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IBM > SEC Filings for IBM > Form 10-Q on 30-Oct-2012All Recent SEC Filings

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Form 10-Q for INTERNATIONAL BUSINESS MACHINES CORP


30-Oct-2012

Quarterly Report


MANAGEMENT'S DISCUSSION AND ANALYSIS
OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2012

Snapshot



Financial Results Summary:



                                                                        Yr. to Yr.
                                                                         Percent/
(Dollars in millions except per share amounts)                            Margin
For the three months ended September 30:            2012       2011       Change
Revenue                                           $ 24,747   $ 26,157         (5.4 )%*
Gross profit margin                                   47.4 %     46.5 %        0.9 pts.
Total expense and other income                    $  6,657   $  7,146         (6.8 )%
Total expense and other income to revenue ratio       26.9 %     27.3 %       (0.4 )pts.
Provision for income taxes                        $  1,251   $  1,188          5.2 %
Net income                                        $  3,824   $  3,839         (0.4 )%
Net income margin                                     15.5 %     14.7 %        0.8 pts.
Earnings per share:
Assuming dilution                                 $   3.33   $   3.19          4.4 %
Basic                                             $   3.36   $   3.23          4.0 %
Weighted-average shares outstanding:
Assuming dilution                                  1,149.3    1,204.9         (4.6 )%
Basic                                              1,137.2    1,188.6         (4.3 )%



* 1.8 percent decrease adjusted for currency

Currency:

The references to "adjusted for currency" or "at constant currency" in the Management Discussion do not include operational impacts that could result from fluctuations in foreign currency rates. Certain financial results are adjusted based on a simple mathematical model that translates current period results in local currency using the comparable prior year period's currency conversion rate. This approach is used for countries where the functional currency is the local country currency. This information is provided so that certain financial results can be viewed without the impact of fluctuations in foreign currency rates, thereby facilitating period-to-period comparisons of business performance. See "Currency Rate Fluctuations" on pages 67 and 68 for additional information.

Operating (non-GAAP) Earnings:

In an effort to provide better transparency into the operational results of the business, the company separates business results into operating and non-operating categories. Operating earnings is a non-GAAP measure that excludes the effects of certain acquisition-related charges and retirement-related costs, and their related tax impacts. For acquisitions, operating earnings exclude the amortization of purchased intangible assets and acquisition-related charges such as in-process research and development, transaction costs, applicable restructuring and related expenses and tax charges related to acquisition integration. For retirement-related costs, the company characterizes certain items as operating and others as non-operating. The company includes defined benefit plan and nonpension postretirement benefit plan service cost, amortization of prior service cost and the cost of defined contribution plans in operating earnings. Non-operating retirement-related cost includes defined benefit plan and nonpension postretirement benefit plan interest cost, expected return on plan assets, amortized actuarial gains/losses, the impacts of any plan curtailments/settlements and multi-employer plan costs, pension insolvency costs and other costs. Non-operating costs are primarily related to changes in pension plan assets and liabilities which are tied to financial market performance and the company considers these costs to be outside the operational performance of the business.

Overall, the company believes that providing investors with a view of operating earnings as described above provides increased transparency and clarity into both the operational results of the business and the performance of the company's pension plans; improves visibility to management decisions and their impacts on operational performance; enables better comparison to peer companies; and allows the company to provide a long-term strategic view of the business going forward. For its 2015 earnings per share road map, the company is utilizing an operating view to establish its objectives and track its


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progress. The company's segment financial results reflect operating earnings, consistent with the company's management and measurement systems.

The following tables provide the company's non-GAAP operating earnings for the third quarter and first nine months of 2012 and 2011.

                                                                      Yr. to Yr.
(Dollars in millions except per share amounts)                         Percent
For the three months ended September 30:           2012      2011       Change
Net income as reported                            $ 3,824   $ 3,839         (0.4 )%
Non-operating adjustments (net of tax):
Acquisition-related charges                           141       133          5.8
Non-operating retirement-related costs/(income)       191       (17 )         nm
Operating (non-GAAP) earnings*                    $ 4,155   $ 3,954          5.1 %
Diluted operating (non-GAAP) earnings per share   $  3.62   $  3.28         10.4 %


nm - not meaningful

* See pages 75 to 77 for a more detailed reconciliation of net income to operating earnings.

