James J. Kavanaugh
Senior Vice President and Chief Financial Officer at International Business Machines
Thanks, Arvind. In the second quarter, we delivered $15.8 billion in revenue, $2.8 billion of operating pre-tax income and $2.43 operating diluted earnings per share. Our 4% revenue growth at constant currency, combined with greater than 200 basis points of operating pre-tax margin expansion, drove 17% operating pre-tax income growth and 11% operating diluted earnings per share growth, highlighting our strong execution. And through the first half, we generated $4.5 billion of free cash flow. Our free cash flow generation is the strongest first half level we have reported in many years.
We are pleased with these results, exceeding our expectations for revenue, profitability, free cash flow, and earnings per share. Revenue growth was led by software and infrastructure. It is clear that our investments in innovation are yielding results and driving strong organic growth across these segments. Software grew by 8% with solid growth across Hybrid Platform & Solutions and Transaction Processing and strong transactional performance. Infrastructure had great performance, up 3%, delivering growth across IBM Z and Distributed Infrastructure. Consulting was up 2% and continued to be impacted by a pullback in discretionary spending.
Looking at our profit metrics, we expanded operating gross margin by 190 basis points and operating pre-tax margin by 220 basis points over the last year, inclusive of about a 30 basis point currency headwind to pre-tax margin. Margin expansion was driven by our operating leverage, product mix, and ongoing productivity initiatives. Driving productivity is core to our operating and financial model. This includes enabling a higher-value workforce through automation and AI, streamlining our supply chain, aligning our teams by workflow, and reducing our real estate footprint. These actions allowed for continuing investment in innovation with R&D up 9% in the first half. This includes investments in both AI and hybrid cloud as well as infrastructure ahead of our next Z program in 2025, which we expect to accelerate our organic growth profile over time.
Our results this quarter reflect broad-based growth and the strength in the fundamentals of our business, with revenue up about $300 million, operating pre-tax income up about $400 million, adjusted EBITDA up more than $350 million and free cash flow up about $500 million. For the first half, we generated $4.5 billion of free cash flow, up $1.1 billion year-over-year. The largest driver of this first half growth comes from adjusted EBITDA, up about $550 million year-over-year, and timing of capex. We are a few points ahead of our two-year average attainment levels through the first half.
In terms of cash uses, we returned $3.1 billion to shareholders in the first half in the form of dividends. From a balance sheet perspective, we have a very strong liquidity position with cash of $16 billion, up $2.5 billion since year end 2023. Our debt balance at the end of the second quarter was flat with year-end 2023 at $56.5 billion, including $11.1 billion from our financing business. Putting this all together, our business fundamentals remain solid with continued revenue growth, margin expansion, cash generation, and a strong balance sheet with financial flexibility to support our business.
Turning to the segments, Software revenue growth accelerated to 8% this quarter. Both Hybrid Platform & Solutions and Transaction Processing grew, as clients leverage the capabilities of our AI and hybrid cloud platforms. This performance reflects the investments we've been making in Software, both organically, which drove more than 6 points of the growth as well as acquisitions. As mentioned in January, the Software revenue growth drivers for the year include Red Hat growth, the combination of innovation, recurring revenue, and Transaction Processing as well as acquisitions.
Let me spend a minute on each of these elements. In Red Hat, annual bookings growth accelerated to over 20% this quarter. Within that performance, OpenShift annual bookings were up over 40% and RHEL and Ansible growth was double digit. The strength reflects the demand for our hybrid cloud solutions, including app modernization, management automation, generative AI, and virtualization. In the subscription-based business, the majority of revenue is under contract for the next two quarters. Think of it as our cRPO for the next six months. This metric is growing in the mid-teens and accelerated more than 5 points versus the first half of the year.
We continue to bring new innovation to our portfolio and it's contributing nicely to our software performance. Our new innovation includes generative AI offerings like watsonx, our AI middleware, watsonx assistants, the recently announced IBM Concert and others, which contributed about $0.5 billion to our AI book of business inception to date. And we delivered good growth across our recurring revenue base, which is about 80% of the annual software revenue. This is evident in Hybrid Platform & Solutions, where our ARR is now $14.1 billion and up 9% since last year.
Transaction Processing delivered 13% revenue growth. This performance demonstrates the innovation and value of our mission-critical hardware stack across IBM Z, power and storage. The combination of growing demand for capacity, good client renewals, and strong large deal performance fueled our results. And notably, our new generative AI portfolio innovation, watsonx Code Assistant for Z is resonating well with clients. Together, these dynamics contributed to both recurring and transactional software revenue growth again this quarter.
Revenue performance this quarter also benefited from our focused M&A strategy, including synergies realized across the portfolio. This included the recent Apptio acquisition. Less than 12 months since closing, we have accelerated annual bookings and are seeing an uptick in ARR growth already in the mid-teens. The synergy between Apptio's FinOps offerings and our broader automation portfolio helps clients manage, optimize, and automate technology spending decisions.
Earlier this month, we completed the acquisition of StreamSets and webMethods from Software AG and expect the HashiCorp acquisition to close by year end. Looking at Software profit, gross profit margin expanded and segment profit was up over 350 basis points year-to-year, with the latter reflecting operating leverage driven by our revenue scale and mix this quarter.
Our Consulting revenue was up 2%, consistent with last quarter and largely reflecting organic growth. In April, we discussed that we were seeing solid demand for our large transformational offerings as clients continue to prioritize driving productivity with AI and analytics. At the same time, we saw a pullback on discretionary projects as clients prioritized their spending. The second quarter buying behavior played out much in the same way.
