IBM 2015 Q3 Form 10-Q Summary
Business context and reporting period
International Business Machines Corporation reported unaudited results for the three and nine months ended September 30, 2015, compared with the same 2014 periods. IBM described an ongoing shift toward higher-value enterprise IT, particularly cloud, analytics, social, mobile and security. Its Microelectronics business sale to GLOBALFOUNDRIES closed July 1, 2015; results are reported as discontinued operations.
Financial results and liquidity
| Metric | Q3 2015 | Q3 2014 | Nine months 2015 | Nine months 2014 |
|---|---|---|---|---|
| Revenue | $19.280bn | $22.397bn | $59.682bn | $68.680bn |
| Income from continuing operations | $2.962bn | $3.455bn | $8.904bn | $10.237bn |
| Diluted continuing-operations EPS | $3.02 | $3.46 | $9.03 | $10.09 |
| Net income | $2.950bn | $18m | $8.727bn | $6.539bn |
| Gross margin | 48.9% | 48.6% | 49.1% | 48.8% |
- Reported revenue declined 13.9% in Q3 and 13.1% year to date. Management attributed much of the decline to currency and divestitures; revenue was down about 1% in each period after the relevant adjustments.
- Operating earnings, a company-defined non-GAAP measure, were $3.272bn in Q3, down 10.9%; operating diluted EPS was $3.34, down 9.2%. For nine months, operating earnings were $9.953bn, down 8.8%, and operating diluted EPS was $10.09, down 6.2%. Non-GAAP results exclude specified acquisition and retirement-related items.
- Q3 strategic-imperatives revenue grew 17% reported and 27% adjusted for currency and the System x divestiture. Nine-month growth was 20% reported and over 30% adjusted for currency and divestitures. In contrast, Q3 Global Business Services revenue fell 13.1% reported and 5% adjusted for currency; Software fell 10% reported and 3% adjusted for currency.
- Operating cash flow was $11.729bn for nine months, versus $10.809bn. Management-defined free cash flow was $7.003bn, up from $5.783bn; this measure deducts the change in Global Financing receivables and net capital expenditures from operating cash flow.
- At September 30, cash and marketable securities totaled $9.568bn; total debt was $39.660bn, including $7.538bn short-term and $32.122bn long-term debt. Working capital was $8.379bn and the current ratio was 1.25. Total debt declined $1.144bn from year-end 2014.
- Nine-month dividends and gross share repurchases were $3.636bn and $3.846bn, respectively. The quarterly dividend was $1.30 per share. A further $4.0bn repurchase authorization was announced after quarter-end.
Material changes, outlook and management commentary
- Net income comparisons are significantly affected by the 2014 Microelectronics disposal charge: discontinued-operations losses were $3.437bn in Q3 2014 and $12m in Q3 2015; for nine months they were $3.698bn and $176m, respectively. Thus, reported net income rose sharply despite lower continuing-operations income.
- IBM said Q3 revenue fell short of its expectations. Management cited a slower-than-planned Global Business Services transformation, weaker storage disk demand, and softness in software transactions late in the quarter. It also noted that currency reduced reported revenue and earnings growth.
- Management expected 2015 GAAP diluted EPS from continuing operations of $13.25–$14.25 and operating diluted EPS of $14.75–$15.75; 2015 free cash flow was expected to be approximately flat year over year. Longer term, IBM described expectations for double-digit growth in strategic-imperatives revenue, low-single-digit revenue growth, high-single-digit operating EPS growth and free-cash-flow realization in the 90% range. These are forward-looking expectations, not guarantees.
- IBM reported $108m of additional pre-tax charges in the first nine months related to the Microelectronics disposal; the cumulative pre-tax charge was $4.8bn, and further charges were possible. The sale included a 10-year semiconductor manufacturing sourcing agreement.
- Retirement-related plan cost was $1.953bn for nine months, up 31.6%. A Spanish court ruling led IBM to record an additional $230m pre-tax pension obligation in Q1 2015. IBM estimated total 2015 retirement-plan cost of about $2.6bn and contributions of about $2.6bn.
- IBM completed seven acquisitions for aggregate consideration of $782m in the first nine months. Subsequent events included closing the Merge Healthcare acquisition for enterprise value of about $1bn and approval of an additional $4bn share-repurchase authorization.
Risks, contingencies and unusual matters
- IBM disclosed that the SEC was investigating revenue-recognition accounting for certain transactions in the U.S., U.K. and Ireland; IBM said it was cooperating. The filing does not provide a clear estimate of any potential loss.
- Other disclosed matters include U.S. Department of Justice and SEC inquiries concerning alleged foreign-corruption issues, pension litigation in the U.K. and Spain, environmental claims, and tax disputes. IBM said recorded legal liabilities were not material, but it generally could not estimate reasonably possible losses for the matters discussed.
- The U.K. pension appeal, if unsuccessful, could require reversal of plan changes and an estimated one-time pre-tax charge of about $250m, plus ongoing benefit accruals. IBM also cited approximately $450m of potential Brazilian non-income-tax matters and an Indian tax assessment notice valued at about $817m; IBM disputed these matters.
- Management cited risks including currency and client-spending conditions, execution of transformation and growth initiatives, cybersecurity and privacy, pension and tax matters, litigation, financing-receivable credit risk, and acquisition and divestiture execution. IBM stated that disclosure controls were effective at period-end and reported no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether reported revenue trends improve after separating currency effects and divestitures, and whether growth in strategic imperatives offsets declines in legacy businesses.
- Progress in Global Business Services and software transactions, storage demand, services signings and backlog conversion.
- Delivery against the 2015 EPS and free-cash-flow outlook, including the effects of currency, tax benefits, pension costs and share repurchases.
- Cash generation and debt levels, including the distinction between IBM operating debt and debt supporting Global Financing.
- Developments in the SEC revenue-recognition inquiry, pension litigation, tax disputes and other contingencies, for which potential exposure is not fully quantified in the filing.