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As Of Filer Filing For·On·As Docs:Size Issuer Filing Agent 2/28/20 Ibm Credit LLC 10-K 12/31/19 103:16M Toppan Merrill Bridge/FA |
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM i 10-K
i ANNUAL REPORT
Pursuant to Section 13 or 15(d) of the i Securities Exchange Act of 1934
FOR THE YEAR ENDED i DECEMBER 31, 2019
(Commission file number)
i IBM CREDIT LLC
(Exact name of registrant as specified in its charter)
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i Delaware | | i 22-2351962 |
(State or Other Jurisdiction of Incorporation or Organization) | | (IRS employer identification number) |
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i One North Castle Drive | | |
i Armonk, i New York | | i 10504 |
(Address of principal executive offices) | | (Zip Code) |
i 914- i 765-1900
(Registrant’s telephone number)
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
i Limited Liability Company Interests
Indicate by check mark if the registrant is a well-known seasoned issuer as defined in Rule 405 of the Securities Act. Yes ☐ i No ☒
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ☐ i No ☒
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. i Yes ☒ No ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). i Yes ☒ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
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Large accelerated filer ☐ | | | | Accelerated filer ☐ |
i Non-accelerated filer ☒ | | | | Smaller reporting company i ☐ |
| | | | Emerging growth company i ☐ |
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Exchange Act Rule 12b-2). Yes i ☐ No ☒
REDUCED DISCLOSURE FORMAT
IBM Credit LLC (IBM Credit), an indirect, wholly owned subsidiary of International Business Machines Corporation, meets the requirements set forth in General Instruction I(1) of Form 10-K. In accordance with published guidance from the Securities and Exchange Commission’s Division of Corporation Finance, this Annual Report on Form 10-K omits certain disclosure items that correspond to the disclosure items that IBM Credit is permitted to omit from a Form 10-K pursuant to General Instruction I(2) of Form 10-K.
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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations. | 17 |
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Item 7A. Quantitative and Qualitative Disclosures About Market Risk. | 39 |
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Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure. | 84 |
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Item 10. Directors, Executive Officers and Corporate Governance. | 85 |
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Item 13. Certain Relationships and Related Transactions, and Director Independence. | 85 |
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PART I
Item 1. Business.
Overview
IBM Credit LLC (IBM Credit or the company), a Delaware limited liability company, is an indirect, wholly owned subsidiary of International Business Machines Corporation (IBM). All of the limited liability company interests in IBM Credit are owned by IBM GF International Holdings LLC, a Delaware limited liability company (the Member), which is also an indirect, wholly owned subsidiary of IBM. IBM Credit is engaged in providing financing solutions for information technology (IT) hardware, software and services.
IBM Credit was originally established as a subsidiary of IBM to provide financing solutions and remanufacturing and remarketing operations, in each case primarily for IBM products sold in the United States. Today, the company maintains a global organizational structure aligned with its operating segments, Client Financing and Commercial Financing. Client Financing primarily provides financing to end-user clients, which consist primarily of large, medium-sized and small corporations and other businesses, for their purchase of IBM products and services and original equipment manufacturers’ (OEM) IT products and services, in each case in order to finance clients’ total solution requirements. Client Financing also provides loans to IBM to finance the acquisition of IT assets used in client services contracts. The company believes the financing arrangements are predominantly for products and services that are critical to the end-user clients’ business operations. Commercial Financing provides working capital financing to suppliers, distributors, and resellers of IBM and OEM IT products and services. Beginning in the second quarter of 2019 and continuing throughout the year, the company wound down the portion of its Commercial Financing operations that provides short-term working capital solutions for OEM IT suppliers, distributors and resellers. The company had receivables of $0.6 billion and $8.5 billion relating to its OEM IT Commercial Financing operations for the periods ended December 31, 2019, and 2018, respectively. IBM Credit will continue to provide differentiated end-to-end financing solutions, including commercial financing in support of IBM partner relationships.
For information regarding the company’s operations by segment, see Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and note N, “Segment Information,” to the Consolidated Financial Statements.
IBM Credit has the benefit of both deep knowledge of the company’s and IBM’s client base and insight into the hardware, software and services traditionally financed. These factors allow the company to effectively manage two of the major risks associated with financing: credit and residual value. These risks and others are discussed more fully in Item 1A, “Risk Factors.” The company also maintains long-term relationships with its clients through various stages of the IT asset life cycle — including initial purchase, technology upgrades and end-of-lease asset disposition.
Organizational Structure
IBM Credit was incorporated in Delaware in 1981 as IBM Credit Corporation and was subsequently converted to a limited liability company and renamed IBM Credit LLC in 2003.
IBM Credit operates as part of IBM’s Global Financing (IGF) business segment. The IGF business segment encompasses two primary activities: IBM Credit’s financing business and IBM’s remanufacturing and remarketing business. The remanufacturing and remarketing business includes sales, marketing and inventory management of used IBM and OEM IT products, and is conducted by IBM subsidiaries that are not part of IBM Credit.
In 2016, IGF established new entities to separate certain assets and liabilities related to IBM Credit’s financing business from IBM in the majority of countries where IGF operates. In most countries in which IBM Credit’s financing business operated as a division of the IBM legal entity, a subsidiary was formed that acquired the assets and liabilities related to the financing business from the existing IBM legal entity. The remanufacturing and remarketing business and related assets and liabilities remained in the existing IBM legal entity. In the few countries where the financing business was not considered material to IBM Credit on a consolidated basis, such operations remained in the existing IBM legal entity.
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Item 1. Business – (continued)
These countries’ operating results are not reported as part of IBM Credit. In countries in which the financing business already operated in a separate legal entity and included the remanufacturing and remarketing business, such legal entity was transferred to IBM Credit. In connection with each such transfer, the legal entity divested its assets and liabilities related to the remanufacturing and remarketing business to IBM prior to its transfer to IBM Credit. In 2017, IBM Credit directly or indirectly acquired all of the foreign legal entities that operate the financing business, as referenced above, as part of a strategy to drive operational benefits by consolidating the financing business under IBM Credit.
Business Segments
The company’s two operating segments, Client Financing and Commercial Financing, are business units that offer financing solutions based upon the needs of the company’s clients. The segments represent components of the company for which separate financial information is available and utilized on a regular basis by the chief operating decision maker in determining how to allocate resources and evaluate performance.
Each segment’s business and the financing solutions that generate the segment’s revenue, results of operations and asset portfolio are discussed further in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and in note N, “Segment Information,” to the Consolidated Financial Statements.
Client Financing
The company provides leases and loan financing to end-user clients and acquires installment payment plans offered to end-user clients by IBM. End-user clients are primarily IBM clients who elect to finance their acquisition of IBM’s hardware, software, and services, as well as OEM IT hardware, software and services, to meet their total solution requirements. In addition, the company provides loans to IBM, primarily in support of IBM’s Global Technology Services segment’s acquisition of IT assets, which are used in its external, revenue-producing services contracts.
Client Financing solutions are typically delivered as follows:
● | Leases, Loans and Installment Payment Plans: Leases are primarily sales-type, direct financing and operating leases for IBM’s hardware and select OEM IT hardware in areas in which IBM and the company have experience. Loans are primarily made to end-user clients to finance purchases of IBM and select OEM software and services, and are generally unsecured. These leases and loans are typically documented in contracts between IBM Credit and the end-user client. |
In certain countries, the leases and loans are originated by IBM directly to the end-user client, and the company purchases the receivables and related equipment from IBM. In addition, IBM Credit supports IBM’s client offerings of installment payment plans for hardware, software and services to the end-user by purchasing receivables related to such payment plans from IBM.
● | IBM Total Solution Offerings that include Financing: For certain IBM offerings, IBM Credit’s financing contract is bundled with IBM’s product and service contract to create a combined periodic payment schedule for the entire offering (Total Solution Offering). For Total Solution Offerings, the financing and non-financing amounts due are provided in a single, combined periodic invoice for the IBM end-user client, such that each amount due to IBM Credit for the financing payment is collected by IBM along with the amounts due to IBM for the non-financing items. In these cases, IBM acts as IBM Credit’s billing and collection agent and forwards the financing payments to IBM Credit. |
For IBM Total Solution Offerings in certain countries, as well as for certain government and other contracts, IBM Credit is not a party to IBM’s contract with the end-user client. Instead, IBM directly provides the end-user client with the financing. IBM Credit acquires a participation interest from IBM that represents the financing portion of such payments and assumes the associated credit risk of IBM’s end-user client from IBM. For additional information, see note C, “Relationship with IBM and Related Party Transactions,” to the Consolidated Financial Statements.
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Item 1. Business – (continued)
● | Other Financing to IBM: In certain countries, the company provides loans to IBM, primarily in support of IBM’s Global Technology Services segment’s acquisition of IT assets used in its external, revenue-producing client services contracts. The loan portfolio balance is renewed and repriced periodically with a net settlement for advances on new equipment acquisitions or repayments of principal on prior acquisitions. For additional information, see note C, “Relationship with IBM and Related Party Transactions,” to the Consolidated Financial Statements. |
Client Financing solutions are typically marketed and sold by IBM Credit employees, primarily in cooperation with IBM and business partner sales teams during the product and services sales cycle. Client Financing solutions are generally offered at market rates that are competitive with what individual clients could obtain from other lenders. Client Financing solutions may also be offered at discounted rates, resulting from financing incentives provided by IBM, business partners or OEM IT providers through various financing incentive programs, allowing IBM Credit to realize a market yield. For additional information, see the “Financing Incentive Programs” section.
The company recovers the residual value of leased equipment by selling to IBM assets that have been returned from lease at cost, which approximates fair value. In addition, IBM may migrate a client to new technology. In the event this migration results in an early termination of a lease, IBM will purchase the returned equipment from the company at a pre-negotiated price, which is a function of the discounted value of the scheduled future lease payments and the residual value. For additional information on the residual value of leased assets and the sale of equipment returned from lease to IBM, see note A, “Significant Accounting Policies,” and note C, “Relationship with IBM and Related Party Transactions,” to the Consolidated Financial Statements.
Commercial Financing
IBM Credit provides working capital financing to suppliers (consisting of IBM and suppliers of OEM IT products and services), distributors (typically third parties that purchase IT products from suppliers and provide those products to resellers) and resellers. This financing may take the form of loans to distributors and resellers, which are generally unsecured obligations of the client, but may be collateralized by inventory or accounts receivable. This financing may also include factoring, in which IBM Credit purchases receivables from suppliers, distributors or resellers.
IBM Credit generally extends payment terms in the range of 30 to 90 days to distributors and resellers in respect of their inventory purchases, while providing early settlement to suppliers at the supplier’s election. Suppliers generally provide financing incentives to reduce their distributors’ or resellers’ cost of financing for this term. The extended payment terms and early settlement provide liquidity to these clients. Commercial Financing is also important to suppliers and distributors because it enables them to shed credit risk, which is assumed by IBM Credit. For certain creditworthy distributors or resellers, IBM Credit may, at its discretion, allow a further extension of the repayment period for an additional financing charge. In addition, IBM Credit purchases interests in certain of IBM’s trade and other accounts receivable at a discount and assumes the credit risk of the IBM client. In the second quarter of 2019, the company suspended the program under which IBM Credit purchases interests in IBM’s trade accounts receivable.
Beginning in the second quarter of 2019 and continuing throughout the year, the company wound down the OEM IT portion of its Commercial Financing operations. The company will continue to provide differentiated end-to-end financing solutions, including commercial financing in support of IBM partner relationships.
Financial Regulation and Supervision
IBM Credit’s operations are subject to financial regulation, including licensing requirements and supervision, within and outside the U.S. Although IBM Credit operates in all 50 states and in certain U.S. territories, the company is only required to be licensed for the type of financing it provides in a very limited number of states or territories. The company believes it is in material compliance with all licensing requirements in these states and territories. None of the company’s lender licenses are consumer finance licenses, as the company does not extend credit to consumers. In certain of these jurisdictions, as a result of being licensed as a non-bank lender, the company is or may be subject to compliance examinations, audits or information requests, including with respect to client complaints, by the relevant licensing
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Item 1. Business – (continued)
agency. With respect to the type of commercial financing activities conducted by IBM Credit, state and local laws in the U.S. generally regulate debt collection practices and creditors’ rights, establish maximum interest rates and other charges and prohibit discrimination in the extension of credit and related activities.
In addition to state and local laws, IBM Credit is subject to certain federal financial laws and regulations, including, for example, the Equal Credit Opportunity Act which, among other things, prohibits discrimination in the extension of credit and related activities.
IBM Credit’s financing business outside the U.S. is generally conducted through subsidiaries and is subject to local financial laws and regulations, including, in certain jurisdictions, reporting requirements and the requirement to maintain an anti-money laundering program. A limited number of IBM Credit’s foreign subsidiaries are authorized or licensed as banks, credit institutions or non-bank lenders that are subject to heightened regulation, including, for example, capital requirements and prudential supervision by local authorities. The company’s regulated subsidiaries in these countries are subject to periodic examinations related to their financing business.
IBM Credit monitors its financing operations for compliance with applicable laws and regulations. The company believes it is in material compliance with all licensing requirements as are necessary to conduct its financing business both within and outside the United States and is in material compliance with all laws and regulations applicable to its financing operations.
Portfolio Risk Management
IBM Credit conducts a credit evaluation of its clients prior to extending financing. The credit evaluation takes into account current information about the client, such as published credit ratings, financial statements, news reports and current market implied credit analysis, as well as the current economic environment, outstanding obligations to the company and prior collection history. In some cases, commercial factors, including IBM’s relationship with a client, are also considered in making origination and other business decisions. Counterparty risks are managed at an overall IBM level and all subsidiaries, including IBM Credit, operate within those policies, principles and delegations. When appropriate, actions are taken to mitigate credit risk, such as requiring the inclusion of covenants from the client to protect against credit deterioration during the life of the obligation and obtaining credit enhancements, such as payment guarantees and letters of credit. The company performs additional credit evaluations of its clients on a regular basis. For additional information, see note F, “Financing Receivables, Receivables Purchased/Participated from IBM,” to the Consolidated Financial Statements.
IBM Credit employs a rigorous process to optimize portfolio risk and to obtain additional credit capacity in support of new business opportunities. IBM Credit engages in portfolio risk mitigation by entering into various non-recourse and limited recourse agreements with third parties consisting primarily of domestic and foreign financial institutions including banks, commercial and vendor finance companies, equipment lessors, credit insurers and other specialty finance companies. Third party arrangements may be funded or unfunded and include participations, sales and assignments, factoring, credit insurance, and other credit risk mitigation structures under discretionary or committed facilities. In limited instances, the company sells financing receivables and operating leases (and related assets) to third parties.
Financing Incentive Programs
IBM and OEM IT suppliers from time to time sponsor financing incentive programs that allow the company to offer waived or reduced rate financing for marketing program offerings and sales promotions. Pursuant to these programs, IBM or OEM IT suppliers offer a discount to IBM Credit that enables the company to realize a market yield on any Client Financing agreements entered into either directly or indirectly under these incentive programs. Market yield is based on the credit quality of the client and the length of the contract.
The volume of financing incentive programs sponsored by IBM and OEM IT suppliers, and the split of those programs between leases and loans, may vary over time depending upon the marketing strategies of the respective supplier.
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Item 1. Business – (continued)
In addition, the company provides financing which includes an interest free period to suppliers, distributors and resellers of IBM products and services, which is funded by IBM. These fees are included in the Commercial Financing segment as financing revenue. For additional information, see note C, “Relationship with IBM and Related Party Transactions,” to the Consolidated Financial Statements.
Client Services
Once a financing arrangement is in place, the company provides its clients with timely direct settlement of financial obligations with such clients’ suppliers. The company provides account management and client service and support throughout the financing relationship, including reminders for payment, processing of payments and handling of client billing questions. The company also provides end-of-lease options, including purchase, extension or return of leased equipment.
Relationship with IBM
IBM Credit is a captive finance company and an indirect, wholly owned subsidiary of IBM. IBM Credit generally conducts its financing activities with IBM on an arm’s-length basis, subject in certain cases, particularly with respect to originations, to commercial factors, including IBM’s relationship with a client. The following is a description of certain material relationships between IBM and IBM Credit regarding support, borrowing, licensing, service and other arrangements. For additional information, see Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and note C, “Relationship with IBM and Related Party Transactions,” to the Consolidated Financial Statements.
IBM Support Agreement
IBM Credit and IBM are parties to a support agreement, which became effective on May 2, 2017 (Support Agreement). Pursuant to the Support Agreement, IBM has agreed with IBM Credit that IBM will:
● | retain, directly or indirectly, beneficial ownership of at least 51 percent of the equity voting interests in IBM Credit at all times; |
● | cause IBM Credit to, on the last day of each of IBM Credit’s fiscal years, have a consolidated tangible net worth of at least $50 million (with consolidated tangible net worth for purposes of this discussion of the Support Agreement understood to mean (a) the total assets of IBM Credit and its subsidiary companies less (b) the intangible assets and total liabilities of IBM Credit and its subsidiary companies); and |
● | cause the leverage ratio of IBM Credit to be no more than 11 to 1 for each of IBM Credit’s fiscal quarters (with leverage ratio for purposes of this discussion of the Support Agreement understood to mean, for any calendar quarter, IBM Credit’s debt-to-equity ratio as reported in, and calculated in the manner set forth in, IBM Credit’s periodic report covering such fiscal quarter). |
In the event that IBM Credit’s leverage ratio as of the end of any fiscal quarter is higher than 11 to 1, then, upon demand by IBM Credit, IBM has agreed to make or cause to be made a capital contribution to IBM Credit in an amount sufficient to cause the leverage ratio to not exceed 11 to 1.
The Support Agreement is not a guarantee by IBM of any indebtedness, other obligation, or liability of any kind of IBM Credit.
IBM or IBM Credit may each terminate the Support Agreement upon giving the other party 30 days prior written notice, with a copy of such notice to each rating agency that is then rating any outstanding debt (with debt for purposes of this discussion defined as IBM Credit’s indebtedness for borrowed money that either (i) is rated by one or more rating agencies or (ii) is designated by the board of managers of IBM Credit as constituting debt for purposes of the Support Agreement). The Support Agreement may be modified or amended only by the written agreement of IBM and IBM
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Item 1. Business – (continued)
Credit and upon 30 days prior written notice to each rating agency rating any outstanding debt. However, such termination, modification or amendment will not be effective with respect to any debt outstanding at the time of such termination, modification or amendment unless (a) such termination, modification or amendment is permitted under the documentation governing such debt, (b) all affected holders of such debt (or, in the case of debt incurred pursuant to documentation that permits the Support Agreement to be terminated, modified, or amended with the consent of less than all of the holders of such debt, the requisite holders of such debt) otherwise consent in writing or (c) with respect to debt that is rated by one or more rating agencies at the request of IBM or IBM Credit, each such rating agency confirms in writing that the rating assigned to such debt by such rating agency will not be withdrawn or reduced because of the proposed action.
Under the terms of the Support Agreement, the Support Agreement is not enforceable against IBM by anyone other than (a) IBM Credit or (b) if any case is commenced under the United States Bankruptcy Code (11 U.S.C. §§ 101 et seq.), or any successor statutory provisions (the Bankruptcy Code), in respect of IBM Credit, the debtor in possession or trustee appointed by the court having jurisdiction over such proceeding. In the event of (1) a breach by IBM in performing a provision of the Support Agreement and (2) the commencement of such a case under the Bankruptcy Code with respect to IBM Credit while any debt is outstanding, the remedies of a holder of debt shall include the right, if no proceeding on behalf of IBM Credit has already been commenced in such case, to file a petition in respect of IBM Credit thereunder with a view to the debtor in possession, or the trustee appointed by the court having jurisdiction over such proceeding, pursuing IBM Credit’s rights under the Support Agreement.
The Support Agreement is governed by and construed in accordance with the laws of the State of New York.
Borrowing Relationship
The company has credit facilities with IBM that allow the company to obtain short- and long-term funding on an as-needed basis and the company seeks to substantially match-fund the term, currency and interest rate variability of its debt against its underlying financing assets. The general terms of the loans under these credit facilities are set forth in standard intercompany loan agreements, which include standard default clauses (including failure to pay interest or principal when due, bankruptcy and ceasing to be a wholly owned subsidiary). IBM Credit is entitled to prepay loans issued under these credit facilities from time to time, subject to payment of any agreed penalty or premium. Loans with IBM under such agreements are included in the Consolidated Statement of Financial Position as debt payable to IBM. Interest expense incurred on these borrowings from IBM is included in financing cost in the Consolidated Statement of Earnings. For additional information on short- and long-term funding, see note H, “Borrowings,” to the Consolidated Financial Statements.
Services and Other Arrangements
The company sources a number of services from IBM, including functional support for treasury, accounting, legal, tax, human resources, marketing and IT services. In certain instances, IBM acts as IBM Credit’s billing and collection agent and forwards the financing payments to IBM Credit. The company also has the right to use certain IBM intangibles in its business. Where practical, charges of the expenses incurred by IBM in the provision of these functional support services are based upon direct usage. For the remainder, where possible, expenses are charged based on measurable non-financial drivers, such as number of employees. When a clear and measurable non-financial driver cannot be established, these expenses are charged based on a measurable financial driver, such as net margin. Management believes that these methods are reasonable. In addition, the company conducts its global operations primarily from IBM leased or IBM owned facilities for which IBM charges the company for occupancy expenses based on square footage space usage with no fixed term commitment. For additional information regarding the historical allocation of expenses by IBM to the company, see note C, “Relationship with IBM and Related Party Transactions,” to the Consolidated Financial Statements.
The company participates in various IBM stock-based compensation plans, including awards of Restricted Stock Units and Performance Share Units. For additional information, see note C, “Relationship with IBM and Related Party Transactions,” to the Consolidated Financial Statements.
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Item 1. Business – (continued)
The company participates in certain multiemployer retirement-related plans that are sponsored by IBM. Charges from IBM to the company in relation to these multiemployer plans (including non-pension, post-retirement benefits) are limited to service costs. The company is charged by IBM based on the number of employees. Contributions and any other types of costs for these multiemployer plans are the responsibility of IBM. In certain countries, the company participates in plans that are accounted for as multiple-employer plans. For these plans, the retirement-related plan obligation is owned by the company and is generally calculated using actuarial valuations. Under these plans, IBM manages the assets and allocates them to the company based on the company’s obligation. The company also participates in certain defined contribution plans and is charged by IBM based on the number of employees. For additional information, see note M, “Retirement-Related Benefits,” to the Consolidated Financial Statements.
Expenses related to the services discussed above are included in Selling, General and Administrative (SG&A) expense in the Consolidated Statement of Earnings. It is not practical to estimate the actual costs that would have been incurred had IBM Credit been a separate company during the periods presented. These costs also may not be indicative of the expenses that IBM Credit will incur in the future or would have incurred if the company had obtained these services from a third party.
The company also invests a portion of its excess cash in short-term interest-bearing accounts with IBM, which can be withdrawn upon demand. For additional information, see note C, “Relationship with IBM and Related Party Transactions,” to the Consolidated Financial Statements.
Tax Sharing Agreement
The company’s U.S. federal and certain state and foreign operations are included in various IBM consolidated tax returns; in such cases, IBM makes payments to tax authorities on the company’s behalf. IBM and the company maintain a tax sharing agreement for any operations included in an IBM consolidated tax return (Tax Sharing Agreement). Pursuant to the Tax Sharing Agreement, IBM charges the company for any taxes owed and reimburses the company for tax attributes generated. Such charges or reimbursements are based upon a calculation of the company’s relevant pro forma stand-alone tax return. For additional information, see note L, “Taxes,” to the Consolidated Financial Statements.
Competition
The company operates in a highly competitive environment, where financing for users of IBM hardware, software and services and OEM IT products and services is available through a variety of sources. The company’s strong relationship with IBM provides the company with access to capital and the ability to manage increased exposures, each of which generates a competitive advantage. The key competitive factors in Client Financing and Commercial Financing include interest rates charged, IT product experience, client service, contract flexibility, ease of doing business, global capabilities and residual values. In providing financing solutions to clients, the company competes with three types of companies: other captive financing entities of IT companies, non-captive financing entities and financial institutions.
Employees and Related Workforce
At December 31, 2019, IBM Credit and its subsidiaries employed approximately 2,200 people globally.
Geographic Results
The company reports revenue on a geographic basis within Item 7, “Management Discussion and Analysis of Financial Condition and Results of Operations.” The geographies include the Americas, Europe/Middle East/Africa (EMEA), and Asia Pacific. The company also provides information regarding total revenue and earning assets in the U.S. and foreign countries in note N, “Segment Information,” to the Consolidated Financial Statements.
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Item 1. Business – (continued)
Available Information
IBM Credit 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. 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. In addition, IBM’s website (www.ibm.com/investor) contains a significant amount of information about IBM Credit, 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 or furnished to the SEC. These materials are also available free of charge on or through IBM’s website.
Forward-looking and Cautionary Statements
Certain statements contained in this Annual Report on Form 10-K may constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995 (Reform Act). 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. The company may also make forward-looking statements in other reports filed with the SEC and in materials delivered to lenders and in press releases. In addition, the company’s and IBM representatives may from time to time make oral forward-looking statements. Forward-looking statements provide current expectations of future events based on certain assumptions and include any statement that does not directly relate to any historical or current fact. Words such as “anticipates,” “believes,” “expects,” “estimates,” “intends,” “plans,” “projects” and similar expressions, may identify such forward-looking statements. Any forward-looking statement in this Form 10-K speaks only as of the date on which it is made, except as required by law. The company assumes no obligation to update or revise any forward-looking statements. In accordance with the Reform Act, set forth under Item 1A, “Risk Factors” in this Form 10-K are cautionary statements that accompany those forward-looking statements. Readers should carefully review such cautionary statements as they identify certain important factors that could cause actual results to differ materially from those in the forward-looking statements and from historical trends. Those cautionary statements are not exclusive and are in addition to other factors discussed elsewhere in this Form 10-K, in the company’s filings with the SEC or in materials incorporated therein by reference.
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Item 1A. Risk Factors.
The Company’s Financial Condition is in Large Part Dependent upon IBM: A significant portion of IBM Credit’s financing business consists of financing associated with the sale of IBM’s products and services. Financing originations, which determine the company’s financing asset base, are impacted by IBM’s product and services sales volumes and IBM Credit’s participation rates in those sales. Participation rates reflect the propensity of IBM’s clients to finance their transactions through IBM Credit in lieu of paying IBM up-front cash or financing through a third party. As discussed on page 6 under “Financing Incentive Programs,” IBM Credit participates in certain marketing programs in conjunction with IBM that allow the company to offer financing to end-user clients, which provides IBM Credit with a competitive advantage in financing IBM’s offerings. Any change in these marketing programs or IBM’s distribution methods, or any reduction in the company’s ability to offer competitively priced financing to IBM end-user clients, could reduce the company’s participation rates in IBM’s product and service offerings, which could have a material adverse effect on the business, financial condition, results of operations and cash flows of the company. IBM also provides IBM Credit with other types of operational and administrative support, which are integral to the conduct of the company’s business. For additional information, see note C, “Relationship with IBM and Related Party Transactions,” to the Consolidated Financial Statements. Any changes in the levels of support from IBM could also negatively impact the company’s results. Further, if there were significant changes in IBM’s liquidity or capital position, the quality of IBM’s offerings, transfers of ownership of IBM’s products or services, or other factors impacting IBM or its products, such changes could significantly affect IBM Credit’s financial condition and results of operations. In addition, IBM has one of the strongest brand names in the world, and its brand and overall reputation could be negatively impacted by many factors, including if IBM does not continue to be recognized for its industry-leading technology and solutions and as a cognitive leader. If negative perceptions tarnish IBM’s or IBM Credit’s brand image and reputation, IBM Credit’s ability to attract and retain customers and talent could be impacted. The success of IBM’s business and operations and demand for IBM products and services are subject to a number of risks, including, among others:
● | IBM’s ability to reach its growth and productivity objectives under its long-term business strategy; |
● | IBM’s ability to continue its cutting-edge innovation and ability to commercialize such innovations; |
● | Risks from IBM’s investments in key strategic areas to drive revenue growth and market share; |
● | IBM’s relationship with its critical suppliers; |
● | Quality issues with IBM products; |
● | IBM’s reliance on third party distribution channels and ecosystems; and |
● | Risks from IBM’s acquisitions, alliances and dispositions, including integration challenges. |
Additionally, the company’s credit ratings depend, in part, on the existence of the Support Agreement with IBM. If this arrangement, or replacement arrangements, if any, are modified, or if a credit rating of IBM is lowered, the company’s credit ratings could be negatively impacted, potentially leading to higher borrowing costs and negatively impacting the company’s ability to offer competitively priced financing to its clients, which could have a material adverse effect on the business, financial condition, results of operations and cash flows of the company.
Downturn in Economic Environment Could Impact the Company’s Business: If there is a downturn in the economic environment, generally or specific to certain industries in which IBM Credit’s clients operate, clients may be unable to meet their debt obligations and they may not enter into new financing arrangements, which could negatively impact the company’s financial results.
Technology Sector Innovation Initiatives Could Impact Clients’ Propensity to Enter into Financing Arrangements: As IBM and other suppliers of technology transform their offerings and enter new market segments, some new offerings and delivery models may be less conducive to traditional financing than the historical offerings. While the company makes efforts to adapt IBM Credit’s financing business and offerings to these changes, the company may not be successful and this could have negative impacts on the company’s financial results and long-term success.
The Company’s Reliance on Partner Relationships Could Impact Its Business: The company offers its solutions directly and through a variety of business partners, including suppliers, distributors and resellers of IT hardware, software and
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Item 1A. Risk Factors – (continued)
services. Changes in the business condition, financial or otherwise, of these parties could negatively impact the company and affect its ability to bring its solutions to market. If the company moves into new areas, partners may be unable to keep up with changes in IBM Credit’s offerings, and the company may be unable to recruit and enable appropriate partners. In addition, the failure of partners to comply with all applicable laws and regulations may prevent the company from working with them, which could negatively impact the company and affect its ability to bring solutions to market.
