IBM 2007 Annual Report Download - page 84

82
Notes to Consolidated Financial Statements
International Business Machines Corporation and Subsidiary Companies
Management Discussion ..................................14
Consolidated Statements ..................................58
Notes ........................................................... 64
A-F ............................................................. 64
A. Significant Accounting Policies ..................64
B. Accounting Changes ...................................73
C. Acquisitions/Divestitures ...................... 76
D. Financial Instruments
(excluding derivatives) .......................... 82
E. Inventories ............................................. 83
F. Financing Receivables ........................... 83
G-M ..................................................................84
N-S ...................................................................94
T-W ................................................................102
was valued at $1,725 million, comprised of: $650 million in cash,
$542 million in Lenovo equity and $533 million in net liabilities
transferred. Transaction related expenses and provisions were $628
million, resulting in a net pre-tax gain of $1,097 million which was
recorded in Other (income) and expense in the Consolidated
Statement of Earnings in the second quarter of 2005. In addition, the
company paid Lenovo $138 million in cash primarily to assume addi-
tional liabilities outside the scope of the original agreement. This
transaction had no impact on Income from Continuing Operations.
Total net cash proceeds, less the deposit received at the end of 2004
for $25 million, related to these transactions were $487 million.
The equity received at the closing date represented 9.9 percent of
ordinary voting shares and 18.9 percent of total ownership in
Lenovo. Subsequent to the closing date, Lenovo’s capital structure
changed due to new third-party investments. As a result, the com-
pany’s equity at June 30, 2005 represented 9.9 percent of ordinary
voting shares and 17.05 percent of total ownership in Lenovo. The
equity securities have been accounted for under the cost method of
accounting. The equity is subject to specific lock-up provisions that
restrict the company from divesting the securities. These restrictions
apply to specific equity tranches and expire over a three-year period
from the closing date. The Lenovo equity was valued at $542 million
at the closing date and is recorded in Investments and sundry assets
in the Consolidated Statement of Financial Position. In addition, the
company recorded an equity deferral of $112 million to reflect the
value of the lock-up provisions. This deferral was recorded as a
contra-investment in Investments and sundry assets.
As part of the agreements with Lenovo, the company will provide
certain services. These services include marketing support, informa-
tion technology, human resources support and learning services. These
service arrangements are primarily for periods of three years or less
and can be terminated earlier by Lenovo. The company estimated the
fair value of these service arrangements, and, as a result, has deferred
$262 million of the transaction gain. This amount will be recorded
as revenue, primarily in the Global Services segments, as services are
provided to Lenovo. The deferred amount was recorded in Deferred
income in the Consolidated Statement of Financial Position.
The company also recorded direct and incremental expenses and
related provisions of $254 million associated with the divestiture,
consisting of $74 million for certain indemnities; $64 million for
employee-related charges; $40 million in real estate and information
technology costs; $20 million in transaction expenses; $22 million of
goodwill; and $34 million in other expenses. The company, as part of
the agreement, retained the right and will be given a preference to
provide maintenance, warranty and financing services to Lenovo.
The company retained the warranty liability for all Personal
Computing business products sold prior to the closing date. Lenovo
will have the right to use certain IBM Trademarks under a Trademark
License Agreement for a term of five years. In addition, the company
entered into an arm’s-length supply agreement with Lenovo for a
term of five years, designed to provide the company with computers
for its internal use.
In the third quarter of 2005, as a result of the third-party invest-
ments previously described, Lenovo was required to repurchase the
first equity tranche at a specified share price. The equity repurchase
resulted in the receipt of $152 million of cash and a pre-tax gain of
$17 million. As a result of this transaction, the company’s equity in
Lenovo at September 30, 2005 represented 9.9 percent of ordinary
voting shares and 14.88 percent of total ownership.
Also, in the second half of the year, the company received an
additional $23 million of cash from Lenovo related to working capi-
tal adjustments, net of expenses related to employee matters. These
transactions were consistent with the company’s previous estimates.
Overall, including the gain on the equity sale recorded in the third
quarter, the company recorded an additional net pre-tax gain of $11
million; the resulting net pre-tax gain for the year ending December
31, 2005 is $1,108 million.
In addition, at December 31, 2005, the deferred income bal-
ance related to the services arrangements previously discussed is
$169 million.
Note D. Financial Instruments
(excluding derivatives)
Fair Value of Financial Instruments
Cash and cash equivalents, marketable securities and derivative finan-
cial instruments are recognized and measured at fair value in the
company’s financial statements. Notes and other accounts receivable
and other investments are financial assets with carrying values
that approximate fair value. Accounts payable, other accrued expenses
and short-term debt are financial liabilities with carrying values
that approximate fair value. The carrying amount of long-term
debt is approximately $23.0 billion and $13.8 billion and the
estimated fair value is $26.5 billion and $16.2 billion at December 31,
2007 and 2006, respectively.
In the absence of quoted prices in active markets, considerable
judgment is required in developing estimates of fair value. Estimates
are not necessarily indicative of the amounts the company could real-
ize in a current market transaction. The following methods and
assumptions were used to estimate fair values: