KD 2023Q4

Good day and thank you for standing by. Welcome to the Kyndryl Fiscal Fourth Quarter 2023 Earnings Conference Call. At this time all participants are in a listen-only mode. After the speaker’s presentation there will be a question-and-answer session. Please be advised that today’s conference is being recorded. I would now like to hand the conference over to your host today, Lori Chaitman, Global Head of Investor Relations at Kyndryl. Please go ahead.

Good morning, everyone and welcome to Kyndryl’s earnings call for the fourth quarter and fiscal year ended March 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, 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. 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 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 will hold a Q&A session. I'd now like to turn the call over to Martin.

Thank you, Lori, and thanks to each of you for joining us today. I am enthusiastic about all that we at Kyndryl have accomplished in our first full fiscal year as an independent company, and I could not be more proud of our teams around the world. We delivered solid fourth quarter results exceeding our recent guidance. We exceeded our year one targets for all three of our Alliances, advance delivery, and accounts. We're solidifying our leadership position in mission-critical IT services and we are signing new contracts that will drive margin expansion going forward. In short, we are taking full advantage of the new freedom associated with our independence and autonomy. We've proven we can deliver on ambitious plans to transform and strengthen our business. This gives us tremendous confidence as we look ahead to fiscal 2024 and beyond. On today's call, I'll update you on our strategy, on the remarkable progress we've made to date on our three A's initiatives, and on the opportunities we see ahead. David will then review our recent financial results and discuss our fiscal year 2024 outlook. Just over a year ago, we introduced our three A's, and since then, we've successfully executed each of these initiatives and exceeded the year one milestones that we laid out. We've reshaped our business through our global practices and Alliances and we've created new avenues for delivering higher value services to customers through Kyndryl Consult, Kyndryl Bridge, and Kyndryl Vital. We're building resiliency and productivity through Advanced Delivery and we're fixing focus accounts. We're expanding our capabilities across our six global practices from cloud, core and security to network, data, and workplace services. And along the way we've also made great strides in creating a services-oriented culture, one that is flat and fast and focused on Kyndryl’s and our customers' shared success. I can say confidently that we have laid a solid foundation and this year our fiscal 2024 will be a year of acceleration. We will continue to execute our strategy, deliver on cost optimization, and serve even more of our customers' needs. Our efforts will strengthen our overall business performance and drive meaningful margin expansion, putting us on track toward our aggressive medium-term transformation goals and setting us up to deliver more value to our customers and our shareholders. Let me start with our progress on our three A's initiatives which were at the heart of our efforts in fiscal 2023. Through our Alliances, we delivered $1.2 billion in hyperscaler signings, exceeding our $1 billion target for this brand new line of business by about 20%. We've expanded the portion of customer relationships that include hyperscaler related content and we've also continued to increase our hyperscaler certifications to 35,000, more than double where we were a year ago. Our Advanced Delivery initiative is transforming the way we deliver our services with automation tools and resources. To date, we've been able to free up more than 5,500 delivery professionals to address new revenue opportunities and to backfill attrition. As a result, we're generating annualized savings of approximately $275 million, well above our $200 million year-end objective. In our accounts initiative, we're aggressively addressing elements of our business with substandard margins and we're now realizing approximately $210 million in pretax benefits a year, surpassing our $200 million fiscal year target. Each quarter there are more customer examples that demonstrate our team's successful execution on our three A's. The underlying theme among them is that our combination of Alliances and our expanded capabilities, including Kyndryl Consult, Bridge, and Vital is resonating with our customers and providing Kyndryl with new revenue streams and higher value opportunities. For instance, we recently revamped our scope of work with a longstanding global communications customer by leveraging our relationship with a hyperscale partner. This resulted in an expanded multiyear contract valued at more than $100 million that incorporates Kyndryl Consult and many of our practices including cloud, security, digital workplace, and ongoing mission-critical managed services. Under this contract, we'll accelerate our customer’s digital transformation in roughly 100 countries while also driving significant efficiencies for their operations. As a business, we come to the table with great attributes, doing mission-critical work, possessing inherent customer stickiness, generating recurring revenue, and having industry-leading scale. In just over a year as an independent company, we've proven through our new Alliances that leading technology providers see value in partnering with us because of the vital role we play for thousands of enterprise customers. We've proven that customers see value in working with us and are doing so in new and expanded ways as demonstrated by incremental signings and growth in Kyndryl Consult. We've proven that we can drive increased profitability in our business with our focus accounts and we've proven that we can execute on an aggressive, multifaceted global strategy to position our business for future success. The proof points we've delivered over the last year highlight how we're leveraging our strengths to drive value creation, both for our customers and our shareholders. Importantly, our fiscal 2024 launching point is a strong one. We've set new milestones for each of our three A's that will reflect further progress towards the ambitious multiyear goals we shared a year ago. For Alliances, we expect to generate more than $300 million in hyperscale related revenue in fiscal 2024 and to continue growing our hyperscale related signings as we build the portion of our customer relationships that include cloud-based content. Our growth will stem from joint enablement activities with our partners, co-marketing to enterprise customers, and incremental training programs, all of which are directed towards Kyndryl delivering solutions that address customers' most pressing needs. For advanced delivery, we expect to exit fiscal 2024 with $450 million in annualized savings on a cumulative basis. This will give us $200 million more in-year savings than in fiscal 2023, and we continue to see significant automation opportunities across our delivery operations as we incorporate more technology into our service offerings, increasing service levels, and reducing their costs to serve. Our accounts initiative has been and will continue to be a global effort focused on customer relationships and contracts with substandard margins. Exiting fiscal 2024, we expect to be generating roughly $400 million of cumulative annualized benefits from this initiative, a roughly $200 million year-over-year increase. I want to highlight how energized we are by our progress and by the opportunities these initiatives still represent. We're executing a powerful transformation strategy and we continue to lean into it 24/7 around the world. We've used successful execution of our three A's as the clearest and fastest path towards achieving sustainable, profitable growth. And our experience in reshaping customer relationships gives us great confidence in our future trajectory. When we launched these initiatives, we shared medium-term objectives expected to take four to five years to achieve, and with another year of solid progress, we will be well on track to achieve these aggressive goals on or ahead of schedule. As I said earlier, fiscal 2024 will be a year of acceleration for Kyndryl. We expect to again make significant progress on our three A's to benefit from our cost optimization efforts and to grow Kyndryl Consult. We'll drive towards higher margins and sustainable profitable growth and we'll continue to serve our customers in what we call the Kyndryl Way, being restless, empathetic, and devoted in our pursuit of operational, strategic, and financial progress. Looking at 2024 and beyond, the successful execution of our three A's will shift our business towards scalable intellectual property and aiding IT decisions further up the technology stack. To drive progress, we're focusing our customer engagements on how Kyndryl delivers innovation and thought leadership. With Kyndryl Consult, we're focused on delivering and accelerating customer business outcomes in areas our customers want to transform: cloud applications, cybersecurity, digital workplace, next-generation networks, and of course mainframe modernization. Our scale and expertise in running large IT environments enable us to gain insights that no one else has and to capture those insights in Kyndryl Bridge, our open integration platform that gives our customers more control over their mission-critical systems. The dashboards, tools, and real-time insights available in Bridge enhance service visibility, deliver higher service level performance, and increase speed to problem resolution. They're creating opportunities for us to expand into selected domains within the application layer which will drive additional customer value. We then leverage the unique co-creation approach of Kyndryl Vital with Bridge to break complex problems into sustained innovative solutions that are both innovative and pragmatic. And AI already plays an important role for us. In our services and our operations, Kyndryl is both an enabler of AI and machine learning for our customers and a user of these tools. In the IT environments we operate, Kyndryl helps customers implement AI at scale by providing end-to-end data availability for processing and analytics. And as an IT services provider, we develop and utilize AI-enhanced tools like the Console and Bridge which is a self-learning data fabric for control and operations that is driving insights and productivity. Our customers recognize our capabilities are unique and in demand and they appreciate the value we're bringing to the table and that's evident through our Kyndryl Consult performance this past year. Consult signings were 31% in constant currency in fiscal 2023 and we anticipate another year of double-digit growth in fiscal 2024. This growth demonstrates how we're capitalizing on the opportunities we have as an independent company regardless of the macro environment we're operating in. In the process, we're leveraging the attributes that make Kyndryl of unique value: the unmatched experience of our team in managing complex IT estates, the intellectual property we've developed to do this efficiently, and the vast amount of operational data we collect that permits a level of intelligence no competitor can match. These actions will allow us to access incremental market opportunities, grow our share of wallet with existing customers, and win new customers. What we've done then is create an exciting value proposition for all of us at Kyndryl as we head into our second fiscal year as a standalone company. So the three key messages I hope you take away from our discussion today are first, we did what we said we were going to do and more in fiscal 2023, exceeding our targets for each of the three A's. Second, we're a leader in our space and are leveraging our capabilities to advise, implement, manage, and optimize Advanced Delivery solutions that are absolutely best in class, money-making, and money-saving for customers and more profitable for us. And third, the three A's plus Kyndryl Consult, Kyndryl Bridge, and our cost-saving efforts, our deep understanding of the entanglements between infrastructure and applications, and our experience in fiscal 2023 all give us great confidence and momentum as we move forward. Now with that, I'll hand it over to David to take you through our results and our outlook.

