Kyndryl Holdings, Inc. (NYSE:KD) Q3 2023 Earnings Conference Call November 8, 2023 8:30 AM ET

Company Participants

Lori Chaitman - Global Head, IR

Martin Schroeter - Chairman & CEO

David Wyshner - CFO

Conference Call Participants

Divya Goyal - Scotiabank

David Togut - Evercore

James Friedman - Susquehanna Financial Group

Operator

Good day and thank you for standing by and welcome to the Kyndryl's Earnings Conference Call. At this time, all participants are in listen-only mode. After the speakers presentation there will be a question and answer session. [Operator Instructions]. Please note that today's conference is being recorded.

I would now like to hand the conference over to your first speaker of the day, Lori Chaitman, Head of Investor Relations.

Lori Chaitman

Good morning, everyone, and welcome to Kyndryl's earnings call for the second fiscal quarter ended September 30, 2023. Before we begin, I'd like to remind you that our remarks today will include forward-looking statements. These statements are subject to risk factors that may cause our actual results to differ materially from those expressed or implied. These forward-looking statements speak only to our expectations as of today and we are under no obligation to update them.

For more details on these risks, please see the Risk Factors section of our annual report on Form 10-K for the year ended March 31, 2023. In today's remarks, we'll also refer to certain non-GAAP financial 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 investor.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 like to now turn the call over to Martin. Martin?

Martin Schroeter

Thank you, Lori, and thanks to each of you for joining us. Last week we marked our second anniversary as an independent company and we're delivering progress at an accelerated pace.

Today I want to talk about why we've been able to succeed. Of course our first half performance reflects continued progress and strong execution positioning us really well for the year as a whole and we're raising our full year earnings outlook.

Our 3A's initiatives centered on alliances and advanced delivery and accounts are paving the way for profitable growth. Kyndryl Consult, Kyndryl Bridge and our efficiency efforts are also driving our results and as an organization we're delivering strong performance that is evident both in our financial metrics and in our customer satisfaction scores.

On today's call David will review our recent financial results, our raised fiscal 2024 outlook and how we're changing Kyndryl's profile for the better. However let's not lose sight of why this performance is happening.

We are vital to our customers current and future technology needs. Our capabilities align with the powerful secular trends in IT and this makes us an indispensable partner for our customers.

In other words our progress is being fueled by the leadership position we have in our industry, our new freedom of action we have as an independent company and how that perfectly aligns with the larger forces shaping the evolution of IT.

We're helping customers navigate these secular trends and we're already capturing the growth opportunities they present. And because we're at the heart of these trends of enabling our customers IT futures as well as their current operations performing mission critical work across a broader technology ecosystem our business is sustainable and important over the long-term.

That's why we're seeing growth in alliances with our hyperscaler partners in adoption of Kyndryl Bridge in consult signings and revenue, in customer satisfaction, in public cloud management and in areas like apps data and AI.

So yes we're fixing focus accounts that are - so that our margins are better but Kyndryl's transformation is about so much more than that. It's about Kyndryl being the leader in providing and enabling our customers to have and leverage the technology they need to win. The results we're presenting today just as they did last quarter and last year are evidence of our strength market leadership and ability to fix the challenges we inherited.

The margins on the signings we're putting into our backlog the execution of our 3A initiatives our success with our new partners and our ability to enable our customers to harness secular IT trends are reminders that we were always more than just a turnaround, and that we've always been a market leader a leader that is well positioned to capture future growth.

To appreciate our growth opportunities it's important to understand how we're building on our heritage and leveraging our expertise to meet customer needs and forge new higher value revenue streams.

Our 30 plus year heritage and managing mission critical IT systems is a very powerful asset and we're seeing hybrid IT estates to plant migrate everything to cloud as a central theme among large enterprise CIOs.

Our recent survey of hundreds of IT and business leaders indicated that while they aim to run nearly 40% of their workloads on a cloud or distributed platform the overwhelming majority also view mainframes as essential to their business operations and likely to remain at the core of their tech stack.

With that in mind our new alliances with hyperscalers combined with our expansive knowledge of legacy technologies give Kyndryl a unique ability to help organizations achieve their IT and business objectives.

With Kyndryl Consult, our technology experts advise our customers and co-create with our partners to modernize and optimize hybrid solutions and accelerate business outcomes.

With a hybrid infrastructure businesses can strategically choose where and how to host specific workloads based on their requirements. We're working with customers everywhere to ensure that the right workload runs on the right platform.

This leads to improved performance and cost savings. And we've been consistently generating double digit revenue growth in Kyndryl Consult by delivering thought leadership and mainframe modernization and strong capabilities and automation, cloud migration and management data optimization and security and resiliency.

