DXC Technology Company (DXC) Earnings Call Transcript & Summary

Good morning, everybody. I'm Bryan Bergin from Cowen. I cover services and software. Thanks for being here today. I'm very pleased to have DXC with us. Ken Sharp, CFO; John Sweeney, Head of IR. Thank you guys for being here. DXC is a global IT services company serving over 6,000 enterprise clients, roughly half of the Fortune 500, over 130,000 employees, and it's undergoing a significant turnaround effort and you're showing traction on that effort. So thanks again for being here.

I'd like to get into some of the moving pieces that are going on the right direction. To start, I think you reported fourth quarter results last week. So let's start there. It's -- what would you say are the most critical items that stood out to you in the fourth quarter? And then step back too for the fiscal year, what really quick for you? Where do you feel the company executed about.

Yes. No, that's great, Brian, and thanks for having us today. We really appreciate it. So I think it's been an interesting year. I'd say specifically for the fourth quarter was the continuation of the cash generation, right, for me. We spent a lot of time. I think we were just talking about before we came up quality of earnings. I think it's really important. We had a company that generated adjusted cash flow and adjusted earnings for years, and we came in over the last, I think, Johnson now almost 2 years and been really focused on getting -- well, first off, we got rid of adjusted cash flow because I don't think anybody figure out what it was anyway and the cash in the bank is what mattered. And then we really turned into what are the consumers of cash went through the business and how do we get better earnings. So having a swing of about $1.4 billion in cash flow. John tells me regularly, I'll never have that again in my career. So I should keep saying $1.4 billion. I know we said we're doing much better in our script. But I think how many times did we say we improved cash flow by $1.4 billion. I thought that was the line that would get picked up. So anyway, I would say cash is definitely something we're really proud of. I think the business just had needed better discipline and to meet cash is a lot about discipline at the end of the day. So certainly, the -- taking care of our people in Russia and Ukraine, the Russian invasion in Ukraine was pretty problematic. I think people had a lot of -- there was a lot of overhang and concern. We quickly went into a quiet period. All that happened, and we really couldn't talk about it. So I think people had a view that something more material happened to the business. I think we dealt with a very difficult situation well. I think our people, more importantly, dealt with, is a very difficult situation. So I think that was very important for us to get through there. We talk about a people-first approach, right? So we got to demonstrate that again, having daily calls, worrying about trying to figure out how to get buses from one part of the Ukraine to the other and move people to the border and how much you're paying cash to get a bus driver -- the driver cost and how you get to $7,500 to them. It seemed like that was my day job for a while. So it was good that I think that worked out. And then just the progress we're making. Mike is a growth guy, our CEO, the progress around the organic revenue declines. The business historically didn't report organic revenue. They were doing a series of acquisitions. A lot of those didn't get integrated in. That's where we think we've got a lot of opportunity in the business, right, continuing driving the business together, drive kind of a unified face to the customer and making sure we're leveraging our accounts. We talk about a platinum strategy and how we take one account, radiate all the offerings. And I think there's been some positive uptake on that. That's where you can certainly see the revenue improvements as well as you say, the organic revenue improvements.

Okay. So transparency, quality results, cash, cash, cash, doing a good job taking care of people. Those have been successful for you this fiscal year. As you look at fiscal '23, where are you focused, where you have to do much better?

1 Yes. I think it's an easy one, right, because we called it out on the call, our GIS business, and it's funny, we spent some time with Mike's Mentor, Bill Green, the Accenture, former Accenture, CEO and Chairman. We spent some -- we always spend some time with him. And last quarter, we were kind of going through some pieces in what we're doing. And Bill's comment was you deserve to be able to have a reasonable margin in your business and I completely agree, right? Our GIS business is high capital intensity. And as we report our earnings, it's relatively low margin at the end of the day. So you can look at that and say, we need to do better on the economic side, that allows us to create a sustainable business. So if you can't get a real return in your business, how do you actually have a sustainable business, how do you able to reward your workforce and keep them. So I think when you look at our business, it's 2 pieces, one side, the GBS side, more digital, higher values do when I think play well. So okay, we got to keep that moving. The second side being the GIS side, we know where we have to go. We know what we need to do to improve it, and it's spending that energy over the next year to do that. And I probably should have said earlier, that's probably the most important thing that happened last year is as we spent more time the management teams knew just getting into the business, understanding the levers, what we can do to drive and be able to move the business forward.

