IBM 2012 Third-Quarter Form 10-Q Summary
Business context and reporting period. International Business Machines Corporation (IBM) reported unaudited results for the quarter and nine months ended September 30, 2012, compared with the same periods in 2011. IBM operates across Global Services, Software, Systems and Technology, and Global Financing. Unless otherwise noted, financial amounts below are in U.S. dollars.
Financial performance
- Third quarter: Revenue was $24.747 billion, down 5.4% reported and 1.8% at constant currency. Gross profit margin rose to 47.4% from 46.5%. Net income was $3.824 billion, down 0.4%; diluted GAAP EPS was $3.33, up 4.4%, helped by a 4.6% reduction in weighted-average diluted shares.
- First nine months: Revenue was $75.203 billion, down 2.9% reported and 0.1% at constant currency. Gross margin increased to 46.7% from 45.7%. Net income rose 3.9% to $10.771 billion; diluted GAAP EPS increased 9.3% to $9.27.
- Operating non-GAAP results: Diluted operating EPS was $3.62 for the quarter, up 10.4%, and $9.90 for the nine months, up 12.9%. Operating earnings exclude specified acquisition-related and retirement-related items; IBM cautions that its measure may not be comparable to similarly titled measures at other companies.
- Segment trends: Software revenue was down 0.9% in the quarter but up 1.4% for the nine months, both reported; Software pre-tax income increased 6.3% and 8.5%, respectively. Systems and Technology revenue fell 13.1% in the quarter and 9.7% year to date, with weaker margins and pre-tax income. Global Services revenue declined 4.6% in the quarter and 2.3% year to date, while service margins improved. Growth-market revenue increased 3.1% constant currency for the nine months.
- Cash flow and shareholder returns: Nine-month operating cash flow was $13.240 billion, versus $12.750 billion. Investing activities used $4.912 billion and financing activities used $8.185 billion. Management-defined free cash flow was $8.670 billion, up from $7.640 billion. IBM returned $11.804 billion through repurchases and dividends during the nine months.
- Liquidity and debt: At September 30, cash and marketable securities totaled $12.254 billion. Total debt was $33.668 billion, up $2.348 billion from year-end 2011. Working capital was $8.642 billion and the current ratio was 1.22. The consolidated debt-to-capitalization ratio was 60.8%; IBM’s core ratio, excluding Global Financing debt and equity, was 36.0%, versus 32.0% at year-end.
Material changes and unusual items
- IBM recorded a $447 million pre-tax gain in the quarter on the first two phases of the sale of its Retail Stores Solutions business to Toshiba Tec. The gain contributed approximately $280 million of net income; the divestiture also reduces future revenue and profit. IBM expected an overall pre-tax gain of approximately $500 million upon completion of the sale.
- A UK court ruling concerning a defined-benefit pension plan resulted in a $162 million pre-tax charge ($125 million after tax) in the quarter. The ruling was issued October 12, 2012, after quarter-end, and IBM recorded the obligation in the third quarter. IBM UK was considering appeal rights.
- IBM completed ten acquisitions during the first nine months for aggregate consideration of $2.613 billion. The acquisitions added $1.879 billion of goodwill. IBM announced an agreement to acquire Kenexa, expected to close in the fourth quarter of 2012.
- Retirement-related plan costs were $1.862 billion for the first nine months, up 31.2% year over year, driven in part by actuarial losses and the UK pension charge. IBM expected approximately $700 million of legally mandated contributions to non-U.S. defined-benefit plans in 2012.
Outlook, commentary, and risks
- In October 2012, IBM set full-year 2012 diluted EPS expectations of at least $14.29 GAAP and reaffirmed at least $15.10 operating non-GAAP, reflecting the UK pension charge in the GAAP outlook. The non-GAAP outlook excludes specified acquisition and retirement-related costs.
- For the fourth quarter, management expected Global Services constant-currency revenue growth consistent with the third-quarter rate; Software constant-currency revenue growth in the mid-single digits with double-digit pre-tax income growth; and Systems and Technology constant-currency revenue growth in the mid-single digits excluding the divested business. IBM expected System z revenue growth of 20%–30%.
- IBM reiterated its 2015 objective of at least $20 operating diluted EPS and described growth markets, analytics, cloud, Smarter Planet solutions, productivity, and share repurchases as key drivers. Management cited an $8 billion productivity-improvement objective through its 2015 roadmap.
- Management identified economic weakness and corporate IT spending, currency movements, execution of growth and productivity plans, competition, acquisition integration, cybersecurity and privacy, pension costs, tax matters, customer credit and financing risks, and legal or environmental matters as risks to results. The company stated it could not estimate reasonably possible losses for certain litigation and proceedings.
- Notable contingencies include approximately $550 million of disputed Brazilian non-income tax matters, which IBM said it believes it will prevail on; an appeal by Indiana after a court awarded IBM $52 million plus interest and costs; and environmental and other litigation. IBM reported no material recorded legal liabilities for the quarter. It also disclosed $2.3 billion of net receivables exposure in Portugal, Italy, Ireland, Greece, and Spain.
Most important facts for investors to verify
- Whether underlying revenue trends and fourth-quarter segment expectations materialized, particularly in Software and Systems and Technology, and after adjusting for currency and the Retail Stores Solutions sale.
- How much reported earnings and margins depended on the $447 million divestiture gain, share repurchases, and exclusions in IBM’s non-GAAP measures.
- Whether the UK pension litigation, related appeals, and future pension assumptions could create further costs or funding needs.
- Whether debt growth, cash generation, and the pace of repurchases and dividends remain consistent with IBM’s liquidity and capital-allocation plans.
- Developments in tax disputes, including the Brazilian matters, and customer credit quality, particularly in the named European countries.