DXC Technology Company (DXC) — Q1 2020 Earnings Call Transcript

Thank you, and good afternoon, everyone. I'm pleased you're joining us for DXC Technology's First Quarter Fiscal 2020 Earnings Call. Our speakers on today's call will be Mike Lawrie, our Chairman, President and Chief Executive Officer; and Paul Saleh, our Chief Financial Officer. The call is being webcast at dxc.com/investorrelations, and we posted slides to our website, which will accompany the discussion today. Slide 2 informs our participants that DXC Technology's presentation includes certain non-GAAP financial measures and certain 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. On Slide 3, you'll 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 annual report on Form 10-K and other SEC filings. I'd like to remind our listeners that DXC Technology assumes no obligation to update the information presented on the call except as required by law. Now I'd like to introduce DXC Technology's Chairman, President and CEO, Mike Lawrie.

Okay. Thank you. Good afternoon, everyone. I am going to follow my standard format, then turn this over to Paul. And then we'll be available for any questions. First, our non-GAAP EPS in the first quarter was $1.74. The adjusted EBIT was $652 million, and the adjusted EBIT margin was 13.3%. We generated $72 million of adjusted free cash flow in the first quarter. Our revenue in the first quarter was $4.89 billion on a GAAP basis. In constant currency, revenue was down 4.2% year-over-year, pretty much in line with what we expected. The book-to-bill was 0.9x for the quarter, reflecting a couple of delays in some deals that we had expected to close in Q1. In the first quarter, the Digital revenue grew 35% year-over-year primarily driven by enterprise and cloud apps, cloud infrastructure, and our digital workplace. Our industry IP and BPS revenue grew 3.5% year-over-year. The Digital book-to-bill was 1.3x, and the industry IP and BPS book-to-bill was 1.2x. In June, we completed the acquisition of Luxoft, which strengthens DXC's value proposition as an end-to-end mainstream IT and digital services market leader. We also announced a joint DXC and Microsoft Azure digital transformation practice, building on our long-standing relationship with Microsoft. In the next few days, we also plan to announce a strategic partnership with Google Cloud, which will enable enterprise clients to modernize IT and integrate digital solutions capitalizing on Google Cloud Platform. Finally, we now expect additional currency headwinds for the full year. Combined with some of the delays in these deals as well as additional pressure on our traditional business, we're revising our revenue guidance for the whole year to a range of $20.2 billion to $20.7 billion. Our non-GAAP EPS target is now $7 to $7.75. We continue to target adjusted free cash flow of 90% or more of adjusted net income. Let me just go into a little more detail. The first quarter non-GAAP EPS was $1.74. The effective tax rate was 20.1%. The first quarter adjusted EBIT was $652 million, and the adjusted EBIT margin was 13.3%, including the impact of the investments I discussed last quarter, an accelerated mix shift to Digital, and some delays executing resources in high-cost complex countries. We continued to make significant investments in digital talent, including both hiring new employees and upskilling our existing workforce. We are expanding our digital transformation centers and investing in joint practices with partners such as AWS, Microsoft, and Google. These investments are necessary to continue building on the strong momentum we have in the digital business, and we continue to plan on roughly $100 million of incremental investments this year. The first quarter also has the most impact from the accelerated client savings we discussed last quarter. We're seeing these trade-offs translate into greater opportunities and a qualified digital pipeline, which was up roughly 80% year-over-year in Q1. During the quarter, we saw an acceleration in the shift from traditional infrastructure to digital solutions. Our cloud infrastructure business was up 36% year-over-year, which was faster growth than what we had expected. As we migrate client workloads out of the legacy environments, there are stranded costs that we have to address including assets as well as people. Given the accelerated pace and expanded scope of cloud migrations, we weren't able to get these costs out during the first quarter, but we're taking action and expect to remove the stranded costs by the end of the third quarter. Our delivery team was also behind on its fiscal '20 cost improvement plan, particularly on workforce actions in high-cost countries. As we continue to expand deployment of our Bionix automation program into additional geographies and client environments, it is taking longer to eliminate the headcount as we automate activities. In some cases, we're required to implement the full automation solution prior to removing any of the resources. We are implementing actions to improve execution and second half profit, including accelerated labor pyramid improvements, reductions in non-billable and underutilized resources, and further optimization of non-labor spend such as hardware maintenance and software rates. Adjusted free cash flow for the quarter was $72 million or 15% of adjusted net income, reflecting lumpiness of cash flow, including the timing of our sales commission payments, our fiscal 2019 bonus payments, and prepaid software enterprise license agreements. However, we continue to expect adjusted free cash flow to be 90% or more of adjusted net income for the year. Now let me turn to revenue. As I said, in the first quarter, revenue was $4.89 billion on a GAAP basis. All revenue comparisons I'll discuss will be in constant currency. In the first quarter, revenue was down 4.2% year-over-year, in line with what we expected. The book-to-bill in the quarter was 0.9, reflecting some delays on some large deals. In the first quarter, GBS revenue was $2.2 billion, which was up 0.5% year-over-year. The year-over-year improvement reflects continued momentum in our enterprise and cloud applications business as well as the addition of Molina and two weeks of the Luxoft business. As I discussed last quarter, accelerated cloud adoption is eliminating some of the services associated with rationalizing and refactoring traditional applications. This dynamic is an ongoing headwind for legacy application services. GBS book-to-bill in the quarter was 1.1, and bookings were up 22% year-over-year, reflecting strong bookings in the enterprise cloud apps, analytics, and industry IP and BPS. GIS revenue was $2.7 billion in the first quarter, down 7.6% year-over-year. This reflects the accelerated client savings we've discussed last quarter as well as increased momentum in digital migrations. Cloud and digital workplace both grew more than 35% year-over-year. Similar to the dynamic I discussed in traditional applications, these accelerated shifts pressure the traditional GIS business as clients lift and shift existing workloads to recognize immediate savings. Over time, we typically grow revenue by migrating additional workloads into our multi-cloud environment, but the initial shift often results in less near-term revenue. We're also seeing some slowdown in additional add-on project work in the legacy environment as more investment is made in the digital solutions. To offset these traditional headwinds, we're taking a much more aggressive approach on the GIS pipeline development. We've expanded our sales efforts, targeting large infrastructure outsourcing opportunities for new clients with a focus on deals that involve modernization of the traditional environment while at the same time investing in digital projects. We're still early in this process; however, we're seeing good traction. Total infrastructure pipeline in the first quarter was up 32% year-over-year and 22% sequentially. We expect to drive additional revenue during the second half of the year. The GIS book-to-bill in the quarter was 0.7x, reflecting the lumpiness in large deal signings and some of the delays that I mentioned previously. Let me move on to our digital industry IP and BPS results. Digital revenue was up 35% year-over-year, including two weeks of revenue from Luxoft. Excluding Luxoft, Digital revenue grew 31%, and the book-to-bill in the quarter was 1.3x. As I've discussed, we're seeing a good enterprise spend environment in digital, particularly with respect to enterprise cloud migrations. As we partner with our clients on these transformations, we continue to see strong momentum in our cloud infrastructure solutions. This business grew 36% year-over-year, reflecting accelerated migrations and continued demand for multi-cloud solutions. We're seeing good traction in this business across geographies and industries. During the first quarter, we won a deal with a major European aerospace and defense company to provide cloud migration, security, and analytics services. We're leveraging our knowledge of the legacy estate to modernize the client's IT architecture and help them thrive in a highly competitive market. We built an Agile platform that enables development and deployment of solutions such as next-generation smart factories, asset use optimization, and application of artificial intelligence to everyday business challenges. Enterprise cloud apps and consulting continues to perform well with a 17.1% year-over-year growth, including strong growth in our Americas region, particularly in our Microsoft, ServiceNow, and SAP practices. We're also partnered