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MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION FOR THE THREE MONTHS ENDED MARCH 31, 2012
(Edgar Glimpses Via Acquire Media NewsEdge)
Snapshot
Financial Results Summary:
Yr. to Yr.
Percent/
(Dollars in millions except per share amounts) Margin
For the three months ended March 31: 2012 2011 Change
Revenue $ 24,673 $ 24,607 0.3 %*
Gross profit margin 45.1 % 44.1 % 0.9 pts.
Total expense and other income $ 7,283 $ 7,041 3.4 %
Total expense and other income to revenue ratio 29.5 % 28.6 % 0.9 pts.
Provision for income taxes $ 769 $ 954 (19.4 )%
Net income $ 3,066 $ 2,863 7.1 %
Net income margin 12.4 % 11.6 % 0.8 pts.
Earnings per share:
Assuming dilution $ 2.61 $ 2.31 13.0 %
Basic $ 2.65 $ 2.34 13.2 %
Weighted-average shares outstanding:
Assuming dilution 1,174.2 1,240.0 (5.3 )%
Basic 1,159.1 1,222.2 (5.2 )%
3/31/12 12/31/11
Assets $ 115,347 $ 116,433 (0.9 )%
Liabilities $ 94,563 $ 96,197 (1.7 )%
Equity $ 20,783 $ 20,236 2.7 %
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* 1.0 percent adjusted for currency
Currency:
The references to "adjusted for currency" or "at constant currency" in the
Management Discussion do not include operational impacts that could result from
fluctuations in foreign currency rates. Certain financial results are adjusted
based on a simple mathematical model that translates current period results in
local currency using the comparable prior year period's currency conversion
rate. This approach is used for countries where the functional currency is the
local country currency. This information is provided so that certain financial
results can be viewed without the impact of fluctuations in foreign currency
rates, thereby facilitating period-to-period comparisons of business
performance. See "Currency Rate Fluctuations" on page 54 for additional
information.
Operating (non-GAAP) Earnings:
In an effort to provide better transparency into the operational results of the
business, the company separated business results into operating and
non-operating categories beginning January 1, 2011. Operating earnings is a
non-GAAP measure that excludes the effects of certain acquisition-related
charges and retirement-related costs, and their related tax impacts. For
acquisitions, operating earnings exclude the amortization of purchased
intangible assets and acquisition-related charges such as in-process research
and development, transaction costs, applicable restructuring and related
expenses and tax charges related to acquisition integration. For
retirement-related costs, the company has characterized certain items as
operating and others as non-operating. The company includes defined benefit plan
and nonpension postretirement benefit plan service cost, amortization of prior
service cost and the cost of defined contribution plans in operating earnings.
Non-operating retirement-related cost includes defined benefit plan and
nonpension postretirement benefit plan interest cost, expected return on plan
assets, amortized actuarial gains/losses, the impacts of any plan
curtailments/settlements and multi-employer plan costs, pension insolvency costs
and other costs. Non-operating costs are primarily related to changes in pension
plan assets and liabilities which are tied to financial market performance and
the company considers these costs to be outside the operational performance of
the business.
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Overall, the company believes that providing investors with a view of operating
earnings as described above provides increased transparency and clarity into
both the operational results of the business and the performance of the
company's pension plans; improves visibility to management decisions and their
impacts on operational performance; enables better comparison to peer companies;
and allows the company to provide a long-term strategic view of the business
going forward. For its 2015 earnings per share Road Map, the company is
utilizing an operating view to establish its objectives and track its progress.
The company's segment financial results reflect operating earnings, consistent
with the company's management and measurement systems.
The following table provides the company's non-GAAP operating earnings for the
first quarter of 2012 and 2011.
Yr. to Yr.
(Dollars in millions except per share amounts) Percent
For the three months ended March 31: 2012 2011 Change
Net income as reported $ 3,066 $ 2,863 7.1 %
Non-operating adjustments (net of tax):
Acquisition-related charges 126 117 7.7
Non-operating retirement-related costs/(income) 73 10
nm
Operating (non-GAAP) earnings* $ 3,265 $ 2,990 9.2 %
Diluted operating (non-GAAP) earnings per share: $ 2.78 $ 2.41 15.4 %
--------------------------------------------------------------------------------
nm - not meaningful
* See page 61 for a more detailed reconciliation of net income to operating
earnings.
Financial Performance Summary:
In the first quarter of 2012, the company reported $24.7 billion in revenue,
expanded gross, pre-tax and net income margins and delivered double-digit
diluted earnings per share growth of 13.0 percent as reported and 15.4 percent
on an operating (non-GAAP) basis. The company generated $4.3 billion in cash
from operations in the quarter driving significant shareholder returns of $3.9
billion in common stock repurchases and dividends, while also enabling the
ongoing transformation of the business - acquiring key capabilities and
focusing the portfolio on areas where the company can add the most value. In the
first quarter, the company closed five acquisitions for a total of $1.4 billion
increasing its capabilities in the key growth initiatives. As a result of its
performance, in April 2012, the company increased its full year 2012 earnings
per share expectation from the expectation disclosed in January 2012 to at least
$14.27 per share as reported and at least $15.00 per share for operating
(non-GAAP) earnings per share.