Additionally Kyndryl Bridge integrates AI operational data and Kyndryl's expertise to give customers visibility across their technology estates including multicloud and hybrid landscapes with insights to help them understand predict and act for better business outcomes.

We have more tech stack operating data than anyone in the world and through our ability to leverage AI we are providing our customers and ourselves an advantage in managing and developing their systems. Kyndryl Bridge uses automation to enable more secure, stable and reliable technology operations for our customers.

With the benefit of AI machine learning Kyndryl Bridge is identifying patterns and systems and infrastructure and is now performing one billion automations a year for our customers across secure tech stacks.

And one of the benefits that we're seeing from Bridge and its ability to operate as a self-healing architecture is that the frequency of significant incidences down more than 30% so far this year in those accounts who've moved on to Bridge.

So through our heritage, Kyndryl Consult and Kyndryl Bridge we're meeting customers where they are in their digital evolution and helping them move forward. Our capabilities and innovation are putting us at the center of collaborative customer relationships in which technology drives business outcomes in a reliable and secure way.

This is allowing us to access incremental market opportunities to grow our share of wallet with existing customers and to win new customers and obviously transform parts of Kyndryl.

Beyond enterprises need to manage and optimize their infrastructures, our market position and our capabilities are allowing us to benefit from the key secular trends in IT. The adoption of artificial intelligence, technology skills shortages, the needs to modernize and partial in many cases cloud migration, all of which are creating growth opportunities for us.

Given our presence across a range of enterprise technologies, AI represents a multifaceted opportunity for us. As I mentioned AI sits at the center of our Kyndryl Bridge platform and is producing actionable insights for us and our customers every day.

As the largest infrastructure services provider in the world we generate large amounts of data about IT systems. We use this data in Kyndryl Bridge and it gives us the ability to identify application performance patterns under almost any condition so we can prevent incidents from occurring and reduce required maintenance.

AI is also a go-to-market opportunity for us as customers seek to build AI and their own generative AI into processes they know that their AI is only going to be as good as their data.

This is creating demand for our expertise in how to architect data to set the foundation for AI and for Gen AI applications and we're working with both existing and new alliance partners to help facilitate AI in complex environments and to develop joint capabilities.

We see this both as a growth opportunity for us and as a natural extension of the data network digital workplace and security services we already offer. In fact signings in our applications data and AI practice are up more than 30% this year. A second trend is that many organizations just can't attract and develop the range and scale of skilled IT resources they need particularly in certain disciplines.

IT skills are in short supply throughout the world and in-sourced infrastructure work doesn't benefit from the scale, the know-how, the training, the investment, and the innovation that Kyndryl brings to the table as a third party service provider including the expansion of our hyperscaler certifications since our spin, because our scale and associated ability to home grow talented resources the skill shortages in the marketplace are making Kyndryl value proposition even stronger.

We manage today more than 60% of the outsourced mainframe capacity in the world and we invest in maintaining this world-class team. Our know-how and alliances with leading technology providers also give us unparalleled expertise in enterprise CIOs to need to modernize complex environments.

Simply put nobody can retrofit their IT plane while it's flying like we can. And when we combine need capabilities with customers needs to enhance security and resiliency and efficiency with their desire for innovation we become an indispensable business partner.

As I mentioned earlier selective migration of certain workloads to the cloud is a prime example of where large organizations are looking to modernize innovate and drive efficiency.

Our hyperscaler related signings are up more than 35% so far this year and our hyperscaler related revenues are up even more and some of our largest new logo signings have been for customers who want to leverage our hyperscaler alliances and cloud migration expertise.

And because we serve as an operator and integrator and an advisor to our customers and their digital business transformations, we naturally find ourselves at the nexus of each of these broader market currents.

An essential theme underlying our strategies and our approach to the market is that we're capturing and building value in our business. As we've shared previously our gross margin the time of our spin the margin that our backlog was producing was in the mid teams, but we've dramatically changed the projected margins on new business that we're signing and raising these margins more than 50% to 26% over the last 12 months.

From a financial perspective this is a game changer for our business. David will walk you through the math of our gross profit book-to-bill ratio being above one, but the growth vector the source of value creation that we're delivering is that even though we're engineering a decline in our revenue this year we're building absolute profit dollar growth into our backlog.

We're adding more to the top of our earnings funnel that is flowing out into our P&L this year. At the same time as we move further from our spin more and more of our revenues are coming from higher margin post-spin signings.

This fiscal year only about a third of our revenues coming from post-spin signings next year it'll be roughly half of our revenue coming from post-spin signings and in fiscal 2026, it'll be roughly two-thirds from our post-spin signings. So the inflection point when our P&L is largely determined by our higher margin post-spin signings will dramatically change our earnings profile again.