with Salesforce to win a major multiyear deal with four global luxury retail brands. We are providing development and support services on Salesforce Commerce Cloud, supporting roughly 35 B2C websites globally. Security revenue performance improved in the quarter and grew 5.7% year-over-year with particular strength in Asia and Europe. During the quarter, we won a multiyear deal to provide managed security services for a major European car manufacturer, leveraging standard DXC offerings as well as partnered offerings with Micro Focus, Fortify, and Carbon Black. The solution includes threat intelligence, security event monitoring, vulnerability management, forensic investigations, and regulatory and policy compliance controls. We also saw improved performance in industry IP and BPS, with revenue up 3.5% year-over-year in constant currency driven by a 7% growth in our industry IP offerings. With the addition of Molina, we're seeing strong demand in our U.S. state Medicaid business. During the first quarter, we signed add-on deals with Tennessee, California, and Ohio worth over $100 million each. Industry IP and BPS book-to-bill in the quarter was 1.2x. Now my fourth point, during the first quarter, we completed the acquisition of Luxoft, which strengthens DXC's unique value proposition as a leading end-to-end IT services provider. Luxoft will continue to be led by Dmitry Loschinin, who will report directly to me. Luxoft brings a 13,000-person workforce that provides digital strategy consulting and engineering services for companies across North America, Europe, and Asia. Luxoft will retain its brand and operate as a DXC Technology company, but we've already launched joint go-to-market efforts to cross-sell solutions to both companies’ current clients and to target new clients across industry verticals. Processes and incentives have been put in place to promote and reward cross-selling, and we're encouraged by the early progress we're seeing in the joint pipeline of opportunities. The acquisition also expands DXC's access to digital talent by leveraging Luxoft's presence in key markets, especially Eastern Europe, and by broadly deploying Luxoft's unique talent acquisition and management platform. We're undertaking several changes to quickly apply Luxoft's strengths and capabilities to DXC's business. Within Luxoft, we're creating industry-leading verticals in automotive and financial services. These two verticals will serve more than 20 major automotive OEMs and more than half of the top financial institutions in the Americas and Europe. Two key digital offerings, the Internet of Things and blockchain, will also be combined within Luxoft. We continue to expect Luxoft to provide roughly $700 million in revenue during the last three quarters of the fiscal year in addition to the two weeks of revenue we were able to recognize by closing the deal in the middle of June. Now turning to our partnerships. We recently announced a joint practice with Microsoft Azure. The DXC and Microsoft Azure digital transformation practice enhances our deep and long-standing relationship with Microsoft. This joint practice will provide clients with a highly integrated approach to modernizing their IT systems on Azure. The result would be a reduced time to digital and a more rapid movement of client workloads from legacy IT to a modern cloud architecture on Azure. Additionally, we recently signed a strategic partnership with Google Cloud. This partnership will allow us to modernize mission-critical IT for enterprise clients and integrate digital solutions capitalizing on the Google Cloud Platform. Under our partnership agreement, DXC will also be launching centers of excellence for Google Cloud Platform and Google Cloud artificial intelligence to provide clients with secure, Agile, and scalable cloud-based digital platforms that leverage our advanced analytics capability. We’ll be providing more information on this as the partnership evolves. The Microsoft Azure and Google Cloud practice complement our ongoing cloud work with AWS, Oracle, and VMware to give our clients access to the largest cloud providers in the world. Now my fifth point, before I turn this over to Paul, we now expect an additional $150 million to $200 million of currency headwind for the full year. As I’ve discussed, we're also seeing more impact on our traditional business as accelerated client migrations pressure near-term revenue. Combined with some of the delays I’ve talked about, we're revising our revenue guidance for the full year to a range of $20.2 billion to $20.7 billion. In addition to this lower revenue outlook, delays in some of our cost savings actions will lower our margins, and our non-GAAP EPS target is now $7 to $7.75. We continue to expect adjusted free cash flow to be 90% or more of adjusted net income.

