DXC Technology Company (NYSE:DXC) Q2 2024 Earnings Call Transcript

DXC Technology Company (NYSE:DXC) Q2 2024 Earnings Call Transcript November 1, 2023

Operator: Thank you. Good afternoon, everybody. I’m pleased that you’re joining us for DXC Technology’s Second Quarter Fiscal Year 2024 Earnings Call. Our speakers on the call today will be Mike Salvino, Chairman, President and CEO and Rob Del Bene, our EVP and CFO. The call is being webcast at DXC’s Investor Relations website and the webcast includes slides that will accompany this discussion today. Today’s presentation includes certain non-GAAP financial measures, which we believe provide useful information to our investors. In accordance with the SEC rules, we provide reconciliation to measures of the respective and most directly comparable non-GAAP measures. These reconciliations can be found in the tables included in today’s earnings release and in the webcast slides.

Certain comments we make on the call will be forward-looking. These statements are subject to known risks and uncertainties, which could cause actual results to differ materially from those expressed on the call. A discussion of these risks and uncertainties is included in our quarterly report on Form 10-Q and other SEC filings. I’d now like to remind our listeners that DXC Technology assumes no obligation to update the information presented on this call, except as required by law. And with that, I’d like to introduce DXC Technology’s Chairman, President and CEO, Mike Salvino. Mike?

Mike Salvino: Thanks, John, and I appreciate everyone joining the call today, and I hope you and your families are doing well. Today’s agenda will begin with an update on our overall business performance. Next, I will update you on our performance of our GBS and GIS businesses. Rob will then discuss our financial results in detail and our guidance. And finally, I will make some closing remarks before opening the call up for questions. We are pleased with our financial performance in Q2, as our leadership team continues to strengthen and execute on our offering based operating model. Organic revenue for Q2 was minus 3.6%, above our guidance and consistent with our Q1 performance. Our GBS business performed better than we expected at 2.4% organic revenue growth and GIS showed progress going from organic revenue of minus 9.9% in Q1 to minus 9.1% in Q2.

Our EBIT margin was 7.3%, which is better than our guidance and quarter-on-quarter was an 80-basis point improvement due to both GBS and GIS margins improving. EPS was $0.70 at the high end of our guidance and book-to-bill was 0.81 and our trailing 12-month book-to-bill is now 1.02. Free cash flow was $91 million, which was an increase over the minus $75 million we delivered in Q1. This execution shows that we are beginning to see the benefits of our new offering-based operating model. where we are now running global offerings with the goal of driving revenue growth and expanding margins, EPS and free cash flow. The Q2 results clearly showed we achieved all 4 goals when compared to Q1 performance. As you have heard consistently from us over the last several quarters, our management team is laser-focused on transitioning DXC from stability to higher performance.

That work started with reinforcing our financial foundation and customer relationships and moved on to ensuring we have the right talent in the right places to execute on our growth and expansion goals. With the moves that we have made over the last several months, I now believe we absolutely have that team in place. In Q2, we added two more senior executives to our leadership team to strengthen our ability to run our offering-based operating model and consistently deliver on our financial commitments. Howard, Andrew and Rob marked three senior executives with significant senior management experience and expertise in critical parts of our business that have joined us to play key roles for DXC alongside the other talented members of our senior leadership team.

Howard will be running our applications offering and be accountable for our AI strategy. Andrew will be running our modern workplace offering, and obviously, Rob is our new CFO, who has been making a huge impact in driving our financial performance. Howard has joined us from IBM. He is an IT services expert with proven experience in creating growth strategies and executing against them as he did at IBM with their cloud business. Prior to IBM, Howard was the CTO of Bank of America, which gives him a unique perspective of what customers want in an IT service provider. Howard is the perfect choice to lead our applications offering. Andrew joins us after working for some of the largest and well-respected brands in the technology industry. Most recently, he was the Chief Digital Officer at Microsoft, where he was our customer for the modern workplace services, we provide to them.

Prior to Microsoft, I worked with Andrew at Accenture, where he was the CIO and delivered innovative digital services to a very demanding workforce. His ability to run global P&Ls and deliver these services make them the perfect choice to run our global modern workplace offering. Howard and Andrew, combined with Chris, who runs ITO, gives us three former CXOs of Fortune 500 companies, leading almost 70% of our revenue. These three bring deep customer and industry relationships to DXC and the ability to attract top talent to help us deliver on our financial targets. Now turning to our GBS business. GBS grew organically for the tenth consecutive quarter in Q2 and now accounts for 49.7% of our total revenue. As we have stated repeatedly, consistently growing this high-value business and having it become the majority revenue source of DXC, is important to our overall growth strategy.

