Fiscal Second Quarter 2027 Earnings Conference Call - KYNDRYL HOLDINGS INC

Explicit Guidance:

• Fiscal 2027 Revenue: Expected to be flattened, down 2% in constant currency (including acquisition contribution in the second half).
• Fiscal 2027 Adjusted Pre-Tax Income: Range of $600–$700 million (includes approx. $200 million in workforce rebalancing charges and similar amount of savings).
• Fiscal 2027 Free Cash Flow: Reaffirmed range of $400–$500 million.
• Fiscal 2027 Amortization Expense: Expected to remain at current levels, totaling approx. $1.3 billion for the full year.
• Fiscal 2027 Interest Expense: Expected to be approx. $160 million.
• Fiscal 2028 Operating Expense Savings: Annualized run rate expected of $400–$500 million following the completion of workforce rebalancing.
• Fiscal 2028 Free Cash Flow: The $1 billion target remains on track.
• Gross Margins: Full-year 2027 expected to improve, exiting the fourth quarter close to 25%.
• Pre-Tax Margins on Signings: Average projected pre-tax margins in the high single digits; target remains stable at 8%.

Business-Segment Outlook:

• Kindel Consult: Growth expected to resume in the second half after Q2 was the low point for constant currency growth; full-year growth projected in the high single-digit to low double-digit range.
• U.S. Segment: Expected to continue driving strong growth (up 9% in Q2, with ~6 points driven by Consult growth).
• International Segments: Spain and Latin America showing positive momentum; Europe expected to recover in signings and revenue as sovereignty solutions are deployed.
• Backlog & Signings: Average projected gross margin on new signings held at 25%; 43 deals signed in the last 12 months exceeded $50 million (11 in Q2), with ~1/3 containing scope expansions or new logos (up from 1/4 prior year).
• Healthcare IT Leaders: Integration underway to expand application implementation and managed services capabilities in clinical, operational, and workforce systems.
• ServiceNow Partnership: Launching a new co-developed solution next week combining ServiceNow workflows with Kindle Bridge data to provide IT estate context.
• Sovereignty Solution: New differentiated solution to be announced next week to address customer data sovereignty and regulatory requirements, particularly in Europe.

Market and Competitive Outlook:

• AI Modernization Demand: Driving enterprise demand for infrastructure, application, and data modernization; nearly half of organizations are behind on modernization goals, creating opportunity.
• Hyperscalers: Positive momentum and demand for modernization across public and private cloud environments.
• Pricing & Margins: Gross margin expansion expected as revenue mix shifts to higher-value services; ability to capture value from new scope and logos while maintaining 25% gross margin on signings.
• Customer Behavior: Customers balancing innovation (AI deployment) with operational stability; increased deal cycles for large commitments ($10M+) due to AI provider strategy debates.
• Broadcom Alliance: Expanded relationship to provide end-to-end consulting for VMware Cloud Foundation, aiding private cloud modernization.

Macro / Industry Outlook:

• Geopolitics & Sovereignty: Ongoing debates regarding data sovereignty and mission-critical system security in Europe and globally impacting customer decision timelines.
• Interest Rates: Higher rates and borrowings have increased interest expense; future outlook factored into full-year guidance.
• Regulatory Environment: Increasing regulatory demands driving need for "policy as code" and automated compliance within AI use cases (e.g., European banking sector).
• Economic Climate: Customers focused on operational stability and cost optimization alongside transformation.

Strategic Initiatives:

• Workforce Rebalancing (WFR): Substantially completed; savings expected to be realized in the second half of 2027, largely offsetting first-half charges.
• AI Innovation Labs: Expanded network to Dallas and Luxembourg (adding to Liverpool) to test high-value AI use cases and deploy Kindrel Agentic Framework.
• Kindle Bridge: Platform now foundational for deploying, governing, and orchestrating agents; integrating operational data with AI governance.
• M&A: Completed acquisition of Healthcare IT Leaders; integrating teams to drive synergy and move up the value stack in healthcare.
• Partnerships: Expanded Broadcom alliance; upcoming ServiceNow co-developed solution launch.
• Digital Twins & Automation: Deploying digital twins and automation to streamline operations for global luxury goods client.

Risks and Headwinds to Outlook:

• Decompression in Q3: Expected difficult comparison (comp) in the third quarter.
• Geopolitical & Sovereignty Delays: Ongoing debates on data sovereignty in Europe and AI provider strategy uncertainty may extend sales cycles for large deals.
• Workforce Rebalancing Charges: Full-year guidance includes $200 million in one-time charges; timing of savings realization in H2 is critical.
• Working Capital Volatility: Seasonality of vendor payments and prepaid software subscriptions (notably in Q1) impacts free cash flow timing.
• Commercial Matters: Minor resolution in Q2 provided $3M benefit; excluded from long-term structural outlook.

Management Tone on the Future:

• Confidence: Management expresses confidence in delivering fiscal 2027 results and progress toward fiscal 2028 objectives; describes Q2 as the "low point" for Q2 constant currency growth in Consult, signaling a turnaround in H2.
• Strategic Shift: Emphasis on moving from "reimagining relationships" (Blueprint) to "AI-led modernization" and "productivity sharing" to drive future margins.
• Margin Expectations: Rejection of the idea that pre-tax margins on new signings need to exceed 8%; focus is on maintaining high single-digit PTI margins while leveraging higher-margin partner offerings (ServiceNow) and data insights for future growth.
• Financial Flexibility: Strong balance sheet (Net leverage <1x) and $4.8B liquidity support continued investment and capital allocation priorities.

Miscellaneous:

• Segment Reporting: Minor change made to segment reporting, transitioning India from "Principal Markets" to "Strategic Markets."
• Debt Structure: Completed $1B senior notes issuance (due 2029 and 2032) to refinance maturing notes; maturities well-laddered through 2041.
• Commercial Paper: Established commercial paper program to diversify short-term working capital funding sources.
• Focus Accounts: "Blueprint" focus account initiative largely complete with 80%+ of P&L now represented by post-spin contracts; long tail remains but not a primary growth driver.