Kyndryl Holdings, Inc. (KD) Earnings Call Transcript & Summary

All right. Here we go. No time to waste. My name is Tien-Tsin Huang. I cover the IT services sector at JPMorgan. And this is the Kyndryl session. This is being webcast. We're going to -- we're happy to take questions. I'll do a fireside chat with the team. But if you have any questions, please use the portal, and we'll make time at the end to take your questions. So with us from Kyndryl, Martin Schroeter, CEO, Chairman; also David Wyshner, the CFO, is here with us. Thank you both for spending the time.

Thank you, Tien-Tsin. Nice to be here.

It's been a fun stock to cover. A lot has happened in the last year since we all last got together. And I thought we'd just start with that, right? I mean it's been, what, 3 years?

3.5 years.

3.5 years as an independent company, and I know that there was a lot of challenges to overcome in the eyes of investors, and you've gotten that and achieved positive revenue growth last quarter. So congrats on that. But for those that are maybe newer to the name, Martin and David, what's gone right in your mind? I know a lot of it is, of course, execution and having a good strategy. But maybe walk us through how we got here and why you feel good that it is sustainable, this positive revenue growth?

Sure, sure. Thank you. And again, thanks for the time today, Tien-Tsin. And thanks for everybody who's spending some time with us. 3.5 years ago, Tien-Tsin, I think we had a lot to prove. I think at a macro level, we had to prove that there was an investable thesis to what Kyndryl did because it wasn't obvious necessarily that infrastructure services, even though we were the leaders, we still are the leaders, it wasn't obvious that there was an investable thesis here. And as you said, we picked a strategy that was pretty straightforward. We called it -- we shorthanded it to the 3 As, which is for us really about becoming part of the ecosystem that really mattered to our customers by creating alliances with the Microsofts, the Googles, AWSs of the world. It was about improving. We had great delivery, but improving the quality of our delivery and moving our delivery organization to what I'll call kind of the next level. That was what we called advanced delivery. And that's allowed us to not only improve quality, but it's allowed us to automate. It's allowed us to keep our labor costs under control and generate pretty substantial profits. And then third, we had -- we were spun out with a series of relationships that were just not sustainable over the long term from a financial perspective. And so those -- what we call focus accounts were where we spent a lot of time to reimagine those relationships. And so what I think we've proven, Tien-Tsin, over the last 3.5 years is that there is a way to create and capture value in the space. We've -- in that period, we've improved profitability fairly dramatically. We've generated substantial amounts of cash flow last year and guided again to another improvement this year. And so what's exciting, what's sort of -- we find ourselves now at a spot where, as you said, we grew last quarter, and we told the world last week in earnings that we'll grow for the full year. And that means to me that we've kind of now hit the start line, right? We're now at the starting line where we become what we always said we would, which was a firm that can grow, that's a firm that can generate substantial amounts of cash. And it's a firm because of the business model and the visibility that we have to our book of business, it's one that allows us to both reinvest in the firm as well as return capital to shareholders, and we started that process in November of last year when the Board authorized our initial share repurchase. So we've proven quite a bit. We've proven our value to our customers. We've proven we can capture that. We've proven that we can generate cash. We've proven we can return capital to shareholders. So it's an exciting, again, time to be at the -- what I'll call the starting line for Kyndryl. Anything, you -- no? Okay.

Okay. I don't take for granted how hard it is to run and prepare to get to that starting line. So I think that's important to call out. But a couple of follow-ups to that, Martin. I'm thinking you and David, I know put a lot of thought into these things. Just the mid-single-digit target, right? I know you're at the starting line now. You're going to -- you've given the guidance of growing plus 1%, call it, this year, getting to mid-single digit. Why is that the right benchmark for Kyndryl?

