International Business Machines (IBM)

Q3 2011 Earnings Call

October 17, 2011 4:30 pm ET


Mark Loughridge - Chief Financial officer of Finance & Enterprise Transformation and Senior Vice President

Patricia Murphy - IR


Keith F. Bachman - BMO Capital Markets U.S.

Benjamin A. Reitzes - Barclays Capital, Research Division

Louis R. Miscioscia - Collins Stewart LLC, Research Division

Mark A Moskowitz - JP Morgan Chase & Co, Research Division

Katy Huberty - Morgan Stanley, Research Division

Chris Whitmore - Deutsche Bank AG, Research Division

A.M. Sacconaghi - Sanford C. Bernstein & Co., LLC., Research Division

David Grossman - Stifel, Nicolaus & Co., Inc., Research Division

Scott D. Craig - BofA Merrill Lynch, Research Division

Bill C. Shope - Goldman Sachs Group Inc., Research Division



Welcome, and thank you for standing by. [Operator Instructions] Today's conference is being recorded. [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 Chief Financial Officer, 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 the 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

Thanks for joining us today. In the third quarter, we drove 8% revenue growth, expanded gross pretax and net operating margins and delivered operating earnings per share of $3.28, up 15% year-to-year. We're increasing our full year 2011 expectation for operating earnings per share to at least $13.35. This is up $0.10 from our previous view of at least $13.25 and up $0.35 from the beginning of the year.

Looking at the drivers of our performance, our software profit was up 12%, driven by Key Branded Middleware revenue growth of 17%. Hardware profit growth of 8% was led by Power Systems, where we had outstanding revenue growth and margin performance. We're continuing to drive competitive displacements and extend our share gains in UNIX.

Services delivered strong profit growth, with pretax income up 13% in both segments. Services revenue growth was again led by growth markets, up double digits at constant currency. Our growth markets' performance was terrific across all of our segments. Revenue from these countries was up 19% or 13% at constant currency. This is our fifth consecutive quarter of double-digit constant currency growth in growth markets, with double-digit revenue growth in 40 countries. Consistent with our model, growth markets, along with our other key growth initiatives, are driving our revenue performance.

Turning to profit, we expanded operating gross margin by 0.5%. The improvement was broad-based, with strong performance in systems and technology. With 10% growth in operating pretax income and 9% growth in operating net income, we expanded pretax and net operating margins as well.

Our third quarter operating tax rate reflects an updated view of the full year rate to 24.5%. The rate in the quarter is up 60 basis points year-to-year, which impacted EPS growth by $0.03. Bottom line, we delivered operating EPS of $3.28, which is up 15% year-to-year. Our strong earnings performance resulted in $3.5 billion of free cash flow in the quarter, and in the last 12 months we've generated over $16 billion of free cash flow. And we've delivered significant returns to shareholders, with over $4 billion in share repurchase and dividends this quarter and more than $18 billion over the last year.

Now I'll get into third quarter details, starting with revenue by geography. Our geographic performance was again led by the growth markets in North America. I'll discuss the geographic results on a local-currency basis. Revenue in our major market countries was essentially flat year-to-year. The U.S., our largest market, was up 4%, and Canada was up 7%, driven by continued momentum in our software business and great performance in Power Systems. In Europe, we had good growth in Spain, which was up 9%; and in the U.K., up 5%. We've now had 8 consecutive quarters of constant currency revenue growth in the U.K.

Our growth markets, again, had fantastic performance, outpacing the majors by 12 points. With 13% revenue growth, this is the fifth consecutive quarter of double-digit revenue growth in share gains compared to a strong third quarter last year. Performance was broad-based. As I mentioned, we had double-digit growth in 40 growth market countries including each of the BRICs. Our success is broad-based from a segment perspective as well. In fact, growth markets led the performance in each segment, with strong growth and expected share gains in GTS, GBS, Software and Systems and Technology. Within growth markets, we're expanding into new countries and territories to reach new clients and enterprises. And so far this year, we've opened over 80 new branches.

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