DXC Technology Company (NYSE:DXC) Q3 2024 Earnings Call Transcript

DXC Technology Company (NYSE:DXC) Q3 2024 Earnings Call Transcript February 1, 2024

DXC Technology Company beats earnings expectations. Reported EPS is $0.813, expectations were $0.77. DXC Technology Company isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Thank you for standing by. My name is Christina and I will be your conference operator today. At this time, I would like to welcome everyone to the DXC Technology Q3 Earnings Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. [Operator Instructions] I would now like to turn the floor over to John Sweeney, Vice President of Investor Relations. John, you may begin your conference.

John Sweeney: Thank you, and good afternoon, everybody. I’m pleased that you’re joining us for DXC Technology’s third quarter fiscal year 2024 earnings call. Our speakers on the call today will be Raul Fernandez, 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 SEC rules, we provide a reconciliation of these measures to their respective and most directly comparable 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 annual report on Form 10-K and other SEC filings. I’d now like to remind our listeners that DXC Technology assumes no obligation to update the information presented on the call except as required by law. And with that, I’d like to introduce DXC Technology’s President and CEO, Raul Fernandez. Raul?

Raul Fernandez: Thanks, John, and good evening, everyone. Thank you for joining today’s call. I’m Raul Fernandez, President and CEO of DXC. Before we start, I would like to thank Mike Salvino for his contributions to DXC. As you saw in the press release issued before the call today, the Board of Directors has appointed me to be the President and CEO of DXC. I’m honored and excited to take those positions and therefore, I’m no longer Interim CEO. Let me take you through our agenda for the call. I will start my commentary by sharing my observations of DXC. We will then review the business performance and discuss each of our six offerings. Rob will then discuss our financial results in more detail. And finally, I will leave you with a few key takeaways before opening the call up for questions.

As you can see on Slide 5, we had solid performance in the third quarter. Organic revenue growth came in at the midpoint of our guidance range. Adjusted EBIT margin and non-GAAP EPS were both above our guidance range. Free cash flow was $585 million in the quarter, an excellent result and up 26% as compared to prior year. As you may know, I have been a DXC Board member since 2020, having previously served as Chairman of the Nominating and Corporate Governance Committee and as a member of the Compensation Committee. A little over 40 days ago, I was appointed Interim President and CEO. In my first 40 days plus, I have met with employees, customers, partners and investors. As a director, you get a good sense of the business, its values and its challenges.

But as an operator, you get to go deeper and fully appreciate the talents, technologies and great work that our employees do every day around the world. You also get a really good sense of how we can work smarter and elevate our performance. In the last 40 days, I have learned to more deeply appreciate the mission-critical nature of the work our employees do on behalf of our clients, the digital systems that we build and implement and the technology and software that we operate for global brands. And here’s a great example of our capabilities. I recently visited our Madrid office and met with the leadership and full team. I got to listen to the great capabilities that we have and the team briefed me on the work they do with Banco Sabadell, a leading Spanish financial institution.

The bank decided to realign their business processes by splitting applications testing from development and maintenance in order to improve quality, time to market and cost efficiency. DXC partnered with Banco Sabadell to achieve this goal. Legacy application development increased and the speed of bringing applications into production accelerated by 50%. The team reduced application modernization cost by 40% and reduced testing time by 30%. As a result of this initial success, the bank is expanding our engagement into other critical business operations. Now I will take a few minutes to share my priorities and the near-term actions we are taking. The foundation of our business is service delivery excellence. DXC is trusted with delivering mission-critical IT services for our customers, and we will continue to drive an intense focus on delivery and customer satisfaction.

While our company has an impressive collection of assets, technology and people, it’s clear that we need to sharpen our execution and accelerate our performance. To accomplish this, we are going to continue the full implementation of our operating model, establishing global offerings with full responsibility for offering development, delivery, solution design and P&L accountability. In addition, we will sharpen our sales execution through a geographic market-based sales team. This will enable us to develop market-leading offerings with the right solutioning and pricing and with local sales execution. I have learned that there are many compelling attributes of DXC that are either underappreciated or unknown outside the company. We will change this by doing a better job of highlighting each of our six offerings, showcasing how we tailor our services to empower customer success.

