IBM 2013 Third-Quarter Form 10-Q Summary
Business context and reporting period
International Business Machines Corporation (IBM) reported unaudited results for the three and nine months ended September 30, 2013, compared with the same 2012 periods. Unless stated otherwise, amounts are U.S. dollars. IBM describes operating earnings and constant-currency results as non-GAAP measures; they are not substitutes for reported GAAP results.
Key financial metrics
| Metric | Three months ended September 30, 2013 | Nine months ended September 30, 2013 |
|---|---|---|
| Revenue | $23.720 billion, down 4.1% reported and 1.6% at constant currency | $72.052 billion, down 4.2% reported and 2.1% at constant currency |
| Gross profit margin | 48.0%, up 0.6 percentage points | 47.5%, up 0.7 points |
| Net income | $4.041 billion, up 5.7% | $10.299 billion, down 4.4% |
| Diluted GAAP EPS | $3.68, up 10.5% | $9.27, unchanged |
| Diluted operating EPS (non-GAAP) | $3.99, up 10.2% | $10.21, up 3.1% |
| Operating cash flow | $3.760 billion | $10.957 billion, down $2.283 billion |
| Free cash flow (company presentation) | $2.2 billion | $6.620 billion, versus $8.670 billion |
Third-quarter net income rose despite lower revenue and pretax income, helped by a 16.0% effective tax rate versus 24.6% a year earlier. The nine-month effective tax rate was 18.0%, compared with 23.5%. Management attributed lower rates in part to discrete tax benefits and said the underlying full-year rate was expected to be approximately 23%.
At September 30, cash and marketable securities totaled $10.232 billion. Total debt was $36.180 billion, up $2.911 billion from December 31, 2012; long-term debt was $28.478 billion and short-term debt $7.702 billion. Working capital was $8.311 billion and the current ratio 1.21, versus $5.807 billion and 1.13 at year-end. The consolidated debt-to-capitalization ratio was 64.4%, compared with 63.7% at year-end; IBM’s “core” ratio, excluding Global Financing debt and equity, was 38.7%, up from 36.1%.
Nine-month investing cash outflow was $4.423 billion and financing cash outflow was $6.870 billion. IBM spent $8.062 billion on share repurchases and paid $3.033 billion in dividends during the period. Nine-month cash and cash equivalents ended at $10.072 billion, down $340 million from January 1.
Material changes versus the prior comparable period
- Systems and Technology revenue fell 16.6% in the quarter and 15.1% for nine months; its pretax result was a $167 million loss for the quarter and a $713 million loss for nine months. Weakness included Power Systems, System x and storage, with China and other growth markets contributing to the decline. System z revenue grew.
- Global Services revenue declined 2.8% reported in the quarter but increased about 1% at constant currency; IBM cited improved performance and expanded margins. Its estimated backlog was $141.1 billion, up 2.5% reported (5.6% at constant currency). Quarterly signings fell 7.0% reported, while nine-month signings rose 18.0%.
- Software revenue increased 0.6% in the quarter and 1.5% for nine months; key branded middleware grew 2.7% and 4.5%, respectively.
- Currency reduced reported revenue growth by approximately 2.5 points in the quarter and 2.1 points for the first nine months. Management highlighted yen depreciation as a profit headwind.
- Nine-month operating cash flow and free cash flow declined. IBM cited working-capital movements, service-contract fulfillment, higher workforce-rebalancing payments and cash taxes, as well as lower collections.
- IBM completed seven acquisitions for an aggregate cost of $2.734 billion during the first nine months, including SoftLayer for $1.977 billion. Goodwill increased to $30.882 billion from $29.247 billion at year-end.
Outlook, management commentary, risks and unusual items
- IBM’s October 2013 guidance was full-year 2013 GAAP diluted EPS of at least $15.01 and operating diluted EPS of at least $16.25 “all in,” or at least $16.90 excluding the second-quarter $1.0 billion workforce-rebalancing charge. Management reiterated its 2015 target of at least $20 operating diluted EPS.
- Management expected China-related weakness to continue for another couple of quarters, with growth-market performance improving in the fourth quarter and returning to revenue growth early in 2014. It expected mid-single-digit growth in growth markets at constant currency in 2014.
- IBM expected 2013 free cash flow not to increase year over year. It projected 2014 free cash flow to rise by approximately $1 billion, including cash-tax effects, while cash taxes were expected to be a roughly $2 billion headwind; management projected 15–20% free cash flow growth in 2014 excluding cash-tax impacts and similar growth in 2015 with taxes becoming a tailwind.
- IBM agreed to sell its worldwide customer-care business process outsourcing operation to SYNNEX for approximately $505 million, including cash and SYNNEX stock. Closings were expected in phases through 2014, subject to conditions; IBM forecast a total pretax gain of $125–$175 million.
- Tax benefits were material to reported earnings: third-quarter discrete benefits included approximately $148 million from foreign tax audit activity. Nine-month benefits also included tax agreement, legislation and retroactive tax-law effects, partly offset by an approximately $177 million charge related to intercompany IP licensing.
- Retirement-related plan costs were $2.165 billion for nine months, up 16.3%; non-operating retirement costs increased. IBM expected 2013 total pretax retirement-related cost of approximately $2.9 billion and approximately $500 million of legally mandated non-U.S. pension contributions.
- IBM disclosed ongoing legal, regulatory and tax matters, including U.S. and Polish anti-corruption investigations and a SEC inquiry into cloud-revenue reporting. The filing also discusses UK pension litigation, environmental claims and Brazilian non-income-tax disputes with approximately $700 million in potential amounts at issue; IBM said it believed it would prevail. For certain proceedings, reasonably possible losses could not be estimated.
- Additional risk factors include economic and IT-spending conditions, execution and growth initiatives, acquisitions, currency, customer credit and financing, pension funding, tax audits, cybersecurity, intellectual property and litigation. Management said disclosure controls were effective and reported no material change in internal control over financial reporting during the quarter.
Most important facts for investors to verify
- Whether revenue and Systems and Technology performance improve as management forecast, particularly in China and other growth markets.
- How much EPS growth reflects operating performance versus lower taxes, share repurchases and non-GAAP adjustments; review the reconciliation and the workforce-rebalancing charge.
- Whether operating cash flow and free cash flow recover, and how cash taxes, working capital and pension funding affect that recovery.
- Debt growth, leverage measures and the sustainability of repurchases and dividends relative to free cash flow.
- Completion timing and realized gain from the SYNNEX divestiture, along with integration and returns from SoftLayer and other acquisitions.
- Developments in the cloud-revenue inquiry, anti-corruption investigations, tax disputes and other contingencies, including any changes to accrued liabilities or loss estimates.