Thank you, Mike. As usual, I'll start by covering some items that are excluded from our non-GAAP results. In the first quarter, we had restructuring costs of $142 million pretax or $0.42 per diluted share, and this is primarily related to workforce optimization. In the quarter, we had $105 million pretax or $0.31 per diluted share of integration, separation, and transaction-related costs, including costs associated with the Luxoft transaction. In the first quarter, amortization of acquired intangibles was $138 million pretax or $0.40 per diluted share. Excluding the impact of these special items, non-GAAP income before taxes from continuing operations was $591 million, and non-GAAP EPS was $1.74. Turning now to our first quarter results in more detail. GAAP revenue in Q1 was $4.89 billion, down 4.2% year-over-year in constant currency. Adjusted EBIT in the quarter was $652 million. Adjusted EBIT margin was 13.3%, reflecting the investments we're making to help clients accelerate their digital transformations with us as well as incremental investments we're making to support the continued momentum in our digital business. Our EBIT margin in the quarter was lower than we had anticipated. We experienced delays in executing on our cost takeout plans. While we reduced our headcount by 3,900 people in the quarter, we fell short of our expectations as we experienced delays in exiting resources in high-cost complex countries. In our Bionix program, we've expanded beyond DXC's delivery centers into clients' environments. This involves reengineering of client processes before savings can be realized, and it is taking more time to execute on these joint efforts. We still intend to execute on our original workforce optimization plans, but the benefit will now be pushed out to the second half of the year. In the quarter, our non-GAAP tax rate was 20.1%, reflecting our global mix of income and the benefit of a return to provision true-up in certain foreign jurisdictions. Turning now to our segment results. GBS revenue was $2.16 billion in the first quarter, up 0.5% year-over-year in constant currency. In the first quarter, GBS segment profit was $366 million, and profit margin was 17% compared with 18.2% in the prior year. GBS margins reflect the investments we are making in hiring and training digital talent as well as the expansion of our digital transformation centers. GIS revenue was $2.73 billion in the first quarter. GIS segment profit in the first quarter was $340 million, and profit margin was 12.4%. GIS margin reflects the investment we are making to help accelerate our clients' digital transformations and the timing on some of our cost takeout actions. Turning to other financial results, adjusted free cash flow in the quarter was $72 million or 15% of adjusted net income. This reflects the timing of annual payments for software licenses and maintenance, investment made to consolidate real estate facilities, and the timing of refresh programs on a few large accounts. As a result, our CapEx was $357 million in the quarter or 7.3% of revenue, but we expect our CapEx to moderate over the course of the year. During the quarter, we paid $51 million in dividends. We also repurchased $400 million of shares through a combination of open market purchases and an accelerated share repurchase program. In total, we returned $451 million in capital to shareholders. We continue to be opportunistic in returning more capital to our shareholders. Cash at the end of the quarter was $1.9 billion. During the quarter, we funded the Luxoft acquisition with $2 billion of additional debt. We also paid down $430 million of current maturities of long-term debt. At the end of the quarter, our total debt was $9.4 billion including capitalized leases, for a net debt to total capitalization ratio of 36.5%. Let me close by covering our revised fiscal '20 targets. We're targeting revenue of $20.2 billion to $20.7 billion, including Luxoft. This revised outlook includes the impact of $150 million to $200 million of additional currency headwinds from a strengthening dollar since the beginning of May. Our revised outlook also reflects the near-term impact from delayed deal closings as well as slippage on a few large transformation milestones. However, we expect a second half improvement in revenue as those deals close and we convert on our strong pipeline, including cross-sell opportunities with Luxoft. We're now targeting non-GAAP EPS of $7 to $7.75 for the full year, reflecting the impact of lower revenue as well as the first half delays in executing on our delivery cost takeout programs. We now expect to achieve $250 million to $300 million of cost savings this year versus our original target of $400 million. We expect the lower revenue and delays in cost takeout to impact second quarter margins by about 1 point sequentially, but we expect margins to improve in the second half of the year through labor actions, supply chain improvements, and real estate consolidation. Our workforce optimization actions include labor pyramids and location mix improvements. While we've driven significant productivity improvements in our delivery organization the last several quarters, we have additional opportunities to extract greater efficiencies from our middle-management layers, including the number of managers as well as their location mix. In supply chain, we're in the process of renegotiating several large software contracts as well as driving additional vendor consolidation to achieve incremental savings. In real estate, we plan to eliminate an additional 600,000 square feet of office space and close three additional data centers throughout the year. Our EPS target assumes a tax rate of 26% to 28% for the full year, reflecting our tax attributes in foreign jurisdictions as well as the increased BEAT liability due to the Luxoft acquisition. Given our lower tax rate in Q1, we expect a higher tax rate over the next three quarters of about 30%. We continue to expect adjusted free cash flow to be 90% or more of adjusted net income. I'll now hand the call back to the operator for the Q&A session.

