International Business Machines Annual Report 2018

FY2018 Annual Report · International Business Machines

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2018
Annual
Report

Dear IBM Investor:
2018 was a defining year for IBM and our
clients. Your company returned to growth,
just as businesses readied to enter
Chapter 2 of their digital reinventions.

For years, we have focused on building the tools businesses

need in the 21st century. Our investments have reshaped IBM

2018: Return to Growth
In 2018, IBM achieved $79.6 billion in revenue and operating

to lead in the emerging, high-value segments of the IT market,

earnings per share of $13.81. For the full year, we returned to

including analytics, artificial intelligence, cloud, security,

revenue growth, grew earnings per share and stabilized margins.

blockchain and quantum computing. At the same time, we have

Our strategic and continued investment in innovative

deepened our longstanding commitment to the responsible

technology drove our improved competitive position and profit

stewardship of technology.

IBM is now ready to help our clients advance their

business transformations.

dynamics. Offerings that address data, AI, cloud, analytics and

cybersecurity now represent more than half of our revenue—up
from a quarter just four years ago—accounting for approximately

In my letter to you this year, I will describe IBM’s

$40 billion in revenue in 2018.

performance in 2018. I will outline how clients are poised

Our investment of more than $5 billion in research and

to enter Chapter 2 of their digital reinventions, with help from

development produced thousands of breakthrough innovations,

IBM, and how this translates to growth for IBM, for businesses

which led to IBM’s 26th consecutive year of U.S. patent leadership.

and for the world.

Of the 9,100 patents granted to IBM in 2018, more than 1,600
were related to AI and 1,400 to cybersecurity—more than any

other company in either area.

This focus on breakthrough innovation has created

New IBM investments are further energizing our portfolio.

IBM’s strongest portfolio ever and has driven results:

In late 2018, we announced plans to acquire Red Hat, the world’s

leading open source technology provider for the enterprise.

– Total cloud revenues were more than $19 billion in 2018, up

With this acquisition, which is expected to close in the second

12 percent. In the fourth quarter alone, IBM signed 16 client

half of 2019, IBM will enhance our position as the world’s number

services agreements worth more than $100 million to help

one hybrid cloud provider, helping clients unlock the full business

optimize business performance on the IBM Cloud. Today,

value of the cloud.

47 of the Fortune 50 depend on the IBM Cloud.

We also continued to divest stand-alone software and

– IBM is the world’s enterprise AI leader. Solutions enabled

At the same time, we remained committed to returning

by IBM Watson are helping produce better decision-making

capital to our shareholders. In 2018, we returned more than

and business outcomes through more than 20,000 client

$10 billion to you, our shareholders, including dividends

engagements, across 20 industries to date. IDC ranked

of $5.7 billion and gross share repurchases of $4.4 billion.

IBM number one in AI market share. We continue to pioneer
innovations in natural language processing, speech processing,

We raised our dividend for the 23rd consecutive year—IBM’s
103rd straight year of providing one.

services assets that are no longer strategic for IBM.

computer vision and machine learning.

– IBM Blockchain is the global leader in improving trust and

Moving Clients to the Next Chapter of Digital Reinvention
For the past several years, businesses around the world have been

transparency across business networks by creating a new

driving their digital reinventions to take advantage of data, their

way for clients to share and secure data. IBM Blockchain

most powerful source of competitive advantage.

now powers more than 500 client projects, with more than

This first chapter has been defined largely by experimenting

85 active networks transforming supply chains, global

with narrow and disparate AI applications and moving simple

shipping and cross-border finance.

workloads—typically consumer and customer-facing applications—

to the cloud.

– IBM Security, the world’s largest cybersecurity enterprise,

Now, we are beginning to see the contours of Chapter 2

has 8,000 subject matter experts serving more than 17,000

among pioneering businesses: moving from experimentation to

clients in more than 130 countries. The industry’s leading

true business transformation at scale with AI and hybrid cloud.

AI and cloud-based security solutions include IBM Security

This next chapter of digital reinvention will be enterprise-

Connect, launched in 2018, which allows clients to gather,

driven. It will be characterized first by scaling AI and embedding

integrate and analyze security data across multiple applications

it everywhere in business. Second, in cloud, it will be characterized

and tools, in a vendor-agnostic way.

by moving mission-critical applications to hybrid cloud—

– IBM Systems produces innovative infrastructure for AI

and on-premise IT capabilities, so businesses can create

and hybrid cloud. The z14 is one of IBM’s most successful

the environment most suitable for their enterprise workloads.

mainframe programs in history, with broad global adoption

Underpinning it all is the growing importance of trust, both

using a combination of multiple public clouds, private clouds,

across 27 different industry segments. In addition, the
U.S. Department of Energy’s POWER9-based supercomputers,

Summit and Sierra, were ranked the most powerful

supercomputers in the world in 2018.

in technologies and in their impact on the world.

Scaling AI throughout the Enterprise
In Chapter 2 of their digital reinventions, businesses will begin

to scale AI across the enterprise, as some first movers are already

– IBM Services was a key driver of IBM’s performance in 2018.

demonstrating.

Forty-seven engagements worth more than $100 million

Take the world’s leading banks, for example. While many

each helped major clients—like Bank of the Philippine Islands,

have been applying AI to specific challenges, some first movers

Juniper Networks, Nordea, Westpac and Aditya Birla Retail—

are scaling AI across the enterprise. Orange Bank, one of the

move to the next stage of their digital transformations.

fastest growing mobile banks in France, now manages all customer

service through IBM Watson. Similarly, Banco Bradesco

is now using IBM Watson to assist every member of its services

team—resolving customer inquiries in seconds with nearly

95 percent accuracy.

IBM brought AI for business into the mainstream

with the introduction of our Watson platform in 2014. Today,

IBM Watson is the most open and trusted AI for business,

available to run on any environment—on premise, and in private

and public clouds. Businesses can apply Watson to data wherever

it is hosted and infuse AI into their applications, regardless of

where they reside.

With Watson Studio, Watson Machine Learning and Watson

OpenScale, IBM delivers a suite of tools that allow enterprises

to build, deploy and manage their AI models in a hybrid cloud
environment. IBM Watson OpenScale, a first-of-a-kind platform

introduced in 2018, also enables businesses to manage their AI—

no matter where it was built or where it runs—with transparency,

explainability and bias mitigation. Addressing these factors, which

traditionally have held businesses back, is critical for scaling

AI throughout an enterprise.

Through IBM Services, we are helping our clients around

the world apply AI to core business processes and workflows,

infusing their businesses with automation, intelligence and

continuous learning to transform everything from supply chains

and HR to finance and operations.

In 2018, we also launched a new service called IBM Talent

and Transformation that addresses the often overlooked cultural

aspects of AI. This service helps our clients ensure their teams

have the right skills and talent—and the supporting culture and

Virginia M. Rometty
Chairman, President and

work environment—to support a new way of working that is critical

Chief Executive Officer

to scaling AI for business.

Moving Mission-Critical Work to Hybrid Cloud
In the first chapter of digital reinvention, cloud deployments

largely focused on easily portable workloads for productivity and

commodity computing. This primarily was driven by user-facing
applications inspired by advances in consumer technology.

As a result, only 20 percent of enterprise workloads today have

moved to the cloud.

The remaining 80 percent of enterprise workloads provides

the real value opportunity for business—transforming mission-

critical workloads and applications for the cloud. The challenge is

that most businesses have unique regulatory or data requirements

and anywhere from five to 15 clouds across multiple providers.

That is why businesses moving to Chapter 2 will need to embrace

a new, hybrid cloud approach. It is one that will allow them to more

easily move data and scale AI and other applications across public,

private and on-premise IT in their enterprises, with consistent

management and security protocols, using open source technology.

For example, BNP Paribas, a leading European bank,

is working with IBM to speed and scale the launch of new digital

and AI customer services across the cloud, while protecting

the security and confi dentiality of customer data. Similarly, global

telecom leader Vodafone Business is partnering with IBM to

innovate the way it delivers

multicloud and digital

capabilities—including AI,

edge computing, 5G and
software-defi ned networking

solutions—to its customers.

IBM Services provides

end-to-end cloud integration

capabilities and is helping

thousands of businesses

migrate, integrate and

manage applications and

workloads seamlessly and

“We are ready for this
moment of moving
clients to Chapter 2
of their digital
reinventions with our
unique integration of
innovative technology,
industry expertise
and a reputation for
trust and security
earned over decades.”

securely across any cloud environment. Industry experts from

IBM Services are co-creating cloud-enabled solutions with clients

in our IBM Garages. Using design thinking and agile methods,

we are helping clients implement new ways of working, such as

rapid prototyping and iteration to more quickly move technology

projects from pilot to production at scale.

We are ready for this moment of moving clients to Chapter 2

of their digital reinventions with our unique integration of innovative

technology, industry expertise and a reputation for trust and

security earned over decades. IBM is now moving the world’s

major enterprises to the next era, an effort that will be enhanced

by our planned acquisition of Red Hat.

Chapter 2 of Trust and Responsible Stewardship
We recognize that our clients and the consumers they serve

expect more than groundbreaking innovation and industry

expertise. They want to work with technology partners they

can trust to protect their data and handle it responsibly.

They want to work with partners who know how to bring new

technologies into the world safely and help society benefi t from

them. And they want their partners to create inclusive workplaces

and communities where diversity thrives.

IBM Leadership

#1 AI for business
20,000+ IBM Watson client

engagements across 20 industries.

#1 in hybrid cloud
47 of the Fortune 50 rely on

IBM Cloud. Revenue for IBM Cloud

topped $19 billion in 2018.

#1 in enterprise services
IBM Services, with end-to-end

cloud and AI capabilities, closed

47 client agreements worth more

than $100 million each in 2018.

#1 in enterprise security
IBM Security manages 70 billion

cybersecurity events per day for

clients in more than 130 countries.

#1 in enterprise systems
IBM Z is at the heart of world

commerce with 30 billion transactions

per day, including 87 percent of all

credit card transactions.

#1 in blockchain
IBM Blockchain Platform was

ranked number one by analyst ﬁ rms

Juniper Research and Everest Group.

#1 in U.S. patents for the
26th consecutive year
IBM inventors received a record 9,100

patents, including more than 3,000

in AI, cloud and quantum computing.

#1 and #2 fastest
supercomputers in the world
Built by IBM for the U.S. Department

of Energy, based on IBM POWER9 CPUs

tuned for AI workloads.

These expectations are linked by a common theme:

As IBM sees it, the promise of technology is to empower

responsibility. Responsibility has been a hallmark of IBM’s culture

people to do good, access new opportunities and make the world

for 107 years—from our labs to our boardroom. IBMers’ unwavering

better, safer and smarter—for the many, not just the few.

global commitment to the responsible stewardship of data and

powerful new technologies has earned us the trust of clients

and society as a whole.

IBM Poised to Lead
In summary, we have returned your company to growth. We have

In 2018, as trust in technology came under heightened

positioned IBM’s products, services and people to enable clients

global scrutiny, we published our IBM Principles for Trust and

to write the next chapter of their digital reinventions. And we have

Transparency, which have long guided our company. They stress

done it all while reaffirming IBM’s longstanding reputation for

our belief that the purpose of new technologies is to augment—

trust, integrity and responsibility.

not replace—human intelligence, and that the data and insights

Our work ahead is to build on this progress and bring these

derived from technology belong to the businesses who own

capabilities to life for our clients. I want to thank all of our clients

them. The principles also emphasize that new technologies

for partnering with us while we reinvented IBM, and for choosing

brought into the world must be open, transparent, explainable
and free of bias.

us for their own journeys of transformation.

I also would like to thank our investors for their confidence

We know that AI, like other transformative technologies

in IBM. Finally, I would like to thank the hundreds of thousands

before it, will have a profound impact on peoples’ jobs and the

of IBMers whose expertise has prepared us to lead in this new

workplace. That is why, in 2018, IBM further expanded access to

chapter of digital reinvention.

the pathways through which students and professionals can build

I am honored to steward this great company, and I am filled

skills for today’s technology era. That includes “new collar” jobs,

with optimism about what we can achieve in partnership with our

where having the right skills matters more than having a specific

clients and society. Together, we are changing work and business—

degree. Through our work in 11 U.S. states and 13 countries, there

and ultimately, the world.

Virginia M. Rometty
Chairman, President and Chief Executive Officer

will be 200 Pathways in Technology Early College High Schools—

or P-TECHs—serving a pipeline of 125,000 students in the 2019

school year.

2018 also saw the rapid growth of our IBM Apprenticeship

Program, which trains people in 21st-century skills ranging

from blockchain and digital design to cybersecurity—and which

expanded nearly twice as fast as we had projected in its first year.

Yet skills are only part of today’s workforce opportunity.

In 2018, fueled by record diverse hiring, promotion and retention,

we achieved our greatest progress in a decade on diversity

representation among global executive women and

underrepresented minorities. We also continued advocating

with governments around the world for policies that help

ensure workplaces are as inclusive and diverse as the world
we live in.

Recognizing that responsible stewardship should not

be confined within IBM’s walls, we also are working aggressively

to empower others to do lasting good. We are, for example,

a founding partner in Call for Code, a global initiative that

works with software developers to create solutions that can

help save lives. Last year, 100,000 open source developers from

156 countries responded to the call, creating more than 2,500

applications to help communities recover from natural disasters.

In an effort to provide additional and useful information regarding the company’s
financial results and other financial information, as determined by generally
accepted accounting principles (GAAP), these materials contain non-GAAP financial
measures on a continuing operations basis, including operating earnings per share
and operating pre-tax income. The rationale for management’s use of this non-GAAP
information is included on pages 18 and 19 of the company’s 2018 Annual Report,
which is Exhibit 13 to the Form 10-K submitted with the SEC on February 26, 2019.
For reconciliation of these non-GAAP financial measures to GAAP and other
information, please refer to page 41 of the company’s 2018 Annual Report.

Leading
businesses
are reinventing
themselves with
IBM Services
and Solutions
across AI, cloud,
blockchain,
quantum
and more.

IBM Services

United Airlines:
Reinvention
takes flight

To ignite a major business transformation, United Airlines
turned to IBM iX—the business design arm of IBM Services—and
a set of business applications from a global partnership between

IBM and Apple called IBM MobileFirst for iOS. These applications

combine the power of enterprise data and analytics with an

elegant user experience, allowing United to broadly rethink how

its crews work and how its work flows.

United and IBM used the IBM Garage method to design

apps for the airline’s growing deployment of iOS devices.
The IBM Garage method, used by IBM Services with clients around

the world, emphasizes co-creation and frequent iteration. It has

allowed United to build complete, integrated mobile platforms that

start with a user’s experience and extend to all the airline’s core

business processes. United is now able to foster better and faster

collaboration across diverse teams and time zones, enabling

Flight attendant Deb Winchell knows
better than most how stressful
a delay can be—for customers and
staff alike.

More than 60%
savings in app development
costs, compared to a
traditional approach

it to focus on its core mission of transporting customers to their

even report an issue while a plane is still in the air, so the ground

destinations on time. The apps are also giving flight attendants

crew can get to work as soon as the plane lands. Customers on

like Deb Winchell new ways to help customers enjoy their flights,

the next flight are far less likely to be affected because the app

which makes everyday travel just a little less stressful for

streamlines communication. “It’s been a game changer for us,”

everyone involved.

Deb says. “It lets us care for our customers right in the moment—

Frontline crews know that many factors can contribute
to delays. “Most challenges stem from things I can’t control,”
Deb says. “But when I can make a difference in a customer’s travel

experience, it can be huge.” That’s why it’s important to resolve

issues before they affect customers. Deb can now be more

and nothing’s better than that.”

The agile IBM Garage method helps organizations think

beyond their existing systems and focus on what customers
actually need. When combined with IBM Cloud and IBM Watson,
it’s nothing less than a way for organizations to reinvent

proactive with apps co-designed by United and IBM iX. Deb can

themselves—an approach that’s being adopted by enterprises

With new mobile tools, United staff can
quickly report and resolve issues that
previously required multiple steps.

around the world as they move to the next stage of digital

reinvention. For example, it has helped create a startup culture in

Banco Bradesco, one of Brazil’s largest banks. Bradesco can now

quickly respond to the rising demand from its 75 million mobile

banking customers. It has also showed East Carolina University

new value in discarded data that enabled the school to predict

possible outcomes, report strengths, weaknesses and deficits, and

enable advisors to better assist students and improve educational

programs. Digital reinvention isn’t just a product or a platform.

And it’s certainly more than just a buzzword. It’s a promise:

a new way to innovate and rethink a company from the ground

up and help customers and businesses alike.

IBM Blockchain

Walmart:
Linked by
safer food

It starts with a single report of severe food-borne illness.
Then more reports pour in from around the country and from

them, a culprit emerges: a common type of lettuce. But where,

specifically, did the tainted lettuce come from? The work of

With the IBM Food Trust, Walmart’s
food safety professionals can
trace produce back to its source
in just seconds.

Walmart and IBM, powered by IBM Blockchain, is giving us

tracing time was reduced from seven days to just 2.2 seconds.

a better way to answer this question.

“With blockchain, all the trace media’s already there,” explains

Until recently, tracing food hasn’t been easy or fast.

Tejas Bhatt, senior director, Food Safety, for Walmart.

And the risk that represents is significant. The World Health
Organization has estimated that there are 600 million cases

of foodborne illness each year, leading to 420,000 deaths.

And it can be daunting to trace how food goes through the supply

Blockchain technology is also changing the way companies

like Walmart collaborate with their supply chains—even with
potential competitors. The IBM Food Trust ecosystem connects
supply chains like Walmart’s and also those of other major retailers

chain. For example, four days of a farm’s production of red-

and global companies such as Carrefour, Dole, Golden State Foods,

and green-leaf lettuce and cauliflower can generate more than

Driscoll’s and Nestlé—all without sharing any information they

200 separate tracking numbers that are printed onto cartons

don’t want to share. Beyond safety, consumers increasingly value

and pallets for shipping to buyers. Finding individual boxes of

the kind of information that a system built on IBM Blockchain can

particular at-risk produce in this environment means searching

provide. With blockchain, growers, distributors and retailers can

through a haystack of paper records. IBM Food Trust—using

provide consumers digitized certifications of existing organic or fair

blockchain technology—connects growers, processors, distributors

trade products along with detailed documentation from different

and retailers through a permissioned, permanent and shared

points in the process, from farm to table. Ed Treacy, vice president,

record of food-system data that drastically cuts the time

Supply Chain and Sustainability at the Produce Marketing

needed to trace produce from farm to store. In a pilot program,

Association, says blockchain “can speed up investigations into

From
7 days

Down to
2.2 seconds

IBM Blockchain adds new transparancy
to the global food supply chain.

contaminated food, authenticating the origin of food and providing

insights about the conditions and pathway through which the

food traveled.”

As more companies adopt a digital, end-to-end traceability

protocol, the IBM Food Trust’s goal is to make the world’s food
supply safer—something that is sorely needed. In 2018, the U.S.
Food and Drug Administration and U.S. Department of Agriculture

issued more than 300 food recalls. In addition to the societal and

business impact, these recalls waste huge stocks of food and

erode consumer trust. And if outbreaks multiply and answers are

slow in coming, customers can become desensitized and begin to

ignore overly broad warnings such as “throw away all lettuce in

your refrigerator.” Work by companies like Walmart and other

participants in the IBM Food Trust are laying the foundation for

better management of our global food supply: rapid insight into

what’s happened when something goes wrong, reducing waste,

and a safer journey from the farm to our local markets and,

ultimately, to our dinner table.

Experts from
Crédit Mutuel and
IBM Services are
working together in
a “Cognitive Factory.”

But that’s just the start. Crédit Mutuel is making important

decisions—about data, compliance and regulation, cybersecurity,
and managing applications across the enterprise. To achieve
digital banking at scale, IBM and Crédit Mutuel are crafting a hybrid

cloud strategy that encompasses multiple clouds and on-premise

systems, including the mainframe. At the same time, experts

from Crédit Mutuel and IBM Services are working together

in a “Cognitive Factory” that provides a fertile environment for

identifying, building and deploying new AI solutions. With many

internal IT teams involved, IBM and Crédit Mutuel are also creating

industrial tools and training assets to efficiently expand cognitive

solutions to 100% of the business lines of the company.

Crédit Mutuel’s reinvention represents a synthesis of human

and machine that gives banking new power. Employees can find

the optimal blend of talent and data, use their talents to the fullest,

Watson eliminates distractions
that come between branch
director François-Xavier Maille
and his clients.

IBM Cloud · IBM Watson

Crédit Mutuel:
A bank thinks
bigger

When Crédit Mutuel embarked on its “together#newworld”
initiative—a five-year project to become a leading digital bank—
it brought in IBM to help it reinvent itself.

delve more deeply into clients’ financial challenges and develop

smarter, more creative solutions. Extrapolate IBM’s immediate

impact on Crédit Mutuel to the entire world of financial services,

Crédit Mutuel’s goal: to engage with customers more
deeply, both online and offline, while providing new products
and the fastest service—all in an environment of trust and security.

To do that, the bank is infusing IBM Watson into the applications

its advisors use and is embracing IBM Cloud as a platform

for innovation, trust and security.

François-Xavier Maille, director of one of the premier

branches of Crédit Mutuel bank in Paris, was the first to deploy
the initial AI solution: a Watson virtual assistant that helps
employees answer customers’ questions. “The application has

60%
faster responses to
business inquiries

175,000
daily emails routed
and prioritized

and you can see the implications for how banking consumers

liberated our people from a few recurring tasks so they can devote

experience and engage with their financial institutions: More

their time and talents to understanding our clients’ aspirations,

relevant innovation for customers. Lower client turnover for banks.

challenges, and circumstances,” says François-Xavier. Today,

Greater confidence in asset management for consumers. Higher

23,000 Crédit Mutuel advisors across France rely on the Watson

employee engagement and contributions. Growing customer

tool, which helps employees answer business-related questions

satisfaction. And more predictable performance for institutions.

60% faster. The bank intends to use Watson across all of its

AI accelerates access to relevant information and liberates people

business lines.

to provide a human touch.

DeKalb is shifting to a systems-based approach to care.
The IBM Watson Health solution helped Ellen Hargett, executive

director of DeKalb’s Quality Institute, and her team change the way

they measure system-wide performance by organizing data and

analysis into a usable dashboard. For each key performance metric

on the dashboard, Ellen established tactical teams to fully

understand the metrics, determine the “why” behind them and

recommend tactics for improvement. Across healthcare, a

systems-based approach can also produce a significant positive

impact on resources. For example, sepsis is not only a medical

challenge for hospitals. It’s also the most costly reason for

hospitalization, consuming $24 billion each year in the U.S. alone.

DeKalb’s efforts to quantify, analyze and shift the diagnosis and

treatment of sepsis have not only led to a lower mortality rate but

also significantly reduced the length of stay for patients.

Individual treatments are now based on data informed
by large-scale findings across large populations. Historically,
doctors diagnosed through trained intuition. In recent decades,

however, this approach has been replaced by “empirical medicine”

that’s based on data. The result is more standardized treatments

and improved outcomes. At DeKalb, data is shared with healthcare

professionals, providing them with information to spot large

patterns or gaps. Watson Health’s data-driven tools allow

healthcare institutions to organize and visualize data and take

fast action to address weaknesses or roll out improvements.

A data-driven approach to challenges like sepsis also helps

doctors expand their understanding of the syndrome, improving

diagnosis and treatment. This trajectory will eventually create

Christina English is helping to lead
DeKalb Medical’s fight against sepsis.

IBM Watson Health

DeKalb Medical:
Stronger medicine

DeKalb Medical takes a systems-based, data-intensive

a new era of healthcare. As medical professionals tap data at both

approach to fighting dangerous infections with the help
of IBM Watson Health. One of the lesser-known challenges
it faces is sepsis, which is caused by an infection that triggers

an inflammatory immune response. Sepsis is notoriously

difficult to diagnose and treat, making it the third-leading

cause of death in the U.S.

Nurses see it all, and sepsis requires them to race
against the clock. But with the intelligent use of data, delivered
by IBM Watson Health and deployed by a team led by Christina

English, a quality management specialist and former bedside

nurse, clinicians at DeKalb are getting a step ahead to help

patients get better, faster. Previously, Christina and her team had

to fight sepsis with siloed and sometimes subjective information.

“We knew what to look for, but we didn’t understand the

importance of the symptoms, how they worked together and how

a clearly defined set of treatment measures is critical to success,”

she says. Using IBM CareDiscovery, part of Watson Health’s set

of performance-improvement solutions for healthcare providers,

Christina and her team were able to gather and analyze industry

benchmarks as well as their own performance metrics in order

to identify sepsis “flags” and pinpoint where DeKalb could take

proactive measures.

the systemic and individual levels, an age of “precision medicine”

will arise. It will be a time when understanding derived from the

many can be tailored and applied to the needs of the individual.

This data-driven
approach will eventually
create a new era
of healthcare.

30%
fewer lives lost
to sepsis

IBM Watson

Hydro One:
Outsmarting
the storm

Another late spring storm was rolling toward the Canadian
utility Hydro One. But in its ongoing battle with ice, snow,
wind and thunderstorms, this time the utility found calm in the

predictive power of The Weather Company and IBM Watson.

Derek Roles, director, Emergency Preparedness and

Restoration, is Hydro One’s first line of defense for a service area
that covers most of Ontario. Twenty years of experience and
an encyclopedic knowledge of winter storms have helped him

manage through many major disruptions, so Derek can usually

plan for the worst. Now, though, he can predict it. And that

changes everything. In the past, recovery teams were deployed

only after the weather had passed. Now, however, Derek doesn’t

just keep up with the weather—he stays ahead of it. This shift

was made possible because Derek and his team put data and

AI to work: they trained Watson to predict outages using five years

of Hydro One historical outage data and a massive amount of

Ontario’s historical weather information. Derek’s new predictive

tools help him paint a clearer picture of how a storm will affect

the utility’s electrical distribution network.

Hydro One has committed itself to a more proactive

approach, and the utility has not only gained a new way to
fight storms, but has also changed its basic business operations
to strengthen its customers’ experience and service quality.

With Watson, Hydro One’s
Derek Roles, director, Emergency
Preparedness and Restoration,
can restore power more quickly
after a storm.

Predictive intelligence is
starting to create new options
that can make extreme
weather more manageable
and less disruptive.

33%
faster electricity
restoration than
similar storms

Emergency
Recovery Award
from the Edison
Electric Institute

The predictive power of AI enables Hydro One to activate its

Weather exerts a tremendous influence on the economy.

emergency organization structure in advance and create detailed

It affects productivity, sales and energy consumption, and

team deployment plans, positioning some crews in the storm’s

it can disrupt supply chains and transportation systems.

predicted path while making sure other crews are well rested.

Severe weather can upend lives and businesses for hours, weeks,

The utility is also able to staff call centers more effectively and

years or even forever. So there’s a logic behind the expression

notify customers of a storm’s potential impact on their service.

“ride out the storm”—that’s often been the only option.

So when a storm hits, restoration plans are already in motion and

But predictive intelligence is starting to create new options that

work crews can spring into action faster than ever before, quickly

can make extreme weather more manageable and less disruptive.

and safely scaling repairs from the main transmission grid to

This is especially critical at a time when severe weather is the

smaller circuits to individual customer locations in remote areas.

leading cause of power disruptions in many countries. Global

economic losses resulting from weather disasters totaled

$215 billion last year. By putting the power of data and Watson

to work, Hydro One is modeling new solutions for previously

intractable weather problems everywhere—problems that

can now be better understood and managed, along with human

risks that can now be met head-on with artificial intelligence.

IBM Quantum

ExxonMobil:
Quantum
understanding

Every energy company’s
dual challenge:

Provide access
to scalable,
affordable
energy

Reduce
the risks
of climate
change

Vijay Swarup, ExxonMobil vice president for Research

and Development, says energy research requires curiosity,
optimism, patience and dissatisfaction. Dissatisfaction because
he believes things can be better. But what, exactly, can be better?

Nothing less than our understanding of the world.

Researchers now have a new tool to explore new ways
to solve problems: quantum computing. And Vijay’s quite precise
about the trouble with our current understanding. “There are some

problems so big, all we can do is approximate,” he says. Whether

he’s in a business suit or the lab coat he wears at ExxonMobil’s

expansive New Jersey research facility, Vijay clearly enjoys trying

to solve what he calls today’s pressing dual challenge: ensuring

that people have access to scalable, affordable energy, and doing

so in the context of climate change and the need for sustainable

solutions. This is where IBM Q comes into the picture. Quantum

computers have long been considered theoretical. But today,

they’re becoming a reality, with huge potential for energy

companies like ExxonMobil. That said, using a quantum computer

also calls for significant change in how researchers think about

approaching their work. “Computation has always been an integral

part of the research we’ve done here, but quantum’s radically

different,” Vijay explains. “Now, we must first figure out which

problems are most suited to a quantum approach and only then

can we answer a more interesting question: How can you program

a quantum computer to solve energy problems?”

ExxonMobil joins a group of global corporations

partnering with IBM to work side-by-side on IBM’s fully
functional quantum computers. As Vijay says, quantum’s a
priority that requires pairing the “best minds with the best minds.”

So ExxonMobil has a team that will meet regularly with IBM’s

quantum researchers. Barclays has its own team working

ExxonMobil’s vice president
for Research and Development,
Vijay Swarup, is leading
the company’s exploration
of quantum computing.

on quantum, as do Samsung and Daimler. Working as part of the

IBM Q Network alongside global universities and national research

labs, these corporations see the potential of a massive shift in how

computers can help solve some of the most enduring challenges—

issues that, once solved, could transform entire industries.

“IBM Q System One is the world’s first integrated universal quantum

computing system designed for scientific and commercial use,”

says Dario Gil, director, IBM Research. “We are at the beginning

of an exciting journey. Our research, systems and business teams—

along with our IBM Q Network partners—have a bold vision.

They are thinking big. These are the true pioneers.”

Nature is no longer estimated but predicted and

understood. That’s the goal. So when IBM unveiled its quantum
machines, companies like ExxonMobil saw great promise. But when

you talk to Vijay about promise, his thoughts turn to the great needs

that are facing the world. “Our global population is increasing

from 7 billion to 9 billion and, all across the world, a growing middle

class requires more resources and, especially, more energy.”

Quantum might be well suited to solve super-complex problems,

such as advanced models which could lead to better approaches

to carbon capture and lower emissions sources of energy. But what

excites Vijay most is that the collaboration with IBM researchers
could lead to a fresh ability to predict and anticipate how nature

operates—which could lead to an understanding of what’s actually

happening, as opposed to an approximation of what might be

happening. “With a little curiosity, patience and not settling for

the status quo, I know we can get there,” he says.

IBM Q System One is the world’s
first integrated quantum computing
system for commercial use.

More clients
are partnering
with IBM to write
the next chapters
of their digital
reinventions.

Belron applied IBM Watson Visual
Recognition to its Autoglass Body
Repair business to speed up insurance
processing, move repairs along
quickly and help its customers get
back on the road fast.

Thought Machine, a London-based
fintech startup, has built Vault,
a new, cloud-native core banking
infrastructure launching on
IBM Cloud. It has also partnered with
IBM Services to provide advisory
and delivery capabilities to its clients.

Travelport, a travel commerce
platform, is working with IBM Watson
to integrate disparate information
sources and make stronger corporate
travel recommendations. As a result,
finding the lowest travel costs for
a company will be quicker and easier.

Japan Airlines is using an IBM Watson-
powered chatbot, Makana-chan,
to answer customers’ questions about
its popular Tokyo-to-Honolulu flights.
Makana-chan eases the burden
on live agents and is very popular
with passengers.

Maersk, the container logistics giant,
is using IBM Blockchain to create
TradeLens, a global blockchain
solution for the shipping ecosystem.
This global transformation will lead
to faster delivery times, lower costs
and a noticeable difference in the way
we get the things we use every day.

KMD, Denmark’s largest technology
company, is dedicated to connecting
its clients to the latest technologies.
The company is using IBM Services
to provide a critical foundation
of servers, networks and other
technologies that help it handle
large volumes of data with high
levels of security.

Bausch + Lomb simplified the
service and maintenance process
for its high-tech Stellaris Elite Vision
Enhancement System for cataract and
retina surgery. Using IBM Cloud, the
company can now pinpoint or respond
to technical and service requests
and limit or minimize downtime.

Fluor Corporation builds mega-
projects across the globe. Data
generated by these projects has
been harnessed by working with
IBM Research and IBM Services.
Fluor recently introduced two new
AI-powered systems to uncover
and predict how unmitigated trends
could affect key project indicators.

BNP Paribas is accelerating its digital
transformation and improving its
operational efficiency. The bank will
now integrate IBM Cloud-hosted data
centers dedicated to the bank, and
will strengthen its hybrid cloud “as a
service” capabilities while ensuring
the security and confidentiality of their
customers’ data—including not using
public clouds for hosting any customer
or other production environments
with sensitive information.

Whirlpool Corporation is using
IBM Cloud to help manage all
the data from its manufacturing
of connected home appliances.
Whirlpool will be using the cloud
to manage critical enterprise
applications, which will give it more
flexibility to scale and innovate.

Telefónica turned to IBM Blockchain
to capture call data in real time
and save it in a format that’s trusted,
traceable and accessible to network
providers and carriers worldwide,
making international phone calls feel
seamless despite all the technological
leaps they require.

Smart Dubai, working with
IBM Blockchain and IBM Cloud,
has launched the region’s first
government-endorsed blockchain
service: Dubai Blockchain Platform.
It is designed to make the technology
more accessible to the Dubai
government, the UAE national
government and private companies.

Suunto, creator of the Movesense
microsensor, launched a Movesense
development community enabled
in the IBM Cloud. This let Suunto
dramatically scale its offerings.
Today, more than 800 developers
are working with Movesense, helping
Suunto bring the device to new
customers all over the world.

KPMG is using IBM Watson to
power a contract analysis solution
for its clients. The solution examines
contracts, breaks them into their
component parts and interprets each
part with a high degree of accuracy.
It’s faster and less expensive than
manual methods, while freeing up
skilled resources to perform more
productive tasks.

Krungsri Bank, one of Thailand’s
largest financial institutions,
is working with IBM Services to
lay the foundation for its future.
An IBM Blockchain pilot is in
progress, and the bank is planning
to develop new services for
its customers.

Profility, a post-surgery rehabilitation
solutions provider, needed to integrate
large volumes of data as well as
meet stringent HIPAA regulations.
They chose IBM Cloud because
of its flexible software and secure,
dedicated hardware. Their system
is widely used and has resulted
in shorter rehab stays and fewer
hospital readmissions.

The Australian Federal Government
has set its sights on being one of the
world’s top three digital governments
by 2025. In July 2018, it announced
a five-year agreement that covers
solutions from IBM Cloud, IBM Watson,
IBM Security, IBM Research and the
IBM Q quantum computing initiative.

View these stories
and more at
ibm.com/annualreport

Responsible
stewardship and
trust have been
hallmarks of
IBM’s culture—
from our labs to
the boardroom—
for more than
a century.

IBM is recognized as
one of the World’s Most
Ethical Companies by
the Ethisphere Institute,
highlighting our influence
in driving positive change
in business and society
around the world.

Data Responsibility
At IBM, we’ve always followed straightforward principles

to act responsibly and earn trust. Today, our principles include:

– The purpose of new technologies is to augment—not replace—

human intelligence.

– Data and insights belong to their owner.

– New technology, including AI, must be transparent

and explainable.

Recent actions demonstrate our principles at work, including:

• Advocating for public policies to protect the privacy and
security of data and working with governments worldwide
on strategies that will ensure privacy and responsible handling

of data, without undermining innovation.

• Partnering with STOP THE TRAFFIK, law enforcement and

financial services institutions to stop human trafficking by using

IBM software analytics to identify suspicious trends, hotspots

and financial transactions.

Modern slavery, a $150 billion business, has a new foe:
an AI data hub on the IBM Cloud.

• Launching AI Fairness 360, an open source software toolkit to

help developers actively detect and reduce bias in datasets and AI.

• Releasing Diversity in Faces, a first-of-its-kind dataset,

to help reduce bias in facial recognition systems, making them

fairer and more accurate.
1 million annotated human facial images

Jobs and Skills
In the 1940s, IBM partnered with Columbia University to create

Diversity and Inclusion
In 2018, fueled by record diverse hiring, promotion and

a new discipline: computer science. In 2018, we continued this

retention, IBM achieved our greatest progress in a decade

tradition by expanding training and education for the growing

on diversity representation among global executive women

number of “new collar” jobs for today’s era of data and AI.

and underrepresented minorities. We also continued advocating

Recent examples include:

with governments around the world for policies that help

ensure workplaces are as inclusive and diverse as the world

• Developing new talent with our 12-month IBM Apprenticeship

we live in. We received widespread recognition in 2018

Program in areas including cybersecurity, digital design,
mainframe administration and software development. Hundreds

for this leadership, including:

of apprentices—ranging in age from 18 to 59—have joined the

• Being honored with a 2018

Catalyst Award for leadership
in advancing women in business,

becoming the first company to

win the award four times and the

only tech company so honored

in the last 20 years.

• Being named a 2018 Diversity Best Practices Leading

Inclusion Index Company by Working Mother.

• Scoring a perfect 100 percent for the 15th consecutive year

in the Human Rights Campaign Corporate Equality Index.

program, which includes training and on-the-job experience

guided by an IBM mentor.

Brandon Whittington, IBM Blockchain Solutions support
engineer and graduate of the IBM’s Apprenticeship Program

• Launching Skills Build, an IBM volunteer initiative that helps
more than three million primary and secondary school students

learn about new technologies.

• Continuing to transform education via P-TECH—Pathways
to Technology Early College High School. In the 2019 school

year, there will be:
200 P-TECH schools serving a pipeline of
125,000 students across
13 countries and 11 U.S. states

IBMers at the Pride March in New York

P-TECH students at a graduation ceremony

Financial Highlights
International Business Machines Corporation and Subsidiary Companies

($ in millions except per share amounts)

For the year ended December 31:

Revenue

Net Income

Income from continuing operations

Operating (non-GAAP) earnings**

Earnings per share of common stock—continuing operations

Assuming dilution

Basic

Diluted operating (non-GAAP)**

Net cash provided by operating activities

Capital expenditures, net

Share repurchases

Cash dividends paid on common stock

Per share of common stock

At December 31:

Cash, cash equivalents, restricted cash and marketable securities

Total assets

Working capital

Total debt

Total equity

Common shares outstanding (in millions)

Stock price per common share

2018

2017

$ 79,591

$ 79,139

$ 8,728*

$ 5,753*

$ 8,723*

$ 5,758*

$ 12,657

$ 12,807***

$ 9.51*

$ 6.14*

$ 9.56*

$ 6.17*

$ 13.81

$ 13.66***

$ 15,247

$ 16,724

$ 3,716

$ 3,312

$ 4,443

$ 4,340

$ 5,666

$ 5,506

$ 6.21

$ 5.90

2018

2017

$ 12,222

$ 12,842****

$123,382

$125,356

$ 10,918

$ 12,373

$ 45,812

$ 46,824

$ 16,929

$ 17,725

892

922

$ 113.67

$ 153.42

* Includes charges of $2.0 billion in 2018 and $5.5 billion in 2017 associated with U.S. tax reform.

** See page 41 for a reconciliation of net income to operating earnings.

*** Recast to reflect adoption of the FASB guidance on presentation of net periodic pension and nonpension postretirement benefit costs.

****Recast to reflect adoption of the FASB guidance on restricted cash.

Report of Financials
International Business Machines Corporation and Subsidiary Companies

MANAGEMENT DISCUSSION
Overview

Forward-Looking and Cautionary Statements

Management Discussion Snapshot

Description of Business

Year in Review

Prior Year in Review

Other Information

Looking Forward

Liquidity and Capital Resources

Critical Accounting Estimates

Currency Rate Fluctuations

Market Risk

Cybersecurity

Employees and Related Workforce

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
A Significant Accounting Policies

B Accounting Changes

C Acquisitions/Divestitures

D Financial Instruments

Inventories

F Financing Receivables

G Property, Plant and Equipment

H Investments and Sundry Assets

Intangible Assets Including Goodwill

J Borrowings

K Other Liabilities

L Equity Activity

M Contingencies and Commitments

N Taxes

O Revenue Recognition

Report of Management

P Research, Development and Engineering

Report of Independent Registered

Public Accounting Firm

CONSOLIDATED FINANCIAL STATEMENTS
Earnings

Comprehensive Income

Financial Position

Cash Flows

Changes in Equity

Q Earnings Per Share of Common Stock

R Rental Expense and Lease Commitments

S Stock-Based Compensation

T Retirement-Related Benefits

U Segment Information

V Subsequent Events

Five-Year Comparison of Selected Financial Data

Selected Quarterly Data

Performance Graphs

Stockholder Information

Board of Directors and Senior Leadership

103

106

107

108

111

115

117

120

122

123

124

127

141

146

147

148

149

150

151

OVERVIEW
The financial section of the International Business Machines
Corpor ation (IBM or the company) 2018 Annual Report includes
the Management Discussion, the Consolidated Financial
Statements and the Notes to Consolidated Financial State-
ments. This Over view is designed to provide the reader with
some perspective regarding the information contained in the
financial section.

•

The references to “adjusted for currency” or “at constant
currency” in the Management Discussion do not include
operational impacts that could result from fluctuations in
foreign currency rates. When the company refers to growth
rates at constant currency or adjusts such growth rates for
currency, it is done so that certain financial results can be
viewed without the impact of fluctuations in foreign
currency exchange rates, thereby facilitating period-to-
period comparisons of its business performance. Financial
results adjusted for currency are calculated by translating
current period activity in local currency using the comparable
prior-year period’s currency conversion rate. This approach
is used for countries where the functional currency is the
local currency. Generally, when the dollar either strengthens
or weakens against other currencies, the growth at constant
currency rates or adjusting for currency will be higher or lower
than growth reported at actual exchange rates. See “Currency
Rate Fluctuations” on page 66 for additional information.

•

Within the financial statements and tables in this Annual
Report, certain columns and rows may not add due to the
use of rounded numbers for disclosure purposes.
Percentages reported are calculated from the underlying
whole-dollar numbers.

Operating (non-GAAP) Earnings
In an effort to provide better transparency into the operational
results of the business, the company separates business results
into operating and non-operating categories. Operating earnings
from continuing operations is a non-GAAP measure that excludes
the effects of certain acquisition-related charges, intangible asset
amortization expense resulting from basis differences on equity
method investments, retirement-related costs, discontinued
operations and related tax impacts. Due to the unique, non-
recurring nature of the enactment of U.S. tax reform, the company
characterizes the one-time provisional charge recorded in the
fourth quarter of 2017 and all 2018 adjustments to that charge
as non-operating. Adjustments include true-ups, accounting
elections, any changes to regulations, laws, audit adjustments,
etc. that affect the recorded one-time charge. For acquisitions,
operating (non-GAAP) earnings exclude the amortization of
purchased intangible assets and acquisition-related charges
such as in-process research and development, transaction costs,
applicable restructuring and related expenses, tax charges
related to acquisition integration and pre-closing charges. For
the 2019 operating (non-GAAP) earnings per share expectation,
acquisition-related charges associated with the Red Hat, Inc. (Red
Hat) acquisition exclude pre-closing charges, such as financing
costs. These charges are excluded as they may be inconsistent
in amount and timing from period to period and are dependent
on the size, type and frequency of the company’s acquisitions.
All other spending for acquired companies is included in both
earnings from continuing operations and in operating (non-GAAP)
earnings. Throughout the Management Discussion and Analysis,
the impact of acquisitions over the prior 12-month period may
be a driver of higher expense year to year. For retirement-related
costs, the company characterizes certain items as operating and
others as non-operating, consistent with GAAP. The company
includes defined benefit plan and nonpension postretirement
benefit plan service cost, 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 cost, interest cost, expected return on plan

Organization of Information
•

The Management Discussion is designed to provide readers
with an overview of the business and a narrative on the
company’s financial results and certain factors that may
affect its future prospects from the perspective of the
company’s management. The “Management Discussion
Snap shot,” beginning on page 19, presents an overview of
the key performance drivers in 2018.

•

Beginning with the “Year in Review” on page 27, the Manage-
ment Discussion contains the results of operations for each
reportable segment of the business and a discussion of
the company’s financial position and cash flows. Other key
sections within the Management Discussion include:
“Looking Forward” on page 59, and “Liquidity and Capital
Resources” on page 60, which includes a description of
management’s definition and use of free cash flow.

The Consolidated Financial Statements are presented on
pages 70 through 75. These statements provide an overview
of the company’s income and cash flow performance and
its financial position.

The Notes follow the Consolidated Financial Statements.
Among other items, the Notes contain the company’s
accounting policies (pages 76 to 88), acquisitions and
divestitures (pages 91 to 94), certain contingencies and
commitments (pages 115 to 117), revenue (pages 120 to 122)
and retirement-related plans information (pages 127 to 141).

The Consolidated Financial Statements and the Notes have
been prepared in accordance with accounting principles
generally accepted in the United States (GAAP).

On December 22, 2017, the Tax Cuts and Jobs Act (U.S.
tax reform) was enacted in the U.S. This Act resulted in the
company recording a charge of $5.5 billion in the fourth-
quarter 2017. For the full-year 2018, the company recorded
additional charges of $2.0 billion, including $1.9 billion in
the fourth quarter, primarily related to the election to
include Global Intangible Low-Taxed Income (GILTI) in
measuring deferred taxes. Refer to note N, “Taxes,” on
pages 117 to 119 for additional information.

Effective January 1, 2018, the company adopted the
Financial Accounting Standards Board (FASB) guidance on
presentation of net periodic pension and nonpension
postretirement benefit costs (net benefit cost). The
guidance is primarily a change in financial statement
presentation, but it did impact the consolidated and
reportable segment gross profit margins and expense and
other income. As a result, the company aligned its
presentation of operating (non-GAAP) earnings to conform
to the FASB presentation of these costs in the Consolidated
Statement of Earnings. The periods presented in this
Annual Report are reported on a comparable basis.

Management Discussion International Business Machines Corporation and Subsidiary Companies19

assets, amortized actuarial gains/losses, the impacts of any plan
curtailments/settlements, pension insolvency costs and other
costs. Non-operating retirement-related costs are primarily
related to changes in pension plan assets and liabilities which are
tied to financial market performance, and the company considers
these costs to be outside of the operational performance of
the business.

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

FORWARD-LOOKING AND CAUTIONARY STATEMENTS
Certain statements contained in this Annual Report may
constitute forward-looking statements within the meaning of the
Private Secur ities Litigation Reform Act of 1995. Any forward-
looking statement in this Annual Report speaks only as of the
date on which it is made; the company assumes no obligation
to update or revise any such statements. Forward-looking
statements are based on the company’s current assumptions
regarding future business and financial performance; these
statements, by their nature, address matters that are uncertain
to different degrees. Forward-looking statements involve a
number of risks, uncertainties and other factors that could cause
actual results to be materially different, as discussed more fully
elsewhere in this Annual Report and in the company’s filings with
the Securities and Exchange Commission (SEC), including the
company’s 2018 Form 10-K filed on February 26, 2019.

MANAGEMENT DISCUSSION SNAPSHOT

($ and shares in millions except per share amounts)

For the year ended December 31:

Revenue

Gross profit margin

Total expense and other (income)

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

Income from continuing operations before income taxes

Provision for income taxes from continuing operations

Income from continuing operations

Income from continuing operations margin

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

Net income

Earnings per share from continuing operations:

Assuming dilution

Consolidated earnings per share—assuming dilution

Weighted-average shares outstanding

Assuming dilution

Assets++
Liabilities++
Equity++

* 0.0 percent adjusted for currency.

2018

2017

$ 79,591

$ 79,139

46.4%

46.7%**

$ 25,594

$ 25,543**

32.2%

32.3%**

$ 11,342
$ 2,619+
$ 8,723+

$ 11,400
$ 5,642+
$ 5,758+

11.0%

7.3%

$ 5
$ 8,728+

$ (5)
$ 5,753+

$ 9.51+
$ 9.52+

$ 6.14+
$ 6.14+

916.3

937.4

$123,382

$125,356

$106,452

$107,631

$ 16,929

$ 17,725

Yr.-to-Yr.
Percent/Margin
Change

0.6%*

(0.3) pts.

0.2%

(0.1 ) pts.

(0.5)%

(53.6)%

51.5%

3.7 pts.

51.7%

54.9%

55.0%

(2.2)%

(1.6)%

(1.1)%

(4.5)%

** Recast to reflect adoption of FASB guidance on presentation of net periodic pension and nonpension postretirement benefit costs.
+ Includes charges of $2.0 billion or $2.23 of diluted earnings per share in 2018 and $5.5 billion or $5.84 of diluted earnings per share in 2017

associated with U.S. tax reform.

++At December 31

NM—Not meaningful

Management Discussion International Business Machines Corporation and Subsidiary Companies20

The following table provides the company’s operating (non-
GAAP) earnings for 2018 and 2017.

($ in millions except per share amounts)

For the year ended December 31:

Net income as reported

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

Income from continuing operations

Non-operating adjustments (net of tax)

Acquisition-related charges

Non-operating retirement-related costs/(income)

U.S. tax reform charge

Operating (non-GAAP) earnings*

Diluted operating (non-GAAP) earnings per share

2018
$ 8,728+

5
$ 8,723+

649

1,248

2,037

$12,657

$ 13.81

2017
$ 5,753 +

(5)
$ 5,758 +

718

856**

5,475

$12,807**

$ 13.66**

Yr.-to-Yr.
Percent Change

51.7%

51.5%

(9.7)

45.9

(1.2)%

1.1%

* See page 41 for a more detailed reconciliation of net income to operating (non-GAAP) earnings.

** Recast to reflect adoption of FASB guidance on presentation of net periodic pension and nonpension postretirement benefit costs.
+ Includes charges of $2.0 billion in 2018 and $5.5 billion in 2017 associated with U.S. tax reform.

NM—Not meaningful

In 2018, the company delivered solid strategic imperatives revenue
growth, generating $39.8 billion of revenue and growing 9 percent
as reported and adjusted for currency, with double-digit growth
in cloud and security. Cloud revenue of $19.2 billion increased 12
percent as reported and adjusted for currency, with as-a-Service
revenue up 22 percent as reported and adjusted for currency. The
annual exit run rate for as-a-Service revenue increased to $12.2
billion in 2018 compared to $10.3 billion in 2017.

From a geographic perspective, Americas revenue declined
1.7 percent year to year as reported (1 percent adjusted for
currency) with a decline in the U.S. of 2.4 percent. Europe/Middle
East/Africa (EMEA) increased 4.5 percent (1 percent adjusted
for currency). Asia Pacific was essentially flat year to year as
reported and adjusted for currency.

The consolidated gross margin of 46.4 percent decreased 0.3
points year to year and reflects the impacts of portfolio mix and
investment, partially offset by benefits from productivity and
improving services margins through the year. The operating (non-
GAAP) gross margin of 46.9 percent decreased 0.4 points versus
the prior year primarily driven by the same factors.

In 2018, the company reported $79.6 billion in revenue and $8.7
billion in income from continuing operations, which included
charges of $2.0 billion associated with U.S. tax reform. Operating
(non-GAAP) earnings were $12.7 billion, which excludes the tax
reform charges. Diluted earnings per share from continuing
operations were $9.51 as reported and $13.81 on an operating
(non-GAAP) basis. The company generated $15.2 billion in cash
from operations, $11.9 billion in free cash flow and delivered
shareholder returns of $10.1 billion in gross common stock
repurchases and dividends.

Total consolidated revenue in 2018 increased 0.6 percent as
reported and was flat adjusted for currency compared to the prior
year. Cognitive Solutions increased 0.2 percent as reported and
was essentially flat adjusted for currency. Solutions Software
grew 0.8 percent as reported (essentially flat adjusted for
currency), while Transaction Processing Software declined 1.2
percent as reported (2 percent adjusted for currency). Global
Business Services (GBS) increased 2.9 percent as reported and
2 percent adjusted for currency led by growth in Consulting.
Technology Services & Cloud Platforms (TS&CP) grew 0.5
percent as reported and was flat adjusted for currency, with
growth in Infrastructure Services and Integration Software
offset by declines in Technical Support Services. Within TS&CP,
there was continued strong growth in cloud revenue which
increased 23 percent year to year as reported and adjusted
for currency. Systems decreased 2 percent as reported and
adjusted for currency, with IBM Z declining year to year reflecting
product cycle dynamics. Storage Systems also decreased in a
competitive environment with ongoing pricing pressures, while
Power Systems grew as reported and adjusted for currency,
with strong performance in Power9-based processors and Linux
throughout the year.

Management Discussion International Business Machines Corporation and Subsidiary Companies21

Total liabilities decreased $1.2 billion (increased $1.3 billion
adjusted for currency) from December 31, 2017 driven by:

•

Decreases in total debt ($1.0 billion), deferred income
($0.7 billion) and compensation and benefits ($0.5 billion);
partially offset by

•

Increases in taxes ($1.1 billion).

Total equity of $16.9 billion decreased $0.8 billion from
December 31, 2017 as a result of:

•

Decreases from dividends ($5.7 billion) and treasury stock
($4.6 billion) primarily due to share repurchases; partially
offset by

Increases from net income ($8.7 billion) and the transition
adjustment related to the adoption of the new revenue
standard ($0.6 billion).

The company generated $15.2 billion in cash flow provided
by operating activities, a decrease of $1.5 billion compared to
2017, driven primarily by a decrease in cash provided by financing
receivables ($0.8 billion), a decrease in cash sourced from sales
cycle working capital ($0.2 billion) and an increase in cash
income tax payments ($0.1 billion). Net cash used in investing
activities of $4.9 billion was $2.2 billion lower than the prior year,
primarily driven by decreases in cash used for net non-operating
receivables ($1.5 billion) and lower net purchases of marketable
securities and other investments ($0.5 billion). Net cash used
in financing activities of $10.5 billion increased $4.1 billion
compared to 2017, driven primarily by a decrease in net cash
sourced from debt transactions ($3.7 billion), with a lower level
of issuances and a higher level of maturities in the current year.

In January 2019, the company disclosed that it is expecting
GAAP earnings per share from continuing operations of at least
$12.45 and operating (non-GAAP) earnings of at least $13.90 per
diluted share for 2019. The company expects free cash flow to be
approximately $12 billion in 2019. Free cash flow realization is
expected to be approximately 100 percent of GAAP net income.
Refer to page 61 in the Liquidity and Capital Resources section
for additional information on this non-GAAP measure. Refer to
the Looking Forward section on pages 59 and 60 for additional
information on the company’s expectations.

Total expense and other (income) increased 0.2 percent in
2018 compared to the prior year. The year-to-year performance
was driven by decline in intellectual property (IP) income (2
points) and a higher level of workforce rebalancing charges
(1 point), offset by continued focus on efficiency resulting in
lower spending (3 points). Total operating (non-GAAP) expense
and other (income) decreased 0.4 percent year to year, driven
primarily by the same factors.

Pre-tax income from continuing operations of $11.3 billion
decreased 0.5 percent and the pre-tax margin was 14.3 percent,
a decrease of 0.2 points versus 2017. The continuing operations
effective tax rate for 2018 was 23.1 percent, including charges
of $2.0 billion associated with U.S. tax reform. This is compared
to an effective tax rate of 49.5 percent in 2017 which included
a $5.5 billion charge associated with U.S. tax reform. Without
these impacts, the continuing operations tax rate for 2018 would
have been 5.4 percent, compared to a 2017 rate of 1.5 percent.
Net income of $8.7 billion increased 51.7 percent year to year
as a result of the lower tax reform charges in 2018. Operating
(non-GAAP) pre-tax income from continuing operations of
$13.7 billion was flat year to year and the operating (non-GAAP)
pre-tax margin from continuing operations decreased 0.1 points
to 17.3 percent. Operating (non-GAAP) income from continuing
operations of $12.7 billion decreased 1.2 percent with an
operating (non-GAAP) income margin from continuing operations
of 15.9 percent, down 0.3 points year to year. The operating
(non-GAAP) effective tax rate from continuing operations in 2018
was 7.9 percent, compared to 6.8 percent in the prior year.

Diluted earnings per share from continuing operations of $9.51 in
2018 increased 54.9 percent year to year, which included lower
year-to-year charges associated with U.S. tax reform. Operating
(non-GAAP) diluted earnings per share of $13.81 increased
1.1 percent versus 2017. In 2018, the company repurchased
32.9 million shares of its common stock at a cost of $4.4 billion
and had $3.3 billion remaining in the current share repurchase
authorization at December 31, 2018.

At December 31, 2018, the balance sheet remains strong and
the company continues to be committed to maintaining a strong
investment grade rating. Cash, restricted cash and marketable
securities at December 31, 2018 were $12.2 billion, a decrease
of $0.6 billion from December 31, 2017. Key drivers in the
balance sheet and total cash flows were:

Total assets decreased $2.0 billion (increased $1.2 billion
adjusted for currency) from December 31, 2017 driven by:

•

A decline in receivables of $1.6 billion ($0.6 billion adjusted
for currency) driven by a decline in trade receivables of
$1.5 billion, and

A decrease in net intangibles and goodwill of $1.2 billion
($0.6 billion adjusted for currency) resulting from currency
impacts and intangibles amortization; partially offset by

An increase in deferred costs of $1.0 billion ($1.2 billion
adjusted for currency) driven primarily by capitalized sales
commissions costs due to the adoption of the new revenue
standard.

Management Discussion International Business Machines Corporation and Subsidiary Companies22

DESCRIPTION OF BUSINESS
Please refer to IBM’s Annual Report on Form 10-K filed with the
SEC on February 26, 2019 for Item 1A. entitled “Risk Factors.”

The company creates value for clients by providing integrated
solutions and products that leverage: data, information
technology, deep expertise in industries and business processes,
with trust and security and a broad ecosystem of partners and
alliances. IBM solutions typically create value by enabling new
capabilities for clients that transform their businesses and
help them engage with their customers and employees in new
ways. These solutions draw from an industry-leading portfolio
of consulting and IT implementation services, cloud, digital
and cognitive offerings, and enterprise systems and software
which are all bolstered by one of the world’s leading research
organizations.

IBM Strategy
IBM’s strategy is wholly focused on the needs of its clients. IBM
is a technology company, but first and foremost it is an enterprise
company. IBM serves enterprises of all sizes, and IBM’s longest-
standing clients are leaders in their industries—the world’s
leading financial services institutions, airlines, manufacturers,
consumer goods and retail companies. IBM’s mission is to help
its clients transform their companies and lead in their industries.

