Conduent Incorporated (CNDT) Earnings Call Transcript & Summary

Okay. Good afternoon, everyone. This is Ashwin Shirvaikar. I'm Citi's payments processors and IT services analyst. And I welcome you all to the afternoon sessions, Day 3 of our Global Technology Conference. Next up for us is Conduent. And from Conduent, we are very fortunate to have Cliff Skelton, who is the CEO; and Brian Webb-Walsh, who's the CFO. And I believe Alan Katz is also going to be on. Thank you, folks, for doing this, for being on. We'll start in just 30 seconds, a quick logistical note to the folks who are listening in or dialed in. If you have any questions at any time during this particular session, you'll see an e-mail at the bottom of your screen. Just send the question to that e-mail, type it in, and I'll try to incorporate that in the conversation. And if you're not seeing an e-mail, it's ashwin.shirvaikar@citi.com. It's on all of the reports we write. And so with that out of the way, lots to discuss here, so let's jump right in.

And I want to, Cliff, maybe start with you. And because there's always a few investors in the room that tend to be new to a company, maybe 2, 3 high-level points on what Conduent does, what Conduent is, how it differentiates from others in the BPO market, a few minutes, and then we'll jump right in to the other questions.

Yes. Thanks, Ashwin. And as you and I were talking earlier, I appreciate everybody being here and getting away from the Tiger King episode that everybody has been watching. I appreciate everybody's time today. Let me just give you a quick kind of high-level view of Conduent, what makes us different, because in my view, we are very different. We're very diverse. We're very broad. That diversity gives us an opportunity to weather the storm in cases like COVID in many instances. And sometimes, it can provide some concentration risk or lack of concentration. So let me talk about it a little bit. The way I would like to characterize the company is, think of it as in 2 major components: a commercial sector and a public sector. And the public sector is sort of divided in 2 parts. The diversity of the commercial sector is quite significant. And we have a health care business. Within that health care business, we have 4 components. We've had a pharmaceutical component, we have a payer component, provider component and then a workers' compensation component. Each one of these businesses that I'm describing is somewhere in the neighborhood of $550 million to $750 million in revenue. We've got a third-party call center business. If you think about that, it's simply just that third-party call centers for 21 very, very large clients. So let me -- we backtrack just for a second. If you think about the company, think of it as divided into a solutions environment, a services environment and an environment where it provides both solutions and services. And I'll describe some of those here in a minute. In the health care business, for example, we do have solutions, a Strataware solution in our workers' comp business would be an example of that, a Midas solution in our provider business for administration and quality assurance in the hospitals and doctors' offices. So that's health care, and then that's call centers, which is the second component of commercial. And then we have an HROS, our human resources outsourcing business and learning business. Think of that also as 4 components: an HR outsourcing business, where you have a portal to go in and look at and take care of your dependents in any kind of HR environment for your company; we've got a benefits administration component there for 401(k) and pension administration; we've got a benefit wallet business, which is HSA, where you can put pretax dollars into your account for health care payments; and then we have a learning business. So that's this group, this environment called human resources outsourcing. We then have a transaction processing business, a typical commercial BPO business which would be things like scanning and indexing, print and mail and that sort of thing. So that -- think of those as sort of the traditional BPO business that many others have. We've got collections and financial services. We've got servicing and financial services. So that -- what I just described sort of talks about the commercial business, which is roughly, call it, 55% to 60% of our portfolio. Then you move over to the public sector business. Think of that as in thirds. We have a transportation business, which, in turn, has 4 components: a tolling business, going through toll booths; a transit business, buses, trains, subways, payment processing and collections; an enforcement business, red light cameras, speeding cameras; and a parking business. All those add up to what we call transportation business primarily serving states, generally serving states. And then we have 2 government businesses, lastly, one, a government health care business, which is primarily Medicaid claims processing and eligibility work and back to the solutions and services. The eligibility work is primarily a services business. The claims business is a solutions and a services business. So that's government health care. And then lastly, a government services business, which has been very strong here in this COVID environment, which does a lot of work in payments, unemployment insurance payments, prepaid cards, child support, SNAP, which is food stamps, and PSNAP, which is lunch programs for kids that normally get subsidized lunches at school. Now PSNAP is where they're at home and they're getting those subsidies at home. Though that particular business is significantly up in COVID, whereas our transportation business is slightly down and as are a couple of the others, but net-net, they sort of they come close to evening themselves out, although not exactly perfectly.

Okay. No, that's a really good overview. It actually leads to my next question, which, obviously at this point, the strategic review process that you guys did is several months old. But when new investors do work on the company, we always tend to get this question with regards to why the decision to not divest or monetize any of the businesses, was it because there is a strategic overlap? What is that overlap? Is it a function of valuation? Did you want to maybe get those businesses to a certain point and then try again? Can you help us with sort of the thinking? And I realize this is a few months old at this point, but it would still be helpful.

