Edgar Filing: INTERNATIONAL BUSINESS MACHINES CORP

FORM 10 - Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10 - Q

QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE QUARTER ENDED SEPTEMBER 30, 2013

1-2360

(Commission file number)

INTERNATIONAL BUSINESS MACHINES CORPORATION

(Exact name of registrant as specified in its charter)

New York		13-0871985
(State of incorporation)		(IRS employer identification number)

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

914-499-1900

(Registrant’s telephone number)

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

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

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

Large accelerated filer ý				Accelerated filer ¨

Non-accelerated filer ¨				Smaller reporting company ¨
(Do not check if a smaller reporting company)

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

The registrant has 1,085,854,383 shares of common stock outstanding at September 30, 2013.

Index

		Page
Part I - Financial Information:

Item 1. Consolidated Financial Statements:


Consolidated Statement of Earnings for the three and nine months ended September 30, 2013 and 2012		3

Consolidated Statement of Comprehensive Income for the three and nine months ended September 30, 2013 and 2012		4

Consolidated Statement of Financial Position at September 30, 2013 and December 31, 2012		5

Consolidated Statement of Cash Flows for the nine months ended September 30, 2013 and 2012		7

Consolidated Statement of Changes in Equity for the nine months ended September 30, 2013 and 2012		8

Notes to Consolidated Financial Statements		9

Item 2. Management’s Discussion and Analysis of Results of Operations and Financial Condition		42

Item 4. Controls and Procedures		83

Part II - Other Information:

Item 1. Legal Proceedings		83

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds and Issuer Repurchases of Equity Securities		83

Item 6. Exhibits		84

PART I - Financial Information

Item 1. Consolidated Financial Statements:

INTERNATIONAL BUSINESS MACHINES CORPORATION
AND SUBSIDIARY COMPANIES

CONSOLIDATED STATEMENT OF EARNINGS
(UNAUDITED)


			Three Months Ended September 30,				Nine Months Ended September 30,
(Dollars in millions except per share amounts)			2013		2012		2013		2012
Revenue:
Services		$	14,225	$	14,626	$	42,811	$	44,279
Sales			8,987		9,642		27,735		29,424
Financing			509		479		1,506		1,500
Total revenue			23,720		24,747		72,052		75,203
Cost:
Services			9,098		9,515		27,950		29,285
Sales			2,975		3,242		9,108		10,003
Financing			268		258		805		784
Total cost			12,341		13,016		37,863		40,072
Gross profit			11,380		11,732		34,189		35,131
Expense and other income:
Selling, general and administrative			5,255		5,908		17,512		17,632
Research, development and engineering			1,468		1,534		4,661		4,722
Intellectual property and custom
	development income		(191)		(303)		(621)		(847)
Other (income) and expense			(62)		(606)		(214)		(796)
Interest expense			97		124		289		350
Total expense and other income			6,567		6,657		21,627		21,060
Income before income taxes			4,812		5,074		12,562		14,071
Provision for income taxes			772		1,251		2,263		3,300
Net income		$	4,041	$	3,824	$	10,299	$	10,771

Earnings per share of common stock:
	Assuming dilution	$	3.68	$	3.33	$	9.27	$	9.27
	Basic	$	3.70	$	3.36	$	9.35	$	9.38
Weighted-average number of common
	shares outstanding: (millions)
	Assuming dilution		1,098.8		1,149.3		1,110.7		1,161.8
	Basic		1,090.9		1,137.2		1,101.8		1,148.4

Cash dividend per common share		$	0.95	$	0.85	$	2.75	$	2.45

(Amounts may not add due to rounding.)

