International Business Machines Management Discusses Q1 2012 Results - Earnings Call Transcript

International Business Machines (IBM)

Q1 2012 Earnings Call

April 17, 2012 4:30 pm ET

Executives

Patricia Murphy -

Mark Loughridge - Chief Financial Officer of Finance & Enterprise Transformation

Analysts

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

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

Benjamin A. Reitzes - Barclays Capital, Research Division

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

Joseph D. Foresi - Janney Montgomery Scott LLC, Research Division

Katy Huberty - Morgan Stanley, Research Division

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

Edward Maguire - Credit Agricole Securities (USA) Inc., Research Division

Robert Cihra - Evercore Partners Inc., Research Division

Chris Whitmore - Deutsche Bank AG, Research Division

Presentation

Operator

Welcome, and thank you for standing by. [Operator Instructions] 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

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 first 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'll 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

Thank you for joining us today. In the first quarter, we have reported $24.7 billion in revenue, expanded gross pretax and net operating margins and delivered operating earnings per share of $2.78, which is up 15% year-to-year. And now, 90 days into the year, we're increasing our full year 2012 expectation for operating EPS to at least $15. This is up $0.15 from our previous view of at least $14.85.

Looking at the results by segment. We continued our strong performance in software as we aggressively address opportunities in analytics, cloud and Smarter Planet. Our software profit was up 12%.

In services, we expanded margins and increased Total Services profit by 11% as we leverage our productivity initiatives and mix to higher margin offerings in markets. Services revenue growth was again led by growth markets, which were up 10% at constant currency. And our backlog in growth markets was up 14% at constant currency.

As expected, our hardware business declined as compared to a very strong growth of 19% in the first quarter of last year. This quarter, we extended our leadership in the UNIX market as we continued our competitive displacements in POWER.

And just last week, we announced PureSystems, the first new class of computing in over 20 years. This solution leverages IBM's decades-long investment in innovation and radically simplifies enterprise computing. This should start to contribute to the systems performance in the second half of the year.

Turning to profit. Our ongoing focus on productivity, together with the relative strength of our software business, drove strong margin performance. We expanded operating gross margin by over a point, led by services. And our operating net margin was up a similar amount, 1.1 points. Within net income, this quarter, we had a couple of unique items that impacted the dynamic between operating pretax income and our tax rate.

You'll recall that in the first quarter of last year, our workforce rebalancing was essentially offset by one-time investment gains. This quarter, our workforce rebalancing was very similar to last year. But this year, the charge was offset by a one-time tax benefit associated with a tax restructuring in Latin America. Excluding this one-time benefit, we expect our full year annual effective tax rate to still be in the range of 25%.

So a very similar dynamic to last year: with a gain offsetting our workforce rebalance charges, though, this year, the offset is included below the PTI line in tax. So through margin expansion, together with effective use of cash, we delivered operating EPS of $2.78, which was up 15% year-to-year.

Turning to cash flow. We generated almost $2 billion of free cash flow in the quarter, really strong performance. In addition to returning value to shareholders through a combination of share repurchase and dividends, our cash flow is enabling the ongoing transformation of the business, acquiring key capabilities and focusing our portfolio on the areas where we can add the most value.

This quarter, we closed 5 acquisitions for a total of $1.3 billion. The acquisitions increased our capabilities in analytics and cloud and our Smarter Planet initiatives. Now we'll get into the first quarter details starting with revenue by geography, where, as always, I'll discuss the results on a local currency basis.

In the first quarter, revenue at constant currency was very consistent with the fourth quarter and in line with our expectations. Revenue in our major market countries was essentially flat year-to-year. Within the Americas, performance was led by Canada, which was up 9%. The U.S. was flat, off of last year's strong growth of 7%. Europe, again, grew at 1%, in line with the fourth quarter, so we're seeing some stability there.

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