Good morning, and welcome to the Kyndryl Fiscal Third Quarter 2023 Earnings Conference Call. [Operator Instructions] Please be advised that today's call is being recorded. I would now like to turn the call over to Lori Chaitman, Global Head of Investor Relations at Kyndryl. Thank you. You may begin.

Good morning, everyone, and welcome to Kyndryl's earnings call for the quarter ended December 31, 2022, the third 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'll also refer to certain non-GAAP financial measures. Corresponding GAAP measures and a reconciliation of non-GAAP measures to GAAP measures for historical periods are provided in the presentation materials for today's 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'll hold a Q&A session. I'd like to now turn the call over to Martin. Martin?

Thank you, Lori, and thanks to each of you for joining us today. Kyndryl is continuing to drive progress both as the world's leading provider of IT infrastructure services and as an independent public company. On today's call, I'll update you on our strategy and the meaningful progress we've made on our AAA initiatives, Alliances, Advanced Delivery and Accounts. David will then provide you with a more detailed review of our financial results and discuss our full year 2023 outlook. Our transformation is well underway, and I'm proud of what our teams have accomplished. The essential nondiscretionary nature of our business provides our revenue streams with some natural insulation to macro factors. As a result, demand for our services remains stable across the markets we serve. Equally important and independent of the broader economy, our continued execution on our three-A is delivering the benefits we need to strengthen our overall business performance and drive us to profitable growth. Our continued progress, combined with the nature of our business, should ultimately allow us to regularly return capital to shareholders. I'll circle back on this topic in a few minutes. It's been about 15 months since we became an independent company and the world's largest pure-play IT infrastructure services provider. We employ nearly 90,000 people. We operate in over 60 countries, and we serve thousands of customers. We address a large and growing market through our array of practices and services offerings. With 30 years of mission-critical experience, we have unmatched technical expertise in managing complex hybrid IT environments for large organizations. And in our business, scale matters. It gives us the ability to invest in leading technology, advanced delivery and automation, enabling us to expand our competitive advantage as well as our comparative advantage over in-sourced infrastructure management. In this environment,…

Thanks, Martin, and hello, everyone. Today, I'd like to discuss our quarterly results, our balance sheet and liquidity, the importance of our three-A initiative and our outlook. Our financial results for the quarter ended December 31, our fiscal third quarter, reflect progress on our top line growth efforts, external factors such as currency movements and sequential margin expansion. In the quarter, we generated revenue of $4.3 billion, which represents a 2% increase in constant currency from our pro forma results a year ago, led by 19% growth in Kyndryl Consult and increased seasonal factors this year, including amounts related to customer contracts with minimum annual revenue commitments and seasonal variances in volumes. Demand for our services has remained resilient amid increased global macro uncertainty. Kyndryl Consult signings and revenue were both at record levels, with Consult representing 20% of our total signings and 12% of our total revenue. Consult signings translate into revenue at a faster pace, given that the more in-year project-based work compared to our longer-term managed services activities. Adjusted EBITDA in the quarter was $580 million. This represents an adjusted EBITDA margin of 13.5%. The year-over-year decline in our adjusted EBITDA margin compared to pro forma 2021 results was primarily due to currency, partially offset by higher revenue and benefits from our three-A. Adjusted pretax loss was $4 million. Currency movements had a negative year-over-year impact of $90 million on adjusted pretax income. As we've mentioned before, currency is having a significant impact on us because we have dollar-denominated costs in our global operations in addition to having international earnings. And our currency hedges in various contractual protections haven't fully offset the effects of the unprecedented dollar strengthening that occurred in 2022. Higher revenue and progress on our three-A helped to offset currency impacts and inflationary cost…

[Operator Instructions] We'll take our first question from Tien-Tsin Huang with JPMorgan.

I want to ask on the signings front. David, you were just commenting on that. The signings were ahead of our expectations here. So can you maybe just elaborate on the better margin profile of the deals side? I know David just went through some of that. But I'm just asking because we get questions from investors all the time about clients focusing on cost cutting. So what does that mean for pricing, et cetera, but it sounds like you're getting better pricing and embedded delivery. So can you just square that for us?

