September 30:

2017

2016

Change

Total consolidated expense and other (income)

$
18,434

$
20,056

(8.1
)%
Non-operating adjustments:

Amortization of acquired intangible assets

$
(382
)
$
(371
)
2.8
%
Acquisition-related charges

(19
)
(1
)
nm

Non-operating retirement-related (costs)/income

(474
)
(206
)
130.0

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

$
17,559

$
19,478

(9.9
)%
Total consolidated expense-to-revenue ratio

32.6
%
34.5
%
(1.9
)pts.
Operating (non-GAAP) expense-to-revenue ratio

31.0
%
33.5
%
(2.5
)pts.


							Yr. to Yr.
(Dollars in millions)							Percent
For the six months ended June 30:	2019			2018			Change
Total consolidated expense and other (income)	$	12,402		$	13,534		(8.4)	%
Non-operating adjustments:
Amortization of acquired intangible assets	$	(194)		$	(219)		(11.6)	%
Acquisition-related charges		(141)			(1)		nm
Non-operating retirement-related (costs)/income		(274)			(796)		(65.6)
Operating (non-GAAP) expense and other (income)	$	11,793		$	12,518		(5.8)	%
Total consolidated expense-to-revenue ratio		33.2	%		34.6	%	(1.4)	pts.
Operating (non-GAAP) expense-to-revenue ratio		31.6	%		32.0	%	(0.5)	pts.

nm - not meaningful

Total expense and other (income) decreased 2.8 percent in the second quarter of 2019 versus the prior year primarily due to lower non-operating retirement-related costs ($258 million) as a result of the amortization period change to the U.S. Pension Plan in the first quarter.

There were several nonrecurring items in the quarter. The closure of the two software divestitures resulted in a gain of $578 million in other income. Within SG&A, the company took actions to revitalize skills and address structure and stranded costs associated with these divestitures, resulting in a workforce rebalancing charge of approximately $500 million. In addition, the company took a charge for an unfavorable legal ruling received in late June, related to a case that had been under dispute for nearly a decade. Together, these gains and charges were essentially neutral to the company's total expense and profit in the second quarter.

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

Table of Contents

Management Discussion —– (continued)

Selling, General and Administrative Expense


					Yr. to Yr.
(Dollars in millions)					Percent
For the three months ended June 30:	2019		2018		Change
Selling, general and administrative expense:
Selling, general and administrative — other	$	4,335	$	4,190	3.5	%
Advertising and promotional expense		421		407	3.3
Workforce rebalancing charges		495		23	nm
Amortization of acquired intangible assets		95		109	(12.8)
Stock-based compensation		93		88	5.8
Bad debt expense		17		40	(56.2)
Total consolidated selling, general and administrative expense	$	5,456	$	4,857	12.3	%
Non-operating adjustments:
Amortization of acquired intangible assets	$	(95)	$	(109)	(12.8)	%
Acquisition-related charges		(54)		(1)	nm
Operating (non-GAAP) selling, general and administrative expense	$	5,307	$	4,746	11.8	%

Yr. to Yr.

(Dollars in millions)

Percent

For the three months ended September 30:

2017

2016

Change

Selling, general and administrative expense:

Selling, general and administrative — other

$
3,898

$
3,983

(2.1
)%
Advertising and promotional expense

337

341

(1.4
)
Workforce rebalancing charges

17

25

(31.1
)
Retirement-related costs

175

174

0.7

Amortization of acquired intangible assets

125

136

(8.1
)
Stock-based compensation

88

105

(16.5
)
Bad debt expense

7

(32
)
nm

Total consolidated selling, general and administrative expense

$
4,648

$
4,732

(1.8
)%
Non-operating adjustments:

Amortization of acquired intangible assets

$
(125
)
$
(136
)
(8.1
)%
Acquisition-related charges

0

(3
)
nm

Non-operating retirement-related (costs)/income

(53
)
(53
)
(0.5
)
Operating (non-GAAP) selling, general and administrative expense

$
4,470

$
4,541

(1.6
)%

nm — not meaningful

Yr. to Yr.

(Dollars in millions)

Percent

For the nine months ended September 30:

2017

2016

Change

Selling, general and administrative expense:

Selling, general and administrative — other

$
12,293

$
12,697

(3.2
)%
Advertising and promotional expense

1,090

1,051

3.7

Workforce rebalancing charges

188

1,038

(81.9
)
Retirement-related costs

690

551

25.3

Amortization of acquired intangible assets

382

371

2.8

Stock-based compensation

277

295

(6.1
)
Bad debt expense

40

90

(56.0
)
Total consolidated selling, general and administrative expense

$
14,959

$
16,093

(7.0
)%
Non-operating adjustments:

Amortization of acquired intangible assets

$
(382
)
$
(371
)
2.8
%
Acquisition-related charges

(12
)
6

nm

Non-operating retirement-related (costs)/income

(326
)
(183
)
78.0

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

$
14,240

$
15,545

(8.4
)%


					Yr. to Yr.
(Dollars in millions)					Percent
For the six months ended June 30:	2019		2018		Change
Selling, general and administrative expense:
Selling, general and administrative — other	$	8,383	$	8,490	(1.3)	%
Advertising and promotional expense		853		809	5.5
Workforce rebalancing charges		514		563	(8.7)
Amortization of acquired intangible assets		192		219	(12.2)
Stock-based compensation		167		169	(1.0)
Bad debt expense		37		52	(29.8)
Total consolidated selling, general and administrative expense	$	10,147	$	10,302	(1.5)	%
Non-operating adjustments:
Amortization of acquired intangible assets	$	(192)	$	(219)	(12.2)	%
Acquisition-related charges		(81)		(1)	nm
Operating (non-GAAP) selling, general and administrative expense	$	9,873	$	10,082	(2.1)	%

nm -— not meaningful

Total selling, general and administrative (SG&A) expense ~~decreased 1.8~~increased 12.3 percent in the ~~third~~second quarter of ~~2017~~2019 versus the prior year driven primarily by the following factors:

· ~~Lower spending from increased focus on driving expense efficiency (3 points); partially offset by~~

· ~~The effects of currency (1 point); and~~

· ~~The impact of acquisitions completed in the prior 12-month period (1 point).~~

●

Higher workforce rebalancing charges (10 points); and

●

Higher spending (4 points) including higher acquisition-related charges and litigation-related matters; partially offset by

●

The effects of currency (2 points).

Operating (non-GAAP) expense ~~decreased 1.6~~increased 11.8 percent year to year primarily driven by the same factors.

SG&A expense decreased 1.5 percent in the first six months of 2019 versus the prior year driven primarily by the ~~same factors, excluding higher non-operating retirement-related costs net of the one-time non-operating UK gain.~~

~~SG&A expense decreased 7.0 percent in the first nine months of 2017 versus the first nine months of 2016 driven primarily by the following factors:~~

~~Management Discussion — (continued)~~

· ~~Lower workforce rebalancing charges (5 points);~~

· ~~Lower spending (2 points); and~~

· ~~The~~ effects of currency ~~(1 point); partially offset by~~(3 points).

Table of Contents

Management Discussion – (continued)

· ~~The impact of acquisitions completed in the prior 12-month period (1 point).~~

Operating (non-GAAP) expense decreased ~~8.4~~2.1 percent year to year, also primarily driven ~~primarily~~ by the ~~same factors.~~

~~Third-quarter SG&A reflects a year-to-year impact~~effects of $105 million related to several commercial disputes and a benefit of $91 million resulting from the favorable resolution of pension-related litigation in the UK. Operating (non-GAAP) SG&A does not include the benefit from the pension litigation.

currency.

Bad debt expense decreased ~~$51~~$16 million year to year in the first ~~nine~~six months of ~~2017, primarily driven by increased reserves in Brazil in the prior year.~~2019. The receivables provision coverage was ~~1.9~~1.7 percent at ~~September~~June 30, ~~2017,~~2019, an increase of 10 basis points from December 31, 2018 and a decrease of 10 basis points ~~compared to December 31, 2016 and a decrease of 100 basis points~~ from ~~September~~June 30, ~~2016. The decrease year to year in the receivables provision coverage was due primarily to write-offs of previously reserved receivables in December 2016.~~2018.

Research, Development and Engineering


					Yr. to Yr.
(Dollars in millions)					Percent
For the three months ended June 30:	2019		2018		Change
Research, development and engineering expense	$	1,407	$	1,364	3.1	%

Yr. to Yr.

(Dollars in millions)

Percent

For the three months ended September 30:

2017

2016

Change

Total consolidated research, development and engineering expense

$
1,342

$
1,397

(3.9
)%
Non-operating adjustment:

Non-operating retirement-related (costs)/income

$
(51
)
$
(7
)
615.0
%
Operating (non-GAAP) research, development and engineering expense

$
1,291

$
1,390

(7.1
)%


					Yr. to Yr.
(Dollars in millions)					Percent
For the six months ended June 30:	2019		2018		Change
Research, development and engineering expense	$	2,840	$	2,769	2.6	%

Yr. to Yr.

(Dollars in millions)

Percent

For the nine months ended September 30:

2017

2016

Change

Total consolidated research, development and engineering expense

$
4,360

$
4,320

0.9
%
Non-operating adjustment:

Non-operating retirement-related (costs)/income

$
(148
)
$
(23
)
547.8
%
Operating (non-GAAP) research, development and engineering expense

$
4,212

$
4,297

(2.0
)%

Research, development and engineering (RD&E) expense was ~~7.0~~7.3 percent and ~~7.7~~7.6 percent of revenue in the ~~third~~second quarter and first ~~nine~~six months of ~~2017,~~2019, respectively, compared to ~~7.3~~6.8 percent and ~~7.4~~7.1 percent in ~~prior year~~the prior-year periods, respectively. ~~The company continues to invest in research and development as it builds new markets and maintains its leadership in enterprise IT.~~

RD&E expense in the ~~third~~second quarter of ~~2017 decreased 3.9~~2019 increased 3.1 percent year to year primarily driven by:

· ~~Lower spending, net of higher retirement-related costs (5 points); partially offset by~~

· ~~The effects of currency (1 point).~~

Operating (non-GAAP) RD&E expense decreased 7.1 percent in the third quarter of 2017 compared to the prior year, driven primarily by the same factors, excluding higher non-operating retirement-related costs.

●

Higher spending (4 points), including investment in the next generation mainframe; partially offset by

●

The effects of currency (1 point).

RD&E expense in the first ~~nine~~six months of ~~2017~~2019 increased ~~0.9~~2.6 percent year to year primarily driven by:

●

Higher spending (4 points); partially offset by

●

The effects of currency (2 points).

· ~~The impact of acquisitions completed in the prior 12-month period (2 points); partially offset by~~

~~Management Discussion — (continued)~~

· ~~Lower spending, net of higher retirement-related costs.~~

Operating (non-GAAP) RD&E expense decreased 2.0 percent in the first nine months of 2017 compared to the prior year, driven primarily by the same factors, excluding higher non-operating retirement-related costs.

Intellectual Property and Custom Development Income


					Yr. to Yr.
(Dollars in millions)					Percent
For the three months ended June 30:	2019		2018		Change
Intellectual Property and Custom Development Income:
Licensing of intellectual property including royalty-based fees	$	144	$	180	(20.2)	%
Custom development income		62		66	(6.6)
Sales/other transfers of intellectual property		16		4	306.5
Total	$	222	$	250	(11.4)	%

Table of Contents

Management Discussion – (continued)

Yr. to Yr.

(Dollars in millions)

Percent

For the three months ended September 30:

2017

2016*

Change

Intellectual Property and Custom Development Income:

Licensing of intellectual property including royalty-based fees

$
236

$
474

(50.1
)%
Custom development income

62

53

16.4

Sales/other transfers of intellectual property

10

1

607.5

Total

$
308

$
528

(41.7
)%


					Yr. to Yr.
(Dollars in millions)					Percent
For the six months ended June 30:	2019		2018		Change
Intellectual Property and Custom Development Income:
Licensing of intellectual property including royalty-based fees	$	194	$	429	(54.8)	%
Custom development income		113		134	(15.6)
Sales/other transfers of intellectual property		17		4	304.7
Total	$	323	$	567	(43.0)	%

* Reclassified to conform to 2017 presentation.

Yr. to Yr.