As you can see from the results this quarter, we are delivering on that goal. The 2.4% organic revenue growth was moderately ahead of our growth expectations for the quarter, due to the stronger performance across all three offerings. Also, I was pleased to see us expand margins from 11.3% in Q1 to 12.5% in Q2. Our insurance offering has benefited the most. From our new operating model because it’s been in the model the longest, our insurance offering delivers a SaaS model to our customers, and we are the world’s largest provider of insurance software and BPS solutions to the industry. Under our new model, Ray can now focus on selling these capabilities to existing customers and delivering services more efficiently. His team has done an outstanding job of beginning the modernization process of our insurance software products, positioning our insurance offering for further growth.

This is just one example of how our right model and right leader approach is clearly making a positive impact and starting to generate solid financial performance. I believe that kind of production across DXC is only beginning. Another key attribute of our growth strategy is selling our GBS offerings to our GIS customers. On a yearly basis, we generate roughly $370 million in revenue by selling analytics and engineering to our GIS customers, and this is growing 11% in FY ’24 so far. The new operating model is allowing Michael and his team to continue having success in a very tough market. Another example of us having the right model and the right leader is our applications offering, which generates roughly $1.2 billion of revenue by selling to GIS customers but it is not growing in FY ’24 so far.

Fixing this as one of Howard’s highest initial priorities, as we have charged him with responding to the AI demand and getting our customer base ready to accept this technology. Moving now to our GIS business, where this quarter, we moderately moved it in the right direction, shrinking the decline in revenue from minus 9.9% in Q1 and to minus 9.1% in Q2, while margin increased from 5.2% in Q1 to 5.8% in Q2. Like GBS, all 3 offerings performed better than our expectations. Let me highlight the progress we have made in the quarter to continue fixing our ITO business. We have discussed moving to an infrastructure-light model. As part of this effort and as we’ve communicated on prior calls, we plan on selling facilities. Chris and Rob are making progress on this initiative with plans to sell facilities in the back end of the year.

Executing on this will allow us to sell underutilized assets, making us more efficient overall and helping us fix the margin of the GBS business moving forward. We recently have signed a deal to become the partner of choice for AWS. This partnership incentivizes us and our customers to move their systems that are essential to their operations to the cloud. We plan to use this deal to move some of our customers that are using a data center that is on-prem and suboptimized to the cloud to improve the cost economics for our customers and ourselves. Now let me turn the call over to Rob to discuss the details of our financials.

Rob Del Bene: Thank you, Mike. Before I get into the numbers, I would like to say the team has made good progress with the implementation of the offering based operating model with improved execution and expect us to build on this performance going forward. I’ll now provide you with a quick rundown of our 2Q performance. Organic revenue was down 3.6%, which came in above our organic revenue guidance range and in line with first quarter’s performance. Of the 3.6% year-to-year decline, 160 basis points came from a reduced level of low-margin resale revenues, which was in line with our expectations. Adjusted EBIT margin came in at 7.3%, also above our guidance range. The margin increased 80 basis points sequentially and was down 20 basis points on a year-to-year basis.

Within this number, there is a significant reduction of 60 basis points from the pension income contribution on a year-to-year basis. So without the pension income, our non-GAAP EBIT margin moved from 6.3% in 2Q ’23 to 6.7%. Non-GAAP EPS was $0.70 at the high end of our guidance range, down $0.05 year-to-year and up $0.07 sequentially. SG&A was well managed in the quarter with spending in line with our expectations. Free cash flow for the quarter was $91 million, benefiting from our continued focus on working capital management and a lower level of CapEx. In the quarter, our book-to-bill was 0.81, and the trailing 12 months is now 1.02. The level of bookings through the first half of the year is similar to the first half of fiscal ’23 and the 0.81 is factored into our annual guidance.

Looking forward, based on our pipelines, we expect book-to-bill to improve in the second half of the fiscal year. Moving to our key financial metrics. Our second quarter gross margin of 23.4% was up 120 basis points year-over-year and 230 basis points sequentially, benefiting from our cost reduction initiatives. SG&A was 9.4% of revenues, up 60 basis points year-over-year. Depreciation and amortization was down $7 million compared to the prior year. Other income decreased $28 million year-to-year, driven primarily by a $25 million decline in non-cash pension income. Taking this all together, adjusted EBIT margin was down 20 basis points year-over-year. Excluding pension income in both periods, the EBIT margin would have been up about 40 basis points year-to-year.

