01—Abstract
Summary
Summary of the 10-K filed February 27, 2007. Cited figures are marked; the original filing is the authoritative source.
IBM's 2006 Form 10-K (filed February 27, 2007) shows a company that is shifting its mix toward higher-value software and services while divesting commoditizing businesses.
Reported revenue was essentially flat at $91.4 billiona (+0.3%, flat adjusted for currency), but excluding the Personal Computing business divested to Lenovo in April 2005, revenue grew 3.6% (3.2% adjusted for currency). Pre-tax income from continuing operations rose 8.9% to $13.3 billion, diluted EPS from continuing operations increased 23.4% to $6.06, and net income reached $9.5 billion. Gross profit margin improved 1.8 points to 41.9%, driven by Global Services productivity gains and the absence of lower-margin PC sales.
The effective tax rate fell to 29.3% from 34.6%, which contributed meaningfully to the earnings growth. Software was the standout performer, growing 8.2% to $18.2 billionb, with Key Branded Middleware up 17.1% (WebSphere +23.3%, Tivoli +26.3%). Software is now the largest contributor to pre-tax profit, at roughly $5.5 billion, and the segment's acquisitions (Micromuse, FileNet, Internet Security Systems, MRO Software) totaled about $4.8 billion across 13 deals in 2006.
Hardware revenue declined 7.6% as reported, though it grew 4.8% excluding PCs, with System z and storage strength offset by weakness in System i, System p and Printing. Global Services revenue rose 1.8% to $48.2 billionc, and services signings reached $49.2 billion with a backlog of about $116 billion. Cash generation and capital returns remained strong: operating cash flow was $15.0 billion, and the company returned over 100% of net income to shareholders through dividends ($1.7 billion) and share repurchases ($8.0 billion).
Total debt was flat at $22.7 billiond, though much of it sits within Global Financing, whose debt-to-equity target is about 7:1. Stockholders' equity fell 13.9% to $28.5 billion, mainly because of a $9.5 billion non-cash charge from adopting SFAS No. 158 on pension accounting.
Management's long-term model targets 10–12% EPS growth. Key risks include Japan's 10.1% revenue decline, the pending Ricoh printing joint venture, pending litigation (including SEC investigations and the Platform Solutions and Amazon patent cases), and the expectation that IP income will continue to decline.
02—Key points
Key Highlights
- Revenue was $91.4B, up 0.3% as reported but 3.6% excluding the divested Personal Computing business, which was sold to Lenovo in April 2005.
- Diluted EPS from continuing operations rose 23.4% to $6.06; pre-tax income grew 8.9% to $13.3B, and the effective tax rate fell from 34.6% to 29.3%.
- Software revenue grew 8.2% to $18.2B and is now the largest profit contributor (about $5.5B pre-tax); Key Branded Middleware grew 17.1%, led by WebSphere and Tivoli.
- Gross profit margin improved 1.8 points to 41.9%, driven by Global Services productivity gains and the exit from lower-margin PCs.
- Operating cash flow was $15.0B; IBM returned over 100% of net income through $8.0B in buybacks and $1.7B in dividends, with the quarterly dividend raised to $0.30 in 2006.
- Global Services signings reached $49.2B (up 4%) and backlog grew to about $116B, though BTO signings fell 33%.
- Stockholders' equity fell 13.9% to $28.5B, mainly from a $9.5B non-cash charge on adopting SFAS No. 158; Japan revenue declined 10.1% while China, India, Russia and Brazil grew about 10% combined.
03—Questions
Frequently Asked Questions
How did IBM perform on an underlying basis in 2006, given the Lenovo PC divestiture?
Reported revenue barely moved (+0.3%) because 2005 included four months of PC sales that were absent in 2006. Excluding the divested business, revenue grew 3.6% (3.2% at constant currency), and Software and Global Services led the growth while Hardware grew 4.8% ex-PCs.
What drove the large increase in EPS and how sustainable is it?
EPS from continuing operations rose 23.4%, but roughly half of the earnings growth came from a lower effective tax rate (29.3% vs. 34.6%), which benefited from one-time items such as the IRS audit settlement and the absence of a 2005 repatriation charge. Underlying pre-tax income grew 8.9%, and the lower share count (diluted weighted shares down 4.6%) from buybacks also contributed.
Is IBM's balance sheet or debt position a concern?
Total debt was essentially flat at $22.7B, but most of it supports Global Financing, which operates at about 7:1 debt-to-equity. Non-Global Financing debt fell sharply to $395 million from $2.1 billion. Stockholders' equity dropped to $28.5B largely due to a non-cash pension accounting adjustment, and the company stated the change has no effect on debt covenants or credit ratings (S&P A+, Moody's A1).
Which business segments and geographies are the main risks or weak spots?
Hardware revenue fell 7.6% as reported, and System i, System p and Printing Systems declined. Japan (about half of Asia Pacific revenue) fell 10.1%. Integrated Technology Services and Business Transformation Outsourcing had weak patches, and IP income continues to decline (down 5% in 2006 and 19% in 2005), with management not expecting it to contribute to growth.
What are the notable pending legal and strategic events?
IBM is subject to SEC investigations, including a formal probe of 2005 earnings disclosures and equity compensation expensing, plus a Wells Notice tied to Dollar General. Other matters include a nationwide class action on an education assistance program, the SCO Group litigation, and patent suits against Amazon and Platform Solutions. Strategically, IBM agreed in January 2007 to form a joint venture with Ricoh for its Printing Systems business, which IBM will hold at 49% initially before exiting over three years.
04—Continue