Sure, Tien-Tsin. That's exactly right. On the signings that we have, the over $3 billion of signings in the quarter, we're seeing a mix that's similar to our overall business. So far this year, roughly 60% of our signings have been in blueprint accounts, about 40% in focus accounts. And what we're -- as I mentioned, what we're doing is keeping the blueprint accounts similar to where they've been, maybe up a point or 2 and really driving major progress on the focus accounts. And the way we're getting there is by running the plays, as we've called them, that we want to have to make our focus accounts better. It can involve expanding the scope of relationships, having more consult business associated with them, sometimes taking elements of scope out that aren't economic or that won't be economic for us as well as adjusting pricing to get there. And the combination of those actions is producing exactly the sort of impacts we want to have on the margins associated with these accounts. In fact, one of the things we're looking at and tracking internally is how much year 1 gross margin and how much aggregate gross profit we're signing on our -- on the new contracts that we bring into the poles and add to our backlog. And we're really excited about the gross margin, the gross profit that we're adding with our sales and renewal activities.

All right. Great. Maybe my follow-up, I'll ask on the outlook. You did raise your revenue outlook by $500 million. The margins are the same. How much of the raise in the revenue was from upside to the third quarter versus a raise in the outlook, I heard Consult was doing quite well. And maybe just any comments on gross margin, which was quite strong in the third quarter. Curious if you're thinking on gross margin in the fourth or ahead has changed. I know it takes time to feather in the gross margin changes from signings, but I figured I'd ask it up front here.

Yes. When you look at the revenue raise, the constant currency revenue increase was about 0.5 point at the low end, the high end and the midpoint. So the majority of the increase is in the absolute dollar forecast of revenue is due to currency, but we're seeing about a 0.5 point increase due to operational activity. I would say a fair amount of that was in the third quarter. But the Consult piece, we expect to play out and favorably influence the fourth quarter as well. The Consult signings have been really strong this year, and that should benefit us in the fourth quarter and even as we turn the page into fiscal '24. I think the margin elements associated with the signings that we've had will come in over time. Some of the Consult business tends to turn into revenues faster, and those margins will come through. On the flip side, when we extend a managed services contract, sometimes that actually has 6 or 12 months to run on the pre-existing contract. And that's often the piece where it's hardest for us to increase the pricing. We end up focusing on the pricing over the duration of the contract extension. So if we have to sort of continue or near continue the pricing that's already in place, we'll end up getting some more of the aggregate margin in the later years or the non-first year of the -- of that contract extension. And that's really why the margin improvement associated with signings layers in over time.

The other thing, Tien-Tsin, thanks for joining this morning. I would add to David's from a -- at a high level, I think what to me is particularly encouraging, and I've been very impressed with how much this team has gotten done in a short period of time. We have brought high-value offerings to market that really reflect where our customers want to take us, where they want us to help them. And so what you're seeing here is a lot of momentum on the signings line because of the role we play in these environments, combined with the work this team has done in creating high-value offerings in the practices that we're taking to market. So this -- as David said, well, these show up in the P&L over time, but this momentum is continuing to build as we get ready to get back to consistent revenue growth. And as David pointed out, if we just had in the P&L, what we signed now, we'd already be at -- what we have recently signed, we'd already be at a really good profit margin relative to today. So a lot of what you're seeing is the result of a team working very quickly. Given the role we play in our customers' environments, very quickly to retool, bring to market higher value offerings that make us a solid part of our customers' future. And that momentum, I expect will continue.

Operator, do we have another question in the queue, please?

We will take our next question from Jamie Friedman with Susquehanna.

Nice results here. Martin, in your prepared remarks at the beginning, you had said something in the effect of the business being naturally insulated to macro factors. In a macro so topical, Martin, I was hoping you could elaborate on that comment?

Sure. Sure, Jamie. So look, the role we play in our customers' environment running mission-critical systems does naturally insulate us from sort of the highs and lows, if you will, of a lot of economic activity at the end of the day business. And remember, we serve the most important companies on their most important mission-critical processes. These businesses have to stay and run their infrastructure 7 days a week, 24 hours a day. That's the nature of what we do. And so while customers may have a different view of their economic situation going forward, they still have to run their infrastructure. And in fact, as the economy's volatility -- as our customers start to plan for that volatility, we sit right at the sort of the heart and the center of how they can be helped most because they look to us to help them become more efficient. They look to us to help them optimize, all of which helps them deal with the economic realities of their customers, their end users or the markets in which they operate. So we have a natural insulation because of what we do. And a really -- I think a really positive way for us, we tend to thrive in environments where they get really focused on optimizing, they get really focused on productivity, because that's what we do for a living. So this is a good environment, a good demand environment for us. Stable because of what we do today, but a set of capabilities and offerings that can help them navigate what could be a more volatile economic environment.

