Alight, Inc. (ALIT) Earnings Call Transcript & Summary

Greetings, and welcome to the Alight conference call. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Jeremy Cohen, Head of Investor Relations for Alight. Thank you. You may begin.

Good morning, and thank you for joining us. Earlier today, the company filed its required pro forma financial statements, following the completed sale of the Professional Services segment and the HCM and Payroll Outsourcing businesses within our Employer Solutions segment. We have also posted supplemental slides to accompany our filing that we'll be going through on today's webcast to help in your understanding of our expectations around the go-forward business, and these can be found in the Investor Relations section of the company's website at investor.alight.com. Before we get started, please note that some of the company's discussion today will include forward-looking statements. Such forward-looking statements are not guarantees of future performance. Actual results may differ materially from those expressed or implied in the forward-looking statements due to a variety of factors. These factors are discussed in more detail in the company's filings with the SEC, including the company's most recent Form 10-K as updated by the company's most recent Form 10-Q, and as such factors may be further updated from time to time in the company's periodic filings. The company does not undertake any obligation to update forward-looking statements. Also, during this webcast, the company will be presenting certain non-GAAP financial measures. Reconciliations of certain -- of the company's historical non-GAAP financial measures to their most directly comparable GAAP financial measures appear in today's presentation materials. On the webcast from management today are Stephan Scholl, CEO; and Jeremy Heaton, CFO. We will not be taking questions on today's webcast as we are currently in the quiet period ahead of our second quarter earnings release, which is scheduled for August 6. Given the timing of today's webcast and proximity to earnings, the focus of today's discussion is on historic financials filed today for the go-forward business. I will now hand it over to Stephan.

Thanks, Jeremy, and good morning. Last week, we completed the sale of our Payroll and Professional Services business, marking a new and exciting chapter for Alight. This important milestone will help accelerate our transformation towards a simplified platform company focused on employee well-being and benefits. For clients, Alight is now a more agile company with a renewed focus on proprietary technology that allows us to deepen our relationships and drive better cost, experience and productivity outcomes. And with that focus, we will align resources to strengthen our advantages around technology, innovation, data analytics and delivery. For investors, this transaction accelerates the achievement of several original 2026 midterm targets and unlocks a more capital-efficient company with higher margins and recurring revenue. Let me put that into context. Since I joined Alight, we have paid down billions of dollars of debt, reducing net leverage from above 6x to now 2.8x. We've taken recurring revenue from 82% to 91%. We've grown adjusted EBITDA margins from 21% to now 25%, on route to our midterm expectations of 28%. And there are real operational efficiencies as almost half of our employee base moves into the new organization, enabling us to simplify our infrastructure even more. And on that higher profitability and simplified model, operating cash flow conversion has improved from 19% in 2021 to 54% in 2023, and is expected to climb further to 55% to 65% this year. Post transaction, we will also benefit from greater focus and energy towards our commercial momentum and growth as we ramp throughout 2024. We've talked about the 2024 revenue dynamics given last year's bookings and volumes. And now with our performance release today, you can see our historical revenue CAGR of 10% that we have grown this business over the last few years, both organically and through strategic acquisitions. That commercial momentum continues in the second quarter with both grid expansions and new logo wins, including several in the Fortune 100, which we look forward to sharing during our upcoming earnings call. While Alight is in a state of transition to a simpler, more focused company, I'm really excited about the team we have in place to drive growth, and I can't thank enough the employees from both organizations for the tremendous collaboration it took to achieve this significant milestone. With that, I'll turn it over to Jeremy to walk us through the historic financials, which we hope will enhance your understanding of the go forward Alight. Jeremy, over to you.

