IBM 2016 Q3 Form 10-Q Summary
Reporting period: Quarter and nine months ended September 30, 2016. Amounts are U.S. dollars; financial statement figures are in millions unless stated otherwise. Comparisons are with 2015 unless noted. IBM reorganized its reportable segments in January 2016 and recast prior-period segment data for comparability.
Financial performance and position
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Revenue | $19,226 | $19,280 | $58,149 | $59,682 |
| Gross profit margin | 46.9% | 48.9% | 47.1% | 49.1% |
| Income from continuing operations | $2,854 | $2,962 | $7,375 | $8,904 |
| Net income | $2,853 | $2,950 | $7,371 | $8,727 |
| Diluted EPS, continuing operations | $2.98 | $3.02 | $7.67 | $9.03 |
| GAAP operating cash flow | $4.2 billion | $4.2 billion | $13.3 billion | $11.7 billion |
| Free cash flow (non-GAAP) | $2.4 billion | Not stated clearly for Q3 | $6.9 billion | $7.0 billion |
- Q3 revenue fell 0.3% reported and 1.1% at constant currency. Nine-month revenue declined 2.6% reported and 1.9% at constant currency.
- Q3 pretax income from continuing operations fell 9.9% to $3.263 billion; continuing-operations net income declined 3.6%. Nine-month pretax income fell 32.3% to $7.345 billion, and continuing-operations net income fell 17.2%.
- Q3 diluted operating EPS, a non-GAAP measure, was $3.29, down 1.5%. Nine-month operating EPS was $8.59, down 14.9%. IBM excludes acquisition-related and non-operating retirement costs from this measure.
- At September 30, cash and marketable securities totaled $9.968 billion; total debt was $42.483 billion, including $26.133 billion attributed to Global Financing. Long-term debt was $35.563 billion.
- Current assets were $41.433 billion and current liabilities $34.447 billion; working capital was $6.986 billion and the current ratio 1.20, compared with 1.24 at year-end 2015. Total assets were $115.606 billion, liabilities $98.447 billion, and equity $17.159 billion.
- Nine-month shareholder returns included $3.927 billion in dividends and $2.632 billion in share repurchases. The company repurchased 17.8 million shares during the nine-month period.
Material changes and operating trends
- Strategic imperatives—cloud, analytics and engagement—grew 16% in Q3 and 14% for the first nine months, both reported and at constant currency. Trailing 12-month revenue was $31.8 billion, or 40% of IBM revenue.
- Q3 cloud revenue was $3.4 billion, up 44% reported; cloud as-a-Service grew more than 60%, with a $7.5 billion annual run rate at quarter-end. Nine-month cloud revenue was $9.5 billion, up 36%.
- Q3 segment revenue: Cognitive Solutions increased 4.5%; Technology Services & Cloud Platforms increased 2.4%; Global Business Services declined 0.4%; Systems declined 21.0%. Systems weakness reflected product-cycle pressures in z Systems and declines in Power Systems.
- Margins weakened: consolidated gross margin declined 2.1 percentage points in Q3 and 1.9 points year to date. Management cited investment, acquisitions and as-a-Service offerings not yet at scale.
- IBM completed 12 acquisitions in the first nine months for aggregate cost of $5.688 billion, including The Weather Company and Truven Health Analytics. Goodwill increased $4.380 billion from year-end, primarily from acquisitions.
- Nine-month expense included $1.038 billion of workforce rebalancing charges, up from $575 million, and $294 million of real-estate capacity charges. R&D expense rose 11.2% to $4.320 billion. Intellectual-property and custom-development income increased to $1.110 billion from $489 million, with significant transactions contributing to the increase.
Outlook, risks and unusual items
- IBM reaffirmed 2016 guidance: GAAP continuing-operations EPS of at least $12.23; operating EPS of at least $13.50; and free cash flow at the high end of an $11–$12 billion range. Management expected the operating tax rate to be about 18% for the remainder of 2016, excluding discrete benefits.
- Long-term objectives cited were low-single-digit revenue growth, high-single-digit operating EPS growth and free-cash-flow realization of 90–100%. For Q4, management expected year-over-year annuity growth and a typical sequential increase of $2.5 billion in transactional business.
- The nine-month 2016 effective tax rate was negative 0.4%, principally reflecting a $1.0 billion refund of Japanese taxes, plus $0.2 billion interest, following final resolution of a long-standing tax matter. Q3 also included a $91 million discrete tax benefit from foreign tax audit activity.
- IBM recorded a $218 million pretax impairment charge on certain property, plant and equipment during the first nine months.
- Contingencies include an SEC investigation into revenue recognition for certain U.S., U.K. and Ireland transactions; IBM said it is cooperating. IBM also disclosed FCPA-related investigations involving Poland and other countries, which it said it is cooperating with.
- Brazilian non-income tax matters had a stated potential amount of approximately $740 million; IBM believes it will prevail and said the amount is not a meaningful indicator of liability. A U.K. pension-plan appeal, if unsuccessful, could result in an estimated one-time pretax charge of approximately $250 million plus ongoing accruals. IBM generally could not estimate reasonably possible losses for other proceedings.
- IBM expected approximately $600 million of contributions to non-U.S. defined-benefit and multi-employer plans in 2016 and approximately $2.6 billion for all retirement-related plans. Management noted that lower September 2016 pension discount rates could materially affect stockholders’ equity, but not cash flows.
- The company reported compliance with significant debt covenants. It had access to a $10 billion global credit facility at quarter-end; in October, the facility was increased to $10.25 billion and extended to November 2021. The board also authorized an additional $3 billion for share repurchases in October.
Important facts for investors to verify
- Whether growth in cloud and other strategic imperatives can offset ongoing declines in Systems and pressure in traditional services, and whether new offerings reach scale sufficient to restore margins.
- The cash-flow outlook and the company’s non-GAAP free-cash-flow definition, which excludes changes in Global Financing receivables and subtracts net capital expenditures.
- Debt maturities and refinancing needs: $6.561 billion of long-term debt was classified as current at September 30, 2016.
- Acquisition integration, purchase accounting, and the contribution and profitability of recent acquisitions; IBM announced its intent to acquire Promontory Financial Group, expected to close in Q4 2016.
- Developments in the SEC revenue-recognition investigation, FCPA matters, tax disputes and U.K. pension litigation, including any changes to loss estimates or accruals.