Thanks, Martin and hello everyone. Today, I'd like to discuss our quarterly results, our balance sheet and liquidity, the substantial value being created by our three A's, and our outlook for fiscal year 2024. Our fourth quarter results reflect solid operational execution and progress on our key initiatives. In the quarter, we grew revenue by 1% in constant currency to $4.3 billion. Demand for our services has remained resilient amid increased global macro uncertainty and we continued to gain momentum in higher-margin advisory services. Kyndryl Consult signings grew 30% in constant currency year-over-year and generated 13% of our revenue in the quarter, the highest percentage ever. Our adjusted EBITDA in the quarter was $476 million and represented a margin of 11.2%. Adjusted pretax loss was $61 million, only a $10 million decline in profit compared to the prior year quarter despite currency headwinds and higher software costs. Currency movements had a negative year-over-year impact of $22 million since we have dollar-denominated costs in our global operations, in addition to having international earnings. IBM software costs increased by $50 million year-over-year pursuant to the contract that our former parent put in place prior to our spin. And importantly, progress on our three A's helped offset currency impacts in the software cost increase. Among our geographic segments, we delivered year-over-year constant currency revenue growth in three out of four segments and our strongest margins were again in Japan and the United States. We address our customers’ needs not only through our geographic operating segments but 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 Kyndryl Consult signings coming from cloud, apps, data and AI, security, and other growth areas. As we look back on the quarter, we're pleased that we delivered results that were above the midpoint of the revenue and adjusted pretax margin guidance that we recently provided. For fiscal year 2023, we generated $17 billion of revenue, adjusted EBITDA of nearly $2 billion, and an adjusted pretax loss of $217 million. Foreign exchange had a $229 million negative pretax impact on us, so we would have been pretax positive if it weren't for the dramatic moves in currency. In the fourth quarter, we initiated actions to reduce our global headcount as part of our transformation and in order to lower our costs and foster productivity. This impacted people across shared services, our delivery network, and our in-country operations. It's resulting in us recording a $55 million charge in the March quarter, plus approximately $95 million in fiscal 2024. We also fully or partially vacated more than 50 of our 375 owned or leased sites around the world. This resulted in a charge of $70 million in the quarter. The workforce rebalancing and site consolidation charges are excluded from our adjusted results. We expect these actions to produce a strong ROI. In particular, the workforce actions will generate approximately $150 million of savings in fiscal year 2024 and $200 million in fiscal 2025. And our real estate actions will reduce our facilities costs by approximately $50 million a year. And while a third of the cost take-outs are enabling actions for our three A's, nearly two-thirds are incremental savings beyond the three A's. Turning to our cash flow and balance sheet, we generated adjusted free cash flow of $352 million in the year ended March 31. We've provided a bridge from our adjusted pretax loss to our free cash flow for the year. Our gross capital expenditures were $865 million, and we received $23 million of proceeds from asset dispositions. Working capital contributed to cash flow as we stepped up our management of both receivables and payables globally. In the March quarter, our adjusted free cash flow was negative as we expected, due to the combination of our adjusted pretax loss and seasonal factors. The cash flow seasonality stems primarily from the fact that license agreements that cover a year or multiple years often need to be paid for in the March quarter. Our financial position remains strong. Our cash balance at March 31 was $1.8 billion. Our cash balance combined with available debt capacity under committed borrowing facilities, gave us $5 billion of liquidity at quarter end. Our debt maturities are well laddered from late 2024 to 2041. We had no borrowings outstanding under our revolving credit facility and our net debt at quarter end was $1.4 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. There's no change in our approach to capital allocation. Our top priorities continue to be to maintain strong liquidity, remain investment grade, and reinvest in our business. We used the cash flow we generated in fiscal 2023 to fund spin-related cash outlays, including required system migration. Over time, Kyndryl's leadership position in IT infrastructure services combined with benefits from our three A initiatives should allow us to significantly expand our margins and ultimately be in a position to consider regularly returning capital to shareholders, all while remaining investment grade. As Martin mentioned, we continue to progress on our three A's initiatives. Our momentum supports our continued expectation that our Alliances initiative will drive signings, revenue, and over time, roughly $200 million in annual pretax income. Our Advanced Delivery initiative will drive cost savings equating over time