Good morning, and welcome to the Kyndryl Fiscal Second Quarter 2023 Earnings Conference Call. Currently, all callers have been placed in a listen only mode. And following management's prepared remarks, the call will be open for your questions. [Operator Instructions] Please be advised that today's call is being recorded. I will now turn the call over to Lori Chaitman, Global Head of Investor Relations at Kyndryl. You may begin.

Good morning, everyone, and welcome to Kyndryl's earnings call for the quarter ended September 30, 2022, the second quarter of our fiscal year. 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, and these statements speak only to our expectations as of today. 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 December 31, 2021. Kyndryl does not update forward-looking statements and disclaims any obligation to do so. In today's remarks, we will 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 event, which are available on our website at investor.kyndryl.com. With me here today are Kyndryl's Chairman and Chief Executive Officer, Martin Schroeter; and Kyndryl's Chief Financial Officer, David Wyshner. Following our prepared remarks, we will hold a Q&A session. I'd now like to turn it over to our Chairman and CEO, Martin Schroeter. Martin?

Thank you, Lori, and thanks to each of you for joining us today. This is an exciting week for Kyndryl, it’s the one year anniversary since we separated from IBM to become the world's largest IT infrastructure services company, designing, managing and modernizing complex mission critical systems at scale for some of the world's largest organizations. Our transformation is well underway. We're executing on our strategy to drive profitable growth and I'm even more enthusiastic about the opportunity today than I was a year ago. We understand that the macro environment is top of mind for many people and we recognize the market uncertainties, currency headwinds and inflation pressure that multinational corporations including Kyndryl are facing today. For Kyndryl, the essential nondiscretionary nature of our business provides our revenue streams with some natural insulation to macro factors. Equally important, our execution on our AAA's initiatives, alliances, advanced delivery and accounts will deliver benefits we need to strengthen our overall business performance independent of the broader economy. On today's call, I'll update you on our strategy and how we're executing on our three days. Then David will share details on our quarterly results, link our recent progress to our financial goals and update our fiscal 2023 outlook to reflect currency headwinds and higher energy costs. As the world's largest IT infrastructure services company building on 30 plus years of mission critical experience, we entered our independence with expert people, long standing customer relationships and a ton of intellectual capital. We serve thousands of customers and operate in over 60 countries. Many of our customers have been working with Kyndryl for decades and we have top tier customer satisfaction scores as measured by Net Promoter Score. With our independence, we doubled the size of our addressable market, formed meaningful alliances with nearly…

Thanks, Martin, and hello, everyone. Today I'd like to discuss our quarterly results, our balance sheet and liquidity, why our AAA's initiatives are so important to us and our outlook. Our financial results for the quarter ended September 30, our fiscal second quarter reflect progress on our top line growth efforts as well as external factors such as currency movements and higher energy costs. In the quarter, we generated revenue of $4.2 billion, which represents a 2% increase in constant currency from our pro forma results a year ago. If you exclude two points of pass through revenue from our former parent, our Q2 revenues were consistent with the prior year quarters, demonstrating the progress we're making to strengthen our revenue trajectory. An important component of this progress is the sequential revenue growth we've been driving in our advisory services, which today are approximately 11% of our revenue and 19% of our total signings. These signings translate into revenue at a faster pace given that there are more in year project based work compared to our long term managed services activities. Adjusted EBITDA in the quarter was $428 million, this represents an adjusted EBITDA margin of 10.2%. The year over year decline in our adjusted EBITDA margin compared to pro forma 2021 results was primarily due to a number of exogenous and spin related items. Exogenous factors impacted margins by more than 4 points year over year, and includes some software licenses being treated as a subscription rather than an amortized expense and asset sale gain and accrual reversal in last year's September quarter, a dilutive impact from IBM related pass throughs and revenue timing, higher energy costs and currency. Adjusted pretax loss was $102 million, which is roughly one margin point softer than our March quarter and June quarter…

Thank you. [Operator Instructions] We'll take our first question from Tien-Tsin Huang with JP Morgan. Your line is open. Please go ahead.

Hi, good morning. Thanks for taking my question. Just wanted to -- maybe if you wouldn't mind rehash or break down the three point increase in the constant currency revenue outlook that'd be great. Thanks.

