DXC Technology Company (DXC) Earnings Call Transcript & Summary

Hello. It's Bryan Keane at Deutsche Bank. I cover the payments processors and IT services companies here, and we're excited to have DXC Technology. We have both Mike Salvino, the CEO; and Ken Sharp, the CFO. In the format today, we'll go through a little fireside chat and ask some questions to Mike and Ken. And then if you have any questions you'd like me to ask, feel free to enter it into the portal there in the bottom there for the questions. So with that guide, thanks for being with us.

Mike, I wanted to start off, DXC has made significant progress on its transformation moving from the stabilization phase of the foundation phase to the next fiscal year, they started of the acceleration phase. How confident are you in reaching this elusive acceleration phase? Because I know -- in the past, we've heard about other management teams talk about getting to acceleration phase and not quite getting there. So interested in your thoughts on finally DXC entering that acceleration phase?

Well, Bryan, first and foremost, thanks for having DXC. Thanks for having Ken and I. We appreciate the opportunity to speak to you and the folks on the video or the phone. I also appreciate the fact that you prefaced that around the past, right? Because since we got here, we've delivered on pretty much everything we said we were going to do. And what we're doing is we're running a very structured playbook. So I appreciate you also acknowledging stabilization to the foundation phase that we're in to then moving into fiscal year '23 and '24 trying to accelerate all the pieces we put together in the foundation phase. And how we execute each one of those phases is along the transformation journey. And that's the thing that gives us confidence, okay? Obviously, I reiterated in Q1, the 2024 numbers. And when I talk about the transformation phase, this is brick-by-brick doing stuff that builds a very sustainable company. So when you think about the story that now has turned into hard evidence, and I'll get to the hard evidence here in a second. But our transformation story is very simple, 5 things. The first one is inspire and take care of our people. And what I've shown you there is a lot of people, when I started, said that we couldn't attract. We've now built a leadership team that's second to none. And those are the folks that are executing on this. I mentioned that I've rebuilt 75% of the leadership team and then roughly 50% of the team underneath them. And the way we've taken care of our colleagues during COVID and quite frankly, last week with IDA, is incredibly inspirational. We've raised, like I said on Investor Day, employee engagement from 56% to 72%, all right, which is also allowing us to continue to keep attrition down and to attract new people because our DXC story is resonating with the people out in the industry. The second piece of the transformation story is our focus on our customers. when you saw in our Investor Day, people like Lloyds, people like Deutsche Bank, like FedEx, like Microsoft, Campbell's and so forth. Those are testimonials that we would have never gotten 2 years ago. And those weren't just middle managers. Those were CIOs, presidents who are, for instance, the CEO of Brighthouse was talking about how valuable DXC was and how mission critical the stuff that we do for them is. So the focus on the customers is paying off. If you remember Slide 14 of our latest quarterly earnings, you will have seen that we now continue to cut into this negative revenue decline. We basically cut it in half for the last 2 quarters, and I guided to cutting it in half again in Q2. Because if you go back to Q3 of FY '21, everybody asked, okay, well, is that the bottom? It was roughly minus 10%. The next quarter, we cut it to 6.5%. The next quarter, we cut it to 3.7% and now I've guided to 1.2%. Bryan, that's all focused on the customers and making sure we deliver because we firmly believe that when you deliver for our customer, they will turn around and give you more work, which is why the book-to-bill is there, okay, at 1.0. Because we are starting to bring that new revenue on, that's how we're cutting into the negative revenue decline. The third piece of the transformation story is optimized cost. When you go back and look at that chart, you will see in the upper right that we've taken margins from 4.2% to 8%. And where we're headed is we're going to go catch the peer group. The peer group usually has margins somewhere in the range of 10% to 15%. And then when you look at seize the market, look, there's no better indicator than our book-to-bill number. And the biggest thing is when you look at the 5 quarters that we've had back to back to back to back to back, is that we've changed the mix. And the key to the book-to-bill is that mix because I can't have all renewals, and I can't have all new work. Because if I only have new work, then that means that we're not renewing the work that we do have, which will make the whole thing go backwards. So the fact that 5 quarters ago, our new work was 33% and the renewals were the remainder to the quarter we just announced, our renewals were 43% and the new work is 57%. That's a nice change. And then the last thing I will comment around what gives us confidence that this stuff is sustainable, and we won't have what you mentioned around the fits and starts is the financial foundation that Ken is delivering on. So the fact that we paid down $7 billion of debt, we think the $5 billion is absolutely something that's manageable. We are obviously very focused on an investment-grade profile. You saw that we were in the market with our bond offerings. All that's doing is putting us on further strong financial foundation for the future. So I look at this and going, look, it's not a story anymore, Bryan, which is what we came out with 2 years ago. That story now is entrenched with hard core evidence.