As we shared last quarter where this will show up is in our adjusted pre-tax income and margins. We've put adjusted pre-tax losses behind us and our forecast implies more than $350 million of adjusted pre-tax income improvements this year compared to last.

And the margins at which we're signing contracts and the other actions we're implementing have us on path to deliver higher earnings each year on our way to high single digit adjusted pre-tax margins. And yes, the math associated with that is ultimately a billion dollars or more of adjusted PTI with a high conversion of our net earnings into cash.

In short while we continue to do the important vital work we always have for our customers we're successfully transforming elements of our business very quickly because of our great people our new culture our unique capabilities to meet mission critical needs our powerful IP and data and our outstanding execution each of which is aligned with the secular trends in the market.

We are pleased with the significant progress we've made so far. We're enthusiastic about our momentum going into the second half of the year and very excited about the path in front of us.

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

David Wyshner

Thanks Martin and hello everyone. Today I'd like to discuss our quarterly results, the outstanding progress we're making on our 3A's, the growth and gross profit that we've been building into our contracted book of business and our updated outlook for fiscal year 2024.

We have a lot of good news to share. Our second quarter results reflect strong operational execution and continued progress on our key initiatives. In the quarter revenue total $4.1 billion, a 5% decline in constant currency.

A year-over-year decline in revenue was anticipated and primarily driven by our intentional exit from negative no and low margin revenue streams within ongoing customer relationships not by macro factors.

We continue to gain momentum in higher margin advisory services. Kyndryl Consult revenues grew 17% year-over-year in constant currency which highlights how we're growing our share in this higher margin higher value ad space.

Consult signings grew even faster increasing 32% year-over-year in constant currency. This performance reflects how the opportunities for growth in Kyndryl Consult services stemming from our new alliances with third-party technology providers are outweighing the macro issues pressuring some other firms.

Our Q2 signings were down 3% year-over-year in constant currency. Outside of our core enterprise practice where we've concentrated on removing pass-through revenue and addressing focus accounts signings were up in the single digits.

Our adjusted EBITDA grew 34% to $574 million. Our adjusted EBITDA margin was 14.1% a year-over-year increase of 390 basis points. At the risk of being immodest we view this as remarkable execution. Nearly four points of margin expansion is a proof point for our ability to drive meaningful profit growth in our business.

Adjusted pre-tax income was $25 million, a $127 million improvement in profit compared to the prior year quarter. As I'll discuss in a moment our continued progress on our 3A's is the key driver of our earnings growth.

We address our customer's needs through our geographic operating segments and 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, app state and AI, security and other growth areas.

More generally as we look back on the quarter, we're thrilled to have delivered results that position us to exceed the full year earnings targets that we've already raised once before. Our strategy is working. Our 3A initiatives are driving continuous improvement throughout our operations and fostering additional progress each quarter.

As a reminder at the start of the year we've provided fiscal 2024 targets of $300 million in revenue tied to hyperscaler alliances, $450 million in cumulative annualized cost savings from advanced delivery by fiscal year end and $400 million of cumulative annualized pre-tax benefit from our accounts initiative.

Heading into the second half of our fiscal year we're well on track to exceed our alliances target and are raising our targets for our advanced delivery and accounts initiatives. Through our alliances we're building a portion of our customer relationships that include cloud-based content.

In the second quarter we recognize more than $100 million in hyperscaler related revenue, putting our run rate ahead of our $300 million full year target. Our hyperscaler certifications total more than 37,000 which is more than double what they were two years ago and now include even more advanced certifications.

Our advanced delivery initiative is transforming the way we deliver our services and Kyndryl Bridge is driving our progress. To-date we've been able to free up more than 7,500 delivery professionals to address new revenue opportunities and back to electrician. This is worth roughly $425 million a year to us representing a $50 million increase in our annual run rate this past quarter.

We continue to see significant automation opportunities across our delivery operations as we increase service levels, reduce our costs, and incorporate more technology into our offerings. Our accounts initiative has been and will continue to be a global effort focused on fixing elements of contracts with substandard margins.

In the second quarter we increased the annual profitability of our focus accounts to $400 million, which was our initial target for year end. Successful execution of our 3A's is our fastest path toward achieving sustainable profitable growth and the progress our teams have made on these initiatives is incredible.

As a result we're increasing our annualized savings target for both our advanced delivery and accounts initiatives by $100 million. Turning to our cash flow and balance sheet. In the quarter we generated positive adjusted free cash flow of $69 million.

Our gross capital expenditures in the quarter were $175 million and we received $113 million of proceeds from asset dispositions as a disproportionate amount of our planned FY 2024 asset sales occurred in Q2.

