Earnings Transcript for CNDT - Q4 Fiscal Year 2023

Operator: Greetings, and welcome to the Conduent Q4 2023 Earnings Announcement. [Operator Instructions]. As a reminder, this conference is being recorded. It is now my pleasure to introduce 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 Fourth quarter and full year 2023 earnings. We hope you had a chance to review our press release issued earlier this morning. Joining me today is Cliff Skelton, our President and CEO; and Steve Wood, our CFO. Today's agenda is as follows

Clifford Skelton: Thanks, Giles, and thank you all for joining Conduent's Q4 and year-end 2023 earnings call. Hopefully, this will be the last call, earnings call where we don't have Q&A at the end. We've been working to establish a sell-side group to help provide services so that we have Q&A on the next call. But let me start by saying, like everyone else, a lot's happened in our company since the last Q3 earnings call, both from within our own portfolio and our clients. As you know, Conduent retains a very diverse platform of products and services, spanning the myriad of industries in both commercial and the government space across federal, state and local levels. At times, we take advantage in the times we suffer through the changing financial pressures, our commercial clients' experience and oftentimes, the changing landscape, political and otherwise, that our government partners experience. But regardless of all that, the diversity of our offerings can be both a blessing and oftentimes, a headwind. On one hand, we're positioned to capture more opportunities than most because of our diversity. On the other hand, that diversity requires horizontal bandwidth and with that, sometimes, comes opportunity cost. This is all to say, we continue to be very focused on narrowing the company's scope. We want to be more nimble. We want to be more growth oriented. And you'll see in today's presentation a description of how we're progressing against this rationalization efforts you've heard us talk about in the past, and Steve Wood, our CFO, will take you through the resulting financial expectations, particularly indexed on a 2025 exit rate. We see this as described previously in our Q1 2023 investor briefing as a 3-year journey. And we just finished year 1 of that journey in a year where we announced 2 divestitures with expected net proceeds just shy of $500 million. Both of those expected to close in increments in the first half of 2024. You might have noticed, we also announced a $75 million share repurchase program in 2023. Meanwhile, let's begin with the results in 2023. Steve will, of course, take you through all the details. But Q4 and 2023 with large finished pretty strong for us. When compared to the outlook we presented in Q3 earnings, we exceeded expectations across adjusted revenue, EBITDA and EBITDA margins. Adjusted revenue for Q4 was $953 million and $3.7 billion for the full year. Adjusted EBITDA was $103 million and $378 million for Q4 and full year, respectively, and our adjusted EBITDA margin was 10.8% and 10.2%, respectively. Again, all these measurements exceeded our expectations for Q4 and the full year. However, regarding sales for the year, our performance was a bit of a tale of 2 cities. On 1 hand, our new business, ACV was down slightly year-over-year and quarter-over-quarter, but roughly flat sequentially. On the other hand, TCV, total contract value, an indication of future long-term growth, exhibited the best achievement since we became Conduent, up 20% to $2,257 billion. Meanwhile, revenue retention in 2023 was slightly better year-over-year. However, sales really, especially in the commercial space, created a sequential reduction in our net ARR number. As you might recall, our main focus is to keep that net ARR number positive and increasing to the new normal. And it doesn't take into account volume changes associated with market conditions or small shifts in the portfolio. But much like many of our commercial competitors experienced, market buying trends were slower in 2023. Steve will talk about that here in a minute. But it did add headwind to our sales performance. Net-net, 2023 from a financial perspective was stronger than most of our recent predictions but certainly had room to improve in both sales and cash generation. Speaking of cash, Steve will take you through the details, but the timing of our expected tax return, implementation milestone achievements in our Transportation business, both made for a year, we expect to improve upon in 2024. Regarding 2024, it's going to be a difficult or at least a different kind of compare. Again, Steve will provide an analysis of 2024 absent divestiture activity. But the fact is there will be a lot of divestiture activity and the revenue, expense changes, proceed increments and other predictions will have to include some level of predictability in 2024 expectations or flexibility anyway. For the last 3 earnings, we referred you back to the investor event we had in March. I'm not going to disappoint as I'll mention that yet again, as it does remain the linchpin for our go-forward strategy and execution plan. We've always stated that a rationalized portfolio will tee up several levers for the future. Let me talk about a couple of those levers. First and importantly, we expect to generate roughly $1 billion in capital to be used for highest and best future benefit. Some of that capital allocation will have timing components to it with increasing flexibility and optionality over time. That would include the obvious return to shareholder options and debt reduction as well as acquisition or internal investment options. Of course, there'll be more to come on that as the proceeds begin to flow in here later in March. Second, a more nimble, more global portfolio platform. Third, a narrower scope of products and capabilities that allow for better management bandwidth allocation while retaining that defensive nature we enjoy with a diverse portfolio. Fourth, better cash flow conversion rates and an enhanced valuation. Now as I mentioned, we announced the first 2 of our anticipated divestitures, which are expected to close and monetize as I also said in the first half of 2024. There are others in process as well. Again, the mission is to land on a $3 billion-ish, 3% to 5% growing company with reduced debt and an enhanced valuation at that 2025 exit. Steve will detail some components of that plan, but it's all of our job to make it happen. Lastly, we compete every day out in the market like everyone else, whether it's for new business or new talent in our workforce. Our team moved 59,000 associates worked very hard in 2023 to improve every aspect of our performance against that competitive landscape, and I'm proud of what we accomplished. Whether it's in the financials or the culture improvements or the industry recognition or the strong improvement in our client relationships, we made significant progress. And that progress takes time to bear fruit, but the foundation is built, and the next level of achievement is clearly on the horizon. So with that, I'll thank you in advance. And now I'll turn it over to Steve for the details. Steve?