One of the biggest priorities for IBM clients is to derive
competitive advantage through insights and the latest digital
technologies. Better insight about the wants and needs of
their customers will help them distinguish themselves in the
marketplace. Data-driven insight will also influence how they
design and produce their own products, as well as help them
identify opportunities in new markets.

However, most companies are harnessing only a small percent
of the valuable data they collect. As IBM clients embark on
the next chapter of their digital journey, the proper collection,
use, safeguarding and management of data is of paramount
importance. Choosing the right digital technologies to analyze
the data is also necessary.

IBM helps clients harness the power of their data through
technologies like AI, analytics and blockchain; on a hybrid cloud
that connects data across traditional and new environments; with
services that put a client’s data and insight to use in and for their
business. Underpinning all of this, IBM safeguards client data
with world-class technologies and approaches to security.

By reinventing themselves digitally around insight, clients
become what IBM calls Cognitive Enterprises.

What IBM Brings to Clients
Businesses are choosing IBM because they want to partner
with a company that can uniquely integrate three core
capabilities:

1. They want the most innovative technology, like AI,

blockchain, cybersecurity and quantum delivered in a
hybrid cloud environment.

2. They want industry expertise—from a partner that deeply
understands their industry and can apply innovation to
their business processes to drive transformation and
competitive advantage.

3. And, finally, they want a total commitment to trust and

security. Clients want to partner with a company that will
protect their valuable data and insights, and one that
develops and deploys new innovations with a commitment
to do so responsibly.

IBM is unique in that it can integrate all three core capabilities
for clients.

Innovative Technology
IBM has a long history of bringing innovative technology to the
world. For 26 years, IBM has led the world in U.S. patents; six
IBMers are Nobel Laureates; and IBM engineers have developed
innumerable first-of-its-kind products and services. Current
examples of IBM’s innovative technology include:

•

Analytics and AI: IBM’s long-standing leadership in
managing and extracting insights from data starts with a
portfolio of analytics and database offerings. A few years
ago, IBM brought AI into the mainstream with the Watson
platform, which to date has been the foundation of many
Enterprise AI implementations in production. Recently, IBM
augmented its Watson platform with a set of AI tools that
enable clients to trace the origins of the data their AI models
use, explain what is behind their recommendations and
ensure that bias has not crept into results. These
innovations are making AI more consumable by everyday
users—not just data scientists.

Security: Businesses built around data require an
unparalleled level of data security. IBM is the leader in
information security for enterprises—with leadership in
both security software and services. Security is embedded
inside all of IBM’s products and services. For example,
IBM Z offers pervasive security by building data encryption
directly in its computing processor. In addition, IBM’s
services businesses are world class in embedding security
into the solutions they build and run for IBM clients.

Blockchain is an exciting technology that is just beginning to
transform business processes. IBM’s platform has been
rated number one by leading analyst firms such as Juniper
Research and Everest Group. Blockchain technology
enables multiple parties to conduct business with each
other on a single, unified distributed system, eliminating the
costly and time-consuming hand-offs of fragmented
systems. IBM is deploying blockchain technology with
clients to transform how global trade is transacted, how
food safety is tracked and how supply chains are managed.

Management Discussion International Business Machines Corporation and Subsidiary Companies23

•

Cloud: Enterprise clients are in the very early stages of
the move to cloud. IBM estimates that only 20 percent of
workloads have moved to the cloud—with work ahead for
the remaining 80 percent. The first part was to move
business workloads that exist as a layer over core
processes. The hard part is ahead: moving the mission-
critical systems that run banking, retail, telecom and other
industries. Some of these workloads will remain in
traditional IT systems, some will move to a private cloud
inside the safety of a client’s firewall, others will move to
public clouds, and some will surge between all of these.
Wherever a workload may reside, it will need to share
its data across environments. All of this requires an
approach that is open, highly interoperable between
environments, and even interoperable between different
public clouds. This is what IBM has long called hybrid
cloud—and this describes the solution for the 80 percent of
the workloads that is to come. With in-depth experience
across all three environments, IBM brings the strongest
hybrid cloud solution to the market for enterprises—which
will be strengthened through the acquisition of Red Hat.

Industry Expertise
Changing a business requires in-depth understanding of how a
business works and how technology can make it work differently.

IBM brings both industry expertise and innovative technology to
clients through the IBM services and products businesses. This
combination makes IBM unique and essential.

A few examples of this capability are highlighted below:

•

Global Business Services: the IBM GBS business is one of
the world’s largest professional services businesses. Its
mission is to help clients along the journey to becoming a
Cognitive Enterprise.

Global Technology Services: the IBM GTS business runs
some of the world’s largest data centers—and thereby
some of the world’s most mission-critical workflows and
franchises. GTS helps clients along their journey to
the hybrid cloud—leveraging the best of their existing
systems in the context of the regulatory, security and
workflow of their industry.

•

Industry and Domain-Specific Solutions: augmenting IBM’s
services businesses are software and solutions designed for
specific industries and domains. For example:

Health: IBM has become a leader in applying advanced
digital technologies to healthcare, including the
application of AI and data analytics to the diagnosis and
treatment of patients, bringing smart decisions to Health
Care payers, and helping Life Sciences companies
develop innovative products and services.

Financial Services: IBM is a leading provider in the
Financial Services industry; with IBM’s Promontory
Financial Group, a leading advisor in Financial Regulation
and Compliance, IBM offers an advanced set of solutions
for managing Risk and Compliance, a critical workflow in
the Financial Services industry.

Trust and Security
Data and AI—together, they are both the opportunity and
the issue of current times. They can make the world a better,
healthier and more productive place; but only if businesses and
consumers trust the companies putting data and AI to work.

IBM is a 107-year old business—and the reason it has been
successful for so long is because it has earned the trust of
its clients. IBM has not only followed guidelines around the
responsible handling of data and the stewardship of new
technology, but created them, published them, and invited others
to adopt similar commitments. IBM’s principles make clear that:

•

The purpose of new technologies is to augment—not
replace—human expertise;

Data and insights derived from AI belong to their owners
and creators (not their IT partners); and,

•

New technologies must be transparent and explainable.

There are many companies in the IT industry who bring
technology products to the marketplace. Many bring technology
services to the marketplace. A few companies do both, but no one
can do it as well as IBM when it comes to meeting the needs of
clients. By bringing together technology and workflow, combining
it with industry expertise, innovation and deployment, IBM helps
clients and industries truly transform themselves.

This is what truly sets IBM apart.

Business Model
The company’s business model is built to support two principal
goals: helping enterprise clients to move from one era to the
next by bringing together innovative technology and industry
expertise, and providing long-term value to shareholders. The
business model has been developed over time through strategic
investments in capabilities and technologies that have long-term
growth and profitability prospects based on the value they deliver
to clients.

The company’s global capabilities include services, software,
systems, fundamental research and related financing. The broad
mix of businesses and capabilities are combined to provide
integrated solutions and platforms to the company’s clients.

The business model is dynamic, adapting to the continuously
changing industry and economic environment, including the
company’s transformation into cloud and as-a-Service delivery
models. The company continues to strengthen its position
through strategic organic investments and acquisitions in higher-
value areas, broadening its industry expertise and integrating AI
into more of what the company offers. In addition, the company
is transforming into a more agile enterprise to drive innovation
and speed, as well as helping to drive productivity, which
supports investments for participation in markets with significant

Management Discussion International Business Machines Corporation and Subsidiary Companies

long-term opportunity. The company also regularly evaluates its
portfolio and proactively maximizes shareholder value of non-
strategic assets by bringing products to end of life, engaging in
IP partnerships or executing divestitures.

Transaction Processing Software: includes software that
primarily runs mission-critical systems in industries such as
banking, airlines and retail.

This business model, supported by the company’s financial
model, has enabled the company to deliver strong earnings, cash
flows and returns to shareholders over the long term.

Business Segments and Capabilities
The company’s major operations consist of five business
segments: Cognitive Solutions, Global Business Services,
Technology Services & Cloud Platforms, Systems and Global
Financing.

Cognitive Solutions comprises a broad portfolio of primarily
software capabilities that help IBM’s clients to identify actionable
new insights and inform decision-making for competitive
advantage. Leveraging IBM’s research, technology and industry
expertise, this business delivers a full spectrum of capabilities,
from descriptive, predictive and prescriptive analytics to
artificial intelligence. Cognitive Solutions includes Watson, the
first enterprise AI platform that specializes in driving value and
knowledge from the 80 percent of the world’s data that sits
behind company firewalls. It enables businesses to reimagine
their workflows across a variety of industries and professions
and gives organizations complete control of their insights, data,
training and IP.

Additionally, Cognitive Solutions includes the new Watson
OpenScale technology—a first of a kind, open technology
platform that addresses key challenges of AI adoption. It enables
companies to manage AI transparently throughout the full AI
lifecycle, irrespective of where their AI applications were built
or in which environment they currently run.

IBM’s solutions are provided through the most contemporary
delivery methods including through cloud environments and
as-a-Service models. Cognitive Solutions consists of Solutions
Software and Transaction Processing Software.

Cognitive Solutions Capabilities
Solutions Software: provides the basis for many of the
company’s strategic areas. IBM has established the world’s
deepest portfolio of enterprise AI, including analytics and data
management platforms, cloud data services, talent management
solutions, and solutions tailored by industry. Watson Platform,
Watson Health and Watson Internet of Things (IoT) are certain
capabilities included in Solutions Software. IBM’s world-class
security platform weaves in AI to deliver integrated security
intelligence across clients’ entire operations, including their
cloud, applications, networks and data, helping them to prevent,
detect and remediate potential threats.

Global Business Services (GBS) provides clients with consulting,
application management and business process services.
These professional services deliver value and innovation to
clients through solutions which leverage industry, technology
and business strategy and process expertise. GBS is the
digital reinvention partner for IBM clients, combining industry
knowledge, functional expertise, and applications with the power
of business design and cognitive and cloud technologies. The
full portfolio of GBS services is backed by its globally integrated
delivery network and integration with technologies, solutions and
services from IBM units including IBM Watson, IBM Cloud, IBM
Research, and Global Technology Services.

In 2018, focused on digital reinvention, GBS assisted clients on
their journeys to becoming Cognitive Enterprises, helping them
engage their customers with new digital value propositions,
transform workflows using AI, and build hybrid, open cloud
infrastructures. This was delivered by the operating model
rolled out in 2017—Digital Strategy and iX, Cognitive Process
Transformation and Cloud Application Innovation, cross industry
and globally.

GBS Capabilities
Consulting: provides business consulting services focused on
bringing to market solutions that help clients shape their digital
blueprints and customer experiences, define their cognitive
operating models, unlock the potential in all data to improve
decision-making, set their next-generation talent strategies and
create new technology architectures in a cloud-centric world.

Application Management: delivers system integration,
application management, maintenance and support services for
packaged software, as well as custom and legacy applications.
Value is delivered through advanced capabilities in areas such
as security and privacy, application testing and modernization,
cloud application migration and automation.

Global Process Services (GPS): delivers finance, procurement,
talent and engagement, and industry-specific business process
outsourcing services. These services deliver improved business
results to clients through a consult-to-operate model which
includes the strategic change and/or operation of the client’s
processes, applications and infrastructure. GBS is redefining
process services for both growth and efficiency through the
application of the power of cognitive technologies like Watson,
as well as the IoT, blockchain and deep analytics.

Technology Services & Cloud Platforms (TS&CP) provides
compre hensive IT infrastructure and platform services that
create business value for clients. Clients gain access to leading-
edge, high-quality services, flexibility and economic value. This is
enabled through leverage of insights drawn from IBM’s decades
of experience across thousands of engagements, the skills of
practitioners, advanced technologies, applied innovation from
IBM Research and global scale.

Management Discussion International Business Machines Corporation and Subsidiary Companies25

TS&CP Capabilities
Infrastructure Services: delivers a portfolio of project services,
managed and outsourcing services, and cloud-delivered services
focused on clients’ enterprise IT infrastructure environments
to enable digital transformation and deliver improved quality,
flexibility and economic value. The portfolio includes a
comprehensive set of hybrid cloud services and solutions to
assist enterprise clients in building and running contemporary IT
environments. These offerings integrate long-standing expertise in
service management and technology with the ability to utilize the
power of new technologies, drawn from across IBM’s businesses
and ecosystem partners. The portfolio is built using the IBM
Services Platform with Watson, designed to augment human
intelligence with cognitive technologies, and addresses hybrid
cloud, digital workplace, business resiliency, network, managed
applications, cloud and security. The company’s capabilities,
including IBM Cloud, cognitive computing and hybrid cloud
implementation, provide high-performance, end-to-end innovation
and an improved ability for clients to achieve business objectives.

Technical Support Services: delivers comprehensive support
services to maintain and improve the availability of clients’ IT
infrastructures. These offerings include maintenance for IBM
products and other technology platforms, as well as open source
and vendor software and solution support, drawing on innovative
technologies and leveraging the IBM Services Platform with
Watson capabilities.

Integration Software: delivers industry-leading hybrid cloud
solutions that empower clients to achieve rapid innovation,
hybrid integration and process transformation with choice
and consistency across public, dedicated and local cloud
environments, leveraging the IBM Platform-as-a-Service
solution. Integration Software offerings and capabilities help
clients address the digital imperatives to create, connect and
optimize their applications, data and infrastructure on their
journey to become cognitive businesses.

Systems provides clients with innovative infrastructure
platforms to help meet the new requirements of hybrid cloud
and enterprise AI workloads. More than one-third of Systems
Hardware’s server and storage sales transactions are through the
company’s business partners, with the balance direct to end-user
clients. IBM Systems also designs advanced semiconductor and
systems technology in collaboration with IBM Research, primarily
for use in the company’s systems.

Systems Capabilities
Systems Hardware: includes IBM’s servers: IBM Z, Power
Systems and Storage Systems.

Servers: a range of high-performance systems designed to
address computing capacity, security and performance needs
of businesses, hyperscale cloud service providers and scientific
computing organizations. The portfolio includes IBM Z, a trusted
enterprise platform for integrating data, transactions and insight,
and Power Systems, a system designed from the ground up for
big data and enterprise AI, optimized for hybrid cloud and Linux,
and delivering open innovation with OpenPOWER.

Storage Systems: data storage products and solutions that
allow clients to retain and manage rapidly growing, complex
volumes of digital information and to fuel data-centric cognitive
applications. These solutions address critical client requirements
for information retention and archiving, security, compliance and
storage optimization, including data deduplication, availability
and virtualization. The portfolio consists of a broad range of flash
storage, disk and tape storage solutions.

Operating Systems Sof tware: IBM Z operating system
environments include z/OS, a security-rich, high-performance
enterprise operating system, as well as Linux. Power Systems
offers a choice of AIX, IBM i or Linux operating systems. These
operating systems leverage POWER architecture to deliver
secure, reliable and high performing enterprise-class workloads
across a breadth of server offerings.

Global Financing encompasses two primary businesses:
financing, primarily conducted through IBM Credit LLC (IBM
Credit), and remanufacturing and remarketing. IBM Credit is
a wholly owned subsidiary of IBM that accesses the capital
markets directly. IBM Credit, through its financing solutions,
facilitates IBM clients’ acquisition of information technology
systems, software and services in the areas where the company
has expertise. The financing arrangements are predominantly
for products or services that are critical to the end users’
business operations. The company conducts a comprehensive
credit evaluation of its clients prior to extending financing. As
a captive financier, Global Financing has the benefit of both
deep knowledge of its client base and a clear insight into the
products and services financed. These factors allow the business
to effectively manage two of the major risks associated with
financing, credit and residual value, while generating strong
returns on equity. Global Financing also maintains a long-term
partnership with the company’s clients through various stages
of the IT asset life cycle—from initial purchase and technology
upgrades to asset disposition decisions.

Global Financing Capabilities
Client Financing: lease, installment payment plan and loan
financing to end users and internal clients for terms up to seven
years. Assets financed are primarily new and used IT hardware,
software and services where the company has expertise. Internal
financing is predominantly in support of Technology Services &
Cloud Platforms’ long-term client service contracts. All internal
financing arrangements are at arm’s-length rates and are based
upon market conditions.

Commercial Financing: short-term working capital financing
to suppliers, distributors and resellers of IBM and Original
Equipment Manufacturer (OEM) products and services. The OEM
portion will begin winding down starting in the second quarter of
2019 and continuing throughout the calendar year. Commercial
Financing also includes internal activity where Global Financing
factors a selected portion of the company’s accounts receivable
primarily for cash management purposes, at arm’s-length rates.

Management Discussion International Business Machines Corporation and Subsidiary Companies26

Remanufacturing and Remarketing: assets include used
equipment returned from lease transactions, or used and surplus
equipment acquired internally or externally. These assets may
be refurbished or upgraded, and sold or leased to new or existing
clients both externally or internally. Externally remarketed
equipment revenue represents sales or leases to clients and
resellers. Internally remarketed equipment revenue primarily
represents used equipment that is sold internally to Systems
and Technology Services & Cloud Platforms. Systems may also
sell the equipment that it purchases from Global Financing to
external clients.

IBM Worldwide Organizations
The following worldwide organizations play key roles in IBM’s
delivery of value to its clients:

• Global Markets

• Research, Development and Intellectual Property

Global Markets
IBM has a global presence, operating in more than 175 countries
with a broad-based geographic distribution of revenue. The
company’s Global Markets organization manages IBM’s global
footprint, working closely with dedicated country-based
operating units to serve clients locally. These country teams
have client relationship managers who lead integrated teams of
consultants, solution specialists and delivery professionals to
enable clients’ growth and innovation.

By complementing local expertise with global experience and
digital capabilities, IBM builds deep and broad-based client
relationships. This local management focus fosters speed
in supporting clients, addressing new markets and making
investments in emerging opportunities. The Global Markets
organization serves clients with expertise in their industry as
well as through the products and services that IBM and partners
supply. IBM continues to expand its reach to new and existing
clients through digital marketplaces, digital sales and local
Business Partner resources.

Research, Development and Intellectual Property
IBM’s research and development (R&D) operations differentiate
the company from its competitors. IBM annually invests
approximately 7 percent of total revenue for R&D, focusing on
high-growth, high-value opportunities. IBM Research works
with clients and the company’s business units through global
labs on near-term and mid-term innovations. It delivers many
new technologies to IBM’s portfolio every year and helps clients
address their most difficult challenges. IBM Research scientists
are conducting pioneering work in artificial intelligence, quantum
computing, blockchain, security, cloud, nanotechnology, silicon
and post-silicon computing architectures and more—applying
these technologies across industries including financial services,
healthcare, blockchain and IoT.

In 2018, for the 26th consecutive year, IBM was awarded more
U.S. patents than any other company. IBM’s 9,100 patents
awarded in 2018 represent a diverse range of inventions in
strategic growth areas for the company, including more than
3,000 patents related to work in artificial intelligence, cloud,
cybersecurity and quantum computing.

The company actively continues to seek IP protection for its
innovations, while increasing emphasis on other initiatives
designed to leverage its IP leadership. Some of IBM’s
technological breakthroughs are used exclusively in IBM
products, while others are licensed and may be used in IBM
products and/or the products of the licensee. As part of its
business model, the company licenses certain of its intellectual
property assets, which constitute high-value technology, but
may be applicable in more mature markets. The licensee drives
the future development of the IP and ultimately expands the
customer base. This generates IP income for the company both
upon licensing, and with any ongoing royalty arrangements
between it and the licensee. While the company’s various
proprietary IP rights are important to its success, IBM believes its
business as a whole is not materially dependent on any particular
patent or license, or any particular group of patents or licenses.
IBM owns or is licensed under a number of patents, which vary
in duration, relating to its products.

Management Discussion International Business Machines Corporation and Subsidiary Companies27

YEAR IN REVIEW
Results of Continuing Operations
Segment Details
The following is an analysis of the 2018 versus 2017 reportable segment results. The table below presents each reportable segment’s
external revenue and gross margin results. Segment pre-tax income includes transactions between segments that are intended to
reflect an arm’s-length transfer price and excludes certain unallocated corporate items.

($ in millions)

For the year ended December 31:

2018

2017

Yr.-to-Yr.
Percent/
Margin
Change

Yr.-to-Yr.
Percent Change
Adjusted for
Currency

Revenue

Cognitive Solutions

Gross margin

Global Business Services

Gross margin

Technology Services & Cloud Platforms

Gross margin

Systems

Gross margin

Global Financing

Gross margin

Other

Gross margin

Total consolidated revenue

Total consolidated gross profit

Total consolidated gross margin

Non-operating adjustments

Amortization of acquired intangible assets

Retirement-related costs/(income)

Operating (non-GAAP) gross profit

Operating (non-GAAP) gross margin

* Recast to reflect adoption of the FASB guidance on presentation of net benefit cost.

(0.4)%

2.0%

(0.1)%

(2.3)%

(6.5)%

19.9%

0.0%

$18,481

$18,453

77.5%

78.6%*

16,817

16,348

26.7%

24.9%*

34,462

34,277

40.5%

8,034

49.8%

1,590

29.1%

207

40.3%*

8,194

53.2%*

1,696

29.3%

171

(140.7)%

(173.9)%*

$79,591

$79,139

$36,936

$36,943*

46.4%

46.7%*

0.2%

(1.1) pts.

2.9%

1.7 pts.

0.5%

0.2 pts.

(2.0)%

(3.4) pts.

(6.3)%

(0.2) pts.

21.0%

33.2 pts.

0.6%

0.0%

(0.3) pts.

372

—

449

—*

$37,307

$37,392*

(17.2)%

—%

(0.2)%

46.9%

47.2%*

(0.4) pts.

Management Discussion International Business Machines Corporation and Subsidiary Companies28

Cognitive Solutions

($ in millions)

For the year ended December 31:

Cognitive Solutions external revenue

Solutions Software

Transaction Processing Software

Cognitive Solutions revenue of $18,481 million was essentially
flat as reported and adjusted for currency in 2018 compared to
the prior year. On an as-reported and constant currency basis,
there was growth in Solutions Software, while Transaction
Processing Software declined year to year.

Solutions Software revenue of $12,903 million grew 0.8 percent
as reported (essentially flat adjusted for currency) compared
to the prior year, led by the company’s analytics and security
platforms. Within analytics, the company had broad-based
growth across the Db2 portfolio, including analytics appliances
and increasing demand for IBM Cloud Private for Data, which
accelerated in the fourth quarter of 2018. The company
continued to have solid demand for integrated security and
services solutions with strong growth in security intelligence and
orchestration offerings. Across the industry verticals, Watson
Health and Watson Media & Weather grew revenue as reported
and adjusted for currency compared to the prior year. Certain
Solutions Software offerings which address horizontal domains,
specifically collaboration, commerce and talent, have been
impacted by secular shifts in the market. In December 2018,
the company announced its intent to divest its collaboration
and on-premise marketing and commerce products to HCL. This
transaction is expected to close by mid-year 2019.

Transaction Processing Software revenue of $5,578 million
decreased 1.2 percent as reported (2 percent adjusted for
currency) in 2018 compared to the prior year. There was
improved revenue performance sequentially in the fourth
quarter 2018 versus the third quarter 2018 reflecting clients’

2018

$18,481

$12,903

5,578

2017

$18,453

$12,806

5,647

Yr.-to-Yr.
Percent
Change

Yr.-to-Yr.
Percent Change
Adjusted for
Currency

0.2%

0.8%

(1.2)

(0.4)%

0.3%

(1.9)

commitment to the company’s platform for the long-term and
the value it provides in managing mission-critical workloads and
predictability in spending.

Cognitive Solutions total strategic imperatives revenue of $12.3
billion grew 3 percent as reported and 2 percent adjusted for
currency year to year. Cloud revenue of $2.6 billion grew 2 percent
as reported and adjusted for currency, with an as-a-Service exit
run rate of $2.0 billion.

($ in millions)

For the year ended December 31:

2018

2017*

Cognitive Solutions

Yr.-to-Yr.
Percent/
Margin
Change

External gross profit

$14,319

$14,503

(1.3)%

External gross profit

margin

Pre-tax income

Pre-tax margin

77.5%

78.6%

(1.1) pts.

$ 7,154

$ 6,795

33.8%

32.2%

5.3%

1.5 pts.

* Recast to reflect adoption of the FASB guidance on presentation of net

benefit cost.

Cognitive Solutions gross profit margin decreased 1.1 points to
77.5 percent in 2018 compared to the prior year. The gross profit
margin decline was driven by an increasing mix toward SaaS and
increased royalty cost associated with IP licensing agreements
in 2018 compared to the prior year.

Pre-tax income of $7,154 million increased 5.3 percent
compared to the prior year with a pre-tax margin improvement
of 1.5 points to 33.8 percent, primarily driven by operational
efficiencies and mix.

Management Discussion International Business Machines Corporation and Subsidiary Companies

Global Business Services

($ in millions)

For the year ended December 31:

Global Business Services external revenue

Consulting

Global Process Services

Application Management

2018

$16,817

$ 7,705

1,259

7,852

2017

$16,348

$ 7,262

1,265

7,821

Yr.-to-Yr.
Percent
Change

Yr.-to-Yr.
Percent Change
Adjusted for
Currency

2.9%

6.1%

(0.5)

0.4

2.0%

5.1%

(0.5)

Global Business Services revenue of $16,817 million increased 2.9
percent as reported and 2 percent adjusted for currency in 2018
compared to the prior year. This performance reflects the progress
the company has made to reposition this business, with strong
growth in Consulting, led by key offerings in digital and cloud
application, where the business is bringing together technology
and industry expertise to help clients on their digital journey.

Consulting revenue of $7,705 million increased 6.1 percent as
reported (5 percent adjusted for currency) compared to the
prior year. The improvement was driven by the company’s digital
strategy, including Digital Commerce and CRM offerings and
accelerated growth in next generation enterprise applications,
led by strong demand for consulting and implementation services.
GPS revenue of $1,259 million was essentially flat year to year
as reported and decreased 1 percent adjusted for currency.
GPS performance improved during the second half of 2018 on a
year-to-year basis as reported and adjusted for currency, as the
business has been reinventing industry workflows by leveraging
automation and infusing AI. In January 2019, the company
announced the intent to divest its Seterus mortgage servicing
platform business (reported within GPS), which is expected
to close in the first quarter of 2019. Application Management
revenue of $7,852 million was flat as reported and declined 1
percent adjusted for currency compared to 2017. The company
continues to help clients move to the cloud with offerings such as
Cloud Migration Factory and cloud application development. The
business continued to decline in the more traditional application
management engagements.

Within GBS, total strategic imperatives revenue of $10.8 billion
grew 10 percent year to year as reported (9 percent adjusted
for currency). Cloud revenue of $4.7 billion grew 19 percent as
reported and adjusted for currency, with an as-a-Service exit run
rate of $2.1 billion.

($ in millions)

For the year ended December 31:

2018

2017*

Global Business Services

Yr.-to-Yr.
Percent/
Margin
Change

External gross profit

$4,484

$4,077

10.0%

External gross profit

margin

Pre-tax income

Pre-tax margin

26.7%

24.9%

1.7 pts.

$1,676

$1,362

23.0%

9.8%

8.2%

1.6 pts.

* Recast to reflect adoption of the FASB guidance on presentation of net

benefit cost.

GBS gross profit margin increased 1.7 points to 26.7 percent
year to year and pre-tax income of $1,676 million increased
23.0 percent year to year. The pre-tax margin increased 1.6
points to 9.8 percent. The year-to-year improvements in margins
and pre-tax income are the result of the shift to higher-value
offerings, realignment of resources to key skill areas, increased
productivity and utilization as well as a benefit from currency,
due to the company’s global delivery model.

Management Discussion International Business Machines Corporation and Subsidiary Companies30

Technology Services & Cloud Platforms

($ in millions)

For the year ended December 31:

Technology Services & Cloud Platforms external revenue

Infrastructure Services

Technical Support Services

Integration Software

Technology Services & Cloud Platforms revenue of $34,462
million increased 0.5 percent as reported (flat adjusted for
currency) in 2018 compared to the prior year, with growth in
Infrastructure Services and Integration Software, offset by
a decline in Technical Support Services. Cloud revenue grew
double-digits as reported and adjusted for currency. New
and existing clients are engaging IBM to manage their critical
infrastructure and deliver innovation, including migrating
their operations to an open hybrid cloud environment, while
simultaneously achieving predictable spending.

Infrastructure Services revenue of $23,007 million increased 1.4
percent as reported (1 percent adjusted for currency) compared
to the prior year. In Infrastructure Services, the business has
prioritized the portfolio to deliver high-value solutions that bring
productivity to clients and allow for expanding workloads, while
exiting some lower-value offerings. Technical Support Services
revenue of $6,961 million decreased 3.3 percent as reported
(3 percent adjusted for currency) year to year. This business
was impacted by the hardware product cycle dynamics in 2018,
but continued to grow its multi-vendor services offerings which
provide clients with an integrated approach by bringing expertise
and access to different vendor solutions. Integration Software
revenue of $4,493 million grew 2.3 percent as reported (2
percent adjusted for currency) compared to the prior year. There
was strong double-digit growth year to year in SaaS offerings,
with continued strong adoption of IBM Cloud Private, which
helps clients modernize their traditional workloads and provides
access to over 100 integrated IBM software offerings including
blockchain, Watson, IoT and analytics.

Within Technology Services & Cloud Platforms, strategic
imperatives revenue of $12.2 billion increased 18 percent year to
year as reported and adjusted for currency. Cloud revenue of $8.8
billion grew 23 percent as reported and adjusted for currency,
with an as-a-Service exit run rate of $8.0 billion.

2018

$34,462

$23,007

6,961

4,493

2017

$34,277

$22,690

7,196

4,390

Yr.-to-Yr.
Percent
Change

Yr.-to-Yr.
Percent Change
Adjusted for
Currency

0.5%

1.4%

(3.3)

2.3

(0.1)%

0.7%

(3.5)

1.9

($ in millions)

For the year ended December 31:

2018

2017*

Technology Services &
Cloud Platforms

External Technology

Yr.-to-Yr.
Percent/
Margin
Change

Services gross profit

$10,307

$10,215

0.9%

External Technology

Services gross profit
margin

External Integration

34.4%

34.2%

0.2 pts.

Software gross profit

$ 3,651

$ 3,587

1.8%

External Integration

Software gross profit
margin

81.3%

81.7%

(0.4) pts.

External total gross profit

$13,958

$13,802

1.1%

External total gross
profit margin

Pre-tax income

Pre-tax margin

40.5%

40.3%

0.2 pts.

$ 3,786

$ 4,286

(11.7)%

10.7%

12.3%

(1.5) pts.

* Recast to reflect adoption of the FASB guidance on presentation of net

benefit cost.

Technology Services & Cloud Platforms gross profit margin
of 40.5 percent was essentially flat year to year. The 2018
margin reflects benefits from productivity initiatives, including
automation of delivery processes infused with AI and global
workforce optimization. Pre-tax income of $3,786 million
decreased 11.7 percent. The pre-tax margin declined 1.5 points
year to year to 10.7 percent, reflecting the company’s continued
investment to expand its go-to-market capabilities and develop
new offerings for the hybrid market.

Management Discussion International Business Machines Corporation and Subsidiary Companies31

Services Backlog and Signings

($ in billions)

At December 31:

Total backlog

2018

$116.1

2017

$121.0

Yr.-to-Yr.
Percent
Change

Yr.-to-Yr.
Percent Change
Adjusted for
Currency

(4.1)%

(0.6)%

The estimated total services backlog at December 31, 2018 was
$116 billion, a decrease of 4.1 percent as reported (1 percent
adjusted for currency).

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.

Total services backlog includes Infrastructure Services,
Consulting, Global Process Services, Application Management
and Technical Support Services (TSS). Total backlog is intended
to be a statement of overall work under contract which is either
noncancellable, or which historically has very low likelihood
of termination, given the criticality of certain services to the
company’s clients. Total backlog does not include as-a-Service
arrangements that allow for termination under contractual
commitment terms. Backlog estimates are subject to change and
are affected by several factors, including terminations, changes
in the scope of contracts, periodic revalidations, adjustments for
revenue not materialized and adjustments for currency.

Services signings are management’s initial estimate of the
value of a client’s commitment under a services contract. There
are no third-party standards or requirements governing the

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

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

($ in millions)

For the year ended December 31:

Total signings

Systems

($ in millions)

For the year ended December 31:

Systems external revenue

Systems Hardware

IBM Z

Power Systems

Storage Systems

2018

2017

Yr.-to-Yr.
Percent
Change

Yr.-to-Yr.
Percent Change
Adjusted for
Currency

$44,700

$42,869

4.3%

4.9%

2018

$8,034

$6,363

2017

$8,194

$6,494

Yr.-to-Yr.
Percent
Change

Yr.-to-Yr.
Percent Change
Adjusted for
Currency

(2.0)%

(5.4)

8.8

(5.5)

(1.7)

(2.3)%

(5.6)

8.7

(5.9)

(2.4)

Operating Systems Software

1,671

1,701

Systems revenue of $8,034 million decreased 2.0 percent year
to year as reported (2 percent adjusted for currency) driven by
strong IBM Z performance in the prior year and continuing price
pressures impacting Storage Systems. Both hardware platforms
were down year to year for the full year, as reported and adjusted
for currency. This performance was partially offset by strong
growth in Power Systems (which grew as reported and adjusted

for currency in 2018). Systems Hardware revenue of $6,363
million declined 2.0 percent as reported (2 percent adjusted
for currency). Operating Systems Software revenue of $1,671
million decreased 1.7 percent as reported (2 percent adjusted
for currency) compared to the prior year.

Management Discussion International Business Machines Corporation and Subsidiary Companies32

Within Systems Hardware, IBM Z revenue decreased 5.4 percent
as reported (6 percent adjusted for currency) year to year, driven
by the strong performance in 2017 of the z14 mainframe which
was launched in the third quarter of 2017. The z14 continues to
be one of the most successful programs within IBM Z history,
and the company continued to grow the install base by adding
new clients and new mission-critical workloads to the platform.

Power Systems revenue increased 8.8 percent as reported
(9 percent adjusted for currency) year to year. As reported and
adjusted for currency, there was double-digit revenue growth in
both the low-end and high-end portfolio, mitigated by a decline
in the midrange products. Overall performance was driven by
Linux and continued strong adoption of the new POWER9-based
architecture. In the fourth quarter of 2018, the business released
the next generation POWER9 processors in the high-end.
These systems are designed for handling advanced analytics,
cloud environments and data-intensive workloads in AI, HANA
and UNIX markets. In 2018, the company delivered the most
powerful commercially available supercomputers built with
POWER9 technology to the U.S. Department of Energy labs.

Storage Systems revenue decreased 5.5 percent as reported
(6 percent adjusted for currency) year to year, with declines in
midrange products, mitigated by continued strong growth in flash
array offerings. The storage market remains very competitive,
with ongoing pricing pressures. The company continues to
introduce new innovative products with enhanced functionality
into its products, such as the extension of the next-generation
NVMe technology into its midrange products in December 2018.
This technology is expected to be extended across the storage
portfolio in the first half of 2019.

Within Systems, total strategic imperatives revenue of $4.5 billion
grew 4 percent year to year as reported (3 percent adjusted for
currency). Cloud revenue of $3.1 billion declined 10 percent as
reported and adjusted for currency, reflecting IBM Z product
cycle dynamics.

($ in millions)

For the year ended December 31:

2018

2017*

Systems

External Systems

Yr.-to-Yr.
Percent/
Margin
Change

Hardware gross profit

$2,590

$2,893

(10.5)%

External Systems

Hardware gross
profit margin

External Operating

Systems Software
gross profit

External Operating

Systems Software
gross profit margin

External total
gross profit

External total gross
profit margin

Pre-tax income

Pre-tax margin

40.7%

44.6%

(3.8) pts.

$1,412

$1,469

(3.9)%

84.5%

86.4%

(1.9) pts.

$4,002

$4,362

(8.2)%

49.8%

53.2%

(3.4) pts.

$ 904

$1,128

(19.9)%

10.2%

12.6%

(2.4 ) pts.

* Recast to reflect adoption of the FASB guidance on presentation of net

benefit cost.

The Systems gross profit margin decreased 3.4 points to 49.8
percent in 2018 compared to the prior year. The overall decrease
year to year was driven by the mix away from IBM Z and margin
declines in Power Systems and Storage Systems.

Pre-tax income of $904 million declined 19.9 percent and pre-tax
margin decreased 2.4 points year to year to 10.2 percent driven
by the strong performance in IBM Z in the prior year, and the
continued investment in innovation across the Systems portfolio.

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

Management Discussion International Business Machines Corporation and Subsidiary Companies33

Results of Operations

($ in millions)

For the year ended December 31:

2018

2017

Yr.-to-Yr.
Percent
Change

External revenue

Internal revenue

Total revenue

Pre-tax income

$1,590

$1,696

(6.3 )%

1,610

$3,200

$1,361

1,471

$3,168

$1,278 *

9.5

1.0 %

6.5%

* Recast to reflect adoption of the FASB guidance on presentation of net

benefit cost.

In 2018, Global Financing delivered external revenue of $1,590
million and total revenue of $3,200 million, with an increase in
gross margin of 1.0 points. Total pre-tax income of $1,361 million
increased 6.5 percent compared to 2017 and return on equity
decreased 2.0 points to 30.8 percent.

In 2018, Global Financing total revenue increased 1.0 percent
compared to the prior year. This was due to an increase in internal
revenue of 9.5 percent, driven by an increase in internal financing
(up 17.6 percent to $424 million), and an increase in internal used
equipment sales (up 6.8 percent to $1,187 million). External
revenue declined 6.3 percent due to a decrease in external used
equipment sales (down 30.8 percent to $366 million), partially
offset by an increase in external financing (up 4.9 percent to
$1,223 million).

The increase in external financing revenue was due to the
increase in the average asset balances, partially offset by lower
asset yields. The increase in internal financing revenue was
primarily due to higher asset yields and average asset balances.

Total sales of used equipment represented 48.5 percent and 51.8
percent of Global Financing’s revenue for the years ended December 31,
2018 and December 31, 2017, respectively. The decrease in 2018
was due to lower volume of external used equipment sales, partially
offset by increases in internal transactions. The gross profit margin
on used sales was 54.2 percent and 47.4 percent for the years
ended December 31, 2018 and December 31, 2017, respectively.
The increase in the gross profit margin was driven by a shift toward
higher margin internal equipment sales.

Global Financing pre-tax income increased 6.5 percent year to
year primarily driven by an increase in gross profit ($52 million)
and a decrease in total expense ($32 million).

The decrease in return on equity from 2017 to 2018 was primarily
due to lower net income. Refer to page 40 for the details of the
after-tax income and return on equity calculations.

Total unguaranteed residual value of leases, including operating
leases, at December 31, 2018 and 2017 was $699 million and
$724 million, respectively. In addition to the unguaranteed
residual value, on a limited basis, Global Financing will obtain
guarantees of the future value of the equipment to be returned
at end of lease.

Third-party residual value guarantees increase the minimum
lease payments as provided for by accounting standards that
are utilized in determining the classification of a lease as a
sales-type lease, direct financing lease or operating lease. The
aggregate asset values associated with the guarantees of sales-
type leases were $231 million and $716 million for the financing
transactions originated during the years ended December 31,
2018 and December 31, 2017, respectively. In 2018, the residual
value guarantee program resulted in the company recognizing
approximately $148 million of revenue that would otherwise have
been recognized in future periods as operating lease revenue. If
the company had chosen to not participate in a residual value
guarantee program in 2018 and prior years, the 2018 impact
would be substantially mitigated by the effect of prior year
asset values being recognized as operating lease revenue in
the current year. The aggregate asset values associated with
the guarantees of direct financing leases were $163 million and
$154 million for the financing transactions originated during the
years ended December 31, 2018 and 2017, respectively. The
associated aggregate guaranteed future values at the scheduled
end of lease were $18 million and $45 million for the financing
transactions originated during the years ended December 31,
2018 and 2017, respectively. The cost of guarantees was $2
million and $4 million for the years ended December 31, 2018
and 2017, respectively.

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

($ in millions)

For the year ended December 31:

Total revenue

Americas

Europe/Middle East/Africa

Asia Pacific

* Recast to conform to current period presentation.

2018

$79,591

$36,994

25,491

17,106

2017*

$79,139

$37,641

24,397

17,102

Yr.-to-Yr.
Percent
Change

Yr.-to-Yr.
Percent Change
Adjusted for
Currency

0.6%

(1.7)%

4.5

0.0

0.0%

(0.7)%

1.3

(0.4)

Total revenue of $79,591 million in 2018 increased 0.6 percent as reported (flat adjusted for currency) compared to the prior year.

Management Discussion International Business Machines Corporation and Subsidiary Companies34

Americas revenue decreased 1.7 percent year to year as reported
(1 percent adjusted for currency) with a decline in North America,
as reported and adjusted for currency, and a decline in Latin
America as reported, but growth adjusted for currency. Within
North America, the U.S. decreased 2.4 percent and Canada
increased 1.4 percent (2 percent adjusted for currency). In Latin
America, Brazil decreased 0.9 percent as reported, but grew 8
percent adjusted for currency, and Mexico increased 2.8 percent
(4 percent adjusted for currency).

EMEA revenue increased 4.5 percent as reported and 1 percent
adjusted for currency. Germany increased 8.0 percent (4 percent
adjusted for currency) and the UK increased 6.2 percent (3
percent adjusted for currency). Spain increased 15.4 percent
(11 percent adjusted for currency) and France grew 3.4 percent
as reported, but declined 1 percent adjusted for currency. Italy
increased 4.0 percent as reported (flat adjusted for currency).

Asia Pacific revenue was essentially flat year to year as reported
and adjusted for currency. Japan increased 3.0 percent as
reported (1 percent adjusted for currency). Australia grew 2.0
percent as reported (5 percent adjusted for currency). China
decreased 7.8 percent (9 percent adjusted for currency) and
India decreased 10.1 percent (6 percent adjusted for currency).

Total Expense and Other (Income)

($ in millions)

For the year ended December 31:

2018

2017

Total consolidated expense

Yr.-to-Yr.
Percent/
Margin
Change

and other (income)

$25,594

$25,543*

0.2%

Selling, General and Administrative Expense

($ in millions)

For the year ended December 31:

2018

2017

Yr.-to-Yr.
Percent
Change

Selling, general and

administrative expense

Selling, general and

administrative—other

$16,438

$17,100 *

(3.9)%

Advertising and promotional

expense

1,466

1,445

1.5

Workforce rebalancing

charges

Amortization of acquired

intangible assets

Stock-based compensation

Bad debt expense

Total consolidated

selling, general and
administrative expense

Non-operating adjustments

Amortization of acquired

intangible assets

Acquisition-related charges

Non-operating retirement-
related (costs)/income

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

598

435

361

199

202.2

496

384

(12.2)

(6.0)

(20.9)

$19,366

$19,680*

(1.6)%

(435)

(15)

(496)

(13)

(12.2)

17.6

—

—*

—

$18,915

$19,170*

(1.3)%

* Recast to reflect adoption of the FASB guidance on presentation of net

benefit cost.

Total selling, general and administrative (SG&A) expense
decreased 1.6 percent in 2018 versus 2017, driven primarily by
the following factors:

•

Lower spending (4 points); partially offset by

Non-operating adjustments

Amortization of acquired

intangible assets

Acquisition-related charges

Non-operating retirement-
related (costs)/income

Operating (non-GAAP)

expense and
other (income)

Total consolidated

(437)

(16)

(496)

(52)

(11.9)

(70.2)

(1,572)

(1,341)*

17.3

•

Higher workforce rebalancing charges (2 points).

$23,569

$23,654*

(0.4)%

Operating (non-GAAP) SG&A expense decreased 1.3 percent
year to year driven primarily by the same factors.

expense-to-revenue ratio

32.2%

32.3%*

(0.1) pts.

Operating (non-GAAP)

expense-to-revenue ratio

29.6%

29.9%*

(0.3) pts.

Bad debt expense increased $12 million in 2018 compared to
2017. The receivables provision coverage was 1.6 percent at
December 31, 2018, unchanged from December 31, 2017.

* Recast to reflect adoption of the FASB guidance on presentation of net

benefit cost.

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

Management Discussion International Business Machines Corporation and Subsidiary Companies35

Yr.-to-Yr.
Percent
Change

83.7%

Research, Development and Engineering Expense

Other (Income) and Expense

($ in millions)

For the year ended December 31:

2018

2017*

Yr.-to-Yr.
Percent
Change

$5,379

$5,590

(3.8)%

For the year ended December 31:

2018

2017

Other (income) and expense

Foreign currency transaction

losses/(gains)

$ (427)

$ 405

—

Interest income

(Gains)/losses on

derivative instruments

434

(264)

(341)

(144)

Total consolidated

research, development
and engineering

Non-operating adjustment

Non-operating retirement-
related (costs)/income

Operating (non-GAAP)

research, development
and engineering

$5,379

$5,590

(3.8)%

* Recast to reflect adoption of the FASB guidance on presentation of net

benefit cost.

Research, development and engineering (RD&E) expense was
6.8 percent of revenue in 2018 and 7.1 percent of revenue in 2017.

RD&E expense decreased 3.8 percent in 2018 versus 2017
primarily driven by the company’s leveraging of development
partnerships consistent with its IP licensing strategy and lower
spending year to year.

Intellectual Property and Custom Development Income

($ in millions)

For the year ended December 31:

2018

2017

Yr.-to-Yr.
Percent
Change

Net (gains)/losses from

securities and
investment assets

Retirement-related

costs/(income)

Other

Total consolidated other
(income) and expense

Non-operating adjustments

Amortization of acquired

intangible assets

Acquisition-related

charges

Non-operating retirement-
related costs/(income)

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

(101)

(20)

404.2

1,572

(63)

1,341*

(116)

17.3%

(46.0)

$ 1,152

$ 1,125*

2.5%

(2)

—

(39)

(99.2)%

(1,572)

(1,341)*

17.3

$ (422)

$ (255)

65.3%

* Recast to reflect adoption of the FASB guidance on presentation of net

Licensing of intellectual
property including
royalty-based fees

$ 723

$1,193

(39.4)%

benefit cost.

NM—Not meaningful

Custom development income

275

252

9.3

Sales/other transfers of
intellectual property

Total

35.0

$1,026

$1,466

(30.0)%

Total consolidated other (income) and expense was expense of
$1,152 million in 2018 compared to $1,125 million in 2017. The
increase in expense of $28 million year over year was primarily
driven by:

Licensing of intellectual property including royalty-based
fees decreased 39.4 percent in 2018 compared to 2017. The
company entered into new partnership agreements in 2018,
which included three transactions with period income greater
than $100 million. There were also three transactions greater
than $100 million in 2017. The company licenses IP to partners
who allocate their skills to extend the value of assets that are
high value, but may be in mature markets. 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.

•

Higher retirement-related costs ($232 million); partially
offset by

• Higher interest income ($120 million); and

•

Higher gains from securities and investment assets
($81 million).

Interest Expense

($ in millions)

For the year ended December 31:

2018

2017

Yr.-to-Yr.
Percent
Change

Interest expense

Total

$723

$615

17.6%

Interest expense increased $108 million compared to 2017.
Interest expense is presented in cost of financing in the
Consolidated Statement of Earnings only if the related external
borrowings are to support the Global Financing external business.
Overall interest expense (excluding capitalized interest) in 2018
was $1,480 million, an increase of $207 million year to year, driven
by higher average interest rates and higher average debt levels.

Management Discussion International Business Machines Corporation and Subsidiary Companies36

Stock-Based Compensation
Pre-tax stock-based compensation cost of $510 million
decreased $24 million compared to 2017. This was due primarily
to decreases related to the conversion of stock-based awards
previously issued by acquired entities ($4 million), performance
share units ($7 million) and restricted stock units ($13 million).
Stock-based compensation cost, and the year-to-year change,
was reflected in the following categories: Cost: $82 million, down
$9 million; SG&A expense: $361 million, down $23 million; and
RD&E expense: $67 million, up $8 million.

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

($ in millions)

For the year ended December 31:

2018

2017

Retirement-related

plans—cost

Service cost

$ 431

$ 429

Multi-employer plans

40*

Cost of defined

Yr.-to-Yr.
Percent
Change

0.4%

(5.4)

contribution plans

1,024

1,046

(2.1)

As discussed in the “Operating (non-GAAP) Earnings” section on
pages 18 and 19, the company characterizes certain retirement-
related costs as operating and others as non-operating. Utilizing
this characterization, operating retirement-related costs in 2018
were $1,494 million, a decrease of $22 million compared to
2017, primarily driven by lower defined contribution plans cost
($22 million). Non-operating costs of $1,572 million increased
$232 million in 2018 compared to 2017, driven primarily
by lower expected return on plan assets ($296 million), an
increase in other costs ($93 million) related to benefits from
pension litigation in the prior year and an increase in recognized
actuarial losses ($70 million); partially offset by lower interest
costs ($235 million).

Income Taxes
The continuing operations effective tax rate for 2018 was 23.1
percent, a decrease of 26.4 points versus the prior year. In 2018,
the accounting for impacts of U.S. tax reform was completed and
the effects of measurement period adjustments were recognized
as a net full-year 2018 charge of $2.0 billion (17.7 points). This is
compared to a charge of $5.5 billion (48.0 points) in 2017 related
to the impact of the enactment of U.S. tax reform, a year-to-year
decrease of 30.4 points. Without these impacts, the continuing
operations tax rate for 2018 would have been 5.4 percent,
compared to a 2017 rate of 1.5 percent. The adjusted year-to-year
increase of 3.9 points is primarily driven by the following factors:

•

A lower benefit year to year in the utilization of foreign
tax credits of 5.9 points;

Total operating costs/

(income)

Interest cost

Expected return on

plan assets

Recognized actuarial

losses

Amortization of prior

service costs/(credits)

Curtailments/settlements

Other costs

Total non-operating
costs/(income)

Total retirement-related

$ 1,494

$ 1,516*

(1.5)%

$ 2,726

$ 2,961

(7.9)%

•

(4,049)

(4,346)

(6.8)

2,941

2,871

2.5

(73)

(88)*

(76)*

(16.6)

(39.9)

•

Benefits in 2017 related to an intra-entity asset transfer
of 5.1 points and the tax write down of an investment
of 1.7 points;

A year-to-year increase in tax charges related to
intercompany payments of 1.3 points; partially offset by

Benefits in 2018 related to domestic and foreign audit
activity (6.8 points), geographic mix of pre-tax earnings in
2018 (2.1 points) and the re-assessment of valuation
allowances (1.2 points).

The continuing operations operating (non-GAAP) effective tax
rate was 7.9 percent in 2018, an increase of 1.1 points versus
2017, principally driven by the same factors described above.

For more information on U.S. tax reform impacts, see note N,
“Taxes,” on pages 117 to 119.

$ 1,572

$ 1,341*

17.3%

plans—cost

$ 3,066

$ 2,857

7.3%

* Recast to reflect adoption of the FASB guidance on presentation of net

benefit cost.

NM—Not meaningful

Total pre-tax retirement-related plan cost increased by $209
million compared to 2017, primarily driven by lower expected
return on plan assets ($296 million), an increase in other costs
($93 million) related to benefits from pension litigation in the prior
year and an increase in recognized actuarial losses ($70 million);
partially offset by lower interest costs ($235 million).

Management Discussion International Business Machines Corporation and Subsidiary Companies37

Consistent with accounting standards, the company remeasured
the funded status of its retirement and postretirement plans at
December 31. At December 31, 2018, the overall net underfunded
position was $13,133 million, an increase of $243 million from
December 31, 2017 driven by lower asset returns, partially
offset by lower interest cost and an increase in discount rates.
At year end, the company’s qualified defined benefit plans were
well funded and the cash requirements related to these plans is
expected to be approximately $400 million in 2019 and in the
$350 million to $400 million range in 2020. In 2018, the return
on the U.S. Personal Pension Plan assets was (1.8) percent and
the plan was 104 percent funded at December 31. Overall, global
asset returns were (1.9) percent and the qualified defined benefit
plans worldwide were 99 percent funded at December 31, 2018.

During 2018, the company generated $15,247 million in cash
from operations, a decrease of $1,477 million compared to
2017. In addition, the company generated $11,876 million in free
cash flow, a decrease of $1,117 million versus the prior year.
See page 61 for additional information on free cash flow. The
company returned $10,109 million to shareholders in 2018, with
$5,666 million in dividends and $4,443 million in gross share
repurchases. In 2018, the company repurchased 32.9 million
shares and had $3.3 billion remaining in share repurchase
authorization at year end. The company’s cash generation
permits the company to invest and deploy capital to areas with
the most attractive long-term opportunities.

Global Financing Financial Position Key Metrics

($ in millions)

At December 31:

2018

2017

Cash and cash equivalents

$ 1,833

$ 2,696

Net investment in sales-type

and direct financing leases (1)

Equipment under operating leases—

external clients (2)

Client loans

Total client financing assets

Commercial financing receivables

Intercompany financing receivables (3) (4)

Total assets

Debt

Total equity

6,924

7,253

444

12,802

20,170

11,838

4,873

477

12,450

20,180

11,590

5,056

$41,320

$41,096

31,227

31,434

$ 3,470

$ 3,484

(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 page 72.

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

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.

For the year ended December 31:

2018

2017

Earnings per share of

common stock from
continuing operations

Assuming dilution

$ 9.51*

$ 6.14*

$ 9.56

$ 6.17

Basic

Diluted operating
(non-GAAP)

Weighted-average shares
outstanding (in millions)

$13.81

$13.66**

1.1%

Yr.-to-Yr.
Percent
Change

54.9%

Assuming dilution

Basic

916.3

912.0

937.4

932.8

(2.2)%

* Includes a charge of $2.0 billion or $2.23 of diluted earnings per share
in 2018 and $5.5 billion or $5.84 of diluted earnings per share in 2017
associated with U.S. tax reform.

** Recast to reflect adoption of the FASB guidance on presentation of net

benefit cost.

Actual shares outstanding at December 31, 2018 and 2017
were 892.5 million and 922.2 million, respectively. The average
number of common shares outstanding assuming dilution was
21.1 million shares lower in 2018 versus 2017. The decrease was
primarily the result of the common stock repurchase program.

Financial Position
Dynamics
At December 31, 2018, the company continued to have the
financial flexibility to support the business over the long term.
Cash, restricted cash and marketable securities at year end
were $12,222 million. During the year, the company continued to
manage the investment portfolio to meet its capital preservation
and liquidity objectives.

Total debt of $45,812 million decreased $1,012 million from prior
year-end levels. The commercial paper balance at December 31,
2018 was $2,995 million, an increase of $1,499 million from the
prior year end. Within total debt, $31,227 million is in support
of the Global Financing business which is leveraged at a 9 to 1
ratio. The company continues to have substantial flexibility in
the debt markets. During 2018, the company completed bond
issuances totaling $4,000 million, with terms ranging from 2 to
5 years, and interest rates ranging from 2.65 to 3.60 percent
depending on maturity. The company has consistently generated
strong cash flow from operations and continues to have access
to additional sources of liquidity through the capital markets and
its Credit Facilities.

Management Discussion International Business Machines Corporation and Subsidiary Companies38

At December 31, 2018, substantially all financing assets were
IT-related assets, and approximately 55 percent of the total
external portfolio was with investment-grade clients with no
direct exposure to consumers. This investment-grade percentage
is based on the credit ratings of the companies in the portfolio.
Additionally, the company takes actions to transfer exposure to
third parties. On that basis, the investment-grade content would
increase by 16 points to 71 percent, a slight increase year to year.

The company has a long-standing practice of taking mitigation
actions, in certain circumstances, to transfer credit risk to
third parties, including credit insurance, financial guarantees,
nonrecourse borrowings, transfers of receivables recorded as
true sales in accordance with accounting guidance or sales of
equipment under operating lease.

IBM Working Capital

($ in millions)

At December 31:

Current assets

Current liabilities

Working capital

Current ratio

2018

2017

$49,146

$49,735

38,227

37,363

$10,918

$12,373

1.29:1

1.33:1

Working capital decreased $1,454 million from the year-end
2017 position. The key changes are described below:

Current assets decreased $590 million (increased $1,009 million
adjusted for currency) due to:

•

A decline in receivables of $1,067 million ($261 million
adjusted for currency) driven by a decline in trade
receivables of $1,496 million; partially offset by

An increase of $519 million ($598 million adjusted for
currency) in prepaid expenses and other current assets
primarily due to the reclassification of certain trade
receivables due to the adoption of the new revenue
standard.

Current liabilities increased $865 million ($2,076 million adjusted
for currency) as a result of:

•

An increase in short-term debt of $3,220 million ($3,284
million adjusted for currency) primarily as a result of
reclassifications of $7,252 million from long-term debt to
reflect upcoming maturities and an increase in commercial
paper of $1,499 million; partially offset by maturities of
$5,586 million. The increase in short-term debt was
partially offset by

A decrease in taxes payable of $1,173 million ($1,099
million adjusted for currency) principally driven by the
resolution in the first-quarter 2018 of certain matters
related to the ongoing U.S. tax audit of the company’s
2013-2014 tax returns; and

•

A decrease in other accrued expenses and liabilities of
$569 million driven by currency-related decreases of
$502 million; and

•

A decrease in deferred income of $387 million ($44 million
adjusted for currency).

Receivables and Allowances
Roll Forward of Total IBM Receivables Allowance
for Credit Losses

($ in millions)

January 1,
2018

$668

Additions* Write-offs**

$66

$(64 )

Other+

$(31 )

December 31,
2018

$639

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

** Refer to note A, “Significant Accounting Policies,” on pages 76 to 88 for
additional information regarding Allowance for Credit Loss write-offs.

+ Primarily represents translation adjustments.

The total IBM receivables provision coverage was 1.6 percent at
December 31, 2018, unchanged compared to December 31, 2017.

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:

($ in millions)

At December 31:

Recorded investment (1)

Specific allowance for credit losses

Unallocated allowance for credit losses

Total allowance for credit losses

2018

2017

$31,182

$30,892

220

292

258

336

Net financing receivables

$30,890

$30,556

Allowance for credit losses coverage

0.9%

1.1%

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

consolidated results.

The percentage of Global Financing receivables reserved was
0.9 percent at December 31, 2018, compared to 1.1 percent
at December 31, 2017. In 2018, write-offs of $41 million
of receivables previously reserved resulted in a 14 percent
reduction in the specific reserves, from $258 million at
December 31, 2017, to $220 million at December 31, 2018.
See note F, “Financing Receivables,” on pages 103 to 106
for additional information. Unallocated reserves decreased
10 percent from $78 million at December 31, 2017, to $72 million
at December 31, 2018.

Management Discussion International Business Machines Corporation and Subsidiary Companies39

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

($ in millions)

January 1,
2018

$336

Additions* Write-offs**

$14

$(41 )

Other+

$(17 )

December 31,
2018

$292

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

** Refer to note A, “Significant Accounting Policies,” on pages 76 to 88 for
additional information regarding Allowance for Credit Loss write-offs.