Okay. Okay. Now you gave a revenue outlook for fiscal '23, down 1% to down 2% organic constant currency. It does imply an improving trajectory as the year moves forward. So we're going to dig in here first. You mentioned GIS. Obviously, that's where you have to do the most work. Can you get into some of the details on what you're going to be doing there? So you have optimism as you go through the year because of some of the -- you mentioned on the call contracts in hand that you have for modern workplace. But at the same time, you stress intentions to pursue profitable growth. So you kind of pushing [indiscernible] or can you kind of tease those out for us?

Sure. This goes back to the GIS business, right? We need to make sure when we're signing work, it's a reasonable return at the end of the day. You look at how much capital you're investing. In my case, I tend to not want to put capital into deals. I think we had a legacy history of leveraging the balance sheet. It's actually not an understatement by any stretch, specifically for the GIS side of the business. So working through that. And that is -- I think that does create some headwinds on the revenue side. That's why we guided arguably a little bit lighter. And that's, I think, part of why we missed the organic revenue get last year. And I know Russia, Ukraine had an impact, but certainly, the push on getting better quality revenue is there. So I think as you look through the year, I think we're pretty comfortable with what we have, right? I think we expect GBS to continue kind of its positive trajectory and improving GIS, the book-to-bill, you mentioned modern workplace, the trailing 12 months to sit at 1.12. I think we've got some pretty good visibility. We've been able to go into the market, win there. The solution we built, the team we built around that, the sales team, I think we're getting good uptake, so we feel pretty good about it.

Okay. When we think about the 2 biggest pieces of GIS, so ITO and the modern workplace, can you give us a sense of the mix of those 2 layers that are -- that may not be classified as optimized type of business that you want?

Yes. So I think when you look at the business, and I always go by customer, right? And we've got a lot of cost in the business. There's a lot of moving pieces and complexity. But specifically, I would say there's about 30% -- 20% to 30% of the customers we really need to focus on driving different economics right? Whether that's COLA increases for inflation, whether that's, hey, the contract just doesn't work the way it is. We need to go restructure the contract. I've been -- I get involved in those personally. I've got one on my plate, it happens to tie into one of our Board members. So we all have to work on that in a gingerly fashion, right? But I think it's quite helpful to be able to have those dialogues. And we weren't having those before, right? I think when Mike first came in, we had very negative Net Promoter Scores. We had customers that were clean the business, and we had a lot of unhappy people. So now you can look at our Net Promoter Scores positive. I think Mike said on the call. 31 John, yes. So I think we feel pretty good about it being able to work. We think we're adding value for them. We're delivering on the mission-critical skills. We just need to make sure we have a reasonable return at the end of the day. Look, I grew up on a farm. So doing a lot of hard work and not getting anywhere, doesn't feel like a great way of running your business. So we're going to work with that pretty hard.

Okay. And you have the conversations already, it sounds like you're having some success, are you also opening opportunities to kind of broaden the relationship as you do that?

Yes, absolutely. Now I'll be clear, right? Customers don't come in and say, it's great. I'm happy to get a price increase, and there's always a lot of dialogue around it. And it's interesting because when you literally get into the contracts and you have like a COLA clause, for example, you'll find out you have 5 agreements with them. And in those 5 agreements, they're paying COLA in 2 of them and the other 3, they're not. So when you're into the details and you're driving the business and you're having those dialogues, I think things happen differently when you're not doing that, I think we weren't into the details historically. And people were skirring around just spending their time trying to just keep things on the tracks because of the negativity I mentioned earlier, I just think you have a lot more approval conversations.

Okay. Let's just shift to GBS now. So in that '23 outlook, what level of growth do you expect in that segment?

Yes. I think when we look at it, right, it's around the same as we were this year, maybe up a little bit. I think we've had a relatively good run. Most of the folks that Mike just brought in are more on the GBS side is growth side, and that's kind of where he spends his energy, right, specifically around the revenue growth. So I would expect something similar, maybe a little bit better as we go.

