DXC Technology Company (DXC) Earnings Call Transcript & Summary

All right, we're going to kick off. This is the DXC session. My name is Bryan Bergin. I cover IT services, fintech and payments here at TD Cowen. Thank you all for joining us. Very pleased to have with us from DXC CEO, Raul Fernandez; and CFO, Rob Del Bene. Guys, thanks for joining us.

Thank you.

Appreciate your hospitality.

So let's kick off with really an intro and a background question. So Raul, I think the -- it's important for us to understand, given you formally became CEO earlier this year, maybe spend a little bit on your background. And then you did step into an interim CEO role. What was kind of the pitch -- the realization of, "Okay, I'm going to take this to be full-time CEO." And what was the kind of the pitch to the Board initially?

Yes, yes, yes. Let me back up a bit. So I started -- I got a chance to start my professional career like literally with 3 engineers and myself doing pre-Web 1.0 work, client server development, custom app development. Right place, right time, Internet did grew the company dramatically. I started with my own money, got some private equity's money in. We grew it, took it public, sold it. So the whole life cycle of pre-sales, solutioning, delivery, people, I've lived it, right, from 0 to, I forget, like 3,000 people when we sold the company. And M&A and all that sort of stuff. So as a practitioner, I did this, it was a couple of decades ago, since then invested in different tech companies, media, sports, entertainment. I've been on a bunch of Boards, including Broadcom, GameStop, Kate Spade, so diverse background on verticals. And I was on this Board. And you really do -- now I've been on both sides a couple of times, whether it's public or private, it's 2 different points of view. When you're inside and operating, you get a completely different point of view, no matter how active you are as a Board member. And so when I stepped in, in late December, the first thing I did is met with our customers, start meeting with our employees, started looking at our systems and our processes. And quickly realized that there are a lot of things that I've seen done better in other organizations. There are a lot of things that were being done better by competitors, right? If I take every business unit and I say, "Okay, what are your comps?" You can isolate metrics, then you can measure each business unit metrics against like best-in-class and see what the gap analysis is and then figure out what you need to do to at least get first average and then above average. And it just -- it was a realization that there is a lot of work to be done, but none of it was rocket science, it was very basic execution. It wasn't one big lever to pull. It was a lot of little dials to turn and levers to push and to pull and it really spanned the whole organization. So everything from the people side, utilization, where they are in the world, what skill sets, to presales, to solutioning, to delivery, to upselling, to renewals. So like really looking at the whole life cycle. And there's a lot of things that we're working on now to get better in class. And then I met with 3 dozen customers since then, not in that first month. And just can you walk -- every time I walked away with appreciation of the work we do, that's really mission critical. I think that term gets used a lot. But in this case, it's really critical to the companies that we provide services for and software for. Trusted partner, long history in many cases, this is a combination of DXC and CSC. But if you then take the CSC line and take it back in time, it's EDS, it's a whole bunch of companies, right, that have been around for a long time that make up the DNA of this company. I have a 23andMe chart of the company, which has all the logos that make up who we are today. It's pretty cool to see. And as you know, we came together as an entity, 7-ish years ago. And -- but as operating companies, whether it's on the CSC side or the HP side, we've got client relationships that go back 20, 30, 40 years. And we have employees, and I think one we were talking about at dinner last week, celebrating 50th?

Yes.

50th Anniversary. Amazing. So it's -- so again, a solid foundation, great customers. But even in interacting with customers, I'd meet with a customer. I know what work we're doing there. And I'd say, "Do you know what other work we're doing in engineering and consulting," if it's an ITO customer. And so far, 34 for 34, they're like, "No, I didn't know you did that. So definitely introduce Howard to me and we would like to follow up." So again, a small example of cross-selling opportunities in your accounts. So it hit me that what had to be done was something that I was fit to do because I've done it before. That I had the energy, I had the passion, I had the confidence in the team that was there plus new teammates that we brought in. And then it was achievable, that it was doable. It is something that requires work, and it will take some time, and we will prove it over time, but it isn't an area where I know -- applying ourselves in a better, smarter way and bringing in new talent to -- operating at a higher level, we can be in a better place.

Okay. So let's dig in on this turnaround strategy. You mentioned a good example here on really the cross-selling opportunity. What are some of the other top areas where you have the most urgency upfront?

I think in terms of urgency, it is a combination of performing better. So any chance we get to compete, we just make sure we have the best solution out there, the smart pricing, competing on deals that we want to compete with. So some of the things in the past that were heavy on resale, low on margin, chasing revenue as opposed to chasing quality revenue with the right margin structure. We've cut all that off. We've changed the incentive system so that it aligns with more accountability, and everything has a tighter line of sight. So our new operating model has much more visibility all the way through. And then thinking about the rationalization of our headcount, our systems, our back-office processes, our legal entities. So it's a journey that combines transforming on the restructuring side and then performing on the competitive side, winning, keeping, rewinning and getting net new logos.