                                                                        Yr. to Yr.
(Dollars in millions except per share amounts)                           Percent
For the nine months ended September 30:             2012       2011       Change
Net income as reported                            $ 10,771   $ 10,365          3.9 %
Non-operating adjustments (net of tax)
Acquisition-related charges                            399        376          6.0
Non-operating retirement-related costs/(income)        328        (20 )         nm
Operating (non-GAAP) earnings*                    $ 11,498   $ 10,721          7.2 %
Diluted operating (non-GAAP) earnings per share   $   9.90   $   8.77         12.9 %


nm - not meaningful

* See pages 75 to 77 for a more detailed reconciliation of net income to operating earnings.

Financial Performance Summary:

In the third quarter of 2012, the company reported $24.7 billion in revenue, expanded gross, pre-tax and net income margins and delivered diluted earning per share growth of 4.4 percent as reported and 10.4 percent on an operating (non-GAAP) basis. The company's as reported financial performance was impacted by a pre-tax charge of $162 million ($125 million on an after-tax basis) related to a court ruling in the United Kingdom (UK) regarding one of IBM UK's defined benefit pension plans. This charge is not included in the company's operating (non-GAAP) earnings presentation. As reported earnings per share increased 7.8 percent compared to the third quarter of 2011 excluding this charge. The company generated $4.5 billion in cash from operations in the third quarter driving shareholder returns of $4.0 billion in common stock repurchases and dividends. In October 2012, the company adjusted its full year 2012 diluted earnings per share expectation to at least $14.29 per share to reflect the impact of the UK pension charge, while reiterating its operating (non-GAAP) earnings per share expectation of at least $15.10 per share for the full year. The operating (non-GAAP) earnings per share expectation reflects a 12 percent increase compared to the full year 2011.

The company's performance in the third quarter was driven by strength in its solutions offerings, the solid annuity base and the ongoing focus on productivity. First, the company continued to drive very good results in its solutions offerings across software and services - offerings that address key demand areas including Smarter Planet, business analytics and cloud. Second, the company's annuity businesses - which represent approximately half of total annual revenue and sixty percent of total annual profit - provided a solid base of revenue and profit in the quarter. Third, the company continues to execute its productivity initiatives and remains on track to deliver $8 billion of productivity improvements over the 2015 road map. The benefit from these initiatives, together with the mix to more profitable businesses, has helped drive the company's margin expansion.

Across all of its business segments, the company continues to have strong performance in its key growth initiatives. In the growth markets, the company is continuing to expand into new markets, building out IT infrastructures and focusing on targeted industries. For the first nine months of 2012, revenue in the growth markets has increased 3.1 percent or 7 percent at constant currency. The company's business analytics solutions help clients identify, manage and predict outcomes by


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leveraging huge amounts of data. The broad portfolio of analytics solutions drove increased revenue of 14 percent on a year to date basis through the third quarter, led by the Global Business Services (GBS) consulting practice. The SmartCloud portfolio addresses the full scope of enterprise client requirements. With strong growth across all offerings, from private cloud to public cloud to industry based solutions, cloud revenue through the first nine months of 2012 has already exceeded full year revenue for 2011. The Smarter Planet solution portfolio is also driving strong performance with revenue growth of more than 20 percent on a year to date basis compared to the prior year driven by Smarter Commerce and industry specific solutions. Within the company's offerings in business analytics, cloud and Smarter Planet, approximately half of the revenue is software. As a result, the success that the company is having in these areas is improving the business mix and margins.

In the third quarter, the company completed the first two phases of the sale of its Retail Store Solutions (RSS) business to Toshiba Tec. The company recognized a pre-tax gain of $447 million on the transaction. With a discrete tax rate applied to the gain, based on the countries closed in these phases, the transaction contributed approximately $280 million of net income in the quarter. The transaction also results in a loss of revenue and profit related to the divested operations.

Revenue in the third quarter declined 5.4 percent versus the prior year, including a negative currency impact of approximately 4 points. At constant currency, revenue was down 1.8 percent, 1 percent normalized for the RSS divestiture. Within the quarter, revenue results through the first two months were consistent with second quarter performance. Performance in September was more challenging with the impact most pronounced in Software and GBS, and from a geographic perspective in North America and the growth markets.

