James J. Kavanaugh
Chief Financial Officer and Senior Vice President, Finance and Operations at International Business Machines
Thanks Arvind. Over the last year, we have been very clear on the two most important measures of success; revenue growth, and free cash flow generation. I'll start with these key metrics. In the third quarter, our revenue of $17.6 billion was up as reported, and down modestly at constant currency. Excluding the content that will go to Kyndryl, IBM's revenue grew 2%, with an improving trend over the last three quarters. Our cash generation was up for the quarter, year-to-date and trailing 12 months. This excludes the cash charges associated with the separation of Kyndryl and the structural actions initiated at the end of last year.
Looking at our revenue from a segment perspective, Global Business Services growth accelerated to 11%, and our software revenue was up 2%. These businesses will be our growth drivers into the future, and together represent over 70% of our post-separation revenue profile. Systems declined this quarter by 12%, reflecting product cycle dynamics.
Across our segments, IBM's cloud revenue was up 11% over last year and it's up 17% excluding the cloud revenue going to Kyndryl. This is led by Global Business Services and Cloud & Cognitive Software, which are up 27% and 28% respectively over that period.
Moving on to the profit dynamics, pre-tax margin is up 10 basis points sequentially, but down 100 basis points year-to-year. Since we saw the demand environment improving in the fourth quarter of last year, we have been increasing investments in skills, innovation and our ecosystem organically and through acquisitions. In the third quarter, we continued to aggressively hire, bringing in technical talent in Red Hat and highly skilled expertise in Consulting. We're scaling resources in our garages to provide a more experiential consulting and sales approach. We're adding client success managers to help clients get the most value out of their IBM solutions and we're increasing investments in R&D to deliver innovations in our hybrid cloud platform, AI and emerging technologies like quantum.
The structural actions we initiated at the end of last year are funding some of these investments. Roughly two-thirds of the savings from these actions address stranded costs from the separation and create financial flexibility to be reinvested for growth. The other one-third address the Global Technology Services profit profile ahead of the separation, and we're seeing improvement in the GTS gross margin.
Our third quarter operating tax rate came in about 5%, which is lower than what we talked about last quarter. This was due to discrete tax benefits that occurred earlier than we previously expected as we prepare for the Kyndryl separation. It's important to note that our view of the full year operating tax rate has not changed since January.
I'll comment on our free cash flow and balance sheet position. We generated $5 billion of adjusted free cash flow year-to-date and $11.1 billion over the last year. Both exclude cash impacts of about $1.8 billion for the structural actions initiated late last year and transaction charges associated with the separation of Kyndryl. Our adjusted free cash flow over the last year is up about $300 million, with growth in our underlying business performance mitigated by a cash tax headwind. Our cash balance at the end of September was $8.4 billion, up slightly from June, but down about $6 billion from year-end. Over the same period, our debt is down $7 billion. In addition to debt reduction, year-to-date, we've used $3 billion for acquisitions, and over $4 billion for shareholder return through dividends. Our solid cash generation and disciplined financial management provides the fuel to invest in our business and pay an attractive dividend.
Turning to the segments, Cloud and Cognitive Software revenue grew 2%. We have a strong recurring revenue base in software. Renewal rates for subscription and support were up again this quarter, contributing to the increase in our software deferred income balance over the last year. By business area, Cloud and Data Platforms revenue was up 9%, while Cognitive Applications declined 1% and Transaction Processing Platforms was down 9%. We recently shared plans to provide new software revenue categories starting in the fourth quarter. We will combine our two software growth vectors, Cloud and Data Platforms and Cognitive Applications, and within that, provide greater transparency into performance and trends by business area.
Looking across these growth vectors, Red Hat, Security and Automation fueled revenue growth this quarter. Red Hat revenue was up 17% on a historically-normalized basis and 23% all-in. Going forward, we will focus on this all-in growth, given these views will converge over the next year, as the impact of the deferred revenue impairment dissipates. Red Hat revenue growth was driven by double-digit growth in both Infrastructure and Application Development and emerging technologies and we had more than 40% growth in OpenShift recurring revenue. Growth in Automation was led by key solutions like Cloud Pak for Integration and Cloud Pak for Business Automation as well as a strong start to our recent Instana and Turbonomic acquisitions.