Signings for the quarter were $5.7 billion, driven by solid demand for large engagements across finance and supply chain transformation, cloud modernization and application development. This contributed to backlog growth of 5% year-over-year and our trailing 12-month book-to-bill remaining over 1.15. Meanwhile, continued discretionary spending constraints impacted our small engagement performance and backlog realization in the quarter.
As Arvind mentioned, our book of business in generative AI inception to date is greater than $2 billion, and about three-quarters of it represents consulting signings with strong quarter-over-quarter momentum. Our extensive industry and domain expertise has placed us in an early leadership role, which is crucial at the onset of a technology shift. IBM has both technology and consulting, which is a unique and powerful combination to help clients navigate this technology transition.
Similar to previous technology shifts such as the advent of the Internet, globalization, and cloud computing, generative AI is driving the next wave of growth. In a human capital-based business, signings represents clients reprioritizing spend on this technology transition, while there is some potential for lift as the total addressable market expands. We are delivering value in two ways: first, partnering with our clients to design and scale AI solutions, whether that be leveraging AI capabilities of IBM, our partners, or a combination; second, we are developing new ways of working, driving productivity and improving delivery, all with our Consulting Advantage platform.
In summary, GenAI is acting as a catalyst for companies to grow revenues, cut costs and change the ways they work, creating a significant opportunity for us. We are seeing this already as IBM is the strategic partner of choice for clients using this technology, including WPP, Elevance Health and the U.K.'s Department of Work and Pensions.
Turning to our lines of business. Business Transformation revenue grew 6%, led by finance and supply chain transformations. Data transformation also contributed to growth. In Technology Consulting, revenue was up 1%. Growth was driven by application modernization services. Application Operations revenue declined, reflecting weakness in on-prem custom application management, partially offset by strength in cloud-based application management offerings.
Looking at Consulting profit, we expanded gross profit margins by 40 basis points, driven by productivity and pricing actions we have taken. Segment profit margin was modestly down, reflecting continued labor inflation and currency.
Moving to Infrastructure, revenue was up 3%. We're capitalizing on the strong and broad-based demand for our hardware platforms, especially IBM Z. Within Hybrid infrastructure, IBM Z revenue was up 8% this quarter. We're now more than two years into the z16 cycle and the revenue performance continues to outperform prior cycles.
Our clients are facing increasing demands for workloads, given rapid business expansion, the complex regulatory environment, and increasing cybersecurity threats and attacks. IBM Z addresses these needs with the combination of cloud-native development for hybrid cloud, embedded AI at scale, quantum-safe security, energy efficiency, and strong reliability and scalability. Increasing workloads translates to more Z capacity or MIPS, which are up about threefold over the last few cycles. IBM Z remains an enduring platform for mission-critical workloads, driving both hardware and related software, storage, and services adoption.
In Distributed Infrastructure, revenue grew 5%, driven by strength in both power and storage. Power growth was fueled by demand for data-intensive workloads on Power10 led by SAP HANA. Storage delivered growth again this quarter, including growth in high-end storage tied to the z16 cycle and solutions tailored to protect, manage and access data for scaling generative AI.
Looking at Infrastructure profit, we delivered solid gross profit margin expansion, and segment profit accelerated quarter-to-quarter to the high teens. Segment profit margin was down 230 basis points in the quarter, reflecting key investments we're making in the business across areas like AI, hybrid cloud, and quantum and almost 1 point of impact due to currency.
Now let me bring it back to the IBM level to wrap up. We feel good about our performance in the first half, with revenue growth reflecting the investments we've been making both organically as well as acquisitions. Our focus on execution and the strength in the fundamentals of our business resulted in strong performance in the quarter across revenue, margin expansion, and growth in profitability and earnings.
Looking to the full year 2024, we are holding our view on revenue. We see full year constant currency revenue growth in line with our mid-single digit model, still prudently at the low end. For free cash flow, given the strength in our performance in the first half, we feel confident in raising our expectations to greater than $12 billion, driven primarily by growth in adjusted EBITDA. This also includes a modest contribution resulting from the Palo Alto QRadar transaction, largely offset by related structural actions to address stranded costs. We continue to expect to curate our transaction to close by the end of the third quarter.
On to segments. In Software, we had solid first half performance, up more than 7%. This performance reflects strength in our recurring revenue base and early traction in GenAI. With this performance, we are raising our view of growth in Software to high-single digits for the year. And given ongoing productivity initiatives and operating leverage, we now expect Software segment profit margin to expand by over 1 point.
In Consulting, given the continued pressure we have seen on spending related to discretionary projects, we now expect low-single digit growth for the year and segment profit margin to expand by about 0.5 point. And given the strength in Infrastructure in the first half, we now expect it to be about neutral for the year with segment profit margin in the mid- to high teens. With these segment dynamics, we are raising our expectations of operating pre-tax margin expansion to over 0.5 point year-to-year. And we are maintaining our view of operating tax rate in the mid-teens range, consistent with last year.
On currency, given the strengthening of the dollar, we now expect a 100 basis point to 200 basis point impact to revenue growth for the year. For the third quarter, we see revenue growth consistent with the full year. For profit, we expect our net income skew through the third quarter to remain a couple points ahead of the prior year, driven by the strength of our business. And again, we expect the gain in the Palo Alto QRadar transaction will be offset by related structural actions to address stranded costs.
In closing, we are pleased with our performance this quarter and for the first half, driving confidence in our updated expectations. We are positioned to grow revenue, expand operating profit and grow free cash flow for the year.
Arvind and I are now happy to take your questions. Olympia, let's get started.