Yes. Look, in the medium term, it's the right benchmark for a number of things. First, we didn't want to overly rely on high revenue growth given the physics of this business. And while we told everybody in Investor Day, we were going to in the next -- in the near -- in the medium term, in the next few years, we're going to triple cash flow and we're going to double profits, we didn't want the world to think we were going to have to grow double digit in order to deliver that in terms of revenue, and we don't. So when we talked about mid-single-digit growth at the end of the medium term, it's really in the context, one of -- that's the only -- that's all we need in order to drive substantial cash flow growth and substantial profit growth. So that's one. Two, the physics of this business, which are very powerful, as I said, and allow us to return capital, you also can't overcome the physics. So while we had a great -- as an example, a great signings year last year, over $18 billion, a book-to-bill north of 1. The year prior, because we were trying to address these focus accounts, the 2 years prior, actually, our book-to-bill was sub-1. And so while one great signings year is not enough to change the physics of the business. So what we're focused on now is the continuation of another book-to-bill north of 1 this year and the year after that and the year after that. All of that allows us to deliver and only requires that we deliver sort of mid-single-digit revenue growth. So it's all we need to do in order to drive, again, great cash flow and earnings growth. It's also -- it requires, given the physics of this business and the backlog nature of it, requires a few years in a row of a healthy book-to-bill in order for us to grow. Now we'll see. We're not ready to talk what's beyond the medium term. I would say that our -- the markets we serve are probably growing a little bit faster as we shift into those markets. So again, we'll see how the next few years play out. But for now, in the medium term, mid-single digits is the right place for us to think about for us to finish as we get back to growth.

No, it's a great goal to have given where the peers are. I don't know, David, anything to add to that?

No.

Let's talk -- I have to ask it, right? I know I've asked it before. I don't know you get the question a lot, just the cyclicality of the business. I thought you did a good job on the call and at Investor Day talking about why it's more defensive and you're not tied to a lot of discretionary spend. But can you drill in on that?

Yes. I think there are really a number of reasons why we tend to be less cyclical and really not significantly cyclical. First of it is -- first reason is really the nature of the work we do. It's mission-critical. It's nondiscretionary. It's operating the core systems for large enterprises. And I think that starts out by giving us a significant amount of protection in the cycle. The second reason I'd point to is the long-term contracts we have with so many of our customers. It locks us and them in, and it makes sense, too, given the nature of what we do for them. And then the third is that even in a situation where others might start to see impacts of the cycle, things like efficiency and productivity and optimization that we do tend to become more top of mind for enterprise customers. And so even in situations where there is a cycle, things that we're talking to customers about things we can do for them move up on their priority list. And so for all those reasons, we see ourselves as being really significantly insulated from, probably not immune to, but significantly insulated from the macro.

Okay. Good. Now you have a lot of signings. I think 1.2 book-to-bill for last year, which is great. A lot of that has large deals embedded within the signings. So tell us what the nature of these deals are all about? Who are you taking share from? Who are you winning against? And of course, the timeliness of these signings coming into revenue, what do you see there?

Yes. So a few things. Let me maybe start with what are they when we do a big deal. So we had a few big deals last year. We would expect to have a few big deals each year. And obviously, they're all a little bit different. Some are in regulated industries, some are not. But by and large, as an example, we had a pretty substantial deal last year to run the infrastructure for a credit card company. It's an existing -- it's been a customer for many, many years. They appreciate about us, the innovation we bring. They trust us to run their systems. This is a company that needs to generate roughly 40 million authorizations a week in order to run their platform. And so they trust us. We have the deep engineering expertise. We have the scale that they need. There is both a mix of mainframe as well as x86 content. There's some public cloud that's in there. So what that deal represented for us was a renewal, but also an expansion of what we're doing for them. And that expansion allows them to take advantage of some innovation they see out in public clouds, and we'll manage that whole hybrid environment for them. It allows us to provide them the level of resiliency that a credit card company, you can imagine would need as their infrastructure becomes more complex. And then we also have a series of data architecture work, some consult work going on. So it really just running the infrastructure of a credit card company, as you would imagine, is a pretty substantial and comprehensive scope for what we do. Same time, we are moving one of our big customers, one of our big health care customers to a cloud. So we -- this particular customer has chosen Microsoft Azure. And we partnered with Microsoft to help move what is ultimately going to be a health care firm that I think they have 15 million or 16 million members. And so they need -- again, they need scale, but they also need the deep expertise, and they need Microsoft and Kyndryl showing up together to make sure that they get the kind of resiliency, the kind of security and the scale, again, of what it takes to run a health care system that has that many people because that many people, for instance, generates probably 30 million lab tests every 6 months or so, all that has to be tracked, et cetera, et cetera, et cetera. So the nature of these is infrastructure. It is making sure that the mission-critical elements of what they need to bring to serve their customers every day, whether it's hospital system, health care systems, credit card companies, banks, et cetera, make sure it's there working all the time.