Yes. It's a great question, Ashwin. And when I look at the strategic review process, I look at it with several components. The divestiture component just being one as an enabling component, but the strategy review was really around how do we pivot to growth, what are the components in our pivot to growth. And we believe that the components are certainly the tactics in this growth pillar, the tactics within this efficiency pillar and the tactics within this quality pillar. And across the 3 of those, we feel like if we do things different than we've been doing them, this company can and will pivot to growth. And we're seeing the early signs of that right now. Now a potential enabler for that, a potential enabler for that could be to divest a business that may have some scarcity value on the outside, that may, in turn, have some investment requirements on the inside, that could be a component of the consideration. It could be a component where a business is not perfectly interlocked and synergistic such that creating more shared services and operational scale may not help us with that business because it's so different, like our transportation business. And so when we looked to that, we said, we want to be opportunistic. We want to look at it and say, for the right valuation, we would consider selling a business that kind of fits that criteria, those criteria. And we made significant progress. I wouldn't say it's over. What I would say is we continue to be opportunistic. We continue to see interest, but COVID has changed everything in a pretty significant way. And our view is there's still opportunity here, but we're -- we don't need to divest in order to make our strategy work. It might springboard it some in our strategy. And for the right valuation, we certainly would, could and would entertain that. And so it remains a consideration set. We just don't want the market to think that this can't be done without it. And so it's still in scope, still on the radar. And we just haven't made any of those decisions yet.

Okay. No, that -- actually, that makes sense. I mean you never want to take actions with your back to the wall or something like that, but why not wait if it results in a better outcome. In the meantime, though, you've announced the optimized-, enhanced-, expand-type view. And now you had this for about 0.5 year now. So could you speak to the progress that you've made perhaps by segment even?

Sure. Well, the epiphany, I think, that we had in over the course of the last 6 to 9 months is that those 3 pillars can be achieved, a, without a divestiture and b, without a massive investment. And you can get there with the continuation of a fundamental turnaround plan. So if you look at the growth pillar, that goes really hand in glove with the quality pillar. We can't sell without a better and improved reputation, which is happening now. And that reputation in the past was tarnished by some quality issues that we had in our -- primarily in our technology environment. That's been considerably improved, I mean, drastically improved in our quality pillar. And so what we're seeing is more confidence in the marketplace and more referenceability in the marketplace. So in our growth pillar, especially, for example, in our call center business and in some of our transaction processing business, in some of our commercial health care business, what we're seeing is that confidence build is creating a sales execution that's significantly improved. As I may have mentioned in the past, in 2019, we sold just under $1 billion of new business. Our quota for this year is $1.6 billion and we're on track for that. And so as you may have heard in the last earnings, Q2 was the highest quota in the history of Conduent in terms of new business signings. We don't see that execution ramp letting up. And we're really proud of that. And so a lot of the work we did in that growth pillar around segmenting our sales organization, top-grading our sales organization, creating a different go-to-market model, governing different in hand in glove with this quality improvement capability, with our new CIO and our new operations lead which uplifted our stability, we see that continuing and that growth pillar is working. Now in the middle one in the efficiency pillar, that's where I say we had an epiphany, which was we think with a change in our operating model in 2021, creating more shared services, we can drive margin expansion. We can drive client confidence in terms of new business. And that efficiency play is going to help us, we believe, both in margin. And then, of course, price reinvestment, et cetera, can be an outcome of that margin expansion. And here's what I mean by that. Today, we have businesses where, let's say, print or mailrooms or scanning services are resident within the vertical. It's the same work across verticals, but we've never horizontalized the capability. That creates massive expense opportunities as opposed to simple cost reductions. So the simple answer to your question is those 3 pillars are still alive and well, and we still look at the components of the growth pillar across the optimize, enhance and expand businesses. That strategy is the same. COVID changed the attack plan just a little bit, where we don't have a big capital outlay and cash is king. And so we're attacking it a little different in the midst of COVID, but the mission is the same, the strategy is the same.

Okay. Okay. And I'm going to throw a few buzzwords at you, AI, cloud, the previous strategy around digital interactions. At the end of the day, you guys sit on a lot of different transactions and the underlying transaction data. And so my thinking is the previous strategy, sort of, at least the loose thought process around use of data was not wrong, perhaps it was execution. But what's your view with regards to how Conduent can evolve as more and more IT, more and more digital processes, more and more processes become digital and go to the cloud?

