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spk08: Good day, and thank you for standing by. Welcome to the Kendrell Fiscal Third Quarter 2024 Earnings Conference Call. At this time, all participants are on the listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question during the session, you will need to press star 11 on your telephone. You will then hear an automated message advising your hand is raised. To withdraw your question, please press star 11 again. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker. Lori Chapman, Global Head of Investor Relations. Please go ahead.
spk05: Good morning, everyone, and welcome to Kindrel's earnings call for the third fiscal quarter ended December 31st, 2023. Before we begin, I'd like to remind you that our remarks today will include forward-looking statements. These statements are subject to 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 factor 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 metrics, corresponding GAAP metrics, and a reconciliation of non-GAAP metrics to gap metrics for historical periods are provided in the presentation materials for today's event, 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'll hold a Q&A session. I'd now like to turn the call over to Martin.
spk11: Thank you, Lori, and thanks to each of you for joining us. Kindrel continues to make great progress in delivering value to customers and to shareholders. Today, we'll provide an update on our strong execution and our accelerated progress as the leader in mission-critical IT infrastructure services. Our strategy, centered around our alliances, advanced delivery, and accounts initiatives, Kindrel Consult and Kindrel Bridge, is paving the way for profitable growth. We're again raising our full-year earnings outlook, which reflects our progress and our prospects. To fully appreciate how we reached this point so quickly and to understand Kindrel's growth potential, it's important to recognize the critical role we play for our customers and the leadership position we hold in our industry. We're a vital and trusted partner for our customers' current and future technology needs. We have a strong heritage in running complex applications that are highly dependent upon mission-critical infrastructure, such as the mainframe. And as an independent company, our freedom of action has allowed us to quickly capitalize on opportunities that are unique to Kindrel. As a result, we're building a strong track record of successful execution that is clearly visible in our results. Benefits from our three A's have driven and will continue to drive tangible financial progress. We formed alliances with key technology leaders, which has significantly increased our addressable market, and we continue to grow these relationships. In November, we expanded our relationship with AWS on two fronts. First, to jointly develop and deliver generative AI, and the second to collaborate on mainframe modernization. We've announced similar alliances with Microsoft and will soon be announcing an expanded collaboration with Google Cloud on GenAI. We've expanded our service delivery capabilities through Kindle Bridge. We're now performing over 1 billion automations each year, addressing risks before they become incidents and building resiliency. Our advanced delivery efforts are generating savings of 500 million a year for us. In our accounts initiative, we've engaged collaboratively with our customers and have already addressed roughly half of these accounts. And as a result, we've grown our aggregate margins on focus accounts by seven points. Our progress extends beyond the three A's as we leverage Kindle Bridge our deep insights and the trust our customers have in us to drive growth in Kindrel Consult. Consult revenues are up 16% year-to-date, and we already have roughly 750 customers using Kindrel Bridge, our AI-powered open integration platform. These areas are foundational to growing our business and fueling our long-term growth. Importantly, our strategic progress is driving stronger financial results. We're now three quarters through our fiscal year, and it's clear that fiscal 2024 is a proof point for us. We grew signings in the first 10 months of the year with higher value services. Earnings are expected to be up meaningfully this year compared to last, and we've generated positive adjusted free cash flow in the first nine months of the year. We are enthusiastic about how our strategies and our approach to the market are driving performance. Our customers value the technical expertise and services we provide as they advance their own digital transformations. Our powerful business dynamics are creating significant value and will continue to be bold and ambitious about how we come together with our partners to deliver value for our customers. They already see us behaving as a flatter, faster, and more focused organization, which is aligned to our new services culture, what we call the Kindle way. We operate at the heart of large organizations' technology estates, so it's natural for us to be at the center of the secular IT trends. Our customers look to us for capabilities and scale to address these trends from risks like cybersecurity and skill shortages to opportunities like cloud and AI. Our success is fueled by providing customers with solutions that leverage both our own know-how and our alliance partners' capabilities. Our expanded hyperscaler relationships, combined with our extensive knowledge of complex hybrid IT estates, are why customers are partnering with Kindrel to achieve their IT and business objectives as they address the larger forces shaping the evolution of IT, namely the adoption of artificial intelligence, which we know is top of mind for enterprise CIOs, technology skill shortages, the modernization needs to address aging infrastructure challenges, and cloud migration. Let me share a few examples. In the healthcare industry, where digital applications are scaling at a remarkable pace and privacy regulations present unique challenges, modernizing IT environments and moving workloads to the cloud are particularly complicated. We've been advising two large healthcare companies throughout the migration of their complex platform-based IT systems onto the cloud, including their patient record systems. This migration work is strengthening the user experience for patients and caregivers while generating meaningful operating efficiencies for our customers. For a global auto manufacturer, we're using AI-enabled Kindrel Bridge to deliver real-time insights and automate processes in order to enhance day-to-day IT performance. This work is not just about IT, it's also producing efficiencies across the customer's manufacturing facilities. And we're working with a large multinational communications provider to define and implement their strategy to modernize their IT estate and migrate applications to the cloud with the goal of reducing energy consumption by about 70%. There are two key themes among these examples. Other new scope we're adding and other new customers we're bringing on. First, our capabilities and our technology alliances position us to do important work for important companies, many of which are household names. Second, the nature of the services we provide is evolving. Our independence is fueling mission-critical work that is more consultative, more multi-vendor, more hybrid, and more value-added, as we help customers address the trends shaping IT. And if you want proof, this quarter Kindrel Consult delivered its largest signings quarter yet, with double-digit constant currency growth in both signings and revenue. And through our alliances, we've generated more than $300 million of hyperscaler-related revenue so far this year, and increasing our current target for this activity to 400 million. Let me also emphasize that Kindrel is an AI beneficiary and AI enabler. As the largest infrastructure services provider in the world, we generate large amounts of data about IT systems. We're using artificial intelligence with this data in our Kindrel Bridge platform to identify application performance patterns, produce actionable insights, reduce required maintenance, and prevent incidents from occurring. And beyond our own use of AI, our customers know that their AI is only going to be as good as their data. So they're looking for Kindrel's expertise in how to architect their data to set the foundation for the investments they're making in AI and Gen AI. More generally, because we serve as an operator, an integrator, and advisor to our customers in their digital business transformations, we naturally find ourselves at the nexus of broader market trends. The unique combination of our advisory and engineering talent intellectual property, and vast amounts of operational data positions Kindrel as an essential business and technology services partner. We're accessing incremental market opportunities, growing our share of wallet with existing customers, winning new customers, and transforming Kindrel. As our business evolves and we move further away from our spin, our revenue mix will continue to shift to higher margin post-spin signings. This fiscal year, only one-third of our revenue is coming from post-spin signings. Next year, we'll move to half of our revenue from coming from post-spend signings, and in fiscal 2026, it will be roughly two-thirds. This inflection point, when our P&L is largely determined by our higher margin post-spend signings, will dramatically change our earnings profile. As I highlighted earlier, our forecast for fiscal 2024 now implies more than $360 million of adjusted pre-tax income improvement this year compared to last. And while our efforts to shed low to no margin revenue will continue to impact top-line growth this calendar year, we expect to deliver margin expansion and higher earnings each year with revenue growth returning in calendar 2025. As David will explain in more detail, the margins at which we're signing contracts and the other actions we're taking to increase our profitability have us on a path to deliver high single-digit adjusted pre-tax margins by fiscal 2027, and yes, The math associated with that is ultimately a billion dollars or more of adjusted pre-tax income with a high conversion of our net earnings into cash. We're making substantial progress, earning the trust and respect of our customers and partners through exceptional and reliable delivery. We're providing innovative solutions that drive real business outcomes and earning stronger margins in our ROI from our work. We're driving powerful business dynamics for value creation and we'll continue to be bold and ambitious about how we come together to deliver value with our partners for our customers. And with that, I'll hand over to David to take you through our results and our outlook.