Net interest expense increased $9 million year-over-year to $25 million, primarily due to a higher level of variable interest expense on short-term debt. Non-GAAP EPS was down $0.05 compared to the prior year, driven by a $0.03 decline from higher interest expense, a $0.06 reduction from a higher tax rate and a $0.06 reduction due to lower pension income. These increases were partially offset by a $0.09 improvement due to lower share count driven by our ongoing share repurchase activity. Now turning to our segment results. Our business mix continues to trend to our higher-margin GBS segment. As a percentage of total revenue, GBS is now very close to 50% of revenues. We anticipate that this trend will continue and that shortly, the GBS segment will be the majority of our revenue.

GBS grew 2.4% organically and posted the tenth consecutive quarter of organic growth, which reflects the deep industry-based customer value delivered by the GBS teams. The GBS profit margin declined 20 basis points year-over-year, with the decrease driven by the impact of lower pension income. Turning to GIS. Organic revenue declined 9.1% with a modest reduction of the decline sequentially. GIS profit margin decreased 40 basis points year-over-year, again, driven by the reductions in pension income. Now let’s take a closer look at our offerings. Analytics and engineering revenue performance was up 5.3% below the first quarter growth rate. We are seeing a moderating level of demand, as customers are more cautious due to the current macroeconomic environment.

Applications revenue declined 80 basis points, similar to first quarter performance. While our applications performance has been stable, we are expecting to see improving book-to-bill performance in the second half of the year based on the opportunities we see in our enterprise applications business in public sector and in banking. Insurance software and BPS continued to grow with revenue up 5.2% and insurance SaaS component of the portfolio accelerated to high single-digit growth. The insurance platform and deep industry EPS skills of our team is resonating in the market. Security declined 1.8% year-to-year. Cloud infrastructure and IT outsourcing revenues declined 9.8% year-to-year organically. The year-to-year performance continues to be impacted by two primary factors that I outlined in the first quarter earnings call, the impact of which were anticipated in our 2Q guide.

The first is decline from contracts that were terminated some time ago and continue to wind down. The second factor is the decline in resale revenues which drove 41% of our second quarter decrease in Cloud and ITO. The modern workplace business declined 9% year-to-year. And as with ITO, the business performed as expected in our 2Q guide. Our expectation is that the sequential performance in revenue will stabilize through the second half of this year. Turning to financial foundation metrics. Debt levels decreased modestly in the first quarter to $4.5 billion. Restructuring and TSI expense increased to $38 million, with the increase entirely due to the restructuring of facility leases part of our effort to right-size our facility footprint. We are tightly managing restructuring, and we’ll continue to evaluate opportunities to streamline our operations.

Operating lease payments and related expenses were $91 million, down $17 million year-to-year, reflecting continued management of our real estate commitments. In the quarter, capital expenditures were $157 million, down $38 million year-to-year. Finance lease originations were $24 million, flat year-to-year. As a percentage of revenue, capital expenditures and lease originations declined to 5.3% of revenues, as we tightly manage our capital and leasing commitments. As I mentioned earlier, free cash flow for the quarter was $91 million, bringing our first half total to $16 million, slightly better than last year’s performance. We have several large drivers of cash expenditures in the first half of the year such as bonus payments, payments to suppliers for annual renewals of software and related maintenance and cash taxes.

These cash outflows will be significantly lower in the second half of the fiscal year and combined with a higher adjusted EBIT and continued progress on working capital efficiency, we are maintaining our free cash flow goal of $800 million. Turning to capital deployment. We made continued progress on our $1 billion share repurchase program for fiscal year 2024. Year-to-date, DXC has repurchased about 10% of our shares outstanding. This is in addition to the 7.4% of shares that we repurchased in fiscal year ’22 and 10.6% in fiscal year ’23. It is important to note that in aggregate, our $1 billion share repurchase program will be funded through free cash flow and our asset sale program. And just to note, there’s approximately $500 million remaining for the second half of the fiscal year.

Turning now to third quarter. We expect Q3 organic revenue to decline from minus 4% to minus 5%, reflecting the weaker demand environment. Adjusted EBIT margin of 7% to 7.5% and non-GAAP diluted EPS of $0.75 to $0.80. Turning to our full year guidance. We are reaffirming our organic revenue growth from negative 3% to negative 4%, our adjusted EBIT margin of 7% to 7.5% and EPS from $3.15 to $3.40. We are also maintaining our free cash flow guidance of $800 million. We have increased the tax rate. Our non-GAAP EPS guidance reflects a tax rate of 30%, up from our previous expectation of 29%. We are making progress on our $250 million asset sale program, which is a planned source of cash in fiscal year ’24. In 2Q, we realized $61 million bringing our year-to-date asset sale total to $65 million.

We have a portfolio of assets that will enable us to achieve a $250 million objective and expect to execute by the end of the fiscal year. These cash-generating transactions could result in a non-cash loss that is not factored into our guidance and as we have more clarity on the specific assets and timing, we’ll provide an update in 4Q guidance. With that, let me turn the call back to Mike for his final thoughts.

