James J. Kavanaugh
Senior Vice President and Chief Financial Officer at International Business Machines
Thanks, Arvind. I'll get right into the financial highlights. In the second quarter, we delivered $15.5 billion in revenue, $2.5 billion of operating pretax income, which is a margin of 16.2%, and operating earnings per share of $2.31. In the first half of the year, we generated $3.3 billion of free cash flow. Our revenue was up 16%. This includes nearly 5 points of incremental revenue from Kyndryl.
As always, we discuss revenue growth at constant currency. But given the focus on the sharply strengthening dollar, I'll mention that currency translation impacted our reported revenue by over 6 points of growth, or $900 million. That's over $200 million more than the spot rates would have suggested 90 days ago.
Today's IBM has a higher growth profile driven by our growth vectors of software and consulting. More than half of our annual revenue is recurring with about two-thirds of that in high-value software. Software revenue this past quarter was up 12% and Consulting up 18%. Infrastructure performance, which reflects a good start to our z16 product cycle, was up 25%. Software and Infrastructure each include about 7 points of growth from the commercial relationship with Kyndryl. These results reflect the investments we've been making in innovation, our ecosystem, and talent, all aligned to our strategic areas of hybrid cloud and AI.
We integrate consulting and technology to deliver these hybrid cloud and AI solutions. Our platform approach not only benefits our clients but also provides an attractive economic model for IBM and our partners, with a multiple of Software and Consulting revenue generated for every dollar of platform revenue. Our hybrid cloud revenue from our full stack capabilities across Software, Consulting, and Infrastructure, was up 19% over the last year. It has grown to $21.7 billion, or 36% of our total revenue.
Looking at our P&L metrics, operating gross profit dollars were up, driven by strong revenue performance in our high-value businesses. Our year-to-year gross margin decline reflects escalating labor and component costs. We're addressing this through pricing, though it takes some time to show up in our margin profile, especially in Consulting. Our operating pretax income was up, and we expanded margin by 420 basis points. We had an operating tax rate of about 16.5%, which is up about 2 points versus last year and our operating net income margin expanded 330 basis points.
Let me comment on a few dynamics within our profit performance. Our pretax profit reflects the benefit from actions we've taken to streamline our operations and simplify our go-to-market model, as well as profit contribution from incremental sales for the new commercial relationship post separation.
Our profit this quarter also reflects recent portfolio actions. At the end of June, we closed on the divestiture of our healthcare software assets, generating a pretax gain of about $230 million in the period. Mitigating that benefit to our overall profit results, we took charges to address stranded costs associated with the divestiture and absorbed operating losses related to the health business, together over $75 million. We also announced the orderly winddown of our Russian operations, resulting in incremental charges in the quarter. Together with the year-to-year lost business due to the winddown, Russia impacted our profit results by another roughly $100 million.
I also want to comment on the impact of currency. I mentioned that over the last 90 days, we dealt with a sharply strengthening dollar. We execute hedge programs that cover the majority, but not all, of the currency exposure. The combination of the rate and velocity of movement this quarter and the fact that we don't hedge 100% results in a currency impact to our profit and cash flow.
Turning the free cash flow, we generated over $2 billion in the quarter and $3.3 billion for the first half, with good working capital performance. This first half free cash flow is about 33% of our full year expected range, consistent with the average over the last few years. I'll remind you the $1 billion-plus of proceeds from the health divestiture is reflected in cash from investing activities versus in our free cash flow.
Turning to the segments. Software revenue grew 12%. This includes about 7 points from the Kyndryl software content. Growth was driven by our hybrid cloud and AI capabilities. Hybrid cloud revenue for the segment now represents $9 billion over the last year, up 23%. Software subscription and support renewal rates were up again this quarter. This contributes to our solid and growing recurring revenue base, which represents about 80% of software. From a revenue category perspective, our software growth vector of hybrid platform and solutions grew 9%. This includes about a 0.5 point benefit from the Kyndryl commercial relationship. We again drove pervasive growth across Red Hat, Automation, Data & AI, and Security.
