James J. Kavanaugh
Senior Vice President and Chief Financial Officer at International Business Machines
Thanks, Arvind. I'll start with the financial highlights. In the third quarter, we delivered $14.1 billion in revenue. $2 billion of operating pre-tax income and a margin of nearly 14% and operating earnings per share of $1.81. Through the first three quarters of the year, we generated over $4 billion of free cash flow. Our revenue was up 15% which includes about 5 points of contribution from sales to Kyndryl. While we'll discuss our results today at constant currency, I'll mention that with the continuing strengthening of the US dollar, currency translation impacted our reported revenue growth by more than 8 points or nearly $1.1 billion. As Arvind said, our revenue growth this quarter was pervasive. Software revenue was up 14% and Consulting up 16%. These are our growth factors and represent over 70% of our revenue. Infrastructure was up 23%, reflecting solid product cycle dynamics. Software and infrastructure include about 8 and 9 points of growth respectively. From the commercial relationship with Kyndryl, more than half of our revenue is recurring and this annuity content which is driven by software continues to grow. Performance was also broad-based by geography. Americas, EMEA and Asia-Pacific revenue were all up double-digits and we gained share overall. These revenue results reflect the execution of more focused hybrid cloud and AI strategy, based on a platform centric approach and leveraging a broad ecosystem of partners. Our full stack capabilities across software, consulting and infrastructure delivered 20% growth in hybrid cloud revenue over the last year to over $22 billion.
Looking at our profit metrics. Operating pre-tax income was up and margin expanded by 180 basis points year-to-year. These profit dynamics reflect our portfolio shift toward higher value led by software. This mix shift is contributing to profit and margin. Our pre-tax profit also includes the contribution from incremental sales to Kyndryl. Like our clients, we are focused on digitally transforming our own operations, applying AI and automation to drive productivity and efficiency in the spend base. This provides flexibility to continue to invest in talent, innovation and our ecosystem in an inflationary environment.
90 days ago, we spent some time talking about currency dynamics. I'll remind you of a few of the key points. A stronger dollar impacts our revenue and gross profit dollars. We execute a hedging program which defers versus eliminates the impact of currency. The gains from these hedging programs are reflected primarily in other income and expense, but with the rate and magnitude of the movements and because we don't hedge all currencies, we do have a currency impact to our overall profit and cash flow.
Wrapping up the discussion on profit dynamics. The currency impacts and a good amount of investments are in gross profit, while the mitigating hedging benefits and operational productivity are reflected primarily in expense. As a result, pre-tax income is a better indicator of our profit performance. Our operating tax rate was about 16%. Compared to last year tax is a significant year-to-year headwind to operating net income and operating EPS growth, which were both down modestly year-to-year.
Turning to free cash flow. We generated $4.1 billion in the first three quarters, that's up over $900 million year-to-year. We're wrapping on payments related to the Kyndryl separation and the 2020 structural actions in driving working capital efficiencies. In terms of uses of cash in the first three quarters, we invested over $1 billion in acquisition, which was more than offset by proceeds from divested businesses. And we returned nearly $4.5 billion to shareholders in the form of dividends. From a balance sheet perspective, we issued debt in July to prudently get ahead of our 2023 maturity. Our debt balance is up since June, but down nearly $1 billion since December. We ended the quarter in a strong liquidity position with cash of $9.7 billion. This is up over $2 billion from year end and well in excess of the minimum cash required for our business.
