Highlights From IBM's Q2 Conference Call: Revenue Growth of 12%; Raises FY Guidance

IBM (NYSE: IBM) reported Q2 EPS of $3.09, $0.06 better than the analyst estimate of $3.03. Revenue for the quarter came in at $26.67 billion versus the consensus estimate of $25.35 billion. Shares are trading up 4.12% today.

Highlights From IBM's Q2 Conference Call:

• IBM sees FY2011 EPS of $13.25, versus the consensus of $13.22. The company previously guided FY11 EPS to at least $13.15.
  
• (Mark Loughridge) In the second quarter we delivered revenue growth of 12% and operating earnings per share of $3.09, up 18% year-to-year.
  
• With this performance, we are increasing our full year 2011 expectation for operating earnings per share to at least $13.25, which is up $0.10 from our previous view of at least $13.15 and up $0.25 from the beginning of the year.
  
• The 12% revenue growth was driven by our transactional businesses in hardware and software. Software growth was driven by key branded middleware which was up 21%. Our systems revenue was up 20%, with strong performance in System z, POWER and System x servers. In services, our total backlog increased to $144 billion. That's up almost $15 billion from last year, with $13 billion from currency and $2 billion of constant currency performance.
  
• Services revenue was up 10%. Within this, growth markets were up 22% or 10% at constant currency. Overall, growth market performance was strong, and revenue from these countries was up 13% at constant currency, our fourth consecutive quarter of double digit constant currency performance.
  
• Turning to profit, we increased operating pre-tax income by 10%, and operating net income 11%. Bottom line, we delivered operating EPS of $3.09, which was up 18% year-to-year. Our strong earnings performance resulted in $3.4 billion of free cash flow in the quarter, and in the last 12 months, we have generated $16 billion of free cash flow.
  
• Major markets revenue was up 3%. The U.S., our largest market, was up 6% and Canada was up 11%, driven by momentum in our server and software buinesses.
  
• In Europe, we had a modest improvement in the year-to-year growth rate with continued growth in U.K., France and Spain, and this quarter Germany and Italy returned to growth. Rounding out the G7, in Japan our revenue was down 5%, consistent with the first quarter growth rate.
  
• We also had double digit growth and share gains in each of the BRIC countries.
  
• The combined revenue in the BRICs was up 21%. But our success goes beyond the BRICs. We had double digit growth in almost 40 growth market countries. Our growth is broad based from a segment perspective as well. This quarter we had 24% growth in hardware with great performance in all system brands.
  
• Our software business supports the growth markets build-out with WebSphere providing key underlying infrastructure capabilities. This quarter WebSphere grew almost 40% in the growth markets and our services revenue was up 10% with terrific performance in both GTS and GBS.
  
• The services backlog in growth markets is up about 50% at actual rates over the last two years. What is driving this performance? We are continuing to expand into new markets and build out IT infrastructure in support of economic growth.
  
• Turning to revenue and gross margin by segment, the total services revenue growth rate was 10% or 2% at constant currency. In services, we had great year-to-year performance in the growth markets with double digit constant currency revenue growth and improved gross margin which was two points higher than the services margin in the major markets.
  
• Systems & Technology had another great quarter with 17% revenue growth. System z mainframes were up about 60%. System x up 15%, and POWER systems were up 12% as we continue to displace competitive systems.
  
• Our software business also grew 17%.
  
• The two services segments delivered $15.1 billion in revenue, up 10% as reported, and up 2% at constant currency.
  
• Global Technology Services grew 11% or 3% at constant currency, and Global Business Services grew 9% or 1% at constant currency. Total outsourcing revenue was $7.1 billion, up 12% as reported, or 3% at constant currency.
  
• This was driven by revenue from backlog which was up 3% and growth from sales into our existing base accounts.
  
• Our total transactional revenue of $6.1 billion was up 9%, or 1% at constant currency.
  
• We had outstanding performance this quarter in the growth markets, with constant currency revenue up double digits in both the outsourcing and transactional businesses, driving significant share gains for total services in the growth markets.
  
• Total backlog was $144 billion, up $15 billion year-to-year, with $13 billion from currency and $2 billion from performance.
  
• Integrated Technology Services revenue grew 11% as reported and 3% at constant currency. Here too the growth markets were the key driver, with revenue up 14% at constant currency. And revenue for cloud-related services within ITS was up over 200%.
  
• Turning to Global Business Services, revenue was $4.9 billion. Application outsourcing revenue was up 12% as reported, and 4% at constant currency.
  
• Consulting and systems integration, which includes consulting, AMS systems integration and the U.S. federal business grew 7% as reported and was flat at constant currency.
  
• Software had had a terrific quarter with revenue of $6.2 billion, which is up 17% year-to-year or 10% at constant currency. Key branded middleware grew 21%, gaining share for the 15th straight quarter, and extending our leadership in the middleware market.
  
• Key branded middleware accounted for 64% of total software revenue, as we continue to mix into higher growth areas of the business. Segment pre-tax income was $2.3 billion, up 12% year-to-year. Now, let me take you through the drivers by brand. WebSphere had another powerful quarter, growing 55% year-to-year and gaining share.
  
