Kyndryl Holdings, Inc.

Good morning, everyone, and welcome to Kindle's earnings call for the second fiscal quarter ended September 30th, 2023. Before we begin, I'd like to remind you that our remarks today will include forward-looking statements. These statements are subject to the risk factors that may cause our actual results to differ materially from those expressed or implied. These forward-looking statements speak only to our expectations as of today, and we are under no obligation to update them. For more details on some of these risks, please see the risk factors section of our annual report on Form 10-K for the year ended March 31, 2023. In today's remarks, we'll also refer to certain non-GAAP financial measures. Corresponding GAAP measures and a reconciliation of non-GAAP measures to GAAP measures for historical periods are provided in the presentation materials for today's events which are available on our website at investors.kindrel.com. With me here today are Kindrel's Chairman and Chief Executive Officer, Martin Schroeder, and Kindrel's Chief Financial Officer, David Weichner. Following our prepared remarks, we will hold a Q&A session. I'd now like to turn the call over to Martin. Martin?

Thank you, Lori, and thanks to each of you for joining us. Last week, we marked our second anniversary as an independent company, and we are delivering progress at an accelerated pace. Today, I want to talk about why we've been able to succeed. Of course, our first-half performance reflects continued progress and strong execution, positioning us really well for the year as a whole, and we're raising our full-year earnings outlook. Our 3As initiatives, centered on alliances and advanced delivery and accounts, are paving the way for profitable growth. Kindrel Consult, Kindrel Bridge, and our efficiency efforts are also driving our results. And as an organization, we're delivering strong performance that is evident both in our financial metrics and in our customer satisfaction scores. On today's call, David will review our recent financial results, our raised fiscal 2024 outlook, and how we're changing Kindrel's profile for the better. However, let's not lose sight of why this performance is happening. We are vital to our customers' current and future technology needs. Our capabilities align with the powerful secular trends in IT, and this makes us an indispensable partner for our customers. In other words, our progress is being fueled by the leadership position we have in our industry, our new freedom of action we have as an independent company, and how that perfectly aligns with the larger forces shaping the evolution of IT. We're helping customers navigate these secular trends and we're already capturing the growth opportunities they present. And because we're at the heart of these trends of enabling our customers' IT futures as well as their current operations, performing mission-critical work across a broader technology ecosystem, our business is sustainable and important over the long term. That's why we're seeing growth in alliances, whether hyperscaler partners, in adoption of Kindrel Bridge, in consult signings and revenue, in customer satisfaction, in public cloud management, and in areas like apps, data, and AI. So yes, we're fixing focus accounts so that our margins are better, but Kindrel's transformation is about so much more than that. It's about Kindrel being the leader in providing and enabling our customers to have and leverage the technology they need to win. The results we're presenting today just as they did last quarter and last year, are evidence of our strength, market leadership, and ability to fix the challenges we inherited. The margins on the signings we're putting into our backlog, the execution of our 3A initiatives, our success with our new partners, and our ability to enable our customers to harness secular IT trends are reminders that we were always more than just a turnaround and that we've always been a market leader, a leader that is well-positioned to capture future growth. To appreciate our growth opportunities, it's important to understand how we're building on our heritage and leveraging our expertise to meet customer needs and forge new, higher-value revenue streams. Our 30-plus-year heritage in managing mission-critical IT systems is a very powerful asset. And we're seeing hybrid IT estates supplant migrate everything to cloud as a central theme among large enterprise CIOs. Our recent survey of hundreds of IT and business leaders indicated that while they aim to run nearly 40% of their workloads on a cloud or distributed platform, the overwhelming majority also view mainframes as essential to their business operations and likely to remain at the core of their tech stack. With that in mind, our new alliances with hyperscalers combined with our expansive knowledge of legacy technologies give Kindrel a unique ability to help organizations achieve their IT and business objectives. With Kindrel Consult, our technology experts advise our customers and co-create with our partners to modernize and optimize hybrid solutions and accelerate business outcomes. With a hybrid infrastructure, businesses can strategically choose where and how to host specific workloads based on their requirements. We're working with customers everywhere to ensure that the right workload runs on the right platform. This leads to improved performance and cost savings. And we've been consistently