IBM — Q3 2020 Form 10-Q Summary
Reporting period: Three and nine months ended September 30, 2020; comparisons are with the corresponding 2019 periods. Amounts are in U.S. dollars. The filing is unaudited.
Financial performance
| Metric | Q3 2020 | Q3 2019 | Nine months 2020 | Nine months 2019 |
|---|---|---|---|---|
| Revenue | $17.56B | $18.03B | $53.25B | $55.37B |
| Gross profit margin | 48.0% | 46.2% | 47.0% | 45.9% |
| Income from continuing operations | $1.70B | $1.67B | $4.24B | $5.77B |
| Diluted continuing-operations EPS | $1.89 | $1.87 | $4.72 | $6.46 |
| Operating (non-GAAP) diluted EPS | $2.58 | $2.68 | $6.60 | $8.10 |
| Cash from operating activities | $4.3B | Not stated here | $12.34B | $11.32B |
| Free cash flow (non-GAAP) | $1.1B | Not stated here | $4.75B | $5.88B |
Q3 GAAP pre-tax income rose 20% to $1.83B, while continuing-operations income increased 1.5%. Nine-month GAAP income declined 26.5%; results included a $939M one-time net tax benefit in Q1 from an intra-entity intellectual-property sale. Operating measures exclude specified acquisition-related, intangible-amortization, retirement-related and other items and are not GAAP results.
Business trends and changes versus prior periods
- Q3 revenue fell 2.6% reported, or 3.1% excluding divested businesses and adjusting for currency. Nine-month revenue fell 3.8% reported, or 1.6% on that adjusted basis.
- Cloud & Cognitive Software grew 6.8% in Q3, led by Cloud & Data Platforms, up 20.3%. Total cloud revenue was $6.0B, up 19% reported. By contrast, Q3 Global Business Services fell 4.7%, Global Technology Services fell 3.6%, Systems fell 15.1%, and Global Financing fell 20.5%.
- Q3 gross margin expanded 1.8 percentage points, reflecting software mix and productivity. Nine-month operating costs were affected by Red Hat-related spending and amortization, higher workforce-rebalancing charges, and increased non-operating retirement costs. The prior-year nine-month period included Red Hat acquisition cash outflows and substantially higher divestiture gains.
- Q3 services signings increased 5.3%; estimated services backlog was $108.0B, up 0.4% reported but down 1.3% adjusted for currency.
Cash, debt and liquidity
- At September 30, cash, restricted cash and marketable securities totaled $15.75B, versus $9.01B at December 31, 2019. The nine-month cash-flow statement reports a $6.24B increase in cash, cash equivalents and restricted cash.
- Total debt was $65.41B, up $2.52B since year-end; this included $10.29B short-term debt and $55.13B long-term debt. Cash and securities are substantial, but debt and current maturities remain significant.
- Working capital was $1.85B and the current ratio was 1.05. IBM reported $15.25B in unused credit facilities and said it had no current plans to draw on them. It reported compliance with debt covenants and a target leverage profile consistent with a single-A credit rating.
- IBM paid $4.34B in dividends in the first nine months and made no common-stock repurchases. The repurchase program remained suspended following the Red Hat acquisition.
Outlook, commentary and risks
- IBM did not provide full-year 2020 expectations, citing COVID-19-related uncertainty. Management said client project delays and purchase deferrals affected transactional software, project-oriented services and volume-based services.
- On October 8, 2020, IBM announced a planned tax-free spin-off of its managed infrastructure services unit into a new public company, targeted for completion by the end of 2021, subject to customary conditions and final Board approval. IBM expects sustainable mid-single-digit revenue growth after separation and said it expects to show progress, including improved revenue growth, by mid-2021. These are forward-looking expectations, not guarantees.
- For Q4 2020, management expected the sequential revenue increase to be in line with historical averages and operating EPS growth to be consistent with or slightly ahead of recent historical averages, before a planned charge of approximately $2.3B for structural actions. Q4 comparisons were against a strong prior-year quarter.
- Management cited a solid Q4 pipeline in hybrid cloud and AI. It expects GBS to return to pre-COVID revenue growth rates by mid-2021. IBM also expects 2020 retirement-plan contributions of approximately $2.2B and retirement-related costs of approximately $2.7B.
- Risks include pandemic-driven demand and credit deterioration, execution and disruption costs related to the proposed separation, currency movements, competition, cybersecurity and privacy matters, pension costs, tax examinations, and legal proceedings. IBM disclosed approximately $700M of potential amounts relating to Brazilian non-income-tax disputes, while stating it believes it will prevail and that the amount is not a meaningful indicator of liability; it could not estimate losses for many other proceedings.
Important facts for investors to verify
- Track whether cloud growth, especially Red Hat and Cloud & Data Platforms, offsets declines in services, systems and financing.
- Assess the quality and sustainability of cash generation: nine-month free cash flow fell to $4.75B, while operating cash flow benefited from working-capital actions, receivables sales and approximately $550M of tax-payment deferrals or exemptions.
- Review debt maturities, refinancing and leverage plans; $9.68B of long-term debt was classified as current at quarter-end.
- Monitor the proposed spin-off’s approvals, timetable, costs, separation terms and the expected $2.3B Q4 structural charge.
- Separate recurring operating performance from the $939M one-time tax benefit and other adjustments; review IBM’s non-GAAP reconciliations alongside GAAP results.