+ Primarily represents translation adjustments.

Global Financing’s bad debt expense was $14 million in 2018,
compared to $17 million in 2017. The year-to-year decrease in
bad debt expense was primarily due to lower specific reserve
requirements in 2018.

Noncurrent Assets and Liabilities

($ in millions)

At December 31:

Noncurrent assets

Long-term debt

2018

2017

$74,236

$75,621

$35,605

$39,837

Noncurrent liabilities (excluding debt)

$32,621

$30,432

The decrease in noncurrent assets of $1,385 million (an increase
of $177 million adjusted for currency) was driven by:

•

A decrease in net intangibles and goodwill of $1,178 million
resulting from intangibles amortization and currency
impacts of $553 million.

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

($ in millions)

At December 31:

Total company debt

2018

2017

$45,812

$46,824

Total Global Financing segment debt

$31,227

$31,434

Debt to support external clients

27,536

27,556

Debt to support internal clients

3,690

3,878

Non-Global Financing debt

14,585

15,390

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

Non-Global Financing debt of $14,585 million declined $805
million from prior year-end levels.

At December 31:

Global Financing debt-to-equity ratio

2018

9.0x

2017

9.0x

Long-term debt decreased $4,232 million ($3,994 million
adjusted for currency) primarily driven by:

•

Reclassifications to short-term debt of $7,252 million to
reflect upcoming maturities; and

Early retirement of long-term debt of $942 million; partially
offset by

•

Issuances of $4,673 million.

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.

Noncurrent liabilities (excluding debt) increased $2,189 million
($3,236 million adjusted for currency) primarily driven by:

•

An increase in other liabilities of $2,209 million, primarily
driven by the company’s election to include GILTI in
measuring deferred taxes ($1,927 million).

Global Financing provides financing predominantly for the
company’s external client assets, as well as for assets under
contract by other IBM units. As previously stated, the company
measures Global Financing as a stand-alone entity, and
accordingly, interest expense relating to debt supporting Global
Financing’s external client and internal business is included in
the “Global Financing Results of Operations” on page 33 and
in note U, “Segment Information,” on pages 141 to 146. In the
company’s Consolidated Statement of Earnings, the external
debt-related interest expense supporting Global Financing’s
internal financing to the company is reclassified from cost of
financing to interest expense.

Management Discussion International Business Machines Corporation and Subsidiary Companies40

Equity
Total equity decreased by $795 million from December 31, 2017
primarily due to decreases from dividends ($5,666 million),
and treasury stock ($4,564 million) primarily due to share
repurchases; partially offset by increases from net income
($8,728 million) and transition adjustments related to the
adoption of the new revenue standard ($580 million).

Cash Flow
The company’s cash flows from operating, investing and
financing activities, as reflected in the Consolidated Statement
of Cash Flows on page 73 are summarized in the table below.
These amounts include the cash flows associated with the Global
Financing business.

($ in millions)

For the year ended December 31:

2018

2017

Net cash provided by/(used in)

continuing operations

Operating activities

Investing activities

Financing activities

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

Net change in cash, cash equivalents

$ 15,247

$16,724

(4,913)

(7,081)*

(10,469)

(6,418)

Net cash provided by operating activities decreased $1,477
million in 2018 driven by the following key factors:

•

A decrease in cash provided by financing receivables of
$764 million driven by an increase in client financing
receivables due to higher volumes;

•

A decrease in cash sourced from sales cycle working capital
of $240 million; and

•

An increase in cash income tax payments of $148 million.

Net cash used in investing activities decreased $2,167 million
driven by:

•

A decrease from net non-operating financing receivables of
$1,525 million; and

A decrease in net purchases of marketable securities and
other investments of $485 million.

Net cash used in financing activities increased $4,051 million
driven by the following factors:

•

A decrease in net cash sourced from debt transactions of
$3,746 million primarily driven by a lower level of issuances
and a higher level of maturities in the current year.

(495)

937

Global Financing Return on Equity Calculation

($ in millions)

and restricted cash

$ (630)

$ 4,161*

At December 31:

2018

2017+

* Recast to reflect adoption of the FASB guidance on restricted cash.

Numerator

Global Financing after-tax income (1) *

$1,065

$1,114

Denominator

Average Global Financing equity (2) **

$3,460

$3,393

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

30.8%

32.8%

* 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 five

quarters.

+ Recast to reflect the adoption of the FASB guidance on presentation of

net benefit cost.

Management Discussion International Business Machines Corporation and Subsidiary Companies41

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. Please refer to the “Operating (non-GAAP) Earnings” section on pages
18 and 19 for the company’s rationale for presenting operating earnings information.

($ in millions except per share amounts)

For the year ended December 31, 2018:

Gross profit

Gross profit margin

SG&A

RD&E

Other (income) and expense

Total expense and other (income)

Pre-tax income from continuing operations

GAAP

$36,936

Acquisition-
Related
Adjustments

Retirement-
Related
Adjustments

Tax Reform
Charges

Operating
(non-GAAP)

$ 372

$ —

$37,307

46.4%

0.5 pts.

— pts.

46.9%

$19,366

$(451)

$ —

$18,915

5,379

1,152

25,594

11,342

—

(2)

(453)

824

—

(1,572)

1,572

—

5,379

(422)

23,569

13,739

Pre-tax margin from continuing operations

14.3%

1.0 pts.

2.0 pts.

— pts.

17.3%

Provision for income taxes*

Effective tax rate

$ 2,619

$ 176

$ 324

$(2,037)

$ 1,082

23.1%

(0.1)pts.

(0.3)pts.

(14.8)pts.

7.9%

Income from continuing operations

$ 8,723

$ 649

$ 1,248

$ 2,037

$12,657

Income margin from continuing operations

11.0%

0.8 pts.

1.6 pts.

2.6 pts.

15.9%

Diluted earnings per share from continuing operations

$ 9.51

$0.71

$ 1.36

$ 2.23

$ 13.81

* The tax impact on operating (non-GAAP) pre-tax income 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.

($ in millions except per share amounts)

For the year ended December 31, 2017:

Gross profit

Gross profit margin

SG&A

RD&E

Other (income) and expense

Total expense and other (income)

Pre-tax income from continuing operations

Acquisition-
Related
** Adjustments

Retirement-
Related

Adjustments**

Tax Reform
Charge

Operating
(non-GAAP)**

$ 449

$ —

$37,392

GAAP

$36,943

46.7%

0.6 pts.

— pts.

47.2%

$19,680

$(509)

$ —

$19,170

5,590

1,125

25,543

11,400

—

(39)

(548)

997

—

(1,341)

1,341

—

5,590

(255)

23,654

13,738

Pre-tax margin from continuing operations

14.4%

1.3 pts.

1.7 pts.

— pts.

17.4%

Provision for income taxes*

Effective tax rate

$ 5,642

$ 279

$ 485

$(5,475)

$ 931

49.5%

(1.6) pts.

(1.3) pts.

(39.9) pts.

6.8%

Income from continuing operations

$ 5,758

$ 718

$ 856

$ 5,475

$12,807

Income margin from continuing operations

7.3%

0.9 pts.

1.1 pts.

6.9 pts.

16.2%

Diluted earnings per share from continuing operations

$ 6.14

$0.77

$ 0.91

$ 5.84

$ 13.66

* The tax impact on operating (non-GAAP) pre-tax income 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.

** Recast to reflect adoption of the FASB guidance on presentation of net periodic pension and nonpension postretirement benefit costs.

Management Discussion International Business Machines Corporation and Subsidiary Companies42

Consolidated Fourth-Quarter Results

($ and shares in millions except per share amounts)

For the fourth quarter:

Revenue

Gross profit margin

Total expense and other (income)

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

Income from continuing operations before income taxes

Provision for income taxes from continuing operations

Income/(loss) from continuing operations

Income/(loss) from continuing operations margin

Loss from discontinued operations, net of tax

Net income/(loss)

Earnings/(loss) per share from continuing operations:

Assuming dilution

Consolidated earnings/(loss) per share—assuming dilution

Weighted-average shares outstanding

Assuming dilution

* (1.2) percent adjusted for currency.

2018

2017

$21,760

$22,543

49.1%

49.0%**

$ 6,253

$ 6,580**

28.7%

29.2%**

$ 4,434
$ 2,481+
$ 1,954+

$ 4,469
$ 5,522+
$ (1,053)+

9.0%

(4.7)%

$ (2)
$ 1,951+

$ (1)
$ (1,054)+

$ 2.15+
$ 2.15+

$ (1.14)+
$ (1.14)+

Yr.-to-Yr.
Percent/
Margin
Change

(3.5)%*

0.1 pts.

(5.0)%

(0.5)pts.

(0.8)%

(55.1)

13.6 pts.

70.7%

905.2

924.5

(2.1)%

** Recast to reflect adoption of the FASB guidance on presentation of net benefit cost.
+ Includes a charge of $1.9 billion or $2.15 of diluted earnings per share in 2018 and $5.5 billion or $5.90 of diluted earnings per share in 2017

associated with U.S. tax reform.

NM—Not meaningful

The following table provides the company’s operating (non-GAAP) earnings for the fourth quarter of 2018 and 2017.

($ in millions except per share amounts)

For the fourth quarter:

Net income/(loss) as reported

Loss from discontinued operations, net of tax

Income/(loss) from continuing operations

Non-operating adjustments (net of tax)

Acquisition-related charges

Non-operating retirement-related costs/(income)

U.S. tax reform charge

Operating (non-GAAP) earnings*

Diluted operating (non-GAAP) earnings per share

* See page 47 for a more detailed reconciliation of net income to operating (non-GAAP) earnings.

**Recast to reflect adoption of the FASB guidance on presentation of net benefit cost.
+ Includes a charge of $1.9 billion in 2018 and $5.5 billion in 2017 associated with U.S. tax reform.

NM—Not meaningful

2018
$1,951+

(2)
1,954+

171

348

1,944

$4,417

$ 4.87

2017
$(1,054 )+

(1)
(1,053)+

181

174**

5,475

$ 4,777**

$ 5.14 **

Yr.-to-Yr.
Percent
Change

70.7%

(5.3)

99.5

(7.5)%

(5.3)%

Management Discussion International Business Machines Corporation and Subsidiary Companies43

adjusted for currency. However, there were declines in France
and other countries. Asia Pacific decreased 2.7 percent as
reported (1 percent adjusted for currency). There was growth in
Japan as reported and adjusted for currency. Australia declined
as reported, but grew adjusted for currency, and China decreased
year to year as reported and adjusted for currency.

The consolidated gross profit margin of 49.1 percent and
operating (non-GAAP) gross margin of 49.5 percent both
increased 0.1 points compared to the prior year, with margin
expansion in the services businesses, offset by a decline in the
Systems gross margin and an impact from mix.

Total expense and other (income) decreased 5.0 percent in the
fourth quarter compared to the prior year. The year-to-year
decrease was driven by the effects of currency (4 points) and
lower spending (3 points), partially offset by lower intellectual
property income (2 points). The expense dynamics reflect the
company’s focus on driving productivity in the business and new
ways of working, including using agile methodologies, leveraging
automation and infusing AI into its processes. Total operating
(non-GAAP) expense and other (income) decreased 5.2 percent
year to year driven primarily by the same factors.

Pre-tax income from continuing operations of $4.4 billion in the
fourth quarter decreased 0.8 percent year to year, however,
the pre-tax margin of 20.4 percent increased 0.6 points. The
continuing operations effective tax rate for the fourth quarter was
55.9 percent, which included a $1.9 billion charge related to U.S.
tax reform. Normalized for this charge, the continuing operations
effective tax rate for the quarter would have been 12.9 percent.
Income from continuing operations in the fourth quarter was
$2.0 billion compared to a loss from continuing operations of
$1.1 billion in 2017, which included a $5.5 billion charge related
to U.S. tax reform. Operating (non-GAAP) pre-tax income from
continuing operations of $5.0 billion decreased 1.1 percent year
to year. Operating (non-GAAP) pre-tax margin from continuing
operations increased 0.5 points to 23.1 percent. Operating
(non-GAAP) income from continuing operations of $4.4 billion
decreased 7.5 percent. The operating (non-GAAP) effective tax
rate from continuing operations in the fourth quarter of 2018 was
12.2 percent versus 6.1 percent in the prior year.

Diluted earnings per share from continuing operations was $2.15
in the fourth quarter compared to a loss per share of $(1.14)
in the prior year, with both years including charges associated
with U.S. tax reform. Operating (non-GAAP) diluted earnings per
share of $4.87 decreased 5.3 percent versus the fourth quarter
of 2017. In the fourth quarter, the company repurchased 17.0
million shares of its common stock at a cost of $2.1 billion and
had $3.3 billion remaining in the share repurchase authorization
at December 31, 2018.

Snapshot
In the fourth quarter of 2018, the company reported $21.8 billion
in revenue and net income from continuing operations of $2.0
billion, which included a charge of $1.9 billion associated with U.S.
tax reform. Fourth-quarter operating (non-GAAP) earnings were
$4.4 billion, which excludes the tax charge. Fourth-quarter diluted
earnings per share from continuing operations was $2.15 and
operating (non-GAAP) diluted earnings per share from continuing
operations was $4.87. The company generated $4.1 billion in cash
from operations and $6.5 billion in free cash flow in the fourth
quarter of 2018 and delivered shareholder returns of $3.5 billion
through gross common stock repurchases and dividends.

In the fourth quarter, revenue decreased 3.5 percent as reported
and 1 percent adjusted for currency. Cognitive Solutions was
flat as reported, but grew 2 percent adjusted for currency,
with growth in Solutions Software, 1 percent as reported and 3
percent adjusted for currency, led by analytics and AI offerings.
Transaction Processing Software decreased 1 percent year
to year as reported, but grew 1 percent adjusted for currency
reflecting strong transactional performance in the quarter. GBS
increased 4.1 percent as reported, and 6 percent adjusted for
currency, led by Consulting. There was growth across all GBS
lines of business as reported and adjusted for currency as the
company focuses on clients’ digital transformation. Technology
Services & Cloud Platforms decreased 2.9 percent as reported,
but was flat adjusted for currency. Infrastructure Services
declined year to year as reported, but was flat adjusted for
currency. There was strong growth in signings reflecting demand
for hybrid cloud implementations and productivity solutions.
Within TS&CP, Integration Software grew year to year driven by
continued strong adoption of IBM Cloud Private and improved
transactional volumes. Systems decreased 21.3 percent as
reported and 20 percent adjusted for currency, reflecting the
impact of the IBM Z product cycle dynamics. Growth in Power
Systems, as reported and adjusted for currency was more than
offset by declines in IBM Z and Storage Systems.

The company continued to deliver solid strategic imperatives
revenue growth, generating $11.5 billion of revenue and growing
3 percent as reported and 5 percent adjusted for currency.
Strategic imperatives revenue growth was impacted by the IBM Z
cycle. Excluding IBM Z, strategic imperatives growth would have
been 9 percent as reported and 11 percent adjusted for currency.
There was strong growth across analytics, cloud and security,
excluding IBM Z. Total Cloud revenue of $5.7 billion increased 3
percent as reported and 6 percent adjusted for currency, and was
also impacted by the IBM Z cycle. Total Cloud revenue growth,
excluding IBM Z, would have been 15 percent as reported and 19
percent adjusted for currency. Cloud-as-a-Service revenue was
up 18 percent (21 percent adjusted for currency) and the annual
exit run rate for as-a-Service revenue increased to $12.2 billion in
the fourth quarter of 2018 compared to $11.4 billion in the third
quarter of 2018. Analytics revenue of $6.4 billion increased 6
percent as reported (8 percent adjusted for currency).

From a geographic revenue perspective, Americas decreased
5.3 percent (4 percent adjusted for currency) year to year, with
declines in the U.S. and Canada, partially offset by growth in Latin
America. EMEA decreased 1.3 percent as reported, but grew 2
percent adjusted for currency. Germany grew as reported and
adjusted for currency and the UK declined as reported, but grew

Management Discussion International Business Machines Corporation and Subsidiary Companies44

Results of Continuing Operations
Segment Details
The following is an analysis of the fourth quarter of 2018 versus the fourth quarter of 2017 reportable segment external revenue and
gross margin results. Segment pre-tax income includes transactions between the segments that are intended to reflect an arm’s-
length transfer price and excludes certain unallocated corporate items.

($ in millions)

For the fourth quarter:

Revenue

Cognitive Solutions

Gross margin

Global Business Services

Gross margin

Technology Services & Cloud Platforms

Gross margin

Systems

Gross margin

Global Financing

Gross margin

Other

Gross margin

Total consolidated revenue

Total consolidated gross profit

Total consolidated gross margin

Non-operating adjustments

Amortization of acquired intangible assets

Retirement-related costs/(income)

Operating (non-GAAP) gross profit

Operating (non-GAAP) gross margin

2018

2017

$ 5,455

$ 5,432

79.4%

4,322

27.6%

8,929

42.3%

2,621

50.8%

402

29.1%

79.2%*

4,152

24.6%*

9,198

40.8%*

3,332

55.7%*

450

29.5%

(20)

Yr.-to-Yr.
Percent/
Margin
Change

Yr.-to-Yr.
Percent Change
Adjusted for
Currency

0.4%

0.2 pts.

4.1%

3.0 pts.

(2.9)%

1.5 pts.

2.2%

6.5%

0.0%

(21.3)%

(20.1)%

(4.9) pts.

(10.7)%

(8.6)%

(0.3) pts.

(1.2)%

(186.2)%

70.2%*

(256.5) pts.

$21,760

$10,687

$22,543

$11,049*

49.1%

49.0%*

—

—*

$10,776

$11,149*

49.5%

49.5%*

(3.5)%

(3.3)%

0.1 pts.

(10.4)%

—%

(3.3)%

0.1 pts.

* Recast to reflect adoption of the FASB guidance on presentation of net benefit cost.

NM—Not meaningful

Cognitive Solutions
Cognitive Solutions revenue of $5,455 million grew 0.4 percent
as reported and 2 percent adjusted for currency in the fourth
quarter of 2018 compared to the prior year, with growth in
Solutions Software as reported and adjusted for currency. The
company continued to deliver innovation to clients and scale
platforms and solutions, driving growth in transactional revenue
and SaaS signings. Although Transaction Processing Software
declined as reported, it grew adjusted for currency as the
business capitalized on a strong pipeline of larger transactions
driven by client buying cycles.

In the fourth quarter, Solutions Software revenue of $3,823
million grew 0.9 percent as reported and 3 percent adjusted for
currency. Within Solutions Software, high-value areas such as
analytics and AI drove growth as clients use IBM solutions to
leverage their data for competitive advantage. Certain analytics
platforms, such as the Db2 portfolio including analytics
appliances, and Data Science offerings had broad-based growth
in the fourth quarter as the company continues to innovate and
enhance functionality within these offerings. In addition, client

demand for IBM Cloud Private for Data has accelerated with over
100 clients adopting the platform in the first six months since its
launch. There was also solid demand for integrated security and
services solutions, as well as growth in key areas within Watson
Health and Watson IoT offerings.

Transaction Processing Software revenue of $1,632 million
decreased 0.6 percent as reported, but grew 1 percent adjusted
for currency compared to the prior year. There was strong
transactional performance in the quarter reflecting clients’
continued commitment to IBM’s platform for the long-term given
the value the company provides in managing mission-critical
workloads and for predictability in spending.

Cognitive Solutions total fourth-quarter strategic imperatives
revenue of $3.7 billion increased 7 percent as reported and 9
percent adjusted for currency. Cloud revenue of $0.7 billion grew
4 percent as reported and 5 percent adjusted for currency, with
an as-a-Service exit run rate of $2.0 billion.

Management Discussion International Business Machines Corporation and Subsidiary Companies45

Cognitive Solutions gross profit margin of 79.4 percent in the
fourth quarter of 2018 was essentially flat compared to the prior
year. Pre-tax income of $2,437 million increased 7.2 percent
compared to the prior year. The pre-tax margin grew 2.9 points,
to 40.3 percent driven by operating leverage from growth in
revenue, operational efficiencies and a mix toward software,
with continued investment in key strategic areas.

Global Business Services
Global Business Services revenue of $4,322 million increased
4.1 percent as reported (6 percent adjusted for currency) in the
fourth quarter of 2018 compared to the prior year with growth
as reported and adjusted for currency across all three lines of
business. GBS’ performance reflects the repositioning of this
business and the value clients recognize when combining the
company’s technology and industry expertise as they integrate
their digital initiatives and internal process transformation.

Consulting revenue of $2,008 million increased 7.5 percent as
reported (10 percent adjusted for currency). The growth during
the fourth quarter was led by the company’s digital strategy and
next generation Enterprise Applications. GPS revenue of $325
million increased 2.4 percent as reported (5 percent adjusted for
currency) driven by Cognitive Process Services offerings, which
leverage automation and AI to reinvent industry workflows.
Application Management revenue of $1,989 million increased
1.1 percent as reported (4 percent adjusted for currency). This
return to growth was driven by strong performance in Cloud
Migration Factory and cloud application development, while
traditional application management engagements declined as
clients continue to migrate to the cloud. The growth also reflects
the achievement of significant milestones across a few accounts.

GBS strategic imperatives revenue of $2.9 billion grew 11
percent as reported (14 percent adjusted for currency) year to
year. Cloud revenue of $1.4 billion grew 30 percent as reported
(34 percent adjusted for currency), with an as-a-Service exit run
rate of $2.1 billion.

GBS fourth-quarter gross profit margin increased 3.0 points year
to year to 27.6 percent. Pre-tax income of $566 million increased
73.4 percent year to year. The pre-tax margin increased 5.2
points to 12.9 percent. The strong growth in margins reflects
operating leverage as a result of revenue growth driven by a mix
to higher-value offerings, as well as benefits from currency, given
GBS’ global delivery model, and the yield from productivity and
utilization initiatives.

Technology Services & Cloud Platforms
Technology Services & Cloud Platforms revenue of $8,929 million
decreased 2.9 percent as reported, but was flat adjusted for
currency in the fourth quarter of 2018 compared to the prior year.
There was continued strong growth in cloud revenue, as new and
existing clients turn to IBM to manage their critical infrastructure
and help deliver innovation in an open hybrid cloud environment.

Infrastructure Services revenue of $5,819 million declined 2.9
percent as reported (flat adjusted for currency) compared to
the prior year. As the company prioritizes the offerings within its
portfolio, it is moving away from certain lower-value offerings,
which will impact revenue performance in the near term, but will
improve margin growth in the longer term. Technical Support
Services revenue of $1,722 million decreased 6.4 percent as
reported (3 percent adjusted for currency), driven primarily by
the dynamics of the Systems hardware product cycle. Integration
Software revenue of $1,387 million increased 1.8 percent as
reported (4 percent adjusted for currency) compared to the prior
year. There was continued strong adoption of IBM Cloud Private,
an innovative platform that assists clients in modernizing their
traditional workloads, and improved transactional performance
in the quarter. The company continues to enable clients in the
open hybrid cloud environment through innovative new offerings.

Technology Services & Cloud Platforms strategic imperatives
revenue of $3.2 billion grew 10 percent year to year as reported
(13 percent adjusted for currency). Cloud revenue of $2.4 billion
grew 19 percent as reported (22 percent adjusted for currency),
with an as-a-Service exit run rate of $8.0 billion.

Technology Services & Cloud Platforms gross profit margin
increased 1.5 points to 42.3 percent, driven primarily by service
delivery improvements resulting from infusing AI and automation
into business processes and leveraging productivity and talent
optimization efforts. Pre-tax income of $1,392 million decreased
3.4 percent. The pre-tax margin of 15.2 percent was flat year to
year and improved sequentially compared to the third quarter
of 2018. The company continues to invest in developing new
offerings to capture the hybrid market opportunities.

Systems
Systems revenue of $2,621 million declined 21.3 percent year to
year as reported (20 percent adjusted for currency) in the fourth
quarter of 2018. Systems Hardware revenue of $2,175 million
decreased 24.1 percent as reported (23 percent adjusted for
currency). The year-to-year revenue decline was driven primarily
by IBM Z product cycle dynamics and a decrease in Storage
Systems (as reported and adjusted for currency), partially
offset by growth in Power Systems (as reported and adjusted
for currency). Operating Systems Software revenue of $446
million decreased 4.4 percent as reported (3 percent adjusted
for currency) compared to the prior year.

Within Systems Hardware, fourth-quarter IBM Z revenue declined
45.2 percent as reported (44 percent adjusted for currency) year
to year as a result of the IBM Z product cycle and strong demand
for z14 in the prior year. Since launching the z14 six quarters ago,
this platform continues to track ahead of prior programs, and the
install base grew as new clients and new workloads continued
to be added to the platform. Over 55 percent of installed MIPs
inventory is in emerging workload areas.

Management Discussion International Business Machines Corporation and Subsidiary Companies46

Power Systems revenue grew 8.6 percent as reported (10 percent
adjusted for currency) year to year driven by Linux and continued
strong performance of the new POWER9-based processors. The
low-end and high-end portfolios had double-digit growth in the
quarter. The release of the next generation POWER9 processor
was completed during the quarter, with HANA certification
extended to high-end processors. Power Systems are designed
for handling advanced analytics and data-intensive workloads in
cloud environments within AI, HANA and UNIX markets.

In the fourth quarter, EMEA revenue performance by country
varied. The UK decreased 0.9 percent as reported, but increased
3 percent adjusted for currency. France decreased 14.2 percent
as reported and 11 percent adjusted for currency. Italy decreased
1.2 percent as reported, but increased 2 percent adjusted
for currency. Germany increased 7.9 percent as reported and
12 percent adjusted for currency. Spain increased 12.7 percent
as reported and 17 percent adjusted for currency. Russia grew
4.0 percent as reported and adjusted for currency.

Within Asia Pacific, China decreased 25.0 percent as reported
and 23 percent adjusted for currency primarily due to strong
performance in the financial sector in the prior year. India
decreased 10.4 as reported, but was essentially flat adjusted for
currency. Australia decreased 1.6 percent as reported, but grew
5 percent adjusted for currency. Japan increased 5.6 percent as
reported and 5 percent adjusted for currency.

Total Expense and Other (Income)

($ in millions)

For the fourth quarter:

2018

2017*

Yr.-to-Yr.
Percent/
Margin
Change

Total consolidated expense

and other (income)

$6,253

$6,580

(5.0)%

Non-operating adjustments

Amortization of acquired

intangible assets

(106)

(115)

(7.1)

Acquisition-related

charges

Non-operating retirement-
related (costs)/income

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

Total consolidated

(13)

(33)

(61.1)

(387)

(371)

4.2

$5,746

$6,061

(5.2)%

expense-to-revenue ratio

28.7%

29.2%

(0.5)pts.

Operating (non-GAAP)

expense-to-revenue ratio

26.4%

26.9%

(0.5)pts.

* Recast to reflect adoption of the FASB guidance on presentation of net

benefit cost.

Total expense and other (income) decreased 5.0 percent in the
fourth quarter with an expense-to-revenue ratio of 28.7 percent
compared to 29.2 percent in the fourth quarter of 2017. Total
operating (non-GAAP) expense and other (income) decreased
5.2 percent year to year. The year-to-year decrease in total
expense and other (income) was primarily the result of the effects
of currency (4 points) and lower spending (3 points), partially offset
by lower intellectual property income (2 points). The expense
dynamics reflected the impacts from currency and the continued
efficiency in the underlying spending, offset by continued
investment to build and reinvent new solutions and platforms.

Storage Systems revenue decreased 8.0 percent as reported
(7 percent adjusted for currency) with declines in midrange, and
the market remains very competitive with price pressure. There
was double-digit growth (as reported and adjusted for currency)
in high-end hardware products and in all-flash array offerings.

Systems strategic imperatives revenue of $1.6 billion declined
23 percent year to year as reported (22 percent adjusted for
currency). Cloud revenue of $1.1 billion decreased 32 percent
as reported (31 percent adjusted for currency). Both reflected
IBM Z product cycle dynamics.

The Systems gross profit margin decreased 4.9 points to 50.8
percent in the fourth quarter of 2018 compared to the prior
year. The overall decrease year to year was driven primarily by
product cycle dynamics with a mix away from IBM Z and margin
declines in Power Systems and Storage Systems, partially offset
by Operating Systems Software margin improvement. In the
fourth quarter of 2018, pre-tax income of $551 million declined
39.2 percent and pre-tax margin decreased 6.5 points year to
year to 19.3 percent driven by the strong fourth-quarter 2017
performance in Systems Hardware. The company continues to
develop next-generation technology and deliver new innovative
functionality across its Systems portfolio.

Global Financing
Global Financing revenue of $402 million decreased 10.7 percent
year to year. Global Financing fourth-quarter pre-tax income
decreased 27.9 percent to $319 million and the pre-tax margin of
41.3 percent decreased 3.1 points year to year. The decrease in
pre-tax income was driven by a decrease in gross profit, partially
offset by a decrease in SG&A expense and financing receivable
provisions.

Geographic Revenue
Total revenue of $21,760 million decreased 3.5 percent as
reported and 1 percent adjusted for currency in the fourth
quarter of 2018 compared to the prior year. Americas revenue
of $10,222 million decreased 5.3 percent as reported and 4
percent adjusted for currency. EMEA fourth-quarter revenue of
$7,081 million decreased 1.3 percent as reported, but increased
2 percent adjusted for currency. Asia Pacific revenue of $4,458
million declined 2.7 percent and 1 percent adjusted for currency.

Within Americas, revenue in the U.S. decreased 7.0 percent year
to year, driven primarily by the strong IBM Z performance in the
prior year. Canada decreased 4.1 percent as reported, but was
flat adjusted for currency. Latin America increased 4.8 percent
as reported and 17 percent adjusted for currency. Within Latin
America, Brazil increased 8.1 percent as reported and 20 percent
adjusted for currency. Mexico increased 12.6 percent as reported
and 16 percent adjusted for currency.

Management Discussion International Business Machines Corporation and Subsidiary Companies47

Cash Flow
The company generated $4.1 billion in cash flow from operating
activities in the fourth quarter of 2018, a decrease of $1.6
billion compared to the fourth quarter of 2017, primarily due
to a decline from financing receivables. Net cash sourced from
investing activities of $0.5 billion was $4.3 billion higher than
the prior year’s net use of cash, primarily driven by an increase
in cash from net proceeds from disposition of marketable
securities and other investments ($2.3 billion) and an increase
from net non-operating financing receivables ($1.6 billion). Net
cash used in financing activities of $4.6 billion increased $3.7
billion compared to the prior year, primarily driven by higher net
debt maturities ($2.3 billion) and higher gross common stock
repurchases ($1.4 billion).

GAAP Reconciliation
The tables below provide a reconciliation of the company’s
income statement results as reported under GAAP to its
operating earnings presentation which is a non-GAAP measure.
The company’s calculation of operating (non-GAAP) earnings, as
presented, may differ from similarly titled measures reported by
other companies. Refer to the “Operating (non-GAAP) Earnings”
section on pages 18 and 19 for the company’s rationale for
presenting operating earnings information.

($ in millions except per share amounts)

For the fourth quarter 2018:

Gross profit

Gross profit margin

SG&A

RD&E

Other (income) and expense

Total expense and other (income)

Pre-tax income from continuing operations

Acquisition-
Related
Adjustments

Retirement-
Related
Adjustments

Tax Reform
Charges

Operating
(non-GAAP)

$ 89

$ —

$10,776

GAAP

$10,687

49.1%

0.4 pts.

— pts.

—pts.

49.5%

$ 4,701

$(119)

$ —

$ 4,582

1,358

185

6,253

4,434

—

(1)

(119)

208

—

(387)

387

—

1,358

(203)

5,746

5,030

Pre-tax margin from continuing operations

20.4%

1.0 pts.

1.8 pts.

—pts.

23.1%

Provision for income taxes*

Effective tax rate

$ 2,481

$ 37

$ 39

$(1,944)

$ 613

55.9%

(1.6)pts.

(3.5)pts.

(38.7)pts.

12.2%

Income from continuing operations

$ 1,954

$ 171

$ 348

$ 1,944

$ 4,417

Income margin from continuing operations

9.0%

0.8 pts.

1.6 pts.

8.9pts.

20.3%

Diluted earnings per share from continuing operations

$ 2.15

$0.19

$0.38

$ 2.15

$ 4.87

* 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.

($ in millions except per share amounts)

For the fourth quarter 2017:

Gross profit

Gross profit margin

SG&A

RD&E

Other (income) and expense

Total expense and other (income)

Pre-tax income from continuing operations

Acquisition-
Related
** Adjustments

Retirement-
Related

Adjustments**

Tax Reform
Charge

Operating
(non-GAAP)**

$ 99

$ —

$11,149

GAAP

$11,049

49.0%

0.4 pts.

— pts.

49.5%

$ 5,013

$(116)

$ —

$ 4,897

1,378

374

6,580

4,469

—

(32)

(148)

247

—

(371)

371

—

1,378

(30)

6,061

5,087

Pre-tax margin from continuing operations

19.8%

1.1 pts.

1.6 pts.

— pts.

22.6%

Provision for income taxes*

Effective tax rate

$ 5,522

$ 67

$ 197

$(5,475)

$ 310

123.6%

(4.7) pts.

(5.1) pts.

(107.6) pts.

6.1%

Income/(loss) from continuing operations

$ (1,053)

$ 181

$ 174

$ 5,475

$ 4,777

Income/(loss) margin from continuing operations

(4.7)%

0.8 pts.

24.3 pts.

21.2%

Diluted earnings/(loss) per share from

continuing operations

$ (1.14)

$0.19

$ 5.90

$ 5.14

* 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.

** Recast to reflect adoption of the FASB guidance on presentation of net periodic pension and nonpension postretirement benefit costs.

Management Discussion International Business Machines Corporation and Subsidiary Companies48

PRIOR YEAR IN REVIEW
This section provides a summary of the company’s financial performance in 2017 as compared to 2016. For additional information,
see the company’s 2017 Annual Report.

($ and shares in millions except per share amounts)

For the year ended December 31:

Revenue

Gross profit margin

Total expense and other (income)

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

Income from continuing operations before income taxes

Provision for income taxes from continuing operations

Income from continuing operations

Income from continuing operations margin

Loss from discontinued operations, net of tax

Net income

Earnings per share from continuing operations:

Assuming dilution

Consolidated earnings per share—assuming dilution

Weighted-average shares outstanding

Assuming dilution

Assets++
Liabilities++
Equity++

2017

2016

$ 79,139

$ 79,919

46.7%**

48.2%**

$ 25,543**

$ 26,186**

32.3%**

32.8%**

$ 11,400
$ 5,642+
$ 5,758+

$ 12,330

$ 449

$ 11,881

Yr.-to-Yr.
Percent/
Margin
Change

(1.0)%*

(1.5) pts.

(2.5)%

(0.5 ) pts.

(7.5)%

(51.5)%

7.3%

14.9%

(7.6) pts.

$ (5)
$ 5,753+

$ (9)

$ 11,872

$ 6.14+
$ 6.14+

$ 12.39

$ 12.38

937.4

958.7

$125,356

$117,470

$107,631

$ 99,078

$ 17,725

$ 18,392

(44.7)%

(51.5)%

(50.4)%

(2.2)%

6.7%

8.6%

(3.6)%

* (1.3) percent adjusted for currency.

** Recast to reflect adoption of the FASB guidance on presentation of net benefit cost.
+ Includes a charge of $5.5 billion associated with U.S. tax reform, or $5.84 of diluted earnings per share in 2017.
++At December 31

NM—Not meaningful

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

($ in millions except per share amounts)

For the year ended December 31:

Net income as reported

Loss from discontinued operations, net of tax

Income from continuing operations

Non-operating adjustments (net of tax)

Acquisition-related charges

Non-operating retirement-related costs/(income)

U.S. tax reform charge

Operating (non-GAAP) earnings*

Diluted operating (non-GAAP) earnings per share

* See page 58 for a more detailed reconciliation of net income to operating (non-GAAP) earnings.

** Recast to reflect adoption of the FASB guidance on presentation of net benefit cost.
+ Includes a charge of $5.5 billion associated with U.S. tax reform.

NM—Not meaningful

2017
$ 5,753+

(5)
$ 5,758+

2016

$11,872

(9)

$11,881

718

856**

5,475

735

265**

—

$12,807**

$12,880**

$ 13.66**

$ 13.44**

Yr.-to-Yr.
Percent
Change

(51.5)%

(44.7)

(51.5)%

(2.3)

223.3

(0.6)%

1.6%

Management Discussion International Business Machines Corporation and Subsidiary Companies49

Snapshot
In 2017, the company reported $79.1 billion in revenue and $5.8
billion in income from continuing operations, which included a
charge of $5.5 billion associated with the enactment of U.S. tax
reform. Operating (non-GAAP) earnings were $12.8 billion, which
excluded the tax reform charge. Diluted earnings per share from
continuing operations were $6.14 as reported and $13.66 on
an operating (non-GAAP) basis. The company generated $16.7
billion in cash from operations, $13.0 billion in free cash flow and
delivered shareholder returns of $9.8 billion in gross common
stock repurchases and dividends.

Total consolidated revenue in 2017 decreased 1.0 percent as
reported and 1 percent year to year adjusted for currency. The
company returned to revenue growth in the fourth quarter with
an increase of 3.6 percent as reported and 1 percent adjusted for
currency. Year-to-year revenue performance improved sequentially
in the second half of 2017 compared to first-half performance.
Contributors to the second-half improvement included:
momentum in cloud and as-a-Service offerings, strong Systems
growth across IBM Z, Power Systems and Storage Systems,
improved software transactional performance and improved
growth in Consulting.

Cognitive Solutions increased 1.5 percent as reported and
1 percent adjusted for currency with growth in Solutions Software
and Transaction Processing Software as reported and adjusted
for currency. Solutions Software performance included growth
in annuity revenue, led by as-a-Service solutions. Global Business
Services decreased 2.1 percent as reported and 2 percent
adjusted for currency with declines across all lines of business.
GBS strategic imperatives revenue increased 10 percent as
reported and adjusted for currency year to year as the business
shifted resources and moved into the high-value strategic
areas of digital, cloud and analytics. Technology Services
& Cloud Platforms decreased 3.0 percent as reported and
3 percent adjusted for currency, primarily driven by a decline in
Infrastructure Services. Technology Services & Cloud Platforms
strategic imperatives revenue was up 19 percent as reported and
18 percent adjusted for currency year to year, driven by hybrid
cloud services, security and mobile. Systems increased 6.2
percent as reported and 5 percent adjusted for currency driven
by strong contribution from the z14 mainframe in the second half
of 2017 and growth in Storage Systems.

The company continued to deliver solid growth in its strategic
imperatives which generated $36.5 billion of revenue and grew
11 percent as reported and adjusted for currency. Total Cloud
revenue of $17.0 billion increased 24 percent as reported and
adjusted for currency, with as-a-Service revenue up 31 percent
as reported and adjusted for currency. The annual exit run rate
for as-a-Service revenue increased to $10.3 billion in 2017
compared to $8.6 billion in 2016. Analytics revenue of $20.6
billion increased 6 percent as reported and adjusted for currency.
Mobile increased 19 percent as reported and adjusted for
currency and Security increased 55 percent (54 percent adjusted
for currency).

The consolidated gross margin of 46.7 percent decreased 1.5
points year to year and reflected investments and mix, partially
offset by benefits from productivity. The operating (non-GAAP)
gross margin of 47.2 percent decreased 1.6 points versus the
prior year primarily driven by the same factors.

Total expense and other (income) decreased 2.5 percent in
2017 compared to the prior year. The year-to-year decrease
was primarily the result of continued focus on efficiency in
spending and reduced expenses for workforce transformation.
This included a lower level of workforce rebalancing charges
(3 points), lower operational spending (3 points) and a 2016
charge for real estate actions (1 point). The year-to-year decrease
in total expense and other (income) was partially offset by
higher retirement-related costs (3 points), spending related to
acquisitions completed in the prior 12 months (1 point) and a
decline in IP income (1 point). Total operating (non-GAAP)
expense and other (income) decreased 6.2 percent year to year,
driven primarily by the same factors, excluding the impact of
higher non-operational retirement related costs.

Pre-tax income from continuing operations of $11.4 billion
decreased 7.5 percent and the pre-tax margin was 14.4 percent,
a decrease of 1.0 points versus 2016. The continuing operations
effective tax rate for 2017 was 49.5 percent, which included a
charge of $5.5 billion from the enactment of U.S. tax reform in
December 2017, compared to 3.6 percent in 2016. The charge
encompassed several elements, including taxes on accumulated
overseas profits and the revaluation of certain deferred tax
assets and liabilities. The low tax rate in 2016 was primarily the
result of a refund ($1.0 billion) of previously paid Japan taxes
plus interest. Income from continuing operations of $5.8 billion
decreased 51.5 percent, impacted by the tax reform charge, and
the net income margin was 7.3 percent, a decrease of 7.6 points
versus 2016. Net income of $5.8 billion decreased 51.5 percent

Management Discussion International Business Machines Corporation and Subsidiary Companies50

Total liabilities increased $8.6 billion ($4.0 billion adjusted for
currency) from December 31, 2016 driven by:

•

Increases in total debt ($4.7 billion) and taxes ($3.5 billion).

Total equity of $17.7 billion decreased $0.7 billion from
December 31, 2016 as a result of:

•

Decreases from dividends ($5.5 billion) and share
repurchases ($4.3 billion); partially offset by

Increases from net income ($5.8 billion), retirement-related
benefit plans ($2.3 billion) and equity translation
adjustments ($0.8 billion).

The company generated $16.7 billion in cash flow provided by
operating activities, a decrease of $0.4 billion compared to 2016,
driven primarily by performance-related declines within net
income and an increase in cash tax payments, partially offset by an
increase in cash provided by receivables. Net cash used in investing
activities of $7.1 billion was $3.8 billion lower than the prior year,
primarily driven by a decrease in cash used for acquisitions
($5.2 billion). Net cash used in financing activities of $6.4 billion
increased $0.5 billion compared to 2016, driven primarily by
increased gross common share repurchases ($0.8 billion).

year to year. Operating (non-GAAP) pre-tax income from
continuing operations of $13.7 billion decreased 0.3 percent
year to year and the operating (non-GAAP) pre-tax margin from
continuing operations was 17.4 percent. Operating (non-GAAP)
income from continuing operations of $12.8 billion decreased
0.6 percent with an operating (non-GAAP) income margin from
continuing operations of 16.2 percent, essentially flat year to
year. The operating (non-GAAP) effective tax rate from continuing
operations in 2017 was 6.8 percent, which included the effect
of discrete tax benefits in the first and second quarters of 2017.

Diluted earnings per share from continuing operations of $6.14
in 2017, which included the one-time charge associated with
U.S. tax reform, decreased 50.4 percent year to year. Operating
(non-GAAP) diluted earnings per share of $13.66 increased 1.6
percent versus 2016. In 2017, the company repurchased 27.2
million shares of its common stock at a cost of $4.3 billion.

At December 31, 2017, the balance sheet remained strong and
well positioned to support the business over the long term. Cash,
restricted cash and marketable securities at December 31, 2017
were $12.8 billion, an increase of $4.1 billion from December 31,
2016. Key drivers in the balance sheet and total cash flows were:

Total assets increased $7.9 billion ($3.0 billion adjusted for
currency) from December 31, 2016 driven by:

•

Increases in cash, restricted cash and marketable securities
($4.1 billion), total receivables ($2.9 billion), retirement plan
assets ($1.6 billion) and goodwill ($0.6 billion); partially
offset by

•

Decreases in intangible assets ($0.9 billion).

Management Discussion International Business Machines Corporation and Subsidiary CompaniesResults of Continuing Operations
Segment Details
The following is an analysis of the 2017 versus 2016 reportable segment results. The table below presents each reportable segment’s
external revenue and gross margin results. Segment pre-tax income includes transactions between segments that are intended to
reflect an arm’s-length transfer price and excludes certain unallocated corporate items.

($ in millions)

For the year ended December 31:

2017

2016

Revenue

Cognitive Solutions

Gross margin

Global Business Services

Gross margin

Technology Services & Cloud Platforms

Gross margin

Systems

Gross margin

Global Financing

Gross margin

Other

Gross margin

Total consolidated revenue

Total consolidated gross profit

Total consolidated gross margin

Non-operating adjustments

Amortization of acquired intangible assets

Retirement-related costs/(income)

Operating (non-GAAP) gross profit

Operating (non-GAAP) gross margin

* Recast to reflect adoption of the FASB guidance on presentation of net benefit cost.

Cognitive Solutions

($ in millions)

For the year ended December 31:

Cognitive Solutions external revenue

Solutions Software

Transaction Processing Software

Yr.-to-Yr.
Percent/
Margin
Change

Yr.-to-Yr.
Percent Change
Adjusted for
Currency

1.5%

(3.2) pts.

(2.1)%

(1.8) pts.

(3.0)%

(1.5) pts.

6.2%

(2.5) pts.

0.3%

(9.4) pts.

1.0%

(1.8)%

(3.4)%

5.4%

(0.7)%

(40.7)%

(41.1)%

$18,453

$18,187

78.6%*

81.8%*

16,348

16,700

24.9%*

26.7%*

34,277

35,337

40.3%*

41.8%*

8,194

7,714

53.2%*

55.7%*

1,696

1,692

29.3%

171

38.7%

289

(173.9)%*

(184.7)%*

$79,139

$79,919

10.8 pts.

(1.0)%

(1.3)%

$36,943*

$38,516*

46.7%*

48.2%*

(4.1)%

(1.5) pts.

449

—*

494

—*

$37,392*

$39,010*

(9.2)%

—%

(4.1)%

47.2%*

48.8%*

(1.6) pts.

2017

$18,453

$12,806

5,647

2016

$18,187

$12,589

5,598

Yr.-to-Yr.
Percent
Change

Yr.-to-Yr.
Percent Change
Adjusted for
Currency

1.5%

1.7%

0.9

1.0%

1.3%

0.3

The growth in Solutions Software revenue was led by key areas
including security, industry platforms and Watson offerings,
as the company continued to embed cognitive into its security
offerings and drive vertical solutions. The company continued to
expand the market for Watson Health which had strong double-
digit revenue growth as reported and adjusted for currency
compared to the prior year. There was year-to-year growth in
annuity revenue as reported and at constant currency with strong
double-digit growth in SaaS revenue as reported and adjusted

for currency. Transaction Processing Software revenue grew as
reported, but was essentially flat adjusted for currency compared
to the prior year.

Cognitive Solutions total strategic imperatives revenue of $12.0
billion grew 2 percent year to year as reported and adjusted
for currency. Cloud revenue of $2.5 billion grew 19 percent as
reported and adjusted for currency, with an as-a-Service exit run
rate of $2.1 billion.

Management Discussion International Business Machines Corporation and Subsidiary Companies52

($ in millions)

For the year ended December 31:

2017*

2016*

Cognitive Solutions

Gross margin in Cognitive Solutions was impacted by continued
investment and an increased mix toward SaaS. There was also a
higher level of royalty cost associated with IP licensing
agreements compared to the prior year.

Yr.-to-Yr.
Percent/
Margin
Change

External gross profit

$14,503

$14,883

(2.6)%

External gross profit

margin

Pre-tax income

Pre-tax margin

78.6%

81.8%

(3.2)pts.

$ 6,795

$ 6,325

32.2%

30.4%

7.4%

1.8 pts.

* Recast to reflect adoption of the FASB guidance on presentation of net

benefit cost.

Global Business Services

($ in millions)

For the year ended December 31:

Global Business Services external revenue

Consulting

Global Process Services

Application Management

Global Business Services revenue decreased in 2017 compared
to the prior year, with declines across Consulting, GPS and
Application Management. The company continued to transform
this business and shift its practices to digital, cognitive and
cloud. Total strategic imperatives revenue of $9.8 billion grew
10 percent as reported and adjusted for currency year to year.
Cloud revenue of $4.0 billion grew 34 percent as reported
(35 percent adjusted for currency), with an as-a-Service exit run
rate of $1.3 billion. However, this growth was more than offset by
declines in the more traditional areas that the company has been
shifting away from such as large ERP and on-premise enterprise
application implementation.

2017

$16,348

$ 7,262

1,265

7,821

2016

$16,700

$ 7,332

1,388

7,980

Yr.-to-Yr.
Percent
Change

Yr.-to-Yr.
Percent Change
Adjusted for
Currency

(2.1)%

(1.0)%

(8.8)

(2.0)

(1.8)%

(0.4)%

(9.0)

(1.9)

($ in millions)

For the year ended December 31:

2017*

2016*

Global Business Services

Yr.-to-Yr.
Percent/
Margin
Change

External gross profit

$4,077

$4,457

(8.5)%

External gross profit

margin

Pre-tax income

Pre-tax margin

24.9%

26.7%

(1.8) pts.

$1,362

$1,683

(19.0)%

8.2%

9.8%

(1.7) pts.

* Recast to reflect adoption of the FASB guidance on presentation of net

benefit cost.

Profit performance for 2017 was impacted by investments to
drive transformation and reflected pricing and profit pressure in
the more traditional IT services. The company’s continued focus
is on improving productivity with a streamlined practice model
and new project management approaches.

Management Discussion International Business Machines Corporation and Subsidiary Companies53

2017

$34,277

$22,690

7,196

4,390

2016

$35,337

$23,543

7,272

4,521

Yr.-to-Yr.
Percent
Change

Yr.-to-Yr.
Percent Change
Adjusted for
Currency

(3.0)%

(3.6)%

(1.0)

(2.9)

(3.4)%

(4.1)%

(1.5)

(3.4)

The TS&CP gross profit margin decline in 2017 was driven
primarily by large contract conclusions, delays in productivity
improvements, mix from Integration Software and investments
in cloud, which were partially offset by savings from prior-year
workforce rebalancing. Pre-tax income performance included
a lower level of charges related to workforce and real estate
actions in 2017 compared to 2016.

Technology Services & Cloud Platforms

($ in millions)

For the year ended December 31:

Technology Services & Cloud Platforms external revenue

Infrastructure Services

Technical Support Services

Integration Software

Technology Services & Cloud Platforms revenue decreased in
2017 compared to the prior year, with declines across all lines
of business. The revenue decline in Infrastructure Services
reflected the impact of contract conclusions at the end of 2016
and the shift away from lower-value work within the business.
While Technical Support Services also declined year to year, the
company focused on growing its multi-vendor support services
providing clients a single source of expertise across different
vendor solutions. Within Integration Software, although the
annuity base remained relatively stable year to year in 2017,
transactional revenue declined as the portfolio shifted to the
IBM Cloud. Strategic imperatives revenue of $10.4 billion grew
19 percent year to year as reported (18 percent adjusted for
currency). Cloud revenue of $7.1 billion grew 21 percent as
reported (20 percent adjusted for currency), with an as-a-Service
exit run rate of $6.9 billion.

($ in millions)

For the year ended December 31:

2017*

2016*

Technology Services &
Cloud Platforms

External Technology

Yr.-to-Yr.
Percent/
Margin
Change

Services gross profit

$10,215

$10,927

(6.5)%

External Technology

Services gross profit
margin

External Integration

34.2%

35.5%

(1.3) pts.

Software gross profit

$ 3,587

$ 3,830

(6.4)%

External Integration

Software gross profit
margin

81.7%

84.7%

(3.0) pts.

External total gross profit

$13,802

$14,757

(6.5)%

External total gross profit

margin

Pre-tax income

Pre-tax margin

40.3%

41.8%

(1.5) pts.

$ 4,286

$ 4,643

(7.7)%

12.3%

12.9%

(0.6) pts.

* Recast to reflect adoption of the FASB guidance on presentation of net

benefit cost.

Management Discussion International Business Machines Corporation and Subsidiary Companies54

Systems

($ in millions)

For the year ended December 31:

Systems external revenue

Systems Hardware

IBM Z

Power Systems

Storage Systems

2017

$8,194

$6,494

2016

$7,714

$5,926

Operating Systems Software

1,701

1,788

Yr.-to-Yr.
Percent
Change

Yr.-to-Yr.
Percent Change
Adjusted for
Currency

6.2%

9.6%

24.0

(3.7)

7.7

(4.9)

5.4%

8.6%

22.3

(4.3)

7.0

(5.3)

The year-to-year growth in Systems revenue was driven by a
combination of strong z14 market acceptance following its
successful launch in the third quarter of 2017 and growth
in Storage Systems. In 2017, all-flash array offerings were a
catalyst for Storage Systems growth, with strong double-digit
growth throughout the year. Power Systems revenue decreased
with declines in the mid-range and low-range products, partially
offset by growth in the high-end. This performance reflected the
company’s shift to a growing Linux market while continuing to
serve a high-value, but declining UNIX market. Total strategic
imperatives revenue of $4.3 billion grew 28 percent year to year
as reported (26 percent adjusted for currency). Cloud revenue
of $3.4 billion grew 26 percent as reported (25 percent adjusted
for currency).

The Systems gross profit margin decrease was driven by margin
declines across all product lines, partially offset by product mix
primarily toward higher margin IBM Z, reflecting product cycle
dynamics. Pre-tax income growth was driven by the strong
performance in Systems Hardware. Overall 2017 performance
reflected a successful repositioning of the business through
continuous reinvention of core platforms and expansion into
new workloads.

Global Financing

($ in millions)

For the year ended December 31:

2017

2016

Yr.-to-Yr.
Percent
Change

($ in millions)

For the year ended December 31:

2017*

2016*

Systems

External Systems Hardware

Yr.-to-Yr.
Percent/
Margin
Change

Results of Operations

External revenue

Internal revenue

Total revenue

Pre-tax income

$1,696

$1,692

0.3%

1,471

1,802

(18.4)

$3,168

$3,494

(9.3)%

$1,278*

$1,654*

(22.8)%

* Recast to reflect adoption of the FASB guidance on presentation of net

gross profit

$2,893

$2,719

6.4%

benefit cost.

External Systems Hardware

gross profit margin

44.6%

45.9%

(1.3)pts.

External Operating Systems
Software gross profit

External Operating Systems
Software gross profit
margin

$1,469

$1,577

(6.9)%

86.4%

88.2%

(1.8)pts.

External total gross profit

$4,362

$4,296

1.5%

External total gross
profit margin

Pre-tax income

Pre-tax margin

53.2%

55.7%

(2.5)pts.

$1,128

$ 925

21.9%

12.6%

10.9%

1.7pts.

* Recast to reflect adoption of the FASB guidance on presentation of net

benefit cost.

The decline in Global Financing total revenue was driven by a
decline in internal revenue with external revenue essentially flat
compared to the prior year. External revenue grew 0.3 percent
due to an increase in external used equipment sales (up 14.9
percent), partially offset by a decline in external financing (down
5.2 percent). The decline in internal revenue of 18.4 percent was
driven by a decrease in internal used equipment sales (down 25.2
percent), partially offset by an increase in internal financing (up
13.9 percent). The decrease in Global Financing pre-tax income
was primarily driven by a decrease in gross profit, partially offset
by a decline in financing receivables provisions.

Management Discussion International Business Machines Corporation and Subsidiary Companies55

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

($ in millions)

For the year ended December 31:

Total revenue

Americas

Europe/Middle East/Africa

Asia Pacific

* Recast to conform to 2018 presentation.

2017*

2016*

$79,139

$37,641

24,397

17,102

$79,919

$37,697

24,805

17,417

Yr.-to-Yr.
Percent
Change

Yr.-to-Yr.
Percent Change
Adjusted for
Currency

(1.0)%

(0.1)%

(1.6)

(1.8)

(1.3)%

(0.6)%

(2.7)

(0.9)

Americas revenue was essentially flat year to year as reported,
but decreased 1 percent adjusted for currency with a decline in
North America partially offset by growth in Latin America, both
as reported and adjusted for currency. Within North America, the
U.S. decreased 1.4 percent and Canada increased 4.9 percent
(3 percent adjusted for currency). In Latin America, Brazil
increased 7.6 percent (1 percent adjusted for currency) and
Mexico increased 9.2 percent (10 percent adjusted for currency).

EMEA revenue decreased 1.6 percent as reported and 3 percent
adjusted for currency. The UK decreased 11.2 percent (7 percent
adjusted for currency) and Germany decreased 3.2 percent
(6 percent adjusted for currency). France increased 6.7 percent
(4 percent adjusted for currency), and Spain was up 8.3 percent
(6 percent adjusted for currency).

Asia Pacific revenue decreased 1.8 percent as reported and
1 percent adjusted for currency. Japan decreased 1.2 percent
as reported, but increased 2 percent adjusted for currency.
India grew 8.6 percent as reported and 5 percent adjusted
for currency. China decreased 9.7 percent (9 percent adjusted
for currency) and Australia decreased 5.8 percent (9 percent
adjusted for currency).

Total Expense and Other (Income)

($ in millions)

For the year ended December 31:

2017

2016

Total consolidated expense

Yr.-to-Yr.
Percent/
Margin
Change

and other (income)

$25,543* $26,186*

(2.5)%

Non-operating adjustments

Amortization of acquired

intangible assets

Acquisition-related charges

Non-operating retirement-
related (costs)/income

Operating (non-GAAP)

expense and
other (income)

Total consolidated

(496)

(52)

(503)

(5)

(1.4)

(1,341)*

(448)*

199.5

$23,654* $25,230*

(6.2)%

expense-to-revenue ratio

32.3%*

32.8%*

(0.5 )pts.

Operating (non-GAAP)

expense-to-revenue ratio

29.9%*

31.6%*

(1.7 )pts.

* Recast to reflect adoption of the FASB guidance on presentation of net

benefit cost.

NM—Not meaningful

Management Discussion International Business Machines Corporation and Subsidiary Companies56

Selling, General and Administrative Expense

Research, Development and Engineering Expense

($ in millions)

For the year ended December 31:

2017

2016

Selling, general and

administrative expense

Selling, general and

Yr.-to-Yr.
Percent
Change

For the year ended December 31:

2017*

2016*

Yr.-to-Yr.
Percent
Change

Total consolidated

research, development
and engineering

$5,590

$5,726

(2.4)%

administrative—other

$17,100 * $17,513 *

(2.4)%

Non-operating adjustment

Advertising and promotional

expense

1,445

1,327

8.9

Workforce rebalancing

charges

Amortization of acquired

intangible assets

Stock-based compensation

Bad debt expense

Total consolidated

selling, general and
administrative expense

Non-operating adjustments

Amortization of acquired

199

1,038

(80.9)

496

384

503

401

(1.4)

(4.1)

(36.5)

$19,680* $20,869*

(5.7)%

Non-operating retirement-
related (costs)/income

Operating (non-GAAP)

research, development
and engineering

—

$5,590

$5,726

(2.4)%

* Recast to reflect adoption of the FASB guidance on presentation of net

benefit cost.