generating double digit revenue growth in Kindle Consult by delivering thought leadership and mainframe modernization and strong capabilities in automation, cloud migration and management, data optimization, and security and resiliency. Additionally, Kindrel Bridge integrates AI, operational data, and Kindrel's expertise to give customers visibility across their technology estates, including multi-cloud and hybrid landscapes with insights that help them understand, predict, and act for better business outcomes. We have more tech stack operating data than anyone in the world, and through our ability to leverage AI, we are providing our customers and ourselves an advantage in managing and developing their systems. Kindrel Bridge uses automation to enable more secure, stable, and reliable technology operations for our customers. With the benefit of AI machine learning, Kindrel Bridge is identifying patterns and systems and infrastructure and is now performing 1 billion automations a year for our customers across secure tech stacks. And one of the benefits that we're seeing from Bridge and its ability to operate as a self-healing architecture is that the frequency of significant incidents is down more than 30% so far this year in those accounts who've moved on to Bridge. So through our heritage, Kindrel Consult and Kindrel Bridge, we're meeting customers where they are in their digital evolution and helping them move forward. Our capabilities and innovation are putting us at the center of collaborative customer relationships in which technology drives business outcomes in a reliable and secure way. This is allowing us to access incremental market opportunities to grow our share of wallet with existing customers and to win new customers and obviously transform parts of Kindle. Beyond enterprises need to manage and optimize their infrastructures, our market position and our capabilities are allowing us to benefit from the key secular trends in IT. The adoption of artificial intelligence, technology skill shortages, the needs to modernize, and partial, in many cases, cloud migration, all of which are creating growth opportunities for us. Given our presence across a range of enterprise technologies, AI represents a multifaceted opportunity for us. As I mentioned, AI sits at the center of our Kindle Bridge platform and is producing actionable insights for us and our customers every day. As the largest infrastructure services provider in the world, we generate large amounts of data about IT systems, We use this data in Kindle Bridge, and it gives us the ability to identify application performance patterns under almost any condition so we can prevent incidents from occurring and reduce required maintenance. AI is also a go-to-market opportunity for us. As customers seek to build AI and their own generative AI into processes, they know that their AI is only going to be as good as their data. This is creating demand for our expertise in how to architect data to set the foundation for AI and for GenAI applications. And we're working with both existing and new alliance partners to help facilitate AI in complex environments and to develop joint capabilities. We see this both as a growth opportunity for us and as a natural extension of the data network digital workplace and security services we already offer. In fact, signings in our applications data and AI practice are up more than 30% this year. A second trend is that many organizations just can't attract and develop the range and scale of skilled IT resources they need, particularly in certain disciplines. IT skills are in short supply throughout the world, and in-source infrastructure work doesn't benefit from the scale, the know-how, the training, the investment, and the innovation that Kindle brings to the table as a third-party service provider. including the expansion of our hyperscaler certifications since our spin. Because our scale and associated ability to home grow talented resources, the skill shortages in the marketplace are making Kindrel value proposition even stronger. We manage, today, more than 60% of the outsourced mainframe capacity in the world, and we invest in maintaining this world-class team. Our know-how and alliances with leading technology providers also give us unparalleled expertise in enterprise CIOs' need to modernize complex environments. Simply put, nobody can retrofit their IT plane while it's flying like we can. And when we combine these capabilities with customers' needs to enhance security and resiliency and efficiency with their desire for innovation, we become an indispensable business partner. As I mentioned earlier, selective migration of certain workloads to the cloud is a prime example of where large organizations are looking to modernize, innovate, and drive efficiency. Our hyperscaler related signings are up more than 35% so far this year, and our hyperscaler related revenues are up even more. And some of our largest new logo signings have been for customers who want to leverage our hyperscaler alliances and cloud migration expertise. And because we serve as an operator, an integrator, and an advisor to our customers in their digital business transformations, we naturally find ourselves at the nexus of each of these broader market currents. And a central theme underlying our strategies and our approach to the market is that we're capturing and building value in our business. As we've shared previously, our gross margin, the time