Sure. Good morning, Tien-Tsin, and thanks for the question. What we're seeing is a number of things positively impacting our revenue. First and foremost is Kyndryl Consult revenues being higher than we expected. And as we mentioned, those are growing at double digits in revenues and the signings have been well north of that. So that's been a positive for us. Another positive is actually coming from our focus account initiative. We had assumed in our initial projections that we would have some revenue loss associated with revising the relationships and working with -- and working on the focus accounts. And so far that hasn't really materialized. It's been less common play for us to run with the focus accounts rather than expanding scope and improving margins that way. We've also picked up a little bit of incremental pass through and OEM resale revenue compared to our projections. And so that's probably about a quarter of the pickup that we had. And then the last piece that's impacting us is that, we are getting some inflation adjustment revenues. So as you know, we've got provisions in various contracts that adjust based on wage inflation or other factors and that's created some additional revenue for us as well. But in the scheme of things, that probably works against us, because we don't fully -- we don't have full offsets for inflation as we look across our entire contract base, but we are seeing a partial offset, some mitigation through those provisions in our contracts. That's really what's driving it. And I would say we're particularly excited about the Kyndryl Consult growth that we're seeing across our geographies.

Yes. Perfect. That's great to hear. So maybe as my follow-up I'll ask on Kyndryl Consult. It's -- as you called out strong bookings there as well, performing a little bit better double digit growth, et cetera, how would you characterize your investments to want to grow that? I mean, should we think about that as tip of the spear type of work that can drive more follow on business for broader Kyndryl? Is there more expansion potentially in other geographies, for example? Just trying to better understand where the strategic fit is and one growing that business?

Yes, sure. Thanks, Tien-Tsin. It's Martin. Thanks for -- like David said, thanks for joining and these are great questions. So look, we do think of Kyndryl Consult as a lead into fueling our managed services businesses as we've -- as you know and we've spent time on this. We are underweight in the advisory portion of our business at only about 10% relative to the opportunity we see in the marketplace. And then opportunity is very much global. It's one that we think will play quite well everywhere. So our focus here and we've been clear we think we can grow this advisory business Kyndryl Consult to be probably half as big again within our own revenue stream in the medium term. And it is a terrific pathway for us to also to supporting that managed business. So it's gone very well. We have been able to expand the relationships we have with our customers. They do trust us to run their most important systems. And so therefore, the obvious opportunity for us is to help them more broadly as we build out our practices. And this is one -- I would also say it's one where -- this was an under -- sort of an under tapped, under leveraged opportunity pre spin, because the business was very focused on building the managed side as opposed to the advisory side. So this is a very natural fit for us. It's global to answer your where and it has -- so it's part of our return to growth, but also has very appealing margin characteristics. So it's a very logical play for us.

That's great. Thanks and good results in there for sure in the areas you can control. Thanks.

Thanks, Tien-Tsin. Operator, next question please.

We'll go next to Millie Wu with Evercore ISI. Your line is open. Please go ahead.

Hi. Thanks for taking the question. This is Millie Wu on for David Togut from Evercore. So first question about the management, given the change in macroeconomic environment, what are you seeing in terms of changes in demand for KDs service lines? And in particular, which segments do you expect to be more resilient than others?

Yes, good. Millie, thank you for the question. Thanks for joining. Look, for us a couple of things to keep in mind. As we noted in our prepared remarks, the essential sort of non-discretionary nature of what we do insulates our revenue streams from big swings in demand. And then -- and I think it’s important then also to add to that the position we're in creates I think a set of idiosyncratic, both opportunities and -- I’ll call it idiosyncratic tailwinds and idiosyncratic headwinds for us. On the tailwind side, look, as I just mentioned Tien-Tsin and David talked about as well, demand for our Kyndryl Consult, our advisory business is very strong, very solid revenue opportunities. And that converts much more rapidly into revenue than a typical longer term managed deal. So demand is strong for our advisory business. And as we move in and really build out these relationships with our new alliance partners, you can see, we're well positioned to sign $1 billion this year against those hyperscalers alone. So really -- but I think both of those, our position in the marketplace plus our relatively new alliance partner says that the opportunity that we have and the demand we see on the tailwind side is probably idiosyncratic to us. On the headwind side and you can see it in a number places. On the headwind side, advisory constructs tend to be shorter tenure than managed services constructs. So while we see what David noted in his prepared remarks, we see good annual contract value growth in revenue and gross profits for our advisory business. We also know that they're shorter tenors, so they don't produce the same kind of a signings number that a managed services would. But we're focused on that ACV. We're focused…

Thank you so much.

[indiscernible] Do you have another question or operator we can move to the next question. Thank you. Operator?

We'll take our next question from Jamie Friedman with Susquehanna. Your line is open. Please go ahead.

Hi. Good results here, guys. Just wanted to ask, first of all, Martin, it's roughly one year anniversary of the company as a separate public entity. So if you could share with us what's surprised you over the last year? What has delighted you? What's frustrated you? Any perspective on the one year journey would be great.

