DXC Technology Company (DXC) — Q1 2022 Earnings Call Transcript

Thank you, and good afternoon, everyone. I'm pleased that you're joining us for DXC Technology's First Quarter 2022 Earnings Call. Our speakers on the call today will be Mike Salvino, our President and CEO; and Ken Sharp, our Executive Vice President and CFO. This call is being webcast at dxc.com/investorrelations, and the webcast includes slides that will accompany the presentation today. Today's presentation includes certain non-GAAP financial 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 direct comparable GAAP measures. These reconciliations can be found in the tables included in today's earnings release and on the webcast slides. Certain comments we make on the call will be forward-looking statements. These 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 these 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 this call, except as required by law. And with that, I'd like to introduce DXC Technology's President and CEO, Mike Salvino. Mike?

Thanks, John, and I appreciate everyone joining the call today, and I hope you and your families are doing well. Today's agenda will begin with a quick update on our solid Q1 performance, which continues to show that revenue, adjusted EBIT margin, book-to-bill, and non-GAAP EPS, all have a positive trajectory compared to past quarters. During our Investor Day in June, we gave you additional insights into the steps of our transformation journey. Those steps include inspiring and taking care of our colleagues, focusing on our customers, optimizing costs, seizing the market, and building a strong financial foundation. I will provide updates on each step and then hand the call over to Ken to share our Q1 financial results, guidance, and more details on how we are building a strong financial foundation. Finally, I will make some closing remarks before opening the call for questions. Regarding our Q1 performance, our revenues were $4.14 billion, and our adjusted EBIT margin was 8%. This represents the fourth straight quarter of both revenue stabilization and sequential margin expansion, and we expect both trends to continue in Q2. Book-to-bill for the quarter was 1.12. This is the fifth straight quarter that we have delivered a 1.0 or better book-to-bill, and we expect our success in winning in the market to continue in Q2. Our non-GAAP EPS was $0.84 in the quarter, which is up 300% compared to $0.21 that we delivered in Q1 of FY '21. The positive trajectory of all four of these numbers gives us confidence that our playbook is working. Our playbook has three phases: the stabilization phase was completed in FY '21. This phase enabled us to make great progress with our colleagues and customers on revenue, margin, book-to-bill, and reducing our debt. We are now focused on the foundation phase, which focuses on the steps that will allow us to deliver growth. The goals of this phase are: first, to continue to increase our employee engagement while attracting and retaining highly talented colleagues; second, stabilize year-on-year organic revenue; third, expand adjusted EBIT margins; fourth, consistently deliver a book-to-bill number of 1.0 or greater, with a nice mix of new work and renewals; and finally, under Ken's leadership, deliver a financial foundation that increases discipline and improves our cash flow and earnings power. Now I will discuss the good progress we are making on each step of our transformation journey, beginning with inspiring and taking care of our colleagues. We are executing a people-first strategy; attracting and retaining talent is fundamental to enable our growth. Our refreshed leadership team has deep industry experience and is