Red Hat revenue, all in, grew 17%. Revenue growth was fueled by new adoption and expansion of RHEL and OpenShift as both solutions continue to take share. These key offerings address hybrid cloud requirements in industries like financial services, public sector, and telecommunications across environments and out to the edge. Automation revenue was up 8%. Solid performance in both AIOps and management and integration demonstrates the importance of automation in the IT journeys of our clients.
We had strength in offerings like Turbonomic and Instana for observability, Cloud Pak for Watson AIOps and our modern integration platform, Cloud Pak for Integration. Data & AI revenue grew 4%. This growth was led by demand for data fabric, data management, and asset and supply chain management solutions. We also just expanded our data fabric portfolio with the acquisition of Databand.ai, which helps organizations with data observability.
Security revenue was up 5% with growth in threat management and identity, as enterprises continue to adopt a zero-trust security strategy and implement additional identity controls. We're continuing to invest in our security capabilities, having completed two acquisitions in the threat management space over the last few quarters. Across the four hybrid platform and solution business areas, our annual recurring revenue, or ARR, is nearly $12.9 billion, up 8%.
Turning to our software value vector, transaction processing, revenue grew 19%, including 22 points from the Kyndryl content. We continue to have strong renewal rates for this mission-critical software and performed in line with our expectations this quarter. Looking at software profit, we delivered operating leverage given the solid revenue growth and new Kyndryl commercial relationship. Our pretax margin was up 4 points and keeps us on track for a full-year software margin in the mid-20s.
Moving on to Consulting, we again saw pervasive growth with double-digit revenue growth across all business lines and geographies. Revenue was up 18% compared to 8% growth a year ago. We maintain a solid book-to-bill ratio of 1.1 on a trailing 12-month basis, as clients are choosing to co-create with IBM, trusting our deep industry expertise.
The expansion of our skills, capabilities, and ecosystems are enabling us to capture demand as we drive adoption of our hybrid cloud platform and help clients with their digital transformations. Consulting's hybrid cloud revenue grew 32% over the last year to $8.6 billion. Momentum behind our Red Hat practice remains strong. We nearly doubled our Red Hat consulting revenue in the quarter and continued solid Red Hat bookings, which now exceeds $6 billion inception to date. Our strategic partnerships also contributed to our performance in the quarter. Revenue from these partnerships continue to grow. Solid double digits led by Azure, AWS, SAP, and Salesforce.
Turning to our lines of business transformation grew 16%, as clients look to IBM to help them transform critical workflows at scale. Growth in business transformation was pervasive and led by our offerings focused on customer experience transformation, data transformation, and our SAP practices. In technology consulting, where we architect and implement clients' cloud platforms and strategies, revenue was up 23%. Cloud modernization and cloud application development led a significant portion of the growth, with on-prem modernization also contributing to the strong revenue performance in the quarter. Application operations revenue grew 17%. Growth was solid across our cloud offerings, mitigated by declines in the on-prem space. In this business, we are optimizing the management of applications and providing cloud platform services required to run our clients' hybrid cloud environments.
Moving to Consulting profit. Our pretax margin expanded 1 point as we deliver operating leverage and benefit from IBM's more streamlined G&A and go-to-market structure. Our Consulting margins reflect the significant investments we have been making to capture demand and fuel our revenue growth. We continue to invest in our partner ecosystem, scale acquisitions, and add skills. Consulting, which makes up well over half of IBM's workforce, is most impacted by the inflationary labor market and increasing labor costs as we bring in increased capacity. We are starting to capture the reality of these higher costs in our pricing. But given the time from contract signing to revenue realization, it's taking some time to see it in our margins.
Turning to the Infrastructure segment. Revenue was up 25%, including about 7 points from the incremental Kyndryl content. Hybrid infrastructure revenue grew 41% and infrastructure support revenue grew 5%, including about 7 and 9 points of Kyndryl benefit, respectively. Within hybrid infrastructure z Systems revenue was up 77%. This reflects solid execution around our z16 program, building on the momentum from z15. Is Arvind mentioned, z16 brings the power of embedded AI at scale, cyber-resilient security, and cloud-native development for hybrid cloud to our clients. We are seeing growth in new workloads like Linux and demand for AI capabilities like real-time fraud detection leveraging the on-chip AI accelerator. Clients are investing into these systems platform as an essential part of their hybrid cloud infrastructure.