Okay. It sounds like analytics and engineering trends, those were durably a good performance in spite, obviously, where some of the delivery is safe. How is that -- as you think about analytics and engineering and the migration of some of your workforce from Eastern Europe, how will that footprint look in, say, a year from now?

Yes. So I think we had a pretty big overhang with Russia. And being a global company, we serve companies in the U.S. that are U.S. government contractors, and that's a little bit of my background. I think that Russia exposure was an overhang for us. So we took this opportunity to get away from that, right? Be a global IT service provider, be a little bit clearer around how you deliver, where you deliver, make your customers more comfortable. So I mean, I think we had a great opportunity. The door was open. We took it. So we're pulling all of our back office that was part of the Luxoft business. And all the delivery in the go-to-market out of Russia. So I think that's the first piece that we won't be there, right? We announced that we're going through the process. We made some really quick headwind -- really quick tailwinds with that sold the domestic business. So I think it's positive. I think we were a relatively quick mover. One thing you'll know from Mike is he's a quick mover. So that makes us all a little bit of a quick mover. So I think you'll have that piece. And I do think at the end of the day, the delivery side will be probably a bit more spread out in Europe. And then also, you'll see probably a little bit more go to India at the end of the day. I would say for me on the GBS side, where I'm really excited is probably more on -- is on the insurance software side as well. And I think we can certainly talk a little bit about that.

Okay. Why don't we just use that out now? I know it's going to be -- you talked about some big relationships there. I want to talk about that and then also just the applications line as well.

Okay. All right. So on the insurance side, we're breaking that out this year. So you'll see some new numbers, right? So -- and we'll pull that out of the applications business. And you, I think, know this, but legacy, I was a CSC person and left about a decade ago. So coming back in and not finding what we call our Financial Services group anywhere was really odd, right? So then picking through the pieces to figure out, we put the insurance software off to the side, the banking software and then the BPO/BPS business is for that, that if you think about the software-led BPO/BPS type work, they were all kind of spread around. And I don't know the strategic rationale for that. I don't think it's a good rationale because now all of a sudden, you take it, you move it away and you have services people selling software, and you end up having really bad decision-making in that, whether you're investing in the products appropriately or more importantly, when you're engaged with the customers, you've got a product that has certain pricing dynamics and not actually -- and treating it like a service model. And over time, that's what you're going to get to is not a good model, right? I looked at a renewal with a customer. I think in 8 years, we had no price increases. -- and for a piece of code and software that's integral to what the customer is doing. That's not fair to our employees, certainly, it's not fair to our shareholders. So Ray August coming in. He is a legacy -- was running the business at CSC back when I was there. He's a veteran of the software business, knows it really well, having him come in, build his team, put all of this together and run it the way it needs to be run, I think, is a great opportunity for the company.

Great. And once again, into the details a contract level detail and turning out and fixing the business.

Yes, absolutely.

Okay. Free cash flow, let's move to that. So you touched on 4Q and '22 earlier in commentary, but let's talk about the bridge forward. So you ended fiscal '22 at $743 million. That did include some notable proactive measures that we had discussed. You're projecting $800 million in fiscal '23, and you affirmed that $1.5 billion, $24 target. As you think about that $743 million to $1.5 billion, what are the biggest swing factors there?

Sure. And this is something we've been laser-focused on, right? And when we set the $800 million this year, we want to make sure we're continuing to invest in the business deal with it and have the right trajectory to be able to deliver the $1.5 billion right? So that's a huge focus is where I spend the vast majority of my energy. I just think cash is really important, right? Cash rates, all kind of optionality for us, and it's something that wasn't focused on in the past. So when you think about a bridge, I think there's a handful of items that jump out that are pretty big swingers for us. So certainly, the margin expansion, that's a piece. And then when you think about restructuring and PSI, I think we were -- when John and I first showed up, we had a Board of our big opportunities. Restructuring and TSI with one of $1 billion opportunity.

$900 million...