Yes. Well, thank you and thank you for your comment about the results we feel as well. We feel like we're making great progress here and we've got a very clear I think strategy on how we get revenue back to growth, how we improve gross profit. So we feel good about the progress. Look, this has been -- this has been a wonderful journey of a very important business to how the world works. The Kyndryl’s around the world have remained energized about where we're going and have been completely focused on continuing to deliver every day to customers, because we know that this journey and all the things that we will execute in the future rely on us continuing to deliver every day for the customers. So I've been amazed by the depth of our technical talent. I've been amazed at how quickly our teams are reskilling and how they want to move into the future technologies with our customer. We've all been, I think, been -- I wouldn't say pleasantly surprised, we've all been encouraged by all the customers on the journey with us. It's been a terrific year of progress in keeping the customers -- keeping our customer base with us. And at the end of the day, I guess my one reflection, my one comment I'd add on my observations. This is as much a culture journey for this company as anything else. And yes, the alliances that we've built are really important and the new announcements we've made around bringing innovation to the market like Kyndryl Bridge and new design capabilities like Kyndryl Vital and obviously creating additional value with Kyndryl Consult. Those are all really important, but we are also in the midst of a very important culture journey and we're also in the midst of a very important transformation for how we run our business. So while, as you know, tomorrow is the one year anniversary, so we are not only one year old, but we're also halfway through our transition to service agreement period with IBM. We have two years to get off those TSA. So there is a ton going on on how we bring innovation to customers. There's a ton going on on how we built skills to help integrate other technologies with our customers. All that's quite exciting, but we're also going through here a substantial cultural transformation and a substantial transformation on how we work. And that is -- that's a heavy lift. That's a lot to get done. And the teams are doing a wonderful job as we reshape almost not everything, but almost everything about how we operate. So this has been a wonderful journey. Hopefully that gives you a sense of how excited we are. Hopefully that gives you a sense of how much progress we feel like we're making and then we've got a very clear path to turning around this business.

Yes. That’s encouraging. And if I could just follow-up about the Japan market. I know you could probably spend a whole session on it, but it's one that I'm less familiar with, although Accenture talked about it a lot. So, I think your growth there was really exceptional. It's a big market for you. What at a high level is different there than, say, elsewhere? Any context on Japan would be helpful, because I'm not sure most of us on this call are that familiar with that end market.

Yes. Look, I mean, I'll ask David if he has anything to add to my answer, but I guess the thing to note about the Japanese market is, it is a market that has evolved more rapidly than others into a services led kind of a market. And one of the reasons we are -- one of the reasons it's our second biggest country and one of the reasons that we do so well there is because we built terrific services capabilities for the biggest companies, the banking systems, the manufacturers, et cetera, et cetera. So for us, given the nature of the work we do, for us it's a business that where we have a wonderful reputation of being able to do mission critical with the companies that really matter and that drive their economy and it's an economy that is very services oriented and likes to consume things on a services basis. So this is a good long term opportunity for us because I think that services orientation that we see in Japan continues to evolve and continues to get stronger. So it gives us an opportunity to really do what we do well, which is both integrate others technologies where -- in a place where they don't want to consume it as a product, they really do want to consume it as a service, it gives us a chance to integrate and it gives us a chance to bring them some innovation as they evolve, as they rethink their business model. So it's big because of the nature of the work we do, it's big because of the role we play and it's big because it's evolved more rapidly as the services led consumption model.

Thank you.

Thanks Jamie for your question. Operator, can we take the next question please?

We'll go next to Divya Goyal with Scotiabank. Your line is open. Please go ahead.

Good morning, guys. Nice quarter there. I just wanted to get some color -- sorry about my sore throat there, but I just wanted to get some color on, say, the macroeconomic headwinds overall. From a debt standpoint, I know David mentioned that the maturities are out there, long out there, but from an interest standpoint how does that affect your EBITDA margin -- sorry, EPS -- your net margins basically is what I want to understand.

Sure. I would say our interest costs are essentially fixed and we're not seeing impacts from higher interest rates in our numbers. And I think it would be a -- it will still be a couple of years before we need to refinance any of the debt that we have outstanding. So macro in terms of interest rates really isn't having an impact on us. Where we are seeing macro impacts is, as we mentioned, will be in the area of currency, particularly because we have both earnings translation as well as dollar denominated costs in various parts of our business. We're seeing macro or exogenous impacts from higher energy costs. And that's primarily true in the US and in Europe and in certain parts of Europe, in particular, where electricity costs for data centers are up very significantly. And then third is, as Martin mentioned, the macro effects in terms of demand for our services, we're really not seeing significant impacts there. There continues to be good demand for services, we think our business is resilient and fairly insulated. And we feel the general customer demand remains strong and we can benefit from the idiosyncratic opportunities that are available to us as an independent company to be able to grow even in an environment that -- where there's a lot going on from a macro standpoint.

Thank you, Divya.

