~~0000051143us-gaap:EmployeeStockOptionMember2019-07-012019-09-30~~

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM ~~10 - Q~~10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE QUARTER ENDED ~~SEPTEMBER 30, 2019~~MARCH 31, 2020

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)

One New Orchard Road Armonk, New York	10504
(Address of principal executive offices)	(Zip Code)

914-499-1900

(Registrant’s telephone number)

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

Title of each class	Trading symbol	Name of each exchange on which registered
Capital stock, par value $.20 per share	IBM	New York Stock Exchange
		NYSE Chicago ~~Stock Exchange~~
~~1.375%~~2.750% Notes due ~~2019~~2020	IBM ~~19B~~20B	New York Stock Exchange
~~2.750%~~1.875% Notes due 2020	IBM ~~20B~~20A	New York Stock Exchange
~~1.875%~~0.500% Notes due ~~2020~~2021	IBM ~~20A~~21B	New York Stock Exchange
~~0.500%~~2.625% Notes due ~~2021~~2022	IBM ~~21B~~22A	New York Stock Exchange
~~2.625%~~1.250% Notes due ~~2022~~2023	IBM ~~22A~~23A	New York Stock Exchange
~~1.25%~~0.375% Notes due 2023	IBM ~~23A~~23B	New York Stock Exchange
~~0.375%~~1.125% Notes due ~~2023~~2024	IBM ~~23B~~24A	New York Stock Exchange
~~1.125%~~2.875% Notes due ~~2024~~2025	IBM ~~24A~~25A	New York Stock Exchange
~~2.875%~~0.950% Notes due 2025	IBM ~~25A~~25B	New York Stock Exchange
~~0.950%~~0.875% Notes due 2025	IBM ~~25B~~25C	New York Stock Exchange
~~0.875%~~0.300% Notes due ~~2025~~2026	IBM ~~25C~~26B	New York Stock Exchange
~~0.300%~~1.250% Notes due ~~2026~~2027	IBM ~~26B~~27B	New York Stock Exchange
~~1.250%~~0.300% Notes due ~~2027~~2028	IBM 28B	New York Stock Exchange
1.750% Notes due 2028	IBM ~~27B~~28A	New York Stock Exchange
~~1.750%~~1.500% Notes due ~~2028~~2029	IBM ~~28A~~29	New York Stock Exchange
~~1.500%~~1.750% Notes due ~~2029~~2031	IBM 2931	New York Stock Exchange
~~1.750%~~0.650% Notes due ~~2031~~2032	IBM 32A	New York Stock Exchange
1.200% Notes due 2040	IBM 40	New York Stock Exchange
7.00% Debentures due 2025	IBM 3125	New York Stock Exchange
~~8.375%~~6.22% Debentures due ~~2019~~2027	IBM 1927	New York Stock Exchange
~~7.00%~~6.50% Debentures due ~~2025~~2028	IBM 2528	New York Stock Exchange
~~6.22%~~7.00% Debentures due ~~2027~~2045	IBM 2745	New York Stock Exchange
~~6.50%~~7.125% Debentures due ~~2028~~2096	IBM 2896	New York Stock Exchange
~~7.00% Debentures due 2045~~	~~IBM 45~~	~~New York Stock Exchange~~
~~7.125% Debentures due 2096~~	~~IBM 96~~	~~New York Stock Exchange~~

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

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐

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

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

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

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

The registrant had ~~885,637,454~~887,891,957 shares of common stock outstanding at ~~September 30, 2019.~~

March 31, 2020.

Table of Contents

Index

9
	Page
~~Part I - Financial Information~~:

~~Item 1. Consolidated Financial Statements (Unaudited)~~:

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

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

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

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

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

~~Notes to Consolidated Financial Statements~~	10

~~Item 2. Management’s Discussion and Analysis of Results of Operations and Financial Condition~~	64

~~Item 4. Controls and Procedures~~	~~104~~

~~Part II - Other Information~~:

~~Item 1. Legal Proceedings~~	~~105~~

~~Item 2. Unregistered Sales of Equity Securities and Use of Proceeds and Issuer Repurchases of Equity Securities~~	~~105~~

~~Item 5. Other Information~~	~~105~~

~~Item 6. Exhibits~~	~~106~~

~~Table of Contents~~

Part I - Financial Information:

Item 1. Consolidated Financial ~~Statements:~~Statements (Unaudited):

~~INTERNATIONAL BUSINESS MACHINES CORPORATION~~

~~AND SUBSIDIARY COMPANIES~~

~~CONSOLIDATED STATEMENT OF EARNINGS~~

~~(UNAUDITED)~~

Consolidated Income Statement for the three months ended March 31, 2020 and 2019

Consolidated Statement of Comprehensive Income for the three months ended March 31, 2020 and 2019

Consolidated Balance Sheet at March 31, 2020 and December 31, 2019

Consolidated Statement of Cash Flows for the three months ended March 31, 2020 and 2019

Consolidated Statement of Equity for the three months ended March 31, 2020 and 2019

Three Months Ended September 30,

Nine Months Ended September 30,

(Dollars in millions except per share amounts)

2019

2018

2019

2018

Revenue:









Services

$
11,703

$
12,043
*
$
35,454
*
$
36,848
*
Sales

5,981

6,324
*

18,817
*

19,787
*
Financing

343

389

1,099

1,195

Total revenue

18,028

18,756

55,370

57,830

Cost:









Services

7,840

7,951
*

24,293
*

25,238
*
Sales

1,635

1,714
*

4,979
*

5,498
*
Financing

217

287

710

846

Total cost

9,692

9,953

29,982

31,582

Gross profit

8,336

8,803

25,388

26,249

Expense and other (income):









Selling, general and administrative

5,024

4,363

15,171

14,665

Research, development and engineering

1,553

1,252

4,393

4,021

Intellectual property and custom development income

(166)

(275)

(489)

(842)

Other (income) and expense

(31)

275

(850)

968

Interest expense

432

191

990

530

Total expense and other (income)

6,813

5,807

19,215

19,341

Income from continuing operations before income taxes

1,522

2,996

6,173

6,908

Provision for/(benefit from) income taxes

(151)

304

407

138

Income from continuing operations

$
1,673

$
2,692

$
5,766

$
6,770

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

(1)

2

(5)

7

Net income

$
1,672

$
2,694

$
5,761

$
6,777

Earnings/(loss) per share of common stock:









Assuming dilution:









Continuing operations

$
1.87

$
2.94

$
6.46

$
7.36

Discontinued operations

0.00

0.00

(0.01)

0.01

Total

$
1.87

$
2.94

$
6.45

$
7.37

Basic:









Continuing operations

$
1.89

$
2.95

$
6.50

$
7.39

Discontinued operations

0.00

0.00

(0.01)

0.01

Total

$
1.89

$
2.95

$
6.49

$
7.40

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









Assuming dilution

892.8

915.2

892.5

920.0

Basic

886.0

911.2

887.3

915.6

* ReclassifiedNotes to ~~conform to current period presentation. Refer to note 1, “Basis~~Consolidated Financial Statements

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

Item 4. Controls and Procedures

Part II - Other Information:

Item 1. Legal Proceedings

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

Item 6. Exhibits

Table of Contents

Part I - Financial Information

Item 1. Consolidated Financial Statements:

INTERNATIONAL BUSINESS MACHINES CORPORATION

AND SUBSIDIARY COMPANIES

CONSOLIDATED INCOME STATEMENT

(UNAUDITED)


	Three Months Ended March 31,
(Dollars in millions except per share amounts)	2020		2019
Revenue:
Services	$	11,373	$	11,915	*
Sales		5,895		5,862	*
Financing		302		404
Total revenue		17,571		18,182
Cost:
Services		7,843		8,272	*
Sales		1,624		1,603	*
Financing		181		264
Total cost		9,649		10,139
Gross profit		7,922		8,043
Expense and other (income):
Selling, general and administrative		5,955		4,691
Research, development and engineering		1,625		1,433
Intellectual property and custom development income		(116)		(101)
Other (income) and expense		182		(73)
Interest expense		326		210
Total expense and other (income)		7,972		6,160
Income/(loss) from continuing operations before income taxes		(49)		1,883
Provision for/(benefit from) income taxes		(1,226)		289
Income from continuing operations	$	1,176	$	1,593
Income/(loss) from discontinued operations, net of tax		(1)		(2)
Net income	$	1,175	$	1,591

Earnings/(loss) per share of common stock:
Assuming dilution:
Continuing operations	$	1.31	$	1.78
Discontinued operations		0.00		0.00
Total	$	1.31	$	1.78
Basic:
Continuing operations	$	1.32	$	1.79
Discontinued operations		0.00		0.00
Total	$	1.32	$	1.79

Weighted-average number of common shares outstanding: (millions)
Assuming dilution		895.0		893.9
Basic		888.0		889.6

* Reclassified to conform to current period presentation. Refer to note 1, “Basis of Presentation,” for additional information.

(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

(UNAUDITED)


	Three Months Ended September 30,				Nine Months Ended September 30,				Three Months Ended March 31,
(Dollars in millions)	2019		2018		2019		2018		2020		2019
Net income	$	1,672	$	2,694	$	5,761	$	6,777	$	1,175	$	1,591
Other comprehensive income/(loss), before tax:
Foreign currency translation adjustments		(509)		(22)		(333)		(535)		(919)		171
Net changes related to available-for-sale securities:
Unrealized gains/(losses) arising during the period		3		0		1		(2)		0		(1)
Reclassification of (gains)/losses to net income		—		—		—		—		—		—
Total net changes related to available-for-sale securities		3		0		1		(2)		0		(1)
Unrealized gains/(losses) on cash flow hedges:
Unrealized gains/(losses) arising during the period		(439)		(46)		(798)		(134)		(180)		(352)
Reclassification of (gains)/losses to net income		488		28		418		408		91		98
Total unrealized gains/(losses) on cash flow hedges		49		(18)		(380)		274		(90)		(254)
Retirement-related benefit plans:
Prior service costs/(credits)		—		0		—		(1)		(4)		—
Net (losses)/gains arising during the period		0		(1)		113		83		8		(4)
Curtailments and settlements		3		2		7		7		8		1
Amortization of prior service (credits)/costs		(3)		(18)		(9)		(55)		1		(3)
Amortization of net (gains)/losses		461		737		1,385		2,231		570		464
Total retirement-related benefit plans		461		719		1,496		2,264		582		458
Other comprehensive income/(loss), before tax		4		678		784		2,001		(427)		375
Income tax (expense)/benefit related to items of other comprehensive income		(249)		(209)		(380)		(807)		(260)		(67)
Other comprehensive income/(loss), net of tax		(245)		470		404		1,194		(686)		308
Total comprehensive income/(loss)	$	1,427	$	3,164	$	6,165	$	7,970	$	489	$	1,899

(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~~BALANCE SHEET

(UNAUDITED)

ASSETS

At September 30,

At December 31,
(Dollars in millions)

2019

2018
Assets:




Current assets:




Cash and cash equivalents

$
10,087

$
11,379
Restricted cash

138

225
Marketable securities

733

618
Notes and accounts receivable — trade (net of allowances of $286 in 2019 and $309 in 2018)

6,753

7,432
Short-term financing receivables (net of allowances of $225 in 2019 and $244 in 2018)

12,330

22,388
Other accounts receivable (net of allowances of $35 in 2019 and $38 in 2018)

1,876

743
Inventories, at lower of average cost or net realizable value:


Finished goods

351

266
Work in process and raw materials

1,361

1,415
Total inventories

1,712

1,682
Deferred costs

1,978

2,300
Prepaid expenses and other current assets

2,515

2,378
Total current assets

38,121

49,146
Property, plant and equipment

31,670

32,460
Less: Accumulated depreciation

21,608

21,668
Property, plant and equipment — net

10,063

10,792
Operating right-of-use assets — net*

4,901

—
Long-term financing receivables (net of allowances of $32 in 2019 and $48 in 2018)

7,739

9,148
Prepaid pension assets

5,481

4,666
Deferred costs

2,535

2,676
Deferred taxes

4,994

5,216
Goodwill

57,951

36,265
Intangible assets — net

15,613

3,087
Investments and sundry assets

2,221

2,386
Total assets

$
149,620

$
123,382


	At March 31,		At December 31,
(Dollars in millions)	2020		2019
Assets:
Current assets:
Cash and cash equivalents	$	11,218	$	8,172
Restricted cash		152		141
Marketable securities		647		696
Notes and accounts receivable — trade (net of allowances of $337 in 2020 and $299 in 2019)		6,927		7,870
Short-term financing receivables (net of allowances of $186 in 2020 and $188 in 2019)		12,126		14,192
Other accounts receivable (net of allowances of $28 in 2020 and $33 in 2019)		1,616		1,733
Inventory, at lower of average cost or net realizable value:
Finished goods		298		220
Work in process and raw materials		1,488		1,399
Total inventory		1,786		1,619
Deferred costs		1,948		1,896
Prepaid expenses and other current assets		2,509		2,101
Total current assets		38,931		38,420
Property, plant and equipment		31,089		32,028
Less: Accumulated depreciation		21,464		22,018
Property, plant and equipment — net		9,626		10,010
Operating right-of-use assets — net		4,871		4,996
Long-term financing receivables (net of allowances of $52 in 2020 and $33 in 2019)		7,708		8,712
Prepaid pension assets		6,933		6,865
Deferred costs		2,459		2,472
Deferred taxes		8,782		5,182
Goodwill		57,517		58,222
Intangible assets — net		14,666		15,235
Investments and sundry assets		1,911		2,074
Total assets	$	153,403	$	152,186

* 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~~BALANCE SHEET – (CONTINUED)

(UNAUDITED)

LIABILITIES AND EQUITY

At September 30,

At December 31,
(Dollars in millions)

2019

2018
Liabilities:

Current liabilities:




Taxes

$
2,154

$
3,046
Short-term debt

8,530

10,207
Accounts payable

4,042

6,558
Compensation and benefits

3,504

3,310
Deferred income

11,223

11,165
Operating lease liabilities*

1,377

—
Other accrued expenses and liabilities

4,235

3,941
Total current liabilities

35,066

38,227
Long-term debt

57,797

35,605
Retirement and nonpension postretirement benefit obligations

15,925

17,002
Deferred income

3,382

3,445
Operating lease liabilities*

3,790

—
Other liabilities

15,564

12,174
Total liabilities

131,524

106,452
Equity:


IBM stockholders’ equity:


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

55,808

55,151
Shares authorized: 4,687,500,000


Shares issued: 2019 - 2,237,055,309


2018 - 2,233,427,058


Retained earnings

160,709

159,206
Treasury stock - at cost

(169,474)

(168,071)
Shares: 2019 - 1,351,417,855


2018 - 1,340,947,648


Accumulated other comprehensive income/(loss)

(29,086)

(29,490)
Total IBM stockholders’ equity

17,956

16,796
Noncontrolling interests

139

134
Total equity

18,096

16,929
Total liabilities and equity

$
149,620

$
123,382


	At March 31,		At December 31,
(Dollars in millions except per share amount)	2020		2019
Liabilities:
Current liabilities:
Taxes	$	2,348	$	2,839
Short-term debt		11,642		8,797
Accounts payable		4,172		4,896
Compensation and benefits		3,029		3,406
Deferred income		13,377		12,026
Operating lease liabilities		1,327		1,380
Other accrued expenses and liabilities		4,777		4,357
Total current liabilities		40,673		37,701
Long-term debt		52,685		54,102
Retirement and nonpension postretirement benefit obligations		16,474		17,142
Deferred income		3,769		3,851
Operating lease liabilities		3,799		3,879
Other liabilities		15,874		14,526
Total liabilities		133,275		131,202
Equity:
IBM stockholders’ equity:
Common stock, par value $0.20 per share, and additional paid-in capital		56,092		55,895
Shares authorized: 4,687,500,000
Shares issued: 2020 - 2,238,932,461
2019 - 2,237,996,975
Retained earnings		162,626		162,954
Treasury stock - at cost		(169,437)		(169,413)
Shares: 2020 - 1,351,040,504
2019 - 1,350,886,521
Accumulated other comprehensive income/(loss)		(29,283)		(28,597)
Total IBM stockholders’ equity		19,999		20,841
Noncontrolling interests		129		144
Total equity		20,128		20,985
Total liabilities and equity	$	153,403	$	152,186

* 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 CASH FLOWS

(UNAUDITED)


	Nine Months Ended September 30,				Three Months Ended March 31,
(Dollars in millions)	2019		2018		2020		2019
Cash flows from operating activities:
Net income	$	5,761	$	6,777	$	1,175	$	1,591
Adjustments to reconcile net income to cash provided by operating activities
Depreciation		3,188		2,337		1,012		1,143
Amortization of intangibles		1,221		1,031		622		303
Stock-based compensation		468		371		189		113
Net (gain)/loss on asset sales and other		(828)		(18)		315		(176)
Changes in operating assets and liabilities, net of acquisitions/divestitures		1,509		631		1,162		1,785
Net cash provided by operating activities		11,319		11,128		4,476		4,759

Cash flows from investing activities:
Payments for property, plant and equipment		(1,710)		(2,613)		(630)		(539)
Proceeds from disposition of property, plant and equipment		452		192		46		81
Investment in software		(468)		(418)		(153)		(156)
Acquisition of businesses, net of cash acquired		(32,630)		(123)		(13)		(1)
Divestitures of businesses, net of cash transferred		927		—		26		33
Non-operating finance receivables — net		6,096		377		(20)		193
Purchases of marketable securities and other investments		(2,813)		(6,024)		(1,096)		(1,138)
Proceeds from disposition of marketable securities and other investments		3,081		3,241		938		674
Net cash provided by/(used in) investing activities		(27,064)		(5,368)		(902)		(853)

Cash flows from financing activities:
Proceeds from new debt		31,496		4,714		6,055		5,979
Payments to settle debt		(8,891)		(4,246)		(5,285)		(1,768)
Short-term borrowings/(repayments) less than 90 days — net		(2,140)		376		586		21
Common stock repurchases		(1,361)		(2,393)		—		(920)
Common stock repurchases for tax withholdings		(186)		(148)		(44)		(61)
Financing — other		68		82		13		9
Cash dividends paid		(4,269)		(4,250)		(1,440)		(1,397)
Net cash provided by/(used in) financing activities		14,717		(5,864)		(115)		1,863

Effect of exchange rate changes on cash, cash equivalents and restricted cash		(352)		(399)		(403)		(102)
Net change in cash, cash equivalents and restricted cash		(1,379)		(503)		3,057		5,668

Cash, cash equivalents and restricted cash at January 1		11,604		12,234		8,314		11,604
Cash, cash equivalents and restricted cash at September 30	$	10,225	$	11,731
Cash, cash equivalents and restricted cash at March 31					$	11,371	$	17,272

(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 ~~CHANGES IN~~ EQUITY

(UNAUDITED)


	Common														Common
	Stock and						Accumulated								Stock and						Accumulated
	Additional						Other		Total IBM		Non-				Additional						Other		Total IBM		Non-
	Paid-in		Retained		Treasury		Comprehensive		Stockholders’		Controlling		Total		Paid-in		Retained		Treasury		Comprehensive		Stockholders’		Controlling		Total
(Dollars in millions)	Capital		Earnings		Stock		Income/(Loss)		Equity		Interests		Equity
Equity - July 1, 2019	$	55,404	$	160,467	$	(169,385)	$	(28,841)	$	17,645	$	131	$	17,776
(Dollars in millions except per share amounts)															Capital		Earnings		Stock		Income/(Loss)		Equity		Interests		Equity
Equity - January 1, 2020															$	55,895	$	162,954	$	(169,413)	$	(28,597)	$	20,841	$	144	$	20,985
Cumulative effect of change in accounting principle*																		(66)						(66)				(66)
Net income plus other comprehensive income/(loss):
Net income				1,672						1,672				1,672				1,175						1,175				1,175
Other comprehensive income/(loss)								(245)		(245)				(245)								(686)		(686)				(686)
Total comprehensive income/(loss)									$	1,427			$	1,427									$	489			$	489
Cash dividends paid — common stock ($1.62 per share)				(1,436)						(1,436)				(1,436)				(1,440)						(1,440)				(1,440)
Common stock issued under employee plans (353,035 shares)		404								404				404
Purchases (241,779 shares) and sales (473,196 shares) of treasury stock under employee plans — net				6		27				32				32
Other treasury shares purchased, not retired (822,159 shares)						(115)				(115)				(115)
Common stock issued under employee plans (935,486 shares)																197								197				197
Purchases (310,454 shares) and sales (156,471 shares) of treasury stock under employee plans — net																		3		(24)				(21)				(21)
Changes in noncontrolling interests												8		8												(15)		(15)
Equity – September 30, 2019	$	55,808	$	160,709	$	(169,474)	$	(29,086)	$	17,956	$	139	$	18,096
Equity – March 31, 2020															$	56,092	$	162,626	$	(169,437)	$	(29,283)	$	19,999	$	129	$	20,128

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 - July 1, 2018

$
54,827

$
157,349

$
(165,366)

$
(28,290)

$
18,520

$
128

$
18,648
Net income plus other comprehensive income/(loss):














Net income



2,694





2,694



2,694
Other comprehensive income/(loss)







470

470



470
Total comprehensive income/(loss)









$
3,164



$
3,164
Cash dividends paid — common stock ($1.57 per share)



(1,431)





(1,431)



(1,431)
Common stock issued under employee plans (331,214 shares)

160







160



160
Purchases (31,408 shares) and sales (14,109 shares) of treasury stock under employee plans — net



1

(3)



(2)



(2)
Other treasury shares purchased, not retired (4,288,327 shares)





(627)



(627)


��

(627)
Changes in noncontrolling interests











6

6
Equity - September 30, 2018

$
54,987

$
158,612

$
(165,995)

$
(27,820)

$
19,784

$
134

$
19,918

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

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

~~Table of Contents~~

~~INTERNATIONAL BUSINESS MACHINES CORPORATION~~

~~AND SUBSIDIARY COMPANIES~~

~~CONSOLIDATED STATEMENT OF CHANGES IN EQUITY – (CONTINUED)~~

~~(UNAUDITED)~~

Common

Stock and

Accumulated

Additional

Other

Total IBM

Non-

Paid-in

Retained

Treasury

Comprehensive

Stockholders’

Controlling

Total
(Dollars in millions)

Capital

Earnings

Stock

Income/(Loss)

Equity

Interests

Equity
Equity - January 1, 2019

$
55,151

$
159,206

$
(168,071)

$
(29,490)

$
16,796

$
134

$
16,929
Net income plus other comprehensive income/(loss):














Net income



5,761





5,761



5,761
Other comprehensive income/(loss)







404

404



404
Total comprehensive income/(loss)









$
6,165



$
6,165
Cash dividends paid — common stock ($4.81 per share)



(4,269)





(4,269)



(4,269)
Common stock issued under employee plans (3,628,250 shares)

657







657



657
Purchases (1,377,598 shares) and sales (886,907 shares) of treasury stock under employee plans — net



16

(72)



(56)



(56)
Other treasury shares purchased, not retired (9,979,516 shares)





(1,331)



(1,331)



(1,331)
Changes in other equity



(5)





(5)



(5)
Changes in noncontrolling interests











6

6
Equity - September 30, 2019

$
55,808

$
160,709

$
(169,474)

$
(29,086)

$
17,956

$
139

$
18,096

FASB guidance on credit losses. Refer to note 2, “Accounting Changes.”

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



6,777





6,777



6,777
Other comprehensive income/(loss)







1,194

1,194



1,194
Total comprehensive income/(loss)









$
7,970



$
7,970
Cash dividends paid — common stock ($4.64 per share)



(4,250)





(4,250)



(4,250)
Common stock issued under employee plans (3,208,989 shares)

421







421



421
Purchases (978,004 shares) and sales (365,600 shares) of treasury stock under employee plans — net



13

(101)



(89)



(89)
Other treasury shares purchased, not retired (15,982,033 shares)





(2,388)



(2,388)



(2,388)
Changes in noncontrolling interests











3

3
Equity - September 30, 2018

$
54,987

$
158,612

$
(165,995)

$
(27,820)

$
19,784

$
134

$
19,918


	Common
	Stock and						Accumulated
	Additional						Other		Total IBM		Non-
	Paid-in		Retained		Treasury		Comprehensive		Stockholders’		Controlling		Total
(Dollars in millions except per share amounts)	Capital		Earnings		Stock		Income/(Loss)		Equity		Interests		Equity
Equity - January 1, 2019	$	55,151	$	159,206	$	(168,071)	$	(29,490)	$	16,796	$	134	$	16,929
Net income plus other comprehensive income/(loss):
Net income				1,591						1,591				1,591
Other comprehensive income/(loss)								308		308				308
Total comprehensive income/(loss)									$	1,899			$	1,899
Cash dividends paid — common stock ($1.57 per share)				(1,397)						(1,397)				(1,397)
Common stock issued under employee plans (1,391,989 shares)		137								137				137
Purchases (454,710 shares) and sales (82,862 shares) of treasury stock under employee plans — net				2		(50)				(48)				(48)
Other treasury shares purchased, not retired (6,856,678 shares)						(900)				(900)				(900)
Changes in other equity				(5)						(5)				(5)
Changes in noncontrolling interests												(8)		(8)
Equity - March 31, 2019	$	55,287	$	159,396	$	(169,021)	$	(29,182)	$	16,481	$	126	$	16,607

* 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

Notes to Consolidated Financial Statements

1. Basis of Presentation:

The accompanying Consolidated Financial Statements and footnotes of the International Business Machines Corporation (IBM or the company) have been prepared in accordance with accounting principles generally accepted in the United States of America (GAAP). The financial statements and footnotes are unaudited. In the opinion of the company’s management, these statements include all adjustments, which are only of a normal recurring nature, necessary to present a fair statement of the company’s results of operations, financial position and cash flows.

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amount of assets, liabilities, revenue, costs, expenses and other comprehensive income/(loss) that are reported in the Consolidated Financial Statements and accompanying disclosures. These estimates are based on management’s best knowledge of current events, historical experience, actions that the company may undertake in the future and on various other assumptions that are believed to be reasonable under the circumstances. As a result, actual results may be different from these estimates.

In the first quarter of ~~2019,~~2020, the company ~~made a number~~realigned offerings and the related management system to reflect divestitures completed in the second half of ~~changes to its organizational structure~~2019 and ~~management system.~~tighter integration of certain industry-related consulting services. These changes impacted a few of the company’s reportable segments, but did not impact the ~~company’s~~ Consolidated Financial Statements. Refer to note 8,4, “Segments,” for additional information on the company’s reportable segments. The periods presented in this Form 10-Q are reported on a comparable basis. On April 6, 2020, Arvind Krishna became Chief Executive Officer of IBM and announced a number of management changes which did not impact the company’s reportable segments.

For the three months ended March 31, 2020, the company recorded a benefit from income taxes of $1,226 million. The tax benefit was primarily related to the tax impacts of an intra-entity sale of certain of the company’s intellectual property, which required the recognition of a $3,442 million deferred tax asset. The recognition of this deferred tax asset and the related impacts, resulted in a net one-time benefit in the quarter of $939 million. The company ~~provided recast historical segment information reflecting these~~also recorded other discrete tax benefits in the quarter primarily related to changes in tax law.In the first quarter of 2019, the company reported a ~~Form 8-K dated April 4, 2019.~~provision for income taxes of $289 million.

On July 9, 2019, the company completed the acquisition of all of the outstanding shares of Red ~~Hat.~~Hat, Inc. (Red Hat). Refer to note ~~11, “Acquisitions/~~5, “Acquisitions & Divestitures,” and note ~~12,~~10, “Intangible Assets Including Goodwill,” for additional ~~information on the impacts to the consolidated financial results at and for the three and nine months ended September 30, 2019.~~information.

Noncontrolling interest amounts of ~~$7.1~~$4.5 million and ~~$6.2~~$7.0 million, net of tax, for the three months ended ~~September 30,~~March 31, 2020 and 2019, ~~and 2018, respectively, and $19.0 million and $17.9 million, net of tax, for the nine months ended September 30, 2019 and 2018,~~ respectively, are included as a reduction within other (income) and expense in the Consolidated ~~Statement of Earnings.~~Income Statement.

Interim results are not necessarily indicative of financial results for a full year. The information included in this Form 10-Q should be read in conjunction with the company’s ~~2018~~2019 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 period amounts have been reclassified to conform to the current period presentation. Specifically, beginning in the third-quarter 2019, revenues and related costs for post-contract support provided for perpetual (one-time charge) software licenses ~~were~~have been reclassified from Services Revenue to Sales Revenue and Services ~~Costs~~Cost to Sales ~~Costs~~Cost within the Consolidated ~~Statement of Earnings.~~Income Statement. The revenue and cost amounts reclassified were $0.5 billion ~~$1.0~~and $0.1 billion, ~~and $1.6 billion~~respectively, for the three months ended ~~September 30, 2018, nine months ended September 30, 2019 and nine months ended September 30, 2018, respectively. The cost amounts reclassified were $0.1 billion, $0.2 billion and $0.3~~ ~~billion.~~March 31, 2019. This reclassification had no impact on total revenue, total cost, net income, financial position or cash flows for any periods presented. Other immaterial reclassifications have been annotated where applicable.

2. ~~Accounting Changes:~~

~~New Standards to be Implemented~~

In August 2018, the Financial Accounting Standards Board (FASB) issued guidance which changed the disclosure requirements for fair value measurements and defined benefit plans. The guidance is effective for each of the topics on January 1, 2020 and December 31, 2020, respectively, with early adoption of certain provisions permitted. The company early adopted the provision in the fair value guidance that removed the Level 1/Level 2 transfer disclosures. The

109

Table of Contents

Notes to Consolidated Financial Statements — (continued)

~~company expects~~2. Accounting Changes:

New Standards to ~~early adopt changes~~be Implemented

Simplifying the Accounting for Income Taxes

Standard/Description–Issuance date: December 2019. This guidance simplifies various aspects of income tax accounting by removing certain exceptions to the ~~disclosure requirements~~general principle of the guidance and also clarifies and amends existing guidance to improve consistency in application.

Effective Date and Adoption Considerations–The guidance is effective January 1, 2021 and early adoption is permitted.

Effect on Financial Statements or Other Significant Matters–The company is evaluating the impact of the guidance and adoption date.

Standards Implemented

Reference Rate Reform

Standard/Description–Issuance date: March 2020. This guidance provides optional expedients and exceptions for ~~defined benefit plans~~applying GAAP to contract modifications, hedging relationships, and other transactions that reference London Interbank Offered Rate (LIBOR) or another reference rate expected to be discontinued, subject to meeting certain criteria.

Effective Date and Adoption Considerations–The guidance is effective as of March 12, 2020 through December 31, 2022.

Effect on Financial Statements or Other Significant Matters–The company made a policy election in the ~~fourth~~first quarter of ~~2019. As~~2020 to adopt the ~~guidance~~practical expedient which allows for the continuation of fair value hedge accounting for interest rate derivative contracts upon the transition from LIBOR to Secured Overnight Financing Rate (SOFR) or another reference rate alternative, without any impact to the Consolidated Income Statement. However, it is ~~a change~~still uncertain when the transition from LIBOR to ~~disclosures only,~~another reference rate will occur or whether SOFR will become the accepted market alternative to LIBOR. The company ~~does not expect~~is continuing to evaluate the ~~guidance to have a material~~potential impact inof the ~~consolidated financial results.~~replacement of the LIBOR benchmark on its interest rate risk management activities.

InSimplifying the Test for Goodwill Impairment

Standard/Description–Issuance date: January ~~2017, the FASB issued~~2017. This guidance ~~that~~ simplifies the goodwill impairment test by removing Step 2. ~~The guidance~~It also ~~changes the requirements for~~requires disclosure of any reporting units ~~with~~that have zero or negative carrying amounts if they have goodwill allocated to them.

Effective Date and ~~requires additional disclosures for these reporting units.~~ Adoption Considerations–The guidance iswas effective January 1, 2020 and early adoption iswas permitted. The company ~~will adopt~~adopted the guidance on a prospective basis as of the effective date.

Effect on Financial Statements or Other Significant Matters–The guidance isdid not ~~expected to~~ have a material impact in the consolidated financial results.

InFinancial Instruments–Credit Losses

Standard/Description–Issuance date: June 2016, with amendments in 2018, 2019 and ~~2019,~~2020. This changes the ~~FASB issued~~ guidance for credit ~~impairment~~losses based on an expected loss model rather than an incurred loss model. ~~The guidance~~It 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~~It also expands the scope of financial instruments subject to impairment, including off-balance sheet commitments and residual value.

Table of Contents

Notes to Consolidated Financial Statements — (continued)

Effective Date and Adoption Considerations–The guidance iswas effective January 1, 2020 with one-year early adoption permitted. The company ~~will adopt~~adopted the guidance as of the effective ~~date. A cross-functional team was established to evaluate~~date, using the ~~impact of the guidance on the financial instruments portfolio. All of the changes to systems, processes and policies are on track for completion before the effective date. The guidance is~~transition option whereby prior comparative periods were not ~~expected to have a material impact~~retrospectively presented in the ~~consolidated financial results.~~Consolidated Financial Statements.

~~Standards Implemented~~Effect on Financial Statements or Other Significant Matters–At January 1, 2020, an increase in the allowance for credit losses of $81 million was recorded for accounts receivable–trade and financing receivables (inclusive of its related off-balance sheet commitments). Additionally, net deferred taxes were reduced by $14 million in the Consolidated Balance Sheet, resulting in a cumulative-effect net decrease to retained earnings of $66 million. Refer to note 8, “Financing Receivables,” and note 12, “Commitments,” for additional information.

~~The FASB issued guidance in~~Leases

Standard/Description–Issuance date: February 2016, with amendments in 2018 and ~~2019, which changed the accounting for leases. The~~2019. This 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~~Balance Sheet. For lessors, it also ~~made some changes to lessor accounting, including elimination of~~eliminated the use of third-party residual value guarantee insurance in the lease classification test, and overall aligns with ~~the new~~ revenue recognition guidance. Due to changes in lease termination guidance, when equipment is returned to the company prior to the end of the lease term, the carrying amounts of lease receivables are reclassified to loan receivables. The guidance also requires qualitative and quantitative disclosures to assess the amount, timing and uncertainty of cash flows arising from leases.

Effective Date and Adoption Considerations–The company adopted the guidance on its effective date of January 1, 2019, using the transition option whereby prior comparative periods were not retrospectively presented in the Consolidated Financial Statements. The company elected the package of practical expedients not to reassess prior conclusions related to contracts containing leases, lease classification and initial direct costs ~~(IDCs)~~ and the lessee practical expedient to combine lease and ~~nonlease~~non-lease components for all asset classes. The company made a policy election to not recognize ROU assets and lease liabilities for short-term leases for all asset classes.

Effect on Financial Statements or Other Significant Matters–The guidance had a material impact on the Consolidated ~~Statement of Financial Position~~Balance Sheet as of the effective date. As a lessee, at adoption, the company recognized operating and financing ROU assets of $4.8 billion and $0.2 billion, respectively, and operating and financing lease liabilities of $5.1 billion and $0.2 billion, respectively. The transition adjustment recognized in retained earnings on January 1, 2019 was not material. ~~From a lessor perspective,~~None of the other changes ~~in lease termination~~to the guidance ~~and removal of third-party residual value guarantee insurance in the lease classification test did not have~~had a material impact in the company’s consolidated financial ~~results. Refer to note 5, “Leases,” for additional information, including further discussion on~~results at the ~~impact of adoption.~~effective date.

~~In August 2018,~~

For all other standards that the FASB issued guidance on a customer’s accounting for implementation costs incurred in cloud-computing arrangements that are hosted by a vendor. Certain types of implementation costs should be capitalized and amortized over the term of the hosting arrangement. The guidance is effective January 1, 2020 and early adoption is permitted. The company adopted ~~the guidance on January 1,~~in 2019, ~~on a prospective basis. The guidance did not have a~~there was no 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

Table of Contents

Notes to Consolidated Financial Statements — (continued)

releases income tax effects from AOCI once the reason the tax effects were established cease to exist (e.g., when available-for-sale debt securities are sold or if a pension plan is liquidated). This guidance allows for the reclassification of stranded tax effects as a result of the change in tax rates from U.S. tax reform to be recorded upon adoption of the guidance rather than at the actual cessation date. At adoption on January 1, 2018, $2.4 billion was reclassified from AOCI to retained earnings, primarily comprised of amounts relating to retirement-related benefit plans.

In August 2017, the FASB issued guidance to simplify the application of hedge accounting in certain areas, better portray the economic results of an entity’s risk management activities in its financial statements and make targeted improvements to presentation and disclosure requirements. The guidance was effective January 1, 2019 with early adoption permitted. The company adopted the guidance as of January 1, 2018, and it did not have a material impact in the consolidated financial results.

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

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

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

In March 2016, the FASB issued guidance which changed the accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities and classification in the Consolidated Statement of Cash Flows. The guidance was effective and adopted by the company on January 1, 2017, and it did not have a material impact on the Consolidated Statement of Financial Position. The ongoing impact of the guidance could result in increased volatility in the provision for income taxes and earnings per share in the Consolidated Statement of Earnings, depending on the company’s share price at exercise or vesting of share-based awards compared to grant date, however these impacts are not expected to be material. These impacts are recorded on a prospective basis.

~~Table of Contents~~

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

The company continues to estimate forfeitures in conjunction with measuring stock-based compensation cost. The guidance also requires cash payments on behalf of employees for shares directly withheld for taxes to be presented as financing outflows in the Consolidated Statement of Cash Flows. The FASB also issued guidance in May 2017 and June 2018, which relates to the accounting for modifications of share-based payment awards and accounting for share-based payments issued to non-employees, respectively. The company adopted the guidance for modifications in the second quarter of 2017, and guidance for non-employees’ payments in the second quarter of 2018. The guidance had no impact in the consolidated financial results.

3. Revenue Recognition:

Disaggregation of Revenue

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

Revenue by Major Products/Service Offerings



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

For the three months ended March 31:															2020		2019
Cognitive Applications	$	1,383	$	—	$	—	$	—	$	—	$	—	$	1,383	$	1,182	$	1,238	*
Cloud & Data Platforms		2,308		—		—		—		—		—		2,308		2,536		1,917
Transaction Processing Platforms		1,589		—		—		—		—		—		1,589		1,520		1,812

Total Cloud & Cognitive Software																5,238		4,967	*
Consulting		—		1,973		—		—		—		—		1,973		2,071		2,001	*
Application Management		—		1,897		—		—		—		—		1,897		1,840		1,908
Global Process Services		—		247		—		—		—		—		247		225		247

Total Global Business Services																4,136		4,155	*
Infrastructure & Cloud Services		—		—		5,071		—		—		—		5,071		4,916		5,209
Technology Support Services		—		—		1,629		—		—		—		1,629		1,550		1,665

Total Global Technology Services																6,467		6,875
Systems Hardware		—		—		—		1,117		—		—		1,117		997		914
Operating Systems Software		—		—		—		364		—		—		364		371		414

Global Financing*		—		—		—		—		343		—		343

Other Revenue		—		—		—		—		—		107		107
Total	$	5,280	$	4,117	$	6,700	$	1,481	$	343	$	107	$	18,028
Total Systems																1,368		1,328
Global Financing**																299		406
Other																62		451	*
Total revenue															$	17,571	$	18,182

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

~~Revenue by Geography~~

(Dollars in millions)

Total
For the three months ended September 30, 2019:

Revenue

Americas

$
8,514
Europe/Middle East/Africa

5,477
Asia Pacific

4,036
Total

$
18,028

~~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 September 30, 2018:

Software*

Services*

Services*

Systems

Financing

Other*

Revenue

Cognitive Applications

$
1,324

$
—

$
—

$
—

$
—

$
—

$
1,324
Cloud & Data Platforms

1,968

—

—

—

—

—

1,968
Transaction Processing Platforms

1,669

—

—

—

—

—

1,669

Consulting

—

1,900

—

—

—

—

1,900
Application Management

—

1,915

—

—

—

—

1,915
Global Process Services

—

260

—

—

—

—

260

Infrastructure & Cloud Services

—

—

5,393

—

—

—

5,393
Technology Support Services

—

—

1,707

—

—

—

1,707

Systems Hardware

—

—

—

1,339

—

—

1,339
Operating Systems Software

—

—

—

397

—

—

397

Global Financing**

—

—

—

—

388

—

388

Other Revenue

—

—

—

—

—

493

493
Total

$
4,962

$
4,076

$
7,101

$
1,736

$
388

$
493

$
18,756

* Recast to conform to ~~2019~~current period presentation. Refer to note 4, “Segments,” for additional information.

** 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 September 30, 2018:

Revenue

Americas

$
8,853
Europe/Middle East/Africa

5,827
Asia Pacific

4,076
Total

$
18,756

~~Table of Contents~~

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

~~Revenue by Major Products/Service Offerings~~

(Dollars in millions)

Cloud &

Global

Global












For the nine months

Cognitive

Business

Technology

Global

Total
ended September 30, 2019:

Software

Services

Services

Systems

Financing

Other

Revenue

Cognitive Applications

$
4,145

$
—

$
—

$
—

$
—

$
—

$
4,145
Cloud & Data Platforms

6,398

—

—

—

—

—

6,398
Transaction Processing Platforms

5,419

—

—

—

—

—

5,419

Consulting

—

5,915

—

—

—

—

5,915
Application Management

—

5,724

—

—

—

—

5,724
Global Process Services

—

752

—

—

—

—

752

Infrastructure & Cloud Services

—

—

15,454

—

—

—

15,454
Technology Support Services

—

—

4,958

—

—

—

4,958

Systems Hardware

—

—

—

3,358

—

—

3,358
Operating Systems Software

—

—

—

1,204

—

—

1,204

Global Financing*

—

—

—

—

1,100

—

1,100

Other Revenue

—

—

—

—

—

944

944
Total

$
15,962

$
12,391

$
20,412

$
4,562

$
1,100

$
944

$
55,370

* 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 nine months ended September 30, 2019:

Revenue

Americas

$
25,813
Europe/Middle East/Africa

17,354
Asia Pacific

12,203
Total

$
55,370

~~Table of Contents~~

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

~~Revenue by Major Products/Service Offerings~~

(Dollars in millions)

Cloud &

Global

Global












For the nine months

Cognitive

Business

Technology

Global

Total
ended September 30, 2018:

Software*

Services*

Services*

Systems

Financing

Other*

Revenue

Cognitive Applications

$
4,023

$
—

$
—

$
—

$
—

$
—

$
4,023
Cloud & Data Platforms

5,997

—

—

—

—

—

5,997
Transaction Processing Platforms

5,528

—

—

—

—

—

5,528

Consulting

—

5,698

—

—

—

—

5,698
Application Management

—

5,863

—

—

—

—

5,863
Global Process Services

—

765

—

—

—

—

765

Infrastructure & Cloud Services

—

—

16,608

—

—

—

16,608
Technology Support Services

—

—

5,239

—

—

—

5,239

Systems Hardware

—

—

—

4,187

—

—

4,187
Operating Systems Software

—

—

—

1,225

—

—

1,225

Global Financing**

—

—

—

—

1,188

—

1,188

Other Revenue

—

—

—

—

—

1,511

1,511
Total

$
15,548

$
12,326

$
21,846

$
5,412

$
1,188

$
1,511

$
57,830

* 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 nine months ended September 30, 2018:	Revenue

For the three months ended March 31:			2020		2019
Americas	$	26,772	$	8,166	$	8,493
Europe/Middle East/Africa		18,410		5,517		5,727
Asia Pacific		12,648		3,888		3,961
Total	$	57,830	$	17,571	$	18,182

Remaining Performance Obligations

The remaining performance ~~obligation~~obligations (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~~RPO 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.~~

1612

Table of Contents

Notes to Consolidated Financial Statements — (continued)

terminations, changes in the scope of contracts, periodic revalidations, adjustments for revenue that has not materialized and adjustments for currency.

At ~~September 30, 2019,~~March 31, 2020, the aggregate amount of the transaction price allocated to RPO related to customer contracts that are unsatisfied or partially unsatisfied was ~~$115~~$118 billion. ~~Given the profile of contract terms, approximately 58~~Approximately 60 percent of ~~this~~the amount iswas expected to be recognized as revenue ~~over~~in the ~~next~~subsequent two years, approximately 3435 percent ~~between~~ in the subsequent three ~~and~~ to 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 nine~~ months ending ~~September 30, 2019,~~March 31, 2020, revenue was reduced by ~~$42~~$14 million ~~and $33 million, respectively,~~ for performance obligations satisfied (or partially satisfied) in previous periods mainly due to changes in estimates on ~~percentage-of-completion based contracts.~~contracts with cost-to-cost measures of progress.

For the three and nine months ending September 30, 2018, revenue was reduced by $25 million and $50 million, respectively, for performance obligations satisfied (or partially satisfied) in previous periods mainly due to changes in estimates on percentage-of-completion based contracts.

Reconciliation of Contract Balances

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


	At September 30,		At December 31,		At March 31,		At December 31,
(Dollars in millions)	2019		2018		2020		2019
Notes and accounts receivable — trade (net of allowances of $286 and $309 at September 30, 2019 and December 31, 2018, respectively)	$	6,753	$	7,432
Notes and accounts receivable — trade (net of allowances of $337 and $299 at March 31, 2020 and December 31, 2019, respectively)					$	6,927	$	7,870
Contract assets (1)		513		470		488		492
Deferred income (current)		11,223		11,165		13,377		12,026
Deferred income (noncurrent)		3,382		3,445		3,769		3,851

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

The amount of revenue recognized during the three ~~and nine~~ months ended ~~September 30, 2019~~March 31, 2020 that was included within the deferred income balance at ~~June 30, 2019 and~~ December 31, ~~2018~~2019 was ~~$3.6~~$4.2 billion ~~and $7.7 billion, respectively,~~ and was primarily related to services and software.

4.Segments:

During the first quarter of 2020, the company realigned offerings and the related management system to reflect divestitures completed in the second half of 2019 and tighter integration of certain industry-related consulting services. Accordingly, the company updated its Cloud & Cognitive Software segment, Global Business Services segment and the Other – divested businesses category in the first quarter of 2020 and recast the related historical information for consistency with the go-forward performance. Total recast revenue for full-year 2019 was approximately $0.3 billion of IBM’s total $77 billion. There was no change to the Global Technology Services, Systems or Global Financing segments, and there was no impact to IBM’s consolidated results. The following table displays the segment updates:


Management System Change		Resulting Segment Implications
Divestitures of IBM's Risk Analytics and Regulatory Offerings and Sales Performance Management Offerings		- Cloud & Cognitive Software (Cognitive Applications)
		+ Other—divested businesses

Realignment of certain industry-related consulting offerings to the Global Business Services segment		- Cloud & Cognitive Software (Cognitive Applications)
		+ Global Business Services (Consulting)

Table of Contents

Notes to Consolidated Financial Statements — (continued)

SEGMENT INFORMATION


	Cloud &			Global			Global
	Cognitive			Business			Technology						Global			Total
(Dollars in millions)	Software			Services			Services			Systems			Financing			Segments
For the three months ended March 31, 2020:
External revenue	$	5,238		$	4,136		$	6,467		$	1,368		$	299		$	17,508
Internal revenue		813			46			294			148			212			1,514
Total revenue	$	6,052		$	4,183		$	6,761		$	1,516		$	511		$	19,023
Pre-tax income/(loss) from continuing operations	$	933		$	271		$	(178)		$	(217)		$	194		$	1,003
Revenue year-to-year change		4.2	%		(1.1)	%		(5.6)	%		1.7	%		(27.6)	%		(1.9)	%
Pre-tax income year-to-year change		(47.7)	%		(9.1)	%		(164.7)	%		7.6	%		(32.7)	%		(59.0)	%
Pre-tax income/(loss) margin		15.4	%		6.5	%		(2.6)	%		(14.3)	%		37.9	%		5.3	%

For the three months ended March 31, 2019:
External revenue	$	4,967	*	$	4,155	*	$	6,875		$	1,328		$	406		$	17,731	*
Internal revenue		841			74			290			163			300			1,668
Total revenue	$	5,808	*	$	4,229	*	$	7,164		$	1,491		$	706		$	19,398	*
Pre-tax income/(loss) from continuing operations	$	1,785	*	$	298	*	$	275		$	(202)		$	288		$	2,445	*
Pre-tax income/(loss) margin		30.7	%*		7.0	%*		3.8	%		(13.5)	%		40.8	%		12.6	%*

Reconciliations to IBM as Reported:


(Dollars in millions)
For the three months ended March 31:	2020		2019
Revenue:
Total reportable segments	$	19,023	$	19,398	*
Other—divested businesses		18		377	*
Other revenue		44		74
Eliminations of internal transactions		(1,514)		(1,668)
Total consolidated revenue	$	17,571	$	18,182

Pre-tax income from continuing operations:
Total reportable segments	$	1,003	$	2,445	*
Amortization of acquired intangible assets		(473)		(173)
Acquisition-related (charges)/income		0		(39)
Non-operating retirement-related (costs)/income		(264)		(138)
Eliminations of internal transactions		(55)		(89)
Other—divested businesses		25		(56)	*
Unallocated corporate amounts		(284)		(67)
Total pre-tax income from continuing operations	$	(49)	$	1,883

*Recast to conform to current year presentation.

Table of Contents

Notes to Consolidated Financial Statements — (continued)

5. Acquisitions & Divestitures:

Acquisitions

Purchase price consideration for all acquisitions was paid primarily in cash. All acquisitions, except otherwise stated were for 100 percent of the acquired business and are reported in the Consolidated Statement of Cash Flows, net of acquired cash and cash equivalents.

During the three months ended March 31, 2020, the company completed 1 acquisition in the Cloud & Cognitive Software segment. The acquisition did not have a material impact in the Consolidated Financial Statements.

