James J. Kavanaugh
Senior Vice President and Chief Financial Officer at International Business Machines
Thanks, Arvind. I'll start with the financial highlights of the first quarter. We delivered $14.3 billion in revenue, $1.4 billion of operating pretax income, $1.36 of operating earnings per share and $1.3 billion of free cash flow. Our revenue for the quarter was up about 4.5% at constant currency. That includes over 1 point of impact from the businesses we divested. Currency rates impacted our reported revenue growth by 4 points. That is over $100 million more than spot rates would have suggested 90 days ago.
As always, I'll focus my comments on constant currency. Revenue growth this quarter was led by software and consulting. Software revenue was up nearly 6% and consulting up 8%. These are our growth vectors and now represent about threequarters of our annual revenue. Our infrastructure revenue was flat, with continued strength in z Systems. All three of our geographies grew, with high single-digit growth in both EMEA and Asia Pacific. Across our business, more than half of IBM's revenue is recurring, led by high-value software, which is growing at mid-single-digit rate.
Looking at our profit metrics for the quarter. Operating gross margin expanded 80 basis points. We expanded gross margin in all segments with a strong portfolio mix overall. Operating pretax income, excluding the impact of workforce rebalancing, was up 12%, and margin expanded 130 basis points.
You'll recall back in January, I mentioned we were planning to address remaining stranded costs from our portfolio actions and we anticipated a charge of about $300 million. As we executed our plan, we took a charge of $260 million in the first quarter, and we expect to complete this action in the second quarter. This workforce rebalancing charge primarily addresses indirect support function. We are no longer including workforce rebalancing charges in our measure of segment profit to provide a view of our segment results consistent with our ongoing operational profile.
At the IBM level, including the workforce rebalancing activity, operating pretax income was down 4%, and margin was down 50 basis points. Within our margin performance, we absorbed a significant currency headwind. The combination of translation and hedging impacted operating pretax profit growth by about $160 million and operating PTI margin by 70 basis points year-to-year. As I've discussed in the past, this essentially impacts our product-based businesses. Mitigating that, the change in useful lives of our server and networking equipment provides a 50-basis point year-to-year benefit to operating PTI margin, which is included primarily in our infrastructure segment.
Taking it back up a level, IBM's profit performance this quarter benefits from improvements in business mix and ongoing productivity initiatives. We've been digitally transforming IBM, much in the same way we're helping our clients with their transformation, using both IBM and third-party capabilities. Think of IBM as client zero. We are driving G&A efficiencies by reimagining and transforming the way we work. This includes optimizing our infrastructure and application environments as well as redesigning our end-to-end business processes.
Let me give you a few examples. Across IBM's IT environment, we're realizing the value of hybrid cloud. We reduced the average cost of running an application by 90% by moving from a legacy data center environment to a hybrid cloud environment running on Red Hat OpenShift. We've been simplifying our application environment. By standardizing global processes and applying AIOps, we are reducing our application portfolio by more than 35%. We've automated over 24 million transactions with RPA, avoiding hundreds of thousands of manual tasks and eliminating the risk of human error, and we're deploying AI at scale to reengineer our business processes. We're doing that in areas like HR and talent, finance and end-to-end processes like quote-to-cash and source-to-pay. For example, in HR, we now handle 94% of our company-wide HR inquiries with our AskHR digital system, speeding up the completion of many HR tasks by up to 75%. These productivity initiatives free up spending for reinvestment and contribute to margin expansion.
Turning to free cash flow. We generated $1.3 billion in the quarter. This is up $100 million year-to-year and puts us on track to our full year expectation. Growth is driven by our profit performance and working capital efficiencies as well as lower payments for structural action. This was mitigated by an increase in capital expenditures and higher performance-based compensation payments, given last year's strong results. In terms of cash uses, we returned $1.5 billion to shareholders in the form of dividends.