We will emphasize the unique value we deliver and highlight our competitive advantages with much greater clarity. As CEO, it is imperative to stay closely connected to our employees and our customers, as they have great ideas and insights that can be harnessed to take the company to the next level. I’m going to invest the time to get this feedback on an ongoing basis. Focusing on these priorities will allow us to achieve our financial objectives, maintaining our solid investment grade credit rating, investing back into the business and delivering on our capital allocation priorities, including buybacks. The Board and I are fully aligned on our capital allocation strategy. With that said, let’s move to review our three GBS and our three GIS offerings.

In Analytics & Engineering, we engineer great products, services, experiences and operations for global brands. Our A&E team has an unmatched array of talent across AI, engineering, software development and deep industry knowledge. That combination makes us a trusted partner. An example of our tremendous work here is in the auto industry. The competitive landscape for auto manufacturers is shifting to full digital transformation, and we have been instrumental in helping our clients make that transition. A leading, German premium auto manufacturer has told us that, we would not have had autonomous driving without DXC. Next up, Applications. The applications business is made up of two components: custom application development and enterprise applications.

DXC is uniquely positioned to service this market because of our decades long and deep industry expertise. Moreover, because of our heritage in running mission critical systems, we know how to get value quickly and with minimal operational risk. Our focus and strategy has led us to build our strategic business units centered around platforms such as SAP, ServiceNow and Oracle. By developing specific expertise, on these platforms, we are more competitive in large deals for these implementations and integrations while maintaining robust project work capabilities. Early results are encouraging, with new logos increasing quarter-over-quarter. Also the size of new work versus renewals is going in the right direction and our deal sizes are gradually increasing year-over-year.

More data and more tools require our customers to be better and faster across business functions. We have a great experienced global talent base to help with that. As we all know, AI will impact all aspects of society. But in the near term, customers with large data sets are best positioned to extract value from AI. We have many global customers with large data sets, and we have the expertise to help them leverage this data to extract actionable insights and optimize operations for improved efficiency and innovation. To round off our GBS segment, I’m excited to give you a little bit more detail about our insurance software and BPS offering. Our software insurance business unit facilitates the operations of 80% of Fortune 500 insurance companies.

Our work is valued and appreciated by our customers. We earned about 500 customer renewals in fiscal year ’23 demonstrating the stickiness of our platform with our insurance customers. We’re building out our portfolio of SaaS-based products to provide our customers with additional features and solutions and in many cases, are co-developing those solutions with our customers. Turning to GIS. Let’s start with our security offering. Cybersecurity is a top C-suite concern given the increase in global and state sponsored incidents. Customers want simplicity in their security ecosystem. We are able to deliver that for them through our best of suite security solutions in which we devise and implement a security setup where the tools work seamlessly with each other to create the best possible security environment for each customer’s needs.

The need for security continues to grow, and we fully expect to participate in this growth to a better degree than we have historically. In cloud and ITO, DXC is one of the largest service providers in the industry. The key to delivery in this space is to leverage automation, working in conjunction with experienced IT professionals that can handle required interventions. With our new geographic sales organization being closer to the customer, we are focused on increasing our share. We are able to provide experienced live support to your current environment. And with our team, we have all the right capabilities to modernize and streamline IT platforms as we enable our clients’ cloud transitions. Next, we have modern workplace. AI will have a big impact here, enabling greater ticket issue resolution in an automated fashion.

Our customers move from working in one place to embracing a distributed, location agnostic work model. Employees expect mobility, employees expect customer service and support models and a frictionless IT experience. We aim to provide a near zero touch support model that enables employees to onboard, work and solve problems without using traditional IT support mechanisms like calling in and logging in tickets. With this approach, we enhance and hit on the metrics that are important to our customers. These metrics are employee productivity, engagement and sentiment. Our financial focus is on improving the business mix. By this, I mean further reducing low margin resale revenue and driving a higher level of services, including those directly associated with AI and automation.

Okay. With that, I will turn the call over to Rob to discuss the financials.

