Welcome to the Kyndryl session, everyone. I think this is on. My name is Tien-Tsin Huang. I follow the IT services and payments sector, and the, you know, it's been fun following Kyndryl. The stock's done really well. It's been a lot of hard work that's gone into it, so excited to get an update from the team. Martin Schroeter, CEO, Chairman of Kyndryl, David Wyshner, CFO, thank you both for being with us at another conference.
Thank you, Tien-Tsin.
It's by the way, it's nice of you to say that it's fun following us. It's fun being followed now, so.
That's true. That's true. Well, yeah, I hope it's fun for now.
But, no, we're grateful to get to follow the company of course, and again, it's been one of the better performers in our group. For those that are maybe newer to the name, Martin and David, does it make sense to maybe go through the strategy, what's worked and what you're getting credit for, and what's left to do, and what's left ahead, before we go into some of the details?
Yeah, yes, thank you, and good afternoon, everybody. Thank you for spending a little bit of time with us. We're always delighted to talk about Kyndryl. You know, when we were spun out, Tien-Tsin, we had to, I think, prove a few things. We had to prove that the other really meaningful, important companies in enterprise tech wanted to work with us because of what we did, and I think now that we've built a pretty substantial growth vector around our alliance activity, I think we've proven that. I think we've proven that we can get paid for the work we do, and we, for those who have seen our presentations, we've been very consistent in sharing the margin profile of what we're putting into the backlog.
So I think we've proven that we create value and can capture that value from our customers. I think we had to prove that we had to prove that the advice we were providing, that the skills that we had across not just the capabilities that we inherited, but the capabilities that we were investing in. I think we had to prove that those were of value to customers, and I think we did that. You can see that in our Kyndryl Consult business, which continues to have great momentum.
I think we had to prove that we could invest in this business in a way that would make it really compelling for customers to both stay with us and join us. Now, we've been very focused on our customer base. We haven't been so focused on moving outside our customer base yet. But what we've learned enough from deploying our integrated delivery platform called Kyndryl Bridge, and over 1,000 customers now, we've learned enough to know that the innovation we're bringing to the market is really valuable for our customers and really valuable for us in the way we operate. So we've proven that we can make money. We've proven that we can bring innovation and work in new ways.
We've proven that others in the tech space view us as important, and therefore, you know, we're on our path to growth. All of those things have to continue, and while the backlog we inherited continues to diminish in its importance in our PNL, we're only at a point this year where half of our business is coming from what we've done since the spin. But with the proof points behind us now, and the growth vectors showing how rapidly they can grow, I think this is the year that we prove we get back to growth, and then we keep growing from here. So the strategy that we defined, which I believe is unique to us, I think only Kyndryl could execute the strategy. The strategy that we've defined really capture those elements.
We have a strategy, an element around alliances, which is growing quite well. We have an element around focus accounts, which is engaging with our customers and reimagining how we work together and help each other. And we have a strategy around advanced delivery, which is, you know, again, getting Kyndryl Bridge in, create value for customers, create value for us. So all of that has to continue this year, and all of that's in a great spot as we start the year to continue to execute. Team's done a phenomenal job of executing. Underlying all of that is also all of the work we've been doing to create a great services culture. And I hear it from our customers every day that we are showing up differently. We are showing up in a much, much better way.
We are the trusted partner to our customers, and now that we're independent, we are that trusted partner who can help them across their infrastructure, and they believe, and they know that we can bring the best of technology to them. So always more to do. We've proven enough that I think the trajectory we're on and the things we've been talking about for 2.5 years are, you know, we're delivering quarter- after- quarter, year- after- year.
No, it's great. Like, you know, everything you've talked about, the freedom of action and, you know, going through the anniversaries of the spin, you know, it's played out very, very well. So, hats off to you both for that. If we think about the results, and I think the surprise and the celebration was on the pull forward and the inflection around revenue growth in the fiscal fourth quarter. So, walk us on the specifics and the components to get there, and to drive that confidence to say, "Hey, we're gonna break through in the fourth quarter on revenue.
Yeah, sure. So, let's just go back 2.5 years ago, we said, calendar 2025 was when we would return to growth, right?
Yeah, calendar.