RD&E expense was 7.1 percent of revenue in 2017 and 7.2 percent
of revenue in 2016.

RD&E expense decreased 2.4 percent in 2017 versus 2016
primarily driven by:

intangible assets

(496)

(503)

(1.4)

•

Lower spending (4 points); partially offset by

Acquisition-related

charges

Non-operating retirement-
related (costs)/income

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

(13)

—*

•

The impact of acquisitions completed in the prior 12-month
period (1 point); and

—

•

The effects of currency.

$19,170* $20,368*

(5.9)%

($ in millions)

Intellectual Property and Custom Development Income

* Recast to reflect adoption of the FASB guidance on presentation of net

benefit cost.

NM—Not meaningful

Total SG&A expense decreased 5.7 percent in 2017 versus 2016,
driven primarily by the following factors:

• Lower workforce rebalancing charges (4 points); and

•

Lower spending (3 points); partially offset by

•

Spending related to acquisitions in the prior 12 months
(1 point).

Operating (non-GAAP) SG&A expense decreased 5.9 percent
year to year driven primarily by the same factors.

Bad debt expense decreased $32 million in 2017 compared
to 2016. The receivables provision coverage was 1.6 percent
at December 31, 2017, a decrease of 40 basis points from
December 31, 2016.

For the year ended December 31:

2017

2016

Yr.-to-Yr.
Percent
Change

Licensing of intellectual
property including
royalty-based fees

$1,193

$1,390

(14.1)%

Custom development income

252

214

17.5

Sales/other transfers of
intellectual property

Total

(24.2)

$1,466

$1,631

(10.2)%

Licensing of intellectual property including royalty-based fees
decreased 14.1 percent in 2017 compared to 2016. The company
entered into new partnership agreements in 2017, which included
three transactions with period income greater than $100 million,
compared to four transactions greater than $100 million in 2016.

Management Discussion International Business Machines Corporation and Subsidiary CompaniesYr.-to-Yr.
Percent
Change

33.5%

Other (Income) and Expense

($ in millions)

For the year ended December 31:

2017

2016

Other (income) and expense

Foreign currency transaction

losses/(gains)

$ 405

$(116)

(Gains)/losses on

derivative instruments

Interest income

Net (gains)/losses from

securities and
investment assets

Retirement-related

costs/(income)

Other

Total consolidated other
(income) and expense

Non-operating adjustments

Acquisition-related

charges

Non-operating retirement-
related (costs)/income

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

(341)

(144)

260

(108)

(20)

1,341*

(116)

448*

199.5%

$ 1,125*

$ 593*

89.8%

(39)

(7)

444.6

(1,341)*

(448)*

199.5

$ (255)

$ 138

* Recast to reflect adoption of the FASB guidance on presentation of net

benefit cost.

NM—Not meaningful

Total consolidated other (income) and expense was expense of
$1,125 million in 2017 compared to $593 million in 2016. The
increase in expense of $532 million year over year was primarily
driven by:

•

Higher retirement-related costs ($893 million); and

• Lower gains on divestitures ($61 million); partially offset by

•

Real estate capacity charges (reflected in Other in the
table above) in 2016 related to workforce transformation
($328 million); and

•

Lower net exchange losses ($81 million).

Interest Expense

($ in millions)

For the year ended December 31:

2017

2016

Yr.-to-Yr.
Percent
Change

Interest expense

Total

$615

$630

(2.3)%

Interest expense decreased $15 million compared to 2016.
Interest expense is presented in cost of financing in the
Consolidated Statement of Earnings only if the related external
borrowings are to support the Global Financing external business.
Overall interest expense (excluding capitalized interest) in 2017
was $1,273 million, an increase of $67 million year to year,
primarily driven by higher average interest rates.

Income Taxes
The continuing operations effective tax rate for 2017 was
49.5 percent, an increase of 45.8 points versus the prior year. The
fourth-quarter 2017 charge of $5.5 billion related to the impact
of the enactment of the U.S. Tax Cuts and Jobs Act resulted in an
increase to the effective tax rate of 48.0 points. Without this impact,
the continuing operations tax rate would have been 1.5 percent
compared to a 2016 rate of 3.6 percent, with the remaining change
in the rate year to year driven by the following factors:

•

An increased benefit year to year in the utilization of
foreign tax credits of 5.4 points;

A benefit related to an intra-entity asset transfer in the
first quarter of 2017 of 5.1 points;

A benefit due to the tax write down of an investment in the
fourth quarter of 2017 of 1.7 points; and

A benefit due to the geographic mix of pre-tax earnings in
2017 of 1.0 points; partially offset by

The favorable resolution of the longstanding tax matter in
Japan in 2016 of 9.5 points; and

An increase year to year in tax charges related to
intercompany payments of 1.5 points.

The continuing operations operating (non-GAAP) effective tax
rate was 6.8 percent, an increase of 0.2 points versus 2016,
principally driven by the same factors described above. In
2017, the geographic and product mix of pre-tax earnings were
more favorable than the company expected and there was
increased utilization of foreign tax credits. These impacts drove
the underlying continuing operations operating (non-GAAP)
effective tax rate to approximately 12 percent before discrete
period benefits.

Financial Position
Cash, restricted cash and marketable securities at December 31,
2017 were $12,842 million. During 2017, the company continued
to manage the investment portfolio to meet its capital preservation
and liquidity objectives.

Total debt of $46,824 million increased $4,655 million from prior
year-end levels. The commercial paper balance at December 31,
2017 was $1,496 million, an increase of $597 million from the
prior year end. Within total debt, $31,434 million was in support
of the Global Financing business which was leveraged at a 9.0
to 1 ratio. During 2017, the company completed bond issuances
totaling $7,986 million, with terms ranging from 2 to 12 years,
and interest rates ranging from 0.95 to 3.30 percent depending
on maturity. This included IBM Credit’s first public debt issuance
of $3,000 million in September 2017. The company generated
strong cash flow from operations and continued to have access
to additional sources of liquidity through the capital markets and
its Credit Facilities.

Consistent with accounting standards, the company remeasured
the funded status of its retirement and postretirement plans at
December 31. At December 31, 2017, the overall net under-
funded position was $12,890 million, a decrease of $1,949
million from December 31, 2016 driven by asset returns, partially

Management Discussion International Business Machines Corporation and Subsidiary Companies58

offset by interest cost and a decrease in discount rates. The
company’s qualified defined benefit plans were well funded and
the cash requirements related to these plans remain stable going
forward at approximately $400 million per year through 2020. In
2017, the return on the U.S. Personal Pension Plan assets was 9.6
percent and the plan was 104 percent funded at December 31.
Overall, global asset returns were 8.3 percent and the qualified
defined benefit plans worldwide were 100 percent funded at
December 31, 2017.

During 2017, the company generated $16,724 million in cash
from operations, a decrease of $360 million compared to 2016. In
addition, the company generated $12,992 million in free cash flow,
an increase of $1,293 million versus the prior year. The company
returned $9,847 million to shareholders in 2017, with $5,506
million in dividends and $4,340 million in gross share repurchases.
In 2017, the company repurchased 27.2 million shares.

GAAP Reconciliation
The following tables provide a reconciliation of the company’s income statement results as reported under GAAP to its operating
earnings presentation which is a non-GAAP measure. The company’s calculation of operating (non-GAAP) earnings, as presented,
may differ from similarly titled measures reported by other companies. Refer to the “Operating (non-GAAP) Earnings” section on
pages 18 and 19 for the company’s rationale for presenting operating earnings information.

($ in millions except per share amounts)

For the year ended December 31, 2017:

Gross profit

Gross profit margin

SG&A

RD&E

Other (income) and expense

Total expense and other (income)

Pre-tax income from continuing operations

Acquisition-
Related
** Adjustments

Retirement-
Related

Adjustments**

Tax Reform
Charge

Operating
(non-GAAP)**

$ 449

$ —

$37,392

GAAP

$36,943

46.7%

0.6 pts.

— pts.

47.2%

$19,680

$(509)

$ —

$19,170

5,590

1,125

25,543

11,400

—

(39)

(548)

997

—

(1,341)

1,341

—

5,590

(255)

23,654

13,738

Pre-tax margin from continuing operations

14.4%

1.3 pts.

1.7 pts.

— pts.

17.4%

Provision for income taxes*

Effective tax rate

$ 5,642

$ 279

$ 485

$(5,475)

$ 931

49.5%

(1.6) pts.

(1.3) pts.

(39.9) pts.

6.8%

Income from continuing operations

$ 5,758

$ 718

$ 856

$ 5,475

$12,807

Income margin from continuing operations

7.3%

0.9 pts.

1.1 pts.

6.9 pts.

16.2%

Diluted earnings per share from continuing operations

$ 6.14

$0.77

$ 0.91

$ 5.84

$ 13.66

* The tax impact on operating (non-GAAP) pre-tax income 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.

**Recast to reflect adoption of the FASB guidance on presentation of net benefit cost.

($ in millions except per share amounts)

For the year ended December 31, 2016:

Gross profit

Gross profit margin

SG&A

RD&E

Other (income) and expense

Total expense and other (income)

Pre-tax income from continuing operations

Pre-tax margin from continuing operations

Provision for income taxes*

Effective tax rate

Income from continuing operations

Income margin from continuing operations

Acquisition-
Related
** Adjustments

GAAP

Retirement-
Related
Adjustments

Operating

** (non-GAAP)**

$38,516

$ 494

$ —

$39,010

48.2%

0.6 pts.

— pts.

48.8%

$20,869

$ (501)

$ —

$20,368

5,726

593

26,186

12,330

—

(7)

(508)

1,003

—

(448)

448

5,726

138

25,230

13,780

15.4%

1.3 pts.

0.6 pts.

17.2%

$ 449

$ 268

$ 183

$ 900

3.6%

1.7 pts.

1.2 pts.

6.5%

$11,881

$ 735

$ 265

$12,880

14.9%

0.9 pts.

0.3 pts.

16.1%

Diluted earnings per share from continuing operations

$ 12.39

$ 0.77

$ 0.28

$ 13.44

* The tax impact on operating (non-GAAP) pre-tax income 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.

**Recast to reflect adoption of the FASB guidance on presentation of net benefit cost.

Management Discussion International Business Machines Corporation and Subsidiary Companies59

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

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

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

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

At mid-January 2019 spot rates, the company expects a 4 point
currency headwind to first quarter 2019 revenue growth, which
is approximately two points worse than the year-to-year impact
realized in the fourth quarter of 2018. The company expects 1 to
2 point sequential improvement in revenue growth at constant
currency from the fourth quarter 2018 to the first quarter 2019.
For full-year 2019, the company expects to expand gross and
pre-tax margins.

Overall, the company expects GAAP earnings per share from
continuing operations for 2019 to be at least $12.45. Excluding
acquisition-related charges of $0.91 per share, non-operating
retirement-related items of $0.45 per share and tax reform
enactment impacts of $0.09 per share, operating (non-GAAP)
earnings per share is expected to be at least $13.90. For the first

quarter of 2019, the company expects GAAP earnings per share
from continuing operations and operating (non-GAAP) earnings
per share to be approximately 16 percent of the respective full-
year expectations. In January 2019, the company announced
the intent to divest certain software products and its mortgage-
servicing business during the year. The estimates of the impacts
from these divestitures are not dependent on timing of closing
and have been included in the full-year earnings per share
expectations. However, earnings per share expectations do not
include Red Hat, as financial implications for 2019 are heavily
dependent on the timing of the closing. Expectations will be
updated after the transaction closes.

The company expects free cash flow to be approximately $12
billion in 2019. Free cash flow expectations for the year reflect
expected operational profit performance and continued working
capital efficiency, partially offset by a cash tax headwind. Free
cash flow realization, which is defined as free cash flow to
income from continuing operations (GAAP), is expected to be
approximately 100 percent for the year. These expectations
also take into account the estimated impact of the announced
divestitures of the select IBM software products and mortgage
servicing business and an estimate of pre-closing financing costs
associated with the Red Hat acquisition.

For full-year 2019, the company expects the GAAP effective tax
rate to be approximately 14 percent, excluding discrete items. The
company expects its operating (non-GAAP) tax rate for 2019 to be
approximately 11 to 12 percent (which is a 3 to 4 points headwind
year to year), including an estimate of potential discrete items.
The rates will change year to year based on discrete tax events,
such as the settlement of income tax audits and changes in tax
laws, as well as recurring factors including the geographic mix
of income before taxes, state and local taxes and the effects of
various global income tax strategies. The GAAP effective tax rate
could also be affected by adjustments to the previously recorded
charges for U.S. tax reform attributable to any changes in law,
new regulations and guidance, audit adjustments, among others.

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

Beginning in 2019, within the IBM U.S. Qualified Personal
Pension Plan, substantially all the plan participants are now
considered inactive, which, as required by U.S. GAAP, results 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

Management Discussion International Business Machines Corporation and Subsidiary Companies60

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 in 2019.

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

Liquidity and Capital Resources
The company has consistently generated strong cash flow
from operations, providing a source of funds ranging between
$15.2 billion and $17.1 billion per year over the past three years.
The company provides for additional liquidity through several
sources: maintaining an adequate cash balance, access to
global funding sources, committed global credit facilities and
other committed and uncommitted lines of credit worldwide.
The following table provides a summary of the major sources of
liquidity for the years ended December 31, 2016 through 2018.

Cash Flow and Liquidity Trends

($ in billions)

Net cash from

2018

2017

2016

operating activities

$15.2

$16.7

$17.1

Cash, restricted cash and
short-term marketable
securities

Committed global
credit facilities

$12.2

$12.8 *

$ 8.8 *

$15.3

$10.3

* Recast to reflect adoption of the FASB guidance on restricted cash.

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

The major rating agencies’ ratings on the company’s debt
securities at December 31, 2018 appear in the table below. As a
result of the proposed Red Hat transaction, in the fourth quarter
of 2018, Standard and Poor’s lowered IBM and IBM Credit’s long-
term debt rating to A from A+, with no change to the short-term
debt rating of A-1, and Fitch Ratings has lowered IBM and IBM
Credit’s long-term debt rating to A from A+, with no change to
the short-term debt rating of F1. Moody’s placed IBM and IBM
Credit’s long-term debt rating of A1 under review for downgrade,
with no change to the short-term debt rating of Prime-1. IBM will
continue with a disciplined financial policy and is committed to
maintaining strong investment-grade credit ratings.

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

The company is in compliance with all of its significant debt
covenants and provides periodic certification 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.

The company does not have “ratings trigger” provisions in
its debt covenants or documentation, which would allow the
holders to declare an event of default and seek to accelerate
payments thereunder in the event of a change in credit rating.
The company’s contractual agreements governing derivative
instruments contain standard market clauses which can trigger
the termination of the agreement if the company’s credit rating
were to fall below investment grade. At December 31, 2018, the
fair value of those instruments that were in a liability position was
$383 million, before any applicable netting, and this position is
subject to fluctuations in fair value period to period based on
the level of the company’s outstanding instruments and market
conditions. The company has no other contractual arrangements
that, in the event of a change in credit rating, would result in a
material adverse effect on its financial position or liquidity.

IBM and IBM Credit Ratings

Senior long-term debt

Commercial paper

Standard
and Poor’s

Moody’s
Investors
Service

A-1

Prime-1

Fitch
Ratings

The company prepares its Consolidated Statement of Cash Flows
in accordance with applicable accounting standards for cash
flow presentation on page 73 and highlights causes and events
underlying sources and uses of cash in that format on page 40.
For the purpose of running its business, the company manages,
monitors and analyzes cash flows in a different format.

Management Discussion International Business Machines Corporation and Subsidiary Companies61

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

From the perspective of how management views cash flow, in
2018, after investing $3.7 billion in capital investments primarily
in support of the services and cloud-based businesses, the
company generated free cash flow of $11.9 billion, a decrease of

$1.1 billion compared to 2017. The decrease was primarily driven
by higher capital expenditures, declines in sales cycle working
capital and an increase in cash income tax payments.

In 2018, the company continued to focus its cash utilization
on returning value to shareholders including $5.7 billion in
dividends and $4.4 billion in gross common stock repurchases
(32.9 million shares).

Over the past three years, the company generated over $36 billion
in free cash flow. During that period, the company invested over
$6 billion in strategic acquisitions and returned over $28 billion
to shareholders through dividends and gross share repurchases.
The company’s performance during this period demonstrates
that there is fungibility across the elements of share repurchases,
dividends and acquisitions. The amount of prospective returns
to shareholders in the form of dividends and share repurchases
will vary based upon several factors including each year’s
operating results, capital expenditure requirements, research and
development investments and acquisitions, as well as the factors
discussed on page 62. As a result of the proposed transaction
to acquire Red Hat, subject to closing, the company intends to
suspend its share repurchase program in 2020 and 2021.

The company’s Board of Directors considers the dividend
payment on a quarterly basis. In the second quarter of 2018, the
Board of Directors increased the company’s quarterly common
stock dividend from $1.50 to $1.57 per share.

The table below represents the way in which management reviews cash flow as described above.

($ in billions)

For the year ended December 31:

Net cash from operating activities per GAAP

Less: the change in Global Financing receivables

Net cash from operating activities,

excluding Global Financing receivables

Capital expenditures, net

Free cash flow (FCF)

Acquisitions

Divestitures

Share repurchase

Common stock repurchases for tax withholdings

Dividends

Non-Global Financing debt

Other (includes Global Financing receivables

and Global Financing debt)

Change in cash, cash equivalents, restricted cash and

short-term marketable securities

FCF as percent of Income from Continuing Operations

2018

$15.2

(0.3)

15.6

(3.7)

11.9

(0.1)

—

(4.4)

(0.2)

(5.7)

(0.5)

(1.6)

2017

$16.7

0.4

16.3

(3.3)

13.0

(0.5)

(0.2)

(4.3)

(0.2)

(5.5)

1.1

2016

$17.1

1.7

15.4

(3.7)

11.7

(5.7)

(0.5)

(3.5)

(0.1)

(5.3)

1.3

0.8*

2.4*

$ (0.6)

$ 4.1*

$ 0.4*

136%**

226%**

98%

* Recast to reflect adoption of the FASB guidance on restricted cash.

** 111% in 2018 excluding charges of $2.0 billion and 116% in 2017 excluding the charge of $5.5 billion associated with the enactment of

U.S. tax reform.

Management Discussion International Business Machines Corporation and Subsidiary Companies
62

Events that could temporarily change the historical cash flow
dynamics discussed previously include significant changes
in operating results, material changes in geographic sources
of cash, unexpected adverse impacts from litigation, future
pension funding requirements during periods of severe downturn
in the capital markets or the timing of tax payments. Whether
any litigation has such an adverse impact will depend on a
number of variables, which are more completely described in
note M, “Contingencies and Commitments,” on pages 115 to
117. With respect to pension funding, in 2018, the company
contributed $363 million to its non-U.S. defined benefit
plans compared to $409 million in 2017. As highlighted in the
Contractual Obligations table, the company expects to make
legally mandated pension plan contributions to certain non-U.S.
plans of approximately $1.8 billion in the next five years. The
2019 contributions are currently expected to be approximately
$400 million. Contributions related to all retirement-related
plans are expected to be approximately $2.4 billion in 2019,

an increase of approximately $100 million compared to 2018.
Financial market performance could increase the legally
mandated minimum contributions in certain non-U.S. countries
that require more frequent remeasurement of the funded status.
The company is not quantifying any further impact from pension
funding because it is not possible to predict future movements in
the capital markets or pension plan funding regulations.

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

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

Contractual Obligations

($ in millions)

Long-term debt obligations

Interest on long-term debt obligations

Capital (finance) lease obligations

Operating lease obligations

Purchase obligations

Other long-term liabilities:

Minimum defined benefit plan pension funding

(mandated)*

Excess 401(k) Plus Plan

Long-term termination benefits

Tax reserves**

Other

Total

Total Contractual
Payment Stream

2019

$43,155

$ 7,048

9,260

5,628

3,171

1,800

1,581

991

4,172

1,410

1,175

1,581

1,079

400

201

179

551

211

Payments Due In

2020–21

$13,914

1,784

2,147

1,114

700

441

143

363

2022–23

After 2023

$ 7,736

$14,457

1,243

1,085

776

700

493

114

153

5,059

815

202

446

555

683

$71,209

$12,427

$20,611

$12,305

$22,245

* As funded status on plans will vary, obligations for mandated minimum pension payments after 2023 could not be reasonably estimated.

** These amounts represent the liability for unrecognized tax benefits. The company estimates that approximately $551 million of the liability is

expected to be settled within the next 12 months. The settlement period for the noncurrent portion of the income tax liability cannot be reasonably
estimated as the timing of the payments will depend on the progress of tax examinations with the various tax authorities; however, it is not expected
to be due within the next 12 months.

Management Discussion International Business Machines Corporation and Subsidiary Companies63

Total contractual obligations are reported in the previous table
excluding the effects of time value and therefore, may not equal
the amounts reported in the Consolidated Statement of Financial
Position. Certain noncurrent liabilities are excluded from the
previous table as their future cash outflows are uncertain. This
includes deferred taxes, derivatives, deferred income, disability
benefits and other sundry items. Certain obligations related to
the company’s divestitures are included.

Purchase obligations include all commitments to purchase goods
or services of either a fixed or minimum quantity that meet any
of the following criteria: (1) they are noncancelable, (2) the
company would incur a penalty if the agreement was canceled,
or (3) the company must make specified minimum payments
even if it does not take delivery of the contracted products or
services (take-or-pay). If the obligation to purchase goods or
services is noncancelable, the entire value of the contract is
included in the previous table. If the obligation is cancelable,
but the company would incur a penalty if canceled, the dollar
amount of the penalty is included as a purchase obligation.
Contracted minimum amounts specified in take-or-pay contracts
are also included in the table as they represent the portion of
each contract that is a firm commitment.

In the ordinary course of business, the company enters into
contracts that specify that the company will purchase all or a
portion of its requirements of a specific product, commodity or
service from a supplier or vendor. These contracts are generally
entered into in order to secure pricing or other negotiated terms.
They do not specify fixed or minimum quantities to be purchased
and, therefore, the company does not consider them to be
purchase obligations.

Interest on floating-rate debt obligations is calculated using the
effective interest rate at December 31, 2018, plus the interest
rate spread associated with that debt, if any.

Off-Balance Sheet Arrangements
From time to time, the company may enter into off-balance sheet
arrangements as defined by SEC Financial Reporting Release
67 (FRR-67), “Disclosure in Management’s Discussion and
Analysis about Off-Balance Sheet Arrangements and Aggregate
Contractual Obligations.”

At December 31, 2018, the company had no off-balance sheet
arrangements that have, or are reasonably likely to have, a material
current or future effect on the company’s financial condition,
changes in financial condition, revenues or expenses, results of
operations, liquidity, capital expenditures or capital resources. See
the table on page 62 for the company’s contractual obligations, and
note M, “Contingencies and Commitments,” on pages 115 to 117,
for detailed information about the company’s guarantees, financial
commitments and indemnification arrangements. The company does
not have retained interests in assets transferred to unconsolidated
entities or other material off-balance sheet interests or instruments.

Critical Accounting Estimates
The application of GAAP requires the company to make estimates
and assumptions about certain items and future events that directly
affect its reported financial condition. The accounting estimates and
assumptions discussed in this section are those that the company
considers to be the most critical to its financial statements. An
accounting estimate is considered critical if both (a) the nature of the
estimate or assumption is material due to the levels of subjectivity
and judgment involved, and (b) the impact within a reasonable
range of outcomes of the estimate and assumption is material to the
company’s financial condition. Senior management has discussed
the development, selection and disclosure of these estimates with
the Audit Committee of the company’s Board of Directors. The
company’s significant accounting policies are described in note A,
“Significant Accounting Policies,” on pages 76 to 88.

A quantitative sensitivity analysis is provided where that
information is reasonably available, can be reliably estimated and
provides material information to investors. The amounts used to
assess sensitivity (e.g., 1 percent, 10 percent, etc.) are included to
allow users of the Annual Report to understand a general direction
cause and effect of changes in the estimates and do not represent
management’s predictions of variability. For all of these estimates,
it should be noted that future events rarely develop exactly as
forecasted, and estimates require regular review and adjustment.

Pension Assumptions
For the company’s defined benefit pension plans, the
measurement of the benefit obligation to plan participants and
net periodic pension (income)/cost requires the use of certain
assumptions, including, among others, estimates of discount
rates and expected return on plan assets.

Changes in the discount rate assumptions would impact the
(gain)/loss amortization and interest cost components of the
net periodic pension (income)/cost calculation and the projected
benefit obligation (PBO). The company increased the discount
rate assumption for the IBM Personal Pension Plan (PPP), a U.S.-
based defined benefit plan, by 70 basis points to 4.10 percent on
December 31, 2018. This change will decrease pre-tax income
recognized in 2019 by an estimated $17 million. If the discount
rate assumption for the PPP had decreased by 70 basis points on
December 31, 2018, pre-tax income recognized in 2019 would
have increased by an estimated $50 million. Further changes in
the discount rate assumptions would impact the PBO which, in
turn, may impact the company’s funding decisions if the PBO
exceeds plan assets. A 25 basis point increase or decrease in the
discount rate would cause a corresponding decrease or increase,
respectively, in the PPP’s PBO of an estimated $1.1 billion based
upon December 31, 2018 data.

The expected long-term return on plan assets assumption is used
in calculating the net periodic pension (income)/cost. Expected
returns on plan assets are calculated based on the market-
related value of plan assets, which recognizes changes in the
fair value of plan assets systematically over a five-year period in
the expected return on plan assets line in net periodic pension
(income)/cost. The differences between the actual return on
plan assets and the expected long-term return on plan assets

Management Discussion International Business Machines Corporation and Subsidiary Companies64

are recognized over five years in the expected return on plan
assets line in net periodic pension (income)/cost and also as a
component of actuarial (gains)/losses, which are recognized over
the service lives or life expectancy of the participants, depending
on the plan, provided such amounts exceed thresholds which are
based upon the benefit obligation or the value of plan assets, as
provided by accounting standards.

To the extent the outlook for long-term returns changes such
that management changes its expected long-term return on plan
assets assumption, each 50 basis point increase or decrease in
the expected long-term return on PPP plan assets assumption
would have an estimated decrease or increase, respectively, of
$248 million on the following year’s pre-tax net periodic pension
(income)/cost (based upon the PPP’s plan assets at December 31,
2018 and assuming no contributions are made in 2019).

The company may voluntarily make contributions or be required,
by law, to make contributions to its pension plans. Actual
results that differ from the estimates may result in more or less
future company funding into the pension plans than is planned
by management. Impacts of these types of changes on the
company’s pension plans in other countries worldwide would
vary depending upon the status of each respective plan.

In addition to the above, the company evaluates other pension
assumptions involving demographic factors, such as retirement
age and mortality, and updates these assumptions to reflect
experience and expectations for the future. Actual results in
any given year can differ from actuarial assumptions because of
economic and other factors.

For additional information on the company’s pension plans and
the development of these assumptions, see note T, “Retirement-
Related Benefits,” on pages 127 to 141.

Revenue Recognition
Application of GAAP related to the measurement and recognition
of revenue requires the company to make judgments and
estimates. Specifically, complex arrangements with nonstandard
terms and conditions may require significant contract
interpretation to determine the appropriate accounting, including
whether promised goods and services specified in an arrangement
are distinct performance obligations. Other significant judgments
include determining whether IBM or a reseller is acting as the
principal in a transaction and whether separate contracts should
be combined and considered part of one arrangement.

Revenue recognition is also impacted by the company’s ability
to determine when a contract is probable of collection and to
estimate variable consideration, including, for example, rebates,
volume discounts, service-level penalties, and performance
bonuses. The company considers various factors when making
these judgments, including a review of specific transactions,
historical experience and market and economic conditions.
Evaluations are conducted each quarter to assess the adequacy
of the estimates. If the estimates were changed by 10 percent
in 2018, the impact on net income would have been immaterial.

Costs to Complete Service Contracts
The company enters into numerous service contracts through
its services businesses. During the contractual period,
revenue, cost and profits may be impacted by estimates of the
ultimate profitability of each contract, especially contracts for
which the company uses cost-to-cost measures of progress
(i.e. percentage-of-completion (POC) method of accounting). If
at any time these estimates indicate the POC contract will be
unprofitable, the entire estimated loss for the remainder of the
contract is recorded immediately in cost. The company performs
ongoing profitability analyses of its POC-based services contracts
in order to determine whether the latest estimates require
updating. Key factors reviewed by the company to estimate the
future costs to complete each contract are future labor costs and
product costs and expected productivity efficiencies. Contract
loss provisions recorded as a component of other accrued
expenses and liabilities were $24 million and $25 million at
December 31, 2018 and 2017, respectively.

Income Taxes
The company is subject to income taxes in the U.S. and numerous
foreign jurisdictions. Significant judgments are required in
determining the consolidated provision for income taxes.

During the ordinary course of business, there are many
transactions and calculations for which the ultimate tax
determination is uncertain. As a result, the company recognizes
tax liabilities based on estimates of whether additional taxes and
interest will be due. These tax liabilities are recognized when,
despite the company’s belief that its tax return positions are
supportable, the company believes that certain positions may not
be fully sustained upon review by tax authorities. The company
believes that its accruals for tax liabilities are adequate for all open
audit years based on its assessment of many factors, including
past experience and interpretations of tax law. This assessment
relies on estimates and assumptions, and may involve a series
of complex judgments about future events. To the extent that
new information becomes available which causes the company
to change its judgment regarding the adequacy of existing tax
liabilities, such changes to tax liabilities will impact income tax
expense in the period in which such determination is made.

Significant judgment is also required in determining any valuation
allowance recorded against deferred tax assets. In assessing
the need for a valuation allowance, management considers all
available evidence for each jurisdiction including past operating
results, estimates of future taxable income and the feasibility of
ongoing tax planning strategies. In the event that the company
changes its determination as to the amount of deferred tax
assets that can be realized, the company will adjust its valuation
allowance with a corresponding impact to income tax expense in
the period in which such determination is made.

The consolidated provision for income taxes will change period
to period based on nonrecurring events, such as the settlement
of income tax audits and changes in tax laws, as well as recurring
factors including the geographic mix of income before taxes,
state and local taxes and the effects of various global income
tax strategies.

Management Discussion International Business Machines Corporation and Subsidiary Companies65

To the extent that the provision for income taxes increases/
decreases by 1 percent of income from continuing operations
before income taxes, consolidated net income would have
decreased/improved by $113 million in 2018.

Valuation of Assets
The application of business combination and impairment
accounting requires the use of significant estimates and
assumptions. The acquisition method of accounting for business
combinations requires the company to estimate the fair value
of assets acquired including separately identifiable intangible
assets, liabilities assumed, and any noncontrolling interest in
the acquiree to properly allocate purchase price consideration.
Impairment testing for assets, other than goodwill and indefinite-
lived intangible assets, requires the allocation of cash flows to
those assets or group of assets and if required, an estimate of fair
value for the assets or group of assets. The company’s estimates
are based upon assumptions believed to be reasonable, but which
are inherently uncertain and unpredictable. These valuations
require the use of management’s assumptions, which would not
reflect unanticipated events and circumstances that may occur.

Valuation of Goodwill
The company reviews goodwill for impairment annually and
whenever events or changes in circumstances indicate the
carrying value of goodwill may not be recoverable. In 2018,
the company assessed the qualitative risk factors to determine
whether it is more likely than not that the fair value of a reporting
unit is less than its carrying amount.

The company assesses qualitative factors in each of its
reporting units that carry goodwill including relevant events
and circumstances that affect the fair value of reporting units.
Examples include, but are not limited to, macroeconomic,
industry and market conditions, as well as other individual factors
such as:

•

A loss of key personnel;

•

A significant adverse shift in the operating environment of
the reporting unit such as unanticipated competition;

•

A significant pending litigation;

•

A more likely than not expectation that a reporting unit or a
significant portion of a reporting unit will be sold or otherwise
disposed of; and

•

An adverse action or assessment by a regulator.

The company assesses these qualitative factors to determine
whether it is necessary to perform the two-step quantitative
goodwill impairment test. This quantitative test is required only
if the company concludes that it is more likely than not that a
reporting unit’s fair value is less than its carrying amount. After
performing the annual goodwill impairment qualitative analysis
during the fourth quarter of 2018, the company determined it was
not necessary to perform the two-step goodwill impairment test.

Loss Contingencies
The company is currently involved in various claims and legal
proceedings. At least quarterly, the company reviews the status
of each significant matter and assesses its potential financial
exposure. If the potential loss from any claim or legal proceeding is
considered probable and the amount can be reasonably estimated,
the company accrues a liability for the estimated loss. Significant
judgment is required in both the determination of probability
and the determination as to whether an exposure is reasonably
estimable. Because of uncertainties related to these matters,
accruals are based only on the best information available at the
time. As additional information becomes available, the company
reassesses the potential liability related to its pending claims and
litigation, and may revise its estimates. These revisions in the
estimates of the potential liabilities could have a material impact
on the company’s results of operations and financial position.

Global Financing Receivables Allowance for Credit Losses
The Global Financing business reviews its financing receivables
port folio on a regular basis in order to assess collectibility and
records adjustments to the allowance for credit losses at least
quarterly. A description of the methods used by management
to estimate the amount of uncollectible receivables is included
in note A, “Significant Accounting Policies,” on pages 76 to 88.
Factors that could result in actual receivable losses that are
materially different from the estim ated reserve include significant
changes in the economy, or a sudden change in the economic
health of a significant client that represents a concentration in
Global Financing’s receivables portfolio.

To the extent that actual collectibility differs from management’s
estimates currently provided for by 10 percent, Global
Financing’s segment pre-tax income and the company’s income
from continuing operations before income taxes would be higher
or lower by an estimated $29 million depending upon whether
the actual collectibility was better or worse, respectively, than
the estimates.

Residual Value
Residual value represents the estimated fair value of equipment
under lease as of the end of the lease. Residual value estimates
impact the determination of whether a lease is classified as
operating or capital. Global Financing 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 technological innovations. Residual value estimates are
periodically reviewed and “other than temporary” declines
in estimated future residual values are recognized upon
identification. Anticipated increases in future residual values
are not recognized until the equipment is remarketed.

Factors that could cause actual results to materially differ from
the estimates include significant changes in the used-equipment
market brought on by unforeseen changes in technology innovations
and any resulting changes in the useful lives of used equipment.

Management Discussion International Business Machines Corporation and Subsidiary Companies66

To the extent that actual residual value recovery is lower than
management’s estimates by 10 percent, Global Financing’s
segment pre-tax income and the company’s income from
continuing operations before income taxes for 2018 would have
been lower by an estimated $70 million. If the actual residual
value recovery is higher than management’s estimates, the
increase in income will be realized at the end of lease when the
equipment is remarketed.

Currency Rate Fluctuations
Changes in the relative values of non-U.S. currencies to the
U.S. dollar affect the company’s financial results and financial
position. At December 31, 2018, currency changes resulted
in assets and liabilities denominated in local currencies being
translated into fewer dollars than at year-end 2017. The company
uses financial hedging instruments to limit specific currency risks
related to financing transactions and other foreign currency-
based transactions.

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

The company translates revenue, cost and expense in its non-
U.S. operations at current exchange rates in the reported period.
References to “adjusted for currency” or “constant currency”
reflect adjustments based upon a simple mathematical formula.
However, this constant currency methodology that the company
utilizes to disclose this information does not incorporate any
operational actions that management could take to mitigate
fluctuating currency rates. Currency movements impacted the
company’s year-to-year revenue and earnings per share growth
in 2018. Based on the currency rate movements in 2018, total
revenue increased 0.6 percent as reported and was flat at
constant currency versus 2017. On an income from continuing
operations before income taxes basis, these translation impacts
offset by the net impact of hedging activities resulted in a
theoretical maximum (assuming no pricing or sourcing actions)
increase of approximately $300 million in 2018, on both an
as-reported basis and operating (non-GAAP) basis. The same
mathematical exercise resulted in an increase of approximately
$100 million in 2017 on an as-reported basis and an operating
(non-GAAP) basis. The company views these amounts as
a theoretical maximum impact to its as-reported financial
results. Considering the operational responses mentioned
above, movements of exchange rates, and the nature and timing
of hedging instruments, it is difficult to predict future currency
impacts on any particular period, but the company believes it
could be substantially less than the theoretical maximum given
the competitive pressure in the marketplace.

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

During 2018 there were reported economic events impacting
the Argentinean economy, such as significant depreciation
of the Argentine peso, increases in interest rates and the
Argentine government requesting financial assistance from the
International Monetary Fund. The three-year cumulative inflation
rates, using a combination of monthly indices, exceeded the 100
percent threshold for hyperinflation. As a result, effective July 1,
2018, the company changed the functional currency from local
currency to U.S. dollar functional for Argentina with no material
impact. The ongoing impact from the change is not expected to
be material given the size of the company’s operations in the
country (less than 1 percent of total 2018 revenue).

Market Risk
In the normal course of business, the financial position of
the company is routinely subject to a variety of risks. In
addition to the market risk associated with interest rate and
currency movements on outstanding debt and non-U.S. dollar
denominated assets and liabilities, other examples of risk include
collectibility of accounts receivable and recoverability of residual
values on leased assets.

The company regularly assesses these risks and has established
policies and business practices to protect against the adverse
effects of these and other potential exposures. As a result, the
company does not anticipate any material losses from these risks.

The company’s debt, in support of the Global Financing business
and the geographic breadth of the company’s operations,
contains an element of market risk from changes in interest and
currency rates. The company manages this risk, in part, through
the use of a variety of financial instruments including derivatives,
as described in note D, “Financial Instruments—Derivative
Financial Instruments,” on pages 97 to 102.

To meet disclosure requirements, the company performs a
sensitivity analysis to determine the effects that market risk
exposures may have on the fair values of the company’s debt
and other financial instruments.

The financial instruments that are included in the sensitivity
analysis are comprised of the company’s cash and cash
equivalents, marketable securities, short-term and long-term
loans, commercial financing and installment payment receivables,
investments, long-term and short-term debt and derivative
financial instruments. The company’s derivative financial
instruments generally include interest rate swaps, foreign
currency swaps and forward contracts.

Management Discussion International Business Machines Corporation and Subsidiary Companies67

To perform the sensitivity analysis, the company assesses the risk of
loss in fair values from the effect of hypothetical changes in interest
rates and foreign currency exchange rates on market-sensitive
instruments. The market values for interest and foreign currency
exchange risk are computed based on the present value of future
cash flows as affected by the changes in rates that are attributable
to the market risk being measured. The discount rates used for the
present value computations were selected based on market interest
and foreign currency exchange rates in effect at December 31, 2018
and 2017. The differences in this comparison are the hypothetical
gains or losses associated with each type of risk.

Information provided by the sensitivity analysis does not
necessarily represent the actual changes in fair value that the
company would incur under normal market conditions because,
due to practical limitations, all variables other than the specific
market risk factor are held constant. In addition, the results
of the model are constrained by the fact that certain items
are specifically excluded from the analysis, while the financial
instruments relating to the financing or hedging of those items
are included by definition. Excluded items include short-term
and long-term receivables from sales-type and direct financing
leases, forecasted foreign currency cash flows and the company’s
net investment in foreign operations. As a consequence, reported
changes in the values of some of the financial instruments
impacting the results of the sensitivity analysis are not matched
with the offsetting changes in the values of the items that those
instruments are designed to finance or hedge.

The results of the sensitivity analysis at December 31, 2018 and
2017, are as follows:

Interest Rate Risk
At December 31, 2018, a 10 percent decrease in the levels
of interest rates with all other variables held constant would
result in a decrease in the fair value of the company’s financial
instruments of $422 million as compared with a decrease of
$201 million at December 31, 2017. A 10 percent increase in
the levels of interest rates with all other variables held constant
would result in an increase in the fair value of the company’s
financial instruments of $408 million as compared to an increase
of $232 million at December 31, 2017. Changes in the relative
sensitivity of the fair value of the company’s financial instrument
portfolio for these theoretical changes in the level of interest
rates are primarily driven by changes in the company’s debt
maturities, interest rate profile and amount.

Foreign Currency Exchange Rate Risk
At December 31, 2018, a 10 percent weaker U.S. dollar against
foreign currencies, with all other variables held constant, would
result in an increase in the fair value of the company’s financial
instruments of $697 million as compared with an increase of
$363 million at December 31, 2017. Conversely, a 10 percent
stronger U.S. dollar against foreign currencies, with all other
variables held constant, would result in a decrease in the fair
value of the company’s financial instruments of $697 million
compared with a decrease of $363 million at December 31, 2017.

Financing Risks
See the “Description of Business” on page 25 for a discussion of
the financing risks associated with the Global Financing business
and management’s actions to mitigate such risks.

Cybersecurity
While cybersecurity risk can never be completely eliminated, the
company’s approach draws on the depth and breadth of its global
capabilities, both in terms of its offerings to clients and its internal
approaches to risk management. The company offers commercial
solutions that deliver capabilities in areas such as identity and
access management, data security, application security, network
security and endpoint security. IBM’s solutions include pervasive
encryption, security intelligence, analytics, cognitive and artificial
intelligence, and forensic tools that can process information on
customer IT security events and vulnerabilities and provide
detailed information to customers about potential threats and
security posture. The company also offers professional consulting
and technical services solutions for security from assessment
and incident response to deployment and resource augmentation.
In addition, the company offers managed and outsourced
security solutions from multiple security operations centers
around the world. Finally, security is embedded in a multitude
of IBM products and offerings through secure engineering and
operations, and by critical functions (encryption, access control,
etc.) in servers, storage, software, services and other solutions.

From an enterprise perspective, IBM implements a multi-faceted
risk-management approach to identify and address cybersecurity
risks. The company has established policies and procedures that
provide the foundation upon which IBM’s infrastructure and data
are managed. IBM performs ongoing assessments regarding its
technical controls and its methods for identifying emerging risks
related to cybersecurity. The company uses a layered approach
with overlapping controls to defend against cybersecurity attacks
and threats on networks, end-user devices, servers, applications,
data and cloud solutions. The company also has a security
monitoring program and a global incident response process to
respond to cybersecurity threats and attacks. In addition, the
company utilizes a combination of online training, educational
tools, videos and other awareness initiatives to foster a culture
of security awareness and responsibility among its workforce.

Employees and Related Workforce

(In thousands)

For the year ended December 31:

IBM/wholly owned subsidiaries

Less-than-wholly owned subsidiaries

Complementary

2018

350.6

9.4

21.1

As a globally integrated enterprise, the company operates in
more than 175 countries and is continuing to shift its business
to the higher value segments of enterprise IT. The company
continues to remix its skills and people needs to match the best
opportunities in the marketplace.

The complementary workforce is an approximation of equivalent
full-time employees hired under temporary, part-time and
limited-term employment arrangements to meet specific
business needs in a flexible and cost-effective manner.

Management Discussion International Business Machines Corporation and Subsidiary Companies68

Report of Management
International Business Machines Corporation and Subsidiary Companies

Management Responsibility
for Financial Information
Responsibility for the integrity and objectivity of the financial
information presented in this Annual Report rests with IBM
management. The accompanying financial statements have been
prepared in accordance with accounting principles generally
accepted in the United States of America, applying certain
estimates and judgments as required.

IBM maintains an effective internal control structure. It consists,
in part, of organizational arrangements with clearly defined lines
of responsibility and delegation of authority, and comprehensive
systems and control procedures. An important element of the
control environment is an ongoing internal audit program. Our
system also contains self-monitoring mechanisms, and actions
are taken to correct deficiencies as they are identified.

To assure the effective administration of internal controls,
we carefully select and train our employees, develop and
disseminate written policies and procedures, provide appropriate
communication channels and foster an environment conducive to
the effective functioning of controls. We believe that it is essential
for the company to conduct its business affairs in accordance
with the highest ethical standards, as set forth in the IBM
Business Conduct Guidelines. These guidelines, translated into
numerous languages, are distributed to employees throughout
the world, and reemphasized through internal programs to assure
that they are understood and followed.

The Audit Committee of the Board of Directors is composed
solely of independent, non-management directors, and is
responsible for recommending to the Board the independent
registered public accounting firm to be retained for the coming
year, subject to stockholder ratification. The Audit Committee
meets regularly and privately with the independent registered
public accounting firm, with the company’s internal auditors, as
well as with IBM management, to review accounting, auditing,
internal control structure and financial reporting matters.

Management’s Report on Internal Control
Over Financial Reporting
Management is responsible for establishing and maintaining
adequate internal control over financial reporting of the company.
Internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial
reporting and the preparation of financial statements for external
purposes in accordance with accounting principles generally
accepted in the United States of America.

The company’s internal control over financial reporting includes
those policies and procedures that (i) pertain to the maintenance
of records that, in reasonable detail, accurately and fairly reflect
the transactions and dispositions of the assets of the company;
(ii) provide reasonable assurance that transactions are recorded
as necessary to permit preparation of financial statements in
accordance with accounting principles generally accepted in the
United States of America, and that receipts and expenditures
of the company are being made only in accordance with
authorizations of management and directors of the company;
and (iii) provide reasonable assurance regarding prevention or
timely detection of unauthorized acquisition, use, or disposition
of the company’s assets that could have a material effect on the
financial statements.

Because of its inherent limitations, internal control over
financial reporting may not prevent or detect misstatements.
Also, projections of any evaluation of effectiveness to future
periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree
of compliance with the policies or procedures may deteriorate.

Management conducted an evaluation of the effectiveness of
internal control over financial reporting based on the criteria
established in Internal Control—Integrated Framework (2013)
issued by the Committee of Sponsoring Organizations of the
Treadway Commission (COSO). Based on this evaluation,
management concluded that the company’s internal control
over financial reporting was effective as of December 31, 2018.

PricewaterhouseCoopers LLP, an independent registered public
accounting firm, is retained to audit IBM’s Consolidated Financial
Statements and the effectiveness of the internal control over
financial reporting. Its accompanying report is based on audits
conducted in accordance with the standards of the Public
Company Accounting Oversight Board (United States).

Virginia M. Rometty
Chairman, President and Chief Executive Officer
February 26, 2019

James J. Kavanaugh
Senior Vice President and Chief Financial Officer
February 26, 2019

Report of Independent Registered Public Accounting Firm
International Business Machines Corporation and Subsidiary Companies

To the Board of Directors and Stockholders of
International Business Machines Corporation:

Opinions on the Financial Statements and Internal Control
Over Financial Reporting
We have audited the accompanying Consolidated Statement of
Financial Position of International Business Machines Corporation
and its subsidiaries (the “Company”) as of December 31, 2018
and 2017, and the related Consolidated Statements of Earnings,
Comprehensive Income, Changes in Equity, and Cash Flows
for each of the three years in the period ended December 31,
2018, including the related notes (collectively referred to as
the “consolidated financial statements”). We also have audited
the Company’s internal control over financial reporting as of
December 31, 2018, based on criteria established in Internal
Control—Integrated Framework (2013) issued by the Committee
of Sponsoring Organizations of the Treadway Commission (COSO).

In our opinion, the consolidated financial statements referred to
above present fairly, in all material respects, the financial position
of the Company as of December 31, 2018 and 2017, and the
results of its operations and its cash flows for each of the three
years in the period ended December 31, 2018 in conformity with
accounting principles generally accepted in the United States
of America. Also in our opinion, the Company maintained, in all
material respects, effective internal control over financial reporting
as of December 31, 2018, based on criteria established in Internal
Control—Integrated Framework (2013) issued by the COSO.

Basis for Opinions
The Company ’s management is responsible for these
consolidated financial statements, for maintaining effective
internal control over financial reporting, and for its assessment
of the effectiveness of internal control over financial reporting,
included in the accompanying Management’s Report on
Internal Control over Financial Reporting appearing on page
68. Our responsibility is to express opinions on the Company’s
consolidated financial statements and on the Company’s internal
control over financial reporting based on our audits. We are a
public accounting firm registered with the Public Company
Accounting Oversight Board (United States) (PCAOB) and
are required to be independent with respect to the Company
in accordance with the U.S. federal securities laws and the
applicable rules and regulations of the Securities and Exchange
Commission and the PCAOB.

We conducted our audits in accordance with the standards of
the PCAOB. Those standards require that we plan and perform
the audits to obtain reasonable assurance about whether
the consolidated financial statements are free of material
misstatement, whether due to error or fraud, and whether
effective internal control over financial reporting was maintained
in all material respects.

Our audits of the consolidated financial statements included
performing procedures to assess the risks of material
misstatement of the consolidated financial statements, whether
due to error or fraud, and performing procedures that respond
to those risks. Such procedures included examining, on a test
basis, evidence regarding the amounts and disclosures in the
consolidated financial statements. Our audits also included
evaluating the accounting principles used and significant
estimates made by management, as well as evaluating the
overall presentation of the consolidated financial statements.
Our audit of internal control over financial reporting included
obtaining an understanding of internal control over financial
reporting, assessing the risk that a material weakness exists, and
testing and evaluating the design and operating effectiveness
of internal control based on the assessed risk. Our audits also
included performing such other procedures as we considered
necessary in the circumstances. We believe that our audits
provide a reasonable basis for our opinions.

Definition and Limitations of Internal Control over
Financial Reporting
A company’s internal control over financial reporting is a process
designed to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of financial
statements for external purposes in accordance with generally
accepted accounting principles. A company’s internal control
over financial reporting includes those policies and procedures
that (i) pertain to the maintenance of records that, in reasonable
detail, accurately and fairly reflect the transactions and
dispositions of the assets of the company; (ii) provide reasonable
assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with
generally accepted accounting principles, and that receipts and
expenditures of the company are being made only in accordance
with authorizations of management and directors of the company;
and (iii) provide reasonable assurance regarding prevention or
timely detection of unauthorized acquisition, use, or disposition
of the company’s assets that could have a material effect on the
financial statements.

PricewaterhouseCoopers LLP
New York, New York
February 26, 2019

We, or firms that we have ultimately acquired, have served as
the Company’s auditor since 1923. For the period from 1923 to
1958, the Company was audited by firms that a predecessor firm
to PricewaterhouseCoopers LLP ultimately acquired.

Consolidated Statement of Earnings
International Business Machines Corporation and Subsidiary Companies

($ in millions except per share amounts)

For the year ended December 31:

Revenue

Services

Sales

Financing

Total revenue

Cost

Services

Sales

Financing

Total cost

Gross profit

Expense and other (income)

Selling, general and administrative

Research, development and engineering

Intellectual property and custom development income

Other (income) and expense

Interest expense

Total expense and other (income)

Income from continuing operations before income taxes

Provision for income taxes

Income from continuing operations

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

Net income

Earnings/(loss) per share of common stock

Assuming dilution

Continuing operations

Discontinued operations

Total

Basic

Continuing operations

Discontinued operations

Total

Weighted-average number of common shares outstanding

Assuming dilution

Basic

Notes

2018

2017

2016

$51,350

$50,709

$51,268

D&J

26,641

1,599

79,591

34,059

7,464

1,132

42,655

36,936

19,366

5,379

(1,026)

1,152

723

25,594

11,342

2,619

8,723

26,715

1,715

79,139

26,942

1,710

79,919

33,811*

33,792*

7,175*

1,210

42,196*

36,943*

19,680*

5,590*

(1,466)

1,125*

615

25,543*

11,400

5,642

5,758

(5)

6,566*

1,044

41,403*

38,516*

20,869*

5,726*

(1,631)

593*

630

26,186*

12,330

449

11,881

(9)

$ 8,728

$ 5,753

$11,872

$ 9.51

$ 6.14

$ 12.39

0.01

0.00

(0.01)

$ 9.52

$ 6.14

$ 12.38

$ 9.56

$ 6.17

$ 12.44

0.01

0.00

(0.01)

$ 9.57

$ 6.17

$ 12.43

916,315,714

937,385,625

958,714,097

912,048,072

932,828,295

955,422,530

* Recast to reflect adoption of the FASB guidance on presentation of net periodic pension and nonpension postretirement benefit costs.
Amounts may not add due to rounding.

The accompanying notes on pages 76 through 146 are an integral part of the financial statements.

Consolidated Statement of Comprehensive Income
International Business Machines Corporation and Subsidiary Companies

($ in millions)

For the year ended December 31:

Net income

Other comprehensive income/(loss), before tax

Foreign currency translation adjustments

Net changes related to available-for-sale securities

Unrealized gains/(losses) arising during the period

Reclassification of (gains)/losses to net income

Total net changes related to available-for-sale securities

Unrealized gains/(losses) on cash flow hedges

Unrealized gains/(losses) arising during the period

Reclassification of (gains)/losses to net income

Total unrealized gains/(losses) on cash flow hedges

Retirement-related benefit plans

Prior service costs/(credits)

Net (losses)/gains arising during the period

Curtailments and settlements

Amortization of prior service (credits)/costs

Amortization of net (gains)/losses

Total retirement-related benefit plans

Other comprehensive income/(loss), before tax

Income tax (expense)/benefit related to items

of other comprehensive income

Other comprehensive income/(loss)

Total comprehensive income

Amounts may not add due to rounding.

Notes

2018

$ 8,728

2017

$5,753

2016

$11,872

(730)

152

(20)

(38)

(3)

243

102

345

—

(2,490)

(16)

(107)

2,764

150

472

(58)

(363)

(421)

682

(88)

2,889

3,502

3,235

(429)

2,806

$8,559

(263)

209

$12,081

(2)

—

(2)

(136)

449

313

(182)

(2,517)

(73)

2,966

204

(215)

(262)

(476)

$ 8,252

The accompanying notes on pages 76 through 146 are an integral part of the financial statements.

Consolidated Statement of Financial Position
International Business Machines Corporation and Subsidiary Companies

($ in millions except per share amounts)

At December 31:

Assets

Current assets

Cash and cash equivalents

Restricted cash

Marketable securities

Notes and accounts receivable—trade (net of allowances of

$309 in 2018 and $297 in 2017)

Short-term financing receivables (net of allowances of $244 in 2018 and $261 in 2017)

Other accounts receivable (net of allowances of $38 in 2018 and $36 in 2017)

Inventories

Deferred costs

Prepaid expenses and other current assets

Total current assets

Property, plant and equipment

Less: Accumulated depreciation

Property, plant and equipment—net

Long-term financing receivables (net of allowances of $48 in 2018 and $74 in 2017)

Prepaid pension assets

Deferred costs

Deferred taxes

Goodwill

Intangible assets—net

Investments and sundry assets

Total assets

Liabilities and equity

Current liabilities

Taxes

Short-term debt

Accounts payable

Compensation and benefits

Deferred income

Other accrued expenses and liabilities

Total current liabilities

Long-term debt

Retirement and nonpension postretirement benefit obligations

Deferred income

Other liabilities

Total liabilities

Contingencies and commitments

Equity

IBM stockholders’ equity

Notes

2018

2017

$ 11,379

$ 11,972

225

618

7,432

22,388

743

1,682

2,300

2,378

49,146

32,460

21,668

10,792

9,148

4,666

2,676

5,216

36,265

3,087

2,386

262*

608

8,928

21,721

981

1,583

1,820**

1,860* **

49,735

32,331

21,215

11,116

9,550

4,643

2,136**

4,862

36,788

3,742

2,783**

$ 123,382

$ 125,356

$ 3,046

$ 4,219

10,207

6,558

3,310

11,165

3,941

38,227

35,605

17,002

3,445

12,174

6,987

6,451

3,644

11,552

4,510

37,363

39,837

16,720

3,746

9,965

106,452

107,631

D&J

Common stock, par value $.20 per share, and additional paid-in capital

55,151

54,566

Shares authorized: 4,687,500,000

Shares issued (2018—2,233,427,058; 2017—2,229,428,813)

Retained earnings

Treasury stock, at cost (shares: 2018—1,340,947,648; 2017—1,307,249,588)

Accumulated other comprehensive income/(loss)

Total IBM stockholders’ equity

Noncontrolling interests

Total equity

Total liabilities and equity

**Recast to reflect adoption of the FASB guidance on restricted cash.
**Recast to conform to current period presentation.
Amounts may not add due to rounding.

The accompanying notes on pages 76 through 146 are an integral part of the financial statements.

159,206

153,126

(168,071)

(163,507)

(29,490)

16,796

134

16,929

(26,592)

17,594

131

17,725

$ 123,382

$ 125,356

Consolidated Statement of Cash Flows
International Business Machines Corporation and Subsidiary Companies

($ in millions)

For the year ended December 31:

Cash flows from operating activities

Net income

Adjustments to reconcile net income to cash provided by operating activities

Depreciation

Amortization of intangibles

Stock-based compensation

Deferred taxes

Net (gain)/loss on asset sales and other

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

Receivables (including financing receivables)

Retirement related

Inventories

Other assets/other liabilities

Accounts payable

Net cash provided by operating activities

Cash flows from investing activities

Payments for property, plant and equipment

Proceeds from disposition of property, plant and equipment

Investment in software

Purchases of marketable securities and other investments

Proceeds from disposition of marketable securities and other investments

Non-operating finance receivables—net

Acquisition of businesses, net of cash acquired

Divestiture of businesses, net of cash transferred

Net cash used in investing activities

Cash flows from financing activities

Proceeds from new debt

Payments to settle debt

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

Common stock repurchases

Common stock repurchases for tax withholdings

Financing—other

Cash dividends paid

Net cash used in financing activities

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

Net change in cash, cash equivalents and restricted cash

Cash, cash equivalents and restricted cash at January 1

2018

2017

2016

$ 8,728

$ 5,753

$11,872

3,127

1,353

510

853

123

1,006

1,368

(127)

(1,819)

126

15,247

3,021

1,520

534

(931)

1,297

1,014

4,437

2,837

1,544

544

(1,132)

712

(14)

408

197

16,724

17,084

(3,395)

(3,229)

(3,567)

248

(569)

(7,041)

6,487

(503)

(139)

—

460

(544)

424

(583)

(4,949)*

(5,853)*

3,910

(2,028)

(496)

(205)

5,692

(891)

(5,696)*

(454)

(4,913)

(7,081)*

(10,928)*

6,891

(8,533)

1,341

(4,443)

(171)

111

(5,666)

(10,469)

(495)

(630)

12,234

9,643

(6,816)

620

9,132

(6,395)

(4,340)

(3,502)

(193)

175

(5,506)

(6,418)

937

4,161*

8,073*

(126)

204

(5,256)

(5,917)

(51)

188*

7,885*

Cash, cash equivalents and restricted cash at December 31

$ 11,604

$12,234*

$ 8,073*

Supplemental data

Income taxes paid—net of refunds received

Interest paid on debt

$ 1,745

$ 1,423

$ 1,597

$ 1,208

$ 1,078

$ 1,158

* Recast to reflect adoption of the FASB guidance on restricted cash.