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

INTERNATIONAL BUSINESS MACHINES CORPORATION
AND SUBSIDIARY COMPANIES

CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME
(UNAUDITED)


			Three Months Ended September 30,				Nine Months Ended September 30,
(Dollars in millions)				2013		2012		2013		2012
Net income			$	4,041	$	3,824	$	10,299	$	10,771
Other comprehensive income/(loss), before tax:
	Foreign currency translation adjustments			382		501		(959)		164
	Net changes related to available-for-sale securities:
		Unrealized gains/(losses) arising during the period		3		11		0		13
		Reclassification of (gains)/losses to net income		(5)		(27)		(5)		(43)
		Subsequent changes in previously impaired
		securities arising during the period		1		(7)		3		20
	Total net changes related to available-for-sale securities			(1)		(24)		(1)		(10)
	Unrealized gains/(losses) on cash flow hedges:
		Unrealized gains/(losses) arising during the period		(409)		(54)		(58)		65
		Reclassification of (gains)/losses to net income		(27)		(112)		(130)		(246)
	Total unrealized gains/(losses) on cash flow hedges			(436)		(165)		(188)		(181)
	Retirement-related benefit plans:
		Prior service costs/(credits)		0		0		33		0
		Net (losses)/gains arising during the period		105		1		300		66
		Curtailments and settlements		0		(2)		0		(1)
		Amortization of prior service (credits)/costs		(28)		(37)		(86)		(112)
		Amortization of net (gains)/losses		872		613		2,623		1,846
	Total retirement-related benefit plans			949		575		2,869		1,799
Other comprehensive income/(loss), before tax				895		887		1,721		1,771
Income tax (expense)/benefit related to items of
		other comprehensive income		(91)		(109)		(933)		(606)
Other comprehensive income/(loss)				804		778		788		1,165
Total comprehensive income/(loss)			$	4,844	$	4,601	$	11,087	$	11,936

(Amounts may not add due to rounding.)

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

INTERNATIONAL BUSINESS MACHINES CORPORATION
AND SUBSIDIARY COMPANIES

CONSOLIDATED STATEMENT OF FINANCIAL POSITION
(UNAUDITED)

ASSETS

				At September 30,		At December 31,
(Dollars in millions)				2013		2012
Assets:
	Current assets:
		Cash and cash equivalents		$	10,072	$	10,412
		Marketable securities			160		717
		Notes and accounts receivable - trade (net of allowances of $273
			in 2013 and $255 in 2012)		9,865		10,667
		Short-term financing receivables (net of allowances of $280 in 2013
			and $288 in 2012)		16,786		18,038
		Other accounts receivable (net of allowances of $29 in 2013 and
			$17 in 2012)		1,683		1,873
		Inventories, at lower of average cost or market:
			Finished goods		528		475
			Work in process and raw materials		1,964		1,812
		Total inventories			2,492		2,287
		Deferred taxes			1,752		1,415
		Prepaid expenses and other current assets			4,723		4,024
	Total current assets				47,533		49,433

	Property, plant and equipment				40,808		40,501
		Less: Accumulated depreciation			26,931		26,505
	Property, plant and equipment — net				13,877		13,996
	Long-term financing receivables (net of allowances of $72 in 2013
		and $66 in 2012)			11,675		12,812
	Prepaid pension assets				1,476		945
	Deferred taxes				3,682		3,973
	Goodwill				30,882		29,247
	Intangible assets — net				4,003		3,787
	Investments and sundry assets				4,718		5,021
	Total assets			$	117,845	$	119,213

(Amounts may not add due to rounding.)

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

INTERNATIONAL BUSINESS MACHINES CORPORATION
AND SUBSIDIARY COMPANIES

CONSOLIDATED STATEMENT OF FINANCIAL POSITION – (CONTINUED)
(UNAUDITED)

