Q1 2023 Kyndryl Holdings Inc Earnings Call
Good morning, and welcome to the <unk> first quarter 2023 earnings Conference call. Currently all colors have been placed in a listen only mode and following management's prepared remarks, the call will be opened for your questions.
If you would like to ask a question at that time. Please press star one on your telephone keypad.
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At any time, if you should need operator assistance press Star zero.
Please be advised that today's call is being recorded.
Now I'll turn the call over to Lori Chapman Global head of Investor Relations I can draw you may begin.
Good morning, everyone and welcome to <unk> earnings call for the quarter ended June 32020 to the first quarter of our new fiscal year before we begin I'd like to remind everyone 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 in 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.
Kindle does not update forward looking statements and disclaims any obligation to do so in todays 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 events.
Which are available on our website at investors that kindred dot com.
With me here today are <unk>, Chairman and Chief Executive Officer, Martin shorter and Kendall Chief Financial Officer, David Weitzner.
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 Laurie and thanks to each of you for joining us today I am enthusiastic about our momentum and proud of what the team has accomplished over the last three months.
On today's call, we will share casuals quarterly results and update you on our progress.
Discuss our strategy and how we're executing on our three as initiatives alliances advanced delivery and accounts, which are driving us toward profitable growth.
Then David will provide more detail on our first quarter financial results reaffirm our fiscal 2023 outlook and link our recent progress to our financial goals.
It's been nine months since <unk> became an independent publicly traded company and I am just as excited today about the opportunity ahead as I was on day one.
As you can imagine there's never a dull moment post spin there's plenty of work to do to transition internal processes build a new culture and seize market opportunities.
For those of you who are new to the <unk> story prior to our spinoff last November we operated largely as a captive services provider focused on supporting the products and technologies that IBM offer to its customers today.
Today, we are 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.
I'm proud of how quickly we are charting a new course to better serve our customers through our new alliances with a range of top tier technology providers and enhancements of our services delivery driven by upscaling and automation fueled by data IP and best practices.
Our new freedom of action has given us the opportunity to be part of a much larger and growing ecosystem that really matters to our customers expanding our addressable market from about $240 billion to 415 billion and growing.
By 2020 for this it services market is expected to grow to about 510 billion.
Our expanded collaborations with leading technology providers are making us more relevant to our customers and allowing us as their long standing trusted partner to support and accelerate our customers' digital journeys and cloud security data in intelligent automation with the multi vendor strategy.
Equally important with our independence, we can now invest in our business to create new capabilities deliver them at scale by gaining certifications and credentials for our already skilled technologists and thereby grow our share of wallet with our existing customers.
Through our six practices, we can now meet needs that our customers have been asking us to meet for years in areas that we were previously prevented from serving.
We're solidifying our position as a leading global provider of it infrastructure services, we continue to generate twice as much infrastructure services revenue as anyone else and our uniquely focus on this sector of the market.
Our customers Trust us to manage their most critical systems and we do it with the highest level of quality I'm really proud of our delivery teams. They continue to produce top tier net promoter scores generally north of plus 50, we continue to meet more than 99, 7% of our service level agreement thresholds with the June .
Quarter being another quarter of above target performance.
We're pleased to have been named a leader in Gartner Magic quadrant for managed mobility services and to be recognized as one of only four industry engineering specialists and integrators and Gardener's recent report on <unk> and <unk> networking.
Our NPS and SLA metrics, along with a growing list of external accolades highlight the world class nature of our offerings.
There are significant opportunities in front of us and we understand that the macroeconomic environment is on many people's minds right now.
At Kindred, we run mission critical it systems, the hearts and lungs of our customers' operations, including global banking organizations airline reservation systems mobile networks and industrial supply chains.
The essential nature of our business provides us some natural installation to macro factors in.
In addition, our <unk> initiatives gives us a substantial opportunity that are specific to us and independent of the broader economy.
Executing on these initiatives will deliver the benefits we need to strengthen our overall business performance and unlock substantial value for our customers our employees and our stockholders alike.
