DXC Technology Company
Q3 2021 Earnings Call Transcript

Published: 4 Feb 2021

[Company Representatives:]

Mike Salvino - President, Chief Executive Officer Ken Sharp - Executive Vice President, Chief Financial Officer Shailesh Murali - Investor Relations

[Operator:]

Good day everyone and thank you for standing by. Welcome to today’s DXC Technology, Third Quarter Fiscal Year 2021 Earning Call. A quick reminder that today's conference is being recorded. At this time I’d like to turn the floor over to Shailesh Murali. Please go ahead, sir.

[Shailesh Murali:]

Thank you and good afternoon everyone. I'm pleased that you are joining us for DXC Technology’s third quarter fiscal 2021 earnings call. Our speakers on today's call will be Mike Salvino, our President and Chief Executive Officer; and Ken Sharp, our Executive Vice President and Chief Financial Officer.

[Mike Salvino:]

Thank you, Shailesh, and I appreciate everyone joining the call today, and I hope you and your families are doing well. I’ll walk through today's agenda in a moment, but before I do that I want to briefly discuss the press release we issued on Monday, February 1. As we announced last month, we received an unsolicited and non-binding proposal from Atos to purchase the DXC. Our board reviewed the proposal carefully with our financial and legal advisors and found it to be inadequate and lacking certainty given the value our board believes we can create on a standalone basis by executing on our transformation journey. After sharing some high level information with Atos to help them understand why their proposal undervalued DXC, Atos and DXC agreed to discontinue further discussions. We're confident in our transformation journey and our Q3 results shows strong evidence that our team is executing. We are flattered that Atos saw the value we are creating and clearly has taken notice of our new leadership team and how we are delivering for our customers and winning in the market. I was pleased with how we managed the proposal, as it did not linger, we stayed focused on our business and it helped highlight some areas where we can accelerate our transformation journey and create additional value. With the new leadership team in place, I am looking forward to sharing the details of our FY ’22, full year plan and longer term expectations on our Q4 earnings call. We are also planning an Investor Day to discuss in more detail our plans and introduce you to our leadership team.

[Ken Sharp:]

Thank you, Mike. Let me begin by saying how excited I am to join the DXC and be part of the team that Mike has assembled. Let me provide you some insight into my thought process on why I joined, which came down to three main factors. The team Mike assembled, the transformation journey, and third the investment thesis of how DXC would create value. After spending time with Mike and the team, I'm convinced that DXC can execute on the investment thesis I was contemplating. This includes stabilizing revenue, expanding margins and delivering free cash flow. When we achieved this thesis, I believe DXC will be successful in unlocking significant value. Now, let me talk about the team Mike assembled. Let's face it, companies with the best people win. The strength of the team delivering on the transformation journey is clearly visible in our Q3 results. At DXC there are three main areas that our finance team will focus on

[Mike Salvino:]

Thanks Ken and let me share three key takeaways on our progress we are making at DXC. First, we are bringing the DXC to the market and have demonstrated solid momentum in executing on our transformation journey. This is translating into consistent quarter-on-quarter revenue stability, sequential margin expansion and a book-to-bill number of 1x or greater. Second, as we are on track to complete the sale of the healthcare provider software business and use the proceeds to pay down debt, further strengthening our balance sheet. Third, with the additions of Ken and Michael, we have built and finalize the new leadership team that is executing on our transformation journey and producing strong results. In closing, I am pleased with the level of stability momentum we are achieving. We have done well attracting talent, improving the environment for our people, strengthening our customer relationships, taking out costs without disruption and continuing to win in the market. We expect all this positive momentum to continue in Q4, and with that Greg, please open the call up for questions.

[Operator:]

Absolutely, sir. And our first question is going to come from Ashwin Shirvaikar from Citi.

[Ashwin Shirvaikar:]

Well, thank you. Hi Mike, hi Ken, welcome! Good to see the progress here. Mike, you alluded to the process of sort of enhancing the customer relationships and I wanted to ask, what part of – to what extent are you still playing defense, which is you know keeping what is figuring out what your clients want, what their perspective is versus offense. How successful has the recent pushed to cost selling been and so on? And what percent of sold work is sole source and is there a target for that?