Stephen Wood: Thanks, Cliff. As we have done in the past, we are reporting both GAAP and non-GAAP numbers. The reconciliations are in our filings and in the appendix of the presentation. Let's turn to Slide 5 and discuss our key sales metrics. In the fourth quarter, our primary sales metric, new business ACV, was down $42 million versus the prior year at $152 million, roughly flat sequentially against the third quarter and in line with what we expected, absenting the volume of larger deals in the Government segment, which were a feature of our Q4 2022 ACV results when we signed 3 large deals. This quarter did include the signing of another double-digit ACV new logo in our government health care space, comprising a module of our cloud-native Conduent Medicaid suite. Our Commercial segment is still experiencing longer decision-making cycles and cautious buying behavior, but finished the year stronger than it started, up 35% versus Q4 2022. For the full year, ACV was down 13% as compared to 2022, with most of this impact in the Commercial segment, where ACV was down 29%. And this was partially offset in the Government and Transportation segments, which in aggregate, grew their ACV year-over-year by approximately 8%. New business TCV was strong in 2023, growing 20% as compared to full year 2022. This was primarily due to the $1 billion contract we signed in Q2 with the State of Victoria, Australia, in our Transportation segment, where we began implementing the new account-based ticketing platform in Q3, and took over operations of the legacy system from the incumbent in December. As a reminder, this is a 15-year contract, generating implementation revenues over the next 3 to 4 years. Our net ARR activity metric, our combined measure of wins, losses, pricing effects and other contractual changes has continued to remain positive. This trailing 12-month measure does not predict the timing of revenue, but is based on the timing of notification. A full definition of this metric is covered in the appendix of our presentation. The Q4 2023 net ARR activity metric was down sequentially, primarily due to the roll-off of a strong ARR performance in Q4 2022 and lighter signings in certain areas of the Commercial segment during 2023. Losses were broadly in line with where we expected. Very briefly on Slide 6, you can see the large renewal quarter that we had in Q4 2023. Let's now turn to Slide 7, and discuss our full year 2023 P&L metrics. We finished the year with results coming in slightly stronger than how I messaged in our last earnings update, topping both our Q4 and modified full year guide. Revenue for 2023 was $3.72 billion as compared to $3.85 billion in 2022, down 3.3% or 3.6% in constant currency. We experienced stronger-than-anticipated performance in our Government segment, offsetting some softness in both our Commercial and Transportation segments, which I'll cover as I discuss the individual segment results later. Adjusted EBITDA was $378 million for the full year in 2023 as compared to $394 million in 2022. And our adjusted EBITDA margin at 10.2% was substantially unchanged compared to 2022. This was within our original full year guided range and slightly higher than how I laid it out in our last earnings update due to a couple of discrete items that affected the fourth quarter. Let's now turn to Slide 8 and go over the segment results. For the full year, Commercial segment revenues were $1.93 billion, down 3% as compared to 2022. The incremental BenefitWallet revenue in the year was an approximate $54 million tailwind and nonrepeating items in the prior year were an approximate $30 million headwind. New business ramp and add-on sales fell slightly short of outpacing loss business for the year, primarily due to the soft new business environment in 2023 in certain areas of the Commercial segment. The balance of the impact on revenue was lower volumes from some large clients, predominantly in the CX space in certain industries, including travel, logistics and telecom. We believe much of this is macro related and therefore, likely temporary. Commercial segment adjusted EBITDA improved 21% year-over-year, and the adjusted EBITDA margin of 14.2% was up 290 basis points year-over-year. Increased BenefitWallet revenue contributed to this margin improvement, along with operational efficiencies, and this was partially offset by lower volumes and nonrepeating items from the prior year. For the Government segment, full year 2023 revenue performed better than expected, declining 4.9% as compared to 2022. The year-over-year impact of the onetime government stimulus volumes in 2022, was a headwind of $42 million. New business ramp, including the 3 large deals we signed in Q4 2022, combined with stronger government payment volumes, drove the better performance, but not quite enough to outrun the known loss business from prior years. Government segment adjusted EBITDA declined by 