delivering. Brenda, who is our Chief Marketing Officer, is our newest addition. Brenda is a strategic, results-oriented leader who brings deep marketing experience to DXC. 75% of our leadership team is now new to DXC and is bringing in talent based on their personal credibility as talent follows talent. What the team is finding is that the new DXC story is resonating in the market, and new hires want to join DXC because they see the opportunity to progress their careers with a company that's on the right trajectory. We mentioned during our investor call that nearly 50% of our vice presidents across the company are new to DXC within the last 22 months. We are also investing in our people. This quarter, we rewarded high performance by paying annual bonuses that benefited roughly 45,000 of our colleagues. In Q2, we are planning merit increases that will benefit roughly 77,000 of our colleagues. In addition to these investments, we are doing a great job of taking care of our colleagues and their families during the pandemic. This focus on our colleagues is unique and builds trust with them, increases employee engagement, allows us to compete for talent, and enables us to deliver for our customers. The focus on our customers is the second step of our transformation journey. Our investment in our customers is the primary driver of revenue stabilization. During the Investor Day presentation, I couldn't be more proud to have you hear from American Airlines, FedEx, P&G, Lloyd's, Brighthouse, Deutsche Bank, Campbell's, and Microsoft, and I want to thank them again for their support and partnership. It was clear from their comments that the new DXC story is resonating with them because we are delivering. These are all large global companies, and they are saying that their IT estates are important. In fact, they used the word critical. Our strategy of delivering ITO services builds customer intimacy and develops trust that, when our customers want to further transform their business, they turn to us, which allows us to move them up the enterprise technology stack. Additional evidence that our strategy is working is the nice progress we have made on our GBS business, along with the cloud and security layer of our GIS business. All of this gives us confidence that we will deliver on our financial commitments. Now let me turn to our cost optimization program. We continue to do well optimizing our costs and delivering for our customers without disruption. We are focused on four cost levers: contractor conversion, real estate, scaling our GIDCs, and automation through Platform X. These levers have helped us expand our margin going from 7.5% last quarter to 8% this quarter. You will hear from Ken that we expect to continue to expand margins in Q2. Next, this is the market where we are focused on cross-selling to our existing customers and winning new work. The 1.12 book-to-bill that we delivered this quarter is evidence that our plan is working. In Q1, 57% of our bookings were new work, and 43% were renewals. You will see that we are running specific sales campaigns. An example of these campaigns is ITO modernization, which is focused on improving the performance of our customers' IT estates. Another example is our campaign to show our customers how to think about cloud, which combines on-prem, private cloud, and public cloud technology. Our ability to deliver a consistent book-to-bill of 1.0 in each of the last five quarters is evidence that these sales campaigns are working and that we can win in the IT services industry. This momentum and success in the market give us confidence that we will deliver another book-to-bill of 1.0 or greater in Q2. Now let me turn the call over to Ken.