(Dollars in millions)

Percent

For the nine months ended September 30:

2017

2016*

Change

Intellectual Property and Custom Development Income:

Licensing of intellectual property including royalty-based fees

$
921

$
935

(1.5
)%
Custom development income

186

158

18.2

Sales/other transfers of intellectual property

11

17

(38.4
)
Total

$
1,118

$
1,110

0.7
%

* Reclassified to conform to 2017 presentation.

Licensing of intellectual property including royalty-based fees decreased ~~50.1~~20.2 percent and 54.8 percent year to year in the ~~third~~second quarter ~~of 2017~~ and ~~decreased 1.5 percent in the~~ first ~~nine~~six months of ~~2017~~2019, respectively. This was primarily due to a decline in new partnership agreements compared to the ~~prior-year period.~~ ~~The company entered into new partnership agreements in the~~second quarter and first ~~nine~~six months of 2017, which included two transactions with period income greater than $100 million. The company is licensing IP to partners who are allocating their skills to extend the value of assets that are high value, but may be in mature markets. The licensing of intellectual property for the first nine months of 2016 included three transactions with period income greater than $100 million.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.

~~Management Discussion — (continued)~~

Other (Income) and Expense

Yr. to Yr.

(Dollars in millions)

Percent

For the three months ended September 30:

2017

2016

Change

Other (income) and expense:

Foreign currency transaction losses/(gains)

$
37

$
93

(60.3
)%
(Gains)/losses on derivative instruments

(29
)
(23
)
22.0

Interest income

(38
)
(22
)
72.7

Net (gains)/losses from securities and investment assets

(6
)
(5
)
20.9

Other

(79
)
(51
)
54.9

Total consolidated other (income) and expense

$
(114
)
$
(8
)
nm
%
Non-operating adjustment:

Acquisition-related charges

$
0

$
(2
)
(100.0
)%
Operating (non-GAAP) other (income) and expense

$
(114
)
$
(10
)
nm
%


					Yr. to Yr.
(Dollars in millions)					Percent
For the three months ended June 30:	2019		2018		Change
Other (income) and expense:
Foreign currency transaction losses/(gains)	$	172	$	(414)	nm
(Gains)/losses on derivative instruments		(271)		435	nm
Interest income		(167)		(47)	259.1	%
Net (gains)/losses from securities and investment assets		(19)		(59)	(68.1)
Retirement-related costs/(income)		136		394	(65.4)
Other		(597)		(29)	nm
Total consolidated other (income) and expense	$	(747)	$	280	nm
Non-operating adjustments:
Amortization of acquired intangible assets	$	(1)	$	—	nm
Acquisition-related charges		120		—	nm
Non-operating retirement-related (costs)/income		(136)		(394)	(65.4)	%
Operating (non-GAAP) other (income) and expense	$	(764)	$	(115)	nm

nm - not meaningful

Yr. to Yr.

(Dollars in millions)

Percent

For the nine months ended September 30:

2017

2016

Change

Other (income) and expense:

Foreign currency transaction losses/(gains)

$
374

$
514

(27.2
)%
(Gains)/losses on derivative instruments

(351
)
(339
)
3.5

Interest income

(102
)
(76
)
35.5

Net (gains)/losses from securities and investment assets

(16
)
29

nm

Other

(123
)
153

nm

Total consolidated other (income) and expense

$
(218
)
$
281

nm
%
Non-operating adjustment:

Acquisition-related charges

$
(7
)
$
(7
)
(1.0
)%
Operating (non-GAAP) other (income) and expense

$
(225
)
$
274

nm
%


					Yr. to Yr.
(Dollars in millions)					Percent
For the six months ended June 30:	2019		2018		Change
Other (income) and expense:
Foreign currency transaction losses/(gains)	$	(1)	$	(273)	(99.7)	%
(Gains)/losses on derivative instruments		(202)		386	nm
Interest income		(238)		(117)	102.9
Net (gains)/losses from securities and investment assets		(23)		(81)	(71.5)
Retirement-related costs/(income)		274		796	(65.6)
Other		(630)		(19)	nm
Total consolidated other (income) and expense	$	(820)	$	692	nm
Non-operating adjustments:
Amortization of acquired intangible assets	$	(1)	$	—	nm
Acquisition-related charges		144		—	nm
Non-operating retirement-related (costs)/income		(274)		(796)	(65.6)	%
Operating (non-GAAP) other (income) and expense	$	(951)	$	(104)	nm

nm - not meaningful

Table of Contents

Management Discussion – (continued)

Total consolidated other (income) and expense was income of $747 million in the second quarter of 2019 compared to expense of $280 million in the prior year. The $1,027 million year-to-year change was primarily driven by:

●

Higher gains reflected in Other from divestitures ($578 million);

●

Lower non-operating retirement-related costs ($258 million). Refer to “Retirement-Related Plans” for additional information; and

●

Net exchange gains (including derivative instruments) in the current year versus net exchange losses (including derivative instruments) in the prior year ($120 million). These hedging gains help mitigate currency impacts in the Consolidated Statement of Earnings.

Operating (non-GAAP) other (income) and expense was $764 million of income in the second quarter of 2019 and increased $649 million compared to the prior-year period. The year-to-year change was driven primarily by the dynamics described above, excluding the lower non-operating retirement-related costs.

Total consolidated other (income) and expense was income of ~~$114~~$820 million in the ~~third quarter~~first six months of ~~2017~~2019 compared to ~~income~~expense of $8$692 million in the ~~third quarter of 2016.~~prior year. The ~~increase in income of $106~~$1,512 million ~~year to year~~year-to-year change was primarily driven by:

●

Higher gains reflected in Other from divestitures ($578 million);

●

Lower non-operating retirement-related costs ($522 million). Refer to “Retirement-Related Plans” for additional information; and

●

Net exchange gains (including derivative instruments) in the current year versus net exchange losses (including derivative instruments) in the prior year ($316 million). These hedging gains help mitigate currency impacts in the Consolidated Statement of Earnings.

· ~~Lower foreign currency transaction losses ($56 million);~~

· ~~Higher gains on real estate transactions (reflected in Other in the table above) ($19 million); and~~

· ~~Higher interest income ($16 million).~~

~~The consolidated~~Operating (non-GAAP) other (income) and expense was $951 million of income in the first six months of 2019 compared to income of ~~$218~~$104 million in the ~~first nine months~~prior year. The year-to-year change was driven primarily by the dynamics described above, excluding the lower non-operating retirement-related costs.

Interest Expense


					Yr. to Yr.
(Dollars in millions)					Percent
For the three months ended June 30:	2019		2018		Change
Interest expense	$	348	$	173	100.8	%
Non-operating adjustment:
Acquisition-related charges	$	(168)	$	—	nm
Operating (non-GAAP) interest expense	$	180	$	173	3.7	%

nm - not meaningful

Table of ~~2017 compared to expense of $281 million in the first nine months of 2016. The increase in income of $499 million year over year was primarily driven by:~~Contents

· ~~Real estate capacity charges (reflected in Other in the table above) in the prior year related to workforce transformation ($328 million);~~

· ~~Lower foreign currency transaction losses ($140 million);~~

· ~~Reduced losses from securities and investment assets ($45 million), primarily related to the sale of Lenovo shares in the first quarter of 2016; and~~

· ~~Higher interest income ($27 million); partially offset by~~

· ~~Lower gains on divestitures ($42 million).~~

Management Discussion —– (continued)


					Yr. to Yr.
(Dollars in millions)					Percent
For the six months ended June 30:	2019		2018		Change
Interest expense	$	558	$	338	64.9	%
Non-operating adjustment:
Acquisition-related charges	$	(204)	$	—	nm
Operating (non-GAAP) interest expense	$	354	$	338	4.6	%

nm - not meaningful

~~Interest Expense~~

Yr. to Yr.

(Dollars in millions)

Percent

For the three months ended September 30:

2017

2016

Change

Interest expense

$
168

$
158

6.4
%

Yr. to Yr.

(Dollars in millions)

Percent

For the nine months ended September 30:

2017

2016

Change

Interest expense

$
451

$
473

(4.6
)%

Interest expense increased ~~$10~~$174 million and $220 million year to year in the ~~third~~second quarter ~~but decreased $22 million in the~~and first ~~nine~~six months of ~~2017.~~2019, respectively. 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 ~~third~~second quarter and first ~~nine~~six months of ~~2017~~2019 was ~~$335~~$512 million and ~~$947~~$901 million, respectively, an increase of ~~$29~~$145 million and ~~$43~~$188 million ~~respectively,~~ versus the comparable prior-year periods, primarily driven by a higher average debt balance and higher average interest rates as the company issued debt for the Red Hat acquisition.

Operating (non-GAAP) interest expense increased $6 million and ~~higher average~~$16 million year to year in the second quarter and first six months of 2019, respectively, and excludes the Red Hat pre-closing debt ~~balance.~~financing costs.

Retirement-Related Plans

The following ~~tables provide~~table provides the total pre-tax cost for all retirement-related plans. ~~These~~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 June 30:	2019		2018		Change
Retirement-related plans — cost:
Service cost	$	96	$	106	(8.6)	%
Multi-employer plans		8		10	(16.9)
Cost of defined contribution plans		253		248	2.0
Total operating costs/(income)	$	358	$	364	(1.6)	%
Interest cost	$	723	$	684	5.8	%
Expected return on plan assets		(1,047)		(1,016)	3.1
Recognized actuarial losses		454		735	(38.2)
Amortization of prior service costs/(credits)		(3)		(19)	(84.2)
Curtailments/settlements		3		6	(48.3)
Other costs		6		4	32.5
Total non-operating costs/(income)	$	136	$	394	(65.4)	%
Total retirement-related plans — cost	$	494	$	758	(34.8)	%

Yr. to Yr.

(Dollars in millions)

Percent

For the three months ended September 30:

2017

2016

Change

Retirement-related plans — cost:

Service cost

$
111

$
114

(2.5
)%
Amortization of prior service costs/(credits)

(22
)
(28
)
(21.3
)
Cost of defined contribution plans

258

262

(1.4
)
Total operating costs/(income)

$
347

$
347

(0.2
)%
Interest cost

$
746

$
826

(9.6
)%
Expected return on plan assets

(1,096
)
(1,392
)
(21.3
)
Recognized actuarial losses

728

692

5.2

Curtailments/settlements

2

4

(55.8
)
Multi-employer plan/other

(74
)
8

nm

Total non-operating costs/(income)

$
306

$
139

121.1
%
Total retirement-related plans — cost

$
653

$
486

34.4
%

Table of Contents

~~nm - not meaningful~~Management Discussion – (continued)


					Yr. to Yr.
(Dollars in millions)					Percent
For the six months ended June 30:	2019		2018		Change
Retirement-related plans — cost:
Service cost	$	193	$	214	(9.8)	%
Multi-employer plans		17		20	(17.2)
Cost of defined contribution plans		501		516	(2.9)
Total operating costs/(income)	$	711	$	750	(5.3)	%
Interest cost	$	1,451	$	1,376	5.5	%
Expected return on plan assets		(2,097)		(2,040)	2.8
Recognized actuarial losses		911		1,482	(38.5)
Amortization of prior service costs/(credits)		(6)		(37)	(84.4)
Curtailments/settlements		4		6	(29.5)
Other costs		11		11	(3.3)
Total non-operating costs/(income)	$	274	$	796	(65.6)	%
Total retirement-related plans — cost	$	985	$	1,546	(36.3)	%

~~Management Discussion — (continued)~~

Yr. to Yr.

