IBM Q1 2020 Form 10-Q Summary
Business context and reporting period
International Business Machines Corporation (IBM) reported results for the three months ended March 31, 2020, compared with Q1 2019. Results were affected by the COVID-19 pandemic, the 2019 Red Hat acquisition, and divestitures. IBM realigned certain offerings and reporting categories; it recast comparative segment information, with no effect on consolidated results. Arvind Krishna became CEO on April 6, after quarter-end.
Key financial metrics
| Metric | Q1 2020 | Q1 2019 |
|---|---|---|
| Revenue | $17.571 billion | $18.182 billion |
| Gross profit / margin | $7.922 billion / 45.1% | $8.043 billion / 44.2% |
| Pre-tax income from continuing operations | Loss of $49 million | Income of $1.883 billion |
| Income from continuing operations | $1.176 billion | $1.593 billion |
| Net income | $1.175 billion | $1.591 billion |
| Diluted continuing-operations EPS | $1.31 | $1.78 |
| Operating (non-GAAP) earnings / diluted EPS | $1.649 billion / $1.84 | $2.009 billion / $2.25 |
| Operating cash flow / free cash flow | $4.476 billion / $1.358 billion | $4.759 billion / $1.688 billion |
Revenue declined 3.4% as reported, 1.9% at constant currency, and was up 0.1% excluding divested businesses and at constant currency. GAAP continuing-operations margin was 6.7%, versus 8.8%; operating (non-GAAP) margin was 9.4%, versus 11.0%. The quarter’s $1.226 billion income-tax benefit substantially exceeded the $49 million pre-tax loss: it included a $939 million net one-time benefit primarily related to an intra-entity intellectual-property sale, plus other discrete tax benefits.
At March 31, cash, restricted cash, and marketable securities totaled $12.017 billion. Total debt was $64.327 billion, up $1.428 billion from year-end; current liabilities exceeded current assets, with working capital of negative $1.743 billion and a 0.96:1 current ratio. IBM reported $15.25 billion of unused credit facilities and no borrowings under those facilities. Dividends paid were $1.440 billion ($1.62 per share); share repurchases remained suspended.
Material changes versus the prior period
- Cloud & Cognitive Software external revenue rose 5.5% (Cloud & Data Platforms +32.2%, including Red Hat); Global Business Services fell 0.5%; Global Technology Services fell 5.9%; Systems rose 3.0%; and Global Financing fell 26.2%.
- Revenue benefited from Red Hat and cloud growth, but March customer deal activity weakened as clients prioritized essential operations and cash preservation. IBM said software transactions were particularly affected because many typically close late in the quarter.
- Total expenses and other income increased 29.4%, including higher Red Hat spending, acquired-intangible amortization, interest expense, retirement-related costs, and workforce rebalancing. SG&A included $728 million of workforce rebalancing charges; IBM cited approximately $0.9 billion of structural-action charges overall.
- Q1 operating cash flow declined $283 million year over year and free cash flow declined $330 million. Cash and marketable securities increased from year-end, while total debt also rose.
Outlook, management commentary, and risks
- On April 20, IBM withdrew its full-year 2020 expectations because the pandemic’s duration and economic recovery were uncertain. It expected to reassess after Q2 and did not provide replacement annual guidance.
- Management anticipated further near-term changes in customer buying patterns, delayed or replanned services projects, and possible additional pressure on software and transactional hardware deal closures. It nevertheless expected solid free cash flow and ample liquidity under a range of scenarios and stated it remained committed to the dividend.
- IBM expected Q1 structural actions to produce approximately $1.8 billion in gross annualized savings beginning in the second half of 2020, and said further actions were possible in Q2. It estimated 2020 retirement-related plan costs of about $2.7 billion and contributions of about $2.3 billion.
- Customer-contract remaining performance obligations were $118 billion; approximately 60% was expected to be recognized over the next two years. The filing notes that this measure excludes certain cancellable and short-duration arrangements and is subject to change.
- IBM said its COVID-19-related accounting assessments had no material effect on Q1 results, but warned future effects could be material. Risks include economic and client-spending declines, credit losses, currency movements, goodwill or intangible impairment, pension matters, cybersecurity, acquisitions, and legal and tax proceedings.
- Contingencies include a range of litigation and investigations; IBM said it could not estimate reasonably possible losses for certain matters. Brazilian non-income-tax disputes had approximately $750 million of potential exposure across applicable years; IBM said it believed it would prevail and that the amount was not a meaningful liability indicator.
- Subsequent to quarter-end, IBM announced a quarterly dividend increase to $1.63 per share, payable June 10, 2020.
Important facts for investors to verify
- Whether the Q1 tax benefit, especially the $939 million one-time IP-related benefit, materially obscures underlying earnings and the sustainability of the reported tax rate.
- How COVID-19 affected Q2 and full-year revenue, margins, cash flow, customer collections, and credit-loss allowances after the filing date.
- Whether Red Hat and hybrid-cloud growth can offset declines in legacy platforms and services, and whether announced cost savings are realized.
- Debt maturity and refinancing needs, liquidity, covenant compliance, and progress toward management’s stated target leverage profile.
- Potential outcomes and financial exposure from significant litigation, tax disputes, and other contingencies, including the Brazilian matters.