A key enabler of our strategy has been the rapid build out of our technology alliances and capabilities.
Between November and March we signed new collaborations with all three cloud Hyperscale.
Amazon Web services, Google Cloud and Microsoft Azure as well as many other leading technology companies.
Since year end, we've increased our cloud related certifications by 36%, bringing our total to nearly 22000 and giving us more capabilities to deliver cloud services.
This quarter, we've expanded or establish new partnerships with Cisco five nine net app Oracle Red hat <unk>.
Veritas continuing the theme of <unk> aligning with other top tier technology providers now that we're independent.
Customers are seeing how quickly we're leveraging these relationships and they're now asking us to help them migrate a portion of their workloads to the cloud manage their explosive growth in data integrate legacy and new technologies from multiple partners and address their urgent need for cyber security and resiliency. It is remarkable to see how fast.
Our relationships are expanding.
One example of this is a global bank, where we have a nearly 20 year business relationship.
We run mission critical systems, and the infrastructure behind their systems of record.
Our relationship began in the early two thousands with traditional data center outsourcing for one of their divisions, including mainframe services work.
The scope of our work has expanded over time across geographies and divisions. Most recently, though we not only extended our contract tied to legacy systems. We also added hyperscale or cloud work and beyond that the integration required to make sure. The bank is running the right workload on the right platform.
We're now supporting our customer across their architecture data and application security resiliency and systems innovation.
We're adding value as a trusted strategic partner that has the technology expertise to meet their complex evolving multifaceted needs.
And at the same time, we are driving profitable revenue growth for our business as we increase our services revenue from this customer.
This example is just one of the many that have been either executed already or are in the works across a range of industries geographies and customer needs.
Back in February we committed to sharing our progress on our <unk> initiatives. As a reminder, we provided targets of at least $1 billion in signings tied to hyperscale or alliances this fiscal year $200 million in annualized cost savings from advanced delivery by year end and $200 million of <unk>.
Utilized pre tax benefit from our accounts initiatives.
I am pleased with the progress we've made in such a short period of time on <unk> and we're on track to deliver on our fiscal 2023 milestones for each of these initiatives.
And our alliance initiative, we generated $235 million of Hyperscale related signings in the quarter, putting us on track to achieve our $1 billion annual target.
We're increasingly going to market with Hyperscale is to seamlessly meet customers' needs.
As a micro Microsoft Azure expert managed service provider and Premier partner with both AWS and Google we have immediate credibility as well as unique knowledge of our customers' existing infrastructure and workloads.
And the pace at which we've built our teams certifications credentials and capabilities puts us in a position to provide the top tier levels of service that customers have come to expect from <unk>.
This is demonstrated by another strong quarter of signings growth in advisory and implementation services, which were up 27% in constant currency compared to last year.
We are using our new technology partners to grow our share of wallet with existing customers.
And our advanced delivery initiatives, we're investing in heightened intelligent automation and new ways of working which frees up our people to be re skilled and redeployed to in demand opportunities.
This quarter, we expanded our proprietary delivery automation tooling to run more than $24 million automation automation events, a month more than double where we were a year ago.
This significantly increases the level of service and resiliency, we provide to our customers.
In the process, we freed up more than 900 of our people to serve new revenue streams and backfill attrition.
When we free up people, we're increasing our productivity and the associated cost savings are running at an annualized rate of $100 million as of quarter end equal to half of our fiscal 2023 year end objective.
And at the same time, we're creating new opportunities for our people and reducing the extent to which we need to hire external talent.
And our accounts initiative, we are directly engaging with our customers, where we're not generating an adequate return on the efforts and capital were spending.
The response from customers has been positive and a number of them have already expanded our scope of delivery services capitalizing on our broader ecosystem and new capabilities.
In some cases, we're optimizing our cost basis through automation and greater standardization, while in other cases, where we're near contract expiration, we have the opportunity to discuss pricing or agree that kindred will exit elements of work that are unprofitable for us.
