KYNDRYL HOLDINGS, INC. Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations:
Note: The information contained in this item has been updated for changes in certain allocation methodologies related toKyndryl's measure of segment adjusted EBITDA as described in Item 7.01 of the Form 8-K. The changes in the segment measure are further discussed in Note 4 to the Consolidated Financial Statements. In addition, Item 7 has been updated to reflect the impacts of the revision to current annual and prior periods related to accrued contract costs, as described in Item 8.01 of this Form 8-K. The revision is further discussed in Note 19 to the Consolidated Financial Statements. Item 7 has not been updated for any other changes since the filing ofKyndryl's 2021 Annual Report on Form 10-K filed with theSEC onMarch 10, 2022 .
Overview
Included below are year-over-year comparisons between 2021 and 2020. For further information on year-over-year comparisons between 2020 and 2019 not covered in the "Segment Results" below, refer to "Management's Discussion and Analysis of Financial Condition and Results of Operations" in the Form 10 for the period, which was filed with theSEC onSeptember 28, 2021 . Year Ended December 31, (Dollars in millions) 2021 2020 Revenue$ 18,657 $ 19,352 Revenue growth (GAAP) (4) % (5) %
Revenue growth in constant currency(1) (5) % (5)
% Net income (loss) (2,304) (2,007) Adjusted EBITDA(1) 2,069 2,185
(1) Revenue growth in constant currency and adjusted EBITDA are non-GAAP financial metrics. For definitions of these metrics and a reconciliation of adjusted EBITDA to the most directly comparable financial measure calculated and presented in accordance with GAAP, see "?Segment Results."
At December 31,
(Dollars in millions) 2021 2020
Assets $ 13,213 $ 11,205
Liabilities 10,446 6,220
Equity 2,767 4,985
Kyndryl was formed as a wholly-owned subsidiary of IBM inSeptember 2021 to hold the operations of the managed infrastructure services unit of IBM'sGlobal Technology Services segment. OnNovember 3, 2021 , IBM distributed shares representing 80.1% ofKyndryl's outstanding common stock to holders of record of IBM's common stock as of the close of business onOctober 25, 2021 , in a Spin-off that is tax-free forU.S. federal tax purposes. Following the distribution,Kyndryl became an independent, publicly-traded company and is the world's leading managed infrastructure services provider.Kyndryl utilized allocations and carve-out methodologies through the date of distribution to prepare historical financial statements. The consolidated financial statements for periods prior to the Separation herein may not be indicative of our future performance, do not necessarily include the actual expenses that would have been incurred by us and may not reflect our results of operations, financial position and cash flows had we been a separate, standalone company during the historical periods presented. For additional information, see "Basis of Presentation" in Note 1 - Significant Accounting Policies to the accompanying Consolidated Financial Statements. 1 Financial Performance Summary Macro Dynamics The COVID-19 pandemic and related macroeconomic uncertainty beginning inMarch 2020 caused many clients to experience declines in their business volumes and resulted in client priorities shifting toward maintaining operational stability, flexibility, and preservation of cash. The declines in business volumes and shifting client priorities negatively impacted demand for technology services in 2020. In 2021, we saw a broad-based macroeconomic recovery in most regions of the world. Demand for technology services rebounded, as large organizations again demonstrated a need for assistance in designing, building, managing and modernizing their technology systems. Most economists, including theInternational Monetary Fund , expect global macroeconomic growth to continue
in 2022. 2021 Financial Performance
In 2021, we reported$18.7 billion in revenue, a decline of 4 percent when compared to the prior year primarily driven by lower contract volumes due to existing and new clients pausing activities during our planned Separation from our former Parent, as well as expected price declines in certain new and renewed customer contracts. This was a consistent trend across all segments.United States revenue declined 5 percent,Japan declined 4 percent, Principal Markets declined 1 percent and Strategic Markets declined 5 percent compared to 2020. Net loss of$2.3 billion increased by$297 million versus the prior year. The current year Net loss includes a goodwill impairment charge of$469 million , transaction-related costs of$627 million and litigation charges for certain long-standing claims and disputes of$52 million , as well as cost allocations from our former Parent. 2020 Financial Performance
In 2020, we reported$19.4 billion in revenue, a decline of 5 percent when compared to the prior year which was primarily driven by declines inthe United States . Revenue declined primarily due to a reduction in client volumes within industries heavily impacted by the global pandemic. Net loss was$2.0 billion , an increase of$1.1 billion when compared to the prior year, primarily due to higher workforce rebalancing charges of$759 million . We took these structural actions to simplify and optimize our operating model.
