James J. Kavanaugh
Senior Vice President and Chief Financial Officer at International Business Machines
Thanks, Arvind. As always, I'll start with the key financial highlights of the second quarter. We delivered $15.5 billion in revenue, $2.4 billion of operating pre-tax income, $2.18 of operating earnings per share, and through the first half, nearly $3.5 billion of free cash flow. In the second quarter, we had modest revenue growth at constant currency, and that includes over a point of impact from the businesses we divested last year. Currency rates continue to be a headwind to growth with the dollar strengthening over the last 90 days currency impacted our reported revenue growth by about 80 basis points, which is about 0.5 point worse than what spot rates suggested in April.
As is typical, I'll focus my comments on constant currency. Revenue performance was again led by software and consulting. These are growth vectors that together represent about three quarters of IBM's revenue and contribute to a solid base of recurring revenue and profit. Software revenue was up 8% with good growth across both Hybrid Platform & Solutions, led by Red Hat and Data & AI, and transaction processing. IBM Consulting revenue growth of 6% was also broad-based, with growth across all three lines of business and geographies. Our infrastructure revenue in any quarter reflects product cycle dynamics. Infrastructure revenue was down 14%. This, as expected, had a disproportional impact to IBM's overall revenue growth this quarter, given the very successful launch of z16 in the second quarter last year. Looking at the two-year compounding growth rate, infrastructure revenue was up.
Turning to our profit metrics, operating gross margin expanded 140 basis points, driven by our portfolio mix and productivity. We had good performance this quarter with gross margin improvements in every reportable segment. Our operating pre-tax margin was down 70 basis points. Last year, we had a gain of about $230 million from the sale of our healthcare software assets. Without the year-to-year impact of the divestiture gains, our operating pre-tax margin was up 70 basis points. This is a better indication of our ongoing operational performance.
Let me comment on a couple of items within our expense profile that impacted our pre-tax income performance. As we discussed in the last couple of earnings calls, we addressed the remaining stranded cost from our portfolio actions resulting in a higher level of workforce rebalancing activity this year, about $115 million in the quarter. Workforce rebalancing impacted our year-to-year pre-tax margin expansion by another 60 basis points. And then currency remained a year-to-year headwind, not only to revenue but also to our expense and pre-tax profit.
The combination of translation and hedging impacted operating pre-tax profit growth by about $150 million and operating PTI margin by about 80 basis points year-to-year. As I've discussed in the past, this disproportionately impacts our product-based businesses. We have good momentum in our underlying operational profit performance. I mentioned a strong business mix, but we're also making progress on our productivity initiatives. We're digitally transforming IBM as client zero, simplifying workflows and deploying AI across our processes, from IT Operations to HR to Source to Pay. The productivity benefits free up spend for reinvestment and contribute to margin expansion.
Turning to free cash flow, we generated $2.1 billion in the quarter and nearly $3.5 billion in the first half. This first-half performance is up over $100 million year-to-year and keeps us on track to our full-year expectation. Growth is driven by the cash from our profit performance, working capital efficiencies, and lower payments for structural actions. This was mitigated by higher performance-based compensation payments given last year's strong results and higher cash taxes. In terms of cash uses, through the first half, we returned $3 billion to shareholders in the form of dividends and spent about $350 million to acquire six companies.
Later this year, we expect to close the acquisition of Apptio, which complements and advances our IT automation capabilities. From a balance sheet perspective, we continue to have very strong liquidity position with over $16 billion of cash. That's down over a $1 billion since March and up $7.5 billion since December. Our debt balance at the end of the second quarter was over $57 billion, which is up $6.5 billion from year-end. You'll recall earlier in the year we were opportunistic in accessing the debt market and issued debt to prudently get ahead of 2023 and 2024 maturities as well as capital allocation priorities.
Turning to the segments, Software revenue growth accelerated to 8% this quarter. Both Hybrid Platform & Solutions and transaction processing grew as clients leverage our hybrid cloud and AI platform capabilities. This performance again reflects growth across both our recurring revenue base, which is about 80% of annual software revenue, as well as transactional revenue. In Hybrid Platform & Solutions, revenue was up 7%, fueled by growth in Red Hat, Data & AI and automation. Our Hybrid Platform & Solutions ARR is now over $13.6 billion and up 7%, reflecting the importance of our strategic offerings with our clients. Red Hat revenue grew 11%. OpenShift, our leading Hybrid Cloud platform, grew more than 30% in the quarter and now has $1.1 billion in annual recurring revenue. Ansible also delivered double-digit growth and gained market share this quarter.
In automation, revenue was up 2%, reflecting growth across integration, application servers, and business automation as clients drive enhanced business value through productivity and performance optimization. Data & AI revenue was up 11%, the broad-based growth included areas like data management and business analytics, giving enterprise needs for data visualization, organization, analysis, and insights as the underpinnings for AI workloads. Security revenue declined 1%.
We delivered growth and security software driven by data security with Guardium Insights. This was more than offset by declines in Security Services this quarter. In Transaction Processing, revenue grew 10% off of an easier compare last year. The increase in zSystems installed capacity over the last couple of cycles and strong software renewal rates reflect the importance of zSystems platform in a hybrid cloud environment. These dynamics contributed to both recurring and transactional software revenue opportunity again this quarter. Putting this together with price increases, we had strong performance in transaction processing.