of our spin, the margin that our backlog was producing was in the mid-teens. but we've dramatically changed the projected margins on new business that we're signing and raising these margins more than 50% to 26% over the last 12 months. From a financial perspective, this is a game changer for our business. David will walk you through the math of our gross profit book to bill ratio being above one, but the growth vector, the source of value creation that we're delivering is that even, even though we're engineering a decline in our revenue this year, we're building absolute profit dollar growth into our backlog. We're adding more to the top of our earnings funnel that is flowing out into our P&L this year. At the same time, as we move further from our spin, more and more of our revenues are coming from higher margin post-spin signings. This fiscal year, only about a third of our revenue is coming from post-spin signings. Next year, it'll be roughly half of our revenue coming from post-spin signings. And in fiscal 2026, it'll be roughly two-thirds from our post-spend signings. So the inflection point, when our P&L is largely determined by our higher margin post-spend signings, will dramatically change our earnings profile again. As we shared last quarter, where this will show up is in our adjusted pre-tax income and margins. We've put adjusted pre-tax losses behind us, and our forecast implies more than $350 million of adjusted pre-tax income improvement this year compared to last. and the margins at which we're signing contracts and the other actions we're implementing have us on path to deliver higher earnings each year on our way to high single digit adjusted pre-tax margins. And yes, the math associated with that is ultimately a billion dollars or more of adjusted PTI with a high conversion of our net earnings into cash. In short, While we continue to do the important vital work we always have for our customers, we're successfully transforming elements of our business very quickly because of our great people, our new culture, our unique capabilities to meet mission critical needs, our powerful IP and data, and our outstanding execution, each of which is aligned with the secular trends in the market. We are pleased with the significant progress we've made so far. We're enthusiastic about our momentum going into the second half of the year and very excited about the path in front of us. Now with that, I'll hand over to David to take you through our results and our outlook.

Thanks, Martin, and hello, everyone. Today I'd like to discuss our quarterly results, the outstanding progress we're making on our three As, the growth in gross profit that we've been building into our contracted book of business, and our updated outlook for fiscal year 2024. We have a lot of good news to share. Our second quarter results reflect strong operational execution and continued progress on our key initiatives. In the quarter, revenue totaled $4.1 billion, a 5% decline in constant currency. The year-over-year decline in revenue was anticipated and primarily driven by our intentional exit from negative, no, and low margin revenue streams within ongoing customer relationships, not by macro factors. We continued to gain momentum in higher margin advisory services. Kindrel Consult revenues grew 17% year over year in constant currency, which highlights how we're growing our share in this higher margin, higher value add space. Consult signings grew even faster, increasing 32% year over year in constant currency. This performance reflects how the opportunities for growth in Kindrel Consult services stemming from our new alliances with third-party technology providers are outweighing the macro issues pressuring some other firms. Our Q2 signings were down 3% year-over-year in constant currency. Outside of our core enterprise practice, where we've concentrated on removing pass-through revenue and addressing focus accounts, signings were up in the single digits. Our adjusted EBITDA grew 34% to $574 million. Our adjusted EBITDA margin was 14.1%, a year-over-year increase of 390 basis points. At the risk of being immodest, we view this as remarkable execution. Nearly four points of margin expansion is a proof point for our ability to drive meaningful profit growth in our business. Adjusted pre-tax income was $25 million, a $127 million improvement in profit compared to the prior year quarter. As I'll discuss in a moment, our continued progress on our three A's is the key driver of our earnings growth. We address our customers' needs through our geographic operating segments and also through our six global practices, cloud, applications data and AI, security and resiliency, network and edge, digital workplace, and core enterprise. Our business mix continues to evolve to reflect demand, with most of our signings, including Kindrel Consult signings, coming from cloud, App State and AI, security, and other growth areas. More generally, as we look back on the quarter, we're thrilled to have delivered results that position us to exceed the full-year earnings targets that we've already raised once before. Our strategy is working. Our 3A initiatives are driving continuous improvement throughout our operations and fostering additional progress each quarter. As a reminder, at the start of the year, we provided fiscal 2024 targets of $300 million in revenue tied to hyperscaler alliances, $450 million in cumulative annualized cost savings from advanced