[Mike Salvino:]

Ashwin, first of all good to hear you. On the customer relationships, the key thing is, I like page 13 a lot. That's where we show the enterprise technology stack and the key testament to customers’ getting better are the fact that they're giving us more work. So I look at that and the reason why I wanted to show you that progress was when you looked at Q1 this year and the minus-5.7%, you'll see that all of that was negative, and what we have said point time and time again is that we're going to rebuild these relationships and then we're going to start stabilizing the revenue. So having all four of the areas of the enterprise technology stack negative in Q1 and then flipping those two three positives with only one negative is huge and that's a testament to what myself and the team are doing. I think the customer relationship area went from an area of weakness to now an area of strength. And then Ashwin just to finish that, when you look at that 1.8% negative ITO, that’s probably the number I'm most positive about and proud of on that whole stack, because that was the thing when I came in that everybody said that that was the work that that was moving away from us and it's actually not moving away from us anymore. The last thing is this, when I look at the amount of work that we're winning, 55% new work 45% from renewals, you can see that the renewals are usually sole sourced and a good portion of the new work also is sole sourced on those customer relationships.

[Ashwin Shirvaikar:]

That's great to hear. So I guess the obvious follow up then becomes, as you look at your emerging sort of business profile, if you have then posted divestitures, including the improving stack, can you comment on what and a sort of a normalized margin profile might look like or at least help us frame that?

[Mike Salvino:]

The way I would frame the margin profile is, you've seen us all throughout this year continue to expand the adjusted EBIT margin. We also see that there are still levers, we can pull. So when I mentioned the fact of what we've gone through over the next 30 days, that’s we sharpened our pencil on other areas that we can also pull. So those levers would include things like real estate, things like overhead. Ken’s all over the overhead. I've talked before about contractor conversion. What that means is I’m going to start paying a premium for a contractor and hire the person. And then the other thing that I'm excited about is our operation automation, something I've done with in my past. We’re done with our pilot, Vinod has a done a great job with that. So you should expect from us continued margin expansion.

[Ashwin Shirvaikar:]

Got it. Thank you. Keep up the good work.

[Mike Salvino:]

Thanks Ashwin. Greg, next question.

[Operator:]

Absolutely, sir. Next from Morgan Stanley we have James Faucette.

[James Faucette:]

Thank you very much. Well, going on kind of Ashwin’s comment, obviously you’ve done a lot to kind of reorient the business. You’ve highlighted multiple times stabilizing it and that’s obviously I think been surprising to some people, you’ve been able to do that so quickly. Sitting here today, as we look forward, how are you thinking about “where the puck is going” like what kinds of abilities or practices do you think are going to be important for DXC to add and how do you think about going about adding those?

[Mike Salvino:]

So the – James, good to hear your voice and thanks for the question. I have said before that when you look at the enterprise technology stack, I like the hand that we have. We’ve got good scope and scale across the way that our clients think about technology. So when you think about whether its ITO cloud security application in analytics and engineering, there's stuff that we have to do there. And look, I know that you're not thrilled about us rationalizing and then delivering, but that focus will allow us to get to where we need to be on revenue growth, because we've got too many things going on in the industry right now and we need more focus. That, along with the decision that we made to keep our modern workplace couldn't be more thrilled that the ecosystem has decided to partner with us, specifically Microsoft and get into that area with us. Now, having said that, we obviously want to see the mix changing too. We’ve got to move from the bottom of the stack in terms of the top of the stack. But the others stat I will give you is we still have a customer base where they are aspiring to move roughly 20% of their work over the next two years to the cloud, but 80% of that work that is remaining, 60% they want to see modernized. So look, I like the handle we have James. We're going to continue to make sure we're focused on selling the stuff that we have and then I think I will end with you’ve seen I've got a propensity to buy tactical tuck-ins. I'm not big on buying big things, I'm big on buying things that help me focus on that enterprise technology stack and then I know can scale through our best accounts. So that's where I take the relationships and push it against our offerings and marrying the two, I should be able to sell more to those best clients.

[James Faucette:]

That’s very useful, and I know that you and Ken have both talked about preparing a broader presentation for the investment community at a future analyst meeting, etcetera, and particularly as it related to capital allocation and returns, but you know as you think about those type of tactical tuck-in, is that something that you think you can go through a period of time or just be opportunistic, or is that something that you end up being kind of similar to the big players in the space, doing on a consistent and kind of prescribed basis, at least in terms of proportion of capital allocation.

[A - Mike Salvino:]

I’ll say James with what we said in our script, and that's the fact that we plan on coming back in Q4 and showing you our capital allocation strategy. So in that strategy you'll see our thoughts on dividend, our thoughts on buy back and then our thoughts on investment. And with Ken having 60 days in the seat, 30 of which were spent in the dealing with the latest proposal, I just want a little bit more time to go through that.

[James Faucette:]

That’s great, thanks a lot.

[A - Mike Salvino:]

Thank you, James. Greg, next question?

[Operator:]

Alright sir, next we have from DeepDive Equity we have Rod Bourgeois. Please go ahead sir.

[Rod Bourgeois:]

Hey guys! Hey, nice incremental turnaround progress in the December quarter in you’re guiding toward revenue stability. But guys, let me ask about the elephant in the room. You apparently just told Atos that its takeover premium was so inadequate that they walked away even though it seems merging with DXC was Atos’s best strategic idea. So to have so clearly pushed off Atos’s takeover bid, you have to be banking on a fundamental trajectory for DXC that's more compelling, seemingly more compelling beyond your outlook for revenue stability. So here's my question, what fundamental improvement drivers are giving you such conviction to turn down the takeover premium today and I'm not necessarily asking for fiscal ‘22 guidance. I suspect you're waiting until fiscal ‘21 is over to do that, but I would like to ask, what are the fundamental drivers that are giving you such conviction today about your trajectory and your willingness to turn down the takeover bid?

[A - Mike Salvino:]

Rod thanks, good to hear your voice. So look, I'll cover three items, the first one is revenue stability and again, all these things tied back to what we've been saying all along. So on revenue stability we just delivered our second quarter of revenue stability and have guided towards the third quarter. So we believe we're headed towards revenue stability year-on-year in FY ‘22 and I think anybody that has followed DXP would say that's pretty strong accomplishment. Second is, within revenue stability it's those customer relationships and I know you all do your customer checks and so forth and those relationships are becoming deeper and deeper, where they're coming to us as a trusted partner for more work. The second thing is adjusted EBIT margin that I mentioned to Ashwin. The fact that we are expanding margin and the key thing is sustainability and we believe that we can keep it sustainable along with having levers like the facilities, like operational automation, contractor conversion and even overhead to name a few. We think we’ve still got levers to pull on to continue to expand this thing, the margin going forward. And then, look, you can't have revenue and margin without winning in the market and we think because of the book-to-bill of 1.0 or greater that the pendulum swung a little bit in our favor. We're seeing the need to fix these IT environments before you can get transformed. We think CIOs are looking at us now and saying that the biggest thing that will kill a transformation to anything digital is if the existing environment doesn't work and that's why I highlighted the green 1.8 in Q3 from a growth standpoint on a sequential basis. The other thing is this, when you look at our existing customers, there's no doubt they are buying more and I love the progress that we're making on the ecosystem. That's why when Ken mentioned what we did with our partners, we're now going after our partners the same way we did our customers. We are rebuilding those relationships, because that ecosystems important to us and again I'll highlight the fact that Microsoft was willing to team with DXC to get into modern workplace, that's a game changer. So that's what we were looking at Rod and when you put all that together and take the board through it, you see more value than what the proposal was all about.

[Rod Bourgeois:]

Alright, so great! So it’s a good segue to my other question I wanted to ask on. Are you seeing real evidence that DXC's competitive position has improved? If I look at IBM it’s preparing for its spin off and that's been a distraction for IBM in the market and Atos is behavior suggests that its organic prospects are not too encouraging. So you've got two major competitors that are in that status. So especially given the competitor backdrop there, I really like to know if you're seeing any tangible evidence that your turnaround is helping your competitive position. Can you share any tangible evidence of what's happening on the competitive front?

[Mike Salvino:]

So Rod the first thing is, I'll continue to go back to the book-to-bill number, that's tangible evidence. I mean keeping that thing up above 1.0 is huge and then look, it goes without saying, we recently engaged with a competitor and when a competitor wants to engage with you, you can rest assured they’ve seen, right, good trends for us in the market. So look, that's the tangible evidence. We're very pleased about our position. We're also very pleased that, like I said during the last earnings call or at least I mentioned it just a little bit is the fact that we're very clear about what we got to go get done. The strategic alternatives initiatives are over and it's all about execution now. So Rod, that’s how I’d answer your question, thanks.

[Rod Bourgeois:]

Thanks guys.

[Mike Salvino:]

Greg, next question.

[Operator:]

Next question will come from Lisa Ellis with Moffett Nathanson.

[Lisa Ellis:]

Hi, good afternoon. Good to hear your guys’ voices. First one, Mike for you yet another kind of follow-up on the Atos approach. I would imagine as you are the best, probably not the only one of those that you're going this year. So can you just talk more broadly about how you think about the pros and cons of the larger scale merger versus what you can do on your own?

[Mike Salvino:]

Well look, in terms of what we can do our own, we really like our chances, okay. We are confident in our transformation journey and like I’ve shown, I've laid out a plan and you guys can see that Lisa we are executing against that plan. It was never part of my plan to come here in 16 months and then all of a sudden sell the company; you can't recruit a brand new leadership team if that's your strategy. So I like our chances in terms of DXC on a standalone basis.