The Company’s Financial Performance Could be Impacted by Its Ability to Collect Receivables in a Timely Manner and Result in Incurring Potential Unexpected Credit Losses: Changes in the concentration of credit and the credit risk of IBM Credit’s clients can be impacted by global, country, industry and client specific economic conditions, which in turn may impact clients’ working capital and their ability to make scheduled payments on the company’s financing receivables. In addition, client disputes regarding product quality, service delivery, amounts due to the company under Total Solution Offerings or other circumstances, may cause clients to delay scheduled payments when due. IBM Credit’s ability to collect receivables and generate sufficient cash to meet its business obligations, including servicing its debt, can have a significant impact on the company’s business operations.
Additionally, the company’s client base includes a variety of enterprises, from small and medium businesses to the world’s largest organizations and governmental entities. The company performs regular credit evaluations of its clients’ financial conditions. These credit evaluations rely in part on third party information, including information provided by the company’s clients, and may not successfully predict client financial conditions and detect and prevent fraud or misconduct by the company’s end-user clients or other third parties. Any such fraud or misconduct could have a significant impact on the company’s ability to collect receivables. If the company becomes aware of information related to the creditworthiness of a client, or if actual default rates on receivables in the future differ from those currently anticipated, the company may have to adjust its allowance for credit losses, which could affect the company’s financial position and results of operations.
Changes to Residual Value Could Adversely Affect the Profitability of the Company’s Lease Transactions: The recorded residual values of lease assets are estimated at the inception of a lease to be the expected fair value of the assets at the end of the lease term. The estimated residual value of leased equipment is based on a number of factors, including historical market sales prices, past remarketing experience, known significant market or product trends and IBM’s remarketing plans. If residual values significantly decline or are incorrectly estimated, due to economic factors, product quality issues, market or client behavior changes, fraud or misconduct by end-user clients or other third parties, unforeseen technology innovations or any other circumstances, it may lower financing margin and income or result in losses.
The Company’s Financial Performance Could be Impacted by Exposure to Currency and Financing Risks and Changes in Market Liquidity Conditions: The company derives a significant percentage of its revenues and costs from its operations in local currency environments, which are affected by changes in the relative values of the U.S. dollar and foreign currencies. Further, inherent in the company’s business are risks related to the interest rate and currency fluctuations on the associated debt and liabilities. Changes in interest rates or changes in the global economy (including currency fluctuations) could have a negative impact on both revenue and net margin. Although the company seeks to substantially match-fund the term, currency and interest rate variability of its debt against its underlying financing assets, risks may arise from a mismatch between assets and the related liabilities used for funding. The company employs several strategies to manage these risks, including the use of derivative financial instruments. However, there can be no assurance that the company’s efforts to manage its currency and financing risks will be successful. The company’s financial performance is exposed to a wide variety of industry sector dynamics worldwide that could impact IBM Credit’s ability to generate sufficient cash to service its debt. The company’s earnings and cash flows, as well as its access to funding, could be negatively impacted by changes in market liquidity conditions. For more information about the company’s liquidity position, see Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” in this Form 10-K.
IBM Credit’s ability to make payments on, or to refinance, its indebtedness and to fund the company’s operations depends on its ability to generate cash and its ability to access the capital markets. These factors, to a certain extent, are
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Item 1A. Risk Factors – (continued)
subject to general economic, financial, competitive, legislative, regulatory, capital market and other conditions that are beyond the company’s control. The availability and cost of financing is also influenced by the company’s credit ratings, which depend in part on the existence of the Support Agreement with IBM. If IBM Credit is unable to generate sufficient cash flows in the future to service its debt, the company may be required to refinance all or a portion of its existing debt or to obtain additional financing. There can be no assurance that any refinancing will be available or that additional financing could be obtained on acceptable terms. In the absence of other funding alternatives, a protracted period where the company could not access the capital markets would likely lead to a slowdown in originations. The inability to service or refinance the company’s existing debt, which has a dependency on IBM, or to obtain additional financing could have a material adverse effect on the financial position, liquidity, and results of operations of the company.
Certain of the Company’s Operations Are Subject to Financial Regulation, Supervision and Licensing under Various Laws and Regulations: The company is required to comply with a range of financial laws and regulations within and outside the U.S., which may be costly to adhere to and may affect both the results of its operations and its ability to service its earning assets. Compliance with these laws and regulations requires that the company maintain certain licenses and be subject to examinations or audits by supervisory authorities in certain jurisdictions in which it operates. Failure to comply with such laws and regulations in any particular jurisdiction could result in significant civil penalties and other sanctions, such as a revocation of the company’s license to do business in that jurisdiction. In the event the company were to become subject to any such sanctions, its business in the affected jurisdiction could be adversely affected, which in turn could have a material adverse effect on IBM Credit’s business prospects, results of operations or financial condition.
Due to the Company’s Global Presence, Its Business and Operations Could Be Impacted by Local Legal, Economic, Political, Health and Other Conditions: The company is a global business, so changes in the laws or policies of the countries in which the company operates, or inadequate development or enforcement of laws or policies, could affect the company’s business and overall results of operations. Substantial revisions that U.S. and foreign governments are undertaking or considering in areas such as the regulation and supervision of financial institutions, including financing and leasing companies, may have an effect on the company’s structure, operations, sales, liquidity, capital requirements, effective tax rate and performance. The company’s results of operations could also be affected by economic and political changes around the world and by macroeconomic changes, including recessions, inflation, currency fluctuations between the U.S. dollar and foreign currencies and adverse changes in trade relationships between countries. Further, if the company expands its client base and the scope of its offerings, both within the U.S. and globally, the company may be impacted by additional regulatory or other risks, including compliance with U.S. and foreign financial industry laws and regulations, data privacy requirements, enforcement of intellectual property protection, anti-money laundering laws, tax laws, anti-competition regulations, anti-corruption laws, and import, export and trade restrictions. Further, uncertainty has been created by international trade disputes. Tariffs and sanctions resulting from these disputes could affect IBM’s ability to move goods and services across borders, or could impose added costs to those activities, which could impact the company’s operations. Measures taken to date by IBM and the company to mitigate these impacts could be made less effective should trade sanctions or tariffs change. In addition, any widespread outbreak of an illness, pandemic or other local or global health issue, natural disasters, climate change impacts, or uncertain political climates, international hostilities, or any terrorist activities, could negatively affect customer demand and the company’s operations. For example, the U.K. referendum to exit from the E.U., commonly referred to as “Brexit”, has caused global economic, trade and regulatory uncertainty. The company is actively monitoring and planning for Brexit.
Cybersecurity and Privacy Considerations Could Impact the Company’s Business: There are numerous and evolving risks to cybersecurity and privacy, including risks originating from intentional acts of criminal hackers, hacktivists, nation states, and competitors; from intentional and unintentional acts of customers, contractors, business partners, vendors, employees and other third parties; and from errors in processes or technologies. Computer hackers and others routinely attempt to attack the security of our technology systems and networks, and to fraudulently induce customers, contractors, business partners, vendors, employees, and other third parties to disclose information, transfer funds, or unwittingly provide access to systems or data. The company is at risk of security breaches not only of its own systems and networks, but also those of its clients, contractors, business partners, vendors, employees and other third parties.
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Item 1A. Risk Factors – (continued)
Cyber threats are continually evolving, making it difficult to detect and defend against certain threats and vulnerabilities that can persist over extended periods of time. The systems utilized by the company involve the storage, processing and transmission of sensitive data, including proprietary or confidential data, regulated data, and personal information of employees, clients and others. Successful cybersecurity attacks or other security incidents could result in, for example, one or more of the following: unauthorized access to, disclosure, modification, misuse, loss, or destruction of company, client, or other third party data or systems; theft or import or export of sensitive, regulated, or confidential data including personal information and intellectual property; the loss of access to critical data or systems through ransomware, crypto mining, destructive attacks or other means; and business delays, service or system disruptions or denial of service. In the event of such actions, the company, its clients, and other third parties could be exposed to liability, litigation, and regulatory or other government action, as well as the loss of existing or potential clients, damage to brand and reputation, and other financial loss. In addition, the cost and operational consequences of responding to cybersecurity incidents and implementing remediation measures could be significant.
The global regulatory environment with regard to cybersecurity, privacy and data protection issues is increasingly complex and will continue to impact the company’s business, including through increased risk, increased costs and expanded or otherwise altered compliance obligations. The enactment and expansion of data protection and privacy laws and regulations around the globe, the lack of harmonization of such laws and regulations, and the potential regulation of new and emerging technologies will continue to result in increased compliance costs and risks.
The Company Is Subject to Legal Proceedings and Investigatory Risks: As a global company with business operations, employees and clients in many countries, the company is or may become involved as a party and/or may be subject to a variety of claims, demands, suits, investigations, tax matters and other proceedings that arise from time to time in the ordinary course of its business. The company believes that it has adopted appropriate risk management and compliance programs. Legal and compliance risks, however, will continue to exist and additional legal proceedings and other contingencies, the outcome of which cannot be predicted with certainty, may arise from time to time. Additional information on legal matters is included in note K, “Contingencies and Commitments,” to the Consolidated Financial Statements.
Tax Matters Could Impact the Company’s Results of Operations and Financial Condition: The company is subject to income taxes in both the U.S. and numerous foreign jurisdictions. The company’s provision for income taxes and cash tax liability in the future could be negatively affected by numerous factors including, but not limited to, income before taxes being lower than anticipated in countries with lower statutory tax rates and higher than anticipated in countries with higher statutory tax rates, changes in the valuation of deferred tax assets and liabilities, and changes in tax laws, regulations, accounting principles or interpretations thereof, which could negatively impact the company’s results of operations and financial condition in future periods. The Organization for Economic Cooperation and Development (OECD) is issuing guidelines that are different, in some respects, than long-standing international tax principles. As countries unilaterally amend their tax laws to adopt certain parts of the OECD guidelines, this may increase tax uncertainty and may negatively impact the company’s income taxes. Local country, state, provincial or municipal taxation may also be subject to review and potential override by regional, federal, national or similar forms of government.
The company’s U.S. federal and certain state and foreign operations are included in various IBM consolidated tax returns and therefore are not directly subject to corporate income taxes but instead settle their tax liabilities with IBM. Any subsequent tax assessments or benefits resulting from tax examinations are the responsibility of IBM. For separate income tax return filings for jurisdictions that are not included in IBM’s tax return, the company is subject to the continuous examination of such income tax returns by tax authorities in those jurisdictions. The company regularly assesses the likelihood of adverse outcomes resulting from these examinations to determine the adequacy of its provision for income taxes. There can be no assurance that the outcomes from these continuous examinations will not have an adverse effect on the company’s provision for income taxes and cash tax liability.
The Company Could Be Impacted by Its Business with Government Clients: The company’s clients include numerous governmental entities and clients whose primary customers are government-owned entities. Some of the company’s
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Item 1A. Risk Factors – (continued)
agreements with these clients may be subject to periodic funding approval. Funding reductions or delays could negatively impact public sector demand for IBM’s products and services, and therefore, demand for the company’s financing offerings could be negatively impacted. Also, some agreements may contain provisions allowing the client to terminate without cause or may provide for higher liability limits for certain losses. In addition, the company could be suspended or debarred as a governmental contractor and could incur civil and criminal fines and penalties, which could negatively impact the company’s results of operations, financial results and reputation.
The Company’s Use of Accounting Estimates Involves Judgment and Could Impact the Company’s Financial Results: The application of generally accepted accounting principles requires the company to make estimates and assumptions about certain items and future events that directly affect the company’s reported financial condition. In addition, adopting new accounting standards can also pose challenges to the company. The company’s most critical accounting estimates including the methods used by management to estimate the amount of uncollectible receivables are described in note A, “Significant Accounting Policies,” to the Consolidated Financial Statements. In addition, as discussed in note K, “Contingencies and Commitments,” to the Consolidated Financial Statements, the company makes certain estimates including decisions related to legal proceedings and reserves. These estimates and assumptions involve the use of judgment. As a result, actual financial results may differ.
Ineffective Internal Controls Could Impact the Company’s Business and Operating Results: The company’s internal controls over financial reporting may not prevent or detect misstatements because of its inherent limitations, including the possibility of human error, the circumvention or overriding of controls, or fraud. Even effective internal controls can provide only reasonable assurance with respect to the preparation and fair presentation of the financial statements. If the company fails to maintain the adequacy of its internal controls, including any failure to implement required new or improved controls, or if the company experiences difficulties in its implementation, the company’s business and operating results could be harmed and the company could fail to meet its financial reporting obligations.
Risks Related to the Company’s Securities: The company issues debt securities in the capital markets from time to time, with a variety of different maturities. The value of the company’s debt securities fluctuates based on many factors, including the methods employed for calculating principal and interest, the maturity of the securities, the aggregate principal amount of securities outstanding, the redemption features for the securities, the level, direction and volatility of interest rates, changes in exchange rates, exchange controls, governmental regulations and other factors over which the company has little or no control. The company’s ability to pay interest and repay the principal for its debt securities is dependent upon its ability to manage its business operations, as well as the other risks described under this Item 1A, “Risk Factors.” There can be no assurance that the company will be able to manage any of these risks successfully. In addition, changes by any rating agency to the company’s outlook or credit ratings can negatively impact the value and liquidity of the company’s debt securities. The company does not make a market in its debt securities and cannot provide any assurances with respect to the liquidity or value of such securities. Further, a secondary market may never develop or be maintained for any series of the debt securities. If a secondary market does develop, it may not continue or it may not be sufficiently liquid to allow bondholders to resell debt securities if or when desired or at a price that bondholders consider acceptable.
15
Item 1B. Unresolved Staff Comments.
Not applicable.
Item 2. Properties.
IBM Credit’s principal executive offices are located in an office building owned by IBM in Armonk, New York. The company is globally located and conducts its business primarily from IBM leased or IBM owned facilities around the world. IBM charges the company for the use of these facilities based on square footage space usage with no fixed term commitment. For additional information regarding the company’s shared facilities, see note C, “Relationship with IBM and Related Party Transactions,” to the Consolidated Financial Statements.
Item 3. Legal Proceedings.
See note K, “Contingencies and Commitments,” to the Consolidated Financial Statements.
Item 4. Mine Safety Disclosures.
Not applicable.
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PART II
Item 5. Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
IBM Credit is a Delaware limited liability company and an indirect, wholly owned subsidiary of IBM. At December 31, 2019, all limited liability company interests in IBM Credit were owned by the Member, which is also an indirect, wholly owned subsidiary of IBM. The company has no other class of equity securities issued and outstanding. Dividends are declared and paid by IBM Credit as determined by its Board of Managers. The company paid $1,231 million in cash distributions to IBM during 2019.
Item 6. Selected Financial Data.
IBM Credit has omitted this section pursuant to General Instruction I(2)(a) of Form 10-K.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
The “Management Discussion and Analysis of Results of Operations and Financial Condition” (Management Discussion and Analysis) 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 and Analysis presents an overview of the key performance drivers in 2019.
The Management Discussion and Analysis contains the results of operations for each reportable segment of the business and a discussion of the company’s financial position and cash flows. The summary of key financial information presented within the Management Discussion and Analysis should be read in conjunction with the Consolidated Financial Statements and notes thereto, and with Item 1A, “Risk Factors,” and “Forward-Looking and Cautionary Statements” included herein. Other key sections within the Management Discussion and Analysis include: “Liquidity and Capital Resources” and “Looking Forward.”
Overview
IBM Credit generates revenue from the financing activities of its two operating segments, Client Financing and Commercial Financing.
Client Financing generates revenue by providing leases and loan financing to end-user clients and IBM, as well as purchasing installment payment plans, leases, loans and participated receivables from IBM.
Lease and loan contracts between IBM Credit and end-user clients are included in the Consolidated Statement of Financial Position as financing receivables or equipment under operating leases, and the revenue is included as financing revenue or operating lease revenue in the Consolidated Statement of Earnings.
In certain countries, IBM originates leases, loans and installment payment plans with its end-user clients and IBM Credit acquires the related receivables (and related assets underlying the leases) at a discounted purchase price under certain financing incentive programs. IBM Credit accounts for the acquisition of these receivables as a purchase of receivables. These receivables are included within financing receivables in the Consolidated Statement of Financial Position. Income is recognized by the company over the term of the financing, and the income is recorded as financing revenue in the Consolidated Statement of Earnings.
For IBM Total Solution Offerings in certain countries, as well as for certain government and other contracts, IBM Credit is not a party to IBM’s contract with the end-user client. Instead, IBM directly provides the end-user client with the lease, loan or installment payment plan. IBM Credit acquires a participation interest in IBM receivables that represents the financing portion of such transactions and assumes the associated credit risk of the IBM end-user client from IBM. These participation interests are included in the Consolidated Statement of Financial Position as receivables
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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations – (continued)
purchased/participated from IBM and the financing income earned from these receivables is included in financing revenue in the Consolidated Statement of Earnings.
In certain countries, the company provides loans to IBM, primarily in support of its Global Technology Services segment’s acquisition of IT assets used in external, revenue-producing client services contracts. This financing is included in the Consolidated Statement of Financial Position as financing receivables from IBM. The financing income earned from these receivables is included in financing revenue in the Consolidated Statement of Earnings.
The company sells to IBM equipment returned from lease at cost, which approximates fair value. In addition, IBM may migrate a client to new technology. In the event this migration results in an early termination of a lease, IBM will purchase the returned equipment from the company at a pre-negotiated price, which is a function of the discounted value of the scheduled future lease payments and the residual value. These sales are recorded net within the Client Financing segment in other (income) and expense in the Consolidated Statement of Earnings.
Commercial Financing provides working capital financing to suppliers, distributors and resellers of IT products and services where the company generally extends payment terms in the range of 30 to 90 days. A portion of the interest cost may include financing incentives from IBM or providers of OEM IT products and services to cover an interest-free period. Financing may take the form of loans to distributors and resellers, which are generally unsecured obligations of the clients, but may be collateralized by inventory or accounts receivable. These financing transactions are included in the Consolidated Statement of Financial Position as financing receivables and the financing income is included in financing revenue in the Consolidated Statement of Earnings. Income earned from financing incentives related to Commercial Financing is included in financing revenue in the Consolidated Statement of Earnings and is recognized over the term of the financing. Beginning in the second quarter of 2019 and continuing throughout the year, the company wound down the OEM IT portion of its Commercial Financing operations.
The company also purchases interests in certain of IBM’s trade and other accounts receivable at a discount and assumes the credit risk of IBM’s clients. These transactions are included in receivables purchased/participated from IBM in the Consolidated Statement of Financial Position and the financing income is included in financing revenue in the Consolidated Statement of Earnings. The discount is recognized as financing revenue over the term of the financing. In the second quarter of 2019, IBM and the company suspended the program under which IBM Credit purchases interests in IBM’s trade accounts receivable. For additional information, see note F, “Financing Receivables, Receivables Purchased/Participated from IBM.”
The company allocates interest expense and SG&A expense to each of its operating segments. Interest expense is allocated based on average assets in each segment. SG&A expense is allocated based on a measurable financial driver, such as net margin.
Key drivers of the company’s financial results include the overall health of the economy and its impact on corporate IT budgets, interest rates and originations. Financing originations, which determine the asset base of the annuity-like business, are also dependent upon the demand for IT products and services, IBM’s product cycles and services offerings and client participation rates. Participation rates reflect the propensity of clients to finance their transaction through the company in lieu of paying the supplier up-front with cash or financing through a third party. The economy can also impact the credit quality of the company’s receivables portfolio and therefore the level of provision for credit losses. Interest rates and the overall economy (including currency fluctuations) can affect both revenue and net margin. Interest rates directly impact the company by increasing or decreasing financing revenue and associated borrowing costs.
Within the Management Discussion and Analysis, certain columns and rows and other figures may not add due to the use of rounded numbers for disclosure purposes. Percentages reported are calculated from the underlying whole-dollar numbers.
18
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations – (continued)
Year in Review
The following section provides a summary of the company’s consolidated financial results for 2019 as compared to 2018:
| | | | | | | | | |
| | | | | | | | Yr.-to-Yr. |
|
| | | | | | | | Percent/ |
|
(Dollars in millions) | | | | | | | | Margin |
|
For the year ended December 31: |
| 2019 |
| 2018 |
| Change |
| ||
Revenue | | $ | 1,600 | | $ | 1,779 |
| (10.1) | % |
Net margin | | $ | 913 | | $ | 1,083 |
| (15.7) | % |
Net margin percentage | |
| 57.1 | % |
| 60.9 | % | (3.8) | pts. |
Total expense and other (income) | | $ | 295 | | $ | 352 |
| (16.4) | % |
Income before income taxes | | $ | 619 | | $ | 731 |
| (15.3) | % |
Provision for income taxes | | $ | 188 | | $ | 133 |
| 41.2 | % |
Net income | | $ | 430 | | $ | 597 |
| (27.9) | % |
Net income margin | | | 26.9 | % | | 33.6 | % | (6.7) | pts. |
| | | | | | | | | |
| | | | | | | | Yr.-to-Date |
|
(Dollars in millions) | | | | | | | | Percent |
|
At December 31: |
| 2019 |
| 2018 |
| Change |
| ||
Assets | | $ | 28,412 | | $ | 39,497 |
| (28.1) | % |
Liabilities | | $ | 25,726 | | $ | 36,076 |
| (28.7) | % |
Member’s interest | | $ | 2,686 | | $ | 3,420 |
| (21.5) | % |
| | | | | |
At December 31: |
| 2019 |
| 2018 | |
Debt-to-equity ratio* |
| 9.0 | x | 8.9 | x |
* | The debt-to-equity ratio is calculated by dividing the total amount of debt outstanding by the total amount of Member’s interest in the company at the end of the reporting period presented. |
Return on Equity
| | | | | | | |
(Dollars in millions) | | | | | | | |
At December 31: |
| 2019 |
| 2018 |
| ||
Net income (1) | | $ | 430 | | $ | 597 | |
Average equity (2)* | | $ | 2,899 | | $ | 3,402 | |
Return on equity (1)/(2) | |
| 14.8 | % |
| 17.5 | % |
* | Average of the ending balance of Member’s interest for the last five quarters. |
In 2019, the company delivered revenue of $1,600 million and net income of $430 million. In 2018, the company had revenue of $1,779 million, and net income of $597 million.
Total revenue decreased $180 million, or 10.1 percent, in 2019 as compared to 2018, driven by a decrease in financing revenue of $123 million, or 8.5 percent, and by a decrease in operating lease revenue of $57 million, or 17.0 percent. The decrease in financing revenue reflects the company’s Commercial Financing portfolio actions, which began in the second quarter of 2019. The decline in operating lease revenue was due to a lower average asset balance in 2019 compared to 2018.
In 2019, net margin, which is calculated as revenue less financing costs and depreciation of equipment under operating lease, was $913 million, a decrease of $170 million, or 15.7 percent, as compared to 2018. The decline in revenue and increase in financing costs were partially offset by a decrease in depreciation expense when compared to the prior year.
19
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations – (continued)
The decline in depreciation expense was driven by lower average operating lease asset balances. Net margin percentage of 57.1 percent in 2019 decreased by 3.8 points compared to the prior year.
Total expense and other (income) of $295 million decreased $58 million, or 16.4 percent, in 2019 compared to $352 million in 2018.
Pre-tax income of $619 million in 2019 decreased 15.3 percent as compared to the prior year. Pre-tax income margin percentage of 38.7 percent in 2019 decreased on a year-to-year basis by 2.4 points.
The effective tax rate for 2019 was 30.5 percent, an increase of 12.2 points, as compared to 2018. The change in the effective tax rate was primarily attributable to guidance issued by the U.S. Treasury in January 2019 regarding U.S. Tax Cuts and Jobs Act (U.S. tax reform) repatriation tax (20 points). This was partially offset by a year-to-year benefit due to the Global Intangible Low-Taxed Income (GILTI) provision (5 points). For additional information, see note L, “Taxes,” to the Consolidated Financial Statements.
Net income decreased $167 million on a year-to-year basis, primarily driven by the declines in net margin noted above. Return on equity of 14.8 percent in 2019 decreased by 2.7 points driven primarily by the decrease in net income year to year.
The company generated $231 million in cash flow from operating activities in 2019, a decrease of $868 million as compared to the prior year, driven by higher net cash payments to IBM related to outstanding accounts payable and higher net cash income tax payments. Investing activities were a net source of cash of $7,312 million in 2019 versus a net use of cash of $1,903 million in 2018, primarily driven by a decrease in net short term financing receivables. Net cash used by financing activities of $7,679 million increased $7,649 million, driven primarily by lower funding requirements associated with financing receivables. The decrease in financing receivables reflects the wind down of the OEM IT Commercial Financing operations.
Business Segments and Capabilities
IBM Credit and its subsidiaries are reported by the company’s parent, IBM, as part of IBM’s Global Financing segment, which also includes IBM’s remanufacturing and remarketing business. The company’s operating segments, Client Financing and Commercial Financing, are business units that offer financing solutions based upon the needs of the company’s clients. The Client Financing and Commercial Financing business segments are described in more detail in Item 1, “Business.”
20
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations – (continued)
Results of Operations
Segment Details
The following is an analysis of the reportable segment results for the year ended December 31, 2019, as compared to the year ended December 31, 2018. The table below presents each reportable segment’s revenue, net margin, and pre-tax income results.
| | | | | | | | | | |
| | | | | | | | |
| |
| | | | | | | | Yr.-to-Yr. |
| |
| | | | | | | | Percent/ |
| |
(Dollars in millions) | | |
| |
| Margin |
|
| ||
For the year ended December 31: |
| 2019 |
| 2018 |
| Change |
| | ||
Client Financing | | |
|
| |
|
|
| | |
Revenue | | $ | 1,187 | | $ | 1,206 |
| (1.6) | % | |
Net margin | |
| 624 | |
| 677 |
| (7.8) | % | |
Net margin percentage | |
| 52.6 | % |
| 56.1 | % | (3.6) | pts. | |
Pre-tax income | | $ | 434 | | $ | 490 |
| (11.4) | % | |
Pre-tax margin | |
| 36.6 | % |
| 40.7 | % | (4.1) | pts. | |
Commercial Financing | |
| | |
| |
| | | |
Revenue | | $ | 413 | | $ | 574 |
| (28.0) | % | |
Net margin | |
| 289 | |
| 406 |
| (28.8) | % | |
Net margin percentage | |
| 70.1 | % |
| 70.8 | % | (0.7) | pts. | |
Pre-tax income | | $ | 184 | | $ | 240 |
| (23.2) | % | |
Pre-tax margin | |
| 44.6 | % |
| 41.9 | % | 2.8 | pts. | |
Total Segments | |
| | |
| |
| | | |
Revenue | | $ | 1,600 | | $ | 1,779 |
| (10.1) | % | |
Net margin | |
| 913 | |
| 1,083 |
| (15.7) | % | |
Net margin percentage | |
| 57.1 | % |
| 60.9 | % | (3.8) | pts. | |
Pre-tax income | | $ | 619 | | $ | 731 |
| (15.3) | % | |
Pre-tax margin | |
| 38.7 | % |
| 41.1 | % | (2.4) | pts. | |
Client Financing
Client Financing revenue of $1,187 million in 2019 decreased by $19 million, or 1.6 percent, as compared to 2018, driven by operating lease revenue which declined $57 million, or 17.0 percent, mainly due to a decline in the average asset balance in 2019. The decline was partially offset by financing revenue which increased $38 million, or 4.3 percent, primarily driven by variable lease revenue reported in 2019 due to the adoption of the new lease standard.
Net margin decreased $53 million, or 7.8 percent, as compared to 2018. The decrease was driven by lower revenue as noted above and an increase in interest expense of $40 million due to higher interest rates, partially offset by lower average debt balances in 2019.
Pre-tax income decreased $56 million, or 11.4 percent, in 2019 as compared to 2018. The decrease was primarily driven by the decline in net margin noted above and a decrease in profit from sales of equipment upon lease termination of $20 million, partially offset by lower provisions for credit losses of $28 million.
Commercial Financing
Commercial Financing revenue of $413 million in 2019 declined $161 million, or 28.0 percent, as compared to 2018, primarily reflecting the wind down of the OEM IT Commercial Financing operations.
Net margin decreased $117 million, or 28.8 percent, as compared to 2018. The decrease was driven by the decline in revenue as noted above, partially offset by a decrease in interest expense of $44 million. The decrease in interest expense
21
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations – (continued)
was mainly due to the lower average debt balances in 2019 in support of a lower asset base, partially offset by higher interest rates, when compared to the prior-year period.
Pre-tax income decreased $56 million, or 23.2 percent, as compared to 2018, driven primarily by the decrease in net margin noted above and lower releases of provisions for credit losses of $14 million, partially offset by lower SG&A expenses of $32 million which was in line with the segment’s performance. Pre-tax income also includes a gain of $16 million from divested commercial financing capabilities. For additional information, see note O, “Divestiture,” to the Consolidated Financial Statements.
Geographic Revenue
| | | | | | | | | |
| | | | | | | | Yr.-to-Yr. |
|
(Dollars in millions) | | | | | | | | Percent |
|
For the year ended December 31: |
| 2019 |
| 2018 |
| Change |
| ||
Revenue | | $ | 1,600 | | $ | 1,779 |
| (10.1) | % |
Geographies | |
| | |
|
|
| | |
Americas | | $ | 958 | | $ | 1,018 |
| (5.9) | % |
Europe/Middle East/Africa (EMEA) | |
| 375 | |
| 468 |
| (19.9) | |
Asia Pacific | |
| 267 | |
| 294 |
| (9.0) | |
Americas revenue of $958 million decreased $60 million, or 5.9 percent, in 2019 as compared to 2018, driven by declines in financing revenue of $36 million, as well as declines in operating lease revenue of $24 million.
