Kyndryl Holdings Inc

NYSE:KD

Earnings Call Transcript 2022-Q1

[Operator]

00:05 Good morning and welcome to the Kyndryl Quarter Earnings Conference Call. Currently all callers have been placed in a listen-only mode, and following management's prepared remarks, the call will be opened for your questions. [Operator Instructions] Please be advised that today's call is being recorded.

00:36 I will now turn the call over to Lori Chaitman Global Head of Investor Relations at Kyndryl. Thank you, you may begin.

[Lori Chaitman, Global Head of Investor Relations]

00:44 Good morning, everyone and welcome to Kyndryl's earnings call for the quarter ended March 31, 2022.

00:52 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. And these statements speak only to our expectations as of today. For more details on some of these risks, please see the Risk Factors section of our Annual Report on Form 10-K for the year ended December 31, 2021. Kyndryl does not update forward-looking statements and expressly disclaims any obligation to do so.

01:30 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 material for today’s event, which are available on our website at investors.kyndryl.com.

01:51 I'm excited to join the Kyndryl team as the new Global Head of Investor Relations. And I look forward to interacting with all of you. 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.

02:12 I'd like to now turn the call over to our Chairman and CEO, Martin Schroeter. Martin?

[Martin Schroeter, Chairman and Chief Executive Officer]

02:18 Thank you, Lori and welcome to Kyndryl. We're very happy to have you here. And thanks to each of you for joining us today to hear more about Kyndryl's first full quarter results as an independent company.

02:31 I'm pleased to update you on the progress we've made in recent months and our strategy as the world's largest IT infrastructure services provider. Before we get into the financials, our thoughts remain with the people of Ukraine and Kyndryl’s 74 Ukraine employees. I stand with those calling for peace and an end to the war in Ukraine. I've been moved by the generous spirit of many of our employees who have given their colleagues support during this difficult time.

03:00 From a business perspective we have little exposure to Ukraine and no facilities or subsidiaries in Russia. Our focus remains on the human aspect and our people. We're committed to providing continued support for Kyndryl employees in Ukraine, their families and our customers.

03:18 Now, turning to the business highlights. On our March 1 year-end earnings call we outlined our near-term financial objectives and strategy to put us on a path toward profitable revenue growth. We've taken significant steps forward on that path with financial results and signings in the three month period between January and March in line with our expectations and with progress on our strategic goals as well. We ended the quarter with over $2 billion in cash and on a solid financial footing to execute our strategy. And in just a few months we've made meaningful advances on our three major initiatives, our three A's, alliances, advanced delivery and accounts.

04:03 On today's call, I'll provide more detail on how we are leveraging our expanded alliances with key technology partners, the investments we're making in our delivery capabilities and people through upskilling and automation, and how we're proactively addressing existing accounts with substandard margins. David, will provide more detail on our quarterly financial results, discuss our outlook for the fiscal year that began in April 2022 and reiterate our medium-term goals.

04:33 As a reminder to many of you and as background for those who are new to the Kyndryl story, prior to our spin-off last November we operated largely as a captive services provider focused on supporting the products and technologies that IBM offered to its customers. In the process, we became trusted experts at designing, managing and modernizing complex mission critical systems at scale for large organizations.

05:00 As an independent company we've rapidly taking action to expand our total addressable market dramatically from about $240 billion to about $415 billion to take advantage of the new opportunities and alliances available to us in the cloud, security, data and automation. And this larger addressable market is expected to grow to about $510 billion by 2024. We have the capabilities to gain share in this growing market with six global practice areas that give us an end-to-end perspective with world-class intellectual property, data and know-how with extensive alliances with other technology leaders with an optimized delivery model, with an incredibly skilled global team of nearly 90,000 Kyndryl's with in-depth knowledge of our customers industries and with an evolving culture that is restless, empathetic and devoted to customers.

05:59 We're also well positioned to benefit from the macro trends that underpin many of our customer interactions, such as their ongoing digital transformation journeys that include the migration of some, but not likely all workloads to the cloud, the explosive growth of data, the integration of legacy and new technologies from multiple vendors and the urgent need for cyber security and resiliency.

06:24 Our capabilities in these areas differentiate us and give us substantial opportunities for growth. Our starting point is both exciting and under-appreciated. It's far too early for us to declare a victory yet, our strategy is working. I want to highlight that we're making progress and demonstrating that Kyndryl is a unique and different business now that we're independent.