Our engagement efforts so far resulted in a meaningful increase in the projected margins associated with these accounts, reflecting our focus on signing profitable business.
In the June quarter were already realizing pre tax benefits at a rate of roughly $52 million a year, putting us on track to achieve our $200 million a year end run rate goal.
The momentum we are demonstrating in our <unk> initiatives is driving us towards the strategic objectives, we laid out last year.
Transforming tangible to operate across a broader technology ecosystem evolving our business mix returning to revenue growth and expanding our margins.
We're operating differently with a new mission and value proposition as we execute on our three <unk> initiatives, we move forcefully to strengthen the margin profile of our business and progress toward our goal to return to profitable revenue growth in calendar year 2025, we will unlock substantial value.
We will continue building a culture that is flat fast and focused on customer success and will continue positioning <unk> to be the employer of choice and the partner of choice for customers and technology partners alike now.
Now with that I'll hand 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 and our outlook.
Our financial results for the quarter ended June 30, our fiscal first quarter were in line with our expectations and position us to achieve the full year targets, we laid out in may in.
In the quarter, we generated revenue of $4 $3 billion, which.
<unk> only a 2% decline in constant currency from our pro forma results a year ago.
This includes two points of revenue growth, we picked up from pass through revenues related to our former parent.
Because most of our revenue in any given quarter is the product of contracts signed over the prior several years. Our revenue decline reflects the continuing effects of having been operated as a captive subsidiary of IBM prior to our spinoff not the future potential of our business.
Adjusted EBITDA in the quarter was $491 million this.
And the adjusted EBITDA margin of 11, 4%.
On a year over year basis, our adjusted EBITDA margin was down primarily due to the decline in revenue a currency headwind of 60 basis points and a 50 basis point impact from some of our software licenses being treated as a subscription rather than a prepaid and amortized expense.
Notably our gross margin increased 60 basis points sequentially from our March quarter to our June quarter. This is a better reflection of the operational progress we're making.
Adjusted pre tax loss was $50 million, which is sequentially consistent with our March quarter results and down year over year, primarily due to lower revenue and $48 million and currency headwinds.
Among our geographic segments, we delivered year over year constant currency revenue growth in our Japan and strategic market segments.
And our strongest margins were in Japan, and the United States.
Changes and have various IBM related costs are hitting each of our segments under our new commercial agreement with IBM complicate year over year margin comparisons by segment.
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 networking edge digital workplace and core enterprise.
Our business mix is evolving to reflect demand with nearly 80% of our signings coming from cloud apps data and AI security and other growth areas and only 20% from core Enterprise's Z cloud.
More importantly, our adjusted quarterly results were very much in line with our expectations.
Turning to our cash flow and balance sheet, our adjusted free cash flow was negative $32 million in the quarter.
<unk> provided a bridge from our Q1 adjusted pre tax loss of $50 million to our free cash flow.
Our gross capital expenditures in the quarter, including some capex due to our separation were $213 million and we received $7 million of proceeds from asset dispositions.
Working capital and other didn't contribute to cash flow in the quarter, but this is an opportunity for us for the year as a whole.
Our financial position remains strong our cash balance at June 30 was $1 9 billion.
Which reflects both a decline in the dollar value of our international cash and our use of $65 million per transaction related payments.
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 lettered from late 2024 to 2041, we had no borrowings outstanding under our revolving credit facility and our net debt at quarter end was $1 3 billion.
As a result, our net leverage sits well within our target range. We are rated investment grade by both Moody's and S&P and to add to that on Tuesday that you announced that they rate us as investment grade as well.
As we think about capital allocation, our top priorities are to maintain strong liquidity remain investment grade and reinvest in our business.
As we've said before we view being investment grade is a commercial imperative given the importance of this to our customers.
And because of the spin related cash outlays, we have in front of US most of the free cash flow, we'll generate this year is in many ways already spoken for.
As Martin mentioned, we're making rapid progress on our <unk> initiatives.
Our momentum supports our expectation that over the medium term 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 pre tax income and.
