IBM 2016 Q2 Form 10-Q Summary
Business context and reporting period
International Business Machines Corporation (IBM) reported unaudited results for the quarter and six months ended June 30, 2016. Comparisons are with the corresponding 2015 periods; segment results were recast for IBM’s January 2016 organizational changes. IBM described its strategy as transforming toward cognitive solutions and cloud platforms, while shifting investment and resources toward strategic growth areas.
Financial results
| Metric | Q2 2016 | Six months 2016 |
|---|---|---|
| Revenue | $20.238B, down 2.8% reported (2.6% adjusted for currency) | $38.923B, down 3.7% reported (2.3% adjusted for currency) |
| Gross profit margin | 47.9%, down 2.0 percentage points | 47.2%, down 1.9 points |
| Income from continuing operations | $2.505B, down 29.0% | $4.521B, down 23.9% |
| Net income | $2.504B, down 27.4% | $4.518B, down 21.8% |
| Diluted EPS from continuing operations | $2.61, down 27.1% | $4.69, down 22.0% |
| Operating (non-GAAP) diluted EPS | $2.95, down 23.2% | $5.30, down 21.5% |
| Cash from operating activities | $3.4B | $9.088B, up $1.594B |
| Free cash flow (non-GAAP) | $2.1B | $4.426B, versus $4.450B |
Q2 services revenue rose to $13.018B from $12.597B, while sales revenue fell to $6.792B from $7.733B and financing revenue declined to $429M from $484M. Q2 GAAP pre-tax income was $3.049B, down 27.8%; diluted continuing-operations EPS was $2.61. Six-month GAAP pre-tax income was $4.082B, down 43.5%. The six-month tax benefit was $439M, principally reflecting resolution of a Japanese tax matter; the 2015 comparison included a $1.283B tax provision.
At June 30, cash and cash equivalents were $10.017B and marketable securities were $600M. Total debt was $44.525B, up $4.635B from year-end; approximately 60% supported Global Financing. Working capital was $9.939B and the current ratio was 1.30:1. Stockholders’ equity was $15.889B including noncontrolling interests. Six-month dividends were $2.590B and share repurchases were $1.775B.
Material changes and business performance
- Strategic imperatives (cloud, analytics, mobile, social and security) grew 12% in Q2 and 13% in the first half, both reported; trailing-12-month revenue was $30.7B, about 38% of IBM revenue. Q2 cloud revenue grew 30%, and cloud-as-a-service grew 50%.
- Systems revenue fell 23.2% in Q2, primarily reflecting product-cycle dynamics. Cognitive Solutions revenue grew 3.5%; Technology Services & Cloud Platforms declined 0.5%; Global Business Services declined 2.0%; and Global Financing declined 11.3%.
- Q2 consolidated gross margin declined amid investment and the cost of building scale in as-a-Service businesses. Management also cited acquisition costs, workforce transformation and product-cycle effects as pressures on earnings.
- IBM completed 11 acquisitions in the first half at an aggregate cost of $5.674B, including The Weather Company ($2.278B) and Truven Health Analytics ($2.612B). Net cash used for acquisitions in the cash-flow statement was $5.405B.
- Six-month operating cash flow increased mainly because cash tax payments were lower; free cash flow was essentially flat year over year. Investing cash outflow increased substantially, primarily due to acquisitions.
Outlook, commentary, risks and unusual items
- For 2016, IBM lowered its minimum GAAP continuing-operations EPS expectation to $12.23 from $12.35, mainly due to acquisition-related expenses. It maintained operating (non-GAAP) EPS guidance of at least $13.50 and free-cash-flow guidance of $11B–$12B, expected at the high end. Management expected Q3 EPS to be 22%–24% of the full-year amount, most likely in the middle to high end of that range.
- Longer-term management targets were low-single-digit revenue growth, high-single-digit operating EPS growth and free-cash-flow realization in the 90% range. Management cautioned that cloud investment, transition to as-a-Service and acquisition dilution would weigh on near-term margins and earnings.
- The first half included $1.013B of workforce-rebalancing charges, compared with $463M a year earlier, and $328M of real-estate capacity charges. Separately, a $252M pre-tax impairment was recorded for properties classified as held for sale. IBM expected most gross savings from workforce actions in Q4 2016.
- The Japan tax dispute was resolved in IBM’s favor, generating a $1.0B tax refund and $0.2B interest in Q1. IBM recorded a $43M first-quarter pre-tax loss related to Venezuelan currency changes, bringing the first-half loss to $45M.
- Notable disclosed proceedings include an SEC investigation into revenue recognition for certain U.S., U.K. and Ireland transactions; DOJ and SEC inquiries concerning alleged FCPA issues; and a U.K. pension appeal that, if unsuccessful, could require reversal of plan changes and an estimated one-time pre-tax charge of about $250M plus ongoing accruals. IBM said it could not estimate losses for many proceedings. It also cited approximately $585M of potential Brazilian non-income-tax matters, while stating it believed it would prevail.
- Risks highlighted include economic and client-spending conditions, execution of transformation and innovation, cybersecurity and privacy, currency movements, customer credit and financing risk, acquisitions, pensions, taxes and legal proceedings. IBM reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether strategic-imperative and cloud growth can offset continued declines in Systems and traditional services, and whether cloud growth converts to improved margins as scale develops.
- How acquisition integration, purchase accounting, goodwill and intangible-asset amortization affect future reported earnings and cash generation.
- Whether the $11B–$12B 2016 free-cash-flow outlook and at-least-$13.50 operating EPS guidance remain achievable; note free cash flow is a company-defined non-GAAP measure.
- Debt and liquidity trends, including the increase in total debt and the core debt-to-capitalization ratio, which rose to 59.5% from 54.3% at year-end 2015.
- Developments in the revenue-recognition investigation, FCPA inquiries, pension litigation and tax matters, including any changes to potential charges or cash exposure.
- Effects of the unusual first-half tax benefit, workforce and real-estate actions, currency losses and other nonrecurring items on comparisons and future-period results.