Amounts may not add due to rounding.

The accompanying notes on pages 76 through 146 are an integral part of the financial statements.

Consolidated Statement of Changes in Equity
International Business Machines Corporation and Subsidiary Companies

($ in millions)

2016

Common
Stock and
Additional
Paid-In Capital

Retained
Earnings

Treasury
Stock

Accumulated
Other
Comprehensive
Income/(Loss)

Total IBM
’
Stockholders
Equity

Non-
Controlling
Interests

Total
Equity

Equity, January 1, 2016

$53,262

$146,124

$(155,518)

$(29,607)

$14,262

$162

$14,424

Net income plus other

comprehensive income/(loss)

Net income

Other comprehensive

income/(loss)

Total comprehensive income/(loss)

Cash dividends paid—

11,872

209

$12,081

11,872

209

$12,081

common stock ($5.50 per share)

(5,256)

695

Common stock issued under

employee plans
(3,893,366 shares)

Purchases (854,365 shares)

and sales (383,077 shares)
of treasury stock under
employee plans—net

Other treasury shares purchased,
not retired (23,283,400 shares)

Changes in other equity

(22)

Changes in noncontrolling interests

(77)

(3,455)

(59)

(3,455)

(22)

(59)

(3,455)

(22)

(16)

Equity, December 31, 2016

$53,935

$152,759

$(159,050)

$(29,398)

$18,246

$146

$18,392

Amounts may not add due to rounding.

The accompanying notes on pages 76 through 146 are an integral part of the financial statements.

($ in millions)

2017

Common
Stock and
Additional
Paid-In Capital

Retained
Earnings

Treasury
Stock

Accumulated
Other
Comprehensive
Income/(Loss)

Total IBM
’
Stockholders
Equity

Non-
Controlling
Interests

Total
Equity

Equity, January 1, 2017

$53,935

$152,759

$(159,050)

$(29,398)

$18,246

$146

$18,392

Cumulative effect of change in

accounting principle*

Net income plus other

comprehensive income/(loss)

Net income

Other comprehensive

income/(loss)

Total comprehensive income/(loss)

Cash dividends paid—

102

5,753

102

5,753

2,806

$ 8,559

102

5,753

2,806

$ 8,559

common stock ($5.90 per share)

(5,506)

Common stock issued under

employee plans
(4,311,998 shares)

Purchases (1,226,080 shares)
and sales (463,083 shares)
of treasury stock under
employee plans—net

Other treasury shares purchased,
not retired (27,237,179 shares)

Changes in other equity

Changes in noncontrolling interests

631

(134)

(4,323)

(116)

(4,323)

(116)

(4,323)

(15)

Equity, December 31, 2017

$54,566

$153,126

$(163,507)

$(26,592)

$17,594

$131

$17,725

* Reflects the adoption of the FASB guidance on intra-entity transfers of assets.

Amounts may not add due to rounding.

The accompanying notes on pages 76 through 146 are an integral part of the financial statements.

Consolidated Statement of Changes in Equity
International Business Machines Corporation and Subsidiary Companies

($ in millions)

2018

Common
Stock and
Additional
Paid-In Capital

Retained
Earnings

Treasury
Stock

Accumulated
Other
Comprehensive
Income/(Loss)

Total IBM
’
Stockholders
Equity

Non-
Controlling
Interests

Total
Equity

Equity, January 1, 2018

$54,566

$153,126

$(163,507)

$(26,592)

$17,594

$131

$17,725

Cumulative effect of changes in

accounting principle

Revenue*

Stranded tax effects/other*

Net income plus other

comprehensive income/(loss)

Net income

Other comprehensive

income/(loss)

Total comprehensive income/(loss)

Cash dividends paid—

580

2,422

8,728

580

(2,422)

8,728

(476)

$ 8,252

(476)

$ 8,252

common stock ($6.21 per share)

(5,666)

585

Common stock issued under

employee plans
(3,998,245 shares)

Purchases (1,173,416 shares)
and sales (424,589 shares)
of treasury stock under
employee plans—net

Other treasury shares purchased,
not retired (32,949,233 shares)

Changes in other equity

Changes in noncontrolling interests

(117)

(4,447)

(103)

(4,447)

(103)

(4,447)

Equity, December 31, 2018

$55,151

$159,206

$(168,071)

$(29,490)

$16,796

$134

$16,929

* Reflects the adoption of FASB guidance. Refer to note B, “Accounting Changes.”

Amounts may not add due to rounding.

The accompanying notes on pages 76 through 146 are an integral part of the financial statements.

NOTE A. SIGNIFICANT ACCOUNTING POLICIES
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).

Within the financial statements and tables presented, certain
columns and rows may not add due to the use of rounded
numbers for disclosure purposes. Percentages presented are
calculated from the underlying whole-dollar amounts. Certain
prior year amounts have been reclassified to conform to the
current year presentation. This is annotated where applicable.

On December 22, 2017, the Tax Cuts and Jobs Act (U.S. tax
reform) was enacted in the U.S. This Act introduced many
changes, including lowering the U.S. corporate tax rate to 21
percent, changes in incentives, provisions to prevent U.S. base
erosion and significant changes in the taxation of international
income, including provisions which allow for the repatriation of
foreign earnings without U.S. tax.

The enactment of U.S. tax reform resulted in a provisional charge
of $5.5 billion to tax expense in the fourth-quarter and year-
ended December 31, 2017. The charge was primarily the result
of the one-time U.S. transition tax, and any foreign tax costs on
undistributed foreign earnings, as well as the remeasurement
of deferred tax balances to the new U.S. federal tax rate. During
the fourth quarter of 2018, the accounting for impacts of U.S.
tax reform was completed and the effects of measurement
period adjustments were recognized as a charge to tax expense
of $1.9 billion and $2.0 billion in the fourth quarter and year
ended December 31, 2018, respectively. The 2018 charges were
primarily attributable to the election to include Global Intangible
Low-Taxed Income (GILTI) in measuring deferred taxes, in
addition to refinements to the one-time U.S. transition tax and
foreign tax costs on undistributed foreign earnings. Refer to note
N, “Taxes,” on pages 117 to 119 for additional information.

Noncontrolling interest amounts of $17 million, $17 million and $16
million, net of tax, for the years ended December 31, 2018, 2017
and 2016, respectively, are included as a reduction within other
(income) and expense in the Consolidated Statement of Earnings.

Principles of Consolidation
The Consolidated Financial Statements include the accounts of
IBM and its controlled subsidiaries, which are primarily majority
owned. Any noncontrolling interest in the equity of a subsidiary
is reported in Equity in the Consolidated Statement of Financial
Position. Net income and losses attributable to the noncontrolling
interest is reported as described above in the Consolidated
Statement of Earnings. The accounts of variable interest entities

(VIEs) are included in the Consolidated Financial Statements, if
required. Investments in business entities in which the company
does not have control, but has the ability to exercise significant
influence over operating and financial policies, are accounted for
using the equity method and the company’s proportionate share
of income or loss is recorded in other (income) and expense. The
accounting policy for other investments in equity securities is
described on pages 86 and 87 within “Marketable Securities.”
Equity investments in non-publicly traded entities lacking
controlling financial interest or significant influence are primarily
measured at cost, net of impairment, if any. All intercompany
transactions and accounts have been eliminated in consolidation.

Use of Estimates
The preparation of financial statements in conformity with GAAP
requires management to make estimates and assumptions that
affect the amounts of assets, liabilities, revenue, costs, expenses
and other comprehensive income/(loss) (OCI) 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. See “Critical Accounting Estimates” on pages 63
to 66 for a discussion of the company’s critical accounting estimates.

Revenue
Effective January 1, 2018, the company adopted the new
accounting standard related to the recognition of revenue in
contracts with customers under the modified retrospective
transition method. This method was applied to contracts that
were not complete as of the date of initial application. The
impact related to adopting the new standard was not material.
Certain changes resulting from adopting the new standard,
such as terminology differences, impacted the company’s
description of its significant accounting policies in 2018.
For further information regarding the adoption of the new standard,
see note B, “Accounting Changes,” on pages 89 to 91, and
note O, “Revenue Recognition,” on pages 120 to 122.

The company accounts for a contract with a client when it has
written approval, the contract is committed, the rights of the
parties, including payment terms, are identified, the contract has
commercial substance and consideration is probable of collection.

Revenue is recognized when, or as, control of a promised product
or service transfers to a client, in an amount that reflects the
consideration to which the company expects to be entitled
in exchange for transferring those products or services. If
the consideration promised in a contract includes a variable
amount, the company estimates the amount to which it expects
to be entitled using either the expected value or most likely
amount method. The company’s contracts may include terms
that could cause variability in the transaction price, including,
for example, rebates, volume discounts, service-level penalties,
and performance bonuses or other forms of contingent revenue.

Notes to Consolidated Financial Statements International Business Machines Corporation and Subsidiary Companies77

The company only includes estimated amounts in the
transaction price to the extent it is probable that a significant
reversal of cumulative revenue recognized will not occur when
the uncertainty associated with the variable consideration is
resolved. The company may not be able to reliably estimate
contingent revenue in certain long-term arrangements due to
uncertainties that are not expected to be resolved for a long
period of time or when the company’s experience with similar
types of contracts is limited. The company’s arrangements
infrequently include contingent revenue. Estimates of variable
consideration and the determination of whether to include
estimated amounts in the transaction price are based on
all information (historical, current and forecasted) that is
reasonably available to the company, taking into consideration
the type of client, the type of transaction and the specific facts
and circumstances of each arrangement. Changes in estimates
of variable consideration are included in note O, “Revenue
Recognition,” on pages 120 to 122.

The company’s standard billing terms are that payment is due upon
receipt of invoice, payable within 30 days. Invoices are generally
issued as control transfers and/or as services are rendered.
Additionally, in determining the transaction price, the company
adjusts the promised amount of consideration for the effects of
the time value of money if the billing terms are not standard and
the timing of payments agreed to by the parties to the contract
provide the client or the company with a significant benefit
of financing, in which case the contract contains a significant
financing component. As a practical expedient, the company
does not account for significant financing components if the period
between when the company transfers the promised product or
service to the client and when the client pays for that product or
service will be one year or less. Most arrangements that contain a
financing component are financed through the company’s Global
Financing business and include explicit financing terms.

The company may include subcontractor services or third-party
vendor equipment or software in certain integrated services
arrangements. In these types of arrangements, revenue from
sales of third-party vendor products or services is recorded
net of costs when the company is acting as an agent between
the client and the vendor, and gross when the company is the
principal for the transaction. To determine whether the company
is an agent or principal, the company considers whether it obtains
control of the products or services before they are transferred
to the customer. In making this evaluation, several factors are
considered, most notably whether the company has primary
responsibility for fulfillment to the client, as well as inventory
risk and pricing discretion.

The company recognizes revenue on sales to solution providers,
resellers and distributors (herein referred to as resellers) when
the reseller has economic substance apart from the company
and the reseller is considered the principal for the transaction
with the end-user client.

The company reports revenue net of any revenue-based taxes
assessed by governmental authorities that are imposed on and
concurrent with specific revenue-producing transactions.

In addition to the aforementioned general policies, the following
are the specific revenue recognition policies for arrangements
with multiple performance obligations and for each major
category of revenue.

Arrangements with Multiple Performance Obligations
The company’s global capabilities as a cognitive solutions and
cloud platform company include services, software, hardware
and related financing. The company enters into revenue
arrangements that may consist of any combination of these
products and services based on the needs of its clients. For
example, a client may purchase a server that includes operating
system software. In addition, the arrangement may include
post-contract support for the software and a contract for post-
warranty maintenance service for the hardware. These types
of arrangements may also include financing provided by the
company. These arrangements consist of multiple products and
services, whereby the hardware and software may be delivered in
one period and the software support and hardware maintenance
services are delivered over time. In another example, the
company may assist the client in building and running an
enterprise information technology (IT) environment utilizing a
private cloud on a long-term basis and the client periodically
purchases hardware and/or software products from the company
to upgrade or expand the facility. The services delivered on
the cloud are provided on a continuous basis across multiple
reporting periods, and the hardware and software products are
provided in each period the products are purchased.

The company continues to build new products and offerings
and continuously reinvent its platforms and delivery methods,
including through the use of cloud and as-a-Service models.
These are not separate businesses; they are offerings across
the segments that address market opportunities in analytics,
data, cloud and security. Revenue from these offerings follows
the specific revenue recognition policies for arrangements with
multiple performance obligations and for each major category of
revenue, depending on the type of offering, which are comprised
of services, hardware and/or software.

To the extent that a product or service in multiple performance
obligation arrangements is subject to other specific accounting
guidance, such as leasing guidance, that product or service is
accounted for in accordance with such specific guidance. For all
other products or services in these arrangements, the criteria
below are considered to determine when the products or services
are distinct and how to allocate the arrangement consideration to
each distinct performance obligation. A performance obligation
is a promise in a contract with a client to transfer products or
services that are distinct. If the company enters into two or

Notes to Consolidated Financial Statements International Business Machines Corporation and Subsidiary Companies78

more contracts at or near the same time, the contracts may
be combined and accounted for as one contract, in which case
the company determines whether the products or services in
the combined contract are distinct. A product or service that is
promised to a client is distinct if both of the following criteria
are met:

with an alternative use and the company has an enforceable right
to payment plus a reasonable profit for performance completed
to date. In most other services arrangements, the performance
obligation is satisfied over time because the client simultaneously
receives and consumes the benefits provided as the company
performs the services.

•

The client can benefit from the product or service either on
its own or together with other resources that are readily
available to the client (that is, the product or service is
capable of being distinct); and

The company’s promise to transfer the product or service to
the client is separately identifiable from other promises in
the contract (that is, the product or service is distinct within
the context of the contract).

If these criteria are not met, the company determines an
appropriate measure of progress based on the nature of
its overall promise for the single performance obligation.
When products and services are distinct, the arrangement
consideration is allocated to each performance obligation on a
relative standalone selling price basis. The revenue policies in
the Services, Hardware and/or Software sections below are then
applied to each performance obligation, as applicable.

To the extent the company grants the customer the option
to acquire additional products or services in one of these
arrangements, the company accounts for the option as a distinct
performance obligation in the contract only if the option provides
a material right to the customer that it would not receive without
entering into the contract (e.g., a discount incremental to the
range of discounts typically given for the product or service), in
which case the client in effect pays in advance for the option to
purchase future products or services. The company recognizes
revenue when those future products or services are transferred
or when the option expires.

Services
The company’s primary services offerings include infrastructure
services, including outsourcing, and other managed services;
application management services; global process services
(GPS); maintenance and support; and consulting, including the
design and development of complex IT systems to a client’s
specifications (e.g., design and build). Many of these services can
be delivered entirely or partially through cloud or as-a-Service
delivery models. The company’s services are provided on a time-
and-material basis, as a fixed-price contract or as a fixed-price
per measure of output contract and the contract terms range
from less than one year to over 10 years.

In services arrangements, the company typically satisfies the
performance obligation and recognizes revenue over time. In
design and build arrangements, the performance obligation is
satisfied over time either because the client controls the asset
as it is created (e.g., when the asset is built at the customer site)
or because the company’s performance does not create an asset

In outsourcing , other managed ser vices, application
management, GPS and other cloud-based services arrangements,
the company determines whether the services performed during
the initial phases of the arrangement, such as setup activities, are
distinct. In most cases, the arrangement is a single performance
obligation comprised of a series of distinct services that are
substantially the same and that have the same pattern of transfer
(i.e., distinct days of service). The company applies a measure
of progress (typically time-based) to any fixed consideration and
allocates variable consideration to the distinct periods of service
based on usage. As a result, revenue is generally recognized over
the period the services are provided on a usage basis. This results
in revenue recognition that corresponds with the value to the
client of the services transferred to date relative to the remaining
services promised.

Revenue from time-and-material contracts is recognized on an
output basis as labor hours are delivered and/or direct expenses
are incurred. Revenue from as-a-Service type contracts, such as
Infrastructure-as-a-Service, is recognized either on a straight-
line basis or on a usage basis, depending on the terms of the
arrangement (such as whether the company is standing ready to
perform or whether the contract has usage-based metrics). If the
as-a-Service contract includes setup activities, those promises in
the arrangement are evaluated to determine if they are distinct.

Revenue related to maintenance and support services and
extended warranty is recognized on a straight-line basis over the
period of performance because the company is standing ready
to provide services.

In fixed-price design and build contracts, revenue is recognized
based on progress toward completion of the performance
obligation using a cost-to-cost measure of progress (i.e.,
percentage-of-completion (POC) method of accounting ).
Revenue is recognized based on the labor costs incurred to
date as a percentage of the total estimated labor costs to fulfill
the contract. Due to the nature of the work performed in these
arrangements, the estimation of cost at completion is complex,
subject to many variables and requires significant judgment.
Key factors reviewed by the company to estimate costs to
complete each contract are future labor and product costs and
expected productivity efficiencies. If circumstances arise that
change the original estimates of revenues, costs, or extent of
progress toward completion, revisions to the estimates are
made. These revisions may result in increases or decreases in
estimated revenues or costs, and such revisions are reflected in
revenue on a cumulative catch-up basis in the period in which the
circumstances that gave rise to the revision become known by
the company. Refer to note O, “Revenue Recognition,” on pages
120 to 122 for the amount of revenue recognized in the reporting
period on a cumulative catch-up basis (i.e., from performance
obligations satisfied, or partially satisfied, in previous periods).

Notes to Consolidated Financial Statements International Business Machines Corporation and Subsidiary Companies79

The company performs ongoing profitability analyses of its
design and build services contracts accounted for using a cost-
to-cost measure of progress in order to determine whether the
latest estimates of revenues, costs and profits require updating.
If at any time these estimates indicate that the contract will be
unprofitable, the entire estimated loss for the remainder of the
contract is recorded immediately. For other types of services
contracts, any losses are recorded as incurred.

In some services contracts, the company bills the client prior
to recognizing revenue from performing the services. Deferred
income of $5,424 million and $5,870 million at December 31,
2018 and 2017, respectively, is included in the Consolidated
Statement of Financial Position. In other services contracts, the
company performs the services prior to billing the client. When
the company performs services prior to billing the client in design
and build contracts, the right to consideration is typically subject
to milestone completion or client acceptance and, beginning
January 1, 2018, the unbilled accounts receivable is classified
as a contract asset. At December 31, 2018 and January 1, 2018,
contract assets for services contracts of $421 million and $471
million, respectively, are included in prepaid expenses and
other current assets in the Consolidated Statement of Financial
Position. The remaining amount of unbilled accounts receivable
of $1,075 million and $1,756 million at December 31, 2018 and
2017, respectively, is included in notes and accounts receivable—
trade in the Consolidated Statement of Financial Position.

Billings usually occur in the month after the company performs
the services or in accordance with specific contractual provisions.

Hardware
The company’s hardware offerings include the sale or lease of
system servers and storage solutions. These products can also
be delivered through as-a-Service or cloud delivery models, such
as Storage-as-a-Service. The company also offers installation
services for its more complex hardware products. Hardware
offerings are often sold with distinct maintenance services,
described under the Services section above.

Revenue from hardware sales is recognized when control has
transferred to the customer which typically occurs when the
hardware has been shipped to the client, risk of loss has transferred
to the client and the company has a present right to payment for
the hardware. In limited circumstances when a hardware sale
includes client acceptance provisions, revenue is recognized either
when client acceptance has been obtained, client acceptance
provisions have lapsed, or the company has objective evidence
that the criteria specified in the client acceptance provisions
have been satisfied. Revenue from hardware sales-type leases
is recognized at the beginning of the lease term. Revenue from
rentals and operating leases is recognized on a straight-line basis
over the term of the rental or lease.

Revenue from as-a-Service arrangements is recognized either
on a straight-line basis or on a usage basis as described in the
Services section above. Installation services are accounted for
as distinct performance obligations with revenue recognized as
the services are performed. Any cost of standard warranties is

accrued when the corresponding revenue is recognized. Shipping
and handling activities that occur after the client has obtained
control of a product are accounted for as an activity to fulfill
the promise to transfer the product rather than as an additional
promised service and, therefore, no revenue is deferred and
recognized over the shipping period.

Software
The company’s software offerings include solutions software,
which contains many of the company’s strategic areas including
analytics, data and security; transaction processing software,
which primarily runs mission-critical systems for clients;
integration software, which helps clients to create, connect and
optimize their applications data and infrastructure; and operating
systems software, which provides operating systems for IBM Z
and Power Systems hardware. Many of these offerings can be
delivered entirely or partially through as-a-Service or cloud
delivery models, while others are delivered as on-premise
software licenses.

Revenue from perpetual (one-time charge) license software is
recognized at a point in time at the inception of the arrangement
when control transfers to the client, if the software license is
distinct from the post-contract support offered by the company.
In limited circumstances, when the software requires continuous
updates to provide the intended functionality, the software license
and post-contract support are not distinct and revenue for the
single performance obligation is recognized over time as the post-
contract support is provided. This is only applicable to certain
security software perpetual licenses offered by the company.
Prior to the adoption of the new revenue standard, the company
recognized revenue for these software licenses at a point in time
at the inception of the arrangement. This change did not have a
material impact on the company’s financial statements.

Revenue from post-contract support is recognized over the
contract term on a straight-line basis because the company is
providing a service of standing ready to provide support, when-
and-if needed, and is providing unspecified software upgrades
on a when-and-if available basis over the contract term.

Revenue from software hosting or Software-as-a-Service
arrangements is recognized either on a straight-line basis or
on a usage basis as described in the Services section above. In
software hosting arrangements, the rights provided to the client
(e.g., ownership of a license, contract termination provisions and
the feasibility of the client to operate the software) are considered
in determining whether the arrangement includes a license. In
arrangements that include a software license, the associated
revenue is recognized in accordance with the software license
recognition policy above rather than over time as a service.

Revenue from term license software is recognized at a point in
time for the committed term of the contract (which is typically one
month due to client termination rights). However, if the amount
of consideration to be paid in exchange for the license depends
on client usage, revenue is recognized when the usage occurs.

Notes to Consolidated Financial Statements International Business Machines Corporation and Subsidiary Companies80

Financing
Financing income attributable to sales-type leases, direct
financing leases and loans is recognized on the accrual basis
using the effective interest method. Operating lease income is
recognized on a straight-line basis over the term of the lease.

Standalone Selling Price
The company allocates the transaction price to each performance
obligation on a relative standalone selling price basis. The
standalone selling price (SSP) is the price at which the company
would sell a promised product or service separately to a client.
In most cases, the company is able to establish SSP based on
the observable prices of products or services sold separately
in comparable circumstances to similar clients. The company
typically establishes a standalone selling price range for its
products and services which are reassessed on a periodic basis
or when facts and circumstances change.

In certain instances, the company may not be able to establish
a SSP range based on observable prices and the company
estimates SSP. The company estimates SSP by considering
multiple factors including, but not limited to, overall market
conditions, including geographic or regional specific factors,
competitive positioning, competitor actions, internal costs,
profit objectives and pricing practices. Additionally, in certain
circumstances, the company may estimate SSP for a product or
service by applying the residual approach. This approach has
been most commonly used when certain perpetual software
licenses are only sold bundled with one year of post-contract
support and a price has not been established for the software.
Estimating SSP is a formal process that includes review and
approval by the company’s management.

Services Costs
Recurring operating costs for services contracts are recognized
as incurred. For fixed-price design and build contracts, the costs
of external hardware and software accounted for under the
cost-to-cost measure of progress are deferred and recognized
based on the labor costs incurred to date (i.e., the measure of
progress), as a percentage of the total estimated labor costs
to fulfill the contract as control transfers over time for these
performance obligations. Certain eligible, nonrecurring costs
incurred in the initial phases of outsourcing contracts and
other cloud-based services contracts (i.e., setup costs) are
capitalized when the costs relate directly to the contract, the
costs generate or enhance resources of the company that will be
used in satisfying the performance obligation in the future, and
the costs are expected to be recovered. These costs consist of
transition and setup costs related to the installation of systems
and processes and other deferred fulfillment costs, including,
prepaid assets used in services contracts (i.e., prepaid software
or prepaid maintenance), and other deferred fulfillment costs
eligible for capitalization. Capitalized costs are amortized on a
straight-line basis over the expected period of benefit, which

includes anticipated contract renewals or extensions, consistent
with the transfer to the client of the services to which the asset
relates. Additionally, fixed assets associated with these contracts
are capitalized and depreciated on a straight-line basis over the
expected useful life of the asset. If an asset is contract specific,
then the depreciation period is the shorter of the useful life
of the asset or the contract term. Amounts paid to clients in
excess of the fair value of acquired assets used in outsourcing
arrangements are deferred and amortized on a straight-line
basis as a reduction of revenue over the expected period of
benefit. The company performs periodic reviews to assess the
recoverability of deferred contract transition and setup costs.
This review is done by comparing the carrying amount of the asset
to the remaining amount of consideration the company expects
to receive for the services to which the asset relates, less the
costs that relate directly to providing those services that have
not yet been recognized. If the carrying amount is deemed not
recoverable, an impairment loss is recognized. Refer to note O,
“Revenue Recognition,” on pages 120 to 122 for the amount of
deferred costs to fulfill a contract at December 31, 2018.

In situations in which an outsourcing contract is terminated,
the terms of the contract may require the client to reimburse
the company for the recovery of unbilled accounts receivable,
unamortized deferred costs incurred to purchase specific assets
utilized in the delivery of services and to pay any additional costs
incurred by the company to transition the services.

Software Costs
Costs that are related to the conceptual formulation and design
of licensed software programs are expensed as incurred to
research, development and engineering expense; costs that
are incurred to produce the finished product after technological
feasibility has been established are capitalized as an intangible
asset. Capitalized amounts are amortized on a straight-line
basis over periods ranging up to three years and are recorded
in software cost within cost of sales. The company performs
periodic reviews to ensure that unamortized program costs
remain recoverable from future revenue. Costs to support or
service licensed programs are charged to software cost within
cost of sales as incurred.

The company capitalizes certain costs that are incurred to
purchase or to create and implement internal-use software
programs, including software coding, installation, testing and
certain data conversions. Internal-use software programs also
include software used by the company to deliver Software-as-a-
Service when the client does not receive a license to the software
and the company has no substantive plans to market the software
externally. Capitalized costs are amortized on a straight-line
basis over periods ranging up to three years and are recorded
in selling, general and administrative expense or cost of sales,
depending on whether the software is used by the company in
revenue generating transactions.

Notes to Consolidated Financial Statements International Business Machines Corporation and Subsidiary Companies81

Standard Warranty Liability

($ in millions)

Balance at January 1

Current period accruals

Accrual adjustments to reflect experience

Charges incurred

2018

$ 152

121

(32)

(123)

2017

$ 156

172

(10)

(165)

Balance at December 31

$ 118

$ 152

Extended Warranty Liability (Deferred Income)

($ in millions)

Balance at January 1

Revenue deferred for new extended

warranty contracts

Amortization of deferred revenue

Other*

Balance at December 31

Current portion

Noncurrent portion

2018

$ 566

220

(240)

(13)

$ 533

$ 271

$ 262

2017

$ 531

267

(260)

$ 566

$ 277

$ 289

* Other consists primarily of foreign currency translation adjustments.

Shipping and Handling
Costs related to shipping and handling are recognized as incurred
and included in cost in the Consolidated Statement of Earnings.

Expense and Other Income
Selling, General and Administrative
Selling, general and administrative (SG&A) expense is charged
to income as incurred, except for certain sales commissions,
which are capitalized and amortized as of January 1, 2018. For
further information regarding capitalizing sales commissions, see
“Incremental Costs of Obtaining a Contract” above. Expenses
of promoting and selling products and services are classified as
selling expense and, in addition to sales commissions, include
such items as compensation, advertising and travel. General and
administrative expense includes such items as compensation,
legal costs, office supplies, non-income taxes, insurance and
office rental. In addition, general and administrative expense
includes other operating items such as an allowance for credit
losses, workforce rebalancing charges for contractually obligated
payments to employees terminated in the ongoing course of
business, acquisition costs related to business combinations,
amortization of certain intangible assets and environmental
remediation costs.

Certain eligible, nonrecurring costs incurred in the initial phases
of arrangements in which IBM provides Software-as-a-Service
are deferred and amortized over the expected period of benefit,
which includes anticipated contract renewals or extensions,
consistent with the policy described for Services Costs. Recurring
operating costs in these contracts are recognized as incurred.

Incremental Costs of Obtaining a Contract
Incremental costs of obtaining a contract (e.g., sales
commissions) are capitalized and amortized on a straight-
line basis over the expected customer relationship period if
the company expects to recover those costs. The company
previously expensed these costs as incurred. The expected
customer relationship period is determined based on the average
customer relationship period, including expected renewals, for
each offering type and ranges from three to six years. Expected
renewal periods are only included in the expected customer
relationship period if commission amounts paid upon renewal
are not commensurate with amounts paid on the initial contract.
Incremental costs of obtaining a contract include only those
costs the company incurs to obtain a contract that it would not
have incurred if the contract had not been obtained. The company
has determined that certain commission programs meet the
requirements to be capitalized. Some commission programs are
not subject to capitalization as the commission expense is paid
and recognized as the related revenue is recognized. Additionally,
as a practical expedient, the company expenses costs to obtain a
contract as incurred if the amortization period would have been
a year or less. These costs are included in selling, general and
administrative expenses.

Product Warranties
The company offers warranties for its hardware products that
generally range up to three years, with the majority being either
one or three years. Estimated costs for standard warranty
terms are recognized when revenue is recorded for the related
product. The company estimates its warranty costs standard
to the product based on historical warranty claim experience
and estimates of future spending, and applies this estimate to
the revenue stream for products under warranty. Estimated
future costs for warranties applicable to revenue recognized in
the current period are charged to cost of sales. The warranty
liability is reviewed quarterly to verify that it properly reflects the
remaining obligation based on the anticipated expenditures over
the balance of the obligation period. Adjustments are made when
actual warranty claim experience differs from estimates. Costs
from fixed-price support or maintenance contracts, including
extended warranty contracts, are recognized as incurred.

Revenue from extended warranty contracts is initially recorded
as deferred income and subsequently recognized on a straight-
line basis over the delivery period because the company is
providing a service of standing ready to provide services over
such term. Changes in deferred income for extended warranty
contracts, and in the warranty liability for standard warranties,
which are included in other accrued expenses and liabilities
and other liabilities in the Consolidated Statement of Financial
Position, are presented in the following tables:

Notes to Consolidated Financial Statements International Business Machines Corporation and Subsidiary Companies82

Advertising and Promotional Expense
The company expenses advertising and promotional costs as
incurred. Cooperative advertising reimbursements from vendors
are recorded net of advertising and promotional expense in
the period in which the related advertising and promotional
expense is incurred. Advertising and promotional expense, which
includes media, agency and promotional expense, was $1,466
million, $1,445 million and $1,327 million in 2018, 2017 and
2016, respectively, and is recorded in SG&A expense in the
Consolidated Statement of Earnings.

Research, Development and Engineering
Research, development and engineering (RD&E) costs are
expensed as incurred. Software costs that are incurred to
produce the finished product after technological feasibility has
been established are capitalized as an intangible asset.

Intellectual Property and Custom Development Income
The company licenses and sells the rights to certain of its
intellectual property (IP) including internally developed
patents, trade secrets and technological know-how. Certain IP
transactions to third parties are licensing/royalty-based and
others are transaction-based sales/other transfers. Income
from licensing arrangements is recognized at the inception of the
license term if the nature of the company’s promise is to provide a
right to use the company’s intellectual property as it exists at that
point in time (i.e., the license is functional intellectual property)
and control has transferred to the client. If the nature of the
company’s promise is to provide a right to access the company’s
intellectual property throughout the license period (i.e., the
license is symbolic intellectual property), such as a trademark
license, income is recognized over time. Licensing arrangements
include IP partnerships whereby a business partner licenses
source code from the company and becomes responsible for
developing, maintaining and enhancing the product. The company
retains its customers and go-to-market capability and any royalty
cost due to the partner is recognized in cost of sales. The IP
partner has the rights to market the product and its derivative
works under its own brand and remits royalty to the company on
those sales, which are recorded as royalty-based fees. Income
from royalty-based fee arrangements is recognized at the later
of when the subsequent sale or usage occurs or the performance
obligation to which some or all of the royalty has been allocated
has been satisfied (or partially satisfied). Depending on the
nature of the transaction, an IP partnership would be accounted
for as a divestiture if the company concludes the transaction
meets the definition of a business. The company also enters
into cross-licensing arrangements of patents, and income from
these arrangements is recognized when control transfers to the
customer. In addition, the company earns income from certain
custom development projects with strategic technology partners
and specific clients. The company records the income from these
projects over time as the company satisfies the performance
obligation if the fee is nonrefundable and is not dependent upon
the ultimate success of the project.

Other (Income) and Expense
Other (income) and expense includes interest income (other
than from Global Financing external transactions), gains and
losses on certain derivative instruments, gains and losses from
securities and other investments, gains and losses from certain
real estate transactions, foreign currency transaction gains and
losses, gains and losses from the sale of businesses, other than
reported as discontinued operations, and amounts related to
accretion of asset retirement obligations. Other (income) and
expense also includes certain components of retirement-related
costs, including interest costs, expected return on plan assets,
amortization of prior service costs (credits), curtailments and
settlements and other net periodic pension/postretirement
benefit costs.

Business Combinations and
Intangible Assets Including Goodwill
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.
Goodwill represents the excess of the purchase price over the fair
value of net assets, including the amount assigned to identifiable
intangible assets. The primary drivers that generate goodwill
are the value of synergies between the acquired entities and
the company and the acquired assembled workforce, neither
of which qualifies as a separately identifiable intangible asset.
Goodwill recorded in an acquisition is assigned to applicable
reporting units based on expected revenues. Identifiable
intangible assets with finite lives are amortized over their useful
lives. Amortization of completed technology is recorded in cost,
and amortization of all other intangible assets is recorded in
SG&A expense. Acquisition-related costs, including advisory,
legal, accounting, valuation and other costs, are expensed in the
periods in which the costs are incurred. The results of operations
of acquired businesses are included in the Consolidated Financial
Statements from the acquisition date.

Impairment
Long-lived assets, other than goodwill and indefinite-lived
intangible assets, 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. Goodwill and indefinite-lived intangible
assets are tested at least annually, in the fourth quarter, for
impairment and whenever changes in circumstances indicate an
impairment may exist. The goodwill impairment test is performed
by reporting unit, which is an operating segment, a component
or multiple components of an operating segment. A component
meets the definition of a reporting unit if it is one level below an
operating segment, is considered to be a business with discrete
financial information available and is regularly reviewed by
segment management. Components are aggregated as a single
reporting unit if they have similar economic characteristics.

Notes to Consolidated Financial Statements International Business Machines Corporation and Subsidiary Companies83

Depreciation and Amortization
Property, plant and equipment are carried at cost and depreciated
over their estimated useful lives using the straight-line method.
The estimated useful lives of certain depreciable assets are as
follows: buildings, 30 to 50 years; building equipment, 10 to 20
years; land improvements, 20 years; production, engineering,
office and other equipment, 2 to 20 years; and information
technology equipment, 1.5 to 5 years. Leasehold improvements
are amortized over the shorter of their estimated useful lives or
the related lease term, rarely exceeding 25 years.

As noted on page 80 within “Software Costs,” capitalized software
costs are amortized on a straight-line basis over periods ranging
up to 3 years. Other intangible assets are amortized over periods
between 1 and 7 years.

Environmental
The cost of internal environmental protection programs that are
preventative in nature are expensed as incurred. When a cleanup
program becomes likely, and it is probable that the company will
incur cleanup costs and those costs can be reasonably estimated,
the company accrues remediation costs for known environmental
liabilities. The company’s maximum exposure for all environmental
liabilities cannot be estimated and no amounts are recorded for
environmental liabilities that are not probable or estimable.

Asset Retirement Obligations
Asset retirement obligations (ARO) are legal obligations
associated with the retirement of long-lived assets. These
liabilities are initially recorded at fair value and the related
asset retirement costs are capitalized by increasing the
carrying amount of the related assets by the same amount as
the liability. Asset retirement costs are subsequently depreciated
over the useful lives of the related assets. Subsequent to initial
recognition, the company records period-to-period changes in
the ARO liability resulting from the passage of time in interest
expense and revisions to either the timing or the amount of the
original expected cash flows to the related assets.

Defined Benefit Pension and
Nonpension Postretirement Benefit Plans
The funded status of the company’s defined benefit pension plans
and nonpension postretirement benefit plans (retirement-related
benefit plans) is recognized in the Consolidated Statement
of Financial Position. The funded status is measured as the
difference between the fair value of plan assets and the benefit
obligation at December 31, the measurement date. For defined
benefit pension plans, the benefit obligation is the projected
benefit obligation (PBO), which represents the actuarial present
value of benefits expected to be paid upon retirement based
on employee services already rendered and estimated future
compensation levels. For the nonpension postretirement benefit
plans, the benefit obligation is the accumulated postretirement
benefit obligation (APBO), which represents the actuarial present
value of postretirement benefits attributed to employee services
already rendered. The fair value of plan assets represents the

current market value of assets held in an irrevocable trust fund,
held for the sole benefit of participants, which are invested by the
trust fund. Overfunded plans, with the fair value of plan assets
exceeding the benefit obligation, are aggregated and recorded as
a prepaid pension asset equal to this excess. Underfunded plans,
with the benefit obligation exceeding the fair value of plan assets,
are aggregated and recorded as a retirement and nonpension
postretirement benefit obligation equal to this excess.

The current portion of the retirement and nonpension post-
retirement benefit obligations represents the actuarial present
value of benefits payable in the next 12 months exceeding the
fair value of plan assets, measured on a plan-by-plan basis.
This obligation is recorded in compensation and benefits in the
Consolidated Statement of Financial Position.

Net periodic pension and nonpension postretirement benefit
cost/(income) is recorded in the Consolidated Statement of
Earnings and includes service cost, interest cost, expected
return on plan assets, amortization of prior service costs/(credits)
and (gains)/losses previously recognized as a component of
OCI and amortization of the net transition asset remaining
in accumulated other comprehensive income/(loss) (AOCI).
Service cost represents the actuarial present value of participant
benefits earned in the current year. Interest cost represents
the time value of money cost associated with the passage of
time. Certain events, such as changes in the employee base,
plan amendments and changes in actuarial assumptions, result
in a change in the benefit obligation and the corresponding
change in OCI. The result of these events is amortized as a
component of net periodic cost/(income) over the service lives
or life expectancy of the participants, depending on the plan,
provided such amounts exceed thresholds which are based upon
the benefit obligation or the value of plan assets. The service
cost component of net benefit cost is recorded in Cost, SG&A
and RD&E in the Consolidated Statement of Earnings (unless
eligible for capitalization) based on the employees’ respective
functions. The other components of net benefit cost are
presented separately from service cost within other (income)
and expense in the Consolidated Statement of Earnings. Refer
to note B, “Accounting Changes,” on pages 89 to 91, for additional
information on the presentation change relating to pension costs
beginning on January 1, 2018.

(Gains)/losses and prior service costs/(credits) are not
recognized as a component of net periodic cost/(income) in
the Consolidated Statement of Earnings as they arise, but
are recognized as a component of OCI in the Consolidated
Statement of Comprehensive Income. Those (gains)/losses
and prior service costs/(credits) are subsequently recognized
as a component of net periodic cost/(income) pursuant to the
recognition and amortization provisions of applicable accounting
guidance. (Gains)/losses arise as a result of differences between
actual experience and assumptions or as a result of changes in
actuarial assumptions. Prior service costs/(credits) represent the
cost of benefit changes attributable to prior service granted in
plan amendments.

Notes to Consolidated Financial Statements International Business Machines Corporation and Subsidiary Companies84

The measurement of benefit obligations and net periodic cost/
(income) is based on estimates and assumptions approved
by the company’s management. These valuations reflect the
terms of the plans and use participant-specific information such
as compensation, age and years of service, as well as certain
assumptions, including estimates of discount rates, expected
return on plan assets, rate of compensation increases, interest
crediting rates and mortality rates.

the need for a valuation allowance, management considers all
available evidence for each jurisdiction including past operating
results, estimates of future taxable income and the feasibility
of ongoing tax planning strategies. When the company changes
its determination as to the amount of deferred tax assets that
can be realized, the valuation allowance is adjusted with a
corresponding impact to income tax expense in the period in
which such determination is made.

Defined Contribution Plans
The company’s contribution for defined contribution plans is
recorded when the employee renders service to the company.
The charge is recorded in Cost, SG&A and RD&E in the
Consolidated Statement of Earnings based on the employees’
respective functions.

Stock-Based Compensation
Stock-based compensation represents the cost related to stock-
based awards granted to employees. The company measures
stock-based compensation cost at the grant date, based on
the estimated fair value of the award and recognizes the cost
on a straight-line basis (net of estimated forfeitures) over the
employee requisite service period. The company grants its
employees Restricted Stock Units (RSUs), including Retention
Restricted Stock Units (RRSUs) and Performance Share Units
(PSUs) and periodically grants stock options. RSUs are stock
awards granted to employees that entitle the holder to shares
of common stock as the award vests, typically over a one- to
five-year period. The fair value of the awards is determined and
fixed on the grant date based on the company’s stock price,
adjusted for the exclusion of dividend equivalents. The company
estimates the fair value of stock options using a Black-Scholes
valuation model. Stock-based compensation cost is recorded in
Cost, SG&A, and RD&E in the Consolidated Statement of Earnings
based on the employees’ respective functions.

The company records deferred tax assets for awards that result
in deductions on the company’s income tax returns, based on
the amount of compensation cost recognized and the statutory
tax rate in the jurisdiction in which it will receive a deduction.
The differences between the deferred tax assets recognized
for financial reporting purposes and the actual tax deduction
reported on the income tax return are recorded as a benefit or
expense to the provision for income taxes in the Consolidated
Statement of Earnings.

Income Taxes
Income tax expense is based on reported income before income
taxes. Deferred income taxes reflect the tax effect of temporary
differences between asset and liability amounts that are
recognized for financial reporting purposes and the amounts that
are recognized for income tax purposes. These deferred taxes
are measured by applying currently enacted tax laws. Valuation
allowances are recognized to reduce deferred tax assets to the
amount that will more likely than not be realized. In assessing

The company recognizes tax liabilities when, despite the
company’s belief that its tax return positions are supportable,
the company believes that certain positions may not be fully
sustained upon review by tax authorities. Benefits from tax
positions are measured at the largest amount of benefit that is
greater than 50 percent likely of being realized upon settlement.
The current portion of tax liabilities is included in taxes and the
noncurrent portion of tax liabilities is included in other liabilities
in the Consolidated Statement of Financial Position. To the
extent that new information becomes available which causes
the company to change its judgment regarding the adequacy of
existing tax liabilities, such changes to tax liabilities will impact
income tax expense in the period in which such determination
is made. Interest and penalties, if any, related to accrued
liabilities for potential tax assessments are included in income
tax expense.

The U.S. Tax Cuts and Jobs Act introduced GILTI, which subjects
a U.S. shareholder to current tax on income earned by certain
foreign subsidiaries. The Financial Accounting Standards Board
(FASB) allows companies to either (1) recognize deferred taxes
for temporary differences that are expected to reverse as GILTI in
future years (deferred method) or (2) account for taxes on GILTI
as period costs in the year the tax is incurred (period method).
The company elected the deferred method and in order to record
the initial deferred taxes for GILTI, the company estimated the
impact of foreign temporary differences on GILTI in future years.
This included consideration of statutory limitation impacts on
the GILTI calculation.

Translation of Non-U.S. Currency Amounts
Assets and liabilities of non-U.S. subsidiaries that have a local
functional currency are translated to U.S. dollars at year-end
exchange rates. Translation adjustments are recorded in OCI.
Income and expense items are translated at weighted-average
rates of exchange prevailing during the year.

Inventories, property, plant and equipment—net and other
non-monetary assets and liabilities of non-U.S. subsidiaries
and branches that operate in U.S. dollars are translated at the
approximate exchange rates prevailing when the company acquired
the assets or liabilities. All other assets and liabilities denominated
in a currency other than U.S. dollars are translated at year-end
exchange rates with the transaction gain or loss recognized in other
(income) and expense. Income and expense items are translated at
the weighted-average rates of exchange prevailing during the year.
These translation gains and losses are included in net income for
the period in which exchange rates change.

Notes to Consolidated Financial Statements International Business Machines Corporation and Subsidiary Companies85

Derivative Financial Instruments
Derivatives are recognized in the Consolidated Statement of
Financial Position at fair value and are reported in prepaid
expenses and other current assets, investments and sundry
assets, other accrued expenses and liabilities or other liabilities.
Classification of each derivative as current or noncurrent is
based upon whether the maturity of the instrument is less than
or greater than 12 months. To qualify for hedge accounting,
the company requires that the instruments be effective in
reducing the risk exposure that they are designated to hedge.
For instruments that hedge cash flows, hedge designation criteria
also require that it be probable that the underlying transaction
will occur. Instruments that meet established accounting criteria
are formally designated as hedges. These criteria demonstrate
that the derivative is expected to be highly effective at offsetting
changes in fair value or cash flows of the underlying exposure
both at inception of the hedging relationship and on an ongoing
basis. The method of assessing hedge effectiveness and
measuring hedge results is formally documented at hedge
inception. The company assesses hedge effectiveness and
measures hedge results at least quarterly throughout the
designated hedge period.

Where the company applies hedge accounting, the company
designates each derivative as a hedge of: (1) the fair value of
a recognized financial asset or liability, or of an unrecognized
firm commitment (fair value hedge attributable to interest rate
or foreign currency risk); (2) the variability of anticipated cash
flows of a forecasted transaction, or the cash flows to be received
or paid related to a recognized financial asset or liability (cash
flow hedge attributable to interest rate or foreign currency risk);
or (3) a hedge of a long-term investment (net investment hedge)
in a foreign operation. In addition, the company may enter into
derivative contracts that economically hedge certain of its risks,
even though hedge accounting does not apply or the company
elects not to apply hedge accounting. In these cases, there exists
a natural hedging relationship in which changes in the fair value
of the derivative, which are recognized currently in net income,
act as an economic offset to changes in the fair value of the
underlying hedged item(s).

Changes in the fair value of a derivative that is designated as a
fair value hedge, along with offsetting changes in the fair value of
the underlying hedged exposure, are recorded in earnings each
period. For hedges of interest rate risk, the fair value adjustments
are recorded as adjustments to interest expense and cost of
financing in the Consolidated Statement of Earnings. For hedges
of currency risk associated with recorded financial assets or
liabilities, derivative fair value adjustments are recognized in
other (income) and expense in the Consolidated Statement
of Earnings. Changes in the fair value of a derivative that is
designated as a cash flow hedge are recorded, net of applicable
taxes, in OCI, in the Consolidated Statement of Comprehensive
Income. When net income is affected by the variability of the
underlying cash flow, the applicable offsetting amount of the gain
or loss from the derivative that is deferred in AOCI is released
to net income and reported in interest expense, cost, SG&A

expense or other (income) and expense in the Consolidated
Statement of Earnings based on the nature of the underlying
cash flow hedged. Effectiveness for net investment hedging
derivatives is measured on a spot-to-spot basis. Changes in the
fair value of highly effective net investment hedging derivatives
and other non-derivative financial instruments designated as net
investment hedges are recorded as foreign currency translation
adjustments in AOCI. Changes in the fair value of the portion of a
net investment hedging derivative excluded from the assessment
of effectiveness are recorded in interest expense and cost of
financing. If the underlying hedged item in a fair value hedge
ceases to exist, all changes in the fair value of the derivative are
included in net income each period until the instrument matures.
When the derivative transaction ceases to exist, a hedged asset
or liability is no longer adjusted for changes in its fair value except
as required under other relevant accounting standards.

Derivatives that are not designated as hedges are recorded in
earnings for each period and are primarily reported in other
(income) and expense. When a cash flow hedging relationship is
discontinued, the net gain or loss in AOCI must generally remain
in AOCI until the item that was hedged affects earnings. However,
when it is probable that a forecasted transaction will not occur
by the end of the originally specified time period or within an
additional two-month period thereafter, the net gain or loss in
AOCI must be reclassified into earnings immediately.

The company reports cash flows arising from derivative financial
instruments designated as fair value or cash flow hedges
consistent with the classification of cash flows from the underlying
hedged items that these derivatives are hedging. Accordingly, the
cash flows associated with derivatives designated as fair value
or cash flow hedges are classified in cash flows from operating
activities in the Consolidated Statement of Cash Flows. Cash
flows from derivatives designated as net investment hedges and
derivatives that do not qualify as hedges are reported in cash
flows from investing activities in the Consolidated Statement of
Cash Flows. For currency swaps designated as hedges of foreign
currency denominated debt (included in the company’s debt
risk management program as addressed in note D, “Financial
Instruments,” on pages 95 to 102), cash flows directly associated
with the settlement of the principal element of these swaps are
reported in payments to settle debt in cash flows from financing
activities in the Consolidated Statement of Cash Flows.

Financial Instruments
In determining the fair value of its financial instruments, the
company uses a variety of methods and assumptions that are
based on market conditions and risks existing at each balance
sheet date. See note D, “Financial Instruments,” on pages 95 to
102 for further information. All methods of assessing fair value
result in a general approximation of value, and such value may
never actually be realized.

Notes to Consolidated Financial Statements International Business Machines Corporation and Subsidiary Companies86

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

•

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

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

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

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

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

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

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

•

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

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

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

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

Certain non-financial assets such as property, plant and
equipment, 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 years ended December 31, 2018,
2017 and 2016.

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.

Cash Equivalents
All highly liquid investments with maturities of three months or
less at the date of purchase are considered to be cash equivalents.

Marketable Securities
Effective January 1, 2018, with the adoption of the new FASB
guidance on recognition, measurement, presentation and
disclosure of financial instruments, the company measures equity
investments at fair value with changes recognized in net income.

Debt securities included in current assets represent securities
that are expected to be realized in cash within one year of the
balance sheet date. Long-term debt securities that are not
expected to be realized in cash within one year and alliance
equity securities are included in investments and sundry assets.
Debt securities are considered available for sale and are reported
at fair value with unrealized gains and losses, net of applicable
taxes, in OCI. The realized gains and losses for available-for-sale
debt securities are included in other (income) and expense in the
Consolidated Statement of Earnings. Realized gains and losses
are calculated based on the specific identification method.

Notes to Consolidated Financial Statements International Business Machines Corporation and Subsidiary Companies87

In determining whether an other-than-temporary decline in
market value has occurred, the company considers the duration
that, and extent to which, the fair value of the investment is below
its cost, the financial condition and near-term prospects of the
issuer or underlying collateral of a security; and the company’s
intent and ability to retain the security in order to allow for an
anticipated recovery in fair value. Other-than-temporary declines
in fair value from amortized cost for available-for-sale debt
securities that the company intends to sell or would more likely
than not be required to sell before the expected recovery of the
amortized cost basis are charged to other (income) and expense
in the period in which the loss occurs. For debt securities that
the company has no intent to sell and believes that it more likely
than not will not be required to sell prior to recovery, only the
credit loss component of the impairment is recognized in other
(income) and expense, while the remaining loss is recognized in
OCI. The credit loss component recognized in other (income) and
expense is identified as the amount of the principal cash flows
not expected to be received over the remaining term of the debt
security as projected using the company’s cash flow projections.

Inventories
Raw materials, work in process and finished goods are stated
at the lower of average cost or net realizable value. Cash flows
related to the sale of inventories are reflected in net cash
provided by operating activities in the Consolidated Statement
of Cash Flows.

Allowance for Credit Losses
Receivables are recorded concurrent with billing and shipment of
a product and/or delivery of a service to customers. A reasonable
estimate of probable net losses on the value of customer receivables
is recognized by establishing an allowance for credit losses.

Contract Assets and Notes and Accounts Receivable—Trade
As of January 1, 2018, the company classifies the right to
consideration in exchange for products or services transferred
to a client as either a receivable or a contract asset. A receivable
is a right to consideration that is unconditional as compared
to a contract asset which is a right to consideration that is
conditional upon factors other than the passage of time. The
majority of the company’s contract assets represent unbilled
amounts related to design and build services contracts when
the cost-to-cost method of revenue recognition is utilized,
revenue recognized exceeds the amount billed to the client, and
the right to consideration is subject to milestone completion or
client acceptance. Contract assets are generally classified as
current and are recorded on a net basis with deferred income
(i.e., contract liabilities) at the contract level. At December 31,
2018 and January 1, 2018 contract assets of $470 million and
$557 million, respectively, are included in prepaid expenses and
other current assets in the Consolidated Statement of Financial
Position. At December 31, 2017, these assets were classified
as notes and accounts receivable—trade in the Consolidated
Statement of Financial Position.

An allowance for contract assets, if needed, and uncollectible
trade receivables is estimated based on a combination of write-off
history, aging analysis and any specific, known troubled accounts.

Factored Receivables
The company enters into various factoring agreements with
third-party financial institutions to sell its receivables (includes
notes and accounts receivable—trade, financing receivables and
other accounts receivables) under nonrecourse agreements.
Accounts receivable sales arrangements are utilized in the
normal course of business as part of the company’s cash and
liquidity management. Facilities in the U.S., Canada and several
countries in Europe enable the company to sell certain accounts
receivable, without recourse, to third parties in order to manage
credit, collection, concentration and currency risk.

These transactions are accounted for as a reduction in receivables
and are considered sold when: (1) they are transferred beyond the
reach of the company and its creditors; (2) the purchaser has the
right to pledge or exchange the receivables; and (3) the company
has surrendered control over the transferred receivables.
The proceeds from these arrangements are reflected as cash
provided by operating activities in the Consolidated Statement
of Cash Flows.

The gross amounts factored (the gross proceeds) under these
programs (primarily relating to notes and accounts receivable—
trade) for the year ended December 31, 2018 were $2.2 billion
compared to $1.9 billion for the year ended December 31,
2017. Within the accounts receivables sold and derecognized
from the Consolidated Statement of Financial Position, $0.9
billion and $0.7 billion remained uncollected from customers at
December 31, 2018 and 2017, respectively. The fees and the net
gains and losses associated with the transfer of receivables were
not material for any of the periods presented.

Financing Receivables
Financing receivables include sales-type leases, direct financing
leases and loans. Leases are accounted for in accordance
with lease accounting standards. Loan receivables, including
installment payment plans, which are generally unsecured, are
primarily for software and services. Loans are financial assets
which are recorded at amortized cost, which approximates fair
value. Commercial financing receivables are carried at amortized
cost, which approximates fair value. These receivables are for
working capital financing to suppliers, distributors and resellers of
IBM and OEM IT products and services. The company determines
its allowances for credit losses on financing receivables based on
two portfolio segments: lease receivables and loan receivables.
The company further segments the portfolio into three classes:
Americas, Europe/Middle East/Africa (EMEA) and Asia Pacific.

Notes to Consolidated Financial Statements International Business Machines Corporation and Subsidiary Companies88

When calculating the allowances, the company considers
its ability to mitigate a potential loss by repossessing leased
equipment and by considering the current fair market value
of any other collateral. The value of the equipment is the net
realizable value. The allowance for credit losses for capital
leases, installment payment plan receivables and customer loans
includes an assessment of the entire balance of the capital lease
or loan, including amounts not yet due. The methodologies that
the company uses to calculate its receivables reserves, which
are applied consistently to its different portfolios, are as follows:

Individually Evaluated—The company reviews all financing
receivables considered at risk on a quarterly basis. The review
primarily consists of an analysis based upon current information
available about the client, such as financial statements, news
reports, published credit ratings, current market-implied credit
analysis, as well as the current economic environment, collateral
net of repossession cost and prior collection history. For loans
that are collateral dependent, impairment is measured using the
fair value of the collateral when foreclosure is probable. Using
this information, 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.

Collectively Evaluated—The company records an unallocated
reserve that is calculated by applying a reserve rate to its different
portfolios, excluding accounts that have been individually
evaluated and specifically reserved. This reserve rate is based
upon credit rating, probability of default, term, characteristics
(lease/loan) and loss history. Factors that could result in actual
receivable losses that are materially different from the estimated
reserve include significant changes in the economy, or a sudden
change in the economic health of a significant client in the
company’s receivables portfolio.

Other Credit-Related Policies
Past Due—The company views receivables as past due when
payment has not been received after 90 days, measured from
the original billing date.

Non-Accrual—Non-accrual assets include those receivables
(impaired loans or nonperforming leases) with specific reserves
and other accounts for which it is likely that the company will
be unable to collect all amounts due according to original terms
of the lease or loan agreement. Interest income recognition
is discontinued on these receivables. Cash collections are
first applied as a reduction to principal outstanding. Any
cash received in excess of principal payments outstanding is
recognized as interest income. Receivables may be removed
from non-accrual status, if appropriate, based upon changes in
client circumstances, such as a sustained history of payments.

Impaired Loans—The company evaluates all financing receivables
considered at-risk, including loans, for impairment on a quarterly
basis. The company considers any receivable with an individually
evaluated reserve as an impaired loan. Depending on the level of
impairment, loans will also be placed on non-accrual status as
appropriate. Client loans are primarily for software and services
and are unsecured. These receivables are subjected to credit
analysis to evaluate the associated risk and, when appropriate,
actions are taken to mitigate risks in these agreements which
include covenants to protect against credit deterioration during
the life of the obligation.

Write-Off—Receivable losses are charged against the allowance
in the period in which the receivable is deemed uncollectible.
Subsequent recoveries, if any, are credited to the allowance.
Write-offs of receivables and associated reserves occur to
the extent that the customer is no longer in operation and/or,
there is no reasonable expectation of additional collections
or repossession. The company’s assessments factor in the
history of collections and write-offs in specific countries and
across the portfolio.

Estimated Residual Values of Lease Assets
The recorded residual values of lease assets are estimated at the
inception of the lease to be the expected fair value of the assets at
the end of the lease term. The company periodically reassesses
the realizable value of its lease residual values. Any anticipated
increases in specific future residual values are not recognized
before realization through remarketing efforts. 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 financing income in the period in which
the estimate is changed, as well as an adjustment to unearned
income to reduce future-period financing income.

Common Stock
Common stock refers to the $.20 par value per share capital stock
as designated in the company’s Certificate of Incorporation.
Treasury stock is accounted for using the cost method. When
treasury stock is reissued, the value is computed and recorded
using a weighted-average basis.

Earnings Per Share of Common Stock
Earnings per share (EPS) is computed using the two-class
method. The two-class method determines EPS for each class of
common stock and participating securities according to dividends
and dividend equivalents and their respective participation
rights in undistributed earnings. Basic EPS of common stock
is computed by dividing net income by the weighted-average
number of common shares outstanding for the period. Diluted
EPS of common stock is computed on the basis of the weighted-
average number of shares of common stock plus the effect of
dilutive potential common shares outstanding during the period
using the treasury stock method. Dilutive potential common
shares include outstanding stock awards, convertible notes and
stock options.

