Liquidity and capital resources
The company has consistently generated strong cash flow from operations, providing a source of funds ranging between $14.5 billion and $16.1 billion per year over the past five years. The company provides for additional liquidity through several sources; maintaining a sizable cash balance, access to global funding sources and a committed global credit facility. The following table provides a summary of these major sources of liquidity for the years ended December 31, 2003 through 2007.
Cash flow and liquidity trends
|($ in billions)||2007||2006||2005||2004||2003|
|Net cash from operating activities||$ 16.1||$ 15.0||$ 14.9||$ 15.3||$ 14.5|
|Cash and short-term marketable securities||$ 16.1||$ 10.7||$ 13.7||$ 10.6||$ 7.6|
|Size of global credit facilities||$ 10.0||$ 10.0||$ 10.0||$ 10.0||$ 10.0|
|Trade receivables securitization facility||$ —||$ —||$ 0.5||$ 0.5||$ —|
The major rating agencies’ ratings on the company’s debt securities at December 31, 2007 appear in the following table. The Standard and Poor’s and Moody’s Investors Services ratings remain unchanged from December 31, 2006. In May 2007, Fitch Ratings lowered its ratings on senior long-term debt from AA- to A+ and on commercial paper from F1+ to F1. Fitch changed its ratings following the company’s issuance of new debt utilized to fund the ASR in the second quarter. The company has no contractual arrangements that, in the event of a change in credit rating, would result in a material adverse effect on its financial position or liquidity. The company believes its earnings and cash flow growth provide sufficient flexibility within the existing credit ratings to continue to execute its current investment, dividend and acquisition strategies.
|Standard and Poor’s||Moody’s Investors Service||Fitch Ratings|
|Senior long-term debt||A+||A1||A+|
The company prepares its Consolidated Statement of Cash Flows in accordance with SFAS No. 95, “Statement of Cash Flows,” and highlights causes and events underlying sources and uses of cash in that format in “Financial Position.” For purposes of running its business, the company manages, monitors and analyzes cash flows in a different format.
As discussed in the “Description of Business,” one of the company’s two primary objectives of its Global Financing business is to generate strong return on equity. Increasing receivables is the basis for growth in a financing business. Accordingly, management considers Global Financing receivables as a profit-generating investment, not as working capital that should be minimized for efficiency. After classifying Global Financing accounts receivables as an investment, the remaining net operational cash flow less capital expenditures is viewed by the company as the free cash flow available for investment and distribution to shareholders.
From the perspective of how management views cash flow, in 2007, free cash flow was $12.4 billion, an increase of $1.9 billion compared to 2006. This cash performance was driven primarily by the growth in Net income from continuing operations, continued focus on working capital and lower pension funding year over year.
Over the past five years, the company generated over $50 billion in free cash flow available for investment and distribution to shareholders. As a result, during that period the company invested $9.9 billion in strategic acquisitions, received $1.4 billion from divestitures and returned over $53 billion to shareholders through dividends and share repurchases. The amount of prospective returns to shareholders in the form of dividends and share repurchases will vary based upon several factors including each year’s operating results, capital expenditure requirements, research and development and acquisitions, as well as the factors discussed following the table below.
The company’s Board of Directors meets quarterly to consider the dividend payment. The company expects to fund dividend payments through cash from operations. In the second quarter of 2007, the Board of Directors increased the company’s quarterly common stock dividend from $0.30 to $0.40 per share.
The table below represents the way in which management reviews cash flow as described above.
|($ in billions)|
|For the year ended December 31:||2007||2006||2005||2004||2003|
|Net cash from operating activities (Continuing Operations)||$ 16.1||$ 15.0||$ 14.9||$ 15.3||$ 14.5|
|Less: Global Financing accounts receivable||(1.3)||(0.3)||1.8||2.5||1.9|
|Net cash from operating activities (Continuing Operations), excluding Global Financing receivables||17.4||15.3||13.1||12.9||12.6|
|Capital expenditures, net||(5.0)||(4.7)||(3.5)||(3.7)||(3.9)|
|Free cash flow (excluding Global Financing accounts receivable)||12.4||10.5||9.6||9.1||8.7|
|Non-Global Financing debt||10.9||(1.1)||1.2||0.7||(0.9)|
|Other (includes Global Financing accounts receivable and Global Financing debt)||3.8||1.1||1.9||3.1||1.0|
|Change in cash, cash equivalents and short-term marketable securities||$ 5.5||$ (3.0)||$ 3.1||$ 2.9||$ 1.7|
Events that could temporarily change the historical cash flow dynamics discussed above include significant changes in operating results, material changes in geographic sources of cash, unexpected adverse impacts from litigation or future pension funding during periods of severe and prolonged downturn in the capital markets. Whether any litigation has such an adverse impact will depend on a number of variables, which are more completely described in note N, “Contingencies and Commitments.” In January 2008, the company closed the previously announced Cognos acquisition for approximately $5.0 billion in cash; the Telelogic acquisition is also expected to close for approximately $0.8 billion following the completion of regulatory reviews. With respect to pension funding, in the first quarter of 2007, the company made a $500 million voluntary cash contribution to the U.S. nonpension postretirement plan, and in the first quarter of 2006, the company contributed approximately $1 billion to the U.K. pension plan. In addition, on January 19, 2005, the company contributed $1.7 billion to the qualified portion of the PPP, a U.S. defined benefit plan. As highlighted in the Contractual Obligations table below, the company expects to make legally mandated pension plan contributions to certain non-U.S. plans of approximately $3.3 billion in the next five years. The company is not quantifying any further impact from pension funding because it is not possible to predict future movements in the capital markets or pension plan funding regulations.