Calendar 2025, and really what we did two weeks ago when we provided guidance is we hit that in the earliest possible time, right? The first calendar quarter of 2025, which is our fourth fiscal quarter. Some of that is because obviously we've made a ton of progress, a ton of progress in building a consult business. That consult business, which is already delivering growth to Kyndryl in total, will punch even more strongly in our results this year. And the book to bill in that part of the business, plus the momentum we see, allows us to be confident that as we get through toward the end of this year, that that is a big supporter of growth in, again, our fourth fiscal quarter.
Additionally, what we've been able to accomplish in our alliances activity, which again is it's data services, it's security services, it's resiliency services around helping our customers move on to the hyperscalers. All of that business, which, you know, we delivered last year, we went basically from a standing start, i.e., we didn't have anything when we were spun out. That was already $500 million of revenue to us last year, and that this year will get to about $1 billion of revenue, right? So, the two growth vectors that we pointed to already, two and a half years ago, as what would enable growth in the calendar 2025, there is enough there already that allows us to put growth at the earliest possible time, which is our fourth fiscal quarter of this year.
And then the things that we wanted to get done, the fixes that we wanted to put in place from last year, those fixes are essentially behind us. We said we were going to essentially get out of or discontinue the no-profit resale of other people's equipment. And while it was a three-point headwind to us last year on that engineered decline, we've eliminated. Now, it's not neither a headwind nor a tailwind, and it won't be again. We're not rebuilding something that's just passing other people's revenue through. And similarly, again, the backlog we inherited was a pretty big decline last year, and yes, it's a bit of an impact, but as we get through the year, that continues to diminish.
And like I said, when this year already 50% of our revenues are post-spin backlog, that's a profit statement as much as it is a growth statement. And as we get into next year, then obviously, it gets down to a third and keeps diminishing. So, the headwinds that we were trying to fix continue to diminish. The tailwinds, the growth vectors that we've created, are doing as well as we would have hoped. And so you put all of that together, and in the fourth quarter, we get back to growth.
Anything to add to that, David?
I think that's right. We're really excited about the prospects that we have, and the visibility is good, too. You know, starting the year with 80+% of our revenue coming from our backlog and our signings is really helpful as we model this out. And as Martin said, the growth in consult and how consult signings turn into revenue even faster than our typical managed services signings is a big part of it as well.
Okay. I'll have to ask it again on consult. I know I asked it on the earnings call, but, you know, we've had a lot of your IT services peers here at this conference, and they're still talking about weak discretionary spend, low visibility on short-term project consulting type work, yet you saw acceleration in the quarter. So can you remind us what separates Kyndryl Consult from the peer group, and what's the identity of Kyndryl Consult?
Yeah. So I think maybe the way to attack. Let me tell you what Kyndryl Consult isn't, and then we'll talk a bit about what it is. Because we hear the same thing, this idea of discretionary being cut back, et cetera, et cetera. You know, another way to think about discretionary, I think about them as more like science projects. All CIOs do them. Our CIO has science projects going on. Don't tell David he doesn't know about them.
But every CIO has science projects going. Another way to think about a science project is that it probably doesn't have a really strong business outcome that's tied to it yet. It will at some point, but it doesn't yet. And our CIO customers tell us the same thing: "Look, anything that is not delivering a business outcome with a business case that I can that suits the environment, I can't do." Right? Very logical. So ours is not science experiments. And additionally, we're not in the low-value sort of staff augmentation space, right?
If you have 100 people you need to do something, and all of a sudden you only need 80, you're gonna get rid of somebody else's 20 first. Those parts we see, and but that's not the space in which we sit. Our Kyndryl Consult business is built around and centered around the work we already do on the run side, which is mission-critical. And in the mission-critical world, we have the advantage of, with Kyndryl Bridge, we see all of their infrastructure.
So when our consultants show up, they say, "Look, we see this opportunity for you to improve the way this runs, and here's the business case, and here's the payback, and if you want to go ahead, we, you know, we'll, we'll get this done." So in mission critical, you in any environment, if somebody showed up with a 6-month or a 9-month or a 3-month payback, you would do it. And by the way, even if the payback were a little bit longer, but it was mission critical and you had to, you're gonna do it anyway, right?
So because of the where we sit in the space, we're not working on science projects, we're working on mission-critical infrastructure tied to real business outcomes. And then, and then secondly, I think it's important. W hat it also is, is the front end. We sit at the front end of whatever tech, whatever technology they're trying to figure out will fit into their business. So I don't know if everybody knows this, but it turns out GenAI is kind of a thing people are talking about.