Rob Del Bene: Thank you, Raul. I’ll now provide you with a review of our third quarter performance with results in line or ahead of our 3Q guidance. Organic revenue growth was down 4.5% year-over-year, which came in at the midpoint of our organic revenue guidance. Our results continue to be impacted by the year-to-year decline of resale revenues which was 90 basis points of the 4.5% decline. Adjusted EBIT margin came in at 7.6%, above our guidance range and up 30 basis points quarter-to-quarter. Margin was down 110 basis points year-to-year with the decline due to a 50 basis point impact of lower non-cash pension income, a 40 basis point impact from a lower level of asset sales and a non-recurring 30 basis point impact from executive severance costs.

Without these three impacts, margins would have been up year-to-year. Non-GAAP EPS was $0.87, $0.07 above our guidance range and up $0.17 sequentially. Free cash flow for the quarter was $585 million, the result of disciplined operational management and improving control of capital expenditures and working capital. As I’ve mentioned on previous calls, our free cash flows are seasonally weighted to the second half of the year and that played out in the quarter. Book-to-bill was 0.99 with improved performance from the first half of the fiscal year. The trailing 12-month book-to-bill is 0.93. Now moving to our key financial metrics. Our third quarter gross margin of 22.4% was up 70 basis points year-over-year benefiting from our ongoing labor and non-labor cost reductions.

SG&A was 8.5% of revenues, nearly flat in absolute dollars, as we are maintaining our go-to-market investment levels. Other income decreased $51 million year-to-year, driven primarily by a decline in non-cash pension income, lower gains on asset sales and foreign exchange. Adjusted EBIT margins were down 110 basis points due to, as I mentioned on the first slide, lower pension income, lower asset sales and executive separation costs. Net interest expense was $22 million, an increase of $7 million year-over-year, primarily due to a higher level of variable interest expense on short-term debt. Net interest expense improved $3 million sequentially. Non-GAAP EPS was down $0.08 year-to-year with the main decreases being a higher tax rate of $0.12, $0.06 of lower pension income, $0.05 of lower gains on asset sales and other impacts such as executive severance and higher interest expense.

These decreases were partially offset by a $0.15 benefit from a reduced share count and an $0.08 benefit from non-controlling interest. Now turning to our segment results. Our business mix continues to trend to our higher margin GBS segment and the two segments are now almost equal with GBS at 49.9%, up 120 basis points from a year ago. GBS grew 30 basis points organically. The deceleration in the GBS organic growth rate is a reflection of the challenging market environment. GBS profit margin was 11.9%, consistent with the performance from the first half of the year. We are managing our GBS resource levels to capture future growth opportunities. Turning now to GIS. Organic revenue declined 8.9%, a modest improvement from first half performance.

GIS profit margin increased 40 basis points year-over-year, driven by the ongoing execution of cost reduction initiatives. Now moving on to our individual offerings. First in GBS. Our Analytics & Engineering team, which has world-class industry capabilities in the field of design and engineering has been impacted by the economic environment, bringing our growth rate to low-single digits. In the quarter, we did have an improved book-to-bill due to a high volume of client renewals, which is a strong validation of the value delivered by the A&E team. Moving to our applications offering. Revenue declined 2% and is consistent with the performance of the first half of the year and reflective of our bookings for the last two quarters. In the quarter, we improved our book-to-bill to 1.11x with a number of large renewals, new client acquisitions and an increase in project-based services.

Our insurance offering continues to grow with organic revenue up 2.1%, book-to-bill was 1.58x, up significantly from our first half performance. Bookings in this business vary from quarter to quarter based on the timing of large renewals. In 3Q, we had two significant renewals, reflecting strong customer recognition of the value of our software platform and services capabilities. Our insurance SaaS business continued its strong performance, growing 6% in the quarter. In the fourth quarter, we expect the growth rate to temporarily moderate due to one-time perpetual IP license sale in the fourth quarter of fiscal ’23. Now moving to our GIS segment. Security declined 5.1% year-to-year with revenue flat quarter-to-quarter and in line with the first half of the year.

Bookings were 0.81x. Cloud infrastructure and IT outsourcing revenue declined 10.9% year-to-year. This business continues to be impacted by long-term market declines and shorter-term decreases in lower-margin resale revenues. In the third quarter, resale was over one-third of the decline, and we anticipate that this trend will continue into the fourth quarter. We are taking a very disciplined approach to deal economics and contract management and we’ll continue to evaluate opportunities to reduce excess capacity and capital requirements. This approach is reflected in our book-to-bill results, which was 0.72 in 3Q. Next, we have modern workplace, which declined 4.2% year-to-year. The quarter-to-quarter improvement in performance was driven by two large transactions, which included resale content which we don’t anticipate to recur in the fourth quarter.

