IBM 2011 Second-Quarter Form 10-Q Summary
Business context and reporting period. International Business Machines Corporation (IBM) reported unaudited results for the quarter and six months ended June 30, 2011, compared with the corresponding 2010 periods. IBM’s businesses span services, software, systems and technology, and client financing. Unless noted otherwise, financial amounts below are in U.S. dollars.
Financial results and key metrics
| Metric | Q2 2011 | Q2 2010 | First half 2011 | First half 2010 |
|---|---|---|---|---|
| Revenue | $26.666B | $23.724B | $51.273B | $46.581B |
| Gross profit margin | 46.4% | 45.6% | 45.3% | 44.6% |
| Income before income taxes | $4.885B | $4.575B | $8.702B | $8.090B |
| Net income | $3.664B | $3.386B | $6.526B | $5.987B |
| Diluted EPS | $3.00 | $2.61 | $5.30 | $4.57 |
| Operating cash flow | $4.279B | $3.766B | $8.071B | $8.203B |
- Quarterly performance: Revenue rose 12.4% as reported and 5.1% at constant currency; net income increased 8.2% and diluted EPS 14.9%. Gross margin expanded 0.9 percentage points, while net income margin declined to 13.7% from 14.3%.
- First-half performance: Revenue grew 10.1% as reported and 5.1% at constant currency; net income rose 9.0% and diluted EPS 16.0%. Gross margin improved 0.7 points to 45.3%; net income margin was 12.7%, down 0.1 point.
- Operating (non-GAAP) results: Q2 operating earnings were $3.777B and diluted operating EPS was $3.09, up 11.0% and 17.9%, respectively. First-half operating earnings were $6.767B and diluted operating EPS was $5.50, up 12.0% and 19.3%. IBM’s measure excludes specified acquisition-related and retirement-related items and may not be comparable with similarly titled measures at other companies.
- Revenue mix: Q2 Software revenue grew 16.9%, Systems and Technology 17.5%, Global Technology Services 10.9%, and Global Business Services 8.5%; Global Financing external revenue declined 4.6%. Systems and Technology gross margin expanded 4.9 points in the quarter. Growth markets revenue rose 22.6% in Q2 and 20.2% in the first half, both at reported rates.
- Cash, liquidity and debt: At June 30, cash and marketable securities totaled $11.764B; total debt was $29.772B, up $1.148B from year-end 2010. Current assets were $46.937B and current liabilities $39.843B, for working capital of $7.094B and a current ratio of 1.18:1. First-half investing cash use was $86M and financing cash use was $7.217B. Free cash flow excluding Global Financing receivables was $4.159B, down $287M year over year.
- Shareholder returns: IBM repurchased 24.1 million shares in Q2 and 49.6 million in the first half. First-half repurchases and dividends returned approximately $9.7B to shareholders. The Q2 dividend was $0.75 per share.
Material changes versus the prior comparable period
- Q2 revenue growth was led by Systems and Technology and Software; constant-currency growth was materially below reported growth. IBM cited currency as a major contributor to expense growth as well.
- Q2 total expense and other income increased 20.3%, faster than revenue, and its ratio to revenue rose 1.8 points. SG&A increased 19.2%, with higher currency and acquisition costs and $177M of workforce-rebalancing charges versus $17M a year earlier.
- First-half operating cash flow decreased $131M, primarily reflecting higher net tax payments and weaker cash contribution from operating assets and liabilities, partly offset by higher net income. Investing cash use fell substantially, mainly because of lower acquisition spending and net proceeds from marketable securities and other investments.
- Reported 2010 comparisons include a $591M gain on the sale of IBM’s PLM activities in Q1 2010. IBM also repurchased shares, reducing diluted weighted-average shares by 5.8% in Q2 and 6.0% in the first half.
- Retirement-related plan costs rose 43.2% in Q2 to $458M and 34.0% in the first half to $975M, mainly due to higher recognized actuarial losses.
Outlook, management commentary and risks
- After the quarter, IBM raised its 2011 diluted EPS expectations to at least $12.87 GAAP and $13.25 operating (non-GAAP). The operating outlook excludes $0.40 per share of acquisition-related charges and includes a $0.02 per-share benefit from non-operating retirement-related items.
- IBM’s longer-term objective is at least $20 of operating diluted EPS in 2015. Management described the first half as a strong start and cited business momentum, a strong systems portfolio, software growth, a growing services backlog and a strong balance sheet.
- Management expected second-half services margin expansion and double-digit profit growth, software margin improvement as acquisition integration benefits accrue, and continued Systems and Technology profit growth in Q3; it noted a difficult Q4 comparison for Systems and Technology.
- Estimated Global Services backlog was $144.2B at June 30, up $14.7B year over year, of which $13B reflected currency and about $2B performance. Backlog estimates can change with cancellations, contract scope, revenue realization and currency.
- Key risks identified include weaker economic conditions and corporate IT spending, execution against growth and productivity objectives, innovation and acquisition integration, cybersecurity and data security, currency movements, customer credit and financing risks, pension and tax matters, environmental issues, key personnel and supplier dependencies, and government-business exposure.
- Legal and other contingencies: IBM said recorded legal liabilities were not material, but it could not estimate potential losses across ongoing matters. Notable matters include U.S. and European antitrust investigations, an Acqis patent verdict with $9M damages subject to post-trial proceedings, environmental claims relating to the former Endicott facility, and Brazilian non-income tax disputes with approximately $700M in potential amounts that IBM believes it will defeat. IBM also agreed to a $10M SEC FCPA settlement, subject to court approval. The filing says resolution of one or more matters could affect results in a particular period.
- Subsequent events included a July 22 issuance of $2B of five-year bonds at a 1.95% coupon and board approval of a $0.75 quarterly dividend payable in September.
Important facts for investors to verify
- Reconcile reported and constant-currency growth, and assess how much reported revenue and expense movement reflects exchange rates rather than underlying operations.
- Review the GAAP-to-operating earnings reconciliations and the effects of retirement-related costs, acquisition charges, workforce rebalancing and the prior-year PLM gain.
- Track cash conversion, tax payments, free cash flow, debt maturities and the sustainability of share repurchases and dividends relative to operating cash generation.
- Monitor financing-receivable credit quality, reserve levels, past-due and non-accrual balances, and exposure to changes in customer credit and equipment residual values.
- Follow the stated 2011 EPS outlook and longer-term targets alongside the legal, tax, pension and regulatory matters for which IBM could not estimate potential losses.