Performance in the first quarter was led by the company's growth initiatives.
The growth markets initiative is based on expanding into new markets, building
out the IT infrastructures and leading in targeted industries. The company has
consistently delivered strong performance and share gains, and in the first
quarter, growth markets revenue increased 8.5 percent (9 percent adjusted for
currency) with 40 growth market countries delivering double-digit constant
currency revenue growth. In business analytics, to help its clients deal with
the massive amounts of structured and unstructured data, the company has built a
broad portfolio of analytics solutions through organic investment and
acquisitions, and currently has more than 9000 consultants in Global Business
Services. In the first quarter, business analytics revenue increased 14 percent
(15 percent adjusted for currency). Cloud computing provides an efficient and
flexible delivery platform that improves the economics of information
technology. The company's SmartCloud portfolio addresses the full scope of
enterprise client requirements. Total cloud revenue doubled in the first quarter
when compared to the prior year with strong contribution from all areas -
private cloud, public cloud and the company's industry-based solutions. With
revenue growth of over 25 percent in the first quarter, Smarter Planet continues
to deliver strong growth driven by the Smarter Cities solutions and continued
strength in smarter commerce offerings. Overall, within the company's offerings
in business analytics, cloud and Smarter Planet, approximately half of the
revenue is software. Therefore, the success the company is having in its growth
initiatives is improving the business mix and margin expansion.
Segment performance was led by Software which increased revenue 5.5 percent (7
percent adjusted for currency) driven by key branded middleware which increased
6.6 percent (8 percent adjusted for currency) and gained share for the
18th consecutive quarter. Software pre-tax income increased 12 percent versus
the first quarter of 2011. Global Services expanded margins and increased total
services pre-tax income by 11 percent as the company leverages its productivity
initiatives and mixes to higher margin offerings and markets. Total Global
Services revenue was again led by performance in the growth markets, which
increased 9.4 percent (10 percent adjusted for currency). Systems and Technology
revenue declined, as expected, 6.7 percent (6 percent adjusted for currency)
compared to a very strong growth of 19 percent in the first quarter of 2011. In
the quarter, the
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company extended its leadership in the UNIX market, as it continued the success
in competitive displacements in the Power Systems business.
The consolidated gross profit margin increased 0.9 points versus the first
quarter of 2011 to 45.1 percent. The operating (non-GAAP) gross margin increased
1.2 points to 45.7 percent. Performance was driven by a combination of margin
expansion in both Global Services segments, and an improving segment mix due to
the relative strength of the Software business.
Total expense and other income increased 3.4 percent in the first quarter
compared to the prior year. Total operating (non-GAAP) expense and other income
increased 2.8 percent compared to the first quarter of 2011. The year-to-year
drivers for both categories were approximately:
† Base expense 3 points
† Acquisitions* 2 points
† Currency** (2) points
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* Includes acquisitions completed in prior 12-month period.
** Reflects impacts of translation and hedging programs.
Pre-tax income grew 0.5 percent and the pre-tax margin was 15.5 percent. Net
income increased 7.1 percent and the net income margin of 12.4 percent increased
0.8 points year to year. The effective tax rate for the first quarter was 20.1
percent, compared with 25.0 percent in the prior year, reflecting a one-time
benefit from a tax restructuring in Latin America. Operating (non-GAAP) pre-tax
income grew 3.1 percent and the pre-tax margin was 16.7 percent, an increase of
0.5 points versus the prior year. Operating (non-GAAP) net income increased 9.2
percent and the operating (non-GAAP) net income margin of 13.2 percent increased
1.1 points versus the prior year. The operating (non-GAAP) effective tax rate
was 20.6 percent versus 25.0 percent in the first quarter of 2011.
Diluted earnings per share improved 13.0 percent reflecting the growth in net
income and the benefits of the common stock repurchase program. In the first
quarter, the company repurchased 15.5 million shares of its common stock.
Diluted earnings per share of $2.61 increased $0.30 from the prior year.
Operating (non-GAAP) diluted earnings per share of $2.78 increased $0.37 versus
the first quarter of 2011 driven by the following factors:
† Revenue increase at actual rates: $0.01
† Margin expansion: $0.21
† Common stock repurchases: $0.15
At March 31, 2012, the company's balance sheet and liquidity positions remain
strong and are well-positioned to support the company's objectives. Cash and
marketable securities at quarter end were $12,335 million. Key drivers in the
balance sheet and total cash flows are highlighted below.
Total assets decreased $1,086 million ($1,879 million adjusted for currency)
from December 31, 2011 driven by:
† Decreases in total receivables ($2,947 million) and deferred taxes
($387 million); partially offset by
† Increased goodwill ($1,255 million), marketable securities ($500
million), intangible assets ($249 million) and inventory ($159 million).