That's great, Mike. And then just stepping back, the question that I want to ask is just how good of an IT services business is or how important is DXC? Just high level for investors to understand the position of the company.

So when you -- Brian, when you look at that, let's cover GBS and GIS or let's cover the enterprise technology stack, fair enough? Because that's what I talk about quite a bit. And that enterprise technology stack, you break it up into our 2 businesses, all right? GBS is the top of the stack, and it's roughly $2.2 billion in revenue per quarter and the top of the stack is analytics and engineering applications and then BPO. The bottom of the stack or GIS is cloud security and ITO and modern workplace, okay? So when we look at how valuable DXC is to a client, basically, the key thing that they want is they want to have their IT estate stable, meaning the thing that kills a cloud or a transformation more than anything else is if your existing estate tips over. And when I say tip over, it could go down, it could be penetrated with a security issue and so forth. Because at that point in time, nobody cares about any of the digital transformation that everybody keeps talking about. So us being able to have the knowledge and execute those mission-critical systems that, for instance, [ Maya ] talked about at Investor Day or John Neal, Lloyd's talked about on Investor Day, that's huge. Because that also gives us the pole position to start moving up the enterprise technology stack. Now what do I mean by that? You also heard from our clients on Investor Day that they are depending on us to move them to the cloud, okay? And our strategy is very simple. We plan to ingest more ITO work and then continue to move that work to the cloud. That's how we're going to participate in the cloud market. Now that's basically GIS. And that strategy is working because 'when you look at GIS, we've basically taken that business from roughly minus 20% revenue growth to now minus 9%, and it's going to head towards even lower single-digit negative numbers. Now the key to our success moving forward is we get that business to stable, all right? And the last business we need to fix there is modern workplace, which we're well on path to do that. Now the top of the stack is also a place where we feel like we've got a competitive advantage because we can compete with anybody. When you look at GBS, the key thing that we showed in last quarter is that we popped that business positive for the first time at 2%, okay? And moving forward, what will fuel our growth is that business won't be stable, that's our growth. So you will see that, that business, we believe, not only pop positive, but it will stay positive, and that's what will fuel us towards our guidance that we gave in 2024. You will see that analytics and engineering in Q1 was 12.9%. You'll see that applications was roughly 1%, and we expect those numbers to continue to grow. So that's what makes us unique. And I guess I would just conclude with, there's not too many people in this industry that can do the full stack. Having come from where I came from, I know that there's a lot of our competition that can't touch infrastructure. And the key to the infrastructure space being in this industry for 35 years is the knowledge that we have with those critical systems because moving those applications and the infrastructure to the cloud, you need to have that knowledge. That's what makes us unique.

Yes. I was going to ask about your past experience at Accenture. And Accenture is seen as one of the blue chips in the industry. What things can you bring over from Accenture? Or what parallels are there that you can bring over to DXC?

I mean, look, it's not just Accenture. I mean I'll go also back to Exult the startup, right? I mean this playbook was basically run in those 2 companies. okay? Everybody talks about Accenture being the gold standard. When I took over BPO and then Accenture Operations, that business, all right, was not the gold standard. And we ran the exact same playbook, which was stabilized, build the foundation and then accelerate. And you'll see from my last 5 years that I was there, that business grew in double digits, okay, and continues to flourish now under Manish's leadership. So when I think about that, the first thing is the playbook. The second thing is the team A lot of this team that I've got over here ran the exact same playbook, Bryan, all right? And then the other thing that's key to the team is the people first strategy, all right? Because what I learned a long time ago is talent follows talent. And when you go look at the team that we've built here now, that is the influx of talent that we'll have. In fact, I mean, Ken is on the call, so I'll use him as a perfect example. He's been here for roughly about a year. And in that time, I've got a new Head of IR, Sweeney. I've got a new Chief Accounting Officer, Chris Voci, I've got a new Head of Tax, [ Nate ], a new Head of Internal Audit, [ Bow ] and a new person dealing with our material weakness, [ Jamie ]. These guys are stars, okay? Like I said, people follow people and that's what we're doing over here. So the people first strategy is also unique, all right? The way we care and take care of our people, people talk about that, but very few do it. The third thing is the focus on the customer. That's what we learned, right, in our past that if you focus on the customer, you build a level of customer intimacy, they will turn to you in their time of need. And then the last thing that we touch on when we talk about our levers for cost reduction is platform mix. Bryan, that technology is very, very similar to what I've done in my past. Except this time, it's even better because when you get to build it for the second or third time, it just gets better. What Platform X does, it diagnoses problems before they become problems and then it launches minibots to make sure those problems get corrected before they become issues, all right? The key to that thing is the fact that when operations are stable, which is what we've gotten DXC to with our customers, you can then start automating the work. That means it builds for a better delivery experience and you free up people. My last 2 years at Accenture, I think it was well chronicled, but I freed up roughly 21,000 people using this kind of technology in 2 years. Last year using Platform X, the pilot year, we freed up 1,600 people. I expect to get a 5x, all right, on that this year. And what we do with those people is we don't lose them, okay? We then use those people that when you look at our revenue, how we're bringing the revenue on quicker is you do it with experienced people. So you free those people up because there's no better people to transition the new work than people that have been doing it already. So that's why that book-to-bill number is starting to create the positive impact slicing into this negative revenue that we've been dealing with.