(Dollars in millions)

Percent

For the nine months ended September 30:

2017

2016

Change

Retirement-related plans — cost:

Service cost

$
323

$
335

(3.6
)%
Amortization of prior service costs/(credits)

(66
)
(81
)
(18.5
)
Cost of defined contribution plans

776

802

(3.3
)
Total operating costs/(income)

$
1,033

$
1,056

(2.2
)%
Interest cost

$
2,215

$
2,483

(10.8
)%
Expected return on plan assets

(3,250
)
(4,190
)
(22.4
)
Recognized actuarial losses

2,143

2,069

3.5

Curtailments/settlements

3

19

(81.6
)
Multi-employer plans/other

(46
)
64

nm

Total non-operating costs/(income)

$
1,065

$
444

139.8
%
Total retirement-related plans — cost

$
2,097

$
1,500

39.8
%

~~nm - not meaningful~~

~~In the third quarter of 2017, total~~Total pre-tax retirement-related plan cost ~~increased~~decreased by ~~$167~~$264 million compared to the ~~third~~second quarter of ~~2016, primarily~~2018, driven by ~~lower~~a decrease in recognized actuarial losses ($281 million), primarily due to the change in the amortization period in the U.S. Qualified Personal Pension Plan and higher expected return on plan assets ($~~296~~31 million) ~~and an increase~~, partially offset by higher interest costs ($40 million). Total cost for the first six months of 2019 decreased $561 million versus the first six months of 2018, primarily driven by a decrease in recognized actuarial losses ($36570 million)~~; partially offset by lower interest costs ($79 million) and a reduction in other ($83 million), driven by the pension obligation adjustment recorded related~~ primarily due to the ~~UK pension litigation ($91 million). Total cost for the first nine months of 2017 increased by $597 million versus the first nine months of 2016, primarily driven by lower~~amortization period change and higher expected return on plan assets ($~~940 million) and an increase in recognized actuarial losses ($73~~57 million); partially offset by ~~lower~~higher interest costs ($~~268 million) and other costs ($109~~76 million).

As ~~discussed~~described in the ~~“Snapshot” on page 51,~~“Operating (non-GAAP) Earnings” section, the company characterizes certain retirement-related costs as operating and others as non-operating. Utilizing this characterization, operating retirement-related costs in the ~~third~~second quarter of ~~2017~~2019 were ~~$347~~$358 million, ~~flat~~a decrease of $6 million compared to the ~~third~~second quarter of ~~2016.~~2018. Non-operating costs of ~~$306~~$136 million in the ~~third~~second quarter of ~~2017 increased $168~~2019 decreased $258 million year to year, driven primarily by lower recognized actuarial losses ($281 million) and a higher expected return on plan assets ($~~296~~31 million) ~~and an increase in recognized actuarial losses ($36 million);~~, partially offset by ~~lower~~higher interest costs ($~~79 million) and other costs ($83~~40 million). For the first ~~nine~~six months of ~~2017,~~2019, operating retirement-related costs were ~~$1,033~~$711 million, a decrease of ~~$24~~$39 million ~~compared to the first nine months~~and non-operating costs were $274 million, a decrease of ~~2016, primarily driven by lower defined contribution plan costs ($26 million). Non-operating costs of $1,065~~$522 million ~~increased $621 million in the first nine months of 2017~~ compared to the prior year, driven primarily by lower expected return on plan assets ($940 million) and an increase in recognized actuarial losses ($73 million); partially offset by lower interest costs ($268 million) and other costs ($109 million), driven by the ~~third-quarter pension obligation adjustment in the UK.~~same factors as above.

Taxes

~~Taxes~~

The continuing operations effective tax rate for the ~~third~~second quarter of ~~2017~~2019 was ~~11.0~~9.7 percent, a decrease of ~~1.5~~3.7 points compared to the ~~third~~second quarter of ~~2016.~~2018. The continuing operations effective tax rate for the first ~~nine~~six months of ~~2017~~2019 was ~~1.7~~12.0 percent, an increase of ~~2.2~~16.3 points compared to the first ~~nine~~six months of ~~2016.~~2018. The operating (non-GAAP) tax rate for the ~~third~~second quarter of ~~2017~~2019 was ~~14.7~~11.0 percent, ~~an increase~~a decrease of ~~0.5~~5.0 points compared to the ~~third~~second quarter of ~~2016.~~2018. The operating (non-GAAP) tax rate for the first ~~nine~~six months of ~~2017~~2019 was ~~7.1~~10.6 percent, an increase of ~~3.9~~10.4 points compared to the first ~~nine~~six months of ~~2016.~~2018.

The ~~change~~decrease in the continuing operations effective tax rate ~~for~~in the ~~third~~second quarter of ~~2017 compared to 2016~~2019 was primarily driven by an increase in ~~foreign~~ tax ~~credits, partially offset by a prior year tax benefit related~~benefits attributable to foreign ~~tax~~ audit activity (3.7 points). ~~The change in the operating (non-GAAP) tax rate for the third quarter was driven by the same factors.~~

The change in the continuing operations ~~effective~~ tax rate for the first ~~nine~~six months of ~~2017~~2019 compared to ~~2016~~2018 was ~~primarily~~ driven by the year-to-year benefits above, as well as a discrete tax benefit related to the intra-entity transfer recognized in the first quarter of 2017 and other net discrete period impacts in the first two quarters of 2017 primarily related to foreign taxreduced audit ~~activity. These benefits were more than offset by a prior year tax benefit related to the Japan tax matter (a refund of $1.0 billion plus interest of $0.2 billion).~~resolution benefits. The change in the operating (non-GAAP) tax rate was primarily driven by the same factors.

~~Management Discussion — (continued)~~

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 ~~2012.~~ 2014. 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.The company is no longer subject to income tax examination of its U.S. federal tax return for years prior to 2013. The company is involved in a number of income

Table of Contents

Management Discussion – (continued)

tax-related matters in India challenging tax assessments issued by the India Tax Authorities. The open years 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 ~~interest~~penalties have been provided for any adjustments that are expected to result for these years.

In the first quarter of 2016, the IRS commenced its audit of the company’s U.S. tax returns for 2013 and 2014. The company anticipates that this audit will be completed by the end of the first quarter of 2018.

The amount of unrecognized tax benefits at ~~December 31, 2016 increased~~June 30, 2019 is $6,520 million which can be reduced by ~~$108~~$636 million ~~in the third quarter~~ of ~~2017~~offsetting tax benefits associated with timing adjustments, U.S. tax credits, potential transfer pricing adjustments, and ~~increased by $466 million in the first nine months of 2017 to $4,206 million~~.state income taxes. The ~~overall increase for the nine months ended September 30, 2017 was primarily related to potential U.S. audit matters. The total~~net amount of ~~unrecognized tax benefits that,~~$5,884 million, if recognized, would favorably affect the company’s effective tax ~~rate was $3,107 million at September 30, 2017.~~rate.

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 September 30, 2017, the company has recorded $566 million as prepaid income taxes in India. A significant portion of this balance represents cash tax deposits paid over time to protect the company’s right to appeal various income tax assessments made by the Indian Tax Authorities. The company believes it will prevail on these matters.

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 June 30:	2019		2018		Change
Earnings per share of common stock from continuing operations:
Assuming dilution	$	2.81	$	2.61	7.7	%
Basic	$	2.82	$	2.63	7.2	%
Diluted operating (non-GAAP)	$	3.17	$	3.08	2.9	%
Weighted-average shares outstanding: (in millions)
Assuming dilution		890.8		919.4	(3.1)	%
Basic		886.3		915.1	(3.1)	%

					Yr. to Yr.
					Percent
For the three months ended September 30:	2017		2016		Change

											Yr. to Yr.
											Percent
For the six months ended June 30:							2019		2018		Change
Earnings per share of common stock from continuing operations:
Assuming dilution	$	2.92	$	2.98	(2.0	)%	$	4.58	$	4.42	3.6	%
Basic	$	2.93	$	2.99	(2.0	)%	$	4.61	$	4.44	3.8	%
Diluted operating (non-GAAP)	$	3.30	$	3.29	0.3	%	$	5.42	$	5.53	(2.0)	%
Weighted-average shares outstanding: (in millions)
Assuming dilution	933.2		957.3		(2.5	)%		892.4		922.4	(3.3)	%
Basic	929.4		954.0		(2.6	)%		887.9		917.9	(3.3)	%

Yr. to Yr.

Percent

For the nine months ended September 30:

2017

2016

Change

Earnings per share of common stock from continuing operations:

Assuming dilution

$
7.24

$
7.67

(5.6
)%
Basic

$
7.28

$
7.70

(5.5
)%
Diluted operating (non-GAAP)

$
8.64

$
8.59

0.6
%
Weighted-average shares outstanding: (in millions)

Assuming dilution

940.2

960.7

(2.1
)%
Basic

935.6

957.7

(2.3
)%

Actual shares outstanding at ~~September~~June 30, ~~2017~~2019 were ~~925.8~~885.9 million. The weighted-average number of common shares outstanding assuming dilution during the ~~third~~second quarter and first ~~nine~~six months of ~~2017~~2019 were ~~24.1~~28.6 million (3.1 percent) and ~~20.5~~30.0 million (3.3 percent) shares lower than the same periods of ~~2016.~~2018. The ~~decrease was~~decreases were primarily the result of the common stock repurchase program.

~~Management Discussion — (continued)~~

Financial Position

Dynamics

At ~~September~~June 30, ~~2017,~~2019, the balance sheet ~~remains~~remained strong ~~and~~ with ~~the newly reorganized financing entity, IBM Credit LLC, the company is better positioned~~flexibility to support the ~~business over the long term.~~business. Cash, restricted cash and marketable securities at quarter end were ~~$11,515~~$46,408 million compared to $12,222 million at December 31, 2018, primarily due to incremental debt issuances to fund the Red Hat acquisition. On July 9, 2019, approximately $34,000 million of cash was used to close the Red Hat acquisition. Total debt of $73,039 million at June 30, 2019 increased

Table of Contents

Management Discussion – (continued)

$27,227 million from December 31, 2018, driven by new debt issuances of $31,064 million to primarily be used to fund the Red Hat acquisition; partially offset by debt maturities of $3,778 million. Within total debt, $24,983 million is in support of the Global Financing business.The company continues to manage the investment portfolio to meet its capital preservation and liquidity objectives. Total debt of $45,625 million increased $3,457 million from December 31, 2016, driven by new debt issuances of $9,336 million, partially offset by maturities of $6,259 million. Within total debt, $29,390 million, or approximately 64 percent, is in support of the Global Financing business. This includes IBM Credit LLC’s first public debt issuance of $3,000 million in September 2017. In the first ~~nine~~six months of ~~2017,~~2019, the company generated ~~$10,991~~$7,700 million in net cash from ~~operations.~~operations, compared to $6,896 million in the first six months of 2018. The company has consistently generated strong cash ~~flow~~flows from operations and continues to have access to additional sources of liquidity through the capital markets and its ~~Credit Facilities.~~

credit facilities. The strong free cash flow generated by the company, portfolio actions taken and the suspension of share repurchases position IBM to return to its target leverage ratios within acouple of years.

The assets and debt associated with the Global Financing business are a significant part of the company’s financial ~~position.~~position, which reflects the wind down of its OEM IT commercial financing operations. The financial position amounts appearing on pages 5 and 6 are the consolidated amounts including Global Financing.

Global Financing Financial Position Key Metrics:

At September 30,

At December 31,

(Dollars in millions)

2017

2016

Cash and cash equivalents

$
1,919

$
1,844

Net investment in sales-type and direct financing leases

6,700

6,893

Equipment under operating leases — external clients (1)

504

548

Client loans

11,269

11,478

Total client financing assets

18,473

18,920

Commercial financing receivables

8,561

9,700

Intercompany financing receivables (2) (3)

4,897

4,959

Total assets

$
36,498

$
36,492

Debt

$
29,390

$
27,859

Total equity

$
3,278

$
3,812


	At June 30,		At December 31,
(Dollars in millions)	2019		2018
Cash and cash equivalents	$	1,738	$	1,833
Net investment in sales-type and direct financing leases ⁽¹⁾		6,091		6,924
Equipment under operating leases — external clients ⁽²⁾		337		444
Client loans		12,014		12,802
Total client financing assets		18,442		20,170
Commercial financing receivables		5,903		11,838
Intercompany financing receivables ^(3) (4)		3,952		4,873
Total assets	$	31,003	$	41,320
Debt	$	24,983	$	31,227
Total equity	$	2,780	$	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.

(1)~~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.~~

~~(2)Entire amount eliminated for purposes of IBM’s consolidated results and therefore does not appear on pages 5 and 6.~~

~~(3)These assets, along with all other financing assets in this table, are leveraged at the value in the table using Global Financing debt.~~

At ~~September~~June 30, ~~2017,~~2019, substantially all client and commercial financing assets were IT related assets, and approximately 5257 percent of the total external portfolio was with investment grade clients with no direct exposure to ~~consumers. The~~consumers, an increase ~~in investment grade~~of 3 points year to ~~year (2 points) was driven primarily by rating changes within the existing portfolio, not by changing the company’s approach to the market.~~ year. This investment grade percentage is based on the credit ratings of the companies in the portfolio. Additionally, the company takes actions to transfer exposure to third parties. On that basis, the investment grade content would increase by 15 points to 67 percent, an increase of 2 points year to year.