You may have heard about it. Yeah, yeah, it's kind of a thing. Well, you know, all of our customers, as they think about GenAI, they're thinking about, "Okay, I know the business is gonna figure out some use cases. I'll let the business figure it out. But me as the CIO, me as the CTO, if I'm gonna put this into a run environment, I need to figure out now already, how do I architect my data so I can capture it and use it?
How do I maintain the resiliency features that I have today? Because it's gonna be another thing out there. How do I make sure my data's secure?" So all of that work has to happen long before you get to actually even a science experiment on GenAI, even an idea and how it might work. We sit at the front end of many of these tech trends. Gen AI, mainframe modernization, network and edge. I mean, we sit at the front of that.
So our business is sort of a precursor that CIOs have to undertake in order to be able to respond to their businesses when those technologies are either mature enough or they have the idea or have the use case. So again, mission-critical and business outcome linked, which is popular in every macro environment, and we're at the forefront of the technologies that they are really starting to think about, and CIOs have to be ready for.
Understood. And I think you've talked about double-digit growth being visible, and I know there's still some room for that to become a bigger part of your business. Can you just describe the visibility, number one? And then secondarily, do you have the resources to deploy to get to where you want to be on the consult side?
You want to add?
Yeah. On the, on the first part of that, you know, we've been growing, signing both revenues and signings in consult double digits, and moving consult as a percentage of what we do up significantly. So at the time of our spin, consult was around 10% of our revenue.
Right.
Now it's 15%. The most recent quarter is 16%. It's 20-ish% of our signings, and we see a real opportunity to move it up to be, you know, more than 20%, yeah, 20% or more, of our revenue in the not-too-distant future. And obviously, the growth that's implied by that over the next couple of years is quite significant. Do you want to talk about the resources, or do you want me to?
Sure. Look, we do. We are hiring, obviously, as you would expect in a business growing at this rate and pace. But we also have, you know, we also have sort of a built-in in our delivery labor pool, right? We're 80,000 people, so we have scale. As we deploy Bridge, Bridge is only in 1,000 customers. I say only, that's a lot, but we have 4,000, right? So there's still a long, a lot of runway left on Bridge. As we deploy Bridge, as we turn on the automations, we have an opportunity then to take those people and to help deliver the consult side of this as well.
So yes, we're hiring, yes, we can get the talent, and yes, we've created our own labor pools internally as well to help deliver consult. So works fabulously well. The team has done a really nice job of wiring this in a way that allows us to achieve this myriad of outcomes all at the same time, all while delivering great value for customers. Bridge is, for our teams, it's like the world's greatest opportunity identifier. It's creating 3 million actionable insights a month. My opinion, I think David shares my opinion, is that we haven't even gotten that really wired well yet. We're not at taking advantage of as much of that as we will as we get better at it. We're still kind of new at it. So there's more to do in more customers with more people. There's a long, long growth path ahead of us on this.
Good. Yeah, look, like I said, that's been a positive surprise in how well both Bridge and Consult have done, which is why I wanted to touch upon it upfront. So I think the other question, just in general around cyclicality, away from Consult, tell us how, you know, protected the business is or resilient the business is in general, especially in all the economies. I asked this Martin and David, and I'm sure Lori knows, you know, when people ask about Japan and some of the changes that are happening there, or maybe some geopolitical risk somewhere else, but it feels like you've been fairly resilient across. Can you describe that, why that is?
Yeah. The role we play running Mission Critical is one that I think is fairly well insulated from macro. Our customers feel it, which means we have to be able to respond to them in whatever environment they are. But our revenues stay stable within that environment because even if you're a bank and your business you expect to turn down by one-seventh, that doesn't mean you turn your infrastructure off for a day out of the week. It just doesn't work that way, right?
Right.
So what we need to do, what's important for us, because our revenues are fairly well insulated from whatever the macro environment is, but our teams need to be very responsive to the environment that our customers are in. And that's why it was so important for us to expand our capabilities. That's why it's so important for us to innovate and bring innovation, because we have more and more tools to help them with whatever the challenge is. If the challenge is, "Hey, in this environment, my 40% of my mainframe team is retiring," which is a big, a big problem in a lot of our customers, "I need your help," we can respond to that because we have thousands and thousands of deep mainframe experts who don't look like me. They look like my kids, right?
