Conduent Inc (CNDT) 2017 Q4 法說會逐字稿

Good morning, and welcome to the Conduent Fourth Quarter and Full Year 2017 Earnings Conference Call.

(Operator Instructions) Please note, this event is being recorded.

I would now like to turn the conference over to Alan Katz, Vice President of Investor Relations.

Please go ahead, sir.

Good morning, ladies and gentlemen, and welcome to Conduent's Fourth Quarter and Full Year 2017 Earnings Call.

Joining me on today's call is Ashok Vemuri, Conduent's CEO; and Brian Walsh, Conduent's CFO.

Following our prepared remarks, we will take your questions.

This call is also being webcast.

A copy of the slides used during this call was filed with the SEC this morning and is available for download on the Investor Relations section of the Conduent website.

We will also post a transcript later this week.

During this call, Conduent executives may make comments that contain certain forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995 that by their nature address matters that are in the future and are uncertain.

These statements reflect management's current beliefs, assumptions and expectations as of today, February 21, 2018, and are subject to a number of factors that may cause actual results to differ materially from those statements.

Information concerning these factors is included in Conduent's Annual Report on Form 10-K filed with the SEC.

We do not intend to update these forward-looking statements as a result of new information or future events or developments, except as required by law.

The information presented today includes non-GAAP financial measures.

Because these measures are not calculated in accordance with U.S. GAAP, they should be viewed in addition to and not as a substitute for the company's reported results prepared in accordance with U.S. GAAP.

For more information regarding the definitions of our non-GAAP measures and how we use them as well as limitations as to their usefulness for comparative purposes, please see our press release, which was issued this morning and was furnished to the SEC on Form 8-K.

With that, I will turn the call over to Ashok for his prepared remarks.

Ashok?

Good morning, everyone, and thanks for joining our Q4 and full year earnings call.

During our prepared remarks, Brian and I will cover our financial and operational performance, and highlight the progress we are making to transform Conduent into a profitable, predictable, sustainable and growth-oriented enterprise.

We will also provide our outlook for 2018.

Last year, we launched Conduent to deliver significant value to our shareholders, clients, employees and partners.

We positioned our company to be more unified, focused, agile and better positioned to win in the markets where we compete.

Our 2017 results are in line with our expectations following our first full year.

In some areas, we exceeded our own expectations, creating a sense of momentum and confidence for what lies ahead.

We would not have been able to complete our first year so successfully without the support of many stakeholders.

I'd like to thank my management team and all Conduent employees for their hard work and resilience, our clients for their continued trust and confidence and our business partners for their continued support during a year of tremendous change and accomplishment.

Slide 3 provides an overview of our results for the year.

In terms of our operational performance, we met or exceeded our goals for the year.

And early results from our strategic changes indicate we are on the right path.

Here are some highlights.

Our revenue declined 6% in line with what we projected for our first year.

But when evaluating this result, it is important to view it from the perspective of our inherited history and the change we are making to our go-to-market strategy.

Prior to the spinoff, revenue had been on the decline for many years.

We inherited an opportunity pipeline comprised of low margin, single service line BUs with weak underlying technology.

BU structures were inconsistent and with limited opportunity for upsell or cross-sell.

We knew reversing this revenue trajectory would not happen immediately.

In fact, our first strategic actions to create more focus would actually constrain revenue opportunity in the short term.

We sold businesses, exited countries and ended over 1,000 client relationships.

We raised the standard for deal qualification, both in the content of the transaction and the financial return.

Intentional actions like these contributed to 50% of our revenue decline last year.

During the fourth quarter, these strategic decisions drove 100% of the revenue decline in our commercial sector.

Given these extensive year 1 actions, we are pleased with our ability to deliver revenue within our guidance while laying the groundwork for our future as well as our ability to sustain a $13 billion sales pipeline while improving its quality and composition.

Given this progress, we enter 2018 with the confidence that we are on the right path to generate profitable growth as we come through this year.

Looking now at our operational performance last year.

We made significant progress that has improved the financial capacity of the company.

Operating margins improved 140 basis points and adjusted EBITDA grew 6%.

This was above the high end of our initial guidance, normalizing for divestitures.

Our adjusted EBITDA margin exceeded 11.2%, an increase of 140 basis points.

In addition, we generated $204 million of free cash flow, above the high end of our guidance range, and ended the year with around $300 million on our balance sheet available for investments including acquisitions.

Our Commercial business made significant improvement in profitability last year.

Full year segment margin increased 110 basis points.

Troubled contract remediation has been a key focus for improving results.

We have successfully remediated 5 of 6 major customer experience contracts last year and expect to finalize the sixth within the next 3 months.