From a balance sheet perspective, we have a very strong liquidity position with cash over $17 billion, which is up nearly $9 billion from December. We have been opportunistic in accessing the debt market and issued debt early in the year to prudently get ahead of 2023 and 2024 maturities. Our debt balance at the end of the first quarter was over $58 billion, up nearly $8 billion from year-end.
Turning to the segments. Software revenue grew nearly 6%, in line with software's mid-single-digit model. We had growth in both hybrid platform and solutions and transaction processing. This performance captures the benefits of our growing recurring revenue stream, which is about 80% of annual software revenue with continued strong renewal rates. This, together with growth in software transactions this quarter, demonstrates clients' commitment to our hybrid cloud and AI platforms.
In hybrid platform and solutions, revenue was up 5%, fueled by growth across all business areas. We continue to see client demand for broad capabilities across Red Hat, automation, data in AI and security. Red Hat revenue grew 11%, with growth across all major offerings. We have particular strength in our hybrid cloud platform, OpenShift, and Ansible, our IT automation solution. Both offerings also continue to take market share this quarter. Automation revenue was up 2%, driven by integration and application servers, given client demand for improved IT performance and costs. In data and AI, revenue grew 3%, reflecting growth across data management, business analytics and asset and supply chain management. Many of these offerings, like Db2, serve as the underpinnings for modern AI and mission-critical workloads.
Security revenue was up 2%, with growth across security for hybrid cloud, which includes both identity and threat management and security for data. Bringing this all together, our hybrid platform and solutions' ARR is now at $13.5 billion. In transaction processing, revenue grew 6.5%. The software remains core to our clients' hybrid cloud strategies.
The strong performance of the last couple z Systems' cycles drove significant capacity growth. In fact, installed MIPS growth during our z15 cycle was 2 times that of z14. This translates to software opportunity and contributed to growth in both recurring and transactional revenue. Layering in this year's price increases, we delivered good performance in Transaction Processing this quarter.
Moving to profit for the software segment. Gross margin was up and pretax margin was flat this quarter, with the latter absorbing nearly 1 point of impact from currency. Consulting revenue was up 8%, and I'll remind you, we had a strong growth in the first quarter of last year. Our book-to-bill ratio over the last 12 months was 1.07. Signings in the quarter grew 7%, with similar performance across both larger and smaller engagements. We continue to see broad demand for projects that deliver technology-driven transformation, leveraging a hybrid cloud environment. Within the quarter, demand was solid for cloud modernization offerings, and we had one of our largest Red Hat signings quarters ever.
More recently, clients are particularly focused on driving productivity and cost reductions with greater agility and faster time to value. This is contributing to signings growth from digital transformations in areas such as talent, finance and supply chain transformation. In terms of revenue, while we had solid growth overall, we have seen some clients in the U.S. pull back on more discretionary projects, impacting backlog realization within the quarter.
Bringing it back up to the global level, business transformation grew 6%, technology consulting grew 4% and application operations grew 13%. Revenue growth was led by data and customer experience transformation project, in addition to cloud application development and management.
Our hybrid cloud expertise and depth and breadth of strategic partnerships differentiate IBM Consulting in today's market. Red Hat consulting revenue, now over $2 billion annually, continue to grow at a double-digit rate. And our strategic partnerships continued strong growth, making up over 35% of our revenue in this segment over the last 12 months.
Moving to consulting profit, we expanded both gross and pretax margins. Our pretax margin of about 8% in the quarter was up 50 basis points year-to-year as we continue to benefit from the productivity actions we've taken.
Turning to the Infrastructure segment. Revenue was flat. Hybrid infrastructure revenue was up 4% and infrastructure support revenue was down 4%. Within hybrid infrastructure, z Systems revenue was up 11%. This was a fourth quarter of z16 availability, and the solid program performance has outpaced that of prior cycles.