Because we have scale. We have an ability to bring insights through Bridge to help them when they say, "Hey, I need to save some money. My cloud costs are exploding." Our Kyndryl Bridge consoles can help them in a FinOps way, can help them manage and optimize their cloud spend. Similarly, with how they deploy, how they move onto cloud, similarly, with how they're capturing and achieving their carbon goals, for instance. So our investments have enabled us to bring more capabilities and bring more innovation to them so that we can be responsive to their needs, even though our revenues stay fairly insulated from that macro. It represents, for us, a great opportunity to better align with, again, with their outcomes.
And, you know, things like regulatory changes can actually be helpful to us. They're, you know, changes imposed on businesses essentially from the outside that they have to respond to. And that's, again, necessary, non-discretionary work that we end up helping with. So in Japan, requirements about where technology activities are happening create opportunities for us. In Europe, DORA and the pressures that's putting on financial institutions there is a source of opportunities for us. I'd say, you know, changes in cybersecurity and the threats associated with cyber create opportunities for us as well. And the more non-discretionary, the more mandatory, the more essential it is to respond to a change like that, the more likely it's going to play to our wheelhouse.
Understood. Good. Now, thanks for going through that. So another topic I want to make sure I hit before we open it up is just your. You made a bet with hyperscalers, of course, and that's paid off really, really well. You've added a lot of certified staff against that. But can you give us a little bit more what you exactly do? Where does the relationship begin and I know there's still a lot of opportunity there, but what is the partnership exactly?
Yeah, yeah, sure, sure. So, again, we asserted when we were spun out, we knew, we asserted that the biggest hyperscalers, the biggest tech players, would want to partner with us because of the role we play in our customers' environments, and that's why we were able, for instance, to build and create a pretty deep, meaningful partnership with Microsoft within a week, and Google a month later, and Amazon, et cetera.
And at the heart of those, at the start and at the heart of each of those was kind of three things. One was a joint investment in skills. They're investing in our skills, so we could be, we could be credentialed and experienced on each of their platforms. One was a joint go-to-market so that we can show up together with our customers. That's what CIOs love more than anything else, when their cloud provider and their services provider show up together. And there was a co-innovation element to each of these as well. And since then, and that's, that's what, that's where each of them started. Since then, you know, we continue to evolve this. So we've announced since an expansion of our relationship with Microsoft around GenAI. We've done that similarly with Google.
We've done it with AWS. Our recent, very small tuck-in acquisition was a play to help our customer base move their Power workloads, IBM's Power technology workloads, into Azure. That's what this technology really does well. So each of these relationships started in a very meaningful way. We continue to evolve them to meet the needs of our joint and shared client base, and they'll keep evolving as the ecosystem keeps evolving.
Outside of the hyperscalers, our customers were asking us to help them think through, as I mentioned earlier, the front end of technologies. They asked us, "You know, we need you to help us when we ultimately deploy GenAI. We need you to have your nose under the tent with NVIDIA. We need you to have NVIDIA's tools accessible through Bridge, because that's how we run now." So we signed and announced yesterday a partnership with NVIDIA to help start that process.
So our technical teams can now get together. Some of that will find its way into our cloud work as well. So each of these represent, again, a commitment by the biggest tech companies who need our help, because every one of our customers, everyone has chosen a cloud or multiple clouds, which means everyone has likely made a commitment to cloud consumption, which means everyone needs help in getting, in making that consumption real.
So in the case of Azure, you know, we have a healthcare provider where they're committed to Azure. Fabulous. Azure needs us to help move and manage those workloads, and the customer needs to consume that, so it works out really well. So as our customers evolve their needs, their technologies, we'll bring more and more into this. But for now, this is. It's really worked in a way that allows us to deliver a ton of value to customers and a challenge that nobody else was helping solve.
So this initial burst has gone really, really well. I know that the need to track how the hyperscalers are performing short term is probably less relevant for you. But when you think about innings or where you are in terms of where you want to be on the hyperscaler side, where would you, what would you say to that, Martin?
You know, it depends a lot on the, on the workload itself.
Okay.
