Tech giant International Business Machines Corp. (IBM) reported second quarter 2010 earnings that marginally beat the Zacks Consensus Estimate. The current quarter profitability was fueled by cost controls, margin expansion due to a shift to the higher-margin software business and increased sales in emerging markets.
However, revenues came in slightly below expectations due to currency headwinds and lower services contract signings. Although corporate IT spending is picking up, it is below expectation. Recently, Gartner lowered its IT spending forecast for 2010. Slower recovery in IT spending could hurt IBM’s top line.
IBM lifted its earnings forecast for fiscal 2010, the fourth time in a row, as it stands to benefit from its increased focus on software and services. We believe IBM will need to grow its top line in addition to encouraging profit guidance to restore investors’ confidence.
IBM has been controlling costs to maintain a steady earnings growth. Over the long term, we remain positive on IBM, and thus maintain our Neutral rating on the stock.
Operating Performance
IBM’s quarterly earnings marginally exceeded the Zacks Consensus Estimate of $2.58 per share by 3 cents per share. Net profit improved 9.1% year over year to $3.39 billion, while earnings per share rose 12.5% to $2.61. This compares with a profit of $3.10 billion or $2.32 per share in the year-ago period. Net margin upped 100 basis points year over year to 14.3%. The company cited that it has posted earnings per share growth in the last 30 consecutive quarters, with double-digit growth in the 12 of last 14 quarters.
Gross profit margin grew marginally to 45.6% from 45.5% in the year-ago quarter, led by improved margins in all but the Systems and Technology and Global Technology Services and Other segment. IBM has benefited from the growing focus on high-margin segments, such as Services and Software businesses.
The company benefited from lower interest expenses, which fell 11.1% from the year-ago period and increased Other income, which leaped more than 200% year over year. IBM also benefited from a lower effective tax rate of 26% in the quarter.
Operating expense was flat year over year in the second quarter due to a lower SG&A expense (21.3% of total 2Q revenue), which dropped 1.1% to $5.06 billion, offset by a higher RD&E expense (6.2% of total 2Q revenue), which increased 2.9% to $1.48 billion from the year-ago period.
As a result, the operating margin inched up to 18.0% in the quarter from 17.3% in the year-ago period.
Revenues
Total revenue in the quarter was $500 million below the Zacks Consensus Estimate. Revenues of $23.72 billion in the second quarter were up 2.0% (up 2% when adjusted for currency) compared with the year-ago quarter. The change in currency rates reduced revenues by approximately $500 million in the reported quarter. Overall, sales were down in one of its five segments. Services, Software and Systems and Technology revenues were higher, while Financing fell from the year-ago period.
Revenues by Segment
Total Global Services revenue grew 2% (up 1% adjusting for currency) year over year to $13.72 billion, driven by an increase of 1.4% in Global Technology Services revenues and a 3.3% increase in Global Business Services revenues.
However, signed services contracts (accounting for nearly 60% of total revenue) dropped 12% (down 12%, adjusting for currency) to $12.3 billion. The company’s total outsourcing services signings (GTS Outsourcing and Application Management Outsourcing) decreased 19% (down 19%, adjusting for currency) to $6.5 billion.
Management said that the decrease was due to a number of customers’ renegotiated contracts last year and signed contract extensions. However, the company signed 15 contracts which were greater than $100 million, compared with 13 contracts during the first quarter.
Signings in Transactional services (Consulting, Integrated Technology Services and Application Management Systems Integration) declined 3%. The estimated services backlog on June 30 was $129 billion, a decrease of $2 billion (up $1 billion, adjusting for currency) year over year.
IBM reported improved revenues from its branded key middleware products that include WebSphere, Information Management, Tivoli, Rational products and Lotus products, which rose 9% (10%, adjusting for currency) year over year to $3.3 billion. As a result, the company’s Software segment increased 2.1% (up 2%, adjusting for currency) from the comparable quarter a year ago. Excluding the first-quarter divestiture of the Product Lifecycle Management operations (PLM), Software revenues grew 6% year over year.
Revenues from the company’s Business Analytics operations within Global Business Services and Software climbed 14%, which was very encouraging. We believe IBM will benefit from its spate of new initiatives such as smarter planet, business analytics and optimization and cloud computing.
Systems and Technology revenues increased 3.4% (4% adjusting for currency) year over year to $3.99 billion. Systems revenues were up 1%, attributable to an increase in System x revenues, which grew 30%. This was offset by a decrease of 10% in revenues from POWER Systems. Revenues from System z mainframe server products plummeted 24%. Revenues from System Storage escalated 5% while revenues from Retail Store Solutions shot up 31%. Revenues from Microelectronics OEM ascended 23%.
