IBM 2018 Second-Quarter 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, 2018. Its businesses include software and cognitive solutions, consulting and other services, technology infrastructure and cloud platforms, systems, and financing.
Financial performance
| Metric | Q2 2018 | Six months 2018 |
|---|---|---|
| Revenue | $20.0 billion, up 3.7% reported and 1.6% at constant currency | $39.1 billion, up 4.4% reported and 0.8% at constant currency |
| Gross margin | 46.0%, down 0.5 percentage points year over year | 44.6%, down 0.5 points |
| Income from continuing operations | $2.4 billion, up 3.0% | $4.1 billion, down 0.2% |
| Net income | $2.4 billion, up 3.1% | $4.1 billion, essentially unchanged |
| Diluted EPS from continuing operations | $2.61, up 5.2% | $4.42, up 2.3% |
| Operating diluted EPS (non-GAAP) | $3.08, up 4.8% | $5.53, up 4.7% |
| Cash from operating activities | $2.3 billion | $6.9 billion, versus $7.4 billion |
| Free cash flow (non-GAAP) | $1.9 billion | $3.2 billion, versus $3.6 billion |
Operating earnings exclude specified acquisition-related charges, non-operating retirement costs, and certain tax-reform impacts; they are non-GAAP measures and should be considered alongside GAAP results. Q2 GAAP continuing-operations pretax income rose 13.6% to $2.8 billion, while the tax provision increased to $373 million from $111 million. For the first half, IBM recorded a $166 million tax benefit, primarily reflecting resolution of U.S. tax audit matters.
Balance sheet and liquidity. At June 30, cash and cash equivalents were $10.7 billion; restricted cash and marketable securities brought the combined total to $11.9 billion. Total debt was $45.5 billion, down $1.3 billion from year-end 2017; approximately $31.1 billion supported Global Financing. Current assets were $46.8 billion and current liabilities $35.4 billion, with a 1.32:1 current ratio. Total assets were $121.6 billion, total liabilities $103.0 billion, and equity $18.6 billion. IBM reported $15.3 billion of global credit facilities and said it was in compliance with significant debt covenants.
Material changes and business trends
- Growth was strongest in Systems, where Q2 revenue rose 24.6% reported, led by IBM Z; Technology Services & Cloud Platforms grew 2.5%, while Cognitive Solutions grew 0.5% and Global Business Services grew 2.3%. Global Financing external revenue declined 4.9%.
- Strategic imperatives revenue increased 15% reported in Q2 to $10.1 billion. Cloud revenue grew 20% to $4.7 billion; security grew 81%; analytics grew 7%. As-a-Service revenue’s annual exit run rate was $11.1 billion.
- IBM attributed lower gross margins primarily to business mix and investment in expanding cloud capabilities. First-half operating expenses also reflected higher workforce-rebalancing charges and currency effects, partly offset by lower spending and acquisition synergies.
- First-half operating cash flow decreased $525 million year over year, with higher cash tax payments and lower cash provided by financing receivables partly offset by working-capital improvement. Capital expenditures, including software investment, were higher.
- IBM paid $2.8 billion in dividends and repurchased $1.8 billion of shares in the first half. Its quarterly dividend was $1.57 per share; the board approved the same quarterly dividend for payment in September 2018.
Outlook, commentary, risks, and unusual items
- For 2018, IBM maintained guidance for GAAP diluted EPS of at least $11.60, operating diluted EPS of at least $13.80, and free cash flow of approximately $12 billion. It expected free-cash-flow realization above 100% of GAAP net income.
- Management expected low-single-digit revenue growth and mid-single-digit profit growth over the long term, with high-single-digit operating EPS growth and free-cash-flow realization above 90% of GAAP net income. For 2018, it expected currency to provide a one-point revenue-growth tailwind overall, including a one- to two-point headwind in the second half. It anticipated typical Q3 seasonality and said most productivity benefits from Q1 workforce actions were expected in the second half.
- U.S. tax-reform accounting remained provisional. IBM recorded a $5.475 billion charge in 2017, followed by a $107 million charge in Q1 2018 and a $14 million benefit in Q2; final effects could differ as guidance and the company’s assessment of provisions, including GILTI, are completed.
- IBM adopted the new revenue-recognition standard on January 1, 2018. The company said the impact on current-period results was not material; adoption included a $524 million cumulative increase to opening retained earnings and capitalization of certain contract-acquisition costs. New lease accounting, effective in 2019, was expected to materially affect the balance sheet.
- Potentially significant uncertainties include economic and client-spending conditions, execution of growth and productivity plans, cybersecurity and data privacy, currency, customer credit and financing risks, pension obligations, taxes, litigation, acquisitions, and intellectual-property matters. IBM said it could not estimate reasonably possible losses for certain claims. Brazilian non-income tax matters had an approximately $900 million potential amount; IBM believed it would prevail and said the amount was not a meaningful indicator of liability.
- The SEC informed IBM in May 2018 that it had closed its investigation into certain revenue-recognition transactions without enforcement action. In the Indiana contract dispute, a $78 million award to the State plus interest remained under appeal. IBM reported that its disclosure controls were effective and that no material change in internal control over financial reporting occurred during the quarter.
Important facts for investors to verify
- Reconcile GAAP and non-GAAP earnings, including excluded acquisition, retirement, and tax-reform items.
- Assess whether cloud, security, and Systems growth can offset weaker or flat trends in other businesses, and whether reported growth persists after currency effects.
- Track gross-margin trends, cloud investment, workforce-rebalancing savings, and the timing of expected productivity benefits.
- Monitor operating cash flow and free cash flow against guidance, including receivables, cash taxes, capital spending, dividends, and repurchases.
- Review debt maturities, refinancing and liquidity needs, financing-receivable quality, and the effects of provisional tax accounting and unresolved legal or tax matters.