Total liabilities decreased $1,634 million ($1,858 million adjusted for
currency) from December 31, 2011 driven by:
† Decreases in taxes ($1,129 million), accounts payable ($1,101
million), retirement and nonpension postretirement ($795 million) and
compensation and benefits ($729 million); partially offset by
† Increased total deferred income ($1,129 million) and total debt ($733
million).
Total equity of $20,783 million increased $548 million from December 31, 2011 as
a result of:
† Higher retained earnings ($2,178 million), common stock ($671
million), foreign currency translation adjustments ($398 million) and
retirement-related benefit plans ($363 million); partially offset by
† Increased treasury stock ($3,057 million) driven by share
repurchases.
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The company generated $4,291 million in cash flow provided by operating
activities, an increase of $499 million compared to the first quarter of 2011,
driven primarily by lower net income tax payments in the first quarter of 2012
versus 2011 and improved net income. Net cash used in investing activities of
$2,230 million increased $2,728 million primarily due to cash used for
acquisitions ($1,267 million), purchases of marketable securities and other
investments ($812 million), and decreased cash from sales of marketable
securities and other investments ($800 million). Net cash used in financing
activities of $2,316 million was flat compared to the prior year, primarily due
to a net decrease in cash used for common stock transactions ($772 million),
offset by lower net cash proceeds from total debt ($698 million).
In January 2012, the company disclosed that it was expecting GAAP earnings of at
least $14.16 and operating (non-GAAP) earnings of at least $14.85 per diluted
share for the full year 2012. In April 2012, the company increased its
expectation for GAAP earnings per diluted share to at least $14.27 and its
expectation for operating (non-GAAP) earnings per diluted share to at least
$15.00 for the full year.
First Quarter in Review
Results of Operations
Segment Details
The following is an analysis of the first-quarter 2012 versus the first-quarter
2011 reportable segment external revenue and gross margin results. Segment
pre-tax income includes transactions between the segments that are intended to
reflect an arms-length transfer price and excludes certain unallocated corporate
items.
Yr. to Yr.
Percent
Change
Yr. to Yr. Adjusted
(Dollars in millions) Percent/Margin For
For the three months ended March 31: 2012 2011 Change Currency
Revenue:
Global Technology Services $ 10,035 $ 9,863 1.7 % 2.6 %
Gross margin 35.3 % 33.8 % 1.5 pts.
Global Business Services 4,637 4,710 (1.5 )% (1.0 )%
Gross margin 28.0 % 27.4 % 0.7 pts.
Software 5,600 5,308 5.5 % 6.6 %
Gross margin 87.0 % 87.0 % (0.1) pts.
Systems and Technology 3,749 4,019 (6.7 )% (6.4 )%
Gross margin 34.2 % 37.8 % (3.6) pts.
Global Financing 490 516 (5.1 )% (3.9 )%
Gross margin 50.7 % 53.5 % (2.8) pts.
Other 162 190 (14.9 )% (14.6 )%
Gross margin (74.8 )% (93.3 )% 18.5 pts.
Total consolidated revenue $ 24,673 $ 24,607 0.3 % 1.0 %Total consolidated gross profit $ 11,118 $ 10,858
2.4 %
Total consolidated gross margin 45.1 % 44.1 % 0.9 pts.
Non-operating adjustments:
Amortization of acquired intangible
assets 88 85 3.6 %
Acquisition-related charges 0 0 1.1
Retirement-related costs/(income) 71 14 nm
Operating (non-GAAP) gross profit $ 11,278 $ 10,957
2.9 %
Operating (non-GAAP) gross margin 45.7 % 44.5 % 1.2 pts.
nm - not meaningful
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The following table presents each reportable segment's external revenue as a
percentage of total segment external revenue and each reportable segment's
pre-tax income as a percentage of total segment pre-tax income.
Revenue Pre-tax income
For the three months ended March 31: 2012 2011 2012 2011
Global Technology Services 40.9 % 40.4 % 33.4 % 29.0 %
Global Business Services 18.9 19.3 13.6 15.0
Total Global Services 59.9 59.7 46.9 44.0
Software 22.8 21.7 43.9 40.7
Systems and Technology 15.3 16.5 (2.4 ) 3.1
Global Financing 2.0 2.1 11.6 12.2
Total 100.0 % 100.0 % 100.0 % 100.0 %
Global Services
The Global Services segments, Global Technology Services (GTS) and Global
Business Services (GBS), delivered $14,673 million of revenue in the first
quarter of 2012, an increase of 0.7 percent (1 percent adjusted for currency)
year to year. Performance in the quarter was led by the growth markets with
total services revenue up 9.4 percent (10 percent adjusted for currency) driven
by strong backlog growth. The services segments also had strong performance in
the other growth initiatives: business analytics, cloud, and smarter planet
offerings. Total outsourcing revenue of $6,952 million, which includes GTS
Outsourcing and GBS Application Management Services Outsourcing, increased 1.5
percent (2 percent adjusted for currency) and total transactional revenue of
$5,883 million, which includes Consulting and Systems Integration within GBS and
Integrated Technology Services within GTS, increased 0.1 percent (1 percent
adjusted for currency) year to year.