to roughly $600 million in annual pretax income. And our Accounts initiative will drive annual pretax income of $800 million. We're also driving growth in Kyndryl Consult and among our global practices which is incremental to the benefits coming from our three A initiatives, and we see opportunities to control expenses throughout our business, including through the workforce and real estate consolidation actions we've recently taken. We expect that these efforts over time will contribute roughly $400 million in annual pretax income. In total then, the magnitude of the earnings growth opportunity we're tackling is tremendous relative to our current margins. Progress on our three A's will therefore be a central source of value creation for Kyndryl. I want to circle back to focus accounts because many of you have asked how we're addressing elements of customer contracts with substandard margins. And there's more to it than just price. For most of these customers, we've been running their core systems for years, which has created a unique level of trust and confidence in our capabilities. Our customers recognize that with unfavorable economic terms, the service we've been providing is not sustainable, making it hard for us to deliver the innovation they need to advance their digital transformations. For these reasons, we're generally seeing an openness among our customers to work with us to find solutions. These customer conversations are multifaceted and vary significantly from account to account. We've been seeing several different patterns develop as part of this process. First, we're frequently expanding the scope of our relationships by adding higher value services and leveraging our new capabilities, our practices, Kyndryl Consult, and alliance partners to deliver incremental services such as cloud migration, security, resiliency, data management, and network solutions. Second, we're identifying opportunities to reduce scope by removing the unprofitable elements of a contract. In some cases, we'll relinquish a tower of service with unfavorable terms that's just not economical for us. In other cases, we'll remove unprofitable elements, including low-margin third-party content that customers can procure directly. Third, there are situations where we can apply our Advanced Delivery tools, including Kyndryl Bridge, to replace labor-intensive services with automated technology or adjust the quantity and mix of resources required in order to take out costs and drive productivity. Fourth, as a contract nears expiration and renewal, we renegotiate terms of the relationship in order to generate a better return. And in situations where these efforts have been exhausted and there's no resolution, we will allow that relationship to end and in the interim, optimize the cost to serve until expiration. To date, exiting a relationship has been very much the exception, not the rule, and when we exit it's a purposeful decision on our part. What's most common is some combination of the first three patterns plus a dose of pattern four, pricing as the contract approaches the usual time for renewal and extension. Customers prefer not to switch technology services providers if they don't have to, which helps bring customers to the table to talk about changing scope, changing service structures to drive productivity, and even changing the pricing structure. The key point here is that in our Accounts initiative, we're deploying multiple strategies to strengthen our margins in ways that work for our customers. With fiscal 2023 now behind us, we're providing our outlook for our 2024 fiscal year. We expect to expand our margins this year, largely due to the three A initiatives and workforce rebalancing actions we're taking, and we expect to do this even as our revenues are declining. Our outlook is for revenue to be in the range of $16 billion to $16.4 billion, a decline of 6% to 8% in constant currency. To be clear, the revenue decline we're projecting is primarily due to the soft backlog of fiscal 2024 revenue we were born with plus intentional near-term changes we're implementing to transform our business. Let me break our revenue outlook into components. Approximately three points of the expected decline is simply the revenue backlog we inherited at the time of our separation playing out. Another five to six points of the revenue decline will stem from the actions we're taking to address focused accounts, low-margin equipment sales, and IBM pass-through revenue. We recognize it would have been cleaner if we could have walked away from this revenue the day after our spinoff, but that wasn't an option. Helping to offset these downward pressures on revenue, we anticipate Kyndryl Consult and other new signings will contribute one to two points of overall growth. Based on recent exchange rates, currency is estimated to have roughly $350 million or 200 basis points favorable impact on reported revenue, but where that lands will depend on how exchange rates move over the next 10 months. We estimate that our adjusted EBITDA margin in fiscal 2024 will be 12% to 13%, an increase of 40 to 140 basis points versus fiscal 2023. And our outlook for adjusted pretax margin is expected to be negative 1% to breakeven, which implies margin expansion of 30 to 130 basis points compared to last year. On the pretax line, we see 50 to 125 basis points of margin pressure from our backlog, another 125 basis points of