On July 9, 2019, the company completed the acquisition of all of the outstanding shares of Red Hat at an aggregate cost of $35 billion. Red Hat’s portfolio of open-source and cloud technologies combined with IBM’s innovative hybrid cloud technology and industry expertise are delivering the hybrid multi-cloud capabilities required to address the next chapter of cloud implementations.

On the acquisition date, Red Hat shareholders received $190 per share in cash, representing a total equity value of approximately $34 billion. The company funded the transaction through a combination of cash on hand and proceeds from debt issuances.

The following table reflects the purchase price and the resulting purchase price allocation as of March 31, 2020. An immaterial net purchase price adjustment was recorded in the first-quarter 2020 related to current tax liabilities.


	Amortization	Allocated
(Dollars in millions)	Life (in years)	Amount
Current assets*		$	3,186
Property, plant and equipment/noncurrent assets			939
Intangible assets:
Goodwill	N/A		23,137
Client relationships	10		7,215
Completed technology	9		4,571
Trademarks	20		1,686
Total assets acquired		$	40,735
Current liabilities**			1,390
Noncurrent liabilities			4,265
Total liabilities assumed		$	5,655
Total purchase price		$	35,080

*	Includes $2.2 billion of cash and cash equivalents.

**	Includes $485 million of short-term debt related to the convertible notes acquired from Red Hat that were recognized at their fair value on the acquisition date, which was fully settled as of October 1, 2019.

N/A - not applicable

The goodwill generated is primarily attributable to the assembled workforce of Red Hat and the increased synergies expected to be achieved from the integration of Red Hat products into the company’s various integrated solutions neither of which qualify as an amortizable intangible asset.

The overall weighted-average useful life of the identified amortizable intangible assets acquired was 10.9 years. These identified intangible assets will be amortized on a straight-line basis over their useful lives, which approximates the pattern that the assets’ economic benefits are expected to be consumed over time. The following table presents the goodwill allocated to the segments as of March 31, 2020.

Table of Contents

Notes to Consolidated Financial Statements — (continued)


(Dollars in billions)	Goodwill
Segment	Allocated*
Cloud & Cognitive Software	$	18.5
Global Technology Services		3.1
Global Business Services		1.1
Systems		0.4
Total	$	23.1

*	It is expected that approximately 7 percent of the goodwill will be deductible for tax purposes.

The valuation of the assets acquired, and liabilities assumed is subject to revision. If additional information becomes available, the company may further revise the purchase price allocation as soon as practical, but no later than one year from Red Hat’s acquisition date. Any such revisions or changes may be material. The primary area of the purchase price allocation that is subject to revision relates to certain tax matters.

Divestitures

Select IBM Software Products – On June 30, 2019, IBM and HCL Technologies Limited (HCL) closed a transaction, in which HCL acquired select standalone Cloud & Cognitive Software products for $1,775 million, inclusive of $150 million of contingent consideration. The transaction included commercial software, intellectual property and services offerings. In addition, the transaction includes transition services for IT and other services.

The company received cash of $812 million at closing and $40 million of the contingent consideration in the third quarter of 2019. In addition, during the three months ended March 31, 2020, the company transferred a participating interest in the outstanding receivable to a third-party bank and received $164 million in cash. The company expects to receive the remaining $648 million (net of any additional contingent consideration) by June 30, 2020. The outstanding contingent consideration is expected to be earned within 24 months of the closing. IBM will remit payment to HCL predominantly for servicing certain customer contracts until such contracts are terminated or entitlements are assumed by HCL. Cash of $139 million was remitted during the three months ended March 31, 2020 related to deferred revenue that existed prior to closing. IBM expects to remit an additional $185 million of cash to HCL by the end of 2021. The total pre-tax gain recognized on this transaction as of March 31, 2020 was $625 million. The total gain on sale may change in the future due to contingent consideration or changes in other transaction estimates, however, material changes are not expected.

Select IBM Marketing Platform and Commerce Offerings – On April 4, 2019, IBM and Centerbridge Partners, L.P. (Centerbridge) announced a definitive agreement, in which Centerbridge would acquire select marketing platform and commerce offerings from IBM.The transaction included commercial software and services offerings. In addition, the company is providing Centerbridge with transition services including IT, supply chain management, and other services. Upon closing, Centerbridge announced that this business would be re-branded under the name Acoustic. The closing completed for the U.S. on June 30, 2019. The company received a net cash payment of $240 million and recognized an immaterial pre-tax gain on the U.S. closing. The company expects to receive an additional $150 million of cash within 36 months of the U.S. closing.

A subsequent closing occurred in most other countries on March 31, 2020 and the company recognized an immaterial pre-tax gain. The company expects to close the remaining countries by May 31, 2020. The timing of the remaining closing is subject to change as more information becomes available. The amount of ~~revenue~~the pre-tax gain for the remaining countries will not be determinable until the valuation of the final balance sheet transferred is completed, however, it is not expected to be material.

IBM Risk Analytics and Regulatory Offerings – On September 24, 2019, IBM and SS&C Technologies Holdings, Inc. (SS&C) entered into a definitive agreement in which SS&C would acquire certain Algorithmics and related assets from IBM. The transaction closed in the fourth quarter of 2019. The company recognized an immaterial pre-tax gain on the sale for the year ended December 31, 2019.

Table of Contents

Notes to Consolidated Financial Statements — (continued)

Sales Performance Management Offerings – On November 20, 2019, IBM and Varicent Parent Holdings Corporation (Varicent) entered into a definitive agreement in which Varicent would acquire certain sales performance management assets from IBM. The initial closing of certain countries was completed on December 31, 2019. The company received a net cash payment of $230 million and recognized a pre-tax gain on the sale of $136 million for the year ended December 31, 2019. A subsequent closing for the remaining countries occurred on March 31, 2020 and the company recognized an immaterial pre-tax gain.

The above divested businesses are reported in Other–divested businesses as described in note 4, "Segments."

The pre-tax gains recognized on the divestitures above were recorded in other (income) and expense in the Consolidated Income Statement.

6. Earnings Per Share of Common Stock:

The following table provides the computation of basic and diluted earnings per share of common stock for the three months ended March 31, 2020 and 2019.


	For the Three Months Ended
	March 31, 2020		March 31, 2019
Number of shares on which basic earnings per share is calculated:
Weighted-average shares outstanding during period		887,969,345		889,581,542
Add — Incremental shares under stock-based compensation plans		5,740,415		3,372,460
Add — Incremental shares associated with contingently issuable shares		1,329,477		956,524
Number of shares on which diluted earnings per share is calculated		895,039,238		893,910,526

Income from continuing operations (millions)	$	1,176	$	1,593
Income/(loss) from discontinued operations, net of tax (millions)		(1)		(2)
Net income on which basic earnings per share is calculated (millions)	$	1,175	$	1,591

Income from continuing operations (millions)	$	1,176	$	1,593
Net income applicable to contingently issuable shares (millions)		(2)		—
Income from continuing operations on which diluted earnings per share is calculated (millions)	$	1,174	$	1,593
Income/(loss) from discontinued operations, net of tax, on which basic and diluted earnings per share is calculated (millions)		(1)		(2)
Net income on which diluted earnings per share is calculated (millions)	$	1,173	$	1,591

Earnings/(loss) per share of common stock:
Assuming dilution
Continuing operations	$	1.31	$	1.78
Discontinued operations		0.00		0.00
Total	$	1.31	$	1.78
Basic
Continuing operations	$	1.32	$	1.79
Discontinued operations		0.00		0.00
Total	$	1.32	$	1.79

Stock options to purchase 1,136,899 shares and 1,137,019 shares were outstanding as of March 31, 2020 and 2019, respectively, but were not included in the computation of diluted earnings per share because the options' exercise price during the ~~three~~respective period was greater than the average market price of the common shares, and, ~~nine months ended September 30, 2018 that was included within~~therefore, the ~~deferred income balance at June 30, 2018 and January 1, 2018 was $3.8 billion and $8.0 billion, respectively, and was primarily related to services and software.~~effect would have been antidilutive.

Table of Contents

Notes to Consolidated Financial Statements — (continued)

4.7. Financial ~~Instruments:~~Assets & Liabilities:

Fair Value Measurements

~~Accounting guidance defines fair~~

Fair value is defined 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~~The company ~~is required to classify~~classifies certain assets and liabilities based on the following fair value hierarchy:

●

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

●

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

●

Level 3—Unobservable inputs for the asset or liability.

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

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

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

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

●

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

●

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

~~As an example,~~

The company holds investments in time deposits, certificates of deposit, U.S. government and agency debt, and corporate debt securities that are designated as available-for-sale. The primary objective of the company’s debt investment portfolio is to maintain principal by investing in short-term highly liquid securities with a credit rating of investment grade Aa2 or higher.

Available-for-sale securities are measured for impairment on a recurring basis by comparing the security’s fair value with its amortized cost basis. Effective January 1, 2020 with the adoption of the new standard on credit losses, if 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~~security falls below its amortized cost basis, the ~~derivative.~~

Certain assets that are measured at fair value on a recurring basis can be subject to nonrecurring fair value measurements. These assets include available-for-sale debt securities that are deemed to be other-than-temporarily impaired. In the event of an other-than-temporary impairment of a debt security,change in fair value is recognized in the period the impairment is identified when the loss is due to credit factors. The change in fair value due to non-credit factors is recorded in other comprehensive income when the company does not intend to sell and has the ability to hold the investment. The company’s standard practice is to hold all of its debt security investments classified as available-for-sale until maturity. NaN impairment for credit losses and no material non-credit impairment was recorded for the three months ended March 31, 2020. Prior to the adoption of the new standard, available-for-sale securities were measured ~~using a model described above.~~for

Table of Contents

Notes to Consolidated Financial Statements — (continued)

impairment using an other-than-temporary impairment model. NaN impairment was recorded for the three months ended March 31, 2019.

Certain non-financial assets such as property, plant and equipment, operating right-of-use assets, land, goodwill and intangible assets are also subject to nonrecurring fair value measurements if they are deemed to be impaired. The impairment models used for non-financial assets depend on the type of asset. There were no material impairments of non-financial assets for the ~~nine~~three months ended ~~September 30,~~March 31, 2020 and 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.

The following ~~tables present~~table presents the company’s financial assets and financial liabilities that are measured at fair value on a recurring basis at ~~September 30, 2019~~March 31, 2020 and December 31, ~~2018.~~2019.

(Dollars in millions)












At September 30, 2019

Level 1

Level 2

Level 3

Total

Assets:









Cash equivalents (1)









Time deposits and certificates of deposit

$
—

$
6,251

$
—

$
6,251
(6)
Money market funds

597

—

—

597

Total

$
597

$
6,251

$
—

$
6,848

Equity investments (2)

0

—

—

0

Debt securities – current (3)

—

733

—

733
(6)
Debt securities – noncurrent (2)

—

111

—

111
(6)
Derivative assets (4)

4

533

—

536

Total assets

$
601

$
7,628

$
—

$
8,229

Liabilities:









Derivative liabilities (5)

$
—

$
1,074

$
—

$
1,074


	Fair Value
	Hierarchy	At March 31, 2020				At December 31, 2019
(Dollars in millions)	Level	Assets (7)		Liabilities (8)		Assets (7)		Liabilities (8)
Cash equivalents (1)
Time deposits and certificates of deposit (2)	2	$	7,166	$	N/A	$	4,392	$	N/A
Money market funds	1		526		N/A		427		N/A
Total cash equivalents		$	7,692	$	N/A	$	4,819	$	N/A
Equity investments (3)	1		1		N/A		0		N/A
Debt securities-current (2)(4)	2		647		N/A		696		N/A
Debt securities-noncurrent (2)(5)	2		33		N/A		65		N/A
Derivatives designated as hedging instruments
Interest rate contracts	2		104		—		56		—
Foreign exchange contracts	2		384		446		175		635
Derivatives not designated as hedging instruments
Foreign exchange contracts	2		30		16		10		33
Equity contracts (6)	1,2		1		50		1		4
Total		$	8,892	$	511	$	5,823	$	673

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

(2)	Available-for-sale securities with an amortized cost basis that approximates fair value.

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

~~(3)~~(4)

~~Included~~Primarily includes U.S. treasury bills that are reported within marketable securities in the Consolidated ~~Statement of Financial Position.~~Balance Sheet.

~~(4)~~(5)

Primarily includes corporate debt securities with a maximum maturity of two years that are reported within investments and sundry assets in the Consolidated Balance Sheet.

(6)	Level 1 includes immaterial amounts related to equity futures contracts.

(7)

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~~Balance Sheet at ~~September 30,~~March 31, 2020 were $427 million and $92 million, respectively, and at December 31, 2019 were ~~$395~~$149 million and ~~$141~~$94 million, respectively.

~~(5)~~(8)

The gross balances of derivative liabilities contained within other accrued expenses and liabilities, and other liabilities in the Consolidated ~~Statement of Financial Position~~Balance Sheet at ~~September 30,~~March 31, 2020 were $253 million and $259 million, respectively, and at December 31, 2019 were ~~$203~~$167 million and ~~$870~~$506 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 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.~~

N/A - not applicable

Financial Assets and Liabilities Not Measured at Fair Value

Short-Term Receivables and Payables

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

Table of Contents

Notes to Consolidated Financial Statements — (continued)

Loans and Long-Term Receivables

Fair values are based on discounted future cash flows using current interest rates offered for similar loans to clients with similar credit ratings for the same remaining maturities. At ~~September 30, 2019~~March 31, 2020 and December 31, ~~2018,~~2019, the difference between the carrying amount and estimated fair value for loans and long-term receivables was immaterial. If measured at fair value in the financial statements, these financial instruments would be classified as Level 3 in the fair value hierarchy.

Long-Term Debt

Fair value of publicly-traded long-term debt is based on quoted market prices for the identical liability when traded as an asset in an active market. For other long-term debt (including long-term finance lease liabilities) for which a quoted market price is not available, an expected present value technique that uses rates currently available to the company for debt with similar terms and remaining maturities is used to estimate fair value. The carrying amount of long-term debt was ~~$57,797~~$52,685 million and ~~$35,605~~$54,102 million, and the estimated fair value was ~~$62,398~~$56,760 million and ~~$36,599~~$58,431 million at ~~September 30, 2019~~March 31, 2020 and December 31, ~~2018,~~2019, 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.

~~Table of Contents~~

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

~~Available-for-Sale Debt Securities~~

There were 0 gross realized gains/losses from the sale of available-for-sale debt securities during the three and nine month periods ended September 30, 2019 and gross realized gains/losses for the three and nine months ended September 30, 2018 were immaterial. After-tax net unrealized holding gains/losses on available-for-sale debt securities that have been included in other comprehensive income/loss for the three and nine months ended September 30, 2019 and 2018 were immaterial.

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

~~Derivative Financial Instruments~~

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

As a result of the use of derivative instruments, the company is exposed to the risk that counterparties to derivative contracts will fail to meet their contractual obligations. To mitigate the counterparty credit risk, the company has a 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 30, 2019 and December 31, 2018 was $737 million and $74 million, respectively, for which $116 million of collateral was posted by the company and reduced the position at September 30, 2019, and for which 0 collateral was posted at December 31, 2018. Full collateralization of these agreements would be required in the event that the company’s credit rating falls below investment grade or if its credit default swap spread exceeds 250 basis points, as applicable, pursuant to the terms of the collateral security arrangements. The aggregate fair value of derivative instruments in asset positions at September 30, 2019 and December 31, 2018 was $536 million and $731 million, respectively. This amount represents the maximum exposure to loss at the reporting date if the counterparties failed to perform as contracted. This exposure was reduced by $316 million and $267 million at September 30, 2019 and December 31, 2018, respectively, of liabilities included in master netting arrangements with those counterparties. Additionally, at December 31, 2018, this exposure was reduced by $70 million of cash collateral received from counterparties. NaN collateral was received at September 30, 2019. There were 0 non-cash collateral balances received from counterparties in U.S. Treasury securities at September 30, 2019 and December 31, 2018. At September 30, 2019 and December 31, 2018, the net exposure related to derivative assets recorded in the Consolidated Statement of Financial Position was $220 million and $395 million, respectively. At September 30, 2019 and December 31, 2018, the net position related to derivative liabilities recorded in the Consolidated Statement of Financial Position was $641 million and $116 million, respectively.

~~Table of Contents~~

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

In the Consolidated Statement of Financial Position, the company does not offset derivative assets against liabilities in master netting arrangements nor does it offset receivables or payables recognized upon payment or receipt of cash collateral against the fair values of the related derivative instruments. The amount recognized in other receivables for the right to reclaim cash collateral was $116 million at September 30, 2019. NaN amount was recognized in other receivables at December 31, 2018 for the right to reclaim cash collateral. The amount recognized in accounts payable for the obligation to return cash collateral was $70 million at December 31, 2018. NaN amount was recognized in accounts payable for the obligation to return cash collateral at September 30, 2019. The company restricts the use of cash collateral received to rehypothecation, and therefore reports it in restricted cash in the Consolidated Statement of Financial Position. NaN amount was rehypothecated at September 30, 2019 and December 31, 2018.

The company may employ derivative instruments to hedge the volatility in stockholders’ equity resulting from changes in currency exchange rates of significant foreign subsidiaries of the company with respect to the U.S. dollar. These instruments, designated as net investment hedges, expose the company to liquidity risk as the derivatives have an immediate cash flow impact upon maturity which is not offset by a cash flow from the translation of the underlying hedged equity. The company monitors this cash loss potential on an ongoing basis and may discontinue some of these hedging relationships by de-designating or terminating the derivative instrument in order to manage the liquidity risk. Although not designated as accounting hedges, the company may utilize derivatives to offset the changes in the fair value of the de-designated instruments from the date of de-designation until maturity.

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

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

~~Interest Rate Risk~~

~~Fixed and Variable Rate Borrowings~~

The company issues debt in the global capital markets to fund its operations and financing business. Access to cost-effective financing can result in interest rate mismatches with the underlying assets. To manage these mismatches and to reduce overall interest cost, the company may use interest-rate swaps to convert specific fixed-rate debt issuances into variable-rate debt (i.e., fair value hedges) and to convert specific variable-rate debt issuances into fixed-rate debt (i.e., cash flow hedges). At September 30, 2019 and December 31, 2018, the total notional amount of the company’s interest-rate swaps was $4.7 billion and $7.6 billion, respectively. The weighted-average remaining maturity of these instruments at September 30, 2019 and December 31, 2018 was approximately 2.7 years and 3.5 years, respectively. These interest-rate contracts were accounted for as fair value hedges. The company did not have any cash flow hedges relating to this program outstanding at September 30, 2019 and December 31, 2018.

~~Forecasted Debt Issuance~~

The company is exposed to interest rate volatility on future debt issuances. To manage this risk, the company may use instruments such as forward starting interest-rate swaps to lock in the rate on the interest payments related to the forecasted debt issuances. On May 15, 2019, the company issued an aggregate of $20 billion of indebtedness (see note 13, “Borrowings,” for additional information). Following the receipt of the net proceeds from this debt offering, the company terminated $5.5 billion of forward starting interest-rate swaps. These instruments were designated and accounted for as cash flow hedges for a portion of this issuance and hedged exposure to the variability in future cash flows over a maximum of 30 years. These swaps were the only instruments outstanding under this program at December 31, 2018, and there were 0 instruments outstanding at September 30, 2019.

In connection with cash flow hedges of forecasted interest payments related to the company's borrowings, the company recorded net losses of $196 million and net losses of $35 million (before taxes) at September 30, 2019 and

~~Table of Contents~~

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

December 31, 2018, respectively, in AOCI. The company estimates that $18 million (before taxes) of the deferred net losses on derivatives in AOCI at September 30, 2019 will be reclassified to net income within the next 12 months, providing an offsetting economic impact against the underlying interest payments.

~~Foreign Exchange Risk~~

~~Long-Term Investments in Foreign Subsidiaries (Net Investment)~~

~~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 30, 2019 and December 31, 2018, the total notional amount of forward contracts designated as cash flow hedges of forecasted royalty and cost transactions was $9.9 billion and $9.8 billion, respectively. At September 30, 2019 and December 31, 2018, the weighted-average remaining maturity of these instruments was approximately 0.7 years and 0.8 years, respectively.

At September 30, 2019 and December 31, 2018, in connection with cash flow hedges of anticipated royalties and cost transactions, the company recorded net gains of $337 million and net gains of $342 million (before taxes), respectively, in AOCI. The company estimates that $266 million (before taxes) of deferred net gains on derivatives in AOCI at September 30, 2019 will be reclassified to net income within the next 12 months, providing an offsetting economic impact against the underlying anticipated transactions.

~~Foreign Currency Denominated Borrowings~~

The company is exposed to exchange rate volatility on foreign currency denominated debt. To manage this risk, the company employs cross-currency swaps to convert fixed-rate foreign currency denominated debt to fixed-rate debt denominated in the functional currency of the borrowing entity. These swaps are accounted for as cash flow hedges. The maximum length of time over which the company has hedged its exposure to the variability in future cash flows is approximately 12 years. At September 30, 2019 and December 31, 2018, the total notional amount of cross-currency swaps designated as cash flow hedges of foreign currency denominated debt was $12.2 billion and $6.5 billion, respectively.

At September 30, 2019 and December 31, 2018, in connection with cash flow hedges of foreign currency denominated borrowings, the company recorded net losses of $138 million and net gains of $75 million (before taxes), respectively, in AOCI. The company estimates that $278 million (before taxes) of deferred net gains on derivatives in AOCI at September 30, 2019 will be reclassified to net income within the next 12 months, providing an offsetting economic impact against the underlying exposure.

~~Table of Contents~~

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

~~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 30, 2019 and December 31, 2018, the total notional amount of derivative instruments in economic hedges of foreign currency exposure was $8.2 billion and $5.2 billion, respectively.

~~Equity Risk Management~~

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

~~Other Risks~~

The company may hold warrants to purchase shares of common stock in connection with various investments that are deemed derivatives because they contain net share or net cash settlement provisions. The company records the 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 30, 2019 and December 31, 2018.

The company is exposed to a potential loss if a client fails to pay amounts due under contractual terms. The company may utilize credit default swaps to economically hedge its credit exposures. The swaps are recorded at fair value with gains and losses reported in other (income) and expense in the Consolidated Statement of Earnings. The company did not have any derivative instruments relating to this program outstanding at September 30, 2019 and December 31, 2018.

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

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

~~Table of Contents~~

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

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

Fair Value of Derivative Assets

Fair Value of Derivative Liabilities


Balance Sheet





Balance Sheet




(Dollars in millions)

Classification

9/30/2019

12/31/2018

Classification

9/30/2019

12/31/2018
Designated as hedging instruments:












Interest rate contracts

Prepaid expenses and other current assets

$
9

$
9

Other accrued expenses and liabilities

$
—

$
4

Investments and sundry assets

106

212

Other liabilities

2

76
Foreign exchange contracts

Prepaid expenses and other current assets

368

348

Other accrued expenses and liabilities

165

110

Investments and sundry assets

35

135

Other liabilities

869

129

Fair value of derivative assets

$
518

$
704

Fair value of derivative liabilities

$
1,035

$
320
Not designated as hedging instruments:












Foreign exchange contracts

Prepaid expenses and other current assets

$
12

$
26

Other accrued expenses and liabilities

$
36

$
13
Equity contracts

Prepaid expenses and other current assets

6

2

Other accrued expenses and liabilities

2

51

Fair value of derivative assets

$
18

$
28

Fair value of derivative liabilities

$
38

$
63
Total derivatives



$
536

$
731



$
1,074

$
383
Total debt designated as hedging instruments (1):












Short-term debt



N/A

N/A



$
—

$
—
Long-term debt



N/A

N/A



6,061

6,261

N/A

N/A

$
6,061

$
6,261
Total



$
536

$
731



$
7,134

$
6,644

~~(1)~~

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

~~N/A - not applicable~~

~~At September 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:~~

September 30,

December 31,

(Dollars in millions)

2019

2018

Short-term debt:





Carrying amount of the hedged item

$
(326)

$
(1,878)

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

(1)
(1)

(4)
(1)
Long-term debt:





Carrying amount of the hedged item

$
(4,834)

$
(6,004)

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

(469)
(2)

(333)
(2)

~~(1)~~

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

~~(2)~~

~~Includes ($378) million and ($213) million of hedging adjustments on discontinued hedging relationships at September 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~~

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

Gains/(Losses) of

(Dollars in millions)

Total

Total Hedge Activity

For the three months ended September 30:

2019

2018

2019

2018

Cost of services

$
7,840

$
7,951
*
$
22

$
1

Cost of sales

1,635

1,714
*

10

8

Cost of financing

217

287

(11)

(3)
*
SG&A expense

5,024

4,363

20

47

Other (income) and expense

(31)

275

(561)

(63)

Interest expense

432

191

(35)

(3)
*

* Reclassified to conform to current period presentation.

~~Table of Contents~~

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

Gain (Loss) Recognized in Earnings

Consolidated

Recognized on

Attributable to Risk
(Dollars in millions)

Statement of

Derivatives

Being Hedged(2)
For the three months ended September 30:

Earnings Line Item

2019

2018

2019

2018
Derivative instruments in fair value hedges (1):










Interest rate contracts

Cost of financing

$
3

$
(27)

$
0

$
33

Interest expense

9

(26)

0

33
Derivative instruments not designated as hedging instruments:










Foreign exchange contracts

Other (income) and expense

(114)

(55)

N/A

N/A
Equity contracts

SG&A expense

9

40

N/A

N/A
Total



$
(94)

$
(69)

$
0

$
66

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 September 30:

2019

2018

Earnings Line Item

2019

2018

2019

2018

Derivative instruments in cash flow hedges:















Interest rate contracts

$
—

$
—

Cost of financing

$
(1)

$
—

$
—

$
—

Interest expense

(3)

—

—

—

Foreign exchange contracts

(439)

(46)

Cost of services

22

1

—

—

Cost of sales

10

8

—

—

Cost of financing

(20)

(18)
*

—

—

SG&A expense

11

7

—

—

Other (income) and expense

(447)

(8)

—

—

Interest expense

(61)

(18)
*

—

—

Instruments in net investment hedges (4):















Foreign exchange contracts

435

86

Cost of financing

—

—

7

9
*

Interest expense

—

—

20

9
*
Total

$
(4)

$
40



$
(488)

$
(28)

$
27

$
18

* Reclassified to conform to current period presentation.

~~(1)~~

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

~~(2)~~

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

~~(3)~~

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

~~(4)~~

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

~~N/A - not applicable~~

Gains/(Losses) of

(Dollars in millions)

Total

Total Hedge Activity

For the nine months ended September 30:

2019

2018

2019

2018

Cost of services

$
24,293
*
$
25,238
*
$
52

$
29

Cost of sales

4,979
*

5,498
*

40

(15)

Cost of financing

710

846

(47)

1
*
SG&A expense

15,171

14,665

199

24

Other (income) and expense

(850)

968

(358)

(449)

Interest expense

990

530

(96)

1
*

* Reclassified to conform to current period presentation.

~~Table of Contents~~

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

Gain (Loss) Recognized in Earnings

Consolidated

Recognized on

Attributable to Risk
(Dollars in millions)

Statement of

Derivatives

Being Hedged(2)
For the nine months ended September 30:

Earnings Line Item

2019

2018

2019

2018
Derivative instruments in fair value hedges (1):














Interest rate contracts

Cost of financing

$
51

$
(138)

$
(44)

$
170

Interest expense

105

(128)

(89)

157
Derivative instruments not designated as hedging instruments:










Foreign exchange contracts

Other (income) and expense

(27)

(148)

N/A

N/A
Equity contracts

SG&A expense

153

38

N/A

N/A
Total



$
283

$
(377)

$
(133)

$
327

Gain (Loss) Recognized in Earnings and Other Comprehensive Income

(Dollars in millions)

Consolidated

Reclassified

Amounts Excluded from

For the nine months

Recognized in OCI

Statement of

from AOCI

Effectiveness Testing(3)

ended September 30:

2019

2018

Earnings Line Item

2019

2018

2019

2018

Derivative instruments in cash flow hedges:















Interest rate contracts

$
(168)

$
—

Cost of financing

$
(2)

$
—

$
—

$
—

Interest expense

(5)

—

—

—

Foreign exchange contracts

(630)

(134)

Cost of services

52

29

—

—

Cost of sales

40

(15)

—

—

Cost of financing

(71)

(56)
*

—

—

SG&A expense

45

(14)

—

—

Other (income) and expense

(331)

(301)

—

—

Interest expense

(146)

(52)
*

—

—

Instruments in net investment hedges (4):















Foreign exchange contracts

306

509

Cost of financing

—

—

19

26
*

Interest expense

—

—

38

24
*
Total

$
(491)

$
375



$
(418)

$
(408)

$
57

$
49

* Reclassified to conform to current period presentation.

~~(1)~~

~~(2)~~

~~(3)~~

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

~~(4)~~

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

~~N/A - not applicable~~

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

5. ~~Leases:~~

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

~~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 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 September 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 $140 million, $34 million and $121 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~~

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

~~The following tables present the various components of lease costs:~~

(Dollars in millions)

For the three months ended September 30:

2019
Finance lease cost

$
7
Operating lease cost

423
Short-term lease cost

11
Variable lease cost

90
Sublease income

(7)
Total lease cost

$
523

(Dollars in millions)

For the nine months ended September 30:

2019
Finance lease cost

$
14
Operating lease cost

1,243
Short-term lease cost

26
Variable lease cost

345
Sublease income

(16)
Total lease cost

$
1,613

There were 0 net gains recorded on sale and leaseback transactions for the three months ended September 30, 2019 and the company recorded $41 million of net gains for the nine months ended September 30, 2019.

The following tables present supplemental information relating to the cash flows arising from lease transactions. Cash payments related to 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 nine months ended September 30:

2019

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



Operating cash outflows from finance leases

$
7

Financing cash outflows from finance leases

$
6

Operating cash outflows from operating leases

$
1,154

ROU assets obtained in exchange for new finance lease liabilities

$
149
*
ROU assets obtained in exchange for new operating lease liabilities

$
6,023
*

* 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 nine months ended September 30, 2019 was $1,221 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 September 30:~~	~~2019~~
~~Weighted-average remaining lease term — finance leases~~		~~5.9~~	~~yrs.~~
~~Weighted-average remaining lease term — operating leases~~		~~5.3~~	~~yrs.~~
~~Weighted-average discount rate — finance leases~~		~~1.73~~	%
~~Weighted-average discount rate — operating leases~~		~~3.10~~	%

~~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 September 30, 2019:

Remainder of













Beyond

Imputed



(Dollars in millions)

2019

2020

2021

2022

2023

2023

Interest*

Total
Finance leases

$
10

$
42

$
43

$
36

$
24

$
53

$
(54)

$
155
Operating leases

$
402

$
1,419

$
1,123

$
847

$
604

$
1,160

$
(388)

$
5,167

* 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 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 September 30:

2019
Lease income — sales-type and direct financing leases


Sales-type lease selling price

$
188
Less: Carrying value of underlying assets, excluding unguaranteed residual value

75
Gross profit

113
Interest income on lease receivables

71
Total sales-type and direct financing lease income

$
184
Lease income — operating leases

80
Variable lease income

12
Total lease income

$
276

(Dollars in millions)



For the nine months ended September 30:

2019
Lease income — sales-type and direct financing leases


Sales-type lease selling price

$
516
Less: Carrying value of underlying assets, excluding unguaranteed residual value

204
Gross profit

312
Interest income on lease receivables

222
Total sales-type and direct financing lease income

$
534
Lease income — operating leases

252
Variable lease income

38
Total lease income

$
824

~~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 September 30, 2019, the unguaranteed residual value of sales-type and direct financing leases was $565 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 income. For the three and nine months ended September 30, 2019 and September 30, 2018, respectively, impairment of residual values was immaterial.

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

(Dollars in millions)

Total

Remainder of 2019

$
847

2020

2,344

2021

1,571

2022

759

2023

216

Thereafter

43

Total undiscounted cash flows

$
5,781

Present value of lease payments (recognized as financing receivables)

5,337
*
Difference between undiscounted cash flows and discounted cash flows

$
444

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

~~Operating Leases~~

Equipment provided to clients under an operating lease is carried at cost within property, plant and equipment in the Consolidated Statement of Financial Position and depreciated over the lease term using the straight-line method, generally ranging from one to six years. The depreciable basis is the original cost of the equipment less the estimated residual value of the equipment at the end of the lease term. At September 30, 2019, the unguaranteed residual value of operating leases was $88 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 September 30, 2019:~~

(Dollars in millions)

Total
Remainder of 2019

$
90
2020

119
2021

33
2022

3
2023

0
Thereafter

0
Total undiscounted cash flows

$
245

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 nine months ended September 30, 2019 for assets under operating leases. These assets are included in property, plant and equipment ꟷ ~~net in the Consolidated Statement of Financial Position.~~

6.8. Financing Receivables:

Financing receivables primarily consist of client loan and installment payment receivables (loans), and investment in sales-type and direct financing leases (collectively referred to as client financing receivables) and commercial financing receivables. ~~Client loan and installment payment receivables (loans)~~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~~relate principally to the company’s Systems products and are for terms ranging generally from two to six years. Commercial financing receivables relate primarily to ~~inventory and accounts receivable~~working capital financing for dealers and remarketers of IBM ~~and OEM~~ products. Payment terms for ~~inventory and accounts receivable~~working capital financing generally range from 30 to 90 days.

~~Beginning~~Effective January 1, 2020, the company adopted the new accounting standard related to credit losses, using the transition option whereby prior comparative periods were not retrospectively presented in the ~~second quarter~~Consolidated Financial Statements. Refer to note 2, “Accounting Changes,” for additional information. Under this new guidance, the amortized cost basis of ~~2019~~a financial asset represents the original amount of the financing receivable (including residual value) adjusted for unearned income, deferred initial direct costs, cash collected, write-offs and ~~continuing throughout~~any foreign exchange adjustments. The allowance for credit losses represents future expected credit losses over the ~~year,~~life of the ~~company~~receivables based on past experience, current information and forward-looking economic considerations. Prior to the effective date, financing receivables were measured at recorded investment, which does not include residual value. As a result of the company’s transition option, all prior periods are presented at recorded investment, while current period information 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 significant 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.presented at amortized cost.

3420

Table of Contents

Notes to Consolidated Financial Statements — (continued)

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


	Investment in				Client Loan and				Investment in				Client Loan and
	Sales-Type and		Commercial		Installment Payment				Sales-Type and		Commercial		Installment Payment
(Dollars in millions)	Direct Financing		Financing		Receivables/				Direct Financing		Financing		Receivables
At September 30, 2019:	Leases		Receivables		(Loans)		Total
At March 31, 2020:									Leases		Receivables		(Loans)		Total
Financing receivables, gross	$	5,781	$	2,953	$	11,958	$	20,692	$	5,479	$	2,334	$	12,605	$	20,418
Unearned income		(444)		(5)		(543)		(992)		(471)		(3)		(517)		(991)
Recorded investment	$	5,337	$	2,948	$	11,415	$	19,700
Residual value*										646		—		—		646
Amortized cost									$	5,654	$	2,331	$	12,087	$	20,072
Allowance for credit losses		(81)		(11)		(165)		(257)		(79)		(12)		(147)		(238)
Unguaranteed residual value		565		—		—		565
Guaranteed residual value		61		—		—		61
Total financing receivables, net	$	5,882	$	2,937	$	11,250	$	20,069	$	5,575	$	2,319	$	11,940	$	19,834
Current portion	$	2,433	$	2,937	$	6,960	$	12,330	$	2,112	$	2,319	$	7,695	$	12,126
Noncurrent portion	$	3,449	$	—	$	4,290	$	7,739	$	3,463	$	—	$	4,245	$	7,708

* Includes guaranteed and unguaranteed residual value.


	Investment in				Client Loan and				Investment in				Client Loan and
	Sales-Type and		Commercial		Installment Payment				Sales-Type and		Commercial		Installment Payment
(Dollars in millions)	Direct Financing		Financing		Receivables/				Direct Financing		Financing		Receivables
At December 31, 2018:	Leases		Receivables		(Loans)		Total
At December 31, 2019:									Leases		Receivables		(Loans)		Total
Financing receivables, gross	$	6,846	$	11,889	$	13,614	$	32,348	$	6,077	$	3,836	$	13,592	$	23,504
Unearned income		(526)		(37)		(632)		(1,195)		(509)		(4)		(570)		(1,083)
Recorded investment	$	6,320	$	11,852	$	12,981	$	31,153	$	5,567	$	3,831	$	13,022	$	22,421
Allowance for credit losses		(99)		(13)		(179)		(292)		(72)		(11)		(138)		(221)
Unguaranteed residual value		589		—		—		589		652		—		—		652
Guaranteed residual value		85		—		—		85		53		—		—		53
Total financing receivables, net	$	6,895	$	11,838	$	12,802	$	31,536	$	6,199	$	3,820	$	12,884	$	22,904
Current portion	$	2,834	$	11,838	$	7,716	$	22,388	$	2,334	$	3,820	$	8,037	$	14,192
Noncurrent portion	$	4,061	$	—	$	5,086	$	9,148	$	3,865	$	—	$	4,847	$	8,712

The company utilizes certain of its financing receivables as collateral for nonrecourse borrowings. Financing receivables pledged as collateral for borrowings were ~~$939~~$914 million and ~~$710~~$1,062 million at ~~September 30, 2019~~March 31, 2020 and December 31, ~~2018,~~2019, respectively.

The company did not have any financing receivables held for sale ~~as of September 30, 2019~~at March 31, 2020 and December 31, ~~2018.~~2019.

Allowance for Credit Losses – Financing Receivables

Refer to note A, “Significant Accounting Policies,” in the company’s 2019 Annual Report for a full description of its accounting policies for trade and financing receivables, contract assets and related allowances. The descriptions below include any changes to those policies due to the new standard.

Effective with the adoption of the new credit losses standard, the company’s estimates of its allowances for expected credit losses include consideration of: past events, including any historical default, historical concessions and resulting troubled debt restructurings, current economic conditions, taking into account any non-freestanding mitigating credit enhancements and certain forward-looking information, including reasonable and supportable forecasts.

Collectively Evaluated Financing Receivables

The company determines its allowance for credit losses based on 2 portfolio segments: client financing receivables and commercial financing receivables, and further segments the portfolio into 3 classes: Americas, Europe/Middle East/Africa (EMEA) and Asia Pacific.

3521

Table of Contents

Notes to Consolidated Financial Statements — (continued)

For client financing receivables, the company uses a credit loss model to calculate allowances based on its internal loss experience and current conditions and forecasts, by class of financing receivable. The company records an unallocated reserve that is calculated by applying a reserve rate to its portfolio, excluding accounts that have been individually evaluated and specifically reserved. This reserve rate is based upon credit rating, probability of default, term and loss history. The allowance is adjusted quarterly for expected recoveries of amounts that were previously written off or are expected to be written off. Recoveries cannot exceed the aggregated amount of the previous write-off or expected write-off.

Macroeconomic variables attributed to the expected credit losses for client financing receivables may vary by class of financing receivables based on historical experiences, portfolio composition and current environment. In addition to a qualitative review of credit risk factors across the portfolio, the company considers forward-looking macroeconomic variables such as gross domestic product, unemployment rates, equity prices and corporate profits when quantifying the impact of economic forecasts on its client financing receivables expected allowance for credit losses. The company also considers the impact of current conditions and economic forecasts relating to specific industries, geographical areas, and client-specific exposures on the portfolio. Under this approach, forecasts of these variables over two years are considered reasonable and supportable. Beyond two years, the company reverts to long-term average loss experience. Forward-looking estimates require the use of judgment, particularly in times of economic uncertainty. With evolving global impacts from the COVID-19 pandemic, external economic models have been revised with increased frequency and with alternative scenarios. The company’s allowances at March 31, 2020, reflect the qualitative process described above. Any changes to economic models that occurred after the balance sheet date will be reflected in future periods.

The allowance for commercial financing receivables is estimated based on a combination of write-off history and current economic conditions, excluding any individually evaluated accounts.

At January 1, 2020, upon adoption of the new standard, the company recorded an additional allowance for client and commercial financing receivables (including related off-balance sheet commitments) of $64 million. This was primarily driven by an increase in the client financing receivables allowance. Refer to note 12, “Commitments,” for additional information regarding off-balance sheet commitments.

Client Financing Receivables

The following tables present the amortized cost basis or recorded investment for the client financing receivables portfolio segment at March 31, 2020 and December 31, 2019, further segmented by 3 classes: Americas, Europe/Middle East/Africa (EMEA) and Asia Pacific. The commercial financing receivables portfolio segment is excluded from this presentation, as it is short term in nature and the current estimated risk of loss and resulting impact to the company’s financing results is not material.

Table of Contents

Notes to Consolidated Financial Statements — (continued)


(Dollars in millions)
At March 31, 2020:	Americas		EMEA		Asia Pacific		Total
Amortized cost
Lease receivables	$	3,609	$	1,122	$	923	$	5,654
Loan receivables		6,151		3,663		2,273		12,087
Ending balance	$	9,760	$	4,785	$	3,196	$	17,741

Allowance for credit losses
Beginning balance at December 31, 2019	$	120	$	54	$	36	$	210
Adjustment for adoption of new standard		21		15		5		41
Beginning balance at January 1, 2020
Lease receivables	$	44	$	27	$	18	$	89
Loan receivables		98		42		22		163
Total	$	142	$	69	$	41	$	252
Write-offs	$	(16)	$	(1)	$	(2)	$	(19)
Recoveries		0		—		1		1
Provision		3		7		(1)		9
Other*		(13)		(2)		(1)		(16)
Ending balance at March 31, 2020	$	117	$	73	$	36	$	226
Lease receivables	$	41	$	23	$	15	$	79
Loan receivables	$	75	$	50	$	22	$	147

*	Primarily represents translation adjustments.

Table of Contents

Notes to Consolidated Financial Statements — (continued)

~~Financing Receivables by Portfolio Segment~~

The following tables present the recorded investment by portfolio segment and by class, excluding commercial financing receivables and other miscellaneous financing receivables at September 30, 2019 and December 31, 2018. Commercial financing receivables are excluded from the presentation of financing receivables by portfolio segment, as they are short term in nature and the current estimated risk of loss and resulting impact to the company’s financing results are not material. The company determines its allowance for credit losses based on 2 portfolio segments: lease receivables and loan receivables, and further segments the portfolio into 3 classes: Americas, Europe/Middle East/Africa (EMEA) and Asia Pacific.

(Dollars in millions)












At September 30, 2019:

Americas

EMEA

Asia Pacific

Total
Recorded investment








Lease receivables

$
3,279

$
1,096

$
961

$
5,337
Loan receivables

5,899

3,161

2,356

11,415
Ending balance

$
9,178

$
4,257

$
3,317

$
16,752
Recorded investment collectively evaluated for impairment

$
9,039

$
4,209

$
3,275

$
16,523
Recorded investment individually evaluated for impairment

$
139

$
48

$
43

$
229

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

$
(14)

$
(3)

$
(6)

$
(23)
Recoveries

0

0

0

1
Provision / (benefit)

4

(6)

(1)

(4)
Other*

(3)

(2)

(1)

(6)
Ending balance at September 30, 2019

$
144

$
54

$
48

$
246
Lease receivables

$
35

$
23

$
22

$
81
Loan receivables

$
109

$
31

$
26

$
165

Related allowance, collectively evaluated for impairment

$
29

$
11

$
4

$
44
Related allowance, individually evaluated for impairment

$
115

$
43

$
43

$
202


(Dollars in millions)
At December 31, 2019:	Americas		EMEA		Asia Pacific		Total
Recorded investment
Lease receivables	$	3,419	$	1,186	$	963	$	5,567
Loan receivables		6,726		3,901		2,395		13,022
Ending balance	$	10,144	$	5,087	$	3,359	$	18,590
Recorded investment collectively evaluated for impairment	$	10,032	$	5,040	$	3,326	$	18,399
Recorded investment individually evaluated for impairment	$	112	$	47	$	32	$	191

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	$	(42)	$	(3)	$	(18)	$	(63)
Recoveries		1		0		1		2
Provision		5		(7)		(3)		(5)
Other*		(1)		0		(1)		(2)
Ending balance at December 31, 2019	$	120	$	54	$	36	$	210
Lease receivables	$	33	$	23	$	16	$	72
Loan receivables	$	88	$	31	$	20	$	138

Related allowance, collectively evaluated for impairment	$	25	$	11	$	4	$	39
Related allowance, individually evaluated for impairment	$	96	$	43	$	32	$	171

* Primarily represents translation adjustments.

Write-offs of lease receivables and loan receivables were ~~$11~~$16 million and ~~$12~~$47 million, respectively, for the ~~nine months~~year ended ~~September 30,~~December 31, 2019. ~~Provision~~Provisions for credit losses recorded for lease receivables and loan receivables were a release of $3$6 million and ~~$2 million, respectively, for the nine months ended September 30, 2019.~~

~~The average recorded investment~~an addition of impaired leases and loans for Americas, EMEA and Asia Pacific were $141 million, $48 million and $46 million, respectively, for the three months ended September 30, 2019 and $143 million, $56 million and $76 million, respectively, for the three months ended September 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 September 30, 2019 and 2018.

The average recorded investment of impaired leases and loans for Americas, EMEA and Asia Pacific were $144 million, $49 million and $48 million, respectively, for the nine months ended September 30, 2019 and $136 million, $56 million and $79 ~~million, respectively, for the nine months ended September 30, 2018. Both interest income recognized~~

~~Table of Contents~~

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

~~and interest income recognized on a cash basis on impaired leases and loans were immaterial for the nine months ended September 30, 2019 and 2018.~~

(Dollars in millions)












At December 31, 2018:

Americas

EMEA

Asia Pacific

Total
Recorded investment








Lease receivables

$
3,827

$
1,341

$
1,152

$
6,320
Loan receivables

6,817

3,675

2,489

12,981
Ending balance

$
10,644

$
5,016

$
3,641

$
19,301
Recorded investment collectively evaluated for impairment

$
10,498

$
4,964

$
3,590

$
19,052
Recorded investment individually evaluated for impairment

$
146

$
52

$
51

$
249

Allowance for credit losses








Beginning balance at January 1, 2018








Lease receivables

$
63

$
9

$
31

$
103
Loan receivables

108

52

51

211
Total

$
172

$
61

$
82

$
314
Write-offs

$
(10)

$
(2)

$
(23)

$
(35)
Recoveries

0

0

2

2
Provision

7

9

0

16
Other*

(11)

(3)

(4)

(19)
Ending balance at December 31, 2018

$
158

$
65

$
56

$
279
Lease receivables

$
53

$
22

$
24

$
99
Loan receivables

$
105

$
43

$
32

$
179

Related allowance, collectively evaluated for impairment

$
39

$
16

$
5

$
59
Related allowance, individually evaluated for impairment

$
119

$
49

$
51

$
219

* Primarily represents translation adjustments.

Write-offs of lease receivables and loan receivables were $15 million and $20 million, respectively, for the year ended December 31, 2018. Provisions for credit losses recorded for lease receivables and loan receivables were $14 million and $2 million, respectively, for the year ended December 31, ~~2018.~~2019.

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~~tables summarize information about the amortized cost basis or recorded investment in lease and loan financing receivables, including amortized cost or recorded investment aged over 90 days and still accruing, billed invoices aged over 90 days and still accruing, and amortized cost or recorded investment not accruing.

3724

Table of Contents

Notes to Consolidated Financial Statements — (continued)

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


					Recorded		Billed		Recorded						Amortized		Billed
	Total		Recorded		Investment		Invoices		Investment		Total		Amortized		Cost		Invoices		Amortized
(Dollars in millions)	Recorded		Investment		> 90 Days and		> 90 Days and		Not		Amortized		Cost		> 90 Days and		> 90 Days and		Cost Not
At September 30, 2019:	Investment		> 90 Days(1)		Accruing(1)		Accruing		Accruing(2)
At March 31, 2020:											Cost		> 90 Days (1)		Accruing (1)		Accruing		Accruing (2)
Americas	$	3,279	$	213	$	179	$	13	$	37	$	3,609	$	144	$	110	$	8	$	40
EMEA		1,096		34		17		3		19		1,122		20		6		0		16
Asia Pacific		961		37		19		2		18		923		24		13		1		10
Total lease receivables	$	5,337	$	284	$	215	$	18	$	74	$	5,654	$	188	$	129	$	9	$	65

Americas	$	5,899	$	155	$	64	$	10	$	108	$	6,151	$	115	$	62	$	11	$	54
EMEA		3,161		93		28		15		67		3,663		74		7		3		69
Asia Pacific		2,356		41		16		6		26		2,273		27		10		1		17
Total loan receivables	$	11,415	$	288	$	108	$	31	$	200	$	12,087	$	215	$	80	$	16	$	140

Total	$	16,752	$	572	$	323	$	50	$	274	$	17,741	$	403	$	209	$	26	$	206

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

(2)	Of the amortized cost not accruing, there was a related allowance of $148 million. Financing income recognized on these receivables was immaterial for the three months ended March 31, 2020.


					Recorded		Billed		Recorded
	Total		Recorded		Investment		Invoices		Investment
(Dollars in millions)	Recorded		Investment		> 90 Days and		> 90 Days and		Not
At December 31, 2019:	Investment		> 90 Days (1)		Accruing (1)		Accruing		Accruing (2)
Americas	$	3,419	$	187	$	147	$	11	$	41
EMEA		1,186		28		13		2		17
Asia Pacific		963		19		7		1		11
Total lease receivables	$	5,567	$	234	$	168	$	14	$	69

Americas	$	6,726	$	127	$	71	$	11	$	72
EMEA		3,901		77		8		3		72
Asia Pacific		2,395		26		6		2		21
Total loan receivables	$	13,022	$	231	$	85	$	15	$	166

Total	$	18,590	$	465	$	253	$	29	$	235

(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, ~~$229~~$191 million iswas individually evaluated for impairment with a related allowance of ~~$202 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~~$171 million.