Given the reduction in your outlook for the year just three months in, you appear to be seeing the business deteriorate a little bit faster than you expected three months ago. So beyond the Luxoft integration and the organic investment you're making in digital, are there other strategic options you're considering, meaning at this point is there a plan B on the table? And sort of what are the options for plan B, particularly I guess with a focus on the industry IP and BPS, which you called out is doing fairly well at this point and is pretty independent of the rest of DXC?

Yes, Lisa, this is Mike. All options are always available. I believe our digital performance is strong, and there is potential for improvement over the full year. Specifically, our industry IP and BPS business have strengthened since the end of last fiscal year. Looking at this quarter, I noticed a couple of key developments. One is the acceleration in our transition to the cloud, which is affecting our business. We've seen an impact on our application business and also on the volume metrics in many contracts where we are paid based on volume. We're experiencing significant acceleration in that area. Additionally, our cloud infrastructure business is growing faster than anticipated, prompting us to take more cost actions. We didn't implement those changes as quickly as we intended in the first quarter, but we believe we can make up for that in the second, third, and fourth quarters. The main takeaway is the accelerated cloud migration, which particularly affects our infrastructure business.

Okay. In your opinion, do you have enough confidence in this reset? Do you have a clear understanding of the dynamics, the shift level, and the rates? At this point, are you feeling confident about the outlook for the rest of the year?

Yes. We've got some very strong plans in place to recover. I felt it was important to reflect what we saw in the first quarter that was different than what we saw exiting in the year. That's what I am signaling. It doesn't mean we don't have plans in place to try to recapture the bulk of that, we do. When you see a slightly different trend than what you saw, it's important to the investors to call that out. Yes, are we confident about that? Yes, we are.

So you cut your EPS guide by $0.75 at the midpoint. Can you just break out how much of that is from incremental FX headwind, deal closing delays, larger declines in your legacy IT services business, and then the slower cost takeout versus what you initially planned?

Yes, if we look at it from an EPS perspective, the revenue impact is probably around $0.25 or more. The remaining portion is due to a mix change, with traditional areas performing a bit weaker than expected. While digital is improving, the gap affects us. Additionally, costs were delayed, as we didn't execute as quickly as we had hoped, especially in complex markets. This situation will likely persist through the second quarter, but we anticipate making progress in the third and fourth quarters. Overall, the impact is about $0.75, which breaks down to roughly $0.25 or more from revenue and the rest from costs.

Great. That's really helpful. And then can you just talk about maybe like on a quarterly basis, your expectations for just revenue growth on a constant currency basis?

Currently, we have accounted for the currency as it stands. We estimated an impact of approximately $150 million to $200 million for the full year. There has been some effect on the revenue side. At this point, we anticipate it to be fairly flat for Q2. For the entire year, we expect a pickup in the second half, estimating a couple of hundred million dollars in Q3 and a similar figure in Q4. As noted, margins will be affected in Q2 by around 1 point, but we expect a significant improvement in margins during the second half of the year as our cost reduction measures begin to take effect in Q3 and continue into Q4.

That's very helpful. I have one housekeeping question. What was the revenue contribution from Luxoft in the quarter?

$45 million.

I was wondering if you could help us understand the dynamics. The faster transition to cloud is one aspect. Could you provide an update on what you're hearing from clients about the outsourcing business and the pace at which they are booking digital revenues? Also, please share your confidence that those revenues will actually materialize throughout the year as you anticipated.

Yes. That is pretty much working just as we had discussed before. Again, when I step back and I look at this, the Digital revenue is clearly accelerating above the level that I thought. Excluding Luxoft for a second, it was up 31%. That's about the fastest growth rate we've had in Digital revenue. Some of that is attributable to some of the deals we did. As I said, some of those deals that we did, we saw that impact in the first quarter. My confidence level on that part of the strategy is very high because we're seeing that absolutely flow through. If I look at the pipeline for the balance of the year in Digital, it is very strong. That's before we even add Luxoft into the equation. Our digital strategy is working, and as a matter of fact, it's accelerating. At the same time, we're seeing an acceleration of that impact, particularly on the infrastructure business.

I would add to what Mike has said. The pipeline, as he mentioned, on the Digital is growing 80% on a year-over-year basis, about 18% sequentially. Also, the pipeline on the traditional business is holding up right now. We see actually opportunities as customers are coming to us asking for modernization opportunities.

That's helpful. And then maybe just a little bit more color on the deterioration in the traditional business. Can you maybe talk about over how broad a client base or how many clients that deterioration is that you're seeing? Is it kind of relegated to a few clients? Is it broader than that? And I guess, to the earlier question, what's your level of confidence you won't see that from additional clients in the next couple of quarters?