Basis of Presentation
We prepare our consolidated financial statements in accordance withU.S. GAAP, which requires us to make estimates and assumptions that impact the amounts reported and disclosed in our consolidated financial statements and the accompanying notes. We prepared these estimates based on the most current and best available information, but actual results could differ materially from these estimates and assumptions. COVID-19 has had and we expect will continue to have, significant effects on economic activity, on demand for our services and on our results of operations in 2022. Prior toNovember 4, 2021 , the accompanying financial statements ofKyndryl were derived from the consolidated financial statements and accounting records of the Parent as if the Company operated on a standalone basis during the periods presented and were prepared in accordance withU.S. GAAP and pursuant to the rules and regulations of theSEC . Historically, the Company consisted of the managed infrastructure services unit of the Parent'sGlobal Technology Services segment and did not operate as a separate standalone company. Accordingly, the Parent had reported the financial position and results of operations, cash flows and changes in equity of the Company in the Parent's consolidated financial statements. The accompanying financial statements through the Separation date reflect allocations of certain IBM corporate, infrastructure and shared services expenses, including centralized research, legal, human resources, payroll, finance and accounting, employee benefits, real estate, insurance, information technology, telecommunications, treasury and other expenses. Where possible, these charges were allocated based on direct usage, with the remainder allocated on a pro rata basis of headcount, gross profit, asset or other allocation methodologies that are considered to be a reasonable reflection of the utilization of services provided or the benefit received byKyndryl during
the
periods presented. The
2
accompanying financial statements through the Separation date may not be
indicative of the Company's future performance and do not necessarily reflect
what the financial position, results of operations and cash flows would have
been had it operated as an independent company during the periods presented.
After the Separation on November 3, 2021 , the Company's financial statements for
the periods from November 4, 2021 , through December 31, 2021 , are consolidated
financial statements based on our reported results as a standalone company. All
significant transactions and accounts between Kyndryl entities were eliminated.
All significant intercompany transactions between IBM and Kyndryl prior to the
Separation were included within Net Parent investment on the accompanying
Consolidated Financial Statements.
Prior to the Separation, our operations were included in the consolidated U.S.
federal and certain state and local and foreign income tax returns filed by IBM,
where applicable. The Company also files certain separate foreign income tax
returns. For purposes of the historical periods presented on a "carve-out"
basis, the income tax provisions have been calculated using the separate return
basis, as if we filed separate tax returns.
Post-Separation, the income tax provisions are calculated based on Kyndryl's
operating footprint, as well as tax return elections and assertions. Current
income tax liabilities including amounts for unrecognized tax benefits related
to our activities included in IBM's income tax returns were deemed to be
immediately settled with IBM through the Net Parent investment account in the
Consolidated Balance Sheet and reflected in Net transfers from Parent in the
financing activities section in the Consolidated Statement of Cash Flows.
During the quarter ended March 31, 2022 , the Company identified an $87 million
over-accrual in its accrued contract costs balance that related to a
majority-owned, consolidated joint venture in our Principal Markets segment.
This over-accrual was built up over the pre-Separation periods of January 1,
2012 to November 3, 2021 , resulting in overstatements of cost of services and
accrued contract costs. Although the Company concluded that such impacts were
not material to any prior annual or interim period, we made an immaterial
revision to portions of our 2021 Annual Report and will make immaterial
revisions to prior interim periods in our subsequent Quarterly Reports on Form
10-Q. Further information regarding the revision is included in Note 19 -
Revision of Prior-Period Financial Statements.
Additionally, during the three months ended March 31, 2022 , the Company updated
certain allocation methodologies among segments related to its measure of
adjusted EBITDA, which by itself did not change the aggregate amount of adjusted
EBITDA. The following discussions on segment results, cost and expenses and
financial positions, as well as Note 4 - Segments, have been revised to reflect
the correction for the over-accrual of accrued contract costs and to recast the
segment adjusted EBITDA measures.
Within the financial statements and tables presented, certain columns and rows
may not add due to the use of rounded numbers for disclosure purposes.