Credit Quality Indicators

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

The following tables present the amortized cost basis or recorded investment ~~net of allowance~~ for ~~credit losses for each class of~~financing receivables, excluding commercial financing receivables, by credit quality indicator at ~~September 30, 2019~~March 31, 2020 and December 31, ~~2018.~~2019, respectively. Receivables with a credit quality indicator ranging from Aaa to Baa3 are considered investment grade. All others are considered non-investment grade. Effective January 1, 2020, under the new guidance for credit losses, the company discloses its credit quality by year of origination. Additionally, under the new guidance, the amortized cost is presented on a gross basis, whereas under the prior guidance, the company presented the recorded investment net of the allowance

3825

Table of Contents

Notes to Consolidated Financial Statements — (continued)

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

(Dollars in millions)

Lease Receivables

Loan Receivables
At September 30, 2019:

Americas

EMEA

Asia Pacific

Americas

EMEA

Asia Pacific
Credit ratings:












Aaa – Aa3

$
443

$
11

$
44

$
1,006

$
167

$
160
A1 – A3

727

201

441

855

308

874
Baa1 – Baa3

843

380

153

1,560

1,120

617
Ba1 – Ba2

697

311

149

1,380

830

396
Ba3 – B1

259

123

104

444

476

208
B2 – B3

258

46

44

499

222

62
Caa – D

16

1

5

47

7

14
Total

$
3,245

$
1,073

$
939

$
5,789

$
3,130

$
2,330


(Dollars in millions)	Americas				EMEA				Asia Pacific
At March 31, 2020:	Aaa – Baa3		Ba1 – D		Aaa – Baa3		Ba1 – D		Aaa – Baa3		Ba1 – D
Vintage year:
2020	$	1,422	$	883	$	633	$	806	$	251	$	163
2019		2,213		1,601		966		1,043		1,607		678
2018		1,148		736		400		359		208		82
2017		722		386		141		191		79		37
2016		292		309		94		68		36		20
2015 and prior		18		30		45		40		20		16
Total	$	5,815	$	3,945	$	2,278	$	2,506	$	2,200	$	996


(Dollars in millions)	Lease Receivables						Loan Receivables						Lease Receivables						Loan Receivables
At December 31, 2018:	Americas		EMEA		Asia Pacific		Americas		EMEA		Asia Pacific
Credit ratings:
At December 31, 2019:													Americas		EMEA		Asia Pacific		Americas		EMEA		Asia Pacific
Credit rating:
Aaa – Aa3	$	593	$	45	$	85	$	1,055	$	125	$	185	$	465	$	54	$	43	$	1,028	$	193	$	189
A1 – A3		678		158		413		1,206		436		901		750		181		454		1,186		395		892
Baa1 – Baa3		892		417		297		1,587		1,148		648		955		409		147		1,882		1,527		619
Ba1 – Ba2		852		426		191		1,516		1,175		417		746		326		154		1,513		921		388
Ba3 – B1		433		171		84		770		472		184		215		140		101		471		564		205
B2 – B3		299		90		50		531		249		109		242		50		47		522		253		72
Caa – D		26		10		7		47		28		15		13		2		2		36		18		10
Total	$	3,774	$	1,319	$	1,128	$	6,712	$	3,633	$	2,457	$	3,385	$	1,162	$	947	$	6,638	$	3,871	$	2,376

Troubled Debt Restructurings

The company did not have any significant troubled debt restructurings during the ~~nine~~three months ended ~~September 30, 2019~~March 31, 2020 or for the year ended December 31, ~~2018.~~2019.

9. Leases:

Accounting for Leases as a Lessor

The following table presents amounts included in the Consolidated Income Statement related to lessor activity:


(Dollars in millions)
For the three months ended March 31:	2020		2019
Lease income — sales-type and direct financing leases
Sales-type lease selling price	$	211	$	149
Less: Carrying value of underlying assets, excluding unguaranteed residual value		76		55
Gross profit		135		94
Interest income on lease receivables		74		79
Total sales-type and direct financing lease income	$	208	$	172
Lease income — operating leases		71		90
Variable lease income		30		18
Total lease income	$	310	$	280

Table of Contents

Notes to Consolidated Financial Statements — (continued)

7.10. ~~Stock-Based Compensation:~~Intangible Assets Including Goodwill:

Intangible Assets

~~Stock-based compensation cost~~The following table presents the company's intangible asset balances by major asset class.


	At March 31, 2020
	Gross Carrying		Accumulated		Net Carrying
(Dollars in millions)	Amount		Amortization		Amount*
Intangible asset class
Capitalized software	$	1,760	$	(764)	$	997
Client relationships		8,854		(1,669)		7,185
Completed technology		6,225		(1,566)		4,658
Patents/trademarks		2,287		(483)		1,804
Other**		56		(33)		22
Total	$	19,181	$	(4,515)	$	14,666


	At December 31, 2019
	Gross Carrying		Accumulated		Net Carrying
(Dollars in millions)	Amount		Amortization		Amount*
Intangible asset class
Capitalized software	$	1,749	$	(743)	$	1,006
Client relationships		8,921		(1,433)		7,488
Completed technology		6,261		(1,400)		4,861
Patents/trademarks		2,301		(445)		1,856
Other**		56		(31)		24
Total	$	19,287	$	(4,052)	$	15,235

* Amounts as of March 31, 2020 and December 31, 2019 include a decrease in net intangible asset balances of $92 million and $42 million, respectively, due to foreign currency translation.

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

The net carrying amount of intangible assets decreased $569 million during the first three months of 2020, primarily due to intangible asset amortization. The aggregate intangible amortization expense was $622 million and $303 million for the first quarter ended March 31, 2020 and 2019, respectively. The increase in intangible amortization expense was primarily due to an increase in the gross carrying amount of intangible assets from the Red Hat acquisition which closed in the third quarter of 2019. In addition, in the first three months of 2020, the company retired $154 million of fully amortized intangible assets, impacting both the gross carrying amount and accumulated amortization by this amount.

The future amortization expense relating to intangible assets currently recorded in the Consolidated Balance Sheet is ~~measured~~estimated to be the following at ~~grant date, based on~~March 31, 2020:


	Capitalized		Acquired
(Dollars in millions)	Software		Intangibles		Total
Remainder of 2020	$	415	$	1,372	$	1,787
2021		399		1,738		2,137
2022		170		1,676		1,846
2023		12		1,363		1,375
2024		0		1,313		1,313
Thereafter		—		6,208		6,208

Table of Contents

Notes to Consolidated Financial Statements — (continued)

Goodwill

The changes in the goodwill balances by segment, for the three months ended March 31, 2020 and for the year ended December 31, 2019 are as follows:


									Foreign
									Currency
					Purchase				Translation
(Dollars in millions)	Balance		Goodwill		Price				And Other		Balance
Segment	1/1/2020		Additions		Adjustments		Divestitures		Adjustments**		3/31/2020
Cloud & Cognitive Software	$	43,037	$	10	$	12	$	—	$	(438)	$	42,620
Global Business Services		5,775		—		—		—		(102)		5,672
Global Technology Services		7,141		—		—		—		(167)		6,974
Systems		2,270		—		—		—		(19)		2,251
Other—divested businesses		—		—		—		—		—		—
Total	$	58,222	$	10	$	12	$	—	$	(727)	$	57,517


									Foreign
									Currency
					Purchase				Translation
(Dollars in millions)	Balance		Goodwill		Price				And Other		Balance
Segment	1/1/2019		Additions		Adjustments		Divestitures		Adjustments**		12/31/2019
Cloud & Cognitive Software*	$	24,463	$	18,399	$	133	$	—	$	41	$	43,037
Global Business Services		4,711		1,059		1		(1)		5		5,775
Global Technology Services		3,988		3,119		—		—		34		7,141
Systems		1,847		525		(110)		—		7		2,270
Other—divested businesses*		1,256		—		—		(1,256)		—		—
Total	$	36,265	$	23,102	$	24	$	(1,257)	$	87	$	58,222

* Recast to conform to 2020 presentation.

** Primarily driven by foreign currency translation.

There were 0 goodwill impairment losses recorded during the first three months of 2020 or full year 2019 and the company has 0 accumulated impairment losses. As a result of the changes in the current economic environment related to the COVID-19 pandemic, the company considered whether there was a potential triggering event requiring the evaluation of whether goodwill should be tested for impairment. The company assessed the qualitative risk factors for the Systems reporting unit (given the results of the 2019 annual impairment test) and determined that it was not more likely than not that 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.~~reporting unit was less than its carrying amount as of March 31, 2020.

Three Months Ended September 30,

Nine Months Ended September 30,
(Dollars in millions)

2019

2018

2019

2018
Cost

$
29

$
19

$
71

$
60
Selling, general and administrative

147

95


313


264
Research, development and engineering

44

15


84


47
Pre-tax stock-based compensation cost

$
220

$
129

$
468

$
371
Income tax benefits

(50)

(29)


(104)


(88)
Total net stock-based compensation cost

$
170

$
100

$
364

$
283

Purchase price adjustments recorded in the first three months of 2020 and full-year 2019 were related to acquisitions that were still subject to the measurement period that ends at the earlier of 12 months from the acquisition date or when information becomes available. Net purchase price adjustments recorded during the first three months of 2020 and full-year 2019 were not material.

11. Borrowings:

Short-Term Debt


	At March 31,		At December 31,
(Dollars in millions)	2020		2019
Commercial paper	$	2,519	$	304
Short-term loans		934		971
Long-term debt—current maturities		8,190		7,522
Total	$	11,642	$	8,797

3928

Table of Contents

Notes to Consolidated Financial Statements — (continued)

The weighted-average interest rate for commercial paper at March 31, 2020 and December 31, 2019 was 1.1 percent and 1.6 percent, respectively. The weighted-average interest rate for short-term loans was 4.7 percent and 6.1 percent at March 31, 2020 and December 31, 2019, respectively.

Long-Term Debt

Pre-Swap Borrowing


		Balance		Balance
(Dollars in millions)	Maturities	3/31/2020		12/31/2019
U.S. dollar debt (weighted-average interest rate at March 31, 2020):*
2.3%	2020	$	2,766	$	4,326
2.4%	2021		5,556		8,498
2.6%	2022		6,257		6,289
3.3%	2023		2,413		2,388
3.3%	2024		5,049		5,045
6.7%	2025		645		636
3.3%	2026		4,350		4,350
4.7%	2027		969		969
6.5%	2028		313		313
3.5%	2029		3,250		3,250
5.9%	2032		600		600
8.0%	2038		83		83
4.5%	2039		2,745		2,745
4.0%	2042		1,107		1,107
7.0%	2045		27		27
4.7%	2046		650		650
4.3%	2049		3,000		3,000
7.1%	2096		316		316
		$	40,097	$	44,594
Other currencies (weighted-average interest rate at March 31, 2020, in parentheses):*
Euro (1.1%)	2020–2040	$	18,126	$	14,306
Pound sterling (2.7%)	2020–2022		1,311		1,390
Japanese yen (0.3%)	2022–2026		1,349		1,339
Other (4.1%)	2020–2022		288		375
		$	61,170	$	62,003
Finance lease obligations (2.4%)	2021–2030		246		204
		$	61,417	$	62,207
Less: net unamortized discount			881		881
Less: net unamortized debt issuance costs			151		142
Add: fair value adjustment**			491		440
		$	60,875	$	61,624
Less: current maturities			8,190		7,522
Total		$	52,685	$	54,102

* Includes notes, debentures, bank loans and secured borrowings.

** The portion of the company’s fixed-rate debt obligations that was hedged was reflected in the Consolidated Balance Sheet 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.

Table of Contents

Notes to Consolidated Financial Statements — (continued)

indebtedness and sale and leaseback transactions to 10 percent of the company’s consolidated net tangible assets, and restrict the company’s ability to merge or consolidate unless certain conditions are met. The credit facilities also include a covenant on the company’s consolidated net interest expense ratio, which cannot be less than 2.20 to 1.0, as well as a cross default provision with respect to other defaulted indebtedness of at least $500 million.

The company is in compliance with its 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 first half of 2019, the company issued an aggregate of $20 billion of U.S. dollar fixed- and floating-rate notes and $5.7 billion of Euro fixed-rate notes. The proceeds were primarily used for the acquisition of Red Hat. For additional information on this transaction, refer to note 5, “Acquisitions & Divestitures.” In the first quarter of 2020, the company issued an aggregate of $4.1 billion of Euro fixed-rate notes and the proceeds were primarily used to early redeem outstanding fixed-rate debt which was due in 2021 in the aggregate amount of $2.9 billion. The notes were redeemed at a price equal to 100 percent of the aggregate principal plus a make-whole premium and accrued interest. The company incurred a loss of $49 million upon redemption that was recorded in other (income) and expense in the Consolidated Income Statement.

Pre-swap annual contractual obligations of long-term debt outstanding at March 31, 2020, are as follows:


(Dollars in millions)	Total
Remainder of 2020	$	5,731
2021		6,897
2022		7,180
2023		5,342
2024		6,302
Thereafter		29,964
Total	$	61,417

Interest on Debt


(Dollars in millions)
For the three months ended March 31:	2020		2019
Cost of financing	$	119	$	179
Interest expense		326		210
Interest capitalized		5		2
Total interest paid and accrued	$	449	$	391

Lines of Credit

IBM has a $10.25 billion Five-Year Credit Agreement with a maturity date of July 20, 2024. In addition, the company and IBM Credit LLC have a $2.5 billion 364-day Credit Agreement and a $2.5 billion Three-Year Credit Agreement, with maturity dates of July 16, 2020 and July 20, 2022, respectively.

At March 31, 2020, there were 0 borrowings by the company, or its subsidiaries, under these credit facilities.

12. Commitments:

The company’s extended lines of credit to third-party entities include unused amounts of $2.1 billion and $1.8 billion at March 31, 2020 and December 31, 2019, respectively. A portion of these amounts was available to the company’s business partners to support their working capital needs. In addition, the company has committed to provide

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Notes to Consolidated Financial Statements — (continued)

future financing to its clients in connection with client purchase agreements for $6.0 billion and $6.3 billion at March 31, 2020 and December 31, 2019, respectively. Effective January 1, 2020, the company adopted the new standard on credit losses, which resulted in the recognition of a related allowance for non-cancellable off-balance sheet commitments. Refer to note 2, “Accounting Changes,” for additional information. The allowance for these commitments is recorded in other liabilities in the Consolidated Balance Sheet and was not material at March 31, 2020. The company collectively evaluates the allowance for these arrangements using a provision methodology consistent with the portfolio of the commitments. Refer to note 8, “Financing Receivables,” for additional information.

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 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 and the fair value of these guarantees recognized in the Consolidated Balance Sheet at March 31, 2020 and December 31, 2019 was not material.

Changes in the company’s warranty liability for standard warranties, which are included in other accrued expenses and liabilities and other liabilities in the Consolidated Balance Sheet, and for extended warranty contracts, which are included in deferred income in the Consolidated Balance Sheet, are presented in the following tables.

Standard Warranty Liability


(Dollars in millions)	2020		2019
Balance at January 1	$	113	$	118
Current period accruals		20		19
Accrual adjustments to reflect actual experience		(6)		(1)
Charges incurred		(26)		(29)
Balance at March 31	$	100	$	107

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Notes to Consolidated Financial Statements — (continued)

Extended Warranty Liability


(Dollars in millions)	2020		2019
Balance at January 1	$	477	$	533
Revenue deferred for new extended warranty contracts		40		36
Amortization of deferred revenue		(57)		(64)
Other*		(13)		(3)
Balance at March 31	$	447	$	503
Current portion	$	219	$	242
Noncurrent portion	$	228	$	261

* Other primarily consists of foreign currency translation adjustments.

13.Contingencies:

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

The company records a provision with respect to a claim, suit, investigation or proceeding when it is probable that a liability has been incurred and the amount of the loss can be reasonably estimated. Any recorded liabilities, including any changes to such liabilities for the quarter ended March 31, 2020 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

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Notes to Consolidated Financial Statements — (continued)

~~Pre-tax stock-based compensation cost for the three months ended September 30, 2019 increased $91 million compared~~important to the ~~corresponding period~~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 ~~prior year. This was primarily due~~aggregate), to ~~increases related~~reflect the impact and status of settlement discussions, discovery, procedural and substantive rulings, reviews by counsel and other information pertinent to ~~issuances~~a particular matter.

~~Pre-tax stock-based compensation cost for~~type of any such remedies; the ~~nine months ended September 30, 2019 increased $98 million compared to~~significance of the ~~corresponding period~~impact any such losses, damages or remedies may have in the ~~prior year. This was primarily due~~Consolidated Financial Statements; and the unique facts and circumstances of the particular matter that may give rise to ~~increases related~~additional factors. While the company will continue to ~~issuances and conversions~~defend itself vigorously, it is possible that the company’s business, financial condition, results of ~~stock-based compensation for Red Hat ($79 million) and restricted stock units ($25 million).~~

Asoperations or cash flows could be affected in any particular period by the resolution of ~~September 30, 2019, the total unrecognized compensation cost~~one or more of ~~$1.4 billion related to non-vested awards was expected to be recognized over a weighted-average period of approximately 2.5 years.~~

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

8.~~Segments:~~these matters.

The following ~~tables reflect the continuing operations results~~is a summary of the ~~company’s segments consistent with~~more significant legal matters involving the ~~management and measurement system utilized within the~~ company. ~~Effective with the closing of the transaction~~

The company is a defendant in ~~July, Red Hat is included~~an action filed on March 6, 2003 in the Cloud & Cognitive Software segment. The “Other” segment includes the divested mortgage servicing and select software businesses. 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 basisstate court in Salt Lake City, Utah by the ~~chief operating decision maker (the chief executive officer)~~SCO Group (SCO v. IBM). The company removed the case to Federal Court in ~~determining how~~Utah. Plaintiff is an alleged successor in interest to ~~allocate resources~~some of AT&T’s UNIX IP rights, and ~~evaluate performance. The tables reflect the segments recast for the prior-year period due~~alleges copyright infringement, unfair competition, interference with contract and breach of contract with regard to the company’s ~~segment changes effective~~distribution of AIX and Dynix and contribution of code to Linux and the company has asserted counterclaims. On September 14, 2007, plaintiff filed for bankruptcy protection, and all proceedings in this case were stayed. The court in another suit, the SCO Group, Inc. v. Novell, Inc., held a trial in March 2010. The jury found that Novell is the owner of UNIX and UnixWare copyrights; the judge subsequently ruled that SCO is obligated to recognize Novell’s waiver of SCO’s claims against IBM and Sequent for breach of UNIX license agreements. On August 30, 2011, the Tenth Circuit Court of Appeals affirmed the district court’s ruling and denied SCO’s appeal of this matter. In June 2013, the Federal Court in Utah granted SCO’s motion to reopen the SCO v. IBM case. In February 2016, the Federal Court ruled in favor of IBM on all of SCO’s remaining claims, and SCO appealed. On October 30, 2017, the Tenth Circuit Court of Appeals affirmed the dismissal of all but 1 of SCO’s remaining claims, which was remanded to the Federal Court in Utah.

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.

In December 2017, CIS General Insurance Limited (CISGIL) sued IBM UK regarding a contract entered into by IBM UK and CISGIL in 2015 to implement and operate an IT insurance platform. The contract was terminated by IBM UK in July 2017 for non-payment by CISGIL. CISGIL alleges wrongful termination, breach of contract and breach of warranty. The matter is pending in the London High Court with trial beginning in January ~~2019.~~2020.

In May 2015, a putative class action was commenced in the United States District Court for the Southern District of New York related to the company’s October 2014 announcement that it was divesting its global commercial semiconductor technology business, alleging violations of the Employee Retirement Income Security Act (ERISA). Management’s Retirement Plans Committee and 3 current or former IBM executives are named as defendants. On September 29, 2017, the Court granted the defendants’ motion to dismiss the first amended complaint. On December 10, 2018, the Second Circuit Court of Appeals reversed the District Court order. On January 14, 2020, the Supreme Court of the United States vacated the decision and remanded the case to the Second Circuit.

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

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Notes to Consolidated Financial Statements — (continued)

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 $750 million. The company believes it will prevail on these matters and that this amount is not a meaningful indicator of liability.

14. Equity Activity:

Reclassifications and Taxes Related to Items of Other Comprehensive Income


(Dollars in millions)	Before Tax		Tax (Expense)/		Net of Tax
For the three months ended March 31, 2020:	Amount		Benefit		Amount
Other comprehensive income/(loss):
Foreign currency translation adjustments	$	(919)	$	(122)	$	(1,041)
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	$	(180)	$	45	$	(135)
Reclassification of (gains)/losses to:
Cost of services		(10)		2		(7)
Cost of sales		(9)		2		(6)
Cost of financing		8		(2)		6
SG&A expense		(10)		2		(7)
Other (income) and expense		89		(22)		67
Interest expense		22		(5)		16
Total unrealized gains/(losses) on cash flow hedges	$	(90)	$	23	$	(67)
Retirement-related benefit plans (1):
Prior service costs/(credits)	$	(4)	$	1	$	(3)
Net (losses)/gains arising during the period		8		(2)		6
Curtailments and settlements		8		(3)		6
Amortization of prior service (credits)/costs		1		1		1
Amortization of net (gains)/losses		570		(157)		412
Total retirement-related benefit plans	$	582	$	(160)	$	422
Other comprehensive income/(loss)	$	(427)	$	(260)	$	(686)

(1)	These accumulated other comprehensive income/ (AOCI) components are included in the computation of net periodic pension cost. Refer to note 17, “Retirement-Related Benefits,” for additional information.

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Notes to Consolidated Financial Statements — (continued)

Reclassifications and Taxes Related to Items of Other Comprehensive Income


(Dollars in millions)	Before Tax		Tax (Expense)/		Net of Tax
For the three months ended March 31, 2019:	Amount		Benefit		Amount
Other comprehensive income/(loss):
Foreign currency translation adjustments	$	171	$	0	$	172
Net changes related to available-for-sale securities:
Unrealized gains/(losses) arising during the period	$	(1)	$	0	$	(1)
Reclassification of (gains)/losses to other (income) and expense		—		—		—
Total net changes related to available-for-sale securities	$	(1)	$	0	$	(1)
Unrealized gains/(losses) on cash flow hedges:
Unrealized gains/(losses) arising during the period	$	(352)	$	84	$	(268)
Reclassification of (gains)/losses to:
Cost of services		(10)		3		(7)
Cost of sales		(18)		5		(13)
Cost of financing		29		(7)		22
SG&A expense		(22)		6		(16)
Other (income) and expense		87		(22)		65
Interest expense		33		(8)		24
Total unrealized gains/(losses) on cash flow hedges	$	(254)	$	61	$	(193)
Retirement-related benefit plans (1):
Net (losses)/gains arising during the period	$	(4)	$	1	$	(2)
Curtailments and settlements		1		0		1
Amortization of prior service (credits)/costs		(3)		1		(2)
Amortization of net (gains)/losses		464		(130)		334
Total retirement-related benefit plans	$	458	$	(128)	$	330
Other comprehensive income/(loss)	$	375	$	(67)	$	308

(1)	These AOCI components are included in the computation of net periodic pension cost. Refer to note 17, “Retirement-Related Benefits,” for additional information.

4035

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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, 2020	$	(179)	$	(3,700)	$	(24,718)	$	0	$	(28,597)
Other comprehensive income before reclassifications		(135)		(1,041)		3		0		(1,174)
Amount reclassified from accumulated other comprehensive income		68		—		419		—		488
Total change for the period	$	(67)	$	(1,041)	$	422	$	0	$	(686)
March 31, 2020	$	(246)	$	(4,741)	$	(24,296)	$	0	$	(29,283)

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


					Net Change		Net Unrealized
	Net Unrealized		Foreign		Retirement-		Gains/(Losses)		Accumulated
	Gains/(Losses)		Currency		Related		on Available-		Other
	on Cash Flow		Translation		Benefit		For-Sale		Comprehensive
(Dollars in millions)	Hedges		Adjustments*		Plans		Securities		Income/(Loss)
January 1, 2019	$	284	$	(3,690)	$	(26,083)	$	0	$	(29,490)
Other comprehensive income before reclassifications		(268)		172		(2)		(1)		(99)
Amount reclassified from accumulated other comprehensive income		75		—		333		—		407
Total change for the period	$	(193)	$	172	$	330	$	(1)	$	308
March 31, 2019	$	90	$	(3,519)	$	(25,753)	$	(1)	$	(29,182)

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

15. Derivative Financial Instruments:

In the Consolidated Balance Sheet, the company does not offset derivative assets against liabilities in master netting arrangements nor does it offset receivables or payables recognized upon payment or receipt of cash collateral against the fair values of the related derivative instruments. The amount recognized in accounts payable for the obligation to return cash collateral at March 31, 2020 was $2 million and 0 amount was recognized at December 31, 2019. NaN amount was recognized in other accounts receivable for the right to reclaim cash collateral at March 31, 2020 and $26 million was recognized at December 31, 2019. The company restricts the use of cash collateral received to rehypothecation, and therefore reports it in restricted cash in the Consolidated Balance Sheet. NaN amount was rehypothecated at March 31, 2020 and December 31, 2019. Additionally, if derivative exposures covered by a qualifying master netting agreement had been netted in the Consolidated Balance Sheet at March 31, 2020 and December 31, 2019, the total derivative asset and liability positions each would have been reduced by $249 million and $194 million, respectively.

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Notes to Consolidated Financial Statements — (continued)

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

Interest Rate Risk

Fixed and Variable Rate Borrowings

The company issues debt in the global capital markets to fund its operations and financing business. Access to cost-effective financing can result in interest rate mismatches with the underlying assets. To manage these mismatches and to reduce overall interest cost, the company may use interest-rate swaps to convert specific fixed-rate debt issuances into variable-rate debt (i.e., fair value hedges) and to convert specific variable-rate debt issuances into fixed-rate debt (i.e., cash flow hedges). At March 31, 2020 and December 31, 2019, the total notional amount of the company’s interest-rate swaps was $3.0 billion at both periods. The weighted-average remaining maturity of these instruments at March 31, 2020 and December 31, 2019 was approximately 1.9 years and 2.2 years, respectively. These interest-rate contracts were accounted for as fair value hedges. The company did not have any cash flow hedges relating to this program outstanding at March 31, 2020 and December 31, 2019.

Forecasted Debt Issuance

The company is exposed to interest rate volatility on future debt issuances. To manage this risk, the company may use instruments such as forward starting interest-rate swaps to lock in the rate on the interest payments related to the forecasted debt issuances. In the second quarter of 2019, the company issued an aggregate of $20 billion of indebtedness (refer to note 11, “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. There were 0 instruments outstanding at March 31, 2020 and December 31, 2019.

In connection with cash flow hedges of forecasted interest payments related to the company's borrowings, the company recorded net losses of $188 million and net losses of $192 million (before taxes) at March 31, 2020 and December 31, 2019, respectively, in AOCI. The company estimates that $18 million (before taxes) of the deferred net losses on derivatives in AOCI at March 31, 2020 will be reclassified to net income within the next 12 months, providing an offsetting economic impact against the underlying interest payments.

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. At March 31, 2020 and December 31, 2019, the carrying value of debt designated as hedging instruments was $16.7 billion and $7.3 billion, respectively. The $9.4 billion increase is part of the company’s risk management strategy and is primarily due to the designation of new debt issuances and previously hedged Euro denominated debt. The company also uses cross-currency swaps and foreign exchange forward contracts for this risk management purpose. At March 31, 2020 and December 31, 2019, the total notional amount of derivative instruments designated as net investment hedges was $8.4 billion and $7.9 billion, respectively. At March 31, 2020 and December 31, 2019, the weighted-average remaining maturity of these instruments was approximately 0.2 years and 0.1 years, respectively.

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Notes to Consolidated Financial Statements — (continued)

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 remaining length of time over which the company hedged its exposure is approximately four years. At March 31, 2020 and December 31, 2019, the total notional amount of forward contracts designated as cash flow hedges of forecasted royalty and cost transactions was $9.6 billion and $9.7 billion, respectively. At March 31, 2020 and December 31, 2019, the weighted-average remaining maturity of these instruments was approximately 0.7 years and 0.8 years, respectively.

At March 31, 2020 and December 31, 2019, in connection with cash flow hedges of anticipated royalties and cost transactions, the company recorded net gains of $174 million and net gains of $145 million (before taxes), respectively, in AOCI. The company estimates that $180 million (before taxes) of deferred net gains on derivatives in AOCI at March 31, 2020 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. At March 31, 2020, the maximum length of time remaining over which the company hedged its exposure is approximately eight years. At March 31, 2020 and December 31, 2019, the total notional amount of cross-currency swaps designated as cash flow hedges of foreign currency denominated debt was $2.4 billion and $8.2 billion, respectively. The $5.7 billion decrease in cross-currency swaps is part of the company’s risk management strategy and the previously hedged foreign currency denominated debt has been designated as a hedge of net investment in foreign subsidiaries.

At March 31, 2020 and December 31, 2019, in connection with cash flow hedges of foreign currency denominated borrowings, the company recorded net losses of $308 million and net losses of $185 million (before taxes), respectively, in AOCI. The company estimates that $21 million (before taxes) of deferred net losses on derivatives in AOCI at March 31, 2020 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 Income Statement. At March 31, 2020 and December 31, 2019, the total notional amount of derivative instruments in economic hedges of foreign currency exposure was $4.3 billion and $7.1 billion, respectively.

Equity Risk Management

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Notes to Consolidated Financial Statements — (continued)

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 Income Statement. At March 31, 2020 and December 31, 2019, the total notional amount of derivative instruments in economic hedges of these compensation obligations was $1.1 billion and $1.3 billion, respectively.

Cumulative Basis Adjustments for Fair Value Hedges

At March 31, 2020 and December 31, 2019, the following amounts were recorded in the Consolidated Balance Sheet related to cumulative basis adjustments for fair value hedges:


	March 31,			December 31,
(Dollars in millions)	2020			2019
Short-term debt:
Carrying amount of the hedged item	$	(1,314)		$	—
Cumulative hedging adjustments included in the carrying amount - assets/(liabilities)		(15)			—
Long-term debt:
Carrying amount of the hedged item	$	(2,147)		$	(3,411)
Cumulative hedging adjustments included in the carrying amount - assets/(liabilities)		(475)	(1)		(440)	(1)

(1)	Includes ($391) million and ($404) million of hedging adjustments on discontinued hedging relationships at March 31, 2020 and December 31, 2019, respectively.

The Effect of Derivative Instruments in the Consolidated Income Statement

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


						Gains/(Losses) of
(Dollars in millions)	Total					Total Hedge Activity
For the three months ended March 31:	2020		2019			2020		2019
Cost of services	$	7,843	$	8,272	*	$	10	$	10
Cost of sales		1,624		1,603	*		9		18
Cost of financing		181		264			3		(18)
SG&A expense		5,955		4,691			(191)		141
Other (income) and expense		182		(73)			(101)		(69)
Interest expense		326		210			10		(20)

* Reclassified to conform to current period presentation.

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Notes to Consolidated Financial Statements — (continued)


	Gain (Loss) Recognized in Consolidated Income Statement
	Consolidated	Recognized on				Attributable to Risk
(Dollars in millions)	Income Statement	Derivatives				Being Hedged (2)
For the three months ended March 31:	Line Item	2020		2019		2020		2019
Derivative instruments in fair value hedges (1):
Interest rate contracts	Cost of financing	$	18	$	36	$	(13)	$	(33)
	Interest expense		49		39		(37)		(36)
Derivative instruments not designated as hedging instruments:
Foreign exchange contracts	Other (income) and expense		(11)		18		N/A		N/A
Equity contracts	SG&A expense		(201)		119		N/A		N/A
Total		$	(146)	$	212	$	(50)	$	(69)


	Gain (Loss) Recognized in Consolidated Income Statement and Other Comprehensive Income
(Dollars in millions)					Consolidated	Reclassified				Amounts Excluded from
For the three months	Recognized in OCI				Income Statement	from AOCI				Effectiveness Testing (3)
ended March 31:	2020		2019		Line Item	2020		2019		2020		2019
Derivative instruments in cash flow hedges:
Interest rate contracts	$	—	$	(171)	Cost of financing	$	(1)	$	—	$	—	$	—
					Interest expense		(3)		—		—		—
Foreign exchange contracts		(180)		(181)	Cost of services		10		10		—		—
					Cost of sales		9		18		—		—
					Cost of financing		(7)		(29)		—		—
					SG&A expense		10		22		—		—
					Other (income) and expense		(89)		(87)		—		—
					Interest expense		(18)		(33)		—		—
Instruments in net investment hedges (4):
Foreign exchange contracts		485		19	Cost of financing		—		—		7		8
					Interest expense		—		—		20		9
Total	$	304	$	(333)		$	(91)	$	(98)	$	27	$	17

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

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

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

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

N/A - not applicable

For the three months ending March 31, 2020 and 2019, there were no material gains or losses excluded from the assessment of hedge effectiveness (for fair value or cash flow hedges), or associated with an underlying exposure that did not or was not expected to occur (for cash flow hedges); nor are there any anticipated in the normal course of business.

Table of Contents

Notes to Consolidated Financial Statements — (continued)

16. Stock-Based Compensation:

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


(Dollars in millions)
For the three months ended March 31:	2020		2019
Cost	$	27	$	20
Selling, general and administrative		117		74
Research, development and engineering		45		19
Pre-tax stock-based compensation cost	$	189	$	113
Income tax benefits		(45)		(25)
Total net stock-based compensation cost	$	144	$	88

Pre-tax stock-based compensation cost for the three months ended March 31, 2020 increased $76 million compared to the corresponding period in the prior year. This was primarily due to increases related to the conversions of stock-based compensation previously issued by Red Hat ($65 million), and restricted stock units ($17 million), partially offset by decreases in performance share units ($6 million).

Total unrecognized compensation cost related to non-vested awards at March 31, 2020 was $1.2 billion and is expected to be recognized over a weighted-average period of approximately 2.5 years.

Capitalized stock-based compensation cost was not material at March 31, 2020 and 2019.

~~SEGMENT INFORMATION~~17. Retirement-Related Benefits:

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

Cloud &

Global

Global









Cognitive

Business

Technology

Global

Total

(Dollars in millions)

Software

Services

Services

Systems

Financing

Segments

For the three months ended September 30, 2019:













External revenue

$
5,280

$
4,117

$
6,700

$
1,481

$
343

$
17,921

Internal revenue

686

70

287

195

302

1,541

Total revenue

$
5,966

$
4,187

$
6,988

$
1,676

$
645

$
19,462

Pre-tax income/(loss) from continuing operations

$
1,283

$
573

$
490

$
39

$
275

$
2,661

Revenue year-to-year change

4.0
%

0.8
%

(5.3)
%

(12.6)
%

(11.2)
%

(2.3)
%
Pre-tax income year-to-year change

(37.4)
%

1.2
%

(19.2)
%

(81.3)
%

(10.8)
%

(28.9)
%
Pre-tax income/(loss) margin

21.5
%

13.7
%

7.0
%

2.3
%

42.6
%

13.7
%

For the three months ended September 30, 2018:













External revenue

$
4,962
*
$
4,076
*
$
7,101
*
$
1,736

$
388

$
18,262
*
Internal revenue

777
*

77

279
*

181

338

1,652
*
Total revenue

$
5,738
*
$
4,153
*
$
7,380
*
$
1,917

$
726

$
19,914
*
Pre-tax income/(loss) from continuing operations

$
2,050
*
$
566
*
$
607
*
$
209

$
308

$
3,741
*
Pre-tax income/(loss) margin

35.7
%*

13.6
%*

8.2
%*

10.9
%

42.5
%

18.8
%*

* Recast to conform to 2019 presentation.

~~Reconciliations to IBM as Reported:~~

(Dollars in millions)






For the three months ended September 30:

2019

2018

Revenue:





Total reportable segments

$
19,462

$
19,914
*
Other — divested businesses

48

432
*
Other revenue

59

62

Eliminations of internal transactions

(1,541)

(1,652)
*
Total consolidated revenue

$
18,028

$
18,756

Pre-tax income from continuing operations:





Total reportable segments

$
2,661

$
3,741
*
Amortization of acquired intangible assets

(473)

(207)

Acquisition-related (charges)/income

(255)

(2)

Non-operating retirement-related (costs)/income

(145)

(389)

Eliminations of internal transactions

(84)

(118)
*
Other — divested businesses

(25)

62
*
Unallocated corporate amounts

(157)

(91)

Total pre-tax income from continuing operations

$
1,522

$
2,996

* Recast to conform to 2019 presentation.


					Yr. to Yr.
(Dollars in millions)					Percent
For the three months ended March 31:	2020		2019		Change
Retirement-related plans — cost
Defined benefit and contribution pension plans — cost	$	584	$	437	33.7	%
Nonpension postretirement plans — cost		52		54	(4.1)
Total	$	636	$	491	29.5	%

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 nine months ended September 30, 2019:













External revenue

$
15,962

$
12,391

$
20,412

$
4,562

$
1,100

$
54,426

Internal revenue

2,135

213

879

528

884

4,638

Total revenue

$
18,097

$
12,604

$
21,291

$
5,091

$
1,983

$
59,065

Pre-tax income/(loss) from continuing operations

$
5,052

$
1,188

$
1,000

$
(101)

$
803

$
7,941

Revenue year-to-year change

0.2
%

0.2
%

(5.1)
%

(15.0)
%

(18.3)
%

(3.9)
%
Pre-tax income year-to-year change

(12.3)
%

11.7
%

(11.0)
%

(128.8)
%

(23.0)
%

(15.0)
%
Pre-tax income/(loss) margin

27.9
%

9.4
%

4.7
%

(2.0)
%

40.5
%

13.4
%

For the nine months ended September 30, 2018:













External revenue

$
15,548
*
$
12,326
*
$
21,846
*
$
5,412

$
1,188

$
56,319
*
Internal revenue

2,518
*

249

589
*

576

1,240

5,173
*
Total revenue

$
18,066
*
$
12,575
*
$
22,435
*
$
5,989

$
2,428

$
61,492
*
Pre-tax income/(loss) from continuing operations

$
5,760
*
$
1,063
*
$
1,124
*
$
352

$
1,042

$
9,342
*
Pre-tax income/(loss) margin

31.9
%*

8.5
%*

5.0
%*

5.9
%

42.9
%

15.2
%*

* Recast to conform to 2019 presentation.

~~Reconciliations to IBM as Reported:~~

(Dollars in millions)






For the nine months ended September 30:

2019

2018

Revenue:





Total reportable segments

$
59,065

$
61,492
*
Other — divested businesses

754

1,335
*
Other revenue

190

176

Eliminations of internal transactions

(4,638)

(5,173)
*
Total consolidated revenue

$
55,370

$
57,830

Pre-tax income from continuing operations:





Total reportable segments

$
7,941

$
9,342
*
Amortization of acquired intangible assets

(816)

(613)

Acquisition-related (charges)/income

(396)

(3)

Non-operating retirement-related (costs)/income

(419)

(1,185)

Eliminations of internal transactions

(233)

(615)
*
Other — divested businesses

477

265
*
Unallocated corporate amounts

(380)

(283)

Total pre-tax income from continuing operations

$
6,173

$
6,908

*~~Recast to conform to 2019 presentation.~~

~~Table of Contents~~

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

9. ~~Equity Activity:~~

~~Reclassifications and Taxes Related to Items of Other Comprehensive Income~~

(Dollars in millions)

Before Tax

Tax (Expense)/

Net of Tax
For the three months ended September 30, 2019:

Amount

Benefit

Amount
Other comprehensive income/(loss):






Foreign currency translation adjustments

$
(509)

$
(109)

$
(618)
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

$
(439)

$
110

$
(329)
Reclassification of (gains)/losses to:






Cost of services

(22)

6

(17)
Cost of sales

(10)

3

(7)
Cost of financing

21

(5)

15
SG&A expense

(11)

3

(8)
Other (income) and expense

447

(112)

334
Interest expense

64

(16)

48
Total unrealized gains/(losses) on cash flow hedges

$
49

$
(12)

$
36
Retirement-related benefit plans (1):






Net (losses)/gains arising during the period

$
0

$
0

$
0
Curtailments and settlements

3

(1)

2
Amortization of prior service (credits)/costs

(3)

3

(1)
Amortization of net (gains)/losses

461

(128)

333
Total retirement-related benefit plans

$
461

$
(127)

$
335
Other comprehensive income/(loss)

$
4

$
(249)

$
(245)

~~(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~~

~~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, 2018:

Amount

Benefit

Amount
Other comprehensive income/(loss):






Foreign currency translation adjustments

$
(22)

$
(22)

$
(44)
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

$
(46)

$
11

$
(35)
Reclassification of (gains)/losses to:

Cost of services

(1)

0

(1)
Cost of sales

(8)

3

(6)
Cost of financing*

18

(5)

14
SG&A expense

(7)

2

(5)
Other (income) and expense

8

(2)

6
Interest expense*

18

(5)

14
Total unrealized gains/(losses) on cash flow hedges

$
(18)

$
4

$
(14)
Retirement-related benefit plans (1):






Prior service costs/(credits)

$
0

$
0

$
0
Net (losses)/gains arising during the period

(1)

1

(1)
Curtailments and settlements

2

0

1
Amortization of prior service (credits)/costs

(18)

5

(13)
Amortization of net (gains)/losses

737

(196)

540
Total retirement-related benefit plans

$
719

$
(191)

$
527
Other comprehensive income/(loss)

$
678

$
(209)

$
470

* Reclassified to conform to current period presentation.

~~(1)~~

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

~~Table of Contents~~

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

~~Reclassifications and Taxes Related to Items of Other Comprehensive Income~~

(Dollars in millions)

Before Tax

Tax (Expense)/

Net of Tax
For the nine months ended September 30, 2019:

Amount

Benefit

Amount
Other comprehensive income/(loss):






Foreign currency translation adjustments

$
(333)

$
(72)

$
(405)
Net changes related to available-for-sale securities:






Unrealized gains/(losses) arising during the period

$
1

$
0

$
1
Reclassification of (gains)/losses to other (income) and expense

—

—

—
Total net changes related to available-for-sale securities

$
1

$
0

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






Unrealized gains/(losses) arising during the period

$
(798)

$
196

$
(601)
Reclassification of (gains)/losses to:






Cost of services

(52)

13

(38)
Cost of sales

(40)

11

(29)
Cost of financing

73

(18)

55
SG&A expense

(45)

12

(33)
Other (income) and expense

331

(83)

248
Interest expense

150

(38)

112
Total unrealized gains/(losses) on cash flow hedges

$
(380)

$
93

$
(287)
Retirement-related benefit plans (1):






Net (losses)/gains arising during the period

$
113

$
(23)

$
90
Curtailments and settlements

7

(1)

6
Amortization of prior service (credits)/costs

(9)

4

(5)
Amortization of net (gains)/losses

1,385

(380)

1,005
Total retirement-related benefit plans

$
1,496

$
(401)

$
1,095
Other comprehensive income/(loss)

$
784

$
(380)

$
404

~~(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~~

~~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, 2018:

Amount

Benefit

Amount
Other comprehensive income/(loss):






Foreign currency translation adjustments

$
(535)

$
(128)

$
(663)
Net changes related to available-for-sale securities:






Unrealized gains/(losses) arising during the period

$
(2)

$
1

$
(1)
Reclassification of (gains)/losses to other (income) and expense

—

—

—
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

$
(134)

$
39

$
(95)
Reclassification of (gains)/losses to:

Cost of services

(29)

7

(22)
Cost of sales

15

(4)

11
Cost of financing*

56

(14)

42
SG&A expense

14

(4)

10
Other (income) and expense

301

(76)

225
Interest expense*

52

(13)

39
Total unrealized gains/(losses) on cash flow hedges

$
274

$
(63)

$
210
Retirement-related benefit plans (1):






Prior service costs/(credits)

$
(1)

$
0

$
(1)
Net (losses)/gains arising during the period

83

(22)

60
Curtailments and settlements

7

(2)

5
Amortization of prior service (credits)/costs

(55)

15

(40)
Amortization of net (gains)/losses

2,231

(607)

1,624
Total retirement-related benefit plans

$
2,264

$
(616)

$
1,648
Other comprehensive income/(loss)

$
2,001

$
(807)

$
1,194

* Reclassified to conform to current period presentation.

~~(1)~~

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

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

Net Change

Net Unrealized



Net Unrealized

Foreign

Retirement-

Gains/(Losses)

Accumulated

Gains/(Losses)

Currency

Related

on Available-

Other

on Cash Flow

Translation

Benefit

For-Sale

Comprehensive
(Dollars in millions)

Hedges

Adjustments*

Plans

Securities

Income/(Loss)
January 1, 2019

$
284

$
(3,690)

$
(26,083)

$
0

$
(29,490)
Other comprehensive income before reclassifications

(601)

(405)

89

1

(916)
Amount reclassified from accumulated other comprehensive income

315

—

1,005

—

1,320
Total change for the period

$
(287)

$
(405)

$
1,095

$
1

$
404
September 30, 2019

$
(3)

$
(4,095)

$
(24,988)

$
0

$
(29,086)

* 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, 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

(95)

(663)

65

(1)

(695)
Amount reclassified from accumulated other comprehensive income

305

—

1,584

—

1,889
Total change for the period

$
210

$
(663)

$
1,648

$
(1)

$
1,194
September 30, 2018

$
250

$
(3,451)

$
(24,618)

$
0

$
(27,820)

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

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

~~Stock Repurchases~~

~~The Board of Directors authorizes the company to repurchase IBM common stock. At September 30, 2019,~~ $2,008 million of Board common stock repurchase authorization was available. The company suspended its share repurchase program effective with the close of the Red Hat acquisition in order to focus on reducing debt related to the acquisition.

~~10.~~ ~~Retirement-Related Benefits:~~

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

Yr. to Yr.

(Dollars in millions)

Percent

For the three months ended September 30:

2019

2018

Change

Retirement-related plans — cost







Defined benefit and contribution pension plans — cost

$
459

$
705

(34.9)
%
Nonpension postretirement plans — cost

53

49

8.6

Total

$
512

$
754

(32.1)
%

Yr. to Yr.

(Dollars in millions)

Percent

For the nine months ended September 30:

2019

2018

Change

Retirement-related plans — cost







Defined benefit and contribution pension plans — cost

$
1,337

$
2,152

(37.8)
%
Nonpension postretirement plans — cost

160

149

7.4

Total

$
1,497

$
2,300

(34.9)
%

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

~~Table of Contents~~

~~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 September 30:

2019

2018

2019

2018
Service cost

$
—

$
—

$
93

$
104
Interest cost (1)

470

430

202

204
Expected return on plan assets (1)

(650)

(675)

(391)

(330)
Amortization of prior service costs/(credits) (1)

4

4

(7)

(20)
Recognized actuarial losses (1)

140

381

313

346
Curtailments and settlements (1)

—

—

3

2
Multi-employer plans

—

—

10

9
Other costs/(credits) (1)

—

—

11

5
Total net periodic pension (income)/cost of defined benefit plans

$
(36)

$
140

$
235

$
318
Cost of defined contribution plans

151

152

109

95
Total defined benefit and contribution pension plans cost recognized in the Consolidated Statement of Earnings

$
115

$
292

$
344

$
413


(Dollars in millions)	U.S. Plans				Non-U.S. Plans
For the three months ended March 31:	2020		2019		2020		2019
Service cost	$	—	$	—	$	95	$	93
Interest cost (1)		375		472		129		208
Expected return on plan assets (1)		(542)		(650)		(309)		(399)
Amortization of prior service costs/(credits) (1)		4		4		(5)		(6)
Recognized actuarial losses (1)		207		140		342		314
Curtailments and settlements (1)		—		—		8		1
Multi-employer plans		—		—		7		9
Other costs/(credits) (1)		—		—		5		5
Total net periodic pension (income)/cost of defined benefit plans	$	44	$	(34)	$	274	$	223
Cost of defined contribution plans		155		149		110		98
Total defined benefit and contribution pension plans cost recognized in the Consolidated Income Statement	$	199	$	115	$	385	$	322

(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 nine months ended September 30:

2019

2018

2019

2018
Service cost

$
—

$
—

$
279

$
309
Interest cost (1)

1,411

1,289

616

630
Expected return on plan assets (1)

(1,949)

(2,026)

(1,186)

(1,017)
Amortization of prior service costs/(credits) (1)

12

12

(20)

(62)
Recognized actuarial losses (1)

419

1,144

939

1,057
Curtailments and settlements (1)

—

—

7

7
Multi-employer plans

—

—

26

29
Other costs/(credits) (1)

—

—

22

16
Total net periodic pension (income)/cost of defined benefit plans

$
(107)

$
419

$
683

$
969
Cost of defined contribution plans

440

457

321

306
Total defined benefit and contribution pension plans cost recognized in the Consolidated Statement of Earnings

$
333

$
876

$
1,004

$
1,276

~~(1)~~

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

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 $242 million and $725 million for the three and nine months ended September 30, 2019, respectively, compared to the corresponding periods in the prior year, primarily driven by the change in the amortization period. There was no impact to funded status, retiree benefit payments or funding requirements of the U.S. Qualified PPP as a result of this change.

In 2019, the company expects to contribute approximately $300 million to its non-U.S. defined benefit and multi-employer plans, the largest of which will be contributed to the defined benefit pension plans in Japan, Spain and Belgium. This amount generally represents the legally mandated minimum contribution. Total net contributions to the non-U.S. plans in the first nine months of 2019 were $159 million, of which $95 million was in cash and $65 million in U.S. Treasury securities. Total contributions to the non-U.S. plans in the first nine months of 2018 were $275 million, of which $117 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~~table provides the components of the cost for the company’s nonpension postretirement plans.