And when we look at our signings growth last year, we're up 46% year-over-year, and it was really broad-based, right? When we look across geographies, we see a breadth of strong performance and same among verticals or large versus small deals and among our practices with growth everywhere, including cloud and apps, data and AI and security and resiliency. Consult versus managed, our signings grew at almost exactly the same rate in both of those pieces of our business. So almost any dimension we look at last year, we saw broad-based strength.

Good. I always like the examples. And of course, it's healthy to be broad-based. So thanks for going through that. So let's dig in on some of the details here. You mentioned cloud and hybrid. And I know you have some hyperscaler targets. You were above that in '25. But I get the question a lot, how do you partner with these different players? What's the motivation for you to work together, subcontract out, et cetera? What's sort of the line of sight that you have there as these relationships get bigger and scale up?

Yes. So just -- let's step back for a second and recognize that when Kyndryl was part of IBM -- it wasn't Kyndryl at the time. When it was a division within IBM, it had a very narrow IBM-only focus, very logical that IBM would keep their divisions working on things that were important to IBM. And what this customer base, however, was asking this division even when it was part of IBM was, please help us with our most challenging issues. And they wanted this business to work with Microsoft and Google and AWS, but they just -- the business obviously was there to help IBM. So the minute we spun out, in fact, it was within a week, we had created already a pretty deep and meaningful relationship -- partnership with Microsoft. We did one with Google a month later and AWS just after that. And at the heart of that is because this business can meet customers where they are and now because we've invested and because we have these great partnerships, we can actually help take them where they want to go. So we've repositioned this business to be part of their future, not just part of their past. And we always -- we assumed, we asserted, we believed that it would work, and that's why the hyperscalers, as an example, would want to work with us because they know the critical work that this business was doing. And they know that the customers that their customers -- our shared customers were telling them, you need to work with Kyndryl because they know us better than anybody. So from a CIO's perspective, there is nothing more powerful, there is nothing CIOs like more than having their infrastructure services provider and their cloud showing up together so that it works smoothly, it works well, and it works all the time. So from a responsiveness standpoint, from an innovation standpoint, from an expertise and a trustworthy standpoint, our customers tell us work with our cloud provider -- again, I gave an example of Microsoft, but we do the same with AWS, we do the same with Google, and now we're doing the same with SAP as their RISE partner, work with our infrastructure services provider to make sure this goes as seamlessly as we need it to. So it's a very powerful combination. And that's -- again, that's hyperscalers, that's now SAP, but we do work with Oracle and everybody who has a meaningful role in the enterprise.

And you have the credentialed people, right?

We have the credentialed people, exactly right. So we spent very heavily, we invested very heavily to get the credentials and the skills and the experience. So we now -- as we sit here today, we probably have 40,000-or-so credentialed cloud experts within the firm.

Good. No, that scaled up quickly. The demand was there, you seized it. The estate and the assets that you manage, I guess, create a gravity for it. So no, glad to see that's going as you see. Let's pivot a little bit and talk about Kyndryl Consult. I know I've asked you that question a lot on the earnings calls. Just tell me if I'm annoying you with it, by the way.

Never.

I'll keep asking it probably. You've been defeating a lot of the peer group in terms of performance. It was up 45%, if my old eyes are correct here last quarter. Short-cycle work across the industry has been uneven at best or challenged, but you're going through that. So what differentiates Kyndryl with Kyndryl Consult?