06:47 Following three straight years of declining signings, we delivered 27% constant currency growth in the quarter compared to pro forma signings in the same period last year. And versus calendar 2021, we expect to generate double-digit constant currency growth in signings in fiscal year 2023, which as you know, began on April 1 of this year.

07:12 Within our signings growth, activity related to advisory and implementation services was particularly strong, up 50% year-over-year in constant currency when compared to prior year pro forma signings and representing 16% of our total signings. Growing our advisory and implementation services revenue, which tend to be higher margin and a feeder for Future Managed Services revenue is an important objective for us. Our growth in this area confirms that our strategy is working as customers are increasingly engaging us as their trusted technology services partner.

07:49 To capitalize on our expanded and growing addressable market, while at the same time strengthening our overall business performance, we're focused on three major initiatives: Alliances, Advanced Delivery and Accounts. These initiatives have the potential to transform our business and our team is working hard to execute on them. As you know, we've formed global strategic alliances with Amazon Web Services, Google Cloud and Microsoft. Our alliances with the three major cloud hyperscalers are a significant part of our growth strategy, because they allow us to expand beyond the boundaries of IBM centric technologies to participate in the broader multi-vendor ecosystem where our customers want us to operate.

08:33 Further, and in direct support of our practice areas, we've announced additional strategic alliances over the past few months. Most recently, we've aligned with SAP to combine their business technology platform and our deep expertise in artificial intelligence, data and cyber resiliency services in order to accelerate cost effective path to the cloud for our customers.

08:57 In addition, our strategic partnership with Nokia will help us to reach customers who are looking for LTE and 5G solutions as part of their industry [4.0] (ph) transformations. With Cloudera we will help customers enable and drive hybrid cloud, multicloud and edge computing data initiatives. Our expanded relationship with Lenovo will drive our development of scalable hybrid cloud solutions and edge computing implementations. With Pure Storage we will deliver mission critical and optimization services to enterprises and our expanded alliance with Dell will allow us to embed protection and recovery capabilities in customer solutions.

09:42 We found great interest among technology providers in working with us to make their offerings part of the multi-vendor solutions we provide and we focus on aligning with firms that are world-class in their segments. These strategic alliances are already helping us expand existing customer relationships and win new accounts. For example, we extended and expanded our relationship with Deutsche Bank to include cloud related content, a work that we wouldn't have won before our independence.

10:11 We're now optimizing and managing the anatomic pathology environment for the digital medical imaging system of Catalonia, demonstrating our ability to help customers manage large amounts of sensitive data. In a five-year $160 million agreement, we expanded our relationship with Motiva Enterprises to streamline its IT services and accelerate its cloud journey. Manpower selected us to help transform its IT infrastructure and applications to deliver more flexible and scalable web platform. And we've been at the center of digital transformations for customers around the world, including transitioning critical workloads to the cloud for a leading Irish Bank and providing digital workplace solutions for a major Brazilian pharmacy chain.

11:01 Our enhanced ability to design and implement optimized solutions that combine multiple vendors is driving our progress. In fact, these are just a handful of examples that contributed to our double-digit signings growth in the March quarter. Signings can be lumpy though and our focus now will be on delivering full-year double-digit growth in fiscal 2023 compared to calendar 2021.

11:26 At the same time, we are well aware that signings were both about quantity and quality, and we're making progress on the quality front too. Our projected margin on our signings in the quarter was up sequentially over our fourth-quarter margin, which was up compared to our pre-spin projected margin on signings. Our focus on quality signings also reflects an aspect of our accounts initiative and that we're not going to renew certain contractual elements if they are uneconomic for us even though that disciplined make signings growth harder.

12:00 Last quarter we laid out our targets for the benefits we expect in fiscal 2023 from our Alliances, Advanced Delivery and Accounts initiatives. As a reminder, we shared target of $1 billion in signings tied to hyperscaler alliances, $200 million in annualized cost savings from Advanced Delivery and another $200 million of annualized pre-tax benefit from our Accounts initiative. Our transition quarter between calendar 2021 and fiscal 2023 has given us a head start toward reaching our March '23 targets.