On a geographic basis, revenue performance was led by the growth markets which declined 0.8 percent as reported, but increased 3.7 percent at constant currency with the BRIC countries of Brazil, Russia, India and China delivering growth of 3.5 percent (11 percent adjusted for currency). While both Australia and Mexico declined at a double-digit rate in the quarter, most of the growth market countries continued to perform well. In the third quarter, 35 countries grew constant currency revenue at a double-digit rate reflecting ongoing broad-based strength.

Within the company's segments, Software revenue declined 0.9 percent as reported, but increased 2.9 percent adjusted for currency, driven by double-digit growth across the solutions areas - business analytics, commerce and social business. Global Services revenue decreased 4.6 percent, with constant currency performance essentially flat year to year. Within Global Services, modest growth from the backlog was offset by impacts from shorter term and volume related activity. Systems and Technology revenue declined 13.1 percent (12 percent adjusted for currency); adjusted for the RSS divestiture, revenue declined 10.6 percent (9 percent adjusted for currency) versus the prior year. While revenue declined each month within the quarter, performance in September improved as the company introduced the next generation System z mainframe server.

The consolidated gross profit margin increased 0.9 points versus the third quarter of 2011 to 47.4 percent. The operating (non-GAAP) gross margin increased 1.2 points to 48.1 percent. The improvement was driven by a combination of margin expansion in both services segments, and an improving segment mix due to the relative growth of the software business.

Total expense and other income decreased 6.8 percent in the third quarter compared to the prior year. Total operating (non-GAAP) expense and other income decreased 9.9 percent compared to the third quarter of 2011. The as reported expense and other income decrease was impacted by the charge related to the UK pension litigation. The year to year drivers for both categories were approximately:

                      Total       Operating
                   Consolidated   (non-GAAP)
 Currency *        (7) points    (8) points
 Acquisitions**     3 points      3 points
 Base expense      (2) points    (5) points



* Reflects impacts of translation and hedging programs.

** Includes acquisitions completed in prior 12-month period.

Pre-tax income grew 0.9 percent and the pre-tax margin was 20.5 percent, an increase of 1.3 points versus the third quarter of 2011. Net income declined 0.4 percent due to an increase in the tax rate, but, the net income margin increased 0.8 points to 15.5 percent. The effective tax rate for the third quarter was 24.6 percent, an increase of 1.0 points versus the prior year. This increase was primarily driven by the discrete tax impact resulting from the gain on the RSS divestiture. Operating (non-GAAP) pre-tax income grew 6.6 percent and the operating (non-GAAP) pre-tax margin was 22.3 percent, an increase of 2.5 points versus the prior year. Operating (non-GAAP) net income increased 5.1 percent and the operating (non-GAAP) net


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income margin was 16.8 percent, an increase of 1.7 points compared to the prior year. The operating (non-GAAP) effective tax rate was 24.7 percent versus 23.6 percent in the third quarter of 2011 with the increase driven by the RSS divestiture gain.

Diluted earnings per share improved 4.4 percent reflecting the benefits of the common stock repurchase program. In the third quarter, the company repurchased 15.2 million shares of its common stock. Diluted earnings per share of $3.33 increased $0.14 from the prior year. Operating (non-GAAP) diluted earnings per share increased 10.4 percent reflecting the growth in operating (non-GAAP) net income and the benefits of the common stock repurchase program. Operating (non-GAAP) diluted earnings per share of $3.62 increased $0.34 versus the third quarter of 2011 driven by the following factors:

 Revenue decrease at actual rates:   $ (0.17 )
 Margin expansion:                   $  0.34
 Common stock repurchases:           $  0.17

Margin expansion was the largest contributor to the growth in operating (non-GAAP) earnings per share. There were several factors within margin expansion driving the $0.34 contribution: the gain on the RSS divestiture contributed $0.23; gross margin expansion contributed $0.19 and expense productivity contributed $0.16. These benefits were partially offset by increased workforce rebalancing charges which drove a $0.24 impact.