Notes to Consolidated Financial Statements International Business Machines Corporation and Subsidiary Companies89

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

In August 2018, the 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. As a result, the
company has removed Level 1/Level 2 transfer disclosures
in accordance with the fair value guidance. The company is
evaluating the adoption date for the remaining changes. As the
guidance is a change to disclosures only, the company does not
expect the guidance to have a material impact in the consolidated
financial results.

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

In June 2016, with amendments in 2018, the FASB issued
guidance for credit impairment based on an expected loss
model rather than an incurred loss model. The guidance requires
the consideration of all available relevant information when
estimating expected credit losses, including past events, current
conditions and forecasts and their implications for expected
credit losses. A cross-functional team has been established
that is evaluating the financial instruments portfolio and the
system, process and policy change requirements. The new
guidance expands the scope of financial instruments subject
to impairment, including off-balance sheet commitments and
residual value. The guidance is effective January 1, 2020 with
one-year early adoption permitted. The company will adopt the
guidance as of the effective date and is continuing to evaluate
the impact.

The FASB issued guidance in February 2016, with amendments
in 2018, which changes the accounting for leases. The guidance
requires lessees to recognize right-of-use assets and lease
liabilities for most leases in the Consolidated Statement of
Financial Position. The guidance makes some changes to lessor
accounting, including elimination of the use of third-party
residual value guarantee insurance in the lease classification
test, and overall aligns with the new revenue recognition
guidance. The guidance also requires qualitative and quantitative
disclosures to assess the amount, timing and uncertainty of cash
flows arising from leases. The guidance was effective January 1,
2019 and early adoption was permitted. The company adopted

the guidance on the effective date using the transition option
whereby prior comparative periods will not be retrospectively
presented in the consolidated financial statements. The company
elected the package of practical expedients not to reassess
prior conclusions related to contracts containing leases, lease
classification and initial direct costs and the lessee practical
expedient to combine lease and nonlease components for
all asset classes. The company made a policy election to not
recognize right-of-use assets and lease liabilities for short-term
leases for all asset classes.

A cross-functional implementation team evaluated the lease
portfolio and implemented system, process, control and policy
changes. The company also gathered lease data in order to
comply with the requirements in the guidance, including new
disclosures that will be added to the Notes to the Consolidated
Financial Statements beginning in the first quarter of 2019. The
guidance had a material impact on the Consolidated Statement
of Financial Position as of the effective date. As a lessee, the
company’s undiscounted operating lease commitments were
$5.6 billion at December 31, 2018, which is expected to
approximate the January 1, 2019 balance of operating lease
liabilities, which will be discounted by the company’s incremental
borrowing rate. The transition adjustment recognized in retained
earnings at the effective date is not expected to be material.

From a lessor perspective, 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, which remain outstanding relating to that equipment
and are still expected to be collected, will be reclassified to loan
receivables. The amount that would have been reclassified
from lease receivables to loan receivables in 2018, under the
application of this new guidance, would have been approximately
$263 million. Additionally, the company does not expect the
removal of third-party residual value guarantee insurance in
the lease classification test to have a material impact on the
Consolidated Statement of Earnings.

Standards Implemented
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 AOCI to retained
earnings. The guidance was effective January 1, 2019 with
early adoption permitted, and can be applied either in the
period of adoption or retrospectively to all applicable periods.
The company adopted the guidance effective January 1, 2018,
and elected not to reclassify prior periods. In accordance with its
accounting policy, the company releases income tax effects from
AOCI once the reason the tax effects were established ceases
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, $2,420 million was reclassified from AOCI
to retained earnings, primarily comprised of amounts relating to
retirement-related benefit plans.

Notes to Consolidated Financial Statements International Business Machines Corporation and Subsidiary Companies90

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. For the year ended December 31, 2017, $717 million,
$427 million and $197 million was recast from total cost, SG&A
expense and RD&E expense, respectively, into other (income) and
expense. For the year ended December 31, 2016, $222 million,
$126 million and $25 million was recast from total cost, SG&A
expense and RD&E expense, respectively, into other (income)
and expense. Refer to note T, “Retirement-Related Benefits,” for
additional information.

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. Certain equity investments are now 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 GILTI in
measuring deferred taxes. For additional information regarding
GILTI, refer to note A, “Significant Accounting Policies.” The
revenue guidance did not have a material impact in the company’s
consolidated financial results for the year ended December 31,
2018. The company expects revenue recognition for its broad
portfolio of hardware, software and services offerings to remain
largely unchanged. Refer to note O, “Revenue Recognition,” for
additional information, including further discussion on the impact
of adoption.

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

In October 2016, the FASB issued guidance which requires an
entity to recognize the income tax consequences of intra-entity
transfers of assets, other than inventory, at the time of transfer.
Assets within the scope of the guidance include intellectual
property and property, plant and equipment. The guidance was
effective January 1, 2018 and early adoption was permitted.
The company adopted the guidance on January 1, 2017 using
the required modified retrospective method. At adoption, $95
million and $47 million were reclassified from investments and
sundry assets and prepaid expenses and other current assets,
respectively, into retained earnings. Additionally, net deferred
taxes of $244 million were established in deferred taxes in
the Consolidated Statement of Financial Position, resulting in
a cumulative-effect net increase to retained earnings of $102
million. In January 2017, the company had one transaction that
generated a $582 million benefit to income tax expense, income
from continuing operations and net income and a benefit to both
basic and diluted earnings per share of $0.62 per share for the
year ended December 31, 2017. No transactions impacted the
consolidated financial results for the year ended December 31,
2018. The ongoing impact of this guidance will be dependent on
any transaction that is within its scope.

Notes to Consolidated Financial Statements International Business Machines Corporation and Subsidiary Companies91

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

NOTE C. ACQUISITIONS/DIVESTITURES
Acquisitions
Purchase price consideration for all acquisitions, as reflected in
the tables in this note, was paid primarily in cash. All acquisitions
are reported in the Consolidated Statement of Cash Flows net of
acquired cash and cash equivalents.

2018
In 2018, the company completed two acquisitions at an
aggregate cost of $49 million. These acquisitions were for 100
percent of the acquired businesses.

The Cognitive Solutions segment completed the acquisition of
one privately held business in the second quarter, Armanta, Inc.
(Armanta). The GBS segment completed the acquisition of one
privately held business in the second quarter, Oniqua Holdings
Pty Ltd. (Oniqua).

Each acquisition is expected to enhance the company’s portfolio
of product and services capabilities. Armanta is a provider of
aggregation and analytics software to financial institutions,
enabling data aggregation across multiple systems in near real-
time speed, enhancing decision-making and improving regulatory
compliance. Oniqua is a global innovator in maintenance-
repair-operate inventory optimization solutions and services for
asset-intensive industries.

The acquisitions were accounted for as business combinations
using the acquisition method, and accordingly, the identifiable
assets acquired, the liabilities assumed, and any noncontrolling
interest in the acquired entity were recorded at their estimated
fair values at the date of acquisition. The acquisitions did not
have a material impact in the Consolidated Financial Statements.
The primary items that generated the goodwill are the value of
the synergies between the acquired businesses and IBM and the
acquired assembled workforce, neither of which qualify as an
amortizable intangible asset.

On October 28, 2018, the company announced its intent to
acquire all of the outstanding shares of Red Hat, Inc. (Red Hat).
The combination of Red Hat’s vast portfolio of open-source
technologies, innovative cloud development platform and
developer community, combined with IBM’s innovative hybrid
cloud technology, industry expertise, and commitment to data,
trust and security, will deliver the hybrid cloud capabilities
required to address the next chapter of cloud implementations.
Under the terms of the definitive agreement, Red Hat shareholders
will receive $190 per share in cash, representing a total enterprise
value of approximately $34 billion. On January 16, 2019, Red
Hat stockholders voted to approve the merger with IBM. The
transaction is subject to customary closing conditions, including
regulatory reviews and is expected to close in the second half
of 2019. The company intends to fund the transaction through a
combination of cash and debt. Refer to note J, “Borrowings,” for
additional details on the bridge loan credit facility that IBM has
entered into in support of this transaction.

Notes to Consolidated Financial Statements International Business Machines Corporation and Subsidiary Companies92

2017
In 2017, the company completed five acquisitions at an aggregate
cost of $134 million. All of these acquisitions were for 100
percent of the acquired businesses.

2017 Acquisitions

($ in millions)

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

Agile 3 Solutions is a developer of software used by C-Suite
and senior executives to better visualize, understand and
manage risks associated with the protection of sensitive data
and adds capabilities to the company’s security portfolio. The
acquisition of the cloud and managed hosting services business
of a large U.S. telecommunications company strengthens the
company’s services portfolio and aligns with its cloud strategy.
Cloudigo brings talent and technology that aligns closely with
the company’s cloud platform investments in advanced network
processing. XCC’s technology enhances IBM’s Connections Cloud
platform by providing a single, accessible engagement center for
sharing content. Vivant extends the strategy and design expertise
of IBM Interactive Experience (IBM iX) and helps accelerate
clients’ digital transformations.

The following table reflects the purchase price related to these
acquisitions and the resulting purchase price allocations as of
December 31, 2017.

Current assets

Fixed assets/noncurrent assets

Intangible assets

Goodwill

Completed technology

Client relationships

Patents/trademarks

Total assets acquired

Current liabilities

Noncurrent liabilities

Total liabilities assumed

Total purchase price

N/A—Not applicable

Amortization
Life (in Years)

Total
Acquisitions

N/A

5–7

1–5

$ 18

177

(9)

(34)

(43 )

$134

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

2016
In 2016, the company completed fifteen acquisitions at an
aggregate cost of $5,899 million.

The Weather Company (TWC)—On January 29, 2016, the
company completed the acquisition of TWC’s B2B, mobile
and cloud-based Web-properties, weather.com, Weather
Underground, The Weather Company brand and WSI, its global
business-to-business brand, for cash consideration of $2,278
million. The cable television segment was not acquired by IBM,
but is licensing weather forecast data and analytics from IBM
under a long-term contract. TWC was a privately held business.
Goodwill of $1,717 million was assigned to the Cognitive
Solutions segment. It was expected that none of the goodwill
would be deductible for tax purposes. The overall weighted-
average useful life of the identified intangible assets acquired
was 6.9 years.

Notes to Consolidated Financial Statements International Business Machines Corporation and Subsidiary Companies
93

and cloud infrastructure. Resource/Ammirati is a leading U.S.-
based digital marketing and creative agency, addressing the
rising demand from businesses seeking to reinvent themselves
for the digital economy. Ecx.io enhances GBS’ IBM iX with new
digital marketing, commerce and platform skills to accelerate
clients’ digital transformations. Optevia is a Software-as-
a-Service systems integrator specializing in CRM solutions
for public sector organizations. Aperto also joined IBM iX,
supporting the company’s growth in Europe, with expertise
in digital strategy projects, including website and application
development. Bluewolf extends the company’s analytics,
experience design and industry consulting leadership with one
of the world’s leading Salesforce consulting practices to deliver
differentiated, consumer-grade experiences via the cloud. Fluid,
Inc.’s Expert Personal Shopper business extends the company’s
portfolio of SaaS offerings and services, helping clients conduct
commerce and engage with their customers. Resilient, a provider
of incident response solutions, automates and orchestrates the
many processes needed when dealing with cyber incidents from
breaches to lost devices. EZSource helps developers quickly
and easily understand and change mainframe code based on
data displayed through dashboards and other visualizations.
Promontory, a global market-leading risk management and
regulatory compliance consulting firm, helps address clients’
escalating regulations and risk management requirements.

All of these Other Acquisitions were for 100 percent of the
acquired businesses.

Truven Health Analytics, Inc. (Truven)—On April 8, 2016, the
company completed the acquisition of 100 percent of Truven,
a leading provider of healthcare analytics solutions, for cash
consideration of $2,612 million, of which $2,412 million was paid
in April 2016 and $148 million was paid in July 2017. Truven has
developed proprietary analytic methods and assembled analytic
content assets, creating extensive national healthcare utilization,
performance, quality and cost data. Truven was a privately
held business. Goodwill of $1,933 million was assigned to the
Cognitive Solutions segment. It was expected that approximately
15 percent of the goodwill would be deductible for tax purposes.
The overall weighted-average useful life of the identified
intangible assets acquired was 6.9 years.

Other Acquisitions—The Technology Services & Cloud Platforms
segment completed acquisitions of four businesses: in the first
quarter, Ustream, Inc. (Ustream), a privately held business,
and AT&T’s application and hosting services business; in the
third quarter, G4S’s cash solutions business; and in the fourth
quarter, Sanovi Technologies Private Limited (Sanovi), a privately
held business. GBS completed acquisitions of six privately
held businesses: in the first quarter, Resource/Ammirati, ecx
International AG (ecx.io) and Optevia Limited (Optevia); in the
second quarter, Aperto AG (Aperto) and Bluewolf Group, LLC
(Bluewolf); and in the fourth quarter, Fluid, Inc.’s Expert Personal
Shopper (XPS) business. The Cognitive Solutions segment
completed acquisitions of three privately held businesses: in the
second quarter, Resilient Systems, Inc. (Resilient) and EZ Legacy,
Ltd. (EZSource); and in the fourth quarter, Promontory Financial
Group, LLC (Promontory).

Ustream provides cloud-based video streaming to enterprises
and broadcasters. The acquisition of AT&T’s application and
hosting services business strengthens the company’s cloud
portfolio. The acquisition of the G4S cash solutions business
brings together the engineering skills of G4S with the company’s
analytics and remote technology capabilities to expand delivery
solutions. Sanovi provides hybrid cloud recovery, cloud migration
and business continuity software for enterprise data centers

Notes to Consolidated Financial Statements International Business Machines Corporation and Subsidiary Companies94

The following table reflects the purchase price related to these acquisitions and the resulting purchase price allocations as of
December 31, 2016.

2016 Acquisitions

($ in millions)

Current assets

Fixed assets/noncurrent assets

Intangible assets

Goodwill

Completed technology

Client relationships

Patents/trademarks

Total assets acquired

Current liabilities

Noncurrent liabilities

Total liabilities assumed

Bargain purchase gain

Total purchase price

Amortization
Life (in Years)

The Weather
Company

Truven Health
Analytics

Other
Acquisitions

$ 76

123

$ 171

127

$ 153

110

N/A

1–7

3–7

1–7

1,717

1,933

160

313

349

338

516

593

226

2,738

3,141

1,220

(88)

(372)

(460)

—

(148)

(381)

(529)

—

(96)

(76)

(171)

(40)*

$2,278

$2,612

$1,009

* Bargain purchase gain relating to AT&T’s application and hosting services business was recognized in selling, general and administrative expense in

the Consolidated Statement of Earnings in the three months ended March 31, 2016.

Other—On December 2, 2018, IBM entered into a definitive
agreement to sell certain commercial financing capabilities and
assign a number of its commercial financing contracts, excluding
related receivables which will be collected as they become due
in the normal course of business. These commercial financing
capabilities and contracts have been reported within IBM’s
Global Financing segment. The transaction is expected to close in
the first quarter of 2019, subject to the satisfaction of applicable
regulatory requirements and customary closing conditions. The
financial terms related to the transaction were not material.

Others
2017—In the first quarter of 2017, the company completed one
research-related divestiture. The Cognitive Solutions segment
completed four divestitures; two in the second quarter of 2017
and one each in the third and fourth quarter of 2017. The financial
terms related to these transactions were not material. Overall,
the company recognized a pre-tax gain of $31 million related to
these transactions in 2017.

2016—In the first quarter of 2016, the company completed four
software product-related divestitures. In the fourth quarter of
2016, the company completed the divestiture of one service-
related offering. The financial terms related to these transactions
were not material. Overall, the company recorded a pre-tax gain
of $42 million related to these transactions in 2016.

N/A—Not applicable

For the Other Acquisitions, the overall weighted-average life
of the identified amortizable intangible assets acquired was
6.3 years. These identified intangible assets will be amortized
on a straight-line basis over their useful lives. Goodwill of
$119 million was assigned to the Technology Services & Cloud
Platforms segment, goodwill of $303 million was assigned to the
GBS segment and goodwill of $171 million was assigned to the
Cognitive Solutions segment. It was expected that approximately
55 percent of the goodwill would be deductible for tax purposes.

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

Seterus—On January 3, 2019, IBM and Mr. Cooper Group
announced a definitive agreement, in which Mr. Cooper Group
will acquire IBM’s Seterus home mortgage servicing platform
business. The Seterus content has been reported in Global
Process Services, within IBM’s GBS segment. The transaction
is expected to close in the first quarter of 2019, subject to the
satisfaction of applicable regulatory requirements and customary
closing conditions. The financial terms related to this transaction
are not material.

Notes to Consolidated Financial Statements International Business Machines Corporation and Subsidiary Companies
95

NOTE D. FINANCIAL INSTRUMENTS
Fair Value Measurements
Financial Assets and Liabilities Measured at Fair Value on a Recurring Basis
The following tables present the company’s financial assets and financial liabilities that are measured at fair value on a recurring
basis at December 31, 2018 and 2017.

($ in millions)

At December 31, 2018:

Assets

Cash equivalents (1)

Time deposits and certificates of deposit

Money market funds

Total

Equity investments (2)

Debt securities—current (3)

Derivative assets (4)

Total assets

Liabilities

Derivative liabilities (5)

Level 1

Level 2

Level 3

Total

$ —

—

$7,679

—

7,679

—

618

731

$26

$9,028

$40

$ 343

$ —

$7,679 (6)

—

$ —

7,704

618 (6)

731 (7)

$9,053

$ 383 (7)

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

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

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

(4) The gross balances of derivative assets contained within prepaid expenses and other current assets, and investments and sundry assets in the

Consolidated Statement of Financial Position at December 31, 2018 were $385 million and $347 million, respectively.

(5) The gross balances of derivative liabilities contained within other accrued expenses and liabilities, and other liabilities in the Consolidated Statement

of Financial Position at December 31, 2018 were $177 million and $206 million, respectively.

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

(7) If derivative exposures covered by a qualifying master netting agreement had been netted in the Consolidated Statement of Financial Position, the

total derivative asset and liability positions each would have been reduced by $267 million.

Notes to Consolidated Financial Statements International Business Machines Corporation and Subsidiary Companies96

($ in millions)

At December 31, 2017:

Assets

Cash equivalents (1)

Time deposits and certificates of deposit

Commercial paper

Money market funds

Canadian government securities

Total

Equity investments (2)

Debt securities—current (3)

Debt securities—noncurrent (2)

Derivative assets (4)

Total assets

Liabilities

Derivative liabilities (5)

Level 1

Level 2

Level 3

Total

$ —

—

$ 8,066

$ —

$ 8,066

—

398

8,560

—

608

942

—

398

8,586 (6)

608 (6)

942 (7)

$33

$10,117

$ —

$10,151

$ —

$ 415

$ —

$ 415 (7)

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

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

(3) U.S. Government securities reported as 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, 2017 were $185 million and $757 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, 2017 were $377 million and $38 million, respectively.

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

(7) If derivative exposures covered by a qualifying master netting agreement had been netted in the Consolidated Statement of Financial Position, the

total derivative asset and liability positions each would have been reduced by $255 million.

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)
are financial liabilities with carrying values that approximate
fair value. If measured at fair value in the financial statements,
these financial instruments would be classified as Level 3 in the
fair value hierarchy, except for short-term debt, which would be
classified as Level 2.

Loans and Long-Term Receivables
Fair values are based on discounted future cash flows using
current interest rates offered for similar loans to clients with
similar credit ratings for the same remaining maturities. At
December 31, 2018 and 2017, 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 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
$35,605 million and $39,837 million and the estimated fair value
was $36,599 million and $42,264 million at December 31, 2018
and 2017, respectively. If measured at fair value in the financial
statements, long-term debt (including the current portion) would
be classified as Level 2 in the fair value hierarchy.

Available-for-Sale Securities
Gross realized gains/losses from the sale of available-for-sale
securities during the years ended December 31, 2018 and 2017
were immaterial. After-tax net unrealized holding gains/losses
on available-for-sale securities that have been included in other
comprehensive income/(loss) for the years ended December 31,
2018 and 2017 were immaterial.

Notes to Consolidated Financial Statements International Business Machines Corporation and Subsidiary Companies97

During the fourth quarter of 2014, the company acquired equity
securities in conjunction with the sale of the System x business
which were classified as available-for-sale securities. Based on
an evaluation of available evidence as of December 31, 2015,
the company recorded an other-than-temporary impairment
loss of $86 million resulting in an adjusted cost basis of $185
million as of December 31, 2015. In the first quarter of 2016, the
company recorded a gross realized loss of $37 million (before
taxes) related to the sale of all the outstanding shares. The loss
on this sale was recorded in other (income) and expense in the
Consolidated Statement of Earnings.

Sales of debt and available-for-sale equity investments during
the period were as follows:

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 setoff 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.

($ in millions)

For the year ended December 31:

2018

Proceeds

Gross realized gains
(before taxes)

Gross realized losses

(before taxes)

—

2017

2016

$151

The contractual maturities of substantially all available-for-sale
debt securities are less than one year at December 31, 2018.

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.

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
December 31, 2018 and 2017 was $74 million and $126 million,
respectively, for which no collateral was posted at either date.
Full collateralization of these agreements would be required in
the event that the company’s credit rating falls below investment
grade or if its credit default swap spread exceeds 250 basis
points, as applicable, pursuant to the terms of the collateral
security arrangements. The aggregate fair value of derivative
instruments in asset positions as of December 31, 2018 and 2017
was $731 million and $942 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 $267 million and $255 million at December 31,
2018 and 2017, respectively, of liabilities included in master
netting arrangements with those counterparties. Additionally, at
December 31, 2018 and 2017, this exposure was reduced by $70
million and $114 million of cash collateral, respectively. There
were no non-cash collateral balances in U.S. Treasury securities
at December 31, 2018 and 2017. At December 31, 2018 and
2017, the net exposure related to derivative assets recorded
in the Consolidated Statement of Financial Position was $395
million and $572 million, respectively. At December 31, 2018 and
2017, the net position related to derivative liabilities recorded
in the Consolidated Statement of Financial Position was $116
million and $160 million, respectively.

Notes to Consolidated Financial Statements International Business Machines Corporation and Subsidiary Companies98

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. No amount was
recognized in other receivables at December 31, 2018 and 2017
for the right to reclaim cash collateral. The amount recognized in
accounts payable for the obligation to return cash collateral was
$70 million and $114 million at December 31, 2018 and 2017,
respectively. The company restricts the use of cash collateral
received to rehypothecation, and therefore reports it in restricted
cash in the Consolidated Statement of Financial Position. No
amount was rehypothecated at December 31, 2018 and 2017.

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

In its hedging programs, the company uses forward contracts,
futures contracts, interest-rate swaps, cross-currency 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 December 31, 2018 and 2017, the total notional amount of
the company’s interest-rate swaps was $7.6 billion and $9.1
billion, respectively. The weighted-average remaining maturity
of these instruments at December 31, 2018 and 2017 was
approximately 3.5 years and 4.8 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 December 31, 2018 and 2017.

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 connection with this program, in the fourth
quarter of 2018, the company entered into forward starting
interest-rate swaps. These swaps are linked to future interest
payments on anticipated U.S. dollar debt issuances forecasted to
occur throughout 2019 and 2020. 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 30 years. As of December 31, 2018, the total notional
amount of forward starting interest-rate swaps outstanding was
$5.5 billion. The company did not have any derivative instruments
relating to this program outstanding at December 31, 2017.

At December 31, 2018, in connection with cash flow hedges
of forecasted interest payments related to the company’s
borrowings, the company recorded net losses of $35 million
(before taxes) in AOCI. None of the deferred net losses on
derivatives in AOCI at December 31, 2018 is expected to be
reclassified to net income within the next 12 months.

Foreign Exchange Risk
Long-Term Investments in Foreign Subsidiaries
(Net Investment)
A large portion of the company’s foreign currency denominated
debt portfolio is designated as a hedge of net investment in
foreign subsidiaries to reduce the volatility in stockholders’
equity caused by changes in foreign currency exchange rates in
the functional currency of major foreign subsidiaries with respect
to the U.S. dollar. The company also uses cross-currency swaps
and foreign exchange forward contracts for this risk management
purpose. At December 31, 2018 and 2017, the total notional
amount of derivative instruments designated as net investment
hedges was $6.4 billion and $7.0 billion, respectively. At
December 31, 2018 and 2017, the weighted-average remaining
maturity of these instruments was approximately 0.2 years at
both periods.

Anticipated Royalties and Cost Transactions
The company’s operations generate significant nonfunctional
currency, third-party vendor payments and intercompany
payments for royalties and goods and services among the
company’s non-U.S. subsidiaries and with the company. In
anticipation of these foreign currency cash flows and in view of
the volatility of the currency markets, the company selectively
employs foreign exchange forward contracts to manage its
currency risk. These forward contracts are accounted for as
cash flow hedges. The maximum length of time over which the
company has hedged its exposure to the variability in future cash
flows is four years. At December 31, 2018 and 2017, the total
notional amount of forward contracts designated as cash flow
hedges of forecasted royalty and cost transactions was $9.8
billion and $7.8 billion, respectively. The weighted-average
remaining maturity of these instruments at December 31, 2018
and 2017 was 0.8 years and 0.7 years, respectively.

Notes to Consolidated Financial Statements International Business Machines Corporation and Subsidiary Companies99

At December 31, 2018 and 2017, in connection with cash
flow hedges of anticipated royalties and cost transactions, the
company recorded net gains of $342 million and net gains of
$27 million (before taxes), respectively, in AOCI. The company
estimates that $266 million (before taxes) of deferred net gains
on derivatives in AOCI at December 31, 2018 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 ten years.
At December 31, 2018 and 2017, the total notional amount of
cross-currency swaps designated as cash flow hedges of foreign
currency denominated debt was $6.5 billion at both periods.

At December 31, 2018 and 2017, in connection with cash
flow hedges of foreign currency denominated borrowings, the
company recorded net gains of $75 million and net gains of
$42 million (before taxes), respectively, in AOCI. The company
estimates that $189 million (before taxes) of deferred net gains
on derivatives in AOCI at December 31, 2018, will be reclassified
to net income within the next 12 months, providing an offsetting
economic impact against the underlying exposure.

Subsidiary Cash and Foreign Currency
Asset/Liability Management
The company uses its Global Treasury Centers to manage the
cash of its subsidiaries. These centers principally use currency
swaps to convert cash flows in a cost-effective manner. In
addition, the company uses foreign exchange forward contracts
to economically hedge, on a net basis, the foreign currency
exposure of a portion of the company’s nonfunctional currency
assets and liabilities. The terms of these forward and swap
contracts are generally less than one year. The changes in the
fair values of these contracts and of the underlying hedged
exposures are generally offsetting and are recorded in other
(income) and expense in the Consolidated Statement of Earnings.
At December 31, 2018 and 2017, the total notional amount of
derivative instruments in economic hedges of foreign currency
exposure was $5.2 billion and $11.5 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 December 31, 2018
and 2017, the total notional amount of derivative instruments in
economic hedges of these compensation obligations was $1.2
billion and $1.3 billion, respectively.

Notes to Consolidated Financial Statements International Business Machines Corporation and Subsidiary Companies100

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 December 31, 2018
and 2017.

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 December 31, 2018 and 2017.

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 December 31, 2018 and 2017, 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 December 31, 2018 and 2017, as well as for the years
ended December 31, 2018, 2017 and 2016, respectively.

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

($ in millions)

At December 31:

Designated as hedging

instruments

Fair Value of Derivative Assets

Fair Value of Derivative Liabilities

Balance Sheet
Classification

2018

2017

Balance Sheet
Classification

2018

2017

Interest rate contracts

other current assets

$ 9

$ 2

Prepaid expenses and

Other accrued
expenses and liabilities

$ 4

$ —

Investments and
sundry assets

Foreign exchange

contracts

Prepaid expenses and
other current assets

Investments and
sundry assets

Fair value of
derivative assets

212

348

135

459

111

298

$704

$870

Other liabilities

Other accrued
expenses and liabilities

Other liabilities

Fair value of
derivative liabilities

110

129

318

$ 320

$ 355

Not designated as hedging

instruments

Foreign exchange

Prepaid expenses and

contracts

other current assets

$ 26

$ 61

Prepaid expenses and
other current assets

Fair value of
derivative assets

Equity contracts

Total derivatives

Total debt designated as
hedging instruments (1)

Short-term debt

Long-term debt

Total

$ 28

$731

$ 72

$942

N/A

$731

$942

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

N/A—Not applicable

Other accrued
expenses and liabilities

Fair value of
derivative liabilities

$ 13

$ 57

$ 63

$ 383

$ 60

$ 415

$ —

6,261

6,471

$6,261

$6,471

$6,644

$6,886

Notes to Consolidated Financial Statements International Business Machines Corporation and Subsidiary Companies101

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

($ in millions)

Line Item in the Consolidated Statement of Financial Position
in which the Hedged Item is Included

Short-term debt

Long-term debt

(1) Includes ($6) million of hedging adjustments on discontinued hedging relationships.

(2) Includes ($213) million of hedging adjustments on discontinued hedging relationships.

Carrying Amount
of the Hedged Item
Assets/(Liabilities)

$(1,878)

$(6,004)

Cumulative Amount
of Fair Value Hedging
Adjustment Included
in the Carrying Amount
of Assets/(Liabilities)

$ (4)(1)

$(333)(2)

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:

($ in millions)

For the year ended December 31, 2018

Total

Gains/(losses) of total hedge activity

Cost of
Services

$34,059

Cost of
Sales

$7,464

Cost of
Financing

SG&A
Expense

Other
(Income) and
Expense

$1,132

$19,366

$1,152

(6)

(116)

(434)

Interest
Expense

$723

(6)

Notes to Consolidated Financial Statements International Business Machines Corporation and Subsidiary Companies102

($ in millions)

For the year ended December 31:

Derivative instruments in fair value hedges (1)

Consolidated
Statement of
Earnings Line Item

Gain/(Loss) Recognized in Earnings

Recognized on Derivatives

Attributable to Risk
Being Hedged (2)

2018

2017

2016

2018

2017

2016

Interest rate contracts

Cost of financing

$ (61)

$ 1

$ 28

$ 97

$ 74

$ 58

Interest expense

(58)

Derivative instruments not designated

as hedging instruments

Interest rate contracts

Foreign exchange contracts

Equity contracts

)
Other (income
and expense

SG&A expense

)
Other (income
and expense

—

N/A

(93)

(116)

135

(189)

112

N/A

—

(1)

N/A

$(327)

$153

$ (18)

$189

$144

$121

Total

($ in millions)

For the year ended
December 31:

Derivative instruments
in cash flow hedges

Interest rate
contracts

Foreign exchange

Gain/(Loss) Recognized in Earnings and Other Comprehensive Income

Recognized in OCI

2018

2017

2016

Consolidated
Statement of
Earnings Line Item

Reclassified from AOCI

Amounts Excluded from
Effectiveness Testing (3)

2018

2017

2016

2018

2017

2016

$ (35) $ —

$ — Cost of financing

$ —

Interest expense

—

(23)

324

(22)

—

(8)

(5)

(12)

(68)

(13)

—

(3)

—

Cost of financing *

(75)

SG&A expense

)
Other (income
and expense

Interest expense*

(341)

(71)

contracts

(101)

(58)

243

Cost of services

Cost of sales

Instruments in net

investment hedges (4)

Foreign exchange

contracts

686

(1,607)

311

Cost of financing*

Interest expense*

—

Total

$ 549 $(1,665)

$555

$(449)

$363

$(102)

$64

$45

$74

* Reclassified to conform to 2018 presentation.

Prior period gain or loss amounts and presentation are not conformed to the new hedge accounting guidance that the company adopted in 2018.
Refer to note B, “Accounting Changes,” for further information.

(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 years ended December 31, 2018, 2017 and 2016, 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.

Notes to Consolidated Financial Statements International Business Machines Corporation and Subsidiary Companies

103

NOTE E. INVENTORIES

($ in millions)

At December 31:

Finished goods

2018

2017

$ 266

$ 333

Work in process and raw materials

1,415

1,250

Total

$1,682

$1,583

NOTE F. FINANCING RECEIVABLES
Financing receivables primarily consist of investment in
sales-type and direct financing leases, commercial financing
receivables and client loan and installment payment receivables

(loans). Investment in sales-type and direct financing leases
relates principally to the company’s systems products and are
for terms ranging generally from two to six years. Commercial
financing receivables relate primarily to inventory and accounts
receivable financing for dealers and remarketers of IBM and OEM
products. Payment terms for inventory and accounts receivable
financing generally range from 30 to 90 days. Client loan and
installment payment receivables (loans) are provided primarily
to clients to finance the purchase of hardware, software and
services. Payment terms on these financing arrangements are
generally for terms up to seven years. Client loans and installment
payment financing contracts are priced independently at
competitive market rates.

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

($ in millions)

At December 31, 2018:

Financing receivables, gross

Unearned income

Recorded investment

Allowance for credit losses

Unguaranteed residual value

Guaranteed residual value

Total financing receivables, net

Current portion

Noncurrent portion

($ in millions)

At December 31, 2017:

Financing receivables, gross

Unearned income

Recorded investment

Allowance for credit losses

Unguaranteed residual value

Guaranteed residual value

Total financing receivables, net

Current portion

Noncurrent portion

Investment in
Sales-Type and
Direct Financing
Leases

$6,846

(526)

$6,320

(99)

589

$6,895

$2,834

$4,061

Investment in
Sales-Type and
Direct Financing
Leases

$7,128

(535)

$6,593

(103)

630

100

$7,220

$2,900

$4,320

Commercial
Financing
Receivables

$11,889

(37)

$11,852

(13)

—

$11,838

$ —

Commercial
Financing
Receivables

$11,649

(32)

$11,617

(21)

—

$11,596

$ —

Client Loan and
Installment
Payment
Receivables/
(Loans)

$13,614

(632)

$12,981

(179)

—

$12,802

$ 7,716

$ 5,086

Client Loan and
Installment
Payment
Receivables/
(Loans)

$13,311

(644)

$12,667

(211)

—

$12,456

$ 7,226

$ 5,230

Total

$32,348

(1,195)

$31,153

(292)

589

$31,536

$22,388

$ 9,148

Total

$32,087

(1,210)

$30,877

(336)

630

100

$31,272

$21,721

$ 9,550

Scheduled maturities of minimum lease payments outstanding
at December 31, 2018, expressed as a percentage of the total,
are approximately: 2019, 44 percent; 2020, 26 percent; 2021,
18 percent; 2022, 9 percent; and 2023 and beyond, 3 percent.

The company utilizes certain of its financing receivables as collateral
for nonrecourse borrowings. Financing receivables pledged as
collateral for borrowings were $710 million and $773 million at
December 31, 2018 and 2017, respectively. These borrowings are
included in note J, “Borrowings,” on pages 108 to 111.

The company did not have any financing receivables held for sale
as of December 31, 2018 and 2017.

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
December 31, 2018 and 2017. Commercial financing receivables
are excluded from the presentation of financing receivables
by portfolio segment, as they are short term in nature and
the current estimated risk of loss and resulting impact to the
company’s financing results are not material. The company
determines its allowance for credit losses based on two portfolio
segments: lease receivables and loan receivables, and further
segments the portfolio into three classes: Americas, Europe/
Middle East/Africa (EMEA) and Asia Pacific.

Notes to Consolidated Financial Statements International Business Machines Corporation and Subsidiary Companies
104

($ in millions)

At December 31, 2018:

Recorded investment:

Lease receivables

Loan receivables

Ending balance

Recorded investment, collectively evaluated for impairment

Recorded investment, individually evaluated for impairment

Allowance for credit losses

Beginning balance at January 1, 2018

Lease receivables

Loan receivables

Total

Write-offs

Recoveries

Provision

Other*

Ending balance at December 31, 2018

Lease receivables

Loan receivables

Related allowance, collectively evaluated for impairment

Related allowance, individually evaluated for impairment

* Primarily represents translation adjustments.

Americas

EMEA

Asia Pacific

Total

$ 3,827

6,817

$10,644

$10,498

$ 146

$1,341

3,675

$5,016

$4,964

$ 52

$1,152

2,489

$3,641

$3,590

$ 51

$ 6,320

12,981

$19,301

$19,052

$ 249

$ 63

$ 9

$ 31

$ 103

108

211

$ 172

$ 61

$ 82

$ 314

(10)

(11)

$ 158

$ 53

$ 105

$ 39

$ 119

(2)

(3)

$ 65

$ 22

$ 43

$ 16

$ 49

(23)

(4)

$ 56

$ 24

$ 32

$ 5

$ 51

(35)

(19)

$ 279

$ 99

$ 179

$ 59

$ 219

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.

The average recorded investment of impaired leases and loans for
Americas, EMEA and Asia Pacific was $138 million, $55 million
and $73 million, respectively, for the year ended December 31,
2018. Both interest income recognized, and interest income
recognized on a cash basis on impaired leases and loans were
immaterial for the year ended December 31, 2018.

($ in millions)

At December 31, 2017:

Recorded investment:

Lease receivables

Loan receivables

Ending balance

Recorded investment, collectively evaluated for impairment

Recorded investment, individually evaluated for impairment

Allowance for credit losses

Beginning balance at January 1, 2017

Lease receivables

Loan receivables

Total

Write-offs

Recoveries

Provision

Other*

Ending balance at December 31, 2017

Lease receivables

Loan receivables

Related allowance, collectively evaluated for impairment

Related allowance, individually evaluated for impairment

* Primarily represents translation adjustments.

Americas

EMEA

Asia Pacific

Total

$ 3,911

6,715

$10,626

$10,497

$ 129

$ 54

169

$ 223

(51)

(8)

$ 172

$ 63

$ 108

$ 43

$ 128

$1,349

3,597

$4,946

$4,889

$ 57

$1,333

2,354

$3,687

$3,604

$ 83

$ 6,593

12,667

$19,259

$18,990

$ 269

$ 4

$ 76

$ 133

276

$ 22

$ 165

$ 410

(1)

$ 61

$ 9

$ 52

$ 15

$ 46

(85)

(4)

$ 82

$ 31

$ 51

$ 6

$ 76

(137)

$ 314

$ 103

$ 211

$ 64

$ 250

Notes to Consolidated Financial Statements International Business Machines Corporation and Subsidiary Companies105

Write-offs of lease receivables and loan receivables were
$55 million and $82 million, respectively, for the year ended
December 31, 2017. Provisions for credit losses recorded for
lease receivables and loan receivables were $9 million and $7
million, respectively, for the year ended December 31, 2017.

The average recorded investment of impaired leases and loans for
Americas, EMEA and Asia Pacific was $158 million, $33 million
and $122 million, respectively, for the year ended December 31,
2017. Both interest income recognized, and interest income
recognized on a cash basis on impaired leases and loans were
immaterial for the year ended December 31, 2017.

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
tables present summary information about the recorded investment in lease and loan financing receivables, including recorded
investments aged over 90 days and still accruing, billed invoices aged over 90 days and recorded investment not accruing.

($ in millions)

Total
Recorded
At December 31, 2018: Investment

Recorded
Investment
>90 Days(1)

Recorded
Investment
>90 Days and
Accruing(1)

Billed
Invoices >90
Days and
Accruing

Recorded
Investment Not
Accruing(2)

Americas

EMEA

Asia Pacific

Total lease receivables

Americas

EMEA

Asia Pacific

Total loan receivables

Total

$ 3,827

1,341

1,152

$ 6,320

$ 6,817

3,675

2,489

$12,981

$19,301

$310

$385

$259

$397

$782

$256

$292

$166

$202

$494

$19

$24

$29

$52

$ 57

$ 97

$ 99

$203

$300

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

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

($ in millions)

Total
Recorded
At December 31, 2017: Investment

Recorded
Investment
>90 Days(1)

Recorded
Investment
>90 Days and
Accruing(1)

Billed
Invoices >90
Days and
Accruing

Recorded
Investment Not

Accruing(2) (3)

Americas

EMEA

Asia Pacific

Total lease receivables

Americas

EMEA

Asia Pacific

Total loan receivables

Total

$ 3,911

1,349

1,333

$ 6,593

$ 6,715

3,597

2,354

$12,667

$19,259

$239

$328

$345

$498

$825

$197

$225

$254

$283

$507

$29

$36

$38

$41

$77

$ 44

$107

$ 96

$224

$331

(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, $269 million is individually evaluated for impairment with a related allowance of $250 million.

(3) Recast to conform to current period presentation, which includes billed impaired amounts.

Notes to Consolidated Financial Statements International Business Machines Corporation and Subsidiary Companies

106

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

The following tables present the recorded investment net
of allowance for credit losses for each class of receivables,
by credit quality indicator, at December 31, 2018 and 2017.
Receivables with a credit quality indicator ranging from Aaa to
Baa3 are considered investment grade. All others are considered
non-investment grade. The credit quality indicators do not reflect
mitigation actions that the company takes to transfer credit risk
to third parties.

Lease Receivables

($ in millions)

At December 31, 2018:

Americas

EMEA Asia Pacific

Credit rating

Aaa–Aa3

A1–A3

Baa1–Baa3

Ba1–Ba2

Ba3–B1

B2–B3

Caa–D

$ 593

$ 45

$ 85

678

892

852

433

299

158

417

426

171

413

297

191

Total

$3,774

$1,319

$1,128

Loan Receivables

($ in millions)

At December 31, 2018:

Americas

EMEA Asia Pacific

Credit rating

Aaa–Aa3

A1–A3

Baa1–Baa3

Ba1–Ba2

Ba3–B1

B2–B3

Caa–D

1,206

1,587

1,516

770

531

436

1,148

1,175

472

249

901

648

417

184

109

Total

$6,712

$3,633

$2,457

Lease Receivables

($ in millions)

At December 31, 2017:

Americas

EMEA Asia Pacific

Credit rating

Aaa–Aa3

A1–A3

Baa1–Baa3

Ba1–Ba2

Ba3–B1

B2–B3

Caa–D

$ 422

$ 49

$ 68

855

980

730

443

367

190

371

448

192

544

337

184

Total

$3,847

$1,340

$1,302

Loan Receivables

($ in millions)

At December 31, 2017:

Americas

EMEA Asia Pacific

Credit rating

Aaa–Aa3

A1–A3

Baa1–Baa3

Ba1–Ba2

Ba3–B1

B2–B3

Caa–D

$ 724

$ 129

$ 120

1,469

1,683

1,253

760

630

502

982

1,186

508

204

961

596

325

157

113

Total

$6,607

$3,545

$2,303

Troubled Debt Restructurings
The company did not have any significant troubled debt
restructurings for the years ended December 31, 2018 and 2017.

NOTE G. PROPERTY, PLANT AND EQUIPMENT

($ in millions)

At December 31:

2018

2017

Buildings and building and
leasehold improvements

Information technology equipment

Production, engineering,

office and other equipment

Plant and other property—gross

Less: Accumulated depreciation

Plant and other property—net

Rental machines

Less: Accumulated depreciation

Rental machines—net

Total—net

9,640

17,468

10,073

16,874

4,081

31,636

21,276

10,359

824

392

433

4,060

31,487

20,832

10,655

844

383

462

$10,792

$11,116

$1,055

$ 125

$ 185

Land and land improvements

$ 448

$ 480

Notes to Consolidated Financial Statements International Business Machines Corporation and Subsidiary Companies107

The net carrying amount of intangible assets decreased $655
million during the year ended December 31, 2018, primarily due
to intangible asset amortization, partially offset by additions
resulting from capitalized software. There was no impairment
of intangible assets recorded in 2018 and 2017. The aggregate
intangible amortization expense was $1,353 million and $1,520
million for the years ended December 31, 2018 and 2017,
respectively. In addition, in 2018 and 2017, respectively, the
company retired $1,469 million and $1,753 million of fully
amortized intangible assets, impacting both the gross carrying
amount and accumulated amortization by this amount.

The amortization expense for each of the five succeeding
years relating to intangible assets currently recorded in the
Consolidated Statement of Financial Position is estimated to be
the following at December 31, 2018:

($ in millions)

2019

2020

2021

2022

2023

Capitalized
Software

Acquired
Intangibles

Total

$461

$676

$1,137

320

157

—

565

450

382

886

608

382

NOTE H. INVESTMENTS AND SUNDRY ASSETS

($ in millions)

At December 31:

Derivatives—noncurrent

Alliance investments

Equity method

Non-equity method

Long-term deposits

Other receivables

Employee benefit-related

Prepaid income taxes

Other assets

Total

2018

2017

$ 347

$ 757

192

268

359

263

626

296

271

455

316

590

272*

$2,386

$2,783 *

* Recast to conform to 2018 presentation.

NOTE I. INTANGIBLE ASSETS INCLUDING GOODWILL
Intangible Assets
The following table details the company’s intangible asset
balances by major asset class.

($ in millions)

At December 31, 2018:

Intangible asset class

Gross
Carrying
Amount

Accumulated
Amortization

Net
Carrying
Amount

Capitalized software

$1,568

$ (629)

$ 939

Client relationships

Completed technology

Patents/trademarks

Other*

Total

2,068

2,156

641

(1,123)

(1,296)

(330)

(23)

945

860

311

$6,489

$(3,402)

$3,087

* Other intangibles are primarily acquired proprietary and nonproprietary

business processes, methodologies and systems.

($ in millions)

At December 31, 2017:

Intangible asset class

Gross
Carrying
Amount

Accumulated
Amortization

Net
Carrying
Amount

Capitalized software

$1,600

$ (790)

$ 810

Client relationships

Completed technology

Patents/trademarks

Other*

Total

2,358

2,586

668

(1,080)

(1,376)

(256)

(16)

1,278

1,210

413

$7,260

$(3,518)

$3,742

* Other intangibles are primarily acquired proprietary and nonproprietary

business processes, methodologies and systems.

Notes to Consolidated Financial Statements International Business Machines Corporation and Subsidiary Companies108

Goodwill
The changes in the goodwill balances by reportable segment for the years ended December 31, 2018 and 2017 are as follows:

($ in millions)

Segment

Cognitive Solutions

Global Business Services

Technology Services & Cloud Platforms

Systems

Total

* Primarily driven by foreign currency translation.

($ in millions)

Segment

Cognitive Solutions

Global Business Services

Technology Services & Cloud Platforms

Systems

Total

* Primarily driven by foreign currency translation.

Balance
January 1,
2018

$19,665

4,813

10,447

1,862

$36,788

Balance
January 1,
2017

$19,484

4,607

10,258

1,850

$36,199

Goodwill
Additions

Purchase Price
Adjustments

Divestitures

Foreign
Currency
Translation
and Other
Adjustments*

Balance
December 31,
2018

$10

—

$34

$ 0

(3)

$(3)

$(1)

—

$(290)

$19,384

(92)

(156)

(15)

4,742

10,292

1,847

$(1)

$(553)

$36,265

Goodwill
Additions

Purchase Price
Adjustments

Divestitures

Foreign
Currency
Translation
and Other
Adjustments*

Balance
December 31,
2017

$ 3

—

$16

$(38)

(2)

$(38)

$(20)

$235

$19,665

—

204

179

4,813

10,447

1,862

$(20)

$631

$36,788

There were no goodwill impairment losses recorded during 2018
or 2017 and the company has no accumulated impairment losses.

NOTE J. BORROWINGS
Short-Term Debt

Purchase price adjustments recorded in 2018 and 2017 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 2018 were not material. Net purchase
price adjustments of $38 million were recorded during 2017, with
the primary drivers being deferred tax assets, other taxes payable
and other current liabilities associated with the Truven Health
Analytics, Inc. and The Weather Company acquisitions.

($ in millions)

At December 31:

Commercial paper

Short-term loans

Long-term debt—current maturities

Total

2018

2017

$ 2,995

$1,496

161

7,051

276

5,214

$10,207

$6,987

The weighted-average interest rate for commercial paper at
December 31, 2018 and 2017 was 2.5 percent and 1.5 percent,
respectively. The weighted-average interest rates for short-term
loans were 4.3 percent and 8.8 percent at December 31, 2018
and 2017, respectively.

Notes to Consolidated Financial Statements International Business Machines Corporation and Subsidiary Companies
Long-Term Debt
Pre-Swap Borrowing

($ in millions)

At December 31:

U.S. dollar debt (weighted-average interest rate at December 31, 2018):*

Maturities

2018

2017

109

3.5%

3.0%

2.6%

2.8%

2.4%

3.2%

3.6%

7.0%

3.5%

4.7%

6.5%

3.7%

5.9%

8.0%

5.6%

4.0%

7.0%

4.7%

7.1%

Other currencies (weighted-average interest rate at December 31, 2018, in

parentheses):*

Euros (1.5%)

Pound sterling (2.7%)

Japanese yen (0.3%)

Other (5.6%)

Less: net unamortized discount

Less: net unamortized debt issuance costs

Add: fair value adjustment**

Less: current maturities

Total

2018

2019

2020

2021

2022

2023

2024

2025

2026

2027

2028

2030

2032

2038

2039

2042

2045

2046

2096

2019–2029

2020–2022

2022–2026

2019–2022

$ —

5,465

4,344

5,529

3,536

2,428

2,037

600

1,350

969

313

600

745

$ 4,640

5,540

3,416

4,129

3,481

1,547

2,000

600

1,350

969

313

—

600

745

1,107

650

316

650

316

$30,131

$31,515

10,011

10,502

1,338

1,325

391

1,420

1,291

717

43,196

45,445

802

337

42,656

7,051

826

526

45,052

5,214

$35,605

$39,837

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

** The portion of the company’s fixed-rate debt obligations that is hedged is reflected in the Consolidated Statement of Financial Position as an amount

equal to the sum of the debt’s carrying value and a fair value adjustment representing changes in the fair value of the hedged debt obligations
attributable to movements in benchmark interest rates.

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

During the third quarter of 2017, IBM Credit LLC (IBM Credit), a
wholly owned subsidiary of the company, filed a shelf registration
statement with the Securities and Exchange Commission (SEC)
allowing it to offer for sale public debt securities. IBM Credit
issued fixed- and floating-rate debt securities in September
2017 in the aggregate amount of $3.0 billion with maturity dates
ranging from 2019 to 2022. During 2018, IBM Credit issued fixed-
and floating-rate debt securities in the aggregate amount of $4.0
billion with maturity dates ranging from 2020 to 2023. This debt
is included in the long-term debt table above.

Notes to Consolidated Financial Statements International Business Machines Corporation and Subsidiary Companies
110

than 2.20 to 1.0, as well as a cross default provision with respect
to other defaulted indebtedness of at least $500 million.

The company is in compliance with all of its significant debt
covenants and provides periodic certifications to its lenders.

The failure to comply with its debt covenants could constitute an
event of default with respect to the debt to which such provisions
apply. If certain events of default were to occur, the principal and
interest on the debt to which such event of default applied would
become immediately due and payable.

Post-Swap Borrowing (Long-Term Debt, Including Current Portion)

($ in millions)

For the year ended December 31:

Fixed-rate debt

Floating-rate debt*

Total

2018

Weighted-average
Interest Rate

2.7%

3.0%

Amount

$28,770

13,886

$42,656

2017

Weighted-average
Interest Rate

2.7%

2.1%

Amount

$29,007

16,044

$45,052

* Includes $7,563 million in 2018 and $9,138 million in 2017 of notional interest rate swaps that effectively convert fixed-rate long-term debt into

floating-rate debt. See note D, “Financial Instruments,” on pages 95 to 102.

Pre-swap annual contractual obligations of long-term debt
outstanding at December 31, 2018, are as follows:

($ in millions)

2019

2020

2021

2022

2023

2024 and beyond

Total

Interest on Debt

($ in millions)

Total

$ 7,050

7,273

6,647

4,338

3,403

14,485

$43,196

For the year ended December 31:

2018

2017

2016

Cost of financing

Interest expense

Interest capitalized

Total interest paid
and accrued

$ 757

$ 658

$ 576

723

615

630

$1,482

$1,278

$1,208

Refer to the related discussion on page 143 in note U, “Segment
Information,” for total interest expense of the Global Financing
segment. See note D, “Financial Instruments,” on pages 95 to
102 for a discussion of the use of foreign currency denominated
debt designated as a hedge of net investment, as well as a
discussion of the use of currency and interest rate swaps in the
company’s debt risk management program.

Lines of Credit
On October 28, 2018, the company announced its intent
to acquire all of the outstanding shares of Red Hat, Inc. In
connection with this acquisition, IBM entered into a commitment
letter under which certain banks committed to provide the
company with a 364-day unsecured bridge term loan facility
in an aggregate principal amount of up to $20 billion to fund
the acquisition. The company also entered into a fee letter in

connection with the 364-day bridge facility, under which the
company incurred $40 million in upfront fees during the fourth
quarter of 2018. The company expects to incur additional
fees of up to approximately $25 million during the period the
agreement remains in place. These upfront fees were capitalized
and will be amortized to SG&A in the Consolidated Statement
of Earnings over the expected term of the bridge term loan
facility. For additional information on this transaction, see note
C, “Acquisitions/Divestitures.”

On July 19, 2018, the company amended its existing $10.25
billion Five-Year Credit Agreement. In addition, the company
and IBM Credit LLC entered into a new $2.5 billion, 364-Day
Credit Agreement, to replace the maturing $2.5 billion, 364-
Day agreement, and also amended the existing $2.5 billion
Three-Year Credit Agreement. The amended Five-Year and
Three-Year credit agreements included a modification of terms
to account for the potential discontinuation of LIBOR and to
extend the maturity dates. The new maturity dates for the Five-
Year and Three-Year Credit Agreements are July 20, 2023 and
July 20, 2021, respectively. Each of the facility sizes remained
unchanged. The total expense recorded by the company related
to the Five-Year Credit Agreement was $6.7 million in 2018,
$6.1 million in 2017 and $5.5 million in 2016. The total expense
recorded by the company related to the 364-Day and Three-Year
Credit Agreements was $2.1 million in 2018 and $2.8 million
in 2017. The Five-Year Credit Agreement permits the company
and its Subsidiary Borrowers to borrow up to $10.25 billion on a
revolving basis. Borrowings of the Subsidiary Borrowers will be
unconditionally backed by the company. The company may also,
upon the agreement of either existing lenders, or of the additional
banks not currently party to the Five-Year Credit Agreement,
increase the commitments under the Credit Agreement up to an
additional $1.75 billion. The 364-Day Credit Agreement and the
Three-Year Credit Agreement allow the company and IBM Credit,
(the Borrowers), to borrow up to an aggregate of $5 billion on a
revolving basis. Neither Borrower is a guarantor or co-obligor
of the other Borrower under the 364-Day and Three-Year Credit
Agreements. Subject to certain conditions stated in the Five-
Year, 364-Day and Three-Year credit agreements (the “Credit
Agreements”), the Borrowers may borrow, prepay and re-borrow
amounts under the Credit Agreements at any time during the

Notes to Consolidated Financial Statements International Business Machines Corporation and Subsidiary Companies111

term of the Credit Agreements. Funds borrowed may be used
for the general corporate purposes of the Borrowers. Interest
rates on borrowings under the Credit Agreements will be based
on prevailing market interest rates, as further described in the
Credit Agreements. The Credit Agreements contain customary
representations and warranties, covenants, events of default,
and indemnification provisions. The company believes that
circumstances that might give rise to breach of these covenants
or an event of default, as specified in the Credit Agreements,
are remote.

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

As of December 31, 2018, there were no borrowings by the
company, or its subsidiaries, under the Credit Facilities.

NOTE K. OTHER LIABILITIES

($ in millions)

At December 31:

Income tax reserves

Excess 401(k) Plus Plan

Disability benefits

Derivative liabilities

Workforce reductions

Deferred taxes*

Other taxes payable

Environmental accruals

Warranty accruals

Asset retirement obligations

Acquisition related

Divestiture related**

Other

Total

2018

2017

$ 4,195

$4,193

1,380

1,583

507

206

736

3,696

244

111

173

796

504

804

545

948

262

115

253

577

$12,174

$9,965

* The increase in deferred taxes is due to the company’s election on

GILTI and a reclass from other taxes payable.

** Primarily related to the divestiture of the Microelectronics business.

In response to changing business needs, the company
periodically takes workforce reduction actions to improve
productivity, cost competitiveness and to rebalance skills. The
noncurrent contractually obligated future payments associated
with these activities are reflected in the workforce reductions
caption in the previous table. The noncurrent liabilities are
workforce accruals related to terminated employees who are
no longer working for the company who were granted annual
payments to supplement their incomes in certain countries.
Depending on the individual country’s legal requirements, these
required payments will continue until the former employee
begins receiving pension benefits or passes away. Current
liabilities are included in other accrued expenses and liabilities
in the Consolidated Statement of Financial Position and were
immaterial at December 31, 2018.

The company employs extensive internal environmental
protection programs that primarily are preventive in nature. The
company also participates in environmental assessments and
cleanups at a number of locations, including operating facilities,
previously owned facilities and Superfund sites. The company’s
maximum exposure for all environmental liabilities cannot be
estimated and no amounts have been recorded for non-ARO
environmental liabilities that are not probable or estimable. The
total amounts accrued for non-ARO environmental liabilities,
including amounts classified as current in the Consolidated
Statement of Financial Position, that do not reflect actual
or anticipated insurance recoveries, were $255 million and
$267 million at December 31, 2018 and 2017, respectively.
Estimated environmental costs are not expected to materially
affect the consolidated financial position or consolidated results
of the company’s operations in future periods. However, estimates
of future costs are subject to change due to protracted cleanup
periods and changing environmental remediation regulations.

As of December 31, 2018, the company was unable to estimate
the range of settlement dates and the related probabilities for
certain asbestos remediation AROs. These conditional AROs are
primarily related to the encapsulated structural fireproofing that
is not subject to abatement unless the buildings are demolished
and non-encapsulated asbestos that the company would
remediate only if it performed major renovations of certain
existing buildings. Because these conditional obligations have
indeterminate settlement dates, the company could not develop
a reasonable estimate of their fair values. The company will
continue to assess its ability to estimate fair values at each
future reporting date. The related liability will be recognized once
sufficient additional information becomes available. The total
amounts accrued for ARO liabilities, including amounts classified
as current in the Consolidated Statement of Financial Position
were $146 million and $152 million at December 31, 2018 and
2017, respectively.

NOTE L. EQUITY ACTIVITY
The authorized capital stock of IBM consists of 4,687,500,000
shares of common stock with a $.20 per share par value, of which
892,479,411 shares were outstanding at December 31, 2018 and
150,000,000 shares of preferred stock with a $.01 per share par
value, none of which were outstanding at December 31, 2018.

