International Business Machines Corporation (IBM)
Q1 2009 Earnings Call Transcript
April 20, 2009 4:30 p.m. ET

Executives

Patricia Murphy – Vice President, Investor Relations
Mark Loughridge – Senior Vice President, Chief Financial Officer

Analysts

David Grossman – Thomas Weisel Partners
Toni Sacconaghi – Sanford Bernstein
David Bailey – Goldman Sachs
Benjamin Reitzes – Barclays Capital
Chris Whitmore – Deutsche Bank
Richard Gardner – Citigroup
Keith Bachman – Bank of Montreal
Mark Moskowitz – JP Morgan
Peter Misek – Canaccord Adams
Katie Huberty – Morgan Stanley

Presentation

Operator

Welcome and thank you for standing by. At this time, all participants are in a listen only mode. Today’s conference is being recorded. If you have any objections, you may disconnect at this time. Now, I will turn the meeting over to Ms. Patricia Murphy, Vice President of Investor Relations. Ma’am, you may begin.

Patricia Murphy – Vice President of Investor Relations

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 Chief Financial Officer. Thank you for joining our First Quarter Earnings Presentation. The prepared remarks will be available in roughly an hour and a replay of this web cast 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 8K 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 web site or from us in Investor Relations.

Now, I will turn the call over to Mark Loughridge.

Mark Loughridge – Chief Financial Officer

Thank you for joining us today. This quarter we delivered $1.70 of earnings per share, which was up 4% year-to-year. This positions us well to achieve our objective of at least $9.20 of earnings per share for the year. We generated $1 billion of free cash flow, up $450 million. We ended the quarter with over $12 billion of cash on hand and we reduced total debt by $3 billion. We returned another $2.5 billion to shareholders with $700 million in dividends and $1.8 billion of share repurchases. We have done a lot of work over the last decade to transform the company, shifting to higher value areas, globalizing our business and constantly working to improve efficiency. I will give you a few examples of how the changes we have made have positioned us to deliver this performance in a challenging economic environment.

First, with a focus on higher value offerings and strong services capabilities, we can adapt our offerings to deliver what clients are looking for. Today, clients remain focused on trying to save costs and conserve capital. Our services signings reflect our ability to meet these needs. Total signings were up 10% at constant currency with 27% constant currency growth in our longer-term categories. Second, the actions we have taken have dramatically shifted the mix of our business and our profit model has less dependence on hardware which is more vulnerable to economic conditions. In fact, this quarter effectively all of our pre-tax profit came from software, services and financing. The annuity nature of these businesses provides a solid base of revenue, profit and cash. Third, we have been investing to capture the opportunity in the growth markets. Our constant currency revenue growth in these markets remained about eight points higher than in major markets.

Finally, we have had an ongoing focus on driving productivity in all parts of the business, from sales efficiency to supply chain management to service delivery to global support functions. The result of this work is to reduce our fixed cost base and therefore improve the operational balance points. Bottom line, we have built a more resilient business model and one that generates more profit from each dollar of revenue. IBM’s transformation positions us well for 2009 but more importantly, our model provides the cash we need to invest in new areas that will help drive the next growth cycle for our clients. In addition to our growth markets investments, we have three other key initiatives.

First, is our Smarter Planet strategy where governments, utilities and businesses are applying intelligence to the key processes of the world. This allows clients to create more value and long-term economic growth from their infrastructure investments. The second new opportunity is Business Analytics which leverages our broad capabilities to optimize our clients’ business performance by applying analytics to their business processes. We are already working on advanced analytics projects with a diverse set of clients including TD Bank, MTN South Africa, The New York State Department of Tax and The Sentinel Group. And third is Cloud Computing, an emerging model for delivering and consuming IT enabled services. Each of these three opportunities requires enterprise software, deep industry process knowledge and solution integration capabilities where IBM is very strong and we will leverage our cash position to be opportunistic to accelerate our progress in the areas we believe will fuel growth and competitive differentiation in the future. We will spend more time on these initiatives in our investor briefing in the middle of May but for now, I will get back to our first quarter performance.

Looking at our income statement for the quarter, our revenue was $21.7 billion, down 11% as reported, and 4% at constant currency. As I mentioned, we had outstanding margin performance. Gross margin expanded almost two points driven by improving margin in services and software and the mix to higher value businesses such as software. Our expense was better by 9%, with continued focus on expense management and the benefit from a stronger dollar. Pre-tax margin expanded 1.3 points and net income margin expanded 1.1 points. And finally our ongoing share repurchase activity drove a lower share count. So bottom line, we delivered $1.70 of earnings per share up 4% year-to-year. So let me get into the first quarter details, starting with revenue by segment.

Our revenue performance was impacted by currency and the economic environment but also reflects our broad business capabilities and the contribution of our annuity content. Service revenue was driven by a strong annuity base, though it was impacted by a slowdown in small, faster yielding projects and declines in longer-term signings in 2008. Software revenue growth was driven by demand for mission critical software. Systems and Technology performance reflects the challenges that transaction based business are facing today. Within the segment, our UNIX servers performed well. And in Global Financing, excluding currency impacts, both financing revenue and the sales of used equipment were essentially flat. Our total geographic revenue was down 11% as reported and 3% at constant currency with consistent performance across the geographies. As always, I will focus my comments on the constant currency growth.

Globally, the major markets declined 4%. Our growth markets unit grew eight points faster, up 4% and we continue to outperform in these countries. Revenue from the growth markets represented 17% of IBM’s geographic revenue in the quarter. As these countries build out their public and private infrastructures in this environment they are also focused on cost savings. We have also been delivering these capabilities to clients in the major markets and so we are well-positioned to address these needs. Our growth markets performance reflects the diversity of the regions. While some of these areas are clearly more challenging like Central and Eastern Europe and a few of the smaller Asia Pacific countries, several of the larger countries are showing resiliency and good growth. For example, India grew 12% and China grew 11%.

In India, we again were named the Number One IT service provider in the domestic market. In China, in addition to continued strong demand for our banking infrastructure offerings, our Smarter Planet solutions are gaining traction with clients. Across all of the growth markets we will continue to target our investments to profitable growth areas and capture opportunities in these strategically important markets. When you look at revenue performance by sector, I think you will find it is what you would expect in the current environment. Public sector was the fastest growing sector again this quarter with growth at constant currency in all industries. In addition to solid revenue growth, we also had good signings in the public sector, up almost 50% worldwide at constant currency and over 200% in the U.S. Government and education clients at the federal level are focusing on investments to drive job creation while state and local agencies are looking for cost reductions through infrastructure and process transformation. Healthcare clients are focused on cost reductions with strong demand for outsourcing and transformational offerings. Now I will briefly comment on the other sectors.