Our Data and AI revenue was down modestly. We had strength in Cloud Pak for Data, Weather and Maximo, and declines in on-premise DataOps portfolio and supply chain, as it wrapped on a strong third quarter last year. Security remains a key strategic focus area as we're helping clients adopt Zero Trust architecture with Cloud Pak for Security and XForce services. Growth in Security revenue continued this quarter, led by threat management software and services as clients respond to the evolving cybersecurity environment.
In the spirit of transparency, I'll provide a couple of additional metrics into our performance. Our annual recurring revenue or ARR across these software growth vectors grew 7% percent. This is a good indication of the progress in our hybrid cloud and AI client adoption and we now have over $8 billion in software cloud revenue over the last year, which is up 28%.
Turning to our software value vector, Transaction Processing Platforms, we provide flexibility to our clients in how they purchase this mission-critical software. Over the last 18 months we've seen a preference for OpEx over capex. This continues to pressure perpetual licenses in favor of more consumption-like models, but importantly, we again had strong renewal rates in our Transaction Processing Platforms software. This is a solid indication that clients see long-term value in these offerings. Looking at profit for the software segment, we expanded pre-tax margin sequentially, while we continue to invest in new innovation and our ecosystem.
Moving to Global Business Services, revenue growth accelerated to 11%. Even with this strong revenue performance, our book-to-bill ratio was greater than 1. Our GBS value proposition is aligned to our clients' priorities. We're helping our clients capture new growth opportunities, and increase operational flexibility and productivity with hybrid cloud and AI. We leverage our incumbency, IBM technology and strategic partnerships to modernize their applications, and digitally transform their businesses at scale. GBS revenue growth is led by our cloud offerings. GBS cloud revenue now represents more than $7 billion of revenue over the last year and is up 27%. This performance reflects the continued investments we are making in our Red Hat, Microsoft and AWS practices. As Arvind said, we added over 180 Red Hat client engagements this quarter. This contributes to total Red Hat-related signings of close to $3.5 billion since the acquisition.
Within our 11% revenue growth, Consulting was up 16%. There's solid demand here. We're leveraging our skills and ecosystem partners to transform our clients' business processes and modernize applications based on OpenShift. Global Processing Services revenue was up 19%. Our offerings in finance, procurement, and talent & transformation all grew at double-digit rates. More and more, we are connecting consulting and BPO to transform client workflows using hybrid cloud and AI. Lastly, in Application Management, revenue growth accelerated to 5%, off a prior year that was impacted by the pandemic. Growth this quarter was driven by management of applications in a multi-cloud environment.
I'll shift to GBS profit profile, where our strong revenue performance drove gross and pre-tax profit dollar growth. Our gross and pre-tax margins improved sequentially but were down year-to-year. With the market opportunity we see, we are making conscious decisions to invest ahead of revenue. We are investing in strategic partnerships, new offerings and practices, and integrating and scaling out our acquisitions. As I mentioned earlier, we are investing in skills for GBS. In the last several months, we have increased our go-to-market resources and scaled our practices built around our ecosystem partners and Red Hat. With a competitive labor market, this is putting some pressure on our labor costs, including higher acquisition and retention costs, which is not yet reflected in our current pricing. We expect to capture this value in future engagements, but it will take time to appear in our margin profile.
So now turning to the Systems segment, revenue performance was down 12%, driven by product cycles in IBM Z and Power, mitigated by growth in Storage. In IBM Z, revenue declined 33% in the ninth quarter of z15 availability. While z15 program to-date continues to exceed the strong z14 cycle, the magnitude of that over-achievement has come down a couple of points this quarter. IBM Z is an enduring platform, given market needs for scalability, reliability, security and more recently, cloud-native development. These characteristics, together with our newer, flexible consumption offerings, further demonstrate the value of the IBM Z platform within our hybrid cloud and AI strategy.
Power revenue was down. Late in the quarter, we began the rollout of our next generation Power10, starting with high-end systems. As always, new Power technology is introduced over-time, and the mid-range and low-end Power10 systems will be available during 2022. Storage delivered 11% revenue growth, driven by demand from hyperscalers for our tape products and growth in entry-level all-flash storage following our product refresh earlier this year. Looking at profit in this segment, profit margin was down, reflecting where we are in the IBM Z and Power product cycles.