Thank you, Mike. Turning to our financial performance on Slide 12. For the quarter, DXC exceeded the top end of our revenue, margin, and earnings guidance and continue to deliver a strong book-to-bill. GAAP revenue was $4.14 billion, $10 million higher than the top end of our guidance range. Adjusted EBIT margin was 8% in the quarter, an improvement of 380 basis points compared to the prior quarter. In Q1, bookings were $4.6 billion for a book-to-bill of 1.12, the fifth straight quarter of a book-to-bill greater than 1. Moving on to Slide 13. Our Q1 non-GAAP earnings per share was $0.84 or $0.08 higher than the top end of our guidance, benefiting $0.05 from a lower tax rate. Restructuring and TSI expenses were $76 million, down 58% from prior year. Free cash flow resulted in a use of cash of $304 million compared to a use of cash of $106 million in the prior year. We expect free cash flow to improve significantly as the year progresses. As the next slide shows, our Q1 FY '22 performance continues our trajectory as we deliver on our transformation journey. Starting with organic growth progression, we went from approximately a 10% decline in the first three quarters of FY '21 to down 6.5% in the fourth quarter, and now down to a decline of 3.7%. This is a 40% improvement from the prior quarter. Let me highlight our organic revenue growth calculation and our prior year earnings releases, which were structured to provide the year-over-year deconstruction of revenue changes into FX, acquisitions, dispositions, and organic compared to prior period GAAP revenue. Our previous organic revenue growth calculation was not performed in this manner. As a result, we have revised the organic growth rates for the prior year periods in our earnings deck and have further supplemented our organic calculation to include all the information to support the calculation, providing you complete transparency. This change does not yield a meaningful difference to our historically reported organic revenue growth rates, trajectory, or guidance. Adjusted EBIT margin expanded 380 basis points. Excluding the impact of dispositions, margin expanded almost 600 basis points. We continue to win in the market with consecutive quarters of a book-to-bill greater than 1. And lastly, non-GAAP earnings per share quadrupled. Now moving to our GBS business, composed of analytics and engineering, applications and business process services. Revenue was $1.9 billion in the quarter. Organic revenue growth was positive 2% compared to prior year. In terms of quarterly progression, organic revenues declined about 6% to 7% in the first three quarters of FY '21, declined 3.4% in the fourth quarter and turned to positive 2% this quarter. GBS segment profit was $272 million with a 14.4% profit rate, up 450 basis points from the prior year. GBS bookings for the quarter were $2.4 billion for a book-to-bill of 1.29. As you have seen for a number of quarters, the demand for our GBS offerings, the top half of our technology stack, has been quite robust and now yielding positive organic revenue growth. Turning to our GIS segment, consisting of IT outsourcing, cloud and security, and the modern workplace. Revenue was $2.3 billion, down 9.1% year-over-year on an organic basis. We are seeing the rate of decline moderate this quarter despite the headwinds from our modern workplace business. GIS segment profit was $131 million with a profit margin of 5.8%, a 480 basis point margin improvement over the prior year quarter. GIS bookings were $2.2 billion for a book-to-bill of 0.97 compared to 0.77 in the prior year. It is safe to say revenues continue to stabilize and demonstrate that with improved customer intimacy and delivery, our revenue is not running away, allowing us to build our growth foundation. Now I will break down our segment results, GBS and GIS, into the layers of our enterprise technology stack, starting with GBS. Analytics and engineering revenues were $482 million, up 12.9% compared to prior year. We continue to see high demand for our offerings with a book-to-bill of 1.32 in the quarter. Applications also continue to demonstrate solid progress with revenue of $1.246 billion, growing organically almost 1%. Applications also continue their strong book-to-bill at 1.32. Business process services revenues were $118 million, down 13% compared to the prior year quarter with a book-to-bill of 1.13. Cloud and security revenue was $549 million, up 4.9% compared to the prior year. The cloud business is benefiting from increased demand associated with our hybrid cloud offerings. Book-to-bill was 0.85 in the quarter. IT outsourcing revenue was $1.13 billion, down 9% compared to prior year. To put this decline in perspective, last year, this business declined almost 20% year-over-year. We expect this momentum to continue and organic declines to further abate as the year progresses. Modern workplace revenues were $577 million, down 19.7% compared to prior year. Book-to-bill was 1.0 in the quarter. As you may recall, modern workplace was part of our strategic alternatives and was not part of our transformation journey until recently. As a result, we previously disclosed that the performance would be uneven as we invest in the business, enhancing our