So a few things. As I mentioned, we are their trusted partners running their systems. So we are viewed not only as trustworthy, but we're viewed as deep, deep experts in their -- in the technologies that they're currently running. That's a great starting point for us. But to that, we've also been able to supplement a few things. One, we run with a system called Kyndryl Bridge. That's how we do what we do. And what Kyndryl Bridge does is it gives our customers full visibility to their infrastructure, gives us visibility to their infrastructure. It automates a lot of things. It tells our customers what else they can do. It's creating, I think we're up to about 5 million or 6 million, what we call advanced insights that our customers can take advantage of to optimize. So when -- I go through Kyndryl Bridge because when we show up to help a customer, we actually -- we know what is going to work, and we can align those insights to their -- to the outcomes that they need. It's different from showing up with a few PowerPoints and saying, hey, what do you think if we tried these things, right? So we're not showing up looking for work as much as we have real actionable insights they can take advantage of and improve how they operate. It's also true that we can be more effective, if you will, around keeping them in a regulatory -- in an ever-changing regulatory environment. We can keep them moving at the pace that the regulations do. And while we tend to think of regulators as slow and a little bit, they are not. They are moving really, really fast and regulated environments are a real challenge. So we know more about their systems. We have deeper insights about how they're running today. We can help them with very specific, targeted ideas that are aligned to their business outcomes. And then all of that sits within the context that mission-critical hearts and lungs, you can call it whatever you want. It always has to work. You don't really have a choice about whether or not you take advantage or improve your infrastructure. You have to keep it going. So we're in a space that is not really optional, if you will. So...

Yes. And Kyndryl Consult is becoming, as you know, a more and more significant part of who we are. When we first became independent, it was only 10% of our revenue. Now it's over 20% on its way to 25%, making it a $3 billion business. We expect it to grow double digits again this year. So it's really a significant contributor to our earnings and to our growth.

So what does that imply then with double-digit growth on the consult piece, what does that imply on managed services and the expectations there quarter-to-quarter for the year?

Yes. So managed services is really -- it has been declining. It was the driver of our previous revenue declines. But that we really see managed services stepping up to be a much smaller decliner this year, kind of approaching steady state ideally sometime next year and then returning to growth in like fiscal '27, fiscal '28, somewhere around that time line. So that as we finish up the medium term, the 3-year period that we look at, we can get to the point where managed services and consult are both contributing about the same -- ideally about the same amount to growth, about half our growth coming from each of them, driven by Consult being smaller but growing faster and managed services being larger, but being a contributor to growth.

Good. All right. So before I get to margins and open it up, I have to ask just on the relationship and exposure to IBM. I know the software cost question comes up quite a bit. Where do we stand on that?

Yes. Look, I think -- and I think David talked a little bit about this in our earnings call last year. I do think this is probably the last year we'll be talking about IBM software costs, not because it's still important to us but the commercial arrangement that they created upon our spin goes back to what I'll call a more industry standard relationship. So what they created 3.5 years ago was a kind of a fixed price that went up $200 million each calendar year. And so our software costs have gone up $600 million in the last -- by the end of this calendar year, we'll be up $600 million. And that's the way IBM decided to structure how we consume their software on behalf of our customers. At the end of this year, at the end of this calendar year, we revert to what an industry standard price times quantity model. And we know the price because we have the -- we know the discounts that we get from IBM. And we know the quantity because we know exactly how many licenses we're using. And so for us, the good news is when we get to that P x Q model -- we've done a lot, by the way, to reduce the Q as we work through focus accounts and things over the last 3 years, but when we get to that P x Q model, we don't really -- there's no real difference anymore in -- other than whatever IBM decides to raise everybody's price by, but we see it becoming now sort of an immaterial headwind versus $200 million a year for the last 3 years. So like I said, this calendar year, it's $150 million increase because it's done calendar and our fiscal year ends in March. And then when we get to P x Q, it's sort of an immaterial difference year-to-year for us and that's without having done any more work on the Q. We'll continue to work with our customers and work with IBM to find how do you create a win-win-win so that customers feel like they get a great investment in their IBM software, IBM can generate great deals and relationships with customers, and we obviously then can get out from having to provide the software licenses in certain instances. So we get to, like I said, kind of a flattish -- no more -- not even a notable event anymore at the end of the calendar year, right. So we're excited about that. Now the relationship, look, we work well with IBM. We obviously have a lot of the same customers. And increasingly, our customers want us to partner together. They have a consulting business that does some work with our customers. Obviously, the technology side is still important to our customer base. So it's a relationship that will continue to evolve, and it's going quite well, I think.

