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

I'm Bryan Keane. I cover the IT services sector here at Citi, and we're excited to kick off the Citi TMT Conference with Kyndryl. We have Martin Schroeter, the CEO and Chairman; and Ellen Johnson, who's the CFO. So I'm going to run through my list of questions here. And if anybody has got a question, just feel free to raise your hand, and we can get a mic to you or I can ask a question for you. So first, Martin and Ellen, thanks for coming.

Thank you.

just thinking kind of big picture here, Kyndryl provides the critical IT services to enterprises. In your conversations with CEOs and CIOs, what are the biggest priorities on their tech agenda? And are you guys positioned to remain their partner of choice and deepen the relationship by expanding your scope of service?

Okay. So first, we do run the systems that run the world. So we run 5 of the 7 largest airlines. We run 50 of the largest insurance companies. We run most of the big banks around the world, et cetera, et cetera, et cetera. So our point of view -- my point of view is going to reflect that big, large company sort of set of priorities. Our customers are increasingly focused on really 3 things. One is modernizing their infrastructure. Our customers, and just based on the very quick description I gave you, you would guess that our customers are not the born-on-the-cloud crowd. Our customers have evolved their enterprise IT landscape over, many of them, decades. And so the new technologies that are now available to them, each of which they're keen to pilot and experiment with and then put into scale production, each of them needs to figure out how to modernize that infrastructure. Sometimes it comes from the infrastructure, sometimes it comes from the application side and sometimes it comes from a business process, but each of them needs to modernize because the technologies of today, if you use a metaphor, the technologies of today are a bullet train that can travel 200 miles an hour, but the tracks were built for 30 miles an hour. So #1 priority, our customer base needs to modernize in order to take advantage of the new technologies. And by the way, the new technologies are the ones that the new entrants are trying, the new technologies are the ones that are going to find their way into the fastest movers. So modernization top of their list. Second, we live in an increasingly security risk world, so both cybersecurity and more importantly, the resilience that's required. By and large, our customers, I think, would say that a security risk is not the existential threat. It's the resiliency characteristics that you need in order to come back online in order to continue to provide services for your customers. So in a -- at a time of modernization, at a time of heavy investment to bring those -- that infrastructure up to speed, they also need to be aware of an increasing threat environment, so cybersecurity and resiliency stay top of mind. And then third, and this is different, sort of different in different parts of the world. But our customer base is, again, I gave you a brief description. You would speculate that many of our customers are in regulated industries, certainly, which they are. So there is -- even if regulated or unregulated, there's an increasingly complex geopolitical environment that they need to navigate. And so when they're thinking about who do they trust and how do they partner with us, they're also thinking about longer-term decisions. They're thinking about something that's going to last 5 or 6 or 7 years. And so in an environment where some of the leading technology firms, some of the new AI firms are making like really game-changing announcements every 4 or 5 or 6 weeks, where the regulatory environment is changing rapidly as geopolitics push politicians and others to create new regulatory regimes, our customers have top of mind this whole new set of stakeholders now around how do I get comfortable that I have the right partner that I can stick with. They're going to bring me into the future when I know that in a week or a month or a year, a lot can change again. So the world is getting increasingly complex. And that's why they use their trusted partner for many, many years like Kyndryl. That's why we're also signing a lot of new business. That's why we're also signing a lot of new scope with our customers because we have the expertise, the engineering talent, the innovation that allows them to be comfortable that we can navigate those big priorities, modernization, cybersecurity and resiliency in an ever-changing geopolitical landscape.

Let me just ask you on modernization. I feel like we've been working through that for a long, long time. Is there an inroad of when we finally get fully through? Or is this an ongoing process for years?

I think modernization will always be with us, right? Because today's technology is going to be stale in, sometimes it's an hour, sometimes it's in a decade, right? And plus because of, again, the geopolitical world changing, things come and go in and out of sort of top of mind. So as an example, we are seeing now a bit of a resurgence in private cloud where 5 years ago, 6 years ago, 7 years ago, private cloud had started to not shrink, but public cloud was more important in certain ways. Private cloud is kind of coming back now. Again, in this case, it's because of geopolitical. And the private cloud providers, the people who can build the technology for private clouds have brought a lot of innovation to market. So I don't think the idea of modernization is ever going to go away. I think it's always going to be with us. For us, it means that we have to continuously invest in where the world is going. We have to continually build skills that are relevant for today's times. Our view is that the half-life of skills today is probably 18 to 20 months. That's why we have such a heavy investment in skills and education and constantly, constantly creating new credentialing for our employees. And similarly, the idea of modernization is not just a technology idea, but we know our customers, employees, we know the workforce because our customers tell us the workforce is not ready. So there's a modernization element that's always going to be with the workforces that we help our customers with as well. So I think the short answer is, modernization is here forever.