The company has a long-standing practice of taking ~~mitigation~~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.

~~Management Discussion — (continued)~~ Adjusting for the mitigation actions, the investment grade content would increase to 69 percent, a decrease of 1 point year to year.

IBM Working Capital


	At June 30,		At December 31,
(Dollars in millions)	2019		2018
Current assets	$	77,517	$	49,146
Current liabilities		42,351		38,227
Working capital	$	35,166	$	10,918
Current ratio		1.83:1		1.29:1

Table of Contents

Management Discussion – (continued)

At September 30,

At December 31,

(Dollars in millions)

2017

2016

Current assets

$
44,742

$
43,888

Current liabilities

31,697

36,275

Working capital

$
13,045

$
7,613

Current ratio

1.41:1

1.21:1

Working capital increased ~~$5,432~~$24,248 million from the year-end ~~2016~~2018 position. The key changes are described below:

Current assets increased ~~$854~~$28,372 million ~~(decreased $1,534~~($28,284 million adjusted for currency) due to:

· ~~An increase in cash and cash equivalents of $3,089 million ($2,214 million adjusted for currency); partially offset by~~

· ~~A decline in receivables of $2,118 million ($3,365 million adjusted for currency) primarily as a result of collections of higher year-end balances.~~

●

An increase of $34,186 million ($34,157 million adjusted for currency) in cash, restricted cash, and marketable securities; partially offset by

●

A decline in receivables of $5,826 million ($5,856 million adjusted for currency) primarily driven by a decline in financing receivables of $6,845 million primarily due to the wind down of OEM IT commercial financing; partially offset by an increase in other receivables of $1,038 million primarily related to divestitures.

Current liabilities ~~decreased $4,578~~increased $4,124 million ($~~6,173~~3,995 million adjusted for currency) as a result of:

●

An increase in short-term debt of $4,387 million due to debt issuances of $5,307 million and reclassifications of $3,149 million from long-term debt to reflect upcoming maturities; partially offset by maturities of $3,778 million; and

●

An increase in operating lease liabilities of $1,319 million ($1,313 million adjusted for currency) as a result of the adoption of the new leasing standard on January 1, 2019; partially offset by

●

A decrease in accounts payable of $1,834 million ($1,850 million adjusted for currency) reflecting declines from seasonally higher year-end balances and the wind down of OEM IT commercial financing.

· A decrease in short-term debt of $3,214 million ($3,230 million adjusted for currency) primarily as a result of maturities of $6,258 million; partially offset by reclassifications of $3,670 million from long-term debt to reflect upcoming maturities and a decrease in commercial paper of $899 million; and

· ~~A decrease in accounts payable of $767 million ($969 million adjusted for currency) reflecting declines from typically higher year-end balances.~~

Receivables and Allowances

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

(Dollars in millions)

January 1, 2017

Additions *

Write-offs **

Other***

September 30, 2017

$
776

$
37

$
(157
)
$
33

$
689


(Dollars in millions)
January 1, 2019		Additions / (Releases) *		Write-offs **		Other ***		June 30, 2019
$	639	$	37	$	(86)	$	8	$	597

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

** Refer to note A, “Significant Accounting Policies,” in the company’s ~~2016~~2018 Annual Report ~~on pages 98 and 99~~ for additional information regarding ~~allowance~~Allowance for ~~credit loss~~Credit Loss write-offs.

*** Primarily represents translation adjustments.

The total IBM receivables provision coverage was ~~1.9~~1.7 percent at ~~September~~June 30, ~~2017, a decrease~~2019, an increase of 10 basis points compared to December 31, ~~2016.~~2018. The increase was driven by the overall decline in gross receivables. The majority of the write-offs during the ~~nine~~six months ended ~~September~~June 30, ~~2017~~2019 related to ~~Global Financing~~ receivables which had been previously reserved.

Table of Contents

Management Discussion – (continued)

Global Financing Receivables and Allowances

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


	At June 30,			At December 31,
(Dollars in millions)	2019			2018
Recorded investment ⁽¹⁾	$	23,637		$	31,182
Specific allowance for credit losses		222			220
Unallocated allowance for credit losses		56			72
Total allowance for credit losses		278			292
Net financing receivables	$	23,359		$	30,890
Allowance for credit losses coverage		1.2	%		0.9	%

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

~~Management Discussion — (continued)~~

At September 30,

At December 31,

(Dollars in millions)

2017

2016

Gross financing receivables

$
26,405

$
28,043

Specific allowance for credit losses

258

335

Unallocated allowance for credit losses

96

103

Total allowance for credit losses

354

438

Net financing receivables

$
26,051

$
27,605

Allowance for credit losses coverage

1.3
%
1.6
%

The percentage of Global Financing receivables reserved ~~decreased~~increased from ~~1.6~~0.9 percent at December 31, ~~2016,~~2018, to ~~1.3~~1.2 percent at ~~September~~June 30, ~~2017.~~2019. The ~~decline~~increase was primarily driven ~~by the 2017 write-offs of $119 million of receivables previously reserved, partially offset~~ by the overall decline in gross receivables. ~~Specific~~Unallocated reserves decreased 2322 percent from ~~$335~~$72 million at December 31, ~~2016,~~2018, to ~~$258~~$56 million at ~~September~~June 30, ~~2017. Unallocated~~2019. Specific reserves ~~decreased 7 percent from $103~~remained relatively flat at $220 million at December 31, ~~2016,~~2018, compared to ~~$96~~$222 million at ~~September~~June 30, ~~2017.~~

2019.

Roll Forward of Global Financing Receivables Allowance for Credit Losses

(Dollars in millions)

January 1, 2017

Additions *

Write-offs **

Other ***

September 30, 2017

$
438

$
14

$
(119
)
$
20

$
354


(Dollars in millions)
January 1, 2019		Additions / (Releases)*		Write-offs **		Other ***		June 30, 2019
$	292	$	(5)	$	(16)	$	7	$	278

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

** Refer to note A, “Significant Accounting Policies,” in the company’s ~~2016~~2018 Annual Report ~~on pages 98 and 99~~ for additional information regarding allowance for credit loss write-offs.

*** Primarily represents translation adjustments.

Global Financing’s bad debt expense was a release of $1$9 million for the three months ended ~~September~~June 30, ~~2017,~~2019, compared to ~~a release~~an addition of $2$20 million for the same period in ~~2016~~. 2018, due to lower specific reserves and a higher unallocated reserve release in 2019.

Global Financing’s bad debt expense was ~~$14~~a release of $5 million for the ~~nine~~six months ended ~~September~~June 30, ~~2017,~~2019, compared to ~~$75~~an addition of $24 million for the same period in ~~2016,~~2018, also due to lower specific reserves and a higher unallocated reserve ~~requirements~~release in ~~Brazil in the prior year.~~2019.

Noncurrent Assets and Liabilities


	At June 30,		At December 31,
(Dollars in millions)	2019		2018
Noncurrent assets	$	77,135	$	74,236
Long-term debt	$	58,445	$	35,605
Noncurrent liabilities (excluding debt)	$	36,081	$	32,621

At September 30,

At December 31,

(Dollars in millions)

2017

2016

Noncurrent assets

$
76,894

$
73,582

Long-term debt

$
41,327

$
34,655

Noncurrent liabilities (excluding debt)

$
28,856

$
28,147

~~The increase in noncurrent~~Noncurrent assets ~~of $3,313~~increased $2,899 million ($~~1,153~~2,617 million adjusted for currency) ~~was driven by:~~due to:

●

An increase in operating right-of-use assets of $4,998 million ($4,989 million adjusted for currency) as a result of the adoption of the new leasing standard on January 1, 2019; partially offset by

Table of Contents

Management Discussion – (continued)

●

A decrease in goodwill of $982 million ($1,124 million adjusted for currency) resulting from divestitures; and

●

A decrease in long-term financing receivables of $707 million ($751 million adjusted for currency) as a result of seasonal reductions from higher year-end balances.

· ~~An increase of $2,065~~Long-term debt increased $22,840 million ~~in deferred taxes~~due to:

●

Issuances of $25,757 million primarily to finance the Red Hat acquisition; partially offset by

●

Reclassifications to short-term debt of $3,149 million to reflect upcoming maturities.

Noncurrent liabilities (excluding debt) increased $3,460 million ($~~1,731~~3,366 million adjusted for currency) ~~driven by increases in the U.S. ($998 million) and the first-quarter 2017 intra-entity transfer, including the cumulative effect of adoption of the new FASB guidance ($827 million); and~~due to:

●

An increase in long-term operating lease liabilities of $3,946 million ($3,942 million adjusted for currency) as a result of the adoption of the new leasing standard on January 1, 2019.

· ~~An increase in retirement plans assets of $1,487 million ($1,262 million adjusted for currency) driven by the expected returns on plan assets, partially offset by interest costs; partially offset by~~

· ~~A decrease of $562 million in long-term financing receivables ($888 million adjusted for currency) reflecting seasonal reductions from higher year-end balances.~~

~~Long-term debt increased $6,671 million ($5,662 million adjusted for currency) from the year-end balance primarily driven by:~~

· ~~Issuances of $9,124 million; partially offset by~~

· ~~Reclassification to short-term debt of $3,670 million to reflect upcoming maturities.~~

~~Management Discussion — (continued)~~

~~The increase in noncurrent liabilities (excluding debt) of $708 million (a decrease of $944 million adjusted for currency) was driven by:~~

· An increase in retirement and nonpension postretirement liabilities of $483 million (decreased $598 million adjusted for currency) driven by currency impacts and higher interest and service costs; partially offset by contributions.

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 June 30,		At December 31,
(Dollars in millions)	2019		2018
Total company debt	$	73,039	$	45,812
Total Global Financing segment debt	$	24,983	$	31,227
Debt to support external clients		21,794		27,536
Debt to support internal clients		3,189		3,690
Non-Global Financing debt	$	48,056	$	14,585

At September 30,

At December 31,

(Dollars in millions)

2017

2016

Total company debt

$
45,625

$
42,169

Total Global Financing segment debt

$
29,390

$
27,859

Debt to support external clients

25,433

24,034

Debt to support internal clients

3,957

3,825

Non-Global Financing debt

$
16,235

$
14,309

Total debt of ~~$45,625~~$73,039 million increased ~~$3,457~~$27,227 million from December 31, ~~2016.~~2018, driven by new debt issuances of $31,064 million; partially offset by debt maturities of $3,778 million.

Non-Global Financing debt of $48,056 million increased $33,471 million from December 31, 2018 primarily driven by issuances to fund the Red Hat acquisition.

Global Financing debt of $24,983 million decreased $6,244 million from December 31, 2018, partially due to the company’s wind down of its OEM IT commercial financing operations.

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, ~~& Cloud Platforms,~~ generate long-term, stable revenue streams similar to the Global Financing asset portfolio. Based on their attributes, these Global Technology Services ~~& Cloud Platforms~~ assets are leveraged with the balance of the Global Financing asset base. ~~The increase in debt is consistent with the company’s expectations at year-end 2016 to increase leverage in the Global Financing business.~~

~~Non-Global Financing debt of $16,235 million was up $1,926 million from December 31, 2016 and down $116 million from September 30, 2016.~~

~~Consolidated debt-to-capitalization ratio at September 30, 2017 was 69.8 percent versus 69.6 percent at December 31, 2016 and 71.2 percent at September 30, 2016.~~

Given the significant leverage, the company also presents a debt-to-capitalization ratio which excludes Global Financing debt and equity as management believes this is more representative of the company’s core business operations. This ratio can vary from period to period as the company manages its global cash and debt positions. “Core” debt-to-capitalization ratio (excluding Global Financing debt and equity) was 49.6 percent at September 30, 2017 compared to 49.5 percent at December 31, 2016 and 54.6 percent at September 30, 2016.

~~Global Financing debt-to-equity ratio~~

At September 30,

At December 31,

2017

2016

Global Financing debt-to-equity ratio

9.0
x
7.3
x

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 ~~currency~~interest rate variability underlying the financing receivable and are based on arm’s-length pricing.

