IBM 2018 Q1 Form 10-Q Summary
Business context and reporting period
International Business Machines Corporation reported unaudited consolidated results for the three months ended March 31, 2018, compared with the three months ended March 31, 2017. IBM describes its strategy as shifting toward higher-value technology offerings, including cloud, AI, analytics and security. Revenue grew 5.1% reported, but was flat at constant currency.
Financial results
| Metric | Q1 2018 | Q1 2017 | Change |
|---|---|---|---|
| Revenue | $19.072 billion | $18.155 billion | +5.1% reported; flat at constant currency |
| Gross margin | 43.2% | 43.8% | -0.5 percentage points |
| Income before tax, continuing operations | $1.136 billion | $1.424 billion | -20.2% |
| Income from continuing operations | $1.675 billion | $1.753 billion | -4.4% |
| Net income | $1.679 billion | $1.750 billion | -4.1% |
| Diluted GAAP EPS | $1.81 | $1.85 | -2.2% |
| Diluted operating EPS (non-GAAP) | $2.45 | $2.35 | +4.3% |
| Cash provided by operations | $4.602 billion | $3.955 billion | +$647 million |
| Free cash flow (company-defined, non-GAAP) | $1.349 billion | $1.088 billion | +$261 million |
The reported effective tax rate was a benefit of 47.5%, principally reflecting an $807 million benefit from U.S. tax audit resolutions, partly offset by a $107 million provisional charge related to U.S. tax reform guidance. This unusually large tax benefit supported GAAP earnings despite lower pretax income. Operating EPS excludes specified acquisition, retirement and tax-reform items; it is a non-GAAP measure.
Revenue by reportable segment was $4.299 billion for Cognitive Solutions, $4.174 billion for Global Business Services (GBS), $8.625 billion for Technology Services & Cloud Platforms, $1.500 billion for Systems and $405 million for Global Financing. Reported year-over-year growth was strongest in Systems (+7.5%) and Cognitive Solutions (+5.8%); GBS and Technology Services & Cloud Platforms grew as reported but declined at constant currency. Segment pretax income fell notably in GBS (-48.6%) and Technology Services & Cloud Platforms (-35.2%).
Cash, debt and liquidity
- Cash, restricted cash and marketable securities totaled $13.155 billion at March 31, 2018.
- Total debt was $46.387 billion, down $437 million from year-end 2017; $31.677 billion supported Global Financing. Long-term debt carrying value was $40.410 billion.
- Current assets were $49.122 billion and current liabilities $35.733 billion; working capital was $13.389 billion and the current ratio was 1.37.
- Operating cash flow rose year over year. Investing activities used $1.764 billion, while financing activities used $2.909 billion. IBM paid $1.382 billion in dividends and repurchased $777 million of common stock.
- IBM reported $15.3 billion of global credit facilities and said it remained in compliance with significant debt covenants.
Material changes, outlook and management commentary
- Strategic imperatives revenue was $9.0 billion, up 15% reported and 10% at constant currency. Cloud revenue was $4.2 billion, up 20% reported; security revenue grew 65% reported. These areas were key sources of growth.
- Management attributed higher expenses partly to workforce rebalancing, currency effects and lower intellectual-property income. SG&A included $540 million of workforce rebalancing charges, compared with $167 million in the prior-year quarter. Management expects the annualized gross savings from the Q1 actions to equal twice the investment, with about half of the savings in the second half of 2018.
- Management expects 2018 GAAP diluted EPS from continuing operations of at least $11.58 and operating diluted EPS of at least $13.80. It expects approximately $12 billion of free cash flow, with free-cash-flow realization above 100% of GAAP net income.
- For full-year 2018, IBM expects revenue growth at mid-April spot rates and margin stabilization. It cited anticipated services productivity and cloud scale benefits, alongside a second-half mainframe-cycle mix headwind. Long term, it expects low-single-digit revenue growth and high-single-digit operating EPS growth.
- IBM adopted the new revenue-recognition standard on January 1, 2018. The company said the impact on results was not material; adoption increased opening retained earnings by $524 million and changed certain balance-sheet classifications. It expects the 2019 lease standard to materially affect the balance sheet.
- The Board approved a quarterly dividend of $1.57 per share in April 2018, a 5% increase from $1.50.
Risks, contingencies and unusual items
- IBM disclosed an SEC investigation, begun in 2015, concerning revenue-recognition accounting for certain transactions in the U.S., U.K. and Ireland; IBM said it was cooperating.
- IBM is appealing an Indiana court award that resulted in a net $78 million award to the state, plus interest. It also disclosed approximately $1.0 billion of potential Brazilian non-income-tax matters, while stating it believes it will prevail. Accrued legal liabilities and changes for the quarter were not material; IBM generally could not estimate reasonably possible losses for other matters.
- The $5.475 billion U.S. tax-reform charge recorded in 2017 remained provisional at March 31, 2018; IBM said the final impact could differ, possibly materially. The company was still evaluating the GILTI provisions.
- Other stated risk factors include cybersecurity and data privacy, currency movements, client spending and credit risk, pension costs, legal proceedings, product quality, and execution of innovation and productivity objectives.
Important facts for investors to verify
- Whether reported revenue growth converts into sustained constant-currency growth, particularly in GBS and Technology Services & Cloud Platforms.
- How much of the GAAP earnings result reflects discrete tax benefits, and whether operating EPS growth is accompanied by improving margins and cash generation.
- Whether workforce-rebalancing savings and services productivity offset ongoing investment, currency, and mainframe-cycle pressures.
- Progress toward the $12 billion free-cash-flow outlook, including the effects of taxes, capital spending and financing receivables.
- Developments in the SEC revenue-recognition investigation, significant litigation and tax matters, and the expected balance-sheet impact of the new lease standard.