That's helpful color. If I can add one more question there. I just wanted to understand from a growth standpoint with your hyperscalers and, like, the other relationships broadly beyond IBM. Are you focused mostly on internal sales growth initiatives? Or would you consider M&A at all in, say, the future years as your avenues for growth?

Yes, it's a good question. It's Martin. And look, at this point we have a real focus on getting our teams reskilled, that's working really, really well. We also have, obviously, as we make this place -- as we get this place humming, of course, we'd have an opportunity we think to add to that. But at this point, we stay focused on executing the place we've called. And keep in mind that among the big bets we're making is a bet on our existing customer base and really staying focused on those relationships. And so, we have the skills we need that allows us to grow pretty fast in this area. You can see that from the signings growth and you can see that from the stronger revenue performance here. And so we're still focused on executing what we have in front of us. But of course, over time there may be something that can help us accelerate that. But for now, we're focused on executing the play we've got.

Excellent, Martin. Thanks, guys.

Thanks, Divya. Operator, I think we have one last question.

We do. We will go to Bill Cunningham with Deutsche Bank. Your line is open. Please go ahead.

Hi, good morning. Can we talk about employee retention. If you could remind me just quickly how you guys measure employee retention and how you're doing on that?

Sure. So, our employee retention has been what I'd say at a global level slightly under -- slightly under what we see in the industry, right? But now the retention and -- well, I should say the other way. Our retention is slightly above industry. The losses are slightly below industry, sorry about that. So it's a very local – it tends to be a very local discussion. There is no one global labor market. So when we look at, for instance, our labor pool in India, our retention rate is above -- slightly above market there. But then you get into discussion very quickly of what's happening in Bangalore and Hyderabad and Delhi and Mumbai. And again, in each of those places we're doing well in terms of retaining talent and we're doing well in terms of attracting talent. So when we look at the selectivity that we can have, I give tremendous credit to not only the marketing team for creating a brand that has really gotten people excited. But I give a lot of credit to our alliances team who has moved us into this much broader ecosystem. I give a lot of credit to our local leadership that's created a lot of energy and obviously the nature of the work we do is a big appeal. So, while our retention rates are slightly above -- slightly better than what we see in the industry even as you start to deconstruct it into what's happening locally. We're also able to attract and be very selective on our hiring. And then finally, I mean, I used India as an example, but similarly what we see where we have big delivery centers in Eastern Europe and in other parts of the world. Similarly, our retention rates are quite good. And again, slightly better than market and our ability to attract talent is very high and we can be very selective. In fact, now that we've built the brand I'd say that our independence is a massive tailwind for us to attract talent. For a number of reasons, one, the ability to play in a broader ecosystem is really -- it's meaningful to people, it's meaningful to how they think about building their careers and their skills. So that's a huge tailwind. The nature of the work, as I said, we do is always been very important. So that continues, but our conversion, our shift toward focusing on investing and focusing on being not just integrators, but innovators is also a pretty substantial talent pool. So we built the brand to a spot where we are now well known, people know what Kyndryl is. They know what Kyndryl does and so we've overcome that sort of those early challenges of coming away from the IBM brand. And now everything we're doing is a tailwind to attracting talent and we've had very good success in bringing people on.

Okay. That's helpful. And just a real quick follow-up, if I may. I appreciate -- certainly appreciate the very consistent message that you guys have had in terms of credit ratings, liquidity, making that a priority. But I guess I'd ask the question, open market debt purchases, is that something that you guys have done the work on? And possibly talk to the board about? Thank you.

This is David. We have done the work on that and looked at that. And as we look at the things we do feel the debts certainly attractively priced. But our focus right now is on maintaining liquidity in this environment and making sure we're well positioned from that perspective going forward. So it's not something that at this point we're planning to pursue, but it's a sort of thing we definitely look at.

Okay, terrific. Appreciate the time guys. Thanks.

Thank you, Bill. Let me turn the call back to Martin.

Thank you, Laurie. Thanks everyone for joining us today. Look, since the last time we had a call plus or minus 90 days ago. I'd say really good progress that we see on the AAAs and positions us well for what we said we get done this year. You saw us in the last 90 days announce really three exciting announcements that are going to be a big part of our future around Kyndryl Bridge, Kyndryl Vital and Kyndryl Consult, all three exciting. And then we also know that now IBM has gotten its shares back into the market, so that overhang is gone. And we're looking forward to a big second half of our fiscal year as we continue to execute and stay focused on our customer base, stay focused on building the skills that our customers are asking us to have for them and delivering every day, so we maintain their trust. So it's been an exciting 90 days and we look forward to talking to you in another 90. Thanks everyone.

Great. Thanks Martin. Operator, I'll pass the call back to you.

Thank you. Ladies and gentlemen, this concludes today's Kyndryl second quarter 2023 earnings call and webcast. You may disconnect your line at this time and have a wonderful day.