The Pension Protection Act of 2006 (the Act) was enacted into law in 2006, and, among other things, increases the funding requirements for certain U.S. defined benefit plans beginning after December 31, 2007. No mandatory contribution is required for the U.S. defined benefit plan in 2008.
|($ in millions)|
|Payments Due In|
|Total Contractual Payment Stream||2008||2009-10||2011-12||After 2012|
* Represents future pension contributions that are mandated by local regulations or statute, all associated with non-U.S. pension plans. The projected payments beyond 2012 are not currently determinable. See note U, “Retirement-Related Benefits,” for additional information on the non-U.S. plans’ investment strategies and expected contributions and for information regarding the company’s unfunded pension liability of $14,109 million at December 31, 2007.
** These amounts represent the liability for unrecognized tax benefits under FIN 48. The company estimates that approximately $772 million of the liability is expected to be settled within the next 12 months. The settlement period for the noncurrent portion of the income tax liability cannot be reasonably estimated as the timing of the payments will depend on the progress of tax examinations with the various tax authorities; however, it is not expected to be due within the next 12 months.
|Long-term debt obligations||$ 26,066||$ 3,618||$ 10,450||$ 4,629||$ 7,369|
|Capital (finance) lease obligations||297||88||135||36||38|
|Operating lease obligations||5,074||1,220||1,958||1,143||753|
|Other long-term liabilities:|
|Minimum pension funding (mandated)*||3,258||637||1,308||1,313||—|
|Long-term termination benefits||2,123||254||241||158||1,470|
|Total||$ 43,331||$ 7,440||$ 15,098||$ 7,828||$ 11,001|
Total contractual obligations are reported in the table above excluding the effects of time value and therefore, may not equal the amounts reported in the Consolidated Statement of Financial Position.
Purchase obligations include all commitments to purchase goods or services of either a fixed or minimum quantity that meet any of the following criteria: (1) they are noncancelable, (2) the company would incur a penalty if the agreement was canceled, or (3) the company must make specified minimum payments even if it does not take delivery of the contracted products or services (“take-or-pay”). If the obligation to purchase goods or services is noncancelable, the entire value of the contract is included in the table above. If the obligation is cancelable, but the company would incur a penalty if canceled, the dollar amount of the penalty is included as a purchase obligation. Contracted minimum amounts specified in take-or-pay contracts are also included in the table as they represent the portion of each contract that is a firm commitment.
In the ordinary course of business, the company enters into contracts that specify that the company will purchase all or a portion of its requirements of a specific product, commodity or service from a supplier or vendor. These contracts are generally entered into in order to secure pricing or other negotiated terms. They do not specify fixed or minimum quantities to be purchased and, therefore, the company does not consider them to be purchase obligations.
Off-Balance Sheet Arrangements
In the ordinary course of business, the company enters into off-balance sheet arrangements as defined by the SEC Financial Reporting Release 67 (FRR-67), “Disclosure in Management’s Discussion and Analysis about Off-Balance Sheet Arrangements and Aggregate Contractual Obligations.”
On May 25, 2007, the company entered into ASR agreements with three investment banks. The initial purchase price of the ASR agreements is subject to adjustment based on the volume weighted-average price of the company’s common stock over the contractual settlement period. The settlement can be effected in cash or common shares of the company at the company’s election. In accordance with Emerging Issues Task Force Issue No. 00-19, “Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock,” the financial instruments generated by this settlement mechanism are not recognized in the company’s financial statements until settlement, at which time the settlement payment or receipt is recorded in Stockholders’ equity. The liquidity risk related to the settlement of these contracts is mitigated by the company’s contractual ability to elect cash or share settlement. Additionally, these contracts restrict the maximum amount of shares potentially deliverable by the company. Refer to note M, “Stockholders’ Equity Activity,” for further information on the ASR agreements entered into by the company.
We have no other off-balance sheet arrangements that has, or is reasonably likely to have, a material current or future effect on financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources. See the table above for the company’s contractual obligations and note N, “Contingencies and Commitments,” for detailed information about the company’s guarantees, financial commitments and indemnification arrangements. The company does not have retained interests in assets transferred to unconsolidated entities or other material off-balance sheet interests or instruments.