Okay. Is that incentive structure and that deal kind of the guardrails around the deal pursuits, has that already changed...

We ran really quick in the first few months. And we -- just, 45 days ago, we started our new fiscal year.

Yes, the new fiscal year...

Everything, we were running, sprinting to get all that documented and out there and understood by everybody. And yes, now they're all operating under that new model. And then -- and then as I went around, I found pockets of excellence and leaders that had done a great job. I'll give you a good example, our leader in Spain. Done an incredible job in Spain, the penetration we have with -- in multiple sectors, banking being one of them. We punch way above our weight class in terms of headcount there. And so he was doing a great job there. He had a great backup and now he's running all of Europe, right? And we have a lot of upside in other countries because if we do 1/2 of what we're doing on a pro rata basis in Spain and other countries, it's a great opportunity to grow. And his passion, his commitment and his leadership are great to be applied now in a broader context.

Okay. Okay. So certain things already changed, other things in flight as far as optimizing resources, optimizing systems that will probably carry through this fiscal. From our seat, and we think about tracking and measuring performance, are there things that you would change as far as KPIs, ways that you could demonstrate progress to this plan early on as we go through this first fiscal year.

Yes. I'm going to let him comment on the second piece but let me just start on the first piece. One of the things we've been doing is what metrics have we been publishing and have we been reporting on, what metrics are internal and then what are the right metrics by business unit. And I'll give you one that we all use is book-to-bill. Book-to-bill is interesting, but book-to-bill within a horizon like within 12 months is the -- real relevant, right? Because if it's a 4-year contract, it's -- my book-to-bill and like what is in front of me for the next 12 months? Do I have enough, what else do I have to go get in order to hit the numbers that we're hitting. So we're going to tweak, we're going to obviously internally run a couple of cycles. And then in the fall, winter we'll come out and say, "Okay, here's a new set of metrics that we'd like people to look at. Here's how we define it." And start sharing some of the internal results. But that's what coming. Go ahead.

Yes. And I think with the new operating model and with the -- delivery being completely totally aligned to the offerings and solution design, and standing up a new sales management team globally, we're going to have -- we have today, and we'll continue to improve the metrics and measurements of each one of the business lines. Just it's kind of a get back to basics, utilization, resource management, delivery quality, sales performance, soup to nuts. So those metrics are now being plumbed by business unit, along with the new fiscal year. We're going to be -- we're monitoring them on a weekly, monthly, quarterly basis. And then at the right time, we'll give more information externally on those metrics and the progress we're making.

Okay. Okay. And then maybe we'll talk about the guidance framework as well. So the fiscal year -- so Rob, you were there for the prior fiscal year in its entirety, you step into a new one. Maybe talk about what -- are you doing things differently in fiscal '25 relative to the prior process? Any way that you've changed the framework as you develop that outlook?

Yes. Well, one thing that was clear when I joined was that there was great dissatisfaction in the predictability of our business. And we had missed guidance consistently for 3 years. And that was not acceptable to investors, to the industry or to us, right? So we are managing the business and setting our expectations to a much greater degree based on the metrics of the business. And we're diving deep into the operational metrics, backlog, pipelines, et cetera -- sales progression, closure rates, et cetera, just all of the basics that you would expect us to manage by. That's what we're basing our external guidance on now and not leaning into the wind and not declaring victory in advance but being very measured. And for the last 3 quarters, we've made our guidance and then we plan on continuing that track record.

Okay. Let's dig in on the outlook now for this year, so maybe the underlying assumptions, we'll start the top line. As you built the outlook for revenue, what were you -- maybe on each segment, GBS, GIS, what are some of the underlying assumptions there?