spk13: Thanks, Martin, and hello, everyone. Today I'd like to discuss our quarterly results, the formidable 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 again have a lot of positive developments to share. Our third quarter results reflect strong operational execution and continued progress on our key initiatives. In the quarter, revenue totaled $3.9 billion, a 10% 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 continue to gain momentum in higher margin advisory services. Kindle Consult revenues grew 11% year over year in constant currency, which highlights how we're growing our share in this higher margin, higher value add space. As Martin mentioned, consult signings grew even faster. This performance reflects our unique opportunities for growth in advisory services, due to our independence and our expanding alliances with third-party technology providers. Our total Q3 signings increased 13% year-over-year in constant currency, and fiscal year-to-date signings for January are up 4%. Among our practices, the strongest growth this year has been in security and resiliency and AppState and AI. Our year-to-date signings support our plan to return to revenue growth in calendar 2025 and fiscal 2026. Our third quarter adjusted EBITDA grew 6% to $615 million. As we've said previously, we had a tough comp in Q3 due to the exaggerated seasonality we saw last year, which included earnings from minimum annual revenue commitments. Despite the tough comp though, our adjusted EBITDA margin increased by 210 basis points year-over-year to 15.6%. Our continued margin expansion underscores our ability to drive meaningful profit growth in our business. Adjusted pre-tax income was $63 million, a $67 million improvement in profit year-over-year. Our continued progress on our 3As 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, apps data and AI, security, and other growth areas. More generally, as we look back on the quarter, We're elated to have delivered results that position us to exceed the full-year adjusted pre-tax earnings target that we've already raised twice 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 savings from advanced delivery by fiscal year end, and $400 million of cumulative annualized pre-tax benefit from our accounts initiative. Halfway through the year, we raised our targets for advanced delivery and accounts initiatives by $100 million each. And with the continued strong execution we delivered in the third quarter, we're now raising our full-year target for alliances revenue by $100 million and are well-positioned to meet or exceed our targets for advanced delivery and accounts. Through our alliances, we're building the portion of our customer relationships that include cloud-based content. In the third quarter, we recognized more than $100 million in hyperscaler-related revenue, bringing our year-to-date total to more than $300 million. This surpasses our initial $300 million fiscal 2024 target. And because of this progress, we're raising our full-year target for revenue tied to hyperscaler alliances to $400 million. Our hyperscaler certifications total more than 38,000, 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. We continue to identify and realize significant automation opportunities across our delivery operations as we increase service levels, reduce our costs, and incorporate more technology into our offerings. To date, we've been able to free up more than 8,500 delivery professionals to address new revenue opportunities and backfill attrition. This is worth roughly $500 million a year to us, representing a $75 million increase in our annual run rate this past quarter. Our accounts initiative has been and will continue to be a global effort focused on fixing elements of contracts with substandard margins. In the third quarter, we increased the cumulative annualized profit savings from our focus accounts by $75 million to $475 million. Our focus accounts program has been a galvanizing effort among Kindrel professionals around the world in order to repair hundreds of profit-challenged relationships collaboratively with our customers, and it has been a resounding win for us as a team. Successful execution of our three A's remains our fastest path toward achieving sustainable, profitable growth, and the progress our teams have made on these initiatives has been and is an outstanding source of value creation for Kindrel, our customers, and our shareholders. Turning to our cash flow and balance sheet, in the quarter we generated positive adjusted free cash flow of $348 million. Our gross capital expenditures in the quarter were $174 million, and we received $15 million of proceeds from asset dispositions. Working capital was unusually strong in the quarter, and we expect some of these timing benefits to reverse in the March quarter. Our CapEx is also back-end weighted this year. Our financial position remains strong, and we continue to expect that our full-year adjusted free cash flow will be positive. We've 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 December 31 was $1.7 billion. Our cash combined with available debt capacity under committed borrowing facilities gave us $4.8 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 $1.6 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 our $500 million term loan matures in November, so it now shows up on our balance sheet as a current liability. We intend to refinance this debt in the first half of calendar 2024, subject to market conditions. 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 3A initiatives, is significantly expanding our margins and will drive meaningful free cash flow growth. As a result, 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've delivered in Q3 and so far this year, I'm even more enthusiastic about how we continue to position Kindrel for future margin and profit growth. The December quarter was a continuation of us signing business with stronger margins, and as our business mix increasingly shifts toward more post-spend contracts, you'll see significant margin expansion in our reported results. In the middle graph on slide 12 of our earnings presentation, we've included a gross profit book to bill graph that accentuates how we've been creating and capturing value in our business. With an average projected gross margin of 26% on our $12.5 billion of signings over the last 12 months, we've added over $3 billion of projected gross profit to our backlog. Over the same period of time, we've reported gross profit of $2.8 billion. This means that we've been adding more gross profit to our backlog than our contracted book of business has been producing in our P&L. Having a gross profit book-to-bill ratio above 1 at 1.1 times is a measure of how we're growing what matters most, the expected future profit from committed contracts. And we've been doing this consistently over the last 18 months. I want to remind people who are familiar with our story and highlight for those just beginning to follow us that two years ago, we laid out bold ambitions that over the medium term, our alliances initiative will drive signings revenue in 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. Two years into this journey, our momentum clearly has us on track to achieve these goals. 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're seizing 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 and tackling successfully is tremendous relative to our current margins. Progress on our three A's has been and will be a central source of value creation for Kindrel. I mentioned earlier that transforming focus accounts into higher margin relationships has been a big effort and big win for us. While pricing discipline is part of our approach, it is only a portion of our strategy. We're also expanding the scope of services we provide to our customers in order to strengthen our margins, and the growth in our hyperscaler-related revenues and consult revenues demonstrates this. We're removing low to no margin third-party content from our deals, which, as you know, impacts our reported revenue. And we're driving efficiency in how we provide services with advanced delivery and Kindle Bridge helping us reduce costs. In other words, turning our focus accounts into relationships that generate margins more like the blueprint portion of our revenues is a multifaceted, multi-year exercise that is about more than just pricing. I look at our progress to date as a good thing, but I also embrace the opportunity still available to us since the remaining focus accounts represent a significant opportunity to expand margins that is both specific to Kindrel and something we've proven we can execute. Our updated outlook is for adjusted pre-tax income to be at least $150 million. versus our prior outlook of at least $140 million. This increase implies at least 220 basis points of margin expansion compared to last year. We now expect our fiscal 2024 adjusted EBITDA margin to be at least 14.5%, which represents an increase of at least 290 basis points versus fiscal 2023. Our outlook for revenue continues to be a decline of 6 to 7% in constant currency. which translates to $15.9 to $16.1 billion based on recent exchange rates. 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 nine months, which is why the year-over-year revenue decline in the second half of our fiscal year is greater than in the first half. For the March quarter, we expect year-over-year revenues to decline 9 to 11 percent in constant currency, and for the revenue decline to be most pronounced in our U.S. and strategic markets segments, where our reduction of lower margin elements is most impactful. we expect adjusted pre-tax income to be positive in the quarter. The sequential quarterly comp from Q3 to Q4 is a tough one due to the contractual $50 million quarter-over-quarter increase in IBM software costs that we face. Year-over-year, though, we expect our adjusted pre-tax margin to increase in the fourth quarter, as it has in each of the first three quarters of fiscal 2024. As I mentioned, we expect adjusted free cash flow to be positive this fiscal year. We now project roughly $650 million of net capital expenditures in fiscal 2024. We estimate roughly $825 million of depreciation expense and $1.25 billion of amortization expense this year. We still expect about $300 million of cash outlays for separation-related work, primarily systems migrations, and for our workforce rebalancing actions that are driving significant cost savings. 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. To wrap up, our business model centers around providing mission-critical services to large, complex organizations that are dependent on technology in pursuing digital evolution. The mission-critical nature of what we do distinguishes us from other providers of IT services. Our scale, our know-how, our indispensability, and our freedom of action as an independent company have given us opportunities to become a more profitable business while continuing to serve our customers extremely well. We've been successfully capitalizing on these opportunities in ways that position us for profitable growth in the future. We still have much to do and a lot of additional value that we can generate. And our accomplishments to date, including in the most recent quarter, give us confidence in our ability to deliver continued substantial progress. With that, Martin and I would be pleased to take your questions.