Looking ahead, the fourth quarter of fiscal ’24, we face a difficult comparison due to a high level of resale revenues in the fourth quarter of fiscal ’23. As a result of the upcoming difficult comp we expect modern workplace to decline in the mid-teens in the fourth quarter. Now turning to the financial foundation. Debt levels have remained stable from the beginning of the year at about $4.5 billion. Net interest of $22 million in the quarter was up $7 million as compared to prior year, reflecting the higher interest rate environment on our short-term borrowings. Restructuring and TSI expense was down 31% year-to-year and flat sequentially. Operating lease payments and the related expenses were $88 million, down $9 million year-to-year reflecting continued prudent management of our real estate footprint.

In the quarter, capital expenditures were $121 million, down $41 million year-to-year and $36 million sequentially. Finance lease originations were $15 million, and as a percentage of revenue, capital expenditures and lease originations declined to 5% of revenues, indicative of disciplined management of our capital expenditures and leasing commitments. Turning to capital deployment in 3Q. We deployed $252 million and repurchased 11.3 million shares. In fiscal ’24, DXC has repurchased over 15% of our shares outstanding, which is in addition to the 7.4% of shares that we repurchased in ’22 and 10.6% in fiscal ’23. As we’ve communicated in prior calls, we’re funding our targeted fiscal ’24 $1 billion share repurchase program through a combination of $800 million of free cash flow and asset sales.

Through the third quarter of the fiscal year, our proceeds from asset sales is now approximately $100 million. We have additional sales targeted, which may extend into fiscal ’25. And if so, we’ll adjust our ’24 repurchase plans accordingly. We remain committed to our capital deployment priorities of managing our investment-grade credit rating, investing appropriately in the operations of the company and returning capital to shareholders. There is no change to our approach or our capital deployment strategy. Now turning to the fourth quarter outlook. In GBS, while 3Q bookings improved, we’re seeing longer than anticipated conversion to revenue, which reflects continued caution on the part of our customers. As a result, we expect GBS year-over-year performance to be similar to the third quarter.

GIS year-over-year organic revenue growth is expected to decelerate compared to third quarter, largely due to lower modern workplace resale revenues. This brings total Q4 organic revenue to minus 6.5% to minus 5.5%. We are expecting somewhat similar adjusted EBIT margins compared to the third quarter and anticipate a range of 7.0% to 7.5%. And finally, non-GAAP diluted EPS of $0.80 to $0.85. Turning to our full year ’24 guidance. We are reducing our organic revenue growth to minus 4.5% to minus 4.3%. Adjusted EBIT margin guidance is lowered to 7.1% to 7.2% and EPS to $3 to $3.05, reflecting a tax rate of 34% versus prior full year guidance of 30%, which has an EPS impact of $0.18. We are maintaining our free cash flow guidance of $800 million.

With that, let me turn the call back to Raul for key takeaways.

Raul Fernandez: Thank you, Rob, for your detailed update. I want to express how excited I am to be here leading DXC. I’m convinced that we have a significant opportunity to enhance the execution of this company. We have the right team and the right capabilities to enable us to succeed. I also want to thank the thousands of DXC customers who place their trust in our team every day for this mission-critical work. With that, operator, please open the call for questions.

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Q&A Session

Operator: Thank you. [Operator Instructions] Your first question comes from the line of Bryan Bergin of Cowen. Your line is open.

Bryan Bergin: Hi, guys. Good afternoon. Thank you. Maybe we’ll start with strategy here. And Raul, nice to meet you. I understand you’ve been close to the daily operations here for just over a month. But as you officially become CEO, can you talk about what changes you may be considering? Kind of what do you consider to be maybe the top one or two specific action items for you here in the near term? And just as you think about the offerings, all of the offerings that DXC currently have makes sense to remain in the portfolio?