Intangible Assets

~~Cost of Nonpension Postretirement Plans~~The following table presents the company's intangible asset balances by major asset class.

(Dollars in millions)

U.S. Plan

Non-U.S. Plans
For the three months ended September 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~~.


	At March 31, 2020
	Gross Carrying		Accumulated		Net Carrying
(Dollars in millions)	Amount		Amortization		Amount*
Intangible asset class
Capitalized software	$	1,760	$	(764)	$	997
Client relationships		8,854		(1,669)		7,185
Completed technology		6,225		(1,566)		4,658
Patents/trademarks		2,287		(483)		1,804
Other**		56		(33)		22
Total	$	19,181	$	(4,515)	$	14,666

(Dollars in millions)

U.S. Plan

Non-U.S. Plans
For the nine months ended September 30:

2019

2018

2019

2018
Service cost

$
8

$
10

$
4

$
4
Interest cost (1)

109

99

37

34
Expected return on plan assets (1)

—

—

(4)

(4)
Amortization of prior service costs/(credits) (1)

(2)

(6)

0

0
Recognized actuarial losses (1)

0

7

8

4
Curtailments and settlements (1)

—

—

0

0
Total nonpension postretirement plans cost recognized in Consolidated Statement of Earnings

$
115

$
111

$
45

$
38


	At December 31, 2019
	Gross Carrying		Accumulated		Net Carrying
(Dollars in millions)	Amount		Amortization		Amount*
Intangible asset class
Capitalized software	$	1,749	$	(743)	$	1,006
Client relationships		8,921		(1,433)		7,488
Completed technology		6,261		(1,400)		4,861
Patents/trademarks		2,301		(445)		1,856
Other**		56		(31)		24
Total	$	19,287	$	(4,052)	$	15,235

* Amounts as of March 31, 2020 and December 31, 2019 include a decrease in net intangible asset balances of $92 million and $42 million, respectively, due to foreign currency translation.

~~(1)~~

~~These components of net periodic pension cost~~Other intangibles are ~~included in other (income)~~primarily acquired proprietary and ~~expense in the Consolidated Statement of Earnings.~~non-proprietary business processes, methodologies and systems.

The ~~company contributed $357~~net carrying amount of intangible assets decreased $569 million ~~in U.S. Treasury securities to the U.S. nonpension postretirement benefit and active employee medical trusts~~ during the ~~nine~~first three months of 2020, primarily due to intangible asset amortization. The aggregate intangible amortization expense was $622 million and $303 million for the first quarter ended ~~September 30,~~March 31, 2020 and 2019, respectively. The increase in intangible amortization expense was primarily due to an increase in the gross carrying amount of intangible assets from the Red Hat acquisition which closed in the third quarter of 2019. In addition, in the first three months of 2020, the company retired $154 million of fully amortized intangible assets, impacting both the gross carrying amount and ~~$275 million in U.S. Treasury securities during the nine months ended September 30, 2018.~~ accumulated amortization by this amount.

The ~~contribution of U.S. Treasury securities is considered a non-cash transaction~~future amortization expense relating to intangible assets currently recorded in the Consolidated ~~Statement of Cash Flows.~~Balance Sheet is estimated to be the following at March 31, 2020:

~~11.~~ ~~Acquisitions/Divestitures:~~

~~Acquisitions~~

The company accounts for business combinations using the acquisition method and accordingly, the identifiable assets acquired, the liabilities assumed and any noncontrolling interest in the acquiree are recorded at their acquisition date fair values. Significant judgments and use of estimates are required when performing valuations. For example, the company uses judgments when estimating the fair value of intangible assets using a discounted cash flow model; which involves the use of significant estimates and assumptions with respect to revenue growth rates, customer attrition rate and discount rates.


	Capitalized		Acquired
(Dollars in millions)	Software		Intangibles		Total
Remainder of 2020	$	415	$	1,372	$	1,787
2021		399		1,738		2,137
2022		170		1,676		1,846
2023		12		1,363		1,375
2024		0		1,313		1,313
Thereafter		—		6,208		6,208

4927

Table of Contents

Notes to Consolidated Financial Statements — (continued)

~~Red Hat~~ - ~~On July 9,~~Goodwill

The changes in the goodwill balances by segment, for the three months ended March 31, 2020 and for the year ended December 31, 2019 are as follows:


									Foreign
									Currency
					Purchase				Translation
(Dollars in millions)	Balance		Goodwill		Price				And Other		Balance
Segment	1/1/2020		Additions		Adjustments		Divestitures		Adjustments**		3/31/2020
Cloud & Cognitive Software	$	43,037	$	10	$	12	$	—	$	(438)	$	42,620
Global Business Services		5,775		—		—		—		(102)		5,672
Global Technology Services		7,141		—		—		—		(167)		6,974
Systems		2,270		—		—		—		(19)		2,251
Other—divested businesses		—		—		—		—		—		—
Total	$	58,222	$	10	$	12	$	—	$	(727)	$	57,517


									Foreign
									Currency
					Purchase				Translation
(Dollars in millions)	Balance		Goodwill		Price				And Other		Balance
Segment	1/1/2019		Additions		Adjustments		Divestitures		Adjustments**		12/31/2019
Cloud & Cognitive Software*	$	24,463	$	18,399	$	133	$	—	$	41	$	43,037
Global Business Services		4,711		1,059		1		(1)		5		5,775
Global Technology Services		3,988		3,119		—		—		34		7,141
Systems		1,847		525		(110)		—		7		2,270
Other—divested businesses*		1,256		—		—		(1,256)		—		—
Total	$	36,265	$	23,102	$	24	$	(1,257)	$	87	$	58,222

* Recast to conform to 2020 presentation.

** Primarily driven by foreign currency translation.

There were 0 goodwill impairment losses recorded during the first three months of 2020 or full year 2019 and the company has 0 accumulated impairment losses. As a result of the changes in the current economic environment related to the COVID-19 pandemic, the company considered whether there was a potential triggering event requiring the evaluation of whether goodwill should be tested for impairment. The company assessed the qualitative risk factors for the Systems reporting unit (given the results of the 2019 annual impairment test) and determined that it was not more likely than not that the fair value of the reporting unit was less than its carrying amount as of March 31, 2020.

11. Borrowings:

Short-Term Debt


	At March 31,		At December 31,
(Dollars in millions)	2020		2019
Commercial paper	$	2,519	$	304
Short-term loans		934		971
Long-term debt—current maturities		8,190		7,522
Total	$	11,642	$	8,797

Table of Contents

Notes to Consolidated Financial Statements — (continued)

Long-Term Debt

Pre-Swap Borrowing


		Balance		Balance
(Dollars in millions)	Maturities	3/31/2020		12/31/2019
U.S. dollar debt (weighted-average interest rate at March 31, 2020):*
2.3%	2020	$	2,766	$	4,326
2.4%	2021		5,556		8,498
2.6%	2022		6,257		6,289
3.3%	2023		2,413		2,388
3.3%	2024		5,049		5,045
6.7%	2025		645		636
3.3%	2026		4,350		4,350
4.7%	2027		969		969
6.5%	2028		313		313
3.5%	2029		3,250		3,250
5.9%	2032		600		600
8.0%	2038		83		83
4.5%	2039		2,745		2,745
4.0%	2042		1,107		1,107
7.0%	2045		27		27
4.7%	2046		650		650
4.3%	2049		3,000		3,000
7.1%	2096		316		316
		$	40,097	$	44,594
Other currencies (weighted-average interest rate at March 31, 2020, in parentheses):*
Euro (1.1%)	2020–2040	$	18,126	$	14,306
Pound sterling (2.7%)	2020–2022		1,311		1,390
Japanese yen (0.3%)	2022–2026		1,349		1,339
Other (4.1%)	2020–2022		288		375
		$	61,170	$	62,003
Finance lease obligations (2.4%)	2021–2030		246		204
		$	61,417	$	62,207
Less: net unamortized discount			881		881
Less: net unamortized debt issuance costs			151		142
Add: fair value adjustment**			491		440
		$	60,875	$	61,624
Less: current maturities			8,190		7,522
Total		$	52,685	$	54,102

* Includes notes, debentures, bank loans and secured borrowings.

Table of Contents

Notes to Consolidated Financial Statements — (continued)

In the first half of 2019, the company ~~completed~~issued an aggregate of $20 billion of U.S. dollar fixed- and floating-rate notes and $5.7 billion of Euro fixed-rate notes. The proceeds were primarily used for the acquisition of ~~all~~Red Hat. For additional information on this transaction, refer to note 5, “Acquisitions & Divestitures.” In the first quarter of 2020, the company issued an aggregate of $4.1 billion of Euro fixed-rate notes and the proceeds were primarily used to early redeem outstanding fixed-rate debt which was due in 2021 in the aggregate amount of $2.9 billion. The notes were redeemed at a price equal to 100 percent of the aggregate principal plus a make-whole premium and accrued interest. The company incurred a loss of $49 million upon redemption that was recorded in other (income) and expense in the Consolidated Income Statement.

Pre-swap annual contractual obligations of long-term debt outstanding ~~shares~~at March 31, 2020, are as follows:


(Dollars in millions)	Total
Remainder of 2020	$	5,731
2021		6,897
2022		7,180
2023		5,342
2024		6,302
Thereafter		29,964
Total	$	61,417

Interest on Debt


(Dollars in millions)
For the three months ended March 31:	2020		2019
Cost of financing	$	119	$	179
Interest expense		326		210
Interest capitalized		5		2
Total interest paid and accrued	$	449	$	391

Lines of ~~Red Hat. Red Hat’s portfolio~~Credit

IBM has a $10.25 billion Five-Year Credit Agreement with a maturity date of ~~open-source technologies, innovative cloud development platform~~July 20, 2024. In addition, the company and ~~developer community, combined~~IBM Credit LLC have a $2.5 billion 364-day Credit Agreement and a $2.5 billion Three-Year Credit Agreement, with ~~IBM’s innovative hybrid cloud technology, industry expertise~~maturity dates of July 16, 2020 and commitment to data, trust and security, will deliver the hybrid multicloud capabilities required to address the next chapter of cloud implementations as well as accelerate the company’s growth. Red Hat’s business model is based upon open-source software, which is an alternative to proprietary software in relation to the development and licensing of commercial software code. For Red Hat’s open-source software subscriptions, 0 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.July 20, 2022, respectively.

OnAt March 31, 2020, there were 0 borrowings by the ~~acquisition date, Red Hat shareholders received $190 per share~~company, or its subsidiaries, under these credit facilities.

12. Commitments:

Table of Contents

Notes to Consolidated Financial Statements — (continued)

future financing to its clients in ~~cash, representing~~connection with client purchase agreements for $6.0 billion and $6.3 billion at March 31, 2020 and December 31, 2019, respectively. Effective January 1, 2020, the company adopted the new standard on credit losses, which resulted in the recognition of a ~~total equity value of approximately $34 billion. The company funded the transaction through a combination of cash on hand and proceeds from debt issuances.~~related allowance for non-cancellable off-balance sheet commitments. Refer to note ~~13, “Borrowings”~~2, “Accounting Changes,” for additional ~~details~~information. The allowance for these commitments is recorded in other liabilities in the Consolidated Balance Sheet and was not material at March 31, 2020. The company collectively evaluates the allowance for these arrangements using a provision methodology consistent with the portfolio of the commitments. Refer to note 8, “Financing Receivables,” for additional information.

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 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 ~~financing~~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 ~~transaction.~~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.

Standard Warranty Liability


(Dollars in millions)	2020		2019
Balance at January 1	$	113	$	118
Current period accruals		20		19
Accrual adjustments to reflect actual experience		(6)		(1)
Charges incurred		(26)		(29)
Balance at March 31	$	100	$	107

Total
(Dollars in millions)

Consideration
Cash paid for outstanding Red Hat common stock

$
33,769
Cash paid for Red Hat equity awards

24
Cash paid to settle warrants

1,008
Cash consideration

$
34,801
Fair value of stock-based compensation awards attributable to pre-combination services

174
Stock issued to holders of vested performance share units

45
Settlement of pre-existing relationships

60
Total consideration

$
35,079

~~The following table reflects the preliminary purchase price allocation as of the acquisition date.~~

(Dollars in millions)

Life (in years)

Amount
Current assets*

$
3,190
Property, plant and equipment/noncurrent assets

955
Intangible assets:

Goodwill

N/A

23,102
Client relationships

10

7,215
Completed technology

9

4,571
Trademarks

20

1,686
Total assets acquired

$
40,719
Current liabilities**

1,378
Noncurrent liabilities

4,262
Total liabilities assumed

$
5,640
Total purchase price

$
35,079

*	~~Includes $2.2 billion of cash and cash equivalents.~~

Includes $485 million of short-term debt related to the convertible notes acquired from Red Hat that were recognized at their fair value on the acquisition date, of which $50 million is included in the company’s Consolidated Statement of Financial Position as of September 30, 2019. This remaining balance was settled on October 1, 2019.

~~N/A – Not applicable~~

The goodwill generated is primarily attributable to the assembled workforce of Red Hat and the increased synergies expected to be achieved from the integration of Red Hat products into the company’s various integrated solutions, neither of which qualify as an amortizable intangible asset.

The overall weighted-average useful life of the identified amortizable intangible assets acquired is 10.9 years. These identified intangible assets will be amortized on a straight-line basis over their useful lives, which approximates the

5031

Table of Contents

Notes to Consolidated Financial Statements — (continued)

~~pattern~~Extended Warranty Liability


(Dollars in millions)	2020		2019
Balance at January 1	$	477	$	533
Revenue deferred for new extended warranty contracts		40		36
Amortization of deferred revenue		(57)		(64)
Other*		(13)		(3)
Balance at March 31	$	447	$	503
Current portion	$	219	$	242
Noncurrent portion	$	228	$	261

* Other primarily consists of foreign currency translation adjustments.

13.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 ~~assets’ economic benefits are expected~~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 ~~consumed over time. Goodwill~~subject to claims challenging its IP rights and associated products and offerings, including claims of ~~$23.1 billion has been assigned~~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 ~~segments~~company’s pension, retirement and other benefit plans), as ~~follows: Cloud & Cognitive Software $18.4 billion, Global Technology Services $3.1 billion, Global Business Services $1.1 billion,~~well as actions with respect to contracts, product liability, securities, foreign operations, competition law and ~~Systems $0.5 billion. It is expected that 6 percent~~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 ~~goodwill will be deductible for tax purposes.~~

The valuation of the assets acquired and liabilities assumed is preliminary and subject to revision as more detailed analyses are completed. If additional information about the fair value of assets acquired and liabilities assumed becomes available, the company may further revise the preliminary purchase price allocation as soon as practical, but no later than one year from the acquisition date. Any such revisions or changes may be material.

The company recognized acquisition-related costs, such as legal and advisory fees, related to the acquisition within SG&A in the Consolidated Statement of Earnings of $98 million and $171 million for the three and nine months ending September 30, 2019, respectively. Within the amounts recognized in SG&A, $55 million represents amortized costs related to bridge term loan facility fees for the nine months ended September 30, 2019. There were 0 ~~bridge loan fees for the three months ended September 30, 2019. In addition, for the period beginning on the acquisition date through September 30, 2019, the company recognized~~ $16 million, $101 million and $68 million of compensation expense, within cost, SG&A and RD&E, respectively in the Consolidated Statement of Earnings, related to employee retention plans. The remaining compensation expense of approximately $230 million associated with the retention plans will be recognized over the remaining requisite service periods, which range from six months to three years from the acquisition date.

~~The acquisition of Red Hat settled a pre-existing vendor/customer relationship~~locations in which the company ~~had historically paid in advance for purchases of Red Hat products. Because the terms~~does business. Some of the ~~agreements were determined~~actions to ~~approximate fair value as~~which the company is party may involve particularly complex technical issues, and some actions may raise novel questions under the laws of the ~~acquisition date,~~various jurisdictions in which these matters arise.

In accordance with the relevant accounting guidance, the company ~~did not recognize any gain or~~provides disclosures of matters for which the likelihood of material loss ~~separately from~~is at least reasonably possible. In addition, the ~~acquisition,~~company also discloses matters based on its consideration of other matters and ~~$60 million was included as part~~qualitative factors, including the experience of other companies in the industry, and investor, customer and employee relations considerations.

With respect to certain of the ~~fair value~~claims, suits, investigations and proceedings discussed herein, the company believes at this time that the likelihood of ~~consideration transferred on the acquisition date.~~

The Consolidated Statement of Earnings includes revenue and a pre-tax loss attributable to Red Hat since the date of acquisition for both the three and nine months ended September 30, 2019 of $371 million and $981 million, respectively. The pre-taxany material loss is ~~primarily driven by~~remote, given, for example, the ~~deferred revenue fair value adjustment, retention expenses, intangible asset amortization and deal fees. It excludes interest expense.~~

~~The following table presents~~procedural status, court rulings, and/or the ~~supplemental consolidated financial results~~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 ~~on an unaudited pro forma basis, as~~is unable to provide estimates of reasonably possible losses or range of losses, including losses in excess of amounts accrued, if any, for the ~~acquisition had been consummated on January 1, 2018 through~~following reasons. Claims, suits, investigations and proceedings are inherently uncertain, and it is not possible to predict the periods shown below. The primary adjustments reflected in the pro forma results relate to: (1) the debt used to fund the acquisition, (2) changes driven by acquisition accounting, including amortization of intangible assets and the deferred revenue fair value adjustment, (3) employee retention plans, (4) elimination of intercompany transactions between IBM and Red Hat, and (5) the presentation of acquisition-related costs. Acquisition-related costs are non-recurring in nature and the pro forma net income amounts shown below include $356 millionultimate outcome of these ~~costs.~~

~~The unaudited pro forma financial information presented below does not purport~~matters. It is the company’s experience that damage amounts claimed in litigation against it are unreliable and unrelated to ~~represent the actual results of operations that IBM~~possible outcomes, and Red Hat would have achieved had the companies been combined during the periods presented and is not intended to project the future results of operations that the combined company may achieve after the acquisition. Historical fiscal periodsas such are not aligned under this presentation. The unaudited pro forma financial information does not reflect any potential cost savings, operating efficiencies, long-term debt pay down estimates, suspension of IBM’s share repurchase program, financial synergies or other strategic benefits that may be realized as a resultmeaningful indicators of the ~~acquisition~~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 ~~also does not reflect any restructuring costs to achieve those benefits.~~

(Unaudited)

Three Months Ended September 30,

Nine Months Ended September 30,
(Dollars in millions)

2019

2018

2019

2018
Revenue

$
18,567

$
19,236

$
57,424

$
58,987
Net income

$
2,249

$
2,079

$
5,664

$
4,278

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

5132

Table of Contents

Notes to Consolidated Financial Statements — (continued)

~~Divestitures~~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.

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

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

The company is a defendant in an action filed on March 6, 2003 in state court in Salt Lake City, Utah by the SCO Group (SCO v. IBM). The company removed the case to Federal Court in Utah. Plaintiff is an alleged successor in interest to some of AT&T’s UNIX IP rights, and alleges copyright infringement, unfair competition, interference with contract and breach of contract with regard to the company’s distribution of AIX and Dynix and contribution of code to Linux and the company has asserted counterclaims. On September 14, 2007, plaintiff filed for bankruptcy protection, and all proceedings in this case were stayed. The court in another suit, the SCO Group, Inc. v. Novell, Inc., held a trial in March 2010. The jury found that Novell is the owner of UNIX and UnixWare copyrights; the judge subsequently ruled that SCO is obligated to recognize Novell’s waiver of SCO’s claims against IBM ~~Software Products~~ –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 1 of SCO’s remaining claims, which was remanded to the Federal Court in Utah.

In May 2015, a putative class action was commenced in the United States District Court for the Southern District of New York related to the company’s October 2014 announcement that it was divesting its global commercial semiconductor technology business, alleging violations of the Employee Retirement Income Security Act (ERISA). Management’s Retirement Plans Committee and 3 current or former IBM executives are named as defendants. On September 29, 2017, the Court granted the defendants’ motion to dismiss the first amended complaint. On December 6,10, 2018, ~~IBM~~the Second Circuit Court of Appeals reversed the District Court order. On January 14, 2020, the Supreme Court of the United States vacated the decision and ~~HCL Technologies Limited (HCL) announced~~remanded the case to the Second Circuit.

Table of Contents

Notes to Consolidated Financial Statements — (continued)

14. Equity Activity:

Reclassifications and Taxes Related to Items of Other Comprehensive Income


(Dollars in millions)	Before Tax		Tax (Expense)/		Net of Tax
For the three months ended March 31, 2020:	Amount		Benefit		Amount
Other comprehensive income/(loss):
Foreign currency translation adjustments	$	(919)	$	(122)	$	(1,041)
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	$	(180)	$	45	$	(135)
Reclassification of (gains)/losses to:
Cost of services		(10)		2		(7)
Cost of sales		(9)		2		(6)
Cost of financing		8		(2)		6
SG&A expense		(10)		2		(7)
Other (income) and expense		89		(22)		67
Interest expense		22		(5)		16
Total unrealized gains/(losses) on cash flow hedges	$	(90)	$	23	$	(67)
Retirement-related benefit plans (1):
Prior service costs/(credits)	$	(4)	$	1	$	(3)
Net (losses)/gains arising during the period		8		(2)		6
Curtailments and settlements		8		(3)		6
Amortization of prior service (credits)/costs		1		1		1
Amortization of net (gains)/losses		570		(157)		412
Total retirement-related benefit plans	$	582	$	(160)	$	422
Other comprehensive income/(loss)	$	(427)	$	(260)	$	(686)

(1)	These accumulated other comprehensive income/ (AOCI) components are included in the computation of net periodic pension cost. Refer to note 17, “Retirement-Related Benefits,” for additional information.

Table of Contents

Notes to Consolidated Financial Statements — (continued)

Reclassifications and Taxes Related to Items of Other Comprehensive Income


(Dollars in millions)	Before Tax		Tax (Expense)/		Net of Tax
For the three months ended March 31, 2019:	Amount		Benefit		Amount
Other comprehensive income/(loss):
Foreign currency translation adjustments	$	171	$	0	$	172
Net changes related to available-for-sale securities:
Unrealized gains/(losses) arising during the period	$	(1)	$	0	$	(1)
Reclassification of (gains)/losses to other (income) and expense		—		—		—
Total net changes related to available-for-sale securities	$	(1)	$	0	$	(1)
Unrealized gains/(losses) on cash flow hedges:
Unrealized gains/(losses) arising during the period	$	(352)	$	84	$	(268)
Reclassification of (gains)/losses to:
Cost of services		(10)		3		(7)
Cost of sales		(18)		5		(13)
Cost of financing		29		(7)		22
SG&A expense		(22)		6		(16)
Other (income) and expense		87		(22)		65
Interest expense		33		(8)		24
Total unrealized gains/(losses) on cash flow hedges	$	(254)	$	61	$	(193)
Retirement-related benefit plans (1):
Net (losses)/gains arising during the period	$	(4)	$	1	$	(2)
Curtailments and settlements		1		0		1
Amortization of prior service (credits)/costs		(3)		1		(2)
Amortization of net (gains)/losses		464		(130)		334
Total retirement-related benefit plans	$	458	$	(128)	$	330
Other comprehensive income/(loss)	$	375	$	(67)	$	308

(1)	These AOCI components are included in the computation of net periodic pension cost. Refer to note 17, “Retirement-Related Benefits,” for additional information.

Table of Contents

Notes to Consolidated Financial Statements — (continued)

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


					Net Change		Net Unrealized
	Net Unrealized		Foreign		Retirement-		Gains/(Losses)		Accumulated
	Gains/(Losses)		Currency		Related		on Available-		Other
	on Cash Flow		Translation		Benefit		For-Sale		Comprehensive
(Dollars in millions)	Hedges		Adjustments*		Plans		Securities		Income/(Loss)
January 1, 2020	$	(179)	$	(3,700)	$	(24,718)	$	0	$	(28,597)
Other comprehensive income before reclassifications		(135)		(1,041)		3		0		(1,174)
Amount reclassified from accumulated other comprehensive income		68		—		419		—		488
Total change for the period	$	(67)	$	(1,041)	$	422	$	0	$	(686)
March 31, 2020	$	(246)	$	(4,741)	$	(24,296)	$	0	$	(29,283)

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


					Net Change		Net Unrealized
	Net Unrealized		Foreign		Retirement-		Gains/(Losses)		Accumulated
	Gains/(Losses)		Currency		Related		on Available-		Other
	on Cash Flow		Translation		Benefit		For-Sale		Comprehensive
(Dollars in millions)	Hedges		Adjustments*		Plans		Securities		Income/(Loss)
January 1, 2019	$	284	$	(3,690)	$	(26,083)	$	0	$	(29,490)
Other comprehensive income before reclassifications		(268)		172		(2)		(1)		(99)
Amount reclassified from accumulated other comprehensive income		75		—		333		—		407
Total change for the period	$	(193)	$	172	$	330	$	(1)	$	308
March 31, 2019	$	90	$	(3,519)	$	(25,753)	$	(1)	$	(29,182)

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

15. 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 ~~HCL~~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.

In the Consolidated Balance Sheet, the company does not offset derivative assets against liabilities in master netting arrangements nor does it offset receivables or payables recognized upon payment or receipt of cash collateral against the fair values of the related derivative instruments. The amount recognized in accounts payable for the obligation to return cash collateral at March 31, 2020 was $2 million and 0 amount was recognized at December 31, 2019. NaN amount was recognized in other accounts receivable for the right to reclaim cash collateral at March 31, 2020 and $26 million was recognized at December 31, 2019. The company restricts the use of cash collateral received to rehypothecation, and therefore reports it in restricted cash in the Consolidated Balance Sheet. NaN amount was rehypothecated at March 31, 2020 and December 31, 2019. Additionally, if derivative exposures covered by a qualifying master netting agreement had been netted in the Consolidated Balance Sheet at March 31, 2020 and December 31, 2019, the total derivative asset and liability positions each would ~~acquire select standalone Cloud & Cognitive Software products~~have been reduced by $249 million and $194 million, respectively.

Table of Contents

Notes to Consolidated Financial Statements — (continued)

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

Interest Rate Risk

Fixed and Variable Rate Borrowings

The company issues debt in the global capital markets to fund its operations and financing business. Access to cost-effective financing can result in interest rate mismatches with the underlying assets. To manage these mismatches and to reduce overall interest cost, the company may use interest-rate swaps to convert specific fixed-rate debt issuances into variable-rate debt (i.e., fair value hedges) and to convert specific variable-rate debt issuances into fixed-rate debt (i.e., cash flow hedges). At March 31, 2020 and December 31, 2019, the total notional amount of the company’s interest-rate swaps was $3.0 billion at both periods. The weighted-average remaining maturity of these instruments at March 31, 2020 and December 31, 2019 was approximately 1.9 years and 2.2 years, respectively. These interest-rate contracts were accounted for ~~$1,775~~as fair value hedges. The company did not have any cash flow hedges relating to this program outstanding at March 31, 2020 and December 31, 2019.

Forecasted Debt Issuance

The company is exposed to interest rate volatility on future debt issuances. To manage this risk, the company may use instruments such as forward starting interest-rate swaps to lock in the rate on the interest payments related to the forecasted debt issuances. In the second quarter of 2019, the company issued an aggregate of $20 billion of indebtedness (refer to note 11, “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. There were 0 instruments outstanding at March 31, 2020 and December 31, 2019.

In connection with cash flow hedges of forecasted interest payments related to the company's borrowings, the company recorded net losses of $188 million ~~inclusive~~and net losses of ~~$150~~$192 million (before taxes) at March 31, 2020 and December 31, 2019, respectively, in AOCI. The company estimates that $18 million (before taxes) of ~~contingent consideration.~~the deferred net losses on derivatives in AOCI at March 31, 2020 will be reclassified to net income within the next 12 months, providing an offsetting economic impact against the underlying interest payments.

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. At March 31, 2020 and December 31, 2019, the carrying value of debt designated as hedging instruments was $16.7 billion and $7.3 billion, respectively. The ~~software products in-scope included AppScan, BigFix, Unica, Commerce, Portal,~~ $9.4 billion increase is part of the company’s risk management strategy and is primarily due to the designation of new debt issuances and previously hedged Euro denominated debt. The company also uses cross-currency swaps and foreign exchange forward contracts for this risk management purpose. At March 31, 2020 and December 31, 2019, the total notional amount of derivative instruments designated as net investment hedges was $8.4 billion and $7.9 billion, respectively. At March 31, 2020 and December 31, 2019, the weighted-average remaining maturity of these instruments was approximately 0.2 years and 0.1 years, respectively.

Table of Contents

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

Anticipated Royalties and ~~Connections.~~ Cost Transactions

The ~~transaction included commercial software, intellectual property~~company’s operations generate significant nonfunctional currency, third-party vendor payments and intercompany payments for royalties and goods and services ~~offerings.~~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 remaining length of time over which the company hedged its exposure is approximately four years. At March 31, 2020 and December 31, 2019, the total notional amount of forward contracts designated as cash flow hedges of forecasted royalty and cost transactions was $9.6 billion and $9.7 billion, respectively. At March 31, 2020 and December 31, 2019, the weighted-average remaining maturity of these instruments was approximately 0.7 years and 0.8 years, respectively.

Foreign Currency Denominated Borrowings

The company is exposed to exchange rate volatility on foreign currency denominated debt. To manage this risk, the company employs cross-currency swaps to convert fixed-rate foreign currency denominated debt to fixed-rate debt denominated in the functional currency of the borrowing entity. These swaps are accounted for as cash flow hedges. At March 31, 2020, the maximum length of time remaining over which the company hedged its exposure is approximately eight years. At March 31, 2020 and December 31, 2019, the total notional amount of cross-currency swaps designated as cash flow hedges of foreign currency denominated debt was $2.4 billion and $8.2 billion, respectively. The $5.7 billion decrease in cross-currency swaps is part of the company’s risk management strategy and the previously hedged foreign currency denominated debt has been designated as a hedge of net investment in foreign subsidiaries.

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 ~~transaction includes transition services for IT~~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 ~~other services.~~liabilities. The ~~initial~~ terms of ~~the transition services~~these forward and swap contracts are generally less than one ~~year, however, HCL can renew certain services up to an additional~~ year.

The ~~transaction closed on June 30, 2019. The company received cash~~changes in the fair values of ~~$812 million at closing~~these contracts and ~~$40 million~~ of the contingent consideration in the third quarter of 2019. The company expects to receive an additional $813 million (net of any additional contingent consideration) within 12 months of closing. The outstanding contingent consideration is expected to be earned within 24 months of the closing. The company recognized a pre-tax gain on the sale of $556 million on June 30, 2019, which wasunderlying hedged exposures are generally offsetting and are recorded in other (income) and expense in the Consolidated ~~Statement~~Income Statement. At March 31, 2020 and December 31, 2019, the total notional amount of ~~Earnings. Due to changes~~derivative instruments in ~~transaction estimates, the company recognized an additional pre-tax gain~~economic hedges of $72 million in the third quarter of 2019. 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.foreign currency exposure was $4.3 billion and $7.1 billion, respectively.

~~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.Equity Risk ManagementThe transaction included commercial software and services offerings. In addition, the company started providing Centerbridge with transition services including IT, supply chain management, and other services. Upon closing, Centerbridge announced that this business would be re-branded under the name Acoustic. The closing completed for the U.S. on June 30, 2019. The company expects a subsequent closing for the remaining countries to occur within 12 months of the U.S. closing. The timing of the subsequent closing is subject to change as more information becomes available. The company received a net cash payment of $240 million on June 30, 2019 and expects to receive an additional $150 million within 36 months of the U.S. closing.

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

~~Seterus~~ ~~– On January 3, 2019, IBM~~market price changes in certain broad market indices and ~~Mr. Cooper Group announced a definitive agreement, in which Mr. Cooper Group acquired IBM’s Seterus home mortgage servicing platform business. The transaction closed~~ in the ~~first quarter of 2019. The financial terms~~company’s own stock primarily related to ~~this transaction were~~certain obligations to employees. Changes in the overall value of these employee compensation obligations are recorded in SG&A expense in the Consolidated Income Statement. Although not ~~material.~~

~~The above 3 divested businesses are reported in other – divested businesses. Refer to note 8, “Segments,” for additional information.~~

~~Others~~ ‒ ~~In addition to the above,~~designated as accounting hedges, the company ~~completed or signed~~utilizes derivatives, including equity swaps and futures, to economically hedge the ~~following divestitures:~~

~~2019~~ – In the first quarter of 2019, the Global Financing segment sold certain commercial financing capabilities and assigned a number of its commercial financing contracts, excluding related receivables which will be collected as they become due in the normal course of business. In the third quarter of 2019, IBM completed 1 divestiture in the Global Business Services segment and entered into a definitive agreement to sell select assets reported in the Cloud & Cognitive Software segment. The financial terms related to each of these transactions were not material.

5238

Table of Contents

Notes to Consolidated Financial Statements — (continued)

~~12.~~Cumulative Basis Adjustments for Fair Value Hedges

At March 31, 2020 and December 31, 2019, the following amounts were recorded in the Consolidated Balance Sheet related to cumulative basis adjustments for fair value hedges:


	March 31,			December 31,
(Dollars in millions)	2020			2019
Short-term debt:
Carrying amount of the hedged item	$	(1,314)		$	—
Cumulative hedging adjustments included in the carrying amount - assets/(liabilities)		(15)			—
Long-term debt:
Carrying amount of the hedged item	$	(2,147)		$	(3,411)
Cumulative hedging adjustments included in the carrying amount - assets/(liabilities)		(475)	(1)		(440)	(1)

(1)	Includes ($391) million and ($404) million of hedging adjustments on discontinued hedging relationships at March 31, 2020 and December 31, 2019, respectively.

The Effect of Derivative Instruments in the Consolidated Income Statement


						Gains/(Losses) of
(Dollars in millions)	Total					Total Hedge Activity
For the three months ended March 31:	2020		2019			2020		2019
Cost of services	$	7,843	$	8,272	*	$	10	$	10
Cost of sales		1,624		1,603	*		9		18
Cost of financing		181		264			3		(18)
SG&A expense		5,955		4,691			(191)		141
Other (income) and expense		182		(73)			(101)		(69)
Interest expense		326		210			10		(20)

* Reclassified to conform to current period presentation.

Table of Contents

Notes to Consolidated Financial Statements — (continued)


	Gain (Loss) Recognized in Consolidated Income Statement
	Consolidated	Recognized on				Attributable to Risk
(Dollars in millions)	Income Statement	Derivatives				Being Hedged (2)
For the three months ended March 31:	Line Item	2020		2019		2020		2019
Derivative instruments in fair value hedges (1):
Interest rate contracts	Cost of financing	$	18	$	36	$	(13)	$	(33)
	Interest expense		49		39		(37)		(36)
Derivative instruments not designated as hedging instruments:
Foreign exchange contracts	Other (income) and expense		(11)		18		N/A		N/A
Equity contracts	SG&A expense		(201)		119		N/A		N/A
Total		$	(146)	$	212	$	(50)	$	(69)


	Gain (Loss) Recognized in Consolidated Income Statement and Other Comprehensive Income
(Dollars in millions)					Consolidated	Reclassified				Amounts Excluded from
For the three months	Recognized in OCI				Income Statement	from AOCI				Effectiveness Testing (3)
ended March 31:	2020		2019		Line Item	2020		2019		2020		2019
Derivative instruments in cash flow hedges:
Interest rate contracts	$	—	$	(171)	Cost of financing	$	(1)	$	—	$	—	$	—
					Interest expense		(3)		—		—		—
Foreign exchange contracts		(180)		(181)	Cost of services		10		10		—		—
					Cost of sales		9		18		—		—
					Cost of financing		(7)		(29)		—		—
					SG&A expense		10		22		—		—
					Other (income) and expense		(89)		(87)		—		—
					Interest expense		(18)		(33)		—		—
Instruments in net investment hedges (4):
Foreign exchange contracts		485		19	Cost of financing		—		—		7		8
					Interest expense		—		—		20		9
Total	$	304	$	(333)		$	(91)	$	(98)	$	27	$	17

(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

Table of Contents

Notes to Consolidated Financial Statements — (continued)

16. ~~Intangible Assets Including Goodwill:~~Stock-Based Compensation:


(Dollars in millions)
For the three months ended March 31:	2020		2019
Cost	$	27	$	20
Selling, general and administrative		117		74
Research, development and engineering		45		19
Pre-tax stock-based compensation cost	$	189	$	113
Income tax benefits		(45)		(25)
Total net stock-based compensation cost	$	144	$	88

Total unrecognized compensation cost related to non-vested awards at March 31, 2020 was $1.2 billion and is expected to be recognized over a weighted-average period of approximately 2.5 years.

Capitalized stock-based compensation cost was not material at March 31, 2020 and 2019.

17. Retirement-Related Benefits:


					Yr. to Yr.
(Dollars in millions)					Percent
For the three months ended March 31:	2020		2019		Change
Retirement-related plans — cost
Defined benefit and contribution pension plans — cost	$	584	$	437	33.7	%
Nonpension postretirement plans — cost		52		54	(4.1)
Total	$	636	$	491	29.5	%

Table of Contents

Notes to Consolidated Financial Statements — (continued)

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

Cost/(Income) of Pension Plans


(Dollars in millions)	U.S. Plans				Non-U.S. Plans
For the three months ended March 31:	2020		2019		2020		2019
Service cost	$	—	$	—	$	95	$	93
Interest cost (1)		375		472		129		208
Expected return on plan assets (1)		(542)		(650)		(309)		(399)
Amortization of prior service costs/(credits) (1)		4		4		(5)		(6)
Recognized actuarial losses (1)		207		140		342		314
Curtailments and settlements (1)		—		—		8		1
Multi-employer plans		—		—		7		9
Other costs/(credits) (1)		—		—		5		5
Total net periodic pension (income)/cost of defined benefit plans	$	44	$	(34)	$	274	$	223
Cost of defined contribution plans		155		149		110		98
Total defined benefit and contribution pension plans cost recognized in the Consolidated Income Statement	$	199	$	115	$	385	$	322

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

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

Intangible Assets

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


							At March 31, 2020
	At September 30, 2019						Gross Carrying		Accumulated		Net Carrying
(Dollars in millions)	Gross Carrying		Accumulated		Net Carrying		Amount		Amortization		Amount*
Intangible asset class	Amount		Amortization		Amount
Capitalized software	$	1,686	$	(702)	$	985	$	1,760	$	(764)	$	997
Client relationships		8,996		(1,312)		7,684		8,854		(1,669)		7,185
Completed technology		6,413		(1,386)		5,027		6,225		(1,566)		4,658
Patents/trademarks		2,291		(401)		1,890		2,287		(483)		1,804
Other*		56		(29)		26
Other**								56		(33)		22
Total	$	19,443	$	(3,830)	$	15,613	$	19,181	$	(4,515)	$	14,666


	At December 31, 2019
	Gross Carrying		Accumulated		Net Carrying
(Dollars in millions)	Amount		Amortization		Amount*
Intangible asset class
Capitalized software	$	1,749	$	(743)	$	1,006
Client relationships		8,921		(1,433)		7,488
Completed technology		6,261		(1,400)		4,861
Patents/trademarks		2,301		(445)		1,856
Other**		56		(31)		24
Total	$	19,287	$	(4,052)	$	15,235

* ~~Other intangibles are primarily acquired proprietary~~Amounts as of March 31, 2020 and ~~non-proprietary business processes, methodologies~~December 31, 2019 include a decrease in net intangible asset balances of $92 million and ~~systems~~$42 million, respectively, due to foreign currency translation.

At December 31, 2018
(Dollars in millions)

Gross Carrying

Accumulated

Net Carrying
Intangible asset class

Amount

Amortization

Amount
Capitalized software

$
1,568

$
(629)

$
939
Client relationships

2,068

(1,123)

945
Completed technology

2,156

(1,296)

860
Patents/trademarks

641

(330)

311
Other*

56

(23)

32
Total

$
6,489

$
(3,402)

$
3,087

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

The net carrying amount of intangible assets ~~increased $12,526~~decreased $569 million during the first ~~nine~~three months of ~~2019,~~2020, primarily due to ~~the acquisition of Red Hat, partially offset by~~ intangible asset amortization. Intangible assets of $13,472 million generated from the acquisition of Red Hat have been assigned to the segments as follows: Cloud & Cognitive Software $10,729 million, Global Technology Services $1,819 million, Global Business Services $617 million and Systems $306 million. For additional information on the acquisition of Red Hat, see note 11, “Acquisitions/Divestitures.”

The aggregate intangible amortization expense was ~~$614~~$622 million and ~~$1,224~~$303 million for the ~~third~~first quarter ended March 31, 2020 and ~~first nine months~~2019, respectively. The increase in intangible amortization expense was primarily due to an increase in the gross carrying amount of ~~2019, respectively, versus $348 million and $1,031 million for~~intangible assets from the Red Hat acquisition which closed in the third quarter ~~and~~of 2019. In addition, in the first ~~nine~~three months of ~~2018, respectively. In the first nine months of 2019,~~2020, the company retired ~~$543~~$154 million of fully amortized intangible assets, impacting both the gross carrying amount and accumulated amortization by this amount. ~~In addition,~~

The future amortization expense relating to intangible assets currently recorded in the ~~first nine months of 2019,~~Consolidated Balance Sheet is estimated to be the ~~company divested select intangible assets with a gross carrying amount of $317 million and $253 million of accumulated amortization.~~following at March 31, 2020:


	Capitalized		Acquired
(Dollars in millions)	Software		Intangibles		Total
Remainder of 2020	$	415	$	1,372	$	1,787
2021		399		1,738		2,137
2022		170		1,676		1,846
2023		12		1,363		1,375
2024		0		1,313		1,313
Thereafter		—		6,208		6,208

5327

Table of Contents

Notes to Consolidated Financial Statements — (continued)

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 30, 2019:

Capitalized

Acquired



(Dollars in millions)

Software

Intangibles

Total
2019 (for Q4)

$
149

$
473

$
623
2020

471

1,850

2,321
2021

296

1,745

2,041
2022

66

1,681

1,748
2023

1

1,367

1,368

Goodwill

The ~~change~~changes in the goodwill balances by segment, for the ~~nine~~three months ended ~~September 30, 2019~~March 31, 2020 and for the year ended December 31, ~~2018~~2019 are as follows:


									Foreign												Foreign
									Currency												Currency
					Purchase				Translation								Purchase				Translation
(Dollars in millions)	Balance		Goodwill		Price				And Other		Balance		Balance		Goodwill		Price				And Other		Balance
Segment	1/1/2019		Additions		Adjustments		Divestitures		Adjustments*		9/30/2019		1/1/2020		Additions		Adjustments		Divestitures		Adjustments**		3/31/2020
Cloud & Cognitive Software	$	24,594	$	18,399	$	0	$	—	$	(174)	$	42,819	$	43,037	$	10	$	12	$	—	$	(438)	$	42,620
Global Business Services		4,711		1,059		1		(1)		(76)		5,694		5,775		—		—		—		(102)		5,672
Global Technology Services		3,988		3,119		—		—		(41)		7,066		7,141		—		—		—		(167)		6,974
Systems		1,847		525		—		—		(1)		2,372		2,270		—		—		—		(19)		2,251
Other — divested businesses		1,126		—		—		(1,126)		—		—
Other—divested businesses														—		—		—		—		—		—
Total	$	36,265	$	23,102	$	1	$	(1,126)	$	(291)	$	57,951	$	58,222	$	10	$	12	$	—	$	(727)	$	57,517


									Foreign
									Currency
					Purchase				Translation
(Dollars in millions)	Balance		Goodwill		Price				And Other		Balance
Segment	1/1/2019		Additions		Adjustments		Divestitures		Adjustments**		12/31/2019
Cloud & Cognitive Software*	$	24,463	$	18,399	$	133	$	—	$	41	$	43,037
Global Business Services		4,711		1,059		1		(1)		5		5,775
Global Technology Services		3,988		3,119		—		—		34		7,141
Systems		1,847		525		(110)		—		7		2,270
Other—divested businesses*		1,256		—		—		(1,256)		—		—
Total	$	36,265	$	23,102	$	24	$	(1,257)	$	87	$	58,222

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

Foreign



Currency

Purchase

Translation

(Dollars in millions)

Balance

Goodwill

Price

And Other

Balance
Segment

1/1/2018

Additions

Adjustments

Divestitures

Adjustments**

12/31/2018
Cloud & Cognitive Software*

$
24,973

$
9

$
0

$
(1)

$
(388)

$
24,594
Global Business Services*

4,782

24

(3)

—

(92)

4,711
Global Technology Services*

4,044

—

0

—

(56)

3,988
Systems

1,862

—

0

—

(15)

1,847
Other — divested businesses*

1,127

1

0

0

(2)

1,126
Total

$
36,788

$
34

$
(3)

$
(1)

$
(553)

$
36,265

* Recast to conform to ~~2019~~2020 presentation.

** Primarily driven by foreign currency translation.

Goodwill additions recorded in the first nine months of 2019 are related to the acquisition of Red Hat during the third quarter of 2019. For additional information on this transaction, see note 11, “Acquisitions/Divestitures.”

There were 0 goodwill impairment losses recorded during the first ~~nine~~three months of ~~2019~~2020 or full year ~~2018~~2019 and the company has 0 accumulated impairment losses. As a result of the changes in the current economic environment related to the COVID-19 pandemic, the company considered whether there was a potential triggering event requiring the evaluation of whether goodwill should be tested for impairment. The company assessed the qualitative risk factors for the Systems reporting unit (given the results of the 2019 annual impairment test) and determined that it was not more likely than not that the fair value of the reporting unit was less than its carrying amount as of March 31, 2020.

Purchase price adjustments recorded in the first ~~nine~~three months of ~~2019~~2020 and ~~full year 2018~~full-year 2019 were related to acquisitions that were still subject to the measurement period that ends at the earlier of 12 months from the acquisition date or when

~~Table of Contents~~

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

information becomes available. Net purchase price adjustments recorded during the first ~~nine~~three months of ~~2019~~2020 and ~~full year 2018~~full-year 2019 were not material.

~~13.~~11. Borrowings:

Short-Term Debt


	At September 30,		At December 31,		At March 31,		At December 31,
(Dollars in millions)	2019		2018		2020		2019
Commercial paper	$	2,988	$	2,995	$	2,519	$	304
Short-term loans		395		161		934		971
Long-term debt — current maturities		5,147		7,051
Long-term debt—current maturities						8,190		7,522
Total	$	8,530	$	10,207	$	11,642	$	8,797

The weighted-average interest rate for commercial paper at September 30, 2019 and December 31, 2018 was 1.9 percent and 2.5 percent, respectively. The weighted-average interest rate for short-term loans was 2.5 percent and 4.3 percent at September 30, 2019 and December 31, 2018, respectively.

5528

Table of Contents

Notes to Consolidated Financial Statements — (continued)

Long-Term Debt

Pre-Swap Borrowing

Balance

Balance
(Dollars in millions)

Maturities

9/30/2019

12/31/2018
U.S. dollar debt (weighted-average interest rate at September 30, 2019):*






8.4%

2019

$
752

$
5,465
2.4%

2020

4,333

4,344
2.7%

2021

8,527

5,529
2.7%

2022

6,305

3,536
3.2%

2023

2,391

2,428
3.2%

2024

5,061

2,037
6.8%

2025

624

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

$
45,438

$
30,131
Other currencies (weighted-average interest rate at September 30, 2019, in parentheses):*






Euros (1.3%)

2019–2031

$
15,022

$
10,011
Pound sterling (2.7%)

2020–2025

1,346

1,338
Japanese yen (0.2%)

2022–2026

1,347

1,325
Other (6.2%)

2020–2022

360

391

$
63,512

$
43,196
Less: net unamortized discount



890

802
Less: net unamortized debt issuance costs



148

76
Add: fair value adjustment**



470

337

$
62,944

$
42,656
Less: current maturities



5,147

7,051
Total



$
57,797

$
35,605


		Balance		Balance
(Dollars in millions)	Maturities	3/31/2020		12/31/2019
U.S. dollar debt (weighted-average interest rate at March 31, 2020):*
2.3%	2020	$	2,766	$	4,326
2.4%	2021		5,556		8,498
2.6%	2022		6,257		6,289
3.3%	2023		2,413		2,388
3.3%	2024		5,049		5,045
6.7%	2025		645		636
3.3%	2026		4,350		4,350
4.7%	2027		969		969
6.5%	2028		313		313
3.5%	2029		3,250		3,250
5.9%	2032		600		600
8.0%	2038		83		83
4.5%	2039		2,745		2,745
4.0%	2042		1,107		1,107
7.0%	2045		27		27
4.7%	2046		650		650
4.3%	2049		3,000		3,000
7.1%	2096		316		316
		$	40,097	$	44,594
Other currencies (weighted-average interest rate at March 31, 2020, in parentheses):*
Euro (1.1%)	2020–2040	$	18,126	$	14,306
Pound sterling (2.7%)	2020–2022		1,311		1,390
Japanese yen (0.3%)	2022–2026		1,349		1,339
Other (4.1%)	2020–2022		288		375
		$	61,170	$	62,003
Finance lease obligations (2.4%)	2021–2030		246		204
		$	61,417	$	62,207
Less: net unamortized discount			881		881
Less: net unamortized debt issuance costs			151		142
Add: fair value adjustment**			491		440
		$	60,875	$	61,624
Less: current maturities			8,190		7,522
Total		$	52,685	$	54,102

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

** The portion of the company’s fixed-rate debt obligations that iswas hedged iswas reflected in the Consolidated ~~Statement of Financial Position~~Balance Sheet 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 0 debt securities issued and outstanding by IBM International Group Capital LLC, which is an indirect, 100 percent owned finance subsidiary of IBM, the parent. Any debt securities issued by IBM International Group Capital LLC would be fully and unconditionally guaranteed by the parent.