offerings and innovating the end-user experience. As our transformation journey takes hold, we expect modern workplace performance to improve similarly to the trend we have seen with our IPO business. One of our key initiatives to drive cash flow and improve earnings power is to wind down restructuring and TSI costs. We expect to reduce this from an average of $900 million per year over the last four years to $550 million in FY '22 and about $100 million in FY '24. On Slide 19, we detail our efforts to strengthen our balance sheet. We are proud of what we achieved on this front, reducing our debt by $7 billion while improving our net debt leverage ratio to 0.9 times. Further, we have reached our targeted debt level of $5 billion with relatively low maturities through FY '24. From our improved balance sheet, let's move to cash flow for the quarter. First-quarter cash flow from operations totaled an outflow of $29 million. Free cash flow for the quarter was negative $304 million. As you likely realize with Mike's leadership, we will continue to make decisions to better position the company for the longer term, creating a sustainable business. Certain of these decisions impacted cash flow this quarter. As our guidance anticipated, we plan to take certain actions that impacted the Q1 cash flow. We remain on track to deliver our full-year free cash flow guidance of $500 million. Let's now turn to our financial priorities on Slide 21. We are working to build a stronger financial foundation and use that base to drive the company forward in a disciplined and rigorous fashion, unleashing DXC's true earnings power. Our second priority is to have a strong balance sheet. We achieved our targeted debt level. We are encouraged by our almost 50% year-over-year interest expense reduction. We continue to focus on reducing interest expense and are evaluating refinancing options given the advantageous interest rate environment. Third, we will focus on improving cash flow. During the quarter, we paid $88 million to draw to conclusion a long-standing $3 billion take-or-pay contract for IT hardware. These types of contracts are not efficient, and we are reducing our exposure. Additionally, we paid down $300 million of capital leases and asset financing in order to allow us to dispose of IP hardware purchased under the previously mentioned take-or-pay arrangement and realize a tax deduction once we dispose of the unutilized assets. Given our relatively low borrowing cost, it makes less sense to enter into capital leases as the borrowing costs are higher and create other complexities. We continue to reduce capital lease and asset financing origination from approximately $1.1 billion in FY '20 to $450 million in FY '21, and believe that we will remain at that level or lower for FY '22. As we continue to curtail capital lease origination, our average quarterly lease payment will reduce from about $230 million a quarter in FY '21 to about $170 million near term. Our efforts to limit capital leases create upward pressure on capital expenditures. Though, on balance, we expect to reduce cash outflows for both capital leases and capital expenditures over time. Lastly, we terminated our German AR securitization program, negatively impacting cash flow by $114 million for the quarter. Going forward, this will result in interest savings, strengthen our balance sheet but more importantly, it will bring us closer to our customers as cash collections are tied to their success. Fourth, we will reduce restructuring and TSI expense, improving our cash flow. Fifth, as we generate free cash flow, we will appropriately deploy capital to invest in our business and return capital to our shareholders, all the while continuing to maintain our investment grade credit profile. During the quarter, we executed $67 million of stock buybacks to offset dilution, taking advantage of what we believe was an attractive valuation in the market. I should note, we continue to make progress with our efforts to optimize our portfolio, unlocking value as we divest non-core assets, including both businesses and facilities. We expect to continue these efforts. Our results today include the benefit from the sale of assets, partially offset by other discrete items and the headwind of 30 basis points of margin associated with the disposition of our health care provider software business. Moving on to second-quarter guidance on Slide 22. Revenues between $4.08 billion and $4.13 billion. This translates to organic revenue declines of down 1% to down 3%. Adjusted EBIT margins of 8% to 8.4%. Non-GAAP diluted earnings per share in the range of $0.80 to $0.84. As we look forward to the rest of the year, I would note that we expect $175 million of tax payments in Q2 related to the gains on dispositions. We also updated our FY '22 interest guidance to approximately $180 million, a $20 million improvement and reduced our full-year non-GAAP tax rate by 200 basis points to 26%. As noted on Slides 23 and 24, we are reaffirming our FY '22 and longer-term guidance. Lastly, we expect to see further improvement in the quarterly year-over-year organic revenue growth rates as we move through the year. With that, I will now turn the call back to Mike for his closing remarks.