Raul Fernandez: Yeah. I’ve been spending a lot of time with the business units individually with the geographies and looking at some areas that I think we can execute at a faster, more efficient pace, how we sell, how we solution, how we deliver, how that turns into revenue and ultimately, how that revenue becomes more profitable. There’s a lot of little things that add up and make a big impact. And I think a focus on those things, a focus on execution, operational excellence. This business has a lot of rates times hours, but rates times hours can become frameworks. Those frameworks can become replicable solutions. There’s a lot of things that I think we can do that the industry does that I’ve done over the years in not just my company, but in other companies that I’ve advised, invested in or been on the board of.

And I think it just gets down to a lot of better execution across the board. That also includes messaging. I think as I sit and hear the mission-critical systems that we develop, we deploy and maintain, it’s an incredible amount of great case studies, great content, great solutions, great wins for great global brands. And we really have undersold ourselves in the storytelling and case study area. And so that’s going to be another focus area. I think it’s a lot of focus on execution across our business units. We talked a little bit about finalizing our go-to-market model. We’re accelerating all of that. So it’s about speed, efficiency and delivering better and faster.

Bryan Bergin: Just a question on the offerings, do they all make sense?

Raul Fernandez: Yeah. I think the offerings all make sense. I think they all have different comps. If you were to sit back as a private company and say, how would you value this, you’d probably take a whole different set of comps across the board. I’m only here 40 days. I’ll have more to say on that in the next call and the one after that.

Bryan Bergin: That makes sense. Maybe, Rob, one just on free cash flow. So if the move to breakeven in growth may be a little bit more distant in a slower spending environment, can you talk about what else you can optimize in free cash flow drivers and maybe capital lease outlays as we think about the future here on free cash flow?

Rob Del Bene: Yeah. Absolutely. And I think we’ve demonstrated in the prior quarters and in the third quarter that we are tightly managing those capital expenditures and new lease commitments, and we’ve made steady progress in bringing down those requirements and contributing to the free cash flow and that’s going to continue, that’s not a temporary discipline. It’s a discipline that will continue into the future. The working capital management that we exhibited in the third quarter was improved as well, and we will continue that march into the future as well. So I do think there is room for continued improvement across the board, and that’s what we’re going to drive.

Bryan Bergin: All right. Thank you.

Rob Del Bene: Welcome.

Operator: Your next question comes from the line of James Friedman from Susquehanna. Your line is open.

James Friedman: Hi. Thanks for taking my question. Congratulations, Raul. You mentioned in your prepared remarks that you were anticipating potentially participating, I think was the language in the growth in security. And it does seem to us like it has underperformed the wider market. So I was just wondering, how is it that you’re going to accelerate growth there?

Raul Fernandez: Sure. Great question. Thanks and nice to meet you. I think there’s a couple of issues. One is how we have traditionally sold it. It’s been an ingredient across multiple business unit sales and did not have a focus on selling the great people, the great projects, the great case studies that we have as a stand-alone. So we’re emphasizing the ability to go-to-market directly in Mark’s business unit and being able to tell the story, both in combination with the other business units, which is kind of the history but also by itself, I got to participate in the last 30 days in an RFP exercise where we made it down to the final four, we didn’t make it past the final four, but it gave me a really good sense of where we could do better, how we can position ourselves better.

As you know, that segment is growing, and we’re not growing anywhere near the rate of the market. So there’s some upside there that I think if we approach it with the right additional talent and the right focus, we can see those results because the demand backdrop is there and our abilities and our capabilities and our people are here. So connecting those two is the first step.

James Friedman: And then if I could follow up on the insurance segment. So conversely, that’s really been a darling child outperforming the other segments and probably the market as a whole. So I’m just curious, when you look at that segment, what is it that differentiates that in the marketplace? You had some comments in your prepared remarks. But so what are the kind of standout qualities of the insurance practice?

Raul Fernandez: I think if you were to look at the insurance business as a standalone, you’d see that it’s a mix of traditional perpetual license and maintenance. You’ve seen that has a mix of SaaS revenue, other business process outsourcing services and other professional services. And I think if you were to look at it and value it on its own, you’d look at very different comps and very different metrics. Today, it is one of 6 where we’re indexing in terms of the metrics that we look at, the metrics we follow, more towards the people side of the business and less towards the SaaS side of the business. And I think we can do a better job at positioning it and also picking the right metrics that matter for the business unit. So that is one that I’m extremely excited about because the fundamentals are there. And I think if we do a better job at telling the story and selling the story, we’ll be able to extract more value there.