You talked about, Mike, the change in kind of the employee. Any metrics you can give us on employee morale? It looks like that's been important to turn that around? And then on the flip side, I think the client satisfaction scores have also gone up just since your tenure. So maybe you could just talk about the 2 sides of the equation here, the employee side versus the client side?

Yes. So Bryan, what I'll do there, I mean, the neat part about both of those points you're bringing up is that's basically our mantra now right? That's what DXC stands for, delivering excellence for our colleagues and our customers. So on the colleague front, we took the employee engagement from 56% to 72%, and we expect it to continue. The big deal there, Brian, is 77% of the women in men of DXC participated in that. That's a big number. all right? And we're pretty proud about that. If you also look at the external stuff that anybody can go to is Glassdoor has definitely changed its sentiment around the company. So we're pretty proud about those 2 specific pieces of evidence. When you look at customer stuff, same thing, that's why I point to you know how hard it is to get customers to put their brand next to yours, and for people to get on video and talk about it, that's a big deal. But the specifics is we've raised the NPS score -- our NPS score by 44 points, right? And we're pretty much touching the industry average now of 20 to 30, and we're very focused on that. And that's just not a number. What we do is, on a regular basis, from a quarterly standpoint, the way we do NPS is we do interviews with a set of customers and we also do surveys. And then that combines together to give us the data we need to figure out what do we need to work on next. I always talked about when I started the voice of the customer. But Bryan, that's how we're getting the voice of the customer. And that's how you build the level of customer intimacy. It's not just delivering for them, but it's also listening to what their needs are, all right? Now the biggest thing that our clients are now seeing in the new DXC is that we're being more proactive and innovative. We're not just running these contracts, all right, and hoping that the delivery is sound, okay? We're running the contracts, and we're bringing them new ideas on the ITO estate, along the cloud, on analytics and engineering, quite frankly, on security. -- to make sure they're on top of their various technology needs.

There's been a lot of concern around sourcing the talent on the supply side. Have you guys seen some of those same issues? And how are you solving that problem?

The way -- look, the way we solve that problem is, again, being in the industry for 35 years, Bryan, we've always had hot skills, okay? I mean I can go all the way back to the '90s around okay, the hot skills were fore trend, then they were C++, then we got to the turn of the century and the hot skills at that point in time due to Y2K were SAP resources. And then you keep going. So how we deal with hot skills is, one, we make sure we build the appropriate bench because hot skills means you ran out of town, all right? The second thing is you give them a hot skills bonus to make sure they're focused because their skills are important for that time frame. So we're building the bench, we're making sure that we're paying our people the right amount for the hot skills. But what we're looking at is this, the way we're managing our attrition is we have our 2 key buckets. The first 1 is retention, and the retention is the career path. And the cool part about DXC is we're a $17 billion company, but there's plenty of room to grow within DXC from a career standpoint and us being very clear about somebody's career progression is the thing that's helping people understand why DXC can be a great place for their career. The second thing is recruiting. I mean, it's kind of cool because we feel like a new company, all right? And that market, that messaging is playing out in the marketplace to say, who now we ought to be taking a look at DXC, look who joined them in terms of their leadership team. So it could be 10, could be married, could be Chris Drumgoole, who I just promoted to COO. He is a perfect example of somebody coming in and continuing to move in his career path where he came from GE and probably said, "Hey, CIO is as far as I can go." It's a perfect example of people increasing their career path and doing it with a company that's got the right trajectory.