It's a great question. I look at cloud as sort of a little bit segmented and we're certainly moving to the cloud. And almost all of the new business we're signing is in the public cloud and we have a big migration program to the cloud. But your point is spot on in terms of data and automation. What I would say is The Street is littered with companies that have tried to monetize data and haven't been able to do it and with big investments. And I -- my view is the monetization of data itself is a difficult endeavor because it's the client's data. Generally speaking -- in many cases, it's the client's data. And so while that's down the horizon, we don't want to be a lost leader there. We want to be a fast follower there. That said, digitization in AI is absolutely critical to our business. And it's not a disintermediary for us. We think it's an opportunity for us. It doesn't disintermediate the opportunity for new business. The work is the same. If we can take that work and digitize it and optimize it and do it with less people and fewer people and fewer handoffs and higher quality, that's a win for everybody. It's a win for margin. It's a win for a client. And it's a growth opportunity. So we're heavily focused on AI and machine learning in our call centers, in our transaction processing space. We've got a lot of new capabilities in terms of handwriting recognition in our scanning space, which is usually an Achilles' heel for BPOs that do a lot of scanning and indexing. And so we're seeing real progress, and we will continue to invest modestly and incrementally in that space because we think it drives -- it's immediately a feedback and an immediate improvement to our efficiency. Payback is immediate is what I was trying to get at.

Right. Makes sense. I'm going to ask you an unfair question here. Should investors reasonably expect that the activist investors will give you a good period of time, a few quarters, a couple of years to actually succeed?

So a lot's inferred in your question and I'll be very direct. The active investors that we experience and work with today and I'm not just saying this to pander. It's been great. Our investors and our activist investors want one thing, they want shareholder value improvement, which is the same thing I want and we want in our company. We have to turn the growth trajectory of the company around and we have to rebuild confidence in the marketplace so investors will invest in our company. In order to do that, we've got to do all the things we are doing, and that's exactly what our activist investors expect us to do. Now your point is how long would they give you? I can tell you, I've been in this job for a year, and I've had lots of meetings, not a single one has been one where the spirit and intent of what we were trying to do wasn't matched. It's always matched. We all want the same thing. And so I think at least there's no indication that our turnaround plan needs to be faster than is happening today in order to be given the forbearance and the road -- and the runway, if you will, to achieve it. There's no -- I have no indication that there's angst and worry that we're not on the right track and the right time line. That's from where I sit. So...

Okay. Okay. No, that's good to know. I mean it's -- no gun to your head is one less thing to worry about.

If there is, I don't see it, Ashwin.

No. I don't see a gun either. So what are clients saying then about your strategy as you reached out to them over the course of -- not -- yes, over the course of the year, but more so the last 5 to 6 months, when you kind of said, okay, here's what we're going to do, we're going to invest, we're going to optimize, we're going to grow? What are they saying to you?

It's interesting because there are anomalies to what I'm about to say because it can be business-dependent. And there -- so it could -- I'm 80% correct in what I'm about to say. But clients, number one, they have a ticket to play. Before they will even consider you for retention or for a new sale, they have to believe that you're stable and they have to believe that you're predictable. We've been unstable and unpredictable in years past from time to time. We have and are fixing that. Most of that is fixed. That's never -- it never gets perfect. So it's always a journey. That's a critical ingredient. It's a ticket to play. From that point, clients buy or stay for 3 reasons. They either buy or stay for technology, the technology capability that we provide compared to the competition. In most cases -- this is an 80-20 rule I was getting at. In most cases, in this business, with probably one exception, the technology is not an impediment for us. Our technology is as good or even better than the competition. So we think that's not our issue, although we have to constantly stay on top of it. The second thing they will stay or leave for is price, and that's just market. And we've got to understand price. We've got to get our cost and our efficiency in -- down to where we can start to expand margins and then make sure that we stay price-competitive. Generally speaking, again, with a few exceptions that I've seen in the last year, but almost entirely, price has not been the issue. The third thing is relationship. If we manage the relationship with a view of the client's strategy and not our strategy, clients will stay with us and they will buy more from us and we'll sell more. And that's what we're starting to see. So the direct answer to your question is, clients are saying, I like it, I'm seeing it, I'm believing it, but you're not there yet. I need consistency, I need repeatability, and when I see that, I'm buying more and more. And they're buying more now. I mean we're on track for a 60-plus-percent improvement in what clients are buying from us in 2020 compared to 2019. But we need to keep it going.

Yes. Yes. That makes sense. So trying to sort of full circle, and I want to go back to your comment on investment and so on and so forth. But one question is, among the many complications that you had to think through and worry about has been your balance sheet. So how are you thinking with regards to refinancing sort of your relatively near-term maturities?

Brian, why don't you take that?