Yes. We look at our top 200 or 300 clients, which is what I look at. Across that, I'm not going to name any specific client, but we are seeing an acceleration of this move to cloud infrastructure. It is somewhat industry-specific. Some industries that we are more exposed to, like consumer packaged goods, are migrating more rapidly to the cloud than, let's say, financial services or insurance. It's not so much that there are new clients; we're just seeing a slightly more rapid adoption of the cloud infrastructure in the top 200 or 300 clients that we have. However, that’s being offset by some of this digital revenue we talked about. We’ve shored up most of our large contracts and renewed most of those large contracts, so we don’t have a lot of those on the horizon this year. We’re being more aggressive in targeting new clients from an IT modernization standpoint. That’s what we’re seeing in the pipeline. We have a stronger pipeline on traditional IT modernization than we’ve had in years as we begin to shift towards a more aggressive play around IT modernization.

I was wondering if you could talk a little bit about the competitive dynamics in the market. Are you seeing any shifting in, say, the last 6, 9 months? Particularly, I'm thinking about IBM here, if they're emerging more as a competitor.

No. Particularly in the digital world, we are competing more frequently with an Accenture for example, particularly in some of the areas like our enterprise cloud apps business. Think about that as SAP and the upgrade to S/4HANA. We are running into some of those players more often and we're having quite a bit of success with that. On traditional, more outsourcing things, we see the same competitors we've seen. We haven’t really seen any difference in that. I would say there's quite a bit of price competition. There’s certainly pricing pressure around some of those traditional outsourcing and IT modernization programs. But many of our competitors are seeing the same dynamics in their infrastructure business that we are seeing. There hasn’t been any significant change from a competitive posture over the last 3 or 4 months.

Historically, you've given us a multiyear view, a three-year view. Can you update any of that now that you've got Luxoft in-house?

No, we're not going to update that today. At some point, it will be important to sit down, do another analyst meeting and go through what those longer-term models look like. For now, we’re focused on recovering some of the shortfalls we had in the first quarter and building a plan to get where we need to get to here on a full-year basis. But long term, there's no changes to that model.

My first question is it seems that based on the information you provided in these questions, you should be able to exit the year approaching breakeven overall. So I first wanted to confirm that possibility. But then as we break out GIS, GBS, are we in a situation where it's primarily you can get a little bit of growth from GBS, but GIS is in a much longer multiyear situation because of these accelerated cloud migrations, pricing, and productivity, things like that? Could you break that down a bit for us?

Yes. I would say your comment is well taken in the sense that as we exit the year, we would have recovered quite a bit of that revenue shortfall that would have happened particularly in Q2. From our original expectations, we're maybe off by about $100 million to $150 million from our original exit rate. That being said, you're absolutely right. The GBS business will be a little bit closer to its original target because that’s where we have a whole lot of our digital assets. But the GIS will have a little bit longer road ahead just because of the trends Mike indicated will take longer to moderate. As we get new deals with the pipeline, we hope to do better over time.

The trend here is quite straightforward. We're seeing an accelerated shift to the cloud. That is clearly impacting our ITO business. It’s being offset by some of the things we're doing by participating in many of their digital projects, integrating those digital projects into the existing IT infrastructure. So there’s nothing different here from a strategy standpoint other than it has accelerated a little bit. Now we've got to make some adjustments from both a cost standpoint and going out and attracting new clients beyond our current installed base in this IT modernization space. That’s the fundamental message here.

I notice you haven't altered the free cash flow conversion, but there will be a corresponding decrease in free cash flow due to the lowered guidance. My question is whether this impacts the scale or timing of your capital return strategies. Could you elaborate on your capital allocation?

No. I think it will not make a significant impact on our capital return. We view it much more opportunistically in relation to other opportunities, such as tuck-in acquisitions or the investments we're making in the business. We still expect 90% or more of free cash flow for the full year, even though we started the year at a lower point.

The pace of change in the business seems to be accelerating on a couple of different fronts as you outlined, Mike. Does that speak to the need to evolve some of the internal forecasting processes you guys use? It just seems like there was some pretty significant change in just 2, 2.5 months relative to when you reported your Q4. I'm just wondering if you guys are contemplating any changes in terms of how you formulate your forward guidance as you think ahead.