The Global Financing ~~provides financing predominantly for the company’s external client assets, as well as for assets under contract by other IBM units.~~ debt-to-equity ratio remained at 9.0 to 1 at June 30, 2019.

Table of Contents

Management Discussion – (continued)

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 65~~ and in ~~“Segment Information” on pages 29 and 30.~~

~~Management Discussion — (continued)~~

note 8, “Segments.” 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 increased ~~by $1,365~~$847 million from December 31, ~~2016 as a result of an increase in retained earnings of $2,806 million, an increase in~~2018, primarily due to increases from net income ($4,089 million) and retirement-related ~~amounts of $1,446 million and an increase of $794 million related to currency translation,~~plans ($760 million); partially offset by decreases from dividends paid ($2,833 million) and an increase in treasury stock ~~of $3,762 million~~($1,315 million) primarily due to ~~common stock~~share repurchases.

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.


(Dollars in millions)
For the six months ended June 30:	2019		2018
Net cash provided by/(used in) continuing operations:
Operating activities	$	7,700	$	6,896
Investing activities		3,309		(2,399)
Financing activities		22,894		(5,428)
Effect of exchange rate changes on cash, cash equivalents and restricted cash		27		(344)
Net change in cash, cash equivalents and restricted cash	$	33,930	$	(1,274)

(Dollars in millions)

For the nine months ended September 30:

2017

2016

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

Operating activities

$
10,991

$
13,105
* **
Investing activities

(3,278
)
(7,289
)*
Financing activities

(5,499
)
(4,619
)**
Effect of exchange rate changes on cash and cash equivalents

875

155

Net change in cash and cash equivalents

$
3,089

$
1,352

* Revised classification of certain financing receivables. Refer to note 1, “Basis of Presentation,” for additional information.

** Reclassified to reflect adoption of the FASB guidance on share-based compensation.

Net cash provided by operating activities ~~decreased by $2,114~~increased $804 million as compared to the first ~~nine~~six months of ~~2016~~2018 driven primarily by:

●

An increase of $799 million in cash provided by financing receivables.

Investing activities were a net source of cash of $3,309 million in the ~~following factors:~~

· Anfirst six months of 2019 compared to a net use of cash of $2,399 million in the first six months of 2018. The year-to-year increase in ~~net income tax payments~~cash flow of ~~$1,211~~$5,708 million was driven ~~by the prior year Japan tax refund received;~~by:

·
● An increase of $3,406 million in cash provided by net non-operating finance receivables primarily driven by the wind down of OEM IT commercial financing operations; and
● An increase in cash provided by current year divestitures of $888 million; and
● A decrease in cash used for net capital expenditures of $852 million.

Financing activities were a net source of cash of $22,894 million in the first six months of 2019 compared to a net use of cash of $5,428 million in the first six months of 2018. The year-to-year increase in cash ~~provided by financing receivables~~flow of ~~$868 million; and~~

· ~~Performance-related declines within net income; partially offset by~~

· ~~Working capital improvements of $1,009~~$28,321 million ~~driven by strong cash collections.~~

~~Net cash used in investing activities decreased $4,011 million as compared to the first nine months of 2016~~was driven by:

●

An increase in net cash sourced from debt transactions of $27,824 million primarily driven by a higher level of issuances as the company prepared to close the Red Hat acquisition.

Table of Contents

· ~~A decrease in net cash used related to acquisitions of $5,002 million.~~

~~Net cash used in financing activities increased $880 million as compared to the first nine months of 2016 driven by:~~

· ~~An increase in common stock repurchases of $1,043 million; partially offset by~~

· ~~An increase in net cash sourced from debt transactions of $422 million primarily driven by a higher level of issuances which exceeded higher maturities.~~

Management Discussion —– (continued)

Looking Forward

The company’s strategies, investments and actions are all ~~taken~~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.

Within the IT industry, there are major shifts occurring—driven by cognitive, including data and analytics, cloud and changes in the ways individuals and enterprises are engaging. The company is bringing togetherAs part of its cognitive technologies on cloud platforms to create industry-based solutions in order to solve enterprise clients’ real problems. The company continues to address the higher value areas of enterprise IT and is amassing a unique set of capabilities and is differentiating itself from other technology providers as it moves into new spaces, and in some cases, creating entirely new markets. IBM is more than a hardware, software and services company; it has emerged as a cognitive solutions and cloud platform company, focused on industry differentiation. The company’slong-term strategic ~~imperatives represent revenue from its cloud, analytics, mobile, social and security solutions, across its segments, and are a signpost of progress in addressing these market shifts.~~

~~In 2017,~~model, the company ~~is continuing~~expects to ~~embed cognitive~~continue to allocate capital efficiently and ~~cloud across the business,~~effectively to ~~build new platforms~~investments, and ~~solutions and reinvent core capabilities. This is fueling the shift toward strategic imperatives revenue. Consistent with the long-term model, over the course of 2017, the company has continued~~ to ~~acquire and integrate key capabilities, remix skills, invest in areas of growth and~~ return value to shareholders. ~~This is all taken into account in~~Over the ~~full-year view. Overall,~~last several years, the company ~~continues~~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 ~~expect~~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.

On July 9, 2019, the company closed the Red Hat acquisition. Due to the timing of the closing, the company has not updated full year expectations to include Red Hat or Red Hat related activity. Full year expectations will be updated at an investor briefing webcast on August 2, 2019. Through the second quarter, the company remains on track to achieve GAAP earnings per share from continuing operations for ~~2017 to be~~2019 of at least ~~$11.95.~~$12.45. Excluding acquisition-related charges of ~~$0.75~~$0.76 per share, ~~and~~ non-operating retirement-related items of ~~$1.10~~$0.45 per share and tax reform enactment impacts of $0.24 per share, operating (non-GAAP) earnings per share is ~~expected~~on track to be at least ~~$13.80.~~$13.90. Earnings per share expectations do not include Red Hat or Red Hat related activity, other than pre-closing financing costs, which are included in GAAP results. The company remains on track to achieve free cash flow of approximately $12 billion in 2019. The free cash flow expectation also does not include estimated impacts from Red Hat.

~~Overall, looking forward~~At closing, Red Hat shareholders were entitled to receive $190 per share in cash, which represented a total equity value of approximately $34 billion and was remitted to the ~~fourth quarter~~paying agent. The company funded the transaction through a combination of ~~2017, as a result~~cash on hand and proceeds from debt issuances. The company previously announced its intent to suspend its share repurchase program in 2020 and 2021. Upon closing of the ~~typical large transactional base in the fourth quarter, there is a range of possible scenarios. In 2016,~~Red Hat acquisition, the company ~~increased revenue~~suspended its share repurchase program, which was earlier than previously stated. With the strong free cash flow generated by ~~$2.5 billion from third to fourth quarter. In 2017,~~ the company, ~~expects stronger sequential performance than~~portfolio actions taken and the ~~typical third~~suspension of share repurchases, this positions IBM to ~~fourth quarter increase,~~return to its target leverage ratios within a couple of years. The company will continue with ~~potentially $300 million~~a disciplined financial policy and is committed to ~~$400 million more revenue, depending on currency, due in part~~maintaining strong investment grade credit ratings and supporting a solid and growing dividend.

IBM’s acquisition of Red Hat brings together the best-in-class hybrid cloud providers and will enable companies to securely unlock the ~~mainframe cycle.~~full value of cloud for their businesses. The ~~company’s GAAP~~company has been building hybrid cloud capabilities across the business to address the next chapter of cloud and ~~operating (non-GAAP) gross margins have shown good progression in recent quarters, driven by mix~~to prepare for this important milestone. IBM and ~~some moderation in~~Red Hat are strongly positioned to address this opportunity and accelerate hybrid cloud adoption. The acquisition of Red Hat reinforces IBM’s high-value model, combining the ~~headwinds from investment. In~~power and flexibility of Red Hat’s open hybrid cloud technologies with the ~~fourth quarter~~scale and depth of ~~2017,~~IBM’s innovation and industry expertise, which is expected to elevate all of IBM as Red Hat grows and the company ~~expects GAAP~~sells more software and ~~operating (non-GAAP) gross margins to be consistent with~~services.

As previously stated, the sequential improvement the company has experienced the last few years of an approximate 2.5 to 3.5 point increase in gross margins from third to fourth quarter. In expense, the company expects to continue to drive efficiency in spending, however with the weaker U.S. dollar, currency hedges are expected to have an impact. The company continues to ~~have~~expect the acquisition of Red Hat, including related activity to be accretive to free cash flow in the first year, and accretive to operating (non-GAAP) earnings per share by the end of the second year after closing. Consistent with the acquisition of a ~~strong pipeline~~highly profitable software business, non-cash purchase accounting adjustments will result in the acquisition being dilutive to full-year 2019 earnings per share expectations. In an acquisition, U.S. GAAP requires the company to record all assets acquired and liabilities assumed at the acquisition

Table of ~~IP income opportunities. At mid-October spot rates,~~Contents

Management Discussion – (continued)

date fair value. This includes the ~~currency impact~~acquired deferred revenue balance. This will result in a non-cash adjustment to the acquired deferred revenue ~~growth for~~balance and a reduction to reported revenue post-closing. The level of adjustment will reflect the ~~fourth-quarter 2017~~high margin profile of Red Hat’s business, and deferred revenue is expected to be ~~approximately~~replenished over the subsequent two to three years, given Red Hat’s high renewal rates and a ~~three-point tailwind,~~stable and growing client base. Additional information will be provided when the company provides updated full-year 2019 expectations at the August 2^nd briefing.

Beginning in the second quarter of 2019 and continuing throughout the year, IBM’s Global Financing business is winding down the portion of its commercial financing operations, which ~~would result~~provides short-term working capital solutions for OEM information technology suppliers, distributors and resellers. This is consistent with IBM’s capital allocation strategy and high-value focus. IBM Global Financing will continue to provide differentiated end-to-end financing solutions, including commercial financing in support of IBM partner relationships. The wind down of this activity is expected to reduce IBM’s revenue, with a ~~neutral~~nominal impact to ~~a one-point tailwind to full-year 2017.~~

~~Free cash flow realization, defined as~~profit, however it does not change the company’s earnings per share and free cash flow expectations for 2019.

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 ~~income from continuing operations (GAAP), was 96 percent over~~ the ~~last twelve months~~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 ~~again expected~~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 ~~in line with the longer-term model of over 90 percent in 2017. The company continues~~an impact to ~~expect full year~~ free cash flow to be relatively flat year to year, as the first half year-to-year headwind shifts to a tailwind driven by lower tax and workforce rebalancing payments in 2017. This also reflects the level of profit consistent with the company’s full year expectations of earnings per share.

The company’s tax rate reflects its mix of business, both country and product mix. The company continues to expect that the 2017 GAAP tax rate will be approximately 3 points lower than the operating (non-GAAP) tax rate expectation. Expectations for the operating (non-GAAP) tax rate are approximately 15 percent plus or minus three points, excluding discrete items. This range was widened in 2017 due to mix variables and tax reform discussions underway in the U.S, which could result in planning actions this year. The tax rates for the first nine months of 2017, excluding discrete items, were in line with the company’s January 2017 expectations. The company may have discrete tax items in the fourth quarter of 2017, however the amount and timing is unknown and any benefits may be mitigated by other actions. The rate will change year to year based on nonrecurring 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, the timing and amount of foreign dividend repatriation, state and local taxes and the effects of various global income tax strategies.

In January 2017, the company reorganized its client and commercial financing business as a wholly owned subsidiary, IBM Credit LLC. As announced, the financing business target leverage was increased from 7:1 to 9:1. The subsidiary began accessing the capital markets directly in September 2017, with its first public debt issuance. At September 30, 2017, this business continues to be leveraged at a debt-to-equity ratio of 9:1.

~~Management Discussion — (continued)~~

realization.