And our accounts initiative will drive annual pre tax income of $800 million.
We're also pursuing growth in advisory and implementation services and among our global practices, which is incremental to the benefits coming from our <unk> initiatives and we see opportunities to control expenses throughout our business.
We expect that these efforts over time will contribute roughly $400 million in.
In annual pre tax income.
Sometimes investors ask us.
What the market doesn't fully appreciate about the kindred story.
Here's one item I would like to highlight from a financial perspective.
We are a company that generated $134 million in pro forma adjusted pre tax income last year.
Which has tangible plans to drive $2 billion of contributions to our annual pretax income over the medium term.
The magnitude of the earnings growth opportunity. We're tackling is a big deal and will be a foundational source of value creation for kinderhook.
I hope that margins to update on our progress on these initiatives gives us confidence in our eagerness and ability to seize this enormous opportunity.
In light of the progress, we're making on our key initiatives and in our business generally we are reaffirming the fiscal 2023 earnings guidance. We provided in May and are updating our revenue forecast solely to reflect movements in exchange rates.
In particular, we continue to expect to drive double digit constant currency growth in signings in fiscal 'twenty three compared to calendar year 2021.
Consistent with the outlook, we shared in May we continue to expect our revenue to decline, 3% to 4% in constant currency compared to the 12 months ended March 2022, and 4% to 6% in constant currency compared to fiscal 2021.
With the dollar having continued to strengthen this guidance now implies revenue of $16 three to $16 5 billion this fiscal year.
Our outlook continues to be for adjusted pre tax margin to be in the range of zero to 1%.
This is consistent with our 2020 and 2021 pro forma results. Despite a 120 basis points of expected currency headwinds this year.
And we continue to expect our adjusted EBITDA margin to be 13% to 14% in fiscal 2023.
As Martin mentioned, we believe demand for it infrastructure services is largely insulated from broader macroeconomic trends and to date, we have not seen any significant changes in our customers' approach.
Digital transformation and procuring talent best practices and global scale continue to be important to large organizations.
Let me comment on a few other macro factors that investors often ask about.
First while services demand feels solid general price inflation is driving wage inflation, we have been doing well in terms of attracting and retaining the people, we need but at higher prices and big headline inflation figures are impacting the salaries that existing employees and new hires expect.
We're also seeing inflationary pressures in other areas, especially in energy costs, but our contracts typically contain inflation protection mechanisms that mitigate the effects of rising costs.
Second currency movements are having an unusually pronounced impacts this year.
<unk> not only the value of our foreign earnings, but also the dollar value of international cash and our margins since the composition of our costs often differs from the currencies in which we source our revenues.
Our hedging strategies and mitigating actions are helping us offset inflation and currency pressure. The currency alone is having a $200 million negative impact on our projected pre tax earnings growth this year.
From a cash flow perspective, we continue to target about $750 million of gross capital expenditures and $700 million of net capital expenditures compared to about $900 million of depreciation expense.
As a reminder, there is some seasonality in our revenues and margins with the October to December quarter, typically being the strongest.
While our results in our September quarter should be broadly similar to our June quarter, we see our full year margins being higher than our Q1 margins because of the favorable December quarter seasonality and the ramping of benefits from our <unk> initiatives.
Over the medium term, we remain committed to returning to revenue growth by calendar 2025, delivering margin expansion and driving free cash flow growth.
We have a solid game plan to drive our progress in this game play and starts with the steps we've already taken to expand our technology partnerships and with the meaningful initiatives. We're implementing this year.
Separately.
<unk>, we've gotten a number of questions comments and wows from investors about one particular slide we published in May the slides that provides a breakdown between our margin challenged focus accounts and the rest of our business.
As this slide highlighted our aggregate results mask. The fact that within <unk>, we have a strong $10 billion business, which we referred to as a blueprint for how we want to operate.
This blueprint consists of accounts that represented about 60% of our revenue generate average gross margins north of 20% and reflect our.
Our ability to get paid appropriately for the mission critical services, we provide.
