IBM — Form 10-Q Summary
Reporting period: Quarter and nine months ended September 30, 2011. IBM’s interim financial statements are unaudited. Comparisons are with the corresponding 2010 periods unless otherwise noted.
Business context and results
IBM reported growth across most major businesses, supported by Software, Systems and Technology, and strong growth-market demand. Growth in reported revenue and earnings per share also benefited from currency movements and share repurchases.
| Metric | Q3 2011 | Q3 2010 | First nine months 2011 | First nine months 2010 |
|---|---|---|---|---|
| Revenue | $26.157 billion | $24.271 billion | $77.430 billion | $70.852 billion |
| Gross profit | $12.173 billion | $11.001 billion | $35.416 billion | $31.787 billion |
| Gross margin | 46.5% | 45.3% | 45.7% | 44.9% |
| Income before taxes | $5.027 billion | $4.677 billion | $13.729 billion | $12.767 billion |
| Net income | $3.839 billion | $3.589 billion | $10.365 billion | $9.576 billion |
| Diluted GAAP EPS | $3.19 | $2.82 | $8.48 | $7.38 |
| Diluted operating EPS (non-GAAP) | $3.28 | $2.85 | $8.77 | $7.45 |
Q3 revenue increased 7.8% as reported (2.7% adjusted for currency); nine-month revenue increased 9.3% (4.3% adjusted for currency). GAAP diluted EPS rose 13.1% in Q3 and 14.9% year to date. IBM’s non-GAAP operating measure excludes specified acquisition-related and retirement-related items; it is not a substitute for GAAP results.
Financial position, cash flow and capital returns
- Cash and liquidity: Cash and cash equivalents were $11.303 billion at September 30, versus $10.661 billion at December 31, 2010. Working capital was $9.345 billion and the current ratio was 1.26, compared with $7.554 billion and 1.19 at year-end. IBM also cited a $10 billion global credit facility.
- Debt: Total debt was $30.160 billion, up $1.536 billion from year-end; long-term debt was $24.089 billion and short-term debt $6.071 billion. The consolidated debt-to-capitalization ratio rose to 57.4% from 55.3%; IBM’s core ratio, excluding Global Financing debt and equity, was 27.8% versus 22.6%.
- Cash flow, nine months: Operating cash flow was $12.750 billion, essentially unchanged from $12.754 billion. Investing activities used $891 million, versus $4.425 billion; financing activities used $10.886 billion, versus $10.569 billion. Cash increased $643 million to $11.303 billion.
- Free cash flow: Management’s measure excluding Global Financing receivables was $7.640 billion, versus $7.616 billion. IBM said it returned $14.058 billion to shareholders through $11.465 billion of repurchases and $2.593 billion of dividends.
- Shareholder returns: IBM repurchased 19.8 million shares in Q3 and 69.3 million in the first nine months. The quarterly dividend was $0.75 per share; the board subsequently authorized an additional $7 billion for repurchases.
Material changes and business drivers
- Q3 segments: Software external revenue increased 12.9% to $5.817 billion; Systems and Technology rose 3.6% to $4.482 billion; Global Services increased 7.7% to $15.154 billion. Global Financing external revenue declined 1.7% to $520 million.
- Growth markets: Revenue increased 19.3% in Q3 and 19.9% year to date, adjusted for currency increasing 12.8% in both periods. They represented about 23% of geographic revenue in Q3 and 22% year to date.
- Margins and expenses: Q3 gross margin improved 1.2 percentage points, while total expense and other income grew 13.0%, faster than revenue. For nine months, expense and other income rose 14.0%; net income margin edged down 0.1 percentage point to 13.4%.
- Retirement costs: Total retirement-related plan cost increased 33.8% to $1.419 billion for nine months, primarily due to higher recognized actuarial losses. IBM expected full-year 2011 retirement-related cost of about $1.9 billion, approximately $500 million above 2010.
- Nonrecurring comparison: The 2010 nine-month period included a $591 million gain from the sale of PLM activities, contributing to the year-over-year change in other income and expense. IBM also reported a $173 million second-quarter tax provision reduction from an IRS agreement, largely offset by other one-time tax items.
Outlook, risks and contingencies
- Guidance: In October, IBM raised its full-year 2011 minimum diluted EPS outlook to $12.95 GAAP and $13.35 on its non-GAAP operating basis. It targeted at least $20 operating diluted EPS in 2015. For Q4, it expected GTS performance similar to Q3, GBS revenue growth in the low-to-mid single digits at constant currency, similarly strong Software performance, and solid Systems and Technology revenue and profit despite a difficult comparison.
- Management commentary: IBM highlighted growth initiatives including business analytics, cloud, Smarter Planet and acquisitions. Estimated Global Services backlog was $136.9 billion, up $2.4 billion year over year, but down $7.3 billion from June 30; backlog and signings are management estimates and may change.
- Legal and regulatory matters: IBM disclosed ongoing intellectual-property, employment, environmental, privacy, competition and other proceedings. The DOJ had notified IBM of an antitrust investigation; a Health Net-related class action concerns unaccounted-for hard drives; and Endicott environmental claims include unspecified damages. IBM said recorded legal liabilities were not material, but it could not estimate reasonably possible losses for certain matters. Brazilian non-income tax disputes had a stated potential amount of approximately $600 million; IBM said it believed it would prevail.
- Tax and pension exposures: Unrecognized tax benefits were $5.4 billion at September 30, including $1.555 billion associated with a disputed foreign tax-loss issue. IBM reported a lawsuit challenging the tax authority decision and an IRS audit beginning for 2008–2010. Non-U.S. pension contributions expected for 2011 were approximately $800 million, the legally mandated minimum.
- Other risks: Management cited economic and IT-spending conditions, currency fluctuations, customer credit and financing risk, pension-market exposure, acquisitions, cybersecurity, intellectual property, environmental and tax matters, and execution of growth and productivity objectives. Derivative contracts may permit termination if IBM’s credit rating falls below investment grade; IBM reported no material credit-rating-triggered liquidity arrangements beyond those contractual provisions.
Important facts for investors to verify
- Reconcile GAAP EPS guidance with IBM’s non-GAAP operating EPS definition and exclusions.
- Assess the durability of revenue and margin growth, particularly in Software and Systems and Technology, and the performance of Global Financing.
- Track cash generation against large repurchases and dividends, alongside rising total debt and the core debt-to-capitalization ratio.
- Review pension assumptions, actuarial-loss sensitivity, required contributions, and the effect of the expected full-year retirement cost.
- Monitor developments in the DOJ investigation, Health Net matter, Endicott claims, Brazilian tax disputes, and other contingencies for outcomes or loss estimates not clear from this filing.
- Evaluate acquisition integration and the stated Q4 outlook, including the difficult Systems and Technology comparison and the estimated, changeable services backlog.