Yr. to Yr.
Percent
Change
Yr. to Yr. Adjusted
(Dollars in millions) Percent ForFor the three months ended March 31: 2012 2011 Change Currency
Global Services external revenue: $ 14,673 $ 14,573 0.7 %
1.5 %
Global Technology Services $ 10,035 $ 9,863 1.7 % 2.6 %
Outsourcing 5,904 5,794 1.9 2.8
Integrated Technology Services 2,295 2,224 3.2 4.1
Maintenance 1,837 1,845 (0.4 ) 0.5
Global Business Services $ 4,637 $ 4,710 (1.5 )% (1.0 )%
Outsourcing 1,049 1,055 (0.6 ) 0.1Consulting and Systems Integration 3,589 3,654 (1.8 )
(1.4 )
Global Technology Services revenue of $10,035 million increased 1.7 percent (3
percent adjusted for currency) versus the first quarter of 2011. The revenue
growth rate year to year in the first quarter of 2012 at constant currency was
consistent with the last three quarters. Revenue performance was led by the
growth markets which were up 8.8 percent (10 percent adjusted for currency). GTS
Outsourcing revenue increased 1.9 percent (3 percent adjusted for currency) in
the first quarter and gained share. Integrated Technology Services (ITS) revenue
increased 3.2 percent (4 percent adjusted for currency) in the first quarter of
2012 compared to the first quarter of 2011, led by the growth markets which
increased 14 percent year to year, adjusted for currency.
Global Business Services revenue of $4,637 million decreased 1.5 percent (1
percent adjusted for currency) versus the first quarter of 2011 and growth
continued to be impacted by weakness in Japan and the Public Sector. Application
Outsourcing revenue decreased 0.6 percent (flat adjusted for currency) and
Consulting and Systems Integration (C&SI) revenue, which includes Consulting,
Application Management Services systems integration and the U.S. Federal
business, decreased 1.8 percent (1 percent adjusted for currency) year to year.
GBS is leading many of the engagements across the company in the higher value
solutions of business analytics and Smarter Planet. In the first quarter of
2012, GBS business analytics revenue increased 16 percent and Smarter Planet
revenue grew 18 percent year to year. Geographically, the growth markets
continued to perform well with revenue up 11.5 percent (12 percent adjusted for
currency), while the major markets continued to be effected by Japan, and by the
Public Sector, which declined more sharply in the first quarter. Revenue
declines in Japan and in the
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Public Sector, which combined represent over one-third of total GBS revenue,
impacted the overall GBS constant currency growth rate in the first quarter of
2012 by 6 points.
Yr. to Yr
Percent/
(Dollars in millions) Margin
For the three months ended March 31: 2012 2011 Change
Global Technology Services:
External gross profit $ 3,540 $ 3,330 6.3 %
External gross profit margin 35.3 % 33.8 % 1.5 pts.
Pre-tax income $ 1,480 $ 1,238 19.6 %
Pre-tax margin 14.3 % 12.2 % 2.2 pts.
Global Business Services:
External gross profit $ 1,301 $ 1,290 0.8 %
External gross profit margin 28.0 % 27.4 % 0.7 pts.
Pre-tax income $ 601 $ 640 (6.1 )%
Pre-tax margin 12.5 % 13.0 % (0.6 )pts.
GTS gross profit increased 6.3 percent in the first quarter of 2012 and gross
profit margin improved 1.5 points year to year. The gross margin expansion was
driven primarily by improved gross profit performance in outsourcing. Pre-tax
income increased 19.6 percent to $1,480 million in the first quarter of 2012 and
pre-tax margin expanded 2.2 points to 14.3 percent year to year. GTS continued
to benefit from efforts to deliver productivity and efficiency, within the
segment, and in conjunction with the company's enterprise productivity
initiatives. In addition, GTS continues to yield higher margins in the faster
growing growth markets. GTS is also realizing the benefits from a systematic and
disciplined approach to solving problems in a select set of lower margin
contracts within its large overall portfolio of outsourcing contracts.
GBS gross profit increased 0.8 percent in the first quarter of 2012 and gross
margin improved 0.7 points to 28.0 percent, with margin improvement in
Application Outsourcing partially offset by a lower margin in C&SI. GBS segment
pre-tax income declined 6.1 percent to $601 million with a pre-tax margin of
12.5 percent. GBS pre-tax income was also impacted by Japan in the first
quarter. Two large contracts in Japan impacted segment pre-tax income by
approximately $60 million.
Total Global Services segment pre-tax income was $2,081 million in the first
quarter of 2012, an increase of $204 million or 10.8 percent year to year. The
combined pre-tax margin expanded 1.3 points versus the first quarter of 2011 as
the Services business leverages productivity initiatives and mixes to higher
margin offerings and markets.
