International Business Machines Corporation (IBM)

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International Business Machines (IBM)

Q3 2012 Earnings Call

October 16, 2012 04:30 PM ET

Executives

Patricia Murphy - VP, IR

Mark Loughridge - SVP and CFO

Analysts

Toni Sacconagh - Sanford Bernstein

Ben Reitzes - Barclays

Steve Milunovich - UBS

David Grossman - Stifel Nicolaus

Bill Shope - Goldman Sachs

Mark Moskowitz - JPMorgan

Keith Bachman - Bank of Montreal

Katy Huberty - Morgan Stanley

Jim Suva - Citigroup

Chris Whitmore - Deutsche Bank

Presentation

Operator

Welcome and thank you for standing by. (Operator Instructions). Now, I will turn the meeting over to Ms. Patricia Murphy, Vice President of Investor Relations. Ma'am, you may begin.

Patricia Murphy

Thank you. This is Patricia Murphy, Vice President of Investor Relations for IBM. I'm here with Mark Loughridge, IBM's Senior Vice President and CFO, Finance and Enterprise Transformation. Thank you for joining our third quarter earnings presentation. The prepared remarks will be available in roughly an hour and a replay of this webcast will be posted to our Investor Relations website by this time tomorrow.

Our presentation includes certain non-GAAP financial measures in an effort to provide additional information to investors. All non-GAAP measures have been reconciled to their related GAAP measures in accordance with SEC rules. You will find reconciliation charts at the end, and in the Form 8-K submitted to the SEC.

Let me remind you that certain comments made in this presentation may be characterized as forward-looking under the Private Securities Litigation Reform Act of 1995. Those statements involve a number of factors that could cause actual results to differ materially. Additional information concerning these factors is contained in the Company's filings with the SEC. Copies are available from the SEC, from the IBM website, or from us in Investor Relations.

Now, I'll turn the call over to Mark Loughridge.

Mark Loughridge

In the third quarter, we reported $24.7 billion in revenue, expanded gross pretax and net operating margins and increased operating earnings per share by 10% to $3.62. For the year, we're maintaining our full year 2012 expectation for operating EPS of at least $15.10, that's up 12% over last year.

Looking at our third quarter revenue by geography, Europe was fairly consistent with last quarter, Japan's revenues stabilized, the BRIC countries in total performed well again, but North America declined. When I look at our skew of business in the quarter, through the first two months, our revenue was fairly consistent with our second quarter performance. The third month of the quarter was more challenging. This quarter we delivered double digit operating earnings per share growth driven by our strength in our solutions offerings, a solid annuity base and our ongoing work on productivity.

First, we continue to drive very good results in our solutions offerings across software and services that address key demand areas like Smarter Planet, business analytics and cloud. Second, our annuity businesses which represent about half of our annual revenue and 60% of our profit provided a solid base of revenue and profit.

And third, we're continuing to execute on our productivity initiatives on track to deliver $8 billion of productivity over the 2015 roadmap. The benefit from these initiatives together with our mix to more profitable businesses helped to drive our margin expansion. Now before I get into the financial metrics, I want to remind you that this quarter we closed the sale of our Retail Store Solutions point-of-sales business to Toshiba TEC in most countries. The transaction results in a loss of revenue in profit for the divested operations, a gain on the sale and an impact to our tax rate. As we go through the presentation, I will clarify the impact of each of these.

In the quarter IBM's revenue was down 5% including a currency headwind of nearly 4 points. At constant currency we were down 2% or down 1% if you normalize for the RSS divestitures. But in spite of this revenue decline we had solid operating profit growth with pretax income up 7% and net income up 5%. Our margin expansion was driven by our productivity initiatives, improving business mix and the overall currency dynamics.

This quarter we expanded operating gross margin by 1.2 points with about 60% due to improvements in margins and the balance from mix. With good expense management we improved operating PTI margin by 2.5 points. This quarter our tax rate was up over 1 point year-to-year. The increase was driven by a higher tax rate on the gain from the sale of our RSS business. We now expect an operating effective tax rate excluding one-time items in the range of 24.5% for the year.

Bottom-line, we delivered operating EPS of $3.62 which was up 10% year-to-year. When you look at the year-to-year drivers of our operating EPS performance the 5% decline in revenue at constant margin impacted profit growth by $0.17 per share. Margin expansion was the largest contributor to our growth. Within that, the gain on the RSS divestiture contributed $0.23, gross margin expansion added $0.19 and our expense productivity another $0.16. On the other hand, we did have an increase in our workforce rebalancing activity for an impact of $0.24.

Our ongoing share repurchase program contributed the balance at a level fairly consistent with the first two quarters of the year. As you can see the dynamics are very similar to first half performance. Now I will get into the third quarter details starting with revenue by geography where I'll discuss the results on a constant currency basis.

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