International Business Machines Corp. (IBM) reported strong fourth quarter 2010 earnings, beating the Zacks Consensus Estimate by a dime. This solid result was primarily driven by continued margin expansion in the quarter, based on better than expected revenue performance by Hardware and Software.
Revenue also beat the Zacks Consensus Estimate, driven by strong growth in both the Hardware and Software segments. IBM reported gains across all of its business units. A rejuvenated Services business contributed to growth, ending the year with a healthy backlog, reflecting strong revenue growth prospect going forward.
Operating Performance
IBM posted earnings of $4.18 per share in the fourth quarter, well above the Zacks Consensus Estimate of $4.08, representing a 2.5% surprise. Net profit improved 9.23% year over year to $5.23 billion, while earnings per share rose 16.4%. This compares with a profit of $4.81 billion or $3.59 per share in the year-ago quarter.
Net margin upped 40 basis points year over year to 18.1%. The company cited that it has posted earnings per share growth in the last 32 consecutive quarters with double-digit growth in 14 of the last 16 quarters.
IBM posted earnings of $11.52 per share in fiscal 2010, surpassing the Zacks Consensus Estimate of $11.44, as well as beating its 2010 roadmap of $10.00–$11.00. Net profit increased 10.5% year over year to $14.83 billion, with net margin expanding 90 basis points to 14.9%.
Gross profit was $14.23 billion, up 8.2% year over year and 29.3% quarter over quarter. Gross margins increased 70 basis points to 49.0% on a year-over-year basis, primarily driven by strong margin performance m by Systems and Technology and Software. On a quarter-over-quarter basis, gross margin increased 370 basis points.
In fiscal 2010, gross profit increased 5.1% year over year to $46.01 billion, with margin increasing 40 basis points to 46.1% as compared with the prior-year quarter.
Operating expense increased 7.0% year over year to $7.3 billion in the quarter, primarily due to higher acquisition costs, R&D (up 8.0% year over year and 7.8% quarter over quarter) and SG&A expense (up 7.0% year over year and 15.6% quarter over quarter). In fiscal 2010, operating expenses increased 2.5% year over year to $26.29 billion.
Operating income was $6.70 billion, up 9.4% year over year and 52.6% quarter over quarter. Operating margin increased 60 basis points to 23.1% in the quarter.
In fiscal 2010, operating income was $18.2 billion, up 6.7% year over year. Operating margin expanded 40 basis points to 18.2% in fiscal 2010.
Revenues
Total revenue increased 6.6% year over year and 19.6% quarter over quarter to $29.02 billion, well above the Zacks Consensus Estimate of $28.27 billion. According to the management, this was the best constant-currency revenue growth in almost a decade, primarily driven by Hardware and Software revenues.
Growth was seen across all major markets, with revenues climbing 5% at constant currency. These markets primarily include the U.S., France and Italy. The developing markets comprising the BRIC (Brazil, Russia, India and China) nations generated 19% revenue growth.
In fiscal 2010, total revenue increased 4.3% year over year to $99.87 billion.
Revenues by Segment
Services: Total Global Services revenue grew 2.0% year over year and 6.1% quarter over quarter to $14.92 billion, driven by an increase of 1.1% in Global Technology Services revenues to $10.17 billion and a 3.9% increase in Global Business Services revenues to $4.8 billion.
The estimated services backlog as of December 31, 2010 was $142.0 billion, an increase of $5 billion ($4.0 billion at constant currency/cc) year over year and $8.0 billion ($7.0 billion at cc) quarter over quarter. Signings in Transactional Services (Consulting, Integrated Technology Services and Application Management Systems Integration) increased 8% (9% at cc) year over year to $8.0 billion.
Signed Services Contracts (accounting nearly 60% of total revenue) increased 18.0% to $22.1 billion. Nineteen such contracts, signed by IBM, were worth more than $100 million each. IBM's total Outsourcing Services signings (GTS Outsourcing and Application Management Outsourcing) increased 24.0% (23.0% at cc) to $14.1 billion.
In fiscal 2010, Total Global Services revenues increased 3.0% (1% at cc) year over year, driven by 2.0% (1.0% at cc) revenue growth from the Global Technology Services and 3.0% (2.0%, adjusting for currency) growth from the Global Business Services segments. Total services signings were $57.7 billion.
Software: IBM reported improved revenues from its branded key middleware products that include WebSphere, Information Management, Tivoli, Rational products and Lotus products, which rose 13.0% (15.0% at cc) year over year to $4.7 billion. Accordingly, revenues from the company's Software segment increased 7.0% (8.0% at cc) year over year to reach $7.0 billion.
Excluding the first-quarter divestiture of the Product Lifecycle Management operations (PLM), Software revenues grew 11.0% (12.0% at cc) over the prior year. Operating systems revenue of $690.0 million increased 11.0% (12.0% at cc) compared with the prior-year quarter.