spk09: Operator?
spk08: Operator? Yes, can you all hear me? Yes. Now we can. Thank you. We will now open the line for questions. As a reminder, to ask a question, please press star 11 on your telephone and wait for your name to be announced. To withdraw your question, please press star 11 again. We ask that you please limit yourself to one question and one follow-up. Please stand by while we compile the Q&A roster. Martin, are you all ready for your first question?
spk12: We are ready, operator. Thank you.
spk08: Our first question is from David Togut with Evercore ISI. Your line is now open.
spk14: Thank you. Good morning, and good to see the 13% year-over-year bookings growth in the quarter. Could you talk about the underlying strength in bookings, both at Kindrel Consult and at Alliances, and to what extent that strength is sustainable going forward?
spk11: Yeah, thank you, David. Obviously, I'll ask David to join me if he had anything to supplement my answer with. But a few things, I think, about what we saw in the quarter. Obviously, as you said, well, good growth got us back not only in the quarter, but got us back to to growth on a full year basis or a year-to-date basis. And I think what's important are a couple things. As you know, we have a headwind in growing signings, which is because we're being selective about the content. Having said that, you know, we do have these growth factors that we've been talking about, including Kindrel Consult, including our alliance activity. which is, I think, demonstrative of the role we play in our customers' environments. And it shows how our customers trust us with their most challenging work. And the work we're doing in Consult and the work we're doing with our partners is just evidence that the important role we play for our customers' future is now continues to play out, notwithstanding the headwind we have as we're more selective. It also reflects the capabilities we've been building over the last couple of years and moving into the bigger total addressable market that we've talked about since we were spun out As further signs, I guess I'll add one more data point, because while we have good growth in consult, also maintained good double-digit growth in the quarter and on a year-to-date basis, and good growth in the alliance activity, we also did see more larger deals. We saw 15 deals greater than $100 million through the end of the year, so the first nine months of this year, versus eight deals greater than $100 million through the same time period the prior year. So, again, all evidence, I think, of the trust and the confidence that our customer base has in us, even as we've kind of worked through the headwind of being selective about content. David, anything you'd like?
spk13: Just to add that, you know, year-to-date, consults are on 14% of our revenue in the quarters, in the range of 15%. And that's really giving us confidence that we can ultimately move up, move ConsultUp to being 20% or more of our aggregate revenue.
spk14: Thank you, David. Thanks. Yeah, just as a quick follow up, if I could ask about the $348 million in free cash flow in the quarter. David, you called out some working capital benefits, which were mostly timing related, and it sounds like CapEx is more fourth quarter related. Would you still expect to be free cash flow positive in the fourth fiscal quarter of this year?
spk13: We expect to be free cash flow positive for the year as a whole, probably not in the fourth quarter itself. And as you mentioned, we had some working capital benefits that helped us in the third quarter, which made our free cash flow in the quarter particularly strong. And our capital expenditures are back end loaded this year. There's going to be more of that in the fourth quarter. And then we have the usual March quarter seasonality where we have certain payments, annual, biannual payments for things like software that tend to go out in the first quarter of the year. So the March quarter is typically a tougher working capital and free cash flow quarter for us. but there's no change in our outlook, our expectation that we'll be free cash flow positive for the year as a whole.
spk07: Thanks so much. Operator, next question, please.
spk08: Our next question comes from the line of Tensin Wong with J.P. Morgan. Your line is now open.
spk01: Hey, thanks. Good morning. Good results here. I like the gross profit book-to-bill metric here, greater than one. I'm just curious, the risk of realization for that? Can you go through that contract execution, things like pricing, delivery capability, things like that? I'm just curious about the realization risk of that book to bill.
spk13: Sure. Our experience is good in terms of realization associated with our book to bill. We do an analysis of contracts that we've priced that measures the actual realized profit compared to what we'd estimated. We call it our did versus bid analysis. And in the most recent version of that, most of the contracts we looked at averaged within a point of what we actually expected to generate. I think it was around seven-tenths of a point. So I think our realization of the signings and the gross profit associated with them tends to be very good. We have, I'd say, good visibility and good confidence with respect to it.
spk01: Perfect. Thanks for that, David. Just my quick follow-up, then. I think, Martin, you mentioned the 15 deals greater than $100 million, and I think Industry-wide, we've been hearing a lot of mixed results on the short-term projects, the discretionary spend. Your consult advisory business seems to be doing well. Just remind us maybe the difference here, and I know you're somewhat bringing that up to a good standard here, but are you seeing any impact from demand as we cross over into the calendar year here on the short-term project stuff?
spk11: Thanks, Tingen. Again, and we've talked a bit about this in the past, the nature of what we're consulting on is probably less opportunistic or less variable because we're consulting on the things that we run. We're consulting on infrastructure. We're consulting and helping our customers on securing their data, making their systems more resilient, making sure that the data is architected in a way that that they can get to it and protect it, et cetera, et cetera, et cetera. So, so the, the, uh, the mission critical nature of our run business is also, you know, I would say the mission critical nature of the consult business companies have challenges and it's not, you know, we're not helping with science experiments. We're not helping with, with sort of the nice to haves. We're helping with how do you make sure your infrastructure is secure, resilient, and able to meet the needs of the business. So I just think it's the nature of what we do that's different from a lot of others. And I think that's what drives, you know, Consult to be a solid double-digit performance. It's probably just unique to us. Understood. Thank you for that. Thanks, Denjen.
spk02: Operator, next question, please.
spk08: Our next question comes from the line of Divya Goyal with Scotiabank. Your line is now open.
spk03: Good morning, everyone. Great quarter.
spk04: So Martin, further to this comment that you made, I was actually very curious to understand that how have these AI tailwinds been actually changing the way Kindles now interacting with the clients per se? Like in terms of your focus accounts, are they starting to prioritize Kindle? And actually, have you been seeing increased conversion there? And for that matter, your Blueprint account, are you seeing increased conversion? And obviously, Kindle itself is working alongside the client. But help us understand how has AI been a driver of these revenues as well?