Our financial position remains strong and we continue to expect that our full year adjusted free cash flow will be positive. We provided a Bridge from our adjusted pre-tax income to our free cash flow as well as a Bridge from our adjusted EBITDA to our free cash flow in the appendix.

Our cash balance in September 30 was $1.4 billion. Our cash combined with available debt capacity under committed borrowing facilities gave us $4.6 billion of liquidity at quarter end.

Our debt maturities are well laddered from late 2024 to 2041. We had no borrowings outstanding under a revolving credit facility and our net debt at quarter end was $1.8 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 and all three agencies recently reaffirmed our ratings. We're thrilled to have exited the transition services agreement with our former parent and to have completed the migration to our fit for purpose operating financial and HR systems in the two years following our spin.

This was a large complex and important series of projects delivered on time and on budget that will allow us to adapt our processes and drive operating efficiencies in ways that we couldn't until now.

On capital allocation our top priorities continue to be to maintain strong liquidity, remain investment grade and reinvest in our business. Our leadership position in IT infrastructure services combined with benefits from our 3A initiatives is significantly expanding our margins and will drive meaningful free cash flow growth. And over time, we'll be in a position to consider regularly returning capital to shareholders all while remaining investment grade.

As encouraged as I am by the earnings growth we delivered in Q2 I'm even more enthusiastic about how we continue to position Kyndryl for future margin and profit growth.

As an independent company we've 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 in the high single digits for pre-tax profit.

As Martin mentioned the September quarter was a continuation of that favorable trend and as our business mix increasingly shifts toward more post-spin contracts you will see significant margin expansion.

In our earnings presentation we've shared a simple analysis that accentuates how we've been creating and capturing value in our business. With an average projected gross margin of 26% on our $12 billion of signings over the last 12 months we've added over $3 billion of gross profit to our backlog.

Over the same period of time we've reported gross profit of $2.7 billion. This means we've been adding more gross profit to our backlog than our contracted book of business has been throwing off in the form of gross profit reported in our P&L.

Having a gross profit book-to-bill ratio above one at 1.1 is a measure of how we're growing what matters most, the expected future profit from committed contracts. We continue to make significant progress on our 3A's initiatives and the momentum-to-date supports our continued expectation that over the medium term our alliances initiative will drive signings revenue and roughly $200 million in annual pre-tax income.

Our advanced delivery initiative will drive cost savings equating to roughly $600 million in annual pre-tax income and our accounts initiative will drive annual pre-tax income of $800 million or more.

We're also driving growth in Kyndryl Consult and among our global practices, which is incremental to the benefits coming from our 3A initiatives and we see opportunities to control expenses throughout our business. We expect that these efforts will contribute roughly $400 million in annual pre-tax income over the next few years.

In total then, the magnitude of the earnings growth opportunity we're tackling is tremendous relative to our current margins. Progress on our 3A's is a central source of value creation for Kyndryl.

With another strong quarter to build on we're again raising our profit outlook for our 2024 fiscal year. We're growing our margins this year largely due to the 3A initiatives, growth in Kyndryl Consult and productivity gains. We now expect our fiscal 2024 adjusted EBITDA margin to be roughly 14.5%, a half point higher than our previous estimate.

This represents an increase of roughly 290 basis points versus fiscal 2023, and we're raising our outlook for adjusted pre-tax income to be at least $140 million versus our prior outlook of at least $100 million. This increase implies more than a 200 basis point margin expansion compared to last year.

Importantly we would have increased our full year outlook for adjusted pre-tax income by $30 million more were it not for the strengthening of the dollar and weakening of the Yen over the last several months. The 3A's workforce rebalancing, real estate consolidation, growth in Kyndryl Consult are pricing strategies and other actions are all contributing to our margin growth.

Our outlook for revenue is a decline of 6% to 7% year-over-year in constant currency which translates to $15.8 billion to $16 billion based on recent exchange rates. The strength of the U.S. dollar over the last six months has reduced our revenues measured in dollars, but it doesn't impact our constant currency outlook which we are narrowing to the favorable end of our initial range driven in part by the strength in our Consult signings.

Also as a reminder the year-over-year revenue decline we're projecting is primarily due to the soft backlog of fiscal 2024 revenue we were born with, plus intentional near-term actions we're taking to transform our business. These changes typically involve removing selected low or negative margin scope from ongoing customer relationships.

We've accelerated these actions over the last six to nine months, so the year-over-year revenue decline in the second half of our fiscal year will be greater than in the first half. For the December quarter on a year-over-year basis we expect revenues to decline in the high single digits in constant currency and for the revenue decline to be most pronounced in our U.S. and strategic market segments where our reduction of pass-through elements is most impactful.