Revenues from the WebSphere family of software products soared 32.0% year over year. Information Management software revenues increased 10.0%. Revenues from Tivoli software rose 12.0%. Revenues from Lotus software however slipped 3.0%, and Rational software increased 10.0%.
Revenues from Business Analytics operations within Global Business Services and Software climbed an encouraging 19%. We believe that IBM will benefit from its spate of new initiatives like smarter planet, business analytics and optimization and cloud computing.
In fiscal 2010, software segment revenues increased 5.0% (5.0% at cc).
Hardware: Systems and Technology revenues increased 21.0% (22.0% at cc) year over year to $6.3 billion. Systems revenues were up 20.0%, attributable to an increase in System x revenues, which grew 18.0%. Revenue from POWER Systems increased 2.0% year over year.
Revenues from System z mainframe server products soared 69.0% and MIPS (millions of instructions per second) also climbed 58.0%, riding on new product launches. Revenues from System Storage escalated 8.0% while revenues from Retail Store Solutions increased 26.0% year over year. Revenues from Microelectronics OEM ascended 30.0%.
In fiscal 2010, Systems and Technology segment revenue increased 11.0% (11.0% at cc).
Financing: Revenues from Global Financing increased 1.0% (up 1.0% at cc) year over year to $628.0 million.
In fiscal 2010, Global Financing segment revenues decreased 3.0% (4.0% at cc).
Revenue by Region
From a geographic perspective, fourth quarter 2010 revenues were up 9.0% (up 9.0% at cc) in the Americas and grew 14.0% (up 7.0%, adjusting for currency) in the Asia-Pacific region. Europe, Middle East & Africa (EMEA) revenues were down 2.0% (up 4.0%, adjusting for currency) in the quarter. IBM witnessed a growth of 19.0% (up 17.0% at cc) in the reported quarter from Brazil, Russia, India and China (BRIC), validating the company's strength in the emerging countries.
Year-over-year revenues from OEM customers upped 21.0% and revenues from the growth markets, which include South Africa, Vietnam and the Czech Republic, increased 15.0% (up 13.0%, adjusting for currency).
In fiscal 2010, revenue from America increased 5.0% (3.0% at cc) year over year. Revenues from Europe, Middle East & Africa decreased 2.0% (up 1.0% at cc). Asia-Pacific revenues increased 12.0% (5.0% at cc) year over year. OEM revenues increased 23.0% and revenues from the company's growth markets increased 16.0% (11.0% at cc).
Balance Sheet
IBM ended the quarter with $11.65 billion in total cash and marketable securities, compared with $11.09 billion in the sequentially preceding quarter.
At year end, Global Financing debt totaled $21.85 billion versus $22.00 billion in the prior quarter and $21.93 billion at year-end 2009, resulting in a debt-to-equity ratio of 7.0 to 1. Non-global financing debt totaled $5.8 billion, an increase of $2.1 billion since year-end 2009, resulting in a debt-to-capitalization ratio of 23.0%, deterioration from 16.0% at year-end 2009.
The company reported cash flow from operations (excluding Global Financing receivables) of $9.79 billion versus $4.18 billion in the previous quarter. In the reported quarter, IBM generated free cash flow of $8.68 billion, up from $3.17 billion in the prior quarter.
In fiscal 2010, IBM reported cash flow from operations (excluding Global Financing receivables) of $20.28 billion versus $18.87 billion in the previous year. In the reported quarter, IBM generated free cash flow of $16.30 billion, up from $15.12 billion in the previous year.
In fiscal 2010, the company returned $18.6 billion to shareholders through $3.2 billion in dividend payouts and $15.4 billion in share repurchases.
Guidance
IBM expects to deliver full-year 2011 GAAP earnings per share of at least $12.56; and operating (non-GAAP) earnings per share of roughly $13.00, which positions the company on track for the 2015 target of earning no less than $20 per share on a non-GAAP basis.
Our Take
We remain optimistic on the company's long-term growth after the bullish fiscal 2010 results. Strong service backlog, diversified product pipeline, higher growth from outsourcing and business analytics will cumulatively boost top-line growth going forward.
We also believe IBM's growing initiatives in smarter planet, business analytics and optimization, and cloud computing will drive long-term growth. Besides, the ability to generate strong free cash flow, expand margins, and a robust balance sheet make the stock attractive over the long term.
On the flip side, currency fluctuations, weakness in European markets, increasing outsourcing competition from small players, and slower-than-expected IT spending growth are some of the headwinds. IBM competes against the likes of Oracle Corp. (ORCL) and Hewlett Packard Co. (HPQ). We have a long-term Neutral recommendation on the stock.
Currently, IBM retains a Zacks #2 Rank, which implies a short-term Buy rating on the stock.
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