Turning to the segments. Software revenue grew 14%. This includes about 8 points of Kyndryl contribution. Both of our revenue categories, Hybrid Platform & Solutions and transaction processing through this quarter. This performance reflects our strong and growing recurring revenue base, which is about 80% of our annual software revenue. And Softwares hybrid cloud revenue is now $9.2 billion over the last year, up 20%. In Hybrid Platform & Solutions revenue was up 8%, including about 1.5 point contribution from the Kyndryl commercial relationship. The growth was broad-based. Red Hat revenue all-in grew 18%. As a leader in open-source technologies for the enterprise, Red Hat's performance was again fueled by market share gains across RHEL, OpenShift and Ansible this quarter. With our enterprise incumbency and global scale, we continue to see an increase in large deals as well as strong cross-sell and up-sell across Red Hat solutions. Automation revenue grew 3%. This quarter's performance reflects continued adoption in areas like AIOps and management and Integration, while we're also wrapping a strong acquisition content from last year. We're bringing innovation to our clients this quarter, such as new Instana observability capabilities for Z systems in a hybrid cloud environment. In data and AI revenue was up 4%.
Let me highlight just a few of the growth areas this quarter. Data Management fuels advanced analytics. Data Fabric helps clients discover and unlock the value of their data wherever it resides. And Information Exchange enables the timely and secure flow of complex B2B information. And offerings like Envizi, an environmental intelligence suite are resonating with clients as they prioritize sustainability efforts. Security revenue was up 6%, with growth in both data security and threat management. In data security, we're seeing adoption of guardian insights as we continue to deliver new product innovation. Threat management growth was led by Cloud Pak for security, which helps clients prevent and respond to modern threats across disparate security leads.
Across Hybrid Platform & Solutions the annual recurring revenue or ARR is now $13 billion and up 9%. Transaction processing revenue was up 33%, including about 26 points of Kyndryl contribution. The increase in Z systems installed capacity over the last couple of cycles and continued strong renewal rates are recognition of the importance of this platform in a hybrid cloud environment. As a result, the transaction processing annuity base is now growing.
Looking at software profit. We delivered operating leverage given the solid revenue growth and new Kyndryl commercial relationship. Our pre-tax margin was up more than 4 points over last year. Consulting revenue grew 16%. This is the fifth consecutive quarter of double-digit growth. This strong performance was again broad-based, with revenue growing at double-digit rates across all business lines and geographies. Over the last year, our book-to-bill ratio is $1.05. Clients trust IBM's deep industry expertise and co-creation approach throughout our hybrid cloud and digital transformation journeys. As IBM Consulting designs and enables enterprise hybrid cloud strategies, this business delivered $8.9 billion in hybrid cloud revenue over the last year, that's up 28%. Our Red Hat consulting practice continues to be a meaningful contributor to revenue growth, growing strong double-digits as we add new engagements. Since IBM acquired Red Hat just over three years ago, consulting has led nearly 1,400 Red Hat engagements with over $6.5 billion in aggregate bookings. Strategic partnerships also contributed to performance, continuing to grow revenue at a double-digit rate.
Turning to our lines of business. Business transformation revenue grew 14% as clients look to IBM to help them transform critical workflows at scale. Growth in business transformation was pervasive, driven by supply chain, finance, data and client experience transformations. Working with our partners like SAP, Salesforce and Adobe, we help our clients optimize their operations and improve the way they engage with their customers. In Technology Consulting, where we architect and implement clients' cloud platforms and strategies, revenue was up 17%. Once again growth was led by cloud application development and cloud modernization, including our Red Hat practice which as I mentioned was strong double-digits. Application Operations revenue grew 17%. IBM helps clients optimize their operations and reduce cost by taking over the management of clients applications in hybrid and multi-cloud environments. We leverage AI to help predict problems before they happen and monitor our clients different environments with dashboards, enabling action to be taken quickly.
Moving to Consulting profit. Our pre-tax margin of about 10% is down year-to-year. So, up nearly 3 points from the second quarter. As we discussed in prior quarters, Consulting is most impacted by the labor cost inflation. Those dynamics continue to put pressure on the margin profile. However, coming out of the third quarter, we are seeing signs of progress. Our utilization rates are improving as we exited the quarter. Our acquisitions are scaling and are on a path to margin accretion. And, we've seen two quarters of price margin improvement year-over-year, that will benefit our margin profile going forward.