Percentages presented are calculated from the underlying whole-dollar amounts.
Certain items have been recast to conform to current-period presentation.
Segment Results
As a result of the Separation, in the fourth quarter of 2021, the Company
implemented a new operating model and reporting structure resulting in four
reportable segments:
3
The following table presents our reportable segments' revenue and adjusted
EBITDA for the years ended
Year Ended December 31, Year-over-Year Change
(Dollars in millions) 2021 2020 2019 2021 vs. 2020 2020 vs. 2019
Revenue
United States $ 4,805 $ 5,084 $ 5,340 (5) % (5) %
Japan 2,923 3,042 2,929 (4) % 4 %
Principal Markets 7,085 7,187 7,587 (1) % (5) %
Strategic Markets 3,844 4,040 4,424 (5) % (9) %
Total revenue $ 18,657 $ 19,352 $ 20,279 (4) % (5) %
Revenue growth in constant
currency(1) (5) % (5) %
Adjusted EBITDA(1)
United States $ 842 $ 940 $ 974 (10) % (3) %
Japan 501 534 468 (6) % 14 %
Principal Markets 341 375 609 (9) % (38) %
Strategic Markets 540 488 660 11 % (26) %
Corporate and other(2) (154) (153) (144) NM NM
Total adjusted EBITDA(1) $ 2,069 $ 2,185 $ 2,566 (5) % (15) %
NM - not meaningful
(1) Revenue growth in constant currency and adjusted EBITDA are non-GAAP financial metrics. See the information below for definitions of these metrics and a reconciliation of adjusted EBITDA to the most directly comparable financial measure calculated and presented in accordance with GAAP.
(2) Represents net amounts not allocated to segments
We report our financial results in accordance with GAAP. We also present certain non-GAAP financial measures to provide useful supplemental information to investors. We provide these non-GAAP financial measures as we believe it improves visibility to underlying results and the impact of management decisions on operational performance and enables better comparison to peer companies. Revenue growth in constant currency is a non-GAAP measure that eliminates the effects of exchange rate fluctuations when translating from foreign currencies tothe United States dollar. It is calculated by using the average exchange rates that existed for the same period of the prior year. Constant-currency measures are provided so that revenue can be viewed without the effect of fluctuations in currency exchange rates, which is consistent with how management evaluates our revenue results and trends. Additionally, management uses adjusted EBITDA to evaluate our performance. Adjusted EBITDA is a non-GAAP measure and defined as net income (loss) excluding net interest expense, depreciation and amortization (excluding depreciation of right-of-use assets and amortization of capitalized contract costs), pension costs other than pension servicing costs and multi-employer plan costs, early extinguishment of debt charges, workforce rebalancing and restructuring charges, transaction-related and integration-related items, goodwill and long-lived asset impairment charges, foreign currency impacts of highly inflationary countries, significant litigation costs, stock-based compensation expense and income taxes. We believe that adjusted EBITDA is a helpful supplemental measure to assist investors in evaluating our operating results as it excludes certain items whose fluctuation from period to period does not necessarily correspond to changes in the operations of our business. We provide this non-GAAP financial measure as we believe it improves visibility to underlying results and the impact of management decisions on operational performance, enables better comparison to peer companies and allows us to provide a long-term strategic view of the business. These disclosures are provided in addition to and not as a substitute for the percentage change in revenue and profit or loss measures on a GAAP basis compared to the corresponding period in the prior year. Other companies may calculate and define similarly labeled items differently, which may limit the usefulness of this measure for comparative purposes. 4 The following table provides a reconciliation of GAAP net income (loss) to adjusted EBITDA: Year Ended December 31, (Dollars in millions) 2021 2020 2019 Net income (loss)$ (2,304) $ (2,007) $ (939) Provision for income taxes 402 247 366 Workforce rebalancing charges 39 918 159 Transaction-related costs 627 21 - Stock-based compensation expense 71 64 51 Impairment expense 469 - - Interest expense 64 63 76 Depreciation expense 1,300 1,445 1,469 Amortization expense 1,314 1,408 1,335 Other adjustments * 88 27 50 Adjusted EBITDA (non-GAAP)$ 2,069 $ 2,185 $ 2,566 * Other adjustments represents pension expense other than pension servicing costs and multi-employer plan costs, significant litigation costs and currency impacts of highly inflationary countries.United States Year Ended December 31, Year-over-Year (Dollars in millions) 2021 2020 Change Revenue$ 4,805 $ 5,084 (5) % Adjusted EBITDA 842 940 (10) %