Moving to profit for the Software segment, our pre-tax margin was up a half a point while absorbing over a point of impact from currency. We delivered operating leverage given both the revenue scale and mix this quarter. Consulting revenue was up 6%. In April, we discussed that we were seeing sustained demand for larger transformations that delivered meaningful ROI. At the same time, other projects considered to be more discretionary were being delayed, predominantly in the United States. The second quarter client buying behavior played out much in the same way.
Our signings were solid, up over 20% with double-digit growth in both large and small engagements. This takes our book-to-bill ratio up to 1.1 over the last 12 months. We address continued demand for technology-driven transformations as clients prioritize projects that drive cost savings and increase productivity. Turning to our lines of business and consulting, growth across our service offerings was broad-based. Business transformation grew 5%, driven by data and technology transformations, including AI and analytics-focused projects. Digital transformations continue to be underpinned by clients embracing a Hybrid Cloud strategy. Technology Consulting grew 5%, and Application Operations grew 8% as we again saw strength in cloud-based application services across development, modernization, and management.
Contributing to growth across the business, our strategic partnerships grew signings and revenue double digits with solid performance from partnerships with AWS and Azure. Our Red Hat practice also grew signings and revenue double digits. We have an annualized revenue run rate in excess of $2 billion. Moving to consulting profit, we expanded both gross and pre-tax margins by 180 basis points. Our margin expansion is a reflection of the pricing and productivity actions we've taken, more than offsetting the increased labor cost and investments.
Turning to the Infrastructure segment, revenue was down 14%, reflecting product cycle dynamics. This impacted both hybrid infrastructure and infrastructure support. Within hybrid infrastructure, zSystems revenue declined 30%. We've wrapped on strong revenue performance last year, up 77% when z16 launched in the seasonally strong quarter. Through the first five quarters of availability, revenue was well ahead of prior cycles. z16 brings the power of embedded AI at scale, cyber-resilient security, and cloud-native development for hybrid cloud to our clients. For example, clients are adopting IBM z16 and the Telum Processor as the foundation for real-time AI insights across significant volumes of data. Distributed Infrastructure revenue was down 6%. Let me remind you, we're wrapping on strong growth last year, up 17% driven by strength in storage and Power10 high-end systems.
Moving to infrastructure profit, we expanded gross margins 200 basis points, while pre-tax margin was down 40 basis points, including about a point of impact from currency. Now that I've gone through the segment results, let me bring it back up to the IBM level to wrap up. We feel good about our first-half performance with momentum in our growth vectors of software and consulting and a solid recurring revenue base driven by our high-value software. We're delivering strong gross margin performance with growth across our segments, driven by portfolio mix and productivity.
Our overall year-to-year profit dynamics, as expected, reflect the impact of last year's divestiture. As we look to the full year of 2023, we're holding our view of the year on our two primary metrics, revenue growth, and free cash flow. We see constant currency revenue growth of 3% to 5%, and we expect free cash flow of about $10.5 billion, which I'll remind you is up over a $1 billion year-to-year. Let me comment on a few items within these full-year expectations. We expect IBM's operating pre-tax margin to expand by about 0.5 year-to-year, driven by a combination of product mix and progress on our productivity initiatives. That's consistent with our view 90 days ago and in line with our model.
We're also maintaining our view of our tax rate for the year, which is in the mid to high teens range. And then finally, while there has been some volatility in currency rates over the last couple of weeks, at current spot rates, currency translation is still expected to be fairly neutral to our revenue growth for the year. I'll remind you that our profit and cash dynamics this year are impacted by the wrap on last year's hedging gains, which is about a point of headwind to our pre-tax margin expansion.
In terms of segment dynamics, in Software, we had a good first half and now expect revenue growth at the high end of software's mid-single-digit model. This is all-in, including acquisitions. Our revenue growth drives operating leverage with software pre-tax margin expected to expand a 1.5 to 2 points year-to-year. In Consulting, we've repositioned our business to address today's clients' needs. What we saw in the second quarter didn't change our view of the year. We continue to expect consulting revenue growth in the range of 6% to 8%, and to expand consulting pre-tax margin by at least a point.
And then for infrastructure, as I described in the past, revenue is roughly flat over the mid-term model horizon, with performance in any year reflecting product cycle dynamics. In the second quarter, we wrapped on the z16 introduction in a seasonally strong quarter. For the year, as you expect, 2023 infrastructure revenue will decline, impacting IBM's overall revenue growth by over a point. We continue to expect pre-tax margin in the low teens. Our expectations for 2023 reflect our higher growth, higher value business with strong cash generation, what we have referred to as Today's IBM.
The analysts' estimates also reflect these dynamics, and as we look at the third quarter, the average of analysts' estimates looks reasonable. In closing, we are pleased with our first half performance, and it keeps us on track to deliver revenue growth, expand margin, and grow free cash flow for the year. I'm happy to provide more color on the quarter and our expectations in the Q&A.
Patricia, let's get started.