EMEA revenue of $375 million decreased $93 million, or 19.9 percent, in 2019 as compared to 2018, driven by declines in financing revenue of $75 million, as well as declines in operating lease revenue of $18 million.
Asia Pacific revenue of $267 million decreased $27 million, or 9.0 percent, in 2019 as compared to 2018, driven by declines in operating lease revenue of $14 million, as well as declines in financing revenue of $12 million.
The declines in financing revenue across all geographies reflect the Commercial Financing portfolio actions.
Total Expense and Other (Income)
| | | | | | | | | |
| | | | | | | | Yr.-to-Yr. |
|
| | | | | | | | Percent/ |
|
(Dollars in millions) | | | | | | | | Margin |
|
For the year ended December 31: |
| 2019 |
| 2018 |
| Change |
| ||
Total expense and other (income) |
| |
|
| |
|
|
| |
Selling, general and administrative | | $ | 372 | | $ | 375 |
| (0.8) | % |
Provisions for/(benefit from) credit losses | |
| (5) | |
| 9 |
| NM | |
Other (income) and expense | |
| (72) | |
| (31) |
| 132.8 | |
Total expense and other (income) | | $ | 295 | | $ | 352 |
| (16.4) | % |
Total expense-to-revenue ratio | |
| 18.4 | % |
| 19.8 | % | (1.4) | pts. |
NM - Not meaningful
Total expense and other (income) of $295 million decreased $58 million, or 16.4 percent, in 2019 as compared to 2018. For additional information regarding total expense and other (income), see the following analysis by category.
22
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations – (continued)
Selling, General and Administrative
| | | | | | | | | |
| | | | | | | | Yr.-to-Yr. |
|
(Dollars in millions) | | | | | | | | Percent |
|
For the year ended December 31: |
| 2019 |
| 2018 |
| Change |
| ||
Selling, general and administrative expense: |
| |
|
| |
|
|
| |
Selling, general and administrative - other | | $ | 159 | | $ | 153 |
| 3.6 | % |
Contracted services | |
| 18 | |
| 18 |
| (0.9) | |
Functional support services and other related party expenses | |
| 195 | |
| 204 |
| (4.6) | |
Total selling, general and administrative expense | | $ | 372 | | $ | 375 |
| (0.8) | % |
Total SG&A expense decreased $3 million, or 0.8 percent, as compared to 2018, due to a decrease in functional support services expense charged to the company by IBM of $9 million, partially offset by an increase in other SG&A of $6 million. For additional information on support expenses charged by IBM, see note C, “Relationship with IBM and Related Party Transactions,” to the Consolidated Financial Statements.
Provision for Credit Losses
Provisions for credit losses were a release of $5 million in 2019 as compared to additions of $9 million in 2018, driven by lower specific reserve requirements, partially offset by a lower unallocated reserve release in the current year. For additional information on provisions for credit losses, see note F, “Financing Receivables, Receivables Purchased/Participated from IBM,” to the Consolidated Financial Statements.
Other (Income) and Expense
| | | | | | | | | | |
| | | | | | | | Yr.-to-Yr. |
| |
(Dollars in millions) | | | | | | | | Percent |
| |
For the year ended December 31: |
| 2019 |
| 2018 |
| Change |
| |||
Other (income) and expense |
| |
|
| |
|
| |
| |
Foreign currency transaction (gains)/losses | | $ | 1 | | $ | 10 | | | (90.3) | % |
(Gains)/losses on derivative instruments | |
| — | |
| (7) | |
| (100.0) | |
(Gains)/losses on sale of equipment upon lease termination | |
| (78) | |
| (98) | |
| (20.7) | |
Other expense and (income) | |
| 5 | |
| 65 | |
| (92.0) | |
Total other (income) and expense | | $ | (72) | | $ | (31) | | | 132.8 | % |
Total other (income) and expense was $72 million of income, an increase of $41 million in 2019 as compared to 2018. Other expense declined $59 million, in line with the wind down of the OEM IT Commercial Financing operations, and included a pre-tax gain of $16 million from divested commercial financing capabilities. Year-to-year declines in other expense were partially offset by a $20 million decrease in gains on sales of equipment returned upon lease termination.
Income Taxes
The effective tax rate for 2019 was 30.5 percent, an increase of 12.2 points, as compared to 2018. The increase in the effective tax rate was primarily driven by the impacts of U.S. tax reform (20 points) and was partially offset by a year-to-year benefit due to the GILTI provision (5 points).
Financial Position Summary
The company’s primary use of funds is to originate financing receivables and operating leases with end-users, suppliers, distributors, resellers and IBM. Financing receivables consist of sales-type leases and loans to end-user clients, purchases of installment payment plans from IBM and working capital financing to suppliers, distributors and resellers. Operating leases are for IBM and OEM IT products. Beginning in the second quarter of 2019 and continuing throughout
23
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations – (continued)
the year, the company wound down the OEM IT portion of its Commercial Financing operations. For additional information see note F, “Financing Receivables, Receivables Purchased/Participated from IBM.”
Receivables purchased/participated from IBM include purchased interests in certain of IBM’s trade and other accounts receivable and IBM receivables that have been participated to IBM Credit. In the second quarter of 2019, IBM and the company suspended the program under which IBM Credit purchases interests in IBM's trade accounts receivable. For additional information see note F, "Financing Receivables, Receivables Purchased/Participated from IBM." Financing receivables from IBM include loan financing to IBM’s Global Technology Services segment. For additional information relating to financing activities with IBM, see note C, “Relationship with IBM and Related Party Transactions.”
Total assets of $28,412 million at December 31, 2019, decreased $11,085 million (including a decrease of $27 million from currency) as compared to year-end 2018, driven by:
● | A decline in total financing receivables of $9,298 million (including a decrease of $25 million from currency), primarily driven by a decline in commercial financing receivables of $7,987 million and a decline in purchased receivables from IBM of $1,313 million. These declines reflect the Commercial Financing portfolio actions. For additional information see note F, "Financing Receivables, Receivables Purchased/Participated from IBM;" and |
● | A decline in other receivables from IBM of $1,505 million (including an increase of $2 million from currency), predominantly due to a decrease in cash invested with IBM of $1,504 million. For additional information relating to other receivables from IBM, see note C, “Relationship with IBM and Related Party Transactions.” |
At December 31, 2019, substantially all Client Financing and Commercial Financing assets were IT related assets, and approximately 62 percent of the company’s total asset portfolio, excluding financing receivables from IBM and receivables purchased from IBM, was with investment grade clients with no direct exposure to consumers, an increase of 7 points year to year. This investment grade percentage is based on the credit ratings of the companies in the portfolio. Additionally, the company takes actions to transfer exposure to third parties. On that basis, the investment grade content would increase to 68 percent, a decrease of 4 points year to year.
Total liabilities of $25,726 million at December 31, 2019, decreased $10,351 million (including an increase of $1 million from currency) as compared to year-end 2018 primarily driven by:
● | A decrease in total debt of $6,439 million (including a decrease of $58 million from currency) driven by lower funding requirements associated with financing receivables; |
● | A decline in accounts payable to IBM of $2,709 million (including an increase of $59 million from currency), which reflects the settlements of purchases of equipment and receivables/loans (for software and services); and |
● | A decline in accounts payable to third parties of $1,271 million (including an increase of $2 million from currency), primarily driven by the wind down of the OEM IT Commercial Financing operations. |
Total Member’s interest of $2,686 million at December 31, 2019 decreased $735 million as compared to December 31, 2018, as a result of:
● | Cash distributions to IBM of $1,231 million; partially offset by |
● | Net income of $430 million, and |
● | Non-cash capital contribution from IBM of $64 million. |
24
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations – (continued)
Originations of Financing Receivables and Operating Leases
Originations are management’s estimate of the gross additions for Client Financing and Commercial Financing assets. There are no industry standards or requirements governing the reporting of financing asset originations. Management believes that the estimated values of financing asset originations disclosed in the table below provide insight into the potential future cash flows and earnings of the company.
The Client Financing origination values presented below include participations and exclude the company’s loans to IBM’s Global Technology Services segment, which are executed under a loan facility and are not considered originations.
Originations
| | | | | | | | | |
| | | | | | | | Yr.-to-Yr. | |
(Dollars in millions) |
| | | | | | | Percent |
|
For the year ended December 31: |
| 2019 |
| 2018 |
| Change |
| ||
Client Financing | | $ | 14,252 | | $ | 14,300 |
| (0.3) | % |
Commercial Financing | |
| 35,627 | |
| 70,138 |
| (49.2) | % |
Total originations | | $ | 49,878 | | $ | 84,438 |
| (40.9) | % |
For the year ended December 31, 2019, the company originated $14,252 million of Client Financing leases and loans, as compared to $14,300 million for the year ending December 31, 2018. The year-to-year decrease of $48 million was driven by lower OEM IT originations in the current year, partially offset by higher lease volumes due to client migration to the IBM z15 mainframe. For the year ending December 31, 2019, the company originated $35,627 million of Commercial Financing receivables as compared to $70,138 million for the year ending December 31, 2018. The decrease of $34,512 million as compared to the prior year end reflects the Commercial Financing portfolio actions. For additional information see note F, "Financing Receivables, Receivables Purchased/Participated from IBM."
Segment Assets
| | | | | | | | | | | | | | | | | |
| | Client Financing | | Commercial Financing |
| ||||||||||||
| | | | | | | | Yr.-to-Yr. | | | | | | | | Yr.-to-Yr. | |
(Dollars in millions) | | | | | | | | Percent | | | | | | | | Percent | |
For the year ended December 31: |
| 2019 |
| 2018 |
| Change |
| 2019 |
| 2018 |
| Change |
| ||||
Financing receivables, net | | $ | 13,978 | | $ | 14,474 |
| (3.4) | % | $ | 3,387 | | $ | 11,374 |
| (70.2) | % |
Equipment under operating leases, net | |
| 212 | |
| 386 |
| (45.1) | |
| — | |
| — |
| — | |
Financing receivables from IBM | |
| 3,870 | |
| 3,609 |
| 7.2 | |
| — | |
| — |
| — | |
Receivables purchased/participated from IBM, net | |
| 4,303 | |
| 4,065 |
| 5.9 | |
| 56 | |
| 1,369 |
| (95.9) | |
Total assets | | $ | 22,362 | | $ | 22,533 |
| (0.8) | % | $ | 3,443 | | $ | 12,743 |
| (73.0) | % |
Total Client Financing assets of $22,362 million at December 31, 2019 decreased $172 million as compared to year-end 2018. The decline in Client Financing assets was driven primarily by a decline in net financing receivables, partially offset by increases in financing receivables from IBM and receivables participated from IBM.
The Client Financing receivables portfolio at December 31, 2019 represented the following industry profile: Financial (36 percent), Manufacturing (15 percent), Government (13 percent), Services (11 percent), Retail (7 percent), Communications (6 percent), Healthcare (6 percent) and Other (5 percent). The receivables portfolio at December 31, 2018 represented the following industry profile: Financial (33 percent), Government (14 percent), Manufacturing (14 percent), Services (13 percent), Retail (7 percent), Communications (7 percent), Healthcare (6 percent) and Other (6 percent).
The decrease in Commercial Financing assets of $9,300 million at December 31, 2019, as compared to December 31, 2018, reflects the Commercial Financing portfolio actions. For additional information see note F, "Financing Receivables, Receivables Purchased/Participated from IBM."
25
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations – (continued)
The financing assets of the company were funded with $24,095 million of total debt at December 31, 2019, as compared to $30,534 million of debt at December 31, 2018. The decline of $6,439 million was primarily driven by lower funding requirements associated with financing receivables.
Financing Receivables and Allowances
The following table presents net financing receivables (excluding residual values and loan financing to IBM’s Global Technology Services segment, which the company considers collectable and without third party risk) and the allowance for credit losses.
| | | | | | | |
|
| | | | | ||
(Dollars in millions) | | | | | | | |
At December 31: |
| 2019 |
| 2018 |
| ||
Recorded investment | | $ | 21,301 | | $ | 30,906 | |
Specific allowance for credit losses | |
| 114 | |
| 121 | |
Unallocated allowance for credit losses | |
| 42 | |
| 71 | |
Total allowance for credit losses | |
| 155 | |
| 192 | |
Net financing receivables | | $ | 21,145 | | $ | 30,714 | |
Allowance for credit losses coverage | |
| 0.7 | % |
| 0.6 | % |
Roll Forward of Financing Receivables Allowance for Credit Losses
(Dollars in millions)
| | | | | | | | | | | | | |
| Additions / (Releases) |
| Write-offs * |
| Other ** |
| |||||||
$ | 192 | | $ | (5) | | $ | (32) | | $ | (1) | | $ | 155 |
* Represents reserved receivables that were written off during the period.
** Primarily represents translation adjustments.
The allowance for credit losses on financing receivables at December 31, 2019 was $155 million, or 0.7 percent of gross financing receivables. At December 31, 2018, the allowance for credit losses on financing receivables was $192 million, or 0.6 percent, of gross financing receivables.
Specific reserves decreased $7 million to $114 million at December 31, 2019 as compared to December 31, 2018, due to write-offs, partially offset by higher reserve requirements in the Americas.
Unallocated reserves decreased $30 million to $42 million at December 31, 2019, as compared to December 31, 2018, driven by lower reserve requirements as a result of lower asset balances in the Client Financing and Commercial Financing businesses.
Provisions for credit losses were a release of $5 million in 2019 as compared to $9 million of additions in 2018. The year-to-year decrease was driven by lower specific reserve requirements, partially offset by a lower unallocated reserve release in the current year.
Residual Value
Residual value is a risk of the company’s business, and management of this risk is dependent upon the ability to accurately project future equipment values at lease inception. The company has insight into product plans and cycles for IBM products and closely monitors OEM IT product announcements. Based upon this product information, the company continually monitors projections of future equipment values and compares them with the residual values reflected in the portfolio.
26
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations – (continued)
The company optimizes the recovery of residual values by extending lease arrangements with current clients. Assets returned from lease are sold to IBM at cost, which approximates fair value. In addition, IBM may migrate a client to new technology. In the event this migration results in an early termination of a lease, IBM will purchase the returned equipment from the company at a pre-negotiated price, which is a function of the discounted value of the scheduled future lease payments and the residual value.
The following table presents the recorded amount of unguaranteed residual value for sales-type and direct financing leases, as well as operating leases at December 31, 2019 and 2018. In addition, the table presents the residual value as a percentage of the related original amount financed and a run out of when the unguaranteed residual value assigned to equipment on leases at December 31, 2019 is expected to be returned to the company.
Unguaranteed Residual Value
| | | | | | | | | | | | | | | | | | |
| | Total | | Estimated Run Out of 2019 Balance | ||||||||||||||
(Dollars in millions) | | | | | | | | | | | | | | | | | 2023 and | |
At December 31: |
| 2018 |
| 2019 |
| 2020 |
| 2021 |
| 2022 |
| Beyond | ||||||
Sales-type and direct financing leases | | $ | 491 | | $ | 531 | | $ | 99 | | $ | 133 | | $ | 183 | | $ | 117 |
Operating leases | |
| 114 | |
| 84 | |
| 55 | |
| 23 | |
| 3 | |
| 3 |
Total unguaranteed residual value | | $ | 605 | | $ | 615 | | $ | 154 | | $ | 156 | | $ | 186 | | $ | 120 |
Related original amount financed | | $ | 10,148 | | $ | 9,048 | |
|
| |
|
| |
|
| |
|
|
Percentage | |
| 6.0 | % |
| 6.8 | % |
|
| |
|
| |
|
| |
|
|
Consolidated Fourth-Quarter Financial Results
| | | | | | | | | |
|
| | |
| | |
| Yr.-to-Yr. |
|
| | | | | | | | Percent/ |
|
(Dollars in millions) | | | | | | | | Margin |
|
For the fourth quarter ended December 31: | | 2019 | | 2018 | | Change |
| ||
Revenue | | $ | 335 | | $ | 446 |
| (24.8) | % |
Net margin | | $ | 194 | | $ | 256 |
| (24.2) | % |
Net margin percentage | |
| 58.0 | % |
| 57.5 | % | 0.4 | pts. |
Total expense and other (income) | | $ | 36 | | $ | 48 |
| (25.0) | % |
Income before income taxes | | $ | 158 | | $ | 208 |
| (24.1) | % |
Provision for/(benefit from) income taxes | | $ | (7) | | $ | 21 |
| NM | |
Net income | | $ | 165 | | $ | 187 |
| (11.8) | % |
Net income margin | | | 49.3 | % | | 42.0 | % | 7.3 | pts. |
NM - Not meaningful
Fourth Quarter Financial Performance Summary:
In the fourth quarter of 2019, the company delivered revenue of $335 million and net income of $165 million. In the fourth quarter of 2018, the company had revenue of $446 million and net income of $187 million.
Total revenue decreased $110 million, or 24.8 percent, in the fourth quarter of 2019 as compared to the fourth quarter of 2018, driven by a decrease in financing revenue of $87 million, or 24.2 percent, and a decrease in operating lease revenue of $23 million, or 27.4 percent. The decrease in financing revenue reflects the Commercial Financing portfolio actions. The decline in operating lease revenue was due to a lower average asset balance in the current period compared to the prior-year period.
Net margin was $194 million in the fourth quarter of 2019, a decline of $62 million, or 24.2 percent, as compared to the fourth quarter of 2018. The decrease was primarily driven by the decline in revenue, partially offset by a decline in financing costs of $34 million and a decrease in depreciation expense of $14 million. The decrease in financing costs
27
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations – (continued)
was driven by a decrease in interest expense. Net margin percentage of 58.0 percent in the fourth quarter of 2019 increased by 0.4 points compared to the same period in the prior year.
Total expense and other (income) of $36 million decreased $12 million, or 25.0 percent, in the fourth quarter of 2019 when compared to the fourth quarter of 2018.
Pre-tax income in the fourth quarter of 2019 of $158 million decreased 24.1 percent when compared to the fourth quarter of 2018. The pre-tax income margin percentage of 47.2 percent in the fourth quarter of 2019 increased on a year-to-year basis by 0.4 points.
Provisions for income taxes were a benefit of $7 million in the fourth quarter of 2019 compared to $21 million of expense in the fourth quarter of 2018, primarily driven by an increase in foreign tax credits.
Net income decreased $22 million in the fourth quarter of 2019 as compared to the fourth quarter of 2018, which reflects the wind down of the OEM IT Commercial Financing operations, partially offset by a decline in the effective tax rate in the fourth quarter of 2019 when compared to the prior-year period.
Results of Operations
Segment Details
The following is an analysis of the reportable segment results for the fourth quarter ended December 31, 2019, as compared to the fourth quarter ended December 31, 2018. The table below presents each reportable segment’s revenue, net margin, and pre-tax income results.
| | | | | | | | | |
| | | | | | | | Yr.-to-Yr. |
|
| | | | | | | | Percent/ |
|
(Dollars in millions) | | | | | | | | Margin |
|
For the fourth quarter ended December 31: |
| 2019 |
| 2018 |
| Change |
| ||
Client Financing | | |
|
| |
|
|
| |
Revenue | | $ | 281 | | $ | 293 |
| (4.2) | % |
Net margin | |
| 152 | |
| 152 |
| 0.2 | % |
Net margin percentage | |
| 54.3 | % |
| 51.9 | % | 2.3 | pts. |
Pre-tax income | | $ | 131 | | $ | 136 |
| (4.2) | % |
Pre-tax margin | |
| 46.5 | % |
| 46.5 | % | 0.0 | pts. |
Commercial Financing | |
| | |
| |
| | |
Revenue | | $ | 54 | | $ | 153 |
| (64.4) | % |
Net margin | |
| 42 | |
| 104 |
| (59.9) | % |
Net margin percentage | |
| 76.9 | % |
| 68.3 | % | 8.6 | pts. |
Pre-tax income | | $ | 28 | | $ | 72 |
| (61.6) | % |
Pre-tax margin | |
| 51.0 | % |
| 47.3 | % | 3.7 | pts. |
Total Segments | |
| | |
| |
| | |
Total revenue | | $ | 335 | | $ | 446 |
| (24.8) | % |
Net margin | |
| 194 | |
| 256 |
| (24.2) | % |
Net margin percentage | |
| 58.0 | % |
| 57.5 | % | 0.4 | pts. |
Pre-tax income | | $ | 158 | | $ | 208 |
| (24.1) | % |
Pre-tax margin | |
| 47.2 | % |
| 46.8 | % | 0.4 | pts. |
Client Financing
Client Financing revenue of $281 million in the fourth quarter of 2019 decreased by $12 million, or 4.2 percent, as compared to the same period in 2018. The decrease in revenue was driven by a decline in operating lease revenue of $23
28
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations – (continued)
million, or 27.4 percent, mainly due to a decline in average assets during 2019. The decline was partially offset by variable lease revenue reported in the current-year period due to the adoption of the new leasing standard.
Net margin was essentially flat, as compared to the same period in 2018. Net margin percentage of 54.3 percent increased by 2.3 points when compared to the prior-year period driven by a mix away from the operating lease portfolio.
Pre-tax income in the fourth quarter of 2019 decreased $6 million, or 4.2 percent, as compared to the fourth quarter of 2018, driven primarily by higher SG&A expense partially offset by higher profit from sales of equipment upon lease termination in the current-year period.
Commercial Financing
Commercial Financing revenue of $54 million in the fourth quarter of 2019 decreased $98 million, or 64.4 percent, as compared to the same period in 2018. The decline reflects the Commercial Financing portfolio actions executed in 2019.
Net margin decreased $62 million, or 59.9 percent, in the fourth quarter of 2019 as compared to the same period in 2018. The decrease was driven by the decline in revenue, partially offset by a decrease in interest expense of $36 million. The decrease in interest expense was mainly due to the lower average debt balances in 2019 in support of a lower asset base, partially offset by higher interest rates, when compared to the prior-year period.
Pre-tax income in the fourth quarter of 2019 decreased $44 million, or 61.6 percent, as compared to the fourth quarter of 2018, driven primarily by the decline in net margin partially offset by lower SG&A expense in the current year period.
Geographic Revenue
| | | | | | | | | |
| | | | | | | | Yr.-to-Yr. |
|
(Dollars in millions) | | | | | | | | Percent |
|
For the fourth quarter ended December 31: |
| 2019 |
| 2018 |
| Change |
| ||
Revenue | | $ | 335 | | $ | 446 |
| (24.8) | % |
Geographies | |
| | |
|
|
| | |
Americas | | $ | 209 | | $ | 261 |
| (20.0) | % |
Europe/Middle East/Africa (EMEA) | |
| 68 | |
| 115 |
| (41.4) | |
Asia Pacific | |
| 58 | |
| 69 |
| (15.1) | |
The declines in revenue across all geographies reflect the Commercial Financing portfolio actions.
Total Expense and Other (Income)
| | | | | | | | | |
| | | | | | | | Yr.-to-Yr. |
|
| | | | | | | | Percent/ |
|
(Dollars in millions) | | | | | | | | Margin |
|
For the fourth quarter ended December 31: |
| 2019 |
| 2018 |
| Change |
| ||
Total expense and other (income) |
| |
|
| |
|
|
| |
Selling, general and administrative | | $ | 90 | | $ | 83 |
| 9.0 | % |
Provisions for/(benefit from) credit losses | |
| (1) | |
| (15) |
| (95.1) | |
Other (income) and expense | |
| (54) | |
| (20) |
| 169.3 | |
Total expense and other (income) | | $ | 36 | | $ | 48 |
| (25.0) | % |
Total expense-to-revenue ratio | |
| 10.7 | % |
| 10.7 | % | 0.0 | pts. |
Total expense and other (income) of $36 million in expense decreased $12 million, or 25.0 percent, in the fourth quarter of 2019 as compared to the prior-year period. For additional information regarding total expense and other (income), see the following analysis by category.
29
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations – (continued)
Selling, General and Administrative
| | | | | | | | | |
| | | | | | | | Yr.-to-Yr. |
|
(Dollars in millions) | | | | | | | | Percent |
|
For the fourth quarter ended December 31: |
| 2019 |
| 2018 |
| Change |
| ||
Selling, general and administrative expense: |
| |
|
| |
|
|
| |
Selling, general and administrative - other | | $ | 36 | | $ | 37 |
| (3.7) | % |
Contracted services | |
| 6 | |
| 5 |
| 17.2 | |
Functional support services and other related party expenses | |
| 49 | |
| 41 |
| 19.8 | |
Total selling, general and administrative expense | | $ | 90 | | $ | 83 |
| 9.0 | % |
Provision for Credit Losses
Provisions for credit losses were a release of $1 million in the fourth quarter of 2019 as compared to a release of $15 million in the fourth quarter of 2018, primarily driven by higher reserve releases in the prior-year period. For additional information on provisions for credit losses, see note F, “Financing Receivables, Receivables Purchased/Participated from IBM,” to the Consolidated Financial Statements.
Other (Income) and Expense
| | | | | | | | | |
| | | | | | | | Yr.-to-Yr. |
|
(Dollars in millions) | | | | | | | | Percent |
|
For the fourth quarter ended December 31: |
| 2019 |
| 2018 |
| Change |
| ||
Other (income) and expense: |
| |
|
| |
|
|
| |
Foreign currency transaction (gains)/losses | | $ | (1) | | $ | 1 |
| NM | % |
(Gains)/losses on derivative instruments | |
| 0 | |
| 0 |
| (100.0) | |
(Gains)/losses on sale of equipment upon lease termination | |
| (50) | |
| (37) |
| 35.5 | |
Other expense and (income) | |
| (2) | |
| 16 |
| NM | |
Total other (income) and expense | | $ | (54) | | $ | (20) |
| 169.3 | % |
NM - Not meaningful
Total other (income) and expense was $54 million in income in the fourth quarter of 2019, an increase of $34 million when compared to the fourth quarter of 2018. Other expense declined $18 million year to year, in line with the wind down of the OEM IT Commercial Financing operations, and gains on the sale of equipment upon lease termination increased $12 million as a result of client migration to IBM’s z15 mainframe in the current year period.
Income Taxes
The effective tax rate for the fourth quarter of 2019 was negative 4.4 percent as compared to 10.2 percent in the fourth quarter of 2018. The year-to-year decrease in the effective tax rate was primarily driven by an increased benefit in foreign tax credits.
Cash Flow
The company generated $135 million in cash flow from operating activities in the fourth quarter of 2019, a decrease of $151 million as compared to the same period in the prior year. Net cash used in investing activities of $2,062 million in the fourth quarter of 2019 increased by $1,012 million when compared to the fourth quarter of the prior year. This was driven by higher outflows in the current year to fund Client Financing originations. Net cash provided by financing activities of $1,519 million increased $888 million in the fourth quarter of 2019 compared to the same period in 2018, driven by year-to-year increases in net proceeds of debt issuances from IBM.
30
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations – (continued)
Prior Year in Review
Refer to pages 19 to 28 of IBM Credit’s Annual Report on Form 10-K for the year ended December 31, 2018, filed with the SEC on February 27, 2019, for a discussion on the company’s financial performance for 2018 as compared to 2017.
Other Information
Liquidity and Capital Resources
IBM Credit funds its current and future obligations through the generation of cash flows from operations and its access to the short- and long-term capital markets, as well as through the support provided by IBM’s overall liquidity position and access to capital markets. The debt used to fund the company’s financing assets as of December 31, 2019 was primarily comprised of loans from IBM.
The company generated $231 million in cash flows from operations in 2019. The company had balances of $1,687 million of cash and cash equivalents and $509 million in cash invested with IBM as of December 31, 2019. Refer to the company’s cash flow and liquidity trends on page 33 for additional information.
The consolidated tangible net worth of the company was $2,577 million and $3,286 million as of December 31, 2019 and 2018, respectively, with consolidated tangible net worth calculated as total assets of IBM Credit and its consolidated subsidiaries less intangible assets and total liabilities of IBM Credit and its consolidated subsidiaries.
In 2019 the company made cash distributions to IBM of $1,231 million, which was partially offset by a non-cash contribution to the company in the amount of $64 million from IBM. The future amount of third-party debt and contributions from and distributions to IBM may vary as the company continues to manage leverage to the targeted debt-to-equity ratio of 9 to 1. The company’s actual debt-to-equity ratio may vary based on several factors, including differences between management’s expectations and actual results of operations.
The company's debt-to-equity ratio was 9.0 to 1 and 8.9 to 1 for the period ending at December 31, 2019 and 2018, respectively. Refer to the company’s debt-to-equity ratio on page 34 for additional information.
On July 18, 2019, the company entered into a new $2.5 billion 364-day Credit Agreement to replace its existing $2.5 billion 364-day Credit Agreement, and extended the maturity date of its existing $2.5 billion Three-Year Credit Agreement to July 20, 2022 (together, the Credit Agreements). The size of each facility was unchanged. As of December 31, 2019, the company had no borrowings outstanding against these Credit Agreements.
The company’s Credit Agreements each contain significant debt 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 IBM’s consolidated net tangible assets, and restrict the ability of the company or IBM to merge or consolidate with a third party, unless certain conditions are met. The Credit Agreements also include several financial covenants, including that (i) IBM will not permit the consolidated net interest expense ratio, for any period of four consecutive fiscal quarters taken as a single accounting period, to be less than 2.20 to 1.0; (ii) the company will not permit its tangible net worth to be less than $50 million as of the end of the fiscal year and (iii) the company’s leverage ratio cannot be greater than 11 to 1 as of the last day of the fiscal quarter. The Credit Agreements each contain a cross default provision with respect to other defaulted indebtedness of at least $500 million. The company’s indenture governing its debt securities contains significant covenants which obligate the company to promptly pay principal and interest, limit the aggregate amount of liens (other than permitted liens) to 15 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 company is in compliance with all of its significant debt covenants and is obligated to provide periodic certifications to its lenders. The failure to comply with its debt covenants could constitute an event of default. If certain events of default were to occur, the principal and interest on the debt to which any event of default applied would become immediately due and payable. The Borrowers are also restricted from amending, modifying or terminating the Support
31
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations – (continued)
Agreement in any manner materially adverse to the lenders. For additional information on the Support Agreement, see note C, “Relationship with IBM and Related Party Transactions,” to the Consolidated Financial Statements.