The company’s indenture governing its debt securities and its various credit facilities each contain significant covenants which obligate the company to promptly pay principal and interest, limit the aggregate amount of secured ~~indebtedness and sale and leaseback transactions to 10 percent of the company’s consolidated net tangible assets, and~~

5629

Table of Contents

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.

~~On May 15,~~In the first half of 2019, the company issued an aggregate of $20 billion of ~~indebtedness in the following 8 tranches: $1.5~~U.S. dollar fixed- and floating-rate notes and $5.7 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.Euro fixed-rate notes. The proceeds ~~from these debt issuances~~ were primarily used for the acquisition of Red Hat. For additional information on this transaction, ~~see~~refer to note ~~11, “Acquisitions/~~5, “Acquisitions & Divestitures.”

~~Additionally, the long-term debt table above includes Euro bonds that were issued in~~ In the first quarter of ~~2019~~2020, the company issued an aggregate of $4.1 billion of Euro fixed-rate notes and the proceeds were primarily used to ~~partially finance~~early redeem outstanding fixed-rate debt which was due in 2021 in the ~~acquisition~~aggregate amount of ~~Red Hat~~$2.9 billion. The notes were redeemed at a price equal to 100 percent of the aggregate principal plus a make-whole premium and accrued interest. The company incurred a loss of $49 million upon ~~closing.~~

redemption that was recorded in other (income) and expense in the Consolidated Income Statement.

Pre-swap annual contractual obligations of long-term debt outstanding at ~~September 30, 2019,~~March 31, 2020, are as follows:


(Dollars in millions)	Total		Total
2019 (for Q4)	$	1,949
2020		7,352
Remainder of 2020			$	5,731
2021		9,741		6,897
2022		7,121		7,180
2023		5,278		5,342
2024 and beyond		32,071
2024				6,302
Thereafter				29,964
Total	$	63,512	$	61,417

Interest on Debt


(Dollars in millions)
For the nine months ended September 30:	2019		2018
For the three months ended March 31:					2020		2019
Cost of financing	$	483	$	568	$	119	$	179
Interest expense		990		530		326		210
Interest capitalized		5		3		5		2
Total interest paid and accrued	$	1,478	$	1,101	$	449	$	391

Lines of Credit

~~On July 18, 2019, the company extended the maturity date of its existing~~IBM has a $10.25 billion Five-Year Credit ~~Agreement.~~Agreement with a maturity date of July 20, 2024. In addition, the company and IBM Credit LLC ~~entered into~~have a ~~new $2.5 billion 364-day Credit Agreement to replace the existing~~ $2.5 billion 364-day Credit Agreement and ~~also extended the maturity date of the existing~~a $2.5 billion Three-Year Credit ~~Agreement. The new~~Agreement, with maturity dates ~~for the Three-Year~~of July 16, 2020 and ~~Five-Year Credit Agreements are~~ July 20, 2022, ~~and July 20, 2024,~~ respectively. ~~Each of the facility sizes remain unchanged~~

. ~~As of September 30, 2019,~~

At March 31, 2020, there were 0 borrowings by the company, or its subsidiaries, under ~~the Credit Facilities.~~these credit facilities.

5712. Commitments:

~~Table~~The company’s extended lines of ~~Contents~~

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

~~14.~~~~Contingencies:~~

~~As a company with a substantial employee population~~third-party entities include unused amounts of $2.1 billion and ~~with clients in more than 175 countries, IBM is involved, either as plaintiff or defendant, in a variety~~$1.8 billion at March 31, 2020 and December 31, 2019, respectively. A portion of ~~ongoing claims, demands, suits, investigations, tax matters and proceedings that arise from time~~these amounts was available 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~~company’s business partners 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.~~support their working capital needs. 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~~has committed 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 30, 2019 were not material to the Consolidated Financial Statements.

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.

5830

Table of Contents

Notes to Consolidated Financial Statements — (continued)

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

The company is a defendant in an action filed on March 6, 2003 in state court in Salt Lake City, Utah by the SCO Group (SCO v. IBM). The company removed the case to Federal Court in Utah. Plaintiff is an alleged successor in interest to some of AT&T’s UNIX IP rights, and alleges copyright infringement, unfair competition, interference with contract and breach of contract with regard to the company’s distribution of AIX and Dynix and contribution of code to Linux and the company has asserted counterclaims. On September 14, 2007, plaintiff filed for bankruptcy protection, and all proceedings in this case were stayed. The court in another suit, the SCO Group, Inc. v. Novell, Inc., held a trial in March 2010. The jury found that Novell is the owner of UNIX and UnixWare copyrights; the judge subsequently ruled that SCO is obligated to recognize Novell’s waiver of SCO’s claims against IBM and Sequent for breach of UNIX license agreements. On August 30, 2011, the Tenth Circuit Court of Appeals affirmed the district court’s ruling and denied SCO’s appeal of this matter. In June 2013, the Federal Court in Utah granted SCO’s motion to reopen the SCO v. IBM case. In February ~~2016, the Federal Court ruled in favor of IBM on all of SCO’s remaining claims, and SCO appealed. On October 30, 2017, the Tenth Circuit Court of Appeals affirmed the dismissal of all but~~ ~~1 of SCO’s remaining claims, which was remanded to the Federal Court in Utah.~~

On May 13, 2010, IBM and the State of Indiana (acting on behalf of the Indiana Family and Social Services Administration) sued one another in a dispute over a 2006 contract regarding the modernization of social service program processing in Indiana. After six weeks of trial, on July 18, 2012, the Indiana Superior Court in Marion County rejected the State’s claims in their entirety and awarded IBM $52 million plus interest and costs. On February 13, 2014, the Indiana Court of Appeals reversed portions of the trial judge’s findings, found IBM in material breach, and ordered the case remanded to the trial judge to determine the State’s damages, if any. The Indiana Court of Appeals also affirmed approximately $50 million of the trial court’s award of damages to IBM. On March 22, 2016, the Indiana Supreme Court affirmed the outcome of the Indiana Court of Appeals and remanded the case to the Indiana Superior Court. On August 7, 2017, the Indiana Superior Court awarded the State $128 million, which it then offset against IBM’s previously affirmed award of $50 million, resulting in a $78 million award to the State, plus interest. On September 28, 2018, the Indiana Court of Appeals affirmed the Superior Court’s $78 million award to the State, but reversed the Superior Court by awarding IBM interest on its previously affirmed $50 million award. On June 26, 2019, the Indiana Supreme Court reversed the Court of Appeals regarding the time at which the award of interest to IBM began to run, but otherwise affirmed the Superior Court’s and the Court of Appeals’ awards. The sole matter remaining is the determination of the parties’ respective interest awards.

Following the 2017 final judgment of the Appeal Court in London holding that IBM UK acted lawfully in 2010 in closing its UK defined benefit plans to future accruals for most participants and in implementing a new retirement policy, the Employment Tribunal in Southampton UK is expected to address approximately 290 individual actions alleging constructive dismissal and age discrimination brought against IBM UK in 2010 by employees who left the company at that time. The individual actions were previously stayed. The parties have an agreement to settle substantially all of the cases.

~~Table of Contents~~

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

September 29, 2017, the Court granted the defendants’ motion to dismiss the first amended complaint. On December 10, 2018, the Second Circuit Court of Appeals reversed the District Court order. On June 3, 2019, the Supreme Court of the United States granted defendants’ request to hear the case.

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

~~15.~~ ~~Commitments:~~

The company’s extended lines of credit to third-party entities include unused amounts of $3,060 million and $7,368 million at September 30, 2019 and December 31, 2018, respectively. A portion of these amounts was available to the company’s business partners to support their working capital needs. 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 $5,003 million~~$6.0 billion and ~~$4,432 million~~$6.3 billion at ~~September 30, 2019~~March 31, 2020 and December 31, ~~2018,~~2019, respectively. Effective January 1, 2020, the company adopted the new standard on credit losses, which resulted in the recognition of a related allowance for non-cancellable off-balance sheet commitments. Refer to note 2, “Accounting Changes,” for additional information. The allowance for these commitments is recorded in other liabilities in the Consolidated Balance Sheet and was not material at March 31, 2020. The company collectively evaluates the allowance for these arrangements using a provision methodology consistent with the portfolio of the commitments. Refer to note 8, “Financing Receivables,” for additional information.

In addition, the company guarantees certain loans and financial commitments. The maximum potential future payment under these financial guarantees ~~was $23 million~~ and ~~$26 million at September 30, 2019 and December 31, 2018, respectively. The~~the fair value of ~~the~~these guarantees recognized in the Consolidated ~~Statement of Financial Position is~~Balance Sheet at March 31, 2020 and December 31, 2019 was not material.

~~Table of Contents~~

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

Changes in the company’s warranty liability for standard warranties, which are included in other accrued expenses and liabilities and other liabilities in the Consolidated Balance Sheet, and for extended warranty contracts, which are included in deferred income ~~for extended warranty~~in the Consolidated Balance Sheet, are presented in the following tables.

Standard Warranty Liability


(Dollars in millions)	2019		2018		2020		2019
Balance at January 1	$	118	$	152	$	113	$	118
Current period accruals		66		84		20		19
Accrual adjustments to reflect actual experience		(1)		(31)		(6)		(1)
Charges incurred		(86)		(93)		(26)		(29)
Balance at September 30	$	98	$	112
Balance at March 31					$	100	$	107

Table of Contents

Notes to Consolidated Financial Statements — (continued)

Extended Warranty Liability


(Dollars in millions)	2019		2018		2020		2019
Aggregate deferred revenue at January 1	$	533	$	566
Balance at January 1					$	477	$	533
Revenue deferred for new extended warranty contracts		124		138		40		36
Amortization of deferred revenue		(194)		(178)		(57)		(64)
Other*		(8)		(12)		(13)		(3)
Aggregate deferred revenue at September 30	$	455	$	514
Balance at March 31					$	447	$	503
Current portion	$	226	$	242	$	219	$	242
Noncurrent portion	$	230	$	273	$	228	$	261

* Other primarily consists of foreign currency translation adjustments.

13.Contingencies:

6132

Table of Contents

Notes to Consolidated Financial Statements — (continued)

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.

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

The company is a defendant in an action filed on March 6, 2003 in state court in Salt Lake City, Utah by the SCO Group (SCO v. IBM). The company removed the case to Federal Court in Utah. Plaintiff is an alleged successor in interest to some of AT&T’s UNIX IP rights, and alleges copyright infringement, unfair competition, interference with contract and breach of contract with regard to the company’s distribution of AIX and Dynix and contribution of code to Linux and the company has asserted counterclaims. On September 14, 2007, plaintiff filed for bankruptcy protection, and all proceedings in this case were stayed. The court in another suit, the SCO Group, Inc. v. Novell, Inc., held a trial in March 2010. The jury found that Novell is the owner of UNIX and UnixWare copyrights; the judge subsequently ruled that SCO is obligated to recognize Novell’s waiver of SCO’s claims against IBM and Sequent for breach of UNIX license agreements. On August 30, 2011, the Tenth Circuit Court of Appeals affirmed the district court’s ruling and denied SCO’s appeal of this matter. In June 2013, the Federal Court in Utah granted SCO’s motion to reopen the SCO v. IBM case. In February 2016, the Federal Court ruled in favor of IBM on all of SCO’s remaining claims, and SCO appealed. On October 30, 2017, the Tenth Circuit Court of Appeals affirmed the dismissal of all but 1 of SCO’s remaining claims, which was remanded to the Federal Court in Utah.

Table of Contents

Notes to Consolidated Financial Statements — (continued)

14. Equity Activity:

Reclassifications and Taxes Related to Items of Other Comprehensive Income


(Dollars in millions)	Before Tax		Tax (Expense)/		Net of Tax
For the three months ended March 31, 2020:	Amount		Benefit		Amount
Other comprehensive income/(loss):
Foreign currency translation adjustments	$	(919)	$	(122)	$	(1,041)
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	$	(180)	$	45	$	(135)
Reclassification of (gains)/losses to:
Cost of services		(10)		2		(7)
Cost of sales		(9)		2		(6)
Cost of financing		8		(2)		6
SG&A expense		(10)		2		(7)
Other (income) and expense		89		(22)		67
Interest expense		22		(5)		16
Total unrealized gains/(losses) on cash flow hedges	$	(90)	$	23	$	(67)
Retirement-related benefit plans (1):
Prior service costs/(credits)	$	(4)	$	1	$	(3)
Net (losses)/gains arising during the period		8		(2)		6
Curtailments and settlements		8		(3)		6
Amortization of prior service (credits)/costs		1		1		1
Amortization of net (gains)/losses		570		(157)		412
Total retirement-related benefit plans	$	582	$	(160)	$	422
Other comprehensive income/(loss)	$	(427)	$	(260)	$	(686)

(1)	These accumulated other comprehensive income/ (AOCI) components are included in the computation of net periodic pension cost. Refer to note 17, “Retirement-Related Benefits,” for additional information.

Table of Contents

Notes to Consolidated Financial Statements — (continued)

~~16.~~ ~~Earnings Per Share~~Reclassifications and Taxes Related to Items of ~~Common Stock~~Other Comprehensive Income:

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

For the Three Months Ended


September 30, 2019

September 30, 2018
Number of shares on which basic earnings per share is calculated:




Weighted-average shares outstanding during period

886,018,372

911,152,848
Add — Incremental shares under stock-based compensation plans

5,368,268

2,566,139
Add — Incremental shares associated with contingently issuable shares

1,453,105

1,493,644
Number of shares on which diluted earnings per share is calculated

892,839,745

915,212,631

Income from continuing operations (millions)

$
1,673

$
2,692
Income/(loss) from discontinued operations, net of tax (millions)

(1)

2
Net income on which basic earnings per share is calculated (millions)

$
1,672

$
2,694

Income from continuing operations (millions)

$
1,673

$
2,692
Net income applicable to contingently issuable shares (millions)

—

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

$
1,673

$
2,692
Income/(loss) from discontinued operations, net of tax, on which basic and diluted earnings per share is calculated (millions)

(1)

2
Net income on which diluted earnings per share is calculated (millions)

$
1,672

$
2,694

Earnings/(loss) per share of common stock:




Assuming dilution




Continuing operations

$
1.87

$
2.94
Discontinued operations

0.00

0.00
Total

$
1.87

$
2.94
Basic




Continuing operations

$
1.89

$
2.95
Discontinued operations

0.00

0.00
Total

$
1.89

$
2.95

Stock options to purchase 761,659 shares and 388,335 shares were outstanding as of September 30, 2019 and 2018, respectively, but were not included in the computation of diluted earnings per share because the options' exercise price during the respective period was greater than the average market price of the common shares, and, therefore, the effect would have been antidilutive.


(Dollars in millions)	Before Tax		Tax (Expense)/		Net of Tax
For the three months ended March 31, 2019:	Amount		Benefit		Amount
Other comprehensive income/(loss):
Foreign currency translation adjustments	$	171	$	0	$	172
Net changes related to available-for-sale securities:
Unrealized gains/(losses) arising during the period	$	(1)	$	0	$	(1)
Reclassification of (gains)/losses to other (income) and expense		—		—		—
Total net changes related to available-for-sale securities	$	(1)	$	0	$	(1)
Unrealized gains/(losses) on cash flow hedges:
Unrealized gains/(losses) arising during the period	$	(352)	$	84	$	(268)
Reclassification of (gains)/losses to:
Cost of services		(10)		3		(7)
Cost of sales		(18)		5		(13)
Cost of financing		29		(7)		22
SG&A expense		(22)		6		(16)
Other (income) and expense		87		(22)		65
Interest expense		33		(8)		24
Total unrealized gains/(losses) on cash flow hedges	$	(254)	$	61	$	(193)
Retirement-related benefit plans (1):
Net (losses)/gains arising during the period	$	(4)	$	1	$	(2)
Curtailments and settlements		1		0		1
Amortization of prior service (credits)/costs		(3)		1		(2)
Amortization of net (gains)/losses		464		(130)		334
Total retirement-related benefit plans	$	458	$	(128)	$	330
Other comprehensive income/(loss)	$	375	$	(67)	$	308

(1)	These AOCI components are included in the computation of net periodic pension cost. Refer to note 17, “Retirement-Related Benefits,” for additional information.

6235

Table of Contents

Notes to Consolidated Financial Statements — (continued)

For the Nine Months Ended


September 30, 2019

September 30, 2018
Number of shares on which basic earnings per share is calculated:




Weighted-average shares outstanding during period

887,291,199

915,632,501
Add — Incremental shares under stock-based compensation plans

4,007,433

3,000,429
Add — Incremental shares associated with contingently issuable shares

1,228,726

1,373,960
Number of shares on which diluted earnings per share is calculated

892,527,357

920,006,890

Income from continuing operations (millions)

$
5,766

$
6,770
Income/(loss) from discontinued operations, net of tax (millions)

(5)

7
Net income on which basic earnings per share is calculated (millions)

$
5,761

$
6,777

Income from continuing operations (millions)

$
5,766

$
6,770
Net income applicable to contingently issuable shares (millions)

0

(1)
Income from continuing operations on which diluted earnings per share is calculated (millions)

$
5,766

$
6,769
Income/(loss) from discontinued operations, net of tax, on which basic and diluted earnings per share is calculated (millions)

(5)

7
Net income on which diluted earnings per share is calculated (millions)

$
5,762

$
6,776

Earnings/(loss) per share of common stock:




Assuming dilution




Continuing operations

$
6.46

$
7.36
Discontinued operations

(0.01)

0.01
Total

$
6.45

$
7.37
Basic




Continuing operations

$
6.50

$
7.39
Discontinued operations

(0.01)

0.01
Total

$
6.49

$
7.40

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, 2020	$	(179)	$	(3,700)	$	(24,718)	$	0	$	(28,597)
Other comprehensive income before reclassifications		(135)		(1,041)		3		0		(1,174)
Amount reclassified from accumulated other comprehensive income		68		—		419		—		488
Total change for the period	$	(67)	$	(1,041)	$	422	$	0	$	(686)
March 31, 2020	$	(246)	$	(4,741)	$	(24,296)	$	0	$	(29,283)

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


					Net Change		Net Unrealized
	Net Unrealized		Foreign		Retirement-		Gains/(Losses)		Accumulated
	Gains/(Losses)		Currency		Related		on Available-		Other
	on Cash Flow		Translation		Benefit		For-Sale		Comprehensive
(Dollars in millions)	Hedges		Adjustments*		Plans		Securities		Income/(Loss)
January 1, 2019	$	284	$	(3,690)	$	(26,083)	$	0	$	(29,490)
Other comprehensive income before reclassifications		(268)		172		(2)		(1)		(99)
Amount reclassified from accumulated other comprehensive income		75		—		333		—		407
Total change for the period	$	(193)	$	172	$	330	$	(1)	$	308
March 31, 2019	$	90	$	(3,519)	$	(25,753)	$	(1)	$	(29,182)

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

~~Stock options to purchase 886,899 shares~~15. Derivative Financial Instruments:

The company operates in multiple functional currencies and ~~264,628 shares (average of first, second~~is a significant lender and ~~third quarter share amounts) were outstanding as of September 30, 2019 and 2018, respectively, but were not included~~borrower in the ~~computation~~global markets. In the normal course of ~~diluted earnings per share because~~business, the ~~options' exercise~~company is exposed to the impact of interest rate changes and foreign currency fluctuations, and to a lesser extent equity and commodity price ~~during~~changes and client credit risk. The company limits these risks by following established risk management policies and procedures, including the ~~respective period was greater than~~use of derivatives, and, where cost effective, financing with debt in the ~~average market price~~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.

In the Consolidated Balance Sheet, the company does not offset derivative assets against liabilities in master netting arrangements nor does it offset receivables or payables recognized upon payment or receipt of cash collateral against the fair values of the ~~common shares,~~related derivative instruments. The amount recognized in accounts payable for the obligation to return cash collateral at March 31, 2020 was $2 million and 0 amount was recognized at December 31, 2019. NaN amount was recognized in other accounts receivable for the right to reclaim cash collateral at March 31, 2020 and $26 million was recognized at December 31, 2019. The company restricts the use of cash collateral received to rehypothecation, and therefore reports it in restricted cash in the ~~effect~~Consolidated Balance Sheet. NaN amount was rehypothecated at March 31, 2020 and December 31, 2019. Additionally, if derivative exposures covered by a qualifying master netting agreement had been netted in the Consolidated Balance Sheet at March 31, 2020 and December 31, 2019, the total derivative asset and liability positions each would have been ~~antidilutive.~~reduced by $249 million and $194 million, respectively.

Table of Contents

Notes to Consolidated Financial Statements — (continued)

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

Interest Rate Risk

Fixed and Variable Rate Borrowings

The company issues debt in the global capital markets to fund its operations and financing business. Access to cost-effective financing can result in interest rate mismatches with the underlying assets. To manage these mismatches and to reduce overall interest cost, the company may use interest-rate swaps to convert specific fixed-rate debt issuances into variable-rate debt (i.e., fair value hedges) and to convert specific variable-rate debt issuances into fixed-rate debt (i.e., cash flow hedges). At March 31, 2020 and December 31, 2019, the total notional amount of the company’s interest-rate swaps was $3.0 billion at both periods. The weighted-average remaining maturity of these instruments at March 31, 2020 and December 31, 2019 was approximately 1.9 years and 2.2 years, respectively. These interest-rate contracts were accounted for as fair value hedges. The company did not have any cash flow hedges relating to this program outstanding at March 31, 2020 and December 31, 2019.

Forecasted Debt Issuance

The company is exposed to interest rate volatility on future debt issuances. To manage this risk, the company may use instruments such as forward starting interest-rate swaps to lock in the rate on the interest payments related to the forecasted debt issuances. In the second quarter of 2019, the company issued an aggregate of $20 billion of indebtedness (refer to note 11, “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. There were 0 instruments outstanding at March 31, 2020 and December 31, 2019.

Foreign Exchange Risk

Long-Term Investments in Foreign Subsidiaries (Net Investment)

Table of Contents

Notes to Consolidated Financial Statements — (continued)

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 remaining length of time over which the company hedged its exposure is approximately four years. At March 31, 2020 and December 31, 2019, the total notional amount of forward contracts designated as cash flow hedges of forecasted royalty and cost transactions was $9.6 billion and $9.7 billion, respectively. At March 31, 2020 and December 31, 2019, the weighted-average remaining maturity of these instruments was approximately 0.7 years and 0.8 years, respectively.

Foreign Currency Denominated Borrowings

The company is exposed to exchange rate volatility on foreign currency denominated debt. To manage this risk, the company employs cross-currency swaps to convert fixed-rate foreign currency denominated debt to fixed-rate debt denominated in the functional currency of the borrowing entity. These swaps are accounted for as cash flow hedges. At March 31, 2020, the maximum length of time remaining over which the company hedged its exposure is approximately eight years. At March 31, 2020 and December 31, 2019, the total notional amount of cross-currency swaps designated as cash flow hedges of foreign currency denominated debt was $2.4 billion and $8.2 billion, respectively. The $5.7 billion decrease in cross-currency swaps is part of the company’s risk management strategy and the previously hedged foreign currency denominated debt has been designated as a hedge of net investment in foreign subsidiaries.

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 Income Statement. At March 31, 2020 and December 31, 2019, the total notional amount of derivative instruments in economic hedges of foreign currency exposure was $4.3 billion and $7.1 billion, respectively.

Equity Risk Management

Table of Contents

Notes to Consolidated Financial Statements — (continued)

Cumulative Basis Adjustments for Fair Value Hedges

At March 31, 2020 and December 31, 2019, the following amounts were recorded in the Consolidated Balance Sheet related to cumulative basis adjustments for fair value hedges:


	March 31,			December 31,
(Dollars in millions)	2020			2019
Short-term debt:
Carrying amount of the hedged item	$	(1,314)		$	—
Cumulative hedging adjustments included in the carrying amount - assets/(liabilities)		(15)			—
Long-term debt:
Carrying amount of the hedged item	$	(2,147)		$	(3,411)
Cumulative hedging adjustments included in the carrying amount - assets/(liabilities)		(475)	(1)		(440)	(1)

(1)	Includes ($391) million and ($404) million of hedging adjustments on discontinued hedging relationships at March 31, 2020 and December 31, 2019, respectively.

The Effect of Derivative Instruments in the Consolidated Income Statement


						Gains/(Losses) of
(Dollars in millions)	Total					Total Hedge Activity
For the three months ended March 31:	2020		2019			2020		2019
Cost of services	$	7,843	$	8,272	*	$	10	$	10
Cost of sales		1,624		1,603	*		9		18
Cost of financing		181		264			3		(18)
SG&A expense		5,955		4,691			(191)		141
Other (income) and expense		182		(73)			(101)		(69)
Interest expense		326		210			10		(20)

* Reclassified to conform to current period presentation.

Table of Contents

Notes to Consolidated Financial Statements — (continued)


	Gain (Loss) Recognized in Consolidated Income Statement
	Consolidated	Recognized on				Attributable to Risk
(Dollars in millions)	Income Statement	Derivatives				Being Hedged (2)
For the three months ended March 31:	Line Item	2020		2019		2020		2019
Derivative instruments in fair value hedges (1):
Interest rate contracts	Cost of financing	$	18	$	36	$	(13)	$	(33)
	Interest expense		49		39		(37)		(36)
Derivative instruments not designated as hedging instruments:
Foreign exchange contracts	Other (income) and expense		(11)		18		N/A		N/A
Equity contracts	SG&A expense		(201)		119		N/A		N/A
Total		$	(146)	$	212	$	(50)	$	(69)


	Gain (Loss) Recognized in Consolidated Income Statement and Other Comprehensive Income
(Dollars in millions)					Consolidated	Reclassified				Amounts Excluded from
For the three months	Recognized in OCI				Income Statement	from AOCI				Effectiveness Testing (3)
ended March 31:	2020		2019		Line Item	2020		2019		2020		2019
Derivative instruments in cash flow hedges:
Interest rate contracts	$	—	$	(171)	Cost of financing	$	(1)	$	—	$	—	$	—
					Interest expense		(3)		—		—		—
Foreign exchange contracts		(180)		(181)	Cost of services		10		10		—		—
					Cost of sales		9		18		—		—
					Cost of financing		(7)		(29)		—		—
					SG&A expense		10		22		—		—
					Other (income) and expense		(89)		(87)		—		—
					Interest expense		(18)		(33)		—		—
Instruments in net investment hedges (4):
Foreign exchange contracts		485		19	Cost of financing		—		—		7		8
					Interest expense		—		—		20		9
Total	$	304	$	(333)		$	(91)	$	(98)	$	27	$	17

(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

Table of Contents

Notes to Consolidated Financial Statements — (continued)

16. Stock-Based Compensation:


(Dollars in millions)
For the three months ended March 31:	2020		2019
Cost	$	27	$	20
Selling, general and administrative		117		74
Research, development and engineering		45		19
Pre-tax stock-based compensation cost	$	189	$	113
Income tax benefits		(45)		(25)
Total net stock-based compensation cost	$	144	$	88

Total unrecognized compensation cost related to non-vested awards at March 31, 2020 was $1.2 billion and is expected to be recognized over a weighted-average period of approximately 2.5 years.

Capitalized stock-based compensation cost was not material at March 31, 2020 and 2019.

17. Retirement-Related Benefits:


					Yr. to Yr.
(Dollars in millions)					Percent
For the three months ended March 31:	2020		2019		Change
Retirement-related plans — cost
Defined benefit and contribution pension plans — cost	$	584	$	437	33.7	%
Nonpension postretirement plans — cost		52		54	(4.1)
Total	$	636	$	491	29.5	%

Table of Contents

Notes to Consolidated Financial Statements — (continued)

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

Cost/(Income) of Pension Plans


(Dollars in millions)	U.S. Plans				Non-U.S. Plans
For the three months ended March 31:	2020		2019		2020		2019
Service cost	$	—	$	—	$	95	$	93
Interest cost (1)		375		472		129		208
Expected return on plan assets (1)		(542)		(650)		(309)		(399)
Amortization of prior service costs/(credits) (1)		4		4		(5)		(6)
Recognized actuarial losses (1)		207		140		342		314
Curtailments and settlements (1)		—		—		8		1
Multi-employer plans		—		—		7		9
Other costs/(credits) (1)		—		—		5		5
Total net periodic pension (income)/cost of defined benefit plans	$	44	$	(34)	$	274	$	223
Cost of defined contribution plans		155		149		110		98
Total defined benefit and contribution pension plans cost recognized in the Consolidated Income Statement	$	199	$	115	$	385	$	322

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

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

Cost of Nonpension Postretirement Plans


(Dollars in millions)	U.S. Plan				Non-U.S. Plans
For the three months ended March 31:	2020		2019		2020		2019
Service cost	$	2	$	3	$	1	$	1
Interest cost (1)		26		36		10		12
Expected return on plan assets (1)		—		—		(1)		(1)
Amortization of prior service costs/(credits) (1)		1		(1)		0		0
Recognized actuarial losses (1)		7		1		6		3
Curtailments and settlements (1)		—		—		0		0
Total nonpension postretirement plans cost recognized in Consolidated Income Statement	$	36	$	39	$	16	$	15

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

The company does not anticipate any significant changes to the expected plan contributions in 2020 from the amounts disclosed in the 2019 Annual Report.

The table below includes contributions to the following plans:


(Dollars in millions)	Plan Contributions
For the three months ended March 31:	2020		2019
U.S. nonpension postretirement benefit plan	$	136	$	194
Non-U.S. DB and multi-employer plans		82		94
Total plan contributions	$	217	$	288

During the three months ended March 31, 2020 and 2019, $255 million and $256 million, respectively, was contributed in U.S. Treasury securities, which is considered a non-cash transaction (includes the Active Medical Trust).

Table of Contents

Notes to Consolidated Financial Statements — (continued)

18. Subsequent Events:

On ~~October 29, 2019,~~April 28, 2020, the company announced that the Board of Directors approved aan increase in the quarterly dividend ~~of $1.62~~to $1.63 per common share. The dividend is payable ~~December~~June 10, ~~2019~~2020 to shareholders of record on ~~November~~May 8, ~~2019.~~2020.

6343

Table of Contents

Item 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS

OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION

FOR THE THREE ~~AND NINE~~ MONTHS ENDED ~~SEPTEMBER 30, 2019~~MARCH 31, 2020

Snapshot

Financial Results Summary — Three Months Ended ~~September 30:~~March 31:


							Yr. to Yr.								Yr. to Yr.
							Percent/								Percent/
(Dollars and shares in millions except per share amounts)							Margin								Margin
For the three months ended September 30:	2019			2018			Change**
For the three months ended March 31:									2020			2019			Change*
Revenue	$	18,028		$	18,756		(3.9)	%*	$	17,571		$	18,182		(3.4)	%**
Gross profit margin		46.2	%		46.9	%	(0.7)	pts.		45.1	%		44.2	%	0.9	pts.
Total expense and other (income)	$	6,813		$	5,807		17.3	%	$	7,972		$	6,160		29.4	%
Income from continuing operations before income taxes	$	1,522		$	2,996		(49.2)	%
Income/(loss) from continuing operations before income taxes									$	(49)		$	1,883		nm
Provision for/(benefit from) income taxes from continuing operations	$	(151)		$	304		nm		$	(1,226)		$	289		nm
Income from continuing operations	$	1,673		$	2,692		(37.8)	%	$	1,176		$	1,593		(26.2)	%
Income from continuing operations margin		9.3	%		14.4	%	(5.1)	pts.		6.7	%		8.8	%	(2.1)	pts.
Net income	$	1,672		$	2,694		(37.9)	%	$	1,175		$	1,591		(26.1)	%
Earnings per share from continuing operations - assuming dilution	$	1.87		$	2.94		(36.4)	%	$	1.31		$	1.78		(26.4)	%
Weighted-average shares outstanding - assuming dilution		892.8			915.2		(2.4)	%		895.0			893.9		0.1	%

									At 3/31/2020			At 12/31/2019
Assets									$	153,403		$	152,186		0.8	%
Liabilities									$	133,275		$	131,202		1.6	%
Equity									$	20,128		$	20,985		(4.1)	%

*	~~(2.6) percent adjusted for currency.~~2020 results were impacted by Red Hat acquisition-related activity.

** ~~2019 results were impacted by Red Hat purchase accounting~~(1.9) percent adjusted for currency; 0.1 percent excluding divested businesses and ~~acquisition-related activity.~~adjusted for currency.

nm - not meaningful

Organization of Information:

In the first quarter of 2020, we realigned offerings and the related management system to reflect divestitures completed in the second half of 2019 and tighter integration of certain industry-specific consulting services. These changes impacted Cloud & Cognitive Software and Global Business Services, but did not impact the Consolidated Financial Statements. Total recast revenue for full-year 2019 was approximately $0.3 billion of IBM’s total $77 billion. Refer to note 4, “Segments,” for additional information on our reportable segments. The periods presented in this Form 10-Q are reported on a comparable basis. We provided recast historical segment information reflecting these changes in a Form 8-K dated April 21, 2020. Additionally, on April 6, 2020, Arvind Krishna became Chief Executive Officer of IBM and announced a number of management changes which did not impact our reportable segments.

On July 9, 2019, ~~the company~~IBM acquired 100 percent of the outstanding shares of Red Hat, Inc. (Red Hat). Red Hat is reported within the Cloud & Cognitive Software segment, in Cloud & Data Platforms. ~~The consolidated financial results at and as of~~Compared to the ~~three and nine months ended September 30, 2019 reflect~~prior-year period, the impacts of the acquisition on IBM; including: recognition of goodwill, intangible assets and related amortization and deferred tax liabilities, along with other purchase accounting adjustments including a deferred revenue fair value adjustment. The Consolidated Income Statement ~~of Earnings~~ for the three ~~and nine~~ months ended ~~September 30, 2019~~March 31, 2020 includes impacts from ~~these~~ purchase accounting adjustments, higher interest expense, ~~transaction-related costs~~higher intangible assets amortization and other acquisition-related activities. Refer to note ~~11, “Acquisitions/Divestitures”~~5, “Acquisitions & Divestitures,” for additional information.

Table of Contents

Effective with the first quarter of 2019, the company made a number of changes to its organizational structure and management system. As a result of these changes, the company revised its reportable segments. There was no change to the company’s Consolidated Financial Statements. Refer to note 8, “Segments” for additional information on the company’s 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.Management Discussion – (continued)

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

~~Table of Contents~~

~~Management Discussion – (continued)~~

used for countries where the functional currency is the local currency. Generally, when the dollar either strengthens or weakens against other currencies, the growth at constant currency rates or adjusting for currency will be higher or lower than growth reported at actual exchange rates. Refer to “Currency Rate Fluctuations” for additional information.

Revenue Adjusted for Divested Businesses and Constant Currency:

To provide better transparency on the recurring performance of the ongoing business, the company provides revenue growth rates excluding divested businesses and at constant currency. These divested businesses are included in the ~~company’s Other segment.~~

category “Other–divested businesses.”

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 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~~management 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 retention, restructuring and related expenses, tax charges related to acquisition integration and pre-closing charges, such as financing costs. These charges are excluded as they may be inconsistent in amount and timing from period to period and are 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, the impact of acquisitions over the prior 12-month period may be a driver of higher expense year to year. For retirement-related costs, ~~the company~~management characterizes certain items as operating and others as non-operating, consistent with GAAP. The company includes defined benefit plan and nonpension postretirement benefit plan service costs, multi-employer plan costs and the cost of defined contribution plans in operating earnings. Non-operating retirement-related costs include defined benefit plan and nonpension postretirement benefit plan amortization of prior service costs, interest cost, expected return on plan assets, amortized actuarial gains/losses, the impacts of any plan curtailments/settlements and pension insolvency costs and other costs. Non-operating retirement-related costs are primarily related to changes in pension plan assets and liabilities which are tied to financial market performance, and the company considers these costs to be outside of the operational performance of the business.

Overall, ~~the company~~management 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 comparison to peer companies; and allows the company to provide a long-term strategic view of the business going forward. ~~The company’s~~Our reportable segment financial results reflect pre-tax operating earnings from continuing operations, consistent with ~~the company’s~~our management and measurement system.In addition, these non-GAAP measures provide a perspective consistent with areas of interest ~~the~~ ~~company~~we routinely ~~receives~~receive from investors and analysts.

6545

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Management Discussion – (continued)

The following table provides the company’s operating (non-GAAP) earnings for the ~~third~~first quarter of ~~2019~~2020 and ~~2018.~~2019.


					Yr. to Yr.						Yr. to Yr.
(Dollars in millions except per share amounts)					Percent						Percent
For the three months ended September 30:	2019		2018		Change**
For the three months ended March 31:							2020		2019		Change*
Net income as reported	$	1,672	$	2,694	(37.9)	%	$	1,175	$	1,591	(26.1)	%
Income/(loss) from discontinued operations, net of tax		(1)		2	nm			(1)		(2)	(58.7)
Income from continuing operations	$	1,673	$	2,692	(37.8)	%	$	1,176	$	1,593	(26.2)	%
Non-operating adjustments (net of tax):
Acquisition-related charges		586		153	281.9			371		164	126.7
Non-operating retirement-related costs/(income)		130		289	(55.1)			250		111	124.9
U.S. tax reform charges		5		—	nm			(149)		141	nm
Operating (non-GAAP) earnings*	$	2,394	$	3,134	(23.6)	%
Operating (non-GAAP) earnings**							$	1,649	$	2,009	(17.9)	%
Diluted operating (non-GAAP) earnings per share	$	2.68	$	3.42	(21.6)	%	$	1.84	$	2.25	(18.2)	%

*	~~Refer to page 102 for a more detailed reconciliation of net income to operating earnings.~~2020 results were impacted by Red Hat acquisition-related activity.

** ~~2019 results were impacted by Red Hat purchase accounting and acquisition-related activity.~~Refer to page 73 for a more detailed reconciliation of net income to operating earnings.

nm - not meaningful

Environmental Dynamics

On March 11, 2020, the World Health Organization (WHO) declared the novel coronavirus (COVID-19) a global pandemic. This resulted in significant governmental measures being initiated around the globe, including travel bans and border closings, shelter-in-place orders, closures of non-essential businesses and social distancing requirements in efforts to slow down and control the spread of the virus.

The health of IBM employees, our clients, business partners and community remain our primary focus. We are actively engaged to ensure our preparedness plans and response activities are aligned with recommendations of the WHO, the U.S. Centers for Disease Control and Prevention and governmental regulations.

IBM's technical and industry leaders are considering all options to help government and health agencies monitor and manage the outbreak. IBM's Summit supercomputer is helping researchers at the U.S. Department of Energy identify drug compounds that could disable the coronavirus. IBM's Watson Health unit is working directly with health organizations around the world to better understand the nature of COVID-19. The IBM Clinical Development system has been made available, without charge, to national health agencies to reduce the time and cost of clinical trials by providing data and analysis from web-enabled devices. Our cognitive Operational Risk Insight tool has also been made available to not-for-profit organizations. IBM has extended its online education resources for teachers, students and parents on IBM Skills, offering them the ability to tap into new knowledge, skills and online credentials, anytime, anywhere and for free. We are also working with the City of New York through delivery of 300,000 tablets with educational software and free cellular data connections to help students learn remotely. In just a matter of a few weeks, we have already committed over $200 million in terms of contributions and volunteer time.

The COVID-19 pandemic is an unprecedented, global challenge and it has placed every company in uncharted waters. In this current environment, the underlying fundamentals of our business remain sound:

●

IBM has always focused on the enterprise space, and within that our business is more concentrated in large enterprises;

●

We run our clients’ most critical processes, such as core banking systems, supply chains, and claims processing;

●

From an industry perspective, the majority of our revenue comes from clients in financial services, telecom, and the public sector – including government and healthcare;

Table of Contents

Management Discussion – (continued)

●

We have long-term relationships with our clients, in the form of multi-year services contracts, recurring software streams, and financing arrangements. Approximately 60 percent of our annual revenue is in recurring businesses;

●

While we are not immune to disruptions in our transactional content or volume reductions, our client profile and annuity base provide some level of stability, not only in our revenue, but also in profit and cash, as we manage through these challenging times;

●

Our innovative technology and our industry-specific expertise are assets to our clients; and,

●

Our balance sheet remains strong with solid liquidity and access to capital and we remain committed to our dividend to provide value to shareholders.

The long-term economic effects of the pandemic remain unknown. However, this environment has only reinforced the need for clients to modernize their businesses for the new world, with cloud and AI at the core of their digital reinventions. Our hybrid cloud and AI platforms, together with our expertise in running critical processes, ideally position us to guide clients on their journeys.

Financial Performance Summary — Three Months Ended ~~September 30:~~March 31:

Overall for the first quarter of 2020, through February we were tracking roughly in line with our expectations. As we proceeded through March and the COVID-19 health situation and resulting social distancing became more widespread, we saw a noticeable change in clients’ priorities. There was effectively a pause as clients understandably dealt with their most pressing needs. This was most pronounced in our software business where the vast majority of transactions typically close in the last two weeks of the quarter. For those clients that did engage at the end of the quarter, there was a shift to maintaining the stability of their operations and preservation of cash. Clients moved ahead with spending that addressed immediate and essential needs, including running mission critical processes and securing a remote workforce.

In the ~~third~~first quarter of ~~2019, the company~~2020, we reported ~~$18.0~~$17.6 billion in revenue, ~~$1.7~~$1.2 billion in income from continuing operations and operating (non-GAAP) earnings of ~~$2.4~~$1.6 billion, resulting in diluted earnings per share from continuing operations of ~~$1.87~~$1.31 as reported and ~~$2.68~~$1.84 on an operating (non-GAAP) basis. ~~The company~~We also generated ~~$3.6~~$4.5 billion in cash from operations, ~~$1.8~~$1.4 billion in free cash flow and delivered shareholder returns of ~~$1.6~~$1.4 billion in dividends and gross common stock repurchases. These results reflect solid performance in the key high-value areas of data and AI, security, cloud and digital. The company continued to bring new innovations to the market, launching the new z15 mainframe and containerizing its software portfolio. The combination of IBM and Red Hat will help accelerate clients’ cloud journeys and Red Hat contributed to strong third-quarter revenue performance within the Cloud & Cognitive Software segment.dividends.

Total consolidated revenue decreased ~~3.9~~3.4 percent as reported ~~and 3~~but increased 0.1 percent ~~adjusted for currency compared to the prior year;~~ excluding divested businesses ~~revenue declined 1.9 percent as reported~~ and ~~1 percent~~ adjusted for currency. Cloud & Cognitive Software increased ~~6.4~~5.5 percent as reported and 87 percent adjusted for ~~currency.~~currency with strong performance in Red Hat, Internet of Things (IoT), data and AI and in security services. Within this segment, Cloud & Data Platforms, ~~including~~which includes Red Hat grew ~~17.2~~32.2 percent ~~(19~~(34 percent adjusted for currency) ~~and Cognitive Applications grew 4.5 percent (6 percent adjusted for currency);~~but was partially offset by ~~a decline~~declines in Cognitive Applications and Transaction Processing ~~Platforms of 4.8 percent (4 percent adjusted for currency).~~ Platforms. Global Business Services (GBS) ~~increased 1.0~~decreased 0.5 percent as reported ~~and 2~~but grew 1 percent adjusted for currency ~~led~~driven by Consulting which grew ~~3.8~~3.5 percent (5 percent adjusted for currency) ~~driven~~. This growth was led by ~~next generation~~offerings that help clients with their digital reinventions, including cloud advisory and application ~~offerings.~~modernization, and offerings that leverage AI to bring intelligence into business processes. Global Technology Services (GTS) decreased ~~5.6~~5.9 percent as reported (4 percent adjusted for currency), with declines in Infrastructure & Cloud Services and Technology Support Services. ~~While there was continued growth in services that help clients move and manage cloud workloads, overall performance was impacted by lower in-period revenue from client business volumes.~~ Systems ~~decreased 14.7~~grew 3.0 percent as reported (14 percent adjusted for currency) primarily reflecting the back end of the z14 product cycle. IBM Z declined 20.6 percent (20 percent adjusted for currency) year to year due to the z14 cycle with the new z15 shipments beginning the last week of September. Storage Systems decreased 5.5 percent (4 percent adjusted for currency). In an environment where client behavior shifted at the end of the quarter, our hardware portfolio held up well reflecting the importance of IBM Z and ~~Power Systems declined 27.5 percent (27 percent adjusted~~high-end storage for ~~currency) compared with strong performance in the prior year.~~mission-critical operations, as well as product cycle dynamics.

Total cloud revenue ~~of $5.0~~was $5.4 billion in the ~~third~~first quarter of ~~2019 grew 11~~2020 with strong growth of 19 percent as reported, 21 percent adjusted for currency and 1223 percent excluding divested businesses and adjusted for currency. Over the trailing 12 months, total cloud revenue was ~~$20.0~~$22.0 billion, up 513 percent (8(15 percent adjusted for currency) year to year. With the cloud architecture of Linux, containers and Kubernetes, our acquisition and integration of Red Hat has bolstered our position in hybrid cloud.

6647

Table of Contents

Management Discussion – (continued)

From a geographic perspective, Americas revenue declined 3.8 percent year to year as reported ~~(3 percent~~but was flat excluding divested businesses and adjusted for ~~currency).~~currency. Europe/Middle East/Africa (EMEA) decreased ~~6.0~~3.7 percent (2but grew 1 percent excluding divested businesses and adjusted for ~~currency) and~~currency. Asia Pacific declined ~~1.0~~1.9 percent year to year as reported ~~(2 percent~~but was flat excluding divested businesses and adjusted for ~~currency).~~currency.

Total consolidated gross margin of ~~46.2~~45.1 percent ~~decreased 0.7~~increased 0.9 points year to year, ~~primarily due to acquisition- related activity for~~reflecting strong margin performance in our services businesses and the contribution of Red Hat (including the deferred revenue adjustment, amortization of intangibles and retention costs) and from the businesses divested in the second quarter, partially offset by improvements in operating leverage.Hat. Operating (non-GAAP) gross margin of ~~47.4~~46.2 percent ~~was flat~~increased 1.5 points versus the prior year, primarily driven by the same factors as ~~above, excluding the amortization of intangibles.~~above.

Total expense and other (income) increased ~~17.3~~29.4 percent in the ~~third~~first quarter of ~~2019~~2020 versus the ~~prior year~~prior-year period primarily driven by higher spending including Red Hat, ~~investments in software~~amortization of intangible assets associated with the acquisition of Red Hat, interest expense, workforce rebalancing charges, and ~~systems innovation, and lower intellectual income (IP) income,~~non-operating retirement-related costs, partially offset by lower ~~non-operating retirement-related costs and~~expense from divested businesses. Total operating (non-GAAP) expense and other (income) increased ~~15.9~~26.1 percent year to year, driven primarily by the factors above excluding the higher ~~spending described above.~~amortization of intangible assets and non-operating retirement-related costs.

~~Pre-tax~~The pre-tax loss from continuing operations in the first quarter of 2020 was $49 million, compared to pre-tax income from continuing operations of ~~$1.5~~$1.9 billion ~~decreased 49.2 percent and~~in the first quarter of 2019. The pre-tax margin was ~~8.4~~(0.3) percent, a decrease of ~~7.5~~10.6 points versus the prior-year period. ~~This decline~~The current period was impacted by Red Hat acquisition-related spending. It also included charges of approximately $0.9 billion primarily ~~driven by the purchase accounting deferred revenue adjustment (lower revenue without an equivalent adjustment~~for structural actions to ~~cost~~improve competitiveness in GTS and ~~expense) and the acquisition-related activity.~~accelerate our shift to a cognitive enterprise. The continuing operations ~~effective tax rate for~~benefit from income taxes in the ~~third~~first quarter of ~~2019~~2020 was ~~(9.9) percent, a decrease of 20.1 points~~$1.2 billion compared to a tax provision of $0.3 billion in the ~~third~~first quarter of ~~2018.~~ 2019. The ~~year-to-year decrease~~current year benefit from income taxes was primarily driven by a net tax benefit ~~from~~related to an intra-entity sale of certain of the ~~realization of a tax only capital loss in a subsidiary (10.7 points), an increase in tax benefits attributable to audit activity (4.3 points), as well as a benefit due to~~company’s intellectual property and the ~~mix of geographic income year to year (5.0 points), primarily driven by Red Hat.~~related impacts. Net income of ~~$1.7~~$1.2 billion decreased ~~37.9~~26.1 percent and the net income margin was ~~9.3~~6.7 percent, a decrease of ~~5.1~~2.1 points year to year.

Operating (non-GAAP) pre-tax income from continuing operations of ~~$2.4~~$0.7 billion decreased ~~33.4~~69.2 percent year to year and the operating (non-GAAP) pre-tax margin from continuing operations decreased ~~5.9~~8.4 points to ~~13.3~~3.9 percent. The operating (non-GAAP) ~~tax rate for~~benefit from income taxes was $1.0 billion in the ~~third~~first quarter of ~~2019 was 0.1 percent, a decrease of 12.7 points~~2020, compared to a tax provision of $0.2 billion in the ~~third~~first quarter of ~~2018.~~2019. The ~~change in the~~ operating (non-GAAP) ~~tax rate~~benefit from income taxes was primarily driven by the same ~~factors mentioned~~factor described above. Operating (non-GAAP) income from continuing operations of ~~$2.4~~$1.6 billion decreased ~~23.6~~17.9 percent with an operating (non-GAAP) income margin from continuing operations of ~~13.3~~9.4 percent, down ~~3.4~~1.7 points year to year.

Diluted earnings per share from continuing operations of ~~$1.87~~$1.31 in the ~~third~~first quarter of ~~2019~~2020 decreased ~~36.4~~26.4 percent and operating (non-GAAP) diluted earnings per share of ~~$2.68~~$1.84 decreased 21.6 percent versus the third quarter of 2018. In the third quarter of 2019, the company repurchased 0.8 million shares of its common stock at a cost of $0.1 billion and had $2.0 billion remaining in the current share repurchase authorization at September 30, 2019. The company suspended its share repurchase program at the time of the Red Hat closing.