LIABILITIES AND EQUITY

(Dollars in millions)			At September 30,		At December 31,
(Dollars in millions)			2013		2012
Liabilities:
	Current liabilities:
		Taxes	$	4,746	$	4,948
		Short-term debt		7,702		9,181
		Accounts payable		6,263		7,952
		Compensation and benefits		4,210		4,745
		Deferred income		11,658		11,952
		Other accrued expenses and liabilities		4,643		4,847
	Total current liabilities			39,222		43,625
	Long-term debt			28,478		24,088
	Retirement and nonpension postretirement benefit obligations			17,994		20,418
	Deferred income			4,087		4,491
	Other liabilities			8,057		7,607
	Total liabilities			97,837		100,229
Equity:
IBM stockholders’ equity:
	Common stock, par value $0.20 per share, and additional paid-in capital			51,203		50,110
		Shares authorized: 4,687,500,000
		Shares issued: 2013 - 2,205,819,186
		2012 - 2,197,561,159
	Retained earnings			124,885		117,641
	Treasury stock - at cost			(131,240)		(123,131)
		Shares: 2013 - 1,119,964,803
		2012 - 1,080,193,483
	Accumulated other comprehensive income/(loss)			(24,971)		(25,759)
	Total IBM stockholders’ equity			19,877		18,860
Noncontrolling interests				131		124
Total equity				20,008		18,984
Total liabilities and equity			$	117,845	$	119,213


(Amounts may not add due to rounding.)

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

INTERNATIONAL BUSINESS MACHINES CORPORATION
AND SUBSIDIARY COMPANIES

CONSOLIDATED STATEMENT OF CASH FLOWS
(UNAUDITED)

		Nine Months Ended September 30,
(Dollars in millions)			2013		2012
Cash flows from operating activities:
Net income		$	10,299	$	10,771
Adjustments to reconcile net income to cash provided by operating activities
	Depreciation		2,457		2,572
	Amortization of intangibles		1,007		952
	Stock-based compensation		455		510
	Net (gain)/loss on asset sales and other		(139)		(697)
	Changes in operating assets and liabilities, net of acquisitions/divestitures		(3,121)		(868)
Net cash provided by operating activities			10,957		13,240

Cash flows from investing activities:
	Payments for property, plant and equipment		(2,559)		(3,082)
	Proceeds from disposition of property, plant and equipment		256		233
	Investment in software		(406)		(476)
	Acquisition of businesses, net of cash acquired		(2,562)		(2,266)
	Divestitures of businesses, net of cash transferred		247		587
	Non-operating finance receivables — net		284		718
	Purchases of marketable securities and other investments		(3,718)		(2,596)
	Proceeds from disposition of marketable securities and other investments		4,035		1,971
Net cash used in investing activities			(4,423)		(4,912)

Cash flows from financing activities:
	Proceeds from new debt		10,066		9,589
	Payments to settle debt		(7,740)		(4,991)
	Short-term borrowings/(repayments) less than 90 days — net		1,074		(2,177)
	Common stock repurchases		(8,062)		(8,988)
	Common stock transactions — other		826		1,198
	Cash dividends paid		(3,033)		(2,816)
Net cash used in financing activities			(6,870)		(8,185)

Effect of exchange rate changes on cash and cash equivalents			(4)		(156)
Net change in cash and cash equivalents			(340)		(13)

Cash and cash equivalents at January 1			10,412		11,922
Cash and cash equivalents at September 30		$	10,072	$	11,909


(Amounts may not add due to rounding.)

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

INTERNATIONAL BUSINESS MACHINES CORPORATION
AND SUBSIDIARY COMPANIES
CONSOLIDATED STATEMENT OF CHANGES IN EQUITY
(UNAUDITED)