So now let me turn to Global Technology Services. Revenue was down 5%, which is a one-point deceleration from last quarter. The year-to-year trajectory of revenue generated from the backlog has been improving over the last few quarters. In the first half of the year, we also had modest improvements in client-based business volumes and project activity, which contributes to in-period revenue. However, this quarter, clients paused our new project activity as the separation was imminent, resulting in the revenue deceleration. At the time we decided to separate our managed infrastructure services business, we undertook a series of actions to improve the margin, profit, and cash generation profile of the business, including a substantial charge in the fourth quarter of 2020. The results of these actions can be seen in the margin improvement over the last several quarters. In this quarter, we again expanded gross margin, up 120 basis points. Kyndryl will take this improved profit profile into the separation.
I'll wrap-up with a view of our progress year-to-date and then talk about some of the fourth quarter dynamics. As we entered 2021, we laid out our expectations for the year for our two most important measures -- revenue and free cash flow. We expected to grow revenue for IBM at actual rates, with underlying constant currency performance stronger in the second half than the first. We expected to grow revenue for IBM excluding Kyndryl at constant currency and we expected to generate $11 billion to $12 billion of adjusted free cash flow. That of course excludes the cash impacts of the Kyndryl transaction costs and the structural actions I mentioned earlier.
Now, we're three quarters into the year, and we just completed the last full quarter of IBM on a pre-separation basis. It's a good time to take a snapshot against those objectives. Through the first three quarters, our revenue at actual rates is up 2%, our revenue growth trajectory at constant currency has been improving throughout the year, and excluding Kyndryl, our third quarter revenue was up 2% year-to-year. And our adjusted free cash flow over the last 12 months is $11.1 billion.
Since the beginning of the year, we have streamlined our go-to-market. We have increased investments and closed 10 acquisitions. These actions and investments will help drive revenue growth, but it takes time to fully realize the benefits. Overall, our results over the first three quarters of 2021 reflect progress we've been making toward our mid-term model. During the fourth quarter, we will complete the separation of Kyndryl, which is on track for November 3rd. The fourth quarter, therefore, is a major milestone as we transition to the future IBM.
Now let me provide some color on three areas for the fourth quarter. First, the revenue trajectory of the new segments. Second, I'll comment on our tax rate. And third, the impact of the separation of Kyndryl to IBM's consolidated results for November and December on an operating basis.
I'll start with the revenue trajectory of our segments as we'll report them in the fourth quarter. As always, I'll talk about it on a constant currency basis. But I'll remind you the US dollar continues to strengthen and would be a 1 point to 2 point headwind to growth based on current spot rates. To provide a better view of trends, I'll focus on the growth rates before the revenue from incremental sales to Kyndryl. We see continued momentum in our growth vectors of software and consulting. We expect our Software revenue growth rate to improve versus the third quarter. And in IBM Consulting, we again expect double-digit revenue growth. In Infrastructure, given product cycle dynamics, we expect fairly consistent performance with the third quarter, which was a high single-digit decline.
Second, tax. I mentioned the timing of discrete tax benefits occurred earlier than we previously anticipated, as we prepare for the Kyndryl separation. We still expect our full year tax rate to be in the low teens range, in line with what we indicated back in January. That's our all-in rate, including discrete tax items, and implies a fourth quarter tax rate in the high teens.
And then finally, IBM's fourth quarter consolidated results will reflect the Kyndryl separation. I'll frame the revenue and earnings per share implications based on the last couple of years. Kyndryl historically represented just under $5 billion of revenue in the fourth quarter, with about $3.5 billion of that in November and December. At the same time, we estimate we'll get about $350 million from incremental sales in those two months from the new commercial relationship. The net impact to IBM consolidated results is a reduction of about $3 billion of revenue for November and December due to the separation. And for those two months, we estimate an impact of $0.20 to $0.25 of earnings per share including the new commercial relationship. At the time of separation, Kyndryl will be presented in discontinued operations, with the balance of IBM in continuing operations. We will provide a historical restatement of continuing operations before the end of the year.
We are on the threshold of the future IBM. We expect to exit the fourth quarter in a position to deliver our mid-term model of mid-single digit revenue growth and cumulative free cash flow of $35 billion in 2022 to 2024.
So with that, we'll be happy to take your questions. I'll turn it back to Patricia.