headwinds will result from the $200 million software cost increase that IBM imposed on us at the time of our spin. Nevertheless, our execution on the three A's and our cost reduction efforts will drive margin expansion. We expect our focus accounts to contribute $200 million more profit this year, and we expect our Advanced Delivery initiative to generate $200 million of incremental savings this year. As a result, these two initiatives should add approximately 225 basis points of margin in fiscal 2024. Similarly, we expect the additional savings from our workforce rebalancing and real estate consolidation actions will add roughly 75 basis points of pretax margin. In short, a helpful way to look at our fiscal 2024 outlook is that at this point in our turnaround, when revenues are still declining, we expect to increase margins by 150 to 250 basis points on a gross basis before increased IBM software costs, and by roughly 30 to 130 basis points net of the contractually obligated increase in software costs. From a seasonality perspective, our December quarter in absolute dollars tends to be our strongest in revenue and adjusted EBITDA, and we expect that the contribution from the three A's will continue to build over the course of the year. One additional housekeeping note related to our segments. We recently completed a zero-sum amendment to our software agreement with IBM that will change how software costs are allocated among our segments. This will help our principal market segment but will be a headwind for our U.S. and strategic market segments in fiscal 2024. For cash flow, we project roughly $750 million of net capital expenditures in fiscal 2024 and about $850 million of depreciation expense. We also expect about $300 million of cash outlays for transaction-related costs and the workforce rebalancing actions I discussed earlier. This will be the last year in which we incur transaction-related charges associated with our spin. We remain committed to returning to revenue growth by calendar 2025 and over the medium term, delivering significant margin expansion and driving free cash flow growth. We have a solid game plan to drive our strategic progress, and this game plan starts with the steps we've already taken to expand our technology Alliances, manage our costs, and earn a return on all of our revenues. And for any investors who are new to the Kyndryl story, I have included the current version of a slide we first published last May. It's the slide that provides a breakdown between our margin-challenged focus accounts and the rest of our business. Our aggregate results obscure the fact that within Kyndryl, we started with a strong $10 billion business, which we refer to as a blueprint for how we want to operate. This blueprint consists of accounts that represent about 60% of our revenue, generate average gross margins north of 20%, and reflect our ability to get paid appropriately for the mission-critical services we provide. Our other roughly $8 billion of focused accounts revenue was generating virtually no gross margin and after SG&A expenses was losing money. Our Accounts initiative is all about the opportunity to make our focus accounts look more like the majority blueprint of our business over time by addressing elements of our customer relationships that generate substandard margins. Over time, if we close even half of the gross margin gap between our focus accounts and our blueprint accounts, we will generate the $800 million in incremental earnings that we've targeted from these accounts. That's why our Accounts initiative is a major priority and a major opportunity for us. In executing the Accounts initiative we're paying close attention to the margin on signing for both of our segments. We have included a new slide that highlights our progress. Immediately following the spin, we were signing business with an expected gross margin of roughly 20% and a pretax margin in the mid-single digits. These signings themselves represented higher margins than the roughly breakeven older deals that were the bulk of our revenues. Over the course of fiscal 2023, we combined pricing discipline and collaborative engagement with customers to move our projected margins on all new signings up to the mid-20s for gross profit and in the high single digits for pretax profit. The March quarter was a continuation of that favorable trend. Importantly, what this means is that throughout fiscal 2023, we were signing agreements that fully support the medium-term margins we're aiming for. In fact, if our P&L reflected only our recently signed deals, we'd be operating at mid- to high single-digit adjusted pretax margins. But because of the prevalence of multiyear contracts in our business, most of our revenue is still coming from lower-margin pre-spin legacy signings. As a result, you can't currently see the full benefit of the higher margins at which we're now pricing contracts, but that will change with time as our business mix increasingly tilts toward more post-spin contracts. In closing, as an independent company, we're solidifying our position as a cost-effective gold standard provider of essential IT services. We expect to deliver meaningful margin expansion in fiscal 2024, and we're executing on the strategies and initiatives that will drive longer-term progress, future growth, and stronger earnings in our business. With that, Martin and I would be pleased to take your questions.