This blueprint is most of what we do and its source of stockholder value hiding in plain sight.
And the reason that this value is underappreciated is our other roughly $8 billion of focus accounts revenue.
This revenue stream generates virtually no gross margin and after SG&A expenses is 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 sub standard margins.
Over time, if we close even half of that gross margin gap between our focus accounts and our blueprint accounts 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 for us.
As Martin highlighted in the June quarter pre tax margins associated with new signings tied to our focus accounts were up meaningfully.
Since the beginning of the year. The overall pre tax margin of our signings has been in the mid to high single digits.
With that means is that if our P&L for the next few quarters reflected only our recently signed deals we'd be operating at mid to high single digit adjusted pre tax margins not the zero to 1% margin generated largely by our pre spin legacy signings.
In fact, even though our signings were down year over year in the June quarter, when measured based on revenue.
The gross profit we expect to generate over the next year from our June quarter signings is up year over year and its gross profit and then pretax profit that we're most focused on.
In closing as an independent company, we're solidifying our position as a cost effective gold standard provider of essential services.
We are advancing toward the fiscal 2023 earnings targets, we laid out in may.
We're also executing on the strategies and initiatives that will drive longer term progress future growth and stronger earnings in our business.
I am, particularly enthusiastic about our strong progress on our <unk> initiatives and the margins are recent signings will generate.
Compared to our P&L, our tangible progress in these areas better exemplifies our potential our zeal to transform our business and our drive to create stockholder value.
With that let me turn things back to Martin.
Thanks, David before we turn to Q&A, Let me remind you why we're so enthusiastic about <unk> future.
As an independent company, we are seizing our now larger market opportunity, bringing incremental and differentiated value to customers and focusing on driving profitable growth.
We're committed to investing in our business and we'll continue extending relationships with our ecosystem partners and customers.
We are a trusted partner with tremendous expertise experience and scale.
And as technology continues to evolve our customers look to casual to keep them operating efficiently and ahead of the technology curve.
Our <unk> initiatives will deliver substantial benefits.
We have the financial flexibility to execute our growth strategy to invest in our people and to create a winning culture a culture that will create significant value for our employees our customers and our stockholders.
With that David and I look forward to your questions.
At this time, if you wish to ask a question. Please press star and one on your telephone keypad, you may remove yourself from the queue by pressing the pound key.
We will take our first question from Tien Tsin Huang from JP Morgan.
Okay, great. Thanks, I appreciate the continuing to add some.
If it came through in the call.
I wanted to ask I suppose on timing, but that's okay I'm curious about.
Visibility, there and timing notes.
Revenue conversion et cetera have you observed any changes and I know you talked about double digit signings growth looking ahead, so hence the.
Visibility question.
Yeah. Thanks, Thanks, Tien tsin and thanks for joining the call.
A few things I'd say first obviously are our confidence in growing signings double digit this year stems from the pipeline that we're looking at and we've got a terrific pipeline.
We see it in the.
The parts of our business, where we're really focus such as our <unk> business, which grew quite well this quarter as it did the prior quarter such as the progress, we're making with our Hyperscale Alliance partner. So so we feel great about the pipeline.
But as you also know we're really focused on the margin profile of these and as David noted we the gross profit dollars for instance in the signings from just this most recent quarter. The gross profit dollars in the next year also grow.
Within that signings pool, so while.
The overall signings for that short period of 90 days were down the gross profit dollars still provide us growth for the next 12 months, which again is our focus so we feel we feel really good about the pipeline we feel really good about the team is executing in the areas that are that are of a virus.
Our biggest focus and we feel really good about.
<unk> profile of what we're signing now having said all of that.
Look when your focus when one is focused on the quality of what youre signing and when one is really focused on making sure we get the right things into the backlog that Ken elongate deal cycles. They can elongate the discussions with our customers.
We are okay, because we want to get to the right signings the right signings profile, which we did in the which we did in the most recent quarter, we did in the quarter prior to that so so we see excuse me, we see a great pipeline of the kinds of quality deals and the kind of quality revenue streams to go into the backlog as evidenced.