spk11: Yeah. So thank you, Divya. A couple of things. First, AI is both something we use in how we deliver our services. And Kindle Bridge has a massive machine learning model and more data than anybody else that helps customers get insights. As we said in our prepared remarks, we've got over 750 customers now getting insights from Bridge on how to optimize those systems. And what that work also allows us to do is then to help customers think through which leads, by the way, to consult opportunities for us. But it also helps customers as they think about now how they want to deploy AI. And many are now starting to move into Gen AI, obviously. The work that has to happen around Gen AI, the work that has to happen around any AI is all about how do you architect your data? How do you get your data organized? And even though it's in an experimental phase, The work we do tends to precede the science experiments that have to happen. So we're at the front end of what customers are thinking about as they start to explore either for their systems, mostly for systems of engagement, as they start to explore how to use their data to reach new customers, to reach their customers better. But this has a long, long tail to it, even though we're at the front end. as ai becomes more used in systems of engagement and systems of record which is you know where our mission critical work sits i i think we've got a very long tail to how our uh our consultants and kindle consult help customers so this is a long secular trend that i think is going to drive growth for quite a while for us that's very helpful and just to just to understand and a quick one here
spk04: Kindle is a very mission critical infrastructure services company to the global macro. And we've talked about this in the past, but how exactly does the global macro conditions impact you? And to what extent could they negatively impact you? Um, given the nature of work you do versus the application services companies that have been, um, indicating slowdown in growth and, um, a weak outlook for fiscal 2024, broadly speaking?
spk11: Yeah, look, we are what I would say is insulated to the macro, but we are, you know, the macro is the world we live in. It's the world our customers live in as well. So as their world changes, it will put different new pressures on how they run their infrastructure, what they might what they might experience or the direction they may want to go. So in the short term, we don't see much of an impact. As we've said in the past, we're fairly well insulated. But over the long term, as customers rethink the world, which leads maybe to industry consolidation, other things, we will experience that. But that's over the longer term. And again, in any macro environment, Our customer base and all customers are going to always be thinking about how do I take advantage of the innovation I see? How do I move into the world in order to serve my customers? And we just have to be able to keep up with them with the capabilities that they're looking for at any given time. But again, that's what we've been doing is helping them move to the future in whatever macro environment we happen to be in.
spk06: That's great, Martin. Thanks a lot for all the info.
spk11: Thanks, Divya.
spk06: Thanks. Brad, I believe we have one more question in the queue.
spk08: Our last question comes from the line of Jamie Friedman with Susquehanna. Your line is now open. Hi.
spk16: Good morning, and let me echo the compliments, good results here. I was wondering, David, if you could help us bridge between slides 12 and slide 7. In other words, how to think about the – to timing related to the gross profit book to bill as it waterfalls over to the pre-tax margin. Any comment on that would be helpful.
spk13: Absolutely. Thanks. And I think slide seven, the one that shows how our business mix is evolving, really does operate as the bridge here. And as a reminder, that's the slide that shows that this year Only about a third of our revenue and therefore a third of our P&L is really being driven by post-spin signings that have these attractive high single-digit margins associated with them. And we're still in a situation where two-thirds of our revenue is coming from older pre-spin signings that really aren't generating significant profit for us. And the inflection point that's really important for us is next year moving to that mix of revenues being kind of 50-50 between post-spin and pre-spin. And the fiscal year after that, our revenues and our P&L for the first time really sort of being dominated by the post-spin signings. And what we expect that to translate into, and I feel we have good visibility around is the bars that you see on the right side of page seven, that as the more profitable signings, the more profitable book of business becomes a predominant part of our revenue, that really creates the opportunity for the margin improvement that we're looking for. And then by the time we get to fiscal 27, where 85% or so of our revenues are coming from the the business that we've signed post-spin rather than what we inherited, that's how we, you know, we deliver high single-digit margins. So this really, you know, the margins at which we're signing business just become a larger and larger part of our overall business mix. And by the time we get to, you know, fiscal 27, where it's 85% post-spin, that's how we see ourselves at high single-digit pre-tax margins in aggregate.
spk12: Yeah, I think that's well said.
spk11: I guess when I think about it as we get into next year, I think we've got still the headwind that we had this year, which we obviously have been able to overcome, and that's the software cost increase that IBM created in the spin. So that's the headwind. But the tailwinds we see, David said it well, we get more of our post-spin backlog that comes through We obviously get the full year benefit of everything we were able to execute this year and will continue to execute next year. So we'll get the in period execution benefits from that. And then we also get a tailwind, I think, from lower depreciation as we get into next year. So. So, yes, we have headwinds as we go into it. David described that chart well, I think.
spk10: But we've also got some tailwinds as we get into the year.
spk16: And then for my follow-up, maybe for Martin, in terms of the projected revenue growth beginning in calendar 2025, how do you think about the factors, the growing at that? In other words, how much of that is impacted? How much of that is under your own control? Is any of that at risk to discretionary or macro? How do you think about that?
spk11: Yeah, look... we have uh as we've said a number of times we have engineered a decline in our business and and i would say on the other side where we focused on getting to growth like kindrel consult and their alliances activity we're growing quite well and as i sit here today while we have you know many many more quarters of signings to get under our belt um As I sit here today, I feel as good as ever that those two growth drivers, along with all the other things we're building our capabilities around, that they get us back to growth in the timeframes that we've said previously. With, as David said, well, the margin profile, as more of that comes through our P&L. So as I sit here today, I still believe that our alliance activity, our Kindrel consult. We've proven that we can grow where we want to grow. And we've proven that the customers are willing to and want to expand their work with us and their relationship with us, even as we engineer this decline. Now, the biggest chunk of that engineer decline is this fiscal year. As we move into next fiscal year, the engineer decline reduces. The OEM content becomes becomes sort of what I'll call a neutral, right? We've taken a ton of it out. It becomes a neutral going forward. We still have some more work to do on focus accounts, which will have an impact, but the bulk of it is in this fiscal year, and as we move into next year, then we'll have a reduced impact from that engineer decline and more impact from – more benefit from Kindrel Consult and the alliances activity as it keeps going. I feel really good about where we are in what we've described now for, you know, a bit over two years about getting back to growth and calendar year 25 and driving the profitability that we've been talking about and converting that, you know, at a very high rate to cash. Got it. Thank you. Thank you. So, yeah. Thanks, Laurie. So, thanks, everybody, for joining again today. We certainly appreciate the interest in Kindrel. Look, I got to tell you, I'm very proud of the progress this team has delivered and continues to execute on the strategy that we laid out, three A's plus plus. We're building this business the right way. We have the right strategy that is and can be and is being executed, and we have the right culture. So we, as a business, Kindle continues to solidify its leadership position. We continue to strengthen the relationships we have with our customers and our partners. You can see that spread throughout the financials. And now as we, you know, in our third year, third calendar year as a firm, I remain as excited as ever about the opportunity as we keep serving our customers' mission-critical needs and keep developing new capabilities to bring them into the future. So thanks, everybody, for joining.
spk08: This concludes today's conference call. Thank you for your participation. You may now disconnect. you Thank you. Thank you. standing by. Welcome to the Kendrell Fiscal Third Quarter 2024 Earnings Conference Call. At this time, all participants are on a listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question during the session, you will need to press star 11 on your telephone. You will then hear an automated message advising your hand is raised. To withdraw your question, please press star 11 again. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker. Lori Chapman, Global Head of Investor Relations. Please go ahead.