Yes. No, for sure. And another milestone to get to. So it's good to get through it. So before I open it up, I have to ask about gross margin and gross profit book-to-bill. I thought sort of the most important maybe hidden KPI was that, that book-to-bill on gross profit was up 1.5x, right, David?

It's his favorite number.

No, it's pretty wild actually to see how elevated that is. So it speaks to the gross profit visibility that you have. I know I spent a lot of time on revenue. But from here, how does that cascade into gross profit? And is this sustainable to some degree from this 1.5?

Yes. The number that Tien-Tsin is referring to is what we refer to as our gross profit book-to-bill last year being 1.5. And that means that the gross profit that we added to our backlog through our signings, to our committed backlog was 1.5, 1.5x the gross margin that we reported last year through our P&L. And what that means is that we're embedding value in our backlog, sort of contractually committed revenue and ultimately gross profit at a higher rate than our backlog is -- has currently been churning it out. And to me, that's a measure of value creation over the course of the year that we're achieving through our increased signings and the strong margins at which we're signing business. And having a gross profit book-to-bill be above 1 now for 3 straight years points to how sustainable it is. Will it continue to be at 1.5? Well, that's tough because our denominator is going to continue to grow as these higher-margin contracts are producing more gross margin -- more gross profit in our earnings. But the 3 straight years of gross profit book-to-bill being above 1, I think, really points to its sustainability.

Okay. Good. Questions from the audience, happy to take them now. Otherwise, I have to keep going. Anyone? We have a mic. Brendan, do you want to do one?

Sure. Martin and David, thank you very much for being here. A question that we're getting a lot more often now, and it's kind of an exciting question to get more often because it's more fun position to be in, is there's higher visibility to the cash flow generation in the business now. And you guys authorized a $300 million buyback, but now people like what's next? How do you decide between perhaps acquisitions to augment the growth profile or fill out areas in the business you might want to or just ladder up on the share repurchases.

Yes. Thank you, Brendan. Look, a few things. We are in a pretty fortunate position that we do have this fabulous visibility to the backlog to, as David described, to the profitability that sits within it and therefore, to the cash flow that it will generate and that puts us in a position where we can both reinvest in the business. We did a small tuck-in acquisition last year as an example, and we'll continue to look at those small tuck-in acquisitions. But it also puts us in a position where we can return capital to shareholders. And as you noted well, Brendan, we initiated -- our Board initiated a share repurchase program in November of last year. And we see that sort of those 2 paths continue to be open to us. We still have some left on our authorization. When we first -- when it was first authorized, we said 12 to 18 months. That was in November. So I think we're now 7 to 12 months left. And then obviously, as I said, we see some small tuck-in acquisition opportunities to either extend the lead we have in the marketplace or maybe accelerate our position and our entry into a marketplace. So there are a few things we're always looking at. But again, smaller and tuck-in and plenty of cash to do both, reinvest to support growth, to support the future as well as return capital to shareholders. Now our cash flow is seasonal. First quarter, as an example, very heavy outflow quarter and then the next 3 quarters will bring everything back in for the year. So there's some seasonality to our cash flow. But the long term, again, good visibility, ability to invest, ability to return capital for the long term.

Anyone else? Let's do quickly on the margin front. I know it was up 200 bps last year. Workforce rebalancing is always a consideration. But what kind of line of sight do you have on the expansion from below gross margin? And then, of course, in the same lines, is there an opportunity with AI and some of the things you're examining to maybe accelerate some of the automation work beyond what we've talked about with 3As?