So if in what I'll call the systems of engagement world, you know, we're kind of middle game now, right? New systems of engagement. If we run a lot of retailers, so we run their supply chains, and you would imagine in a retailer, it's not just the digital storefront that people need to see, but it's everything that's back end that connects their supply chain and orders and billing and delivery and all that stuff. In that world, those systems of engagement that you see, those have moved to the cloud. That's where the innovation's been for a while, so w e're well down that path.
In the systems of record world, same retailer, but the thing that's actually keeping track of who ordered what and where it's going, and the mainframe on which all that sits and helps them fill out their ledger and do their books, that is not, that's not anywhere near even the early innings yet, because systems of record are having, i t's just a different, it's a different world, right? So systems of engagement will keep going, will keep barreling down this path, new content there, innovation there. The systems of record world will likely stay in its current state, or it'll evolve and they'll find innovation, but that's a longer journey. All of which spells opportunity for us because it makes the infrastructure more complex, and complexity is what our customers struggle with. Complexity is what we solve.
Perfect. Good. No, thanks for going through that. So let me, let's take questions if we have any. Happy to take them. Or I can keep going. So let's do a little bit on gross margins. I know we talk a lot about revenue and building up to the revenue, but the plan of signing business at higher gross margin, I think you're at an inflection point. You're about halfway plus there. Pricing is not so much of an issue for you. So maybe tell us the levers that you've been pulling, and the success, and why you've gotten to that point on the gross margin, and what to look forward ahead.
Yeah, so, you know, when we spun out 2.5 years ago, I think we were all very confident, I know I was, the team was very confident that we would get paid for the great work we do. Customers do like what we do, right? Very high service levels and doing very important work. So what we had to prove was that we can create value and get paid for it, and we also wanted to make sure the investors could see the progress, the continued progress. And so we've been showing in our quarterly releases, we've been showing the gross profit dollar.
First, the gross profit profile of what goes in, and then the gross profit dollar growth that we've been putting in. And it was important because the fix, if you will, the part of us turning this business around required us to engage with customers and say: "Look, the spin-out has caused us to be unable to invest in you the way we'd like to. We'd like to reimagine how this works. And we have all these new capabilities that you can now take advantage of, and we have all these great partners that we can help you with, so let's reimagine this."
And what that's meant is that in certain instances, we've taken content out of those contracts, and we've asked, for instance, at the right time, you can get it to work, we've asked a customer t o go direct to IBM, for instance, to buy their mainframes and their software stack. We'll take it out of our contract, and we'll just engage. And the reason that's so meaningful to us is because the way IBM spun us out and the commercial relationship they created, we had a pool of accounts that in total were, like, zero GP, right? And there was a lot of IBM software in those accounts.
Sure.
So, we've been showing not only that we get paid for the work by putting good business in, we've also been showing the progress we're making on improving the backlog that we inherited by taking out content. A nd all of that, again, all of that's done on a, as we engineer a decline in revenue. So, for us to deliver consistently 25%, 26% suggests that if the only, i t tells you that if the only thing we were working off of was what we put in the backlog, and we didn't have any of the inherited content, we'd be making 9% PTI, right?
Operating PTI. But a gain, we're only halfway there for that, right? Half and half, and that'll keep improving. But it also says that we can deliver that kind of margin profile even on a substantially reduced engineered decline on revenue. So as we bring revenue back to growth, and as the old stuff is less and less important or less and less relevant to our P&L, you can imagine the kind of leverage we should be able to drive in this business as we get to revenue growth, our own content, and, you know, less and less of the old stuff. So I feel good about the work the team has done. David's team leads the pricing function, if you will.
David and team have done a phenomenal job of consistently and in a very disciplined way, us getting paid for the great work we do. Our quality has remained as high as ever. We've invested in order to help create some of that, but we've got a great margin profile. We have to let it come through the P&L, which is, in our business, a backlog-based business. It is a really powerful model once you get through that and you're, you know, you're working with the stuff that you have, but it is a bit diabolical until you get through that, right?
Yeah, no, it's wonderful.
But I feel, I feel great about our margin profile and what we've, what we've been able to, to put into the backlog, and now we've just got to keep working it through. Anything you'd?