Revenues from Global Financing decreased 4.1% (down 5%, adjusting for currency) year over year to $544 million.
Revenue by Geography
From a geographic perspective, revenues were up 3% (up 2%, adjusting for currency) in the Americas and grew 9% (up 3%, adjusting for currency) in the Asia-Pacific region. Europe, Middle East & Africa (EMEA) were down 6% (down 1%, adjusting for currency) in the quarter. Year-over-year revenues from OEM customers increased 26% and revenues from the growth markets increased 14% (up 9%, adjusting for currency) and represented 20% of total geographic revenue.
The weakness in the European region (sales fell 6% to $7.4 billion) that hurt IBM's sizable overseas sales was offset by the strength in Brazil, Russia, India and China (BRIC), where it witnessed a growth of 22%, validating the company’s strength in emerging countries.
Balance Sheet
IBM ended the quarter with $12.24 billion in total cash and marketable securities, compared with $14.0 billion in the previous quarter. The company reported cash flow from operations (excluding Global Financing receivables) of $$3.99 billion versus $2.3 billion in the previous quarter. For the quarter, IBM generated free cash flow of $3.02 billion, up from $1.4 billion reported in the year-ago period. The company returned $4.9 billion to shareholders through $0.8 billion in dividends and $4.1 billion in share repurchases.
At quarter end, Global Financing debt totaled $21.2 billion versus $22.4 billion at year-end 2009, resulting in a debt-to-equity ratio of 7.1 to 1. Non-global financing debt totaled $5.5 billion, an increase of $1.7 billion since year-end 2009, resulting in a debt-to-capitalization ratio of 23.1%, down from 16.0% in the fourth quarter of 2009.
Guidance Raised
Historically, IBM’s earnings have consistently surpassed the Zacks Consensus Estimate, and IBM has raised its guidance for almost every quarter over the last three years. For fiscal year 2010, the company again raised its earnings forecast to at least $11.25 per share from the previously expected $11.20 per share. However, earnings expectation is a penny below the Zacks Consensus.
The increase in guidance suggests that the company is expected to benefit from the uptick in spending. IBM expects growth to pick up in the second half of the year, attributable to the new product cycles in the hardware division. Moreover, the new mainframe computers and high-end servers could lead to growth in hardware sales in 2010. IBM pointed out that the increase in hardware sales were one of the reasons for upward revision to the 2010 guidance.
Read the full analyst report on "IBM"
Zacks Investment Research
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IBM lifted its earnings forecast for fiscal 2010, the fourth time in a row, as it stands to benefit from its increased focus on software and services. We believe IBM will need to grow its top line in addition to encouraging profit guidance to restore investors’ confidence.
IBM has been controlling costs to maintain a steady earnings growth. Over the long term, we remain positive on IBM, and thus maintain our Neutral rating on the stock.
Operating Performance
IBM’s quarterly earnings marginally exceeded the Zacks Consensus Estimate of $2.58 per share by 3 cents per share. Net profit improved 9.1% year over year to $3.39 billion, while earnings per share rose 12.5% to $2.61. This compares with a profit of $3.10 billion or $2.32 per share in the year-ago period. Net margin upped 100 basis points year over year to 14.3%. The company cited that it has posted earnings per share growth in the last 30 consecutive quarters, with double-digit growth in the 12 of last 14 quarters.
Gross profit margin grew marginally to 45.6% from 45.5% in the year-ago quarter, led by improved margins in all but the Systems and Technology and Global Technology Services and Other segment. IBM has benefited from the growing focus on high-margin segments, such as Services and Software businesses.
The company benefited from lower interest expenses, which fell 11.1% from the year-ago period and increased Other income, which leaped more than 200% year over year. IBM also benefited from a lower effective tax rate of 26% in the quarter.
Operating expense was flat year over year in the second quarter due to a lower SG&A expense (21.3% of total 2Q revenue), which dropped 1.1% to $5.06 billion, offset by a higher RD&E expense (6.2% of total 2Q revenue), which increased 2.9% to $1.48 billion from the year-ago period.
As a result, the operating margin inched up to 18.0% in the quarter from 17.3% in the year-ago period.
Revenues
Total revenue in the quarter was $500 million below the Zacks Consensus Estimate. Revenues of $23.72 billion in the second quarter were up 2.0% (up 2% when adjusted for currency) compared with the year-ago quarter. The change in currency rates reduced revenues by approximately $500 million in the reported quarter. Overall, sales were down in one of its five segments. Services, Software and Systems and Technology revenues were higher, while Financing fell from the year-ago period.