We expect adjusted pre-tax income to be positive with adjusted pre-tax margin up year-over-year in the quarter despite it being the quarter that is our toughest earnings comp this year due to the exaggerated seasonality that we had in Q3 last year.

As I mentioned we expected adjusted free cash flow to be positive this fiscal year. We now project roughly $700 million of net capital expenditures in fiscal 2024 which is 7% lower than our initial projection as we push to be less capital intensive and we project about $850 million of depreciation expense.

We continue to expect about $300 million of cash outlays for separation-related work primarily systems migrations and for workforce rebalancing actions that are driving significant cost savings.

This will be the last year in which we incur spin-related charges. So we expect our adjusted earnings to move closer to our reported GAAP earnings over time. In fact next year our principal adjustments should be only non-cash stock-based comp and non-cash intangible amortization.

We remain committed to our target of 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.

To wrap up, our business model centers around providing mission critical services to large complex organizations that are dependent on technology and pursuing digital evolution. We call this operating at the heart of progress.

Operating at the heart of progress is also becoming a distinguishing feature of who we are as a corporation, delivering progress on alliances, advanced delivery and unprofitable accounts. Delivering progress with Kyndryl Consult and AI enabled Kyndryl Bridge, delivering progress through a global migration to new operating, financial and HR systems following our spin.

Delivering progress in our margins and adjusted earnings as an independent company and delivering progress in our winning culture and in the breadth of solutions we provide to customers. As Martin highlighted we are symbiotically delivering progress for our customers and for ourselves as the world's leading provider of IT infrastructure services.

With that Martin and I would be happy to take your questions.

Question-and-Answer Session

Operator

Thank you. At this time we will conduct the question and answer session. [Operator Instructions] Our first question comes from Divya Goyal from Scotiabank. Please go ahead.

Divya Goyal

Good morning everyone. Great quarter. David and Martin, further to your comments, overall we can see obviously the company doing the right things, progressing the right way. I wanted to get some color on what are your overall discussions with your clients like? Obviously Kyndryl delivers mission critical projects and does mission critical infrastructure work. But given the broader macro and geopolitical concerns out there, how are the clients thinking, and how do you see that progressing into early part of 2024 and towards the latter part of 2024? And how does that fit in with Kyndryl's continued progress?

Operator

Please go ahead. You're off mute.

Divya Goyal

Sorry, did you hear my question?

Operator

We did hear your question. I think they're on mute. Bear with us one second.

Martin Schroeter

Alright. Can you hear me now?

Operator

We can. Go ahead.

Martin Schroeter

Good. Thank you. So thanks for the question, Divya, and thanks for the nice intro to the question as well. What we - and you said it, well, what we experience is driven by the role we play in our customers' environments. We are mission critical. We are the trusted partner as we have been for many of our customers for decades. And so, the nature of the discussion and you see this in some of our charts, the nature of the discussion that we have with our customers is really about the secular trends that they want to take advantage of and/or that they need to manage.

The industry-wide skill shortage is very real for CIOs today, and we see the results of that and we see the effect of that in how strongly we are able to drive our consulting performance and the role we can play in helping them navigate what are obviously very complex infrastructures. We see it in helping them with even the basics, right? When you think about what Kyndryl Bridge helps our customers do, it helps them understand their environments, it helps them keep up with the never-ending best practices that every technology provider is putting out constantly in order to optimize their systems.

And so the role we play I think makes us a bit different from others, and I guess it's reflective if you will of the two things or the things we can do for them. One is, we can help them save money, that's part of what Bridge helps them do, it helps them optimize their systems and that's important. And I wouldn't say that saving money today is any more important than it has been in the past. And then we can help them, prepare them, get themselves prepared to take advantage of the innovation no matter where they see it, which is part of what creates these hybrid environments that we're so good at helping them manage.

So we don't see, again, I think it is unique to us because of the role, we don't see the macro in any of the places in which we operate. We don't see the macro having a profound difference in the nature of the discussions. The discussions for us are still around the secular trends that they want to take advantage of and prepare themselves for whatever the macro is either today or whatever the macro is going to be in a year's time.

Lori Chaitman

Thanks Martin. Operator next question please.

Operator

Bear with us. Our next question comes from David Togut from Evercore. Please go ahead.

David Togut

Thank you and good to see the outperformance especially on advanced delivery and accounts initiatives. Just focusing there even against your raised targets you're already at 80% year-to-date of the raised targets for both advanced delivery and accounts with half of the year to go. So can you flesh out the dynamics around both for the back half of this year and why wouldn't your targets be even higher given your high attainment so far this year?