Mike, you talked about the bookings. I think it has been 5 consecutive quarters of book-to-bill over 1.0 and the importance of that with the new logos and also the existing business. And I think organic growth was down almost 4% in the first quarter. We've been on the steady progression, obviously, over the last several quarters. When do we -- when do you think it is that we turn the corner and move to flat to even positive organic top line growth?

Yes. So Brian, we -- look, we feel comfortable with what our guidance is, all right? And we've guided towards minus 1% to minus 2% for the entire year. But let's just think about the raw numbers. What -- What I said was in Q3 of last year, we were at minus -- roughly minus 10%. It's actually 9.7%, okay? And I continue to show you guys that we have a book-to-bill of over 1. So what that means is if I don't do anything, then that's going to continue to go down, all right? Or if I didn't have a book-to-bill -- And it just stayed at 1 basically that would just cause us to stay at minus 10%, okay? But the book-to-bill being 1 plus and the new work being more than the renewals that allows us to eat into that negative. And that's what we've shown. We've literally cut that in half for the last 2 quarters and then guided to cutting it in half again. So all you got to do is keep doing the math. And at some point in time, this thing flips to being positive, okay? But I'm not going to change the guidance that is out there. We feel very comfortable that we will hit our '22 numbers and also hit our FY '2024 numbers. So -- but that's the best evidence that this isn't a story. This is real numbers. When you go from minus 10% to minus 6.5% to minus 3.7% to then guiding to minus 1% to minus 2% in the quarter. That's good progression that not only are we winning in the marketplace, but we're putting new revenue on top of this and it's sticking.

Got it. And if we flip over to the margins. I know the margin improvement and the leverage and the cost savings. Just thinking about normalized margins at GIS, what that might be because I know they've been depressed, could they potentially reach double digits? And then the big picture on margins, the adjusted EBIT margins -- Can it reach towards kind of the benchmark peers of 15% or so in the future? How long about Journey is this? So just wrapping up trying to think about the margin leverage here in the story.

Okay. So the margin piece, Q1, right, GBS was 14.4%, right? And GIS was 5.8%. All right. And we've taken GIS from 1% to 5.8%. So the way I look at it is go back to our guide, all right? This year is 8.2% to 8.7%. 2024 is 10% to 11%. So we have high confidence that we'll get to both of those numbers. And then beyond that, Bryan, my leadership team knows that I'm looking to catch the peer group, okay? So you've got your peer group at 15%. I think that's a little high, all right? But look, I mean, we're going to be in double digits, and that's where I expect us not only to be, but then we'll continue to increase margins on a, what I would call, more reasonable level as we move forward because growing margins from 4.2% to 8%, all right? That's a big step. Most of that peer group when I catch it, they tweak the margins ever so slightly every year. So -- and that's where I expect us to be. We'll get into double digits and then we'll continue to tweak them a little bit every year because we want to invest in the business, we want to invest in our people. And quite frankly, we want to invest in our shareholders by returning some capital to them, too.

I wanted to ask about the free cash flow. I know it was down, I think, about $300 million last quarter and there's some puts and takes there. And I know you still reiterated the over $500 million for fiscal year '22. Can you talk a little bit about the trajectory of free cash flow and how it flows, not only in this year? And then how do we think about normalized conversion of free cash flow going forward after fiscal year '22?

Okay. So Bryan, thanks for that. So let me start. And then you, Ken, you take it from there. Look, when you look at what we did in Q1 and quite frankly, since Ken has been here, when I look at building the financial foundation, Bryan, what we are doing is making the long-term right decisions to make sure that a lot of the stuff that was done, all right, gets us to the very first question you asked me, which is that whole stability piece and making sure that we don't have fits and starts and so forth. The great example that Ken used last quarter was this take-or-pay agreement. Okay. Where we're prebuying hardware and software. And you know you've been in this industry as long as I have, you know pre-buying any hardware and software as soon as you buy it, what happens. It totally decreases in value. That's like a major no, no, okay? So us finishing that contract was a major deal, which puts us in a better position long term right, to be able to keep more cash so that we can turn around and invest in our people, invest in the business and invest in our shareholders. So Ken, go ahead.

