Good day, and thank you for standing by. Welcome to the Kyndryl's Fiscal Third Quarter 2024 Earnings Conference Call. At this time, all participants are in listen-only mode. After the speakers' presentation, there will be a question-and-answer session. [Operator Instructions]. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker, Lori Chaitman, Global Head of Investor Relations. Please go ahead.

Good morning, everyone, and welcome to Kyndryl's earnings call for the third fiscal quarter ended December 31, 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.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 now like to turn the call over to Martin. Martin?

Thank you, Lori, and thanks to each of you for joining us. Kyndryl 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, Kyndryl Consult and Kyndryl 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 Kyndryl'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 Kyndryl. As a result, we're building a strong track record of successful execution that is clearly visible in our results. Benefits from our three As 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 Gen AI. We've expanded our service delivery capabilities through Kyndryl Bridge. We're now performing over 1 billion automations each year, addressing risks…

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. Kyndryl 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 opportunity 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 through January are up 4%. Among our practices, the strongest growth this year has been in security and resiliency and App State 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.…

Operator?

Yes. Can you all hear me?

Now we can.

We will now open the line for questions. [Operator Instructions]. Martin, are you all ready for your first question?

We are ready, operator. Thank you.

Our first question is from David Togut with Evercore ISI. Your line is now open.

Thank you. Good morning. Good to see the 13% year-over-year bookings growth in the quarter. Could you talk about the underlying strength in bookings, both at Kyndryl Consult and Alliances? And to what extent that strength is sustainable going forward?

Yes. 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 growth on a full year basis or 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, we do have these growth factors that we've been talking about, including Kyndryl 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, 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 the 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 to add.

Just to add that year-to-date, Consult's are on 14% of our revenue in the quarter is in the range of 15% and that's really giving us confidence that we can ultimately move Consult up to being 20% or more of our aggregate revenue.

Thank you David…

Thanks. 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?

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 will be free cash flow positive for the year as a whole.

Thanks so much. Operator next question please.

Our next question comes from the line of Tien-Tsin Huang with JPMorgan. Your line is now open.

Hi, thanks. Good morning, good results. Just I like the gross profit book-to-bill metric here, greater than 1. 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?

Sure. Our experience is good in terms of realization associated with our book-to-bill. We do an analysis of contracts that we priced that we call -- 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 average within a point of what we actually expected to generate, I think, it was around seven-tenths of a point. So they're, I think, a realization of the signings and the gross profit associated with the -- tends to be very good. We have, I'd say, good visibility and good confidence with respect to it.

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 sort of 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?

Yes. Thanks, Tien-Tsin. Look, I think 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 they can get to it and protected, et cetera, et cetera, et cetera. So the mission-critical nature of our run business is also, I would say, the mission-critical nature of the Consult business, companies have challenges and it's not -- we're not helping with science experiments. We're not helping 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 Consult to be a solid double-digit performance. It's probably just unique to us.

Understood.

Our next question comes from the line of Divya Goyal with Scotiabank. Your line is now open.

Good morning, everyone. Great quarter. So 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 Kyndryl is now interacting with the clients per se, like in terms of your focus accounts, are they starting to prioritized Kyndryl? And actually, have you been seeing increased conversion there? And for that matter, your blueprint account. Are you seeing increased conversion and obviously, Kyndryl Consult acting in -- is working alongside the client, but help us understand how has AI been a driver of these revenues as well?

Yes. So thank you, Divya. A couple of things. First, AI is both something we use and how we deliver our services and Kyndryl 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 how to -- and which lead 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 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 -- to reach our 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 Kyndryl 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 understand and a quick one here. Kyndryl is a very mission-critical infrastructure services company. Do 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, given the nature of work you do versus the application services companies that have been indicating slowdown in growth and a weak outlook for fiscal 2024 broadly speaking?

Yes. Look, we are -- what I would say is insulated to the macro, but we are -- 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 experience or with 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. So -- but that's over the long term. And again, you -- in any macro environment, our customer bases 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 that's -- again, that's what we've been doing is moving -- helping them move to the future in whatever macro environment we happen to be in.

That’s great, Martin. Thanks a lot for all the info.

Thanks, Divya.

Operator, do we have one more question in the queue.

Our last question comes from the line of Jamie Friedman with Susquehanna. Your lines now open.

Hi. Good morning. Let me echo the complements 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 timing related to the gross profit book-to-bill as it waterfalls over to the pretax margin? Any comment on that would be helpful.

Absolutely. Thanks. And I think Slide 7, 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 one-third of our revenue and therefore, one-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, they really aren't generating significant profit for us. And in the inflection point that's really important for us is next year moving to that -- the mix of revenues being kind of 50-50 between post-spin and pre-spin in 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 a good visibility around is the bars that you see on the right side of Page 7 that has the more profitable signings, a 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, we're 85% or so of our revenues are coming from the business that we've signed post spin rather than what we inherited. That's how we deliver high single-digit margins. So this really -- 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 fiscal '27 where it's 85% post spin, that's how we see ourselves at high single-digit pretax margins in aggregate.

Yes. I think that's well said. 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 we'll 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 appreciation as we get into next year. So yes, we have headwinds as we go into it. David described that chart well, I think, but we've also got some tailwinds as we get into the year.

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 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?

Yes. 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 Kyndryl Consult and their Alliances activity, we're growing quite well. And as I sit here today, while we have 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 time frames 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 and our Kyndryl 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 engineered decline is this fiscal year. As we move into next fiscal year, the engineer decline reduces. The OEM content becomes sort of what I'll call it neutral, right? We've taken a ton of it out, it becomes a neutral going forward. We still have more -- some more work to do to -- on focused accounts, which will have an impact. But the bulk of it is in this fiscal year. And as we move into next year, then will have a reduced impact from that engineer decline and more impact from -- more benefit Kyndryl Consult and the Alliances activity as it keeps going. So I feel really good about where we are and what we've described now for a bit over two years about getting back to growth in calendar year '25 and driving the profitability that we've been talking about and converting that in a very high rate to cash.

Got it. Thank you.

Thank you. So thanks, also thank everybody, for joining again today. We certainly appreciate the interest in Kyndryl. 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 As 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, Kyndryl continues to solidify its leadership position, we continue to strengthen the relationships we have with our customers and our partners. You'd see that spread throughout the financials. And now as we -- 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.

This concludes today's conference call. Thank you for your participation. You may now disconnect.