~~The company generated $3.6 billion in cash flow provided by operating activities, a decrease of $0.6 billion compared to the third quarter of 2018.~~In the third quarter of 2019, investing activities were a net use of cash of $30.4 billion compared to $3.0 billion in the prior year, primarily driven by cash used for the Red Hat acquisition. Financing activities were a use of cash of $8.2 billion in the third quarter of 2019 compared to $0.4 billion in the prior year. The $7.7 billion increase in financing cash outflows year to year was driven by net cash related to debt transactions. In the third quarter of 2019, there was a net payment of debt of $6.6 billion versus $1.6 billion of net issuances in the prior year.

The company expects GAAP earnings per share from continuing operations of at least $10.58 and continues to expect operating (non-GAAP) earnings of at least $12.80 per diluted share for 2019. The company continues to expect free cash flow to be approximately $12 billion in 2019. Refer to the Liquidity and Capital Resources section for additional information on this non-GAAP measure. Refer to the Looking Forward section for additional information on the company’s expectations.

~~Table of Contents~~

~~Management Discussion – (continued)~~

~~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:

2019

2018

Change**

Revenue

$
55,370

$
57,830

(4.3)
%*
Gross profit margin

45.9
%

45.4
%
0.5
pts.
Total expense and other (income)

$
19,215

$
19,341

(0.7)
%
Income from continuing operations before income taxes

$
6,173

$
6,908

(10.6)
%
Provision for/(benefit from) income taxes from continuing operations

$
407

$
138

195.0
%
Income from continuing operations

$
5,766

$
6,770

(14.8)
%
Income from continuing operations margin

10.4
%

11.7
%
(1.3)
pts.
Net income

$
5,761

$
6,777

(15.0)
%
Earnings per share from continuing operations - assuming dilution

$
6.46

$
7.36

(12.2)
%
Weighted-average shares outstanding - assuming dilution

892.5

920.0

(3.0)
%

At 9/30/2019

At 12/31/2018

Assets

$
149,620

$
123,382

21.3
%
Liabilities

$
131,524

$
106,452

23.6
%
Equity

$
18,096

$
16,929

6.9
%

*	~~(1.7) percent adjusted for currency.~~

**	~~2019 results were impacted by Red Hat purchase accounting and acquisition-related activity.~~

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

Yr. to Yr.

(Dollars in millions except per share amounts)





Percent

For the nine months ended September 30:

2019

2018

Change**

Net income as reported

$
5,761

$
6,777

(15.0)
%
Income/(loss) from discontinued operations, net of tax

(5)

7

nm

Income from continuing operations

$
5,766

$
6,770

(14.8)
%
Non-operating adjustments (net of tax):





Acquisition-related charges

967

478

102.4

Non-operating retirement-related costs/(income)

338

900

(62.5)

U.S. tax reform charges

160

93

71.5

Operating (non-GAAP) earnings*

$
7,230

$
8,241

(12.3)
%
Diluted operating (non-GAAP) earnings per share

$
8.10

$
8.96

(9.6)
%

*	~~Refer to page 103 for a more detailed reconciliation of net income to operating earnings.~~

**	~~2019 results were impacted by Red Hat purchase accounting and acquisition-related activity.~~

~~nm - not meaningful~~

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

In the first nine months of 2019, the company reported $55.4 billion in revenue, $5.8 billion in income from continuing operations and operating (non-GAAP) earnings of $7.2 billion, resulting in diluted earnings per share from continuing operations of $6.46 as reported and $8.10 on an operating (non-GAAP) basis. The company also generated $11.3 billion in cash from operations, $5.9 billion in free cash flow and delivered shareholder returns of $5.6 billion in dividends and gross common stock repurchases.

~~Table of Contents~~

~~Management Discussion – (continued)~~

Total consolidated revenue decreased 4.3 percent as reported and 2 percent adjusted for currency compared to the prior year; excluding divested businesses, revenue declined 3.3 percent and 1 percent adjusted for currency. Cloud & Cognitive Software increased 2.7 percent as reported and 5 percent adjusted for currency. Cloud & Data Platforms grew 6.7 percent as reported and 9 percent adjusted for currency, Cognitive Applications increased 3.0 percent as reported and 5 percent adjusted for currency, while Transaction Processing Platforms declined 2.0 percent as reported but was flat adjusted for currency. GBS grew 0.5 percent as reported and 3 percent adjusted for currency led by Consulting which grew 3.8 percent (6 percent adjusted for currency). GTS decreased 6.6 percent as reported (4 percent adjusted for currency), with declines in Infrastructure & Cloud Services and Technology Support Services. Systems decreased 15.7 percent year to year as reported (14 percent adjusted for currency), with declines across all major business lines within the segment including IBM Z which decreased 34.7 percent (34 percent adjusted for currency) reflecting product cycle dynamics. Total cloud revenue of $14.3 billion in the first nine months of 2019 grew 6 percent as reported and 9 percent adjusted for currency.

From a geographic perspective, Americas revenue declined 3.6 percent year to year as reported (3 percent adjusted for currency). Europe/Middle East/Africa (EMEA) decreased 5.7 percent (flat adjusted for currency). Asia Pacific declined 3.5 percent year to year as reported (2 percent adjusted for currency).

~~The consolidated gross margin of 45.9 percent increased 0.5 points year to year, and the operating (non-GAAP) gross margin of 46.5 percent increased 0.6 points versus the prior year~~. The improved margins in the first nine 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, partially offset by impacts from the Red Hat acquisition.

Total expense and other (income) decreased 0.7 percent in the first nine months of 2019 compared to the prior year. The year-to-year performance was driven by lower non-operating retirement-related costs (4 points), the impact of currency (4 points) and gains from divestitures (3 points), partially offset by higher spending including Red Hat (6 points), amortization of acquired intangible assets and other non-operating activity related to the Red Hat acquisition (3 points) and a decrease in IP income (2 points). Total operating (non-GAAP) expense and other (income) increased 0.7 percent year to year, driven primarily by the same factors excluding the non-operating retirement-related costs and the amortization of acquired intangible assets and other non-operating activity related to the Red Hat acquisition.

Pre-tax income from continuing operations of $6.2 billion decreased 10.6 percent and the pre-tax margin was 11.1 percent, a decrease of 0.8 points versus 2018. Similar to the three months ended September 30, 2019, the nine month period was also impacted by the deferred revenue purchase accounting adjustment and Red Hat acquisition-related activity. The continuing operations effective tax rate for the first nine months of 2019 was 6.6 percent, an increase of 4.6 points compared to the first nine months of 2018. The year-to-year change was primarily driven by ~~a reduced benefit related to audit activity~~compared to the prior year. Net income of $5.8 billion decreased 15.0 percent and the net income margin was 10.4 percent, down 1.3 points year to year. Operating (non-GAAP) pre-tax income from continuing operations of $7.8 billion decreased 10.4 percent year to year and the operating (non-GAAP) pre-tax margin from continuing operations decreased 1.0 point to 14.1 percent. The operating (non-GAAP) tax rate for the first nine months of 2019 was 7.4 percent, an increase of 2.0 points compared to the first nine months of 2018. The change in the operating (non-GAAP) tax rate was primarily driven by the same factors mentioned above. Operating (non-GAAP) income from continuing operations of $7.2 billion decreased 12.3 percent with an operating (non-GAAP) income margin from continuing operations of 13.1 percent, down 1.2 points year to year.

~~Diluted earnings per share from continuing operations of $6.46 in the first nine months of 2019 decreased 12.2 percent and operating (non-GAAP) diluted earnings per share of $8.10 decreased 9.6~~18.2 percent versus the first ~~nine months~~quarter of ~~2018. In the first nine months of 2019, the company repurchased 10.0 million shares of its common stock at a cost of $1.3 billion.~~2019.

In the quarter, we continued to take actions to enhance our balance sheet and liquidity position. At ~~September 30, 2019,~~March 31, 2020, the balance sheet remained strong with the flexibility to support and invest in the ~~business.~~business, with a strong cash position and ample credit available during these uncertain times. Cash, restricted cash and marketable securities at quarter end were ~~$11.0~~$12.0 billion, ~~a decrease~~an increase of ~~$1.3~~$3.0 billion from December 31,

~~Table of Contents~~

~~Management Discussion – (continued)~~

~~2018. Although debt balances have increased since year-end 2018 driven by new issuances to finance the acquisition of Red Hat, the company reduced debt by $6.7 billion since June 30,~~ 2019.

Key drivers in the balance sheet and total cash flows were:

Total assets increased ~~$26.2~~$1.2 billion ($~~28.1~~4.4 billion adjusted for currency) from December 31, ~~2018~~2019 driven by:

●

~~Increases~~An increase in ~~goodwill of $21.7 billion and intangible~~deferred tax assets of ~~$12.5~~$3.6 billion primarily ~~associated with the acquisition~~due to an intra-entity sale of ~~Red Hat;~~IP; and

●

An increase in ~~operating right-of-use assets~~cash, restricted cash and marketable securities of ~~$4.9 billion resulting from the adoption of the new leasing standard on January 1, 2019;~~$3.0 billion; partially offset by

●

A decrease in financing receivables of ~~$11.5~~$3.1 billion primarily ~~due to the wind down~~as a result of ~~OEM IT commercial financing operations.~~collections of seasonally higher year-end balances.

Table of Contents

Management Discussion – (continued)

Total liabilities increased ~~$25.1~~$2.1 billion ($~~26.5~~4.2 billion adjusted for currency) from December 31, ~~2018~~2019 driven by:

●

An increase in total debt of ~~$20.5~~$1.4 billion primarily driven by ~~new issuances~~an increase in commercial paper;

●

An increase in other liabilities of $1.3 billion primarily driven by an increase in deferred tax liabilities related to ~~finance~~ the ~~Red Hat acquisition;~~intra-entity IP sale; and

●

An increase in ~~operating lease~~deferred income of $1.3 billion driven by annual customer billings; partially offset by

●

Decreases in retirement-related liabilities of ~~$5.2~~$0.7 billion ~~resulting from the adoption~~and accounts payable of ~~the new leasing standard.~~$0.7 billion.

Total equity of ~~$18.1~~$20.1 billion ~~increased $1.2~~decreased $0.9 billion from December 31, ~~2018~~2019 as a result of:

●

~~Increases from net income~~Dividends of ~~$5.8~~$1.4 billion and ~~retirement related plans~~a decrease from foreign currency translation of ~~$1.1~~$1.0 billion; partially offset by

●

~~Decreases from dividends~~An increase in net income of ~~$4.3 billion and gross share repurchases of $1.3~~$1.2 billion.

~~The company~~We generated ~~$11.3~~$4.5 billion in cash flow provided by operating activities, ~~an increase~~a decrease of ~~$0.2~~$0.3 billion compared to the first ~~nine months~~quarter of ~~2018, driven primarily by~~2019 which included an increase in ~~cash provided by financing receivables ($0.8 billion).~~interest payments on debt of $0.2 billion. In both the first ~~nine months~~quarter of ~~2019,~~2020 and the prior-year period, investing activities were a net use of cash of ~~$27.1~~$0.9 billion. Financing activities were a use of cash of $0.1 billion in the first quarter of 2020 compared to ~~$5.4~~a source of cash $1.9 billion in the prior year. The year-to-year increase was driven by an increase in cash used for acquisitions ($32.5 billion); partially offset by an increase in cash provided by non-operating finance receivables ($5.7 billion) and a decrease in cash used for net purchases of marketable securities and other investments ($3.1 billion). In the first nine months of 2019, financing activities were a source of cash of $14.7$2.0 billion ~~compared to a use of cash of $5.9 billion in the first nine months of 2018. The $20.6 billion increase in financing cash flows~~change year to year was primarily driven by ~~an increase~~a decrease in net cash sourced from debt ~~transactions ($19.6 billion) primarily driven by a higher~~transactions.

On April 20, 2020, given the level of ~~issuances~~uncertainty around the duration of the COVID-19 health crisis and the potential rate and pace of economic recovery, IBM withdrew full-year 2020 expectations. We expect to ~~finance~~reassess this position based on the ~~Red Hat acquisition.~~clarity of the macroeconomic recovery after the second quarter. Refer to the “Looking Forward” section for additional information.

Table of Contents

~~Third~~Management Discussion – (continued)

First Quarter ~~and First Nine Months~~ in Review

Results of Continuing Operations

Segment Details

The following is an analysis of the ~~third~~first quarter ~~and first nine months~~ of ~~2019~~2020 versus the ~~third~~first quarter ~~and first nine months~~ of ~~2018~~2019 reportable segment external revenue and gross margin results. Segment pre-tax ~~income~~income/(loss) includes

~~Table of Contents~~

~~Management Discussion – (continued)~~

transactions between segments that are intended to reflect an arm’s-length transfer price and excludes certain unallocated corporate items.


									Yr. to Yr.										Yr. to Yr.
									Percent										Percent
							Yr. to Yr.		Change								Yr. to Yr.		Change
(Dollars in millions)							Percent/Margin		Adjusted For								Percent/Margin		Adjusted For
For the three months ended September 30:	2019			2018			Change		Currency
For the three months ended March 31:											2020			2019			Change		Currency
Revenue:
Cloud & Cognitive Software	$	5,280		$	4,962	*	6.4	%	7.8	%	$	5,238		$	4,967	*	5.5	%**	6.8	%
Gross margin		74.1	%		76.1	%*	(2.1)	pts.**				75.4	%		75.6	%*	(0.1)	pts.**
Global Business Services		4,117			4,076	*	1.0	%	2.2	%		4,136			4,155	*	(0.5)	%	0.9	%
Gross margin		31.1	%		30.0	%*	1.1	pts.				27.2	%		26.2	%*	1.0	pts.
Global Technology Services		6,700			7,101	*	(5.6)	%	(4.1)	%		6,467			6,875		(5.9)	%	(4.0)	%
Gross margin		35.8	%		37.0	%*	(1.2)	pts.				34.0	%		33.7	%	0.3	pts.
Systems		1,481			1,736		(14.7)	%	(13.8)	%		1,368			1,328		3.0	%	4.1	%
Gross margin		52.6	%		52.7	%	(0.0)	pts.				50.2	%		46.2	%	4.1	pts.
Global Financing		343			388		(11.7)	%	(10.7)	%		299			406		(26.2)	%	(24.9)	%
Gross margin		36.9	%		26.3	%	10.6	pts.				40.7	%		34.9	%	5.8	pts.
Other		107			493	*	(78.3)	%	(78.0)	%		62			451	*	(86.1)	%	(86.1)	%
Gross margin		(152.2)	%		31.8	%*	(184.0)	pts.				(254.3)	%		29.1	%*	(283.4)	pts.
Total consolidated revenue	$	18,028		$	18,756		(3.9)	%	(2.6)	%	$	17,571		$	18,182		(3.4)	%***	(1.9)	%
Total consolidated gross profit	$	8,336		$	8,803		(5.3)	%**			$	7,922		$	8,043		(1.5)	%**
Total consolidated gross margin		46.2	%		46.9	%	(0.7)	pts.				45.1	%		44.2	%	0.9	pts.
Non-operating adjustments:
Amortization of acquired intangible assets		196			96		105.3	%				188			76		147.6	%
Acquisition-related charges		13			—		nm					—			—		—
Operating (non-GAAP) gross profit	$	8,545		$	8,899		(4.0)	%**			$	8,110		$	8,119		(0.1)	%**
Operating (non-GAAP) gross margin		47.4	%		47.4	%	(0.0)	pts.				46.2	%		44.7	%	1.5	pts.**

*	Recast to reflect segment changes.

**	~~2019~~2020 results were impacted by Red Hat purchase accounting and acquisition-related activity.

~~nm - not meaningful~~

~~Table of Contents~~

~~Management Discussion – (continued)~~

Yr. to Yr.

Percent

Yr. to Yr.

Change

(Dollars in millions)





Percent/Margin

Adjusted For

For the nine months ended September 30:

2019

2018

Change

Currency

Revenue:









Cloud & Cognitive Software

$
15,962

$
15,548
*
2.7
%
4.9
%
Gross margin

75.5
%

76.8
%*
(1.2)
pts.


Global Business Services

12,391

12,326
*
0.5
%
3.3
%
Gross margin

27.8
%

26.5
%*
1.3
pts.


Global Technology Services

20,412

21,846
*
(6.6)
%
(3.6)
%
Gross margin

34.6
%

34.3
%*
0.4
pts.


Systems

4,562

5,412

(15.7)
%
(14.1)
%
Gross margin

51.1
%

49.3
%
1.7
pts.


Global Financing

1,100

1,188

(7.4)
%
(5.0)
%
Gross margin

35.6
%

29.1
%
6.4
pts.


Other

944

1,511
*
(37.5)
%
(35.8)
%
Gross margin

10.8
%

36.4
%*
(25.6)
pts.


Total consolidated revenue

$
55,370

$
57,830

(4.3)
%
(1.7)
%
Total consolidated gross profit

$
25,388

$
26,249

(3.3)
%


Total consolidated gross margin

45.9
%

45.4
%
0.5
pts.


Non-operating adjustments:









Amortization of acquired intangible assets

346

283

22.2
%


Acquisition-related charges

13

—

nm

Operating (non-GAAP) gross profit

$
25,747

$
26,531

(3.0)
%


Operating (non-GAAP) gross margin

46.5
%

45.9
%
0.6
pts.

* ~~Recast to reflect segment changes.~~

~~nm - not meaningful~~**0.1 percent excluding divested businesses and adjusted for currency.

Cloud & Cognitive Software

Yr. to Yr.

Percent

Yr. to Yr.

Change

(Dollars in millions)





Percent

Adjusted For

For the three months ended September 30:

2019

2018*

Change

Currency**

Cloud & Cognitive Software external revenue:

$
5,280

$
4,962

6.4
%
7.8
%
Cognitive Applications

$
1,383

$
1,324

4.5
%
5.6
%
Cloud & Data Platforms

2,308

1,968

17.2

18.8

Transaction Processing Platforms

1,589

1,669

(4.8)

(3.5)

* Recast to reflect segment changes.

**	~~2019 results were impacted by Red Hat purchase accounting.~~


							Yr. to Yr.									Yr. to Yr.
							Percent									Percent
					Yr. to Yr.		Change							Yr. to Yr.		Change
(Dollars in millions)					Percent		Adjusted For							Percent		Adjusted For
For the nine months ended September 30:	2019		2018*		Change		Currency**
For the three months ended March 31:									2020		2019			Change		Currency
Cloud & Cognitive Software external revenue:	$	15,962	$	15,548	2.7	%	4.9	%	$	5,238	$	4,967	*	5.5	%**	6.8	%
Cloud & Data Platforms									$	2,536	$	1,917		32.2	%**	33.8	%
Cognitive Applications	$	4,145	$	4,023	3.0	%	4.9	%		1,182		1,238	*	(4.5)		(3.4)
Cloud & Data Platforms		6,398		5,997	6.7		9.0
Transaction Processing Platforms		5,419		5,528	(2.0)		0.4			1,520		1,812		(16.1)		(14.8)

* Recast to reflect segment changes.

** ~~2019~~2020 results were impacted by Red Hat purchase accounting.

7250

Table of Contents

Management Discussion – (continued)

Cloud & Cognitive Software revenue of ~~$5,280~~$5,238 million increased ~~6.4~~5.5 percent as reported (8(7 percent adjusted for currency) in the ~~third~~first quarter of ~~2019~~2020 compared to the prior year. ~~This~~We had strong performance in Red Hat, IoT, data and AI and in security services. We entered 2020 with a robust offering portfolio and solid pipeline and had strong growth ~~was driven by~~through February. As the global health crisis broadened, in March, software transactions stalled as our clients shifted their focus to resiliency efforts. The most notable impacts were in Cognitive Applications and Transaction Processing Platforms.

In the first quarter, Cloud & Data Platforms ~~which includes Red Hat, partially offset by a decline in Transaction Processing Platforms, as reported and adjusted for currency. For the first nine months of the year, Cloud & Cognitive Software~~ revenue of ~~$15,962~~$2,536 million ~~grew 2.7~~increased 32.2 percent as reported (5 percent adjusted for currency.) There was year-to-year growth in Cloud & Data Platforms, driven primarily by the contribution from Red Hat in the third quarter, and Cognitive Applications, as reported and adjusted for currency. Transaction Processing Platforms decreased 2.0 percent as reported, but grew slightly 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, Internet of Things (IoT) solutions, The Weather Company and security software and services. In the third quarter, Cognitive Applications revenue of $1,383 million grew 4.5 percent as reported (6(34 percent adjusted for currency) compared to the prior year, ~~driven~~led by double-digit growth in Security software and services, and in industry verticals such as the Internet of Things (IoT). The Security performance included continued strong results in threat management software and services offerings. Within IoT, there was good performance across the portfolio as the business continued to invest in new offerings and industry-specifc solutions.

Cloud & Data Platforms includes distributed middleware and data platform software critical for orchestration and integration of multicloud environments, inclusive of public and private clouds, including Red Hat ~~Enterprise Linux (RHEL)~~ and OpenShift running on open source hybrid, multicloud platforms. This business also includes product areas such as WebSphere distributed, analytics platform software (e.g., DB2 distributed, information integration, and enterprise content management) and IoT, Blockchain and AI platforms. The company has innovated in containerizing its software and introduced CloudPaks standardizing on OpenShift as the container platform. Cloud & Data Platforms third-quarter revenue of $2,308 million increased 17.2 percent as reported (19 percent adjusted for currency) compared to the prior year as the company began to execute on the combinedsynergies we are realizing by bringing together Red Hat and IBM ~~hybrid cloud strategy.~~software. The number of Red Hat large deals was up from fourth quarter and first quarter included the signing of the two largest deals in its history. The number of clients using Red Hat and IBM container solutions grew to over 2,200 as Red Hat and IBM emerged as the leading container platform.

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 third quarter, Transaction Processing PlatformsCognitive Applications first-quarter revenue of ~~$1,589~~$1,182 million ~~decreased 4.8~~declined 4.5 percent as reported (4(3 percent adjusted for currency) compared to the prior year. ~~Although much of this business is annuity-based, the year-to-year decline~~In March, many transformational deals were paused, especially in the ~~third~~retail industry.

Transaction Processing Platforms revenue of $1,520 million decreased 16.1 percent as reported (15 percent adjusted for currency) in the first quarter ~~revenue reflects~~compared to the ~~timing of larger transactions that~~prior year. In March, clients shifted away from new capital expenditures to preserve cash and prioritize their operating cash needs. These are ~~tied~~typically large engagements, and in this environment, clients elected to ~~client buying cycles.~~defer purchases which impacted perpetual license sales late in the quarter.

Within Cloud & Cognitive Software, cloud revenue of ~~$1.1~~$1.3 billion grew 6184 percent as reported ~~(63~~(86 percent adjusted for currency) in the ~~third~~first quarter of ~~2019. For~~2020. We have modernized our software to be cloud-native and optimized on OpenShift, which provides a compelling hybrid cloud platform for clients on their digital journeys to the ~~first nine months of 2019,~~cloud. Given the shift in client software demands, we are focused on areas that facilitate the shift to cloud, ~~revenue of $2.6 billion grew 24 percent as reported (26 percent adjusted~~including Red Hat and other cloud and data platform offerings, Cloud Paks for ~~currency).~~operational efficiency and QRadar on Cloud for security threats.

Yr. to Yr.

Percent/

(Dollars in millions)





Margin

For the three months ended September 30:

2019

2018*

Change**

Cloud & Cognitive Software:







External gross profit

$
3,910

$
3,778

3.5
%
External gross profit margin

74.1
%

76.1
%
(2.1)
pts.
Pre-tax income

$
1,283

$
2,050

(37.4)
%
Pre-tax margin

21.5
%

35.7
%
(14.2)
pts.


							Yr. to Yr.
							Percent/
(Dollars in millions)							Margin
For the three months ended March 31:	2020			2019*			Change**
Cloud & Cognitive Software:
External gross profit	$	3,951		$	3,753		5.3	%
External gross profit margin		75.4	%		75.6	%	(0.1)	pts.
Pre-tax income	$	933		$	1,785		(47.7)	%
Pre-tax margin		15.4	%		30.7	%	(15.3)	pts.

*	Recast to reflect segment changes.

** ~~2019 results were impacted by Red Hat purchase accounting and acquisition-related activity.~~

~~Table of Contents~~

~~Management Discussion – (continued)~~

Yr. to Yr.

Percent/

(Dollars in millions)





Margin

For the nine months ended September 30:

2019

2018*

Change**

Cloud & Cognitive Software:







External gross profit

$
12,056

$
11,936

1.0
%
External gross profit margin

75.5
%

76.8
%
(1.2)
pts.
Pre-tax income

$
5,052

$
5,760

(12.3)
%
Pre-tax margin

27.9
%

31.9
%
(4.0)
pts.

* Recast to reflect segment changes.

** 20192020 results were impacted by Red Hat purchase accounting and acquisition-related activity.

In the first quarter, Cloud & Cognitive Software gross profit margin of 75.4 percent was flat on a year-to-year basis.

Pre-tax income of $933 million decreased ~~2.1 points to 74.1~~47.7 percent in the ~~third~~first quarter of 2019 compared to the prior year, driven by portfolio mix and margin declines in software and services. For the first nine months of 2019, gross profit margin decreased 1.2 points to 75.5 percent, driven by the same factors.

~~In the third quarter, pre-tax income of $1,283 million decreased 37.4 percent~~ compared to the prior year. The pre-tax margin of 15.4 points decreased ~~14.2~~15.3 points to 21.5 percent in the third quarter, driven primarily by the purchase accounting impacts from the Red Hat acquisition. For the first nine months of the year, pre-tax income of $5,052 million decreased 12.3 percent compared to the prior year and the pre-tax margin decreased 4.0 points to 27.9 percent. The year-to-year margin decline in the first ~~nine months of 2019 as compared to the same period in 2018 reflects the acquisition of~~quarter. The margin decline was primarily driven by Red Hat ~~ongoing investments in key strategic areas~~acquisition-related activity, and ~~a lower impact of IP partnership agreements~~workforce rebalancing actions taken in the first ~~nine months of 2019.~~

~~Global Business Services~~

Yr. to Yr.

Percent

Yr. to Yr.

Change

(Dollars in millions)





Percent

Adjusted For

For the three months ended September 30:

2019

2018

Change

Currency

Global Business Services external revenue:

$
4,117

$
4,076
*
1.0
%
2.2
%
Consulting

$
1,973

$
1,900

3.8
%
4.9
%
Application Management

1,897

1,915

(1.0)

0.2

Global Process Services

247

260
*
(5.1)

(3.2)

* Recast to reflect segment changes.

Yr. to Yr.

Percent

Yr. to Yr.

Change

(Dollars in millions)





Percent

Adjusted For

For the nine months ended September 30:

2019

2018

Change

Currency

Global Business Services external revenue:

$
12,391

$
12,326
*
0.5
%
3.3
%
Consulting

$
5,915

$
5,698

3.8
%
6.3
%
Application Management

5,724

5,863

(2.4)

0.6

Global Process Services

752

765
*
(1.7)

1.7

* Recast to reflect segment changes.

~~Global Business Services revenue of $4,117 million increased 1.0 percent as reported and 2 percent adjusted for currency in the third~~ quarter of ~~2019 compared to~~2020 which had 2.7 points of impact on the prior year, driven primarily by strong performance in Consulting. For the first nine months of the year, Global Business Services revenue of $12,391 million increased 0.5 percent as reported and 3 percent adjusted for currency. This growth demonstrates GBS’ ability to bring together deep industrypre-tax margin.

~~Table of Contents~~

~~Management Discussion – (continued)~~

~~expertise and technology to provide clients a holistic approach to de-risk and orchestrate their digital transformation journey.~~

In the third quarter, Consulting revenue of $1,973 million grew 3.8 percent as reported and 5 percent adjusted for currency, driven primarily by growth in offerings that address cognitive technology, application modernization, and next-generation enterprise applications, such as S4/Hana, and Salesforce.

Application Management revenue of $1,897 million declined 1.0 percent as reported, but was flat adjusted for currency compared to the third-quarter 2018, driven primarily by growth in application modernization offerings. Cloud application offerings help clients to implement cloud-centric architectures to modernize and automate their application portfolio. As the company has been standardizing on Red Hat OpenShift as the preferred development platform, there was early progress in synergies in the quarter.

~~Global Process Services third-quarter revenue of $247 million decreased 5.1 percent as reported and 3 percent adjusted for currency.~~

Within GBS, cloud revenue of $1.3 billion grew 8 percent as reported (10 percent adjusted for currency) in the third quarter of 2019. For the first nine months of the year, cloud revenue of $3.8 billion grew 13 percent as reported (17 percent adjusted for currency).

Yr. to Yr.

Percent/

(Dollars in millions)





Margin

For the three months ended September 30:

2019

2018*

Change

Global Business Services:







External gross profit

$
1,282

$
1,224

4.8
%
External gross profit margin

31.1
%

30.0
%
1.1
pts.
Pre-tax income

$
573

$
566

1.2
%
Pre-tax margin

13.7
%

13.6
%
0.1
pts.

* Recast to reflect segment changes.

Yr. to Yr.

Percent/

(Dollars in millions)





Margin

For the nine months ended September 30:

2019

2018*

Change

Global Business Services:







External gross profit

$
3,439

$
3,263

5.4
%
External gross profit margin

27.8
%

26.5
%
1.3
pts.
Pre-tax income

$
1,188

$
1,063

11.7
%
Pre-tax margin

9.4
%

8.5
%
1.0
pts.

* Recast to reflect segment changes.

GBS third-quarter gross profit margin of 31.1 percent grew 1.1 points on a year-to-year basis, driven by the continued mix shift to higher-value offerings, the yield from delivery improvement, productivity, and utilization initiatives and a currency benefit from leveraging the global delivery resource model. Pre-tax income increased to $573 million and pre-tax margin of 13.7 percent was flat year to year in the third quarter of 2019 compared to the prior year. For the first nine months of the year, pre-tax income of $1,188 million increased 11.7 percent and the pre-tax margin increased 1.0 points to 9.4 percent. The pre-tax margin for the first nine months of 2019 included a lower level of workforce rebalancing charges year to year.

7551

Table of Contents

Management Discussion – (continued)

Global ~~Technology~~Business Services


								Yr. to Yr.									Yr. to Yr.
								Percent									Percent
						Yr. to Yr.		Change							Yr. to Yr.		Change
(Dollars in millions)						Percent		Adjusted For							Percent		Adjusted For
For the three months ended September 30:	2019		2018			Change		Currency
Global Technology Services external revenue:	$	6,700	$	7,101	*	(5.6)	%	(4.1)	%
Infrastructure & Cloud Services	$	5,071	$	5,393	*	(6.0)	%	(4.5)	%
Technology Support Services		1,629		1,707		(4.6)		(3.1)
For the three months ended March 31:										2020		2019			Change		Currency
Global Business Services external revenue:										$	4,136	$	4,155	*	(0.5)	%	0.9	%
Consulting										$	2,071	$	2,001	*	3.5	%	4.7	%
Application Management											1,840		1,908		(3.6)		(2.1)
Global Process Services											225		247		(8.8)		(6.9)

* Recast to reflect segment ~~changes~~changes.

Global Business Services revenue of $4,136 million decreased 0.5 percent as reported, but increased 1 percent adjusted for currency in the first quarter of 2020 compared to the prior year, driven primarily by solid growth in Consulting.

Yr. to Yr.

Percent

Yr. to Yr.

Change

(Dollars in millions)

Percent

Adjusted For

For the nine months ended September 30:

2019

2018

Change

Currency

Global Technology Services external revenue:

$
20,412

$
21,846
*
(6.6)
%
(3.6)
%
Infrastructure & Cloud Services

$
15,454

$
16,608
*
(6.9)
%
(4.0)
%
Technology Support Services

4,958

5,239

(5.4)

(2.2)

In the first quarter, Consulting revenue of $2,071 million grew 3.5 percent as reported and 5 percent adjusted for currency, led by offerings that help clients with their digital reinventions, including cloud advisory and application modernization, and offerings that leverage AI to bring intelligence into business processes. We have standardized our cloud application modernization offerings on OpenShift and built the world’s largest Red Hat consulting practice. In the quarter, we had good growth in many transformational offerings, including next-generation enterprise applications. However, as the pandemic intensified in March, clients began to deprioritize some of these projects. In this environment, we are aligning our business to the near-term opportunity. This includes addressing our clients’ challenges, such as engaging customers virtually, modernizing and migrating applications to the cloud, empowering a remote workforce, and focusing on cybersecurity and IT resiliency.

Application Management revenue of $1,840 million declined 3.6 percent as reported and 2 percent adjusted for currency compared to the first quarter of 2019.We had continued growth in Cloud Application Management which was offset by declines in the more traditional on-premise services as certain contracts completed.

Global Process Services first-quarter revenue of $225 million decreased 8.8 percent as reported and 7 percent adjusted for currency.As we continued to shift to new platforms around intelligent workflows, we had modest growth in certain cognitive process automation offerings which was offset by declines in traditional business process outsourcing.

Within GBS, cloud revenue of $1.3 billion grew 6 percent as reported (8 percent adjusted for currency) in the first quarter of 2020.

Looking forward in GBS, we have a solid base of business and a growing backlog, though in the near term, we expect customers to continue to delay and replan some projects.


							Yr. to Yr.
							Percent/
(Dollars in millions)							Margin
For the three months ended March 31:	2020			2019*			Change*
Global Business Services:
External gross profit	$	1,125		$	1,087		3.5	%
External gross profit margin		27.2	%		26.2	%	1.0	pts.
Pre-tax income	$	271		$	298		(9.1)	%
Pre-tax margin		6.5	%		7.0	%	(0.6)	pts.

* Recast to reflect segment ~~changes~~.

Global Technology Services revenue of $6,700 million declined 5.6 percent as reported (4 percent adjusted for currency) in the third quarter of 2019 compared to the prior year. There was continued growth in services that help clients move and manage workloads. However, performance in the segment reflects lower in-period revenue from client business volumes in certain markets and some multi-national clients. Although these lower volumes impact near-term revenue and profit, the business had good long-term signings and a solid pipeline of future deals that will deliver productivity to clients. For the first nine months of the year, Global Technology Services revenue of $20,412 million declined 6.6 percent as reported (4 percent adjusted for currency).

In the third quarter, Infrastructure & Cloud Services revenue of $5,071 million decreased 6.0 percent as reported (4 percent adjusted for currency) compared to the prior-year period. Revenue was impacted by certain contracts that are tied to customers’ own business volumes which were lower year to year in certain markets and some multi-national clients. Enterprises are in the initial phases of modernizing their core infrastructures to hybrid multicloud infrastructures. GTS is continuing to shift its portfolio to capture this opportunity and investing in cloud capabilities, while de-emphasizing and exiting certain lower value offerings. Growth in cloud signings reflects the business’s re-alignment of its offerings across the clients’ cloud lifecycle journey of Advise, Move, Build and Manage, infusing offerings with IP and leveraging Red Hat’s capabilities. The business continues to expand its cloud availability zones and data centers. Cloud now comprises over 40 percent of the GTS outsourcing backlog. Technology Support Services third-quarter revenue of $1,629 million decreased 4.6 percent as reported (3 percent adjusted for currency) due primarily to hardware cycle dynamics.changes.

7652

Table of Contents

Management Discussion – (continued)

GBS first-quarter gross profit margin of 27.2 percent grew 1.0 points on a year-to-year basis, primarily driven by the margin expansion in Consulting with our shift to higher-value offerings. We continued to benefit from delivery efficiencies, productivity and utilization improvement and from currency through the leverage of our global delivery resource model. Pre-tax income decreased to $271 million and the pre-tax margin decreased 0.6 points to 6.5 percent in the first quarter of 2020 compared to the prior year, primarily driven by workforce rebalancing actions recorded in the first quarter of 2020, which had 2.4 points of impact on the pre-tax margin.

~~Within GTS, cloud~~Global Technology Services


							Yr. to Yr.
							Percent
					Yr. to Yr.		Change
(Dollars in millions)					Percent		Adjusted For
For the three months ended March 31:	2020		2019		Change		Currency
Global Technology Services external revenue:	$	6,467	$	6,875	(5.9)	%	(4.0)	%
Infrastructure & Cloud Services	$	4,916	$	5,209	(5.6)	%	(3.9)	%
Technology Support Services		1,550		1,665	(6.9)		(4.6)

Global Technology Services revenue of ~~$2.1 billion grew 8~~$6,467 million decreased 5.9 percent as reported ~~(10~~(4 percent adjusted for currency) in the ~~third~~first quarter of ~~2019. For~~2020 compared to the prior year, driven by declines in both business areas. GTS continued its actions to accelerate the shift to higher value segments of the market and took structural actions in the first ~~nine months of~~quarter to improve competitiveness. GTS continued to advance its joint offering and go-to-market capabilities with GBS, which is providing differentiated solutions to our clients. As clients shift mission-critical workloads to the ~~year,~~ cloud, they are looking for this integration across the application and infrastructure stack. GTS total signings and cloud signings grew at a double-digit rate.

In the first quarter, Infrastructure & Cloud Services revenue of ~~$6.2 billion grew 6~~$4,916 million decreased 5.6 percent as reported (9(4 percent adjusted for currency) compared to the prior-year period. We are adopting new delivery methods to support our clients as they focus on infrastructure solutions which enhance IT resiliency and business continuity, address new cybersecurity risks, and reconfigure their IT environments for cost efficiency and business agility. While we expect an impact due to lower business volumes in the near term, this will ultimately lead to an acceleration in the shift of mission-critical workloads to a hybrid multi-cloud platform, built on open standards.

Technology Support Services first-quarter revenue of $1,550 million decreased 6.9 percent as reported (5 percent adjusted for currency).

Yr. to Yr.

Percent/

(Dollars in millions)

Margin

For the three months ended September 30:

2019

2018*

Change

Global Technology Services:








External gross profit

$
2,400

$
2,629

(8.7)
%
External gross profit margin

35.8
%

37.0
%
(1.2)
pts.
Pre-tax income

$
490

$
607

(19.2)
%
Pre-tax margin

7.0
%

8.2
%
(1.2)
pts.

Within GTS, cloud revenue of $2.3 billion grew 10 percent as reported (12 percent adjusted for currency) in the first quarter of 2020.


							Yr. to Yr.
							Percent/
(Dollars in millions)							Margin
For the three months ended March 31:	2020			2019			Change
Global Technology Services:
External gross profit	$	2,196		$	2,316		(5.2)	%
External gross profit margin		34.0	%		33.7	%	0.3	pts.
Pre-tax income/(loss)	$	(178)		$	275		nm
Pre-tax margin		(2.6)	%		3.8	%	(6.5)	pts.

* Recast to reflect segment changes.

Yr. to Yr.

Percent/

(Dollars in millions)

Margin

For the nine months ended September 30:

2019

2018*

Change

Global Technology Services:








External gross profit

$
7,069

$
7,484

(5.5)
%
External gross profit margin

34.6
%

34.3
%
0.4
pts.
Pre-tax income

$
1,000

$
1,124

(11.0)
%
Pre-tax margin

4.7
%

5.0
%
(0.3)
pts.

* Recast to reflect segment changes.nm - not meaningful

Global Technology Services gross profit margin ~~decreased 1.2~~increased 0.3 points to ~~35.8~~34.0 percent in the ~~third~~first quarter of ~~2019. Margin decline~~2020 as compared to the prior year. The increase in margin was primarily driven by ~~the lower in-period client business volumes~~actions taken to improve our competitiveness such as continued scaling of our agile services delivery model to improve productivity. GTS had a pre-tax loss of $178

Table of Contents

Management Discussion – (continued)

million in the first quarter of 2020 as compared to pre-tax income of $275 million in the first quarter of 2019. A significant portion of the first quarter’s structural actions addressed GTS. This improves our position for the future, but resulted in a pre-tax loss in the first quarter. ~~The business has not yet realized~~In this dynamic environment, we are going to continue to evaluate the cost ~~benefits~~competitiveness of the portfolio and we will take further actions if needed. The workforce rebalancing actions taken in the ~~second-quarter 2019, but continues to scale its Agile services delivery model and is accelerating its use~~first quarter of ~~AI and automation in delivery operations, including leveraging Red Hat’s Ansible platform, which is expected to increase delivery productivity. Third-quarter~~2020 had 5.8 points of impact on the pre-tax ~~income decreased to $490 million and pre-tax margin decreased 1.2 points to 7.0 percent, reflecting the decline in gross profit~~ margin. For the first nine months of the year, pre-tax income of $1,000 million decreased 11.0 percent and pre-tax margin of 4.7 percent declined 0.3 points year to year, reflecting a higher level of workforce rebalancing charges year to year.

Services Backlog and Signings

Yr. to Yr.

Percent

Yr. to Yr.

Change

Yr. to Yr.

Change

At September 30,

Percent

Adjusted For

At March 31,

Percent

Adjusted For

(Dollars in billions)

2019

2018

Change

Currency

2020

2019

Change

Currency

Total backlog

107.6

112.8

(4.7)

(2.3)

107.8

111.6

(3.4)

(0.1)

The estimated total services backlog at ~~September 30, 2019~~March 31, 2020 was ~~$107.6~~$107.8 billion, a decrease of ~~4.7~~3.4 percent as reported ~~(2 percent~~and flat adjusted for ~~currency).~~currency.

Total services backlog includes Infrastructure & Cloud Services, Security Services, Consulting, Global Process Services, Application Management and Technology Support Services. Total backlog is intended to be a statement of overall work under contract which is either non-cancellable, or which historically has very low likelihood of termination, given the criticality of certain services to the company’s clients. Total backlog does not include as-a-Service arrangements that allow for termination under contractual commitment terms. Backlog estimates are subject to change

~~Table of Contents~~

~~Management Discussion – (continued)~~

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. Total Services signings can vary over time due to a variety of factors including, but not limited to, the timing of signing a small number of larger contracts, such as in Infrastructure & Cloud Services or Global Process Services.Technology Support Services (TSS) are generally not included in signings as the maintenance contracts tend to be more steady state, where revenues equal renewals. Certain longer-term TSS contracts that have characteristics similar to outsourcing contracts are included in signings.

Contract portfolios purchased in an acquisition are treated as positive backlog adjustments provided those contracts meet ~~the company’s~~IBM’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.

~~Systems~~

Yr. to Yr.

Percent

Yr. to Yr.

Change

(Dollars in millions)

Percent

Adjusted For

For the three months ended September 30:

2019

2018

Change

Currency

Systems external revenue:

$
1,481

$
1,736

(14.7)
%
(13.8)
%
Systems Hardware

$
1,117

$
1,339

(16.6)
%
(15.8)
%
IBM Z





(20.6)

(19.9)

Power Systems





(27.5)

(26.7)

Storage Systems





(5.5)

(4.5)

Operating Systems Software

364

397

(8.1)

(7.1)

Management believes that the estimated values of services backlog and signings disclosed herein provide insight into our potential future revenue, which is used by management as a tool to monitor the performance of the business and viewed as useful decision-making information for investors. The conversion of signings and backlog into revenue may vary based on the types of services and solutions, customer decisions, and as well as other factors, which may include, but are not limited to, macroeconomic environment or external events.

~~Table of Contents~~

~~Management Discussion – (continued)~~

Yr. to Yr.

Percent

Yr. to Yr.

Change

(Dollars in millions)

Percent

Adjusted For

For the nine months ended September 30:

2019

2018

Change

Currency

Systems external revenue:

$
4,562

$
5,412

(15.7)
%
(14.1)
%
Systems Hardware

$
3,358

$
4,187

(19.8)
%
(18.4)
%
IBM Z





(34.7)

(33.8)

Power Systems





(7.7)

(5.8)

Storage Systems





(14.5)

(12.9)

Operating Systems Software

1,204

1,225

(1.7)

0.5

Systems revenue of $1,481 million decreased 14.7 percent as reported (14 percent adjusted for currency) in the third quarter of 2019 compared to the prior year. Systems Hardware revenue of $1,117 million decreased 16.6 percent as reported (16 percent adjusted for currency). The decline was across the product portfolio, but primarily reflects the back end of the z14 mainframe product cycle. The business continues to invest to bring new innovation across the platforms, and introduced the next generation of IBM Z and high-end storage in mid-September. Operating Systems Software revenue of $364 million decreased 8.1 percent as reported (7 percent adjusted for currency) compared to the prior year. For the first nine months of 2019, Systems revenue of $4,562 million decreased 15.7 percent as reported (14 percent adjusted for currency) compared to the first nine months of 2018, driven primarily by IBM Z and Storage Systems. Operating Systems Software revenue decreased 1.7 percent as reported, but increased 1 percent adjusted for currency.

IBM Z revenue declined 20.6 percent as reported (20 percent adjusted for currency) year to year, reflecting the end of the z14 product cycle in the current period compared to solid growth in the third-quarter 2018. The new z15 mainframe began to ship in the last week of the quarter with a good start to the cycle. The z15 mainframe’s capabilities extend the platform’s differentiation with encryption everywhere, cloud native (with the introduction of Red Hat OpenShift) and instant recovery. The z15 will offer clients improved productivity, security and efficiency.

Power Systems revenue decreased 27.5 percent as reported (27 percent adjusted for currency) year to year, as a result of strong performance in the third-quarter 2018 due to the introduction of mid-range and high-end POWER9 products and the roll-out of supercomputers to the U.S. Department of Energy labs.

Storage Systems revenue decreased 5.5 percent as reported (4 percent adjusted for currency), reflecting improvement in year-to-year performance compared to recent quarters, driven by the high-end products and growth in All Flash Array. In mid-September 2019, the company introduced the next generation, high-end storage system DS8900 which delivers comprehensive next-level cyber security, data availability and system resiliency, specifically designed for mission-critical hybrid multicloud environments.

In the third quarter, Operating Systems Software revenue of $364 million decreased 8.1 percent as reported (7 percent adjusted for currency) compared to the prior year. The decline was driven by a decrease in Power Systems and IBM Z operating system software.

7954

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 March 31:	2020		2019		Change		Currency
Total signings	$	8,928	$	7,637	16.9	%	18.7	%

Systems


							Yr. to Yr.
							Percent
					Yr. to Yr.		Change
(Dollars in millions)					Percent		Adjusted For
For the three months ended March 31:	2020		2019		Change		Currency
Systems external revenue:	$	1,368	$	1,328	3.0	%	4.1	%
Systems Hardware	$	997	$	914	9.1	%	10.2	%
IBM Z					59.5		60.9
Power Systems					(32.7)		(31.8)
Storage Systems					17.6		18.6
Operating Systems Software		371		414	(10.5)		(9.3)

Systems revenue of $1,368 million increased 3.0 percent as reported and 4 percent adjusted for currency in the first quarter of 2020 compared to the prior year. Systems Hardware revenue of $997 million grew 9.1 percent as reported and 10 percent adjusted for currency. Operating Systems Software revenue of $371 million decreased 10.5 percent as reported (9 percent adjusted for currency) compared to the prior year.

IBM Z revenue grew 59.5 percent as reported and 61 percent adjusted for currency year to year, reflecting the strong performance of the z15 mainframe during the second full quarter of its availability. The z15 proved to be a crucial element of our clients’ enterprise operations, providing a stable, secure and scalable platform in this current environment.

Power Systems revenue decreased 32.7 percent as reported (32 percent adjusted for currency) year to year. This decline reflects the product cycle, as well as the fact that this platform is skewed toward smaller enterprises, which were impacted more severely by the dynamics in March 2020 from the global pandemic.

Storage Systems revenue grew 17.6 percent as reported and 19 percent adjusted for currency, primarily driven by high-end storage systems. These systems are specifically designed for our clients’ mission-critical applications operating in a hybrid multi-cloud environment, providing comprehensive next-level cybersecurity, data availability and system resiliency.

Within Systems, cloud revenue of ~~$0.5~~$0.4 billion ~~declined 20~~increased 9 percent as reported ~~(19~~(10 percent adjusted for currency) in the ~~third~~first quarter of ~~2019. For the first nine months~~2020.

Table of ~~the year, cloud revenue of $1.6 billion declined 18 percent as reported (17 percent adjusted for currency).~~Contents

Yr. to Yr.

Percent/

(Dollars in millions)

Margin

For the three months ended September 30:

2019

2018

Change

Systems:







External Systems Hardware gross profit

$
478

$
577

(17.1)
%
External Systems Hardware gross profit margin

42.8
%

43.1
%
(0.2)
pts.
External Operating Systems Software gross profit

$
301

$
337

(10.7)
%
External Operating Systems Software gross profit margin

82.6
%

85.0
%
(2.4)
pts.
External total gross profit

$
779

$
914

(14.7)
%
External total gross profit margin

52.6
%

52.7
%
0.0
pts.
Pre-tax income

$
39

$
209

(81.3)
%
Pre-tax margin

2.3
%

10.9
%
(8.6)
pts.

Management Discussion – (continued)

Yr. to Yr.

Percent/

(Dollars in millions)

Margin

For the nine months ended September 30:

2019

2018

Change

Systems:







External Systems Hardware gross profit

$
1,322

$
1,642

(19.5)
%
External Systems Hardware gross profit margin

39.4
%

39.2
%
0.1
pts.
External Operating Systems Software gross profit

$
1,008

$
1,027

(1.8)
%
External Operating Systems Software gross profit margin

83.7
%

83.9
%
(0.1)
pts.
External total gross profit

$
2,330

$
2,670

(12.7)
%
External total gross profit margin

51.1
%

49.3
%
1.7
pts.
Pre-tax income

$
(101)

$
352

nm

Pre-tax margin

(2.0)
%

5.9
%
(7.9)
pts.