Global Services Backlog
The estimated Global Services backlog at March 31, 2012 was $139 billion, a
decrease of 1.9 percent (increase of 1 percent adjusted for currency) compared
to the March 31, 2011 balance, and a decrease of 0.9 percent (1 percent adjusted
for currency) compared to the December 31, 2011 balance. Total growth markets
backlog at March 31, 2012 increased 14 percent, adjusted for currency, compared
to the March 31, 2011 balance, reflecting strong demand for both outsourcing and
transactional services in these markets. The estimated outsourcing backlog at
March 31, 2012 was $91 billion, a decrease of 4.9 percent (2 percent adjusted
for currency) from the March 31, 2011 level, and a decrease of 1.9 percent (2
percent adjusted for currency) from the December 31, 2011 balance.
Yr. to Yr.
Percent
Change
Yr. to Yr. Adjusted
(Dollars in billions) Percent For
At March 31: 2012 2011 Change Currency
Backlog:
Total backlog $ 139.4 $ 142.2 (1.9 )% 0.7 %
Outsourcing backlog $ 90.8 $ 95.5 (4.9 )% (2.3 )%
Total Global Services backlog includes GTS Outsourcing, ITS, GBS Outsourcing,
Consulting and Systems Integration and Maintenance. Outsourcing backlog includes
GTS Outsourcing and GBS Outsourcing. Total backlog is intended to be a statement
of overall work under contract and therefore does include Maintenance. Backlog
estimates are subject to change and are affected by several factors, including
terminations, changes in the scope of contracts, periodic revalidations,
adjustments for revenue not materialized and adjustments for currency.
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Global Services signings are management's initial estimate of the value of a
client's commitment under a Global Services contract. There are no third-party
standards or requirements governing the calculation of signings. The calculation
used by management involves estimates and judgments to gauge the extent of a
client's commitment, including the type and duration of the agreement, and the
presence of termination charges or wind-down costs.
Signings include GTS Outsourcing, ITS, GBS Outsourcing and Consulting and
Systems Integration contracts. Contract extensions and increases in scope are
treated as signings only to the extent of the incremental new value. Maintenance
is not included in signings as maintenance contracts tend to be more steady
state, where revenues equal renewals.
Contract portfolios purchased in an acquisition are treated as positive backlog
adjustments provided those contracts meet the company's requirements for initial
signings. A new signing will be recognized if a new services agreement is signed
incidental or coincidental to an acquisition or divestiture.
Yr. to Yr.
Percent
Change
Yr. to Yr. Adjusted
(Dollars in millions) Percent For
For the three months ended March 31: 2012 2011 Change Currency
Total signings: $ 11,776 $ 10,508 12.1 % 15.0 %
Outsourcing signings $ 5,456 $ 4,716 15.7 % 19.7 %
Transactional signings 6,319 5,791 9.1 11.2
Software
Yr. to Yr.
Percent
Yr. to Yr. Change
(Dollars in millions) Percent Adjusted For
For the three months ended March 31: 2012 2011* Change Currency
Software external revenue: $ 5,600 $ 5,308 5.5 % 6.6 %
Middleware: $ 4,539 $ 4,350 4.3 % 5.4 %
Key branded middleware: 3,469 3,255 6.6 7.6
WebSphere Family 16.3 17.3
Information Management 5.2 6.3
Lotus (0.5 ) 0.5
Tivoli 4.6 5.7
Rational 1.2 2.3
Other middleware 1,070 1,095 (2.2 ) (1.2 )
Operating systems 590 542 8.9 10.0
Other 471 417 13.0 14.1
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* Reclassified to conform with 2012 presentation
Software revenue of $5,600 million increased 5.5 percent (7 percent adjusted for
currency) in the first quarter of 2012 as the business addressed opportunities
in business analytics, cloud and Smarter Planet. The company continues to invest
in the Software business to increase its capabilities in these key growth
initiatives and completed four acquisitions (Green Hat, Emptoris, Worklight,
DemandTec) in the first quarter of 2012.
Key branded middleware revenue increased 6.6 percent (8 percent adjusted for
currency) and gained share for the 18th straight quarter as Software revenue
continues to mix to the fast growing branded middleware. In the first quarter of
2012, branded middleware accounted for 62 percent of total software revenue, an
increase of 1 point from the first quarter of 2011. A third party named the
company the worldwide market share leader in the application infrastructure and
middleware segment. This marks the 11th consecutive year of software leadership
for the company.
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WebSphere revenue increased 16.3 percent (17 percent adjusted for currency) and
gained share for the 14th consecutive quarter. Revenue growth was driven by
strong contribution from the application server products, which increased 16
percent (17 percent adjusted for currency), and continued momentum in the
Smarter Commerce offerings, which increased 18 percent (19 percent adjusted for
currency). In the first quarter of 2012, the company strengthened its Smarter
Commerce integrated portfolio by completing the acquisitions of DemandTec, a
leader of pricing and promotion optimization solutions, and Emptoris, which
helps clients reduce procurement costs and risks.
Information Management revenue increased 5.2 percent (6 percent adjusted for
currency) and gained share in the first quarter of 2012. Business analytics
revenue increased 18 percent (19 percent adjusted for currency) led by Cognos.