For the year endedDecember 31, 2021 ,United States revenue of$4.8 billion decreased 5 percent as compared to the prior year, primarily driven by lower contract volumes due to clients pausing activities during the pandemic and our planned Separation as well as lower pricing. Adjusted EBITDA decreased$99 million from the prior year, primarily due to lower revenue, partially offset by cost reductions. For the year endedDecember 31, 2020 ,United States revenue of$5.1 billion decreased 5 percent as compared to the prior year, driven by declines across the contract portfolio and impacts from the COVID-19 pandemic. Adjusted EBITDA decreased$33 million from the prior year, driven by revenue declines which were partially offset by travel and discretionary cost reductions due to the COVID-19 pandemic as well as realizing benefits from structural actions taken in first quarter of 2020.Japan Year Ended December 31, Year-over-Year (Dollars in millions) 2021 2020 Change Revenue$ 2,923 $ 3,042 (4) %
Revenue growth in constant currency (1) % 2 % Adjusted EBITDA 501 534
(6) %
For the year endedDecember 31, 2021 ,Japan revenue of$2.9 billion decreased 4 percent as compared to the prior year. Revenue decreased primarily as a result of currency exchange rates. Adjusted EBITDA decreased$33 million from the prior year largely due to decreased revenue. For the year endedDecember 31, 2020 ,Japan revenue of$3.0 billion increased 4 percent as compared to the prior year driven by strong performance in new client contracts. Adjusted EBITDA increased$67 million from the prior year behind the strength of revenue growth mixed with lower travel and discretionary costs due to the COVID-19 pandemic. 5 Principal Markets Year Ended December 31, Year-over-Year (Dollars in millions) 2021 2020 Change Revenue$ 7,085 $ 7,187 (1) %
Revenue growth in constant currency (6) % (6) % Adjusted EBITDA 341 375
(9) %
For the year endedDecember 31, 2021 , Principal Markets revenue of$7.1 billion decreased 1 percent as compared to the prior year. Revenue decreased due to certain joint ventures not transferring to us in connection with the Separation partially offset by a favorable currency exchange rate impact of 4 points, primarily driven by the weakening of theU.S. dollar against the euro and British pound. Adjusted EBITDA decreased$34 million from the prior year, primarily due to lower revenue, partially offset by cost reductions from structural actions taken in the prior year. For the year endedDecember 31, 2020 , Principal Markets revenue of$7.2 billion decreased 5 percent as compared to the prior year, driven by declines across the contract portfolio and impacts from the COVID-19 pandemic. Adjusted EBITDA decreased$234 million from the prior year, primarily due to revenue decline in these higher fixed-cost European countries. Strategic Markets Year Ended December 31, Year-over-Year (Dollars in millions) 2021 2020 Change Revenue$ 3,844 $ 4,040 (5) %
Revenue growth in constant currency (7) % (7) % Adjusted EBITDA 540 488
11 %
For the year endedDecember 31, 2021 , Strategic Markets revenue of$3.8 billion decreased 5 percent as compared to the prior year. Revenue decreased due to certain joint-ventures not transferring to us in connection with the Separation and impacts from exiting low-margin accounts, partially offset by a favorable currency exchange rate impact of 2 points, primarily driven by the weakening of theU.S. dollar against the euro. Adjusted EBITDA increased$52 million from the prior year, primarily due to exiting low-margin accounts and realizing benefits from structural actions taken in the prior year. For the year endedDecember 31, 2020 , Strategic Markets revenue of$4.0 billion decreased 9 percent as compared to the prior year, driven primarily by strategic decisions to exit certain loss-making contracts to strengthen our go-forward profit position. Adjusted EBITDA decreased$172 million from the prior year, primarily due to lower revenue as a result of both client volumes and pause of small-deal signings after the announcement of our Separation in the higher fixed-cost European countries.