Mike Salvino: Thanks, Rob, and let me leave you with a few key takeaways. We are starting to see the benefits of our new operating model and our financial performance, and we are focused intently on making sure this continues. We believe we now have the right model and the right leaders to run the global offerings for the 3 businesses where we need to make the most improvement. Having 3 ex-CXOs now running applications, ITO and modern workplace is a big win for us because they have deep relationships with existing CIOs that will prove impactful for us. Our goal for DXC is to grow revenue and expand margins, EPS and free cash flow. Quarter-on-quarter, we made positive progress on each. Concerning revenue growth we grew GBS for the tenth straight quarter.

We moderately slowed the decline in GIS. We also continue to sell our GBS offerings to GIS customers and with the addition of Howard driving our applications offering, we expect to do even more. And we continue to make our high-value GBS business a larger part of our overall revenue, now at 49.7%. While making that progress on revenue, we expanded margin 80 basis points, EPS $0.07 and free cash flow turned positive as we delivered $91 million in the quarter. I am pleased with our financial execution for the quarter. Expect that this execution will continue, and I look forward to updating you on our Q3 progress in February. Operator, please open the call up for questions.

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Q&A Session

Operator: [Operator Instructions] Our first question comes from the line of Bryan Bergin with Cowen. Bryan, go ahead.

Zach Ajzenman: This is Zach Ajzenman on for Bryan. First question on the demand and outlook. So the trailing 12-month bookings remains above 1, but the quarterly book-to-bill was below 1 for the second consecutive quarter. So in this context, we’re just looking to dig into what gives you confidence for the revenue affirmation for fiscal ’24, which implies a 4Q revenue acceleration? And perhaps you can give some context around individual stack layer assumptions that underpin this 4Q revenue improvement.

Mike Salvino: Okay. So Zach, first of all, the bookings in the first half of the year was factored in our guidance when we gave you guidance last quarter. I would tell you the key takeaway from this earnings report is our ability to convert the pipeline to revenues. It’s significantly improved. We talked about project work that we saw on the back end of the year. that clearly has accelerated by us beating our revenue number. And basically, what we’re seeing is this shows that our operating model is really starting to work. We talked about that last quarter that our detailed leaders need to get side-by-side, shoulder-to-shoulder with our customers and start driving the project stuff, and that’s what we’ve done and we think we can continue.

So what we see in our bookings, our bookings have always been lumpy. If you look at last year, if you look at the year before, they are lumpy. And we’re focused now on replenishing the project work. And as I look forward, based on our pipeline, we expect book-to-bill to improve, particularly in the area of GBS. So that hopefully gives you the color you’re looking for. Next question, do you have another question?

Zach Ajzenman: Yes. On free cash flow, just wanted to dig into the factors that are giving you confidence here and being able to achieve that $800 million outlook that was affirmed.

Rob Del Bene: Yes. Sure, Zach. This is Rob Del Bene. As I mentioned in my remarks, there are several factors that hit free cash flow in the first half of the year that won’t be repeated in the second half. So the first is bonus payments. They are always skewed to the first half of the year. And I could give you a rundown of the numbers in more detail. Our impact in 1Q was $130 million due to the bonus payments. We have vendor payments that are normally skewed to the first half of the year, primarily for software and maintenance annual renewals and our projections are that, the second half of the year will be significantly lower due to the SKU into the first half of those annual payments in the range of $450 million. So those 2 factors alone are 580.

The cash taxes are projected to be lower in the second half of the year as well in the $80 million range. And the remainder, we’re confident we’ll come from second half EBIT being better than first half and continued working capital improvements. And we’ve identified specifically where we think we will make those improvements. So that’s the pretty detailed bridge to get to the $800 million.

Operator: Your next question comes from the line of Gates Schwarzmann with Citi. Gates, please go ahead.

Gates Schwarzmann: This is Gates Schwarzmann calling in for Ashwin. You went through the free cash flow bridge. You also had noted that you repurchased a quarter to share since early 2022. Is that the main use of cash going forward or are there any M&A opportunities or other uses like further restructuring that might take precedence.

Mike Salvino: So we basically when you look at our capital allocation, we have 1A, 1B, 1C. So 1A is, will be the buyback. 1B will be our debt, which I think we’ve continually made sure that we stayed at investment-grade profile or better. Then 1C will be our investments. If you go look at our SG&A for this quarter, we’ve made investments around our brand. We’ve also made some investments in some outside help to evaluate some of our SG&A costs. And then the third thing we’ll do is I highlighted for you the uptick in our insurance business in terms of us modernizing our software that’s positioning that offering for growth. So that’s how I’d answer that question.