IBM (NYSE: IBM) raised its full-year constant currency revenue growth guidance to 4%-5% after a second quarter that missed consensus estimates. Revenue of $17.2 billion grew just 1% year-over-year, short of the $17.86 billion estimate. Non-GAAP diluted EPS of $2.93 came in $0.08 below the $3.01 consensus. The guidance raise tells the real story. Management is signaling confidence in an accelerating growth trajectory, even as the quarter ended with late-period headwinds.
Software was the standout segment. Revenue reached $7.8 billion, a 5% year-over-year increase. Red Hat led with 11% growth, and the Data portfolio surged 19%. Automation added 4%. These gains were partly offset by an 8% decline in Transaction Processing, a legacy mainframe business that continues to shrink. Consulting revenue was flat at $5.3 billion, up just 1% in constant currency, with all three sub-segments essentially treading water. Infrastructure was the drag, falling 7% to $3.8 billion. The culprit: IBM Z, down 42% year-over-year. This product cycle trough was widely expected but still painful. Distributed Infrastructure (Power and Storage) grew 37%, building a nearly $500 million order backlog.
The gross margin picture is mixed. GAAP gross margin contracted 110 basis points to 57.7%. Operating (non-GAAP) gross margin fell 70 basis points to 59.4%. The compression reflects a mix shift toward lower-margin consulting and away from high-margin software, plus acquisition-related amortization from the HashiCorp and Confluent deals. Those acquisitions added $10.5 billion to the balance sheet this year, pushing goodwill to $74.6 billion from $67.7 billion at year-end. The company's $10 billion quantum commitment over five years adds another layer of long-term investment.
Free cash flow in the quarter was $2.5 billion, down $0.3 billion year-over-year. Management, however, reiterated its full-year expectation of an approximately $1 billion increase. For the first six months, free cash flow was $4.8 billion, flat year-over-year. The company returned $1.6 billion to shareholders in dividends. Debt rose to $62 billion, up $0.7 billion year-to-date, while cash and marketable securities fell to $8.2 billion from $13.6 billion at year-end, largely due to acquisition spending.
Raising guidance to 4%-5% constant currency revenue growth is notable. It comes despite a quarter that missed on both revenue and earnings. Management is signaling that a second-half pipeline, driven by enterprise AI adoption and the hybrid cloud portfolio, will more than compensate for the IBM Z cycle headwind. The reiterated free cash flow target suggests confidence in productivity initiatives, including AI-driven software development and supply chain optimization. But the margin compression and the reliance on acquisitions for growth raise questions about organic earnings quality. With the stock trading at a premium to historical multiples, the burden is on IBM to deliver the accelerated growth that the guidance implies.