Our first question comes from Tien-Tsin Huang with J.P. Morgan.

Great, thank you. Good morning and thanks for the new slides there. It's easier and helpful. Just on the outlook, if you don't mind me asking that first, just some visibility on the five to six points drag that you called out to reduce the focus accounts. Will we see that as early as Q1, how do you expect that to phase in as the year plays out? And I'm curious if we see delays in the runoff like we did in fiscal 2023, would that put pressure on the margin outlook here or are there other offsets? Can you hear me?

Well, is Tien-Tsin still…

I'm here. Can you hear me?

Yes, there you go, Tien-Tsin. We can hear you now. Can you hear us? Thank you.

Yes. Yes. I wasn't sure if you heard my question or…

I did. Yes. Thank you. We had a little audio issue, so let me start and ask David to comment as well. Again, I apologize for the audio issue. We are now 12 months into the focus account work, which means we have a good understanding of where we stand with each customer. The decision to reduce revenue in some of these accounts is well developed. It takes time to execute, and it will build over time. As you know, it’s cumulative; what we accomplish in the first and second will carry into the third, and we expect to achieve more in the second half. Therefore, the impact will grow over time. I feel confident in our ability to execute on the focus account initiative as we did in the first year. Additionally, as David mentioned regarding the patterns we are observing, the primary trend is an expansion of scope. Even if the revenue does not decrease as much as we predict, we will phase out the lower-margin revenue over time and potentially replace it with higher-margin revenue. We’ve seen this in everything we’ve signed recently, which is driving our strong performance last year. The issue wasn’t that we didn’t reduce the lower-margin revenue; we actually performed better by replacing it with new work, and Kyndryl Consult is growing well within that. Consequently, I don’t believe we are at risk regarding margins, even if the revenue doesn’t decline at that rate, because our customers keep showing interest in expanding the scope of our work with them. I’ll ask David to share his perspective, but this will build over the year. After 12 months of experience, I think we have a good understanding of how this will unfold. Even if the revenue does not decrease as expected, it likely reflects our ability to generate better margins through expanded scope, which means there is no risk to our margin profile for the year. David, would you like to add anything?

Exactly right. I would just add that some of the clarity we have is due to actions already taken. Some of the contracts that will be impacted have been revised or adjusted. Therefore, we will see results in the first quarter partly due to actions we implemented in fiscal 2023 that will manifest in fiscal 2024.

I see. Okay. No, that's great. That's all very thoughtful. So my follow-up, if you don't mind, just I'll ask a macro question. Just thinking about client priorities and if you're seeing any change in client demand at all, given all the talk of macro uncertainties. Is there any impact on short-term project work, it sounds like Consult is doing well, but I figured that I will ask that as well and then just any implementation sort of changes and delays, that kind of thing?

Yes. Look, we're very fortunate, Tien-Tsin. Before I start my answer I must make sure you can still hear me?

Yes. Yes.

We're fortunate that the work we do is essential, so we are not experiencing the demand slowdown that others might be facing. Additionally, as we explore new areas with our partners, we recognize that we have some ground to cover. We're relatively new to the public cloud with our major hyperscale partners. In our first year, we signed $1.2 billion, and we anticipate continued growth, but we are catching up to others who have been in this space longer. The work we do is critical, and there is significant untapped demand for our services. Our customers have been seeking our support in managing their hybrid infrastructures and migrating essential workloads to the cloud. This growing need is evident in the strong performance of Kyndryl Consult and reflects the demand for our services as we engage in this important ecosystem. We haven't experienced any slowdown, as our work remains vital and there is a clear demand for assistance with the complex infrastructure programs that our customers are undertaking now that we are integrated into the ecosystem. Hopefully, this provides clarity.

It is, thank you for the answers.

Thanks Tien-Tsin. Operator, next question please.

Our next question comes from Divya Goyal with Scotiabank.

Good morning everyone. I wanted to clarify whether you are seeing improvement in revenue retention as clients are considering a slowdown in their cloud transformation, especially since there was a bit of excess during the pandemic. Additionally, are clients now focusing more on a distributed infrastructure rather than solely on cloud?

Yes, thanks Divya. I will also ask David to share his point of view, but let me say a few things. But again, before we start, hopefully, Divya, you can hear me?

You're coming through.