Thanks, Ken. Let me leave you with three key takeaways. First, I couldn't be more pleased with the trajectory of the business. Our improvement in revenue, margins, and EPS is evident, and we expect this success to continue. Second, we have momentum and continue to win in the market. We expect our progress in driving a book-to-bill of over 1.0 to continue. Third, our financial foundation is coming together nicely under Ken's leadership. We have made great progress on debt reduction, reducing our restructuring and TSI expense, and delivering on our capital allocation priorities. These three key takeaways show that we have good momentum, we are building the foundation for growth, and we are confident that we will deliver on our financial commitments. With that, operator, please open the call up for questions.

I just wanted to ask, when we look at that enterprise stack, when we go towards positive organic growth, can you just kind of walk us through there the big change items? Mike, I guess it sounds like ITO becomes even less of a drag and just thinking about the components there to get to the positive organic growth in the future.

So when you look at the stack, let's just take GIS and GBS, the drivers that you'll see is, in GIS, ITO, like Ken said, is not only stabilizing but it's going to get better throughout the year. That's because we are focused on taking care of our customers' IT estates, which they think are incredibly important. When we do that, I've been very consistent that we'll build customer intimacy. When we build that customer intimacy, they will turn to us for new work. That's why the book-to-bill continues to be over 1.0. So what we're seeing in that space is we're seeing the need in the IT estates to do the maintenance. And then, like I said, we're running sales campaigns to move them to the cloud. If you go back to our Investor Day, both American Airlines, for example, along with FedEx, talked about us moving them to the cloud. When we think cloud, it will be a combination of on-prem, private, and public. Those are the three technologies we'll put together. So when I think GIS, those businesses are going well. What we have there is we have to continue to turn around modern workplace, and that's going to be on the same path that the ITO business was. That's why I like when Ken was saying that a year ago, ITO was roughly negative 20% and now it's minus 9%, and we expect workplace to do something similar. When we talk about moving up the stack, you can see our numbers in GBS. Analytics and engineering outstanding. That growth there is not only good, but we expect it to continue with the book-to-bill at 1.32. And then same with applications, applications should continue to get better. So Bryan, that's the way we're looking at the business. The focus is to continue to move our clients up the stack. And the biggest thing there is making sure that we take care of not only what they have today but also where they want to go tomorrow.

At Investor Day, you reiterated that DXC focuses on your 175 platinum accounts, the ones that generate about two-thirds of your revenue. Can you give a sense for the health of those accounts relative to the overall company-wide organic revenue decline of 4%? Are they performing better than that? How much better are they growing? Many of them growing with you now. Can you just give us a little bit of color on what's going on with those accounts?

So Lisa, those accounts are the ones that are driving our revenue stability. Those are our biggest accounts. What I said in Investor Day is that we're focused on making sure that we deal with not only the ITO piece but also them moving up the stack. So those are the accounts that are focused on when I look at our new management team in terms of stabilizing our business. They are driving the majority of the stabilization, and that's what I would tell you there. The other thing that's key is the 57% of the new work that we're now getting, and that new work is usually also on those accounts. We are getting some new labels, but our focus is on those platinum accounts.

I wanted to follow up on the affirmation of both your '22 and '24 guidance. As I think about this year, there's a lot of moving parts to both the revenue and the cost. But even if we look at, say, FY '23, what you're intimating is that revenues will continue to flatten out, indeed, just call it flattish, and yet margins will continue to expand. How do you balance that as you're working through the cost actions that presumably help this year? But as you think about the next two years, particularly at the end of this year, how do you continue to expand margins with revenues flattish when presuming a lot of your restructuring activities will have run their course?

So Keith, looking back at our four cost levers, which are contract conversion, real estate, the scaling of our global innovation delivery centers, and automation, it's important to note that we are focused on replacing contractors with our own employees. We believe we have already removed a significant number and there is more to do. We will keep evaluating our real estate strategy, and one approach we're implementing is a workforce model that aligns with our modern workplace solution, which we are adopting internally. With Ken's leadership, we're successfully reducing our real estate costs, and this will continue. The last two levers are crucial because as we stabilize our customer base and resolve service delivery issues, our customers have noted that our delivery process is now smooth, indicating we are performing well. This is the time to enhance operations. First, we need to scale our centers, which we hadn't prioritized in the past. Currently, we are focusing on approximately 20 key global innovation delivery centers. Additionally, through Platform X, we are automating many manual tasks. Overall, these four levers are essential for us to meet our commitments for 2022 and 2024.

I want to look at your stack slide and ask about the workplace business with that negative 19.7% organic growth. I assume that business’ sales process had stalled some when it was up for sale. I'd now like to ask you a bit more about your outlook for that business and the levers that you have to make its trajectory more like the rest of the ITO business that where you're making progress. You have this big partnership with Microsoft, and there's been some recent press on that. Yet, that business is shrinking quite a bit. So it would be helpful to get some more color on what you’re seeing in that business and the levers that you have?