~~nm - not meaningful~~


							Yr. to Yr.
							Percent/
(Dollars in millions)							Margin
For the three months ended March 31:	2020			2019			Change
Systems:
External Systems Hardware gross profit	$	380		$	264		43.6	%
External Systems Hardware gross profit margin		38.1	%		28.9	%	9.2	pts.
External Operating Systems Software gross profit	$	307		$	349		(11.9)	%
External Operating Systems Software gross profit margin		82.9	%		84.2	%	(1.3)	pts.
External total gross profit	$	687		$	613		12.1	%
External total gross profit margin		50.2	%		46.2	%	4.1	pts.
Pre-tax loss	$	(217)		$	(202)		7.6	%
Pre-tax margin		(14.3)	%		(13.5)	%	(0.8)	pts.

Systems gross profit margin ~~of 52.6~~increased 4.1 points to 50.2 percent ~~was flat~~ in the ~~third~~first quarter of ~~2019~~2020 compared to the prior year, ~~with~~primarily driven by a mix to IBM Z and margin expansion ~~in Power Systems and Storage Systems.~~across all three hardware platforms. Systems Hardware margin of ~~42.8~~38.1 percent ~~was flat~~increased 9.2 points compared to the prior year for the same reasons.

The pre-tax loss of $217 million in the first quarter of 2020 increased $15 million compared to the first quarter of 2019. The pre-tax margin decreased 0.8 points to (14.3) points year to ~~year. For~~year, primarily driven by workforce rebalancing actions taken in the first ~~nine months~~quarter of ~~2019, Systems gross profit margin increased 1.7~~2020 which had 3.5 points ~~to 51.1~~of impact on the pre-tax margin.

Global Financing


					Yr. to Yr.
					Percent/
(Dollars in millions)					Margin
For the three months ended March 31:	2020		2019		Change
External revenue	$	299	$	406	(26.2)	%
Internal revenue		212		300	(29.4)
Total revenue	$	511	$	706	(27.6)	%
Pre-tax income	$	194	$	288	(32.7)	%

In the first quarter, Global Financing total revenue of $511 million declined 27.6 percent compared to the prior ~~year,~~year. External revenue decreased 26.2 percent (25 percent adjusted for currency) due to a decrease in external financing (down 30.0 percent to $235 million) and external used equipment sales (down 7.7 percent to $64 million). Internal revenue decreased 29.4 percent, driven by ~~actions taken~~a decrease in ~~2018~~internal used equipment sales (down 31.2 percent to ~~better position~~$129 million) and internal financing (down 26.5 percent to $83 million).

The decrease in external financing revenue reflects the ~~systems cost structure over~~wind down of the ~~longer term. Systems Hardware~~OEM IT commercial financing operations. The decrease in internal financing revenue in the first quarter of 2020 compared to the same period in 2019 was primarily due to lower average asset balances.

Sales of used equipment represented 37.8 percent of Global Financing’s revenue in the first quarter of 2020 compared to 36.5 percent in the first quarter of 2019. The percentage increase was due to a decline in financing revenue. The gross profit margin on used sales was ~~flat year to year, with margin improvement~~52.0 percent and 52.3 percent in ~~Storage Systems, offset by declines in IBM Z and Power Systems.~~

In the ~~third~~first quarter of 2020 and 2019, respectively.

Global Financing pre-tax income ~~of $39 million declined 81.3~~decreased 32.7 percent ~~and pre-tax margin decreased 8.6 points year~~ to year to 2.3 percent. The pre-tax margin was impacted by portfolio mix, the z14 product cycle and investments made to bring new hardware innovation to market. For the first nine months of 2019, Systems had a pre-tax loss of $101 million compared to pre-tax income of $352$194 million in the first ~~nine months~~quarter of ~~the prior year. Pre-tax margin decreased 7.9 points year to year to (2.0) percent, primarily due~~2020 compared to the same ~~factors as the third quarter.~~

~~Global Financing~~

~~Global Financing is a reportable segment that is measured~~period in 2019, due to lower gross profit of $115 million as a ~~stand-alone entity. Global Financing facilitates IBM clients’ acquisition~~result of ~~information technology systems, software and services~~the revenue decline, partially offset by ~~providing financing solutions~~a decrease in expense of $20 million, which was in line with 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,segment’s revenue performance.

8056

Table of Contents

Management Discussion – (continued)

surplus internal equipment and used equipment purchased externally. Residual value is a risk unique to the financing business and management of this risk is dependent upon the ability to accurately project future equipment values at lease inception. Global Financing has insight into product plans and cycles for the IBM products under lease. Based upon this product information, Global Financing continually monitors projections of future equipment values and compares them with the residual values reflected in the portfolio.

~~Results of Operations~~

Yr. to Yr.

Percent/

(Dollars in millions)

Margin

For the three months ended September 30:

2019

2018

Change

External revenue

$
343

$
388

(11.7)
%
Internal revenue

302

338

(10.6)

Total revenue

$
645

$
726

(11.2)
%
Pre-tax income

$
275

$
308

(10.8)
%

Yr. to Yr.

Percent/

(Dollars in millions)

Margin

For the nine months ended September 30:

2019

2018

Change

External revenue

$
1,100

$
1,188

(7.4)
%
Internal revenue

884

1,240

(28.7)

Total revenue

$
1,983

$
2,428

(18.3)
%
Pre-tax income

$
803

$
1,042

(23.0)
%

In the third quarter, Global Financing total revenue of $645 million declined 11.2 percent compared to the prior year. Internal revenue decreased 10.6 percent, driven by a decrease in internal financing (down 21.7 percent to $86 million) and internal used equipment sales (down 5.2 percent to $216 million). External revenue decreased 11.7 percent (11 percent adjusted for currency), due to a decrease in external financing (down 14.6 percent to $261 million) and external used equipment sales (down 1.0 percent to $81 million).

The decrease in total revenue in the first nine months of 2019 compared to the same period of 2018 was due to a decrease in internal revenue of 28.7 percent, driven by a decrease in internal used equipment sales (down 36.0 percent to $593 million) and internal financing (down 7.4 percent to $291 million). External revenue decreased 7.4 percent (5 percent adjusted for currency), driven by a decline in external used equipment sales (down 19.9 percent to $216 million) and external financing (down 3.7 percent to $884 million).

The decrease in internal financing revenue in the third quarter and the first nine months of 2019 compared to the same periods in 2018 was primarily due to lower average asset balances, partially offset by higher asset yields. The decrease in external financing revenue in the third quarter and the first nine months of 2019 compared to the same periods in 2018 reflects the company’s wind down of the OEM IT commercial financing operations.

Total sales of used equipment represented 46.1 percent of Global Financing’s revenue in the third quarter of 2019 compared to 42.7 percent in the third quarter of 2018. The increase was due to declines in internal and external financing revenue. Total sales of used equipment represented 40.8 percent of Global Financing’s revenue in the first nine months of 2019 compared to 49.2 percent in the first nine months of 2018. The decrease was due to lower volumes of both internal and external used equipment sales. The gross profit margin on used sales was 56.6 percent and 50.9 percent in the third quarter of 2019 and 2018, respectively, and 54.4 percent and 56.6 percent in the first nine months of 2019 and 2018, respectively.

Global Financing pre-tax income decreased 10.8 percent to $275 million in the third quarter of 2019 compared to the same period in 2018, due to lower gross profit of $45 million, partially offset by a decrease in expense of $12

~~Table of Contents~~

~~Management Discussion – (continued)~~

million. Pre-tax income decreased 23.0 percent to $803 million in the first nine months of 2019, compared to the same period in 2018, due to lower gross profit of $344 million, partially offset by a decrease in expense of $104 million, which was driven by a decline in IBM shared expenses in line with the segment’s performance, a lower provision for credit losses and a gain from the sale of certain commercial financing capabilities in the first quarter of 2019.

Global Financing return on equity was ~~32.4~~29.4 percent for the three months ended ~~September 30, 2019,~~March 31, 2020, compared to ~~27.5~~13.7 percent for the three months ended ~~September 30, 2018.~~March 31, 2019. The increase ~~was due to a lower average equity balance. Return~~in return on equity was 23.0 percent for the nine months ended September 30, 2019, compared to 30.5 percent for the nine months ended September 30, 2018. The decrease was driven by a decline in net income, which included higher tax expense in the first quarter of ~~2019~~2020 was driven by higher year-to-year net income, as the prior year included higher tax expense due to ~~additional guidance issued by the U.S. Treasury regarding the~~ U.S. tax ~~reform repatriation tax.~~reform. Refer to page ~~101~~72 for the details of the after-tax income and return on equity calculation.

Geographic Revenue

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


																	Yr. to Yr.
							Yr. to Yr.								Yr. to Yr.		Percent Change
							Percent								Percent		Excluding Divested
					Yr. to Yr.		Change						Yr. to Yr.		Change		Businesses And
(Dollars in millions)					Percent		Adjusted For						Percent		Adjusted For		Adjusted For
For the three months ended September 30:	2019		2018		Change		Currency
For the three months ended March 31:									2020		2019		Change		Currency		Currency
Total Revenue	$	18,028	$	18,756	(3.9)	%	(2.6)	%	$	17,571	$	18,182	(3.4)	%	(1.9)	%	0.1	%
Americas	$	8,514	$	8,853	(3.8)	%	(3.4)	%	$	8,166	$	8,493	(3.8)	%	(2.7)	%	(0.3)	%
Europe/Middle East/Africa (EMEA)		5,477		5,827	(6.0)		(1.8)			5,517		5,727	(3.7)		(1.1)		0.7
Asia Pacific		4,036		4,076	(1.0)		(1.9)			3,888		3,961	(1.9)		(1.1)		0.2

Yr. to Yr.

Percent

Yr. to Yr.

Change

(Dollars in millions)

Percent

Adjusted For

For the nine months ended September 30:

2019

2018

Change

Currency

Total Revenue

$
55,370

$
57,830

(4.3)
%
(1.7)
%
Americas

$
25,813

$
26,772

(3.6)
%
(2.6)
%
Europe/Middle East/Africa (EMEA)

17,354

18,410

(5.7)

(0.3)

Asia Pacific

12,203

12,648

(3.5)

(1.8)

Total revenue of ~~$18,028~~$17,571 million decreased ~~3.9~~3.4 percent as reported (2 percent adjusted for currency), but was flat excluding divested businesses and adjusted for currency in the first quarter compared to the prior year.

Americas revenue of $8,166 million decreased 3.8 percent as reported (3 percent adjusted for currency), but was flat excluding divested businesses and adjusted for currency. Within Americas, the U.S. decreased 3.1 percent compared to the prior year. Canada increased 1.0 percent as reported and 2 percent adjusted for currency. Latin America decreased 11.9 percent as reported and 3 percent adjusted for currency, ~~in the third quarter compared to the prior year. Americas revenue of $8,514 million decreased 3.8~~with Brazil declining 15.4 percent as reported and 3 percent adjusted for currency. EMEA revenue of $5,477 million decreased 6.0 percent as reported and 2 percent adjusted for currency. Asia Pacific revenue of $4,036 million decreased 1.0 percent as reported and 2 percent adjusted for currency.

Within Americas, the U.S. decreased 5.6 percent compared to the prior year. Canada increased 7.7 percent as reported and 9 percent adjusted for currency. Latin America decreased 1.2 percent as reported, but increased 2 percent adjusted for currency, with Brazil flat as reported and up 14 percent adjusted for currency.

In EMEA, total revenue of $5,517 million decreased 3.7 percent as reported (1 percent adjusted for currency), but grew 1 percent excluding divested businesses and adjusted for currency. Within EMEA, the UK decreased 11.8 percent as reported (10 percent adjusted for currency) and Germany ~~decreased 11.9~~declined 10.7 percent as reported (8 percent adjusted for currency)~~, the U.K. declined 8.7 percent as reported (3 percent adjusted for currency) and France decreased 7.8 percent as reported (3 percent adjusted for currency)~~. Italy decreased ~~3.1~~0.4 percent as reported, but ~~increased~~grew 3 percent adjusted for currency. France decreased 0.9 percent as reported, but grew 2 percent adjusted for currency. The Middle East and Africa region decreased ~~6.0~~3.9 percent as reported (5(2 percent adjusted for currency).

Asia Pacific revenue of $3,888 million decreased 1.9 percent as reported (1 percent adjusted for currency), but was flat excluding divested businesses and adjusted for currency. Within Asia Pacific, Japan increased ~~6.4~~2.3 percent as reported and 1 percent adjusted for currency compared to the prior year. Australia decreased 16.4 percent as reported (9 percent adjusted for currency), and China decreased 3.7 percent as reported (2 percent adjusted for currency) ~~compared to the prior year. China decreased 17.0~~. India grew 5.5 percent as reported ~~(15~~and 9 percent adjusted for ~~currency), Australia decreased 14.2 percent as reported (8 percent adjusted for currency), and India decreased 2.9 percent as reported (3 percent adjusted for currency).~~currency.

8257

Table of Contents

Management Discussion – (continued)

Total revenue of $55,370 million decreased 4.3 percent as reported and 2 percent adjusted for currency in the first nine months of 2019 compared to the prior year. Americas revenue of $25,813 million decreased 3.6 percent as reported and 3 percent adjusted for currency. EMEA revenue of $17,354 million decreased 5.7 percent as reported and was flat adjusted for currency. Asia Pacific revenue of $12,203 million decreased 3.5 percent as reported and 2 percent adjusted for currency.

Within Americas, the U.S. decreased 4.4 percent compared to the prior year. Canada increased 4.0 percent as reported and 7 percent adjusted for currency. Latin America decreased 4.8 percent as reported, but increased 1 percent adjusted for currency, with Brazil down 10.0 percent as reported and 5 percent adjusted for currency.

In EMEA, Germany declined 9.6 percent as reported (4 percent adjusted for currency) and France decreased 8.9 percent as reported (3 percent adjusted for currency). The U.K. decreased 3.1 percent as reported, but increased 3 percent adjusted for currency. Italy declined 2.8 percent as reported, but increased 3 percent adjusted for currency. The Middle East and Africa region decreased 5.5 percent as reported and 3 percent adjusted for currency.

Within Asia Pacific, Japan increased 3.4 percent as reported (3 percent adjusted for currency) compared to the prior year. China decreased 14.1 percent as reported (11 percent adjusted for currency), Australia declined 15.7 percent as reported (9 percent adjusted for currency), and India decreased 9.1 percent as reported (5 percent adjusted for currency).

Expense

Total Expense and Other (Income)


							Yr. to Yr.								Yr. to Yr.
(Dollars in millions)							Percent								Percent
For the three months ended September 30:	2019			2018			Change*
For the three months ended March 31:									2020			2019			Change*
Total consolidated expense and other (income)	$	6,813		$	5,807		17.3	%	$	7,972		$	6,160		29.4	%
Non-operating adjustments:
Amortization of acquired intangible assets	$	(277)		$	(112)		147.9	%	$	(285)		$	(98)		192.0	%
Acquisition-related charges		(241)			(2)		nm			0			(39)		(99.2)
Non-operating retirement-related (costs)/income		(145)			(389)		(62.6)			(264)			(138)		92.0
Operating (non-GAAP) expense and other (income)	$	6,150		$	5,304		15.9	%	$	7,422		$	5,886		26.1	%
Total consolidated expense-to-revenue ratio		37.8	%		31.0	%	6.8	pts.		45.4	%		33.9	%	11.5	pts.
Operating (non-GAAP) expense-to-revenue ratio		34.1	%		28.3	%	5.8	pts.		42.2	%		32.4	%	9.9	pts.

* ~~2019~~2020 results were impacted by Red Hat ~~purchase accounting and~~ acquisition-related activity.

~~nm - not meaningful~~

Yr. to Yr.

(Dollars in millions)

Percent

For the nine months ended September 30:

2019

2018

Change*

Total consolidated expense and other (income)

$
19,215

$
19,341

(0.7)
%
Non-operating adjustments:







Amortization of acquired intangible assets

$
(470)

$
(331)

42.2
%
Acquisition-related charges

(383)

(3)

nm

Non-operating retirement-related (costs)/income

(419)

(1,185)

(64.6)

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

$
17,942

$
17,822

0.7
%
Total consolidated expense-to-revenue ratio

34.7
%

33.4
%
1.3
pts.
Operating (non-GAAP) expense-to-revenue ratio

32.4
%

30.8
%
1.6
pts.

* 2019 results were impacted by Red Hat purchase accounting and acquisition-related activity.

~~nm - not meaningful~~

The following Red Hat-related expenses are included in the current period, with no corresponding expense in the prior-year ~~periods:~~period: Red Hat operational spending, interest expense from debt issuances to fund the acquisition and other

~~Table of Contents~~

~~Management Discussion – (continued)~~

acquisition-related activity, ~~including:~~primarily amortization of acquired intangible assets ~~retention and legal and advisory fees~~ associated with the transaction.

Total expense and other (income) increased ~~17.3~~29.4 percent in the ~~third~~first quarter of ~~2019~~2020 versus the prior year primarily driven by higher spending including Red Hat, ~~investments in software~~higher amortization of acquired intangible assets associated with the Red Hat transaction, higher workforce rebalancing charges and ~~systems innovation, and lower IP income,~~higher non-operating retirement-related costs, partially offset by lower ~~non-operating retirement-related costs and~~expense from divested businesses. Total operating (non-GAAP) expense and other (income) increased ~~15.9~~26.1 percent year to year, driven primarily by the factors described above excluding the higher ~~spending described above.~~amortization of acquired intangible assets and higher non-operating retirement-related costs.

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

Selling, General and Administrative Expense

Yr. to Yr.

(Dollars in millions)

Percent

For the three months ended September 30:

2019

2018

Change

Selling, general and administrative expense:







Selling, general and administrative — other

$
4,183

$
3,805

9.9
%
Advertising and promotional expense

381

323

18.1

Workforce rebalancing charges

24

26

(8.8)

Amortization of acquired intangible assets

276

110

150.0

Stock-based compensation

147

95

54.0

Bad debt expense

14

4

273.0

Total consolidated selling, general and administrative expense

$
5,024

$
4,363

15.1
%
Non-operating adjustments:







Amortization of acquired intangible assets

$
(276)

$
(110)

150.0
%
Acquisition-related charges

(175)

(2)

nm

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

$
4,573

$
4,251

7.6
%

~~nm — not meaningful~~


					Yr. to Yr.						Yr. to Yr.
(Dollars in millions)					Percent						Percent
For the nine months ended September 30:	2019		2018		Change
For the three months ended March 31:							2020		2019		Change
Selling, general and administrative expense:
Selling, general and administrative — other	$	12,566	$	12,295	2.2	%	$	4,341	$	4,048	7.2	%
Advertising and promotional expense		1,234		1,131	9.1			428		432	(0.9)
Workforce rebalancing charges		538		590	(8.7)			728		19	nm
Amortization of acquired intangible assets		468		329	42.2			284		97	193.2
Stock-based compensation		313		264	18.8			117		74	57.3
Bad debt expense		51		56	(10.0)
Expected credit loss expense								56		20	188.9
Total consolidated selling, general and administrative expense	$	15,171	$	14,665	3.5	%	$	5,955	$	4,691	27.0	%
Non-operating adjustments:
Amortization of acquired intangible assets	$	(468)	$	(329)	42.2	%	$	(284)	$	(97)	193.2	%
Acquisition-related charges		(256)		(3)	nm			0		(27)	(98.8)
Operating (non-GAAP) selling, general and administrative expense	$	14,447	$	14,333	0.8	%	$	5,670	$	4,566	24.2	%

nm — not meaningful

Total selling, general and administrative (SG&A) expense increased ~~15.1~~27.0 percent in the ~~third~~first quarter of ~~2019~~2020 versus the prior year driven primarily by the following factors:

8458

Table of Contents

Management Discussion – (continued)

●

Higher workforce rebalancing charges (15 points);

●

Higher spending ~~(8 points) driven by~~from Red Hat (12 points), driving up total spending ~~(10~~(7 points); and

●

Higher ~~acquisition-related charges and~~ amortization of acquired intangible assets associated with the Red Hat transaction ~~(8 points); partially offset by~~

●

~~The effects of currency (2~~(4 points).

Operating (non-GAAP) expense increased ~~7.6~~24.2 percent year to year primarily driven by the same factors excluding the ~~acquisition-related charges and~~ amortization of acquired intangible assets associated with the Red Hat transaction.

~~SG&A~~Expected credit loss expense increased ~~3.5 percent in the first nine months of 2019 versus the prior year driven primarily by the the following factors:~~

●

~~Higher spending (4 points) driven by Red Hat spending (3 points); and~~

●

~~Higher acquisition-related charges and amortization of acquired intangible assets associated with the Red Hat transaction (2 points); partially offset by~~

●

~~The effects of currency (2 points).~~

Operating (non-GAAP) expense increased 0.8 percent year to year, primarily driven by the same factors excluding the acquisition-related charges and amortization of acquired intangible assets associated with the Red Hat transaction.

~~Bad debt expense decreased $6~~$37 million year to year in the first ~~nine~~three months of ~~2019.~~2020 primarily driven by an increase in specific reserves. The receivables provision coverage was ~~1.9~~2.1 percent at ~~September 30, 2019,~~March 31, 2020, an increase of 3040 basis points from both December 31, ~~2018~~2019 and ~~unchanged from September 30, 2018.~~March 31, 2019. The higher coverage rate at March 31, 2020 also reflects the adoption of the new guidance for credit losses.

Research, Development and Engineering

Yr. to Yr.

(Dollars in millions)

Percent

For the three months ended September 30:

2019

2018

Change

Research, development and engineering expense

$
1,553

$
1,252

24.1
%
Non-operating adjustment:







Acquisition-related charges

$
(53)

$
—

nm

Operating (non-GAAP) research, development and engineering expense

$
1,500

$
1,252

19.8
%


					Yr. to Yr.
(Dollars in millions)					Percent
For the three months ended March 31:	2020		2019		Change
Research, development and engineering expense	$	1,625	$	1,433	13.4	%
Non-operating adjustment:
Acquisition-related charges	$	—	$	—	—
Operating (non-GAAP) research, development and engineering expense	$	1,625	$	1,433	13.4	%

~~nm — not meaningful~~

Yr. to Yr.

(Dollars in millions)

Percent

For the nine months ended September 30:

2019

2018

Change

Research, development and engineering expense

$
4,393

$
4,021

9.3
%
Non-operating adjustment:







Acquisition-related charges

$
(53)

$
—

nm

Operating (non-GAAP) research, development and engineering expense

$
4,340

$
4,021

7.9
%

~~nm — not meaningful~~

~~Table of Contents~~

~~Management Discussion – (continued)~~

Research, development and engineering (RD&E) expense was ~~8.6 percent and 7.9~~9.2 percent of revenue in the ~~third~~first quarter ~~and first nine months~~ of ~~2019, respectively,~~2020 compared to ~~6.7 percent and 7.0~~7.9 percent in the prior-year ~~periods, respectively.~~period.

RD&E expense in the ~~third~~first quarter of ~~2019~~2020 increased ~~24.1~~13.4 percent year to year primarily driven by:

●

Higher spending ~~(21~~(14 points) including Red Hat spending (16 points)~~; and~~

●

~~Higher acquisition-related charges associated with the Red Hat transaction (4 points); partially offset by~~

●

~~The effects of currency (1 point)~~.

~~Operating (non-GAAP) expense increased 19.8 percent year to year primarily driven by the same factors excluding~~ ~~acquisition-related charges associated with the Red Hat transaction.~~

~~RD&E expense in the first nine months of 2019 increased 9.3 percent year to year primarily driven by:~~

●

~~Higher spending (9 points) including investment in the z15 and Red Hat spending in the third quarter (5 points); and~~

●

~~Higher acquisition-related charges associated with the Red Hat transaction (1 point); partially offset by~~

●

~~The effects of currency (1 point).~~

~~Operating (non-GAAP) expense increased 7.9 percent year to year primarily driven by the same factors excluding acquisition-related charges associated with the Red Hat transaction.~~

Intellectual Property and Custom Development Income


					Yr. to Yr.						Yr. to Yr.
(Dollars in millions)					Percent						Percent
For the three months ended September 30:	2019		2018		Change
For the three months ended March 31:							2020		2019		Change
Intellectual Property and Custom Development Income:
Licensing of intellectual property including royalty-based fees	$	93	$	200	(53.6)	%	$	34	$	50	(32.3)	%
Custom development income		62		66	(7.4)			76		51	49.1
Sales/other transfers of intellectual property		11		8	32.7			7		0	nm
Total	$	166	$	275	(39.8)	%	$	116	$	101	14.8	%

Yr. to Yr.

(Dollars in millions)

Percent

For the nine months ended September 30:

2019

2018

Change

Intellectual Property and Custom Development Income:







Licensing of intellectual property including royalty-based fees

$
287

$
630

(54.5)
%
Custom development income

174

200

(12.9)

Sales/other transfers of intellectual property

28

12

121.6

Total

$
489

$
842

(42.0)
%

nm — not meaningful

~~Licensing~~Total intellectual property and custom development income increased 14.8 percent year to year driven by custom development income which grew 49.1 percent driven by new agreements in the first quarter of this year. This was partially offset by a decrease in licensing of intellectual property including royalty-based ~~fees decreased 53.6 percent and 54.5 percent year to year in the third quarter and first~~ ~~nine months of 2019, respectively. This was primarily due to a decline in new partnership agreements compared to the third quarter and first nine months of 2018.~~fees. 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.

8659

Table of Contents

Management Discussion – (continued)

Other (Income) and Expense

Yr. to Yr.

(Dollars in millions)

Percent

For the three months ended September 30:

2019

2018

Change

Other (income) and expense:







Foreign currency transaction losses/(gains)

$
(597)

$
(76)

689.5
%
(Gains)/losses on derivative instruments

561

63

790.3

Interest income

(63)

(70)

(9.3)

Net (gains)/losses from securities and investment assets

(3)

(8)

(69.5)

Retirement-related costs/(income)

145

389

(62.6)

Other

(74)

(23)

222.3

Total consolidated other (income) and expense

$
(31)

$
275

nm

Non-operating adjustments:







Amortization of acquired intangible assets

$
(1)

$
(1)

(50.0)
%
Acquisition-related charges

10

—

nm

Non-operating retirement-related (costs)/income

(145)

(389)

(62.6)

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

$
(166)

$
(115)

44.6
%

~~nm - not meaningful~~


					Yr. to Yr.						Yr. to Yr.
(Dollars in millions)					Percent						Percent
For the nine months ended September 30:	2019		2018		Change
For the three months ended March 31:							2020		2019		Change
Other (income) and expense:
Foreign currency transaction losses/(gains)	$	(598)	$	(349)	71.3	%	$	(126)	$	(172)	(26.8)	%
(Gains)/losses on derivative instruments		358		449	(20.2)			101		69	46.2
Interest income		(301)		(187)	61.0			(51)		(70)	(27.5)
Net (gains)/losses from securities and investment assets		(26)		(89)	(71.3)			(5)		(4)	33.4
Retirement-related costs/(income)		419		1,185	(64.6)			264		138	92.0
Other		(703)		(42)	nm			0		(32)	nm
Total consolidated other (income) and expense	$	(850)	$	968	nm		$	182	$	(73)	nm
Non-operating adjustments:
Amortization of acquired intangible assets	$	(2)	$	(1)	50.0	%	$	(1)	$	(1)	—
Acquisition-related charges		154		—	nm			—		24	(100.0)	%
Non-operating retirement-related (costs)/income		(419)		(1,185)	(64.6)			(264)		(138)	92.0
Operating (non-GAAP) other (income) and expense	$	(1,118)	$	(219)	410.6	%	$	(83)	$	(187)	(55.8)	%

nm - not meaningful

Total consolidated other (income) and expense was ~~income~~expense of ~~$31~~$182 million in the ~~third~~first quarter of ~~2019~~2020 compared to ~~expense~~income of ~~$275~~$73 million in the prior year. The year-to-year change was primarily driven by:

●

~~Lower~~Higher non-operating retirement-related costs ($~~244~~127 million). Refer to “Retirement-Related Plans” for additional information; and

●

~~Higher~~Lower net exchange gains ~~reflected~~(including derivative instruments) of $78 million. Our hedging programs help mitigate currency impacts in ~~other from divestitures ($72 million).~~the Consolidated Income Statement.

Operating (non-GAAP) other (income) and expense was ~~$166~~income of $83 million ~~of income~~ in the ~~third~~first quarter of ~~2019~~2020 and ~~increased $51~~decreased $104 million compared to the prior-year period. The year-to-year change was driven primarily by the ~~higher~~lower net exchange gains ~~from divestitures~~ described above.

~~Table of Contents~~

~~Management Discussion – (continued)~~

Total consolidated other (income) and expense was income of $850 million in the first nine months of 2019 compared to expense of $968 million in the prior year. The year-to-year change was primarily driven by:

●

~~Lower non-operating retirement-related costs ($766 million). Refer to “Retirement-Related Plans” for additional information;~~

●

~~Higher gains reflected in other from divestitures ($650 million); and~~

●

Net exchange gains (including derivative instruments) in the current year versus net exchange losses (including derivative instruments) in the prior year ($340 million). The company’s hedging programs help mitigate currency impacts in the Consolidated Statement of Earnings.

Operating (non-GAAP) other (income) and expense was $1,118 million of income in the first nine months of 2019 compared to income of $219 million in the 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 September 30:

2019

2018

Change

Interest expense

$
432

$
191

125.7
%
Non-operating adjustment:







Acquisition-related charges

$
(24)

$
—

nm

Operating (non-GAAP) interest expense

$
408

$
191

113.2
%

~~nm - not meaningful~~

Yr. to Yr.

(Dollars in millions)

Percent

For the nine months ended September 30:

2019

2018

Change

Interest expense

$
990

$
530

86.9
%
Non-operating adjustment:







Acquisition-related charges

$
(228)

$
—

nm

Operating (non-GAAP) interest expense

$
762

$
530

43.9
%

~~nm - not meaningful~~


					Yr. to Yr.
(Dollars in millions)					Percent
For the three months ended March 31:	2020		2019		Change
Interest expense	$	326	$	210	54.8	%
Non-operating adjustment:
Acquisition-related charges	$	—	$	(36)	(100.0)
Operating (non-GAAP) interest expense	$	326	$	174	86.8	%

Interest expense increased ~~$241~~$115 million ~~and $460 million year to year~~ in the ~~third~~first quarter ~~and first nine months~~ of ~~2019, respectively.~~2020 compared to the prior-year period. Interest expense is presented in cost of financing in the Consolidated Income 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~~first quarter ~~and first nine months~~ of ~~2019~~2020 was ~~$572~~$444 million, ~~and $1,473 million, respectively,~~ an increase of ~~$188 million and $376~~$55 million versus the comparable prior-year ~~periods,~~period, primarily driven by a higher average debt balance, ~~and higher~~partially offset by lower average interest rates in the current ~~year as the company issued debt to finance the Red Hat acquisition.~~year.

Operating (non-GAAP) interest expense increased ~~$217~~$151 million ~~and $232 million year to year~~ in the ~~third~~first quarter ~~and first nine months~~ of ~~2019, respectively, and excludes~~2020 compared to the prior year. The prior-year period excluded Red Hat pre-closing debt financing costs. ~~Interest expense, post-Red Hat closing is included in operating (non-GAAP) interest expense.~~

8860

Table of Contents

Management Discussion – (continued)

Retirement-Related Plans

The following table provides the total pre-tax cost for all retirement-related plans. The operating cost amounts are included in the Consolidated Income 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.						Yr. to Yr.
(Dollars in millions)					Percent						Percent
For the three months ended September 30:	2019		2018		Change
For the three months ended March 31:							2020		2019		Change
Retirement-related plans — cost:
Service cost	$	97	$	109	(11.0)	%	$	99	$	97	1.9	%
Multi-employer plans		10		9	12.4			7		9	(13.3)
Cost of defined contribution plans		260		247	5.1			265		248	7.0
Total operating costs/(income)	$	367	$	365	0.5	%	$	371	$	353	5.1	%
Interest cost	$	721	$	677	6.5	%	$	540	$	728	(25.8)	%
Expected return on plan assets		(1,042)		(1,007)	3.5			(852)		(1,051)	(18.9)
Recognized actuarial losses		455		731	(37.7)			563		458	23.0
Amortization of prior service costs/(credits)		(3)		(18)	(82.7)			1		(3)	nm
Curtailments/settlements		3		2	101.5			8		1	782.5
Other costs		11		5	130.4			5		5	10.8
Total non-operating costs/(income)	$	145	$	389	(62.6)	%	$	264	$	138	92.0	%
Total retirement-related plans — cost	$	512	$	754	(32.1)	%	$	636	$	491	29.5	%

nm - not meaningful

Yr. to Yr.

(Dollars in millions)

Percent

For the nine months ended September 30:

2019

2018

Change

Retirement-related plans — cost:







Service cost

$
290

$
323

(10.2)
%
Multi-employer plans

26

29

(8.4)

Cost of defined contribution plans

761

763

(0.3)

Total operating costs/(income)

$
1,078

$
1,115

(3.4)
%
Interest cost

$
2,172

$
2,053

5.8
%
Expected return on plan assets

(3,139)

(3,047)

3.0

Recognized actuarial losses

1,366

2,212

(38.2)

Amortization of prior service costs/(credits)

(9)

(55)

(83.8)

Curtailments/settlements

7

7

(0.2)

Other costs

22

16

38.2

Total non-operating costs/(income)

$
419

$
1,185

(64.6)
%
Total retirement-related plans — cost

$
1,497

$
2,300

(34.9)
%

Total pre-tax retirement-related plan cost ~~decreased~~increased by ~~$242~~$145 million compared to the ~~third~~first quarter of ~~2018,~~2019, primarily driven by ~~a decrease in recognized actuarial losses ($276 million), primarily due to the change in the amortization period in the U.S. Qualified Personal Pension Plan and higher~~lower expected return on plan assets ($35198 million) and an increase in recognized actuarial losses ($105 million), partially offset by ~~higher~~lower interest costs ($44188 million). Total cost for the first nine months of 2019 decreased $803 million versus the first nine months of 2018, driven by a decrease in recognized actuarial losses ($846 million) primarily due to the amortization period change and higher expected return on plan assets ($92 million); partially offset by higher interest costs ($120 million).

As described in the “Operating (non-GAAP) Earnings” section, ~~the company~~management characterizes certain retirement-related costs as operating and others as non-operating. Utilizing this characterization, operating retirement-related costs in thefirst quarter of 2020 were $371 million, an increase of $18 million compared to the first quarter of 2019, primarily driven by higher defined contribution plans cost ($17 million). Non-operating costs of $264 million in the first quarter of 2020 increased $127 million year to year, driven by lower expected return on plan assets ($198 million) and an increase in recognized actuarial losses ($105 million), partially offset by lower interest costs ($188 million).

Taxes

The continuing operations benefit from income taxes for the first quarter of 2020 was $1,226 million, compared to a tax provision of $289 million in the first quarter of 2019. The operating (non-GAAP) benefit from income taxes for the first quarter of 2020 was $961 million, compared to a tax provision of $224 million in the first quarter of 2019.

The benefit from income taxes in the first quarter of 2020 was primarily driven by a net tax benefit related to an intra-entity sale of certain of the company’s intellectual property and the related impacts of $939 million and an adjustment to the U.S. tax reform charge due to a foreign tax law change in the first quarter of 2020. The operating (non-GAAP) benefit from income taxes was primarily driven by the same factors, except for the adjustment to the U.S. tax reform charge.

IBM’s full-year tax provision and effective tax rate are impacted by recurring factors including the geographic mix of income before taxes, state and local taxes, the effects of various global income tax strategies and any discrete tax events, such as the settlement of income tax audits and changes in or new interpretations of tax laws. The GAAP tax

8961

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Management Discussion – (continued)

~~third quarter of 2019 were $367 million, an increase of $2 million compared~~provision and effective tax rate could also be affected by adjustments to the ~~third quarter of 2018. Non-operating costs of $145 million~~previously recorded charges for U.S. tax reform attributable to any changes in ~~the third quarter of 2019 decreased $244 million year to year, driven primarily by lower recognized actuarial losses ($276 million)~~law, new regulations and a higher expected return on plan assets ($35 million), partially offset by higher interest costs ($44 million). For the first nine months of 2019, operating retirement-related costs were $1,078 million, a decrease of $38 million and non-operating costs were $419 million, a decrease of $766 million compared to the prior year, driven primarily by the same factors as above.guidance, audit adjustments, among others.

~~Taxes~~

The ~~continuing operations effective~~company is no longer subject to income tax ~~rate~~examination of its U.S. federal tax returns for ~~the third quarter of 2019 was (9.9) percent, a decrease of 20.1 points compared~~years prior to ~~the third quarter of 2018.~~2013. The ~~continuing operations effective~~company’s U.S. income tax ~~rate~~returns for ~~the first nine months of 2019 was 6.6 percent, an increase of 4.6 points compared~~2013 and 2014 continue to the first nine months of 2018. The operating (non-GAAP) tax rate for the third quarter of 2019 was 0.1 percent, a decrease of 12.7 points compared to the third quarter of 2018. The operating (non-GAAP) tax rate for the first nine months of 2019 was 7.4 percent, an increase of 2.0 points compared to the first nine months of 2018.

The decrease in the continuing operations effective tax rate in the third quarter of 2019 was primarily driven by a benefit from the realization of a tax only capital loss in a subsidiary (10.7 points), an increase in tax benefits attributable to audit activity (4.3 points), as well as a benefit due to the mix of geographic income year to year (5.0 points), primarily driven by Red Hat. The change in the continuing operations tax rate for the first nine months of 2019 compared to 2018 was primarily driven by reduced benefit related to audit activity (4.6 points). The change in the operating (non-GAAP) tax rate was primarily drivenbe examined by the ~~same factors.~~

IRS with specific focus on certain cross-border transactions in 2013. With respect to major U.S. state and foreign taxing jurisdictions, the company is generally no longer subject to tax examinations for years prior to 2014. The company'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 tax-related matters in India challenging tax assessments issued by the India Tax Authorities. ~~The open~~As of March 31, 2020, the company has recorded $704 million as prepaid income taxes representing cash tax deposits paid over time to protect the company’s right to appeal various income tax assessments made by the India Tax Authorities. Tax years still subject to examination contain matters that could be subject to differing interpretations of applicable tax laws and regulations as it relates to the amount and/or timing of income, deductions and tax credits. Although the outcome of tax audits is always uncertain, the company believes that adequate amounts of tax, interest and penalties have been provided for any adjustments that are expected to result for these years.

The amount of unrecognized tax benefits at ~~September 30, 2019~~March 31, 2020 is ~~$6,899~~$8,392 million which can be reduced by ~~$600~~$585 million ~~of offsetting tax benefits~~ associated with timing adjustments, U.S. tax credits, potential transfer pricing adjustments, and state income taxes. The net amount of ~~$6,299~~$7,807 million, if recognized, would favorably affect the company’s effective tax rate.

Earnings Per Share

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

~~Table of Contents~~

~~Management Discussion – (continued)~~

Yr. to Yr.

Percent

For the three months ended September 30:

2019

2018

Change

Earnings per share of common stock from continuing operations:







Assuming dilution

$
1.87

$
2.94

(36.4)
%
Basic

$
1.89

$
2.95

(35.9)
%
Diluted operating (non-GAAP)

$
2.68

$
3.42

(21.6)
%
Weighted-average shares outstanding: (in millions)







Assuming dilution

892.8

915.2

(2.4)
%
Basic

886.0

911.2

(2.8)
%


					Yr. to Yr.						Yr. to Yr.
					Percent						Percent
For the nine months ended September 30:	2019		2018		Change
For the three months ended March 31:							2020		2019		Change
Earnings per share of common stock from continuing operations:
Assuming dilution	$	6.46	$	7.36	(12.2)	%	$	1.31	$	1.78	(26.4)	%
Basic	$	6.50	$	7.39	(12.0)	%	$	1.32	$	1.79	(26.3)	%
Diluted operating (non-GAAP)	$	8.10	$	8.96	(9.6)	%	$	1.84	$	2.25	(18.2)	%
Weighted-average shares outstanding: (in millions)
Assuming dilution		892.5		920.0	(3.0)	%		895.0		893.9	0.1	%
Basic		887.3		915.6	(3.1)	%		888.0		889.6	(0.2)	%

Actual shares outstanding at ~~September 30, 2019~~March 31, 2020 were ~~885.6~~887.9 million. The weighted-average number of common shares outstanding assuming dilution during the ~~third~~first quarter ~~and first nine months~~ of ~~2019 were 22.4~~2020 was 1.1 million ~~(2.4~~shares (0.1 percent) ~~and 27.5 million (3.0 percent) shares lower~~higher than the same ~~periods~~period of ~~2018. The decreases were primarily the result of the common stock repurchase program.~~2019.

Financial Position

Dynamics

At ~~September 30, 2019,~~March 31, 2020, the balance sheet remained strong with flexibility to support the business. We continue to manage the investment portfolio to meet our capital preservation and liquidity objectives. In this unprecedented environment as a result of the COVID-19 pandemic, while we are supporting our clients and improving the flexibility and competitive position of our operations, we are also taking actions to enhance our balance sheet strength and liquidity position. We accessed the debt markets in early February 2020 with $4,117 million of issuances, while reducing $4,491 million of current and 2021 refinancing needs. In addition, while we do not rely on commercial paper for our funding requirements, it was prudent in the first quarter to take advantage of our access to the market. At March 31, 2020, we

Table of Contents

Management Discussion – (continued)

had $2,519 million of commercial paper, which increased both our cash and debt balances. Cash, restricted cash and marketable securities at quarter end were ~~$10,957 million. The company continues to manage the investment portfolio to meet its capital preservation and liquidity objectives.~~$12,017 million, an increase of $3,008 million since December 31, 2019. Total debt of ~~$66,327~~$64,327 million at ~~September 30, 2019~~March 31, 2020 increased ~~$20,515~~$1,428 million from December 31, ~~2018, driven by new debt issuances of $26,263 million to primarily fund the Red Hat acquisition; partially offset by debt maturities of $5,376 million.~~2019. Within total debt, ~~$23,078~~$22,254 million is Global Financing debt, which is in support of IBM products and services and has a stable credit portfolio.

Our pension plans were well funded at the ~~Global Financing business.~~ end of 2019, with worldwide qualified plans funded at 102 percent. Overall pension funded status as of the end of March was fairly consistent with year-end 2019, and we currently have no change to expected plan contributions in 2020.

In the first ~~nine~~three months of ~~2019, the company~~2020, we generated ~~$11,319~~$4,476 million in net cash from operations, compared to ~~$11,128~~$4,759 million in the first ~~nine~~three months of ~~2018. The company has~~2019. We have consistently generated strong cash flows from operations and ~~continues~~continue to have access to additional sources of liquidity through the capital markets and ~~its~~our $15,250 million of unused credit ~~facilities.~~ facilities~~The strong free cash flow generated by~~. We do not currently have plans to draw on these facilities, however they are available as back-up liquidity. We expect to continue to be opportunistic in the ~~company, portfolio actions taken~~capital markets and ~~the suspension of share repurchases position IBM~~remain fully committed to ~~return to its~~a target leverage ~~ratios within~~profile consistent with a~~couple of years. Through disciplined financial management, the company reduced debt by $6,712 million since June 30, 2019.~~ mid to high single A credit rating. Refer to “Liquidity and Capital Resources” for additional information. In summary, we have a strong cash position and ample credit available during these uncertain times to support and invest in our business.

The assets and debt associated with the Global Financing business are a significant part of ~~the company’s~~our financial position. ~~At September 30, 2019 those balances reflect 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.

~~Table of Contents~~

~~Management Discussion – (continued)~~

Global Financing Financial Position Key Metrics:


	At September 30,		At December 31,		At March 31,		At December 31,
(Dollars in millions)	2019		2018		2020		2019
Cash and cash equivalents	$	2,086	$	1,833	$	1,605	$	1,697
Net investment in sales-type and direct financing leases (1)		5,906		6,924		5,598		6,224
Equipment under operating leases — external clients (2)		276		444		197		238
Client loans		11,250		12,802		11,940		12,884
Total client financing assets		17,431		20,170		17,735		19,346
Commercial financing receivables		2,937		11,838		2,319		3,820
Intercompany financing receivables (3) (4)		3,756		4,873		3,771		3,870
Total assets	$	27,445	$	41,320	$	26,566	$	29,568
Debt	$	23,078	$	31,227	$	22,254	$	24,727
Total equity	$	2,564	$	3,470	$	2,472	$	2,749

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

(2)	Includes intercompany mark-up, priced on an arm’s-length basis, on products purchased from the company’s product divisions which is eliminated in IBM’s consolidated results.

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

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

At ~~September 30, 2019,~~March 31, 2020, substantially all client and commercial financing assets were IT related assets, and approximately 6058 percent of the total external portfolio was with investment grade clients with no direct exposure to consumers, an increase of 63 points year to year. This investment grade percentage is based on the credit ratings of the companies in the portfolio.

~~The company has~~We have a long-standing practice of taking mitigating actions, in certain circumstances, to transfer credit risk to third parties, including credit insurance, financial guarantees, non-recourse borrowings, transfers of receivables recorded as true sales in accordance with accounting guidance or sales of equipment under operating lease. ~~Adjusting for the mitigation actions, the investment grade content would increase to 67 percent, a decrease of 3 points year to year.~~

~~IBM Working Capital~~

At September 30,

At December 31,
(Dollars in millions)

2019

2018
Current assets

$
38,121

$
49,146
Current liabilities

35,066

38,227
Working capital

$
3,055

$
10,918
Current ratio

1.09:1

1.29:1

~~Working capital decreased $7,864 million from the year-end 2018 position. The key changes are described below:~~

~~Current assets decreased $11,025 million ($10,188 million adjusted for currency) due to:~~

●

A decline in receivables of $9,604 million ($9,213 million adjusted for currency) driven by a decline in financing receivables of $10,058 million primarily due to the wind down of OEM IT commercial financing; partially offset by an increase in other receivables of $1,133 million primarily related to divestitures; and

●

~~A decrease of $1,265 million ($917 million adjusted for currency) in cash, restricted cash, and marketable securities.~~

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Table of Contents

Management Discussion – (continued)

IBM Working Capital


	At March 31,		At December 31,
(Dollars in millions)	2020		2019
Current assets	$	38,931	$	38,420
Current liabilities		40,673		37,701
Working capital	$	(1,743)	$	718
Current ratio		0.96:1		1.02:1

Working capital decreased $2,461 million from the year-end 2019 position. The key changes are described below:

Current assets increased $511 million ($1,739 million adjusted for currency) due to:

●

An increase of $3,008 million ($3,416 million adjusted for currency) in cash, restricted cash, and marketable securities; and

●

An increase in prepaid expenses and other current assets of $408 million ($516 million adjusted for currency) primarily driven by an increase in derivative assets; partially offset by

●

A decline in receivables of $3,125 million ($2,514 million adjusted for currency) primarily as a result of collections of higher year-end balances.

Current liabilities ~~decreased $3,161~~increased $2,972 million ($~~2,524~~3,947 million adjusted for currency) as a result of:

●

An increase in short-term debt of $2,845 million ($2,909 million adjusted for currency) due to reclassifications of $3,490 million from long-term debt to reflect upcoming maturities and a net increase in commercial paper of $2,214 million partially offset by maturities of $2,851 million; and

●

An increase in deferred income of $1,351 million ($1,672 million adjusted for currency) driven by annual customer billings; partially offset by

●

A decrease in accounts payable of ~~$2,515~~$724 million ($~~2,464~~630 million adjusted for currency) reflecting declines from seasonally higher year-end ~~balances and the wind down of OEM IT commercial financing;~~balances; and

●

A decrease in ~~short-term debt~~taxes payable of ~~$1,677~~$491 million ($~~1,655~~385 million adjusted for currency) ~~due to maturities of $5,368 million; partially offset by reclassifications of $3,319 million from long-term debt to reflect upcoming maturities and debt issuances of $331 million; partially offset by~~

●

~~An increase in operating lease liabilities of $1,377 million ($1,399 million adjusted for currency) as a result of the adoption of the new leasing standard on January 1, 2019.~~.

Receivables and Allowances

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

(Dollars in millions)

January 1, 2019

Additions / (Releases) *

Write-offs **

Other ***

September 30, 2019
$
639

$
51

$
(104)

$
(8)

$
578


(Dollars in millions)
January 1, 2020 *		Additions / (Releases) **		Write-offs ***		Other +		March 31, 2020
$	612	$	56	$	(38)	$	(27)	$	603

* Opening balance does not equal the allowance at December 31, 2019 due to the adoption of the guidance for the allowance for credit losses.

Refer to note 2, “Accounting Changes,” for additional information.

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

*** Refer to note A, “Significant Accounting Policies,” in ~~the company’s 2018~~our 2019 Annual Report 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~~2.1 percent at ~~September 30, 2019,~~March 31, 2020, an increase of 30 basis points compared to ~~December 31, 2018.~~January 1, 2020. The increase was primarily driven by the overall decline in gross financing ~~receivables.~~receivables due to seasonally higher balances at year end. New additions in the first three months of 2020 were primarily due to certain

Table of Contents

Management Discussion – (continued)

specific reserves. The majority of the write-offs during the ~~nine~~three months ended ~~September 30, 2019~~March 31, 2020 related to receivables which had been previously reserved.

Global Financing Receivables and Allowances

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


	At September 30,			At December 31,			At March 31,			At December 31,
(Dollars in millions)	2019			2018			2020			2019
Recorded investment (1)	$	19,723		$	31,182
Amortized cost/Recorded investment (1)(2)							$	20,096		$	22,446
Specific allowance for credit losses		207			220			157			177
Unallocated allowance for credit losses		50			72			81			45
Total allowance for credit losses		257			292			238			221
Net financing receivables	$	19,466		$	30,890		$	19,858		$	22,224
Allowance for credit losses coverage		1.3	%		0.9	%		1.2	%		1.0	%

(1)	~~Includes~~Prior to the January 1, 2020 adoption of the guidance on credit losses, the presentation was recorded investment, subsequent to adoption the presentation is amortized cost. Both presentations include deferred initial direct costs which are eliminated in IBM’s consolidated results.