Again by the gross profit over the next year or.
As evidenced again by the margin profile and David commented and I did as well in the prepared remarks, we both commented on the pre tax margin profile of whats going into the backlog. So we feel good about the growth we see in.
Probably more importantly, we feel really good about the quality and the profit profile of whats going in.
<unk> related to the related to the signings number.
The June number the June quarter was a tough comp for us we knew that going in because both of our two largest deals in calendar year 2021 cell in the June quarter, and those totaled more than $900 million. So that created a tough comp for us.
Obviously, we don't have that issue going forward and then the second issue is that the December quarter is traditionally our biggest signings quarter and as a result.
How the second half of this calendar year plays out.
Particularly the December quarter ends up being a big driver of how we're how we're going to get to double digit signings growth for fiscal 2023.
Thanks for that.
I did have one if you don't myeloid just wanted to ask on the gross margin since you mentioned and we always like to look at gross margin.
Proxy for contract execution pricing labor costs et cetera. So obviously it sounds like thats doing well there wasn't any unusual items, there, but what about on the capital intensity side as well any change to consider there, especially as we think about.
Cash flow conversion for the.
Rest of the year. Thank you.
Yes, I think we continue to see that business, becoming less capital intensive.
Our capex is underwriting depreciation and we expect that.
To be the case and probably even a bit more so than it was in the June quarter as I look out over the remainder of the year. In addition, I think the amount of cash we ended up laying for capitalized software and.
Transition.
Cost startup cost is.
Probably going to underwrite our amortization as well this year.
It should be helpful to give free cash flow. So again as we move to more advisory work and strengthen the margin profile of the business that we're signing.
We see less capital intensity as part of that and that should be helpful to free cash flow not only in fiscal 2023, but also over the longer term.
Great. Thanks for taking my questions.
Operator can we go to the next question. Please.
Yes.
We'll go next to Jamie Friedman from Susquehanna International Group.
Thank you. This is spencer on for Jamie Congratulations on the results. It seems the years already tracking ahead of plan and some key metrics.
Is the guidance just conservative or are there other considerations, we should be looking at.
Thanks, I think the.
I think we feel very good about the progress that we're making on a number of fronts, particularly the strategic fronts that three A's and the margin at which we are signing up.
Business and when you look at something like advanced delivery, where we've already achieved half of our full year target.
For the benefits that we expect to generate.
It's a sign that we're making good progress.
Hi.
I'm hesitant to characterize the guidance in one direction or another but I would point out that while we're making really good progress on the strategic front and with the with the <unk> and with the partnerships that we have we have also been facing currency headwinds and the amount of that currency impact on our EBITDA and our pre tax margin.
We currently estimate is a bit more than we would have estimated three months ago because of the way exchange rates have moved over this period of time. So when we are seeing progress on the strategic front in areas that we control some of the areas that are outside of our control.
Such as such.
As such as exchange rates are have.
<unk> been a little bit more of a challenge so I really don't want to characterize the guidance one way or another.
Thank you I'll jump back in the queue.
Spencer do you have another question.
Yeah, that's helpful I'll jump back in the queue, Okay great.
Operator.
It looks like you are the key Spencer.
And we'll go back to Spencer.
Alright.
So are you still there.
Yes.
Take myself off the queue.
Okay, Great Oh, you take yourself off mute.
Okay, Alright, alright, so again, thanks, everyone for joining us today.
We're delighted with the significant progress we made this quarter, obviously in our three Asia on getting our business back to profitable growth. We remain very excited about the opportunity ahead.
We do serve our customers' mission critical needs with more capabilities than ever before.
And quite frankly, the idiosyncratic nature of a lot of the opportunities we have to turn this business around.
And the progress, we're making in those keep us energized and motivated to deliver so thanks again for joining and we'll talk to you after the next quarter.
This concludes today's Kendra quarterly earnings call and webcast. You may disconnect. Your line at this time and have a wonderful day.
Okay.