12:36 For Alliances, we had our first several hyperscaler related signings and while it's only May, we've already built a pipeline of more than $1 billion of opportunity. We also increased our cloud [Technical Difficulty] certifications by 10% in the quarter, bringing our total to roughly 17,500 and giving us more capabilities to market and deliver cloud services.

12:58 For advanced delivery, we've expanded our rollout of proprietary delivery automation tooling from a handful of accounts to more than a 100 at quarter end, and we've already freed up more than 900 of our people to serve new revenue streams and backfill attrition. The associated productivity is worth roughly $46 million a year to us. And at the same time this increased automation strengthens the quality of services we deliver and differentiates us in the marketplace.

13:27 In our accounts initiatives, we've moved from identifying and quantifying the opportunity in front of us to developing our strategies for working with customers and engaging with accounts that need extra care and attention. We know this initiative will take time, but we're pleased to report some [indiscernible] already in the form of accounts with actions already taken. Some of these actions begin to contribute immediately to our results, producing pretax benefits at a rate of roughly $26 million a year and some of the changes we and our customers have agreed too will result in benefits that are realized in future quarters.

14:04 In short, we're excited with the progress we've made on major initiatives and we're even more convinced of the significant positive contributions they will make to our business. To close my remarks, there is no change in the medium term strategic objectives we laid out, including our focus on serving our customers and returning to revenue growth in calendar year 2025.

14:26 And I want to reiterate what I said on our year-end call regarding our commitment to Kyndryl's future. Our teams are tackling the opportunities in front of us with urgency and we are moving forcefully to strengthen the margin profile of our business.

14:41 Now, with that, I'll hand it over to David to take you through our results and our outlook.

[David Wyshner, Chief Financial Officer]

14:46 Thanks, Martin. And good morning, good afternoon and good evening everyone. Today, I'd like to discuss our quarterly results, our balance sheet and liquidity and our outlook.

14:57 For starters, as Martin mentioned, our signings in the quarter were up 27% in constant currency versus prior year pro forma signings, due to benefits from our new technology alliances, as well as greater customer clarity about our business compared to last year.

15:17 Our signings increase follows our first major post-spin milestones, which were the new technology, training and go-to-market collaborations with each of the three major cloud hyperscalers. Beyond our signings growth, we delivered quarterly results that were consistent with the guidance we shared in March. In the quarter, we generated revenue of $4.4 billion, which represents a 2% decline in constant currency from our pro forma results a year ago.

15:49 Our results include two points of revenue growth we picked up from pass-through revenues related to IBM. 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 having been operated as a captive subsidiary of IBM prior to our spin-off, not the future growth potential of our business.

16:15 And with the strengthening of the US dollar over the last year, currency headwinds had a 4 point negative impact on our reported revenue growth. Adjusted EBITDA was $536 million, this represents an adjusted EBITDA margin of 12.1%, up slightly from our pro forma margin a year ago, primarily due to a currency headwind of 60 basis points. Adjusted pretax income was negative $51 million, which is $13 million stronger than the pro forma prior-year quarter despite $34 million in currency headwinds.

16:57 Among our geographic segments, we saw the strongest constant currency revenue growth in our Japan and strategic market segments. And our strongest margins were in Japan and the United States. Changes in [indiscernible] 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 customer’s 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 strongest. These are the strongest revenue growth in our cloud and apps data and AI practice.

17:46 Our signings growth in the quarter was driven by strength in our cloud, apps data and AI and security practices and by the 50% growth in advisory and implemented serves signings across our practices that Martin highlighted.

18:02 A few other items tied to our financials. First, as a reminder, our fiscal year end has changed to March, 31 effective for the fiscal year beginning April 1, 2022 and ending March 31, 2023. As a result, the quarter ended March 31, 2020 was a transition period for us that is not part of either our prior year period or our fiscal year 2023, which began a month ago.

18:32 Second, our reported results for the March quarter include $58 million of expense for transaction related costs associated with our spin-off, primarily related to systems migrations, rebranding and a broad-based employee retention plan that IBM put in place. We expect about $300 million of P&L costs and $400 million of transaction-related cash outlays over the next 12 months. These spin related outlays are temporary and should be much less in fiscal 2024.