The U.S. segment had 5% revenue growth, I think, for 2 consecutive quarters. Can you just talk about what is driving that growth and how sustainable it is going forward?

Yes, yes, sure. So first, I would say, arguably, the U.S. is probably the most competitive marketplace there is for a few reasons. One, everybody is here. Every competitor is here. Market access is quite good. So everybody is here. That's one. Two, every technology is here, either it's invented here or it's brought here very quickly. And in that environment, it's my litmus test for how competitive are we? How -- what are the value propositions that we're bringing? How deep are our industry skills? And how are we packaging all of Kyndryl together in order to deliver a compelling value for our customers? And so for us, it's very positive to see that the U.S. has returned to growth, the U.S. has great signings performance because it tells us that what we're delivering to our customers in that most -- arguably most competitive marketplace where there aren't as many distractions as there might be in other places, tells us we're doing really, really well. So we've won some very substantial new logos in the U.S. in certain industries. That was driven by our mission-critical expertise. It's driven by our Kyndryl agentic framework, which tells our customers how to use agentic in their systems. It's also driven by some new business process innovation that we're bringing to things like state governments, where we're running a number of DMVs, a number of divisions of motor vehicle because they need to modernize the way they engage with the citizenry in order to provide a more positive experience. So for me, the growth in the U.S., the demand we're seeing in the U.S., the scope expansion that we're getting from our existing customers, plus the new logos that we have driven in the U.S. is a great indicator of how competitive we are, the value props we're able to put on the table and how our teams are making that shift into the agentic world.

And then can you take all that process and that learnings in the U.S., and can you transfer it abroad?

So the short answer is absolutely. So we run a single global delivery platform. So everything we deliver into the U.S., and we do it on a worldwide platform. Everything we deliver in the U.S., we can deliver anywhere else as well. Now when you get outside the U.S., the value perhaps change because the priorities change a little bit. So there's a lot of discussion right now in Europe, as everybody knows, around sovereignty, data sovereignty, AI sovereignty, services sovereignty and the Europeans are debating and considering how they want to deal with the sovereignty issue. That's part of why I say the U.S. is the most competitive because we just don't have the sovereignty issue here, really is -- it really is who has the best value prop for the problem that our customers are facing, again, across what I mentioned around modernization, cybersecurity and resiliency. In Europe, the priorities are a little bit different. Asia similarly, some places sovereignty is kind of top of mind, in some places, they're really just about how do I get a value prop that's compelling. So the short answer again, for that particular question, we run a single global delivery platform. We can deliver what we deliver in the U.S. anywhere in the world. And we take those value propositions that we've created. We tend to be more industry than geography-based, but we take those value propositions. And we do show up in our customers in order to help them modernize. So as an example, we just signed a pretty substantial new relationship with the Bank of Luxembourg, obviously, European, obviously, regulated, and we will turn the Bank of Luxembourg into the first European agentic bank. That was the structure. I mentioned that one because some of what we've done here in the U.S. is as we start to move up to the application modernization world, shows up very strongly also in the Bank of Luxembourg. So infrastructure modernization is part of what we've been doing for a long time. Application modernization is something that we've been delivering now in the U.S., and now we're bringing some of that to Europe as well with some -- again, some good wins. As I mentioned, private cloud is not as big here in the U.S., but in Europe, private cloud is big. And so we have a lot of new logo, a lot of scope expansion around building and delivering private cloud environments into that customer base because, again sovereignty is kind of top of mind for many of them.

So just staying on that, I think you guys were seeing elongated sales cycles in Europe and Asia Pacific. A lot of that was due to geopolitical and some of the sovereignty issues. Are you still seeing those elongated sales cycles? And then is there a way to get around that, maybe starting a renewal process earlier?