1.8% year-over-year, driven by the impact of the onetime government stimulus volumes in 2022 and lost business, partially offset with the benefit from a portion of a legal settlement of $17 million as well as stronger government payment volumes. The adjusted EBITDA margin of 29.7% was up 90 basis points year-over-year. Transportation segment revenues declined 1.8% in 2023 as compared to 2022. Transportation segment results were negatively impacted from transitioning certain clients on large, long-running implementations through go-live. Some of these programs experienced extended completion timelines largely driven by increased or changing client scope and requirements as we near the end of these multiyear implementations. This caused more of a drag on revenue and margins during the year than we originally anticipated. Transportation segment adjusted EBITDA was $41 million as compared to $84 million in 2022. And the adjusted EBITDA margin of 5.9% was down 590 basis points year-over-year. These extended completion timelines on a handful of our larger implementations caused most of this decline. We continue to focus on implementation and operational discipline and returning the business to more predictable revenue and margin trajectories. Our Q4 Transportation results posted year-over-year revenue growth and a stronger adjusted EBITDA versus Q4 2022. Let's now turn to Slide 9 and discuss the balance sheet and cash flow. Our total liquidity position remains strong with a combined $1.1 billion in cash and available revolving credit facility. We ended the year with $519 million of total cash on the balance sheet, and our $550 million revolving credit facility is almost completely unused. Our net leverage ratio was 2.1x, which is within our range of 2 to 2.5x. Our debt maturities are long dated, and we have no significant debt repayments until the end of 2026. Capital expenditure for the year was 3.1% of revenue, lower than our revised guide on capital spend, and we continue to find opportunities to drive efficiencies in our capital investment programs. We only received $6 million of the $29 million federal tax refund related to 2018 in the fourth quarter of 2023. We have now received the remainder in the first quarter of 2024. Our modified guide for the full year contemplated full receipt of that tax refund. Our $93 million of adjusted free cash flow in Q4 was broadly in line with that modified guide for the full year due to some offsets from some other favorable timing items. We repurchased approximately 6.6 million shares during the quarter at an average price of about $3. And as of the end of the year, we have purchased approximately 8.8 million shares. There is approximately $48 million remaining under our existing $75 million share repurchase authority. Before we move to Slide 10 and talk specifically about 2024 guidance, let me spend a few minutes outlining our approach to how we talk about the year and interlock it for you into our previously discussed outlines that we gave around the divestiture work and what that means for deployable capital and an exit rate for the business in 2025. As we move into 2024 and continue to execute on the financial framework that I laid out last March in our investor briefing, the key message I want to convey is that we believe we are on track to deliver the $1 million of deployable capital by the end of 2025. I'll provide a slightly updated view of the walk to that $1 million of deployable capital later in the presentation. In 2024, we will have impacts of the 2 currently signed divestitures and potentially others. The sale of our BenefitWallet business that we announced in the third quarter will generate approximately $425 million of pretax proceeds and the sales of our Curbside and Public Safety businesses announced in the fourth quarter will generate approximately $230 million of pretax proceeds, as well as removing $30 million to $35 million of liabilities for the leased portfolio of assets associated with that business. Note that related to the sale of the Curbside and Public Safety businesses, $50 million of the proceeds will be received during the first half of 2025. While timing is not certain, we do expect both to close during the first half of 2024. As mentioned earlier, we continue to work on other opportunities, which could also impact the latter part of 2024. Our approach to guiding our expected results is therefore going to be as follows

Clifford Skelton: Thank you, Steve. That concludes our Q4 and full year 2023 earnings call. Thank you very much, everyone, for listening to our review of 2023 and our outlook and plan for the future. We believe in the plan as I hope you do. Thanks, again, for being here, and here's to a great 2024.

Operator: Ladies and gentlemen, thank you for your participation. This concludes today's event. You may disconnect your lines or block off the webcast at this time, and enjoy the rest of your day.

End of Q&A: