Conduent Incorporated
Q3 2022 Earnings Call Transcript

Published: 1 Nov 2022

[Company Representatives:]

Cliff Skelton - President, Chief Executive Officer Steve Wood - Chief Financial Officer Giles Goodburn - Vice President, Investor Relations

[Operator:]

Good afternoon, and welcome to the Conduent Third Quarter 2022 Earnings Announcement. At this time all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions]. Please note that this conference is being recorded. I will now turn the conference over to your host, Giles Goodburn, Vice President, Investor Relations. Thank you. You may begin.

[Giles Goodburn:]

Thank you, operator, and thanks everyone for joining us today to discuss Conduent’s third quarter 2022 earnings. We hope you had a chance to review our Press Release issued earlier this afternoon. Joining me today is Cliff Skelton, our President and CEO; and Steve Wood, our CFO. Today’s agenda is as follows

[Cliff Skelton:]

Thank you, Giles. Welcome everybody! Glad to have you with us today. Let me begin by saying that Q3 felt pretty good for us. Our adjusted revenue came in at $977 million, right where we expected it to be and adjusted EBITDA at $105 million with a 10.7% margin, both slightly better than expected. So very pleased with how Q3 came out, especially given the economic conditions we’re all experiencing these days. Our new business ACV signings were quite strong at $191 million. One of the best Q3’s we’ve had, and so we liked our overall sales performance, especially from our account management teams. Net ARR activity continues to be positive at $70 million. Now as I’ve discussed in the past, that net ARR activity metric is going to be lumpy from quarter-to-quarter, and what we want to see is a positive number every quarter, because it means we’re selling more than we’re off-boarding or losing, if you will. One loss or win, especially in the public sector, can skew any individual quarter, but not the historical trend. In addition to having a strong sales quarter, we also see an expanding pipeline that bodes well for the future, especially in the public sector. Steve is going to get into that here in a moment. We’re also optimistic because we’ve got a lot of big deals on the horizon, again, especially in the public sector. We expect to land a few of these, which should be meaningful. A couple of other key highlights in Q3 that we’re quite proud of

[Steve Wood:]

Thanks Cliff. As we have done in the past, we are reporting both GAAP and non-GAAP numbers. I would like to point out that certain non-GAAP measures adjust for the Midas divestiture. This is similar to past practice. The reconciliations are in our filings and in the appendix of the presentation. Let’s turn to slide five and discuss our key sales metrics. Our primary sales metric ACV grew 27% for the quarter as compared to Q3, 2021. It was also up approximately 6% sequentially and we have now posted sequential growth in this key sales metric for the past five quarters. Year-to-date we are up 15% as compared to the first three quarters of 2021. All three segments posted year-over-year increases in ACV sales attainment, and we were once again particularly strong in the commercial segment with $114 million of ACV. New business ARR was up 3% as compared to Q3, 2021 and is up 1% year-to-date as compared to 2021. Both the commercial and transportation segments are up quarter-over-quarter and year-to-date as compared to 2021. The government segment is currently down, but our late-stage pipeline of opportunities remains extremely strong. TCV was also up approximately 3% as compared to Q3, 2021. The net ARR activity metric, our combined measure of wins, losses, pricing effects and other contractual changes was positive for the seventh quarter but was down sequentially. The reduction was driven by a renewal price adjustment on a long-standing client, as well as a contract termination, both within the government segment. The combined impact of these discrete items on the metric was $75 million. Both items were understood and anticipated, and most importantly, they have already been built into how I guided the revenue expectation for the government segment for 2023 at the beginning of the year, that is a mid to high single digit decline. Their inclusion in the net ARR activity metric this quarter reflects the expiration of the protest period in the former and formal notice of termination in the latter. Let’s now turn to slide six and discuss some of the key sales metric trends. As I mentioned earlier, our trend on new business ACV, our primary sales metric is encouraging with ACV increasing sequentially for the past five quarters. Our TCV will fluctuate significantly quarter-to-quarter as we have said in the past, given the change in mix of deals between segments. Commercial segment deals average about three years, whereas those in the government and transportation segments are typically much longer in duration. This drives a lot of the variability in TCV, as well as average contract length. It was a strong quarter for NRR growing 30% sequentially and 56% year-over-year. ARR was up 3% year-over-year as compared to Q3, 2021 and is up 1% year-to-date as compared to 2021. The sequential decline in ARR as compared to Q2, 2022 is a function of a lighter year so far for government contracts, which we expect to reverse in the coming quarters. Now let’s turn to slide seven and discuss our Q3, 2022 financial results. Overall, as Cliff mentioned earlier, Q3 finished in line with where we expected it and where we guided when we laid out our expectations to you during our Q2 earnings call, slightly better when considering more unfavorable exchange rates impacting our international transit and European commercial businesses. This was a $5 million revenue headwind against that guidance during the quarter and an overall $14 million revenue headwind when compared to Q3, 2021. In terms of the numbers themselves, adjusted revenue for Q3, 2022 was $977 million as compared to $1.02 billion in Q3, 2021, down 4.1% year-over-year or down 2.7% in constant currency. The year-over-year headwind from the one-time government stimulus volumes from 2021 rolling off in the quarter was $68 million. This is the largest quarter to roll off versus 2021 and next quarter, the number is expected to be approximately $34 million. Within the quarter, we did get a $15 million revenue benefit from a minimum contractual revenue commitment from a large client, which was anticipated in how we guided Q3, but that will not repeat sequentially in Q4. Adjusted EBITDA was $105 million for the quarter, down 11.8% as compared to Q3, 2021 and the adjusted EBITDA margin of 10.7% was down 100 basis points year-over-year, again, largely driven by the margin loss from the one-time government stimulus volumes roll-off from 2021. Adjusted EBITDA was slightly ahead of our internal expectations for the quarter driven by ongoing cost efficiency work and a more favorable mix, which included interest rate impact in our BenefitWallet business. Let’s now turn to slide eight and go over the segment results. For Q3, 2022, Commercial segment adjusted revenues were $504 million, up 2.2% year-over-year. The segment benefited from the minimum volume commitment mentioned earlier. Foreign exchange headwinds were $8 million in the quarter as compared to the prior year and we earned an incremental $8 million from higher interest rates on our BenefitWallet business. Adjusted EBITDA for the quarter was $68 million, up 70% as compared to Q3, 2021. Adjusted EBITDA margin was 13.5%, up 540 basis points. Both reflected the impact of the volume commitment noted earlier, as well as higher interest rates positively impacting our benefit wallet business and cost efficiency programs. Within the Government segment, adjusted revenues for the quarter were $291 million, down 15.9% year-over-year as compared to Q3, 2021. The year-over-year impact of the runoff of government stimulus revenues was $68 million in the quarter, which I noted earlier is the largest compare against 2021. Removing that impact, the underlying base business would have been higher by about 4.8% year-over-year. Adjusted EBITDA for the Government segment in Q3, 2022 was $88 million, down approximately 34% year-over-year, reflecting this runoff of government stimulus volumes, partially offset by operational efficiency initiatives. The adjusted EBITDA margin of 30.2% was down 820 basis points year-over-year. Transportation segment revenues in Q3, 2022 were $182 million, up 1.1% year-over-year, including a $6 million headwind from foreign exchange in the quarter impacting our international transit business. For the Transportation segment, adjusted EBITDA for the quarter was $25 million, up 13.6% as compared to Q3, 2021, and the adjusted EBITDA margin was 13.7%, up 150 basis points year-over-year. Let’s turn to slide nine and discuss the balance sheet and cash flow. Our total liquidity position is very strong. We ended the quarter with $587 million in total cash on the balance sheet and our $550 million revolving credit facility is almost completely unused at this point. Our net leverage ratio is 1.7 turns, which we believe is below our normalized range of 2 to 2.5 turns. In addition to the strength of our total liquidity position, our debt maturities are long dated, and we have no significant debt repayments until 2026. As Cliff noted in his prepared remarks, we see opportunities to refine capital allocation. More to come as we get to our primer and our investor and analyst event, but we come at it from a position of relative strength. As I noted in our Q2 earnings call, Capital expenditure as a percentage of revenue decreased during the quarter to 2.8% and we expect Q4 to yield a similar percentage. Let’s turn to slide 10 and review our 2022 outlook. As Cliff mentioned earlier, we are beginning to see some effects of economic headwinds. More specifically, we’re seeing discrete areas of volume softness that started in Q3 and will likely be a factor in Q4 and into 2023, largely within the commercial segment and more specifically in some of our travel and entertainment clients in the CX space. For sizing, this industry segment is less than 8% of Conduent’s commercial revenue base. This volume softness is in addition to the call-out we made in Q2 earnings when we noted a couple of our larger clients experiencing a level of post-pandemic normalization of their volumes, having an approximate $25 million to $30 million headwind this year. We now expect this headwind to be approximately $40 million on a full year basis and slightly more next year. As a point of clarity, these client demand-driven volume reductions are not part of our net ARR activity metric. The combined impact of these in the fourth quarter, along with further headwinds from foreign exchange, as well as timing of certain project revenues within the Transportation segment means we now expect overall Q4 adjusted revenues to be in the range of $985 million to $995 million. This would put us at or slightly above the low end of our previously guided full year range. Therefore at a segment level, we now expect the Commercial segment with these incremental impacts from volumes to be flat on a full year constant currency basis. Within this we expect the effect of currency to be an approximate $23 million headwind. We continue to expect the Government segment to decline approximately 13%, which ignoring the one-time benefit from government stimulus programs in 2021 would have the underlying business growing slightly in 2022. As a reminder, the year-over-year impact from the one-time government stimulus volumes is approximately $189 million. We expect the Transportation segment to be also approximately flat on a full year basis, adjusted for constant currency. The effect here we estimate to be an $18 million FX headwind. Some of the timing difference noted above on project revenues within the transportation business will likely catch up in 2023. Adjusted EBITDA margin for Q4 is expected to be in the range of 9.75% to 10.25%, which would put us at the midpoint of our previously guided full year range. We still expect to convert approximately 15% of adjusted EBITDA to adjusted free cash flow, inclusive of paying off the remaining portion of the deferred payroll taxes under the CARES Act. Similarly, we are not changing our outlook on CapEx or restructuring charges. Finally, we are continuing with our long-range strategy and planning efforts that will inform into our expected investor analyst event later in Q1, 2023 and its primer upcoming in December. Our current view and outlook for 2023, without adjusting for further interest rate or exchange rate variability is that we are expecting adjusted revenue for 2023 to be about flat for the total company, with modest growth in commercial and transportation being offset by the previously messaged decline in government. The volume effects noted earlier, a part of that change to the outlook and we’ll talk more about those in December in terms of how that informs into our thinking around other things, capital allocation. Expect to hear more from us in the coming weeks around the exact timing for both of these communications. That concludes our financial review for Q3, 2022, and I’ll hand it back to Cliff for some more closing comments before we then take some questions. Cliff.

[Cliff Skelton:]

Thanks, Steve. We’ll turn it over to the operator for some questions here in just a minute, but I want to reemphasize a couple of key takeaways that Steve just discussed. First, Q3 was strong. Q4 retail volumes have some modest headwinds in it, putting us slightly above the lower end of our previous guidance, and recessionary like conditions will have a small effect on 2023 volumes, likely creating a flattish 2023. Now we have some big sales expectations in Q4 and into 2023, creating what we hope will be breakthrough expectations potentially influencing the out-years. That all said, please remember a couple of things. We said in 2020 that this would be a three to five year journey. Now after three years, our year-over-year growth has progressed from year-over-year growth decreases of nearly negative 8% to flat and even more impressive when normalized for the influences of COVID, both positive and negative. Yes, the expectation is for a sustained, positive year-over-year growth and that remains the journey we are on in this next phase, but we should first contextualize that from where we started. Meanwhile, our balance sheet is in tremendous shape. Not only do we retain more than reasonable net leverage ratios as Steve discussed, but we have over $1 billion of total liquidity. Conduent is a different company than it was just three short years ago, amidst the pandemic of a century, an unparalleled political climate, rising interest rates and a recession or recessionary-like conditions that are not fully manifested. We’re definitely proud of our progress. So with that, let’s open it up for questions. Operator.

[Operator:]

Thank you. [Operator Instructions]. Our first question comes from Bryan Bergin with Cowen. Please state your question.

[Zachary Ajzenman:]

Thanks. This is Zack Ajzenman on for Bryan. First question is one on the macro and the pipeline. How much has macro uncertainty impacted client behavior at this point? And also, can you characterize current deal cycle cadence and how that informs early views into calendar ‘23?

[Steve Wood:]

Hey Zack! Yeah, we’re not seeing a ton of macroeconomic influence over the pipeline in any negative way. In fact, the pipeline is stronger than it’s ever been, especially as I mentioned earlier in the Government and Transportation businesses. Transportation being more international, Government being primarily in the Government Healthcare business where we see a ton. Where we do see those macroeconomic influences if you will is more in the retail volume space that Steve mentioned in his prepared remarks where call center volume, specifically in the travel industry is causing some reduced revenue headwinds and in some of our technology space, but you know that certainly will recover as we get through these recessionary-like environments. With respect to deal cycle time and the model, I would break it into sort of two parts. One, we are seeing some delays from, let’s call it announcement of a deal to the signing of a deal in the government space specifically and also a little bit in transportation, not so much in commercial. What we’ve got to do and that we can control is when we implement, we’ve got to implement on the time line we committed to with near perfection, as I mentioned in my remarks, because every milestone represents revenue. So we’re all over that, and we see upside to be honest with you, as it relates to the pipeline.

[Zachary Ajzenman:]

Got it, that’s helpful. And our follow-up is on the net ARR metric. Can you just shed a bit more color on the underlying dynamics here? It sounds like it was embedded in the original guide, but perhaps you could talk about the metric and how it’s performed relative to expectations, excluding these select client volume loss.

[Cliff Skelton:]

Yes Zack. Steve, I’ll take this. I think the metric is largely performing the way we expected it to. What you see in the effect of the quarter is obviously the two deals that I referenced causing it to be down sequentially on a trailing 12-month basis in the quarter. But as you said, those were already things that we fully anticipated, and so they’ve been baked into the guidance and into how we were thinking about the outlook. So this is one of those odd examples where the – we’ve got out a little bit in front of that in terms of how we’ve messaged how the Government segment is going to perform in 2022 and into 2023, and this is the metric, a little bit catching up on it. So overall, our expectation is that that metric continues to be positive and Cliff talked about the fact that we’ve got a very strong late-stage pipeline in the government healthcare business, and you know at the point at which those deals hopefully get inked in the next coming quarters, then we were likely to see that net ARR metric spike up again.

[Steve Wood:]

Yes Zack, I wouldn’t react to - I mean as long as that number is positive and the slope is upward, it’s a good sign. I wouldn’t react to the lumpiness of a slightly low quarter, and I wouldn’t overreact in a positive way due to the lumpiness of a really big number quarter. You know it had one deal rolled off in the timing that we thought it would have. You know you would have seen a much higher number, and you’re likely to see a much higher number in the future. That’s also not something we should react to when it’s a trend, not any individual quarter number.

[Zachary Ajzenman:]

Very helpful. Thank you.

[Cliff Skelton:]

You bet. Thank you.

[Operator:]

Thank you. And that’s all the time we have for questions today. I’ll hand the floor back to Cliff Skelton for closing remarks.

[Cliff Skelton:]

Listen, thank you everyone for joining us. As I mentioned, there’s a lot to do. There’s a lot of opportunity, and there’s a lot to be proud of when we consider as I mentioned where we started this journey just three years ago when we were experiencing that negative 8% year-over-year growth rate, and an unstable operating environment and uncertain future. It’s definitely a different company now. I’d like to thank our associates, our clients and our shareholders for their continued support along the journey. I appreciate everybody joining today, and here’s to a great finish in 2022. Thank you very much.

[Operator:]

Thank you. And that concludes today’s conference. All parties may disconnect. Have a great day!