IBM 2016 First-Quarter Form 10-Q Summary
Reporting period: Three months ended March 31, 2016; financial statements are unaudited. Comparisons are with the three months ended March 31, 2015 unless otherwise noted. Dollar amounts are in U.S. dollars.
Business context and reporting period
IBM described its strategy as shifting toward cognitive solutions and cloud platforms, while transforming its workforce and reallocating investment. It reorganized its reporting segments in January 2016; prior-period segment figures were reclassified for comparability, without changing consolidated results.
Key financial results
| Metric | Q1 2016 | Q1 2015 / comparison |
|---|---|---|
| Revenue | $18.684 billion | $19.590 billion; down 4.6% reported and 2.0% at constant currency |
| Gross profit / margin | $8.686 billion / 46.5% | $9.452 billion / 48.2%; margin down 1.8 points |
| Income before tax from continuing operations | $1.034 billion | $3.001 billion; down 65.6% |
| Income tax provision/(benefit) | $(983) million benefit; effective rate (95.1)% | $585 million provision; effective rate 19.5% |
| Income from continuing operations | $2.016 billion; margin 10.8% | $2.415 billion; margin 12.3% |
| Net income / diluted EPS | $2.014 billion / $2.09 | $2.328 billion / $2.35 |
| Operating earnings / diluted EPS (non-GAAP) | $2.270 billion / $2.35 | $2.890 billion / $2.91; EPS down 19.2% |
| Cash from operations | $5.645 billion | $3.610 billion |
| Free cash flow (company measure) | $2.295 billion | $1.081 billion |
The tax benefit chiefly reflected a favorable final resolution of a Japanese tax matter: IBM received approximately $1.0 billion in tax refunds and $0.2 billion in interest. The unusually low tax rate materially increased reported net income relative to pre-tax income.
Cash and marketable securities were $14.869 billion at March 31, 2016. Total debt was $45.557 billion, up $5.667 billion from year-end 2015; $26.782 billion supported Global Financing. Working capital was $12.959 billion and the current ratio was 1.37:1. The core debt-to-capitalization ratio, excluding Global Financing debt and equity, was 62.2%, versus 54.3% at year-end.
Operating cash flow benefited from lower tax payments, including the Japan refund. The company’s free cash flow measure excludes changes in Global Financing receivables and subtracts net capital expenditures. Financing cash flow was a $2.834 billion source, principally reflecting higher debt issuance; acquisition-related investing outflows were $2.590 billion.
Material changes and business performance
- Strategic imperatives revenue (cloud, analytics, mobile, social and security) grew 14% reported and 17% at constant currency. Over the preceding 12 months, these offerings generated $29.8 billion, approximately 37% of IBM revenue.
- Cloud revenue was $2.6 billion, up 34% reported; as-a-Service revenue grew 42%, with a $5.4 billion annual run rate. Analytics revenue was $4.2 billion, up 7% reported.
- Segment revenue declined 1.7% in Cognitive Solutions, 4.3% in Global Business Services, 1.5% in Technology Services & Cloud Platforms, 21.8% in Systems, and 11.2% in Global Financing. Systems weakness reflected the z Systems product cycle and a strong prior-year comparison.
- Services backlog was $122.4 billion, approximately flat reported year over year; quarterly signings declined 22.3% reported to $8.024 billion.
- Six acquisitions were completed for aggregate consideration of $2.642 billion, including The Weather Company for $2.284 billion. Goodwill increased to $34.322 billion, primarily reflecting acquisitions and currency effects.
- IBM repurchased 6.6 million shares for approximately $939 million and paid $1.250 billion in dividends. The quarterly dividend paid was $1.30 per share; a subsequent increase to $1.40 was announced in April.
Management outlook, risks and unusual items
- For 2016, management expected GAAP diluted EPS from continuing operations of at least $12.35 and maintained its non-GAAP operating EPS expectation of at least $13.50. It expected free cash flow at the high end of its $11 billion to $12 billion range.
- Management expected approximately $2 billion of pre-tax profit improvement from Q1 to Q2, including typical seasonality and reduced impact from first-quarter transformation charges. It expected the 2016 operating tax rate to be about 19%, plus or minus a couple of percentage points.
- Management said 2016 workforce actions costing approximately $1 billion were expected to yield about $500 million or slightly more in savings during 2016 and close to $2 billion annualized. It also cited ongoing investment, cloud scale-up costs, software transaction trends, and currency-related hedging effects as near-term profit pressures.
- Q1 included $998 million of workforce rebalancing charges and $328 million of real-estate-related charges in the expense discussion. Separately, IBM recorded a $252 million pre-tax impairment on properties classified as held for sale. Management said transformation actions reduced Q1 operating pre-tax income by $1.5 billion.
- Global Financing’s pre-tax income fell 25% to $386 million. Its allowance coverage rose to 2.6% from 2.1% at year-end, with higher unallocated reserves primarily related to Brazil; bad-debt expense increased to $76 million from $52 million.
- Significant disclosed legal and regulatory matters include a U.S. SEC investigation into revenue recognition, U.S. DOJ and SEC inquiries involving foreign bribery allegations, and UK pension litigation that, if IBM’s appeal fails, could require an estimated one-time pre-tax charge of approximately $250 million plus ongoing accruals. IBM also disclosed approximately $520 million of potential Brazilian non-income-tax matters, which it contests. The filing says recorded legal liabilities were not material and that loss estimates for many matters could not be provided.
- Other risks identified include economic and client-spending weakness, execution of growth and productivity plans, cybersecurity and data privacy, foreign exchange, customer credit, pension and tax matters, acquisitions, and legal proceedings. IBM reported that disclosure controls were effective and that no material change in internal control over financial reporting occurred during the quarter.
Important facts for investors to verify
- Whether revenue and margins improve as strategic-initiative growth offsets declines in traditional offerings, particularly Systems and services signings.
- How much reported earnings and cash flow depend on the one-time Japanese tax refund, and how transformation charges and non-GAAP exclusions affect comparisons.
- Debt growth, upcoming maturities, and the ability to sustain dividends, repurchases, acquisitions, and planned investment.
- Whether Global Financing’s higher Brazil-related reserves adequately reflect credit risk and whether portfolio quality deteriorates further.
- Developments in the revenue-recognition investigation, foreign-corruption inquiries, UK pension appeal, and contested tax matters.
- Acquisition integration, purchase accounting, and the expected timing of revenue and profit contribution from recently acquired businesses.