IBM Q1 2019 Form 10-Q Summary
Business context and reporting period
International Business Machines Corporation (IBM) reported unaudited results for the three months ended March 31, 2019, compared with the three months ended March 31, 2018. In Q1 2019, IBM reorganized its reportable segments, including combining cloud and cognitive software activities; prior-year segment results were recast for comparison. The reorganization did not change consolidated financial statements.
Financial results
| Metric | Q1 2019 | Q1 2018 | Change |
|---|---|---|---|
| Revenue | $18.182 billion | $19.072 billion | Down 4.7% reported; down 0.9% at constant currency |
| Gross profit margin | 44.2% | 43.2% | Up 1.0 percentage point |
| Income from continuing operations | $1.593 billion | $1.675 billion | Down 4.9% |
| Net income | $1.591 billion | $1.679 billion | Down 5.2% |
| Diluted EPS from continuing operations | $1.78 | $1.81 | Down 1.7% |
| Operating diluted EPS (non-GAAP) | $2.25 | $2.45 | Down 8.2% |
| Cash from operating activities | $4.759 billion | $4.602 billion | Up $157 million |
| Free cash flow (management-defined) | $1.688 billion | $1.349 billion | Up $339 million |
Operating (non-GAAP) earnings were $2.009 billion, down 11.6%. IBM’s non-GAAP measure excludes specified acquisition-related charges, non-operating retirement-related costs and U.S. tax reform charges; it is not a GAAP result. The effective tax rate on continuing operations was 15.4%, versus a tax benefit and effective rate of negative 47.5% in Q1 2018, when audit resolutions drove a large benefit. Q1 2019 included a $129 million discrete tax charge related to additional U.S. Treasury tax-reform guidance.
Revenue pressure was concentrated in Global Technology Services, down 7.4% reported, and Systems, down 11.4%. Cloud & Cognitive Software declined 1.5% reported but grew 1.5% at constant currency; Global Business Services revenue was nearly flat reported and grew 4.3% at constant currency. Total cloud revenue was $4.5 billion, up 7% reported and 12% at constant currency. Services backlog was $111.6 billion, down 8.0% reported, and signings were $7.637 billion, down 18.0%.
Financial position, liquidity and capital allocation
- At March 31, cash, restricted cash and marketable securities totaled $18.144 billion, compared with $12.222 billion at December 31, 2018.
- Total debt was $49.976 billion, up $4.165 billion from year-end; this includes $29.522 billion associated with Global Financing. IBM said increased borrowing was partly in preparation for the Red Hat acquisition.
- Current assets were $52.705 billion and current liabilities were $38.871 billion; working capital was $13.834 billion and the current ratio was 1.36.
- Operating cash flow was $4.759 billion. Investing activities used $853 million; financing activities provided $1.863 billion. Cash, cash equivalents and restricted cash increased by $5.668 billion during the quarter.
- IBM paid $1.397 billion in dividends and repurchased $920 million of shares. The company reported $2.438 billion remaining under its then-current repurchase authorization at quarter-end.
- Shareholders’ equity was $16.607 billion, down $323 million from year-end. The lease-accounting adoption added $4.634 billion of operating right-of-use assets and $4.903 billion of operating lease liabilities at March 31.
Material changes, outlook and management commentary
- IBM continued to expect 2019 GAAP diluted EPS of at least $12.45, operating diluted EPS of at least $13.90 and free cash flow of approximately $12 billion. Management expected free-cash-flow realization to be about 100% of GAAP net income. These are company expectations, not guarantees.
- Management expected 2019 gross and pre-tax margins to expand. It forecast a currency headwind of about 2.0 percentage points to full-year revenue growth and expected Q2 revenue to increase sequentially by roughly $900 million to $1 billion from Q1.
- The pending Red Hat acquisition was valued at approximately $34 billion and remained subject to customary closing conditions, including regulatory review. IBM expected closing in the second half of 2019 and planned to use cash and debt. The 2019 EPS outlook excluded Red Hat, other than estimated pre-closing financing costs. IBM said it expected the acquisition to accelerate revenue growth, improve gross margin and be free-cash-flow accretive within 12 months after closing.
- IBM said it intended to suspend share repurchases in 2020 and 2021 to reduce debt following the acquisition, while maintaining its commitment to a growing dividend and strong investment-grade credit ratings. On April 30, the board approved a quarterly dividend of $1.62 per share, payable June 10, 2019.
- Announced software divestitures were expected to close in mid-2019. IBM estimated total pre-tax gains of $500 million to $700 million, while noting that foregone profit, stranded costs and related actions were expected to offset most of the gains’ overall profit and EPS impact. The Seterus mortgage-servicing sale closed in Q1; its financial terms were not material.
- IBM expected to wind down part of Global Financing’s short-term commercial financing operations beginning in Q2 2019, reducing revenue with a nominal profit impact. Management said this did not change 2019 EPS or free-cash-flow expectations.
- IBM reported a $900 million potential amount related to Brazilian non-income tax assessments and litigation, but said it believed it would prevail and that the amount was not a meaningful indicator of liability. It could not estimate reasonably possible losses for many other legal matters; outcomes could affect results or cash flows in a particular period.
Important facts for investors to verify
- Progress and final financing, regulatory status and closing timing for the Red Hat acquisition, and subsequent updates to IBM’s outlook.
- Whether revenue trends, particularly in Global Technology Services and Systems, improve, and whether cloud growth and margin gains offset declines in other businesses.
- Services backlog and signings trends, including the impact of contract terminations, currency and changing business mix.
- Debt levels, credit ratings and IBM’s ability to meet its free-cash-flow, dividend and debt-reduction objectives after the acquisition.
- Realization and net earnings impact of announced divestitures, including gains, stranded costs and lost profits.
- Developments in tax examinations and disputes, including the Brazilian matters and $6.561 billion of unrecognized tax benefits reported at quarter-end.
- Material developments in litigation and other contingencies. IBM stated that recorded legal liabilities and changes during the quarter were not material, but many potential losses could not be estimated.