19:07 More generally our adjusted quarterly results were very much in line with our expectations. Our gross capital expenditures in the quarter were $180 million and we received $9 million in proceeds from asset dispositions. Our adjusted free cash flow was $136 million, we provided a bridge from our Q1 adjusted pretax loss of $51 million to our free cash flow. A key reason that our free cash flow again exceeded our pretax income is that, our net capital expenditures were $75 million below our depreciation expense. This difference is primarily due to our continuing transition toward being less asset intensive. We also saw a cash flow benefit from working capital and other items in the quarter.

20:02 Our financial position remains strong. Our cash balance at March 31 was over $2.1 billion. This cash, combined with available debt capacity under committed borrowing facilities gave us more than $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 just over $1 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.

20:44 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 as 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 will generate this year is in many ways already spoken for.

21:15 Importantly, and using a slide I shared on our last call, I'd like to reiterate that our three A's initiatives driving certifications, signings and revenues for our new ecosystem partners, transforming delivery for upskilling and automation and addressing elements of our business with substandard margins carry significant potential for our business. We anticipate 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.

22:06 We're also pursuing growth in advisory and implementation services and among our global practices, which is incremental to the benefits coming from our three A initiatives, and we're managing expenses carefully throughout our business. We expect that these efforts over time will contribute roughly $400 million in annual pretax income. In total then, we've identified paths that we expect to generate roughly $2 billion of contributions to our annual pretax income over the medium term. I hope that Martin’s update on our progress on these initiatives gives you confidence in our eagerness and ability to seize this enormous opportunity.

22:52 Turning to our outlook, our game plan is to continue to serve our customers seamlessly and to deliver solid results even as we go through the three-year process of transforming our business, preparing to return to top line growth and positioning Kyndryl for stronger margins and higher returns on invested capital. Our outlook for the fiscal year ending next March, our fiscal 2023, assumes that we'll make significant progress on the initiatives we've laid out.

23:23 For starters, compared to calendar year 2021, we expect to drive double-digit constant currency growth in signings in fiscal 2023. The June quarter will be a tough signings comp for us due to two large renewals last year, whereas the December quarter is typically the largest signings quarter in our industry. So our signings progress won't be linear. What's important is that, for the fiscal year as a whole, our anticipated double digit signings growth will put us on track toward our first full year of revenue growth in calendar 2025.

23:59 As a reminder, we typically start each year with nearly 85% of our projected revenue already under contract, given the multi-year term of our customer relationships. Because of the nature of what we do and the long sales cycles and ramp-up times inherent in our business, it will take time for our progress on signings to translate into revenue and profits. Our financial outlook for fiscal 2023 reflects this element of our business model.

24:30 We're expecting revenue of $16.5 billion to $16.7 billion this fiscal year based on recent exchange rates as we're facing a roughly $1 billion year-over-year top line headwind from currency movements. Our guidance implies a revenue decline of 4% to 6% in constant currency from calendar 2021 to fiscal 2023. Comparing the 12 months ending March 2023 to the 12 months ending in March 2022, our guidance implies a year-over-year revenue decline of 3% to 4% in constant currency. These year-over-year revenue comparisons, both include a roughly 1 point benefit from pass through like revenues from customers to IBM that we largely didn't have in 2021.

25:23 Our outlook is for our adjusted pretax margin to be in the range of 0% to 1%. This is consistent with our 2020 and 2021 pro forma results, despite 60 basis points and expected currency headwinds this year. In addition, there is an impact on margins from revenue declining, but at the same time, that we're investing in sales, training and growth capabilities. Offsetting these headwinds is a full-year benefit from the workforce rebalancing actions announced in late 2020 versus only a part year benefit in 2021. And we will expect to get a partial year contribution this year from our new Advanced Delivery and Accounts initiatives.

26:07 From a cash flow perspective, we're targeting about $750 million of gross capital expenditures and $700 million of net capital expenditures compared to about $1 billion of depreciation expense. We continue to view our normalized annual adjusted free cash flow to be roughly $500 million, subject to timing related swings in working capital. As a reminder, in 2021 we generated $904 million in pro forma adjusted free cash flow and ended the year with $2.2 billion of cash on our balance sheet.

26:45 One anomaly we're seeing in our outlook for fiscal 2023 is that, although we expect our adjusted pretax margin to be consistent with our 2020 and 2021 results, we're projecting our adjusted EBITDA margin to be slightly lower year-over-year at around 13% to 14%. The lower adjusted EBITDA margin is primarily related to currency and spin-off related impacts on amortization, namely, a 30 basis point headwind from currency and a 60 basis point headwind due to a portion of our software purchases from IBM being treated as a monthly subscription rather than as a prepaid and amortized software license.