The company expects ~~2017~~2019 pre-tax retirement-related plan cost to be approximately ~~$2.9~~$2.0 billion, ~~an increase~~a decrease of approximately ~~$900 million~~$1 billion compared to ~~2016.~~2018. This estimate reflects current pension plan assumptions at December 31, ~~2016.~~2018. Within total retirement-related plan cost, operating retirement-related plan cost is expected to be approximately ~~$1.4~~$1.5 billion, approximately flat versus ~~2016.~~2018. Non-operating retirement-related plan cost is expected to be approximately ~~$1.5~~$0.6 billion, ~~an increase~~a decrease of approximately ~~$900 million~~$1 billion compared to ~~2016,~~2018, primarily driven by lower ~~income~~actuarial loss amortization resulting from ~~expected return on assets.~~the change in amortization period for the U.S. plan. Contributions for all retirement-related plans are expected to be approximately ~~$2.4~~$2.3 billion in ~~2017,~~2019, approximately flat compared to ~~2016.~~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 ~~September~~June 30, ~~2017,~~2019, currency changes resulted in assets and liabilities denominated in local currencies being translated into more dollars than at year-end ~~2016.~~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 ~~nine~~six months of ~~2017.~~2019. Based on the currency rate movements in the first ~~nine~~six months of ~~2017,~~2019, total revenue decreased ~~2.7~~ 4.4

Table of Contents

Management Discussion – (continued)

percent as reported and ~~decreased 2.2~~1.2 percent at constant currency versus the first ~~nine~~six months of ~~2016.~~2018. On an income from continuing operations before income tax basis, these translation impacts ~~offset~~mitigated by the net impact of hedging activities resulted in a theoretical maximum (assuming no pricing or sourcing actions) ~~decrease~~increase of approximately ~~$10~~$160 million in the first ~~nine~~six months of ~~2017~~2019 on an as-reported basis and ~~a decrease~~an increase of ~~$20~~approximately $140 million on an operating (non-GAAP) basis. The same mathematical exercise resulted in an increase of approximately ~~$50~~$175 million in the first ~~nine~~six months of ~~2016~~2018 on an as-reported basis and an increase of ~~$75~~approximately $200 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.

The company continues to monitor the economic conditions in Venezuela. In mid-February 2016, changes to the currency exchange systems were announced which eliminated the SICAD exchange rate and replaced the SIMADI rate with DICOM, which is expected to be a floating exchange rate. The company recorded a pre-tax loss of $43 million in the first quarter of 2016 in other (income) and expense in the Consolidated Statement of Earnings as a result of the elimination of the SICAD and devaluation in the new exchange. Total pre-tax loss for the first nine months of 2017 was $9 million compared to $46 million in the first nine months of 2016. The company’s net assets denominated in local currency were $8 million at September 30, 2017. The company’s operations in Venezuela comprised less than 1 percent of total 2016 and 2015 revenue, respectively.

Liquidity and Capital Resources

In the company’s ~~2016~~2018 Annual Report, on pages 6860 to ~~71,~~62, there is a discussion of the company’s liquidity including two tables that present ~~five~~three years of data. The table presented on page 6860 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 ~~five~~three years. For the ~~nine~~six months

~~Management Discussion — (continued)~~

ended, or as of, as applicable, ~~September~~June 30, ~~2017,~~2019, those amounts are ~~$11.0~~$7.7 billion ~~for~~of net cash from operating activities, ~~$11.5~~$46.4 billion of cash, restricted cash and short-term marketable securities and ~~$10.25~~$15.3 billion in global credit facilities, respectively. On July 20, 2017, the company and IBM Credit entered into a $2.5 billion 364-day Credit Agreement and a $2.5 billion three-year Credit Agreement. These new agreements permit borrowings up to an aggregate of $5 billion on a revolving basis.

The major rating agencies’ ratings on the company’s debt securities at ~~September~~June 30, ~~2017~~2019 appear in the ~~table below.~~following table:


	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

On July 9, 2019, the company completed the acquisition of all the outstanding shares of Red Hat for $190 per share in cash, representing a total value of approximately $34 billion. The ~~Fitch ratings were reaffirmed~~transaction was funded through a combination of cash on ~~September 30, 2016~~hand and ~~remain unchanged~~proceeds from ~~December 31, 2016. On May 3, 2017,~~debt issuances. In order to reduce this debt and return to target leverage ratios within a couple of years, the company suspended its share repurchase program at the time of the Red Hat acquisition closing. Refer to note 13, “Borrowings,” for additional details of financing this transaction.

After closing the transaction, Moody’s, ~~Investors Service lowered its rating on the company’s senior~~as expected, downgraded IBM and IBM Credit LLC’s long-term debt rating from ~~Aa3~~A1 to ~~A1, while reaffirming~~A2 and improved its outlook to stable. The commercial paper rating ~~on commercial paper. On May 5, 2017,~~from Moody’s remains unchanged. Standard and Poor’s ~~lowered~~ratings remain unchanged. Additionally, Fitch affirmed its ~~ratings~~rating before withdrawing coverage on ~~the company’s senior long-term debt~~IBM for commercial reasons.

IBM will continue with a disciplined financial policy and is committed to ~~A+ from AA- and commercial paper to A-1 from A-1+.~~ ~~IBM remains a~~maintaining strong investment grade ~~company with significant financial flexibility to execute its strategy and capital allocation plans.~~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 ~~September~~June 30, ~~2017,~~2019, the fair value of those instruments that were in a liability position was ~~$352~~$589 million, before any applicable netting, and this position is subject to fluctuations in fair value period to period based on the level of the

Table of Contents

Management Discussion – (continued)

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

In July 2017, the UK's Financial Conduct Authority, which regulates the London Interbank Offered Rate (LIBOR), announced that it intends to phase out LIBOR by the end of 2021. Various central bank committees and working groups continue to discuss replacement of benchmark rates, the process for amending existing LIBOR-based contracts, and the potential economic impacts of different alternatives. The Alternative Reference Rates Committee has identified the Secured Overnight Financing Rate (SOFR) as its preferred alternative rate for USD LIBOR. SOFR is a measure of the cost of borrowing cash overnight, collateralized by U.S. Treasury securities, and is based on directly observable U.S. Treasury-backed repurchase transactions. The company is evaluating the potential impact of the replacement of the LIBOR benchmark interest rate, including risk management, internal operational readiness and monitoring the FASB standard-setting process to address financial reporting issues that might arise in connection with transition from LIBOR to a new benchmark rate.

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 ~~79.~~92. 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, ~~make~~ 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~~Free 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.

~~Management Discussion — (continued)~~

The following is management’s view of cash flows for the first ~~nine~~six months of ~~2017~~2019 and ~~2016~~2018 prepared in a manner

consistent with the description above.


(Dollars in millions)
For the six months ended June 30:	2019		2018
Net cash from operating activities per GAAP	$	7,700	$	6,896
Less: change in Global Financing receivables		2,577		1,778
Net cash from operating activities, excluding Global Financing receivables	$	5,123	$	5,118
Capital expenditures, net		(1,045)		(1,897)
Free cash flow (FCF)	$	4,078	$	3,221
Acquisitions		(43)		(122)
Divestitures		888		—
Share repurchase		(1,236)		(1,767)
Common stock repurchases for tax withholdings		(152)		(143)
Dividends		(2,833)		(2,819)
Non-Global Financing debt		33,399		(611)
Other (includes Global Financing net receivables and Global Financing debt)		84		1,325
Change in cash, cash equivalents, restricted cash and short-term marketable securities	$	34,186	$	(916)

(Dollars in millions)

For the nine months ended September 30:

2017

2016

Net cash from operating activities per GAAP

$
10,991

$
13,105
* **
Less: change in Global Financing receivables

2,468

3,336
*
Net cash from operating activities, excluding Global Financing receivables

8,523

9,769
**
Capital expenditures, net

(2,347
)
(2,801
)
Free cash flow (FCF)

6,176

6,969
**
Acquisitions

(442
)
(5,445
)
Divestitures

35

35

Share repurchase

(3,674
)
(2,632
)
Common stock repurchases for tax withholdings

(153
)
(115
)**
Dividends

(4,119
)
(3,927
)
Non-Global Financing debt

1,896

3,365

Other (includes Global Financing receivables and Global Financing debt)

3,270

3,523

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

$
2,988

$
1,773

* Revised classificationTable of ~~certain financing receivables.~~Contents

** Reclassified to reflect adoption of the FASB guidance on share-based compensation.Management Discussion – (continued)

In the first ~~nine~~six months of ~~2017,~~2019, the company generated free cash flow of ~~$6.2~~$4.1 billion, ~~a decrease~~an increase of ~~$0.8~~$0.9 billion versus the prior year. The year-to-year decrease was driven primarily by a cash tax refund related to the Japan tax matter in the prior year. In addition, working capital contributed to the free cash flow performance in the first nine months of 2017. Net capital expenditures of $2.3 billion included investments to expand the company’s cloud and cognitive capabilities. In the first ~~nine~~six months of ~~2017,~~2019, the company continued to focus its cash utilization on returning value to shareholders including ~~$4.1~~$2.8 billion in dividends and ~~$3.7~~$1.2 billion in gross common stock ~~repurchases.~~

repurchases (9.2 million shares).

Events that could temporarily change the historical cash flow dynamics discussed previously and in the company’s ~~2016~~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 ~~12,~~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 ~~2017.~~2019. Contributions related to all retirement-related plans are expected to be approximately ~~$2.4~~$2.3 billion in ~~2017.~~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 ~~U.S.~~ cash flows ~~continue to be~~are sufficient to fund its current ~~domestic~~ operations and obligations, including investing and financing activities such as dividends and debt service. ~~The company’s U.S. operations generate substantial cash flows, and, in those circumstances where the company has~~When additional ~~cash~~ requirements ~~in the U.S.,~~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 ~~Credit Facilities, repatriating certain foreign earnings and utilizing intercompany loans with certain foreign subsidiaries.~~

The company does earn a significant amount of its pre-tax income outside the U.S. The company’s policy is to indefinitely reinvest the undistributed earnings of its foreign subsidiaries, and accordingly, no provision for federal income taxes has been made on accumulated earnings of foreign subsidiaries. The company periodically repatriates a portion of these earnings to the extent that it does not incur an additional U.S. tax liability. Quantification of the deferred tax liability, if any, associated with indefinitely reinvested earnings is not practicable. While the company currently does not have a need to repatriate funds held by its foreign subsidiaries, if these funds are needed for operations and obligations in the U.S., the company could elect to repatriate these funds which could result in a reassessment of the company’s policy and increased tax expense.

~~Management Discussion — (continued)~~

committed global credit facilities.

Global Financing Return on Equity Calculation

Three Months Ended

Nine Months Ended

September 30,

September 30,

(Dollars in millions)

2017

2016

2017

2016

Numerator

Global Financing after-tax income*

$
194

$
244

$
621

$
829

Annualized after-tax income (a)

$
776

$
977

$
828

$
1,106

Denominator

Average Global Financing equity (b)**

$
3,255

$
3,595

$
3,372

$
3,647

Global Financing return on equity (a)/(b)

23.8
%
27.2
%
24.6
%
30.3
%



	For Three Months Ended						For Six Months Ended
	June 30,						June 30,
(Dollars in millions)	2019			2018			2019			2018
Numerator
Global Financing after-tax income*	$	188		$	272		$	304		$	556
Annualized after-tax income (1)	$	754		$	1,089		$	608		$	1,113
Denominator
Average Global Financing equity (2)**	$	3,028		$	3,486		$	3,175		$	3,485
Global Financing return on equity (1)/(2)		24.9	%		31.2	%		19.2	%		31.9	%

* 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 2two quarters and 3three quarters, for the three months ended ~~September~~June 30, and for the ~~nine~~six months ended ~~September~~June 30, respectively.

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 ~~“Snapshot”~~“Operating (non-GAAP) Earnings” section ~~on page 51~~ for the company’s rationale for presenting operating earnings information.