All right. Wonderful. Mike. So we did in Q1 after we reported the negative 304 that you mentioned, confirmed guidance. We felt very strongly at the time when we did do that. I'll just remind everybody, when we set guidance for FY '22 at $500 million, we knew we had a number of items to deal with to put the business on a sustainable footing that Mike talks about and coming into the company, that's what Mike was concerned about. He wanted us to have a strong financial foundation, create a more predictable business. So we've been just taking off items over the last 3 or 4 quarters to do that from the finance side. And some of that does harm cash flow. So certainly, Mike talked about the $88 million we spent in a large take-or-pay agreement. And when you ask about longer-term cash flow guidance, those kind of agreements and when you look at our spend on capital leases and capital assets from [indiscernible] spending [indiscernible] sorry, we're spending close to 10% of revenue on that. So when you look at our peer group, they run somewhere between 1% and 6% and giving things like that under control, change in the culture in the business, the discipline across capital spend and capital leases. We also talked about last quarter that over the last year, we've driven down the capital lease originations. That's what's signing up for new capital leases from $1.1 billion to a little bit south of $500 million and we committed to do the same thing this year. So we're very, very focused on ensuring that wherever it shows up, it's a use of cash, let's drive it down. As Mike talked about, we want to make sure we have capital to invest in the business we keep our targeted debt level of $5 billion and actually be in a position to either invest in further into the business or return capital to shareholders. So that's where our head goes.

Got it. And what is the -- I've seen you guys recently in the debt market. So I was trying to figure out the anticipated impact of the refinancing and then what the impact will be on the P&L and balance sheet. Maybe you can help us with that, Ken?

Sure. So we did raise about $3 billion in debt, maybe a little bit less than that with a big focus once again on the sustainability of the business. The capital markets are in a great position. So we took advantage of that in a very opportunistic fashion. I'll just remind you, as Mike said earlier, we reduced our debt from -- by $7 billion from $12 billion to $5 billion. So we think we're in great shape. The refinancing, our debt will probably tick up slightly to around $5.3 billion. Our ongoing interest costs should be reduced by $50 million ballpark annually. So we're -- and I think you can do the math from all the bond offerings and what we said we were going to redeem and we're now actually sending out the communicating that to the actual bondholders. So that should all be wrapped up by the time we end the quarter and file the 10-Q. So I think you'll get a real clear picture of our capital structure. We feel very fortunate with what we were able to accomplish, extending the debt maturities flattening the debt maturity towers, we just think puts the company in a much better position longer term.

Bryan, the thing I would add on this is Sunday marks my 2-year anniversary at DXC. And when you think about it and when I reflect on my 2 years here, when you think about the change we've made to our -- with our colleagues, when you think about the change that we've made to our customers and you think about the change we've made to our financial foundation, totally different company, okay, totally different. Because I look at the employee experience, I look at the engagement score. And look, keeping those folks engaged, happy and so forth, that just allows us to deliver better for our customers and deliver means that the systems are working, we're delivering the financial performance and so forth. Then you sit there and look at our customers and them getting behind DXC, that's huge. And then when you look at our financial foundation, I mean, it's pretty nice coming into a company now where I don't have to worry about the investment-grade profile versus stepping in here 2 years ago with $9 billion of debt that was going to $12 billion. So I think we've made a lot of progress. And the thing that I would echo over and over again is the trajectory of this business is heading in the right direction. And we're very confident that our -- not only our playbook, but our transformation journey is absolutely working because we're continuing to stack up really good solid evidence with the hard data around it.

We have about a minute left. So I wanted to just ask on the allocation of capital, especially on M&A activity or buybacks. The stock has dropped back a little bit. How do you think about those?

I mean the way we think about it is we've got 3 buckets, right, continue to invest in our people, continue to invest in the business, continue to invest in our shareholders. So I think you've seen from my track record that I do favor tactical tuck-ins. A tactical tuck-in for me is something around $100 million to $200 million. Now the reason why I always talk about these platinum accounts, the 175 accounts that we're focused on growing in total number along with in total revenue because that's our channel. When you buy something, what you do is take it through that channel. That's how you scale it, that's how you ultimately get to growth. Look, we don't need anything right now to finish the foundation phase. And quite frankly, to get us to the numbers that we put out there for 2024, but we'll continue to look at it. The other thing is, I think Ken and I have been very specific that we are looking to reward our shareholders, right? We did some buybacks in Q1 to get rid of the dilution that was caused by the new shares with our folks, and we'll continue to be opportunistic because Bryan, like you, we think that the stock is undervalued.

Got it. With that, we'll keep it there. Thanks so much, Mike. Thanks so much, Ken. I know you guys are incredibly busy. Thanks for taking the time helping us understand the transformation.

Bryan, thank you. All right. All the best.