David Wyshner

Sure David, thanks. When you look at our targets for advanced delivery and for focus accounts, remember that they're cumulative targets. So we started the year - started this fiscal year with the progress we made last year, which is around $200 million over $200 million related to advanced delivery and over $200 million related to the focus accounts. And we've increased each of those significantly. And as you point out we're at our full year target for accounts.

We're within $25 million of our initial target for advanced delivery and that's really why we raise them each by $100 million. And so, with that that translates into for accounts is about $50 million of incremental progress each quarter in the back half of the year, which is consistent with where we ran last year and obviously we overperformed relative to that in the first half of this year.

And then on the advanced delivery side our forecast calls for $125 million of further improvement in the back half of the year, which again is pretty consistent with where we've been running other than the really strong performance the overperformance we had in the first half of this fiscal year.

David Togut

Appreciate that. And just as a follow-up given the unique dynamics of your large business in Japan where you're generating revenue in Yen and your cost basis in dollars, USD. Is there anything you can do to kind of manage that, let's say, currency mismatch on revenue and expenses going forward and sort of limit the headwinds to revenue and earnings?

Martin Schroeter

Yes, David. There are things we can do there and part of it is our starting point where we started out with the software contract that we did and the customer contracts that we did. And as we go forward there are things we can do to increase the matching between those. So its provisions that we build into our customer contracts that will help protect us more going forward that becomes the most immediate step. Second when we actually get to negotiate the software contract, we'll look to not have it all be dollar denominated so that's part of it as well.

And then there's intra-year there's some there's hedging that we do to mitigate the impact, but that only helps that only mitigates it and really only for a limited period of time. And then the last thing we look at and we'll look at going forward is broader asset liability matching. We started off with our debt all being dollar denominated. And going forward I think I'd like to see a little bit better mix, a little bit different mix of our debt that's more aligned with where our assets are, where our embedded equity is around the world. So that's an opportunity for us as well.

And then lastly just going back to your prior question, I think with respect to the 80% and where we stand already. I think we should make it really clear that if we achieve when we achieve the expected benefits from any of the initiatives we're not standing down. We're going to keep powering ahead. And so if there are opportunities to overperform, over deliver on the initial targets we laid out two years ago. We're actually going - we're actively going to look to take advantage of those.

David Togut

Thank you. Appreciate your comprehensive answer.

Lori Chaitman

Thanks David. Operator next question please.

Operator

Our next question comes from Tien-Tsin from JP Morgan. Please go ahead.

Unidentified Analyst

Hey guys, this is Brendan on for Tien-Tsin. Thanks so much for taking my question and congratulations on the results. Great job. So question for me on the just qualification of like the revenue raise it took up in the revenue midpoint. So you guys obviously outperformed on the accounts initiative to the tune of a $100 million per quarter in the first half. But the revenue moves up a tick. So I think obviously there's Kyndryl Consult outperformance going on there. But could you help us understand the put and takes on the revenue line. If there's anything we're kind of missing aside from those main drivers of accounts initiative and Kyndryl Consult? Thank you.

David Wyshner

Sure I think on an accounts and advanced delivery there on the 3A you'd see impact on revenue there be ends up being fairly limited, but obviously we are making significant progress there in the earnings contribution. So when we look at our the revenue raise, the narrowing to the favorable half of the range, I would say that Kyndryl Consult is very much the biggest driver of that. That's an area where we're outperforming. And in the outperformance, there is probably even a little bit greater than maybe apparent, because we've been more aggressive than stepping away from pass-through revenue from OEM type revenue and are still or are nonetheless able to narrow to the upper half of the range.

So we're very much holding onto accounts. We're optimizing them and taking out content that doesn't make sense. We're growing Kyndryl Consult which tends to be higher margin revenue. And all of that is helping us, really drive more income out of revenue that was - that that is fairly consistent but in the upper half of the range we initially went out with.

Unidentified Analyst

Thanks David. And I'll jump back in the queue with another question.

Lori Chaitman

Thanks Brendan. Operator, I believe there is one more question in the queue.

Operator

Yes. Please stand by. And our last question comes from James Friedman. Please go ahead. James you're live on stage. Please go ahead.

David Wyshner

James, are you there. Did Brendan, operator, did Brendan rejoin the queue with another question.

Operator

He has not. I can bring him to stage.

David Wyshner

Well, you said he had another question, so we give - maybe James can work on a technical challenge and we'll keep moving.

Operator

Brendan, you're live on stage. Please go ahead.

Unidentified Analyst

Great. Hey guys. Thanks so much. So yes, my question number two is on visibility and through this gross profit backlog. So love to hear that it's above one, because that's how you guys are obviously managing the business and that makes sense as a sensible target to me. I'm curious just to think about because of the kind of lengthiness of some of these deals, what are - what if any variables you guys think about still being out there in between booking those gross profits and realizing them whether that's potentially something like wage inflation or just how should we think about any variables outstanding.