Thank you, Stephan, and good morning, everyone. Closing this transaction has been a top priority as it accelerates many of our strategic and financial objectives, which I'm pleased to share with you today. Before diving into the historic results, I want to start with some context as to what we are presenting today. Today's webcast will be focused on the historic performance of the go-forward business. The closing of our transaction took place on July 12, shortly after receiving final regulatory approval. This set in motion today's required filing of the pro forma financial statements that are due within 4 business days of closing as we have previously shared. Given specific accounting requirements, the statements themselves are not consistent across years and also do not fully capture how the business will operate post transaction. That is why we have prepared a supplemental presentation to help investors view our results and key metrics in a more consistent manner across prior periods that we believe better reflects our go-forward business. Please refer to Page 15 in the appendix for more detail. Given the timing of a mid-month deal close within our earnings quiet period, we will be providing a more detailed view of our performance and outlook for the balance of 2024 during our normal course earnings call scheduled for August 6, which will allow for live questions and follow-up discussions, as it pertains to the outlook and any business trends to help further educate the broader market. Let me now move into our discussion on the profile of our go-forward business. Financially, the outcome of the transaction is a more predictable, higher-margin and recurring revenue business with a stronger balance sheet and greater cash generation that we expect to reinvest and return to shareholders. In addition to stronger adjusted EBITDA margins of 25%, recurring revenue over 90% and greater cash flow conversion, we now have the upfront proceeds to execute on delevering the balance sheet and an improved ability to repurchase our attractively valued shares. And strategically, we have ensured through our partnership with Strada that joint clients continue receiving world-class service, while enabling Alight to focus resources on strengthening competitive differentiators in technology, delivery and outcomes for clients. Starting on Slide 4 is an update on deal proceeds, which is more favorable than our original estimate. Of the $1 billion upfront payment, we initially have $986 million of unrestricted cash on hand after paying taxes of $14 million. This excludes transaction costs and our estimated $152 million deal-related payment for the tax receivable agreement, which is due in 2026. We are in the process of repaying $740 million of our debt that will conclude in July, reducing our leverage to 2.8x as Stephan mentioned, with the remaining proceeds available for share repurchases and general corporate purposes. As I mentioned earlier, we can be more aggressive with share repurchases and already bought back $80 million in the second quarter and are in process of another $75 million through our accelerated share repurchase program, which began earlier this week. Finally, we have up to $200 million of seller notes remaining as proceeds which are payable 5.5 years from now and are structured as a PIK note with 8% annual interest. $50 million of the seller note is noncontingent and the remaining $150 million is based on the 2025 adjusted EBITDA performance of the divested business, with a target that is substantially in line with current performance levels. Turning to Slide 5. Annual revenue has grown at a 10% CAGR since 2021, driven by recurring revenue of 11%. When normalizing for acquisitions, organic growth has increased at a 6% CAGR, driven by overall commercial sales activity and expanding participant volumes. The new profile of Alight includes significantly higher recurring revenue. As we have completed the carve-out process and excluded the hosted business that we have now exited, 2023 pro forma recurring revenue was 91% and our beginning of the year revenue under contract was also higher. BPaaS continues as our high-growth category and was a key driver of our expansion, increasing at a 77% CAGR since 2021, and on a trailing 12-month basis through the first quarter, represented 19% of total revenue. BPaaS was also an important part of the growth trajectory for the Payroll business over the past 3 years and drove significant value through the sale process. We expect our BPaaS revenue to grow at 15% per year through the midterm, and will improve our growth profile as it once again quickly becomes a larger portion of the business. Turning to Slide 6. We have included a quarterly view of revenue for the last 5 quarters, and you will see that revenue seasonality remains consistent with the prior business. Fourth quarter continues to be our strongest quarter, driven by the annual enrollment process and retiree health exchange commissions. The first quarter seasonally is elevated relative to 2Q and 3Q, due to project work assisting go-lives that commenced on January 1 each year. Similar to the seasonality of overall revenue, BPaaS revenue also is highest in the fourth quarter. As we've discussed, growth in the first half of 2024 is impacted by our 2023 bookings and associated go-lives, lower project revenues and reduced participant volumes driven by COBRA extensions lapsing from the Affordable Care Act, following the end of the government-defined COVID outbreak period. The COBRA extensions, previously a volume benefit, are now a temporary drag of just over 2 points, with participants rolling off their COBRA elections in 3Q '23. As you can see on Page 7, the collective dynamics predominantly impact the first half, and we expect sequential growth from 2Q into 3Q and 4Q. Now let me cover profitability on Page 