IBM: Income Statement Analysis for the December 2010 Quarter

IBM (NYSE: IBM) earned $4.18 per diluted share on a GAAP basis in the December-ending fourth quarter of fiscal 2010, up 16 percent from $3.59 in the same three months of 2009.

This post examines IBM's Income Statement for the quarter.  Please note we did not issue "look-ahead" estimates in advance of the earnings release.

The principal sources for this income statement analysis were the earnings announcement and the Chief Financial Officer's prepared remarks for the ensuing conference call.

In a second article, we will report IBM's scores as measured by the GCFR financial gauges.  The follow-up post will also provide the latest figures for the various financial metrics we use to analyze Cash Management, Growth, Profitability and Value.


Before getting into the details, we will take one step back to introduce the subject of today's analysis.

International Business Machines, often called Big Blue, is an information technology powerhouse that sells hardware, software, and integration solutions and services to meet the needs of businesses and other large enterprises. 

With roots that can be traced back more than a century, IBM was in the vanguard of the computer industry.  Its mainframes dominated the business for decades and are still a profitable product line for IBM.  Of course, they now work alongside a varied array of personal computers and servers.  IBM successfully adapted to the new technologies enabled by Moore's Law, and it is still considered a bellwether for the sector.  It remains the top ranked Information Technology Services firm in Fortune Magazine's list of the World's Most Admired Companies.

A key element of IBM's strategy in recent years has been to divest low-margin businesses, such as the personal computer division it sold to Lenovo, to focus on high-value products and services that make use of the company's vaunted research and application expertise.  IBM has also grown by expanding into emerging markets and acquiring firms that provide complementary skills or technology.

For example, IBM obtained data warehousing capabilities that support business analytics when it purchased Netezza in 2010 for $1.7 billion.

IBM is included in the Dow Jones Industrial Average and the S&P 500.  The company's current market value is nearly $200 billion.

In 2010, IBM earned $14.8 billion, up 10.5 percent from $13.4 billion in the previous year.  Revenue increased more modestly, from $95.8 billion in 2009 to $99.9 billion.

IBM has five major business: Global Technology Services, Global Business Services, Software, Systems and Technology, and Global Financing.  GTS generated 39 percent of the company's total revenue in 2010. 

Interestingly, Software is responsible for substantially more pre-tax income, about 44 percent of the total, than any other segment.  IBM's software products include WebSphere, Information Management, Tivoli, Lotus and Rational.


Please click here to see a normalized depiction of the actual results for the just-concluded quarter, as well as the quarterly Income Statements for the last couple of years.  Please note that our organization of revenues, expenses, gains, and losses, which we use for all analyses, can and often does differ in material respects from company-used formats.  The standardization facilitates cross-company comparisons.




Revenue in the December quarter rose 6.6 percent, from $27.2 billion last year to $29.0 billion in the last three months.  Revenue growth was due in large part to IBM's business in developing countries.  For example, the company indicated that revenue in the BRIC countries — Brazil, Russia, India and China — increased 19 percent.

The big Global Technology Services operation only had revenue growth of 1.1 percent.  However, strength at Systems and Technology (21 percent revenue growth, driven by "System z" mainframe products!) and Software (7 percent) resulted in the company's overall healthy revenue growth rate.

The Cost of Goods Sold in the quarter was $14.8 billion, or 51.0 percent of revenue.  This ratio translates into a Gross Margin of 49.0 percent, up 70 basis points from 48.3 percent in 2009's fourth quarter.

The latest Gross Margin was the most lucrative for IBM in any quarter in the last 10 years.

IBM's spending on Research and Development increased from $1.46 billion in the December 2009 quarter to $1.58 billion in the latest period, an increase of 8 percent.  In both quarters, R&D expenses were 5.4 percent of Revenue.

Sales, General, and Administrative expenses increased 7 percent, from $5.56 billion to $5.95 billion.  As a percentage of Revenue, SG&A merely edged up from 20.4 percent to 20.5 percent.

The company also recorded $318 million in income from "Intellectual property and custom development."  This amount was just $5 million higher than last year.

IBM's Income Statements in 2010 don't distinguish between Operating and Non-Operating Expenses, but this will change in 2011.  The company will introduce a new concept for non-GAAP Operating Income, which excludes certain acquisition and retirement costs.

Other income less interest expenses in the December 2010 quarter resulted in a net cost of $60 million.  Other income can be volatile from quarter to quarter.

The quarter's effective income tax rate of 24.4 percent led to a $1.7 billion provision for income taxes.  The tax rate was about 20 basis points less burdensome than last year.

At the bottom line, Net Income was $5.26 billion ($4.18 per share), which compares favorably to $4.81 billion ($3.59 per share) in the fourth quarter of 2009.   Fewer shares outstanding, as result of IBM's aggressive share repurchasing activity, resulted in an EPS growth rate (16 percent) more robust than the underlying Net Income growth rate (9.3 percent).

Earnings for all of 2010 were $11.52 per share, up from $10.01 in 2009.  IBM surpassed the $11 upper end of its guidance for the year.

Full disclosure: No position in IBM at time of writing.