27:31 In the current quarter, our new fiscal first quarter that runs from April to June, we expect to generate just under 25% of our full year revenue. There is some seasonality in our margins with the October to December quarter typically being the strongest and the April to June quarter being softer. More generally, our projected growth in signings, including from our new alliances, the benefits from our advanced delivery solutions and the contributions we expect from our accounts initiative all reflect how we're running our business differently and positioning it for a much stronger future.

28:11 We're committed to returning to revenue growth by calendar 2025 and to delivering margin expansion. We have a solid game plan to drive our progress and this game plan starts with the rapid progress we've made in expanding technology partnerships and the meaningful initiatives we're implementing this year.

28:30 In fact, I want to share some details about the composition of our revenues that underscores the under-appreciated attractiveness of a large part of our business and the markets we serve. These dynamics highlight the opportunity that's associated with our accounts initiative, where we're addressing elements of our customer relationships that generate substandard margins. Our aggregate results mask the fact that within Kyndryl we have a strong $10 billion business, which I'll 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. To me, this blueprint is most of what we do in a source of shareholder value hiding in plain sight.

29:32 And the reason that this values under-appreciated is our other roughly $8 billion of focus accounts revenue. This revenue stream generates virtually no gross margin and after SG&A cost it is losing money. Look, the best kind of problem to have is a flexible one. Our accounts initiative is all about the opportunity to make our focus accounts more like the majority blueprint of our business over time. Over the next three years 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.

30:17 In a nutshell, we're excited about the earnings upside associated with our accounts initiative and our blueprint revenues represent the well-established roadmap we can follow to deliver this upside potential. More generally, we're enthusiastic about the fiscal 2023 outlook we've shared today, about the longer-term opportunity in front of us and about how our near-term actions will position us to achieve our longer-term objectives. We're committed to serving our customers, transforming our business and delivering future growth and earnings.

30:54 With that let me turn things back to Martin.

[Martin Schroeter, Chairman and Chief Executive Officer]

30:58 Thanks, David. Before we turn to Q&A let me just quickly summarize why we're so enthusiastic about Kyndryl's future. We're in the early stages of operating independently, shifting to our growth opportunities, seizing our now larger market and bringing incremental and differentiated value to customers. We are the trusted partner with tremendous expertise, experience and scale. As technology continues to evolve our customers will look to Kyndryl to keep them operating efficiently and ahead of the technology curve.

31:34 Our three A initiatives will deliver substantial benefits as 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 shareholders.

31:52 And with that, David and I are pleased to take your questions.

[Operator]

31:58 [Operator Instructions] We'll take our first question today from Tien-Tsin Huang with JP Morgan. Your line is open.

[Tien-Tsin Huang, JP Morgan]

32:15 Hey, guys. Thank you. Good morning. I like this slide 20. I think both of you talked about this transforming focus account into [indiscernible] account. So I'm just curious, just the plan, how do you get that focused account to move up into the higher gross margin categories. Is it just a function of selling more on a digital or modern content, is it pricing discipline, is there going to be some run-off in the book? Just trying to better understand the plan to get there. Thanks.

[Martin Schroeter, Chairman and Chief Executive Officer]

32:43 Yes, sure. Thanks, Tien-Tsin. Good morning and thank you for joining. A few things I'd say: one, , remember that we start -- we start these discussions in a really good place. Our customers like what we do for them, they trust us to run their hearts and lungs. And so these discussions are -- they're very engaged, they're very receptive to working with us. And keep in mind that our relationships in the proximities to our customers we brought with us, right? We didn't -- we're not creating new relationships -- we had the kind of the front and center relationships with these accounts when we're in IBM, and so we brought those.

33:28 So we start in a good place. The patterns we are seeing in how these discussions are evolving are multifaceted. So primarily what we're seeing is an expansion of the relationship. And that's about using our new alliance partners bringing some of our new capabilities to help them on the journeys that they're on, whether that's cloud or data or security. So primary pattern we're seeing is an expansion of the relationship, driven by the ecosystem in which we now operate and the content we have to bring, which is higher margin.

