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Management discussion
International Business Machines Corporation and Subsidiary Companies

Financial condition

Balance sheet

($ in millions)
At December 31: 2008 2007

(a) Includes intercompany mark-up, priced on an arms-length basis, on products purchased from the company’s product divisions, which is eliminated in IBM’s consolidated results.

(b) Entire amount eliminated for purposes of IBM’s consolidated results and therefore does not appear in the Consolidated financial statements (audited).

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

(d) Global Financing debt is comprised of intercompany loans and external debt. A portion of Global Financing debt is in support of the company’s internal business, or related to intercompany mark-up embedded in the Global Financing assets. See total company debt table below.

Cash and cash equivalents $1,269 $755
Net investment in sales-type and direct financing leases 10,203 10,876
Equipment under operating leases:    
External clients(a) 2,139 2,401
Internal clients(b)(c) 1,709 1,872
Client loans 10,615 10,667
Total client financing assets 24,667 25,816
Commercial financing receivables 5,875 6,375
Intercompany financing receivables(b)(c) 2,957 2,984
Other receivables 396 368
Other assets 956 1,288
Total assets $36,119 $37,586
Intercompany payables(b) $5,391 $6,934
Debt(d) 24,360 24,532
Other liabilities 2,875 2,672
Total liabilities 32,626 34,138
Total equity 3,493 3,448
Total liabilities and equity $36,119 $37,586

Sources and uses of funds

The primary use of funds in Global Financing is to originate client and commercial financing assets. Client financing assets for end users consist primarily of IBM hardware, software and services, but also include non-IBM equipment, software and services to meet IBM clients’ total solutions requirements. Client financing assets are primarily sales type, direct financing and operating leases for equipment, as well as loans for hardware, software and services with terms generally for two to seven years. Global Financing’s client loans are primarily for software and services and are unsecured. These loans are subjected to additional credit analysis in order to mitigate the associated risk and, when deemed necessary, covenants are put into agreements to protect against credit deterioration during the life of the obligation. Client financing also includes internal activity as described in Results of operations.

Commercial financing receivables arise primarily from inventory and accounts receivable financing for dealers and remarketers of IBM and non-IBM products. Payment terms for inventory financing and accounts receivable financing generally range from 30 to 90 days. These short-term receivables are primarily unsecured and are also subject to additional credit actions in order to mitigate the associated risk.

Approximately 97 percent of Global Financing’s external financing assets are in the segment’s core competency of technology equipment and solutions financing. At December 31, 2008, approximately 60 percent of the external portfolio is with investment grade clients with no exposure to consumers or mortgage-lending institutions.


The following are total external and internal financing originations.

($ in millions)
For the year ended December 31: 2008 2007 2006
Client financing:      
External $14,790 $14,171 $13,087
Internal 1,039 1,040 1,214
Commercial financing 32,078 30,541 27,969
Total $47,907 $45,752 $42,270

Cash collections exceeded new financing originations for both client and commercial financing in 2008. When combined with currency impacts, this resulted in a net decrease in financing assets from December 31, 2007. The increase in originations in 2008 from 2007, as well as the increase in 2007 versus 2006, was due to improving volumes in both client and commercial financing.

Cash generated by Global Financing in 2008 was primarily deployed to pay intercompany payables and dividends to IBM.

Global Financing receivables and allowances

The following table presents external financing receivables, excluding residual values, and the allowance for doubtful accounts.

($ in millions)
At December 31: 2008 2007
Gross financing receivables $26,599 $27,642
Specific allowance for doubtful accounts 386 230
Unallocated allowance for doubtful accounts 144 138
Total allowance for doubtful accounts 530 368
Net financing receivables $26,069 $27,274
Allowance for doubtful account coverage 2.0% 1.3%

Roll-forward of financing receivables allowance for doubtful accounts

($ in millions)
Jan. 1, 2008 Allowance Used* Additions/
Other** Dec. 31, 2008

* Represents reserved receivables, net of recoveries, that were disposed of during the period.

** Primarily represents translation adjustments.

$368 $(63) $229 $(4) $530

The percentage of financing receivables reserved increased from 1.3 percent at December 31, 2007, to 2.0 percent at December 31, 2008 primarily due to the increase in the specific allowance for doubtful accounts. Specific reserves increased 67.8 percent from $230 million at December 31, 2007 to $386 million at December 31, 2008 due to current economic conditions. Unallocated reserves increased 4.3 percent from $138 million at December 31, 2007, to $144 million at December 31, 2008. Global Financing’s bad debt expense was an addition of $229 million for 2008 and an addition of $70 million for 2007. The increase was primarily attributed to the growth of the specific reserves.