In 2017, the company established a commercial paper program under which the company is permitted to issue unsecured commercial paper notes from time to time, up to a maximum aggregate amount outstanding at any one time of $5 billion. As of December 31, 2019, the company had $304 million of commercial paper outstanding.
The company has a shelf registration statement with the SEC allowing it to offer for sale public debt securities. The company issued $3 billion and $4 billion of debt securities in 2017 and 2018, respectively, at both fixed and floating rates. There were no issuances of debt securities in 2019. For additional information on the company’s debt securities, see note H, “Borrowings,” to the Consolidated Financial Statements.
The major rating agencies’ ratings on the company’s debt securities at December 31, 2019 appear in the table below.
| | | | |
|
| STANDARD |
| MOODY’S |
| | AND | | INVESTORS |
| | POOR’S | | SERVICE |
Long-term debt |
| A |
| A2 |
Commercial paper |
| A-1 |
| Prime-1 |
After closing the Red Hat acquisition, Moody’s, as expected, downgraded IBM and IBM Credit LLC’s long-term debt rating from A1 to A2 and improved its outlook to stable. IBM and IBM Credit LLC remain committed to a target leverage profile consistent with a mid to high single A credit rating within a couple of years.
IBM Credit will continue with a disciplined financial policy and is committed to maintaining strong investment grade credit ratings. The company does not have “ratings trigger” provisions in its debt covenants or documentation, which would allow the holders to declare an event of default and seek to accelerate payments thereunder in the event of a change in credit rating.
In July 2017, the UK's Financial Conduct Authority, which regulates the London Interbank Offered Rate (LIBOR), announced that it intends to phase out LIBOR by the end of 2021. Various central bank committees and working groups continue to discuss replacement of benchmark rates, the process for amending existing LIBOR-based contracts, and the potential economic impacts of different alternatives. The Alternative Reference Rates Committee has identified the Secured Overnight Financing Rate (SOFR) as its preferred alternative rate for USD LIBOR. SOFR is a measure of the cost of borrowing cash overnight, collateralized by U.S. Treasury securities, and is based on directly observable U.S. Treasury-backed repurchase transactions. The use of LIBOR is primarily within the company's Commercial Financing segment where agreements are short term in nature and generally range from 30 to 90 days. The company is evaluating the potential impact of the replacement of the LIBOR benchmark interest rate, including risk management, internal operational readiness and monitoring the FASB standard-setting process to address financial reporting issues that might arise in connection with transition from LIBOR to a new benchmark rate.
In the normal course of business, the company may be exposed to the impact of foreign currency fluctuations and interest rate changes. Although the company seeks to substantially match-fund the term, currency and interest rate variability of its debt against its underlying financing assets, risks may arise from a mismatch between assets and the related liabilities used for funding. The company also employs a rigorous process to optimize portfolio risk management. Portfolio risks include credit and residual value risk. For additional information on the management of these risks by the company, see note A, “Significant Accounting Policies,” and note D, “Financial Instruments,” to the Consolidated Financial Statements, as well as the section entitled “Portfolio Risk Management” in Item 1, “Business,” and Item 7A, “Quantitative and Qualitative Disclosures About Market Risk.”
32
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations – (continued)
Cash Flow and Liquidity Trends
| | | | | | | | | |
(Dollars in millions) | | | | | | | | | |
For the year ended December 31: |
| 2019 |
| 2018 | | 2017 | |||
Net cash provided by operating activities | | $ | 231 | | $ | 1,099 | | $ | 1,034 |
Net cash provided by/(used in) investing activities | | | 7,312 | | | (1,903) | | | (1,482) |
Net cash provided by/(used in) financing activities | | | (7,679) | | | (30) | | | 1,308 |
| | | | | | | | | |
At December 31: |
| 2019 |
| 2018 | | 2017 | |||
Cash and cash equivalents | | $ | 1,687 | | $ | 1,828 | | $ | 2,680 |
Cash invested with IBM, available on-demand (1) | |
| 509 | |
| 2,014 | |
| 911 |
Committed credit facilities (2) | | | 5,000 | | | 5,000 | | | 5,000 |
(1) | Excess cash is periodically invested in interest bearing, on-demand accounts with IBM and is presented as other receivables from IBM in the Consolidated Statement of Financial Position and the Consolidated Statement of Cash Flows. For additional information, see note C, “Relationship with IBM and Related Party Transactions,” to the Consolidated Financial Statements. |
(2) | The Credit Agreements were entered into and/or amended on July 18, 2019. |
Net cash provided by operating activities in 2019 decreased $868 million as compared to 2018, driven primarily by higher net cash payments to IBM related to outstanding accounts payable and higher net cash income tax payments.
Net cash provided by investing activities in 2019 was a source of cash of $7,312 million as compared to a use of cash of $1,903 million in 2018, driven by:
● | Lower net originations of short-term financing receivables of $6,674 million, reflecting the Commercial Financing portfolio actions. For further information see note F, “Financing Receivables, Receivables Purchased/Participated from IBM;” and |
● | Other receivables with IBM in 2019 was a source of cash of $1,506 million as compared to use of cash of $1,200 million in 2018, driven by lower levels of excess cash invested with IBM in 2019. |
Net cash used in financing activities in 2019 increased $7,649 million as compared to 2018, driven by:
● | An increase in net payments on total debt of $6,970 million, driven by lower funding requirements associated with financing receivables, and |
● | An increase in net cash distributions to IBM of $679 million, which reflects the company's objective of achieving a target debt-to-equity ratio of 9 to 1. |
Debt
| | | | | | |
(Dollars in millions) | | | | | | |
At December 31: |
| 2019 |
| 2018 | ||
Short-term debt |
| |
|
| |
|
Debt | | $ | 633 | | $ | 3,035 |
Debt payable to IBM | |
| 8,194 | |
| 10,223 |
Total short-term debt | | $ | 8,827 | | $ | 13,258 |
| | | | | | |
Long-term debt | |
|
| |
|
|
Debt | | $ | 6,517 | | $ | 7,919 |
Debt payable to IBM | |
| 8,751 | |
| 9,357 |
Total long-term debt | | $ | 15,268 | | $ | 17,276 |
Total debt | | $ | 24,095 | | $ | 30,534 |
33
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations – (continued)
Total debt changes generally correspond with the level of Client Financing and Commercial Financing receivables, the level of cash and cash equivalents, the change in payables to IBM and external parties and the change in net investment from IBM.
Total debt was $24,095 million and $30,534 million at December 31, 2019 and 2018, respectively. Total debt payable to IBM was $16,945 million, a decrease of $2,635 million as compared to December 31, 2018. Total third-party debt was $7,150 million, a decrease of $3,804 million from December 31, 2018. The decrease in total debt during the year of 2019 was primarily due to lower funding requirements associated with financing receivables.
The company utilizes certain of its financing receivables as collateral for non-recourse borrowings. Financing receivables pledged as collateral for these borrowings were $1,062 million in 2019 and $710 million in 2018.
For additional information on the company’s debt and debt payable to IBM, see note H, “Borrowings,” to the Consolidated Financial Statements.
The company’s interest rate and foreign currency rate risk management policies and procedures are discussed in Item 7A, “Quantitative and Qualitative Disclosures About Market Risk,” as well as note A, “Significant Accounting Policies” and note D, “Financial Instruments,” to the Consolidated Financial Statements.
Interest on Debt
The company recognized interest expense of $499 million and $503 million in 2019 and 2018, respectively, of which $242 million and $298 million was interest expense on debt payable to IBM in 2019 and 2018, respectively. For additional information on interest expense, see note H, “Borrowings,” to the Consolidated Financial Statements.
Pre-swap annual contractual obligations of long-term debt and long-term debt payable to IBM outstanding at December 31, 2019, are as follows:
| | | | | | | | | | | | | | | | | | | | | |
(Dollars in millions) | | | | | | | | | | | | | | | | | 2025 and | | | | |
At December 31: |
| 2020 |
| 2021 |
| 2022 |
| 2023 |
| 2024 |
| Beyond |
| Total | |||||||
Long-term debt | | $ | 1,986 | | $ | 3,151 | | $ | 591 | | $ | 764 | | $ | 2 | | $ | 0 | | $ | 6,495 |
Debt payable to IBM | |
| 3,961 | | | 2,484 | | | 1,362 | | | 679 | | | 200 | | | 65 | | | 8,751 |
Total | | $ | 5,947 | | $ | 5,635 | | $ | 1,953 | | $ | 1,443 | | $ | 202 | | $ | 65 | | $ | 15,246 |
Debt-to-Equity
The debt-to-equity ratio, as reported in the table below, is, at any given time, the ratio of total debt to total Member’s interest.
| | | | | |
At December 31: |
| 2019 |
| 2018 |
|
Debt-to-equity ratio |
| 9.0 | x | 8.9 | x |
The debt-to-equity ratio is calculated by dividing the total amount of debt outstanding by the total amount of member’s interest in the company at the end of the reporting period presented.
The company’s debt-to-equity ratio was 9.0 to 1 at December 31, 2019 as compared to 8.9 to 1 at year-end 2018. Total Member’s interest of $2,686 million declined by $735 million, or 21.5 percent, and total debt of $24,095 million decreased $6,439 million, or 21.1 percent. The debt-to-equity ratio may vary based on several factors, including differences between management’s expectations and actual results of operations.
34
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations – (continued)
Contractual Obligations
| | | | | | | | | | | | | | | |
(Dollars in millions) | | Total Contractual | | Payments Due In | |||||||||||
| Payment Stream |
| 2020 |
| 2021-22 |
| 2023-24 |
| After 2024 | ||||||
Long-term debt obligations | | $ | 15,246 | | $ | 5,947 | | $ | 7,589 | | $ | 1,645 | | $ | 65 |
Interest on long-term debt obligations | | | 632 | | | 287 | | | 293 | | | 51 | | | 1 |
Total | | $ | 15,878 | | $ | 6,234 | | $ | 7,882 | | $ | 1,696 | | $ | 66 |
Total contractual obligations, as reported in the table above, reflect the principal carrying value of the company’s long-term debt and discounted value for the debt interest payments. Interest on floating-rate debt obligations is calculated using the effective interest rate at December 31, 2019, 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, “Disclosure in Management’s Discussion and Analysis about Off-Balance Sheet Arrangements and Aggregate Contractual Obligations.”
At December 31, 2019 and 2018, the company had no such 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 previous table for the company’s contractual obligations, and note K, “Contingencies and Commitments,” to the Consolidated Financial Statements for additional 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 accounting principles generally accepted in the U.S. (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. The company’s significant accounting policies are described in note A, “Significant Accounting Policies,” to the Consolidated Financial Statements.
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 this report to understand a general direction of 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.
Credit Losses
The company reviews its financing receivables portfolio 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,” to the Consolidated Financial Statements. 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 financing and operating lease receivables portfolio.
35
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations – (continued)
At December 31, 2019, to the extent that actual collectibility differs from management’s estimates currently provided for by 10 percent, the company’s pre-tax income would be higher or lower by an estimated $16 million, depending upon whether the actual collectibility was better or worse, respectively, than the estimates.
Determination of Residual Value
Residual value represents the estimated fair value of equipment under lease as of the end of the lease. Residual value estimates can impact the determination of whether a lease is classified as sales-type, direct financing or operating. The company estimates the future fair value of leased equipment by using historical models, analyzing the current market for new and used equipment, and obtaining forward-looking product information such as marketing plans and technological innovations. Residual value estimates are periodically reviewed and “other than temporary” declines in estimated future residual values are recognized upon identification.
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.
To the extent that actual residual value recovery is lower than management’s estimates by 10 percent, the company’s pre-tax income for December 31, 2019 would have been lower by an estimated $62 million.
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.
For the company’s U.S. federal and certain state and foreign operations included in various IBM consolidated tax returns (and therefore not directly subject to corporate income taxes), IBM makes payments to tax authorities on the company’s behalf. In such cases, IBM and the company maintain a Tax Sharing Agreement for any operations included in an IBM consolidated tax return, pursuant to which IBM charges the company for any taxes owed and reimburses the company for tax attributes generated. Such charges or reimbursements are based upon a calculation of the company’s relevant pro forma stand-alone tax return in which the company records the initial income tax benefits associated with an uncertain tax position using its best estimate at the time the position originates and makes a final settlement of the position with IBM for the recorded amounts. Consequently, any recognition and subsequent changes in assessment about the sustainability of tax positions, including valuation allowances and interest and penalties, are the responsibility of IBM. Because the company bears no risk associated with the sustainability of uncertain tax positions, no uncertain tax liabilities are recorded in the Consolidated Financial Statements for entities that file as part of IBM’s consolidated tax filings.
For separate income tax return filings for jurisdictions that are not included in an IBM consolidated tax return, 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 that 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 for separate income tax return filing jurisdictions. 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
36
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations – (continued)
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. To the extent that the provision for income taxes increased/decreased by 1 percent of income before income taxes, consolidated net income would have decreased/improved by $6.2 million in 2019.
Cybersecurity
While cybersecurity risk can never be completely eliminated, the company’s approach draws on the depth and breadth of IBM’s global capabilities in security services and its internal approaches to risk management.
From an enterprise perspective, IBM implements a multi-faceted risk-management approach to identify and address cybersecurity risks. IBM has established policies and procedures that provide the foundation upon which IBM Credit’s infrastructure and data are managed. IBM Credit performs ongoing assessments regarding its technical controls and adheres to IBM’s established methods for identifying emerging risks related to cybersecurity. IBM uses a layered approach with overlapping controls to defend against cybersecurity attacks and threats on networks, end-user devices, servers, applications and cloud solutions. Through IBM, the company also has a global incident response process to respond to cybersecurity threats. In addition, through IBM, the company utilizes a combination of online training, educational tools, social media, and other awareness initiatives to foster a culture of security awareness and responsibility among its workforce.
Looking Forward
In 2017, IGF’s legal entity structure was reorganized globally to consolidate Client Financing and Commercial Financing under IBM Credit which drives operational benefits. The company has access to the short-term and long-term debt markets as an issuer in the capital markets and as a borrower from IBM. The company will continue to target a debt-to-equity ratio of 9 to 1, which may vary based on several factors, including differences between management’s expectations and actual results of operations. The future amount of third-party debt and contributions from and distributions to IBM may vary as the company continues to manage its leverage to the targeted debt-to-equity ratio. Absent other funding alternatives, a protracted period where the company or IBM could not access the capital markets would likely lead to a slowdown in originations. Financing originations, which determine the asset base of the annuity-like business, are also dependent upon the demand for IT products and services as well as client participation rates.
The company’s financial position provides flexibility and funding capacity which enables the company to be well positioned in the current environment. As a captive finance company, the company’s financing assets result primarily from the financing of IBM products and services. Substantially all of the company’s financing assets are IT-related, which provide a stable base of business. The company’s financing offerings are competitive and available to clients as a result of factors including the company’s borrowing cost, financing incentive programs and access to the capital markets.
Beginning in the second quarter of 2019 and continuing throughout the year, the company wound down the portion of its Commercial Financing operations that provides short-term working capital solutions for OEM IT suppliers, distributors and resellers. The company had receivables of $0.6 billion and $8.5 billion relating to its OEM IT Commercial Financing operations for the periods ended December 31, 2019, and 2018, respectively. IBM Credit will continue to provide differentiated end-to-end financing solutions, including commercial financing in support of IBM partner relationships.
IBM Credit has policies in place designed to manage the risks involved in financing, including credit losses, residual values, liquidity, currency and interest rates. The company will continue to apply rigorous credit policies in both the origination of new business and the evaluation of the existing portfolio and will take risk mitigation actions when necessary. The company has historically been able to manage residual value risk both through insight into IBM’s
37
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations – (continued)
product cycles and monitoring of OEM IT product announcements. The company’s interest rate risk management policy, combined with its pricing strategy, should mitigate margin erosion due to changes in interest rates.
The company’s geographically diverse client base, product and client knowledge, and strategy to substantially match-fund the term, currency and interest rate variability of its debt to the underlying financing assets should enable prudent management of the business going forward, even during periods of uncertainty with respect to the global economy.
38
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
The company operates in multiple currencies and is a lender and issuer in the capital markets and a borrower from IBM. In the normal course of business, the company may be exposed to the impact of interest rate changes and foreign currency fluctuations. The company limits its exposure to core market risks by following established risk management policies and procedures and through the use of match-funding from IBM and third parties. Although the company seeks to substantially match-fund the terms, currency and interest rate variability of its debt against its underlying financing assets, risks may arise from a mismatch between assets and the related liabilities used for funding. The company may also choose to mitigate any remaining exposure relating to interest rate changes and foreign currency fluctuations through the use of interest rate or foreign currency derivatives.
In addition, the company performs a sensitivity analysis to determine the effects that market risk exposure 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, installment payment receivables, participated interests in IBM financing receivables, Commercial Financing receivables, and purchased interest in certain of IBM’s trade and other receivables, investments, short- and long-term debt and derivative financial instruments. The company’s derivative financial instruments generally include interest rate swaps and foreign exchange forward contracts.
To perform the sensitivity analysis, the company assesses the risk of loss from hypothetical changes in interest rates and foreign currency exchange rates in the fair values of market-sensitive instruments. The market values for interest and foreign currency exchange rate 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, 2019 and 2018. 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.
The results of the sensitivity analysis at December 31, 2019 and 2018, are as follows:
Interest Rate Risk
At December 31, 2019, a 10 percent increase or decrease in the interest rates with all other variables held constant would result in an increase or decrease in the fair value of the company’s financial instruments of $6 million as compared to an increase or decrease of $9 million at December 31, 2018. Changes in the relative sensitivity of the fair value of the company’s financial instruments portfolio for these theoretical changes in the level of interest rates are primarily driven by differences between maturities and interest rate profile of assets as compared to liabilities.
Foreign Currency Exchange Rate Risk
At December 31, 2019, a 10 percent weaker or stronger U.S. dollar against foreign currencies, with all other variables held constant, would result in an increase or decrease in the fair value of the company’s financial instruments of $377 million as compared to an increase/decrease of $391 million at December 31, 2018.
Financing Risks
See Item 1, “Business” for a discussion of the financing risks associated with the Client Financing and Commercial Financing business and management’s actions to mitigate such risks.
39
Item 8. Financial Statements and Supplemental Data.
(a) Audited consolidated financial statements of IBM Credit and its subsidiaries for the years ended December 31, 2019, 2018 and 2017.
(b) See the Exhibit Index on the page immediately preceding the exhibits for a list of exhibits filed as part of this Annual Report on Form 10-K.
40
INDEX TO FINANCIAL STATEMENTS AND SCHEDULE
41
Report of Independent Registered Public Accounting Firm
To the Board of Managers and the Member of IBM Credit LLC
Opinion on the Financial Statements
We have audited the accompanying consolidated statement of financial position of IBM Credit LLC and its subsidiaries (the “Company”) as of December 31, 2019 and 2018, and the related consolidated statements of earnings, of comprehensive income, of changes in member's interest and of cash flows for each of the three years in the period ended December 31, 2019, including the related notes and financial statement schedule listed in the accompanying index (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2019 and 2018, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2019 in conformity with accounting principles generally accepted in the United States of America.
Basis for Opinion
These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s consolidated financial statements 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 of these consolidated financial statements 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. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion.
Our audits 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. We believe that our audits provide a reasonable basis for our opinion.
/s/ PricewaterhouseCoopers LLP
New York, New York
We have served as the Company’s auditor since 2016.
42
IBM CREDIT LLC AND SUBSIDIARY COMPANIES
CONSOLIDATED STATEMENT OF EARNINGS
| | | | | | | | | | | | |
(Dollars in millions) |
| | | | | | | | | | | |
For the year ended December 31: | |
| Notes |
| 2019 |
| 2018 |
| 2017 | |||
Revenue | | | | | |
|
| |
|
| |
|
Financing revenue | | | C | | $ | i 1,323 | | $ | i 1,446 | | $ | i 1,322 |
Operating lease revenue | | | | | | i 277 | | | i 333 | | | i 380 |
Total revenue | | | N | | $ | i 1,600 | | $ | i 1,779 | | $ | i 1,702 |
Financing cost (related party cost of $ i 242 in 2019, $ i 298 in 2018 and $ i 265 in 2017) | | | C,H | | $ | i 526 | | $ | i 503 | | $ | i 362 |
Depreciation of equipment under operating lease | | | | | | i 160 | | | i 193 | | | i 231 |
Net margin | | | | | $ | i 913 | | $ | i 1,083 | | $ | i 1,109 |
Expense and other (income) | | | | | | | | | | | | |
Selling, general and administrative | | | | | $ | i 372 | | $ | i 375 | | $ | i 378 |
Provision for/(benefit from) credit losses | | | | | | ( i 5) | | | i 9 | | | i 15 |
Other (income) and expense | | | | | | ( i 72) | | | ( i 31) | | | ( i 39) |
Total expense and other (income) | | | C | | $ | i 295 | | $ | i 352 | | $ | i 354 |
Income before income taxes | | | | | $ | i 619 | | $ | i 731 | | $ | i 755 |
Provision for income taxes | | | C,L | | | i 188 | | | i 133 | | | i 5 |
Net income | | | | | $ | i 430 | | $ | i 597 | | $ | i 750 |
Amounts may not add due to rounding.
The accompanying notes on pages 49 through 83 are an integral part of the financial statements.
43
IBM CREDIT LLC AND SUBSIDIARY COMPANIES
CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME
| | | | | | | | | | | |
(Dollars in millions) | | | | | | | | | | | |
For the year ended December 31: |
| Notes |
| 2019 |
| 2018 |
| 2017 | |||
Net income | | | | $ | i 430 | | $ | i 597 | | $ | i 750 |
Other comprehensive income/(loss), before tax: | | | | | | | | | | | |
Foreign currency translation | | J | | | i 14 | | | ( i 151) | | | i 363 |
Retirement-related benefit plans (1) | | J,M | | | ( i 12) | | | ( i 4) | | | i 3 |
Other comprehensive income/(loss), before tax | | J | | | i 1 | | | ( i 155) | | | i 366 |
Income tax (expense)/benefit related to items of other comprehensive income | | J | | | i 1 | | | ( i 31) | | | i 2 |
Other comprehensive income/(loss), net of tax | | J | | $ | i 2 | | $ | ( i 186) | | $ | i 367 |
Total comprehensive income | | | | $ | i 432 | | $ | i 411 | | $ | i 1,117 |
(1) | Amounts represented relate to multiple-employer plans. |
Amounts may not add due to rounding.
The accompanying notes on pages 49 through 83 are an integral part of the financial statements.
44
IBM CREDIT LLC AND SUBSIDIARY COMPANIES
CONSOLIDATED STATEMENT OF FINANCIAL POSITION
| | | | | | | | |
(Dollars in millions) | | | | | | | | |
At December 31: |
| Notes |
| 2019 |
| 2018 | ||
Assets: | | |
| |
| | |
|
Cash and cash equivalents | | D | | $ | i 1,687 | | $ | i 1,828 |
Financing receivables | | F | |
| i 17,365 | |
| i 25,848 |
(net of allowances of $ i 148 in 2019 and $ i 174 in 2018) | | | | | | | | |
Equipment under operating leases | | | | | i 212 | | | i 386 |
(net of accumulated depreciation of $ i 238 in 2019 and $ i 283 in 2018) | | | | | | | | |
Financing receivables from IBM | | C,F | |
| i 3,870 | |
| i 3,609 |
Receivables purchased/participated from IBM | | C,F | |
| i 4,359 | |
| i 5,433 |
(net of allowances of $ i 8 in 2019 and $ i 18 in 2018) | | | | | | | | |
Other receivables from IBM | | C | | | i 513 | | | i 2,019 |
Other assets | | G | |
| i 406 | |
| i 373 |
Total assets | | | | $ | i 28,412 | | $ | i 39,497 |
| | | | | | | | |
Liabilities and member's interest: | | | | | | | | |
Accounts payable | | | | $ | i 434 | | $ | i 1,705 |
Accounts payable to IBM | | C | | | i 336 | | | i 3,044 |
Debt | | H | |
| i 7,150 | |
| i 10,954 |
Debt payable to IBM | | C,H | |
| i 16,945 | |
| i 19,580 |
Taxes | | L | |
| i 637 | |
| i 547 |
Other liabilities | | I | |
| i 224 | |
| i 246 |
Total liabilities | | | | $ | i 25,726 | | $ | i 36,076 |
Contingencies and commitments | | K | | | | | | |
Member’s interest: | | | |
| | | | |
Member's interest | | | | | i 2,601 | | | i 3,216 |
Retained earnings | | | | | i 116 | | | i 238 |
Accumulated other comprehensive income/(loss) | | | |
| ( i 31) | | | ( i 33) |
Total member's interest | | | | $ | i 2,686 | | $ | i 3,420 |
Total liabilities and member’s interest | | | | $ | i 28,412 | | $ | i 39,497 |
Amounts may not add due to rounding.
The accompanying notes on pages 49 through 83 are an integral part of the financial statements.
45
IBM CREDIT LLC AND SUBSIDIARY COMPANIES
CONSOLIDATED STATEMENT OF CASH FLOWS
| | | | | | | | | |
(Dollars in millions) | | | | | | | |||
For the year ended December 31: |
| 2019 |
| 2018 |
| 2017 | |||
Cash flows from operating activities: |
| |
|
| |
|
| |
|
Net income | | $ | i 430 | | $ | i 597 | | $ | i 750 |
Adjustments to reconcile net income to cash provided by operating activities: | |
| | |
| | |
| |
Provision for/(benefit from) credit losses | |
| ( i 5) | |
| i 9 | |
| i 15 |
Depreciation | |
| i 160 | |
| i 193 | |
| i 231 |
Deferred taxes | |
| i 84 | |
| i 51 | |
| i 14 |
Net (gain)/loss on asset sales and other | |
| ( i 118) | |
| ( i 104) | |
| i 68 |
Change in operating assets and liabilities: | |
| | |
| | |
| |
Other assets/other liabilities | |
| ( i 321) | |
| i 353 | |
| ( i 43) |
Net cash provided by operating activities | | $ | i 231 | | $ | i 1,099 | | $ | i 1,034 |
| | | | | | | | | |
Cash flows from investing activities: | |
| | |
| | |
| |
Originations of financing receivables | | $ | ( i 15,340) | | $ | ( i 14,456) | | $ | ( i 12,028) |
Collection of financing receivables | |
| i 14,478 | |
| i 13,833 | |
| i 12,428 |
Short-term financing receivables - net (1) | |
| i 6,564 | |
| ( i 110) | |
| ( i 1,515) |
Purchase of equipment under operating leases | |
| ( i 55) | |
| ( i 243) | |
| ( i 304) |
Proceeds from disposition of equipment under operating lease | |
| i 69 | |
| i 67 | |
| i 161 |
Other receivables from IBM - net | | | i 1,506 | | | ( i 1,200) | | | ( i 283) |
Other investing activities - net | |
| i 88 | |
| i 206 | |
| i 58 |
Net cash provided by/(used in) investing activities | | $ | i 7,312 | | $ | ( i 1,903) | | $ | ( i 1,482) |
| | | | | | | | | |
Cash flows from financing activities: | |
| | |
| | |
| |
Proceeds from issuance of debt from IBM | | $ | i 8,950 | | $ | i 8,603 | | $ | i 7,869 |
Principal payments on debt from IBM | |
| ( i 9,339) | |
| ( i 8,213) | |
| ( i 8,335) |
Proceeds from issuance of debt | |
| i 1,067 | |
| i 4,713 | |
| i 4,213 |
Principal payments on debt | |
| ( i 2,243) | |
| ( i 894) | |
| ( i 657) |
Short-term borrowings from/(repayments to) IBM - net (1) | |
| ( i 2,205) | |
| ( i 5,119) | |
| ( i 2,043) |
Short-term borrowings/(repayments) - net (1) | |
| ( i 2,678) | |
| i 1,433 | |
| i 1,520 |
Net transfers (to)/from IBM | |
| — | |
| — | |
| ( i 942) |
Contributions from IBM | | | — | | | i 148 | | | i 121 |
Distributions to IBM | | | ( i 1,231) | | | ( i 700) | | | ( i 437) |
Net cash (used in)/provided by financing activities | | $ | ( i 7,679) | | $ | ( i 30) | | $ | i 1,308 |
| | | | | | | | | |
Effect of exchange rate changes on cash and cash equivalents | | $ | ( i 4) | | $ | ( i 18) | | $ | i 48 |
Net change in cash and cash equivalents | | $ | ( i 141) | | $ | ( i 852) | | $ | i 908 |
| | | | | | | | | |
Cash and cash equivalents at January 1 | |
| i 1,828 | |
| i 2,680 | |
| i 1,772 |
Cash and cash equivalents at December 31 | | $ | i 1,687 | | $ | i 1,828 | | $ | i 2,680 |
Supplemental data | | | | | | | | | |
Income taxes paid - net of refunds received | | $ | i 117 | | $ | ( i 5) | | $ | i 301 |
Interest paid on debt | | $ | i 525 | | $ | i 493 | | $ | i 305 |
(1) | Short-term represents original maturities of 90 days or less. |
Amounts may not add due to rounding.
The accompanying notes on pages 49 through 83 are an integral part of the financial statements.