[Lisa Ellis:]

Okay, and then my follow-up is just, you know related to bookings then also linking that to the sequential improvement in revenues, both of which as you’ve highlighted are very encouraging. Can you just talk a little bit about the mechanics? I mean bookings have now been running over 1.1 for about 12 months, which should imply some very healthy revenue acceleration at some point. Can you just dimensionalize a bit kind of how that conversion works, meaning are you still in a situation where your backlog is weak or low until you’re sort of reselling the bathtub so to speak or you know what I mean. Like what – how should we think about when the sort of sequential improvement in revenue is combined with like the bookings growth kind of come together? That’s still a few quarters out or how do you think about that? Thank you.

[Mike Salvino:]

Yes, what we are saying is we just delivered the second quarter stability, right. So that stability marries what's happening with the revenue run off because of the terminations with the positive 1.0 or greater bookings, okay, so just balancing that stuff out. So stability means, obviously that we're not losing more than we are winning. We also guided towards our third quarter revenue stability. So we're clearly looking at ‘22 is that year for year-on-year revenue stability Lisa. That’s – I mean I tell my team it's just math. So what we need to do is continue executing on our transformation journey. So that's the way we look at that.

[Lisa Ellis:]

Terrific! Thank you.

[Mike Salvino:]

Greg, next question.

[Operator:]

Next will come from Bryan Bergin with Cowen and Company.

[Bryan Bergin:]

Hi, thank you. Ken welcome. I want to ask revenue trajectory around the ITO layer. So obviously an improvement is encouraging here. I’m curious whether there’s anything notable in the client portfolio. Any large scale renewals or impending price down, the risk to be aware of, that would not enable DXC to maintaining this type of improvement in the coming period. And do you view this as a business that can ultimately stabilize too, specifically the ITO layer or are the secular headwinds here just too challenging for such a plan.

[Mike Salvino:]

I mean Bryan, I continue to talk about the fact that, and I gave the stats. I took virtual clarity and I went and studied our best clients. And again, what they told me was they aspire over the next two years to move another 20% of the existing work I'm sitting on to the cloud. Now, after I took them through the analysis that virtual clarity does, which is technical feasibility risk business case and their ability to deliver that 20% dropped to 5%. Now I don't much care whether it's 20% or 5%, we need to win our fair share, but Bryan what that means is there still a healthy dose of this whole secular run off. Certainly that stuff is going to move to the cloud, but the other thing I would tell you is we are now into the And Phase of the cloud journey. Now what is that? The OR phase was ITO ‘or’ Cloud, which meant that most of this work on on-prem moved to the public cloud, one or the other. When you're now in the AND phase you're dealing with critical applications and those critical applications just don't move directly to the cloud. In fact you're now managing workloads. Sometimes the application will move to the cloud, sometimes the data will stay there. Why am I going to this level of detail? Because the bottom line is the fact that that's opportunity for us, meaning if clients want to move to the cloud, they need our expertise knowing how to run what they have to move to the cloud. And then what I'm focused our team on is the existing estates. So when you talk to a number of our customers, you will see that we are building these estate maps and these estate maps is basically a road map for us to say what else needs to be updated on those environments and then that is the thing that's helping that green layer give back to zero. Look, I'm not trying to sell to you that the green layer is going to be some sort of growth, but I am selling the fact that that thing can be stabilized if you take care of your customers. So Bryan, that’s the answer to that question.

[Bryan Bergin:]

No problem, it makes sense. And then just talking about a work force, at what stage of the talent refresh are you at? How are you thinking about headcount and hiring here in the next couple of quarters?

[Mike Salvino:]

So look, I mean, I’m absolutely thrilled about our new leadership team and when we hire a new leader, I at least talk about the fact that they owe me 10 new hires and we're going to continue to augment the talent that we have in DXC. So we are now going through – I think the leadership team is rebuilt. I want to get to the middle managers and see how they're doing and then continue to put them into our new operating model that's very customer focused. So Brian, that's the way I would answer that question too.

[Mike Salvino:]

So listen, I want to thank each of you for joining the call today. I couldn't be more pleased about the level of stability and momentum we are achieving by executing on our transformation journey and we are confident that the momentum we created in Q3 will continue in Q4. With that, all the best to you and your families and Greg, please close the call.

[Operator:]

Absolutely, sir. And once again ladies and gentleman, thank you for joining us today. That will conclude our call. We do appreciate you dialing in and participating and you may now disconnect.