INTERNATIONAL BUSINESS MACHINES CORP quarterly report, Q3 FY2010

IBM 2010 Q3 Form 10-Q Summary

Business context and reporting period. International Business Machines Corporation (IBM) filed this unaudited quarterly report for the three and nine months ended September 30, 2010. Comparisons are with the corresponding 2009 periods unless otherwise noted. Amounts are in U.S. dollars; financial statements are prepared under U.S. GAAP.

Financial performance and position

Metric	Q3 2010	Q3 2009	Nine months 2010	Nine months 2009
Revenue	$24.271B	$23.566B	$70.852B	$68.528B
Gross profit / margin	$11.001B / 45.3%	$10.627B / 45.1%	$31.787B / 44.9%	$30.640B / 44.7%
Income before taxes	$4.677B	$4.373B	$12.767B	$11.757B
Net income / margin	$3.589B / 14.8%	$3.214B / 13.6%	$9.576B / 13.5%	$8.612B / 12.6%
Diluted EPS	$2.82	$2.40	$7.38	$6.42

Q3 revenue rose 3.0% reported (3.6% at constant currency); net income rose 11.7% and diluted EPS 17.5%. Nine-month revenue increased 3.4% reported (1.7% at constant currency), net income 11.2%, and diluted EPS 15.0%.
Q3 effective tax rate was 23.3%, versus 26.5%; nine-month rate was 25.0%, versus 26.8%. Management attributed the lower rates mainly to earnings mix in lower-tax jurisdictions and increased foreign tax credits.
Operating cash flow for the first nine months was $12.754B, down from $14.325B. Investing activities used $4.425B; financing activities used $10.569B. Cash and cash equivalents declined to $9.859B from $12.183B at year-end 2009.
Management’s non-GAAP free cash flow measure, excluding Global Financing receivables, was $7.616B versus $7.897B. Capital expenditures net of dispositions were $2.448B; software investment was $433M.
At September 30, cash and marketable securities were $11.086B. Total debt was $27.455B, up from $26.099B at year-end; current and long-term debt were $5.556B and $21.899B. Consolidated debt-to-capitalization was 55.1%, versus 53.4%; the company’s “core” ratio excluding Global Financing was 22.1%, versus 16.0%.
Working capital was $9.026B, down from $12.933B; the current ratio was 1.25:1, versus 1.36:1. IBM reported access to a $10B global credit facility. Its long-term debt ratings were A+ (S&P), A1 (Moody’s) and A+ (Fitch), unchanged from year-end.
IBM repurchased 92.6M shares for $11.774B during the first nine months and paid $2.369B in dividends. The quarterly dividend was $0.65 per share.

Material changes and business trends

Q3 growth was led by Systems and Technology revenue, up 10.4%, and Global Business Services, up 5.4%. Software revenue grew 0.7% reported; excluding divested Product Lifecycle Management (PLM) operations, management said Software grew 6% at constant currency. Global Technology Services increased 0.7%; Global Financing revenue declined 1.3%.
Growth-market revenue rose 15.7% in Q3 and 16.3% for the first nine months; BRIC revenue increased 28.8% and 24.8%, respectively. EMEA reported revenue declined 6.1% in Q3, although it increased 1% at constant currency.
Global Services signings fell 6.5% in Q3 to $11.037B, including a 14.9% decline in outsourcing signings; transactional signings rose 4.3%. Estimated Services backlog was $134B, flat year over year.
Segment performance was mixed year to date: Software pre-tax income rose 17.6% reported (9.8% normalized for specified workforce and divestiture items); Systems and Technology pre-tax income fell 35.4% reported and 17.2% on management’s normalized basis. Segment measures are management measures and are not necessarily GAAP measures.

Outlook, significant items and risks

In October 2010, IBM raised its 2010 diluted EPS expectation to at least $11.40. Management expected Q4 revenue growth of about 4% at constant currency, with Systems and Technology growth similar to Q3 and continued strong Global Business Services performance.
Management’s 2015 objective is at least $20 operating EPS. Operating EPS is a non-GAAP measure; IBM said it planned to begin presenting operating and non-operating results in 2011.
IBM completed 11 acquisitions in the first nine months for aggregate consideration of $3.385B, including Sterling Commerce for $1.415B. The company reported a $591M gain on the March sale of PLM activities. It also announced several subsequent acquisitions and agreed to acquire Netezza for approximately $1.7B, subject to closing.
Other (income) and expense included the PLM gain; this line also reflected currency-related gains and losses. The reported results therefore include items that may not recur at similar levels.
Management expected 2010 retirement-related plan costs of approximately $1.5B and legally mandated non-U.S. pension contributions of about $900M. It expected a 2010 effective tax rate near 25% in the normal course.
Unrecognized tax benefits were $6.026B at September 30, of which $5.446B would favorably affect the effective tax rate if recognized. IBM described ongoing tax examinations and said it expected resolution of certain IRS matters by year-end 2010.
Contingencies include intellectual-property and antitrust matters, environmental and employment claims, and tax disputes. Potential Brazilian non-income tax matters were estimated at approximately $600M; IBM said it believed it would prevail. Recorded legal liabilities and changes during the quarter were not material, but the company cautioned that outcomes are uncertain and could affect results or cash flows.
Management cited economic and IT-spending conditions, execution of growth and productivity plans, acquisitions, cybersecurity, currency, client credit, pension funding, taxes, litigation and environmental matters among forward-looking risks. Management concluded disclosure controls were effective and reported no material quarter-over-quarter change in internal control over financial reporting.

Important facts for investors to verify

Whether the $11.40 2010 EPS floor and Q4 revenue expectations were achieved, and how reported results compare with constant-currency and non-GAAP measures.
Cash generation and working-capital trends, including the effect of Global Financing receivables, taxes and acquisition spending; also assess debt growth and the higher core debt-to-capitalization ratio.
Whether Services signings and backlog translated into revenue, particularly given the Q3 decline in outsourcing signings.
Acquisition integration, purchase accounting, goodwill and intangible-asset growth, and the effects of the PLM divestiture and other unusual income items.
Developments in tax examinations, legal and environmental proceedings, pension costs and funding, and Global Financing credit and residual-value risks.