Revenues by Segment
Total Global Services revenue grew 2% (up 1% adjusting for currency) year over year to $13.72 billion, driven by an increase of 1.4% in Global Technology Services revenues and a 3.3% increase in Global Business Services revenues.
However, signed services contracts (accounting for nearly 60% of total revenue) dropped 12% (down 12%, adjusting for currency) to $12.3 billion. The company’s total outsourcing services signings (GTS Outsourcing and Application Management Outsourcing) decreased 19% (down 19%, adjusting for currency) to $6.5 billion.
Management said that the decrease was due to a number of customers’ renegotiated contracts last year and signed contract extensions. However, the company signed 15 contracts which were greater than $100 million, compared with 13 contracts during the first quarter.
Signings in Transactional services (Consulting, Integrated Technology Services and Application Management Systems Integration) declined 3%. The estimated services backlog on June 30 was $129 billion, a decrease of $2 billion (up $1 billion, adjusting for currency) year over year.
IBM reported improved revenues from its branded key middleware products that include WebSphere, Information Management, Tivoli, Rational products and Lotus products, which rose 9% (10%, adjusting for currency) year over year to $3.3 billion. As a result, the company’s Software segment increased 2.1% (up 2%, adjusting for currency) from the comparable quarter a year ago. Excluding the first-quarter divestiture of the Product Lifecycle Management operations (PLM), Software revenues grew 6% year over year.
Revenues from the company’s Business Analytics operations within Global Business Services and Software climbed 14%, which was very encouraging. We believe IBM will benefit from its spate of new initiatives such as smarter planet, business analytics and optimization and cloud computing.
Systems and Technology revenues increased 3.4% (4% adjusting for currency) year over year to $3.99 billion. Systems revenues were up 1%, attributable to an increase in System x revenues, which grew 30%. This was offset by a decrease of 10% in revenues from POWER Systems. Revenues from System z mainframe server products plummeted 24%. Revenues from System Storage escalated 5% while revenues from Retail Store Solutions shot up 31%. Revenues from Microelectronics OEM ascended 23%.
Revenues from Global Financing decreased 4.1% (down 5%, adjusting for currency) year over year to $544 million.
Revenue by Geography
From a geographic perspective, revenues were up 3% (up 2%, adjusting for currency) in the Americas and grew 9% (up 3%, adjusting for currency) in the Asia-Pacific region. Europe, Middle East & Africa (EMEA) were down 6% (down 1%, adjusting for currency) in the quarter. Year-over-year revenues from OEM customers increased 26% and revenues from the growth markets increased 14% (up 9%, adjusting for currency) and represented 20% of total geographic revenue.
The weakness in the European region (sales fell 6% to $7.4 billion) that hurt IBM's sizable overseas sales was offset by the strength in Brazil, Russia, India and China (BRIC), where it witnessed a growth of 22%, validating the company’s strength in emerging countries.
Balance Sheet
IBM ended the quarter with $12.24 billion in total cash and marketable securities, compared with $14.0 billion in the previous quarter. The company reported cash flow from operations (excluding Global Financing receivables) of $$3.99 billion versus $2.3 billion in the previous quarter. For the quarter, IBM generated free cash flow of $3.02 billion, up from $1.4 billion reported in the year-ago period. The company returned $4.9 billion to shareholders through $0.8 billion in dividends and $4.1 billion in share repurchases.
At quarter end, Global Financing debt totaled $21.2 billion versus $22.4 billion at year-end 2009, resulting in a debt-to-equity ratio of 7.1 to 1. Non-global financing debt totaled $5.5 billion, an increase of $1.7 billion since year-end 2009, resulting in a debt-to-capitalization ratio of 23.1%, down from 16.0% in the fourth quarter of 2009.
Guidance Raised
Historically, IBM’s earnings have consistently surpassed the Zacks Consensus Estimate, and IBM has raised its guidance for almost every quarter over the last three years. For fiscal year 2010, the company again raised its earnings forecast to at least $11.25 per share from the previously expected $11.20 per share. However, earnings expectation is a penny below the Zacks Consensus.
The increase in guidance suggests that the company is expected to benefit from the uptick in spending. IBM expects growth to pick up in the second half of the year, attributable to the new product cycles in the hardware division. Moreover, the new mainframe computers and high-end servers could lead to growth in hardware sales in 2010. IBM pointed out that the increase in hardware sales were one of the reasons for upward revision to the 2010 guidance.
Read the full analyst report on "IBM"
Zacks Investment Research
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