Residual value

Residual value is a risk unique to the financing business and management of this risk is dependent upon the ability to accurately project future equipment values at lease inception. Global Financing has insight into product plans and cycles for the IBM products under lease. Based upon this product information, Global Financing continually monitors projections of future equipment values and compares them with the residual values reflected in the portfolio. See note A, “Significant Accounting Policies,” for the company’s accounting policy for residual values.

Global Financing optimizes the recovery of residual values by selling assets sourced from end of lease, leasing used equipment to new clients, or extending lease arrangements with current clients. Sales of equipment, which are primarily sourced from equipment returned at end of lease, represented 39.7 percent of Global Financing’s revenue in 2008 and 37.3 percent in 2007. The increase was driven primarily by the increase in internal used equipment sales to the Systems and Technology segment. The gross margin on these sales was 50.0 percent and 43.7 percent in 2008 and 2007, respectively. The increase is primarily driven by a shift in mix toward higher margin internal used equipment sales.

The table below presents the recorded amount of unguaranteed residual value for sales-type, direct financing and operating leases at December 31, 2007 and 2008. In addition, the table presents the residual value as a percentage of the original amount financed, and a schedule of when the unguaranteed residual value assigned to equipment on leases at December 31, 2008 is expected to be returned to the company. In addition to the unguaranteed residual value, on a limited basis, Global Financing obtains guarantees of the future value of the equipment to be returned at end of lease. These third-party guarantees are included in minimum lease payments as provided for by accounting standards in the determination of lease classifications for the covered equipment and provide protection against risk of loss arising from declines in equipment values for these assets. The residual value guarantee increases the minimum lease payments that are utilized in determining the classification of a lease as a sales-type lease or an operating lease. The aggregate asset values associated with the guarantees were $1,083 million and $682 million for financing transactions originated during the years ended December 31, 2008 and 2007, respectively. In 2008, the residual value guarantee program resulted in the company recognizing approximately $489 million of revenue that would otherwise have been recognized in future periods as operating lease revenue. If the company had chosen to not participate in a residual value program in 2008 and prior years, the 2008 impact would be substantially mitigated by the effect of prior year asset values being recognized as operating lease revenue in the current year. The associated aggregate guaranteed future values at the scheduled end of lease were $56 million and $38 million for financing transactions originated during the same time periods, respectively. The cost of guarantees was $7 million for the year ended December 31, 2008, and $5 million for the year ended December 31, 2007.

Unguaranteed residual value

($ in millions)
Estimated Run Out of 2008 Balance
  2007 2008 2009 2010 2011 2012 and Beyond
Sales-type and direct financing leases $915 $916 $208 $255 $268 $185
Operating leases 421 378 139 120 85 34
Total unguaranteed residual value $1,336 $1,294 $347 $375 $353 $219
Related original amount financed $24,517 $23,165        
Percentage 5.4% 5.6%        


At December 31: 2008 2007
Debt-to-equity ratio 7.0x 7.1x

The company funds Global Financing through borrowings using a debt-to-equity ratio target of approximately 7 to 1. The debt used to fund Global Financing assets is composed of intercompany loans and external debt. The terms of the intercompany loans are set by the company to substantially match the term and currency underlying the financing receivable and are based on arm’s-length pricing. Both assets and debt are presented in the Global Financing balance sheet.

The Global Financing business provides funding predominantly for the company’s external clients but also provides intercompany financing for the company, as described in the “Description of Business.” As previously stated, the company measures Global Financing as if it were a standalone entity and accordingly, interest expense relating to debt supporting Global Financing’s external client and internal business is included in the “Global Financing Results of Operations” and in note V, “Segment Information.”

In the company’s Consolidated Statement of Earnings, however, the external debt-related interest expense supporting Global Financing’s internal financing to the company is reclassified from cost of financing to interest expense.

The following table provides additional information on total company debt. In this table, intercompany activity is comprised of internal loans and leases at arm’s length pricing in support of Global Services’ long-term contracts and other internal activity. The company believes these assets should be appropriately levered in line with the overall Global Financing business model.

($ in millions)
December 31, 2008
December 31, 2007
Global Financing Segment:   $24,360   $24,532
Debt to support external clients $20,892   $21,072  
Debt to support internal clients 3,468   3,460  
Non-Global Financing Segments:   9,566   10,743
Debt supporting operations 13,034   14,203  
Intercompany activity (3,468)   (3,460)  
Total company debt   $33,926   $35,274

Liquidity and capital resources

Global Financing is a segment of the company and as such, is supported by the company’s overall liquidity position and access to capital markets. Cash generated by Global Financing was primarily deployed to pay intercompany payables and dividends to the company in order to maintain an appropriate debt-to-equity ratio.

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