spk05: Good morning, everyone, and welcome to Kindrel's earnings call for the third fiscal quarter ended December 31st, 2023. Before we begin, I'd like to remind you that our remarks today will include forward-looking statements. These statements are subject to 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 metrics. Corresponding GAAP metrics and a reconciliation of non-GAAP metrics to get metrics. Thank you.
spk08: Good day, and thank you for standing by. Welcome to the Kendrell Fiscal Third Quarter 2024 Earnings Conference Call. At this time, all participants are on a listen-only mode. After the speaker's presentation, there will be a question-and-answer session. To ask a question during the session, you will need to press star 11 on your telephone. You will then hear an automated message advising your hand is raised. To withdraw your question, please press star 11 again. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker, Lori Chapman, Global Head of Investor Relations. Please go ahead.
spk05: Good morning, everyone, and welcome to Kindrel's earnings call for the third fiscal quarter ended December 31st, 2023. Before we begin, I'd like to remind you that our remarks today will include forward-looking statements. These statements are subject to 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 metrics, corresponding GAAP metrics, and a reconciliation of non-GAAP metrics to GAAP metrics for historical periods are provided in the presentation materials for today's event, 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'll hold a Q&A session. I'd now like to turn the call over to Martin. Martin?
spk11: Thank you, Lori, and thanks to each of you for joining us. Kindrel continues to make great progress in delivering value to customers and to shareholders. Today, we'll provide an update on our strong execution and our accelerated progress as the leader in mission-critical IT infrastructure services. Our strategy, centered around our alliances, advanced delivery, and accounts initiatives, Kindrel Consult and Kindrel Bridge, is paving the way for profitable growth. We're again raising our full-year earnings outlook, which reflects our progress and our prospects. To fully appreciate how we reached this point so quickly and to understand Kindrel's growth potential, it's important to recognize the critical role we play for our customers and the leadership position we hold in our industry. We're a vital and trusted partner for our customers' current and future technology needs. We have a strong heritage in running complex applications that are highly dependent upon mission-critical infrastructure, such as the mainframe. And as an independent company, our freedom of action has allowed us to quickly capitalize on opportunities that are unique to Kindrel. As a result, we're building a strong track record of successful execution that is clearly visible in our results. Benefits from our three A's have driven and will continue to drive tangible financial progress. We formed alliances with key technology leaders, which has significantly increased our addressable market, and we continue to grow these relationships. In November, we expanded our relationship with AWS on two fronts. First, to jointly develop and deliver generative AI, and the second to collaborate on mainframe modernization. We've announced similar alliances with Microsoft and will soon be announcing an expanded collaboration with Google Cloud on GenAI. We've expanded our service delivery capabilities through Kindle Bridge. We're now performing over 1 billion automations each year, addressing risks before they become incidents and building resiliency. Our advanced delivery efforts are generating savings of 500 million a year for us. In our accounts initiative, we've engaged collaboratively with our customers and have already addressed roughly half of these accounts. And as a result, we've grown our aggregate margins on focus accounts by seven points. Our progress extends beyond the three A's as we leverage Kindle Bridge our deep insights and the trust our customers have in us to drive growth in Kindrel Consult. Consult revenues are up 16% year-to-date, and we already have roughly 750 customers using Kindrel Bridge, our AI-powered open integration platform. These areas are foundational to growing our business and fueling our long-term growth. Importantly, our strategic progress is driving stronger financial results. We're now three quarters through our fiscal year, and it's clear that fiscal 2024 is a proof point for us. We grew signings in the first 10 months of the year with higher value services. Earnings are expected to be up meaningfully this year compared to last, and we've generated positive adjusted free cash flow in the first nine months of the year. We are enthusiastic about how our strategies and our approach to the market are driving performance. Our customers value the technical expertise and services we provide as they advance their own digital transformations. Our powerful business dynamics are creating significant value and will continue to be bold and ambitious about how we come together with our partners to deliver value for our customers. They already see us behaving as a flatter, faster, and more focused organization, which is aligned to our new services culture, what we call the Kindrel way. We operate at the heart of large organizations' technology estates, so it's natural for us to be at the center of the secular IT trends. Our customers look to us for capabilities and scale to address these trends from risks like cybersecurity and skill shortages to opportunities like cloud and AI. Our success is fueled by providing customers with solutions that leverage both our own know-how and our alliance partners' capabilities. Our expanded hyperscaler relationships, combined with our extensive knowledge of complex hybrid IT estates, are why customers are partnering with Kindrel to achieve their IT and business objectives as they address the larger forces shaping the evolution of IT, namely the adoption of artificial intelligence, which we know is top of mind for enterprise CIOs, technology skill shortages, the modernization needs to address aging infrastructure challenges, and cloud migrations. Let me share a few examples. In the healthcare industry, where digital applications are scaling at a remarkable pace and privacy regulations present unique challenges, modernizing IT environments and moving workloads to the cloud are particularly complicated. We've been advising two large healthcare companies throughout the migration of their complex platform-based IT systems onto the cloud, including their patient record systems. This migration work is strengthening the user experience for patients and caregivers while generating meaningful operating efficiencies for our customers. For a global auto manufacturer, we're using AI-enabled Kindrel Bridge to deliver real-time insights and automate processes in order to enhance day-to-day IT performance. This work is not just about IT, it's also producing efficiencies across the customer's manufacturing facilities. And we're working with a large multinational communications provider to define and implement their strategy to modernize their IT estate and migrate applications to the cloud with the goal of reducing energy consumption by about 70%. There are two key themes among these examples. Other new scope we're adding and other new customers we're bringing on. First, our capabilities and our technology alliances position us to do important work for important companies, many of which are household names. Second, the nature of the services we provide is evolving. Our independence is fueling mission-critical work that is more consultative, more multi-vendor, more hybrid, and more value-added, as we help customers address the trends shaping IT. And if you want proof, this quarter Kindrel Consult delivered its largest signings quarter yet, with double-digit constant currency growth in both signings and revenue. And through our alliances, we've generated more than $300 million of hyperscaler-related revenue so far this year, and increasing our current target for this activity to 400 million. Let me also emphasize that Kindrel is an AI beneficiary and AI enabler. As the largest infrastructure services provider in the world, we generate large amounts of data about IT systems. We're using artificial intelligence with this data in our Kindrel Bridge platform to identify application performance patterns, produce actionable insights, reduce required maintenance, and prevent incidents from occurring. And beyond our own use of AI, our customers know that their AI is only going to be as good as their data. So they're looking for Kindrel's expertise in how to architect their data to set the foundation for the investments they're making in AI and Gen AI. More generally, because we serve as an operator, an integrator, and advisor to our customers in their digital business transformations, we naturally find ourselves at the nexus of broader market trends. The unique combination of our advisory and engineering talent intellectual property, and vast amounts of operational data positions Kindrel as an essential business and technology services partner. We're accessing incremental market opportunities, growing our share of wallet with existing customers, winning new customers, and transforming Kindrel. As our business evolves and we move further away from our spin, our revenue mix will continue to shift to higher margin post-spin signings. This fiscal year, only one-third of our revenue is coming from post-spin signings. Next year, we'll move to half of our revenue from coming from post-spend signings, and in fiscal 2026, it will be roughly two-thirds. This inflection point, when our P&L is largely determined by our higher margin post-spend signings, will dramatically change our earnings profile. As I highlighted earlier, our forecast for fiscal 2024 now implies more than $360 million of adjusted pre-tax income improvement this year compared to last. And while our efforts to shed low to no margin revenue will continue to impact top-line growth this calendar year, we expect to deliver margin expansion and higher earnings each year with revenue growth returning in calendar 2025. As David will explain in more detail, the margins at which we're signing contracts and the other actions we're taking to increase our profitability have us on a path to deliver high single-digit adjusted pre-tax margins by fiscal 2027, and yes, The math associated with that is ultimately a billion dollars or more of adjusted pre-tax income with a high conversion of our net earnings into cash. We're making substantial progress, earning the trust and respect of our customers and partners through exceptional and reliable delivery. We're providing innovative solutions that drive real business outcomes and earning stronger margins in our ROI from our work. We're driving powerful business dynamics for value creation and we'll continue to be bold and ambitious about how we come together to deliver value with our partners for our customers. And with that, I'll hand over to David to take you through our results and our outlook.