Got it. And then for my follow-up, David. The Slide 18 is really quite innovative. And -- it's really a good practice. So this is the one where you're talking about Blueprints versus the Focus accounts. And I apologize, I don't know this if you disclosed it, but what percentage now of the Focus accounts have you remediated tried to reprice? And -- or if you have not disclosed it, is it possible through the disclosures you have to back into it in some way?

Sure. Thanks for the comments on Slide 18. I think it's really an important one. And what we really wanted to highlight -- one of the things we really wanted to highlight on this call was the real progress we're making in signing or extending Focus accounts, amending those relationships, in a way that is substantially changing the profitability of Focus accounts, and we'll substantially change it going forward. I think it's a really important proof point of execution by our team on the strategy we laid out. The way I would think about Focus accounts is that a lot of these are multiyear managed services relationships and working through the portfolio of most of the Focus accounts is going to be a 4-year exercise, I think, with maybe a little bit of a tale of a few longer-term accounts that are on there. And we're 9 months into that 4-year exercise. So that would -- the math associated with that would be 20-ish percent. I think there are 2 additional things going on. First, the first few months of that, it's a ramp-up period associated with it. And as a result, we may not have had a full 9 months of progress there. On the flip side, we are finding opportunities to make progress on Focus accounts even before they come up for renewal by adding scope, by adding consult business in there, and that's going to be helpful to us. And I think that puts us in a position where, over the next 12 months, the opportunity in front of us is to make ideally an outsized amount of progress relative to the overall 4-year play that we're going to have.

Operator, do we have another question in the queue, please?

We do have one final question from Divya Goyal with Scotiabank.

Great quarter. Just talking about the Focus accounts and the Blueprint accounts, I actually was wondering if you could give some color on the specific market, if that is one of the areas we could talk about, where the Focus accounts are somewhat like -- where they're kind of growing? Because when I look at your EBITDA margin, U.S. is in a good shape. It's the principal markets that need a little bit of margin expansion. So would your Focus accounts be in those markets or would that be a thing for later?

Divya, thanks for calling. Look, the Focus accounts are kind of spread around the world. There's not one location where I'd say that we have -- the few it is, it is pretty well spread. So we have opportunity in each of the markets to improve our margin profile. Now having said that, with them spread, we do have a slightly disproportionate share in Europe, which is what you -- which was a big part of what sits in those primary markets. So slightly more, but nothing that says we don't have opportunity everywhere. As for sort of the other view of markets, there's obviously a geographic view, right, the country view. But the other side of this, and David talked about this, I thought quite well, the offerings we're bringing in are reflective now of the value we're creating in spaces like cloud management, in spaces like security and resiliency, in spaces like data applications in AI. So the country is pretty spread slightly disproportionately heavier in Europe and other places. But what we're bringing into these relationships in this -- in a hybrid cloud world, is around the places our customers are going. And now we're getting paid quite well for the value we're creating in, again, data and AI, security and resiliency, et cetera, et cetera, et cetera. So hopefully that adds a little color for you.

That's helpful. We look forward to the progress. If I can shift some gears here and ask a question on your overall debt profile and your expected leverage levels, that would be helpful here.

Sure. Our net debt right now is around $1.2 billion, a combination of $3.2 billion of debt, minus $2 billion of cash on the balance sheet. And as we think about it, we really -- we'd like to keep our net leverage in a range of 0 to 1x EBITDA. We're well within that range right now, and we think that's appropriate for the business, particularly now while -- during a period of time, while our margins are still a bit challenged and where we need to make progress. So we've been targeting 0 to 1x leverage and remaining investment grade and continuing to improve our credit profile over time is very important to us.

All right. Let me -- sorry, operator. Let me just thank everybody for joining us today. As you can tell, I hope from our prepared remarks as well as from the Q&A, we've made an enormous amount of progress in a relatively short period of time, both with the three-A initiative as well as what we've talked about as well in -- for the last year, the plus-plus, which is getting our consulting business to grow much, much faster, which is being successful. And focusing, obviously, on expense management as we retool how we do our work and put contemporary systems and contemporary tools in place. So I feel as confident as I ever have, given all the progress we've made. We are all excited about the opportunity we see ahead. And the role we play in the world in serving our customers' mission-critical systems is one that -- regardless of the economic environment, is one that is going to need Kyndryl. So we're excited about the future. Again, thanks for calling. And operator, I'll turn it back to you.

This concludes today's Kyndryl Third Quarter 2023 Earnings Call and Webcast. You may disconnect your lines at this time, and have a wonderful day.