delivery by fiscal year-end, and $400 million of cumulative annualized pre-tax benefit from our accounts initiative. Heading into the second half of our fiscal year, we're well on track to exceed our alliances target and are raising our targets for our advanced delivery and accounts initiatives. Through our alliances, we're building the portion of our customer relationships that include cloud-based content. In the second quarter, we recognized more than $100 million in hyperscaler-related revenue, putting our run rate ahead of our $300 million full-year target. Our hyperscaler certifications total more than 37,000, which is more than double what they were two years ago, and now include even more advanced certifications. Our advanced delivery initiative is transforming the way we deliver our services, and Kindrel Bridge is driving our progress. To date, we've been able to free up more than 7,500 delivery professionals to address new revenue opportunities and backfill attrition. This is worth roughly $425 million a year to us, representing a $50 million increase in our annual run rate this past quarter. We continue to see significant automation opportunities across our delivery operations as we increase service levels, reduce our costs, and incorporate more technology into our offerings. Our accounts initiative has been and will continue to be a global effort focused on fixing elements of contracts with substandard margins. In the second quarter, we increased the annual profitability of our focus accounts to $400 million, which was our initial target for year end. Successful execution of our three A's is our fastest path toward achieving sustainable profitable growth, and the progress our teams have made on these initiatives is incredible. As a result, we're increasing our annualized savings target for both our advanced delivery and accounts initiatives by $100 million. Turning to our cash flow and balance sheet, in the quarter we generated positive adjusted free cash flow of $69 million. Our gross capital expenditures in the quarter were $175 million, and we received $113 million of proceeds from asset dispositions as a disproportionate amount of our planned FY24 asset sales occurred in Q2. Our financial position remains strong, and we continue to expect that our full-year adjusted free cash flow will be positive. We provided a bridge from our adjusted pre-tax income to our free cash flow, as well as a bridge from our adjusted EBITDA to our free cash flow in the appendix. Our cash balance at September 30 was $1.4 billion. Our cash, combined with available debt capacity under committed borrowing facilities, gave us $4.6 billion of liquidity at quarter end. Our debt maturities are well-laddered from late 2024 to 2041. We had no borrowings outstanding under a revolving credit facility, and our net debt at quarter end was $1.8 billion. As a result, our net leverage sits well within our target range. We are rated investment grade by Moody's, Fitch, and S&P, and all three agencies recently reaffirmed our ratings. We're thrilled to have exited the transition services agreement with our former parent and to have completed the migration to our fit-for-purpose operating financial and HR systems in the two years following our spin. This was a large, complex, and important series of projects delivered on time and on budget that will allow us to adapt our processes and drive operating efficiencies in ways that we couldn't until now. On capital allocation, our top priorities continue to be to maintain strong liquidity, remain investment grade, and reinvest in our business. Our leadership position in IT infrastructure services, combined with benefits from our three initiatives, is significantly expanding our margins and will drive meaningful free cash flow growth. And over time, we'll be in a position to consider regularly returning capital to shareholders, all while remaining investment-grade. As encouraged as I am by the earnings growth we delivered in Q2, I'm even more enthusiastic about how we continue to position Kindrel for future margin and profit growth. As an independent company, we've combined pricing discipline and collaborative engagement with customers to move our projected margins on all new signings up to the mid-20s for gross profit and the high single digits for pre-tax profit. As Martin mentioned, the September quarter was a continuation of that favorable trend, and as our business mix increasingly shifts toward more post-spin contracts, you will see significant margin expansion. In our earnings presentation, we've shared a simple analysis that accentuates how we've been creating and capturing value in our business. With an average projected gross margin of 26% on our $12 billion of signings over the last 12 months, we've added over $3 billion of gross profit to our backlog. Over the same period of time, we've reported gross profit of $2.7 billion. This means we've been adding more gross profit to our backlog then our contracted book of business has been throwing off in the form of gross profit reported in our P&L. Having a gross profit book-to-bill ratio above 1 at 1.1 is a measure of how we're growing what matters most, the expected future profit from committed contracts. We continue to make significant progress on our 3A's initiatives, and the momentum to date supports our continued expectation that over the medium term, Our alliances initiative will drive signings, revenue, and roughly $200 million