Stock Repurchases
The Board of Directors authorizes the company to repurchase
IBM common stock. The company repurchased 32,949,233
common shares at a cost of $4,447 million, 27,237,179 common
shares at a cost of $4,323 million, and 23,283,400 common
shares at a cost of $3,455 million in 2018, 2017 and 2016,
respectively. These amounts reflect transactions executed
through December 31 of each year. Actual cash disbursements
for repurchased shares may differ due to varying settlement
dates for these transactions. At December 31, 2018, $3,339
million of Board common stock repurchase authorization was
available. The company plans to purchase shares on the open
market or in private transactions from time to time, depending
on market conditions. As a result of the proposed transaction
to acquire Red Hat, subject to closing, the company intends to
suspend its share repurchase program in 2020 and 2021.

Notes to Consolidated Financial Statements International Business Machines Corporation and Subsidiary Companies112

Other Stock Transactions
The company issued the following shares of common stock as
part of its stock-based compensation plans and employees
stock purchase plan: 3,998,245 shares in 2018, 4,311,998
shares in 2017, and 3,893,366 shares in 2016. The company
issued 424,589 treasury shares in 2018, 463,083 treasury
shares in 2017 and 383,077 treasury shares in 2016, as a
result of restricted stock unit releases and exercises of stock
options by employees of certain acquired businesses and by
non-U.S. employees. Also, as part of the company’s stock-based

compensation plans, 1,173,416 common shares at a cost of $171
million, 1,226,080 common shares at a cost of $193 million,
and 854,365 common shares at a cost of $126 million in 2018,
2017 and 2016, respectively, were remitted by employees to the
company in order to satisfy minimum statutory tax withholding
requirements. These amounts are included in the treasury stock
balance in the Consolidated Statement of Financial Position and
the Consolidated Statement of Changes in Equity.

Reclassifications and Taxes Related to Items of Other Comprehensive Income

($ in millions)

For the year ended December 31, 2018:

Other comprehensive income/(loss)

Foreign currency translation adjustments

Net changes related to available-for-sale securities

Unrealized gains/(losses) arising during the period

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

Total net changes related to available-for-sale securities

Unrealized gains/(losses) on cash flow hedges

Before Tax
Amount

Tax (Expense)/
Benefit

Net of Tax
Amount

$ (730)

$(172)

$ (902)

$ (2)

—

$ (2)

$ 1

—

$ 1

$ (1)

—

$ (1)

Unrealized gains/(losses) arising during the period

$ (136)

$ 43

$ (93)

Reclassification of (gains)/losses to:

Cost of services

Cost of sales

Cost of financing

SG&A expense

Other (income) and expense

Interest expense

(30)

(8)

341

(19)

(86)

(18)

(22)

(5)

255

Total unrealized gains/(losses) on cash flow hedges

$ 313

$ (69)

$ 244

Retirement-related benefit plans (1)

Prior service costs/(credits)

Net (losses)/gains arising during the period

Curtailments and settlements

Amortization of prior service (credits)/costs

Amortization of net (gains)/losses

Total retirement-related benefit plans

Other comprehensive income/(loss)

$ (182)

(2,517)

(73)

2,966

$ 204

$ (215)

$ 31

576

(2)

(632)

$ (21)

$(262)

$ (151)

(1,941)

(68)

2,334

$ 184

$ (476)

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

additional information.)

Notes to Consolidated Financial Statements International Business Machines Corporation and Subsidiary Companies113

($ in millions)

For the year ended December 31, 2017:

Other comprehensive income/(loss)

Foreign currency translation adjustments

Net changes related to available-for-sale securities

Before Tax
Amount

Tax (Expense)/
Benefit

Net of Tax
Amount

$ 152

$ 617

$ 769

Unrealized gains/(losses) arising during the period

$ 1

$ (1)

$ 0

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

$ (58 )

$ 0

$ (58)

Reclassification of (gains)/losses to:

Cost of services

Cost of sales

Cost of financing*

SG&A expense

Other (income) and expense

Interest expense*

(70)

(3)

(11)

(324)

(9)

124

(8)

(43)

(3)

(9)

(199)

Total unrealized gains/(losses) on cash flow hedges

$ (421)

$ 137

$ (284)

Retirement-related benefit plans (1)

Prior service costs/(credits)

Net (losses)/gains arising during the period

Curtailments and settlements

Amortization of prior service (credits)/costs

Amortization of net (gains)/losses

Total retirement-related benefit plans

Other comprehensive income/(loss)

* Reclassified to conform to 2018 presentation.

$ 0

682

(88)

2,889

$3,502

$3,235

$ 0

(201)

(5)

(1,006)

$(1,182)

$ (429)

$ 0

481

(58)

1,883

$2,320

$2,806

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

additional information.)

Notes to Consolidated Financial Statements International Business Machines Corporation and Subsidiary Companies114

($ in millions)

For the year ended December 31, 2016:

Other comprehensive income/(loss)

Foreign currency translation adjustments

Net changes related to available-for-sale securities

Unrealized gains/(losses) arising during the period

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

Total net changes related to available-for-sale securities

Unrealized gains/(losses) on cash flow hedges

Before Tax
Amount

Tax (Expense)/
Benefit

Net of Tax
Amount

$ (20)

$(120)

$ (140)

$ (38)

$ (3)

$ 14

(13)

$ 1

$ (23)

$ (2)

Unrealized gains/(losses) arising during the period

$ 243

$ (80)

$ 163

Reclassification of (gains)/losses to:

Cost of services

Cost of sales

Cost of financing*

SG&A expense

Other (income) and expense

Interest expense*

(4)

(3)

(5)

(4)

(2)

(26)

(5)

(7)

Total unrealized gains/(losses) on cash flow hedges

$ 345

$(126)

$ 219

Retirement-related benefit plans (1)

Net (losses)/gains arising during the period

Curtailments and settlements

Amortization of prior service (credits)/costs

Amortization of net (gains)/losses

Total retirement-related benefit plans

Other comprehensive income/(loss)

* Reclassified to conform to 2018 presentation.

$(2,490)

$ 924

$(1,566)

(16)

(107)

2,764

$ 150

$ 472

(976)

$ (19)

$(263)

(15)

(74)

1,788

$ 132

$ 209

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

additional information.)

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

($ in millions)

December 31, 2015

Other comprehensive income before reclassifications

Amount reclassified from accumulated other

comprehensive income

Total change for the period

December 31, 2016

Other comprehensive income before reclassifications

Amount reclassified from accumulated other

comprehensive income

Total change for the period

December 31, 2017

Cumulative effect of a change in accounting principle**

Other comprehensive income before reclassifications

Amount reclassified from accumulated other

comprehensive income

Total change for the period

December 31, 2018

Net Unrealized
Gains/(Losses
)
on Cash Flow
Hedges

Foreign
Currency
Translation
Adjustments*

Net Change
Retirement-
Related
Benefit Plans

Net Unrealized
Gains/(Losses
)
on Available-
For-Sale
Securities

Accumulated
Other
Comprehensive
Income/(Loss)

$ 100

163

$(3,463)

$(26,248)

(140)

(1,581)

$ 5

(23)

$(29,607)

(1,581)

219

319

(58)

(226)

(284)

(93)

337

244

(140)

(3,603)

769

1,714

132

(26,116)

495

1,825

2,320

(2,834)

(23,796)

(902)

—

(902)

(2,471)

(2,092)

2,276

184

(2)

(1)

—

(1)

1,791

209

(29,398)

1,206

1,599

2,806

(26,592)

(2,422)

(3,089)

2,612

(476)

$ 284

$(3,690)

$(26,083)

$ 0

$(29,490)

* 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 B, “Accounting Changes.”

Notes to Consolidated Financial Statements International Business Machines Corporation and Subsidiary Companies

115

NOTE M. CONTINGENCIES AND COMMITMENTS
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 years ended December 31, 2018, 2017 and
2016 were not material to the Consolidated Financial Statements.

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

With respect to certain of the claims, suits, investigations and
proceedings discussed herein, the company believes at this
time that the likelihood of any material loss is remote, given, for
example, the procedural status, court rulings, and/or the strength
of the company’s defenses in those matters. With respect to the
remaining claims, suits, investigations and proceedings discussed
in this note, except as specifically discussed herein, the company
is unable to provide estimates of reasonably possible losses or
range of losses, including losses in excess of amounts accrued,
if any, for the following reasons.

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

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

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

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

Notes to Consolidated Financial Statements International Business Machines Corporation and Subsidiary Companies116

court’s ruling and denied SCO’s appeal of this matter. In June
2013, the Federal Court in Utah granted SCO’s motion to reopen
the SCO v. IBM case. In February 2016, the Federal Court ruled in
favor of IBM on all of SCO’s remaining claims, and SCO appealed.
On October 30, 2017, the Tenth Circuit Court of Appeals affirmed
the dismissal of all but one of SCO’s remaining claims, which was
remanded to the Federal Court in Utah.

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

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

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

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

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

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

Notes to Consolidated Financial Statements International Business Machines Corporation and Subsidiary Companies117

Commitments
The company’s extended lines of credit to third-party entities
include unused amounts of $7,368 million and $8,111 million at
December 31, 2018 and 2017, respectively. A portion of these
amounts was available to the company’s business partners to
support their working capital needs. In addition, the company
has committed to provide future financing to its clients in
connection with client purchase agreements for approximately
$4,432 million and $3,569 million at December 31, 2018 and
2017, respectively.

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

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

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

In addition, the company guarantees certain loans and financial
commitments. The maximum potential future payment under
these financial guarantees was $26 million and $19 million at
December 31, 2018 and 2017, respectively. The fair value of the
guarantees recognized in the Consolidated Statement of Financial
Position was immaterial.

NOTE N. TAXES

($ in millions)

For the year ended December 31:

2018

2017

2016

Income from continuing
operations before
income taxes

U.S. operations

$ 627

$ 560

$ 3,650

Non-U.S. operations

10,715

10,840

8,680

Total income from

continuing operations
before income taxes

$11,342

$11,400

$12,330

The income from continuing operations provision for income
taxes by geographic operations is as follows:

($ in millions)

For the year ended December 31:

2018

2017

U.S. operations

$1,199

$2,923

Non-U.S. operations

1,420

2,719

2016

$ 38

411

Total continuing operations

provision for income taxes

$2,619

$5,642

$449

The components of the income from continuing operations
provision for income taxes by taxing jurisdiction are as follows:

($ in millions)

For the year ended December 31:

2018

2017

2016

U.S. federal

Current

Deferred

U.S. state and local

Current

Deferred

Non-U.S.

Current

Deferred

$ (342)

$2,388

$ 186

1,377

(746)

$1,035

$2,465

$ (560)

$ 127

$ 55

$ 244

(292)

(44)

$ (165)

$ 83

$ 200

$2,135

$3,891

$ 988

(386)

(797)

(179)

$1,749

$3,094

$ 809

Total continuing operations

provision for income taxes

$2,619

$5,642

$ 449

Discontinued operations

provision for/(benefit from)
income taxes

Provision for social security,
real estate, personal
property and other taxes

Total taxes included

in net income

(3)

(2)

3,322

3,434

3,417

$5,943

$9,073

$3,864

Notes to Consolidated Financial Statements International Business Machines Corporation and Subsidiary Companies118

A reconciliation of the statutory U.S. federal tax rate to the
company’s effective tax rate from continuing operations is
as follows:

In January 2019, the U.S. Treasury and Internal Revenue Service
issued additional U.S. tax reform guidelines. The company is still
evaluating the impact of these guidelines.

For the year ended December 31:

2018

2017

2016

Statutory rate

Enactment of U.S. tax reform

21%

35%

—

Tax differential on

foreign income

Intra-entity transfers

Domestic incentives

State and local

Japan resolution

Other

Effective rate

(11)

(26)

(21)

(1)

—

(3)

(5)

(2)

—

(2)

23%

49%

—

(1)

(10)

Percentages rounded for disclosure purposes.

The significant components reflected within the tax rate
reconciliation labeled “Tax differential on foreign income”
include the effects of foreign subsidiaries’ earnings taxed at rates
other than the U.S. statutory rate, foreign export incentives, U.S.
taxes on foreign income and any net impacts of intercompany
transactions. These items also reflect audit settlements,
excluding the 2016 Japan resolution, or changes in the amount
of unrecognized tax benefits associated with each of these items.

On December 22, 2017, the U.S. Tax Cuts and Jobs Act was
enacted. U.S. tax reform introduced many changes, including
lowering the U.S. corporate tax rate to 21 percent, changes in
incentives, provisions to prevent U.S. base erosion and significant
changes in the taxation of international income, including
provisions which allow for the repatriation of foreign earnings
without U.S. tax. The enactment of U.S. tax reform resulted in
the company recording a provisional tax expense charge of $5.5
billion in the fourth quarter and year ended December 31, 2017.
This charge was the result of the one-time U.S. transition tax and
any foreign tax costs on undistributed foreign earnings, as well
as the remeasurement of deferred tax balances to the new U.S.
federal tax rate. All components of the provisional charge were
based on the company’s estimates as of December 31, 2017.
During the fourth quarter of 2018, the company completed its
accounting for impacts of U.S. tax reform and the effects of
measurement period adjustments were recognized as charges
of $2.0 billion for the year ended December 31, 2018, including
$1.9 billion in the fourth quarter of 2018. The adjustments were
primarily attributable to the company’s election to include GILTI
in measuring deferred taxes, plus refinements to the one-time
U.S. transition tax and foreign tax costs on undistributed foreign
earnings. The net impact of the measurement period adjustments
on the 2018 effective tax rate was 17.7 percent.

The U.S. Tax Cuts and Jobs Act introduced GILTI which subjects
a U.S. shareholder to current tax on income earned by certain
foreign subsidiaries. The company elected the deferred method
which resulted in an increase to tax expense and deferred tax
liabilities of $2.0 billion in the fourth quarter and year ended
December 31, 2018. Refer to note A, “Significant Accounting
Policies,” on pages 76 to 88 for additional information.

The 2018 continuing operations effective tax rate decreased 26.4
points from 2017 driven by: a decrease in the tax charges related
to the impact of U.S. tax reform described above (30.4 points), a
benefit related to domestic and foreign audit activity (6.8 points),
a more favorable mix of pre-tax earnings in 2018 (2.1 points) and
the re-assessment of valuation allowances (1.2 points). These
benefits were partially offset by a lower benefit year to year in
the utilization of foreign tax credits (5.9 points) and benefits in
2017 related to an intra-entity asset transfer (5.1 points) and a
tax write down of an intercompany investment (1.7 points), as well
as a year-to-year increase in tax charges related to intercompany
payments (1.3 points).

With the exception of the impact of U.S. tax reform, the effect of
tax law changes on deferred tax assets and liabilities did not have
a material impact on the company’s effective tax rate.

Deferred Tax Assets

($ in millions)

At December 31:

Retirement benefits

Share-based and other compensation

Domestic tax loss/credit carryforwards

Deferred income

Foreign tax loss/credit carryforwards

Bad debt, inventory and warranty reserves

Depreciation

Accruals

Intangible assets

Other

Gross deferred tax assets

Less: valuation allowance

Net deferred tax assets

Deferred Tax Liabilities

($ in millions)

At December 31:

Depreciation

Retirement benefits

Goodwill and intangible assets

Leases

Software development costs

Deferred transition costs

GILTI deferred taxes

Undistributed foreign earnings*

Other

2018

2017

$3,620

$3,477

636

964

674

903

348

231

336

620

1,501

9,833

915

646

718

605

1,024

395

293

387

585

1,396

9,526

1,004

$8,918

$8,522

2018

2017

$ 719

$ 641

455

1,200

580

292

233

1,927

981

1,011

483

1,226

584

360

254

—

658

Gross deferred tax liabilities

$7,398

$4,206

* Year-to-year increase primarily driven by a reclass from other taxes

payable within other liabilities.

Notes to Consolidated Financial Statements International Business Machines Corporation and Subsidiary Companies119

For financial reporting purposes, the company has foreign and
domestic loss carryforwards, the tax effect of which is $584
million, as well as foreign and domestic credit carryforwards
of $1,283 million. Substantially all of these carryforwards are
available for at least two years and the majority are available for
10 years or more.

recognized $174 million in interest expense and penalties; and,
in 2016, the company recognized $62 million in interest expense
and penalties. The company has $680 million for the payment of
interest and penalties accrued at December 31, 2018, and had
$799 million accrued at December 31, 2017.

The valuation allowances as of December 31, 2018, 2017 and
2016 were $915 million, $1,004 million and $916 million,
respectively. The amounts principally apply to certain foreign
and domestic loss carryforwards and credits. In the opinion of
management, it is more likely than not that these assets will not
be realized. However, to the extent that tax benefits related to
these carryforwards are realized in the future, the reduction in
the valuation allowance will reduce income tax expense.

The amount of unrecognized tax benefits at December 31,
2018 decreased by $272 million in 2018 to $6,759 million.
A reconciliation of the beginning and ending amount of
unrecognized tax benefits is as follows:

($ in millions)

Balance at January 1

$ 7,031

$3,740

$ 4,574

2018

2017

2016

Additions based on tax

positions related to the
current year

Additions for tax positions

394

3,029

of prior years

1,201

803

560

334

Reductions for tax positions
of prior years (including
impacts due to a lapse of
statute)

Settlements

(1,686)

(181)

(367)

(174)

(1,443)

(285)

Balance at December 31

$ 6,759

$7,031

$ 3,740

The additions to unrecognized tax benefits related to the current
and prior years are primarily attributable to U.S. federal and state
tax matters, as well as non-U.S. tax matters, including transfer
pricing, credits and incentives. The settlements and reductions
to unrecognized tax benefits for tax positions of prior years are
primarily attributable to the resolution of certain U.S. federal
audit activity, non-U.S. audits and impacts due to lapse of statute
of limitations.

The unrecognized tax benefits at December 31, 2018 of
$6,759 million can be reduced by $718 million associated with
timing adjustments, U.S. tax credits, potential transfer pricing
adjustments, and state income taxes. The net amount of $6,041
million, if recognized, would favorably affect the company’s
effective tax rate. The net amounts at December 31, 2017 and
2016 were $6,064 million and $2,965 million, respectively.

Interest and penalties related to income tax liabilities are
included in income tax expense. During the year ended
December 31, 2018, the company recognized a net benefit of $14
million in interest expense and penalties; in 2017, the company

Within the next 12 months, the company believes it is reasonably
possible that the total amount of unrecognized tax benefits
associated with certain positions may be reduced. The potential
decrease in the amount of unrecognized tax benefits is associated
with the anticipated resolution of various U.S. state and non-
U.S. audits. The company estimates that the unrecognized tax
benefits at December 31, 2018 could be reduced by $551 million.

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. Although the IRS could
propose additional adjustments related to these transactions,
the company believes it is adequately reserved on these matters.
In the third quarter of 2018, the U.S. Internal Revenue Service
commenced its audit of the company’s U.S. tax returns for
2015 and 2016. The company anticipates that this audit will be
completed in 2020. With respect to major U.S. state and foreign
taxing jurisdictions, the company is generally no longer subject
to tax examinations for years prior to 2014. The company is no
longer subject to income tax examination of its U.S. federal tax
return for years prior to 2013. The open years contain matters
that could be subject to differing interpretations of applicable tax
laws and regulations as it relates to the amount and/or timing of
income, deductions and tax credits. Although the outcome of tax
audits is always uncertain, the company believes that adequate
amounts of tax, interest and penalties have been provided for any
adjustments that are expected to result for these years.

The company is involved in a number of income tax-related
matters in India challenging tax assessments issued by the
India Tax Authorities. As of December 31, 2018, the company
has recorded $660 million as prepaid income taxes in India. A
significant portion of this balance represents cash tax deposits
paid over time to protect the company’s right to appeal various
income tax assessments made by the India Tax Authorities. The
company believes it will prevail on these matters.

Within consolidated retained earnings at December 31, 2018
are undistributed after-tax earnings from certain non-U.S.
subsidiaries that are not indefinitely reinvested. At December 31,
2018, the company has a deferred tax liability of $981 million
for the estimated taxes associated with the repatriation of these
earnings. Undistributed earnings of approximately $300 million
and other outside basis differences in foreign subsidiaries are
indefinitely reinvested in foreign operations. Quantification of the
deferred tax liability, if any, associated with indefinitely reinvested
earnings and outside basis differences is not practicable.

Notes to Consolidated Financial Statements International Business Machines Corporation and Subsidiary Companies120

NOTE O. REVENUE RECOGNITION
Disaggregation of Revenue
The following tables provide details of revenue by major products/services offerings and by geography.

Revenue by Major Products/Service Offerings

($ in millions)

For the year ended December 31, 2018:

Cognitive
Solutions

Global
Business
Services

Technology
Services
& Cloud
Platforms

Solutions Software

$12,903

$ —

Systems

$ —

Global
Financing

$ —

Other

$ —

Transaction Processing Software

5,578

—

Total
Revenue

$12,903

5,578

7,705

1,259

7,852

23,007

6,961

4,493

6,363

1,671

1,590

—

Consulting

Global Process Services

Application Management

Infrastructure Services

Technical Support Services

Integration Software

Systems Hardware

Operating Systems Software

Global Financing*

Other Revenue

Total

—

23,007

6,961

4,493

—

6,363

1,671

—

1,590

—

7,705

1,259

7,852

—

$18,481

$16,817

$34,462

$8,034

$1,590

207

$207

207

$79,591

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

Revenue by Geography

($ in millions)

For the year ended December 31, 2018:

Americas

Europe/Middle East/Africa

Asia Pacific

Total

Total
Revenue

$36,994

25,491

17,106

$79,591

Remaining Performance Obligations
The remaining performance obligation (RPO) disclosure
provides the aggregate amount of the transaction price yet
to be recognized as of the end of the reporting period and an
explanation as to when the company expects to recognize these
amounts in revenue. It is intended to be a statement of overall
work under contract that has not yet been performed and does
not include contracts in which the customer is not committed,
such as certain as-a-Service, governmental, term software
license and services offerings. The customer is not considered
committed when they are able to terminate for convenience
without payment of a substantive penalty. The disclosure
includes estimates of variable consideration, except when the
variable consideration is a sales-based or usage-based royalty
promised in exchange for a license of intellectual property.

Additionally, as a practical expedient, the company does not
include contracts that have an original duration of one year or
less. Remaining performance obligation estimates are subject
to change and are affected by several factors, including
terminations, changes in the scope of contracts, periodic
revalidations, adjustments for revenue that has not materialized
and adjustments for currency.

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

Revenue Recognized for Performance Obligations
Satisfied (or Partially Satisfied) in Prior Periods
For the year ended December 31, 2018, revenue was reduced
by $51 million for performance obligations satisfied (or partially
satisfied) in previous periods mainly due to changes in estimates
on percentage-of-completion based contracts. Refer to note A,
“Significant Accounting Policies,” for additional information on
percentage-of-completion contracts and estimates of costs
to complete.

Notes to Consolidated Financial Statements International Business Machines Corporation and Subsidiary Companies121

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

($ in millions)

Notes and accounts receivable—trade (net of allowances of $309 and $297

at December 31, 2018 and January 1, 2018, respectively)

Contract assets (1)

Deferred income (current)

Deferred income (noncurrent)

At December 31,
2018

At January 1,

2018(2)

$ 7,432

470

11,165

3,445

$ 8,295

557

11,493

3,758

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

(2) As adjusted, upon adoption of the revenue standard on January 1, 2018.

The amount of revenue recognized during the year ended
December 31, 2018 that was included within the deferred income
balance at January 1, 2018 was $10.2 billion and primarily
related to services and software.

Deferred Costs

($ in millions)

Capitalized costs to obtain a contract

Deferred costs to fulfill a contract:

Deferred setup costs

Other deferred fulfillment costs

Total deferred costs (1)

At December 31,
2018

$ 717

2,085

2,173

$4,975

(1) Of the total, $2,300 million is current and $2,676 million is noncurrent.

Prior to January 1, 2018, the current and noncurrent balance of
deferred costs were included within prepaid expenses and other
current assets and investments and sundry assets, respectively.

On January 1, 2018, in accordance with the transition guidance,
$737 million of in-scope sales commissions that were previously
recorded in the Consolidated Statement of Earnings were
capitalized as costs to obtain a contract. The amount of total
deferred costs amortized during the year ended December 31,
2018 was $3,690 million. There were no material impairment
losses incurred during the period. Refer to note A, “Significant
Accounting Policies,” for additional information on deferred costs
to fulfill a contract and capitalized costs of obtaining a contract.

Transition Disclosures
In accordance with the modified retrospective method transition
requirements, the company has presented the financial statement
line items impacted and adjusted to compare to presentation
under the prior GAAP for each of the annual periods during the
first year of adoption of the new revenue standard. The following
tables summarize the impacts as of and for the year ended
December 31, 2018. The adjustments to prior GAAP include
results of the transition adjustments recorded at adoption and
current period impacts. Refer to note B, “Accounting Changes,”
for additional information on the transition adjustments.

Consolidated Statement of Earnings Impacts

($ in millions except per share amounts)

For the year ended December 31, 2018:

Revenue

Cost

Gross profit

Selling, general and administrative expense

Income from continuing operations before income taxes

Provision for/(benefit from) income taxes

As Reported
under New
Revenue
Standard

Adjustments
to Convert
to Prior GAAP

Adjusted
Amounts
under Prior
GAAP

$79,591

$ (63)

$79,528

42,655

36,936

19,366

11,342

2,619

(40)

(23)

(30)

(6)

42,615

36,912

19,373

11,312

2,613

Net income

$ 8,728

$ (24)

$ 8,704

Earnings/(loss) per share of common stock—continuing operations:

Assuming dilution

Basic

$ 9.51

$ 9.56

$(0.03)

$ 9.49

$ 9.54

Notes to Consolidated Financial Statements International Business Machines Corporation and Subsidiary Companies

122

Consolidated Statement of Financial Position Impacts

($ in millions)

At December 31, 2018:

Assets:

As Reported
under New
Revenue
Standard

Adjustments
to Convert
to Prior GAAP

Adjusted
Amounts
under Prior
GAAP

Notes and accounts receivable—trade (net of allowances)

$ 7,432

$ 533

$ 7,965

Deferred costs (current)

Prepaid expenses and other current assets

Deferred taxes

Deferred costs (noncurrent)

Investments and sundry assets

Total assets

Liabilities:

Taxes

Deferred income (current)

Deferred income (noncurrent)

Total liabilities

Equity:

Retained earnings

Accumulated other comprehensive income/(loss)

Total stockholders’ equity

Total liabilities and stockholders’ equity

Consolidated Statement of Cash Flows Impacts

($ in millions)

For the year ended December 31, 2018:

Cash flows from operating activities:

Net income

Adjustments to reconcile net income to cash provided by operating activities:

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

Net cash provided by operating activities

2,300

2,378

5,216

2,676

2,386

(273)

(430)

190

(444)

—

2,027

1,948

5,406

2,231

2,386

$123,382

$(425)

$122,957

$ 3,046

$ 56

$ 3,102

11,165

3,445

11,232

3,476

$106,452

$ 154

$106,606

$159,206

(29,490)

$ 16,929

$123,382

$(604)

$158,601

$(578)

$(425)

(29,464)

$ 16,351

$122,957

As Reported
under New
Revenue
Standard

Adjustments
to Convert
to Prior GAAP

Adjusted
Amounts
under Prior
GAAP

$ 8,728

$(24)

$ 8,704

554

$15,247

$ —

578

$15,247

NOTE P. RESEARCH, DEVELOPMENT AND ENGINEERING
RD&E expense was $5,379 million in 2018, $5,590 million in
2017 and $5,726 million in 2016. Amounts for 2017 and 2016
have been recast to reflect the adoption of the FASB guidance
on presentation of net benefit cost.

to the development of new and improved products and their uses,
as well as services and their application. Within these amounts,
software-related expense was $3,050 million, $3,145 million and
$3,441 million in 2018, 2017 and 2016, respectively.

The company incurred total expense of $5,027 million, $5,170
million and $5,394 million in 2018, 2017 and 2016, respectively,
for scientific research and the application of scientific advances

Expense for product-related engineering was $352 million,
$420 million and $332 million in 2018, 2017 and 2016,
respectively.

Notes to Consolidated Financial Statements International Business Machines Corporation and Subsidiary Companies
123

NOTE Q. EARNINGS PER SHARE OF COMMON STOCK
The following table presents the computation of basic and diluted earnings per share of common stock.

($ in millions except per share amounts)

For the year ended December 31:

Weighted-average number of shares on which earnings per share

calculations are based

Basic

Add—incremental shares under stock-based compensation plans

Add—incremental shares associated with contingently issuable shares

Assuming dilution

Income from continuing operations

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

Net income on which basic earnings per share is calculated

Income from continuing operations

Net income applicable to contingently issuable shares

Income from continuing operations on which diluted earnings

per share is calculated

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

and diluted earnings per share is calculated

Net income on which diluted earnings per share is calculated

Earnings/(loss) per share of common stock

Assuming dilution

Continuing operations

Discontinued operations

Total

Basic

Continuing operations

Discontinued operations

Total

2018

2017

2016

912,048,072

932,828,295

955,422,530

2,786,316

1,481,326

3,094,373

1,462,957

2,416,940

874,626

916,315,714

937,385,625

958,714,097

$8,723

$8,728

$8,723

(6)

$5,758

(5)

$5,753

$5,758

(2)

$11,881

(9)

$11,872

$11,881

$8,718

$5,756

$11,881

$8,722

$ 9.51

0.01

$ 9.52

$ 9.56

0.01

$ 9.57

(5 )

$5,752

(9 )

$11,872

$ 6.14

0.00

$ 6.14

$ 6.17

0.00

$ 6.17

$ 12.39

(0.01)

$ 12.38

$ 12.44

(0.01)

$ 12.43

Weighted-average stock options to purchase 576,776 common
shares in 2018, 209,294 common shares in 2017 and 405,552
common shares in 2016 were outstanding, but were not included
in the computation of diluted earnings per share because the

exercise price of the options was greater than the average market
price of the common shares for the full year, and therefore, the
effect would have been antidilutive.

Notes to Consolidated Financial Statements International Business Machines Corporation and Subsidiary Companies124

NOTE R. RENTAL EXPENSE AND LEASE COMMITMENTS
Rental expense, including amounts charged to inventories
and fixed assets, and excluding amounts previously reserved,
was $1,944 million in 2018, $1,821 million in 2017 and
$1,508 million in 2016. Rental expense in agreements with
rent holidays and scheduled rent increases is recorded on a
straight-line basis over the lease term. Contingent rentals are
included in the determination of rental expense as accruable.

The table below depicts gross minimum rental commitments
under noncancelable leases, amounts related to vacant space
associated with workforce transformation, sublease income
commitments and capital lease commitments. These amounts
reflect activities primarily related to office space, data centers,
equipment and vehicles.

($ in millions)

Operating lease commitments

Gross minimum rental commitments
(including vacant space below)

Vacant space

Sublease income commitments

Capital lease commitments

2019

2020

2021

2022

2023

Beyond 2023

$1,581

$ 29

$ 11

$ 3

$1,233

$ 23

$ 7

$ 3

$914

$ 14

$ 5

$ 3

$640

$ 9

$ 4

$ 3

$445

$ 5

$ 4

$ 2

$815

$ 8

$ 2

$ 28

NOTE S. STOCK-BASED COMPENSATION
The following table presents total stock-based compensation
cost included in income from continuing operations.

($ in millions)

For the year ended December 31:

Cost

Selling, general and
administrative

Research, development

and engineering

Pre-tax stock-based
compensation cost

Income tax benefits

Net stock-based

2018

$ 82

2017

$ 91

2016

$ 88

361

384

401

510

(116)

534

(131)

544

(179)

compensation cost

$ 393

$ 403

$ 364

Total unrecognized compensation cost related to non-vested
awards at December 31, 2018 and 2017 was $821 million and
$851 million, respectively. The amount at December 31, 2018
is expected to be recognized over a weighted-average period of
approximately 2.6 years.

Capitalized stock-based compensation cost was not material at
December 31, 2018, 2017 and 2016.

Incentive Awards
Stock-based incentive awards are provided to employees under
the terms of the company’s long-term performance plans
(the “Plans”). The Plans are administered by the Executive
Compensation and Management Resources Committee of the
Board of Directors (the “Committee”). Awards available under
the Plans principally include restricted stock units, performance
share units, stock options or any combination thereof.

The amount of shares originally authorized to be issued under
the company’s existing Plans was 273 million at December 31,
2018. In addition, certain incentive awards granted under
previous plans, if and when those awards were canceled, could
be reissued under the company’s existing Plans. As such, 66.2
million additional shares were considered authorized to be issued
under the company’s existing Plans as of December 31, 2018.
There were 100.0 million unused shares available to be granted
under the Plans as of December 31, 2018.

Under the company’s long-standing practices and policies, all
awards are approved prior to or on the date of grant. The awards
approval process specifies the individual receiving the grant,
the number of options or the value of the award, the exercise
price or formula for determining the exercise price and the
date of grant. All awards for senior management are approved
by the Committee. All awards for employees other than senior
management are approved by senior management pursuant to
a series of delegations that were approved by the Committee,
and the grants made pursuant to these delegations are reviewed
periodically with the Committee. Awards that are given as part
of annual total compensation for senior management and
other employees are made on specific cycle dates scheduled
in advance. With respect to awards given in connection with
promotions or new hires, the company’s policy requires approval
of such awards prior to the grant date, which is typically the date
of the promotion or the date of hire.

Stock Awards
Stock awards are made in the form of Restricted Stock Units
(RSUs), including Retention Restricted Stock Units (RRSUs), or
Performance Share Units (PSUs).

Notes to Consolidated Financial Statements International Business Machines Corporation and Subsidiary Companies
125

The tables below summarize RSU and PSU activity under the Plans during the years ended December 31, 2018, 2017 and 2016.

RSUs

Balance at January 1

$141

8,555,263

$147

8,899,092

$159

7,527,341

2018

2017

2016

Weighted-
Average
Grant Price

Number
of Units

Weighted-
Average
Grant Price

Number
of Units

Weighted-
Average
Grant Price

Number
of Units

RSUs granted

RSUs released

RSUs canceled/forfeited

Balance at December 31

PSUs

Balance at January 1

PSUs granted at target

Performance adjustments*

PSUs released

PSUs canceled/forfeited

Balance at December 31**

121

148

139

4,806,790

(2,579,962)

(979,387)

137

153

147

3,540,949

(3,032,531)

(852,247)

140

174

158

3,985,870

(1,860,660)

(753,459)

$130

9,802,704

$141

8,555,263

$147

8,899,092

2018

2017

2016

Weighted-
Average
Grant Price

Number
of Units

Weighted-
Average
Grant Price

Number
of Units

Weighted-
Average
Grant Price

Number
of Units

$144

2,649,313

$155

2,874,758

$173

2,928,932

130

152

135

909,140

(328,120)

(666,244)

(144,394)

137

175

144

824,875

(623,245)

(293,236)

(133,839)

140

194

174

990,336

(387,457)

(419,759)

(237,294)

$136

2,419,695

$144

2,649,313

$155

2,874,758

* Represents the change in shares issued to employees after vesting of PSUs because final performance metrics were above or below specified targets.

** Represents the number of shares expected to be issued based on achievement of grant date performance targets. The actual number of shares

issued will depend on final performance against specified targets over the vesting period.

RSUs are stock awards granted to employees that entitle the
holder to shares of common stock as the award vests, typically
over a one- to five-year period. For RSUs, dividend equivalents
are not paid. The fair value of such RSUs is determined and fixed
on the grant date based on the company’s stock price adjusted
for the exclusion of dividend equivalents.

The remaining weighted-average contractual term of RSUs at
December 31, 2018, 2017 and 2016 is the same as the period
over which the remaining cost of the awards will be recognized,
which is approximately three years. The fair value of RSUs granted
during the years ended December 31, 2018, 2017 and 2016 was
$583 million, $484 million and $557 million, respectively. The
total fair value of RSUs vested and released during the years
ended December 31, 2018, 2017 and 2016 was $381 million,
$463 million and $323 million, respectively. As of December 31,
2018, 2017 and 2016, there was $715 million, $763 million and
$814 million, respectively, of unrecognized compensation cost
related to non-vested RSUs. The company received no cash from
employees as a result of employee vesting and release of RSUs
for the years ended December 31, 2018, 2017 and 2016.

PSUs are stock awards where the number of shares ultimately
received by the employee depends on the company’s
performance against specified targets and typically vest over
a three-year period. For PSUs, dividend equivalents are not
paid. The fair value of each PSU is determined on the grant date,
based on the company’s stock price, adjusted for the exclusion of
dividend equivalents, and assumes that performance targets will
be achieved. Over the performance period, the number of shares
of stock that will be issued is adjusted upward or downward
based upon the probability of achievement of performance
targets. The ultimate number of shares issued and the related
compensation cost recognized as expense will be based on a
comparison of the final performance metrics to the specified
targets. The fair value of PSUs granted at target during the years
ended December 31, 2018, 2017 and 2016 was $118 million,
$113 million and $138 million, respectively. Total fair value of
PSUs vested and released during the years ended December 31,
2018, 2017 and 2016 was $101 million, $51 million and $81
million, respectively.

In connection with vesting and release of RSUs and PSUs,
the tax benefits realized by the company for the years ended
December 31, 2018, 2017 and 2016 were $117 million, $180
million and $118 million, respectively.

Notes to Consolidated Financial Statements International Business Machines Corporation and Subsidiary Companies126

Stock Options
For the years ended December 31, 2018 and 2017, the company
did not grant stock options. For the year ended December 31,
2016, the company made one grant of 1.5 million premium-
priced stock options. The option award was granted with a
three-year cliff vesting period and a 10-year contractual term.
The award’s cost of $12 million is recognized ratably over the
three-year vesting period.

The company estimates the fair value of stock options at the
date of grant using the Black-Scholes valuation model. Key
inputs and assumptions used to estimate the fair value of stock
options include the grant price of the award, the expected option
term, volatility of the company’s stock, the risk-free rate and the
company’s dividend yield. Estimates of fair value are not intended
to predict actual future events or the value ultimately realized by
employees who receive equity awards, and subsequent events
are not indicative of the reasonableness of the original estimates
of fair value made by the company.

The following table summarizes option activity under the Plans during the years ended December 31, 2018, 2017 and 2016.

Balance at January 1

Options granted

Options exercised

Options canceled/expired

Balance at December 31

Exercisable at December 31

2018

2017

2016

Weighted-
Average
Exercise Price

Number of
Shares
Under Option

Weighted-
Average
Exercise Price

Number of
Shares
Under Option

Weighted-
Average
Exercise Price

Number of
Shares
Under Option

$140

1,500,000

$137

1,613,923

$ 94

479,774

—

$140

$ —

1,500,000

—

103

$140

$ —

—

140

1,500,000

(106,132)

(7,791)

1,500,000

—

$137

$103

(361,088)

(4,763)

1,613,923

113,923

The shares under option at December 31, 2018 were in the following exercise price ranges:

Exercise Price Range

$129–$154

Options Outstanding

Weighted-
Average
Exercise Price

Number of
Shares
Under Option

$140

1,500,000

Aggregate
Intrinsic
Value

Weighted-Average
Remaining
Contractual Life
(in Years)

7.1

Exercises of Employee Stock Options
For the year ended December 31, 2018, no stock options were
exercised. The total intrinsic value of options exercised during
the years ended December 31, 2017 and 2016 was $7 million
and $20 million, respectively. The total cash received from
employees as a result of employee stock option exercises for the
years ended December 31, 2017 and 2016 was approximately
$11 million and $33 million, respectively. In connection with
these exercises, the tax benefits realized by the company for
the years ended December 31, 2017 and 2016 were $2 million
and $7 million, respectively.

The company settles employee stock option exercises primarily
with newly issued common shares and, occasionally, with
treasury shares. Total treasury shares held at December 31, 2018
and 2017 were approximately 1,341 million and 1,307 million
shares, respectively.

Notes to Consolidated Financial Statements International Business Machines Corporation and Subsidiary Companies

127

Acquisitions
In connection with various acquisition transactions, there was an
additional 0.2 million options outstanding at December 31, 2018,
as a result of the company’s conversion of stock-based awards
previously granted by the acquired entities. The weighted-
average exercise price of these awards was $39 per share.

IBM Employees Stock Purchase Plan
The company maintains a non-compensatory Employees Stock
Purchase Plan (ESPP). The ESPP enables eligible participants
to purchase full or fractional shares of IBM common stock at
a 5 percent discount off the average market price on the day
of purchase through payroll deductions of up to 10 percent of
eligible compensation. Eligible compensation includes any
compensation received by the employee during the year. The
ESPP provides for offering periods during which shares may be
purchased and continues as long as shares remain available
under the ESPP, unless terminated earlier at the discretion of the
Board of Directors. Individual ESPP participants are restricted
from purchasing more than $25,000 of common stock in one
calendar year or 1,000 shares in an offering period.

Employees purchased 1.0 million, 1.0 million and 1.2 million
shares under the ESPP during the years ended December 31,
2018, 2017 and 2016, respectively. Cash dividends declared
and paid by the company on its common stock also include cash
dividends on the company stock purchased through the ESPP.
Dividends are paid on full and fractional shares and can be
reinvested. The company stock purchased through the ESPP is
considered outstanding and is included in the weighted-average
outstanding shares for purposes of computing basic and diluted
earnings per share.

In July 2014, the “2014 ESPP Reserve” became effective and
25 million additional shares of authorized common stock were
reserved and approved for issuance. The 2014 ESPP provides for
semi-annual offerings commencing July 1, 2014, and continuing
as long as shares remain available under the ESPP, unless
terminated earlier at the discretion of the Board of Directors.

U.S. Plans
Defined Benefit Pension Plans
IBM Personal Pension Plan
IBM provides U.S. regular, full-time and part-time employees
hired prior to January 1, 2005 with noncontributory defined
benefit pension benefits via the IBM Personal Pension Plan (PPP).
The PPP has two plans, a tax qualified plan (Qualified PPP) and a
non-tax qualified plan (Excess PPP). The Qualified PPP is funded
by company contributions to an irrevocable trust fund, which is
held for the sole benefit of participants and beneficiaries. The
Excess PPP, which is unfunded, provides benefits in excess of
IRS limitations for qualified plans.

Benefits provided to the PPP participants are calculated using
benefit formulas that vary based on the participant. The first
method uses a five-year, final pay formula that determines
benefits based on salary, years of service, mortality and other
participant-specific factors. The second method is a cash
balance formula that calculates benefits using a percentage of
employees’ annual salary, as well as an interest crediting rate.

Benefit accruals under the IBM PPP ceased December 31, 2007
for all participants.

Beginning in 2019, substantially all the plan participants in the
U.S. Qualified PPP are considered inactive. As required by U.S.
GAAP, this will change the amortization period of unrecognized
actuarial losses to the average remaining life expectancy of
inactive plan participants, which is 18 years as of December 31,
2018. As a result of this change, there will be a reduction to 2019
amortization expense of approximately $900 million. There will
be no impact to funded status, retiree benefit payments or funding
requirements of the U.S. Qualified PPP due to this change.

U.S. Supplemental Executive Retention Plan
The company also sponsors a nonqualified U.S. Supplemental
Executive Retention Plan (Retention Plan). The Retention Plan,
which is unfunded, provides benefits to eligible U.S. executives
based on average earnings, years of service and age at
termination of employment.

Approximately 19.8 million, 20.8 million and 21.8 million shares
were available for purchase under the ESPP at December 31,
2018, 2017 and 2016, respectively.

Benefit accruals under the Retention Plan ceased December 31,
2007 for all participants.

NOTE T. RETIREMENT-RELATED BENEFITS
Description of Plans
IBM sponsors defined benefit pension plans and defined
contribution plans that cover eligible regular employees, a
supplemental retention plan that covers certain U.S. executives
and nonpension postretirement benefit plans primarily
consisting of retiree medical and dental benefits for eligible
retirees and dependents.

Defined Contribution Plans
IBM 401(k) Plus Plan
U.S. regular, full-time and part-time employees are eligible to
participate in the IBM 401(k) Plus Plan, which is a qualified
defined contribution plan under section 401(k) of the Internal
Revenue Code. Under the IBM 401(k) Plus Plan, eligible
employees receive a dollar-for-dollar match of their contributions
generally up to 6 percent of eligible compensation for those
hired prior to January 1, 2005, and generally up to 5 percent
of eligible compensation for those hired on or after January 1,
2005. In addition, eligible employees generally receive automatic
contributions from the company equal to 1, 2 or 4 percent of
eligible compensation based on their eligibility to participate in
the PPP as of December 31, 2007. Employees generally receive
automatic contributions and matching contributions after the
completion of one year of service.

Notes to Consolidated Financial Statements International Business Machines Corporation and Subsidiary Companies128

Nonpension Postretirement Benefit Plan
U.S. Nonpension Postretirement Plan
The company sponsors a defined benefit nonpension
postretirement benefit plan that provides medical and dental
benefits to eligible U.S. retirees and eligible dependents, as
well as life insurance for eligible U.S. retirees. Benefits provided
vary based on plan design formulas and eligibility requirements.
Under all the plan arrangements, there is a maximum cost to the
company for these benefits.

Since January 1, 2004, new hires, as of that date or later, are
not eligible for company-subsidized nonpension postretirement
benefits.

Non-U.S. Plans
Certain subsidiaries and branches outside the United States
sponsor defined benefit and/or defined contribution plans that
cover eligible regular employees. The company deposits funds
under various fiduciary-type arrangements, purchases annuities
under group contracts or provides reserves for these plans.
Benefits under the defined benefit plans are typically based
either on years of service and the employee’s compensation
(generally during a fixed number of years immediately before
retirement) or on annual credits. The range of assumptions
that are used for the non-U.S. defined benefit plans reflect the
different economic environments within the various countries.

In addition, certain of the company’s non-U.S. subsidiaries
sponsor nonpension postretirement benefit plans that provide
medical and dental benefits to eligible non-U.S. retirees and
eligible dependents, as well as life insurance for certain eligible
non-U.S. retirees. However, most non-U.S. retirees are covered
by local government sponsored and administered programs.

All contributions, including the company match, are made in
cash and invested in accordance with participants’ investment
elections. There are no minimum amounts that must be invested
in company stock, and there are no restrictions on transferring
amounts out of company stock to another investment choice,
other than excessive trading rules applicable to such investments.
Matching and automatic contributions are made once annually at
the end of the year. In order to receive such contributions each
year, a participant must be employed on December 15 of the plan
year. However, matching and auto contributions may be made for
certain types of separations that occur prior to December 15,
including for example, if the participant has completed certain
service and/or age requirements at separation. The company’s
matching contributions vest immediately and participants are
always fully vested in their own contributions.

IBM Excess 401(k) Plus Plan
The IBM Excess 401(k) Plus Plan (Excess 401(k)) is an unfunded,
nonqualified defined contribution plan. Employees whose eligible
compensation is expected to exceed the IRS compensation limit
for qualified plans are eligible to participate in the Excess 401(k).
The purpose of the Excess 401(k) is to provide benefits that
would be provided under the qualified IBM 401(k) Plus Plan if
the compensation limits did not apply.

Amounts deferred into the Excess 401(k) are record-keeping
(notional) accounts and are not held in trust for the participants.
Participants in the Excess 401(k) may invest their notional
accounts in investments which mirror the primary investment
options available under the 401(k) Plus Plan. Participants in
the Excess 401(k) are also eligible to receive company match
and automatic contributions (at the same rate as under the
401(k) Plus Plan) on eligible compensation deferred into the
Excess 401(k) and on compensation earned in excess of the
Internal Revenue Code pay limit once they have completed
one year of service. Amounts deferred into the Excess 401(k),
including company contributions are recorded as liabilities
in the Consolidated Statement of Financial Position. Matching
and automatic contributions are made once annually at the end
of the year. In order to receive such contributions each year, a
participant must be employed on December 15 of the plan year.
However, matching and auto contributions may be made for
certain types of separations that occur prior to December 15,
including for example, if the participant has completed certain
service and/or age requirements at separation.

Notes to Consolidated Financial Statements International Business Machines Corporation and Subsidiary Companies129

Plan Financial Information
Summary of Financial Information
The following table presents a summary of the total retirement-related benefits net periodic (income)/cost recorded in the
Consolidated Statement of Earnings.

($ in millions)

U.S. Plans

Non-U.S. Plans

Total

For the year ended December 31:

2018

2017

2016

2018

2017

2016

2018

2017

2016

Defined benefit pension plans

$ 542

$ 237

$(334)

$1,284

$1,315

$1,039

$1,827

$1,552

$ 705

Retention Plan

—

Total defined benefit pension

plans (income)/cost

$ 559

$ 253

$(317)

$1,284

$1,315

$1,039

$1,843

$1,568

$ 722

IBM 401(k) Plus Plan and

non-U.S. plans

Excess 401(k)

Total defined contribution

plans cost

Nonpension postretirement

$ 588

$ 616

$ 626

$ 412

$ 404

$ 420

$1,000

$1,020

$1,046

—

$ 612

$ 643

$ 650

$ 412

$ 404

$ 420

$1,024

$1,046

$1,070

benefit plans cost

$ 147

$ 180

$ 195

$ 51

$ 62

$ 16

$ 198

$ 242

$ 211

Total retirement-related

benefits net periodic cost

$1,319

$1,076

$ 527

$1,747

$1,781

$1,475

$3,066

$2,857

$2,003

The following table presents a summary of the total PBO for defined benefit pension plans, APBO for nonpension postretirement
benefit plans, fair value of plan assets and the associated funded status recorded in the Consolidated Statement of Financial Position.

($ in millions)

At December 31:

U.S. Plans

Overfunded plans

Qualified PPP

Underfunded plans

Excess PPP

Retention Plan

Nonpension postretirement benefit plan

Benefit Obligations

Fair Value of Plan Assets

Funded Status*

2018

2017

2018

2017

2018

2017

$46,145

$50,602

$48,213

$52,694

$ 2,069

$ 2,092

$ 1,395

$ 1,532

$ —

$ (1,395)

$ (1,532)

273

3,912

310

4,184

—

(273)

(310)

(3,882)

(4,165)

Total underfunded U.S. plans

$ 5,579

$ 6,026

$ 29

$ 18

$ (5,550)

$ (6,007)

Non-U.S. Plans

Overfunded plans

Qualified defined benefit pension plans**

$17,379

$19,537

$19,975

$22,088

$ 2,597

$ 2,551

Nonpension postretirement benefit plans

Total overfunded non-U.S. plans

$17,379

$19,537

$19,975

$22,088

$ 2,597

$ 2,551

Underfunded plans

Qualified defined benefit pension plans**

$22,139

$23,046

$16,783

$18,711

$ (5,356)

$ (4,336)

Nonqualified defined benefit pension plans

6,252

Nonpension postretirement benefit plans

704

6,527

732

—

(6,252)

(6,527)

(640)

(663)

Total underfunded non-U.S. plans

$29,095

$30,306

$16,848

$18,780

$(12,248)

$(11,526)

Total overfunded plans

Total underfunded plans

$63,524

$70,139

$68,190

$74,782

$ 4,666

$ 4,643

$34,675

$36,332

$16,877

$18,799

$(17,798)

$(17,533)

* Funded status is recognized in the Consolidated Statement of Financial Position as follows: asset amounts as prepaid pension assets; (liability)

amounts as compensation and benefits (current liability) and retirement and nonpension postretirement benefit obligations (noncurrent liability).

** Non-U.S. qualified plans represent plans funded outside of the U.S. Non-U.S. non-qualified plans are unfunded.

Notes to Consolidated Financial Statements International Business Machines Corporation and Subsidiary Companies130

At December 31, 2018, the company’s qualified defined benefit
pension plans worldwide were 99 percent funded compared to
the benefit obligations, with the U.S. Qualified PPP 104 percent
funded. Overall, including nonqualified plans, the company’s
defined benefit pension plans worldwide were 91 percent funded.

PPP and the Retention Plan. The defined benefit pension plans
and the nonpension postretirement benefit plans under non-
U.S. Plans consists of all plans sponsored by the company’s
subsidiaries. The nonpension postretirement benefit plan under
U.S. Plan consists of only the U.S. Nonpension Postretirement
Benefit Plan.

Defined Benefit Pension and Nonpension
Postretirement Benefit Plan Financial Information
The following tables through page 133 represent financial
information for the company’s retirement-related benefit plans,
excluding defined contribution plans. The defined benefit pension
plans under U.S. Plans consists of the Qualified PPP, the Excess

The tables below present the components of net periodic
(income)/cost of the retirement-related benefit plans recognized
in the Consolidated Statement of Earnings, excluding defined
contribution plans.

($ in millions)

For the year ended December 31:

Service cost

Interest cost (1)

Expected return on plan assets (1)

Amortization of transition assets (1)

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

Recognized actuarial losses (1)

Curtailments and settlements (1)

Multi-employer plans

Other costs/(credits)*

Defined Benefit Pension Plans

U.S. Plans

Non-U.S. Plans

2018

$ —

1,719

(2,701)

—

2017

$ —

1,913

(3,014)

—

2016

$ —

2,048

(3,689)

—

2018

2017

2016

$ 413

$ 410

$ 420

830

837

(1,342)

(1,325)

(83)

(97)

1,525

1,337

1,314

1,401

1,507

—

(76)

1,035

(1,867)

(106)

1,408

Total net periodic (income)/cost

$ 559

$ 253

$ (317)

$ 1,284

$ 1,315

$ 1,039

($ in millions)

For the year ended December 31:

Service cost

Interest cost (1)

Expected return on plan assets (1)

Amortization of transition assets (1)

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

Recognized actuarial losses (1)

Curtailments and settlements (1)

Total net periodic cost

Nonpension Postretirement Benefit Plans

U.S. Plan

2017

$ 14

154

—

(7)

—

2018

$ 13

132

—

(7)

—

2016

$ 17

165

—

(7)

—

Non-U.S. Plans

2017

$ 6

(7)

2018

$ 5

(6)

$147

$180

$195

$51

$ 62

2016

$ 5

(6)

(5)

(38)

$ 16

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

* The non-U.S. plans amounts include a gain of $91 million in 2017 related to the IBM UK litigation and a retirement-related charge of $56 million

related to the IBM Spain pension litigation for 2016.

Notes to Consolidated Financial Statements International Business Machines Corporation and Subsidiary Companies131

The following table presents the changes in benefit obligations and plan assets of the company’s retirement-related benefit plans,
excluding defined contribution plans.

($ in millions)

Change in benefit obligation

Defined Benefit Pension Plans

Nonpension Postretirement Benefit Plans

U.S. Plans

Non-U.S. Plans

U.S. Plan

Non-U.S. Plans

2018

2017

2018

2017

2018

2017

2018

2017

Benefit obligation at January 1

$52,444

$52,218

$49,111

$44,981

$ 4,184

$ 4,470

$ 732

$ 692

Service cost

Interest cost

Plan participants’ contributions

Acquisitions/divestitures, net

Actuarial losses/(gains)

Benefits paid from trust

Direct benefit payments

Foreign exchange impact

Amendments/curtailments/

settlements/other

—

1,719

1,913

—

(2,743)

1,895

413

830

(27)

(240)

410

837

520

(3,484)

(3,460)

(1,976)

(1,865)

(124)

(123)

(390)

(384)

—

(2,012)

4,657

(96)

132

(71)

(383)

(22)

—

154

(98)

(385)

(24)

—

(7)

(31)

(86)

—

(3)

(6)

(30)

(1)

Benefit obligation at December 31

$47,812

$52,444

$45,770

$49,111

$ 3,912

$ 4,184

$ 705

$ 732

Change in plan assets

Fair value of plan assets at January 1 $52,694

$51,405

$40,798

$36,020

$ 18

$ 26

$ 70

$ 71

Actual return on plan assets

(997)

4,749

Employer contributions

Acquisitions/divestitures, net

Plan participants’ contributions

—

(610)

325

(22)

2,583

368

(28)

335

394

Benefits paid from trust

(3,484)

(3,460)

(1,976)

(1,865)

(383)

(385)

—

(1,754)

3,694

(28)

(2)

—

(70)

(7)

(10)

—

(6)

(1)

Foreign exchange impact

Amendments/curtailments/

settlements/other

Fair value of plan assets

at December 31

$48,213

$52,694

$36,758

$40,798

$ 29

$ 18

$ 65

$ 70

Funded status at December 31

$ 401

$ 250

$ (9,012) $ (8,312)

$(3,882)

$(4,165)

$(640)

$(663)

Accumulated benefit obligation*

$47,812

$52,444

$45,161

$47,974

N/A

* Represents the benefit obligation assuming no future participant compensation increases.

N/A—Not applicable

The following table presents the net funded status recognized in the Consolidated Statement of Financial Position.

($ in millions)

Defined Benefit Pension Plans

Nonpension Postretirement Benefit Plans

U.S. Plans

Non-U.S. Plans

U.S. Plan

Non-U.S. Plans

At December 31:

2018

2017

2018

2017

2018

2017

Prepaid pension assets

$ 2,069

$ 2,092

$ 2,597

$ 2,551

$ 0

2018

$ 0

2017

$ 0

Current liabilities—

compensation and benefits

(120)

(302)

(323)

(340)

(353)

(36)

(17)

Noncurrent liabilities—retirement
and nonpension postretirement
benefit obligations

(1,548)

(1,722)

(11,306)

(10,541)

(3,542)

(3,812)

(605)

(646)

Funded status—net

$ 401

$ 250

$ (9,012) $ (8,312)

$(3,882)

$(4,165)

$(640)

$(663)

Notes to Consolidated Financial Statements International Business Machines Corporation and Subsidiary Companies132

The following table presents the pre-tax net loss and prior service costs/(credits) and transition (assets)/liabilities recognized in
OCI and the changes in the pre-tax net loss, prior service costs/(credits) and transition (assets)/liabilities recognized in AOCI for the
retirement-related benefit plans.