46
IBM CREDIT LLC AND SUBSIDIARY COMPANIES
CONSOLIDATED STATEMENT OF CHANGES IN MEMBER'S INTEREST
| | | | | | | | | | | | | | | |
|
| Prior |
| | |
| | |
| Accumulated |
|
| | ||
| | Investment | | | | | | | | Other | | Total | |||
| | From | | Member's | | Retained | | Comprehensive | | Member's | |||||
(Dollars in millions) |
| Member |
| Interest |
| Earnings |
| Income/(Loss) |
| Interest | |||||
Member’s Interest, January 1, 2017 | | $ | i 3,912 | | $ | — | | $ | — | | $ | ( i 209) | | $ | i 3,703 |
Net income plus other comprehensive income/(loss): | |
|
| |
|
| |
|
| |
|
| |
|
|
Net income | |
| i 137 | |
|
| |
| i 613 | |
|
| |
| i 750 |
Other comprehensive income/(loss), net of tax | |
|
| |
|
| |
|
| |
| i 367 | |
| i 367 |
Total comprehensive income/(loss) | |
|
| |
|
| |
|
| |
|
| | $ | i 1,117 |
Net transfers (to)/from IBM | |
| ( i 942) | |
|
| |
|
| |
|
| |
| ( i 942) |
Total prior investment from Member, March 31, 2017 | | | i 3,106 | | | | | | | | | | | | |
Transfer upon consolidation, April 1, 2017 | | | ( i 3,106) | | | i 3,106 | | | | | | | | | |
Contributions from IBM | | | | | | i 121 | | | | | | | | | i 121 |
Distributions to IBM | | | | | | ( i 126) | | | ( i 311) | | | | | | ( i 437) |
Member’s Interest, December 31, 2017 | | $ | — | | $ | i 3,101 | | $ | i 302 | | $ | i 158 | | $ | i 3,562 |
Amounts may not add due to rounding.
The accompanying notes on pages 49 through 83 are an integral part of the financial statements.
| | | | | | | | | | | | | | | |
| | | | | | | | | | Accumulated | | | | ||
| | | | | | | | | Other | | Total | ||||
| | | | Member's | | Retained | | Comprehensive | | Member’s | |||||
(Dollars in millions) |
| |
| Interest |
| Earnings |
| Income/(Loss) |
| Interest | |||||
Member’s Interest, January 1, 2018 | | | | | $ | i 3,101 | | $ | i 302 | | $ | i 158 | | $ | i 3,562 |
Cumulative effect of change in accounting principle (1) | | | | | | | | | i 5 | | | ( i 5) | | | — |
Net income plus other comprehensive income/(loss): | | | | |
| | | | | | | | | | |
Net income | | | | |
| | | | i 597 | | | | | | i 597 |
Other comprehensive income/(loss), net of tax | | | | |
| | | | | | | ( i 186) | | | ( i 186) |
Total comprehensive income/(loss) | |
| | | | | | | | | $ | i 411 | |||
Contributions from IBM | | | | | | i 148 | | | | | | | | | i 148 |
Distributions to IBM | | | | | | ( i 34) | | | ( i 666) | | | | | | ( i 700) |
Member’s Interest, December 31, 2018 | | | | | $ | i 3,216 | | $ | i 238 | | $ | ( i 33) | | $ | i 3,420 |
(1) | Reflects the adoption of the FASB guidance on stranded tax effects. Refer to note B, "Accounting Changes." |
Amounts may not add due to rounding.
The accompanying notes on pages 49 through 83 are an integral part of the financial statements.
47
| | | | | | | | | | | | | | | |
| | | | | | | | | | Accumulated | | | | ||
| | | | | | | | | Other | | Total | ||||
| | | | Member's | | Retained | | Comprehensive | | Member’s | |||||
(Dollars in millions) | | | |
| Interest |
| Earnings |
| Income/(Loss) |
| Interest | ||||
Member’s Interest, January 1, 2019 | | | | | $ | i 3,216 | | $ | i 238 | | $ | ( i 33) | | $ | i 3,420 |
Net income plus other comprehensive income/(loss): | | | | | |
| |
| | | | | | | |
Net income | | | | |
| | | | i 430 | | | | | | i 430 |
Other comprehensive income/(loss), net of tax | | | | |
| | | | | | | i 2 | | | i 2 |
Total comprehensive income/(loss) | |
| | | | | | | | | $ | i 432 | |||
Contributions from IBM (1) | | | | |
| i 64 | | | | | | | | | i 64 |
Distributions to IBM | | | | | | ( i 679) | | | ( i 553) | | | | | | ( i 1,231) |
Member’s Interest, December 31, 2019 | | | | | $ | i 2,601 | | $ | i 116 | | $ | ( i 31) | | $ | i 2,686 |
(1) | Includes $ i 64 million non-cash equity contribution from IBM. Refer to note C, "Relationship with IBM and Related Party Transactions." |
Amounts may not add due to rounding.
The accompanying notes on pages 49 through 83 are an integral part of the financial statements.
48
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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Footnote | | Page |
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50 | ||
| | |
55 | ||
| | |
56 | ||
| | |
59 | ||
| | |
63 | ||
| | |
Financing Receivables, Receivables Purchased/Participated from IBM | 66 | |
| | |
72 | ||
| | |
72 | ||
| | |
75 | ||
| | |
76 | ||
| | |
77 | ||
| | |
78 | ||
| | |
81 | ||
| | |
81 | ||
| | |
83 | ||
| | |
49
Notes to Consolidated Financial Statements
iNOTE A. SIGNIFICANT ACCOUNTING POLICIES
In 2017, International Business Machines Corporation (IBM or the parent) reorganized the legal entity structure of its global financing operations that reside within IBM’s Global Financing business segment (IGF) to consolidate Client Financing and Commercial Financing under IBM Credit LLC (IBM Credit or the company), an indirect, wholly owned subsidiary of IBM. This change drives operational benefits by consolidating the financing business under IBM Credit in the majority of countries in which IGF operates. IBM’s IGF segment continues to include IBM Credit, as well as IBM’s remanufacturing and remarketing business.
iPrinciples of Consolidation and Basis of Presentation
The accompanying Consolidated Financial Statements and footnotes of IBM Credit have been prepared in accordance with accounting principles generally accepted in the United States of America (GAAP).
Within the Consolidated 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.
Member’s interest in the Consolidated Statement of Financial Position represents the accumulation of the company's net income over time, contributions from IBM and distributions to IBM. During the second quarter of 2017, certain non-U.S. affiliates of IBM Credit became subsidiaries of the company, which were subsequently reported on a consolidated basis. Prior to the consolidation of the financial statements, net non-trade intercompany transactions between IBM Credit and IBM (for example, contributions from IBM and distributions to IBM), were reflected as net transfers (to)/from IBM in the financing activities section of the Consolidated Statement of Cash Flows. Distributions by the company to IBM are considered first to be a return of profit as reflected in the balance of retained earnings in the Consolidated Statement of Financial Position. Any amount distributed to IBM in excess of the company’s available balance currently in retained earnings is considered a return of a portion of the balance of Member’s interest as reflected in the Consolidated Statement of Financial Position.
Cash and cash equivalents primarily represents cash held locally by entities and is included in the Consolidated Financial Statements. The company invests a portion of its excess cash in short-term interest bearing accounts with IBM, which can be withdrawn upon demand. The cash invested with IBM is presented in other receivables from IBM in the Consolidated Statement of Financial Position. For additional information, see note C, “Relationship with IBM and Related Party Transactions.” The amount of restricted cash included in the Consolidated Statement of Financial Position and Consolidated Statement of Cash Flows was immaterial for the periods presented.
All significant intracompany transactions between IBM Credit's businesses have been eliminated. All significant intercompany transactions between IBM Credit and IBM have been included in these Consolidated Financial Statements.
Beginning in the second quarter of 2019, and continuing throughout the year, the company wound down the OEM IT portion of its Commercial Financing operations.
iUse of Estimates
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect amounts that are reported in the Consolidated Financial Statements and accompanying disclosures. Estimates are made for the following, among others: income taxes, loss contingencies, residual values of lease assets, allowance for credit losses and other matters. 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. Actual results may be different from these estimates.
/50
Notes to Consolidated Financial Statements – (continued)
Revenue
Financing revenue includes financing income attributable to sales-type leases, direct financing leases and loans, including installment payment plans and participated receivables, used to finance the purchase of IBM and original equipment manufacturers’ (OEM) information technology (IT) products and services, and is recognized on the accrual basis using the effective interest method over the life of the related financing receivable. Direct costs of originating these leases and loans are deferred and amortized over the term of the related financing receivables using the effective interest method and are included as part of the carrying value of the assets in the Consolidated Statement of Financial Position. Amortization of these direct costs is netted against financing revenue in the Consolidated Statement of Earnings.
Financing revenue also includes income earned from working capital financing for suppliers, distributors and resellers. This income is recognized on an accrual basis using the effective interest method.
Operating lease revenue is recognized on a straight-line basis over the term of the lease. Direct costs of originating these leases are deferred and amortized on a straight-line basis over the lease term and are included as part of the carrying value of the assets in the Consolidated Statement of Financial Position.
iFinancing Receivables and Allowance for Credit Losses
Financing receivables include sales-type leases, direct financing leases, commercial financing receivables and client loans and installment payment receivables (loans). Leases are accounted for in accordance with lease accounting standards. Loan receivables, which are generally unsecured, are primarily for software and services. Loans are financial assets and are recorded at amortized cost, net of allowance for credit losses, which approximate fair value. Commercial Financing receivables are carried at amortized cost, which approximate 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 Client Financing receivables for each of the i three portfolios: lease receivables, loan receivables and participated receivables. The company further segments each of the portfolios into i three classes: Americas, Europe/Middle East/Africa (EMEA) and Asia Pacific.
When calculating the allowances, the company considers its ability to mitigate a potential loss by repossessing leased equipment and by considering the current fair value of any other collateral. The value of the equipment is the net realizable value. The allowance for credit losses for sales-type and direct financing leases, installment payment plan receivables and customer loans includes an assessment of the entire balance of the 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 quarterly and performs an analysis based upon current information available about the client, such as financial statements, news reports, published credit ratings, and 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 collateralized, 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 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 sharp changes in the economy, or a significant change in the economic health of a particular client that represents a concentration in the company’s receivables portfolio.
/51
Notes to Consolidated Financial Statements – (continued)
Other Credit-Related Policies
Past due—The company views receivables as past due when payment has not been received after i 90 days, measured from the original billing date.
Impaired receivables—The company evaluates financing receivables for impairment on a quarterly basis. The company considers any receivable with an individually evaluated reserve as impaired. 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.
Non-accrual—Non-accrual assets are those receivables (impaired loans or non-performing leases included in the receivables portfolio) with specific reserves and other accounts for which it is likely that the company will be unable to collect all amounts due according to the 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 considered interest income and is recognized as financing revenue. Receivables may be removed from non-accrual status, if appropriate, based upon changes in client circumstances, such as a sustained history of payments.
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 there is no reasonable expectation of additional collections. The company’s assessments factor in the financial condition of the client, history of collections and write-offs in specific countries and across the portfolio.
iEstimated 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 residual values for sales-type leases are included in financing receivables in the Consolidated Statement of Financial Position. For additional information, see note F, “Financing Receivables, Receivables Purchased/Participated from IBM.” Residual values for operating leases are included in equipment under operating lease in the Consolidated Statement of Financial Position.
The company periodically reassesses the realizable value of its lease residual values. Anticipated decreases in specific future residual values that are considered to be other-than-temporary are recognized immediately upon identification and are recorded as an adjustment to the residual value estimate. For sales-type and direct financing leases, this reduction lowers the recorded net investment and is recognized as a loss charged to financing revenue in the period in which the estimate is changed, as well as an adjustment to unearned income to reduce future-period financing income. The company has agreed to sell to IBM all equipment returned at end of lease at cost, which approximates fair value.
iCash Equivalents
All highly liquid investments with maturities of three months or less at the date of purchase are considered to be cash equivalents.
iFinancial 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. For additional information, see note D, “Financial Instruments.” All methods of assessing fair value result in a general approximation of value, and such value may never actually be realized.
52
Notes to Consolidated Financial Statements – (continued)
Fair Value Measurements
Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The company classifies certain assets and liabilities based on the following fair value hierarchy:
● | Level 1—Quoted prices (unadjusted) in active markets for identical assets or liabilities that can be accessed at the measurement date; |
● | Level 2—Inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly; and |
● | Level 3—Unobservable inputs for the asset or liability. |
Observable market data is used, 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 includes an assessment of 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 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. |
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.
iIncome Taxes
The company’s provision for income taxes is calculated on reported income before income taxes in the Consolidated Financial Statements using a separate tax return method modified to apply the benefits-for-loss approach, which is consistent with the company’s Tax Sharing Agreement with IBM. Under this approach, the provision for income taxes is computed as if the company filed tax returns on a separate tax return basis and is then adjusted, as necessary, to reflect IBM’s reimbursement for any tax benefits generated by the company. For additional information on the company’s Tax Sharing Agreement with IBM, see note C, “Relationship with IBM and Related Party Transactions.”
53
Notes to Consolidated Financial Statements – (continued)
Deferred income taxes reflect the 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 is more likely than not to be realized when applying the separate tax return method modified to apply the benefits-for-loss approach. 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. 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.
The company recognizes additional tax liabilities when the company believes that certain positions may not be fully sustained upon review by tax authorities. Benefits from tax positions are originally measured at the largest amount of benefit that is greater than 50 percent likely of being realized upon settlement.
The company’s U.S. federal and certain state and foreign operations are included in various IBM consolidated tax returns; in such cases, IBM makes payments to tax authorities on the company’s behalf. IBM and the company maintain a Tax Sharing Agreement for any operations included in an IBM consolidated tax return, pursuant to which IBM charges the company for any taxes owed and reimburses the company for tax attributes generated. Such charges or reimbursements are based upon a calculation of the company’s relevant pro forma stand-alone tax return.
Consistent with the Tax Sharing Agreement, where the company is part of IBM’s consolidated tax filings, the company records taxes based on tax returns as expected to be and ultimately as filed. Initial income tax benefits associated with an uncertain tax position are recorded using best estimates at the time the position originates and a final settlement of the position is made with IBM for the recorded amounts. Consequently, any recognition and subsequent changes in assessment about the sustainability of tax positions, including valuation allowances and interest and penalties, are the responsibility of IBM. Because the company bears i i no / risk associated with the sustainability of uncertain tax positions, there are i i no / uncertain tax liabilities recorded in the Consolidated Financial Statements for entities that file as part of IBM’s consolidated tax filings.
Where the company is not part of IBM’s consolidated tax filings, to the extent that new information becomes available that causes the company to change its judgment regarding the adequacy of existing tax liabilities, such changes to tax liabilities will impact the company’s provision for income taxes 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 the provision for income taxes in the Consolidated Statement of Earnings.
iEquipment under Operating Lease
Equipment under operating lease is carried at cost and depreciated over the lease term using the straight-line method, generally ranging from one to i four years. The depreciable basis is the original cost of the equipment less the estimated residual value of the equipment at the end of the lease term. These 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.
/Expense and Other Income
iSelling, General and Administrative Expense
Selling, General and Administrative (SG&A) expense is charged against income as incurred. Expenses of promoting and selling financing solutions are classified as selling expense and include such items as compensation, advertising, sales commissions and travel. General and administrative expense includes such items as compensation, legal costs, office
54
Notes to Consolidated Financial Statements – (continued)
supplies, non-income taxes, insurance and office rental. A portion of SG&A is charged to the company by IBM. For further information, see note C, “Relationship with IBM and Related Party Transactions.”
iOther Income and Expense
Other income and expense includes the net gain or loss from the sale of IBM and OEM IT equipment to clients, as well as the sale of equipment to IBM upon termination of a lease. These transactions are recorded within the Client Financing Segment in other (income) and expense in the Consolidated Statement of Earnings. Also included are foreign currency gains and losses and fees for credit insurance.
The company sells to IBM equipment returned from lease at cost, which approximates fair value. In addition, IBM may migrate a client to new technology. In the event this migration results in an early termination of a lease, IBM will purchase the returned equipment from the company at a pre-negotiated price, which is a function of the discounted value of the scheduled future lease payments and the residual value.
iTranslation 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 other comprehensive income. Income and expense items are translated at weighted-average rates of exchange prevailing during the year.
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 net 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.
iDerivative Financial Instruments
The company’s earnings and cash flows are subject to fluctuations due to changes in foreign currency exchange rates and interest rates. The company may use derivative financial instruments to manage foreign currency exchange rate and interest rate exposures. Derivatives that the company uses are primarily foreign exchange forward contracts. All derivatives are recorded at fair value. For additional information, see note D, “Financial Instruments.”
iNOTE B. ACCOUNTING CHANGES
iNew Standards to be Implemented
In June 2016, with amendments in 2018 and 2019, the Financial Accounting Standards Board (FASB) issued guidance for credit impairment based on an expected loss model rather than an incurred loss model. It requires the consideration of all available relevant information when estimating expected credit losses, including past events, current conditions and forecasts and their implications for expected credit losses. It also expands the scope of financial instruments subject to impairment, including off-balance sheet commitments and residual value. The guidance was effective January 1, 2020, with one-year early adoption permitted. The company adopted the guidance as of the effective date using the transition option whereby prior comparative periods will not be retrospectively presented in the Consolidated Financial Statements, and has completed its changes to policy, processes, systems and controls accordingly. This included the assessment of data availability and presentation necessary to meet the disclosure requirements of the guidance. At January 1, 2020, an increase in the allowance for credit losses of approximately $ i 30 million was recorded for financing receivables. The company also recorded an allowance for credit losses of approximately $ i 25 million in other liabilities for its off-balance sheet commitments. Additionally, net deferred taxes were reduced by approximately $ i 15 million in the Consolidated Statement of Financial Position, resulting in a cumulative-effect net decrease to retained earnings of approximately $ i 40 million.
/ /55
Notes to Consolidated Financial Statements – (continued)
Standards Implemented
In August 2018, the FASB issued guidance, which changed the disclosure requirements for fair value measurements. The guidance was effective on January 1, 2020, with early adoption of certain provisions permitted. The company adopted the provision in the fair value guidance that removed the Level 1/ Level 2 transfer disclosures in the third quarter of 2018 and the remaining provisions of the guidance are not applicable. As the guidance is a change to disclosures only, it did not have a material impact in the consolidated financial results.
The FASB issued guidance in February 2016, with amendments in 2018 and 2019, which changed the accounting for leases. The guidance requires lessees to recognize right-of-use (ROU) assets and lease liabilities for most leases in the Consolidated Statement of Financial Position. For lessors, it also eliminates the use of third-party residual value guarantee (RVG) insurance in the lease classification test, and overall aligns with the new revenue recognition guidance. Due to changes to lease termination guidance, when equipment is returned to the company prior to the end of the lease term, the carrying amounts of lease receivables will be reclassified to loan receivables. The guidance also requires qualitative and quantitative disclosures to assess the amount, timing and uncertainty of cash flows arising from leases. The company adopted the guidance effective January 1, 2019, using the transition option whereby prior comparative periods were not retrospectively presented in the consolidated financial statements. The company elected the package of practical expedients not to reassess prior conclusions related to contracts containing leases, lease classification and initial direct costs (IDCs). From a lessor perspective, IDCs and removal of third-party RVG insurance in the lease classification test did not have a material impact on the consolidated financial results. At December 31, 2019, lease receivables of $ i 273 million were reclassified to loan receivables. There were no material impacts of adoption from a lessee perspective as there are no material lease arrangements in which the company is a lessee. Refer to note E, “Leases,” for additional information, including further discussion on the impact of adoption.
In February 2018, the FASB issued guidance that allows entities to elect an option to reclassify the stranded tax effects related to the application of U.S. tax reform from accumulated other comprehensive income/(loss) (AOCI) to retained earnings. 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. The guidance was effective January 1, 2019, with early adoption permitted. The company adopted the guidance effective January 1, 2018, and elected not to reclassify prior periods. At adoption on January 1, 2018, $ i 5 million was reclassified from AOCI to retained earnings.
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.
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 on January 1, 2018, using the modified-retrospective transition method. The company concluded that substantially all of its financing and operating lease revenue streams are not within the scope of the guidance, as they are governed by other accounting standards. The guidance did not have an impact in the consolidated financial results.
iNOTE C. RELATIONSHIP WITH IBM AND RELATED PARTY TRANSACTIONS
IBM Credit is a captive finance company and an indirect, wholly owned subsidiary of IBM. IBM Credit generally conducts its financing activities with IBM on an arm’s-length basis, subject in certain cases, particularly with respect to
56
Notes to Consolidated Financial Statements – (continued)
originations, to commercial factors, including IBM’s relationship with a client. The following is a description of certain material relationships between IBM Credit and IBM, regarding support, operating, borrowing, licensing, service and other arrangements.
Support Agreement
Pursuant to a Support Agreement between IBM and IBM Credit, IBM has agreed to retain, directly or indirectly, beneficial ownership of at least i 51 percent of the equity voting interests in the company at all times. IBM has also agreed to cause the company to have a minimum consolidated tangible net worth of at least $ i 50 million on the last day of each of the company’s fiscal years (with consolidated tangible net worth for purposes of this discussion of the Support Agreement understood to mean (a) the total assets of IBM Credit and its consolidated subsidiaries less (b) the intangible assets and total liabilities of IBM Credit and its consolidated subsidiaries). IBM has also agreed to cause the company to maintain a leverage ratio not to exceed i 11 to 1 for each of the company’s fiscal quarters (with leverage ratio for purposes of this discussion of the Support Agreement understood to mean, for any calendar quarter, IBM Credit’s debt-to-equity ratio as reported in, and calculated in the manner set forth in, IBM Credit’s periodic report covering such fiscal quarter). In the event that the company’s leverage ratio at the end of any fiscal quarter is higher than i 11 to 1, then, upon demand by the company, IBM has agreed to make or cause to be made a capital contribution to the company in an amount sufficient to cause the company’s leverage ratio to not exceed i 11 to 1. The Support Agreement is not a guarantee by IBM of any indebtedness, other obligation, or liability of any kind of IBM Credit.
Operating Relationship
The company originates financing with end-user clients, which are primarily IBM customers that elect to finance their acquisition of IBM’s hardware, software, and services. Where IBM Credit’s financing contract is bundled with IBM’s product and service contract to create a combined periodic payment schedule for the entire offering, the offering is termed a Total Solution Offering.
For IBM Total Solution Offerings in certain countries, as well as for certain government and other contracts, IBM Credit is not a party to IBM’s contract with the end-user client. Instead, IBM directly provides the end-user client with the financing. IBM Credit purchases a participation interest from IBM that represents the financing portion of such transactions and assumes the credit risk of IBM’s end-user client. The outstanding amount of these receivables, net of allowance for credit losses, was $ i 4,303 million and $ i 4,065 million as of December 31, 2019 and 2018, respectively, and is included in the Consolidated Statement of Financial Position as receivables purchased/participated from IBM. These receivables earned $ i 191 million, $ i 188 million and $ i 165 million of interest income in 2019, 2018 and 2017, respectively, which is included in the Consolidated Statement of Earnings as financing revenue. For additional information, see note F, “Financing Receivables, Receivables Purchased/Participated from IBM,” to the Consolidated Financial Statements.
Within the Commercial Financing segment, the company purchases interests in certain of IBM’s trade and other accounts receivable at a discount and assumes the associated credit risk of IBM’s client. In the second quarter of 2019, IBM and the company suspended the program under which IBM Credit purchases interests in IBM’s trade accounts receivable. Amounts outstanding, net of allowance for credit losses, at December 31, 2019 and 2018 were $ i 56 million and $ i 1,369 million, respectively, and are included within receivables purchased/participated from IBM in the Consolidated Statement of Financial Position. The finance income earned from these receivables was $ i 25 million, $ i 42 million and $ i 35 million, in 2019, 2018 and 2017, respectively, and is included in financing revenue in the Consolidated Statement of Earnings. For additional information, see note F, “Financing Receivables, Receivables Purchased/Participated from IBM,” to the Consolidated Financial Statements.
In certain countries, the company provides loans to IBM, primarily in support of IBM’s Global Technology Services segment’s acquisition of IT assets, which it uses in external, revenue-producing services contracts. This financing is included in the Consolidated Statement of Financial Position as financing receivables from IBM. The interest income earned from these receivables was $ i 167 million, $ i 171 million and $ i 140 million, in 2019, 2018 and 2017, respectively, and is included in financing revenue in the Consolidated Statement of Earnings. The amount of such financings outstanding at December 31, 2019 and 2018 was $ i 3,870 million and $ i 3,609 million, respectively.
57
Notes to Consolidated Financial Statements – (continued)
The outstanding amounts of other receivables from IBM of $ i 513 million and $ i 2,019 million at December 31, 2019 and 2018, respectively, primarily relate to the investment of a portion of the company's excess cash in short-term interest bearing accounts with IBM, which can be withdrawn upon demand. The company's investment of excess cash with IBM was $ i 509 million and $ i 2,014 million at December 31, 2019 and 2018, respectively. The investment of excess cash with IBM is presented as other receivables from IBM in the Consolidated Statement of Financial Position and the investing section of the Consolidated Statement of Cash Flows. The interest income earned from these investments was $ i 24 million in 2019, $ i 59 million in 2018 and $ i 36 million in 2017, and is included in financing revenue in the Consolidated Statement of Earnings.
In addition, within the Commercial Financing segment, the company provides financing which includes an interest free period to suppliers, distributors and resellers of IBM products and services, which is funded by IBM. Fee income earned under these arrangements was $ i 150 million, $ i 154 million and $ i 144 million in 2019, 2018 and 2017, respectively. These fees are included as financing revenue in the Consolidated Statement of Earnings and are deferred and recognized over the term of the financing arrangement.
Borrowing Relationship
The company has credit facilities with IBM that allow the company to obtain short- and long-term funding on an as-needed basis and the company seeks to substantially match-fund the term, currency and interest rate variability of its debt against its underlying financing assets. The general terms of the loans under the credit facilities are set forth in standard intercompany loan agreements, which include standard default clauses (including failure to pay interest or principal when due, bankruptcy and ceasing to be a wholly owned subsidiary). IBM Credit is entitled to prepay loans issued under these credit facilities from time to time, subject to payment of any agreed to penalty or premium.
These loans are included in the Consolidated Statement of Financial Position as debt payable to IBM. At December 31, 2019 and 2018, the company had borrowings outstanding under such agreements of $ i 16,945 million and $ i 19,580 million, respectively. Interest expense of $ i 242 million, $ i 298 million and $ i 265 million was incurred on loans from IBM during 2019, 2018 and 2017, respectively, and is included as financing cost in the Consolidated Statement of Earnings. For more information on short- and long-term funding, see note H, “Borrowings,” to the Consolidated Financial Statements.
Services and Other Arrangements
The company sources a number of services from IBM, including functional support for treasury, accounting, legal, tax, human resources, marketing and IT services. In certain instances, IBM acts as IBM Credit’s billing and collection agent and forwards the financing payments to IBM Credit. The company also has the right to use certain IBM intangibles in its business. Where practical, charges of the expenses incurred by IBM in the provision of these functional support services are based upon direct usage. For the remainder, where possible, expenses are charged on measurable non-financial drivers, such as number of employees. When a clear and measurable non-financial driver cannot be established, these expenses are charged based on a measurable financial driver, such as net margin. Management believes that these charges are reasonable. In addition, the company conducts its global operations primarily from IBM leased or IBM owned facilities for which IBM charges the company for occupancy expenses based on square footage space usage with no fixed term commitment. For the support services and occupancy expenses referred to above, IBM charged the company $ i 195 million, $ i 204 million and $ i 218 million in 2019, 2018 and 2017, respectively.
The company participates in various IBM stock-based compensation plans, including awards of Restricted Stock Units and Performance Share Units. Amounts charged by IBM to the company related to stock-based compensation expense during the periods reported were not material.
The company participates in certain multiemployer retirement-related plans that are sponsored by IBM. Charges from IBM to the company in relation to these multiemployer plans (including non-pension post-retirement benefits) are limited to service costs. The company is charged by IBM based on the number of employees. Contributions and any other types of costs for these multiemployer plans are the responsibility of IBM. In certain countries, the company
58
Notes to Consolidated Financial Statements – (continued)
participates in plans that are accounted for as multiple-employer plans. For these plans, the retirement-related plan obligation is owned by the company and is generally calculated using actuarial valuations. Under these plans, IBM manages the assets and allocates them to the company based on the company’s obligation. The company also participates in certain defined contribution plans and is charged by IBM based on the number of employees. For additional information, see note M, "Retirement-Related Benefits,” to the Consolidated Financial Statements.
Expenses related to the services discussed above are included in SG&A expense in the Consolidated Statement of Earnings. It is not practical to estimate the actual costs that would have been incurred had IBM Credit been a separate company during the periods presented. These costs also may not be indicative of the expenses that IBM Credit will incur in the future or would have incurred if the company had obtained these services from a third party.
The outstanding amount of accounts payable to IBM was $ i 336 million and $ i 3,044 million at December 31, 2019 and 2018, respectively. The decline in accounts payable to IBM reflects settlements of purchases of equipment and receivables/loans (for software and services). Beginning in the second half of 2019, the majority of such purchases were settled in the same period. This payable account is non-interest bearing and short term in nature and is expected to be settled in the normal course of business.
The company sells to IBM equipment returned at end of lease at cost, which approximates fair value. In addition, IBM may migrate a client to new technology. In the event this migration results in an early termination of a lease, IBM will purchase the returned equipment at a pre-negotiated price, which is a function of the discounted value of the scheduled future lease payments and the residual value. The company's net profit from sales of returned equipment to IBM was $ i 56 million in 2019, $ i 62 million in 2018, and $ i 80 million in 2017. These sales are recorded net in other (income) and expense in the Consolidated Statement of Earnings.