The revenue performance in Cognos was driven by the successful integration of
its predictive capabilities into recent product introductions covering both
Business Intelligence and Financial Performance Management. Within Distributed
Database, the Software business continued to expand the global Netezza customer
base, with approximately two-thirds of new clients from outside North America.
For the first quarter of 2012, Netezza had a win-rate of nearly 80 percent in
head-to-head proof of concept engagements.
Lotus revenue decreased 0.5 percent (increased 1 percent adjusted for currency)
in the first quarter of 2012 year to year and held share.
Tivoli revenue increased 4.6 percent (6 percent adjusted for currency) in the
first quarter of 2012 and held share. Revenue performance was led by Storage
software with growth of 18 percent (19 percent adjusted for currency) in the
quarter. Security software, including Q1Labs, delivered revenue growth of 6
percent (7 percent adjusted for currency), as clients turn to Tivoli for
intelligence, integration and expertise across its comprehensive framework of
solutions.
Rational revenue increased 1.2 percent (2 percent adjusted for currency) and
gained share in the first quarter of 2012. Revenue growth was driven by
Telelogic, which increased 10 percent (12 percent adjusted for currency).
Operating systems revenue increased 8.9 percent (10 percent adjusted for
currency) in the first quarter of 2012, driven primarily by growth in Power
Systems.
Other software revenue increased 13.0 percent (14 percent adjusted for currency)
year over year, driven by growth in software-related services.
Yr. to Yr.
Precent/
(Dollars in millions) Margin
For the three months ended March 31: 2012 2011 Change
Software:
External gross profit $ 4,870 $ 4,620 5.4 %
External gross profit margin 87.0 % 87.0 % (0.1 )pts.
Pre-tax income $ 1,945 $ 1,735 12.1 %
Pre-tax margin 30.2 % 28.3 % 1.9 pts.
Software gross profit increased 5.4 percent to $4,870 million in the first
quarter of 2012 with a gross profit margin of 87.0 percent, essentially flat
year to year. Software delivered segment pre-tax income of $1,945 million in the
first quarter of 2012, an increase of 12.1 percent compared to the first quarter
of 2011. Segment pre-tax margin expanded 1.9 points to 30.2 percent. The
relative strength of the Software business and its success in the key growth
initiatives is contributing significantly to the company's overall gross and
pre-tax margin expansion.
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Systems and Technology
Yr. to Yr.
Percent
Yr. to Yr. Change
(Dollars in millions) Percent Adjusted For
For the three months ended March 31: 2012 2011 Change Currency
Systems and Technology external revenue: $ 3,749 $ 4,019 (6.7 )% (6.4 )%
System z (24.7 )% (24.2 )%
Power Systems 0.2 0.7
System x 0.2 (0.1 )
Storage (3.8 ) (3.0 )
Retail Store Solutions (12.5 ) (11.8 )
Total Systems (5.9 ) (5.5 )
Microelectronics OEM (12.6 ) (12.6 )
Systems and Technology revenue decreased 6.7 percent (6 percent adjusted for
currency) in the first quarter of 2012 versus the same period in 2011. The
decline in performance in the first quarter of 2012 was a result of very strong
revenue growth in the first quarter of 2011 of 19 percent. Growth markets
revenue increased 5.7 percent (5 percent adjusted for currency) in the first
quarter, while the major markets decreased 11.1 percent (10 percent adjusted for
currency) in the first quarter of 2012 on a year-to-year basis.
System z revenue decreased 24.7 percent (24 percent adjusted for currency) in
the first quarter of 2012 versus the first quarter of 2011. MIPS (millions of
instructions per second) shipments decreased 5 percent in the first quarter of
2012 versus the same period of 2011 and the company mixed towards specialty
engines. The decline in revenue and MIPS in the first quarter was expected and
was a result of the strong prior year performance in which revenue increased 41
percent. The performance in the quarter was consistent with prior mainframe
product cycles.
Power Systems revenue increased 0.2 percent (1 percent adjusted for currency) in
the first quarter of 2012 versus the first quarter of 2011, which grew 19
percent, with particular strength in high performance computing solutions. The
company extended its market leadership this quarter, the 16th consecutive
quarter of year-to-year share gains. In the first quarter of 2012, the company
had over 250 competitive displacements resulting in over $200 million of
business; approximately 60 percent were from Hewlett Packard with most of the
balance from Oracle/Sun.
System x revenue increased 0.2 percent (flat adjusted for currency) in the first
quarter of 2012 versus the first quarter of 2011. In the first quarter of 2012,
System x revenue increased 19 percent (17 percent adjusted for currency) in the
growth markets; the 10th consecutive quarter of double-digit revenue growth in
these emerging markets.
Storage revenue decreased 3.8 percent (3 percent adjusted for currency) in the
first quarter versus the comparable period in 2011. Total disk revenue decreased
2 percent (1 percent adjusted for currency) in the first quarter of 2012 versus
the first quarter of 2011. Tape revenue decreased 12 percent (11 percent
adjusted for currency) in the first quarter of 2012 compared to the prior year.
The value in storage solutions continues to shift to software, as storage
software revenue increased 18 percent in the first quarter compared to the prior
year.