($ in millions)

Defined Benefit Pension Plans

Nonpension Postretirement Benefit Plans

U.S. Plans

Non-U.S. Plans

U.S. Plan

Non-U.S. Plans

2018

2017

2018

2017

Net loss at January 1

$18,045

$19,222

$18,275

$20,544

Current period loss/(gain)

Curtailments and settlements

956

—

159

—

1,590

(11)

(740)

(22)

Amortization of net loss included in

net periodic (income)/cost

(1,525)

(1,337)

(1,401)

(1,507)

Net loss at December 31

$17,476

$18,045

$18,452

$18,275

2018

$486

(72)

—

(10)

$405

2017

$605

(99)

—

(20)

$486

2018

$145

2017

$154

(6)

(2)

(7)

$172

$145

Prior service costs/(credits)

at January 1

$ 74

$ 90

$ (90)

$ (188)

$ 45

$ 37

$ 3

$ 1

Current period prior service

costs/(credits)

Curtailments, settlements

and other

Amortization of prior service

(costs)/credits included in net
periodic (income)/cost

Prior service costs/(credits)

—

181

—

(16)

—

at December 31

$ 57

$ 74

$ 172

$ (90)

$ 52

$ 45

$ 4

$ 3

Transition (assets)/liabilities

at January 1

$ — $ —

$ 0

$ —

$ 0

Amortization of transition

assets/(liabilities) included in
net periodic (income)/cost

Transition (assets)/liabilities

—

at December 31

$ — $ —

$ 0

$ —

$ 0

Total loss recognized in
accumulated other
comprehensive income/(loss)*

$17,533

$18,119

$18,624

$18,184

$457

$531

$176

$147

* See note L, “Equity Activity,” for the total change in AOCI, and the Consolidated Statement of Comprehensive Income for the components of net

periodic (income)/cost, including the related tax effects, recognized in OCI for the retirement-related benefit plans.

Notes to Consolidated Financial Statements International Business Machines Corporation and Subsidiary Companies133

The following table presents the pre-tax estimated net loss, estimated prior service costs/(credits) and estimated transition (assets)/
liabilities of the retirement-related benefit plans that will be amortized from AOCI into net periodic (income)/cost in 2019.

($ in millions)

Net loss

Prior service costs/(credits)

Transition (assets)/liabilities

On October 26, 2018, the High Court in London in the case of
Lloyds Pension Group Trustees Limited v Lloyds Bank PLC,
confirmed that the UK defined benefit pension plans are required
to equalize pension benefits to take into account unequal
guaranteed minimum pension benefits accrued during the period
1990-1997. As a result of this court decision, IBM recorded an
increase of $125 million to the PBO for the IBM UK defined
benefit plan, which represents approximately 1 percent of the
UK PBO. This amount was recorded as prior service cost in OCI
for the year ended December 31, 2018.

On March 24, 2014, the Supreme Court of Spain issued a ruling
against IBM Spain in litigation involving its defined benefit and
defined contribution plans. During the fourth quarter of 2016,
an arbitration ruling related to the defined contribution plan
resulted in an additional charge of $56 million. For the year
ended December 31, 2016, the company recorded pre-tax
retirement-related obligations of $56 million in selling, general
and administrative expense in the Consolidated Statement of
Earnings. There were no pre-tax retirement-related obligations
for the years ended December 31, 2018 and 2017. These
obligations are reflected in “Non-U.S. Plans—Other costs/
(credits)” in the table on page 130.

Defined Benefit
Pension Plans

Nonpension Postretirement
Benefit Plans

U.S. Plans

Non-U.S. Plans

U.S. Plan

Non-U.S. Plans

$560

$1,261

—

(26)

—

(2)

—

$11

—

On October 12, 2012, the High Court in London issued a ruling
against IBM United Kingdom Limited and IBM United Kingdom
Holdings Limited, both wholly owned subsidiaries of the company,
in litigation involving one of IBM UK’s defined benefit plans. As a
result of the ruling, the company recorded a pre-tax retirement-
related obligation of $162 million in the fourth quarter of 2012 in
selling, general and administrative expense in the Consolidated
Statement of Earnings. As a result of the final Court of Appeal
ruling received in August 2017, the company adjusted its obligation
under the plan. This adjustment resulted in a gain of $91 million for
the year ended December 31, 2017, which was recorded in selling,
general and administrative expense in the Consolidated Statement
of Earnings. This gain is reflected in “Non-U.S. Plans—Other costs/
(credits)” in the table on page 130. See note M, “Contingencies
and Commitments” for additional information.

Assumptions Used to Determine Plan Financial Information
Underlying both the measurement of benefit obligations and net
periodic (income)/cost are actuarial valuations. These valuations
use participant-specific information such as salary, age and years
of service, as well as certain assumptions, the most significant of
which include estimates of discount rates, expected return on plan
assets, rate of compensation increases, interest crediting rates
and mortality rates. The company evaluates these assumptions,
at a minimum, annually, and makes changes as necessary.

The table below presents the assumptions used to measure the net periodic (income)/cost and the year-end benefit obligations for
retirement-related benefit plans.

Weighted-average assumptions used

to measure net periodic (income)/cost
for the year ended December 31

Discount rate

Expected long-term returns on plan assets

Rate of compensation increase

Weighted-average assumptions used to measure

benefit obligations at December 31

Defined Benefit Pension Plans

U.S. Plans

Non-U.S. Plans

2018

2017

2016

2018

2017

2016

3.40%

5.25%

N/A

3.80%

5.75%

N/A

4.00%

7.00%

N/A

1.76%

3.62%

2.41%

1.80%

3.77%

2.45%

2.40%

5.53%

2.40%

Discount rate

Rate of compensation increase

4.10%

N/A

3.40%

N/A

3.80%

N/A

1.85%

2.18%

1.76%

2.41%

1.80%

2.45%

N/A—Not applicable

Notes to Consolidated Financial Statements International Business Machines Corporation and Subsidiary Companies134

Weighted-average assumptions used

to measure net periodic cost for the
year ended December 31

Discount rate

Expected long-term returns on plan assets

Weighted-average assumptions used to

measure benefit obligations at December 31

Discount rate

N/A—Not applicable

Nonpension Postretirement Benefit Plans

U.S. Plan

Non-U.S. Plans

2018

2017

2016

2018

2017

2016

3.30%

N/A

3.60%

N/A

3.70%

N/A

7.28%

8.91%

8.26%

10.47%

7.06%

9.95%

3.90%

3.30%

3.60%

7.48%

7.28%

8.26%

Discount Rate
The discount rate assumptions used for retirement-related
benefit plans accounting reflect the yields available on high-
quality, fixed-income debt instruments at the measurement
date. For the U.S. and certain non-U.S. countries, a portfolio of
high-quality corporate bonds is used to construct a yield curve.
The cash flows from the company’s expected benefit obligation
payments are then matched to the yield curve to derive the
discount rates. In other non-U.S. countries, where the markets
for high-quality long-term bonds are not generally as well
developed, a portfolio of long-term government bonds is used
as a base, to which a credit spread is added to simulate corporate
bond yields at these maturities in the jurisdiction of each plan,
as the benchmark for developing the respective discount rates.

For the U.S. defined benefit pension plans, the changes in the
discount rate assumptions impacted the net periodic (income)/
cost and the PBO. The changes in the discount rate assumptions
resulted in a decrease in 2018 net periodic income of $124 million,
a decrease in 2017 net periodic income of $64 million and an
increase in 2016 net periodic income of $103 million. The changes
in the discount rate assumptions resulted in a decrease in the PBO
of $3,239 million and an increase of $1,962 million for the years
ended December 31, 2018 and 2017, respectively.

For the U.S. nonpension postretirement benefit plans, the
changes in the discount rate assumptions had no material impact
on net periodic cost for the years ended December 31, 2018,
2017 and 2016 and resulted in a decrease in the APBO of $153
million and an increase of $88 million at December 31, 2018 and
2017, respectively.

For all of the company’s retirement-related benefit plans, the
change in the discount rate assumptions resulted in a decrease
in the benefit obligation of approximately $4.0 billion at
December 31, 2018 and an increase of approximately $2.5 billion
at December 31, 2017.

Expected Long-Term Returns on Plan Assets
Expected returns on plan assets, a component of net periodic
(income)/cost, represent the expected long-term returns on
plan assets based on the calculated market-related value of
plan assets. Expected long-term returns on plan assets take
into account long-term expectations for future returns and the
investment policies and strategies as described on pages 135
and 136. These rates of return are developed by the company
and are tested for reasonableness against historical returns.
The use of expected long-term returns on plan assets may
result in recognized pension income that is greater or less than
the actual returns of those plan assets in any given year. Over
time, however, the expected long-term returns are designed to
approximate the actual long-term returns, and therefore result
in a pattern of income and cost recognition that more closely
matches the pattern of the services provided by the employees.
Differences between actual and expected returns are recognized
as a component of net loss or gain in AOCI, which is amortized as
a component of net periodic (income)/cost over the service lives
or life expectancy of the plan participants, depending on the plan,
provided such amounts exceed certain thresholds provided by
accounting standards. The market-related value of plan assets
recognizes changes in the fair value of plan assets systematically
over a five-year period in the expected return on plan assets line
in net periodic (income)/cost.

For the U.S. defined benefit pension plan, the expected long-term
rate of return on plan assets for the years ended December 31,
2018, 2017 and 2016 was 5.25 percent, 5.75 percent and
7.0 percent, respectively. The change in the rate in 2018 resulted
in a decrease in 2018 net periodic income of $256 million. For the
year ended December 31, 2017, the change in the rate resulted
in a decrease in net periodic income of $656 million. For the year
ended December 31, 2016, the change in the rate resulted in a
decrease in net periodic income of $268 million. For 2019, the
projected long-term rate of return on plan assets is 5.25 percent.

Notes to Consolidated Financial Statements International Business Machines Corporation and Subsidiary Companies135

For the U.S. nonpension postretirement benefit plans, the
company maintains a highly liquid trust fund balance to ensure
timely payments are made. As a result, for the years ended
December 31, 2018, 2017 and 2016, the expected long-term
return on plan assets and the actual return on those assets were
not material.

Plan Assets
Retirement-related benefit plan assets are recognized and
measured at fair value. Because of the inherent uncertainty of
valuations, these fair value measurements may not necessarily
reflect the amounts the company could realize in current market
transactions.

Rate of Compensation Increases and Mortality Rate
The rate of compensation increases is determined by the
company, based upon its long-term plans for such increases. The
rate of compensation increase is not applicable to the U.S. defined
benefit pension plans as benefit accruals ceased December 31,
2007 for all participants. Mortality rate assumptions are
based on life expectancy and death rates for different types of
participants. Mortality rates are periodically updated based on
actual experience. In the U.S., the Society of Actuaries released
new mortality tables in 2014 and updated them in each of the
years 2015 to 2018. The company utilized these tables in its plan
remeasurements at December 31, 2018 and 2017. For the U.S.
retirement-related plans, the change in mortality assumptions
resulted in a decrease to the plan benefit obligations of $27 million
and $345 million at December 31, 2018 and 2017, respectively.

Interest Crediting Rate
Benefits for certain participants in the PPP are calculated using
a cash balance formula. An assumption underlying this formula
is an interest crediting rate, which impacts both net periodic
(income)/cost and the PBO. This assumption provides a basis for
projecting the expected interest rate that participants will earn
on the benefits that they are expected to receive in the following
year and is based on the average from August to October of the
one-year U.S. Treasury Constant Maturity yield plus one percent.

For the PPP, the change in the interest crediting rate to 2.3 percent
for the year ended December 31, 2018 from 1.6 percent for the
year ended December 31, 2017 resulted in a decrease in 2018
net periodic income of $25 million. The change in the interest
crediting rate to 1.6 percent for the year ended December 31,
2017 from 1.3 percent for the year ended December 31, 2016
resulted in a decrease in 2017 net periodic income of $14 million.
The change in the interest crediting rate to 1.3 percent for the
year ended December 31, 2016 from 1.1 percent for the year
ended December 31, 2015 resulted in a decrease in 2016 net
periodic income of $7 million.

Healthcare Cost Trend Rate
For nonpension postretirement benefit plan accounting, the
company reviews external data and its own historical trends for
healthcare costs to determine the healthcare cost trend rates.
However, the healthcare cost trend rate has an insignificant
effect on plan costs and obligations as a result of the terms of
the plan which limit the company’s obligation to the participants.
The company assumes that the healthcare cost trend rate for
2019 will be 6.25 percent. In addition, the company assumes
that the same trend rate will decrease to 5 percent over the
next five years. A one percentage point increase or decrease in
the assumed healthcare cost trend rate would not have had a
material effect on 2018, 2017 and 2016 net periodic cost or the
benefit obligations as of December 31, 2018 and 2017.

Investment Policies and Strategies
The investment objectives of the Qualified PPP portfolio are
designed to generate returns that will enable the plan to meet
its future obligations. The precise amount for which these
obligations will be settled depends on future events, including the
retirement dates and life expectancy of the plans’ participants.
The obligations are estimated using actuarial assumptions, based
on the current economic environment and other pertinent factors
described previously on pages 134 and 135. The Qualified PPP
portfolio’s investment strategy balances the requirement to
generate returns, using potentially higher yielding assets such
as equity securities, with the need to control risk in the portfolio
with less volatile assets, such as fixed-income securities. Risks
include, among others, inflation, volatility in equity values and
changes in interest rates that could cause the plan to become
underfunded, thereby increasing its dependence on contributions
from the company. To mitigate any potential concentration risk,
careful consideration is given to balancing the portfolio among
industry sectors, companies and geographies, taking into account
interest rate sensitivity, dependence on economic growth,
currency and other factors that affect investment returns. During
2016 and 2017, the company changed its investment strategy,
modifying the target allocation primarily by reducing equity
securities and increasing debt securities. These changes were
designed to reduce the potential negative impact that equity
markets might have on the funded status of the plan. There were
no significant changes to investment strategy made in 2018 or
planned for 2019. The Qualified PPP portfolio’s target allocation
is 12 percent equity securities, 80 percent fixed-income
securities, 4 percent real estate and 4 percent other investments.

The assets are managed by professional investment firms and
investment professionals who are employees of the company.
They are bound by investment mandates determined by the
company’s management and are measured against specific
benchmarks. Among these managers, consideration is given,
but not limited to, balancing security concentration, issuer
concentration, investment style and reliance on particular active
and passive investment strategies.

Market liquidity risks are tightly controlled, with $4,295 million
of the Qualified PPP portfolio as of December 31, 2018 invested
in private market assets consisting of private equities and private
real estate investments, which are less liquid than publicly traded
securities. In addition, the Qualified PPP portfolio had $1,500
million in commitments for future investments in private markets
to be made over a number of years. These commitments are
expected to be funded from plan assets.

Notes to Consolidated Financial Statements International Business Machines Corporation and Subsidiary Companies136

Derivatives are used as an effective means to achieve investment
objectives and/or as a component of the plan’s risk management
strategy. The primary reasons for the use of derivatives are
fixed income management, including duration, interest rate
management and credit exposure, cash equitization and to
manage currency strategies.

Outside the U.S., the investment objectives are similar to
those described previously, subject to local regulations. The
weighted-average target allocation for the non-U.S. plans is
24 percent equity securities, 60 percent fixed-income securities,
4 percent real estate and 12 percent other investments, which is
consistent with the allocation decisions made by the company’s
management. In some countries, a higher percentage allocation

to fixed income is required to manage solvency and funding
risks. In others, the responsibility for managing the investments
typically lies with a board that may include up to 50 percent of
members elected by employees and retirees. This can result
in slight differences compared with the strategies previously
described. Generally, these non-U.S. plans do not invest in illiquid
assets and their use of derivatives is consistent with the U.S. plan
and mainly for currency hedging, interest rate risk management,
credit exposure and alternative investment strategies.

The company’s nonpension postretirement benefit plans
are underfunded or unfunded. For some plans, the company
maintains a nominal, highly liquid trust fund balance to ensure
timely benefit payments.

Defined Benefit Pension Plan Assets
The following table presents the company’s defined benefit pension plans’ asset classes and their associated fair value at December 31,
2018. The U.S. Plan consists of the Qualified PPP and the non-U.S. Plans consist of all plans sponsored by the company’s subsidiaries.

($ in millions)

Equity

Equity securities (1)

Equity mutual funds (2)

Fixed income

Government and related (3)

Corporate bonds (4)

Mortgage and asset-backed

securities

Insurance contracts

Cash and short-term investments (6)

Real estate

Derivatives (7)

Other mutual funds (8)

Subtotal

Investments measured at net
asset value using the NAV
practical expedient (9)

Other (10)

U.S. Plan

Non-U.S. Plans

Level 1

Level 2

Level 3

Total

Level 1

Level 2

Level 3

Total

$1,538

$ —

$ — $ 1,538

$2,333

$ 0

$ 2,333

—

19,661

15,849

635

—

1,020

—

(1)

—

19,661

359

16,208

—

640

421

—

1,075

—

322

—

8,951

1,865

—

1,308

431

—

606

—

339

—

8,973

1,865

1,308

753

339

630

2,081

37,164

363

39,608

2,753

13,172

341

16,266

—

8,835

(230)

—

20,525

(32)

Fixed income mutual funds (5)

421

Fair value of plan assets

$2,081

$37,164

$363

$48,213

$2,753

$13,172

$341

$36,758

(1) Represents U.S. and international securities. The U.S. Plan includes IBM common stock of $2 million, representing 0.004 percent of the U.S. Plan

assets. Non-U.S. Plans include IBM common stock of $10 million, representing 0.03 percent of the non-U.S. Plans assets.

(2) Invests in predominantly equity securities.

(3) Includes debt issued by national, state and local governments and agencies.

(4) The U.S. Plan does not include any IBM corporate bonds. Non-U.S. plans include IBM corporate bonds of $3 million representing 0.007 percent of

the non-U.S. Plan assets.

(5) Invests predominantly in fixed-income securities.

(6) Includes cash, cash equivalents and short-term marketable securities.

(7) Includes interest rate derivatives, forwards, exchange traded and other over-the-counter derivatives.

(8) Invests in both equity and fixed-income securities.

(9) Investments measured at fair value using the net asset value (NAV) per share (or its equivalent) as a practical expedient, including commingled

funds, hedge funds, private equity and real estate partnerships.

(10) Represents net unsettled transactions, relating primarily to purchases and sales of plan assets.

Notes to Consolidated Financial Statements International Business Machines Corporation and Subsidiary Companies137

The U.S. nonpension postretirement benefit plan assets of $29
million were invested primarily in cash equivalents, categorized
as Level 1 in the fair value hierarchy. The non-U.S. nonpension
postretirement benefit plan assets of $65 million, primarily in
Brazil, and, to a lesser extent, in Mexico and South Africa, were
invested primarily in government and related fixed-income
securities and corporate bonds, categorized as Level 2 in the
fair value hierarchy.

The following table presents the company’s defined benefit
pension plans’ asset classes and their associated fair value at
December 31, 2017. The U.S. Plan consists of the Qualified PPP
and the non-U.S. Plans consist of all plans sponsored by the
company’s subsidiaries.

($ in millions)

Equity

Equity securities (1)

Equity mutual funds (2)

Fixed income

Government and related (3)

Corporate bonds (4)

Mortgage and asset-backed

securities

Fixed income mutual funds (5)

Insurance contracts

Cash and short-term investments (6)

Real estate

Derivatives (7)

Other mutual funds (8)

Subtotal

Investments measured at net
asset value using the NAV
practical expedient (9)

Other (10)

U.S. Plan

Non-U.S. Plans

Level 1

Level 2

Level 3

Total

Level 1

Level 2

Level 3

Total

$2,215 $ 0

$ — $ 2,215

$3,508 $ 0

$ — $ 3,508

108

—

338

—

100

—

19,762

17,864

619

—

1,903

—

(4)

—

108

19,762

372

18,236

—

623

338

—

2,004

—

221

—

10,103

2,000

—

1,366

606

—

744

—

356

—

10,111

2,000

1,366

827

356

764

2,782

40,144

376

43,302

3,918

14,824

365

19,107

—

9,537

(145)

—

21,744

(52)

Fair value of plan assets

$2,782 $40,144

$376 $52,694

$3,918 $14,824

$365 $40,798

(1) Represents U.S. and international securities. The U.S. Plan includes IBM common stock of $14 million, representing 0.03 percent of the U.S. Plan

assets. Non-U.S. Plans include IBM common stock of $7 million, representing 0.02 percent of the non-U.S. Plans assets.

(2) Invests in predominantly equity securities.

(3) Includes debt issued by national, state and local governments and agencies.

(4) The U.S. Plan includes IBM corporate bonds of $1 million, representing 0.002 percent of the U.S. Plan assets. Non-U.S. plans include IBM corporate

bonds of $1 million representing 0.002 percent of the non-U.S. Plan assets.

(5) Invests in predominantly fixed-income securities.

(6) Includes cash and cash equivalents and short-term marketable securities.

(7) Includes interest rate derivatives, forwards, exchange traded and other over-the-counter derivatives.

(8) Invests in both equity and fixed-income securities.

(9) Investments measured at fair value using the net asset value (NAV) per share (or its equivalent) as a practical expedient, including commingled

funds, hedge funds, private equity and real estate partnerships.

(10) Represents net unsettled transactions, relating primarily to purchases and sales of plan assets.

The U.S. nonpension postretirement benefit plan assets of
$18 million were invested in cash equivalents, categorized as
Level 1 in the fair value hierarchy. The non-U.S. nonpension
postretirement benefit plan assets of $70 million, primarily in

Brazil, and, to a lesser extent, in Mexico and South Africa, were
invested primarily in government and related fixed-income
securities and corporate bonds, categorized as Level 2 in the
fair value hierarchy.

Notes to Consolidated Financial Statements International Business Machines Corporation and Subsidiary Companies138

The following tables present the reconciliation of the beginning and ending balances of Level 3 assets for the years ended December 31,
2018 and 2017 for the U.S. Plan.

($ in millions)

Balance at January 1, 2018

Return on assets held at end of year

Return on assets sold during the year

Purchases, sales and settlements, net

Transfers, net

Balance at December 31, 2018

($ in millions)

Balance at January 1, 2017

Return on assets held at end of year

Return on assets sold during the year

Purchases, sales and settlements, net

Balance at December 31, 2017

Corporate
Bonds

Mortgage and
Asset-Backed
Securities

$372

(23)

—

$359

Corporate
Bonds

$101

259

$372

Mortgage and
Asset-Backed
Securities

(1)

Total

$376

(23)

$363

Total

$106

258

$376

The following tables present the reconciliation of the beginning and ending balances of Level 3 assets for the years ended December 31,
2018 and 2017 for the non-U.S. Plans.

($ in millions)

Balance at January 1, 2018

Return on assets held at end of year

Return on assets sold during the year

Purchases, sales and settlements, net

Transfers, net

Foreign exchange impact

Balance at December 31, 2018

Government and
Related

Private Real
Estate

$ 8

$356

(1)

(3)

(2)

$ 2

(2)

(3)

—

(21)

$339

Total

$365

(2)

(6)

(2)

(21)

$341

Notes to Consolidated Financial Statements International Business Machines Corporation and Subsidiary Companies

139

($ in millions)

Balance at January 1, 2017

Return on assets held at end of year

Return on assets sold during the year

Purchases, sales and settlements, net

Transfers, net

Foreign exchange impact

Balance at December 31, 2017

Government
and Related

Corporate
Bonds

Private Real
Estate

$16

$ 1

$294

(3)

(2)

(6)

(1)

—

Total

$310

(4)

(6)

$ 8

$—

$356

$365

Valuation Techniques
The following is a description of the valuation techniques used
to measure plan assets at fair value. There were no changes in
valuation techniques during 2018 and 2017.

typically valued using the NAV provided by the administrator of
the fund and reviewed by the company. The NAV is based on the
value of the underlying assets owned by the fund, minus liabilities
and divided by the number of shares or units outstanding.

Equity securities are valued at the closing price reported on the
stock exchange on which the individual securities are traded. IBM
common stock is valued at the closing price reported on the New
York Stock Exchange. Mutual funds are typically valued based
on quoted market prices. These assets are generally classified
as Level 1.

The fair value of fixed-income securities is typically estimated
using pricing models, quoted prices of securities with similar
characteristics or discounted cash flows and are generally
classified as Level 2. If available, they are valued using the closing
price reported on the major market on which the individual
securities are traded.

Cash includes money market accounts that are valued at their
cost plus interest on a daily basis, which approximates fair
value. Short-term investments represent securities with original
maturities of one year or less. These assets are classified as
Level 1 or Level 2.

Real estate valuations require significant judgment due to the
absence of quoted market prices, the inherent lack of liquidity
and the long-term nature of such assets. These assets are initially
valued at cost and are reviewed periodically utilizing available
and relevant market data, including appraisals, to determine
if the carrying value of these assets should be adjusted. These
assets are classified as Level 3.

Exchange traded derivatives are valued at the closing price
reported on the exchange on which the individual securities are
traded, while forward contracts are valued using a mid-close
price. Over-the-counter derivatives are typically valued using
pricing models. The models require a variety of inputs, including,
for example, yield curves, credit curves, measures of volatility
and foreign exchange rates. These assets are classified as Level 1
or Level 2 depending on availability of quoted market prices.

Certain investments are measured at fair value using the net
asset value (NAV) per share (or its equivalent) as a practical
expedient. These investments, which include commingled funds,
hedge funds, private equity and real estate partnerships, are

Contributions
Defined Benefit Pension Plans
It is the company’s general practice to fund amounts for
pensions sufficient to meet the minimum requirements set forth
in applicable employee benefits laws and local tax laws. From
time to time, the company contributes additional amounts as it
deems appropriate.

The company contributed $111 million in cash and $213 million in
U.S. Treasury securities to non-U.S. defined benefit pension plans
as well as $38 million in cash to multi-employer plans for the year
ended December 31, 2018. For the year ended December 31,
2017, the company contributed $192 million in cash and $176
million in U.S. Treasury securities to non-U.S. defined benefit
pension plans as well as $40 million in cash to multi-employer
plans. The contribution of U.S. Treasury securities is considered
a non-cash transaction in the Consolidated Statement of Cash
Flows. The cash contributions to multi-employer plans represent
the annual cost included in net periodic (income)/cost recognized
in the Consolidated Statement of Earnings. The company’s
participation in multi-employer plans has no material impact on
the company’s financial statements.

In 2019, the company is not legally required to make any
contributions to the U.S. defined benefit pension plans. However,
depending on market conditions, or other factors, the company
may elect to make discretionary contributions to the Qualified
PPP during the year.

In 2019, the company estimates contributions to its non-U.S.
defined benefit and multi-employer plans to be approximately
$400 million, the largest of which will be contributed to defined
benefit pension plans in Japan, Spain and Belgium. This amount
generally represents legally mandated minimum contributions.

Notes to Consolidated Financial Statements International Business Machines Corporation and Subsidiary Companies140

Financial market performance in 2019 could increase the legally
mandated minimum contribution in certain countries which
require monthly or daily remeasurement of the funded status.
The company could also elect to contribute more than the legally
mandated amount based on market conditions or other factors.

trusts for the year ended December 31, 2018 compared to $394
million during the year ended December 31, 2017. In 2017, excess
cash in the postretirement plan of $70 million was transferred
to the active employee medical trust. The contribution of U.S.
Treasury securities is considered a non-cash transaction in the
Consolidated Statement of Cash Flows.

Defined Contribution Plans
The company contributed $1.0 billion in cash to the defined
contribution plans during each of the years ended December 31,
2018 and 2017. In 2019, the company estimates cash
contributions to the defined contribution plans to be approximately
$1.0 billion.

Nonpension Postretirement Benefit Plans
The company contributed $385 million in U.S. Treasury securities
to the nonpension postretirement and active employee medical

Expected Benefit Payments
Defined Benefit Pension Plan Expected Payments
The following table presents the total expected benefit payments
to defined benefit pension plan participants. These payments
have been estimated based on the same assumptions used to
measure the plans’ PBO at December 31, 2018 and include
benefits attributable to estimated future compensation
increases, where applicable.

($ in millions)

2019

2020

2021

2022

2023

2024–2028

Qualified
U.S. Plan
Payments

$ 3,521

3,537

3,529

3,489

3,440

16,237

Nonqualified
U.S. Plans
Payments

Qualified
Non-U.S. Plans
Payments

Nonqualified
Non-U.S. Plans
Payments

Total Expected
Benefit
Payments

$122

$1,862

$ 336

$ 5,841

123

122

121

574

1,874

1,876

1,911

1,922

9,514

343

397

414

432

5,877

5,924

5,937

5,915

2,293

28,619

The 2019 expected benefit payments to defined benefit pension
plan participants not covered by the respective plan assets
(underfunded plans) represent a component of compensation
and benefits, within current liabilities, in the Consolidated
Statement of Financial Position.

Nonpension Postretirement Benefit Plan Expected Payments
The following table reflects the total expected benefit payments
to nonpension postretirement benefit plan participants. These
payments have been estimated based on the same assumptions
used to measure the plans’ APBO at December 31, 2018.

($ in millions)

2019

2020

2021

2022

2023

2024–2028

U.S. Plan
Payments

$ 377

388

397

394

377

1,587

Qualified
Non-U.S. Plans
Payments

Nonqualified
Non-U.S. Plans
Payments

Total Expected
Benefit
Payments

$ 7

$ 33

$ 416

429

440

439

423

218

1,846

The 2019 expected benefit payments to nonpension
postretirement benefit plan participants not covered by the
respective plan assets represent a component of compensation
and benefits, within current liabilities, in the Consolidated
Statement of Financial Position.

Other Plan Information
The following table presents information for defined benefit
pension plans with accumulated benefit obligations (ABO) in
excess of plan assets. For a more detailed presentation of the
funded status of the company’s defined benefit pension plans,
see the table on page 131.

Notes to Consolidated Financial Statements International Business Machines Corporation and Subsidiary Companies
Notes to Consolidated Financial Statements
International Business Machines Corporation and Subsidiary Companies

141

($ in millions)

At December 31:

Plans with PBO in excess of plan assets

Plans with ABO in excess of plan assets

Plans with assets in excess of PBO

NOTE U. SEGMENT INFORMATION
The company’s major operations consist of five business
segments: Cognitive Solutions, Global Business Services,
Technology Services & Cloud Platforms, Systems and Global
Financing. The segments represent components of the company
for which separate financial information is available that is utilized
on a regular basis by the chief operating decision maker (the chief
executive officer) in determining how to allocate resources and
evaluate performance. The segments are determined based
on several factors, including client base, homogeneity of
products, technology, delivery channels and similar economic
characteristics.

Segment revenue and pre-tax income include transactions
between the segments that are intended to reflect an arm’s-
length, market-based transfer price. Systems that are used
by Technology Services & Cloud Platforms in outsourcing
engagements are primarily sourced internally from the Systems
segment and software is sourced from various segments.
Software used by Technology Services & Cloud Platforms on
external engagements is sourced internally through Cognitive
Solutions and the Systems segments. For providing IT
services that are used internally, Technology Services & Cloud
Platforms and Global Business Services recover cost, as well
as a reasonable fee, that is intended to reflect the arm’s-length
value of providing the services. They enter into arm’s-length
loans at prices equivalent to market rates with Global Financing
to facilitate the acquisition of equipment and software used
in services engagements. All internal transaction prices are
reviewed annually, and reset if appropriate.

2018

2017

Benefit
Obligation

$30,059

29,312

63,524

Plan
Assets

$16,783

16,522

68,190

Benefit
Obligation

$31,416

27,751

70,139

Plan
Assets

$18,711

15,607

74,782

The company utilizes globally integrated support organizations
to realize economies of scale and efficient use of resources. As
a result, a considerable amount of expense is shared by all of
the segments. This shared expense includes sales coverage,
certain marketing functions and support functions such as
Accounting, Treasury, Procurement, Legal, Human Re sources
and Billing and Collections. Where practical, shared expenses
are allocated based on measurable drivers of expense, e.g.,
headcount. When a clear and measurable driver cannot be
identified, shared expenses are allocated on a financial basis
that is consistent with the company’s management system, e.g.,
advertising expense is allocated based on the gross profits of the
segments. A portion of the shared expenses, which are recorded
in net income, are not allocated to the segments. These expenses
are associated with the elimination of internal transactions and
other miscellaneous items.

The following tables reflect the results of continuing operations
of the company’s segments consistent with the management and
measurement system utilized within the company. Performance
measurement is based on pre-tax income from continuing
operations. These results are used, in part, by the chief operating
decision maker, both in evaluating the performance of, and in
allocating resources to, each of the segments.

142

Notes to Consolidated Financial Statements
International Business Machines Corporation and Subsidiary Companies

Management System Segment View

($ in millions)

For the year ended December 31:

2018

External revenue

Internal revenue

Total revenue

Cognitive
Solutions

Global
Business
Services

Technology
Services &
Cloud
Platforms

Systems

Global
Financing

Total
Segments

$18,481

$16,817

$34,462

$8,034

$1,590

$79,383

2,715

326

795

$21,197

$17,143

$35,257

815

$8,848

$ 904

(1.1)%

(19.9)%

10.2%

1,610

$3,200

$1,361

1.0%

6.5%

42.5%

6,261

$85,644

$14,881

0.9%

0.2%

17.4%

Pre-tax income from continuing operations

$ 7,154

$ 1,676

$ 3,786

Revenue year-to-year change

Pre-tax income year-to-year change

Pre-tax income margin

0.5%

5.3%

33.8%

2.6%

23.0%

9.8%

0.9%

(11.7)%

10.7%

2017

External revenue

Internal revenue

Total revenue

2016

External revenue

Internal revenue

Total revenue

Pre-tax income from continuing operations*

$ 6,795

$ 1,362

$ 4,286

Revenue year-to-year change

Pre-tax income year-to-year change*

Pre-tax income margin*

1.4%

7.4%

32.2%

(2.3)%

(19.0)%

8.2%

(3.1)%

(7.7)%

12.3%

$18,453

$16,348

$34,277

$8,194

$1,696

$78,968

2,647

363

657

$21,100

$16,711

$34,934

750

$8,945

$1,128

5.7%

21.9%

12.6%

1,471

$3,168

$1,278

(9.3)%

(22.8)%

40.3%

5,889

$84,857

$14,849

(1.3)%

(2.5)%

17.5%

Pre-tax income from continuing operations*

$ 6,325

$ 1,683

$ 4,643

Revenue year-to-year change

Pre-tax income year-to-year change*

Pre-tax income margin*

3.8%

(12.5)%

30.4%

(3.1)%

(34.4)%

9.8%

0.6%

(17.4)%

12.9%

* Recast to reflect adoption of the FASB guidance on presentation of net benefit cost.

$18,187

$16,700

$35,337

$7,714

$1,692

$79,630

2,630

409

715

$20,817

$17,109

$36,052

750

$8,464

$ 925

(18.0)%

(46.1)%

10.9%

1,802

$3,494

$1,654

(22.0)%

(30.0)%

47.3%

6,307

$85,936

$15,230

(2.7)%

(21.9)%

17.7%

143

Reconciliations of IBM as Reported

($ in millions)

For the year ended December 31:

2018

2017

2016

Revenue

Total reportable segments

$85,644

$84,857

$85,936

Other revenue

207

171

289

Elimination of internal

transactions

Total IBM consolidated

(6,261)

(5,889)

(6,307)

revenue

$79,591

$79,139

$79,919

($ in millions)

For the year ended December 31:

2018

2017

2016

Pre-tax income from

continuing operations

Total reportable segments

$14,881

$14,849 * $15,230 *

Amortization of acquired

intangible assets

Acquisition-related charges

Non-operating retirement-
related (costs)/income

Elimination of internal

transactions

Unallocated corporate

amounts

Total pre-tax income from
continuing operations

(809)

(16)

(945)

(52)

(998)

(5)

(1,572)

(1,341)*

(448)*

(758)

(726)

(1,160)

(385)

(290)

$11,342

$11,400

$12,330

* Recast to reflect adoption of the FASB guidance on presentation of net
benefit cost.

Immaterial Items
Investment in Equity Alliances and
Equity Alliances Gains/(Losses)
The investments in equity alliances and the resulting gains and
(losses) from these investments that are attributable to the
segments did not have a material effect on the financial position
or the financial results of the segments.

Segment Assets and Other Items
Cognitive Solutions assets are mainly goodwill, acquired intangible
assets and accounts receivable. Global Business Services assets
are primarily goodwill and accounts receivable. Technology
Services & Cloud Platforms assets are primarily goodwill, plant,
property and equipment including the assets associated with the
outsourcing business, deferred costs and accounts receivable.
Systems assets are primarily goodwill, manufacturing inventory,
and plant, property and equipment. Global Financing assets are
primarily financing receivables, cash and marketable securities,
and fixed assets under operating leases.

To ensure the efficient use of the company’s space and
equipment, several segments may share plant, property and
equipment assets. Where assets are shared, landlord ownership
of the assets is assigned to one segment and is not allocated
to each user segment. This is consistent with the company’s
management system and is reflected accordingly in the table on
page 144. In those cases, there will not be a precise correlation
between segment pre-tax income and segment assets.

Similarly, the depreciation amounts reported by each segment
are based on the assigned landlord ownership and may not be
consistent with the amounts that are included in the segments’
pre-tax income. The amounts that are included in pre-tax
income reflect occupancy charges from the landlord segment
and are not specifically identified by the management reporting
system. Capital expenditures that are reported by each segment
also are consistent with the landlord ownership basis of
asset assignment.

Global Financing amounts for interest income and interest
expense reflect the interest income and interest expense
associated with the Global Financing business, including the
intercompany financing activities discussed on pages 25 and 26,
as well as the income from investment in cash and marketable
securities. The explanation of the difference between cost of
financing and interest expense for segment presentation versus
presentation in the Consolidated Statement of Earnings is
included on page 39 of the Management Discussion.

Notes to Consolidated Financial Statements International Business Machines Corporation and Subsidiary Companies144

Management System Segment View

($ in millions)

For the year ended December 31:

2018

Assets

Depreciation/amortization of intangibles*

Capital expenditures/investments

in intangibles

Interest income

Interest expense

2017

Assets**

Cognitive
Solutions

Global
Business
Services

Technology
Services &
Cloud
Platforms

Systems

Global
Financing

Total
Segments

$24,244

$8,404

$24,624

$4,030

$41,320

$102,622

987

363

—

102

2,501

—

2,678

—

315

241

—

229

4,135

274

1,647

515

3,612

1,647

515

$24,828

$8,713

$24,619

$3,898

$41,096

$103,153

Depreciation/amortization of intangibles*

1,121

101

2,359

Capital expenditures/investments

373

—

2,290

—

341

189

—

267

4,190

364

1,527

381

3,265

1,527

381

in intangibles

Interest income

Interest expense

2016

Assets**

$25,514

$8,627

$24,085

$3,812

$36,492

$ 98,530

Depreciation/amortization of intangibles*

1,228

104

2,224

Capital expenditures/investments

in intangibles

Interest income

Interest expense

495

—

2,382

—

375

453

—

317

4,248

380

1,547

371

3,764

1,547

371

* Segment pre-tax income from continuing operations does not include the amortization of intangible assets.

** Recast to reflect adoption of the FASB guidance on restricted cash.

Notes to Consolidated Financial Statements International Business Machines Corporation and Subsidiary Companies

Reconciliations of IBM as Reported

($ in millions)

At December 31:

Assets

2018

2017

2016

Total reportable segments $102,622

$103,153* $ 98,530*

145

Geographic Information
The following provides information for those countries that are
10 percent or more of the specific category.

Revenue*

($ in millions)

Elimination of internal

transactions

Unallocated amounts

Cash and marketable

securities

Notes and accounts

receivable

Deferred tax assets

Plant, other property
and equipment

Pension assets

Other

Total IBM consolidated

(7,143)

(6,272)

(5,670)

For the year ended December 31:

2018

2017

2016

10,393

10,162*

6,999*

Other countries

United States

Japan

$29,078

$29,759

$30,194

8,489

42,024

8,239

41,141

8,339

41,386

1,597

5,089

2,463

4,666

3,695

2,554

4,746

2,659

4,643

2,660

5,078

2,656

3,034

3,712*

4,183*

Total IBM consolidated

revenue

$79,591

$79,139

$79,919

* Revenues are attributed to countries based on the location of the client.

Plant and Other Property—Net

($ in millions)

At December 31:

United States

Other countries

Total

2018

2017

2016

$ 4,585

$ 4,670

$ 4,701

5,774

5,985

5,607

$10,359

$10,655

$10,308

assets

$123,382

$125,356 $117,470

* Recast to reflect adoption of the FASB guidance on restricted cash.

Major Clients
No single client represented 10 percent or more of the company’s
total revenue in 2018, 2017 or 2016.

Notes to Consolidated Financial Statements International Business Machines Corporation and Subsidiary Companies146

Revenue by Classes of Similar Products or Services
The following table presents external revenue for similar
classes of products or services within the company’s reportable
segments. Client solutions often include IBM software and
systems and other suppliers’ products if the client solution
requires it. For each of the segments that include services,
Software-as-a-Service, consulting, education, training and other
product-related services are included as Services. For each of
these segments, Software includes product license charges and
ongoing subscriptions.

($ in millions)

For the year ended December 31:

2018

2017

2016

NOTE V. SUBSEQUENT EVENTS
On January 29, 2019, the company announced that the Board of
Directors approved a quarterly dividend of $1.57 per common
share. The dividend is payable March 9, 2019 to shareholders of
record on February 8, 2019.

On January 31, 2019, the company issued $5.7 billion of Euro
bonds as follows: $2.0 billion of 4-year fixed-rate bonds with a
0.375 coupon, $1.1 billion of 6-year fixed-rate bonds with a 0.875
coupon, $1.1 billion of 8-year fixed-rate bonds with a 1.25 coupon
and $1.4 billion of 12-year fixed-rate bonds with a 1.75 coupon.

Cognitive Solutions

Software

Services

Systems

Global Business Services

Services

Software

Systems

Technology Services &
Cloud Platforms

Services

Maintenance

Software

Systems

Servers

Storage

Software

Services

Global Financing

Financing

$13,667

$13,598

$13,969

4,708

106

4,752

103

4,111

107

$16,460

$16,004

$16,399

151

206

179

165

179

121

$24,145

$23,629

$24,311

5,484

3,713

1,119

5,783

3,610

1,254

5,862

3,818

1,346

$ 3,996

$ 3,993

$ 3,567

2,114

1,498

425

2,243

1,520

439

2,083

1,586

478

$ 1,223

$ 1,167

$ 1,231

Used equipment sales

366

530

461

Notes to Consolidated Financial Statements International Business Machines Corporation and Subsidiary CompaniesFive-Year Comparison of Selected Financial Data
International Business Machines Corporation and Subsidiary Companies

147

($ in millions except per share amounts)

For the year ended December 31:

2018

2017

2016

2015

2014

Revenue

$ 79,591

$ 79,139

$ 79,919

$ 81,741

$ 92,793

Income from continuing operations

$ 8,723

$ 5,758

$ 11,881

$ 13,364

$ 15,751

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

$ 5

$ (5)

$ (9)

$ (174)

$ (3,729)

Net income

$ 8,728

$ 5,753

$ 11,872

$ 13,190

$ 12,022

Operating (non-GAAP) earnings*

$ 12,657

$ 12,807**

$ 12,880**

$ 14,519**

$ 16,534**

Earnings/(loss) per share of common stock:

Assuming dilution:

Continuing operations

Discontinued operations

Total

Basic:

Continuing operations

Discontinued operations

Total

$ 9.51

$ 6.14

$ 12.39

$ 13.60

$ 15.59

$ 0.01

$ 0.00

$ (0.01)

$ (0.18)

$ (3.69)

$ 9.52

$ 6.14

$ 12.38

$ 13.42

$ 11.90

$ 9.56

$ 6.17

$ 12.44

$ 13.66

$ 15.68

$ 0.01

$ 0.00

$ (0.01)

$ (0.18)

$ (3.71)

$ 9.57

$ 6.17

$ 12.43

$ 13.48

$ 11.97

Diluted operating (non-GAAP)*

$ 13.81

$ 13.66**

$ 13.44**

$ 14.77**

$ 16.37**

Cash dividends paid on common stock

$ 5,666

$ 5,506

$ 5,256

$ 4,897

$ 4,265

Investment in property, plant and equipment

$ 3,395

$ 3,229

$ 3,567

$ 3,579

$ 3,740

Return on IBM stockholders’ equity

48.0%

31.1%

74.0%

101.1%

72.5%

At December 31:

Total assets

2018

2017

2016

2015

2014

$123,382

$125,356

$117,470

$110,495

$117,271

Net investment in property, plant and equipment

$ 10,792

$ 11,116

$ 10,830

$ 10,727

$ 10,771

Working capital

Total debt

Total equity

$ 10,918

$ 12,373

$ 7,613

$ 8,235

$ 7,797

$ 45,812

$ 46,824

$ 42,169

$ 39,890

$ 40,722

$ 16,929

$ 17,725

$ 18,392

$ 14,424

$ 12,014

* Refer to the table below for the reconciliation of non-GAAP financial information for 2015 and 2014. Also see “GAAP Reconciliation,” on pages 41 and

58 for the reconciliation of non-GAAP financial information for 2018, 2017 and 2016.

** Recast to reflect adoption of the FASB guidance on presentation of net benefit cost.

GAAP Reconciliation
The table below provides a reconciliation of the company’s income and diluted earnings per share from continuing operations 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. Please refer to the
“Operating (non-GAAP) Earnings” section on pages 18 and 19 for the company’s rationale for presenting operating earnings information.

($ in millions except per share amounts)

For the year ended December 31:

2015

Income from continuing operations

Diluted earnings per share from continuing operations

2014

Income from continuing operations

Diluted earnings per share from continuing operations

GAAP

$13,364

$ 13.60

$15,751

$ 15.59

Acquisition-
Related
Adjustments

Retirement-
Related
Adjustments*

Operating
(non-GAAP)*

$ 562

$0.57

$ 670

$0.67

$ 593

$0.60

$ 112

$0.11

$14,519

$ 14.77

$16,534

$ 16.37

* Recast to reflect adoption of the FASB guidance on presentation of net benefit cost.

148

Selected Quarterly Data
International Business Machines Corporation and Subsidiary Companies

($ in millions except per share amounts and stock prices)

2018

Revenue

Gross profit

Income from continuing operations

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

Net income

Operating (non-GAAP) earnings*

Earnings per share of common stock—

continuing operations**

Assuming dilution

Basic

Earnings per share of common stock—total**

Assuming dilution

Basic

Diluted operating (non-GAAP)*

($ in millions except per share amounts and stock prices)

First
Quarter

$19,072

$ 8,247

$ 1,675

$ 4

$ 1,679

$ 2,272

Second
Quarter

$20,003

$ 9,199

$ 2,402

$ 1

$ 2,404

$ 2,834

Third
Quarter

$18,756

$ 8,803

$ 2,692

$ 2

$ 2,694

$ 3,134

Fourth
Quarter

$21,760

$10,687

$ 1,954

$ (2)

$ 1,951

$ 4,417

Full Year

$79,591

$36,936

$ 8,723

$ 5

$ 8,728

$12,657

$ 1.81

$ 1.82

$ 2.61

$ 2.63

$ 2.94

$ 2.95

$ 2.15

$ 2.17

$ 9.51

$ 9.56

$ 1.81

$ 1.82

$ 2.45

$ 2.61

$ 2.63

$ 3.08

$ 2.94

$ 2.95

$ 3.42

$ 2.15

$ 2.17

$ 4.87

$ 9.52

$ 9.57

$ 13.81

2017

Revenue

Gross profit

First
Quarter

$18,155
$ 7,944 +

Second
Quarter

$19,289
$ 8,968 +

Income/(loss) from continuing operations

$ 1,753

$ 2,332

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

$ (3)

$ (1)

$ 1,750
$ 2,224+

$ 2,331
$ 2,760+

Third
Quarter

$19,153
$ 8,981 +

$ 2,726

$ 0

$ 2,726
$ 3,045+

Fourth
Quarter

$22,543
$11,049+

$ (1,053)

$ (1)

$ (1,054)
$ 4,777+

Full Year

$79,139
$36,943+

$ 5,758

$ (5)

$ 5,753
$12,807+

Net income/(loss)

Operating (non-GAAP) earnings*

Earnings/(loss) per share of common stock—

continuing operations**

Assuming dilution

Basic

Earnings/(loss) per share of common stock—total**

$ 1.85

$ 1.86

$ 2.48

$ 2.49

$ 2.92

$ 2.93

$ (1.14)

$ 6.14

$ 6.17

Assuming dilution

Basic

Diluted operating (non-GAAP)*

$ 1.85

$ 2.48

$ 2.92

$ (1.14)

$ 6.14

$ 1.86
$ 2.35+

$ 2.49
$ 2.94+

$ 2.93
$ 3.26+

$ (1.14)
$ 5.14+

$ 6.17
$ 13.66+

Refer to page 73 of the company’s first-quarter 2018 Form 10-Q filed on April 24, 2018, page 89 of the company’s second-quarter 2018 Form 10-Q
filed on July 31, 2018, page 91 of the company’s third-quarter 2018 Form 10-Q filed on October 30, 2018, and page 47 under the heading “GAAP
Reconciliation” for the reconciliation of non-GAAP financial information for the quarterly periods of 2018 and 2017. Also see “GAAP Reconciliation,”
on page 41 for the reconciliation of non-GAAP financial information for full-year 2018 and 2017.

** Earnings Per Share (EPS) in each quarter is computed using the weighted-average number of shares outstanding during that quarter while EPS for

the full year is computed using the weighted-average number of shares outstanding during the year. Thus, the sum of the four quarters’ EPS does not
equal the full-year EPS.

+ Recast to reflect adoption of the FASB guidance on presentation of net benefit cost.

Performance Graphs
International Business Machines Corporation and Subsidiary Companies

149

COMPARISON OF FIVE- AND TEN-YEAR CUMULATIVE TOTAL RETURN FOR IBM,
S&P 500 STOCK INDEX AND S&P INFORMATION TECHNOLOGY INDEX
The following graphs compare the five- and ten-year cumulative
total returns for IBM common stock with the comparable
cumulative returns of certain Standard & Poor’s (S&P) indices.
Due to the fact that IBM is a company included in the S&P 500
Stock Index, the SEC’s rules require the use of that index for
the required five-year graph. Under those rules, the second
index used for comparison may be a published industry or

line-of-business index. The S&P Information Technology Index
is such an index. IBM is also included in this index.

Each graph assumes $100 invested on December 31 (of the initial
year shown in the graph) in IBM common stock and $100 invested
on the same date in each of the S&P indices. The comparisons
assume that all dividends are reinvested.

Five-Year

Ten-Year

240

210

180

150

120

600

540

480

420

360

300

240

180

120

Five-Year

(U.S. Dollar)

IBM Common Stock

S & P 500 Index

2013

2014

2015

2016

2017

2018

$100.00

$ 87.61 $ 77.61

$ 97.16

$ 93.29

$ 72.26

100.00

113.69

115.26

129.05

157.22

150.33

S & P Information Technology Index

100.00

120.12

127.23

144.85

201.10

200.52

Ten-Year

(U.S. Dollar)

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

2018

IBM Common Stock

$100.00 $158.61 $181.26 $230.96 $244.67 $244.22 $213.95 $189.54 $237.28 $227.83 $176.48

S & P 500 Index

100.00 126.46 145.51 148.59 172.37 228.19 259.43 263.02 294.47 358.76 343.03

S & P Information
Technology Index

100.00 161.72 178.20 182.50 209.55 269.13 323.26 342.41 389.84 541.22 539.66

150

Stockholder Information
International Business Machines Corporation and Subsidiary Companies

IBM Stockholder Services
Stockholders with questions about their accounts
should contact:

IBM Stock
IBM common stock is listed on the New York Stock Exchange
and the Chicago Stock Exchange under the symbol “IBM”.

Computershare Trust Company, N.A., P.O. Box 505005,
Louisville, Kentucky 40233-5005, (888) IBM-6700.

Investors residing outside the United States, Canada
and Puerto Rico should call (781) 575-2727.

Stockholders can also reach Computershare Trust Company,
N.A. via e-mail at: ibm@computershare.com

Hearing-impaired stockholders with access to a
telecommunications device (TDD) can communicate directly
with Computershare Trust Company, N.A., by calling (800)
490-1493. Stockholders residing outside the United States,
Canada and Puerto Rico should call (781) 575-2694.

IBM on the Internet
Topics featured in this Annual Report can be found online at
www.ibm.com. Financial results, news on IBM products,
services and other activities can also be found at that website.

IBM files reports with the Securities and Exchange Commission
(SEC), including the annual report on Form 10-K, quarterly
reports on Form 10-Q, current reports on Form 8-K and any
other filings required by the SEC.

IBM’s website (www.ibm.com/investor) contains a significant
amount of information about IBM, including the company’s
annual report on Form 10-K, quarterly reports on Form 10-Q,
current reports on Form 8-K, and all amendments to those
reports filed or furnished pursuant to Section 13(a) or 15(d)
of the Securities Exchange Act of 1934 as soon as reasonably
practicable after such material is electronically filed with or
furnished to the SEC. These materials are available free of
charge on or through IBM’s website.

The SEC maintains a website (www.sec.gov) that contains
reports, proxy and information statements, and other information
regarding issuers that file electronically with the SEC.

Computershare Investment Plan (CIP)
(formerly IBM Investor Services Program)
The Computershare Investment Plan brochure outlines a
number of services provided for IBM stockholders and potential
IBM investors, including the reinvestment of dividends,
direct purchase and the deposit of IBM stock certificates for
safekeeping. Call (888) IBM-6700 for a copy of the brochure.
Investors residing outside the United States, Canada and
Puerto Rico should call (781) 575-2727.

Investors with other requests may write to: IBM Stockholder
Relations, New Orchard Road, M/D 325, Armonk,
New York 10504.

Stockholder Communications
Stockholders can get quarterly financial results, a summary of
the Annual Meeting remarks, and voting results from the
meeting by calling (914) 499-7777, by sending an e-mail to
infoibm@us.ibm.com, or by writing to IBM Stockholder Relations,
New Orchard Road, M/D 325, Armonk, New York 10504.

Annual Meeting
The IBM Annual Meeting of Stockholders will be held on
Tuesday, April 30, 2019, at 10 a.m. at the Charleston Area
Convention Center, North Charleston, South Carolina.

Literature for IBM Stockholders
The literature mentioned below on IBM is available without
charge from:

Computershare Trust Company, N.A., P.O. Box 505005,
Louisville, Kentucky 40233-5005 (888) IBM-6700.

Investors residing outside the United States, Canada and
Puerto Rico should call (781) 575-2727.

The company’s annual report on Form 10-K and the quarterly
reports on Form 10-Q provide additional information on IBM’s
business. The 10-K report is released by the end of February;
10-Q reports are released by early May, August and November.

An audio recording of the 2018 Annual Report will be available
for sight-impaired stockholders in June 2019.

The IBM Corporate Responsibility Report highlights IBM’s
values and its integrated approach to corporate responsibility,
including its innovative strategies to transform communities
through global citizenship. Highlights from the Corporate
Responsibility Report are available online at www.ibm.com/
responsibility/report. The full Corporate Responsibility Report
is available in printed form by downloading the report at
www.ibm.com/responsibility/report.

General Information
Stockholders of record can receive account information and
answers to frequently asked questions regarding stockholder
accounts online at www.ibm.com/investor. Stockholders of
record can also consent to receive future IBM Annual Reports
and Proxy Statements online through this site.

For answers to general questions about IBM from within the
continental United States, call (800) IBM-4YOU. From outside
the United States, Canada and Puerto Rico, call (914) 499-1900.

Board of Directors and Senior Leadership
International Business Machines Corporation and Subsidiary Companies

151

BOARD OF DIRECTORS

Michael L. Eskew
Retired Chairman and
Chief Executive Officer
United Parcel Service, Inc.

David N. Farr
Chairman and Chief Executive Officer
Emerson Electric Co.

Alex Gorsky
Chairman and Chief Executive Officer
Johnson & Johnson

Michelle J. Howard
Retired Admiral
United States Navy

Shirley Ann Jackson
President
Rensselaer Polytechnic Institute

SENIOR LEADERSHIP

Simon J. Beaumont
Vice President
Tax and Treasurer

Michelle H. Browdy
Senior Vice President
Legal and Regulatory Affairs,
and General Counsel

Erich Clementi**
Senior Vice President

Robert F. Del Bene
Vice President and Controller

Mark Foster
Senior Vice President
Global Business Services

Diane J. Gherson
Senior Vice President and
Chief Human Resources Officer

John Granger
Senior Vice President
Cloud Application Innovation

* Term on the Board ends on April 30, 2019

** Retiring from the Company on March 31, 2019

Andrew N. Liveris
Retired Executive Chairman
DowDuPont Inc.

Retired Chairman and
Chief Executive Officer
The Dow Chemical Company

Hutham S. Olayan*
Chairman
The Olayan Group

James W. Owens*
Retired Chairman and
Chief Executive Officer
Caterpillar Inc.

Martha E. Pollack
President
Cornell University

Virginia M. Rometty
Chairman, President and
Chief Executive Officer
IBM

Martin Jetter
Senior Vice President
Europe

James J. Kavanaugh
Senior Vice President and
Chief Financial Officer
Finance and Operations

John E. Kelly III
Executive Vice President

Kenneth M. Keverian
Senior Vice President
Corporate Strategy

Arvind Krishna
Senior Vice President
Cloud and Cognitive Software

Robert W. Lord
Senior Vice President
Cognitive Applications

Christina M. Montgomery
Vice President
Assistant General Counsel
and Secretary

Joseph R. Swedish
Senior Advisor and
Retired Chairman, President
and Chief Executive Officer
Anthem, Inc.

Sidney Taurel
Chairman Emeritus
Eli Lilly and Company

Chairman
Pearson plc

Peter R. Voser
Retired Chief Executive Officer
Royal Dutch Shell plc

Chairman
ABB Ltd.

Frederick H. Waddell
Retired Chairman and
Chief Executive Officer
Northern Trust Corporation

Michelle Peluso
Senior Vice President and
Chief Marketing Officer
Digital Sales and Marketing

Robert J. Picciano
Senior Vice President
Cognitive Systems

Virginia M. Rometty
Chairman, President and
Chief Executive Officer

Thomas W. Rosamilia
Senior Vice President
Systems

Martin J. Schroeter
Senior Vice President
Global Markets, Global Financing,
Marketing and Communications

Bridget A. van Kralingen
Senior Vice President
Industry Platforms and
Global Industries

Juan A. Zufiria Zatarain
Senior Vice President
Global Technology Services

International Business Machines Corporation
New Orchard Road, Armonk, New York 10504
(914) 499-1900

AIX, Aperto, AppScan, BigFix, Bluewolf, Cognitive Enterprise, Db2, Domino,
Global Business Services, Global Technology Services, IBM, IBM Cloud,
IBM Garage, IBM iX, IBM Q, IBM Q Network, IBM Research, IBM Services,
IBM Watson, IBM Z, Notes, POWER, POWER9, Promontory, P-TECH, Resilient,
Sanovi, The Weather Company, Unica, Ustream, Watson, Watson Health,
Watson IoT, Watson OpenScale, z14, z/OS and z Systems are trademarks or
registered trademarks of International Business Machines Corporation or its
wholly owned subsidiaries. Linux is a registered trademark of Linus Torvalds
in the United States, other countries, or both. UNIX is a registered trademark
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