34:15 The other element that we're seeing is, how we re-solution what we're delivering. So, as an example, we use sub-case or content from other providers to help us deliver certain elements. And we have an ability to swap out some of those and bring others in. So we can go look through our vendor lists and see what alternatives we have. And I make that unique -- identify that is a unique pattern, because it allows us, obviously, to keep the revenue, but improve the margin profile.

34:55 And then thirdly, at renewal we have a couple of options, obviously, we renegotiate the price and obviously we work with our customers to make sure that we get to a better spot. We also have the opportunity to take some content out of these deals, where for instance, it's uneconomic. What you see in these deals -- what you seeing these relationships, it’s not all one thing, it's a myriad of services, it's a myriad of pretty broad and complex relationship and we have an ability for instance to ask the vendors, maybe as a software vendor, maybe as a hardware vendor to go directly to the customer and sign a license for the software that we need to manage, et cetera.

35:45 So we have an opportunity to pull some content out. Obviously, that's -- as I said in my prepared remarks, that can represent a headwind to our signings growth, but we are, as David has said, as I've said in the past, we're focused on the quality of building that backlog. So yes, it would represent a slightly smaller relationship, but a much more profitable relationship.

36:09 So again, we started in a really good place here, customers are very engaged in these discussions and receptive, which -- none of which has surprised us, because we brought really good relationships over and they like what we do for them, and these patterns, I think are the ones that over time will just -- we’ll see more and more, either expanding the relationship with new content, carving out some of the vendors that aren't helping our P&L. And then as I said, sometimes will renew without some of the third-party content here. So hopefully that's helpful.

[Tien-Tsin Huang, JP Morgan]

36:42 It is. So just thinking about signings and that being up 20%, I'm assuming, I think you did say the margins were up sequentially on the signings, which suggest that clients are embracing and open to sort of your new construct or following this blueprint model. Is it safe to say that's the [Multiple Speakers]

[Martin Schroeter, Chairman and Chief Executive Officer]

37:03 Yeah. That is the correct interpretation. In fact, the growth we printed was also reflects a few relationships where we didn't renew some of the content, because it wasn’t economic. In those cases, say, those customers they went directly to the vendor and they -- either they bought the licenses or they got some of the content, but we renewed the higher margin, higher value content and we still were able to grow. Now, every quarter is a little bit different and we are focused on growing the full year signings at double-digit, which we're very confident we can do, but it will reflect that higher value content and we will continue to carve out -- we will carve out content that just doesn’t make sense.

[Tien-Tsin Huang, JP Morgan]

37:48 Right. So it's not just a level of growth, but also the quality of it within that double-digit. I think I understand. Thank you, Martin.

[Martin Schroeter, Chairman and Chief Executive Officer]

37:55 Thanks, Tien.

[Lori Chaitman, Global Head of Investor Relations]

37:56 Operator, next question please.

[Operator]

38:00 We will take our next question from David Togut with Evercore ISI. Your line is open.

[Millie Wu, Evercore ISI]

38:08 Hi. Good morning this Millie on for David Togut. Thank you for taking the question. I have a question and may have a follow-up after. So my first question is on free cash flow. Can you give us more color on your fiscal ‘23 free cash flow expectations? And maybe unpack the key drivers, including capital spending and working capital usage among others?

[Martin Schroeter, Chairman and Chief Executive Officer]

38:37 Sure, Millie. Thanks for the question. When we look at free cash flow and our normalized free cash flow of around $500 million a year, I would say the way we get there in fiscal 2023 is, we have close to $100 million of adjusted pretax income at the midpoint of the guidance range we provided, plus about a $300 million gap, maybe a little bit more between the amount of depreciation expense that we have and the amount of net capital expenditures that we're going to have. So a little over $1 billion of depreciation and around $700 million of net CapEx produces about $300 million of free cash flow there. And then we're looking for in the range of $100 million from working capital and other items. And that's going to be an area of focus for us this year as well.

39:35 Obviously, with respect to free cash flow, there is always a possibility of timing differences that has very much worked in our favor in 2021, and probably a little bit in the March quarter as well. So we'll watch those, but the three key components are pretax income, the depreciation CapEx gap and a bit of contribution from working capital.

[Millie Wu, Evercore ISI]

40:01 That's very clear. Thank you so much. And my next question is on your constant currency growth. So last quarter you guided to a 5% decline, a pro forma constant currency revenue growth and you, obviously, outperformed that guidance this quarter with 2% of constant currency pro forma growth. So can you maybe help us, what are the different factors that drove that?