Retail Stores Solutions revenue decreased 12.5 percent (12 percent adjusted for
currency) in the first quarter of 2012 versus the same period in 2011.
Microelectronics OEM revenue decreased 12.6 percent (13 percent adjusted for
currency) in the first quarter of 2012 versus the comparable period of 2011.
43
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Table of Contents
Yr. to Yr.
Percent/
(Dollars in millions) MarginFor the three months ended March 31: 2012 2011 Change
Systems and Technology:
External gross profit
$ 1,281 $ 1,520 (15.7 )%
External gross profit margin 34.2 % 37.8 % (3.6 )pts.
Pre-tax income $ (105 ) $ 132 nm
Pre-tax margin (2.7 )% 3.1 % (5.8 )pts.
nm - not meaningful
System and Technology's gross margin decreased 3.6 points in the first quarter
of 2012 versus the prior year. The decrease was driven by margin declines in
Storage (1.6 points), System x (0.6 points), Microelectronics (0.5 points) and
Power Systems (0.4 points), as well as revenue mix (0.7 points). These declines
were partially offset by a gross margin improvement in System z (0.4 points).
Systems and Technology's pre-tax income decreased $236 million to a loss of $105
million in the first quarter of 2012 when compared to the prior year. Pre-tax
margin declined 5.8 points in the first quarter of 2012 versus the first quarter
of 2011.
Global Financing
See pages 56 to 61 for a discussion of Global Financing's segment results.
Geographic Revenue
In addition to the revenue presentation by reportable segment, the company also
measures revenue performance on a geographic basis. The following geographic,
regional and country-specific revenue performance excludes OEM revenue, which is
discussed separately below.
Yr. to Yr.
Percent
Yr. to Yr. Change
(Dollars in millions) Percent Adjusted For
For the three months ended March 31: 2012 2011 Change Currency
Total Revenue $ 24,673 $ 24,607 0.3 % 1.0 %
Geographies: $ 24,164 $ 23,992 0.7 % 1.5 %
Americas 10,477 10,339 1.3 1.9
Europe/Middle East/Africa 7,578 7,760 (2.4 ) 1.1
Asia Pacific 6,109 5,893 3.7 1.4
Major markets (1.3 )% (0.5 )%
Growth markets 8.5 % 9.0 %
BRIC countries 9.5 % 11.4 %
Total geographic revenue increased 0.7 percent (1 percent adjusted for currency)
to $24,164 million in the first quarter of 2012, led by strong performance in
the growth markets. Adjusted for currency the revenue growth rate in the first
quarter was consistent with the growth rate in the fourth quarter of 2011.
Revenue from the major markets decreased 1.3 percent (flat adjusted for
currency) in the first quarter of 2012 compared to the first quarter of 2011.
Within the Americas, performance was led by Canada with growth of 7.7 percent (9
percent adjusted for currency). In Europe, adjusted for currency, revenue
performance was in line with the fourth quarter of 2011 with the most consistent
performance coming from the U.K. and Spain. The U.K increased 7.8 percent (10
percent adjusted for currency), its 10th consecutive quarter of growth, adjusted
for currency. Spain continues to leverage its global relationships and delivered
its 6th consecutive quarter of revenue growth, adjusted for currency. Germany
revenue in the first quarter of 2012 decreased 3.1 percent as reported and
increased 1 percent at constant currency.
44
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Revenue from the growth markets increased 8.5 percent (9 percent adjusted for
currency) and gained share for the 7th consecutive quarter as the company
accelerates its market expansion initiative. On a constant currency basis,
revenue growth outpaced the major markets by 10 points in the first quarter. In
the BRIC countries (Brazil, Russia, India and China) revenue increased 9.5
percent (11 percent adjusted for currency) with double-digit growth in
China, India and Russia. With approximately 60 percent of the growth markets
business being outside the BRIC countries, all together, the company had
double-digit revenue growth in 40 growth market countries, adjusted for
currency, in the first quarter of 2012. The growth markets strategy to expand
into new markets, build out IT infrastructures and lead in targeted industries
is continuing to drive strong performance and share gains.
Americas revenue increased 1.3 percent (2 percent adjusted for currency) in the
first quarter of 2012 compared to the first quarter of 2011 which grew 9.0
percent (8 percent adjusted for currency). The U.S. was essentially flat versus
a growth of 6.7 percent in the prior year. Revenue in the Latin America growth
markets increased 6.9 percent (10 percent adjusted for currency).
Europe/Middle East/Africa (EMEA) revenue decreased 2.4 percent (increased 1
percent adjusted for currency) in the first quarter of 2012 compared to the
first quarter of 2011. Within the major market countries, revenue performance
was mixed with the U.K. up 7.8 percent (10 percent adjusted for currency), Spain
down 1.8 percent (up 3 percent adjusted for currency), Germany down 3.1 percent
(up 1 percent adjusted for currency), Italy down 6.1 percent (2 percent adjusted
for currency) and France down 14.3 percent (10 percent adjusted for currency).
The EMEA growth markets increased 4.0 percent (8 percent adjusted for currency)
in the first quarter of 2012.
