International Business Machines Earnings Call Nuggets: Linearity and Services Revenue Growth

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


Bill Shope – Goldman Sachs: On your prior earnings call, you had mentioned that the month of September was more challenging than the first two months of the third quarter. Can you talk about how the broader environment and your execution evolved into the December quarter and was there anything unusual this time around that you’d call out in terms of linearity?

Mark Loughridge – SVP and CFO, Finance and Enterprise Transformation: Good question bill. Really, if you look at the monthly performance across the quarter, it was really pretty constant. We saw a good performance through the quarter. Obviously within that, we feel very, very good about the performance we saw in our Software business with key branded middleware of 6%. Breakout performance from our z series content, revenue up 56%. Within that the growth markets up I think a spectacular 65%, MIPS up 66%. The biggest MIPS performance in the history IBM Corporation and its ongoing contribution from our base businesses, and with all that to generate half of our free cash flow in the quarter and a total of $18.2 billion, the largest ever, up $1.6 year-to-year, I think that was just a very, very strong quarter. But if you look across the months, it was fairly constantly month-to-month.

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Services Revenue Growth

Toni Sacconaghi, Jr. – Sanford Bernstein & Co., LLC: I was wondering if you could comment on your expectation for services revenue growth in 2013. The reason that I ask is, I think on the fourth quarter call last year, you talked about getting about 3 points of revenue growth from your backlog driven business and you ended up with services at constant currency about flat this year suggesting that non-backlog revenue growth was down about 6% in the year. So, if you’re looking at backlog revenue growth, the revenue from backlog only growing about 1% this, and again you struggled and had weak current period revenue growth this year. Why shouldn’t we be thinking about revenue growth being down in 2013 in the Services business overall?

Mark Loughridge – SVP and CFO, Finance and Enterprise Transformation: Let’s start by looking at our GBS business. So, the GBS business, if you look at the backlog over the last four years, they’ve actually been growing that backlog each year as they move into 2013. Now within that, as we explained in our third quarter call dynamics, you see a retooling, if you will, or a mix shift into these higher value initiatives that are so important to the IBM Corporation because those growth initiatives drive about 50% software in their mix. So, they have a very high profit for the Corporation. But if you look at that retooling from the GBS perspective, they tend to be longer duration. So, as we look at that duration and four years of backlog growth, both transactional and in total for GBS, we feel that as we enter 2013, GBS should once again return to revenue growth. If you look at the point that you had made on backlog run-out, we included that very discreet chart for the following reason. If you look at the backlog content moving into the year, we were impacted to some degree by the contracts that we restructured as we went through the end of 2011 to 2012 and the magnitude was about a point. Now that’s the point on revenue. How did that perform on a gross profit basis. The fact is, it was a substantial improvement in our gross profit dollars. In 2012, we had a lot of growth GTS business driven by that, but that improvement in gross profit dollars in a sense, Toni, it raises the water line and continues into 2013 and that’s a very big point. That improvement that we saw across those contracts, because we maintained about 80% of the revenue within those contracts, generally drove a much higher level of gross profit dollars in the ongoing base that we’ll enjoy this year, and in fact, we’ll see some modest improvement in the year-to-year gross profit dollars from those contracts moving into next year. So, net-net, the gross profit dollars coming out of the backlog are much stronger because of that. So we expect the overall performance of the gross profit dollars coming out of the backlog to be more typical, say a 2% backlog growth, and this is fairly a 1%. 2% very close to the dynamic we saw last year, and with that dynamic, the services businesses did a good job of driving to the model. And I think the last point that I would make in this rollout, we had about $3 billion worth of very strong contracts roll out of the fourth quarter into the first quarter. We’ve already closed $1 billion of this. And if you look at the complexion of those contracts, they come in the – many of them in the growth markets where we are having real success on that operation (liberal) and the value-add that we are showing our customer base, you see it reflected really in the backlog in our growth markets, which for total services base, that backlog is up 15%, so really strong performance on that basis. You put all that together, we feel very confident as we go into 2013 that the profit generation from our services business in total should meet our model expectations, and frankly, if you look at the first quarter of 2013, we think that the services business will generate double-digit profit growth.

Patricia Murphy – VP, IR: Thank you tony. Can we go to the next question please?

A Closer Look: International Business Machines Earnings Cheat Sheet>>