First, let's discuss the recent developments in that business. It was one of the areas, similar to BPS, that we explored strategic alternatives for. I want to reiterate that this often results in reduced customer support, which we experienced last year when we placed that business in that position. The important aspect now is our expectation that it will follow a similar improvement path as ITO. Last year, ITO was approximately minus 20, and now it's minus 9, showing a positive trend. It remained in the mid-teens negative range last year, and I anticipate the modern workplace will follow suit this year before improving. There are a few key points to consider. Our partnership with Microsoft is vital for us, and we are seeing positive momentum in the marketplace regarding our pipeline. The initial stage we presented is promising, and I expect this to continue. Additionally, I believe our solution is unparalleled, which is why I am implementing it for our own employees. Lastly, addressing the cost factors, we have already made leadership changes, focused on converting contractors, and scaled our delivery. This strategy has proven effective across our entire business, so I am confident it will also succeed in modern workplace.

I have a question on the hiring environment. So given the tightness that we have heard peers experiencing, can you comment on your confidence in hitting the headcount targets in your global delivery centers? And any changes in the cost that you're experiencing around that versus the prior plan?

So regarding costs, there has been no change. I want to emphasize our people-first strategy, which is distinct in this industry. I often discuss our colleagues because we believe that talent is crucial for success in the market, and retaining our best team members is vital. Given the current environment, the new DXC brand, including our story and culture, is resonating in the market. I've replaced 75% of our leadership team, and talent tends to attract more talent. Additionally, 50% of our VPs have joined since I came onboard, bringing in valuable skills essential for running the business. As we advance, there is competition for analytical, application, and cloud skills, just as there is everywhere, but we are certainly securing our share to support our clients. I remain confident in our ability to compete effectively for talent across the board in this space.

Just a little higher level, I mean it's really good to see the book-to-bill coming in at this level consistently now for several quarters above 1, over 1.1 this quarter. If you break down, again, the new and the renewals is also pretty constructive, I think over 50% new business. I mean just a dynamic that gives you so much conviction in that continuing. Is it beyond the demand in the environment? I guess if you could just give us a sense, Mike, of what you're most proud of as the top of the list of what's really winning the most and resonating the most with incremental new logos right now, maybe just if you could touch on the top few right now that's really going.

The biggest thing is we're delivering for our existing clients. The biggest thing when you look at this space is referenceability. When you deliver for those clients, those clients talk to other folks, which allows us to win new logos. I appreciate your comments about the 1.12 book-to-bill because that is not only key to showing that we're winning the market, but that mix is also important. That mix is always going to have renewals, which means clients are still wanting to do work with us and then new work on either existing clients or new clients. When I think about the key thing that we're doing in the market, we've embraced ITO. There are a lot of people that haven't embraced ITO. We've embraced that because that is critical and important to our clients. If it's important to them, it's important to us, and we're delivering. I also talked on Investor Day and continue to talk about customer intimacy. Showing up and listening to these customers resonates in the market, and that's what I keep talking about in terms of the new DXC. Now that gives us a chance to do cloud, to do the applications, to do the analytics work. I'm very proud of stabilizing the GIS business when you look quarter-to-quarter, going from minus 9.3 to minus 9.1. But the key thing is look at GBS, going from minus 3.4% last quarter to a positive 2% this quarter, and we expect that's going to continue. The strategy that we've put in place is working and gives us real confidence to deliver for Q2 as well as our short- and long-term plans.

This is Jonathan on behalf of James. You touched on costs earlier in response to Bryan's question. But can you talk through your ability to pass on any potential wage pressure perhaps in the form of coal? Are clients receptive to these pricing dynamics?

Coal is a pretty standard term within this industry. So we haven't had any issues in terms of getting coal. In terms of passing price pressures on, we're incredibly competitive in this market across the entire stack. So I don't see that being an issue for our margin whatsoever.

So look, I want to thank everybody for joining the call today. I'm very pleased with the momentum we've achieved in Q1, and we are confident that this momentum will continue. We're very excited about the future of DXC because of the positive trajectory of the business. We look forward to speaking with all of you in Q2 for our earnings, and all the best to you and your families. Operator, please close the call.