	Common
	Stock and							Accumulated
	Additional							Other			Total IBM			Non-
		Paid-in		Retained		Treasury			Comprehensive			Stockholders'			Controlling		Total
(Dollars in millions)		Capital		Earnings		Stock			Income/(Loss)			Equity			Interests		Equity
Equity - January 1, 2013		$	50,110	$	117,641	$	(123,131)		$	(25,759)		$	18,860		$	124	$	18,984
Net income plus other
comprehensive income/(loss)
Net income					10,299								10,299					10,299
Other comprehensive income/(loss)										788			788					788
Total comprehensive income/(loss)												$	11,087				$	11,087
Cash dividends declared –
common stock					(3,033)								(3,033)					(3,033)
Common stock issued under
employee plans (8,258,027 shares)			930										930					930
Purchases (1,419,498 shares) and
sales (1,574,179 shares) of treasury
stock under employee plans – net					(22)		(106)						(127)					(127)
Other treasury shares purchased,
not retired (39,926,001 shares)							(8,003)						(8,003)					(8,003)
Changes in other equity			164										164					164
Changes in noncontrolling interests																7		7
Equity - September 30, 2013		$	51,203	$	124,885	$	(131,240)		$	(24,971)		$	19,877		$	131	$	20,008

	Common
	Stock and							Accumulated
	Additional							Other			Total IBM			Non-
		Paid-in		Retained		Treasury			Comprehensive			Stockholders'			Controlling		Total
(Dollars in millions)		Capital		Earnings		Stock			Income/(Loss)			Equity			Interests		Equity
Equity - January 1, 2012		$	48,129	$	104,857	$	(110,963)		$	(21,885)		$	20,138		$	97	$	20,236
Net income plus other
comprehensive income/(loss)
Net income					10,771								10,771					10,771
Other comprehensive income/(loss)										1,165			1,165					1,165
Total comprehensive income/(loss)												$	11,936				$	11,936
Cash dividends declared –
common stock					(2,816)								(2,816)					(2,816)
Common stock issued under
employee plans (12,322,115 shares)			1,149										1,149					1,149
Purchases (2,092,008 shares) and
sales (2,358,099 shares) of treasury
stock under employee plans – net					(40)		(145)						(185)					(185)
Other treasury shares purchased,
not retired (45,838,313 shares)							(9,007)						(9,007)					(9,007)
Changes in other equity			324										324					324
Changes in noncontrolling interests																29		29
Equity - September 30, 2012		$	49,603	$	112,773	$	(120,115)		$	(20,720)		$	21,541		$	126	$	21,666

(Amounts may not add due to rounding.)

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

Notes to Consolidated Financial Statements:

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

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the assets, liabilities, revenue, costs, expenses and accumulated other comprehensive income/(loss) that are reported in the Consolidated Financial Statements and accompanying disclosures. These estimates are based on management’s best knowledge of current events, historical experience, actions that the company may undertake in the future and on various other assumptions that are believed to be reasonable under the circumstances. As a result, actual results may be different from these estimates. See the company's 2012 Annual Report on pages 59 to 61 for a discussion of the company's critical accounting estimates.

Interim results are not necessarily indicative of financial results for a full year. The information included in this Form 10-Q should be read in conjunction with the company's 2012 Annual Report.

Noncontrolling interest amounts in income of $1.8 million and $3.0 million, net of tax, for the three months ended September 30, 2013 and 2012, respectively, and $4.2 million and $8.6 million, net of tax, for the nine months ended September 30, 2013 and 2012, respectively, are included in the Consolidated Statement of Earnings within the other (income) and expense line item.

Within the financial statements and tables presented, certain columns and rows may not add due to the use of rounded numbers for disclosure purposes. Percentages presented are calculated from the underlying whole-dollar amounts. Certain prior year amounts have been reclassified to conform to the current year presentation. This is annotated where applicable.

2. Accounting Changes: In July 2013, the Financial Accounting Standards Board (FASB) issued guidance allowing the use of the Fed Funds Effective Swap Rate (or Overnight Index Swap Rate) as a benchmark interest rate for hedge accounting purposes in addition to interest rates on direct Treasury obligations of the United States government and the LIBOR. In addition, the guidance removes the restriction on using different benchmark rates for similar hedges. The guidance became effective on a prospective basis for qualifying new or redesignated hedging relationships entered into on or after July 17, 2013, and did not have a material impact in the consolidated financial results.