Yes. The runoff and things like that, we've got a pretty good handle on. I think what we need to do a better job on is some of the volume metrics. The way our contracts are set up, you get paid based on volumes. That’s a little difficult to forecast too far out. They fluctuate month to month and certainly fluctuate quarter to quarter. We're going to try to do a better job of understanding that and forecasting it, but there are limits as to how you can forecast those volumes. This has not been a major issue in the past because the volumes were quite stable. However, what we are seeing with this accelerated shift to the clouds, some of those volumes are shifting around. That is now something we’ll need to get a better handle on and forecast.

I think from where we gave you some directions before, by 1 point to 1.5 points for the full year.

You talked about some deals that slipped out of Q1. Did those already close in Q2?

No. I'll be very honest; there are a couple of them I decided not to do. Typically, at the end of the quarter, you find yourself in a situation where one deal, for example, was roughly $400 million. At the end of the quarter, if you give us a bigger discount, we'll sign it. I decided not to proceed with that. I won’t sacrifice that profit for the sake of a book-to-bill number over a one or two-week transition period. We'll get that closed, and we'll finalize it in the second quarter. But that was an example of something we were unwilling to accept. There are probably at least $400 million to $500 million that fell into that category. We do expect to finalize them in the second or third quarter.

When you think of all the strategic options you have, can you outline what may fall within your control given your current financials versus what you may need to get help externally?

All options are on the table. We've got a strategy, and we're executing that strategy. There was some new news here, particularly around the acceleration on the infrastructure business. Does that change the strategy? No. Does it change some of the options that are available? No. Could that change some of the timing to think about some of those? Yes. I don't see any fundamentally different from a strategic options standpoint. All those options have always been on the table.

Great. From an investor perspective, sentiment has been weak for some time now. What's the mood at DXC? It may be different in different types of businesses. What's the mood internally? And what’s the message to existing employees or recruits?

The messaging is very similar; it doesn’t change because it's the facts. If you go into different parts of the world, it is slightly different. For example, in Asia and Australia, where we’ve largely gotten through the transformation, the digital revenue streams offset some of the traditional, well, that's a much more upbeat mood. In our digital transformation centers where people are solely focused on these digital projects, it's a different world. If you go into an account where you’ve got a significant amount of runoff and you're taking costs out, it’s not nearly as positive. It differs based on where you are and where the business is in that transition. But we’re seeing good opportunities to attract people. We hired 25,000 people last year. We continue to hire, particularly in the digital business. Most people see the opportunity around helping our clients modernize their IT infrastructure and helping them on these digital projects.

You're clearly seeing volumes at your clients shift more rapidly to the cloud. Is that spend going completely away from DXC? Or is this more of a case where over time, the spend is still available to you, you can recover that spend but at a lag effect? You mentioned that you're pursuing deals where you give clients upfront savings. I'd like your take on whether this accelerated cloud shift is an outright negative or is it more a situation where you're taking a hit now but with the benefit later of a shift into digital business mix?

I think on balance, it's much more positive. I do think there's a delay; we're seeing that because the increase we're seeing in our cloud infrastructure business is increasing. It was up again, I think, 36% in the first quarter. It’s much more of a lag effect. We're doing other things where revenue associated with the cloud is beginning to be captured as part of the contract. I view it much more as a lag effect than just a negative. As a matter of fact, I go through this all the time. Our top 250 accounts where we've got about $14 billion of revenue, I review every one of those accounts. Where are we? What's the runoff? What's the digital pipeline look like? But there is a timing issue.

Can you quantify how much revenue impact that’s having this year?

I can't give you an accurate number on that right now. I'll be able to look back and make some judgments as to whether that's something we ought to continue or not. Presently, I don’t see any major change in what we've communicated up to this point.

As the volumes move to the cloud and you shift your scope to more digital services, is that a positive margin event? Or is it neutral or negative? What's the margin mix that's happening as you shift into more digital?

I think, Rod, near term, it's a little bit more negative just because transformation project early on doesn't have the same margins as you could imagine from the environment that we were managing in the traditional side. There is a differential in margin early on. We also have to take cost action to deal with some of the stranded assets in the old environment. Net-net, it puts more pressure on the cost side near term. Therefore, the margins are more pressured. But over time, as those costs come out, there are great opportunities for margin expansion on the new digital business.