IBM 2022 Third-Quarter Form 10-Q Summary
Business context and reporting period
International Business Machines Corporation reported results for the quarter and nine months ended September 30, 2022. IBM’s continuing operations comprise Software, Consulting, Infrastructure and Financing. Kyndryl, spun off in November 2021, is reported as a discontinued operation; prior-year comparisons are presented on a recast basis where noted.
Financial performance
| Metric | Q3 2022 | Q3 2021 | Nine months 2022 | Nine months 2021 |
|---|---|---|---|---|
| Revenue | $14.107 billion | $13.251 billion | $43.840 billion | $40.656 billion |
| Gross margin | 52.7% | 53.6% | 52.6% | 54.1% |
| Income/(loss) from continuing operations | $(3.214) billion | $1.037 billion | $(1.087) billion | $2.250 billion |
| Net income/(loss) | $(3.196) billion | $1.130 billion | $(1.071) billion | $3.410 billion |
| Diluted continuing-operations EPS | $(3.55) | $1.14 | $(1.21) | $2.49 |
Q3 revenue increased 6.5% as reported (14.6% adjusted for currency); nine-month revenue increased 7.8% (13.8% adjusted for currency). Management said incremental sales to Kyndryl contributed about five percentage points to revenue growth in both periods. Q3 segment revenue grew 7.5% in Software, 5.4% in Consulting and 14.8% in Infrastructure as reported. For the first nine months, growth was 8.6%, 9.5% and 10.6%, respectively.
IBM recorded a one-time, non-cash, pre-tax pension settlement charge of $5.9 billion ($4.4 billion after tax) in Q3, following the transfer to insurers of approximately $16 billion of U.S. pension obligations and related plan assets. The charge reduced reported Q3 diluted continuing-operations EPS by $4.86. Excluding specified items, operating (non-GAAP) earnings were $1.653 billion and diluted operating EPS was $1.81 in Q3; for the nine months, operating earnings were $5.029 billion and diluted operating EPS was $5.52. These non-GAAP measures exclude, among other items, specified retirement-related costs and acquisition-related charges.
Cash provided by operating activities was $1.9 billion in Q3, according to management, and $6.470 billion for the first nine months, compared with $10.252 billion in the prior-year nine-month period. Management-defined free cash flow was $0.8 billion in Q3 and $4.082 billion year to date, versus $3.162 billion for the prior-year nine months. The year-to-date decline in operating cash flow primarily reflected lower cash from financing receivables, including higher receivable sales in the prior year.
At September 30, cash, restricted cash and marketable securities totaled $9.728 billion. Total debt was $50.880 billion, down $0.824 billion from year-end 2021. Current assets were $28.999 billion and current liabilities $30.466 billion; working capital was negative $1.467 billion and the current ratio was 0.95. IBM reported $44.942 billion of long-term debt and said it was in compliance with its debt covenants. Total cash dividends paid in the first nine months were $4.454 billion.
Material changes and operating trends
- Revenue growth was broad across the main businesses, though reported growth was aided by currency-adjusted comparisons and incremental Kyndryl sales. Hybrid-cloud revenue was $5.176 billion in Q3, up 11% as reported; remaining performance obligations were $53 billion, with about 73% expected to be recognized over the next two years.
- Margins were pressured by labor and component-cost inflation, currency and strategic investment. Q3 gross margin fell 0.9 percentage points based on the reported figures; management cited a 1.0-point decline. Consulting gross margin fell 3.5 points year over year, while management noted sequential improvement.
- Consulting signings were down 10.6% year over year in Q3, but up 5.9% for the first nine months. Management reported a trailing-12-month Consulting book-to-bill ratio of 1.05.
- IBM completed the sale of healthcare software assets for $1.065 billion in proceeds and recognized a $259 million pre-tax gain by September 30. Closings in remaining countries were expected by Q1 2023.
- IBM completed six acquisitions during the first nine months for an aggregate cost of $1.102 billion. It acquired digital product engineering firm Dialexa on October 3, 2022; initial purchase accounting was incomplete at filing.
- IBM transferred its remaining Kyndryl interest through exchange arrangements by September 30. The May exchange included a cash-settled swap and related secured borrowing; associated mark-to-market movements contributed to other income and expense.
Outlook, commentary and risks
Management expressed confidence in IBM’s hybrid-cloud and AI strategy and said it would focus on revenue growth and cash generation while maintaining a “solid and modestly growing” dividend policy. The filing does not provide a specific full-year revenue or earnings forecast. Management expected 2022 retirement-related plan contributions of approximately $2.0 billion and total pre-tax retirement-plan costs of approximately $7.8 billion, including the settlement charge; it did not anticipate significant changes to expected plan contributions.
Management cited inflation, a strengthening U.S. dollar, labor and component costs, and geopolitical uncertainty as headwinds. Currency hedging defers but does not eliminate currency effects. IBM’s orderly wind-down of Russian operations and lost business affected pre-tax income by approximately $180 million in the first nine months; the company said the longer-term effects remained uncertain. Other disclosed risk factors include client spending and economic conditions, acquisitions, cybersecurity and data privacy, customer credit, pension plans, tax matters and legal proceedings.
Notable contingencies include a UK appellate award of approximately $89 million in additional damages to CISGIL, plus interest and litigation costs, with IBM seeking permission to appeal. In the BMC litigation, a trial court awarded $718 million in direct damages and $718 million in punitive damages, plus interest and fees; IBM appealed and stated it did not believe it had material exposure, and recorded no related material liability. IBM also disclosed an IRS dispute involving proposed adjustments that, if sustained, would add approximately $4.5 billion of taxable income; the company is contesting the matter. The filing describes approximately $400 million of potential Brazilian non-income tax matters, which IBM believes it will prevail on. Management said recorded liabilities for contingencies were not material, but it could not estimate reasonably possible losses for many matters.
Most important facts for investors to verify
- The effect of the $5.9 billion pension settlement charge on reported results, and the comparability and reconciliation of IBM’s non-GAAP operating measures.
- Whether revenue growth and the $53 billion remaining performance obligation convert into sustained revenue and cash generation, including the contribution from Kyndryl-related sales.
- Margin trends, especially Consulting, and management’s progress in offsetting wage, component-cost and currency pressures.
- Cash-flow performance, debt maturities and liquidity relative to dividends, acquisitions and other funding needs.
- Developments in the BMC and CISGIL cases, the IRS audit dispute, Brazilian tax matters and other contingencies.
- Progress on the healthcare software divestiture’s remaining country closings and integration of recent acquisitions.