IBM 2012 Annual Report Download - page 62

61
Management Discussion
International Business Machines Corporation and Subsidiary Companies
of uncertainties related to these matters, accruals are based only
on the best information available at the time. As additional informa-
tion becomes available, the company reassesses the potential
liability related to its pending claims and litigation, and may revise its
estimates. These revisions in the estimates of the potential liabilities
could have a material impact on the company’s results of operations
and financial position.
Global Financing Receivables Allowance for Credit Losses
The Global Financing business reviews its financing receivables
port folio at least quarterly in order to assess collectibility. A
description of the methods used by management to estimate the
amount of uncollectible receivables is included in note A, “Significant
Accounting Policies,” on page 85. Factors that could result in actual
receivable losses that are materially different from the estim ated
reserve include sharp changes in the economy, or a significant
change in the economic health of a particular client that represents
a concentration in Global Financing’s receivables portfolio.
To the extent that actual collectibility differs from manage-
ment’s estimates currently provided for by 10 percent, Global
Financing’s segment pre-tax income and the company’s consoli-
dated income before income taxes would be higher or lower by an
estimated $36 million (using 2012 data), depending upon whether
the actual collectibility was better or worse, respectively, than the
estimates.
Residual Value
Residual value represents the estimated fair value of equipment
under lease as of the end of the lease. Residual value estimates
impact the determination of whether a lease is classified as operat-
ing or capital. Global Financing 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. Anticipated increases in future
residual values are not recognized until the equipment is remarketed.
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, Global Financing’s segment
pre-tax income and the company’s consolidated income before
income taxes for 2012 would have been lower by an estimated
$105 million. If the actual residual value recovery is higher than
management’s estimates, the increase in income will be realized at
the end of lease when the equipment is remarketed.
Currency Rate Fluctuations
Changes in the relative values of non-U.S. currencies to the U.S.
dollar affect the company’s financial results and financial position.
At December 31, 2012, currency changes resulted in assets and
liabilities denominated in local currencies being translated into fewer
dollars than at year-end 2011. The company uses financial hedging
instruments to limit specific currency risks related to financing trans-
actions and other foreign currency-based transactions. Further
discussion of currency and hedging appears in note D, “Financial
Instruments,” on pages 94 to 98.
Foreign currency fluctuations often drive operational responses
that mitigate the simple mechanical translation of earnings. During
periods of sustained movements in currency, the marketplace and
competition adjust to the changing rates. For example, when pricing
offerings in the marketplace, the company may use some of the
advantage from a weakening U.S. dollar to improve its position com-
petitively, and price more aggressively to win the business,
essentially passing on a portion of the currency advantage to
its customers. Competition will frequently take the same action.
Consequently, the company believes that some of the currency-
based changes in cost impact the prices charged to clients. The
company also maintains currency hedging programs for cash man-
agement purposes which mitigate, but do not eliminate, the volatility
of currency impacts on the company’s financial results.
The company translates revenue, cost and expense in its non-
U.S. operations at current exchange rates in the reported period.
References to “adjusted for currency” or “constant currency” reflect
adjustments based upon a simple constant currency mathematical
translation of local currency results using the comparable prior
period’s currency conversion rate. However, this constant currency
methodology that the company utilizes to disclose this information
does not incorporate any operational actions that management may
take in reaction to fluctuating currency rates. Based on the currency
rate movements in 2012, total revenue decreased 2.3 percent as
reported and was flat at constant currency versus 2011. On a pre-tax
income basis, these translation impacts offset by the net impact of
hedging activities resulted in a theoretical maximum (assuming no
pricing or sourcing actions) decrease of approximately $100 million
in 2012. The same mathematical exercise resulted in an increase of
approximately $600 million in 2011. The company views these
amounts as a theoretical maximum impact to its as-reported finan-
cial results. Considering the operational responses mentioned
above, movements of exchange rates, and the nature and timing of
hedging instruments, it is difficult to predict future currency impacts
on any particular period, but the company believes it could be sub-
stantially less than the theoretical maximum given the competitive
pressure in the marketplace.
For non-U.S. subsidiaries and branches that operate in U.S. dol-
lars or whose economic environment is highly inflationary, translation
adjustments are reflected in results of operations. Generally, the
company manages currency risk in these entities by linking prices
and contracts to U.S. dollars. The company continues to monitor
the economic conditions in Venezuela. On December 30, 2010, the
official rate for essential goods was eliminated, with no change to
the SITME rate. The SITME rate remained constant throughout 2012
and 2011. In February 2013, the SITME rate was eliminated, and the
official rate was set at 6.3 bolivars fuerte (BsF) to the U.S. dollar. This
devaluation is not expected to have a material impact given the size
of the company’s operations in Venezuela (less than 1 percent of
total 2011 and 2012 revenue, respectively).