It's probably over $100 million right -- so we were trying to sort our way through that and certainly shutting it down. And it seems like, Brian, it would be so easy just to stop it, right? It's not as easy as you think unfortunately, because it gets to be the culture. And when you said $900 million, John, it was $900 million on average for every year, DXC is created. So literally tackling that. I think we've got about $300 million or more cash improvement that will come out of that, which I think is a positive. So the margin expansion, restructuring, PSI, the other area for me that's a real hard one is the CapEx side. So we'll say CapEx and lease originations because we still debate over what the free cash flow definition is, is a classic we turned the analysis. So John one, I still think it should include lease payments so...

Our lease originations...

I would say either one. Yes. I just think you need to run your business differently, right? You need to think about every dollar of cash and hanging on to as much as you can, especially when your valuations where ours is. And it gives you a great opportunity to return it to shareholders and by stock that's at a very low multiple, it makes a lot of sense. So as you go through that, right, getting that kind of lined out, I think, is really important. And then I would just say the CapEx, sorry. And when you look at it as a percentage of revenue, it's pretty elevated, right? I think if you pull our peers, and I think you got to split the business into GBS, arguably is a 1% to 2% CapEx business in every other company, right? So if you go look at that, you go, okay, 1% to 2% -- and then the infrastructure business should really be sitting around 5% to 6%. I'd argue it needs to be a capital-light model. Once again, puts headwinds into revenue because people that like revenue love to buy CapEx, [indiscernible]. And unfortunately, they don't even get a good return on it. So I would much rather see that number go down and get better returns. But I would just say for now, let's think 5% to 6%. And I think when you push that together, we should really be a 3% CapEx business at the end of the day. I'm not arguing we're going to get there tomorrow. I'm not arguing we're getting there in FY '24, but this is something we're on a journey and we're going to get smarter and smarter about it. And then lastly is working capital. I don't think we've done a lot with it. I think we've tried to make sure that it doesn't get worse, but -- and we've been going through and very focused on the balance sheet itself and making sure we don't have problems in dealing with them. But I think there's certainly more we can do on the cash side. A job was joking with John on the way down or a little bit earlier this morning, we were talking about a deal review that I went to -- and the first bullet on the deal review was new CFO of a company, and the comment was around we can bring financial strategies to them. And I'm literally thinking -- I don't think they knew I was the CFO because I like that. There's nothing good about financial strategies to the CFO, if you the CFO of the company doing that. So we course shut that down because it doesn't make any sense. But that's the culture that we're trying to break through.

Okay. Okay. The -- just sticking on this -- on the CapEx side, so that obviously dovetails with modern workplace, less equipment purchases of on. Is that a meaningful headwind from the revenue side? Obviously, a tailwind for CapEx, but as you think about the pieces for this year, any magnitude and scale of just that equipment side?

You will have to see, right? I think that's where I'm more comfortable because if I give you a big number and then Mike looked at it, he might not like what we're doing. I'm getting a little bit. So I think our focus is just to make sure we have good economics. And if we create headwinds, we call them out, right? And you guys will see better cash improvement, better cash flow and better quality of earnings. And that, I think, is the name of the game for us given where we've been. So I think now we're comfortable with the guide we have I think it makes a lot of sense. I think we just kind of got to see what it looks like as we go.

Okay. Okay. The -- as it relates to within the $800 million of free cash flow target for this year, anything to be aware of as it relates to maybe tax implications from the asset sales, anything like that, anything chunky?

Yes. I think just in general, we're going to continue working through it, right? I think we're comfortable with where we are. I think we've made a lot of progress last year. I don't think there's anything specific to call out. The tax side, now we're very, very focused on tax. We've got a whole new tax team in there, some really quality people, which was part of our material weakness remediation to some folks I've worked with in the past. So I think we'll be more thoughtful when we do deals to make sure we're maximizing tax in that product. So I don't see any large tax payments coming but -- and I don't have anything specific in there. That's a cash headwind. I know part of the challenge, right, is we set a guide last year of 500 and came in at 743. I know everybody always wants more and I'm kind of like to think keep things a little slower as we're working through because you said it. It's a -- you said turnaround, we say transformation. It's somewhere in between, I'm sure. So there's a lot of variables that we work with every day. I'm pretty comfortable with the $800 million at the end of the day, if we can do more, certainly, we can do more for me, it's all about getting a sustainable business in FY '15 -- FY '24 and have the ability to drive there. So if I have headwinds to deal with, I want to deal with it, and that's what we did when I first got here. That's part of the reason we had pretty negative cash flow even in the first quarter of last year. And we got a lot of questions, right? And I think our CEO was sitting there looking at and me going, I don't know if I have to fire my CFO or he's going to deliver, and I'd rather not have to have that local in space anymore. So I think our goal is to deliver the $800 million.