Tax Sharing Agreement
The company’s U.S. federal and certain state and foreign operations are included in various IBM consolidated tax returns; in such cases, IBM makes payments to tax authorities on the company’s behalf. IBM and the company maintain a Tax Sharing Agreement for any operations included in an IBM consolidated tax return, pursuant to which IBM charges the company for any taxes owed and reimburses the company for tax attributes generated. Such charges or reimbursements are based upon a calculation of the company’s relevant pro forma stand-alone tax return. For additional information, see note L, "Taxes,” to the Consolidated Financial Statements.
iNOTE 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, 2019 and 2018.
i
/59
Notes to Consolidated Financial Statements – (continued)
| | | | | | | | | | | | | |
(Dollars in millions) | | | | | | | | | | | | |
|
| Level 1 |
| Level 2 |
| Level 3 |
| Total | | |||||
Assets: |
| |
|
| |
|
| |
|
| |
| |
Cash equivalents (1) | | | | | | | | | | | | | |
Time deposits and certificates of deposit |
| $ | — | | $ | i 788 | | $ | — | | $ | i 788 | |
Money market funds | | | i 5 | | | — | | | — | | | i 5 | |
Total cash equivalents | | | i 5 | | | i 788 | | | — | | | i 793 | |
Derivative assets (2) | | | — | | | i 45 | | | — | | | i 45 | |
Total assets | | $ | i 5 | | $ | i 833 | | $ | — | | $ | i 838 | |
Liabilities: | | | | | | | | | | | | | |
Derivative liabilities (3) | | $ | — | | $ | i 18 | | $ | — | | $ | i 18 | |
(1) | Included within cash and cash equivalents in the Consolidated Statement of Financial Position. |
(2) | Included within other assets in the Consolidated Statement of Financial Position. |
(3) | Included within other liabilities in the Consolidated Statement of Financial Position. |
| | | | | | | | | | | | | |
(Dollars in millions) | | | | | | | | | | | | |
|
| Level 1 |
| Level 2 |
| Level 3 |
| Total | | |||||
Assets: |
| |
|
| |
|
| |
|
| |
| |
Cash equivalents (1) |
| |
|
| |
|
| |
|
| |
| |
Time deposits and certificates of deposit | | $ | — | | $ | i 792 | | $ | — | | $ | i 792 | |
Money market funds | |
| i 5 | |
| — | |
| — | |
| i 5 | |
Total cash equivalents | |
| i 5 | |
| i 792 | |
| — | |
| i 797 | |
Derivative assets (2) | |
| — | |
| i 18 | |
| — | |
| i 18 | |
Total assets | | $ | i 5 | | $ | i 810 | | $ | — | | $ | i 815 | |
Liabilities: | |
|
| |
|
| |
|
| |
|
| |
Derivative liabilities (3) | | $ | — | | $ | i 37 | | $ | — | | $ | i 37 | |
(1) | Included within cash and cash equivalents in the Consolidated Statement of Financial Position. |
(2) | Included within other assets in the Consolidated Statement of Financial Position. |
(3) | Included within other liabilities in the Consolidated Statement of Financial Position. |
Financial Assets and Liabilities Not Measured at Fair Value
Short-Term Receivables and Payables
Short-term financing receivables are financial assets with carrying values that approximate fair value. Accounts payable, other accrued expenses and short-term debt (including debt payable to IBM) 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.
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, 2019 and 2018, the difference between the carrying amount and estimated fair value for long-term receivables was immaterial. If measured at fair value in the financial statements, these financial instruments would be classified as Level 3 in the fair-value hierarchy.
Long-Term Debt
Fair value of publicly traded long-term debt is based on quoted market prices for the identical liability when traded as an asset in an active market. For other long-term debt, including debt payable to IBM, 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 (third-party debt as
60
Notes to Consolidated Financial Statements – (continued)
well as debt payable to IBM) was $ i 15,268 million and $ i 17,276 million and the estimated fair value was $ i 15,409 million and $ i 17,199 million at December 31, 2019 and 2018, respectively. If measured at fair value in the financial statements, long-term debt (including the current portion) would be classified as Level 2 in the fair value hierarchy.
Derivative Financial Instruments
The company operates in multiple currencies and is a lender and issuer in the capital markets and a borrower from IBM. In the normal course of business, the company may be exposed to the impact of interest rate changes and foreign currency fluctuations. The company limits its exposure to core market risks by following established risk management policies and procedures and through the use of match-funding with IBM and third parties. Although the company seeks to substantially match-fund the terms, currency and interest rate variability of its debt against its underlying financial assets, risks may arise between assets and the related liabilities used for funding. The company may also choose to mitigate any remaining exposure relating to interest rate changes and foreign currency fluctuations through the use of interest rate or foreign exchange derivatives.
Derivative assets and liabilities are recorded in other assets and other liabilities in the Consolidated Statement of Financial Position and presented on a gross basis. The notional amounts of the derivative instruments do not necessarily represent amounts exchanged by the company with IBM and third parties, and are not necessarily a direct measure of the financial exposure. The company may also enter into master netting agreements with certain counterparties that allow for netting of exposures in the event of default or breach. However, in the Consolidated Statement of Financial Position, the company does not offset derivative assets against liabilities in master netting arrangements. At December 31, 2019, the aggregate fair value of derivative contracts with IBM that were in an asset position totaled $ i 45 million and the aggregate fair value of derivative contracts with IBM that were in a liability position totaled $ i 18 million. At December 31, 2018, the aggregate fair value of derivative contracts with IBM that were in an asset position totaled $ i 18 million and the aggregate fair value of derivative contracts with IBM that were in a liability position totaled $ i 37 million. If derivatives exposures covered by a qualifying master netting agreement with IBM had been netted in the Consolidated Statement of Financial Position, the total derivative asset and liability positions would each have been reduced by $ i 18 million at December 31, 2019 and the total derivative asset and liability positions would each have been reduced by $ i 11 million at December 31, 2018.
Interest Rate Risk
Fixed and Variable Rate Borrowings
The company issues debt in the capital markets to fund its operations. 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 enter into interest-rate swaps with IBM to convert specific fixed-rate debt issuances into variable-rate debt (i.e., fair value hedges) and to convert variable-rate debt issuances into fixed-rate debt (i.e., cash flow hedges). At December 31, 2019, the total notional amount of the company’s interest rate swap contracts with IBM was $ i 2,550 million. The weighted average remaining maturity of these instruments at December 31, 2019 was approximately i 2.0 years. At December 31, 2018, the total notional amount of the company’s interest rate swap contracts with IBM was $ i 3,350 million. The weighted average remaining maturity of these instruments at December 31, 2018 was approximately i 2.4 years. 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, 2019 and December 31, 2018.
Foreign Exchange Risk
Long-Term Investments in Foreign Subsidiaries (Net Investment)
The company enters into foreign exchange derivatives with IBM as a hedge of net investment of its foreign subsidiaries to reduce the volatility in Member’s interest caused by changes in foreign currency exchange rates in the functional currency of major foreign subsidiaries with respect to the U.S. dollar. At December 31, 2019 and 2018, the total notional
61
Notes to Consolidated Financial Statements – (continued)
amount of derivative contracts with IBM designated as net investment hedges was $ i 1,229 million and $ i 1,986 million, respectively. The weighted average remaining maturity of these instruments was i i 0.2 / years at both periods.
Foreign Currency Asset/Liability Management
The company enters into foreign exchange derivative contracts to manage foreign currency exposures associated with the company’s funding from IBM and third parties. These derivatives were not designated as hedges for accounting purposes. However, these derivatives represent economic hedges that provided an economic offset to the underlying foreign currency exposure. The terms of these derivative contracts are generally less than i one year. The gains and losses recognized on economic hedges are recorded in other (income) and expense in the Consolidated Statement of Earnings, and the associated cash flows are included in other investing activities-net, in the Consolidated Statement of Cash Flows. There were i i no / foreign exchange derivative contracts with IBM or with third parties outstanding at December 31, 2019 and 2018.
The following tables provide a quantitative summary of the derivative instrument-related risk management activity as of December 31, 2019 and 2018, as well as for the years ended December 31, 2019, 2018 and 2017, respectively.
Fair Values of Derivative Instruments in the Consolidated Statement of Financial Position
i
| | | | | | | | | | | | | | | | |
| | Fair Value of Derivative Assets | | Fair Value of Derivative Liabilities | ||||||||||||
(Dollars in millions) |
| Balance Sheet |
| | |
| | |
| Balance Sheet |
| | |
|
| |
At December 31: |
| Classification |
| 2019 |
| 2018 |
| Classification |
| 2019 |
| 2018 | ||||
Designated as hedging instruments: | | | | | | | | | | | | | | | | |
Interest rate contracts with IBM |
| Other assets | | $ | i 45 | | $ | i 10 |
| Other liabilities | | $ | — | | $ | i 27 |
Foreign exchange contracts with IBM |
| Other assets | |
| — | |
| i 9 |
| Other liabilities | |
| i 18 | |
| i 11 |
|
| Fair value of derivative assets | | $ | i 45 | | $ | i 18 |
| Fair value of derivative liabilities | | $ | i 18 | | $ | i 37 |
| | | | | | | | | | | | | | | | |
Not designated as hedging instruments: | | | | | | | | | | | | | | | | |
Foreign exchange contracts |
| Other assets | | $ | — | | $ | — |
| Other liabilities | | $ | — | | $ | — |
|
| Fair value of derivative assets | | $ | — | | $ | — |
| Fair value of derivative liabilities | | $ | — | | $ | — |
| | | | | | | | | | | | | | | | |
Total | | | | $ | i 45 | | $ | i 18 | | | | $ | i 18 | | $ | i 37 |
As of December 31, 2019 and 2018, the following amounts were recorded in the Consolidated Statement of Financial Position related to cumulative basis adjustments for fair value hedges:
i
| | | | | | |
(Dollars in millions) | | | | | | |
Line Item in the |
| |
| | ||
Consolidated Statement of Financial Position | | At December 31, | | At December 31, | ||
in which the Hedged Item is Included: | | 2019 | | 2018 | ||
Debt: | | | | | | |
Carrying amount of the hedged item | | $ | ( i 2,574) | | $ | ( i 3,310) |
Cumulative hedging adjustments included in the carrying amount - assets/(liabilities) | | | ( i 28) | | | i 34 |
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, 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:
i
62
Notes to Consolidated Financial Statements – (continued)
| | | | | | | | | | | | |
| | | | Gains/(Losses) of | ||||||||
(Dollars in millions) | | Total | | Total Hedge Activity | ||||||||
For the year ended December 31: |
| 2019 |
| 2018 | | 2019 |
| 2018 | ||||
Financing cost | | $ | i 526 |
| $ | i 503 | | $ | i 23 |
| $ | i 29 |
Other (income) and expense | |
| ( i 72) | |
| ( i 31) | |
| — | |
| i 7 |
| | | | | | | | | | | | | | | | | | | |
| | Gain/(Loss) Recognized in Earnings | |||||||||||||||||
| | Consolidated | | Recognized | | Attributable to Risk | |||||||||||||
(Dollars in millions) | | Statement of | | on Derivatives | | Being Hedged (2) | |||||||||||||
For the year ended December 31: |
| Earnings Line Item |
| 2019 |
| 2018 |
| 2017 |
| 2019 |
| 2018 | 2017 | ||||||
Derivative instruments in fair value hedges (1): | | | | | | | | | | | | | | | | | | | |
Interest rate contracts with IBM |
| Financing cost | | $ | i 50 | | $ | ( i 14) | | $ | ( i 25) | | $ | ( i 62) | | $ | i 8 | $ | i 26 |
| | | | | | | | | | | | | | | | | | | |
Derivative instruments not designated as hedging instruments: | | | | | | | | | | | | | | | | | | | |
Foreign exchange contracts with IBM |
| Other (income) and expense | |
| — | |
| — | |
| ( i 222) | |
| N/A | |
| N/A |
| N/A |
Foreign exchange contracts |
| Other (income) and expense | |
| — | |
| i 7 | |
| ( i 18) | |
| N/A | |
| N/A |
| N/A |
Total | | | | $ | i 50 | | $ | ( i 7) | | $ | ( i 266) | | $ | ( i 62) | | $ | i 8 | $ | i 26 |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Gain/(Loss) Recognized in Earnings and Other Comprehensive Income | |||||||||||||||||||||||||||
| | | | | | | | | | | Consolidated | | | | | | | | | | | | | | | | | | |
| | | | Statement of | | | | Amounts Excluded from | |||||||||||||||||||||
(Dollars in millions) | | Recognized in OCI | | Earnings | | Reclassified from AOCI | | Effectiveness Testing (3) | |||||||||||||||||||||
For the year ended December 31: |
| 2019 |
| 2018 |
| 2017 |
| Line Item |
| 2019 |
| 2018 |
| 2017 |
| 2019 |
| 2018 |
| 2017 | |||||||||
Derivative instruments in net investment hedges: | | |
| |
|
| |
|
|
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
|
Foreign exchange contracts with IBM | | $ | i 10 | | $ | i 125 | | $ | ( i 6) |
| Financing cost | | $ | — | | $ | — | | $ | — | | $ | i 35 | | $ | i 35 | | $ | i 11 |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Total | | $ | i 10 | | $ | i 125 | | $ | ( i 6) |
|
| | $ | — | | $ | — | | $ | — | | $ | i 35 | | $ | i 35 | | $ | i 11 |
(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. |
(3) | The company's policy is to recognize all fair value changes in amounts excluded from effectiveness testing in net income each period. |
N/A - Not applicable
For the years ending December 31, 2019, 2018 and 2017, there were no significant gains or losses excluded from the assessment of hedge effectiveness (for fair value hedges); nor are there any anticipated in the normal course of business.
iNOTE E. LEASES
Accounting for Leases as a Lessee
IBM Credit’s global operations are primarily conducted in IBM leased or owned facilities, for which IBM charges the company for occupancy expenses based on square footage usage, with no fixed term commitment. These arrangements do not represent leases and the company did not record any ROU assets or associated lease liabilities in the Consolidated Statement of Financial Position at January 1, 2019. For additional information, see note C, “Relationship with IBM and Related Party Transactions.” The company has no other material lease arrangements in which it is a lessee.
63
Notes to Consolidated Financial Statements – (continued)
Accounting for Leases as a Lessor
The company enters into leases as a means to provide financing to its clients. Assets under lease include new and used IBM equipment and certain OEM IT products. IBM equipment generally consists of IBM Z, Power and Storage Systems products.
When entering into a contract with its clients, the company determines whether an arrangement contains a lease at its inception. As part of that evaluation, the company considers whether there is an implicitly or explicitly identified asset in the arrangement and whether the client has the right to control that asset.
The company determines whether there is a right to control the use of the asset by assessing the client’s rights to obtain substantially all of the economic benefits from the use of the identified asset and rights to direct the use of the identified asset. The company determines the classification of the lease at the lease commencement date.
Lease payments due to IBM Credit are typically fixed and paid in equal installments over the lease term. The majority of the company’s leases do not contain variable payments that are dependent on an index or a rate. Variable lease payments that do not depend on an index or a rate (e.g., property taxes) that are paid directly by the company and are reimbursed by the client, are recorded as finance income, along with the related cost, in the period in which collection of these payments is probable. Payments that are made directly by the client to a third party, including certain property taxes and insurance, are not considered part of variable payments and, therefore, are not recorded by the company. The company has made a policy election to exclude from consideration in contracts all collections from sales and other similar taxes.
The company’s payment terms for leases are typically unconditional. Therefore, in an instance when the client requests to terminate the lease prior to the end of the lease term, the client would typically be required to pay the remaining lease payments in full. At the end of the lease term, the company allows the client to either return the equipment, purchase the equipment at the then-current fair market value or a pre-stated purchase price, or renew the lease based on mutually agreed upon terms.
iThe following table presents amounts included in the Consolidated Statement of Earnings related to lessor activity:
| | | |
(Dollars in millions) | | | |
For the year ended December 31: |
| 2019 | |
Financing lease revenue | | $ | i 214 |
Operating lease revenue | | | i 277 |
Variable lease revenue | | | i 27 |
Total lease revenue | | $ | i 517 |
Sales-Type and Direct Financing Leases
If a lease is classified as a sales-type or direct financing lease, a net investment in the lease is recorded. For a sales-type lease, the net investment in the lease is measured at commencement date as the sum of the lease receivable and the estimated residual value of the equipment, less unearned income and allowance for credit losses. At December 31, 2019, the unguaranteed residual value of sales-type and direct financing leases was $ i 531 million. For further information on the company’s investment in leases, including residual values, refer to note F, “Financing Receivables, Receivables Purchased/Participated from IBM.”
IBM Credit enters into lease arrangements for the purpose of generating revenue by providing financing. Under a net sales-type lease, eligible IDCs are deferred and recognized over the lease term. Over the term of a sales-type lease, the company recognizes financing revenue on the net investment in the lease and any variable lease payments, which are not included in the net investment in the lease.
For a direct financing lease, the investment in the lease is measured similarly to a sales-type lease, however, the net investment in the lease is reduced by any selling profit, which is typically zero. In a direct financing lease, the selling
64
Notes to Consolidated Financial Statements – (continued)
profit and IDCs are deferred at commencement and recognized over the lease term. Prior to the adoption of the new lease guidance, the company’s leases were generally classified as direct financing leases. Due to the changes in the lease classification requirements under the new lease guidance, the company’s leases are generally classified as sales-type leases and presented on a net basis. The company rarely enters into direct financing leases.
The estimated residual value represents the estimated fair value of the equipment under lease at the end of the lease. Estimating residual value is a risk unique to financing activities, and management of this risk is dependent upon the ability to accurately project future equipment values. The company has insight into product plans and cycles for the IBM and OEM IT products under lease. The company estimates the future fair value of leased equipment by using historical models, analyzing the current market for new and used equipment and obtaining forward-looking product information such as marketing plans and technology innovations.
The company optimizes the recovery of residual values by extending lease arrangements, or selling to IBM all equipment that has been returned at the end of lease. The company has historically managed residual value risk both through insight into IBM’s own product cycles and monitoring of OEM IT product announcements. The company periodically reassesses the realizable value of its lease residual values. Anticipated decreases in specific future residual values that are considered to be other-than-temporary are recognized immediately upon identification and are recorded as an adjustment to the residual value estimate. For sales-type and direct financing leases, this reduction lowers the recorded net investment and is recognized as a loss charged to finance income in the period in which the estimate is changed, as well as an adjustment to unearned income to reduce future-period financing income. For the years ended December 31, 2019 and 2018, impairment of residual values was immaterial.
The following table presents a maturity analysis of the lease payments due to IBM Credit on sales-type and direct financing leases over the next five years and thereafter, at December 31, 2019:
i
| | | | |
(Dollars in millions) | | Total | | |
2020 | | $ | i 2,000 | |
2021 | | | i 1,461 | |
2022 | | | i 817 | |
2023 | | | i 294 | |
2024 | | | i 51 | |
Thereafter | | | i 4 | |
Total undiscounted cash flows | | $ | i 4,626 | (1) |
Present value of lease payments (recognized as financing receivables) | | | i 4,242 | (2) |
Difference between undiscounted cash flows and discounted cash flows | | $ | i 384 | |
(1) | Undiscounted cash flows include billed and due receivables in the 2020 maturity. |
(2) | The present value of the lease payments will not equal the financing receivables balances in the Consolidated Statement of Financial Position due to certain items, including IDCs, allowance for credit losses and residual values, which are included in the financing receivable balance, but are not included in the future lease payments. For a reconciliation of the undiscounted cash flows to the financing receivables recognized in the Consolidated Statement of Financial Position at December 31, 2019, refer to note F, “Financing Receivables, Receivables Purchased/Participated from IBM.” |
/For further information on sales-type and direct financing leases, including guaranteed and unguaranteed residual values, refer to note F, “Financing Receivables, Receivables Purchased/Participated from IBM.”
Operating Leases
Equipment provided to clients under an operating lease is carried at cost within equipment under operating leases in the Consolidated Statement of Financial Position and depreciated over the lease term using the straight-line method, generally ranging from one to i four years. The depreciable base is the original cost of the equipment less the estimated residual value of the equipment at the end of the lease term. At December 31, 2019, the unguaranteed residual value of equipment under operating leases was $ i 84 million.
65
Notes to Consolidated Financial Statements – (continued)
At commencement of an operating lease, IDCs are deferred. As lease payments are made, the company records financing revenue over the lease term. IDCs are amortized over the lease term on the same basis as lease income is recorded.
The following table provides a maturity analysis of the undiscounted lease payments due to IBM Credit on operating leases over the next four years and thereafter, at December 31, 2019:
i
| | | |
(Dollars in millions) | | Total | |
2020 | | $ | i 128 |
2021 | | | i 33 |
2022 | | | i 4 |
2023 | | | i 0 |
Thereafter | | | — |
Total undiscounted cash flows | | $ | i 165 |
Assets under operating lease are tested for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. The impairment test is based on undiscounted cash flows, and, if impaired, the asset is written down to fair value based on either discounted cash flows or appraised values. There were no material impairment losses incurred for equipment provided to clients under an operating lease for the year ended December 31, 2019. These assets are included in equipment under operating leases in the Consolidated Statement of Financial Position.
iNOTE F. FINANCING RECEIVABLES, RECEIVABLES PURCHASED/PARTICIPATED FROM IBM
Financing receivables consist of Client Financing leases, loans and installment payment plans to end-user clients. Assets financed are primarily IT products and services where IBM and the company have experience. Client Financing arrangements are priced to achieve a market yield. Financing receivables also include Commercial Financing, which generally consists of working capital financing to suppliers, distributors and resellers of IBM and OEM IT products and services. Payment terms for working capital financing receivables generally range from i 30 to i 90 days. Beginning in the second quarter of 2019 and continuing throughout the year, the company wound down the portion of its Commercial Financing operations that provides short-term working capital solutions for OEM information technology suppliers, distributors and resellers, which has resulted in a significant reduction of Commercial Financing receivables. The company had receivables of $ i 0.6 billion and $ i 8.5 billion relating to its OEM IT Commercial Financing operations for the periods ended December 31, 2019, and 2018, respectively. IBM Credit will continue to provide differentiated end-to-end financing solutions, including commercial financing in support of IBM partner relationships.
The company purchases interests in certain of IBM’s trade and other accounts receivable at a discount. In the second quarter of 2019, IBM and the company suspended the program under which IBM Credit purchases an interest in IBM’s trade account receivables which has resulted in a reduction of short-term purchased receivables from IBM. These receivables are primarily for IT-related products and services, which are due within i 30 days, and IBM performs all servicing under these arrangements. These receivables are included within the Commercial Financing segment. The company also participates in receivables from IBM for certain long-term financing receivables generated from IBM’s Total Solution Offerings in certain countries as well as for certain government and other contracts. These receivables are included in the Client Financing segment. The company carries the credit risk of IBM’s clients for all purchased and participated receivables from IBM.
i
/66
Notes to Consolidated Financial Statements – (continued)
| | | | | | | | | | | | |
| | | | | | Client Loans and | | | ||||
| | | | Commercial | | Installment | | | ||||
(Dollars in millions) | | Investment in | | Financing | | Payments | | | ||||
| Leases |
| Receivables |
| (Loans) |
| Total | |||||
Financing receivables, gross | | $ | i 4,626 | | $ | i 3,400 | | $ | i 9,566 | | $ | i 17,592 |
Unearned income | | | ( i 384) | | | ( i 4) | | | ( i 373) | | | ( i 761) |
Deferred initial direct costs | | | i 32 | | | — | | | i 71 | | | i 103 |
Recorded investment | | $ | i 4,274 | | $ | i 3,396 | | $ | i 9,264 | | $ | i 16,934 |
Allowance for credit losses | | | ( i 56) | | | ( i 9) | | | ( i 82) | | | ( i 148) |
Unguaranteed residual value | | | i 531 | | | — | | | — | | | i 531 |
Guaranteed residual value | | | i 47 | | | — | | | — | | | i 47 |
Total financing receivables, net | | $ | i 4,796 | | $ | i 3,387 | | $ | i 9,181 | | $ | i 17,365 |
| | | | | | | | | | | | |
| | | | | | Client Loans and | | | ||||
| | | | Commercial | | Installment | | | ||||
(Dollars in millions) | | Investment in | | Financing | | Payments | | | ||||
| Leases |
| Receivables |
| (Loans) |
| Total | |||||
Financing receivables, gross | | $ | i 5,120 | | $ | i 11,422 | | $ | i 9,694 | | $ | i 26,236 |
Unearned income | | | ( i 411) | | | ( i 36) | | | ( i 453) | | | ( i 900) |
Deferred initial direct costs | | | i 46 | | | — | | | i 73 | | | i 119 |
Recorded investment | | $ | i 4,755 | | $ | i 11,386 | | $ | i 9,314 | | $ | i 25,455 |
Allowance for credit losses | | | ( i 65) | | | ( i 11) | | | ( i 98) | | | ( i 174) |
Unguaranteed residual value | | | i 491 | | | — | | | — | | | i 491 |
Guaranteed residual value | | | i 77 | | | — | | | — | | | i 77 |
Total financing receivables, net | | $ | i 5,258 | | $ | i 11,374 | | $ | i 9,216 | | $ | i 25,848 |
Purchased and participated receivables from IBM
| | | | | | |
(Dollars in millions) |
| | | | | |
At December 31: |
| 2019 |
| 2018 | ||
Short-term purchased receivables from IBM | | $ | i 56 | | $ | i 1,373 |
Allowance for credit losses | |
| i 0 | |
| ( i 4) |
Total short-term purchased receivables from IBM, net | | $ | i 56 | | $ | i 1,369 |
| | | | | | |
Long-term participated receivables from IBM | | $ | i 4,310 | | $ | i 4,079 |
Allowance for credit losses | |
| ( i 7) | |
| ( i 14) |
Total long-term participated receivables from IBM, net | | $ | i 4,303 | | $ | i 4,065 |
| | | | | | |
Total purchased and participated receivables from IBM, net | | $ | i 4,359 | | $ | i 5,433 |
The company utilizes certain of its financing receivables as collateral for non-recourse borrowings. Financing receivables pledged as collateral for borrowings were $ i 1,062 million and $ i 710 million at December 31, 2019 and 2018, respectively.
The company did not have any financing receivables held for sale as of December 31, 2019 and 2018.
Financing Receivables by Portfolio Segment
The following tables present the recorded investment in financing receivables and participated receivables from IBM, by portfolio segment and by class, excluding Commercial Financing receivables, purchased receivables from IBM and other miscellaneous financing receivables at December 31, 2019 and 2018. Commercial Financing receivables and purchased receivables from IBM are excluded from the presentation of financing receivables by portfolio segment as they are short
67
Notes to Consolidated Financial Statements – (continued)
term in nature and the current estimated risk of loss and resulting impact to the company’s financing results are not material.
i
| | | | | | | | | | | | |
(Dollars in millions) |
| | |
| | |
| | |
| | |
| Americas | | EMEA | | Asia Pacific | | Total | |||||
Recorded investment | | | | | | | | | | | | |
Lease receivables |
| $ | i 3,160 |
| $ | i 710 |
| $ | i 404 |
| $ | i 4,274 |
Loan receivables |
|
| i 6,173 |
|
| i 2,415 |
|
| i 676 |
|
| i 9,264 |
Participated receivables from IBM | | | i 717 | | | i 1,671 | | | i 1,922 | | | i 4,310 |
Ending balance | | $ | i 10,049 | | $ | i 4,796 | | $ | i 3,003 | | $ | i 17,848 |
Recorded investment collectively evaluated for impairment | | $ | i 9,957 | | $ | i 4,770 | | $ | i 2,993 | | $ | i 17,720 |
Recorded investment individually evaluated for impairment | | $ | i 92 | | $ | i 26 | | $ | i 10 | | $ | i 128 |
| | | | | | | | | | | | |
Allowance for credit losses | |
| | |
| | |
| | |
| |
Beginning balance at January 1, 2019 | |
| | |
| | |
| | |
| |
Lease receivables |
| $ | i 38 |
| $ | i 17 |
| $ | i 10 |
| $ | i 65 |
Loan receivables |
|
| i 66 |
|
| i 28 |
|
| i 5 |
|
| i 98 |
Participated receivables from IBM |
|
| i 3 |
|
| i 8 |
|
| i 3 |
|
| i 14 |
Total | | $ | i 107 | | $ | i 53 | | $ | i 17 | | $ | i 177 |
Write-offs |
| $ | ( i 14) |
| $ | ( i 10) |
| $ | ( i 4) |
| $ | ( i 29) |
Recoveries |
|
| i 0 |
|
| i 0 |
|
| i 0 |
|
| i 1 |
Provision/(benefit) |
|
| i 7 |
|
| ( i 6) |
|
| ( i 2) |
|
| ( i 2) |
Foreign currency translation adjustment |
|
| ( i 1) |
|
| i 0 |
|
| i 0 |
|
| ( i 1) |
Other |
|
| i 0 |
|
| i 0 |
|
| i 0 |
|
| i 0 |
Ending balance at December 31, 2019 | | $ | i 98 | | $ | i 36 | | $ | i 11 | | $ | i 146 |
Lease receivables |
| $ | i 27 |
| $ | i 21 |
| $ | i 8 |
| $ | i 56 |
Loan receivables |
| $ | i 68 |
| $ | i 12 |
| $ | i 2 |
| $ | i 82 |
Participated receivables from IBM |
| $ | i 3 |
| $ | i 3 |
| $ | i 1 |
| $ | i 7 |
| | | | | | | | | | | | |
Related allowance, collectively evaluated for impairment | | $ | i 23 | | $ | i 11 | | $ | i 3 | | $ | i 36 |
Related allowance, individually evaluated for impairment | | $ | i 75 | | $ | i 26 | | $ | i 9 | | $ | i 110 |
Write-offs of lease and loan receivables were $ i 17 million and $ i 11 million, respectively, in 2019. Provisions for credit losses recorded for lease receivables and participated receivables from IBM were an addition of $ i 5 million and a release of $ i 6 million, respectively, in 2019.
The average recorded investment of impaired leases and loans for Americas, EMEA and Asia Pacific was $ i 96 million, $ i 29 million and $ i 12 million, respectively, for the year ended December 31, 2019. 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, 2019.