Martin Schroeter

Yes. So, look, the estimates we provide, Brendan, capture our view today of the things you had, like how much we're going to have to invest in our teams and all that stuff. So we have a view of the contract. The longer the contract, the more conservative we tend to be on the view, because we know that we're going to want to maintain the best workforce in this space in the world, et cetera., et cetera. So we have a series of assumptions around how we have to invest in our workforce. We have a series of assumptions around where, for instance, deals include other people's IP, what those price rises are going to be. So, all of that gets captured.

And I'll point out that our - what we would shorthand to the bid versus bid, right? How did - what did we actually get versus how we bid is very close to what we're showing in our data now for what's going in the backlog. So we're realizing, if you will, what we're assuming. That's one of the reasons we're so comfortable with sharing the data this way. It represents what we have been realizing now. Now, the big execution element is not really all the assumptions around how we're going to invest in our people and the skills they have to bring, et cetera, et cetera. Those are important, and we get those right.

We have to keep delivering, right? The 80 plus thousand Kyndryl, out of the 80 plus thousand two-thirds of us every day are delivering in front of customers, and we're really, really good at it. That's why our customer sat scores are so high. That's why customers love what we do for them, and that's, quite frankly, why they trust us. So, when we get comfortable with sharing what we put into the backlog, it's driven by the confidence that we're getting from, that we're actually delivering those over time, and importantly, we just have to keep the organization executing on delivering every day, which is, again, what we've been good at, and what, in fact, we've been getting better at, and things like Bridge help us with that as well.

So we're very comfortable that we can deliver the margins that we have. The assumptions are robust enough and well proven by now enough that we are delivering those, and then we have opportunities, obviously, to keep getting even better at it by using Bridge and more customers. As we said a couple of months ago, we had Bridge and about 500 customers, and by the end of the year, we'll have it in a thousand customers. So the assumptions are robust, our delivery is phenomenal, the future for us is even more robust with things like Bridge, with our ways of working, et cetera, et cetera. So I think you should assume that we'll keep delivering the margins that we're putting in the backlog.

Unidentified Analyst

Great. Thanks so much.

Lori Chaitman

I believe Susquehanna is back in the queue. Operator?

Operator

Yes. Please standby. Jamie you are on stage. Please go ahead.

James Friedman

Okay. Sorry about my technical difficulties there, Lori. So, congrats on the good execution. I had two questions, maybe one for Martin and one for David. So first, in terms of free cash flow expectations in the second half, could you help us unpack what you're thinking about if there's anything that we need to remember from last year, callouts from the first half, that's one thing.

And then, David, I'd be interested in understanding your perspective on which of the new service lines and new signings are the most accretive to margin. Now, I understand everything is probably accretive to margins, but if you just would help unpacking a couple of these is what you feel are the most strategic or the most margin accretive. I think that would be insightful? Thank you both.

Martin Schroeter

Sure, let me go first on your second question, and I'll ask David to unpack if he has anything to unpack on cash flow. So, look, I think you're right, everything is accretive to margins. In fact, part of the reason that we want to make sure we're sharing everything that's going in the backlog is because it's representative of each of the pieces as well. As we start to think about more or less on a relative basis, right, on an absolute basis, all accretive, all looking quite good, and all consistent with where we want to be in the medium term as more of our P&L is defined and reflects, as we covered in our prepared marks, more of it reflects what we put in the backlog as opposed to what we inherited. We're hitting that inflection point.

So, THERE is a difference, we see a difference already, and I think the difference exists in the marketplace between the margins we can earn in our Consult business and the margins we earn in our run business. I don't know if that persists forever, but we do see higher margins in the Consult business right now than we do in the run business. Now, the opportunity for us in the Consult business is obviously to keep it growing, which we expect it will. And the opportunity for us is to make sure that we keep our skills and our people at the forefront of all those secular trends that they're sitting at the forefront of today.

There is an opportunity for us in the run side of the business to continue to improve margins as well. And Kyndryl Bridge is a great example of how we'll continue to drive margin improvements in the run business. So, right now, on a relative basis, I would point to our Consult business as we see in the market, the Consult business drives slightly higher margin profile for us. And we'll see how that changes over time, but right now it's slightly better than our run business. David, you want to cover?

David Wyshner

Sure. And on free cash flow. For the full year, we expect our adjusted free cash flow to be positive, with the year-to-date number being slightly negative. Certainly, that implies that the second half will be stronger, and that's what we would expect, in particular, because some of the working capital and cash flow seasonality that we have. You may remember that in the first quarter, we have a disproportionate amount of our software license payments, which get amortized over the course of the year or, in some cases, over the course of many years. Indicate, we also have annual incentive payments that are, where all the outflows in Q1, and the accrual happens over the course of the year.