[Martin Schroeter, Chairman and Chief Executive Officer]

40:36 Sure. Our March quarter results include just over 2 points of revenue -- 2 points of revenue growth we picked up from pass through IBM revenues. These are primarily situations where we ended up being contractually responsible for providing services to customers, but IBM is economically responsible. And we hadn't really forecasted those continuing. So it’s about 2 points of the over performance and by the way fiscal 2020 -- our fiscal 2023 guide now assumes a 1 point year-over-year benefit from pass through IBM revenues.

41:15 The remaining upside was really driven by strength in our advisory and implementation services revenues, the portion of signings in this past quarter and in the fourth quarter of 2021 they turned into project work and revenue sooner. So it was helpful to us as well.

[Lori Chaitman, Global Head of Investor Relations]

41:37 Operator, next question please

[Operator]

41:41 [Operator Instructions] We'll take our next question from Jamie Friedman with Susquehanna. Your line is open.

[Lori Chaitman, Global Head of Investor Relations]

41:58 Jamie ?

[Martin Schroeter, Chairman and Chief Executive Officer]

41:59 Jamie, we can't hear you.

[Operator]

42:05 Jamie Friedman, your line is open, please start to mute function on your phone.

[Jamie Friedman, Susquehanna]

42:08 Hi can hear me okay?

[Martin Schroeter, Chairman and Chief Executive Officer]

42:10 We can. Thank you. Good morning.

[Jamie Friedman, Susquehanna]

42:12 Okay. Great. Good morning and congratulations for all the hard work here. I really like this slide 20 in the incremental disclosures you have here. Really appreciate it. But I wanted to ask you a couple related to that. So this is the one where you talk about focus accounts and the blueprint accounts. I'll just add two upfront about the same topic, but in general how do you see the contract renewal discussions going? And then also on contracts, I think that -- I apologize if I got this wrong, on average your contract duration runs about five years, do you see any meaningful trends in contract duration. So first on the renewals and second on the duration. Thank you.

[Martin Schroeter, Chairman and Chief Executive Officer]

42:59 Yeah, sure. Thank you, Jamie. And thanks for joining the call. Good question. So few things, on renewals, I'll step back and say that, from all the work that IBM did last year as we were approaching the spin and then the Kyndryl team since, we have brought -- we really have brought the customer base on this journey with us and the backlog that we brought, the substantial backlog that we bought over with us really does represent like the customer base and their vote of confidence on Kyndryl's and what it can -- what it can ultimately help them achieve, which are a set of really complex journeys related again to them transforming their business to be more competitive.

44:00 So between the work that IBM did, as I said, prior to spin and now our work as an independent firm, customers are coming on this journey and I start there, because it's also reflected in our renewal rates. And we are really doubling down on the relationships we have, the customer base we have, investing quite heavily in making sure they have access to the best skills, making sure that they have access to our partners and what we as a group, as a consortium can bring to helping them on their journeys and these renewal relationships are going well.

44:43 As we start to put -- as we start to put our alliances and our partners and we show up together now as we start to put the capabilities around that and are able to help them -- are able to help our customers go where they want to go. I expect that our renewal rates will remain very high.

45:09 Now, on your average contract, I'll sort of bifurcate it a little bit, in the run side of the business when we're managing infrastructure, I know, four, five, six years can be typical. I see -- we see a slight shortening of some of those -- some of that duration, slight, it's not a meaningful change, I think it's more of a trend in the marketplace. And then the other part of our business, which we are growing and, as you saw, we were able to grow our advisory business by 50% in the signings base, that is a much shorter duration kind of business.

45:53 And part of our focus is because we can convert that into revenue, as David said, part of our upside in the quarter was that we signed a little bit higher mix and that business starts to convert. It also, by the way, I think to link these two now, it's -- when we grow advisory and the reason we're delay with that performance, we grew advisory 50%. And given what I said about our big bet on investing in our customers is, that's a big vote of confidence from our customer base, because over time as they believe in our capabilities to help us advise them, then they also believe very strongly in our capabilities to run their infrastructure for them.