spk13: Thanks, Martin, and hello, everyone. Today I'd like to discuss our quarterly results, the formidable 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 again have a lot of positive developments to share. Our third quarter results reflect strong operational execution and continued progress on our key initiatives. In the quarter, revenue totaled $3.9 billion, a 10% 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 continue to gain momentum in higher margin advisory services. Kindle Consult revenues grew 11% year-over-year in constant currency, which highlights how we're growing our share in this higher margin, higher value-add space. As Martin mentioned, consult signings grew even faster. This performance reflects our unique opportunities for growth in advisory services, due to our independence and our expanding alliances with third-party technology providers. Our total Q3 signings increased 13% year-over-year in constant currency, and fiscal year-to-date signings for January are up 4%. Among our practices, the strongest growth this year has been in security and resiliency and AppState and AI. Our year-to-date signings support our plan to return to revenue growth in calendar 2025 and fiscal 2026. Our third quarter adjusted EBITDA grew 6% to $615 million. As we've said previously, we had a tough comp in Q3 due to the exaggerated seasonality we saw last year, which included earnings from minimum annual revenue commitments. Despite the tough comp though, our adjusted EBITDA margin increased by 210 basis points year-over-year to 15.6%. Our continued margin expansion underscores our ability to drive meaningful profit growth in our business. Adjusted pre-tax income was $63 million, a $67 million improvement in profit year-over-year. Our continued progress on our 3As 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, apps data and AI, security, and other growth areas. More generally, as we look back on the quarter, we're elated to have delivered results that position us to exceed the full-year adjusted pre-tax earnings target that we've already raised twice 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 savings from advanced delivery by fiscal year end, and $400 million of cumulative annualized pre-tax benefit from our accounts initiative. Halfway through the year, we raised our targets for advanced delivery and accounts initiatives by $100 million each. And with the continued strong execution we delivered in the third quarter, we're now raising our full year target for alliances revenue by $100 million and are well-positioned to meet or exceed our targets for advanced delivery and accounts. Through our alliances, we're building the portion of our customer relationships that include cloud-based content. In the third quarter, we recognized more than $100 million in hyperscaler-related revenue, bringing our year-to-date total to more than $300 million. This surpasses our initial $300 million fiscal 2024 target. And because of this progress, we're raising our full year target for revenue tied to hyperscaler alliances to $400 million. Our hyperscaler certifications total more than 38,000, 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. We continue to identify and realize significant automation opportunities across our delivery operations as we increase service levels, reduce our costs, and incorporate more technology into our offerings. To date, we've been able to free up more than 8,500 delivery professionals to address new revenue opportunities and backfill attrition. This is worth roughly $500 million a year to us, representing a $75 million increase in our annual run rate this past quarter. Our accounts initiative has been and will continue to be a global effort focused on fixing elements of contracts with substandard margins. In the third quarter, we increased the cumulative annualized profit savings from our focus accounts by $75 million to $475 million. Our focus accounts program has been a galvanizing effort among Kindrel professionals around the world in order to repair hundreds of profit-challenged relationships collaboratively with our customers, and it has been a resounding win for us as a team. Successful execution of our three A's remains our fastest path toward achieving sustainable, profitable growth, and the progress our teams have made on these initiatives has been and is an outstanding source of value creation for Kindrel, our customers, and our shareholders. Turning to our cash flow and balance sheet, in the quarter we generated positive adjusted free cash flow of $348 million. Our gross capital expenditures in the quarter were $174 million, and we received $15 million of proceeds from asset dispositions. Working capital was unusually strong in the quarter, and we expect some of these timing benefits to reverse in the March quarter. Our CapEx is also back-end weighted this year. Our financial position remains strong, and we continue to expect that our full-year adjusted free cash flow will be positive. We've 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 December 31 was $1.7 billion. Our cash combined with available debt capacity under committed borrowing facilities gave us $4.8 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 $1.6 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 our $500 million term loan matures in November, so it now shows up on our balance sheet as a current liability. We intend to refinance this debt in the first half of calendar 2024, subject to market conditions. 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 3A initiatives, is significantly expanding our margins and will drive meaningful free cash flow growth. As a result, 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've delivered in Q3 and so far this year, I'm even more enthusiastic about how we continue to position Kindrel for future margin and profit growth. The December quarter was a continuation of us signing business with stronger margins, and as our business mix increasingly shifts toward more post-spend contracts, you'll see significant margin expansion in our reported results. In the middle graph on slide 12 of our earnings presentation, we've included a gross profit book to bill graph that accentuates how we've been creating and capturing value in our business. With an average projected gross margin of 26% on our $12.5 billion of signings over the last 12 months, we've added over $3 billion of projected gross profit to our backlog. Over the same period of time, we've reported gross profit of $2.8 billion. This means that we've been adding more gross profit to our backlog than our contracted book of business has been producing in our P&L. Having a gross profit book-to-bill ratio above 1 at 1.1 times is a measure of how we're growing what matters most, the expected future profit from committed contracts. And we've been doing this consistently over the last 18 months. I want to remind people who are familiar with our story and highlight for those just beginning to follow us that two years ago we laid out bold ambitions 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. Two years into this journey, our momentum clearly has us on track to achieve these goals. We're also driving growth in Kindrel Consult and among our global practices, which is incremental to the benefits coming from our 3A initiatives. And we're seizing 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 and tackling successfully is tremendous relative to our current margins. Progress on our three A's has been and will be a central source of value creation for Kindrel. I mentioned earlier that transforming focus accounts into higher margin relationships has been a big effort and big win for us. While pricing discipline is part of our approach, it is only a portion of our strategy. We're also expanding the scope of services we provide to our customers in order to strengthen our margins, and the growth in our hyperscaler-related revenues and consult revenues demonstrates this. We're removing low to no margin third-party content from our deals, which, as you know, impacts our reported revenue. And we're driving efficiency in how we provide services with advanced delivery and Kindle Bridge helping us reduce costs. In other words, turning our focus accounts into relationships that generate margins more like the blueprint portion of our revenues is a multifaceted, multi-year exercise that is about more than just pricing. I look at our progress to date as a good thing, but I also embrace the opportunity still available to us since the remaining focus accounts represent a significant opportunity to expand margins that is both specific to Kindrel and something we've proven we can execute. Our updated outlook is for adjusted pre-tax income to be at least $150 million. versus our prior outlook of at least $140 million. This increase implies at least 220 basis points of margin expansion compared to last year. We now expect our fiscal 2024 adjusted EBITDA margin to be at least 14.5%, which represents an increase of at least 290 basis points versus fiscal 2023. Our outlook for revenue continues to be a decline of 6 to 7% in constant currency. which translates to $15.9 to $16.1 billion based on recent exchange rates. 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 nine months, which is why the year-over-year revenue decline in the second half of our fiscal year is greater than in the first half. For the March quarter, we expect year-over-year revenues to decline 9 to 11 percent in constant currency, and for the revenue decline to be most pronounced in our U.S. and strategic markets segments, where our reduction of lower margin elements is most impactful. we expect adjusted pre-tax income to be positive in the quarter. The sequential quarterly comp from Q3 to Q4 is a tough one due to the contractual $50 million quarter over quarter increase in IBM software costs that we face. Year over year though, we expect our adjusted pre-tax margin to increase in the fourth quarter as it has in each of the first three quarters of fiscal 2024. As I mentioned, we expect adjusted free cash flow to be positive this fiscal year. We now project roughly $650 million of net capital expenditures in fiscal 2024. We estimate roughly $825 million of depreciation expense and $1.25 billion of amortization expense this year. We still expect about $300 million of cash outlays for separation-related work, primarily systems migrations, and for our workforce rebalancing actions that are driving significant cost savings. 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. To wrap up, our business model centers around providing mission-critical services to large, complex organizations that are dependent on technology in pursuing digital evolution. The mission-critical nature of what we do distinguishes us from other providers of IT services. Our scale, our know-how, our indispensability, and our freedom of action as an independent company have given us opportunities to become a more profitable business while continuing to serve our customers extremely well. We've been successfully capitalizing on these opportunities in ways that position us for profitable growth in the future. We still have much to do and a lot of additional value that we can generate. And our accomplishments to date, including in the most recent quarter, give us confidence in our ability to deliver continued substantial progress. With that, Martin and I would be pleased to take your questions.