• Information management grew 18% year-to-year and gained share. Our distributed database had another terrific quarter with strong double digit growth.
  
• Netezza again performed well. Transactional volumes were up 70% year-to-year IBM Netezza has more than a 10 times price performance advantage over Exadata for running analytics workloads.
  
• In summary, software had another very powerful quarter, with revenue up 17% and branded middleware up 21%, gross profit margin up 0.4 of a point and pre-tax income up 12%.
  
• Systems & Technology revenue was $4.7 billion, up 17% year-to-year or 12% at constant currency.
  
• Gross profit margin expanded five points year-to-year, to 41%, driven by margin expansion across the server and storage portfolio and pre-tax margin increased 3.6 points.
  
• Power systems grew 12%, driven by strong growth in both entry and high end systems. We again extended our market leadership this quarter, the 13th consecutive quarter of year-to-year share gain. IBM's strong performance accounted for all the UNIX industry's 5% growth.
  
• Storage hardware revenue grew 10%, driven by disc, which was up 13%. System x revenue grew 15% year-to-year with high end growth of 26%. System x revenue in the growth markets was up 27% at constant currency. Retail store solutions grew 8% and held share and microelectronics OEM revenue was up 4% year-to-year.
  
• We took our dividends up 15% in April, and through June we paid out $1.7 billion in dividends. This is the 16th consecutive year that we have raised our dividend and the eighth year in a row of double digit increases.
  
• Looking at the balance sheet, we ended the quarter with cash balance of $11.8 billion, up $100 million from the end of last year. Total debt was $29.8 billion.
  
• $23.4 billion was in support of our financing business, which is leveraged at 7 to 1. Our non-financing debt was $6.4 billion, and our non-financing debt to cap was 24%, consistent with year end and with a year ago.
  
• With revenue growth of 12% or 5% at constant currency, this is the fourth consecutive quarter of mid-single digit constant currency revenue growth.
  
• (Q&A) Mark, can you walk us through the current competitive landscape in services and outsourcing in particular? You mentioned that you are gaining share here. Where specifically do you think you are seeing the most market share momentum and are you seeing any signs that your competitors are responding to that now? (A) Well, let's look at some of the dynamics that we have in our services business. First of all, when you look at it from a backlog perspective, a really strong backlog quarter for us. Now at $144 billion, up $15 billion year-to-year, and if you look at that balance, on backlog growth, it was pretty strong on both sides. So 11% backlog growth. Within that, though, I would like to point out that we really had strong performance in GMU. So if you break down that backlog growth in total, up $15 billion, about $7 billion was in major markets but $8 billion of that $15 billion was in the growth markets. So growth market backlog is now about 20% of the total, and over the last two years it has doubled - it's up 50%, excuse me. So, within that 50%, then you look at the margin content. The margin content for total services in GMU was two points richer than we see in the major markets. So frankly, underneath those dynamics, we're seeing real strength as we move into growth markets with a lot of opportunity that comes at good margins given the capability that we bring to the table. If you look overall in the services business, now looking towards the second half of the year, we expect to see yield off of that workforce rebalancing that we did have in the second quarter, and with the yield off that, plus the ongoing momentum, because frankly without that restructuring workforce rebalancing charge, we had 10% profit growth in services in the second, you know, balance of the 10% revenue, and now getting the yield off that momentum in the second half, we should see margin expansion and double digit profit growth from our services business. So I think we have got a pretty strong hand and I would like to reemphasize how encouraging we have seen the performance in GMU.
  
• Mark, I was wondering if you could comment on pre-tax margins. I think this was the first time in 15 quarters that they declined year-over-year. I know that currency and acquisitions were a factor, but you have those benefits on the cost side and on the revenue side. You've also mentioned workforce rebalancing several times. Is that really the driver and if so, can you dimension the size of the workforce rebalancing this quarter relative to other quarters and where that impact was felt the most in the P&L? (A) Sure. So if you look at it, as you know, as we detailed the business model, going through to 2015, within that roadmap, we are looking for margin expansion on a net income basis and we are looking for a magnitude of 0.3 to 0.4 of a point. In the second quarter, in fact, if you exclude the workforce rebalancing and within the quarter it was about $175 million, that's up about 160 year-to-year, with the bulk of that in the services part of the business. Without that effect in the second quarter, we were, in fact, at 0.3 of a point margin expansion on net income. If you take it through the first half, then the first half was expansion of 0.2 of a point, and without the second quarter restructuring alone, we would have been up a half a point. Now, again, going into the back half of the year, we will see some yield against that restructuring, but I feel pretty confident that the margin performance we're seeing in the business is going to be improved as we go into the second half of the year, and frankly, the run rate underneath our performance, I think is right on the model. I think it's simply a matter of the workforce rebalancing charges, Toni.

---

Serious News for Serious Traders! Try StreetInsider.com Premium Free!

---

You May Also Be Interested In

• Walmart (WMT) PT Lowered to $130 at UBS on Investment Narrative's Competing Dynamics
• ZKH Group Limited (ZKH) Reports Q2 EPS of $0.04
• TJX Cos. (TJX) Tops Q2 EPS by 3c, Beats on Revenue; Offers FY27 EPS Guidance