So we do typically -- so it's still top of mind, right? So sovereignty is still, like I said, top of mind. We start discussing with our customers usually 18 months before they get to sort of end of the contract term, which is very logical. Whether it signs in the fifth quarter before or the fourth or the third, our customers need to get to the right spot. They obviously don't want to be in the last quarter. They would feel kind of exposed if the whole thing were ending in a few months. But they have time. And as I mentioned earlier, because they're going to make a long-term commitment, 5, 6, 7 years, and they know that the world is going to change dramatically, they're being very thoughtful and -- about who do they want to partner with. And there's a whole new list of stakeholders now in the discussion. I mean not 20, but you do have additional scrutiny from regulators on what are you signing up to do and with whom for a long period of time. You do have additional challenges to navigate in terms of not only the regulatory environment, but the geopolitical environment, as I mentioned. And we've seen a number of countries head down different paths, particularly in Europe on how to deal with geopolitical uncertainty. Some are trying to support local champions and -- for certain workloads, for certain government kinds of workloads. So you have a whole new set of stakeholders. But we have typically sort of seen elongated sales cycles. I don't expect it to change. I don't see it elongating further, but we did see a slight uptick in how long it took to get things closed, again, because you have new stakeholders, you have long-term commitments and you have a world that's changing so fast, they just need to be sure that this long-term commitment is not going to be something that they're unhappy with in 12 months time.

What's driving the strength you guys are seeing in KD Consult and hyperscalers? And do you expect both to continue to be key drivers of growth for KD going forward?

Yes, yes. So the short answer is yes. So we expect -- I expect that the momentum we've seen in Consult and the momentum we've seen in our hyperscaler related businesses will continue. So let me start with hyperscalers because I think it's a -- it's indicative of what kind of results you can drive when you're the trusted partner, when you have deep, deep understanding of your customers' environments, and you align and partner with the companies that really matter to the customer base in our industry. So when we were spun out nearly 5 years ago now, the commercial construct between IBM and Kyndryl meant that Kyndryl had to buy from IBM about $4 billion worth of stuff every year. That was a construct that IBM created. Last year, we finished with just under $2 billion. So we've been successfully pulling the IBM content out. We still do the services. So the labor-driven elements that sit underneath that, we still have, in fact, are growing. We run more than half of the world's outsourced mainframes. But the IBM hardware and software content, which we've been focused on, we called it focus accounts for 4 years, the IBM hardware and software content, we found ways to get our customer base to buy that directly from IBM. So we went in that space. We took the $4 billion down to $2 billion, and it will continue to shrink in our revenue base. At the same time, the revenue we had from working with AWS and Google and Azure was zero at spin. It was zero. And last year, we finished just over, just call it, $2 billion worth of revenue. And we did it because we invested in skills. We have 30,000 credentials now across the hyperscalers. So we invested in skills. We built new capabilities around -- specifically around those clouds around resiliency, around security, around data management. And then we partnered with them and we built a partnering culture because this customer base has been asking this business to help them with their most difficult technical challenges like moving workloads on to the cloud and then managing in a more diverse and complex environment. They've been asking this business for years to do that, but as part of IBM, we didn't have the freedom of action to partner with those businesses. So the hyperscaler business is not just makes us more relevant to our customers' future, but it also now aligns us with where they're growing. And they -- you see the hyperscaler, they're printing growth numbers 30% a quarter, and we're on kind of that same path because, again, the work we do around moving workloads to Azure or GCP or AWS means that the resiliency features that they are exposing the security features that they're exposing as they move into those more complex workloads drives more demand for us. So I see continued good demand in hyperscaler. If we saw it in the first quarter, and we've got -- I think we've got some pretty good growth for the foreseeable future in hyperscalers. On the Kyndryl Consult side, so going back again, going back 5 years when we were spun out, this business was -- again, it has the best engineers who know our customer systems well. Our customer relationships, obviously, we have new customers as well, but some of them go decades. So we deeply, deeply understand these complex systems. And these are the systems that have to run. They have to run. So our customer base, this customer base has been asking Kyndryl prior -- obviously, post spin, but prior, please help us, please advise us, but IBM didn't invest in this business. So we couldn't invest in skills. It couldn't invest in capabilities. It didn't bring the industry knowledge that it needed. And we made a decision very early -- and by the way, so the mix of of Consult within our overall revenue streams was single digit. It was like 8% or 9% of our overall revenue streams were Consult. And we knew because we had the trusted spot in our customers' environments, we had the relationships, all we needed to do -- I mean, I'm going to make it sound easy. It was a lot of work. All we needed to do was invest in skills, bring in some industry talent and then make ourselves relevant to where our customers were going and help them with their most challenging problems. And that's why, just even last fiscal year, we've been running at -- the mix has improved dramatically in terms of how much of our revenue streams are Consult versus managed. But more importantly, even just Consult as a thing, it's had a book-to-bill north of 1 since we started -- since we were spun out. And so we see continued growth in Consult because the role we play in helping customers modernize, in helping them move into an agentic world, that capability sits in Consult.