The company generated $4,514 million in cash flow provided by operating activities, a decrease of $164 million compared to the third quarter of 2011, driven primarily by an increase in taxes paid ($321 million). Net cash used in investing activities of $999 million increased $194 million primarily due to decreased cash from net sales of marketable securities and other investments ($409 million) and cash used for acquisitions ($277 million), partially offset by increased cash from divestitures ($573 million). Net cash used in financing activities of $2,507 million decreased $1,162 million compared to the prior year primarily due to higher net cash from total debt ($976 million) and a net decrease in cash used for common stock transactions ($260 million).

Financial Results Summary:



                                                                               Yr. to Yr.
                                                                                Percent/
(Dollars in millions except per share amounts)                                   Margin
For the nine months ended September 30:               2012          2011         Change
Revenue                                            $   75,203    $   77,430          (2.9 )%*
Gross profit margin                                      46.7 %        45.7 %         1.0 pts.
Total expense and other income                     $   21,060    $   21,687          (2.9 )%
Total expense and other income to revenue ratio          28.0 %        28.0 %         0.0 pts.
Provision for income taxes                         $    3,300    $    3,364          (1.9 )%
Net income                                         $   10,771    $   10,365           3.9 %
Net income margin                                        14.3 %        13.4 %         0.9 pts.
Earnings per share:
Assuming dilution                                  $     9.27    $     8.48           9.3 %
Basic                                              $     9.38    $     8.60           9.1 %
Weighted-average shares outstanding:
Assuming dilution                                     1,161.8       1,222.1          (4.9 )%
Basic                                                 1,148.4       1,205.2          (4.7 )%

                                                    9/30/12       12/31/11
Assets                                             $  115,778    $  116,433          (0.6 )%
Liabilities                                        $   94,112    $   96,197          (2.2 )%
Equity                                             $   21,666    $   20,236           7.1 %



* 0.1 percent decrease adjusted for currency


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Financial Performance Summary:

In the first nine months of 2012, the company delivered diluted earnings per share growth of 9.3 percent as reported and 12.9 percent on an operating (non-GAAP) basis compared to the first nine months of 2011. Normalized for the charge recorded in the third quarter related to the UK pension litigation, as reported earnings per share increased 10.6 percent year to year. The company generated $13.2 billion in cash from operations in the first nine months, returning $11.8 billion to shareholders in common stock repurchases and dividends.

Total revenue decreased 2.9 percent (essentially flat adjusted for currency) compared to the first nine months of 2011. Software revenue increased 1.4 percent (4 percent adjusted for currency) driven by key branded middleware which increased 1.8 percent (5 percent adjusted for currency). Global Technology Services revenue declined 1.6 percent (up 2 percent adjusted for currency), while Global Business Services revenue declined 3.9 percent (1 percent adjusted for currency) and Systems and Technology revenue declined 9.7 percent (8 percent adjusted for currency). Global Financing revenue declined 4.9 percent (1 percent adjusted for currency). On a geographic basis, revenue performance was led by the growth markets which increased 3.1 percent (7 percent adjusted for currency) driven by the BRIC countries which increased 5.8 percent (11 percent adjusted for currency).

The consolidated gross margin increased 1.0 points versus the first nine months of 2011 to 46.7 percent. The operating (non-GAAP) gross margin increased 1.3 points to 47.4 percent compared to the prior year. The improvement in gross margin in the first nine months was driven by Global Services and the improved segment mix driven by growth in Software.

Total expense and other income decreased 2.9 percent in the first nine months of 2012 versus the prior year. Total operating (non-GAAP) expense and other income decreased 4.4 percent compared to the prior year. The year-to-year drivers were approximately:

                      Total       Operating
                   Consolidated   (non-GAAP)
 Currency *        (6) points    (6) points
 Acquisitions**     3 points      2 points
 Base expense       0 points     (1) points



* Reflects impacts of translation and hedging programs.