I'd just emphasize how exciting it is to be signing business with these kinds of margins and knowing that that's going to play out in the future. And in particular, you know, business that we sign, say, in March, right at the end of our fiscal year, with these kind of attractive margins associated with it, that has no impact in the given year. But as those contracts play out, you know, it's just going to flow through into our P&L in a positive way. And so, you know, a lot of the progress we're looking for this year and even in the next year, we've already done, you know, a lot of the work in terms of recontracting to make that happen. To Martin's point, now we get to see that play out with the passage of time.
So with the margin progression going forward, should we expect most of the margin to be driven or the expansion to be driven on the gross margin side versus SG&A and leverage there? I know you've done some workforce rebalancing, which is great that you're including that in your results, by the way, just to say that again. But just the SG&A leverage versus gross margin, what's the ranking there?
You know, our costs of services are so much larger compared to our SG&A. That's going to be the principal source of margin expansion, just mathematically. I do see opportunities for us to bring SG&A down, you know, excluding the items that we exclude for, you know, adjusted results. It was around 16% last year, and if we can move that down over time, a point or two, that'll be great, and it'll contribute to moving to high single-digit pre-tax margins. But the real driver here is in the gross margins side and the rates at which we're signing new business.
Okay. And just since we're going down the P&L here and extending it to free cash, anything to call out the free cash build, David?
Yeah. You know, as our margins are improving, our cash flow profile is improving as well. We've done really well in terms of cash flow conversion over the last couple of years. Fiscal 2023, we reoptimized our working capital position, and that was helpful to cash flow. This past year, we had a favorable gap between CapEx and depreciation that allowed us to generate more free cash flow than we had adjusted pre-tax income, which is a positive.
And now, as we go into fiscal 2025 and beyond, the principal source of free cash flow for us is going to be earnings, significantly higher adjusted pre-tax earnings minus what we pay in cash taxes. You know, I'm not expecting big differences or big gaps between CapEx and depreciation, so that's kind of a wash. Working capital over time should sort of be a wash for us, and as a result, this idea of pre-tax income - $150, $175 million-ish of cash taxes is free cash flow for us. And that's yeah, that's really exciting as we yeah, as we move forward.
When might you be in a position to return to more traditional capital returns?
Yeah, I think it's, as our margins move up, right? The constraint on us so far, and right now, is really our adjusted pre-tax margin, right? If we look back over the last 12 months, you know, it's much better, but it's, you know, it's actually at roughly 1%. And that's not a compelling place to be, in terms of having a discussion with the rating agencies about capital returns, and staying investment grade is very important to us. But as our margins move up, we don't have that much leverage, and so.
You know, I really see margin progress as being the one key deliverable we really need to have in order to be able to think about capital returns to shareholders. And, you know, and then longer term, given the nature of this business, given its predictability, the visibility, the steadiness of it, and the cash flow that we're going to be generating from pre-tax income, you know, we really believe this is the sort of business that can and should and will return capital to shareholders regularly.
Okay, good. We have time for one more question. Yeah, let's ask one quick one of them. Couple minutes left. We have a mic, if you don't mind, since we're webcasting this. Thanks.
Given that you talked about some of the contracts were intertwined with IBM before, and you've been working through that, and they still have a consulting business, how was it determined what was left behind and what came out with you folks?
Yeah, so first, I mean, IBM does the spin, so y ou know, we don't get to pack our suitcase for the journey. They hand us the suitcase, and here we are. But when IBM built its two services business, and take out maintenance, it's a service business. But we'll just talk about the two services businesses they had. Again, I was there a number of years ago. They built capabilities around applications and consulting in what they call GBS, and they built capabilities and services around infrastructure in GTS. And there was no. Not very logical. You'd never build the same thing in two different places. So they had. They were very discreet and very separate and very different and complementary, right, within IBM. So what IBM spun out was the infrastructure piece only.
They kept the applications, they kept their higher-level consulting business, and that's what they still have today. There really, there still is, y ou know, there was no Venn diagram in IBM that said that they both did the same thing, and there's still really no Venn diagram within even two separate firms now because we're solidly in infrastructure. They are in applications and consulting. So it was a pretty clean, discrete starting point, and that's still there today.
Give me the mic. Anything else? Anyone, any final questions? I think we're just about out of time.
Out of time. All right.
We hit the zero. Well, thank you. Time went by so quickly, right?
Yep.
Thank you both for being here.
Thank you.
Thank you.