In addition to capabilities around embedded AI at scale, cloud-native development for hybrid cloud and cyber resilience security, clients are also leveraging z16 for its energy efficiency. For example, consolidating Linux workloads on a single z16 system can reduce energy consumption by up to 75%. We continue to see strong growth in shipped MIPS for new Linux workloads on z16. Distributed infrastructure revenue was flat. Growth in storage was offset by declines in power as we have wrapped on the launch of the Power10 high-end systems.
Moving to infrastructure profit. We expanded both gross and pretax margins. The 80-basis point improvement in pretax margin reflects benefits from both the z Systems' product cycle and changes in useful life, partially offset by nearly 2 points of currency impact.
Now let me bring it back up to the IBM level to wrap it up. When we first introduced today's IBM back in October of 2021, we provided a midterm model for revenue growth, margin expansion and free cash flow growth. We delivered on that model throughout last year and now have a good start to 2023. In the first quarter, we delivered constant currency revenue growth in line with our mid-single-digit model, expanded gross margin, drove productivity in our underlying business and grew our free cash flow.
Looking at full year 2023, as always, I'll start with our two primary metrics: revenue growth and free cash flow. On the top line, we expect constant currency revenue growth of 3% to 5%. And we continue to expect free cash flow of about $10.5 billion, which is up over $1 billion year-to-year. Inherent in our midterm model is margin expansion, driven by improving business mix, efficiency initiatives and productivity enhancement. Driving efficiency and productivity has always been a part of our operating and financial models.
I mentioned some of the initiatives we have underway and we continue to evaluate additional actions. Altogether, the current initiatives are expected to deliver $2 billion in annual run rate savings by the end of 2024. These initiatives provide additional flexibility, enabling reinvestment in the business to support future growth, contributing to margin expansion and increasing financial flexibility.
Let me spend a minute on our expectations for constant currency revenue and pretax profit performance by segment. In software, we continue to expect revenue growth in line with software's mid-single-digit model. This revenue growth drives operating leverage, and we still expect software pretax margin to expand by about 2 points year-to-year. In consulting, we continue to see strong demand for digital transformations and application modernization. So as I said, we are seeing some pressure on more discretionary projects in the United States.
We now see consulting revenue growth in the range of 6% to 8% and continue to expect to expand consulting pretax margin by at least 1 point as we capitalize on the yield of our productivity actions. Infrastructure revenue is roughly flat over the midterm model horizon, with performance in any year reflecting product cycle dynamics. We're about to wrap on the z16 introduction. As a result, we expect 2023 infrastructure revenue to decline, with pretax margin in the low teens.
To provide some perspective, Infrastructure should impact IBM's overall revenue growth by over 1 point. With these segment dynamics, we would expect IBM's operating pretax margin to expand by about 0.5 point year-to-year. That's in line with our model. And we continue to expect our tax rate to be in the mid- to high teens range.
As I mentioned earlier, the dollar has strengthened over the last 90 days. We now expect currency translation to be fairly neutral to our revenue growth for the year, which is about 0.5 point worse than 90 days ago. I'll remind you that our profit and cash dynamics this year are impacted by the unwinding of last year's hedging gain, which is about 1 point of headwind to our pretax margin expansion.
Looking at the second quarter, we expect first to second quarter revenue seasonality to be fairly consistent with last year. That's up about $1.3 billion, though the underlying dynamics are different due primarily to z Systems' product cycle and currency. I'll remind you, we had a successful launch of our z16 in the second quarter of last year, and that creates a year-to-year headwind to growth of about 3 points.
In terms of profit, we now expect a little over one third of our operating net income in the first half and just under two thirds in the second half. This reflects a first half headwind from currency and workforce rebalancing dynamics, both of which flip to a tailwind in the second half. I mentioned the workforce rebalancing activity we have underway. Between the first and second quarter, the charge should be in the range of $300 million, maybe a little more. We still expect this action to pay back by the end of the year.
In closing, we entered the year as a more focused business with solid fundamentals. We had a good start to 2023 and are positioned to deliver revenue growth, expand margins 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.