Sure. I expect most of our margin growth and our guidance for this year works [ at ] about 1.5 points of pretax margin growth. I expect most of that to be driven by gross margin expansion. We're -- over time, we're going to look for opportunities in SG&A as well. This year, we're making a few investments there. So I don't necessarily see that being a -- I see there being sort of an offset this year where we're going to have savings in some area and some investments, particularly as we drive the above-market growth in consult that will give rise to some SG&A investments we're making. So that will probably be flattish this year. But over time, we see opportunities to leverage SG&A, both by driving efficiency there in a number of overhead functions and then also being in a situation where SG&A efficiencies as a percentage are going to be easier to come by in a growing revenue environment than what we've had the last few years.

Sure. Martin, anything to add on the AI perspective and how that might be deployed across Kyndryl before we talk about the cost side.

So let's talk about AI from a few different perspectives. Let's start on one end, what we would have called machine learning and sort of the -- and that is machine learning and AI is what Kyndryl Bridge is really all about. And we have more data than anybody else in infrastructure. We have -- we're adding to that pool of data faster than anybody else's. So within infrastructure and how applications run in infrastructure, infrastructure -- within that space, we've kind of won the data race. And so Kyndryl Bridge will continue then to find new ways of automating things, will find new ways to optimize. But that's what Kyndryl Bridge does. Kyndryl Bridge on one end is very much about machine learning and all the benefits it helps us bring in terms of higher quality, in terms of lower costs, et cetera, et cetera, et cetera. At the other end of the spectrum, like we are helping our customers use generative AI to try to figure out how do they improve. And from our perspective, we're using it -- David's got a few things going on in finance. We have a few things going on in communications. We have a few things going on in legal. We have a few things going on in HR, all as part of how our employees experience us and how we support them. So we have a whole series of experiments of trials going on. But that work is exactly what we're helping our customers get ready for as well and that shows up in the form of keeping our Kyndryl Consult partners busy on data architecture and security and maintaining resilience, et cetera, et cetera, as they start to think about how can they use generative AI in their businesses. So machine learning at the heart of how we do what we do, a few opportunities for us to figure out how do we give better employee experiences using generative AI and then a big consult opportunity, which will ultimately be a run opportunity as our customers try to figure out how do they start to use generative AI. So as an example, we are helping our Japanese customers. We put a little data center with NVIDIA and Dell. We built a little data center right next to one of our existing data centers so that our Japanese customers can start to experiment with generative AI in a place and in a way that allows them to meet all the requirements they have for data, for privacy, et cetera, et cetera, et cetera. And you'll see us doing more and more of that. We announced in the U.K. in Liverpool an AI hub, which is going to be very focused on skills and bringing the next generation of practitioners into the marketplace. I'll be at [ Choose France ] next week, and we'll talk about some investments we're making in France for similar things. So there's a big focus for us on helping our customers get ready whether that's building data centers for them to explore, whether that's building the next the next army of practitioners or helping them get their systems in order their data in order so they can experiment as well.

All right. That's good summary. Just about out of time, less than a minute, but you've already issued the guidance and you're at the starting line as you called out. What are you excited about here in the coming months and quarters as we begin this fiscal year for Kyndryl?

Well, what's not to be excited about. We're back to growth...

[indiscernible] for us.

There you go. Look, being part of a growing company that is profitable and generating cash is obviously what we've been trying to do for 3.5 years, and now we're there. So the successes we've had in the marketplace, the response we're getting from our customers, hearing them talk about how they trust us, how they view us as the experts and how they rely on us has always been a big part of what gets Kyndryl's excited, doing the most important work for the most important firms so the world can work better has always been a big part of the nature of the work that people are excited about and doing that in a growth way is a lot more fun than doing it in a fixed way. So it's all exciting.

Hats off to you both for getting there. I know there's a lot more work to do, but no, it was glad to see it shape out the way it did. But thank you for the update.

Thank you, Tien-Tsin. Nice to see you.