in annual pre-tax income. Our advanced delivery initiative will drive cost savings, equating to roughly $600 million in annual pre-tax income. And our accounts initiative will drive annual pre-tax income of $800 million or more. We're also driving growth in Kindle Consult and among our global practices, which is incremental to the benefits coming from our 3A initiatives, and we see opportunities to control expenses throughout our business. We expect that these efforts will contribute roughly $400 million in annual pre-tax income over the next few years. In total, then, the magnitude of the earnings growth opportunity we're tackling is tremendous relative to our current margins. Progress on our three A's is a central source of value creation for Kindrel. With another strong quarter to build on, we're again raising our profit outlook for our 2024 fiscal year. We're growing our margins this year, largely due to the 3A initiatives, growth in Kindle Consult, and productivity gains. We now expect our fiscal 2024 adjusted EBITDA margin to be roughly 14.5%, a half point higher than our previous estimate. This represents an increase of roughly 290 basis points versus fiscal 2023. And we're raising our outlook for adjusted pre-tax income to be at least $140 million versus our prior outlook of at least $100 million. This increase implies more than a 200 basis point margin expansion compared to last year. Importantly, we would have increased our full year outlook for adjusted pre-tax income by $30 million more were it not for the strengthening of the dollar and weakening of the yen over the last several months. The three A's, workforce rebalancing, real estate consolidation, growth in Kindle Consult, our pricing strategies, and other actions are all contributing to our margin growth. Our outlook for revenue is a decline of 6% to 7% year-over-year in constant currency, which translates to $15.8 to $16 billion based on recent exchange rates. The strength of the US dollar over the last six months has reduced our revenues measured in dollars, but it doesn't impact our constant currency outlook, which we are narrowing to the favorable end of our initial range, driven in part by the strength in our consult signings. Also, as a reminder, the year-over-year revenue decline we're projecting is primarily due to the soft backlog of fiscal 2024 revenue we were born with. plus intentional near-term actions we're taking to transform our business. These changes typically involve removing selected low or negative margin scope from ongoing customer relationships. We've accelerated these actions over the last six to nine months, so the year-over-year revenue decline in the second half of our fiscal year will be greater than in the first half. For the December quarter, on a year-over-year basis, we expect revenues to decline in the high single digits in constant currency, and for the revenue decline to be most pronounced in our U.S. and strategic market segments, where our reduction of pass-through elements is most impactful. We expect adjusted pre-tax income to be positive, with adjusted pre-tax margin up year-over-year in the quarter, despite it being the quarter that is our toughest earnings comp this year. due to the exaggerated seasonality that we had in Q3 last year. As I mentioned, we expect adjusted free cash flow to be positive this fiscal year. We now project roughly $700 million of net capital expenditures in fiscal 2024, which is 7% lower than our initial projection as we push to be less capital intensive. And we project about $850 million of depreciation expense. We continue to expect about $300 million of cash outlays for separation-related work, primarily systems migrations, and for workforce rebalancing actions that are driving significant cost savings. This will be the last year in which we incur spin-related charges, so we expect our adjusted earnings to move closer to our reported gap earnings over time. In fact, next year, our principal adjustments should be only non-cash stock-based comp and non-cash intangible samaritization. We remain committed to our target of returning to revenue growth by calendar 2025 and over the medium term delivering significant margin expansion and driving free cash flow growth. We have a solid game plan to drive our strategic progress, and this game plan starts with the steps we've already taken to expand our technology alliances, manage our costs, and earn a return on all of our revenues. To wrap up, our business model centers around providing mission-critical services to large, complex organizations that are dependent on technology and pursuing digital evolution. We call this operating at the heart of progress. Operating at the heart of progress is also becoming a distinguishing feature of who we are as a corporation. delivering progress on alliances, advanced delivery, and unprofitable accounts, delivering progress with Kindrel Consult and AI-enabled Kindrel Bridge, delivering progress through our global migration to new operating financial and HR systems following our spin, delivering progress in our margins and adjusted earnings as an independent company, and delivering progress in our winning culture and in the breadth of solutions we provide to customers. As Martin highlighted, we are symbiotically delivering progress for our customers and for ourselves as the world's leading provider of IT infrastructure services. With that, Martin and I would be happy to take your questions.