In July 2013, the FASB issued guidance regarding the presentation of an unrecognized tax benefit when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists. Under certain circumstances, unrecognized tax benefits should be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward. The guidance is a change in financial statement presentation only and has no material impact in the consolidated financial results. The guidance is effective beginning January 1, 2014 on either a prospective or retrospective basis.

In March 2013, the FASB issued guidance on when foreign currency translation adjustments should be released to net income. When a parent entity ceases to have a controlling financial interest in a subsidiary or group of assets that is a business within a foreign entity, the parent is required to release any related cumulative translation adjustment into net income. Accordingly, the cumulative translation adjustment should be released into net income only if the sale or transfer results in the complete or substantially complete liquidation of the foreign entity in which the subsidiary or group of assets had resided. The guidance is effective prospectively beginning January 1, 2014. It is not expected to have a material impact in the consolidated financial results.

In February 2013, the FASB issued guidance for the recognition, measurement and disclosure of obligations resulting from joint and several liability arrangements for which the total amount of the obligation within the scope of the guidance is fixed at the reporting date. Examples include debt arrangements, other contractual obligations and settled litigation. The guidance requires an entity to measure such obligations as the sum of the amount that the reporting entity agreed to pay on the basis of its arrangement among its co-obligors plus additional amounts the reporting entity expects to pay on behalf of its co-obligors. The guidance is effective January 1, 2014 and is not expected to have a material impact in the consolidated financial results.

Notes to Consolidated Financial Statements – (continued)

3. Financial Instruments:

Fair Value Measurements

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

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

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

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

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

When available, the company uses unadjusted quoted market prices in active markets to measure the fair value and classifies such items within 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 financial assets are measured at fair value on a nonrecurring basis. These assets include equity method investments that are recognized at fair value at the measurement date to the extent that they are deemed to be other-than-temporarily impaired. Certain assets that are measured at fair value on a recurring basis can be subject to nonrecurring fair value measurements. These assets include available-for-sale equity investments that are deemed to be other-than-temporarily impaired. In the event of an other-than-temporary impairment of a financial investment, fair value is measured using a model described above.

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 nonfinancial assets depend on the type of asset. See Note A,“Significant Accounting Policies,” on pages 76 to 86 in the company’s 2012 Annual Report for further information. There were no material impairments of non-financial assets for the nine months ended September 30, 2013 and 2012, respectively.

Accounting guidance permits the measurement of eligible financial assets, financial liabilities and firm commitments at fair value, on an instrument-by-instrument basis, that are otherwise not permitted to be accounted for at fair value under other accounting standards. This election is irrevocable. The company does not apply the fair value option to any eligible assets or liabilities.

The following tables present the company’s financial assets and financial liabilities that are measured at fair value on a recurring basis at September 30, 2013 and December 31, 2012.

Notes to Consolidated Financial Statements – (continued)

(Dollars in millions)
At September 30, 2013				Level 1		Level 2		Level 3		Total
Assets:
	Cash equivalents(1)
		Time deposits and certificates of deposit	$	—	$	4,422	$	—	$	4,422
		Commercial paper		—		992		—		992
		Money market funds		1,713		—		—		1,713
		U.S. government securities		—		800		—		800
		Other securities		—		10		—		10
	Total			1,713		6,225		—		7,938	(6)
	Debt securities - current (2)			—		160				160	(6)
	Debt securities - noncurrent (3)			1		8		—		9
	Available-for-sale equity investments (3)			32		—		—		32
	Derivative assets (4)
		Interest rate contracts		—		412		—		412
		Foreign exchange contracts		—		371		—		371
		Equity contracts		—		9		—		9
	Total			—		793		—		793	(7)
Total assets			$	1,747	$	7,185	$	—	$	8,932	(7)
Liabilities:
	Derivative liabilities (5)
		Foreign exchange contracts	$	—	$	575	$	—	$	575
		Equity contracts		—		7