Okay. Makes sense.

A couple of moving pieces here.

Brian, you mentioned asset sales and portfolio shaping is another key component of the strategy. So I think the history of the business is, we did a lot of acquisitions, a lot of them didn't really make sense. Ken, his biggest peer for the last 1.5 years was that a German-speaking regulator will be knocking at his door at 6:00 in the morning. So selling the 2 banks, I think he will sleep a little better. But we also have some other businesses that were bought that are not necessarily intuitive. So a Prism software business, very difficult to sell through the platinum channel like things like that. So just cleanup and we can sell these businesses relatively high multiple and then we can turn that to $500 million portfolio-shaping initiatives. And then we can turn around and we can invest that and buying our own stock at a multiple that's 4x EBITDA. So that makes sense, and that's a key component. And just finally, on portfolio shaping, I mean, I think for us, anything that increases the focus of the business for the management team, anything that brings us closer to our FY '24 goals. And anything that we feel add value for DXC, there are obviously items and things that we want to build.

Okay. That makes sense. There's certainly a less distraction of having a word but a German Financial institution or 2. Does that -- on that asset on the dispositions, does there -- you've kind of announced a $1 billion share repo plan in total. Does the timing of some of these asset sales impact when you're out there in the market?

Yes. I think the good news is, right, we have cash flow, right? We've talked about that a little bit. We think our stock is undervalued. You can do multiples. There's a lot of probably good values in the market today, but we think our stock is a great value. We can control the destiny of where we're going. So we've leaned into the share repurchases pretty heavily. I think with the Russia, Ukraine, the market dislocation that happened, we went pretty heavy in the first kind of 4 months out of the gate on the share repurchase. I think by the time we hit the end of June, we'll take out the first $500 million. We just need to keep kind of our thoughts around that. As we go forward, we laid out a model of having $2.5 billion in cash on the balance sheet anything more we'll utilize the share repurchases. So I think we'll keep that model one. I mean the credit rating agencies, it's important for the way we want to run the business to have that investment grade. So that's why we set the parameters where we did. So could it impact timing maybe a little bit. But at the end of the day, I think we've got enough in front of us that we feel good that we'll keep it moving. The banking piece that John mentioned, and he is right, it's not a joke. I literally, when I first found out we had a bank we were closing on the second and trying to buy a third. And I literally -- I just didn't know what to do with that, right? I'm like and then I realized a lot of the cash -- and everybody kept telling me we don't understand the cash balance on the Board and I ought to understand a little bit more of it. So we drilled through it and that's where we get back to having $700 million of bank deposits and you go through, that's pretty meaningful, right, in a company that was in a pretty difficult spot with $12 billion in debt. And there was just a lot of volume that Mike had to deal with. I think he did a phenomenal job. So getting those banks out. We're waiting for one last regulatory approval. So I feel good that's going to happen. That approval takes its time. It's been in now for, I think, what John almost 9 months. So we expect it to be done by the end of September. But things can move, right? And we've said that a couple of times, I think. So I think we've got everything lined up reasonably well to keep the share buybacks going. I think John keeps telling me to go dig through the couch cushions and buy more money. So we're digging through the cash cushions at the end of the day because it just makes a lot of sense.

And I know you've stressed share repo here just given what the valuation is. But how do you think about M&A? And where are you in that I think platinum channel is key for you there? Where are you on that journey?