68
Notes to Consolidated Financial Statements – (continued)
| | | | | | | | | | | | |
(Dollars in millions) |
| | |
| | |
| | |
| | |
| Americas | | EMEA | | Asia Pacific | | Total | |||||
Recorded investment | | | | | | | | | | | | |
Lease receivables | | $ | i 3,433 |
| $ | i 687 |
| $ | i 635 |
| $ | i 4,755 |
Loan receivables | |
| i 6,167 |
|
| i 2,231 |
|
| i 916 |
|
| i 9,314 |
Participated receivables from IBM | | | i 735 | | | i 1,627 | | | i 1,717 | | | i 4,079 |
Ending balance | | $ | i 10,335 | | $ | i 4,545 | | $ | i 3,268 | | $ | i 18,147 |
Recorded investment collectively evaluated for impairment | | $ | i 10,239 | | $ | i 4,505 | | $ | i 3,254 | | $ | i 17,998 |
Recorded investment individually evaluated for impairment | | $ | i 96 | | $ | i 39 | | $ | i 13 | | $ | i 149 |
| | | | | | | | | | | | |
Allowance for credit losses | |
|
| |
|
| |
|
| |
|
|
Beginning balance at January 1, 2018 | |
|
| |
|
| |
|
| |
|
|
Lease receivables | | $ | i 42 |
| $ | i 6 |
| $ | i 15 |
| $ | i 62 |
Loan receivables | |
| i 57 |
|
| i 34 |
|
| i 4 |
|
| i 96 |
Participated receivables from IBM |
|
| i 9 |
|
| i 4 |
|
| i 2 |
|
| i 14 |
Total | | $ | i 107 | | $ | i 43 | | $ | i 21 | | $ | i 172 |
Write-offs | | $ | ( i 6) | | $ | ( i 1) |
| $ | ( i 8) |
| $ | ( i 16) |
Recoveries | |
| — | |
| — |
|
| i 2 |
|
| i 2 |
Provision | |
| i 11 | |
| i 13 |
|
| i 3 |
|
| i 27 |
Foreign currency translation adjustment | |
| ( i 6) | |
| ( i 3) |
|
| ( i 1) |
|
| ( i 10) |
Other | |
| i 1 | |
| i 1 |
|
| i 1 |
|
| i 2 |
Ending balance at December 31, 2018 | | $ | i 107 | | $ | i 53 | | $ | i 17 | | $ | i 177 |
Lease receivables | | $ | i 38 | | $ | i 17 | | $ | i 10 | | $ | i 65 |
Loan receivables | | $ | i 66 | | $ | i 28 | | $ | i 5 | | $ | i 98 |
Participated receivables from IBM | | $ | i 3 | | $ | i 8 | | $ | i 3 | | $ | i 14 |
| | | | | | | | | | | | |
Related allowance, collectively evaluated for impairment | | $ | i 38 | | $ | i 15 | | $ | i 4 | | $ | i 56 |
Related allowance, individually evaluated for impairment | | $ | i 69 | | $ | i 38 | | $ | i 13 | | $ | i 120 |
Write-offs of lease and loan receivables were $ i 13 million and $ i 3 million, respectively, in 2018. Provisions for credit losses recorded for lease receivables, loan receivables and participated receivables from IBM were $ i 9 million, $ i 6 million and $ i 12 million, respectively, in 2018.
The average recorded investment of impaired leases and loans for Americas, EMEA and Asia Pacific was $ i 80 million, $ i 39 million and $ i 18 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.
When determining the allowances, financing receivables are evaluated either on an individual or a collective basis. For the company’s policy on calculating allowance for credit losses, refer to note A, “Significant Accounting Policies.”
69
Notes to Consolidated Financial Statements – (continued)
Past Due Financing Receivables
The company considers a clients’ financing receivables past due when an installment is aged over i 90 days. The following table summarizes the information about the recorded investment in lease and loan receivables and participated receivables from IBM, including recorded investments aged over i 90 days and still accruing, billed invoices aged over i 90 days and recorded investment not accruing.
i
| | | | | | | | | | | | | | | |
| | | | | | | | Recorded | | Billed | | Recorded | |||
| | Total | | Recorded | | Investment | | Invoices | | Investment | |||||
(Dollars in millions) | | Recorded | | Investment | | > 90 Days and | | > 90 Days and | | Not | |||||
| Investment |
| > 90 Days (1) |
| Accruing (1) |
| Accruing |
| Accruing (2) | ||||||
Americas | | $ | i 3,160 | | $ | i 179 | | $ | i 143 | | $ | i 10 | | $ | i 37 |
EMEA | |
| i 710 | | | i 24 | | | i 11 | | | i 1 | | | i 16 |
Asia Pacific | |
| i 404 | | | i 9 | | | i 2 | | | i 0 | | | i 7 |
Total lease receivables |
| $ | i 4,274 |
| $ | i 213 |
| $ | i 156 |
| $ | i 11 |
| $ | i 59 |
| | | | | | | | | | | | | | | |
Americas |
| $ | i 6,173 | | $ | i 107 | | $ | i 66 | | $ | i 10 | | $ | i 56 |
EMEA | |
| i 2,415 | | | i 51 | | | i 3 | | | i 1 | | | i 51 |
Asia Pacific | |
| i 676 | | | i 3 | | | i 1 | | | i 0 | | | i 2 |
Total loan receivables |
| $ | i 9,264 |
| $ | i 161 |
| $ | i 69 |
| $ | i 11 |
| $ | i 110 |
| | | | | | | | | | | | | | | |
Americas |
| $ | i 717 | | $ | i 8 | | $ | i 8 | | $ | i 1 | | $ | i 0 |
EMEA | |
| i 1,671 | | | i 7 | | | i 7 | | | i 1 | | | i 1 |
Asia Pacific | |
| i 1,922 | | | i 6 | | | i 5 | | | i 1 | | | i 1 |
Total participated receivables from IBM |
| $ | i 4,310 |
| $ | i 21 |
| $ | i 20 |
| $ | i 3 |
| $ | i 2 |
| | | | | | | | | | | | | | | |
Total |
| $ | i 17,848 |
| $ | i 394 |
| $ | i 245 |
| $ | i 25 |
| $ | i 171 |
(1) | At a contract level, which includes total billed and unbilled amounts for financing receivables aged greater than i 90 days. |
(2) | Of the recorded investment not accruing, $ i 128 million is individually evaluated for impairment with a related allowance of $ i 110 million. |
/70
Notes to Consolidated Financial Statements – (continued)
| | | | | | | | | | | | | | | |
| | | | | | | | Recorded | | Billed | | Recorded | |||
| | Total | | Recorded | | Investment | | Invoices | | Investment | |||||
(Dollars in millions) | | Recorded | | Investment | | > 90 Days and | | > 90 Days and | | Not | |||||
| Investment |
| > 90 Days (1) |
| Accruing (1) |
| Accruing |
| Accruing (2) | ||||||
Americas | | $ | i 3,433 | | $ | i 288 | | $ | i 247 | | $ | i 18 | | $ | i 44 |
EMEA | |
| i 687 | | | i 24 | | | i 9 | | | i 1 | | | i 15 |
Asia Pacific | |
| i 635 | | | i 29 | | | i 19 | | | i 2 | | | i 11 |
Total lease receivables |
| $ | i 4,755 |
| $ | i 341 |
| $ | i 275 |
| $ | i 21 |
| $ | i 70 |
| | | | | | | | | | | | | | | |
Americas |
| $ | i 6,167 | | $ | i 217 | | $ | i 161 | | $ | i 22 | | $ | i 61 |
EMEA | |
| i 2,231 | | | i 80 | | | i 24 | | | i 3 | | | i 57 |
Asia Pacific | |
| i 916 | | | i 13 | | | i 9 | | | i 1 | | | i 4 |
Total loan receivables |
| $ | i 9,314 |
| $ | i 310 |
| $ | i 194 |
| $ | i 25 |
| $ | i 122 |
| | | | | | | | | | | | | | | |
Americas |
| $ | i 735 | | $ | i 11 | | $ | i 11 | | $ | i 2 | | $ | — |
EMEA | |
| i 1,627 | | | i 9 | | | i 4 | | | i 1 | | | i 5 |
Asia Pacific | |
| i 1,717 | | | — | | | — | | | — | | | — |
Total participated receivables from IBM |
| $ | i 4,079 |
| $ | i 20 |
| $ | i 15 |
| $ | i 3 |
| $ | i 5 |
| | | | | | | | | | | | | | | |
Total |
| $ | i 18,147 |
| $ | i 671 |
| $ | i 484 |
| $ | i 49 |
| $ | i 197 |
(1) | At a contract level, which includes total billed and unbilled amounts for financing receivables aged greater than i 90 days. |
(2) | Of the recorded investment not accruing, $ i 149 million is individually evaluated for impairment with a related allowance of $ i 120 million. |
Credit Quality Indicators
The company’s credit quality indicators, which are based on rating agency data, publicly available information and information provided by clients, as well as other information, 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 client credit ratings.
The following tables present the net recorded investment for each class of receivables, by credit quality indicator, at December 31, 2019 and 2018. 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 risk to third parties.
i
| | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Lease Receivables | | Loan Receivables | | Participated Receivables from IBM | |||||||||||||||||||||
(Dollars in millions) | | | | | | | Asia | | | | | | | | Asia | | | | | | | | Asia | ||||
| Americas |
| EMEA |
| Pacific |
| Americas |
| EMEA |
| Pacific |
| Americas |
| EMEA |
| Pacific | ||||||||||
Credit Ratings: | |
| | |
| | |
| | |
| | |
| | |
| | |
| | |
| | |
| |
Aaa – Aa3 | | $ | i 305 | | $ | i 55 | | $ | i 31 | | $ | i 732 | | $ | i 89 | | $ | i 89 | | $ | i 440 | | $ | i 88 | | $ | i 89 |
A1 – A3 | |
| i 700 | |
| i 88 | |
| i 124 | |
| i 1,166 | |
| i 178 | |
| i 237 | |
| i 71 | |
| i 271 | |
| i 934 |
Baa1 – Baa3 | |
| i 949 | |
| i 153 | |
| i 83 | |
| i 1,756 | |
| i 907 | |
| i 107 | |
| i 104 | |
| i 762 | |
| i 500 |
Ba1 – Ba2 | |
| i 733 | |
| i 206 | |
| i 61 | |
| i 1,461 | |
| i 532 | |
| i 159 | |
| i 49 | |
| i 442 | |
| i 245 |
Ba3 – B1 | |
| i 196 | |
| i 137 | |
| i 62 | |
| i 444 | |
| i 455 | |
| i 46 | |
| i 43 | |
| i 88 | |
| i 126 |
B2 – B3 | |
| i 236 | |
| i 45 | |
| i 32 | |
| i 513 | |
| i 228 | |
| i 33 | |
| i 4 | |
| i 18 | |
| i 26 |
Caa – D | |
| i 13 | |
| i 5 | |
| i 2 | |
| i 32 | |
| i 15 | |
| i 3 | |
| i 2 | |
| i 0 | |
| i 2 |
Total | | $ | i 3,133 | | $ | i 689 | | $ | i 396 | | $ | i 6,105 | | $ | i 2,403 | | $ | i 674 | | $ | i 714 | | $ | i 1,668 | | $ | i 1,921 |
/71
Notes to Consolidated Financial Statements – (continued)
| | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Lease Receivables | | Loan Receivables | | Participated Receivables from IBM | |||||||||||||||||||||
(Dollars in millions) | | | | | | | | Asia | | | | | | | | Asia | | | | | | | | Asia | |||
| Americas |
| EMEA |
| Pacific |
| Americas |
| EMEA |
| Pacific |
| Americas |
| EMEA |
| Pacific | ||||||||||
Credit Ratings: | |
| | |
| | |
| | |
| | |
| | |
| | |
| | |
| | |
| |
Aaa – Aa3 | | $ | i 520 | | $ | i 24 | | $ | i 49 | | $ | i 935 | | $ | i 79 | | $ | i 71 | | $ | i 112 | | $ | i 58 | | $ | i 134 |
A1 – A3 | |
| i 617 | |
| i 82 | |
| i 241 | |
| i 1,108 | |
| i 269 | |
| i 351 | |
| i 133 | |
| i 198 | |
| i 659 |
Baa1 – Baa3 | |
| i 807 | |
| i 214 | |
| i 169 | |
| i 1,450 | |
| i 704 | |
| i 246 | |
| i 174 | |
| i 517 | |
| i 463 |
Ba1 – Ba2 | |
| i 772 | |
| i 207 | |
| i 102 | |
| i 1,387 | |
| i 681 | |
| i 149 | |
| i 167 | |
| i 500 | |
| i 280 |
Ba3 – B1 | |
| i 391 | |
| i 90 | |
| i 36 | |
| i 703 | |
| i 297 | |
| i 52 | |
| i 84 | |
| i 218 | |
| i 99 |
B2 – B3 | |
| i 264 | |
| i 47 | |
| i 26 | |
| i 475 | |
| i 156 | |
| i 37 | |
| i 57 | |
| i 114 | |
| i 70 |
Caa – D | |
| i 23 | |
| i 5 | |
| i 3 | |
| i 42 | |
| i 17 | |
| i 5 | |
| i 5 | |
| i 12 | |
| i 9 |
Total | | $ | i 3,395 | | $ | i 670 | | $ | i 625 | | $ | i 6,101 | | $ | i 2,204 | | $ | i 912 | | $ | i 733 | | $ | i 1,618 | | $ | i 1,714 |
Troubled Debt Restructurings
The company did not have any significant troubled debt restructurings for the years ended December 31, 2019, 2018 and 2017.
iNOTE G. OTHER ASSETS
i
| | | | | | |
(Dollars in millions) | | | | | | |
At December 31: |
| 2019 |
| 2018 | ||
Deferred taxes | | $ | i 142 | | $ | i 120 |
Other receivables | | | i 42 | | | i 104 |
Prepaid taxes | |
| i 94 | |
| i 95 |
Derivatives | |
| i 45 | |
| i 18 |
Other | |
| i 84 | |
| i 35 |
Total | | $ | i 406 | | $ | i 373 |
/
iNOTE H. BORROWINGS
The company may, at times, pledge financing receivables as collateral for non-recourse short- and long-term borrowings. The amount of such non-recourse borrowings are reflected in the short- and long-term debt tables below.
Short-Term Debt
i
| | | | | | |
| | At December 31, | | At December 31, | ||
(Dollars in millions) |
| 2019 |
| 2018 | ||
Commercial paper | | $ | i 304 | | $ | i 2,995 |
Short-term loans | | | i 49 | | | i 17 |
Secured borrowings | | | i 280 | | | i 23 |
Debt | | $ | i 633 | | $ | i 3,035 |
Debt payable to IBM | |
| i 8,194 | |
| i 10,223 |
Total | | $ | i 8,827 | | $ | i 13,258 |
IBM Credit maintains a commercial paper program under which the company is permitted to issue unsecured commercial paper notes from time to time, up to a maximum aggregate amount outstanding at any one time of $ i 5 billion. The proceeds of the commercial paper can be used for general corporate purposes, including, among other items, the repayment of indebtedness and other short-term liquidity needs. The maturity of the commercial paper notes issued can vary but may not exceed i 364 days from the date of issuance. The notes are sold under customary terms in the commercial paper marketplace, and can be issued either at a discount from par or at par, and bear interest rates as agreed upon under the terms and conditions of the agreements between the company and each commercial paper dealer.
/72
Notes to Consolidated Financial Statements – (continued)
The weighted-average interest rate for commercial paper was i 1.6 percent and i 2.5 percent at December 31, 2019 and December 31, 2018, respectively.
The weighted-average interest rate for short-term loans was i 5.2 percent and i 4.3 percent at December 31, 2019 and 2018, respectively, and relates primarily to borrowings in North America.
The weighted-average interest rate for secured borrowings was i 3.6 percent and i 6.9 percent at December 31, 2019 and 2018, respectively. Short-term financing receivables pledged as collateral for short-term secured borrowings were $ i 280 million at December 31, 2019 and $ i 23 million at December 31, 2018.
The weighted-average interest rate for debt payable to IBM was i i 1.6 / percent in each period of December 31, 2019 and 2018.
Long-Term Debt
Pre-Swap Borrowing
i
| | | | | | | | |
|
| |
| Balance |
| Balance | ||
(Dollars in millions) |
| Maturities | | 12/31/2019 |
| 12/31/2018 | ||
Long-term notes (weighted-average interest rate at December 31, 2019) | | | | | | | | |
i 2.2% | | 2019 | | $ | — | | $ | i 1,400 |
i 2.9% | | 2020 | | | i 1,500 | | | i 1,500 |
i 2.5% | | 2021 | | | i 2,850 | | | i 2,850 |
i 2.2% | | 2022 | | | i 500 | | | i 500 |
i 3.0% | | 2023 | | | i 750 | | | i 750 |
| | | | $ | i 5,600 | | $ | i 7,000 |
| | | | | | | | |
Long-term loans ( i 5.4% weighted-average interest rate at December 31, 2019) | | 2020-2021 | | | i 113 | | | i 276 |
Secured borrowings ( i 5.2% weighted-average interest rate at December 31, 2019) | | 2020-2025 | | | i 781 | | | i 687 |
Long-term debt | | | | $ | i 6,495 | | $ | i 7,964 |
Less: net unamortized discount | | | | | i 1 | | | i 2 |
Less: net unamortized debt issuance costs | | | | | i 5 | | | i 9 |
Add: fair value adjustment* | | | | | i 28 | | | ( i 34) |
Debt | | | | $ | i 6,517 | | $ | i 7,919 |
Debt payable to IBM (1.5% weighted-average interest rate at December 31, 2019) | | | |
| i 8,751 | |
| i 9,357 |
Total | | | | $ | i 15,268 | | $ | i 17,276 |
* | 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. |
The company utilizes certain of its financing receivables as collateral. Long-term financing receivables pledged as collateral for long-term secured borrowings were $ i 781 million at December 31, 2019 and $ i 687 million at December 31, 2018, and relate primarily to borrowings in North America and Latin America.
The company has a shelf registration statement in place with the SEC allowing it to offer for sale public debt securities. The company issued fixed- and floating-rate debt securities in September 2017 in the aggregate amount of $ i 3,000 million with maturity dates ranging from 2019 to 2022. During 2018, the company issued fixed- and floating-rate debt securities in the aggregate amount of $ i 4,000 million with maturity dates ranging from 2020 to 2023. There were i no issuances of debt securities in 2019. The net proceeds from the issuance of debt securities are utilized for general corporate purposes. This debt is included in the long-term debt table above.
73
Notes to Consolidated Financial Statements – (continued)
The company’s indenture governing its debt securities contains significant covenants which obligate the company to promptly pay principal and interest, limit the aggregate amount of liens (other than permitted liens) to i 15 percent of the company’s consolidated net tangible assets, and restrict the company’s ability to merge or consolidate unless certain conditions are met.
Post Swap Borrowing (Long-Term Debt)
i
| | | | | | | | | | | | |
| | 2019 | | | 2018 |
| ||||||
| | | | | Weighted-Average | | | | | | Weighted-Average | |
(Dollars in millions) | | | | | Interest | | | | | | Interest | |
For the year ended December 31: |
| Amount |
| Rate |
| | Amount |
| Rate |
| ||
Fixed-rate debt | | | | | | | | | | | | |
Debt | | $ | i 1,846 | | i 3.8 | % | | $ | i 1,967 |
| i 3.9 | % |
Debt payable to IBM | | | i 8,676 | | i 1.5 | % | | | i 9,281 | | i 1.3 | % |
Total fixed-rate debt | | $ | i 10,521 | | | | | $ | i 11,248 | | | |
Floating-rate debt | | | | | | | | | | | | |
Debt* | | $ | i 4,671 | | i 2.5 | % | | $ | i 5,952 | | i 3.1 | % |
Debt payable to IBM | | | i 75 | | ( i 0.4) | % | | | i 77 | | ( i 0.3) | % |
Total floating-rate debt | | $ | i 4,746 | | | | | $ | i 6,028 | | | |
Total debt | | $ | i 6,517 | | | | | $ | i 7,919 | | | |
Total debt payable to IBM | | | i 8,751 | | | | | | i 9,357 | | | |
Total | | $ | i 15,268 | | | | | $ | i 17,276 |
|
| |
* | Includes $ i 2,550 million in 2019 and $ i 3,350 million in 2018 of notional interest rate swaps that effectively convert fixed-rated long-term debt into floating-rate long-term debt. (See note D, "Financial Instruments," for additional information.) |
Pre-swap annual contractual obligations of long-term debt and long-term debt payable to IBM outstanding at December 31, 2019 are as follows:
i
| | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | 2025 and | | | | ||
(Dollars in millions) |
| 2020 |
| 2021 |
| 2022 |
| 2023 |
| 2024 |
| beyond |
| Total | |||||||
Long-term debt | | $ | i 1,986 | | $ | i 3,151 | | $ | i 591 | | $ | i 764 | | $ | i 2 | | $ | i 0 | | $ | i 6,495 |
Debt payable to IBM | |
| i 3,961 | |
| i 2,484 | |
| i 1,362 | |
| i 679 | |
| i 200 | |
| i 65 | |
| i 8,751 |
Total | | $ | i 5,947 | | $ | i 5,635 | | $ | i 1,953 | | $ | i 1,443 | | $ | i 202 | | $ | i 65 | | $ | i 15,246 |
Interest on Debt
The company recognized interest expense of $ i 499 million, $ i 503 million and $ i 362 million for the years ended December 31, 2019, 2018 and 2017, respectively, of which $ i 242 million, $ i 298 million and $ i 265 million was interest expense on debt payable to IBM, respectively.
Lines of Credit
The company has committed lines of credit in some of the geographies which are not significant in the aggregate. Interest rates and other terms of borrowing under these lines of credit vary from country to country, depending on local market conditions.
On July 18, 2019, IBM and the company (together, the Borrowers) entered into a new $ i 2.5 billion, i 364-Day Credit Agreement to replace the maturing $ i 2.5 billion, i 364-Day agreement, and also amended the existing $ i 2.5 billion i Three-Year Credit Agreement (together, the Credit Agreements). The new maturity date for the i Three-Year Agreement is July 20, 2022. The facility size remains unchanged. The Credit Agreements permit the Borrowers to borrow up to an aggregate of $ i 5 billion on a revolving basis. Neither Borrower is a guarantor or co-obligor of the other Borrower under the Credit Agreements. Subject to certain conditions stated in the Credit Agreements, the Borrowers may borrow, prepay
74
Notes to Consolidated Financial Statements – (continued)
and re-borrow amounts under the Credit Agreements at any time during the 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. As of December 31, 2019, the company had i no borrowings outstanding against the Credit Agreements. The company incurred charges of $ i 1.6 million in 2019 and $ i 1.4 million in 2018 related to the Credit Agreements. These charges are recorded as financing cost in the Consolidated Statement of Earnings.
The company’s Credit Agreements each contain significant debt covenants, which obligate the company to promptly pay principal and interest, limit the aggregate amount of secured indebtedness and sale and leaseback transactions to i 10 percent of IBM’s consolidated net tangible assets, and restrict the ability of the company or IBM to merge or consolidate with a third party unless certain conditions are met. The Credit Agreements also include several financial covenants, including that (i) IBM will not permit the consolidated net interest expense ratio, for any period of four consecutive fiscal quarters taken as a single accounting period, to be less than i 2.20 to 1.0; (ii) the company will not permit its tangible net worth to be less than $ i 50 million as of the end of the fiscal year and (iii) the company’s leverage ratio cannot be greater than i 11 to 1 as of the last day of the fiscal quarter. The Credit Agreements each contain a cross default provision with respect to other defaulted indebtedness of at least $ i 500 million.
The company is in compliance with all of its significant debt covenants, and is obligated to provide periodic certifications to its lenders. The failure to comply with its debt covenants could constitute an event of default. If certain events of default were to occur, the principal and interest on the debt to which any event of default applied would become immediately due and payable. The Borrowers are also restricted from amending, modifying or terminating the Support Agreement in any manner materially adverse to the lenders. For additional information regarding the Support Agreement, see note C, “Relationship with IBM and Related Party Transactions.”
iNOTE I. OTHER LIABILITIES
i
| | | | | | |
(Dollars in millions) |
| | |
|
| |
At December 31: |
| 2019 |
| 2018 | ||
Post-retirement Benefits and Accrued Compensation | | $ | i 85 | | $ | i 67 |
Deferred Income | |
| i 36 | |
| i 26 |
Derivatives | | | i 18 | | | i 37 |
Accrued Interest | | | i 54 | | | i 68 |
Other | |
| i 31 | |
| i 48 |
Total | | $ | i 224 | | $ | i 246 |
/
75
Notes to Consolidated Financial Statements – (continued)
NOTE J. EQUITY ACTIVITY
IBM Credit had i i i no / / available-for-sale securities and i i i no / / unrealized gains or (losses) on cash flow hedges during the periods presented in the following tables:
iReclassifications and Taxes Related to Items of Other Comprehensive Income
| | | | | | | | | |
(Dollars in millions) | | Before Tax | | Tax (Expense)/ | | Net of Tax | |||
For the year ended December 31, 2019: | | Amount |
| Benefit |
| Amount | |||
Other comprehensive income/(loss): | | | |
| | | | | |
Foreign currency translation adjustments |
| $ | i 14 | | $ | ( i 3) | | $ | i 11 |
Retirement-related benefit plans (1): |
| | | | | | | | |
Net (losses)/gains arising during the period | | $ | ( i 14) | | $ | i 4 | | $ | ( i 10) |
Curtailments and settlements | |
| i 0 | | | i 0 | | | i 0 |
Amortization of prior service (credits)/costs | |
| i 0 | | | i 0 | | | i 0 |
Amortization of net (gains)/losses | |
| i 2 | | | ( i 1) | | | i 1 |
Total retirement-related benefit plans |
| $ | ( i 12) | | $ | i 3 | | $ | ( i 9) |
Other comprehensive income/(loss) | | $ | i 1 | | $ | i 1 | | $ | i 2 |
(1) | These AOCI components are included in the computation of net periodic pension cost. (See note M, "Retirement-Related Benefits," for additional information.) |
| | | | | | | | | |
(Dollars in millions) | | Before Tax | | Tax (Expense)/ | | Net of Tax | |||
For the year ended December 31, 2018: |
| Amount |
| Benefit |
| Amount | |||
Other comprehensive income/(loss): | | | | | | | | | |
Foreign currency translation adjustments | | $ | ( i 151) | | $ | ( i 32) | | $ | ( i 184) |
Retirement-related benefit plans (1): | | | | | | | | | |
Net (losses)/gains arising during the period | | $ | ( i 4) | | $ | i 1 | | $ | ( i 3) |
Curtailments and settlements | |
| i 0 | | | i 0 | | | i 0 |
Amortization of prior service (credits)/costs | | | ( i 1) | | | i 0 | | | ( i 1) |
Amortization of net (gains)/losses | | | i 1 | | | i 0 | | | i 1 |
Total retirement-related benefit plans | | $ | ( i 4) | | $ | i 1 | | $ | ( i 3) |
Other comprehensive income/(loss) | | $ | ( i 155) | | $ | ( i 31) | | $ | ( i 186) |
(1) | These AOCI components are included in the computation of net periodic pension cost. (See note M, "Retirement-Related Benefits,” for additional information.) |
| | | | | | | | | |
(Dollars in millions) | | Before Tax | | Tax (Expense)/ | | Net of Tax | |||
For the year ended December 31, 2017: |
| Amount |
| Benefit |
| Amount | |||
Other comprehensive income/(loss): | | | |
| | | | | |
Foreign currency translation adjustments | | $ | i 363 |
| $ | i 2 | | $ | i 365 |
Retirement-related benefit plans (1): | | | | | | | | | |
Net (losses)/gains arising during the period | | $ | i 2 |
| $ | ( i 1) | | $ | i 2 |
Curtailments and settlements | |
| i 0 | | | i 0 | | | i 0 |
Amortization of prior service (credits)/costs | |
| ( i 1) |
|
| i 0 | |
| ( i 1) |
Amortization of net (gains)/losses | |
| i 1 |
|
| i 0 | |
| i 1 |
Total retirement-related benefit plans | | $ | i 3 | | $ | ( i 1) | | $ | i 2 |
Other comprehensive income/(loss) | | $ | i 366 | | $ | i 2 | | $ | i 367 |
(1) | These AOCI components are included in the computation of net periodic pension cost. (See note M, “Retirement-Related Benefits,” for additional information.) |
76
Notes to Consolidated Financial Statements – (continued)
Accumulated Other Comprehensive Income/(Loss) (net of tax)
i | | | | | | | | | |
| | | |
| Net Change | | | | |
|
| Foreign |
| Retirement- |
| Accumulated | |||
|
| Currency |
| Related |
| Other | |||
|
| Translation |
| Benefit |
| Comprehensive | |||
(Dollars in millions) |
| Adjustments* |
| Plans |
| Income/(Loss) | |||
| $ | ( i 200) |
| $ | ( i 9) |
| $ | ( i 209) | |
Other comprehensive income before reclassification | | | i 365 | | | i 2 | | | i 367 |
Amount reclassified from accumulated other comprehensive income | | | i 0 | | | i 0 | | | i 0 |
Total change for the period | | | i 365 | | | i 2 | | | i 367 |
| | i 165 | | | ( i 7) | | | i 158 | |
Cumulative effect of a change in accounting principle** | | | ( i 5) | | | — | | | ( i 5) |
Other comprehensive income before reclassification | | | ( i 184) | | | ( i 3) | | | ( i 187) |
Amount reclassified from accumulated other comprehensive income | | | — | | | i 1 | | | i 1 |
Total change for the period | | | ( i 184) | | | ( i 3) | | | ( i 186) |
| | ( i 23) | | | ( i 10) | | | ( i 33) | |
Other comprehensive income before reclassification | | | i 11 | | | ( i 10) | | | i 1 |
Amount reclassified from accumulated other comprehensive income | | | — | | | i 1 | | | i 1 |
Total change for the period | | | i 11 | | | ( i 9) | | | i 2 |
| $ | ( i 12) |
| $ | ( i 19) |
| $ | ( i 31) |
* 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. Refer to note B, “Accounting Changes.”