Yes, thank you. First and foremost, it's important to recognize the critical role we play in managing the banking systems, telecom systems, supply chains, and airline reservation systems. As these infrastructures and customer environments become more complex, it presents a significant opportunity for us to assist them, as these systems must operate continuously. Whether a customer is speeding up or slowing down their transition to public cloud, or reevaluating their approach to public versus hybrid cloud, this creates substantial demand for us. We observe increasing complexity in the world, with our customer base eager to leverage innovation. There is currently a strong interest in AI and associated tools, which requires us to help them structure their data effectively and ensure it is secure and manageable across varied infrastructures. The unique demand we experience at Kyndryl stems more from the intricacies that our customers face than from general macro trends, such as slight shifts in public cloud adoption. This complexity drives our demand, and given that a small percentage of critical mission-driven systems have moved to the cloud thus far, we anticipate sustained long-term demand for managing diverse infrastructures. I'll also ask David to share his insights.

I agree, right. Hybrid environments are helpful to us in terms of the demand they generate. Complexity is helpful to us in terms of the customer demand it generates. More access to data where AI is helpful to us and really more focus by companies and enterprises on efficiency and productivity is a helpful backdrop for us as well. So as Martin said, I think all of those things are working in our favor in this environment.

Thanks, David. Divya, do you have another follow-up?

Thank you for the information. I have a quick question regarding the focus account and the progress on the three A’s. Have you noticed any particular geography being more affected, more profitable, or more effective as you implement these initiatives?

So Divya, let me share my thoughts, and I'll ask David to add his perspective too. When we analyze the three A's individually, our potential to grow in the hyperscaler market globally is quite well balanced since we started from scratch over a year ago. The $1.2 billion revenue reflects a mix similar to our overall signings, with a significant portion coming from the U.S. The Alliance is part of the three A's and will be spread out in a manner consistent with our current business model. Some countries may see quicker growth than others, but overall, the opportunity in the medium term will resemble our existing operations. Our Advanced Delivery initiatives are global, and so the advantages manifest prominently in our operations, particularly in our delivery centers. While we do have some local delivery, the mix varies by country, but it will remain aligned with our current structure. Regarding the focus accounts, they are not distributed precisely as our overall business is. They are present in many regions, but their resolution pace will be particularly pronounced in the U.S. and Western Europe. We also have focus accounts in Japan, which is already a profitable sector for us, and we will address those as well. The impact of the focus accounts will primarily benefit regions where our profitability is under the most pressure: outside of Japan, particularly in Western Europe, and somewhat in the U.S. Thus, from a segment viewpoint, you'll observe that two of the three A's will have benefits spread similarly to our current business, with the focus account advantages significantly affecting Europe and more so in the U.S. compared to Japan. David, do you have anything to add?

Yes. The corollary to that is that our three A's are really global initiatives. It's not two A's in one part of the world and plus something else. The three A's are what we're working on everywhere across our organization. And with respect to focused accounts, really with respect to all three of the A's, they have been what we've been emphasizing. And I think the progress has been remarkably solid and consistent around the world.

Thanks, David.

Thanks Divya. Operator, could we move to the next question please.

Our next question comes from David Togut with Evercore ISI.

Thank you, good morning. Could you comment on the profit margins on the $1.2 billion in hyperscaler bookings you recorded for FY 2023?

Yes, we see the profitability of those agreements as very much in line with the business we have been securing. It is higher than our current profitability and constitutes a significant portion of the expected profitability from these contracts that we detailed, which you can find on Slide 16. We expect the new Alliances to maintain that level of profitability. Often, the hyperscaler component is part of a larger agreement as well. Consequently, it significantly contributes to the results reflected in our projected margins, which are expected to rise considerably from previous levels, positioning us for improved margins in the future. This is a crucial aspect of our overall narrative.

Appreciate that. And then just as a follow-up, I heard you give some of the elements of the free cash flow guide for FY 2024. And I apologize if I missed anything, but working capital was a big source of cash in FY 2023. Could you walk through what your FY 2024 operating cash flow guidance, including assumption on use or source of cash from working capital management? And then just bring us down to free cash flow for FY 2024, if you could?