(Dollars in millions except per share amounts)

Acquisition-related

Retirement-related

Operating

For the three months ended September 30, 2017

GAAP

adjustments

adjustments

(Non-GAAP)

Gross profit

$
8,800

$
114

$
203

$
9,116

Gross profit margin

45.9
%
0.6
pts.
1.1
pts.
47.6
%
S,G&A

$
4,648

$
(125
)
$
(53
)
$
4,470

R,D&E

1,342

—

(51
)
1,291

Other (income) and expense

(114
)
—

—

(114
)
Total expense and other (income)

5,735

(125
)
(103
)
5,507

Pre-tax income from continuing operations

3,065

238

306

3,609

Pre-tax margin from continuing operations

16.0
%
1.2
pts.
1.6
pts.
18.8
%
Provision for income taxes*

$
339

$
79

$
113

$
531

Effective tax rate

11.0
%
1.5
pts.
2.2
pts.
14.7
%
Income from continuing operations

$
2,726

$
159

$
193

$
3,079

Income margin from continuing operations

14.2
%
0.8
pts.
1.0
pts.
16.1
%
Diluted earnings per share from

continuing operations

$
2.92

$
0.17

$
0.21

$
3.30


				Acquisition-			Retirement-			U.S.
(Dollars in millions except per share amounts)				Related			Related			Tax Reform			Operating
For the three months ended June 30, 2019:	GAAP			Adjustments			Adjustments			Charges**			(non-GAAP)
Gross profit	$	9,010		$	73		$	—		$	—		$	9,083
Gross profit margin		47.0	%		0.4	pts.		—	pts.		—	pts.		47.4	%
S,G&A	$	5,456		$	(149)		$	—		$	—		$	5,307
R,D&E		1,407			—			—			—			1,407
Other (income) and expense		(747)			119			(136)			—			(764)
Interest expense		348			(168)			—			—			180
Total expense and other (income)		6,242			(198)			(136)			—			5,907
Pre-tax income from continuing operations		2,768			272			136			—			3,176
Pre-tax margin from continuing operations		14.4	%		1.4	pts.		0.7	pts.		—	pts.		16.6	%
Provision for income taxes*	$	269		$	55		$	40		$	(14)		$	349
Effective tax rate		9.7	%		0.9	pts.		0.8	pts.		(0.4)	pts.		11.0	%
Income from continuing operations	$	2,499		$	217		$	97		$	14		$	2,827
Income margin from continuing operations		13.0	%		1.1	pts.		0.5	pts.		0.1	pts.		14.8	%
Diluted earnings per share from continuing operations	$	2.81		$	0.24		$	0.11		$	0.01		$	3.17

* 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.

(Dollars in millions except per share amounts)

Acquisition-related

Retirement-related

Operating

For the three months ended September 30, 2016

GAAP

adjustments

adjustments

(Non-GAAP)

Gross profit

$
9,013

$
129

$
79

$
9,221

Gross profit margin

46.9
%
0.7
pts.
0.4
pts.
48.0
%
S,G&A

$
4,732

$
(138
)
$
(53
)
$
4,541

R,D&E

1,397

—

(7
)
1,390

Other (income) and expense

(8
)
(2
)
—

(10
)
Total expense and other (income)

5,751

(140
)
(60
)
5,550

Pre-tax income from continuing operations

3,263

269

139

3,671

Pre-tax margin from continuing operations

17.0
%
1.4
pts.
0.7
pts.
19.1
%
Provision for income taxes*

$
409

$
73

$
40

$
521

Effective tax rate

12.5
%
1.1
pts.
0.6
pts.
14.2
%
Income from continuing operations

$
2,854

$
197

$
99

$
3,149

Income margin from continuing operations

14.8
%
1.0
pts.
0.5
pts.
16.4
%
Diluted earnings per share from

continuing operations

$
2.98

$
0.21

$
0.10

$
3.29


				Acquisition-			Retirement-			U.S.
(Dollars in millions except per share amounts)				Related			Related			Tax Reform			Operating
For the three months ended June 30, 2018:	GAAP			Adjustments			Adjustments			Charges**			(non-GAAP)
Gross profit	$	9,199		$	94		$	—		$	—		$	9,292
Gross profit margin		46.0	%		0.5	pts.		—	pts.		—	pts.		46.5	%
S,G&A	$	4,857		$	(110)		$	—		$	—		$	4,746
R,D&E		1,364			—			—			—			1,364
Other (income) and expense		280			—			(394)			—			(115)
Interest expense		173			—			—			—			173
Total expense and other (income)		6,423			(110)			(394)			—			5,918
Pre-tax income from continuing operations		2,776			204			394			—			3,374
Pre-tax margin from continuing operations		13.9	%		1.0	pts.		2.0	pts.		—	pts.		16.9	%
Provision for income taxes*	$	373		$	44		$	109		$	14		$	540
Effective tax rate		13.5	%		0.5	pts.		1.6	pts.		0.4	pts.		16.0	%
Income from continuing operations	$	2,402		$	160		$	286		$	(14)		$	2,834
Income margin from continuing operations		12.0	%		0.8	pts.		1.4	pts.		(0.1)	pts.		14.2	%
Diluted earnings per share from continuing operations	$	2.61		$	0.17		$	0.31		$	(0.01)		$	3.08

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

Table of Contents

Management Discussion —– (continued)

(Dollars in millions except per share amounts)

Acquisition-related

Retirement-related

Operating

For the nine months ended September 30, 2017

GAAP

adjustments

adjustments

(Non-GAAP)

Gross profit

$
25,365

$
349

$
591

$
26,305

Gross profit margin

44.8
%
0.6
pts.
1.0
pts.
46.5
%
S,G&A

$
14,959

$
(393
)
$
(326
)
$
14,240

R,D&E

4,360

—

(148
)
4,212

Other (income) and expense

(218
)
(7
)
—

(225
)
Total expense and other (income)

18,434

(401
)
(474
)
17,559

Pre-tax income from continuing operations

6,931

750

1,065

8,746

Pre-tax margin from continuing operations

12.2
%
1.3
pts.
1.9
pts.
15.5
%
Provision for income taxes*

$
120

$
212

$
288

$
621

Effective tax rate

1.7
%
2.3
pts.
3.1
pts.
7.1
%
Income from continuing operations

$
6,811

$
537

$
777

$
8,125

Income margin from continuing operations

12.0
%
0.9
pts.
1.4
pts.
14.4
%
Diluted earnings per share from

continuing operations

$
7.24

$
0.57

$
0.83

$
8.64


				Acquisition-			Retirement-			U.S.
(Dollars in millions except per share amounts)				Related			Related			Tax Reform			Operating
For the six months ended June 30, 2019:	GAAP			Adjustments			Adjustments			Charges**			(non-GAAP)
Gross profit	$	17,053		$	149		$	—		$	—		$	17,202
Gross profit margin		45.7	%		0.4	pts.		—	pts.		—	pts.		46.1	%
S,G&A	$	10,147		$	(273)		$	—		$	—		$	9,873
R,D&E		2,840			—			—			—			2,840
Other (income) and expense		(820)			142			(274)			—			(951)
Interest expense		558			(204)			—			—			354
Total expense and other (income)		12,402			(335)			(274)			—			11,793
Pre-tax income from continuing operations		4,651			484			274			—			5,409
Pre-tax margin from continuing operations		12.5	%		1.3	pts.		0.7	pts.		—	pts.		14.5	%
Provision for income taxes*	$	558		$	104		$	66		$	(155)		$	574
Effective tax rate		12.0	%		0.8	pts.		0.6	pts.		(2.9)	pts.		10.6	%
Income from continuing operations	$	4,093		$	381		$	208		$	155		$	4,836
Income margin from continuing operations		11.0	%		1.0	pts.		0.6	pts.		0.4	pts.		13.0	%
Diluted earnings per share from continuing operations	$	4.58		$	0.44		$	0.23		$	0.17		$	5.42

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

(Dollars in millions except per share amounts)

Acquisition-related

Retirement-related

Operating

For the nine months ended September 30, 2016

GAAP

adjustments

adjustments

(Non-GAAP)

Gross profit

$
27,401

$
371

$
238

$
28,010

Gross profit margin

47.1
%
0.6
pts.
0.4
pts.
48.2
%
S,G&A

$
16,093

$
(365
)
$
(183
)
$
15,545

R,D&E

4,320

—

(23
)
4,297

Other (income) and expense

281

(7
)
—

274

Total expense and other (income)

20,056

(372
)
(206
)
19,478

Pre-tax income from continuing operations

7,345

743

444

8,532

Pre-tax margin from continuing operations

12.6
%
1.3
pts.
0.8
pts.
14.7
%
Provision for/(benefit from) income taxes*

$
(31
)
$
201

$
106

$
277

Effective tax rate

(0.4
)%
2.4
pts.
1.3
pts.
3.2
%
Income from continuing operations

$
7,375

$
542

$
338

$
8,255

Income margin from continuing operations

12.7
%
0.9
pts.
0.6
pts.
14.2
%
Diluted earnings per share from

continuing operations

$
7.67

$
0.57

$
0.35

$
8.59


				Acquisition-			Retirement-			U.S.
(Dollars in millions except per share amounts)				Related			Related			Tax Reform			Operating
For the six months ended June 30, 2018:	GAAP			Adjustments			Adjustments			Charges**			(non-GAAP)
Gross profit	$	17,445		$	187		$	—		$	—		$	17,633
Gross profit margin		44.6	%		0.5	pts.		—	pts.		—	pts.		45.1	%
S,G&A	$	10,302		$	(220)		$	—		$	—		$	10,082
R,D&E		2,769			—			—			—			2,769
Other (income) and expense		692			—			(796)			—			(104)
Interest expense		338			—			—			—			338
Total expense and other (income)		13,534			(220)			(796)			—			12,518
Pre-tax income from continuing operations		3,911			407			796			—			5,114
Pre-tax margin from continuing operations		10.0	%		1.0	pts.		2.0	pts.		—	pts.		13.1	%
Provision for (benefit from) income taxes*	$	(166)		$	83		$	185		$	(93)		$	8
Effective tax rate		(4.3)	%		2.0	pts.		4.3	pts.		(1.8)	pts.		0.2	%
Income from continuing operations	$	4,078		$	324		$	611		$	93		$	5,106
Income margin from continuing operations		10.4	%		0.8	pts.		1.6	pts.		0.2	pts.		13.1	%
Diluted earnings per share from continuing operations	$	4.42		$	0.35		$	0.66		$	0.10		$	5.53

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

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 ~~the~~ 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 ~~personnel~~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; risks from~~dispositions, including integration challenges, failure to achieve objectives, the assumption of liabilities, and higher debt levels; legal ~~proceedings;~~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 ~~or herein~~ by reference. ~~The~~Any forward-looking statement in this Form 10-Q speaks only as of the date on which it is made. Except as required by law, 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.

100

Table of Contents

Part II — Other Information

Item 1. Legal Proceedings

Refer to note ~~12,~~14, “Contingencies,” ~~on pages 44 to 46 of~~in 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 ~~third~~second quarter of ~~2017.~~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*

July 1, 2017 - July 31, 2017

1,403,534

$
149.09

1,403,534

$
2,191,734,677

August 1, 2017 - August 31, 2017

3,167,041

$
142.65

3,167,041

$
1,739,970,319

September 1, 2017 - September 30, 2017

1,982,071

$
144.56

1,982,071

$
1,453,447,857

Total

6,552,646

$
144.60

6,552,646


				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*
April 1, 2019 - April 30, 2019	741,693	$	141.70	741,693	$	2,333,748,955

May 1, 2019 - May 31, 2019	815,267	$	134.68	815,267	$	2,223,949,220

June 1, 2019 - June 30, 2019	743,719	$	135.66	743,719	$	2,123,055,549

Total	2,300,679	$	137.26	2,300,679

* On October ~~25, 2016,~~30, 2018, the Board of Directors authorized ~~$3.0~~$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.

The company’s acquisition of Red Hat on July 9, 2019 was funded through a combination of debt and cash, with incremental debt issued earlier this year. The company suspended its share repurchase program at the time of closing.