** Includes acquisitions completed in prior 12-month period.

Pre-tax income grew 2.5 percent and the pre-tax margin was 18.7 percent, an increase of 1.0 points versus the first nine months of 2011. Net income increased 3.9 percent and the net income margin increased 0.9 points to 14.3 percent. The effective tax rate for the first nine months of 2012 was 23.5 percent, compared with 24.5 percent in the prior year, primarily reflecting a one-time benefit from a tax restructuring in Latin America, partially offset by the tax impact of the RSS divestiture gain. Operating (non-GAAP) pre-tax income grew 6.1 percent and the operating (non-GAAP) pre-tax margin was 20.0 percent, an increase of 1.7 points versus the prior year. Operating (non-GAAP) net income increased 7.2 percent and the operating (non-GAAP) net income margin of 15.3 percent increased 1.4 points versus the prior year. The operating (non-GAAP) effective tax rate was 23.7 percent versus 24.5 percent in the first nine months of 2011.

Diluted earnings per share improved 9.3 percent reflecting the growth in net income and the benefits of the common stock repurchase program. In the first nine months of 2012, the company repurchased 45.8 million shares of its common stock. Diluted earnings per share of $9.27 increased $0.79 from the prior year. Operating (non-GAAP) diluted earnings per share of $9.90 increased $1.13 versus the first nine months of 2011 driven by the following factors:

 Revenue decrease at actual rates:   $ (0.25 )
 Margin expansion:                   $  0.89
 Common stock repurchases:           $  0.49


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At September 30, 2012, the company's balance sheet and liquidity positions remain strong and are well-positioned to support the company's objectives. Cash and marketable securities at quarter end were $12,254 million. Key drivers in the balance sheet and total cash flows are highlighted below.

Total assets decreased $655 million ($635 million adjusted for currency) from December 31, 2011 driven by:

Decreases in total receivables ($2,783 million) and deferred taxes ($1,027 million), partially offset by

Increased goodwill ($2,057 million) and prepaid pension assets ($581 million).

Total liabilities decreased $2,086 million ($2,164 million adjusted for currency) from December 31, 2011 driven by:

Decreases in retirement and nonpension postretirement ($1,692 million), accounts payable ($1,431 million) and taxes ($1,166 million), partially offset by

Increased total debt ($2,348 million).

Total equity of $21,666 million increased $1,431 million from December 31, 2011 as a result of:

Higher retained earnings ($7,916 million), common stock ($1,473 million) and lower accumulated other comprehensive income/(loss) ($1,165 million); partially offset by

Increased treasury stock ($9,152 million) driven by share repurchases.

The company generated $13,240 million in cash flow provided by operating activities, an increase of $490 million when compared to the first nine months of 2011, primarily driven by the increase in net income ($406 million), a decrease in taxes paid ($731 million) and a decrease in retirement-related contributions ($164 million), partially offset by a decrease in cash provided by financing receivables ($865 million). Net cash used in investing activities of $4,912 million was $4,021 million higher than the first nine months of 2011, primarily due to an increase of cash used of $2,419 million associated with net purchases and sales of marketable securities and other investments, and increased cash used for acquisitions ($2,043 million), partially offset by increased cash from divestitures ($583 million). Net cash used in financing activities of $8,185 million was $2,701 million lower, compared to the first nine months of 2011, primarily due to lower cash used for common stock repurchases ($2,476 million) and increased proceeds associated with debt ($1,279 million), partially offset by lower cash provided by common stock transactions ($831 million) and increased dividend payments ($223 million).

In January 2012, the company disclosed that it was expecting GAAP earnings of at least $14.16 and operating (non-GAAP) earnings of at least $14.85 per diluted share for the full year 2012. In April 2012, the company increased its expectation for GAAP earnings per diluted share to at least $14.27 and its expectation for operating (non-GAAP) earnings per diluted share to at least $15.00 for the full year. In July 2012, the company again increased its expectations for GAAP earnings per diluted share to at least $14.40 and its expectation for operating (non-GAAP) earnings per diluted share to at least $15.10 for the full year. In October 2012, the company adjusted its full year GAAP earnings per diluted share expectation to at least $14.29 per share to reflect the impact of the UK pension charge, while reiterating its operating (non-GAAP) earnings per share expectation of at least $15.10 per share for the full year.


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Third Quarter and First Nine Months in Review

Results of Operations

Segment Details

The following is an analysis of the third quarter and first nine months of 2012 versus the third quarter and first nine months of 2011 reportable segment external revenue and gross margin results. Segment pre-tax income includes transactions between the segments that are intended to reflect an arms-length . . .

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