IBM 2015 Second-Quarter Form 10-Q Summary
Business context and reporting period
International Business Machines Corporation reported unaudited results for the quarter and six months ended June 30, 2015, compared with the same 2014 periods. Amounts are U.S. dollars; financial statement amounts are in millions unless stated otherwise. Prior-period results were reclassified for discontinued operations, including the Microelectronics business. IBM completed that divestiture on July 1, 2015, after quarter-end.
Financial performance and position
| Metric | Three months ended June 30 | Six months ended June 30 |
|---|---|---|
| Revenue | $20.813 billion, down 13.5% reported; down 0.8% adjusted for currency and divestitures | $40.403 billion, down 12.7% reported; down 0.4% adjusted for currency and divestitures |
| Gross profit / margin | $10.390 billion / 49.9%, down 0.2 percentage points | $19.842 billion / 49.1%, up 0.1 percentage points |
| Continuing-operations income | $3.526 billion; diluted EPS $3.58 | $5.942 billion; diluted EPS $6.01 |
| Net income / diluted EPS | $3.449 billion / $3.50 | $5.777 billion / $5.84 |
| Operating earnings (non-GAAP) / diluted EPS | $3.790 billion / $3.84 | $6.680 billion / $6.75 |
| Cash flow | $3.9 billion operating cash flow and $3.4 billion free cash flow, per management discussion | $7.494 billion operating cash flow and $4.450 billion free cash flow |
Quarterly reported revenue declines reflected currency (about 9 percentage points) and divestitures (about 4 points). Six-month declines reflected currency (about 8 points) and divestitures (about 4 points). IBM’s non-GAAP operating measures exclude specified acquisition-related and retirement-related items and may not be comparable with similarly titled measures from other companies.
- Quarterly continuing-operations income fell 17.1%, diluted continuing-operations EPS fell 15.4%, and net income fell 16.6% year over year. For six months, those measures fell 12.4%, 9.2%, and 11.4%, respectively.
- Quarterly continuing-operations pre-tax income was $4.224 billion, down 21.0%; the effective tax rate was 16.5%, versus 20.5%. Six-month pre-tax income was $7.225 billion, down 15.3%; the effective tax rate was 17.8%, versus 20.5%.
- At June 30, cash and marketable securities were $8.760 billion; total debt was $38.668 billion, down $2.136 billion from year-end. Current assets were $45.186 billion and current liabilities $35.535 billion; working capital was $9.651 billion and the current ratio 1.27.
- Total assets were $112.729 billion and total equity $13.837 billion. Dividends paid in the first half were $2.366 billion; common-stock repurchases were $2.303 billion. IBM reported 979.5 million shares outstanding at June 30.
Material changes and operating trends
- Strategic imperatives revenue, including areas such as data, cloud and engagement, grew more than 20% reported in the quarter and more than 30% adjusted for currency and divestitures. Cloud revenue grew over 50% reported in the quarter; its 12-month revenue was $8.7 billion adjusted for divestitures.
- Reported segment revenue declined across Global Technology Services (10.5%), Global Business Services (12.0%), Software (10.1%) and Systems Hardware (31.7%) in the quarter. Management attributed much of the Systems Hardware reported decline to the System x divestiture and currency; adjusted for these, Systems Hardware revenue grew 5%.
- Services profitability weakened: quarterly pre-tax income fell 25.2% at Global Technology Services and 35.3% at Global Business Services. Management cited currency, insufficient near-term productivity, investment spending, and lower revenue on relatively fixed costs. The services backlog was $122.1 billion, down 10.2% reported but up 1.4% at constant currency year over year.
- Systems Hardware quarterly pre-tax income rose 26.2% to $255 million, with gross margin up 8.5 points to 48.2%, reflecting mix and the divestiture of lower-margin System x. z Systems revenue grew 9.2% reported; Power Systems grew 4.8% adjusted for currency.
- Six-month operating cash flow rose $589 million year over year, primarily due to $1.446 billion lower income tax payments. Free cash flow increased $844 million to $4.450 billion. Share repurchases were substantially lower than in the first half of 2014.
Outlook, commentary, risks and unusual items
- For 2015, IBM forecast GAAP diluted EPS from continuing operations of $14.25–$15.00 and maintained non-GAAP operating EPS guidance of $15.75–$16.50. It expected modest year-over-year free-cash-flow improvement and about 90% free-cash-flow realization. Management identified the software revenue trajectory as the primary variable within the operating EPS range.
- IBM expected full-year reported revenue to decline, with currency and divestitures together estimated to reduce growth by 10–11 percentage points. Currency was expected to reduce full-year operating EPS growth by more than $0.80 per share. Management expected operating margin expansion for the year and continued high investment in strategic areas.
- Management’s longer-term expectations included low-single-digit revenue growth, high-single-digit non-GAAP EPS growth, and free-cash-flow realization in the 90% range. These were described as a long-term trajectory, not a fixed endpoint or multi-year commitment.
- The Microelectronics disposal group had a cumulative pre-tax charge of $4.8 billion through June 30, including a further $51 million in the first half of 2015; additional charges could occur. The transaction closed July 1, 2015, and IBM transferred $472 million of net cash at closing.
- Retirement-plan costs rose to $1.380 billion for the first half, from $1.009 billion. This included a $230 million pre-tax Spanish pension obligation following a court ruling. IBM expected 2015 contributions of about $2.7 billion for all retirement plans, including about $600 million to non-U.S. plans.
- The lower first-half tax rate included approximately $127 million of one-time net discrete benefits, primarily from foreign tax audit activity. The company expected its normal effective tax rate to be approximately 20%.
- IBM reported that recorded liabilities for legal matters were not material, but said it could not estimate reasonably possible losses for many proceedings. Notable matters include UK pension litigation, with an estimated potential one-time pre-tax charge of about $250 million plus ongoing accruals if IBM’s appeal fails; Spanish pension litigation; environmental claims in Endicott; and Brazilian non-income-tax disputes with approximately $560 million in potential amounts that IBM said it expects to contest successfully. IBM also disclosed FCPA-related investigations and securities and ERISA class actions related to the semiconductor divestiture.
- Risks identified include weaker economic conditions or client spending, failure to meet growth and productivity goals, execution and investment risks, cybersecurity and privacy, currency movements, customer credit and financing risk, pension and tax matters, legal proceedings, and acquisition, alliance and divestiture execution.
Most important facts for investors to verify
- Whether revenue and profit trends improve after adjusting for currency and divestitures, particularly in Software and Global Services.
- Progress against 2015 EPS and free-cash-flow guidance, including the sensitivity to software performance, currency and tax benefits.
- Whether services backlog growth converts into revenue and whether productivity offsets near-term investment costs.
- The final cash, accounting and any additional charge effects of the Microelectronics divestiture, and the remaining recognition of the System x sale gain.
- Developments in Spanish and UK pension matters, tax disputes, environmental claims and other legal proceedings, as well as pension funding needs.
- Global Financing receivables and credit quality: its allowance coverage rose to 2.4% from 1.9% at year-end, while non-accrual financing receivables were $245 million versus $231 million.