IBM 2005 Annual Report Download - page 47
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ManagementDiscussion
INTERNATIONALBUSINESSMACHINESCORPORATION ANDSUBSIDIARYCOMPANIES
46_ ManagementDiscussion
sales-typeandoperatingleasesatDecember31,2004and2005.
Inaddition,thetable below presentstheresidualvalueasaper-
centageoftheoriginalamountfinanced,andarunoutofwhenthe
unguaranteedresidualvalue assignedtoequipment on leases at
December31,2005 isexpectedtobereturnedtothecompany.In
addition to the unguaranteed residual value below, on a limited
basis,GlobalFinancingwillobtainguaranteesofthefuturevalue
oftheequipment tobereturnedatendoflease.Thesethird-party
guaranteesareincludedinminimumleasepaymentsasprovided
forbyaccountingstandardsinthedeterminationoflease classifi-
cationsforthecoveredequipmentandprovideprotectionagainst
risk of loss arising from declines in equipment values for these
assets. Theresidualvalueguaranteeincreasestheminimum lease
payments that are utilized in determining the classification of a
leaseasasales-typeleaseoranoperatinglease.Revenuefrom
a sales-type lease is recorded at the inception of the lease,
wherebyrevenueonanoperatingleaseisrecognizedoverthelife
ofthelease. Theaggregateassetvalueassociatedwiththeguar-
antees was $651 million and $700 million for financing transac-
tionsoriginatedduringtheyearsendedDecember31,2005and
2004,respectively.In2005,theresidualvalueguaranteeprogram
resultedinthecompanyrecognizing approximately$543million
ofrevenuethatwould otherwisehavebeenrecognizedinfuture
periodsasoperatingleaserevenue.Ifthecompanyhadchosen
tonot participate in a residualvalueprogramin2005 and prior
years,overall revenueswould nothavebeenmateriallyaffected
duetotherelativelyconstantyear-to-yearaggregateassetvalue
associated with the residual value guarantees. The associated
aggregateguaranteedfuturevalueatthescheduledendoflease
was $27 million and $36 million for financing transactions origi-
nated during the same time periods, respectively. The cost of
guaranteeswas$4.3millionforyearendedDecember31,2005,
and$5.7millionforyearendedDecember31,2004.
2005, compared with an addition of $105 million for the year
endedDecember31,2004.Thedeclinewasprimarilyattributed
totheoverallreductioninthefinancingassetportfolio,aswellas
the improvement in economic conditions and improved credit
qualityoftheportfolioin2005ascomparedwith2004.
RESIDUAL VALUE
Residual value is a risk unique to the financing business, and
management of this risk is dependent upon the ability to accu-
ratelyprojectfutureequipmentvalues atleaseinception.Global
Financing has insight into product plans and cycles for the IBM
products under lease. Based upon this product information,
GlobalFinancingcontinuallymonitorsprojectionsoffutureequip-
mentvaluesandcomparesthemwiththeresidualvaluesreflected
inthe portfolio. See note A, “Significant Accounting Policies,” on
page 61 forthecompany’saccountingpolicyforresidualvalues.
GlobalFinancingoptimizestherecoveryofresidualvaluesby
sellingassetssourcedfromendoflease,leasingusedequipment
to new clients, or extending lease arrangements with current
clients. Sales of equipment, which are primarily sourced from
equipmentreturnedatendoflease,represented42.1 percentof
GlobalFinancing’srevenuein2005and36.6percentin2004.The
increase is driven primarily by higher internal used equipment
sales, due to higher sales to the Hardware segment, as well as
earlyterminationsofinternalleasesandsubsequentsaleofequip-
menttoGlobalServices.Thegrossmarginonthesesaleswas38.7
percentand34.5percent in 2005 and2004,respectively. The
increaseingrossmarginwasprimarilyduetothe increaseininter-
nal equipment sales. In addition to selling assets sourced from
endoflease,GlobalFinancingoptimizestherecoveryofresidual
values by leasing used equipment to new clients or extending
leasingarrangements with current clients.The following table
presentstherecordedamountofunguaranteedresidualvaluefor
UNGUARANTEED RESIDUAL VALUE
(Dollarsinmillions)
TOTAL RUNOUT OF2005BALANCE
2009AND
2004* 2005 2006 2007 2008 BEYOND
Sales-typeleases $««««««836 $««««««792 $«238 $«250 $«226 $«««78
Operatingleases 197 214 64 73 50 27
Totalunguaranteedresidualvalue $«««1,033 $«««1,006 $«302 $«323 $«276 $«105
Relatedoriginalamountfinanced $«25,982 $«23,397
Percentage 4.0% 4.3%
* Restatedtoconformwith2005presentation.
DEBT
ATDECEMBER31: 2005 2004
Debt-to-equityratio 6.7x7.0x
Global Financing funds its operations primarily through borrow-
ingsusingadebt-to-equityratioofapproximately7to1.Thedebt
isusedtofundGlobalFinancingassets and iscomposedofinter-
companyloansandexternaldebt.Thetermsoftheintercompany
loansaresetbythecompanytosubstantiallymatchthetermand
currencyunderlyingthereceivable.Theintercompanyloansare
based on arm’s-length pricing. Both assets and debt are pre-
sentedintheGlobalFinancingBalanceSheetonpage 44.
The company’s Global Financing business provides fund-
ing predominantly for the company’s external clients but also
providesintercompanyfinancingforthecompany(internal),as
describedinthe“DescriptionofBusiness” onpage 43.Aspre-
viouslystated,thecompany measuresGlobalFinancingasifit
were a standalone entity and accordingly, interest expense