/
iNOTE K. CONTINGENCIES AND COMMITMENTS
Contingencies
The company is or may be involved in a variety of ongoing claims, demands, suits, investigations, tax matters and proceedings that arise in the ordinary course of its business. Certain of these actions and proceedings are similar to suits filed against other financial institutions and captive finance companies. These include collection and bankruptcy proceedings related to the company’s leases and loans and proceedings concerning client allegations of wrongful repossession or defamation of credit.
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, client and employee relations considerations.
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. 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. As of December 31, 2019, there were no matters for which the likelihood of material loss is at least reasonably possible.
Commitments
The company’s extended lines of credit to third-party entities include unused amounts of $ i 1.8 billion and $ i 7.1 billion at December 31, 2019 and 2018, respectively. These amounts were available to the company’s Commercial Financing suppliers, distributors and resellers to support additional loan advances, or purchases of factored receivables, to meet their working capital liquidity needs. The decrease reflects the company’s wind down of its OEM IT Commercial Financing operations. In addition, the company has committed to provide future financing to its clients in connection with client purchase agreements for $ i 5.4 billion and $ i 0.5 billion at December 31, 2019 and 2018, respectively. In the
/77
Notes to Consolidated Financial Statements – (continued)
fourth quarter of 2019, the purchase of receivables and participation agreements between IBM and the company were amended to closer align the future funding commitments of the company with those of IBM.
iNOTE L. TAXES
i
| | | | | | | | | |
(Dollars in millions) |
| | |
| | |
| |
|
For the year ended December 31: |
| 2019 |
| 2018 |
| 2017 | |||
Income/(loss) before income taxes: | | | | | | | | | |
U.S. operations | | $ | ( i 71) | | $ | ( i 156) |
| $ | i 41 |
Non-U.S. operations | | | i 690 | |
| i 886 |
|
| i 713 |
Total income before income taxes | | $ | i 619 | | $ | i 731 |
| $ | i 755 |
The provision for income taxes by geographic operations is as follows:
i
| | | | | | | | | |
(Dollars in millions) |
| | |
| | |
| |
|
For the year ended December 31: | | 2019 | | 2018 | | 2017 | |||
Provision for/(benefit from) income taxes: | | | | | | | | | |
U.S. operations | | $ | i 51 | | $ | ( i 50) |
| $ | ( i 151) |
Non-U.S. operations | |
| i 137 | |
| i 184 |
|
| i 156 |
Total provision for income taxes | | $ | i 188 | | $ | i 133 |
| $ | i 5 |
The components of the provision for income taxes/(benefits) by taxing jurisdiction are as follows:
| | | | | | | | | |
(Dollars in millions) |
| | |
| | |
| |
|
For the year ended December 31: | | 2019 | | 2018 | | 2017 | |||
U.S. federal: | | | | | | | | | |
Current | | $ | ( i 9) | | $ | ( i 91) |
| $ | ( i 110) |
Deferred | |
| i 65 | |
| i 46 |
|
| ( i 40) |
Total | | $ | i 56 | | $ | ( i 45) |
| $ | ( i 150) |
| | | | | | | | | |
U.S. state and local: | | | | | | | | | |
Current | | $ | ( i 28) | | $ | ( i 21) |
| $ | ( i 21) |
Deferred | |
| i 21 | |
| i 13 |
|
| i 18 |
Total | | $ | ( i 7) | | $ | ( i 8) |
| $ | ( i 3) |
| | | | | | | | | |
Non-U.S.: | | | | | | | | | |
Current | | $ | i 158 | | $ | i 194 |
| $ | i 122 |
Deferred | |
| ( i 18) | |
| ( i 7) |
|
| i 36 |
Total | | $ | i 139 | | $ | i 186 |
| $ | i 158 |
| | | | | | | | | |
Total provision for income taxes | | $ | i 188 | | $ | i 133 |
| $ | i 5 |
If the company’s provision for income taxes had been prepared using the separate tax return method without modification for the benefits-for-loss approach, total taxes included in net income reported for 2019 and 2018 would have been $ i 52 million higher for 2019 and $ i 24 million higher for 2018 as a result of the difference in the calculation of the GILTI provision. There would be no material difference in the total taxes included in net income reported in the year 2017. For additional information, refer to note A, “Significant Accounting Policies,” to the Consolidated Financial Statements.
For the year ended December 31, 2019, the U.S. operations generated a taxable loss. As the company’s U.S. federal and certain state operations are included in various IBM consolidated tax returns, under the Tax Sharing Agreement, the benefits-for-loss approach has been applied and the losses were recorded as a current tax receivable due from IBM to be settled during the first quarter of 2020.
/78
Notes to Consolidated Financial Statements – (continued)
A reconciliation of the statutory U.S. federal tax rate to the company’s effective tax rate is as follows:
i
| | | | | | | |
For the year ended December 31: |
| 2019 |
| 2018 |
| 2017 |
|
Statutory rate |
| i 21 | % | i 21 | % | i 35 | % |
Enactment of U.S. tax reform | | i 19 | | ( i 2) | | ( i 21) | |
Tax differential on foreign income |
| ( i 6) | | i 1 | | ( i 14) | |
State and local |
| ( i 1) | | ( i 1) | | i 0 | |
Valuation allowance |
| ( i 2) | | ( i 1) | | i 1 | |
Effective rate |
| i 31 | % | i 18 | % | i 1 | % |
Percentages rounded for disclosure purposes.
The various components reflected within the tax rate reconciliation table above labeled “Tax differential on foreign income” include the effects of foreign subsidiaries’ earnings taxed at rates other than the U.S. statutory rate and U.S. taxes on foreign income. This line item also reflects the changes in the amount of unrecognized tax benefits associated with each of those components.
On December 22, 2017, U.S. tax reform introduced many changes, including lowering the U.S. corporate income tax rate to i 21 percent, allowing for full expensing for investments in certain property placed in service after September 27, 2017 and before January 1, 2023, 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 charge to tax expense of $ i 116 million and net benefits of $ i 7 million and $ i 162 million for the years ended December 31, 2019, 2018, and 2017, respectively. In 2019, the charge was related to additional tax reform guidance issued by the U.S. Treasury in January 2019 on U.S. tax reform repatriation tax. In 2018, the benefit was attributable to refinements to the one-time U.S. transition tax and foreign tax costs on undistributed foreign earnings. The benefit recorded in 2017 was the result of the re-measurement of deferred tax balances to the new U.S. federal tax rate, as well as the U.S. tax reform repatriation tax and any foreign tax costs on undistributed foreign earnings.
U.S. tax reform also introduced GILTI, which subjects a U.S. shareholder to current tax on income earned by certain foreign subsidiaries. The company has elected to treat GILTI as a period cost if and when incurred, which resulted in the company recording a benefit of $ i 49 million and $ i 20 million for the years ended December 31, 2019 and 2018 respectively as a result of foreign tax credits associated with and in excess of GILTI. Under the Tax Sharing Agreement, the benefits-for-loss approach has been applied and the excess credits were recorded as a current tax receivable due from IBM to be settled during the first quarter of 2020.
The effective tax rate for 2019 was i 30.5 percent, an increase of i 12.2 points, as compared to 2018. The year-to-year change in the effective tax rate was primarily attributable to guidance issued by the U.S. Treasury in January 2019 regarding U.S. tax reform repatriation tax ( i 20 points). This was partially offset by a year-to-year benefit due to the GILTI provision ( i 5 points).
The effect of tax law changes on deferred tax assets and liabilities did not have a material impact in 2019.
The significant components of deferred tax assets and liabilities recorded in other assets and tax liabilities, respectively, in the Consolidated Statement of Financial Position are as follows:
79
Notes to Consolidated Financial Statements – (continued)
Deferred Tax Assets
| | | | | | |
(Dollars in millions) |
| | |
| | |
At December 31: | | 2019 | | 2018 | ||
Bad debt reserves | | $ | i 56 | | $ | i 48 |
Leases | |
| i 81 | |
| i 59 |
Depreciation | |
| i 1 | |
| i 3 |
Foreign tax loss/credit carryforwards | |
| i 71 | |
| i 90 |
Other | |
| i 52 | |
| i 39 |
Gross deferred tax assets | | $ | i 261 | | $ | i 239 |
Less: valuation allowance | |
| ( i 72) | |
| ( i 86) |
Net deferred tax assets | | $ | i 189 | | $ | i 153 |
Deferred Tax Liabilities
| | | | | | |
(Dollars in millions) |
| | |
|
| |
At December 31: | | 2019 | | 2018 | ||
Leases | | $ | i 576 | | $ | i 469 |
Other | |
| i 16 | |
| i 17 |
Gross deferred tax liabilities | | $ | i 592 | | $ | i 486 |
The loss carryforwards as of December 31, 2019 and 2018 were $ i 71 million and $ i 90 million (tax effected), respectively, with all of these carryforwards available for at least two years.
The valuation allowances as of December 31, 2019, 2018 and 2017 were $ i 72 million, $ i 86 million and $ i 96 million, respectively. The amounts principally apply to loss carryforwards, credits and timing differences. 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 company is subject to taxation in the U.S. and various state and foreign jurisdictions. With respect to the company’s U.S. federal and certain state and foreign operations that are included in applicable IBM consolidated tax returns, pursuant to the Tax Sharing Agreement, any subsequent changes to the company’s income tax liability as a result of valuation allowances and tax examinations are the responsibility of IBM. Therefore, any recognition and subsequent changes in assessment about the sustainability of related tax positions, including interest and penalties, are the responsibility of IBM. As such, there have been i i i no / / uncertain tax liabilities recorded in the Consolidated Financial Statements for entities that file as part of IBM’s consolidated tax filings as the company bears no risk associated with any subsequent change in the sustainability of uncertain tax positions.
For the company’s separate income tax return filings, the company is generally no longer subject to tax examinations for years prior to 2014. Current year unrecognized tax benefits recorded in the Consolidated Financial Statements related to certain foreign separate income tax return filers were $ i 10 million at December 31, 2019 and $ i 4 million at December 31, 2018. Interest and penalties related to income tax liabilities are included in income tax expense. In 2019, interest accrued relating to income taxes was immaterial. During the year ended December 31, 2018, the company recognized a net benefit of $ i 5 million in interest expense relating to certain foreign separate income tax return filers, whereas for 2017, the company recognized a net charge of $ i 5 million in interest expense.
Within consolidated retained earnings at December 31, 2019 are undistributed after-tax earnings from certain non-U.S. subsidiaries that are not indefinitely reinvested. At December 31, 2019, the company has a deferred tax liability of $ i 9 million for the estimated taxes associated with the repatriation of these earnings.
80
Notes to Consolidated Financial Statements – (continued)
NOTE M. RETIREMENT-RELATED BENEFITS
IBM Credit employees are eligible to participate in IBM’s retirement plans. Retirement-related plans are accounted for as multiemployer, multiple-employer or defined contribution plans, as required by local regulations.
Multiemployer and Defined Contribution Plans:
IBM charges the company for multiemployer and defined contribution costs based on number of employees. The charges are recorded in the company’s operating results in the Consolidated Statement of Earnings. The amounts of (income) or expense attributed to the company by IBM for the years ended December 31, 2019, 2018 and 2017 were not material.
Charges from IBM to the company in relation to these plans (including non-pension post-retirement benefits) are limited to service costs and defined contribution cost. Contributions to multiemployer and defined contribution plans and any other types of cost are the responsibility of IBM.
Multiple-employer Plans:
For multiple-employer plans (mainly in Germany, Spain and Japan), assets and obligations are based on actuarial valuations or allocations and are recorded in the Consolidated Statement of Financial Position. The net liability for multiple-employer plans for the years ended 2019, 2018 and 2017 was $ i 57 million, $ i 44 million and $ i 40 million, respectively. The gross asset balances were $ i 42 million, $ i 36 million and $ i 37 million at December 31, 2019, 2018 and 2017, respectively. The projected benefit obligation balances were $ i 98 million, $ i 80 million and $ i 77 million at December 31, 2019, 2018 and 2017, respectively.
Actuarial losses in AOCI at December 31, 2019, 2018 and 2017 were $ i 19 million, $ i 10 million and $ i 7 million, respectively. Remeasurement gains and losses recorded to AOCI at December 31, 2019, 2018 and 2017 were losses of $ i 10 million, $ i 3 million, and a gain of $ i 2 million, respectively.
Costs related to multiple-employer plans are recorded in the company’s operating results in the Consolidated Statement of Earnings. The total costs for multiple-employer plans for years ended December 31, 2019, 2018 and 2017 were $ i 4 million, $ i 4 million and $ i 3 million, respectively.
/ iNOTE N. SEGMENT INFORMATION
The company’s operations consist of i two business segments: Client Financing and Commercial 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 in determining how to allocate resources and evaluate performance.
The company is organized on the basis of its financing offerings. The company’s reportable segments are business units that offer different financing solutions based upon the needs of the company’s clients. The segment’s assets are defined by income generating assets within each operating segment and do not represent total assets of the company.
Information about each segment’s business and the financing services that generate each segment’s revenue is located in Item 1, “Business”, and in the “Segment Details” section within Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
/81
Notes to Consolidated Financial Statements – (continued)
The company allocates interest expense and SG&A expense to each of its operating segments. Interest expense is allocated based on the average assets of each segment. SG&A expense is allocated based on a measurable financial driver, such as net margin.
i
| | | | | | | | | |
(Dollars in millions) | | Client | | Commercial | | Total | |||
| Financing |
| Financing |
| Segments | ||||
Revenue | | $ | i 1,187 | | $ | i 413 |
| $ | i 1,600 |
Pre-tax income | |
| i 434 | |
| i 184 |
|
| i 619 |
Depreciation of equipment under operating lease | |
| i 160 | |
| — |
|
| i 160 |
Interest expense | |
| i 376 | |
| i 124 |
|
| i 499 |
Provision for/(benefit from) credit losses | | | ( i 2) | | | ( i 3) | | | ( i 5) |
Assets | |
| i 22,362 | |
| i 3,443 |
|
| i 25,805 |
| | | | | | | | | |
(Dollars in millions) |
| Client |
| Commercial |
| Total | |||
| Financing |
| Financing |
| Segments | ||||
Revenue | | $ | i 1,206 | | $ | i 574 | | $ | i 1,779 |
Pre-tax income | |
| i 490 | |
| i 240 | |
| i 731 |
Depreciation of equipment under operating lease | |
| i 193 | |
| — | |
| i 193 |
Interest expense | |
| i 335 | |
| i 168 | |
| i 503 |
Provision for/(benefit from) credit losses | | | i 27 | | | ( i 18) | | | i 9 |
Assets | |
| i 22,533 | |
| i 12,743 | |
| i 35,277 |
| | | | | | | | | |
(Dollars in millions) |
| Client |
| Commercial |
| Total | |||
| Financing | | Financing | | Segments | ||||
Revenue | | $ | i 1,248 | | $ | i 454 | | $ | i 1,702 |
Pre-tax income | |
| i 574 | |
| i 181 | |
| i 755 |
Depreciation of equipment under operating lease | |
| i 231 | |
| — | |
| i 231 |
Interest expense | |
| i 246 | |
| i 116 | |
| i 362 |
Provision for credit losses | |
| i 14 | |
| i 1 | |
| i 15 |
Assets | |
| i 22,880 | |
| i 12,568 | |
| i 35,448 |
| | | | | | | | | |
(Dollars in millions) | |
|
| |
|
| |
|
|
Reconciliation of IBM Credit as reported |
| 2019 |
| 2018 |
| 2017 | |||
Assets | |
|
| |
|
| |
|
|
Total Reportable Segments |
| $ | i 25,805 |
| $ | i 35,277 |
| $ | i 35,448 |
Cash and cash equivalents | |
| i 1,687 | |
| i 1,828 | |
| i 2,680 |
Other receivables from IBM | | | i 513 | | | i 2,019 | | | i 1,024 |
Deferred taxes | |
| i 142 | |
| i 120 | |
| i 121 |
Derivatives | |
| i 45 | |
| i 18 | |
| i 3 |
Other | |
| i 219 | |
| i 235 | |
| i 240 |
Total consolidated assets |
| $ | i 28,412 |
| $ | i 39,497 |
| $ | i 39,516 |
Major Clients
i i i No / / single client represented 10 percent or more of the company’s total revenue in 2019, 2018 or 2017.
Geographic Information
The following provides information for those countries that are 10 percent or more of the specific category.
82
Notes to Consolidated Financial Statements – (continued)
Revenue*
i
| | | | | | | | | |
(Dollars in millions) | | | | | | | |
| |
For the year ended December 31: |
| 2019 |
| 2018 |
| 2017 | |||
United States | | $ | i 690 | | $ | i 678 | | $ | i 606 |
Other countries | |
| i 910 | |
| i 1,102 | |
| i 1,096 |
Total revenue | | $ | i 1,600 | | $ | i 1,779 | | $ | i 1,702 |
* | Revenues are generally attributed to countries based on the location of the client. |
Financing Receivables, Net of Allowance for Credit Losses
i
| | | | | | | | | |
(Dollars in millions) | | | | | | | |
| |
For the year ended December 31: |
| 2019 |
| 2018 |
| 2017 | |||
United States | | $ | i 9,365 | | $ | i 11,821 | | $ | i 11,892 |
Other countries | |
| i 8,000 | |
| i 14,027 | |
| i 14,174 |
Total net financing receivables | | $ | i 17,365 | | $ | i 25,848 | | $ | i 26,066 |
Equipment under Operating Lease, Net of Depreciation
i
| | | | | | | | | |
(Dollars in millions) | | | | | | | |
| |
For the year ended December 31: |
| 2019 |
| 2018 |
| 2017 | |||
United States | | $ | i 64 | | $ | i 81 | | $ | i 76 |
Other countries | |
| i 147 | |
| i 305 | |
| i 324 |
Total equipment under operating lease - net | | $ | i 212 | | $ | i 386 | | $ | i 401 |
iNOTE O. DIVESTITURE
In the fourth quarter of 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 were collected as they became due in the normal course of business. The transaction closed in the first quarter of 2019 and resulted in a pre-tax gain of $ i 16 million in 2019.
/
83
IBM CREDIT LLC AND SUBSIDIARY COMPANIES
CONSOLIDATED STATEMENT OF EARNINGS
SELECTED QUARTERLY DATA
(UNAUDITED)
| | | | | | | | | | | | | | | |
(Dollars in millions) |
| First |
| Second |
| Third |
| Fourth |
|
| | ||||
2019 | | Quarter | | Quarter | | Quarter | | Quarter | | Full Year | |||||
Revenue | | $ | 482 | | $ | 410 | | $ | 372 | | $ | 335 | | $ | 1,600 |
Net margin | |
| 277 | |
| 230 | |
| 212 | |
| 194 | |
| 913 |
Income before income taxes | |
| 193 | |
| 136 | |
| 131 | |
| 158 | |
| 619 |
Net income | |
| 43 | |
| 113 | |
| 109 | |
| 165 | |
| 430 |
| | | | | | | | | | | | | | | |
(Dollars in millions) |
| First |
| Second |
| Third |
| Fourth |
| | | ||||
2018 | | Quarter | | Quarter | | Quarter | | Quarter | | Full Year | |||||
Revenue | | $ | 449 | | $ | 433 | | $ | 452 | | $ | 446 | | $ | 1,779 |
Net margin | |
| 300 | |
| 259 | |
| 268 | |
| 256 | |
| 1,083 |
Income before income taxes | |
| 191 | |
| 148 | |
| 184 | |
| 208 | |
| 731 |
Net income | |
| 149 | |
| 117 | |
| 144 | |
| 187 | |
| 597 |
Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure.
None.
Item 9A. Controls and Procedures.
Evaluation of Disclosure Controls and Procedures. The company’s management evaluated, with the participation of the Chairman and President, and the Vice President, Finance, the effectiveness of the company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) promulgated under the Exchange Act) as of the end of the period covered by this report. Based on that evaluation, the Chairman and President, and the Vice President, Finance, have concluded that the company’s disclosure controls and procedures were effective as of the end of the latest quarter.
Management’s Report on Internal Control over Financial Reporting. Management is responsible for establishing and maintaining adequate internal control over financial reporting for 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 GAAP.
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 GAAP, 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 at December 31, 2019 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, 2019.
84
Changes in Internal Control over Financial Reporting. There has been no change in the company's internal control over financial reporting that occurred during the fourth fiscal quarter that has materially affected, or is reasonably likely to materially affect, the company's internal control over financial reporting.
Item 9B. Other Information.
None.
PART III
Item 10. Directors, Executive Officers and Corporate Governance.
IBM Credit has omitted this section pursuant to General Instruction I(2)(c) of Form 10-K.
Item 11. Executive Compensation.
IBM Credit has omitted this section pursuant to General Instruction I(2)(c) of Form 10-K.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.
IBM Credit has omitted this section pursuant to General Instruction I(2)(c) of Form 10-K.
Item 13. Certain Relationships and Related Transactions, and Director Independence.
IBM Credit has omitted this section pursuant to General Instruction I(2)(c) of Form 10-K.
Item 14. Principal Accounting Fees and Services.
As an indirect, wholly owned subsidiary of IBM, our principal accounting fees and services are subject to the pre-approval policies and procedures that govern all fees paid to, and all services performed by, PricewaterhouseCoopers (PwC) for audit and audit-related professional services and tax-related advice and services to IBM. For additional information regarding IBM’s policies and procedures, see IBM’s Proxy Statement to be filed with the SEC and delivered to IBM stockholders in connection with IBM’s Annual Meeting of Stockholders to be held on April 28, 2020. The appointment of PwC as IBM’s independent registered public accounting firm was ratified by majority vote of IBM’s shareholders during the annual shareholder’s meeting on April 30, 2019 (see IBM’s 8-K filed with the SEC on May 3, 2019).
The fees for services provided to IBM Credit by PwC for the fiscal periods indicated:
| | | | | | |
(Dollars in millions) |
| 2019 |
| 2018 | ||
Audit Fees | | $ | 6.7 | | $ | 6.6 |
Audit-Related Fees | |
| — | |
| 0.3 |
Tax Fees | |
| — | |
| — |
All Other Fees | |
| — | |
| — |
Total | | $ | 6.7 | | $ | 6.9 |
Audit Fees: comprise fees for professional services necessary to perform an audit or review in accordance with the standards of the Public Company Accounting Oversight Board, including services rendered for the audit of the company’s annual financial statements and review of quarterly financial statements. Also includes fees for services that are normally incurred in connection with statutory and regulatory filings or engagements, such as comfort letters, statutory audits, attest services, consents, and review of documents filed with the SEC.
Audit-Related Fees: comprise fees for services that are reasonably related to the performance of the audit or review of the company’s financial statements, including the support of business acquisition and divestiture activities, independent assessments for service organization control reports and audit and review of the company’s retirement and other benefit-related programs.
85
Tax Fees: comprise fees for tax compliance, tax planning and tax advice. Corporate tax services encompass a variety of permissible services, including technical tax advice related to U.S. international tax matters; assistance with foreign income and withholding tax matters, assistance with sales tax, value added tax and equivalent tax related matters in local jurisdictions/ preparation of reports to comply with local tax authority transfer pricing documentation requirements; and assistance with tax audits.
All Other Fees: comprise fees primarily in connection with certain benchmarking work and permissible advisory services.
86
PART IV
Item 15. Exhibits, Financial Statement Schedules.
(a) The following documents are filed as part of this report:
1. | Financial statements of IBM Credit and its subsidiary companies for the years ended December 31, 2019, 2018 and 2017 as indexed below. |
2. | Financial statement schedule required to be filed by Item 8 of this Form 10-K as indexed below. All other schedules are omitted as the required matter is not present, the amounts are not significant or the information is shown in the Consolidated Financial Statements or the notes thereto. |
INDEX TO FINANCIAL STATEMENTS AND SCHEDULE | Page |
Audited Annual Financial Statements | |
42 | |
Consolidated Statement of Earnings for the Years Ended December 31, 2019, 2018 and 2017 | 43 |
Consolidated Statement of Comprehensive Income for the Years Ended December 31, 2019, 2018 and 2017 | 44 |
Consolidated Statement of Financial Position as of December 31, 2019 and 2018 | 45 |
Consolidated Statement of Cash Flows for the Years Ended December 31, 2019, 2018 and 2017 | 46 |
47 | |
49 | |
92 | |
| |
Selected Quarterly Data (Unaudited) | |
Consolidated Statement of Earnings for the years ended December 31, 2019 and 2018 | 84 |
3. | Exhibits: |
| Reference |
| Description of Exhibits |
| Exhibit Number |
---|---|---|---|---|---|
| | | | | |
| (2) | | Plan of acquisition, reorganization, arrangement, liquidation or succession. | | Not applicable |
| | | | | |
| (3) | | | | |
| | | | | |
| | | | | |
| | | | | |
| | | | | |
| | | | | |
| (4) | | Instruments defining the rights of security holders. | | |
| | | | | |
87
| Reference |
| Description of Exhibits |
| Exhibit Number |
---|---|---|---|---|---|
| | | | | |
| | | | | |
| | | | | |
| | | | | |
| | | | | |
| | | | | |
| | | | | |
| | | | | |
| | | Description of Securities Registered under Section 12 of the Exchange Act. | | 4.1 |
| | | | | |
| (9) | | | Not applicable | |
| | | | | |
| (10) | | | | |
| | | | | |
| | | | | |
| | | | | |
| | | | | |
| | | | | |
| | | | | |
| | | | | |
| | | | | |
| | | | | |
88
| Reference |
| Description of Exhibits |
| Exhibit Number |
---|---|---|---|---|---|
| | | | | |
| | | | | |
| (11) | | Statement re computation of per share earnings | | Not applicable |
| | | | | |
| (12) | | Statement re computation of ratios | | Not applicable |
| | | | | |
| (13) | | Annual report to security holders | | Not applicable |
| | | | | |
| (18) | | Letter re change in accounting principles | | Not applicable |
| | | | | |
| (19) | | Previously unfiled documents | | Not applicable |
| | | | | |
| (21) | | | Not applicable* | |
| | | | | |
| (22) | | Published report regarding matters submitted to vote of security holders | | Not applicable |
| | | | | |
| (23) | | | 23.1 | |
| | | | | |
| (24) | | | 24.1 | |
| | | | | |
| | | | 24.2 | |
| | | | | |
| (31) | | | 31.1 | |
| | | | | |
| | | | 31.2 | |
| | | | | |
| (32) | | | 32.1 | |
| | | | | |
| | | | 32.2 | |
| | | | | |
| 101.INS | | XBRL Instance Document - the instance document does not appear on the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document. | | |
| | | | | |
| 101.SCH | | XBRL Taxonomy Extension Schema Document. | | |
| | | | | |
| 101.CAL | | XBRL Taxonomy Extension Calculation Linkbase Document. | | |
89
| Reference |
| Description of Exhibits |
| Exhibit Number |
---|---|---|---|---|---|
| | | | | |
| 101.DEF | | XBRL Taxonomy Extension Definition Linkbase Document. | | |
| | | | | |
| 101.LAB | | XBRL Taxonomy Extension Label Linkbase Document. | | |
| | | | | |
| 101.PRE | | XBRL Taxonomy Extension Presentation Linkbase Document. | | 101 |
| | | | | |
| 104 | | Cover Page Interactive Data File - the cover page interactive data file does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document. | | 104 |
* | IBM Credit has omitted this exhibit pursuant to General Instruction I(2)(b) of Form 10-K. |
Item 16. Form 10-K Summary.
None.
90
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
| ||
| IBM CREDIT LLC | |
| (Registrant) | |
| | |
| | |
| By: | |
| | |
| | Chairman and President |
| | |
| | Date: February 28, 2020 |
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
| | |||
Signature | | Title | | Date |
| | | | |
| Chairman and President | | ||
| (Chief Executive Officer) | | | |
| | | | |
/s/ Adam Wilson | | Vice President, Finance | | |
| (Chief Financial Officer) | | | |
| | | | |
/s/ Henry Voldman | | Director, Finance | | |
| (Controller) | | |
Simon J. Beaumont | Manager | By: | /s/ Glen Kutler |
Robert F. Del Bene | Manager | | |
Andrew P. Urbansky | Manager | | Attorney-in-fact |
| | | |
| | Date: |
91
SCHEDULE II
IBM CREDIT LLC AND SUBSIDIARY COMPANIES
VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
For the Years Ended December 31:
(Dollars in millions)
| | | | | | | | | | | | | | | |
| | Balance at | | | | | | | | | | | Balance at | ||
| | Beginning | | Additions / | | | | | | | | End | |||
Description |
| of Period |
| (Releases) 1 |
| Write-offs 2 |
| Other 3 |
| of Period | |||||
Allowance For Credit Losses: | | | | | | | | | | | | | | | |
2019 | | $ | i 192 | | $ | ( i 5) | | $ | ( i 32) | | $ | ( i 1) |
| $ | i 155 |
| | | | | | | | | | | | | | | |
2018 | | $ | i 213 | | $ | i 9 | | $ | ( i 21) | | $ | ( i 8) |
| $ | i 192 |
| | | | | | | | | | | | | | | |
2017 | | $ | i 277 | | $ | i 15 | | $ | ( i 91) | | $ | i 11 |
| $ | i 213 |
92
This ‘10-K’ Filing | Date | Other Filings | ||
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1/1/23 | ||||
7/20/22 | ||||
4/28/20 | ||||
Filed on: | 2/28/20 | |||
1/1/20 | ||||
For Period end: | 12/31/19 | |||
7/18/19 | ||||
5/3/19 | 10-Q/A | |||
4/30/19 | 10-Q | |||
2/27/19 | 10-K | |||
1/1/19 | ||||
12/31/18 | 10-K | |||
1/1/18 | ||||
12/31/17 | 10-K | |||
12/22/17 | ||||
9/27/17 | ||||
5/2/17 | ||||
4/1/17 | ||||
3/31/17 | ||||
1/1/17 | ||||
12/31/16 | ||||
List all Filings |