Moving to our Infrastructure segment. Revenue grew 23%. This includes about 9 points from the incremental Kyndryl content. Hybrid Infrastructure revenue grew 41% and Infrastructure Support revenue grew 5%, including about 11 and 7 points of Kyndryl benefit respectively. Looking at Hybrid Infrastructure, Z systems revenue nearly doubled, driven by continued adoption of our newest program z16. This latest program combines embedded AI at-scale, cloud-native development for hybrid cloud and cyber resilience security. In fact, z16 is the industry's first Quantum Safe system, delivering 25 billion encrypted transactions per day for clients. And as Arvind mentioned, we just introduced our newest LinuxOne Server. A highly scalable Linux and Kubernetes based platform with capabilities to reduce clients energy consumption. Z systems remains an enduring platform, playing an important role in a hybrid cloud environment. Distributed Infrastructure revenue was up 21%. Recent innovation across the portfolio enabled broad-based growth within both storage and power. These include the expansion of our Power 10 Server family earlier this quarter and refreshes that a flash storage solutions throughout this year. Looking at Infrastructure profit. Pre-tax margin was up 1 point year-to-year, reflecting mixed benefits from the growth in Z systems.
Now let me take it back up to the IBM level and I'll shift the focus to the full-year and the fourth quarter. Over the last year, we've continued to invest and make portfolio changes to advance our Hybrid Cloud and AI strategy, streamline our go-to-market and digitally transform our own operations. Our more focused strategy and portfolio is aligned to client needs. Our revenue performance so far this year demonstrates that. And based on this revenue performance in the first three quarters, as Arvind said, we now see constant currency revenue growth above our mid-single-digit model for the year. On top of that, Kyndryl sales add about 3.5 points of growth, primarily in the first three quarters of the year, so it's essentially behind us. US dollar continues to strengthen. And at mid October spot rates, currency translation will now be about a 7 point headwind to growth for the year. As I mentioned earlier, this impacts profit and free cash flow as well.
Looking at free cash flow, our other key metric, we continue to expect to generate about $10 billion for the year. That's up over $3 billion from last year. A large part of that growth comes from the wrap on the Kyndryl spin related and structural payments. But we're also driving working capital efficiency and improving operating profit profile. We expect strong free cash flow performance in the fourth quarter, while we continue to face some external headwinds, including appreciation of the US dollar and exit of our Russia operations. Terms of segment performance for 2022. Our view is software has been consistent all year. We continue to expect revenue growth in-line with our mid-single-digit model range, plus 5 to 6 points from sales to Kyndryl. And we still see software pre-tax margin in the mid 20s range for 2022. Our IBM Consulting revenue growth has been great. And we're taking our view up to a mid-teens revenue growth rate for the year, while we're still operating in a competitive labor environment, we see some encouraging signs in our consulting margin profile exiting the third quarter. We now expect a consulting pre-tax margin for the year at the low end of our previous 9% to 10% range, which is up about 1 point year-to-year. Our Infrastructure revenue performance as always reflects product cycle dynamics. With a strong launch of our z16 earlier this year, Infrastructure revenue performance would be above the model level for the year and that's before the 5 to 6 points from sales to Kyndryl. We expect Infrastructure pre-tax margin in the mid-teens.
Looking specifically at the fourth quarter, we expect all-in constant-currency revenue growth at the high end of the mid-single-digit range. At current spot rates, currency translation has increased to an 8 to 9 point headwind to revenue growth in the fourth quarter, that's up 2 to 3 points from 90 days ago. And, then I'll remind you, in a couple of weeks, we've reached the anniversary of our separation of Kyndryl. While the external sales to Kyndryl will remain in our revenue and profit base, we've essentially wrapped around the year-to-year contribution for our revenue and profit growth and margin expansion.
As we enter the fourth quarter, we look forward to closing out our first calendar year of today's IBM. As always we'll provide a view of 2023 during our fourth quarter earnings report in January. Patricia now, let's go on to the Q&A.
