International Business Machines Earnings Call Insights: Confidence in Second Half and EPS Guidance

International Business Machines Corp (NYSE:IBM) recently reported its second quarter earnings and discussed the following topics in its earnings conference call.

Confidence in Second Half

Benjamin Reitzes – Barclays Capital: Mark, what gives you confidence in the second half? It would seem that basically without the benefit of the tax rate, the operational increase is really $0.05 or so from what you thought previously. I just wanted to also be clear on that. What gives you confidence that you can hit those numbers? Perhaps the specifics around how the charge flows through in terms of cost saves and then what segments could possibly grow when you see some leverage.

Mark Loughridge – SVP and CFO, Finance and Enterprise Transformation: Maybe the best way to really answer that is to take a look at the kind of the headwind-tailwind basis. So, if you look at the second half of the year, obviously we have a headwind on currency and more specifically within that the yen. We pointed out in the attachment that even though currency was an impact of 2% in the first half, we see about 3% in the second half. Our hardware business has been an impact to us in the first half of the year and we’re obviously dependent on the Asian GMU economy, which have been challenging in the first half. But I’ll tell you as we look at the second half, we have some very, very distinct tailwinds that we have driven to drive our performance. So, first of all, Software pipeline, we got a very good software pipeline going into the second half of the year, and if you look at that Software performance in the second quarter, boy, they really hit the bar. So, not only did Software grow the total by 5%, but that key branded middleware was up 10% and we gained share in every single one of the sub brands in that Software business. We see real momentum going from that second quarter into the second half of the year. Secondly very, very important, we have services backlog growth on a constant currency basis of 7%. That is the best backlog growth positioning we’ve had in four years going into the second half, 3% at actual but that 7% at constant currency, the best we’ve seen in four years. Now against that in the second quarter, break it down by service lines, GBS returned to growth in the second quarter. They should further profit on that improvement in the entering backlog, and I would expect GBS to be firmly in that mid-single digit revenue growth in the third quarter. Likewise on our GTS business, GTS was down in the second quarter about 2%, but they had about 1.5 point impact from those restructured contracts last year that we spent a lot of time talking about in last year’s earnings call. So, if you adjust for that they came very close to a neutral performance in the second quarter, and with that I would expect GTS to return to low single-digit revenue growth in the third quarter as well. So now we’ve had good performance flow through to the second half from our Software business; better performance from our GTS and GBS business is driving performance; our workforce rebalancing yields, you know, we did a great job closing that right on the $1 billion that we had advised you of us we closed in the first quarter. That will begin to yield in the third quarter of the year and will get a full quarter’s benefit in the fourth quarter, and I think that is quite significant. I clearly alluded to the potential tax settlements that would see in a positive impact in our fourth quarter, but along with that we’ve had real strength in growth initiatives, cloud through the first half of the year, up very, very strong. We had very good positioning of Business Analytics in the second quarter, up 11%; strong performance in our Smarter Planet content, and we’ve taken a very tough position on spending. So you put all that together, I think we have the ingredients for that second half of the year and was based on all of that, in aggregate they gave us the confidence along with the second quarter performance to drive that additional $0.20 to $16.90 excluding the second quarter workforce rebalancing charge.

EPS Guidance

Toni Sacconaghi, Jr. – Sanford Bernstein: Historically, you have provided EPS guidance including all rebalancing charges and any one-time gains, whether they be from IP or from dispositions. I’m hoping you can clarify, because it’s a little nebulous about whether you’re changing your guidance definition of operating earnings or not. So the traditional metric of operating earnings would include the rebalancing charge in there, and then guidance would be $16.25 at least for the year. Is that what we should be putting our models, or are you changing the definition and saying we’re going to exclude these kinds of charges this year and on a go-forward basis and $16.90 should be what analysts put in your model? So if you could address that. I’d also like to understand to the degree that what checks and balances – to the degree that you may continue to include them, but not match them in a given quarter, what checks and balances are there going to be offsetting that gains and charges are ultimately offsetting as they have been historically?

Mark Loughridge – SVP and CFO, Finance and Enterprise Transformation: First of all, I want to be very, very clear that when we attach our objective for 2015 $20, that at least $20 is on an all-in basis. I think, in this earnings announcement I hope to be very clear on the basis for performance in the year. So if you look at the performance that we would view for the year, we’ve been clear on the all-in basis and we’ve also been clear excluding the gains and charge. Now let me provide some distinction on that basis, why I think both of those are very important. First of all, on an all-in basis, we had said that second quarter workforce rebalancing charge would be offset by a future divestiture gains and frankly as we look at it now, we’re in active discussions but very likely on our timeline basis is unlikely that it simply closes in 2013. So, that would impact that original view of our business on an all-in basis of at least $16.70 by $0.65 and then you would add the improvement of $0.20 to that. That gives us $16.25. But I want to say that on the other view our business, excluding gains and charges, that now would be $16.90 and I’m reassuring you and the investors that $16.90 that we will be using as our starting point to set our objectives for 2014 on an all-in basis and 2015 on an all-in basis. So, in other words, as if we had closed that divestiture now, why do I think that’s important? I think that’s important because whether we close that divestiture this year or not would not impact that operational performance exactly as we’ve always (defined) it in 2014 and 2015. Number two. I wanted to be very clear to investors that when we start to position that trajectory, our performance going from ‘13 to ‘14 to ’15, that numbers starts at $16.90, not $16.25. So, from my perspective the view of our business the best establish the trajectory we’re on going from ‘13 to ’14 to ’15, is in end state of $16.90 increased by $0.20 from our original $16.70 view of the business, given that large divestiture has moved out of the year, we would assess the all-in at $16.25. But we are certainly working on other divestiture content and if that lands, we will be adding that to our basis as well. But to reiterate assessing the trajectory for this year, I think is best evaluated, excluding the second quarter charge. And at $16.90 that will now be the basis for establishing that trajectory for 2014 and ‘15 and achieving our objective of at least $20 in 2015 on an all-in basis.