8. The sale of the Payroll and Professional Services business immediately unlocks significant value, with adjusted EBITDA margin up 320 basis points in 2023 relative to the prior business. Management adjustments across each time period include the temporary dissynergy of $20 million, which we expect to manage out by this time next year. In general, margins have been relatively stable since 2021, even as we invested more deeply into our transformation strategy, including platform technology, commercial go-to-market and large contract implementations. SG&A, while not on the slide, was elevated in 2023, primarily due to the acquisition of ReedGroup, and we believe there is a great opportunity to optimize through our integrated work-life technology. We expect to benefit from these prior investments, coupled with our near complete cloud migration as well as continued technology and operating model changes to drive margins another 300 basis points higher through 2026. We have hired an outside firm to support our teams with these changes to our operating model and simplifying the business, inclusive of eliminating dissynergies from the transaction. Our seasonality as it relates to profitability is unchanged. Q3 tends to be lower margin as we make upfront investments and resources that support our Q4 annual enrollment process, which then drives Q4 as our highest margin quarter. Turning to Slide 9. You will see the normalized pro forma adjusted EBITDA earnings bridge of the business when eliminating the $20 million of dissynergies and from realizing the benefits of our cloud migration, which is expected to drive $75 million of annual savings. And Page 10 includes the midterm view of the elements I discussed that are driving an incremental 300 basis points of margin expansion that our teams are executing on every day. Moving to Page 11. We have included several key metrics important to understanding and modeling the business moving forward. First to note is interest expense, which is adjusted to account for the pay down of debt as if it happened at the beginning of 2022 for consistency. The difference in 2023 was a $53 million improvement relative to previously reported results. We will continue to actively manage our debt composition and interest rate exposure. Second to note, our taxes, which we expect will continue to benefit from the TRA post close with a single-digit cash tax rate. Our adjusted effective tax rate is expected to remain in the range of 22% to 25%, with the opportunity to reduce as we simplify our tax infrastructure after the transaction. Next is our adjusted shares outstanding. As I mentioned earlier, since our last earnings call, we have repurchased $80 million worth of shares and then earlier this week received the initial delivery from our $75 million ASR program. Combined, these 2 actions will reduce our shares outstanding by over 3%, which is not yet reflected on this slide. Turning to Slide 12 and our cash and capital structure. We have higher cash conversion metrics through the pro forma, and the transaction now allows us to drive efficiencies at a more accelerated pace moving forward. While we continue to have a net working capital usage as we fund implementation work before go-lives and the subsequent revenue generation, our usage post transaction improves incrementally with the sale of the Payroll business, which was the largest consumer of working capital. Higher profitability and the wind down of our restructuring program should also be additive in driving cash flow conversion rates higher over the midterm. Capital expenditures for the go-forward business are slightly higher than the prior business as a percentage of revenue as the Professional Services business had minimal CapEx. However, by streamlining the business and exiting our data center, we continue to expect CapEx to be between 4% to 5% of revenue over the midterm. On the right side of the page, you can see our updated debt profile. Of the $740 million in overall debt paydown, first, we will fully pay down our $300 million senior secured notes, removing any near-term maturity and leaving our term loan due in 2028 as our only outstanding debt. We will use $440 million of the proceeds to reduce our term loan principal and collectively, this will drive net leverage to 2.8x. We continue to actively manage our debt, which after the repayment is now 100% fixed through 2024 and 70% fixed through 2025. We do not have plans beyond this to actively repay further debt. Before I conclude, I want to provide a brief update on our second quarter as we are finalizing our results. For the new Alight go-forward business, we expect revenue and adjusted EBITDA results to be in line with expectations we set during the first quarter earnings call. The divested business is anticipated to be slightly below expectations, driven by $5 million of Professional Services onetime project revenue. To close out, we are intensely focused on driving sustainable, profitable growth and creating value for all stakeholders. If you take anything away from today, it is these 3 things as seen on the next slide. First, as a simpler company, we will refocus resources and expand on our competitive advantages, which subsequently enhance the client value proposition. Second, our business model remains both durable, resilient, and post transaction only gets stronger with highly recurring revenue streams, stronger margins and better cash flow generation. And third, we are better positioned to deliver on our capital allocation philosophy, as evidenced by our lower leverage and by more consistently buying back our own shares. This concludes today's webcast, and we look forward to discussing our second quarter results with you in early August. Thank you.

Thank you. This concludes today's conference. You may disconnect your lines at this time. Thank you.