DXC Technology Company (DXC) — Q4 2015 Earnings Call Transcript

Good afternoon everyone. I am pleased you have joined us for CSC's fourth quarter and fiscal year 2015 earnings call and webcast. Our speakers on today's call will be Mike Lawrie, our Chief Executive Officer and Paul Saleh, our Chief Financial Officer. As usual, the call is being webcast at csc.com/investorrelations and we've posted some slides on our website which will accompany our discussion today. On slide two, you will see that certain comments we make on the call will be forward-looking. These statements are subject to known and unknown risks and uncertainties which could cause actual results to differ materially from those expressed on the call. A discussion of risks and uncertainties is included in our Form 10-K, Form 10-Q, and other SEC filings. Slide three informs our participants that CSC's presentation includes certain non-GAAP financial measures and further adjustments to these measures which we believe provide useful information to our investors. In accordance with SEC rules, we have provided a reconciliation of these measures to their respective and most directly comparable GAAP measures. These reconciliations can be found in the tables included in today's earnings release, as well as in our supplemental slides. Both documents are available on the Investor Relations section of our website. Briefly, I would like to mention that our fourth quarter 2015 GAAP results include the impact of certain items; including non-cash pension related charges, charges related to our proposed SEC settlement, as well as other expenses, a special restructuring charge, and a tax valuation allowance benefit. In addition, our fourth quarter 2014 GAAP results include the impact of non-cash pension related charges and a benefit from the reversal of contingent consideration associated with our ServiceMesh acquisition. Mike's prepared remarks will exclude the impact of these items on our results. Paul will cover these items in more detail in his remarks. Finally, I would like to remind our listeners that CSC assumes no obligation to update the information presented on the call, except, of course, as required by law. Now, I would like to introduce CSC's CEO, Mike Lawrie.

Thank you and good afternoon to everyone. As you know, within the last hour we shared the news about our intent to separate CSC into two publicly traded companies. But we are also going to be covering our Q4 and full year results and then after we do that we will have our normal Q&A session. I would like to begin by walking you through the separation that we announced. CSC's Board of Directors has unanimously approved a plan to separate CSC into two publicly traded pure play companies. One will serve commercial and government clients globally, and one will serve public sector clients in the United States. Concurrent with the separation, CSC intends to pay a special cash dividend to shareholders of $10.50 per share at closing. The separation is intended to qualify as a tax-free transaction to CSC shareholders and immediately following the separation, shareholders will own shares of both CSC Global Commercial and CSC U.S. Public Sector. The Get Fit journey that we have been talking about for several years has largely been successful. We have taken a lot of costs out and really moved the company in the right direction. At the same time, market needs have changed for the public sector and commercial segments. The Board felt that separating the two businesses will allow these two businesses to tailor their growth and leadership paths to meet those needs, while at the same time creating new opportunities for shareholder value. Our planning is already underway and is being led by a dedicated team focused on the details of the separation for our clients, employees, partners, and other stakeholders. It will be business as usual. Our goal is to maintain laser focus on our client service and continued delivery excellence, and we will be keeping all of our stakeholders up-to-date and informed as we approach major milestones. Let me just go into a little more detail on each of those points. CSC U.S. Public Sector will be a $4.1 billion company focused on public sector agencies in the U.S., including federal, state, and local government, defense and intelligence. And CSC Global Commercial will be an $8.1 billion company driving IT transformations for commercial and non-U.S. government clients around the world. Today's announcement represents a positive milestone in the CSC turnaround. With our Get Fit efforts having strengthened the company, we are positioning the business for long-term growth and leadership. Separating the company into two businesses, each uniquely positioned to lead its market by focusing strongly on the needs of that market and its clients, is the best way to achieve this. Upon separation, the U.S. Public Sector business will be a top three independent provider of IT services to the U.S. government and affiliated public sector entities. Upon completion of the separation, the commercial business we think will enable faster growth with better delivery along with more industry-relevant innovations. The separation is also designed to ensure both companies have capital structures that are consistent with investment-grade credit profiles. We plan to close the transaction by October 25th, subject to regulatory approvals. We have already started activities such as the proposed innovation of U.S. Public Sector contracts, tax opinions, and regulatory reviews. We expect to unlock value with this transaction, and we appreciate our shareholders' support.

Thank you, Mike. Before I review the fourth quarter and full year, let me cover some items that are included in our GAAP results. First, due to improving profitability in our U.K. business over the past two years, we're able to reverse a tax valuation allowance and record a tax benefit of $264 million, or $1.85 per share in the quarter. While we used this opportunity to accelerate efforts to optimize our workforce in high-cost markets, particularly in Europe, we also incurred a special restructuring charge totaling $246 million pretax in the quarter. In terms of our fourth quarter results, revenue was $2.9 billion, down 8% in constant currency. On a sequential basis, fourth-quarter revenue grew 1% in constant currency, driven by 2% growth in commercial revenue. Non-GAAP diluted EPS from continuing operations was $1.26, up 10% from a year ago. For the full year, revenue was $12.2 billion, down 5% in constant currency. Adjusted non-GAAP EPS from continuing operations was $4.64 for the year, which was up 9% from the prior year. Overall, we delivered approximately $480 million of cost savings for the full year and made significant reinvestments into the business to drive growth and enhance our offerings.

Our fourth quarter non-GAAP EPS from continuing operations was $1.26, driven by our continued cost takeout actions. We also generated very strong free cash flow of $717 million for the year. Our NPS business continues to show signs of improvement. The fourth quarter bookings were solid, and our commercial revenue was up sequentially in constant currency, in line with our expectations and driven by improved performance in our GBS business. We continue to see positive signs of momentum from our investments, including a good commercial book-to-bill of 1.2x, which does not include a large contract worth almost $700 million that was awarded during the quarter but signed after quarter-end. We took advantage of a large tax benefit to reinvest in the business by accelerating our efforts to optimize CSC's workforce. Now, looking out into fiscal 2016, we are targeting commercial revenue to be flat to slightly down in constant currency, while NPS revenue is expected to be up slightly. This will translate to total revenue being flat to slightly down on a constant currency basis.

Thank you very much. I have a few quick questions about the separation. Can you provide any insight into the cash costs you anticipate incurring, not just for executing the separation, but also for establishing separate operating infrastructure for each of the business units?

We're estimating somewhere in the neighborhood of $50 million to $75 million. So, we don't see this as a big cost to separate the businesses. We've been running these businesses in such a way where we positioned this to happen for some time.

Okay. And then just on the cash flow, the cash flow guidance of the $750 million to $800 million, does that include the $190 million still due to the SEC? And what impact, if any, is included from the new accounts receivable facility?

The free cash flow guidance does not include any benefit from the sale of receivables through our special facilities, including the $190 million penalty we will likely pay to the SEC.

Thanks, everyone. Congratulations on the announcement. To start off, is there any possibility that this tax division transaction would prevent you from pursuing a merger that could also be tax efficient within the next six to twelve months, whether with the government or a smaller entity?

Vehicles like Reverse Morris Trust could be employed, but our focus is on the strengths of both businesses and their ability to compete independently in their respective markets.

Hey, thanks guys. Maybe just to build on that last answer, I mean were there active efforts made to sell either or both of these businesses before the Board decided to split them into two separate public companies? And if there were such efforts, what were the reasons why those didn't come to fruition?

It’s not appropriate for us to discuss those topics, except to say that this separation served the best interest of our shareholders, employees, partners, and customers. The bottom line here is that what we announced today would have been inconceivable three years ago. The turnaround we've seen over the last couple of years has allowed us to take this important step for continuing transformation.