So, it's natural for our seasonality to be skewed more toward the last three quarters of the year and toward the back half, and as a result, we expect stronger cash flow in the second half of the year. The other point I'd make is that the composition of our free cash flow will probably flip a little bit. In the first half of the year, we've been under-running our full-year run rate on capital expenditures and working capital has worked against us. Capital expenditures should pick up a little bit. We're targeting to get to about $700 million of net CapEx for the year, so that will be a little bit more of a use of cash, and working capital we expect will be more of a source of cash in the second half of the year as we get to positive for the year overall.

And then what I'd really want to highlight is that as we go forward and grow earnings, we expect free cash flow growth to coincide with our adjusted pre-tax earnings growth, with strong conversion of our adjusted pre-tax income to free cash flow over time.

James Friedman

Thank you both for the detailed response. If I could just follow up with on this slide 22, if you - this is the one that breaks out the services by revenue. If you wouldn't mind sharing how you think of what this will look like in the future, like at the end of your guidance. And if that's too specific, if at least qualitatively, you could share like which of these are going to get bigger or smaller, and why? I think that would be helpful context. Thank you.

Martin Schroeter

Sure, let me take a swing, and if David has something, he wants to add to it, we'll certainly give him a chance. For us, the secular trends we see in the marketplace, as we had in an earlier chart, around cloud and hybrid cloud, around the need to manage in that world, around skill shortages, et cetera, to us suggest applications, data, and to us, suggest that our cloud practice, our security and resiliency practice, our network and edge practice, our applications and data and AI practice, all become really strong high single-digit kind of getting close to double-digit kind of growers. I think that's the market in which they sit, and I see a long-term secular arc that we are part of that is going to drive those, and so they'll mix a bit stronger in our signing streams and therefore, over time, in our revenue streams.

Digital workplace is a practice for us that is -- it is a grower, it's in a growing space but probably not at the same rate as those other four practices that I mentioned. And then, over time, look, core enterprise and zCloud, because of the role we play and the scale and the magnitude of the skills that we have, while this is probably a market that's declining, I would expect this could still represent a growth opportunity for us once we get through getting the hardware and the software content as much as possible out of our revenue streams.

Our labor piece of this market and our labor piece of our business is growing. And I would expect over time, given the skills challenges that our customers have that they express around the teams that they're relying on and how do they get more, et cetera, et cetera, I would expect over time even the core enterprise and zCloud business for us could be the labor component, could be and should be and will be a growth opportunity. Although in a declining market because of the nature of where customers are going with cloud and multi-cloud, et cetera, et cetera, et cetera.

So, I see the mix shifting a bit because I see very high, really good high growth in the secular trends. But every one of our practices, I think, still sits in an area, sometimes it's unique to us, every one of our practice sits in an area where we can continue to drive growth for each of them, even if it's just the labor piece, but we can drive growth in each of the practices. But that will cause us a remix, if you will, of the revenue waiting over the timeframes that you're talking about. David, anything you'd add?

David Wyshner

I'd just add that the other axis that's really important to us is the growth in Consult, which really runs across the practices. But as you know, we started off with consulting around 10% of our revenue. It's grown to 14%. Our target is to move it up to 20% and again this really plays across the practices and highlights the fact that we expect to grow our share in Consult, in advisory work, in advisory and implementation work as well. And so that's an important part of how we think about each of the practices.

James Friedman

Thank you.

Lori Chaitman

Thank you. Thanks Jamie for your question. Thanks everyone for joining us today. Martin?

Martin Schroeter

Yes, thank you, Lori. So, look, again, thanks everybody for joining. I am really proud of the progress that we made again this quarter, and the team is, you can tell, us just executing very, very well. And bear in mind that we only had our second birthday last weekend, right? So this is a company that has made a ton of progress and delivered a ton and well ahead, I think, of what many thought we could in a pretty short period of time.

I'd also encourage you to have a look at the corporate citizenship report, our first, and again, this was just before our second birthday. We published it back in September, so we weren't even two years old yet. We published what I think is just a phenomenal example of how we're building this business the right way. So we're delivering on our business goals, and we're also having an impact on how the world works.

And so, as we head into our third year as an independent company, I remain more excited as -- as excited or more excited than I've ever been about where we're going. I see how our teams are moving toward where our customers are going and supporting them on their journeys on these really important secular trends and helping them prepare. And we're building the capabilities that allow all of that to happen within those mission-critical workloads, which is the role we've always played. So thank you again for joining, and we look forward to talking with you in a few months. Thank you. Operator, we're done.

Operator

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