So for GIS, we assumed that the performance in fiscal '25 is consistent with the performance in '24 and that was based on the opening backlogs and our bookings from the last couple of years. So it's very -- and that part of our business, which is Modern Workplace and ITO, backlog plays a huge role on the following year's revenue. So that is kind of the basis of the guidance, plus pipeline, et cetera, and runoff of contracts that terminated in the past. We've gone deep into all of those analytics. Along with that, we assume that our low-margin resale revenue continues to decline. It declined in '24. We're assuming it will continue to decline in '25. So that set the basis of GIS. And so we're not counting on any economic recovery. It's kind of consistent performance based on the metrics. In GBS, we have the Insurance business, which if you strip out the horizontal BPO business, which we currently report in our Insurance line, and it really has nothing to do with Insurance. It's misplaced, and we're going to fix that going forward. But that 25% of the business has been declining. That has masked the true growth of the Insurance business. And there, we grew at mid-single digits in '24. We expect to continue that into '25 and if not do a little bit better. And that is very much backlog and contract based. We -- there is a little disruption year-to-year in that contract portfolio. So that's very predictable in the -- what used to be A&E and Apps, which we're now reporting as Consulting and Engineering business, we have -- which -- and that comes in multiple flavors and it's our biggest business unit now. There's a run component, longer-term contracts and applications, and that's also shorter-term project-based works -- project-based work, rather, in our engineering business. And so it's a combination of project-based and longer-term contracts. There, we had very good bookings in the second half of '24. We see pipelines improving in the beginning of fiscal '25. And we have slightly easier compares on a year-to-year basis in the back half of the year. So with those factors, we have modest increases in performance from the first half of the year into the second half of the year. So first half, we're low single-digit negative, which is consistent with performance in '24 and then in the second half of the year, we have low single-digit positive revenue growth, which, again, are the 3 factors that I just mentioned. So we think we're grounded in facts here and feel good about the guide.

Okay. Now as we walk down income statement, into cash flow. So margin, the outlook there, it seems like there is some incremental margin pressure in '25 despite -- you're saying you're going to walk away from some more low-value, low-margin resales. So what are the puts and takes there on the [ margin ] front?

Yes. And it's mainly -- the predominant decrease year-to-year is a function of the revenue guide. So it's revenue dropping down to the bottom line. So that's the majority of the decline there. Then when you move to free cash flow, and we have been at $700 million plus the last 3 years. Last year was $750 million. And we're projecting $400 million for fiscal '25. Now the strength of cash flow generation has not diminished at all. So same baseline of performance in fiscal '25. But we've chosen to increase restructuring in fiscal '25 by $250 billion (sic) [ $250 million ], and that's for severance. And that's targeted at taking out overhead and indirect resources out of the company. So we're not going to impact service delivery, we're not going to impact sales, it's strictly an overhead. So that's a temporary increase in fiscal '25 in spend. The second item that is the bridge between $750 million and $400 million, is we made a decision with revenue performance in the last few years, we want to moderate the debt levels, bring them down appropriately, prudently. And so the way we're doing that is by stopping capital lease originations. So we're going to run all of our equipment purchases through cap expenditures. So that's a hit to the printed free cash flow number. So those 2 factors combined are what lead to the decline. And then when we spin forward to '26, we fully expect to be back at levels of '24 or better.

Okay. Okay. As far as -- are there areas of net working capital efficiency, you could also lean into? Or have you optimized a lot of what you could?

Yes. No, we still have room to run in working capital. Our receivables have not really -- if you look back over the last 3 years, our DSOs are pretty stable. So we have room for improvement there. We have room for improvement in cash taxes, and we expect some benefits over the next -- some in '25 and also in '26 improvements in cash tax performance. So there are other levers, which we're going to exercise and that's why we're confident about '26.

Got you. So it's a number of pieces that could get you back there. And then as far as the finance leases going through CapEx, is that a 1-year phenomenon...

No, so the impact. Last year, we had $180 million worth of new originations. So that -- think of that as the baseline that we are now flowing through CapEx. Our lease payments in '25 are $275 million that decreases because we have been bringing down the new originations over time. Now we're just taking it to the extreme and zeroing it out. But over time, it has come down. So that $275 million in fiscal '26 goes a little north of $100 million. So that headwind is going to decrease for us over time here.

So I guess when you get through these initiatives and you think about working through getting the top line to turn around, how do we think about the capital intensity when you optimize on your strategy, what's the capital intensity of this business when we think about percentage of revenue type of dynamics?

Yes. The capital from last year on a revenue base of $13.5 billion thereabouts. The capital was -- if you include the lease originations, so you have like-for-like year-to-year, capital was in the $800 million range. And so we're going to bring that down on a year -- that total down on a year-to-year basis. And so we'll be closer to $700 million in fiscal '25. And then from there, it really depends on the pipeline of opportunities and deals. We will be very disciplined and will not sign up for capital-intensive deals that don't provide a return. But if there are opportunities out there, we'll invest the capital. But you could think of that water level in '25 as kind of a baseline, the right baseline.

Okay. And then as we think about, again, on some margin opportunities. So naturally, resource optimization, facilities, but offshoring in the past has been something that's been discussed within the company. Where do you stand with that today? And how much room might you still have to change that mix as you go through the next couple of years?