(2)

The amortized cost basis of a financial asset represents the original amount of the financing receivable (including residual value) adjusted for unearned income, deferred initial direct costs, cash collected, write-offs and any foreign exchange adjustments. Recorded investment excluded residual value.

The percentage of Global Financing receivables reserved increased from ~~0.9~~1.0 percent at December 31, ~~2018,~~2019, to ~~1.3~~1.2 percent at ~~September 30,~~March 31, 2020. The increase in unallocated reserves was impacted by the adoption of the guidance on credit losses in the current year. Specific reserves decreased 11.2 percent from $177 million at December 31, 2019, to $157 million at March 31, 2020.

Roll Forward of Global Financing Receivables Allowance for Credit Losses


(Dollars in millions)
January 1, 2020*		Additions / (Releases)**		Write-offs ***		Other +		March 31, 2020
$	262	$	10	$	(19)	$	(16)	$	238

* Opening balance does not equal the allowance at December 31, 2019 due to the adoption of the guidance for the allowance for credit losses.

Refer to note 2, “Accounting Changes,” for additional information.

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

*** Refer to note A, “Significant Accounting Policies,” in our 2019 Annual Report for additional information regarding allowance for credit loss write-offs.

+ Primarily represents translation adjustments.

Global Financing’s expected credit loss expense (including impacts from off-balance sheet commitments which are recorded in other liabilities) was an addition of $11 million for the three months ended March 31, 2020, compared to an addition of $3 million for the same period in 2019. The increase was ~~primarily~~ driven by higher unallocated reserves in EMEA in the overall decline in gross receivables. Unallocated reserves decreased 30 percent from $72 million at December 31, 2018, to $50 million at September 30, 2019. Specific reserves decreased 6 percent from $220 million at December 31, 2018, to $207 million at September 30, 2019.current year.

Noncurrent Assets and Liabilities


	At March 31,		At December 31,
(Dollars in millions)	2020		2019
Noncurrent assets	$	114,473	$	113,767
Long-term debt	$	52,685	$	54,102
Noncurrent liabilities (excluding debt)	$	39,917	$	39,398

9365

Table of Contents

Management Discussion – (continued)

~~Roll Forward of Global Financing Receivables Allowance for Credit Losses~~

(Dollars in millions)












January 1, 2019

Additions / (Releases)*

Write-offs **

Other ***

September 30, 2019
$
292

$
(6)

$
(23)

$
(6)

$
257

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

** Refer to note A, “Significant Accounting Policies,” in the company’s 2018 Annual Report 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 million for the three months ended September 30, 2019, compared to a release of $6 million for the same period in 2018.~~

Global Financing’s bad debt expense was a release of $6 million for the nine months ended September 30, 2019, compared to an addition of $18 million for the same period in 2018, due to lower specific reserves and a higher unallocated reserve release in 2019.

~~Noncurrent Assets and Liabilities~~

At September 30,

At December 31,
(Dollars in millions)

2019

2018
Noncurrent assets

$
111,499

$
74,236
Long-term debt

$
57,797

$
35,605
Noncurrent liabilities (excluding debt)

$
38,661

$
32,621

Noncurrent assets increased ~~$37,263~~$706 million ($~~38,244~~2,656 million adjusted for currency) due to:

●

~~A net~~An increase in ~~goodwill and net intangible assets~~deferred taxes of ~~$34,211~~$3,600 million ($~~34,634~~3,771 million adjusted for currency) primarily due to ~~the acquisition~~an intra-entity sale of ~~Red Hat; and~~

●

~~An increase in operating right-of-use assets of $4,901 million ($4,991 million adjusted for currency) as a result of the adoption of the new leasing standard on January 1, 2019;~~IP; partially offset by

●

A decrease in long-term financing receivables of ~~$1,408~~$1,004 million ($~~1,337~~821 million adjusted for currency) as a result of reductions from seasonally higher year-end ~~balances.~~balances; and

●

A decrease in net intangible assets and goodwill of $1,274 million ($455 million adjusted for currency) resulting from intangibles amortization and currency impacts.

Long-term debt ~~increased $22,192~~decreased $1,417 million ($~~22,412~~1,186 million adjusted for currency) due to:

●

~~Issuances~~Reclassifications to short-term debt of ~~$25,932~~$3,490 million ~~primarily~~ to ~~finance the Red Hat acquisition;~~reflect upcoming maturities; and

●

Maturities of $2,019 million mainly to early redeem certain outstanding bonds; partially offset by

●

~~Reclassifications to short-term debt~~Issuances of ~~$3,319 million to reflect upcoming maturities.~~$4,342 million.

Noncurrent liabilities (excluding debt) increased ~~$6,041~~$518 million ($~~6,650~~1,418 million adjusted for currency) due to:

●

An increase in ~~long-term operating lease liabilities of $3,790 million ($3,861 million adjusted for currency) as a result of the adoption of the new leasing standard on January 1, 2019; and~~

●

~~An increase in~~ other liabilities of ~~$3,390~~$1,348 million ($~~3,459~~1,675 million adjusted for currency) primarily driven by an increase in deferred tax liabilities ~~due~~related to the ~~acquisition of Red Hat;~~intra-entity IP sale; partially offset by

●

A decrease in retirement and postretirement plans of ~~$1,076~~$668 million ($~~667~~330 million adjusted for currency).

~~Table of Contents~~

~~Management Discussion – (continued)~~

Debt

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


	At September 30,		At December 31,		At March 31,		At December 31,
(Dollars in millions)	2019		2018		2020		2019
Total company debt	$	66,327	$	45,812	$	64,327	$	62,899
Total Global Financing segment debt	$	23,078	$	31,227	$	22,254	$	24,727
Debt to support external clients		19,915		27,536		19,092		21,487
Debt to support internal clients		3,164		3,690		3,162		3,239
Non-Global Financing debt	$	43,249	$	14,585	$	42,073	$	38,173

Total debt of ~~$66,327~~$64,327 million increased ~~$20,515~~$1,428 million from December 31, ~~2018,~~2019, driven by new debt issuances of ~~$26,263~~$4,464 million; partially offset by debt maturities and retirements of ~~$5,376~~$4,870 million. Within total debt, commercial paper was a net increase of $2,214 million.

Non-Global Financing debt of ~~$43,249~~$42,073 million increased ~~$28,664~~$3,901 million from December 31, ~~2018 primarily driven by issuances to fund the Red Hat acquisition.~~2019 and decreased $5,983 million since June 30, 2019.

Global Financing debt of ~~$23,078~~$22,254 million decreased ~~$8,148~~$2,473 million from December 31, ~~2018,~~2019, primarily due to ~~the wind down of OEM IT commercial financing operations.~~lower funding requirements.

Global Financing provides financing predominantly for ~~the company’s~~IBM’s external client assets, as well as for assets under contract by other IBM units. These assets, primarily for Global Technology Services, generate long-term, stable revenue

Table of Contents

Management Discussion – (continued)

streams similar to the Global Financing asset portfolio. Based on their attributes, these Global Technology Services assets are leveraged with the balance of the Global Financing asset base.

The debt used to fund Global Financing assets is composed of intercompany loans and external debt. Total debt changes generally correspond with the level of client and commercial financing receivables, the level of cash and cash equivalents, the change in intercompany and external payables and the change in intercompany investment from IBM. The terms of the intercompany loans are set by the company to substantially match the term, currency and interest rate variability underlying the financing receivable and are based on arm’s-length pricing. The Global Financing debt-to-equity ratio remained at 9.0 to 1 at ~~September 30, 2019.~~March 31, 2020.

~~As previously stated, the company measures~~We measure 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” and in note 8,4, “Segments.” In the ~~company’s~~ Consolidated Income Statement, ~~of Earnings,~~ the external debt-related interest expense supporting Global Financing’s internal financing to ~~the company~~IBM is reclassified from cost of financing to interest expense.

Equity

Total equity ~~increased $1,166~~decreased $856 million from December 31, ~~2018,~~2019, primarily due to increases in foreign currency translation losses ($1,041 million) decreases from dividends paid ($1,440 million); partially offset by increases from net income ($~~5,761~~1,175 million) and retirement-related plans ($~~1,095~~422 million)~~; partially offset by decreases from dividends paid ($4,269 million) and an increase in treasury stock ($1,404 million) primarily due to share repurchases.~~.

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~~Management Discussion – (continued)~~

Cash Flow

~~The company’s~~Our 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 nine months ended September 30:	2019		2018
For the three months ended March 31:					2020		2019
Net cash provided by/(used in) continuing operations:
Operating activities	$	11,319	$	11,128	$	4,476	$	4,759
Investing activities		(27,064)		(5,368)		(902)		(853)
Financing activities		14,717		(5,864)		(115)		1,863
Effect of exchange rate changes on cash, cash equivalents and restricted cash		(352)		(399)		(403)		(102)
Net change in cash, cash equivalents and restricted cash	$	(1,379)	$	(503)	$	3,057	$	5,668

Net cash provided by operating activities ~~increased $191~~decreased $283 million as compared to the first ~~nine~~three months of ~~2018~~2019 driven primarily by:

●

An increase in interest payments on debt of ~~$838 million in cash provided by financing receivables; partially offset by~~approximately $190 million; and

●

Performance-related declines within net ~~income and Red Hat acquisition-related impacts.~~income.

Net cash used in investing activities increased ~~$21,696~~$49 million driven primarily by:

●

~~An increase~~A decrease of $212 million in cash provided by net ~~cash used for acquisitions of $32,507 million; partially offset by~~non-operating finance receivables; and

●

An increase ~~of $5,719 million~~ in cash ~~provided~~used for net capital expenditures of $123 million; partially offset by ~~net non-operating finance receivables primarily driven by the wind down of OEM IT commercial financing operations; and~~

●

A decrease in cash used for net purchases of marketable securities and other investments of ~~$3,051 million; and~~$306 million.

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Management Discussion – (continued)

Financing activities were a net use of cash of $115 million in the first three months of 2020 compared to a net source of cash of $1,863 million in the first three months of 2019. The year-to-year increase in the use of cash of $1,978 million was driven primarily by:

●

A decrease in ~~cash used for~~ net ~~capital expenditures of $1,114 million; and~~

●

~~An increase in~~ cash provided by ~~divestitures of $927 million.~~

Financing activities were a net source of cash of $14,717 million in the first nine months of 2019 compared to a net use of cash of $5,864 million in the first nine months of 2018. The year-to-year increase in cash flow of $20,581 million was driven by:

●

~~An increase in net cash sourced from~~ debt transactions of ~~$19,620~~$2,876 million primarily driven by a higher level of net ~~issuances used~~additions in the prior year to fund the acquisition of Red ~~Hat acquisition; and~~Hat; partially offset by

●

A decrease in cash used for gross common share repurchases of ~~$1,032~~$920 million.

Looking Forward

~~The company~~Long-term strategic model

IBM is focused on chapter 2 of ~~cloud,~~clients’ digital reinventions, which ~~will shift~~includes shifting mission-critical ~~work~~workloads to the cloud and ~~optimize everything from supply chains to core banking systems.~~scaling AI. To address ~~this~~the cloud 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~~is best addressed with a hybrid, multi-cloud, open ~~approach.~~approach, based on a foundation of Linux, with containers and Kubernetes. On July 9, 2019, ~~IBM~~we closed the acquisition of Red Hat, which ~~will~~ significantly ~~change~~changed the cloud landscape and will accelerate our high value business model. Together, IBM and Red Hat offer the leading hybrid, multi-cloud platform built on open source technologies.

2020

On April 20, 2020, given the level of uncertainty around the duration of the COVID-19 health crisis and the potential rate and pace of economic recovery, IBM withdrew full-year 2020 expectations. We expect to reassess this position based on the clarity of the macroeconomic recovery after the second quarter. We maintain confidence in our strategy and our portfolio, which is focused on hybrid cloud and AI and believe the challenges clients are facing today will accelerate their transitions to digital environments. However, we do expect changes to client buying patterns in the near term. In this environment, we have taken quick and prudent actions to manage cost and expense, further improve our liquidity position and focus on opportunities to emerge stronger. While there are a wide range of outcomes for the year, each of which we are prepared for, in each scenario, we expect to have solid free cash flow and ample liquidity to support our business and secure our dividend.

Looking forward to the second quarter of 2020, in services, approximately 80 percent of GBS revenue and 90 percent of GTS revenue in a quarter historically comes from the opening backlog, though our contracts adjust for flexible volumes in our clients’ businesses. We have made progress in our backlog and although it was down on an actual basis, it was essentially flat at constant currency (with GBS up and GTS down modestly) compared to the prior- year period.

Over the last few years, our software transactional content in the second quarter is about 20 to 25 percent of our software revenue. We have a solid pipeline of deals for second-quarter 2020, however, our software performance will depend on how we yield against that pipeline. Since the COVID-19 crisis started to impact our software performance at the end of the first quarter, if that same client buying behavior continues, it is reasonable to expect it could be more impactful to performance in the second quarter.

The Systems hardware business is essentially all transactional. Similar to software, we have a good pipeline in IBM Z and storage. While the current environment is expected to impact closure rates, we expect less of an impact to IBM Z and storage given the essential nature of the purchases and additional capacity requirements, especially in certain industries.

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Management Discussion – (continued)

~~landscape~~In cost and ~~accelerate~~expense, we expect to closely manage our spending and capitalize on new and efficient ways of operating. We expect the company’s high value business model. Together, IBM and Red Hat will drive innovation and shift clients’ mission-critical workloads to the cloud by offering a next-generation hybrid, multi-cloud platform built on open source technologies. The acquisition of Red Hat positions IBM to be the leading hybrid cloud provider.

Consistent with the acquisition of a highly profitable software business, non-cash purchase accounting adjustments will result in the Red Hat 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 date fair value. This includes the acquired deferred revenue balance. This resulted in a non-cash adjustment of $2.2 billion to the acquired deferred revenue balance and will result in a reduction to reported revenue post-closing. The level of adjustment reflects the high margin profile of Red Hat’s business, and deferred revenue is expected to be replenished over the subsequent two to three years, given Red Hat’s high renewal rates and a stable and growing client base.

~~Red Hat is expected to be free cash flow accretive to IBM~~structural actions taken in the first ~~twelve months, with nominal dilution in second-half 2019. The company also remains on track~~quarter to ~~achieve free cash flow~~yield gross annualized savings of approximately ~~$12~~$1.8 billion starting in ~~2019. Combined~~the second half of 2020. We are likely to take additional actions in the second quarter.

As our clients adjust to this crisis, they need a partner they can trust, and IBM is that partner. This is not just about helping our clients navigate this crisis but also ensuring that they emerge even stronger and more resilient. To that end, we have taken concrete steps to focus on near-term opportunities to address the shifting needs of clients, such as leveraging hybrid cloud, using AI for automation and enabling remote work. We have also quickly mobilized to help with the additional software and services profits, and net of incremental interest to finance the transaction and other acquisition-related charges, Red Hat is expected to add $0.5 billion and $1 billion to IBM’s free cash flow in 2020 and 2021, respectively.

The combination of IBM and Red Hat is off to a strong start. In the third quarter, cloud revenue growth accelerated and within the segments, there was good growth in Cloud & Cognitive Software and GBS. In Systems there was a solid start to z15, which began shipping in the last week of the quarter and high-end storage was announced. GTS had strong cloud results, but overall performance was weaker than expectations. In the short term, the company is going to manage this business for margin and cash. Looking forward to the fourth quarter, it is the company’s seasonally largest transaction quarter. The company expects total revenue to increase between $3.5 billion and $3.7 billion from third quarter to fourth quarter of 2019. This is higher than the sequential improvement for the same periods in 2018, due primarily to the introduction of the IBM z15 mainframe late in September of 2019. For the fourth quarter, assuming a steady economic environment, the company is expecting a normal IBM Z cycle, solid software transactional execution while facing a strengthening U.S. dollar.

~~At the company’s~~ August 2, 2019 investor briefing, IBM updated its full year operating (non-GAAP) earnings per share expectation, which was impacted by temporary non-cash items, including: the deferred revenue adjustment recorded in purchase accounting, equity and retention and share repurchase suspension. Through the third quarter, the company expects to achieve GAAP earnings per share from continuing operations for 2019 of at least $10.58. The company continues to expect operating (non-GAAP) earnings per share of at least $12.80, which excludes acquisition-related charges of $1.52 per share, non-operating retirement-related items of $0.51 per share and tax reform enactment impacts of $0.19 per share. In 2020, IBM expects to return to a sustainable revenue growth trajectory.

global battle against COVID-19 with much work already underway.

For ~~full-year 2019,~~ the ~~company expects~~period ended March 31, 2020, we assessed certain accounting-related matters that generally require consideration of current information reasonably available to us and forecasted financial data in the ~~GAAP effective tax rate~~context of unknown future impacts to ~~be approximately 8 to 9 percent, including an estimate for potential discrete tax events (discretes).~~IBM as a result of the COVID-19 pandemic. The company updated its operating (non-GAAP) tax rate expectations at the August 2nd investor briefing. The company expects its operating (non-GAAP) tax rate for 2019 to be approximately 9 to 10 percent, including an estimate of potential discretes. Discretes by their nature are difficult to estimate and the actual impacts will be recorded as the discrete events occur. The rates will change year to year based on discrete tax events, such as the settlement of income tax audits and changes in tax laws, as well as recurring factors including the geographic mix of income before taxes, state and local taxes and the effects of various global income tax strategies. The GAAP effective tax rate could also be affected by adjustmentsaccounting matters assessed included but were not limited to, the ~~previously recorded charges~~allowances for ~~U.S.~~credit losses, the carrying values of goodwill and intangible assets and other long-lived assets, our net investments in sales-type or direct financing leases, any significant lease modifications, valuation allowances for tax ~~reform attributable~~assets and revenue recognition. These assessments did not result in any material impacts to ~~any changes in law, new regulations~~our consolidated financial results as of and ~~guidance, audit adjustments, among others.~~

~~The Red Hat acquisition was funded through a combination of cash and debt, with~~for the incremental debt issued in the first half of 2019. The company will continue with a disciplined financial policy and is committed to maintaining strong investment grade credit ratings. The company is targeting a leverage profile consistent with a mid to high single A credit rating within a couple years, while maintaining its solid and growing dividend. IBM suspended its share repurchase

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~~Management Discussion – (continued)~~

program at the close of the acquisition to direct its free cash flow towards reducing debt levels. The combination of these actions provides the company with the flexibility to invest in the business going forward.

~~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 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 Financingended March 31, 2020. We will continue to ~~provide differentiated end-to-end financing solutions, including commercial financing~~assess these matters in ~~support~~future periods. However, given the inherent uncertainty of ~~IBM partner relationships. The wind down~~the future impacts from the magnitude and/or duration of the pandemic, there can be no assurance that impacts will not be material to our consolidated financial results in future periods.

Our pension plans are well funded coming into this ~~activity is expected to reduce IBM’s revenue, with a nominal impact to profit, however it does not change the company’s earnings per share~~environment and ~~free cash flow~~our expectations for ~~2019.~~

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

~~The company expects 2019~~contributions remain consistent with year-end 2019. We expect 2020 pre-tax retirement-related plan cost to be approximately ~~$2.0~~$2.7 billion, ~~a decrease~~an increase of approximately ~~$1 billion~~$600 million compared to ~~2018.~~2019. This estimate reflects current pension plan assumptions at December 31, ~~2018.~~2019. Within total retirement-related plan cost, operating retirement-related plan cost is expected to be approximately $1.5 billion, approximately flat versus ~~2018.~~2019. Non-operating retirement-related plan cost is expected to be approximately ~~$0.6~~$1.2 billion, ~~a decrease~~an increase of approximately ~~$1 billion~~$600 million compared to ~~2018,~~2019, primarily driven by lower ~~actuarial loss amortization resulting~~income from ~~the change in amortization period for the U.S. plan.~~expected return on assets. Contributions for all retirement-related plans are expected to be approximately ~~$2.2~~$2.3 billion in ~~2019, a decrease~~2020, an increase of approximately $100 million compared to ~~2018.~~2019.

Currency Rate Fluctuations

Changes in the relative values of non-U.S. currencies to the U.S. dollar (USD) affect ~~the company’s~~our financial results and financial position. At ~~September 30, 2019,~~March 31, 2020, currency changes resulted in assets and liabilities denominated in local currencies being translated into fewer dollars than at year-end ~~2018. The company uses~~2019. We use 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~~we may use some of the advantage from a weakening U.S. dollar to improve ~~its~~our position competitively, and price more aggressively to win the business, essentially passing on a portion of the currency advantage to ~~its~~our customers. Competition will frequently take the same action. Consequently, ~~the company believes~~we believe that some of the currency-based changes in cost impact the prices charged to clients. ~~The company~~We also ~~maintains~~maintain currency hedging programs for cash management purposes which temporarily mitigate, but do not eliminate, the volatility of currency impacts on ~~the company’s~~our financial results.

~~The company translates~~We translate revenue, cost and expense in ~~its~~our 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~~we utilize 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~~our year-to-year revenue and earnings per share growth in the first ~~nine~~three months of ~~2019.~~2020. Based on the currency rate movements in the first ~~nine~~three months of ~~2019,~~2020, total revenue decreased ~~4.3~~3.4 percent as reported and ~~1.7~~1.9 percent at constant currency versus the first ~~nine~~three months of ~~2018.~~2019. On an income from continuing operations before ~~income tax basis, these translation impacts mitigated by the net impact of hedging activities~~

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Management Discussion – (continued)

income tax basis, these translation impacts mitigated by the net impact of hedging activities resulted in a theoretical maximum (assuming no pricing or sourcing actions) increase of approximately ~~$240~~$60 million in the first ~~nine~~three months of 2020 on an as-reported basis and an increase of approximately $50 million on an operating (non-GAAP) basis. The same mathematical exercise also resulted in an increase of approximately $60 million in the first three months of 2019 on an as-reported basis and an increase of approximately ~~$210~~$50 million on an operating (non-GAAP) basis. The same mathematical exercise resulted in an increase of approximately $200 million in the first nine months of 2018 on an as-reported basis and an increase of approximately $225 million on an operating (non-GAAP) basis. The company viewsWe view 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~~we believe it could be substantially less than the theoretical maximum given the competitive pressure in the marketplace.

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

Liquidity and Capital Resources

In ~~the company’s 2018~~our 2019 Annual Report, on pages 6057 to ~~62,~~59, there is a discussion of ~~the company’s~~our liquidity including two tables that present three years of data. The table presented on page 6058 includes net cash from operating activities, cash and cash equivalents, restricted cash and short-term marketable securities, and the size of ~~the company’s~~our global credit facilities for each of the past three years. For the ~~nine~~three months ended, or ~~as of,~~at, as applicable, ~~September 30, 2019,~~March 31, 2020, those amounts are ~~$11.3~~$4.5 billion of net cash from operating activities, ~~$11.0~~$12.0 billion of cash and cash equivalents, restricted cash and short-term marketable securities and $15.3 billion in global credit facilities, respectively. While we have no current plans to draw on these credit facilities, they are available as back-up liquidity.

On July 9, 2019, we closed the acquisition of Red Hat for cash consideration of $34.8 billion. The transaction was funded through a combination of cash on hand and proceeds from 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 11, “Borrowings,” for additional details of financing this transaction.

The major rating agencies’ ratings on ~~the company’s~~our debt securities at ~~September 30, 2019~~March 31, 2020 appear in the following ~~table:~~table and remain unchanged from December 31, 2019.

Can
	STANDARD	MOODY’S
	AND	INVESTORS
IBM and IBM Credit LLC ratings:	POOR’S	SERVICE
Senior long-term debt	A	A2
Commercial paper	A-1	Prime-1

~~On July 9, 2019, the company closed the acquisition of Red Hat for cash consideration of $34.8 billion. The transaction was funded through~~We remain committed to a ~~combination of cash on hand and proceeds from debt issuances. In order to reduce this debt and return to~~ target leverage ~~ratios~~profile consistent with a mid to high single A credit rating 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. In the third-quarter 2019, the company reduced debt by $6.7 billion.

After closing the transaction, Moody’s, as expected, downgraded IBM and IBM Credit LLC’s long-term debt rating from A1 to A2 and improved its outlook to stable. The commercial paper rating from Moody’s remains unchanged. Standard and Poor’s ratings remain unchanged. Additionally, Fitch affirmed its rating before withdrawing coverage on IBM for commercial reasons.years.

~~IBM will continue with a disciplined financial policy and is committed to maintaining strong investment grade credit ratings. The company does~~We do not have “ratings trigger” provisions in ~~its~~our 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~~Our debt covenants are well within the required levels. Our contractual agreements governing derivative instruments contain standard market clauses which can trigger the termination of the agreement if ~~the company’s~~our credit rating were to fall below investment grade. At ~~September 30, 2019,~~March 31, 2020, the fair value of those instruments that were in a liability position was ~~$1,074~~$511 million, before any applicable netting, and this position is subject to fluctuations in fair value period to period based on the level of ~~the company’s~~our outstanding instruments and market conditions. ~~The company has~~We have no other contractual arrangements

~~Table of Contents~~

~~Management Discussion – (continued)~~

that, in the event of a change in credit rating, would result in a material adverse effect on ~~its~~our financial position or liquidity.

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

Table of Contents

Management Discussion – (continued)

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~~It is ~~evaluating~~still uncertain when the transition from LIBOR to another reference rate will occur or whether SOFR will become the accepted market alternative to LIBOR. We are continuing to evaluate 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 for additional updates to address financial reporting issues that might arise in connection with transition from LIBOR to a new benchmark rate.

~~The company prepares its~~We prepare our 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~~highlight causes and events underlying sources and uses of cash in that format on ~~page 96.~~pages 67 and 68. For the purpose of running its business, ~~the company~~IBM manages, monitors and analyzes cash flows in a different manner.

Management uses free cash flow as a measure to evaluate its operating results, plan share repurchase levels, strategic investments and assess its ability and need to incur and service debt. The entire free cash flow amount is not necessarily available for discretionary expenditures. ~~The company defines~~We define 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. Free cash flow guidance is derived using an estimate of profit, working capital and operational cash ~~outflows.~~flows. As previously noted, ~~the company views~~we view Global Financing receivables as a profit-generating investment which ~~it seeks~~we seek to maximize and therefore it is not considered when formulating guidance for free cash flow. As a result, ~~the company does~~we do not estimate a GAAP Net Cash from Operations expectation metric.

The following is management’s view of cash flows for the first ~~nine~~three months of ~~2019~~2020 and ~~2018~~2019 prepared in a manner consistent with the description above.


(Dollars in millions)
For the nine months ended September 30:	2019		2018
For the three months ended March 31:					2020		2019
Net cash from operating activities per GAAP	$	11,319	$	11,128	$	4,476	$	4,759
Less: change in Global Financing receivables		3,712		2,874		2,381		2,458
Net cash from operating activities, excluding Global Financing receivables	$	7,607	$	8,254	$	2,095	$	2,302
Capital expenditures, net		(1,725)		(2,839)		(737)		(614)
Free cash flow	$	5,882	$	5,415	$	1,358	$	1,688
Acquisitions		(32,630)		(123)		(13)		(1)
Divestitures		927		—		26		33
Share repurchase		(1,361)		(2,393)		—		(920)
Common stock repurchases for tax withholdings		(186)		(148)		(44)		(61)
Dividends		(4,269)		(4,250)		(1,440)		(1,397)
Non-Global Financing debt		28,432		1,607		3,503		5,890
Other (includes Global Financing net receivables and Global Financing debt)		1,941		1,712		(382)		690
Change in cash, cash equivalents, restricted cash and short-term marketable securities	$	(1,265)	$	1,820	$	3,008	$	5,922

In the first three months of 2020, we generated free cash flow of $1.4 billion, a decrease of $0.3 billion versus the prior year. In the first quarter of 2020, we also continued to return value to shareholders with $1.4 billion in dividends.

Events that could temporarily change the historical cash flow dynamics discussed previously and in our 2019 Annual Report include significant changes in operating results, material changes in geographic sources of cash,

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Management Discussion – (continued)

In the first nine months of 2019, the company generated free cash flow of $5.9 billion, an increase of $0.5 billion versus the prior year. The company made cash payments net of cash received of $32.6 billion to acquire Red Hat while also continuing to return value to shareholders including $4.3 billion in dividends and $1.4 billion in gross common stock repurchases.

Events that could temporarily change the historical cash flow dynamics discussed previously and in the company’s 2018 Annual Report include significant changes in operating results, material changes in geographic sources of cash, unexpected adverse impacts from litigation, future pension funding requirements, periods of severe downturn in the capital markets or the timing of tax payments. Whether any litigation has such an adverse impact will depend on a number of variables, which are more completely described in note ~~14,~~13, “Contingencies,” in this Form 10-Q. With respect to pension funding, ~~the company expects~~we expect to make legally mandated pension plan contributions to certain non-U.S. defined benefit plans of approximately $300 million in ~~2019.~~2020. Contributions related to all retirement-related plans are expected to be approximately ~~$2.2~~$2.3 billion in ~~2019.~~2020. 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~~We are 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~~2020, we are not legally required to make any contributions to the U.S. defined benefit pension plans.

~~The company’s~~Our cash flows are sufficient to fund ~~its~~our current operations and obligations, including investing and financing activities such as dividends and debt service. When additional requirements arise, ~~the company has~~we have several liquidity options available. These options may include the ability to borrow additional funds at reasonable interest rates and utilizing ~~its~~our committed global credit facilities. With our share repurchase program suspended since the close of the Red Hat acquisition, our overall shareholder payout remains at a comfortable level and we remain fully committed to our dividend.

Global Financing Return on Equity Calculation



	For Three Months Ended						For Nine Months Ended						For Three Months Ended
	September 30,						September 30,						March 31,
(Dollars in millions)	2019			2018			2019			2018			2020			2019
Numerator
Global Financing after-tax income*	$	217		$	235		$	521		$	791		$	192		$	116
Annualized after-tax income (1)	$	867		$	940		$	694		$	1,055		$	766		$	463
Denominator
Average Global Financing equity (2)**	$	2,672		$	3,414		$	3,022		$	3,457		$	2,610		$	3,372
Global Financing return on equity (1)/(2)		32.4	%		27.5	%		23.0	%		30.5	%		29.4	%		13.7	%

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

** Average of the ending equity for Global Financing for the last two ~~quarters and four quarters, for the three months ended September 30, and for the nine months ended September 30, respectively.~~quarters.

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Management Discussion – (continued)

GAAP Reconciliation

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


				Acquisition-			Retirement-			U.S.									Acquisition-			Retirement-			U.S.
(Dollars in millions except per share amounts)				Related			Related			Tax Reform			Operating						Related			Related			Tax Reform			Operating
For the three months ended September 30, 2019:	GAAP			Adjustments			Adjustments			Charges**			(non-GAAP)
For the three months ended March 31, 2020:																GAAP			Adjustments			Adjustments			Impacts			(non-GAAP)
Gross profit	$	8,336		$	209		$	—		$	—		$	8,545		$	7,922		$	188		$	—		$	—		$	8,110
Gross profit margin		46.2	%		1.2	pts.		—	pts.		—	pts.		47.4	%		45.1	%		1.1	pts.		—	pts.		—	pts.		46.2	%
S,G&A	$	5,024		$	(451)		$	—		$	—		$	4,573		$	5,955		$	(285)		$	—		$	—		$	5,670
R,D&E		1,553			(53)			—			—			1,500			1,625			—			—			—			1,625
Other (income) and expense		(31)			10			(145)			—			(166)			182			(1)			(264)			—			(83)
Interest expense		432			(24)			—			—			408			326			—			—			—			326
Total expense and other (income)		6,813			(518)			(145)			—			6,150			7,972			(285)			(264)			—			7,422
Pre-tax income from continuing operations		1,522			727			145			—			2,395
Pre-tax income/(loss) from continuing operations																	(49)			473			264			—			688
Pre-tax margin from continuing operations		8.4	%		4.0	pts.		0.8	pts.		—	pts.		13.3	%		(0.3)	%		2.7	pts.		1.5	pts.		—	pts.		3.9	%
Provision for (benefit from) income taxes*	$	(151)		$	142		$	16		$	(5)		$	1
Effective tax rate		(9.9)	%		8.9	pts.		1.3	pts.		(0.2)	pts.		0.1	%
Provision for (benefit from) income taxes* **																$	(1,226)		$	102		$	14		$	149		$	(961)
Income from continuing operations	$	1,673		$	586		$	130		$	5		$	2,394		$	1,176		$	371		$	250		$	(149)		$	1,649
Income margin from continuing operations		9.3	%		3.3	pts.		0.7	pts.		0.0	pts.		13.3	%		6.7	%		2.1	pts.		1.4	pts.		(0.8)	pts.		9.4	%
Diluted earnings per share from continuing operations	$	1.87		$	0.66		$	0.14		$	0.01		$	2.68		$	1.31		$	0.42		$	0.28		$	(0.17)		$	1.84

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

** ~~Operating (non-GAAP) earnings exclude charges associated with~~The effective tax rate is not displayed, as the ~~enactment of U.S. tax reform due to their unique non-recurring nature.~~calculated rate for the three months ended March 31, 2020 is not meaningful.

Acquisition-

Retirement-

U.S.

(Dollars in millions except per share amounts)

Related

Related

Tax Reform

Operating

For the three months ended September 30, 2018:

GAAP

Adjustments

Adjustments

Charges**

(non-GAAP)

Gross profit

$
8,803

$
96

$
—

$
—

$
8,899

Gross profit margin

46.9
%

0.5
pts.

—
pts.

—
pts.

47.4
%
S,G&A

$
4,363

$
(112)

$
—

$
—

$
4,251

R,D&E

1,252

—

—

—

1,252

Other (income) and expense

275

(1)

(389)

—

(115)

Interest expense

191

—

—

—

191

Total expense and other (income)

5,807

(113)

(389)

—

5,304

Pre-tax income from continuing operations

2,996

209

389

—

3,594

Pre-tax margin from continuing operations

16.0
%

1.1
pts.

2.1
pts.

—
pts.

19.2
%
Provision for income taxes*

$
304

$
56

$
100

$
—

$
460

Effective tax rate

10.2
%

1.0
pts.

1.7
pts.

—
pts.

12.8
%
Income from continuing operations

$
2,692

$
153

$
289

$
—

$
3,134

Income margin from continuing operations

14.4
%

0.8
pts.

1.5
pts.

—
pts.

16.7
%
Diluted earnings per share from continuing operations

$
2.94

$
0.17

$
0.31

$
—

$
3.42


				Acquisition-			Retirement-			U.S.
(Dollars in millions except per share amounts)				Related			Related			Tax Reform			Operating
For the three months ended March 31, 2019:	GAAP			Adjustments			Adjustments			Impacts			(non-GAAP)
Gross profit	$	8,043		$	76		$	—		$	—		$	8,119
Gross profit margin		44.2	%		0.4	pts.		—	pts.		—	pts.		44.7	%
S,G&A	$	4,691		$	(124)		$	—		$	—		$	4,566
R,D&E		1,433			—			—			—			1,433
Other (income) and expense		(73)			23			(138)			—			(187)
Interest expense		210			(36)			—			—			174
Total expense and other (income)		6,160			(137)			(138)			—			5,886
Pre-tax income from continuing operations		1,883			212			138			—			2,233
Pre-tax margin from continuing operations		10.4	%		1.2	pts.		0.8	pts.		—	pts.		12.3	%
Provision for income taxes*	$	289		$	49		$	26		$	(141)		$	224
Effective tax rate		15.4	%		0.7	pts.		0.2	pts.		(6.3)	pts.		10.0	%
Income from continuing operations	$	1,593		$	164		$	111		$	141		$	2,009
Income margin from continuing operations		8.8	%		0.9	pts.		0.6	pts.		0.8	pts.		11.0	%
Diluted earnings per share from continuing operations	$	1.78		$	0.18		$	0.13		$	0.16		$	2.25

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

~~102~~

~~Table of Contents~~

~~Management Discussion – (continued)~~

Acquisition-

Retirement-

U.S.

(Dollars in millions except per share amounts)

Related

Related

Tax Reform

Operating

For the nine months ended September 30, 2019:

GAAP

Adjustments

Adjustments

Charges**

(non-GAAP)

Gross profit

$
25,388

$
359

$
—

$
—

$
25,747

Gross profit margin

45.9
%

0.6
pts.

—
pts.

—
pts.

46.5
%
S,G&A

$
15,171

$
(724)

$
—

$
—

$
14,447

R,D&E

4,393

(53)

—

—

4,340

Other (income) and expense

(850)

152

(419)

—

(1,118)

Interest expense

990

(228)

—

—

762

Total expense and other (income)

19,215

(853)

(419)

—

17,942

Pre-tax income from continuing operations

6,173

1,212

419

—

7,805

Pre-tax margin from continuing operations

11.1
%

2.2
pts.

0.8
pts.

—
pts.

14.1
%
Provision for income taxes*

$
407

$
245

$
82

$
(160)

$
575

Effective tax rate

6.6
%

2.1
pts.

0.7
pts.

(2.0)
pts.

7.4
%
Income from continuing operations

$
5,766

$
967

$
338

$
160

$
7,230

Income margin from continuing operations

10.4
%

1.7
pts.

0.6
pts.

0.3
pts.

13.1
%
Diluted earnings per share from continuing operations

$
6.46

$
1.08

$
0.38

$
0.18

$
8.10

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

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

Acquisition-

Retirement-

U.S.

(Dollars in millions except per share amounts)

Related

Related

Tax Reform

Operating

For the nine months ended September 30, 2018:

GAAP

Adjustments

Adjustments

Charges**

(non-GAAP)

Gross profit

$
26,249

$
283

$
—

$
—

$
26,531

Gross profit margin

45.4
%

0.5
pts.

—
pts.

—
pts.

45.9
%
S,G&A

$
14,665

$
(332)

$
—

$
—

$
14,333

R,D&E

4,021

—

—

—

4,021

Other (income) and expense

968

(1)

(1,185)

—

(219)

Interest expense

530

—

—

—

530

Total expense and other (income)

19,341

(333)

(1,185)

—

17,822

Pre-tax income from continuing operations

6,908

616

1,185

—

8,709

Pre-tax margin from continuing operations

11.9
%

1.1
pts.

2.0
pts.

—
pts.

15.1
%
Provision for income taxes*

$
138

$
138

$
285

$
(93)

$
468

Effective tax rate

2.0
%

1.4
pts.

3.0
pts.

(1.1)
pts.

5.4
%
Income from continuing operations

$
6,770

$
478

$
900

$
93

$
8,241

Income margin from continuing operations

11.7
%

0.8
pts.

1.6
pts.

0.2
pts.

14.2
%
Diluted earnings per share from continuing operations

$
7.36

$
0.52

$
0.98

$
0.10

$
8.96

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

~~103~~73

Table of Contents

Management Discussion – (continued)

Forward-Looking and Cautionary Statements

Except for the historical information and discussions contained herein, statements contained in this Form 10-Q may constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are based on the company’s current assumptions regarding future business and financial performance. These statements involve a number of risks, uncertainties and other factors that could cause actual results to differ materially, including, but not limited to, the following: a downturn in economic environment and client spending budgets; the company’s failure to meet growth and productivity objectives; a failure of the company’s innovation initiatives; damage to the company’s reputation; risks from investing in growth opportunities; failure of the company’s intellectual property portfolio to prevent competitive offerings and the failure of the company to obtain necessary licenses; cybersecurity and data privacy considerations; fluctuations in financial results; impact of local legal, economic, political and health conditions; adverse effects from environmental matters, tax matters and the company’s pension plans; ineffective internal controls; the company’s use of accounting estimates; impairment of the company’s goodwill or amortizable intangible assets; the company’s ability to attract and retain key employees and its reliance on critical skills; impacts of relationships with critical suppliers; product quality issues; impacts of business with government clients; currency fluctuations and customer financing risks; impact of changes in market liquidity conditions and customer credit risk on receivables; reliance on third party distribution channels and ecosystems; the company’s ability to successfully manage acquisitions, alliances and dispositions, including integration challenges, failure to achieve objectives, the assumption of liabilities, and higher debt levels; legal proceedings and investigatory risks; risk factors related to IBM securities; and other risks, uncertainties and factors discussed in the company’s Form 10-Qs, Form 10-K and in the company’s other filings with the U.S. Securities and Exchange Commission or in materials incorporated therein by reference. 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.

~~104~~74

Table of Contents

Part II — Other Information

Item 1. Legal Proceedings

Refer to note ~~14,~~13, “Contingencies,” 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~~first quarter of ~~2019.~~2020.


				Total Number	Approximate					Total Number	Approximate
				of Shares	Dollar Value					of Shares	Dollar Value
				Purchased as	of Shares that					Purchased as	of Shares that
	Total Number	Average		Part of Publicly	May Yet Be		Total Number	Average		Part of Publicly	May Yet Be
	of Shares	Price Paid		Announced	Purchased Under		of Shares	Price Paid		Announced	Purchased Under
Period	Purchased	per Share		Program	The Program*		Purchased	per Share		Program	The Program*
July 1, 2019 - July 31, 2019	822,159	$	140.42	822,159	$	2,007,611,768
January 1, 2020 - January 31, 2020							—	$	—	—	$	2,007,611,768

August 1, 2019 - August 31, 2019	—	$	—	—	$	2,007,611,768
February 1, 2020 - February 29, 2020							—	$	—	—	$	2,007,611,768

September 1, 2019 - September 30, 2019	—	$	—	—	$	2,007,611,768
March 1, 2020 - March 31, 2020							—	$	—	—	$	2,007,611,768

Total	822,159	$	140.42	822,159			—	$	—	—

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

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. At ~~September 30, 2019~~March 31, 2020 there was approximately $2.0 billion in authorized funds remaining for purchases under this program.

~~Item 5. Other Information~~

On September 24, 2019, the company announced that F. William McNabb III had been elected to the IBM Board of Directors, effective October 29, 2019. As a result, Article III, Section 2 of the company’s By-Laws was amended to increase the number of directors to thirteen, effective October 29, 2019. The full text of IBM’s By-Laws, as amended effective October 29, 2019, is included as Exhibit 3.2 to this report.

~~105~~75

Table of Contents

Item 6. Exhibits


Exhibit Number

~~3.2~~		~~The By-Laws of IBM, as amended through October 29, 2019.~~

10.1		~~Forms~~Form of LTPP equity award ~~agreements~~agreement for ~~(i) stock options, restricted stock, restricted stock units, cash-settled restricted stock units, SARS and (ii)~~ performance share units ~~as well as~~and the ~~Terms~~terms and ~~Conditions~~conditions of LTPP Equity Awards, effective ~~October 1, 2019,~~March 2, 2020, in connection with the foregoing award agreements.

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

104		Cover Page Interactive Data File – the cover page interactive data file does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document

~~106~~76

Table of Contents

SIGNATURE

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


		International Business Machines Corporation
		(Registrant)

Date:	~~October 29, 2019~~April 28, 2020
		By:	/s/ Robert F. Del Bene
			Robert F. Del Bene
			Vice President and Controller

~~107~~77


(Dollars in millions)
At September 30, 2019	Level 1		Level 2		Level 3		Total
Assets:
Cash equivalents (1)
Time deposits and certificates of deposit	$	—	$	6,251	$	—	$	6,251	(6)
Money market funds		597		—		—		597
Total	$	597	$	6,251	$	—	$	6,848
Equity investments (2)		0		—		—		0
Debt securities – current (3)		—		733		—		733	(6)
Debt securities – noncurrent (2)		—		111		—		111	(6)
Derivative assets (4)		4		533		—		536
Total assets	$	601	$	7,628	$	—	$	8,229
Liabilities:
Derivative liabilities (5)	$	—	$	1,074	$	—	$	1,074


(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


	Fair Value of Derivative Assets					Fair Value of Derivative Liabilities
	Balance Sheet					Balance Sheet
(Dollars in millions)	Classification	9/30/2019		12/31/2018		Classification	9/30/2019		12/31/2018
Designated as hedging instruments:
Interest rate contracts	Prepaid expenses and other current assets	$	9	$	9	Other accrued expenses and liabilities	$	—	$	4
	Investments and sundry assets		106		212	Other liabilities		2		76
Foreign exchange contracts	Prepaid expenses and other current assets		368		348	Other accrued expenses and liabilities		165		110
	Investments and sundry assets		35		135	Other liabilities		869		129
	Fair value of derivative assets	$	518	$	704	Fair value of derivative liabilities	$	1,035	$	320
Not designated as hedging instruments:
Foreign exchange contracts	Prepaid expenses and other current assets	$	12	$	26	Other accrued expenses and liabilities	$	36	$	13
Equity contracts	Prepaid expenses and other current assets		6		2	Other accrued expenses and liabilities		2		51
	Fair value of derivative assets	$	18	$	28	Fair value of derivative liabilities	$	38	$	63
Total derivatives		$	536	$	731		$	1,074	$	383
Total debt designated as hedging instruments (1):
Short-term debt			N/A		N/A		$	—	$	—
Long-term debt			N/A		N/A			6,061		6,261
			N/A		N/A		$	6,061	$	6,261
Total		$	536	$	731		$	7,134	$	6,644


	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	2019		2018		2019		2018
Derivative instruments in fair value hedges (1):
Interest rate contracts	Cost of financing	$	3	$	(27)	$	0	$	33
	Interest expense		9		(26)		0		33
Derivative instruments not designated as hedging instruments:
Foreign exchange contracts	Other (income) and expense		(114)		(55)		N/A		N/A
Equity contracts	SG&A expense		9		40		N/A		N/A
Total		$	(94)	$	(69)	$	0	$	66


	Remainder of										Beyond		Imputed
(Dollars in millions)	2019		2020		2021		2022		2023		2023		Interest*		Total
Finance leases	$	10	$	42	$	43	$	36	$	24	$	53	$	(54)	$	155
Operating leases	$	402	$	1,419	$	1,123	$	847	$	604	$	1,160	$	(388)	$	5,167


(Dollars in millions)	Total
Remainder of 2019	$	847
2020		2,344
2021		1,571
2022		759
2023		216
Thereafter		43
Total undiscounted cash flows	$	5,781
Present value of lease payments (recognized as financing receivables)		5,337	*
Difference between undiscounted cash flows and discounted cash flows	$	444


	Total
(Dollars in millions)	Consideration
Cash paid for outstanding Red Hat common stock	$	33,769
Cash paid for Red Hat equity awards		24
Cash paid to settle warrants		1,008
Cash consideration	$	34,801
Fair value of stock-based compensation awards attributable to pre-combination services		174
Stock issued to holders of vested performance share units		45
Settlement of pre-existing relationships		60
Total consideration	$	35,079


	For the Three Months Ended
	September 30, 2019		September 30, 2018
Number of shares on which basic earnings per share is calculated:
Weighted-average shares outstanding during period		886,018,372		911,152,848
Add — Incremental shares under stock-based compensation plans		5,368,268		2,566,139
Add — Incremental shares associated with contingently issuable shares		1,453,105		1,493,644
Number of shares on which diluted earnings per share is calculated		892,839,745		915,212,631

Income from continuing operations (millions)	$	1,673	$	2,692
Income/(loss) from discontinued operations, net of tax (millions)		(1)		2
Net income on which basic earnings per share is calculated (millions)	$	1,672	$	2,694

Income from continuing operations (millions)	$	1,673	$	2,692
Net income applicable to contingently issuable shares (millions)		—		—
Income from continuing operations on which diluted earnings per share is calculated (millions)	$	1,673	$	2,692
Income/(loss) from discontinued operations, net of tax, on which basic and diluted earnings per share is calculated (millions)		(1)		2
Net income on which diluted earnings per share is calculated (millions)	$	1,672	$	2,694

Earnings/(loss) per share of common stock:
Assuming dilution
Continuing operations	$	1.87	$	2.94
Discontinued operations		0.00		0.00
Total	$	1.87	$	2.94
Basic
Continuing operations	$	1.89	$	2.95
Discontinued operations		0.00		0.00
Total	$	1.89	$	2.95


	For the Nine Months Ended
	September 30, 2019		September 30, 2018
Number of shares on which basic earnings per share is calculated:
Weighted-average shares outstanding during period		887,291,199		915,632,501
Add — Incremental shares under stock-based compensation plans		4,007,433		3,000,429
Add — Incremental shares associated with contingently issuable shares		1,228,726		1,373,960
Number of shares on which diluted earnings per share is calculated		892,527,357		920,006,890

Income from continuing operations (millions)	$	5,766	$	6,770
Income/(loss) from discontinued operations, net of tax (millions)		(5)		7
Net income on which basic earnings per share is calculated (millions)	$	5,761	$	6,777

Income from continuing operations (millions)	$	5,766	$	6,770
Net income applicable to contingently issuable shares (millions)		0		(1)
Income from continuing operations on which diluted earnings per share is calculated (millions)	$	5,766	$	6,769
Income/(loss) from discontinued operations, net of tax, on which basic and diluted earnings per share is calculated (millions)		(5)		7
Net income on which diluted earnings per share is calculated (millions)	$	5,762	$	6,776

Earnings/(loss) per share of common stock:
Assuming dilution
Continuing operations	$	6.46	$	7.36
Discontinued operations		(0.01)		0.01
Total	$	6.45	$	7.37
Basic
Continuing operations	$	6.50	$	7.39
Discontinued operations		(0.01)		0.01
Total	$	6.49	$	7.40


(Dollars in millions)
January 1, 2019		Additions / (Releases) *		Write-offs **		Other ***		September 30, 2019
$	639	$	51	$	(104)	$	(8)	$	578


(Dollars in millions)
January 1, 2019		Additions / (Releases)*		Write-offs **		Other ***		September 30, 2019
$	292	$	(6)	$	(23)	$	(6)	$	257