101

Table of Contents

Item 6. Exhibits

~~Exhibit Number~~


Exhibit Number
~~4.1~~		Indenture dated as of October 1, 1993 between IBM and The Bank of New York Mellon, (as successor to The Chase Manhattan Bank (National Association)) as Trustee. *
10.1		Form of LTTP equity awards agreement for stock options, restricted stock, restricted stock units, cash-settled restricted stock units, and SARS, as well as the Terms and Conditions of LTPP Equity Awards, effective July 15, 2019, in connection with the foregoing award agreement.
~~4.2~~		First Supplemental Indenture to Indenture dated as of October 1, 1993 between IBM and The Bank of New York Mellon, (as successor to The Chase Manhattan Bank (National Association)) as Trustee, dated as of December 15, 1995. *

11		~~Statement re: computation of per share earnings.~~

		~~The statement re computation of per share earnings is note [14], “Earnings Per Share of Common Stock,” in this Form 10-Q.~~

12		~~Statement re: computation of ratios.~~

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 – the instance document does not appear on the Interactive Data File because its XBRL tags are embedded within the Inline XBRL 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

* ~~Refiled by the company in electronic format in accordance with SEC Release Nos. 33-10322 and 34-80132 relating to exhibit hyperlinks, which became effective September 1, 2017.~~

102

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:	~~October 31, 2017~~July 30, 2019
		By:	/s/ Robert F. Del Bene
			Robert F. Del Bene
			Vice President and Controller

103

	At September 30,		At December 31,
(Dollars in millions)	2017		2016
Assets:
Current assets:
Cash and cash equivalents	$	10,915	$	7,826
Marketable securities	600		701
Notes and accounts receivable - trade (net of allowances of $296 in 2017 and $290 in 2016)	8,150		9,182
Short-term financing receivables (net of allowances of $270 in 2017 and $337 in 2016)	18,050		19,006
Other accounts receivable (net of allowances of $39 in 2017 and $48 in 2016)	926		1,057
Inventories, at lower of average cost or market:
Finished goods	430		358
Work in process and raw materials	1,281		1,195
Total inventories	1,711		1,553
Prepaid expenses and other current assets	4,389		4,564
Total current assets	44,742		43,888
Property, plant and equipment	31,937		30,133
Less: Accumulated depreciation	20,880		19,303
Property, plant and equipment — net	11,057		10,830
Long-term financing receivables (net of allowances of $84 in 2017 and $101 in 2016)	8,459		9,021
Prepaid pension assets	4,521		3,034
Deferred taxes	7,289		5,224
Goodwill	36,782		36,199
Intangible assets — net	3,981		4,688
Investments and sundry assets	4,806		4,585
Total assets	$	121,636	$	117,470

(Dollars in millions)
At September 30, 2017	Level 1		Level 2		Level 3		Total
Assets:
Cash equivalents (1)
Time deposits and certificates of deposit	$	—	$	5,553	$	—	$	5,553
Money market funds	1,375		—		—		1,375
U.S. government securities	—		200		—		200
Canadian government securities	—		460		—		460
Total	1,375		6,214		—		7,589		(6)
Debt securities - current (2)	—		599		—		599		(6)
Debt securities - noncurrent (3)	4		7		—		11
Available-for-sale equity investments (3)	5		—		—		5
Derivative assets (4)
Interest rate contracts	—		517		—		517
Foreign exchange contracts	—		416		—		416
Equity contracts	—		23		—		23
Total	—		957		—		957		(7)
Total assets	$	1,384	$	7,775	$	—	$	9,159	(7)
Liabilities:
Derivative liabilities (5)
Foreign exchange contracts	$	—	$	333	$	—	$	333
Equity contracts	—		4		—		4
Interest rate contracts	—		15		—		15
Total liabilities	$	—	$	352	$	—	$	352	(7)

(Dollars in millions)
At December 31, 2016	Level 1		Level 2		Level 3		Total
Assets:
Cash equivalents (1)
Time deposits and certificates of deposit	$	—	$	3,629	$	—	$	3,629
Money market funds	1,204		—		—		1,204
Total	1,204		3,629		—		4,832		(6)
Debt securities - current (2)	—		699		—		699		(6)
Debt securities - noncurrent (3)	1		6		—		8
Available-for-sale equity investments (3)	7		—		—		7
Derivative assets (4)
Interest rate contracts	—		555		—		555
Foreign exchange contracts	—		560		—		560
Equity contracts	—		11		—		11
Total	—		1,126		—		1,126		(7)
Total assets	$	1,212	$	5,460	$	—	$	6,672	(7)
Liabilities:
Derivative liabilities (5)
Foreign exchange contracts	$	—	$	188	$	—	$	188
Equity contracts	—		10		—		10
Interest rate contracts	—		8		—		8
Total liabilities	$	—	$	206	$	—	$	206	(7)

			Gross		Gross
(Dollars in millions)	Adjusted		Unrealized		Unrealized		Fair
At September 30, 2017:	Cost		Gains		Losses		Value
Debt securities — noncurrent(1)	$	7	$	3	$	—	$	11
Available-for-sale equity investments(1)	$	1	$	4	$	0	$	5

	Gain (Loss) Recognized in Earnings and Other Comprehensive Income
														Ineffectiveness and
(Dollars in millions)	Effective Portion						Consolidated	Effective Portion Reclassified						Amounts Excluded from
For the three months	Recognized in OCI						Statement of	from AOCI						Effectiveness Testing(3)
ended September 30:	2017			2016			Earnings Line Item	2017			2016			2017			2016
Derivative instruments in cash flow hedges:
Interest rate contracts	$	—		$	—		Interest expense	$	(7	)	$	(7	)	$	—		$	—
Foreign exchange contracts	(70		)	35			Other (income) and expense	64			(6		)	(1		)	(1		)
							Cost of sales*	1			(7		)	—			—
							Cost of services*	20			3			—			—
							SG&A expense	(6		)	2			—			—
Instruments in net investment hedges(4):
Foreign exchange contracts	(507		)	(131		)	Cost of financing	—			—			0			—
							Interest expense	—			—			8			25
Total	$	(577	)	$	(96	)		$	73		$	(15	)	$	7		$	24

(Dollars in millions)
At December 31, 2016:*	Americas			EMEA			Asia Pacific			Total
Financing receivables:
Lease receivables	$	3,830		$	1,171		$	1,335		$	6,336
Loan receivables	6,185			3,309			2,243			11,737
Ending balance	$	10,015		$	4,480		$	3,578		$	18,073
Collectively evaluated for impairment	$	9,847		$	4,460		$	3,419		$	17,726
Individually evaluated for impairment	$	168		$	20		$	159		$	347
Allowance for credit losses
Beginning balance at January 1, 2016
Lease receivables	$	52		$	17		$	143		$	213
Loan receivables	122			55			200			377
Total	$	175		$	72		$	343		$	590
Write-offs	$	(36	)	$	(48	)	$	(154	)	$	(237	)
Recoveries	2			0			0			2
Provision	65			(1		)	(6		)	58
Other	17			(1		)	(18		)	(3		)
Ending balance at December 31, 2016	$	223		$	22		$	165		$	410
Lease receivables	$	54		$	4		$	76		$	133
Loan receivables	$	169		$	18		$	89		$	276

Collectively evaluated for impairment	$	62		$	13		$	15		$	90
Individually evaluated for impairment	$	161		$	9		$	150		$	320

	At September 30, 2017				At December 31, 2016*
	Recorded		Related		Recorded		Related
(Dollars in millions)	Investment		Allowance		Investment		Allowance
Americas	$	140	$	131	$	168	$	161
EMEA	31		23		20		9
Asia Pacific	102		94		159		150
Total	$	273	$	248	$	347	$	320

					Interest
	Average		Interest		Income
(Dollars in millions)	Recorded		Income		Recognized on
For the three months ended September 30, 2017:	Investment		Recognized		Cash Basis
Americas	$	156	$	0	$	—
EMEA	31		0		—
Asia Pacific	101		0		—
Total	$	288	$	0	$	—

			Fully		<90 Days				Recorded
	Total		Reserved		or Unbilled		Total		Investment
(Dollars in millions)	Past Due		Financing		Financing		Financing		> 90 Days and
At September 30, 2017:	> 90 days (1)		Receivables		Receivables		Receivables		Accruing (2)
Americas	$	28	$	51	$	3,463	$	3,541	$	255
EMEA	9		4		1,283		1,297		15
Asia Pacific	5		32		1,266		1,304		19
Total lease receivables	$	42	$	87	$	6,012	$	6,142	$	290
Americas	$	43	$	80	$	6,057	$	6,180	$	401
EMEA	26		19		3,076		3,120		46
Asia Pacific	6		61		2,122		2,189		9
Total loan receivables	$	75	$	160	$	11,255	$	11,489	$	456
Total	$	117	$	247	$	17,267	$	17,631	$	746

	Cognitive Solutions & Industry Services
							Technology
				Global			Services &
	Cognitive			Business			Cloud						Global			Total
(Dollars in millions)	Solutions			Services			Platforms			Systems			Financing			Segments
For the three months ended September 30, 2017:
External revenue	$	4,400		$	4,093		$	8,457		$	1,721		$	427		$	19,098
Internal revenue	629			92			164			227			272			1,384
Total revenue	$	5,030		$	4,185		$	8,621		$	1,948		$	698		$	20,482
Pre-tax income from continuing operations	$	1,649		$	453		$	1,192		$	339		$	244		$	3,876
Revenue year-to-year change	2.6		%	(2.3		)%	(3.4		)%	12.3		%	(8.5		)%	(0.6		)%
Pre-tax income year-to-year change	4.8		%	(16.8		)%	(7.5		)%	149.7		%	(31.4		)%	(0.5		)%
Pre-tax income margin	32.8		%	10.8		%	13.8		%	17.4		%	34.9		%	18.9		%

For the three months ended September 30, 2016:
External revenue	$	4,235		$	4,191		$	8,748		$	1,558		$	412		$	19,145
Internal revenue	667			93			180			176			352			1,468
Total revenue	$	4,902		$	4,284		$	8,929		$	1,734		$	763		$	20,613
Pre-tax income from continuing operations	$	1,574		$	544		$	1,288		$	136		$	355		$	3,897

Pre-tax income margin	32.1		%	12.7		%	14.4		%	7.8		%	46.5		%	18.9		%

	For the Nine Months Ended
	September 30, 2017			September 30, 2016
Number of shares on which basic earnings per share is calculated:
Weighted-average shares outstanding during period	935,600,777			957,693,385
Add — Incremental shares under stock compensation plans	3,213,758			2,258,854
Add — Incremental shares associated with contingently issuable shares	1,394,930			771,943
Number of shares on which diluted earnings per share is calculated	940,209,466			960,724,182

Income from continuing operations (millions)	$	6,811		$	7,375
Loss from discontinued operations, net of tax (millions)	(3		)	(4		)
Net income on which basic earnings per share is calculated (millions)	$	6,807		$	7,371
Income from continuing operations (millions)	$	6,811		$	7,375
Net income applicable to contingently issuable shares (millions)	(2		)	—
Income from continuing operations on which diluted earnings per share is calculated (millions)	$	6,809		$	7,375
Loss from discontinued operations, net of tax, on which basic and diluted earnings per share is calculated (millions)	(3		)	(4		)
Net income on which diluted earnings per share is calculated (millions)	$	6,806		$	7,371

Earnings/(loss) per share of common stock:
Assuming dilution
Continuing operations	$	7.24		$	7.67
Discontinued operations	0.00			0.00
Total	$	7.24		$	7.67
Basic
Continuing operations	$	7.28		$	7.70
Discontinued operations	0.00			0.00
Total	$	7.28		$	7.70

	9/30/17		12/31/16
Assets	$	121,636	$	117,470	3.5	%
Liabilities	$	101,879	$	99,078	2.8	%
Equity	$	19,757	$	18,392	7.4	%

(Dollars in millions)
January 1, 2017		Additions *		Write-offs **			Other***		September 30, 2017
$	776	$	37	$	(157	)	$	33	$	689

(Dollars in millions except per share amounts)				Acquisition-related			Retirement-related			Operating
For the three months ended September 30, 2017	GAAP			adjustments			adjustments			(Non-GAAP)
Gross profit	$	8,800		$	114		$	203		$	9,116
Gross profit margin	45.9		%	0.6		pts.	1.1		pts.	47.6		%
S,G&A	$	4,648		$	(125	)	$	(53	)	$	4,470
R,D&E	1,342			—			(51		)	1,291
Other (income) and expense	(114		)	—			—			(114		)
Total expense and other (income)	5,735			(125		)	(103		)	5,507
Pre-tax income from continuing operations	3,065			238			306			3,609
Pre-tax margin from continuing operations	16.0		%	1.2		pts.	1.6		pts.	18.8		%
Provision for income taxes*	$	339		$	79		$	113		$	531
Effective tax rate	11.0		%	1.5		pts.	2.2		pts.	14.7		%
Income from continuing operations	$	2,726		$	159		$	193		$	3,079
Income margin from continuing operations	14.2		%	0.8		pts.	1.0		pts.	16.1		%
Diluted earnings per share from
continuing operations	$	2.92		$	0.17		$	0.21		$	3.30