Distributed infrastructure revenue grew 17% this quarter. This growth was led by storage, driven by both high-end storage tied to the z16 cycle and distributed storage. We also had good performance and high-end Power 10. Just last week we announced the expansion of our Power 10 server family, as we deliver flexible and secure infrastructure for hybrid cloud environments.
Looking at Infrastructure profit, pretax margin was up 4 points year to year, reflecting mix benefits from the growth in z Systems, mitigated by the impact of increased component costs and supplier premiums.
Now let me take it back up to the IBM level. We've taken actions and made investments over the last couple of years to execute a platform-centric hybrid cloud and AI strategy. IBM is now a more focused, faster-growing, and higher-value company. And while there is always more work to do, we are confident in our ability to deliver sustainable growth. Our first half results were solid. We continue to see constant currency revenue growth at the high end of the mid-single digit model for the full year. And on top of that, we expect about 3.5 points of growth from the Kyndryl sales, spread over the first three quarters.
I mentioned the impact of currency to our 2Q results. With the significant movement of the U.S. dollar as compared to nearly every currency, at mid-July spot rates, currency translation will now be about a 6 point headwind to revenue growth for the year. That's a degradation of about $1.5 billion from April's rates, with most of that incremental impact still ahead of us in the second half.
Currency is one unique issue we're dealing with. The other is the impact of exiting our Russia operation. Together, these are putting some pressure on our near-term results, and we now expect free cash flow of about $10 billion for the year. These are exogenous issues. Importantly, we feel good about the underlying fundamentals of our business. You see this in our segment expectations.
Halfway through the year, there's no change to our full year view of Software. We continue to expect constant currency revenue growth in line with our mid-single digit model range plus 5 to 6 points from sales to Kyndryl. We also remain on track to a Software pretax margin in the mid-20s range for 2022. Our IBM Consulting revenue growth has been strong, and we continue to expect low-double-digit revenue growth rate for the year, which is above our model.
With continued investment in skills and a competitive labor environment, we now expect a Consulting pretax margin of 9% to 10%, which is up over 1 point year to year. This reflects improving margin performance in the second half, as we increase utilization of the resources we've added and price realization starts to flow to revenue.
Our Infrastructure revenue in any period reflects product cycle dynamics. We had a very strong launch of our z16 platform in the second quarter. This will drive Infrastructure revenue performance above the model level for the year. On top of that, we're planning for about 5 to 6 points of revenue growth from the sales to Kyndryl in 2022. Despite some of the pressures from component cost increases and supplier premiums, we continue to see mid-to-high teens pretax margin for infrastructure for the full year.
These segment revenue and margin dynamics yield about a 3.5-point year-to-year improvement in IBM's pretax margin for the full year. And we continue to expect a mid-to-high teens operating tax rate, which is a headwind to our profit growth. You'll recall that back in January we expected a 40/60 first half/second half profit skew. Now, after our solid start to the year, our view hasn't changed, and we still see 60% of the full year profit in the second half. Looking at the third quarter, we expect all-in constant currency revenue growth in the high-single-digit range, and about a 2-point year-to-year improvement in operating pretax margin.
I want to mention two specific items on the third quarter. First, at current spot rates, currency translation has increased to about an 8-point headwind to revenue growth, impacting our reported revenue, profit, and cash. Second, we haven't had a z Systems product introduction in our large transactional second quarter in about 20 years. This unique timing, coupled with a strong start to the cycle, will result in a larger second to third quarter impact than typical seasonality. So, to be clear, we expect a strong year-to-year growth in z Systems.
In closing, these are interesting times, and we see technology as a way to help our enterprise clients capture today's opportunities and navigate challenges. We feel good about the strategy we are executing and the fundamentals of our business.
Patricia, now let's go on to the Q&A.