So obviously, there's a lot of concern around what AI means for services and the services industry year-to-date is down a significant number. How is AI, in your eyes, changing the traditional managed services business?

Yes, it's a great question. And we hear similar, what is AI going to do to us? I will tell you that AI for us is a tailwind for a couple of reasons. First, we have to sort of establish the business model. Our business model is very much an outcome-based business model. We have to deliver outcomes to our customers. We have to deliver uptime. We have to deliver resiliency features, security features, data management features. So we get paid when we deliver those things. Whether we use 100 people or 80 people or 20 people, our customers need a great value proposition. And as we get more efficient, they expect to share in that. But we've been doing that for years. We've been delivering productivity to customers for years. And these new technologies allow us actually to deliver even more productivity while -- because we're outcome-based, while still sharing in that. That was how, for the last 5 years, we took profitability from substantially very negative, $500 million on an adjusted basis, even a $500 million loss roughly to this year's guide of north of $600 million, right? So we've been able to create great value propositions, grow signings, build our backlog of business. So that means we're delivering great value perhaps all while improving our own profitability because, again, we're an outcome-based business. So AI for us means a couple of things. One, it means we can be more efficient, means we can get to solutions faster. We can get to understanding faster. As we sit here today, we have about 1,600 agents in our infrastructure. An agent would do something as simple as, as soon as there is an issue, collect all the logs, analyze what exactly the state of play was right before it happened and then share with the engineers as soon as they get on the Bridge, here's the data that we have, here's the data that we've collected, and here's what we think you should go look at. That agent does what 20 people would do 5 years ago and take them an hour, right? So for us, embedding agentic AI into how we work -- we are very much customer zero for our customers. Embedding agentic AI makes us faster. It allows us to deliver better services. It allows us to be more efficient. So there is a cost which flows directly to profit side for us, again, because we're outcome-based. On the demand side, our Consult business is getting roughly 15 million to 16 million actionable ideas from Kyndryl Bridge, which is the way we do what we. It's our platform to deliver services. And some of them are sort of simple and we can just execute, but some of them require a discussion with a customer. Have you thought about this? Have you thought about changing this, optimizing this, we can save you money. So our consultants show up with not only a mastery of their environments, a mastery of their industry, but they show up with actionable ideas that our customers can implement to save money. So it's a bit of a revenue driver for us as well on the demand side. So AI for us, in an outcome-based business model, is very much a tailwind to top line and to the bottom line.

So the question always is, on that productivity side, on these enterprises ask, when you're doing these renewals, aren't they asking for bigger price cuts than normal over the last several years because they know you guys are benefiting from AI as well? So who gets -- the big debate is, who gets the productivity gains? Is it the enterprise? Or is it Kyndryl?

Yes. It's both actually. We have created very compelling value propositions that allow us to deliver new scope that either maybe they hadn't had a service provider provide it, but we can do it more efficiently, where they're taking scope away from others. But as long -- you have to have a compelling value proposition, which means you have to be delivering productivity in some form or function to our customers. And then as I mentioned, we do this in a way so that we're benefiting as well. That's already what's in our data. That's how we've been able to improve our profitability so dramatically. So we're used to sharing in the savings that we're generating and the productivity that we're generating with our customers. That's no different from what we've always been doing. Five years ago, when we started -- when we were spun out, our customers said, look, I know you have -- you're investing heavily in your platform and you have all of this data. We have more data about how these systems run and what works and what doesn't than anybody else. They've been asking us for years like, well, when you learn, when you use all this machine learning, I need to some of that in my contract. And of course, we've been sharing that with them for a long time. So that's not new at all for us.