Sure. So our Term Loan A and revolver mature at the end of 2022 and the Term Loan B at the end of 2023. And so we're balancing those maturities with showing more progress in -- on our transformation and turnaround. And the relative low-cost debt that we have today, the low-cost capital structure, our Term Loan A is LIBOR plus 175 and our Term loan B is LIBOR plus 250. So we have an attractive capital structure. So we're balancing all those things. And we think over the next year, being opportunistic and looking to put a plan together is kind of the right timing given those factors.

Understood. Understood. I want to kind of go back to something both of you referenced, which is recent signings, recent results. It was -- especially the last quarter was a positive surprise to The Street. We saw that in the stock reaction. So can you speak with the -- to the current trends because it's kind of where everything comes together. Investors look to -- look for sustainability. Your clients, as you mentioned, Cliff, at least a moment ago, look for sustainability. The -- and when I say investors, I mean, both on the equity side and on the debt stack. So talk about the sustainability of trends, perhaps?

Well, this mission that we're on is a mission of growth and to your point, sustainability of growth. Growth -- the components of growth are reasonably simple, difficult to achieve, but reasonably simple. If our attrition, which happens all the time, especially in government contracting, you expect attrition. Even in the best of circumstances, clients in public endeavors are going to look to see what they can get out there and do RFPs and RFIs, et cetera. But if we can contain our attrition and outpace that attrition with sales, you win. You win, you grow. And so what we saw in the past was we were not carrying and feeding our clients in a way that was retaining as much revenue as we needed to. And that retention can come in various forms. It's not just a renewal. It can -- there's massive volume swings that can be conducted from a client, irrespective of a renewal, and that can really change the model in terms of how much we have to sell in order to grow. There's add-on business we can have. There are -- obviously, there are renewals we can have. There's price reductions components into that mix. So we've got to do better in that bucket while we're selling more. What we're seeing is sustainability in our sales force and we're seeing improvement in retention. The jury is still out on retention. We're working on it, and it's better, but we got to wait and see how the year goes and see how the next few quarters go. It's looking promising. Sales is definitely looking promising. I'll know that it's sustainable when you're not winning on the backs of just big deals. Right now, we're winning on the backs of big deals and some add-on business. And we're starting to see improvements on the singles and doubles and the triples, the $10 million, $20 million, $30 million revenue deals or TCV deals. All know that when you have a quarter where you don't sign a big deal and you still make quota, you're sustainable. And we're a couple of quarters away from that. And so we're seeing good progress. And we're hitting all the marks. We're overachieving and we're going to overachieve, but we need to see consistency and we need to also see a lot of doubles and triples in there.

Okay. Okay. So let's talk then about your sales force, right, because part of the answer here is a committed sales force. I mean you're making the investment to arm the sales force, so to speak, with the right things to sell. Based on Brian's question -- Brian's response, I mean, the other part of how your sales force and their efforts can be hampered is with regards to competition bringing up your balance sheet. But how is your sales force now being compensated? How are they being motivated? Are you adding to the sales force? What's the pitch? What makes someone come work for Conduent today?

Yes. It's a great question. I look at the sales force in really 3 components. I'll get to the, arguably, a very important component last, which is the new business, new product sales and this segmented global sales organization, which I'll talk about here in a second. But the other 2 components are -- 1 component is this client partner component, where we have a 25 to 28 client partners that help our major clients, big clients out in the marketplace, especially in health care, that have to navigate all the various components of this company. They want one-stop shop, and that client partner is a quarterback to make sure that they're getting what they need, and new opportunities surface. And then finally, the account management team because growth, as you know, Ashwin, growth in new business sales has a ramp to it. And The Street, you all are -- you as an analyst and investors are not going to be satisfied with me telling you look at how great we sold, but the ramp didn't come on for 2 years. You want to know what are you doing for me right now, in addition to what are you going to do that manifest in '21 and 2022, which is what the global sales organization is doing. And so that account management team, that add-on business and that retention and that volume swing is really important. So we're focused on that, and we're making sure that every line of business has a solid and aggressive account management team. Back to your point on the global sales organization. Previously, we didn't have one. What we had were industry layers, and there was confusion between who sold, who account-managed, who service-managed, who operationally managed. And therefore, we took our eye off the ball in terms of new product, new logo sales. We pulled all the new logo sales and the sales execs out under a leader that we -- that I've worked for in the past that's proven. He started his career at DDS in sales, 30 years in sales. He and a team that he's put together have created an entirely new model, with a new compensation structure, with new governance routines, with new go-to-market protocols. He's top-graded half of them already. And so what we're seeing is the high overachievers are -- I mean we have sales execs that are selling almost 900% of quota. We have some that are new that just got here that are selling 3%. We got to get out of this top rating and get -- we will always be top-rated at the bottom but we want that middle group to be overachieving as well and getting toward quota every year, and that's what he's working on. And we're seeing real progress there. So we think it's sustainable. It's an entirely new model. He's seen it. It's proven. We just have to execute.