spk08: We will now open the line for questions. As a reminder, to ask a question, please press star 11 on your telephone and wait for your name to be announced. To withdraw your question, please press star 11 again. We ask that you please limit yourself to one question and one follow-up. Please stand by while we compile the Q&A roster. Martin, are you all ready for your first question?
spk12: We are ready, operator. Thank you.
spk08: Our first question is from David Togut with Evercore ISI. Your line is now open.
spk14: Thank you. Good morning, and good to see the 13% year-over-year bookings growth in the quarter. Could you talk about the underlying strength in bookings, both at Kindrel Consult and at Alliances, and to what extent that strength is sustainable going forward?
spk11: Yeah, thank you, David. Obviously, I'll ask David to join me if he had anything to supplement my answer with. But a few things, I think, about what we saw in the quarter. Obviously, as you said, well, good growth got us back not only in the quarter, but got us back to to growth on a full year basis or a year to date basis. And I think what's important are a couple of things. As you know, we have a headwind in growing signings, which is because we're being selective about the content. Having said that, you know, we do have these growth factors that we've been talking about, including Kindrel Consult, including our alliance activity. which is, I think, demonstrative of the role we play in our customers' environments. And it shows how our customers trust us with their most challenging work. And the work we're doing in consult and the work we're doing with our partners is just evidence that the important role we play for our customers' future is now continues to play out, notwithstanding the headwind we have as we're more selective. It also reflects the capabilities we've been building over the last couple of years and moving into the bigger total addressable market that we've talked about since we were spun out As further signs, I guess I'll add one more data point, because while we have good growth in consult, also maintained good double-digit growth in the quarter and on a year-to-date basis, and good growth in the alliance activity, we also did see more larger deals. We saw 15 deals greater than $100 million through the end of the year, so the first nine months of this year, versus $8 deals greater than $100 million through the same time period the prior year. So, again, all evidence, I think, of the trust and the confidence that our customer base has in us, even as we've kind of worked through the headwind of being selective about content. David, anything you'd add?
spk13: Just to add that, you know, year-to-date, consults are on 14% of our revenue in the quarters, in the range of 15%. And that's really giving us confidence that we can ultimately move up, move ConsultUp to being 20% or more of our aggregate revenue.
spk14: Thank you, David. Thanks. Yeah, just as a quick follow up, if I could ask about the $348 million in free cash flow in the quarter. David, you called out some working capital benefits, which were mostly timing related, and it sounds like CapEx is more fourth quarter related. Would you still expect to be free cash flow positive in the fourth fiscal quarter of this year?
spk13: We expect to be free cash flow positive for the year as a whole, probably not in the fourth quarter itself. And as you mentioned, we had some working capital benefits that helped us in the third quarter, which made our free cash flow in the quarter particularly strong. And our capital expenditures are back-end loaded this year. There's going to be more of that in the fourth quarter. And then we have the usual March quarter seasonality where we have certain payments, annual, biannual payments for things like software that tend to go out in the first quarter of the year. So the March quarter is typically a tougher working capital and free cash flow quarter for us. but there's no change in our outlook, our expectation that we'll be free cash flow positive for the year as a whole.
spk07: Thanks so much. Operator, next question, please.
spk08: Our next question comes from the line of Tensin Wong with J.P. Morgan. Your line is now open.
spk01: Hey, thanks. Good morning. Good results here. I like the gross profit book-to-bill metric here, greater than one. I'm just curious, the risk of realization for that is what? Maybe can you go through that contract execution, things like pricing, delivery capability, things like that. I'm just curious about the realization risk of that book to bill.
spk13: Sure. Our experience is good in terms of realization associated with our book to bill. We do an analysis of contracts that we've priced that measures the actual realized profit compared to what we'd estimated. We call it our did versus bid analysis. And in the most recent version of that, most of the contracts we looked at averaged within a point of what we actually expected to generate. I think it was around seven-tenths of a point. So I think our realization of the signings and the gross profit associated with them tends to be very good. We have, I'd say, good visibility and good confidence with respect to it.
spk01: Perfect. Thanks for that, David. Just my quick follow-up, then. I think, Martin, you mentioned the 15 deals greater than $100 million, and I think Industry-wide, we've been hearing a lot of mixed results on the short-term projects, the discretionary spend. Your consult advisory business seems to be doing well. Just remind us maybe the difference here, and I know you're somewhat bringing that up to a good standard here, but are you seeing any impact from demand as we cross over into the calendar year here on the short-term project stuff?
spk11: Thanks, Tingen. Again, and we've talked a bit about this in the past, the nature of what we're consulting on is probably less opportunistic or less variable because we're consulting on the things that we run. We're consulting on infrastructure. We're consulting and helping our customers on securing their data, making their systems more resilient, making sure that the data is architected in a way that that they can get to it and protect it, et cetera, et cetera, et cetera. So, so the, the, uh, the mission critical nature of our run business is also, you know, I would say the mission critical nature of the consult business companies have challenges and it's not, you know, we're not helping with science experiments. We're not helping with, with sort of the nice to haves. We're helping with how do you make sure your infrastructure is secure, resilient, and able to meet the needs of the business. So I just think it's the nature of what we do that's different from a lot of others. And I think that's what drives, you know, Consult to be a solid double-digit performance. It's probably just unique to us. Understood. Thank you for that. Thanks, Denjen.
spk02: Operator, next question, please.
spk08: Our next question comes from the line of, Divya Goyal with Scotiabank. Your line is now open.
spk03: Good morning, everyone. Great quarter.
