IBM 2020 Second-Quarter Form 10-Q Summary
Business context and reporting period
International Business Machines Corporation reported unaudited results for the three and six months ended June 30, 2020, compared with the corresponding 2019 periods. The quarter was shaped by COVID-19 disruption to client spending and project activity, alongside continued investment in hybrid cloud and the integration of Red Hat, acquired in July 2019. Arvind Krishna became CEO on April 6, 2020.
Key financial metrics
| Metric | Q2 2020 | Six months 2020 |
|---|---|---|
| Revenue | $18.123 billion, down 5.4% reported; down 1.9% excluding divestitures and currency | $35.694 billion, down 4.4% reported; down 0.9% excluding divestitures and currency |
| Gross margin | 48.0%, up 1.0 percentage point | 46.6%, up 0.9 percentage point |
| Income from continuing operations | $1.362 billion, down 45.5%; diluted EPS $1.52, down 45.9% | $2.538 billion, down 38.0%; diluted EPS $2.83, down 38.2% |
| Operating earnings and diluted EPS (non-GAAP) | $1.949 billion, down 31.0%; $2.18 per share, down 31.2% | $3.598 billion, down 25.6%; $4.02 per share, down 25.8% |
| Operating cash flow | $3.6 billion, up $0.6 billion year over year | $8.052 billion, versus $7.700 billion |
| Free cash flow (company-defined, non-GAAP) | $2.3 billion | $3.647 billion, down from $4.078 billion |
Q2 GAAP pre-tax income was $1.571 billion, down 43.2%, and continuing-operations margin was 7.5%, down 5.5 points. For the first half, the reported tax benefit was $1.017 billion, versus a $558 million tax provision in 2019; a first-quarter one-time net tax benefit of $939 million was primarily associated with an intra-entity intellectual-property sale and materially affected the comparison.
At June 30, cash and cash equivalents, restricted cash and marketable securities totaled $14.250 billion, up $5.241 billion from year-end 2019. Total debt was $64.738 billion, up $1.838 billion; current liabilities were $38.442 billion and current assets $39.953 billion, resulting in working capital of $1.511 billion and a 1.04 current ratio. IBM reported $15.250 billion in unused credit facilities and no borrowings under those facilities.
Material changes and operating trends
- Q2 segment revenue: Cloud & Cognitive Software was $5.748 billion, up 3.3%; Global Business Services (GBS) was $3.890 billion, down 7.3%; Global Technology Services (GTS) was $6.316 billion, down 7.6%; Systems was $1.852 billion, up 5.7%; and Global Financing was $265 million, down 24.5%.
- Cloud & Data Platforms revenue grew 28.7% in Q2, reflecting Red Hat and hybrid-cloud momentum. Declines in Cognitive Applications and Transaction Processing Platforms partly offset that growth. Total cloud revenue was $6.3 billion, up 30% reported.
- Clients delayed projects and purchases and shifted toward operating spending, weighing particularly on transactional software and project-oriented services. Management cited declines in challenged industries including travel and transportation, retail, automotive and consumer goods. Systems growth reflected IBM Z and Storage Systems; Power Systems declined.
- Consolidated gross margin improved despite lower revenue. Expenses rose, driven in part by Red Hat-related spending and acquired-intangible amortization, lower divestiture gains, and higher non-operating retirement costs. First-half workforce-rebalancing charges were also higher year over year.
- IBM reported $117 billion of remaining performance obligations at June 30; approximately 60% was expected to be recognized over the next two years and 35% in years three through five. RPO excludes certain cancellable and short-duration contracts and is subject to change.
Outlook, risks and unusual items
- IBM withdrew its full-year 2020 expectations on April 20 and provided no replacement guidance, citing uncertainty about the pandemic’s duration and the pace of economic recovery. Management described hybrid cloud and AI as long-term opportunities, while warning that client discretionary projects and transactional purchases could remain pressured.
- Management expected structural actions to begin supporting services cost competitiveness and margins in the second half. It also noted that the z15 product cycle and typical quarterly software transaction patterns could affect second-half results. The filing does not provide full-year revenue, earnings or free-cash-flow guidance.
- Management stated that it remained committed to the dividend and reported a July 28 board approval of a $1.63-per-share quarterly dividend, payable September 10. The share-repurchase program remained suspended following the Red Hat acquisition; no shares were repurchased under the program in Q2.
- IBM cited ample liquidity and access to capital, but total debt increased during the first half. Debt covenants include a minimum consolidated net interest expense ratio of 2.20 to 1.0; IBM reported compliance. Ratings were A from S&P and A2 from Moody’s.
- COVID-19-related deterioration in customer credit quality contributed to higher expected-credit-loss reserves. IBM said its June 30 assessments did not produce material consolidated impacts, but warned future effects could be material given uncertainty. Total IBM receivables allowance coverage was 2.4% at June 30.
- Legal and tax matters include Brazilian non-income-tax disputes with approximately $700 million of potential exposure across applicable years; IBM said it believes it will prevail and that the amount is not a meaningful indicator of liability. The company generally could not estimate reasonably possible losses for other disclosed proceedings. Unrecognized tax benefits were $8.445 billion, before specified potential reductions.
- Other notable items include a $49 million first-quarter loss on early debt redemption and $945 million of acquired-intangible amortization in the first half. Management expects 2020 pre-tax retirement-plan costs of about $2.7 billion and contributions of about $2.3 billion.
Important facts for investors to verify
- How much of the revenue and earnings decline reflects pandemic-related demand versus Red Hat purchase accounting, amortization, divestitures and other non-recurring or non-GAAP adjustments.
- Whether hybrid-cloud growth, including Red Hat, can continue to offset weakness in transactional software, GBS and GTS; assess bookings, signings and conversion of the $117 billion RPO.
- Whether operating cash generation and free cash flow remain sufficient to fund dividends, debt service and investment, particularly as debt maturities approach.
- How COVID-19 and customer-credit trends affect financing receivables, allowance coverage and future credit-loss provisions.
- Developments in the disclosed legal, tax and pension matters, and the timing and durability of the one-time tax benefit.