Corporate and Other
Corporate and other had an adjusted EBITDA loss of$154 million in 2021 compared to a loss of$153 million in 2020. Corporate and other had an adjusted EBITDA loss of$144 million in 2019. 6 Costs and Expenses Year Ended December 31, Percent of Revenue Change (Dollars in millions) 2021 2020 2021 2020 2021 vs. 2020 Revenue$ 18,657 $ 19,352 100.0 % 100.0 % (4) % Cost of services 16,550 17,137 88.7 % 88.6 % (3) %
Selling, general and administrative expenses 2,776 2,948 14.9 % 15.2 % (6) % Workforce rebalancing charges 39 918 0.2 % 4.7 % (96) % Transaction-related costs 627
21 3.4 % 0.1 % NM Impairment expense 469 - 2.5 % - % - % Interest expense 64 63 0.3 % 0.3 % 2 %
Other (income) and expense 35 25 0.2 % 0.1 % 40 % Income (loss) before income taxes$ (1,903) $ (1,760) NM NM - not meaningful
Costs of services were 88.7% of revenue in 2021 compared to 88.6% in 2020, primarily driven by the impact of revenue decrease of advisory & implementation services and price decreases embedded in certain new and renewed contracts mostly offset by benefits realized from prior-year structural actions. Selling, general and administrative expenses were 14.9% of revenue in 2021 compared to 15.2% in 2020, primarily driven by benefits realized from prior-year structural actions, partially offset by additional legal liabilities recorded in the fourth quarter of 2021. Workforce rebalancing charges arising from structural actions to enhance productivity and cost-competitiveness and to rebalance skills that result in payments to employees terminated in the ongoing course of business. Workforce rebalancing charges were 0.2% of revenue in 2021 compared to 4.7% in 2020, when the Company announced a significant workforce reduction, primarily inEurope , in the fourth quarter of 2020. Transaction-related costs were 3.4% of revenue in 2021 compared to 0.1% in 2020, primarily driven by costs related to our Separation, including legal, consulting, audit and other professional fees, information technology transition costs, and employee retention expenses. Impairment expenses were 2.5% of revenue in 2021, primarily driven by an impairment of goodwill we recorded in the fourth quarter of 2021. Interest expense was 0.3% of revenue in 2021 compared to 0.3% in 2020, and includes interest expense associated with the indebtedness we incurred in connection with our Separation. Other (income) and expenses were 0.2% of revenue in 2021 compared to 0.1% in 2020.
Transaction-related Charges
The process of completing our Separation involves significant costs and expenses. Transaction-related charges are primarily related to additional spend to establish certain standalone functions and information technology systems, professional services fees, employee retention expenses and other spend related to contract and supplier novation agreements. These costs primarily include items that are incremental and one-time in nature. Transaction-related charges totaled$627 million in 2021. Transaction-related charges recorded for the year endedDecember 31, 2020 and 2019 were$21 million and$0 , respectively. The$498 million of transaction-related charges incurred in the periods prior to Separation had no tax effect due to the valuation allowances discussed in Note 5 - Taxes. The tax impact of the$129 million of transaction-related charges incurred post-Separation was$33 million .
Income Taxes
The Company's consolidated provision for income taxes and effective tax rate
were as follows:
Year Ended December 31,
(Dollars in millions) 2021 2020
Provision for income taxes $ 402 $ 247
Effective tax rate (21.1) % (14.0) %
In 2021 and 2020, we recorded income tax expense of
7
foreign operations generating taxable income, uncertain tax positions, and tax
charges related to the transfer of
The effective tax rate for 2021 was lower compared to 2020 due primarily to tax charges related to the transfer ofKyndryl's operations from Parent in contemplation of the Company's Separation and nondeductible goodwill impairment. For more information, see Note 5 - Taxes.
Financial Position
Dynamics
Cash and cash equivalents atDecember 31, 2021 , were$2.2 billion , an increase of$2.2 billion when compared to prior year-end sinceKyndryl's cash was managed by the Parent's centralized treasury system in 2020. Total assets of$13.2 billion increased by$2.0 billion fromDecember 31, 2020 predominantly driven by an increase in cash and cash equivalents of$2.2 billion driven by proceeds from debt issuances net of payment made to former Parent; an increase in accounts receivable of$835 million primarily driven by a reduction in factoring of receivables, new commercial activity with our former Parent, and receivables with the former Parent that are no longer settled immediately post-Separation; and an increase in right-of-use assets of$230 million primarily due to entering into post-Separation leases with the former Parent for . . .
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