IBM 2009 Second-Quarter Form 10-Q Summary
Business context and reporting period
International Business Machines Corporation (IBM) reported unaudited results for the three and six months ended June 30, 2009. Comparisons are against the corresponding 2008 periods; balance-sheet comparisons are against December 31, 2008. Dollar amounts are in millions except per-share data. IBM described the operating environment as challenging, with weak global demand and customers conserving cash.
Financial performance
| Metric | Q2 2009 | Q2 2008 | First half 2009 | First half 2008 |
|---|---|---|---|---|
| Revenue | $23,250 | $26,820 | $44,962 | $51,322 |
| Gross profit margin | 45.5% | 43.2% | 44.5% | 42.4% |
| Income before taxes | $4,262 | $3,814 | $7,385 | $7,012 |
| Net income | $3,103 | $2,765 | $5,398 | $5,084 |
| Diluted EPS | $2.32 | $1.97 | $4.02 | $3.61 |
- Revenue declined 13.3% in Q2 and 12.4% for the first half as reported; declines were 6.8% and 5.4%, respectively, after adjusting for currency. IBM attributed the drop to currency and economic weakness, particularly in transactional hardware and consulting.
- Net income rose 12.2% in Q2 and 6.2% for the first half. Diluted EPS increased 17.8% and 11.4%, respectively, supported by higher margins, lower expenses, tax-rate benefits and reduced weighted-average shares from repurchases.
- Q2 net income margin was 13.3%, up 3.0 percentage points; first-half margin was 12.0%, up 2.1 points. Effective tax rates were 27.2% for Q2 and 26.9% for the first half, versus 27.5% in both 2008 periods.
- Segment results were mixed. Q2 revenue fell 26.0% in Systems and Technology, 15.0% in Global Business Services, 9.8% in Global Technology Services and 7.3% in Software; Global Financing declined 10.5%. Software pre-tax income rose 24.1% and Global Technology Services pre-tax income rose 41.3%. Global Services signings were $13,988, down 4.8% reported but up 3% adjusted for currency; estimated backlog was $132 billion.
- Six-month cash from operations was $9,127, versus $8,453 in 2008. Investing activities used $1,897, versus $6,909; financing activities used $8,326, versus $7,083. Cash and cash equivalents ended at $11,678, down $1,063 from year-end; cash plus marketable securities totaled $12,526.
- At June 30, total debt was $29,373, down $4,553 from year-end; stockholders’ equity was $15,473, up $1,889. Working capital was $8,005 and the current ratio was 1.22:1. The core debt-to-capitalization ratio, excluding Global Financing, was 35.0%, versus 48.7% at year-end; consolidated ratio was 65.5%.
- IBM repurchased $3,436 of shares and paid $1,407 in dividends in the first half. The quarterly dividend was $0.55 per share. First-half free cash flow, using management’s definition excluding Global Financing accounts receivable, was $4,490, up $187 year over year.
Material changes and unusual items
- Q2 expense and other income decreased 18.8% year over year; first-half expense decreased 14.4%. IBM cited currency effects and expense management. First-half workforce-reduction expense increased to $335 from $203, and bad-debt expense increased to $121 from $55.
- First-half other income included a $298 gain on the sale of core logistics operations to Geodis. Q2 results also included a $119 provision for losses related to a joint-venture investment. These and other items affected reported non-operating income.
- First-half Global Financing originations fell to $17,543 from $22,807. Its allowance coverage increased to 2.3% from 2.0% at year-end, while bad-debt expense was $83 versus $33 in the first half of 2008.
- IBM completed two small software acquisitions for $40 in aggregate. After quarter-end, it agreed to acquire SPSS for approximately $1.2 billion in cash, subject to approvals and customary closing conditions.
- Accounting-standard adoptions during the period were generally reported as having no material effect on consolidated results; adoption of the participating-securities guidance reduced comparative 2008 EPS by $0.01 for Q2 and $0.02 for the first half.
Outlook, risks and contingencies
- After reiterating a 2009 diluted EPS projection of at least $9.20 in April, IBM raised its projection to at least $9.70 in July 2009. Management expected margin expansion to continue through the rest of the year, double-digit full-year pre-tax profit growth in Global Services, and improved Systems and Technology revenue in Q3 with year-over-year pre-tax profit growth in Q4.
- Management expected 2009 pre-tax retirement-related plan costs of approximately $1.4 billion and an effective tax rate of approximately 26.7%. It expected legally mandated non-U.S. pension contributions of approximately $1.1 billion for 2009.
- Management highlighted investment priorities including Smarter Planet solutions, business analytics and cloud computing. It also cited its previously stated 2010 diluted EPS roadmap of $10–$11 as a longer-term target, and said it believed IBM was ahead of pace; this is not a new 2009 guidance figure.
- Key risks include prolonged economic weakness and reduced IT spending, currency movements, customer and financing-receivable credit risk, pension funding and investment performance, competition, execution of acquisitions and growth initiatives, intellectual-property and data-protection matters, and tax, environmental and legal proceedings.
- IBM disclosed ongoing litigation, including a patent matter scheduled for trial in November 2009, antitrust-related proceedings, and claims concerning contamination at its former Endicott facility. Brazilian non-income-tax matters totaled approximately $2.4 billion; IBM said the potential amount could fall to about $500 million if a favorable decision is upheld. A Mexican tax assessment had potential exposure of approximately $500 million. IBM believed it would prevail; recorded liabilities for the matters discussed were not material, but outcomes remain uncertain.
- IBM reported $4,512 of unrecognized tax benefits at June 30, of which $3,958, if recognized, would favorably affect the effective tax rate. Derivative agreements may require full overnight collateralization under specified credit conditions; IBM reported $494 of derivative liabilities with credit-risk contingent features and $37 of collateral posted.
Important facts for investors to verify
- Whether the $9.70 minimum 2009 diluted-EPS projection and expected second-half margin gains were achieved, and how much depended on repurchases, currency and nonrecurring items.
- Whether revenue and signings stabilized, particularly in Systems and Technology, consulting, and major geographic markets; assess reported and constant-currency trends separately.
- Whether operating cash flow and free cash flow remained strong after pension contributions, workforce actions, dividends, repurchases and debt payments.
- Whether Global Financing credit quality deteriorated further, including allowance coverage, bad-debt expense, originations and residual-value performance.
- Developments in significant tax and legal matters, pension funding, and the proposed SPSS acquisition and its financing.