Asia Pacific revenue increased 3.7 percent (1 percent adjusted for currency)
year over year. The growth markets increased 10.2 percent (9 percent adjusted
for currency), led by growth in China of 16.1 percent (13 percent adjusted for
currency) and India of 3.5 percent (15 percent adjusted for currency). Japan
decreased 3.9 percent (7 percent adjusted for currency).
OEM revenue of $509 million in the first quarter of 2012 decreased 17.1 percent
(17 percent adjusted for currency) driven by the Microelectronics OEM business.
Expense
Total Expense and Other Income
Yr. to Yr.
(Dollars in millions) Percent
For the three months ended March 31: 2012 2011 Change
Total consolidated expense and other
(income) $ 7,283 $ 7,041 3.4 %
Non-operating adjustments:
Amortization of acquired intangible
assets (78 ) (73 ) 6.3
Acquisition-related charges (7 ) (7 ) 1.3
Non-operating retirement-related
(costs)/income (32 ) 10 nm
Total operating (non-GAAP) expense
and other (income) $ 7,166 $ 6,971 2.8 %
Total consolidated
expense-to-revenue ratio 29.5 % 28.6 % 0.9 pts.
Operating (non-GAAP)
expense-to-revenue ratio 29.0 % 28.3 % 0.7 pts.
--------------------------------------------------------------------------------
nm - not meaningful
Total expense and other (income) increased 3.4 percent in the first quarter
compared to the prior year. Total operating (non-GAAP) expense and other
(income) increased 2.8 percent compared to the first quarter of 2011,
respectively. The key drivers of the year-to-year change in total expense and
other (income) for both expense presentations were approximately:
† Base expense 3 points
† Acquisitions* 2 points
† Currency ** (2) points
--------------------------------------------------------------------------------
* Includes acquisitions completed in prior 12-month period.
** Reflects impacts of translation and hedging programs.
For additional information regarding total expense and other income for both
expense presentations, see the following analyses by category.
45
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Selling, general and administrative expense
Yr. to Yr.
(Dollars in millions) Percent
For the three months ended March 31: 2012 2011* Change
Selling, general and administrative
expense:
Selling, general and administrative - other $ 4,922 $ 4,922 0.0 %
Advertising and promotional expense 316 323 (2.3 )
Workforce rebalancing charges 226 223 1.1
Retirement-related costs 217 167 29.7
Amortization of acquired intangible assets 78 73 6.3
Stock-based compensation 119 130 (8.5 )
Bad debt expense 10 (13 ) nm
Total consolidated selling, general and
administrative expense $ 5,886 $ 5,826 1.0 %
Non-operating adjustments:
Amortization of acquired intangibles assets (78 ) (73 ) 6.3
Acquisition-related charges (6 ) (3 ) 112.5
Non-operating retirement-related
(costs)/income (36 ) (10 ) nm
Operating (non-GAAP) selling, general and
administrative expense $ 5,766 $ 5,740 0.5 %
--------------------------------------------------------------------------------
nm - not meaningful
* Reclassified to conform with 2012 presentation.
Total Selling, general and administrative (SG&A) expense increased 1.0 percent
(2 percent adjusted for currency) in the first quarter of 2012 versus the first
quarter of 2011. The increase was driven by acquisition-related spending (2
points), partially offset by currency impacts (1 point), while base expense was
flat. Operating (non-GAAP) SG&A expense increased 0.5 percent (2 percent
adjusted for currency) primarily driven by the same factors. Bad debt expense
increased $22 million in the first quarter of 2012. The accounts receivable
provision coverage is 1.6 percent at March 31, 2012, an increase of 10 basis
points from year-end 2011.
Other (income) and expense
Yr. to Yr.
(Dollars in millions) Percent
For the three months ended March 31: 2012 2011 Change
Other (income) and expense:
Foreign currency transaction
losses/(gains) $ (71 ) $ 96 nm %
(Gains)/losses on derivative instruments 60 (40 ) nm
Interest income (31 ) (36 ) (15.0 )
Net (gains)/losses from securities and
investment assets (6 ) (215 ) (97.1 )
Other (11 ) (8 ) 41.5
Total consolidated other (income) and
expense $ (58 ) $ (202 ) (71.2 )%
Non-operating adjustment:
Acquisition-related charges (1 ) (4 ) (82.1 )
Operating (non-GAAP) other (income) and
expense $ (59 ) $ (206 ) (71.4 )%
nm - not meaningful
Other (income) and expense was income of $58 million and $202 million in the
first quarter of 2012 and 2011, respectively. The decrease in income of $144
million in the first quarter of 2012 was primarily driven by lower gains from
securities and investment asset sales ($209 million) and increased losses on
derivative instruments ($101 million). In the first quarter of 2011, the company
had investment gains of over $200 million, primarily from the sale of Lenovo
shares. This decline in income was partially offset by higher gains from
foreign currency transactions ($168 million) due to foreign currency rate
volatility year to year.
46
-------------------------------------------------------------------------------- Table of Contents
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