IBM Form 10-Q Summary
Reporting period: Three months ended March 31, 2014. Amounts are in U.S. dollars; financial statement amounts are generally in millions. The filing is unaudited.
Financial performance
| Metric | Q1 2014 | Q1 2013 | Change |
|---|---|---|---|
| Revenue | $22.484 billion | $23.408 billion | Down 3.9% reported; down 2.4% at constant currency |
| Gross profit margin | 46.9% | 45.6% | Up 1.3 percentage points |
| Income before taxes | $2.980 billion | $3.606 billion | Down 17.3% |
| Net income | $2.384 billion | $3.032 billion | Down 21.4% |
| Diluted EPS | $2.29 | $2.70 | Down 15.2% |
| Operating diluted EPS (non-GAAP) | $2.54 | $3.00 | Down 15.3% |
| Operating cash flow | $3.326 billion | $4.023 billion | Down $697 million |
| Free cash flow (company measure) | $631 million | $1.696 billion | Down $1.065 billion |
Gross-margin expansion reflected improvement in Global Services and a richer mix toward Software, partly offset by Systems and Technology weakness. GAAP net income margin was 10.6%, compared with 13.0%; the effective tax rate rose to 20.0% from 15.9%. IBM’s non-GAAP operating measures exclude specified acquisition-related and retirement-related items and are not directly comparable to GAAP without the filing’s reconciliations.
Services revenue was $13.982 billion, Sales revenue $7.984 billion, and Financing revenue $517 million. By segment, Software revenue rose 1.6% to $5.661 billion; Global Technology Services fell 2.9% to $9.330 billion; Global Business Services was essentially flat at $4.483 billion; Systems and Technology fell 23.0% to $2.391 billion; and Global Financing revenue increased 2.6% to $512 million. Systems and Technology reported a $660 million pretax loss, versus a $405 million loss.
Financial position, cash flow and capital allocation
- At March 31, cash and cash equivalents were $9.409 billion and marketable securities were $295 million. Total assets were $122.646 billion, total liabilities $105.906 billion, and total equity $16.740 billion.
- Total debt was $43.980 billion, up $4.262 billion from year-end 2013; long-term debt was $34.668 billion and short-term debt $9.312 billion. The consolidated debt-to-capitalization ratio was 72.4%, versus 63.4% at year-end. Management’s “core” ratio, excluding Global Financing debt and equity, was 55.3%, versus 39.0%.
- Working capital was $6.901 billion and the current ratio 1.17:1, compared with $11.196 billion and 1.28:1 at December 31, 2013. Management said liquidity remained strong and cited a $10 billion global credit facility; IBM reported compliance with significant debt covenants.
- Investing activities provided $35 million, compared with $1.012 billion used a year earlier. Financing activities used $4.673 billion, including $8.166 billion for gross share repurchases and $990 million for dividends. Cash fell $1.307 billion during the quarter to $9.409 billion.
- IBM repurchased 45.2 million shares for approximately $8.2 billion. The quarterly dividend paid was $0.95 per share; on April 29, the board approved a subsequent-quarter dividend of $1.10 per share.
Material changes and unusual items
- Revenue was pressured by a 23% decline in Systems and Technology, including declines in System z, Power, System x and Storage. IBM attributed weakness to hardware business-model challenges and product-cycle effects. Growth markets revenue declined 10.7% reported and 5% at constant currency, with substantial weakness in China.
- IBM recorded $873 million of workforce-rebalancing charges, compared with $20 million a year earlier. Management said the action significantly affected Q1 results and expected it to pay back within 2014. Excluding workforce-rebalancing charges, IBM cited better underlying pretax performance in Global Services and Software.
- Operating cash flow and free cash flow were affected by $2.594 billion of cash tax payments, up $1.375 billion year over year, primarily due to audit settlements and other prior-period tax impacts.
- Q1 included a $98 million gain from the phased sale of the customer-care business. IBM expected total pretax gain of $200–$225 million from that divestiture. It also recorded a $34 million gain from a phase of the Retail Store Solutions transfer to Toshiba TEC.
- IBM agreed to sell its x86 server business to Lenovo for $2.3 billion, subject to approvals and closing conditions, with initial closing expected in the second half of 2014. IBM estimated a total pretax gain of about $1 billion, but excluded it from 2014 EPS guidance because timing and amount remained uncertain.
- Two Software acquisitions, Aspera and Cloudant, were completed for a combined purchase price of $286 million. Goodwill recognized was $239 million.
Outlook, commentary and risks
In April 2014, IBM forecast 2014 GAAP diluted EPS of at least $17.00 and operating diluted EPS of at least $18.00. The operating target excluded $0.72 per share of acquisition-related charges and $0.28 per share of non-operating retirement-related costs; the potential Lenovo gain was excluded. IBM retained its longer-term 2015 objective of at least $20 in operating EPS. Management expected 2014 free cash flow to increase by approximately $1 billion year over year, while cash taxes were expected to be a roughly $2 billion annual headwind, largely incurred in Q1.
Management expected continued growth in cloud, analytics, mobile and security, and improving Software revenue growth. It expected Global Services growth at rates similar to Q1 and mid-single-digit profit growth for 2014. It anticipated further hardware revenue declines for the rest of 2014, with a focus on stabilizing that segment’s profit base. IBM also cited currency as a continuing profit headwind. These are forward-looking statements and depend on execution, client spending, market conditions and other risks described in the filing.
Notable exposures include customer and financing credit risk, foreign-exchange and interest-rate movements, pension funding and investment assumptions, and significant legal, tax and regulatory matters. The filing describes ongoing U.S. and international proceedings and investigations, including SEC and DOJ inquiries concerning FCPA matters, an SEC inquiry into cloud-revenue reporting, UK and Spain pension disputes, and environmental claims. IBM said recorded legal liabilities were not material, but it could not estimate reasonably possible losses for certain matters. A Brazil non-income-tax dispute involved approximately $720 million of potential claims; IBM said it expected to prevail. IBM also disclosed an approximately $866 million Indian tax assessment notice and an approximately $454 million prepaid-tax balance in India. On April 16, 2014, after quarter-end, Iusacell sued IBM seeking $2.5 billion in claimed lost-profit damages.
Most important facts for investors to verify
- Whether the 2014 EPS and free-cash-flow targets were achieved, and how much results depended on cost actions, tax timing and non-GAAP adjustments.
- Whether Systems and Technology stabilized, and whether Software and Services growth offset continued hardware declines and divestiture impacts.
- Completion, proceeds and final gain from the Lenovo x86 transaction, as well as remaining customer-care and Toshiba transfer closings.
- Cash generation relative to debt growth and substantial buybacks; IBM’s liquidity, leverage and covenant position.
- Developments in pension litigation and obligations, tax examinations and assessments, FCPA and cloud-revenue investigations, and other legal contingencies.
- Credit quality in Global Financing: its allowance coverage rose to 1.4% from 1.2% at year-end, while non-accrual financing receivables increased to $242 million from $191 million.