Sure. As you mentioned, in fiscal 2023, we were able to generate significant positive adjusted free cash flow despite reporting an adjusted pretax loss. This was partly due to a favorable gap between CAPEX and depreciation, along with substantial improvements in working capital. Going into fiscal 2024, we are not providing a free cash flow guide or outlook, but key factors will include our pretax income or loss, some cash taxes, and interest expenses. The main opportunities for us lie in the gap between CAPEX and depreciation, which we estimate will be in the favorable range of $100 million. We will continue to focus on working capital, as we see it as a major opportunity, with further potential for optimization in payables, receivables, and accrued liabilities. Our aim is to strengthen our free cash flow as much as possible in fiscal 2024.

And just a quick follow-up. Net-net, would you expect working capital to be a source of cash or a use of cash in FY 2024?

We anticipate that it will be a source of cash in fiscal 2024, although not to the same degree as in fiscal 2023.

Thank you very much.

Thanks David. Operator, can we go to the next question please.

Our next question comes from Jamie Friedman with Susquehanna. David Togut asked if working capital would be a source or use of cash in fiscal 2024, and David Wyshner responded that they expect it to be a source of cash, although not to the same extent as in fiscal 2023. David Togut thanked him, and Lori Chaitman then asked to proceed to the next question.

Hi, thank you. Congratulations on reaching a milestone in your first year. I wanted to ask about Slide 16 and your insights on the three A's, specifically the increase in pretax margin from 4% to 9% on post-spin signings. I'm curious if there is a specific reason for this growth over time. Is it because you're starting to capture more easy opportunities, or is it related to pricing adjustments? It seems significant that 9% is much higher than 4%, so what factors are driving this increase now?

Yes, that's a great question. The 4% margin in our first six months included several deals, particularly larger ones, which we began negotiating before the spin. Consequently, some of those signings could be viewed as pre-spin price quotes that affected the margin negatively. Moving into fiscal 2023, we have been signing deals that align with our business strategy, which is why those margins fall in the 7% to 9% pre-tax range. The increase from 7% to 9% highlights the advantages gained from focusing on this issue and learning from our experiences, allowing us to achieve margins now approaching 10%. This will be a crucial area for us moving forward, ensuring we maintain the discipline necessary to secure appropriate margins on the business we are signing.

Thank you for that, David. I would like to inquire about the outlook for 2024, specifically regarding Slide 14. This slide is quite impressive. In terms of revenue, how does it compare now to when you first spun off? For instance, are the three points in the initial backlog any different now compared to then? Also, regarding the five to six points in the reduced focus account headwind, is this still the same or has it changed? This is what investors are wanting to know this morning.

Sure. I would say the three points regarding the backlog remain unchanged. It's all about the backlog playing out and the low to mid-single-digit revenue decline linked to our initial backlog that we've consistently discussed over the past 18 months. The second aspect is the five to six-point impact from reducing focus on lower-margin third-party content, which aligns with our strategy, although we're intensifying our efforts. The mix of the impact between fiscal 2023 and fiscal 2024 has shifted, resulting in a greater impact in fiscal 2024 and less in fiscal 2023 than we initially anticipated. Our revenues were slightly stronger this past year than we expected at the year's start, making it a tougher comparison going forward. As we pull back from the business we aimed to move away from, and even a bit more, the percentage impact in fiscal 2024 is larger. Lastly, we are very enthusiastic about Kyndryl Consult and the growth we're experiencing there. We have seen a 30% increase in signings, and it's now 12% of our revenue for the full year and 13% in the latest quarter. This growth is positively influencing our revenue and demonstrates our enhanced engagement with customers and our increased role in their technology stacks, which is very encouraging.

Okay, thank you David. I will drop back in the queue.

Thanks, Jamie. Operator, it looks like that's our last question. I'm going to pass the call to Martin.

So thanks, everybody for joining today. Look, hopefully, you can hear and get a sense of not only how much progress we've made in our first full year on the three A's, but also that the three A's are what's going to turn this business around in the timeframe or maybe even a little bit faster than what we've said in the past. I feel as though we're on or ahead of schedule in executing on each of the three A's. So we feel really good about what we've gotten done. We now as we've said, both David and I have said on the call, this is a year of acceleration. We're growing where we want to and we will continue to target and to focus on improving the profitability of this business, and that's what you see in our guidance. Very strong pretax margin expansion, notwithstanding the headwinds that have been imposed in some parts of our business, but very strong pretax margin expansion and really focusing this business on the high-value that we know we create with our customers. So thanks again for joining us. A lot of work left to do, but we're excited about where we are. Thank you, operator.

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