46:37 So we see that the vote of confidence on advisory and growth not only that our strategy to move into this ecosystem and be a more relevant partner for our customers to be working, but it's a massive vote of confidence on where they want to go and our ability to help them over the long term. Hopefully that's helpful.

[Jamie Friedman, Susquehanna]

46:56 Yep. That's a great answer. Thank you for that. I'll jump back in the queue.

[Lori Chaitman, Global Head of Investor Relations]

47:00 Operator, next question please.

[Operator]

47:04 We'll go next to Bill Cadigan with Deutsche Bank. Your line is open.

[Bill Cadigan, Deutsche Bank]

47:08 Good morning. Just a couple of housekeeping items. David, can you review the spin in terms of transactional costs for this year? And then also provide any color as to what that's going to look like next year? Thank you.

[David Wyshner, Chief Financial Officer]

47:21 Sure. We're looking for about $300 million of P&L costs this year, fiscal 2023, and probably about $400 million of cash outlays. The principal component is associated with these spin-related costs. Our systems migration work that needs to be done post spin to separate us from IBM systems and which we're still running, that's the largest component. We have rebranding costs that we're incurring and we also have a broad based employee retention program that IBM put in place, under which we're continuing to accrue and that pays out in this December. And that's actually the biggest source of the difference between the P&L cost and the cash outlays, because a portion of that was already accrued prior to year end.

48:17 So, those are the key components of it. All three, the retention program will be done at the end of this calendar year, the systems migration work will carry in to fiscal 2024, but it should be much smaller, the rebranding work will be done this year. And as a result, the amount of spin-related costs that we expect to have in fiscal 2024 should be significantly less than what we have, much less than what we have here in fiscal '23.

[Bill Cadigan, Deutsche Bank]

48:50 So comfortable to say, I mean, at least 50% lower year-over-year. I guess my question is, I'm trying to understand what part of that is sort of structural versus one-time in nature?

[David Wyshner, Chief Financial Officer]

49:00 Yeah. I would view all of it as one-time in nature, some of it just -- and yes. I do think it will be down 50% or more in fiscal 2024. It's all one-time, some of it just has a little bit of a tail that goes into fiscal '24.

[Bill Cadigan, Deutsche Bank]

49:21 Okay, great. Thank you. And then, remind me, how do you guys define medium term in you're kind of -- in your slide deck?

[Martin Schroeter, Chairman and Chief Executive Officer]

49:27 Yeah. I tend to think of medium term is three to five years for us. And in particular, our initiatives, the accounts and alliances and advanced delivery initiatives should very much play out over the next three to five year period with advanced delivery having the potential to be in -- toward the shorter end of that period.

[Bill Cadigan, Deutsche Bank]

49:54 Okay, great. Thank you. And then just one final question. You guys have been very consistent in your messaging around your commitment to the IG rating. Can you talk about just to round that out, the potential of pursuing a rating with Fitch just to make sure that you -- not only from a customer facing perspective, you have to pick up another IG rating, but also in terms of your outstanding public debt, just in terms of providing some assurance that it's going to remain in the index. Thank you.

[Martin Schroeter, Chairman and Chief Executive Officer]

50:24 Sure. As you mentioned we are investment grade with both Moody's and S&P. We do consider that important to us. Not really from a financing cost perspective as much as it's commercially very important to us. And we are going to look to see whether our -- whether the sort of ratings group we have is having too is the right best answer for us or whether other alternative, additional alternatives would make sense.

[Bill Cadigan, Deutsche Bank]

51:04 Great. Thank you for your time.

[Lori Chaitman, Global Head of Investor Relations]

51:06 Operator.

[Operator]

51:08 And this does conclude the Q&A portion of today's call. I would now like to turn the call back over to Martin Schroeter for any additional or closing remarks.

[Martin Schroeter, Chairman and Chief Executive Officer]

51:15 Great. Thank you, operator. And thanks again everyone for joining us today. Look, you can hopefully tell that we're very excited about the progress we've made in our first six months as an independent company. And I hope you also can sense the confidence we have, the steps we're taking along with the long-term journey that our customers are on that define sort of the industry tailwinds in which we operate really do position us to be -- continue to be the leader, to be a world-class growing and a higher profit business in our expanded market. So thanks again for joining and we will talk to you soon.

[Operator]

52:01 This concludes today's Kyndryl Quarterly Earnings Call and Webcast. You may disconnect your line at this time, and have a wonderful day.