spk04: So Martin, further to this comment that you made, I was actually very curious to understand that how have these AI tailwinds been actually changing the way Kindles now interacting with the clients per se? Like in terms of your focus accounts, are they starting to prioritize Kindle and actually, have you been seeing increased conversion there? And for that matter, your Blueprint account, are you seeing increased conversion? And obviously, Kindle itself is working alongside the client. But help us understand how has AI been a driver of these revenues as well?
spk11: Yeah. So thank you, Divya. A couple of things. First, AI is both something we use in how we deliver our services. And Kindle Bridge has a massive machine learning model and more data than anybody else that helps customers get insights. As we said in our prepared remarks, we've got over 750 customers now getting insights from Bridge on how to optimize those systems. And what that work also allows us to do is then to help customers think through which leads, by the way, to consult opportunities for us. But it also helps customers as they think about now how they want to deploy AI. And many are now starting to move into Gen AI, obviously. The work that has to happen around Gen AI, the work that has to happen around any AI is all about how do you architect your data? How do you get your data organized? And even though it's in an experimental phase, the work we do tends to precede the science experiments that have to happen. So we're at the front end of what customers are thinking about as they start to explore either for their systems, mostly for systems of engagement, as they start to explore how to use their data to reach new customers, to reach their customers better. But this has a long, long tail to it. Even though we're at the front end, as AI becomes more used in systems of engagement and systems of record, which is where our mission critical work sits, I think we've got a very long tail to how our consultants and Kindrel Consult help customers. So this is a long secular trend that I think is gonna drive growth for quite a while for us.
spk04: That's very helpful. And just to understand, and a quick one here, Kindle is a very mission critical infrastructure services company to the global macro. And we've talked about this in the past, but how exactly does the global macro conditions impact you? And to what extent could they negatively impact you? Um, given the nature of work you do versus the application services companies that have been, um, indicating slowdown in growth and, um, a weak outlook for fiscal 2024, broadly speaking?
spk11: Yeah, look, we are what I would say is insulated to the macro, but we are, you know, the macro is the world we live in. It's the world our customers live in as well. So as their world changes, it will put different new pressures on how they run their infrastructure, what they might what they might experience or the direction they may want to go. So in the short term, we don't see much of an impact. As we've said in the past, we're fairly well insulated. But over the long term, as customers rethink the world, which leads maybe to industry consolidation, other things, we will experience that. But that's over the longer term. And again, in any macro environment, Our customer base and all customers are going to always be thinking about how do I take advantage of the innovation I see? How do I move into the world in order to serve my customers? And we just have to be able to keep up with them with the capabilities that they're looking for at any given time. But again, that's what we've been doing is helping them move to the future in whatever macro environment we happen to be in.
spk06: That's great, Martin. Thanks a lot for all the info.
spk11: Thanks, Divya.
spk06: Thanks. Brad, I believe we have one more question in the queue.
spk08: Our last question comes from the line of Jamie Friedman with Susquehanna. Your line is now open.
spk16: Hi. Good morning, and let me echo the compliments, good results here. I was wondering, David, if you could help us bridge between slides 12 and slide 7. In other words, how to think about the – to timing related to the gross profit book to bill as it waterfalls over to the pre-tax margin. Any comment on that would be helpful.
spk13: Absolutely. Thanks. And I think slide seven, the one that shows how our business mix is evolving, really does operate as the bridge here. And as a reminder, that's the slide that shows that this year only about a third of our revenue and therefore a third of our P&L is really being driven by post-spin signings that have these attractive high single-digit margins associated with them. And we're still in a situation where two-thirds of our revenue is coming from older pre-spin signings that really aren't generating significant profit for us. And the inflection point that's really important for us is next year moving to that mix of revenues being kind of 50-50 between post-spin and pre-spin. And the fiscal year after that, our revenues and our P&L for the first time really sort of being dominated by the post-spin signings. And what we expect that to translate into, and I feel we have good visibility around is the bars that you see on the right side of page seven, that as the more profitable signings, the more profitable book of business becomes a predominant part of our revenue, that really creates the opportunity for the margin improvement that we're looking for. And then by the time we get to fiscal 27, where 85% or so of our revenues are coming from the the business that we've signed post-spin rather than what we inherited, that's how we, you know, we deliver high single-digit margins. So this really, you know, the margins at which we're signing business just become a larger and larger part of our overall business mix. And by the time we get to, you know, fiscal 27, where it's 85% post-spin, that's how we see ourselves at high single-digit pre-tax margins in aggregate.
spk12: Yeah, I think that's well said.
spk11: I guess, you know, when I think about it as we get into next year, I think we've got still the headwind that we had this year, which we obviously have been able to overcome, and that's the software cost increase that IBM created in the spin. So that's the headwind. But the tailwinds we see, David said it well, we get more of our post-spin backlog that comes through We obviously get the full year benefit of everything we were able to execute this year and will continue to execute next year. So we'll get the period execution benefits from that. And then we also get a tailwind, I think, from lower depreciation as we get into next year. So. So, yes, we have headwinds as we go into it. David described that chart well, I think.
spk10: But we've also got some tailwinds as we get into the year.
spk16: And then for my follow-up, maybe for Martin, in terms of the projected revenue growth beginning in calendar 2025, how do you think about the factors that will help you stick that ever-important landing of actually growing? In other words, how much of that is impacted How much of that is under your own control? Is any of that at risk to discretionary or macro? How do you think about that?
spk11: Yeah, look, we have, as we've said a number of times, we have engineered a decline in our business. And I would say on the other side, where we focused on getting to growth, like Kindrel Consult and their alliances activity, we're growing quite well. And as I sit here today, while we have you know, many, many more quarters of signings to get under our belt. As I sit here today, I feel as good as ever that those two growth drivers, along with all the other things we're building our capabilities around, that they get us back to growth in the timeframes that we've said previously. With, as David said, well, the margin profile, as more of that comes through our P&L. So, as I sit here today, I still believe that our alliance activity, our Kindle consult. We've proven that we can grow where we want to grow. And we've proven that the customers are willing to and want to expand their work with us and their relationship with us, even as we engineer this decline. Now, the biggest chunk of that engineer decline is this fiscal year. As we move into next fiscal year, the engineer decline reduces. The OEM content becomes becomes sort of what I'll call a neutral, right? We've taken a ton of it out. It becomes a neutral going forward. We still have some more work to do on focus accounts, which will have an impact, but the bulk of it is in this fiscal year, and as we move into next year, then we'll have a reduced impact from that engineer decline and more impact from, more benefit from Kindle Consult and the Alliance's activity as it keeps going. So, I feel really good about where we are in what we've described now for, you know, a bit over two years about getting back to growth and calendar year 25 and driving the profitability that we've been talking about and converting that, you know, at a very high rate to cash. Got it. Thank you. Thank you. So, yeah. Thanks, Lori. So, thanks, everybody, for joining again today. We certainly appreciate the interest in Kindrel. Look, I got to tell you, I'm very proud of the progress this team has delivered and continues to execute on the strategy that we laid out, three A's plus plus. We're building this business the right way. We have the right strategy that is and can be and is being executed, and we have the right culture. So we, as a business, Kindrel continues to solidify its leadership position. We continue to strengthen the relationships we have with our customers and our partners. You can see that spread throughout the financials. And now as we, you know, in our third year, third calendar year as a firm, I remain as excited as ever about the opportunity as we keep serving our customers' mission-critical needs and keep developing new capabilities to bring them into the future. So thanks, everybody, for joining.
spk08: This concludes today's conference call. Thank you for your participation. You may now disconnect.
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