Yes. And I think it's split, right? Because I think Mike has been a growth guy. And Mike at Accenture, probably I think he reeled off 8 tuck-in acquisitions when he was there, maybe it was 7%, I can confuse it. So I got it was 8 and 7 years. So for him, that's a critical part of the strategy, getting the platinum channel working really well is his mindset, which is a great mindset by the way that's the same, I think, other companies call it the diamond channel or whatever. So I think it's a great strategy. It brings that whole connectivity of customers and people together. So I think we're still, I'd say, reasonably early days on it. We are very focused on that in the A&E business specifically. And I think we're seeing good uptake. John and I were talking about that. And we -- we've got expansion in the A&E business out of their 2 legacy industries because of the platinum channel. Mike would say he's got a lot of green shoots, which these projects start small and they expand. And it's important to get in with the customer demonstrate the value and capability and then pick up more work. It's not a -- it's not like a 6-month exercise. It's probably a multiyear. And I think he feels pretty good. I don't remember the account number, but it was something like 60 of our platinum accounts have projects in AME going right now, which is a great thing to see.

Nice. Okay. Let me just follow to see if there are any questions in the audience.

Now I'm going to shift to margins. Okay. Great.

So let's just give us a sense of the key drivers there. So what gets you to the target this year. And I know you had a longer-term target for [indiscernible] -- but what are the big pieces overall?

Yes. So we talked -- when we called out in the call, 2 things, right? We called out some margin headwinds that I think are important to make sure people are aware of. One, we're going to take care of our people in Russia and Ukraine. So what that cost, we called out $50 million, we'll do what we need to do to do that. We're hoping, of course, not to spend the money, and that won't be the headwind. But at the end of the day, that's first and foremost, it's our brand, and it's what we're doing and it's what Mike wants to do. And I think it's the absolute right answer in the services business. If you don't put your people first, it's hard to have a successful services business. The second piece is we had, as a company, about $2 billion of surplus funded pension plans, specifically in the U.K., and we've been working with our trustees to try to tackle that, right? I don't like balance sheet risk. So if you tell me I can get rid of risk and deal with the surplus and potentially unlock some value there. I think we're all into that. The challenge with that is GAAP gives you income that has no cash benefit. So we tackle the piece. And some of it is the rates going up. Some of it's what we did in one of the plans we're doing in one of the plans, and we lost about $100 million of GAAP income that didn't generate cash flow. That's really important cash flow part. So I think those are 2 headwinds we come into the year with. So now when we look at the business, and I think it's just the simple stuff that we've been talking about, right, is looking at our vendors, our contractors, making sure we have the right relationships. People weren't into the details historically. We had people -- a lot of take-or-pay agreements structured. We've been tackling those over the last year. We'll continue to do that. We still have what I would categorize as an elevated level of contractors. And when I first got in them, for example, somebody called me and said, "Hey, they knew me and they said, "Hey, let's go spend some time. You're great, you're our largest customer, and they do staff financial work. And unlike, one of your largest customer and the whole firm, probably the wrong thing to tell me, right? So they're now -- I think they have one person left. So we had a firm that was -- I think they charged it to $146 million, right? So getting back into these relationships and figuring out how we're controlling them is really important in the details. The customer side, the COLA, making sure we take these -- what we've targeted in the first level is these 30 accounts, right? How do we ensure we're getting better returns for our people and our shareholders. So I think you'll see some margin improvement on that activity. And it's not that we're going to go top our customers over. It's more around -- and it's funny customers have a very consistent model. They want great people. They want innovation. And then the question is they actually want to pay for it. So if you don't bring innovation, you keep turning the people over, it's hard to actually get paid. So I think our approach has been really good, but keep the people stable, get the attrition down, which Mike has done a nice job. Get the engagement up with our people, get the customer Net Promoter Scores up. So now it's time for us to go back to our customers, work the relationships, as you said earlier, make sure it expands because we've been delivering for them. And we, by the way, the stuff that we deliver and why we talk about credit ratings and so forth, it's mission-critical to them. So how you don't make a good return on something. And I'd like to -- I'm not arguing that I need to make a 40% margin, but certainly, a 10% margin seems quite reasonable for work that's mission-critical that has capital tied to it. We're not there today, and I'm specifically talking about the GIS side. So I think we're on a journey with it, but I think we'll get there long term.

Okay. Well, thank you very much for getting into the weeds here with us getting the initiatives that are going to drive you to the targets. And I want to just thank the audience for listening, and enjoy the rest of the conference. Thank you.

Thank you...

Appreciate it, everybody.