As we've streamlined our portfolio, we created a clearer definition of what we consider to be our core business and took decisions to action our noncore.

We completed 5 divestitures in 2017 and have several more in process as we had outlined in previous earnings calls.

We exited over 1,000 client relationships due to unfavorable terms and limited growth potential.

Underlying these financial results were extensive changes across every facet of our new company.

These included our go-to-market model, our infrastructure, HR policies and performance management.

We rightsized the workforce, while simultaneously attracting new talent.

We consolidated over 50 independent units under 1 brand, while maintaining our client relationships and service levels.

And with a high intensity focus on collections by our sales teams, we returned to a more healthy cash flow profile in 2017, ending the year at 30% of adjusted EBITDA, which was the high end of our guidance.

This compares to having a negative free cash flow in 2016.

I am now on Slide 4. Consistent with what I have done on prior calls, I will share an update on our strategic transformation initiative, which targets delivering $700 million of cumulative cost savings through 2018.

During 2017, we overachieved our transformation goals, exceeding our year-2 target by $45 million.

As a result, we have greater confidence in our ability to meet the 3-year goal we had set for this initiative.

We have a healthy pipeline of transformation initiatives and are executing through these very well.

Let me share a few areas contributing to our strong progress.

First, our real estate.

On previous calls, I have described the fragmented portfolio of businesses that we inherited.

With these businesses came a sprawling, underutilized real estate portfolio, saddling our business with cost and unproductive assets.

Since setting up Conduent, we have eliminated 123 locations or the equivalent of 25% of our total square footage.

We are on our way to take out another 100.

In addition to real estate, we are driving a comprehensive initiative to consolidate our IT and network infrastructure.

In 2017, we addressed our sub-optimized IT-related workforce and vendor relationships.

Next, we expect to see benefits from the platform rationalization work completed last year.

We are also driving a multiyear program, driving data center and network consolidation.

We opened for business at over 100 data centers and 13 separate networks.

We are on track to reduce these to less than a handful of data centers and a single network backbone for the company.

I look forward to sharing our progress here in more detail on future calls.

We have also aggressively attacked our SG&A, reducing it to 10% of revenue for the quarter and 10.2% for the year, an improvement of 60 and 40 basis points, respectively.

A range of actions across the company combined to help us achieve these kind of efficiencies, including streamlining of workforce, organizational realignment and process standardization and importantly, an aggressive adoption of new technologies like automation and analytics.

While we were reducing SG&A in total, we were simultaneously remixing our expenses in support of revenue growth.

Historically, this business had underinvested in go-to-market functions like sales and marketing.

We began rebuilding our selling engine last year.

As I have described on previous calls, we reset our coverage model to be vertically oriented at an inch-wide and mile deep.

Our net sales and engagement management headcount increased by 35 last year and we added an additional 15 in the first 6 weeks of this year.

This will be a growing focus area for us as we look to bring more of our portfolio to our client base and increase our potential for pipeline, signings and revenue growth.

I am now on Slide 5. Consistent with our philosophy of being a predictable, sustainable and profitable business, our next set of changes will be intentional and deliberate.

Before I cover more of our 2017 results, let me contrast this coming year with the one we just completed.

This slide creates a simple comparison based upon a few facets of our business.

For our financial plan, we intend to continue our strong margin performance while improving the revenue trajectory of our core business with a goal of turning positive by year-end.

In 2017, margin improvements were led by our transformation work.

Going forward, margin expansion will come from a combination of both transformation and delivery efficiency.

We expect continued strong cash conversion through high focus on conversion, and DSO improvement.

In terms of our portfolio, 2017 was focused on clarifying our sources of value creation and defining our core.

In 2018, we will sharpen this distinction through additional divestitures of noncore businesses and by acting on potential acquisition targets and new technology investments to modernize our core assets.

We will also amplify our core, infusing it with the latest technology and fueling it with a sales engine that can drive value creation with our clients.

We continue to build our capabilities as a technology company.

During our first year, we needed to inventory and rationalize our technology portfolio.

Starting 2018, we'll begin our work to modernize our offerings with cutting-edge technology, supported with an almost $200 million multiyear investment program.

As a services company, our people are the heart of our business and over time, our goal is to make Conduent a preferred place to work.

We hope to attract the best talent in the industry.

That being said, our work model must become more contemporary and innovative.

We require a global smart sourcing model that delivers the right work from the right locations, a concept we are calling [Accusuring].

This allows our clients to benefit from our capabilities globally, 24 hours a day and provides access to attractive talent pools at competitive cost structures.

Finally last year, we introduced our new name to the market, but we have more work ahead to create a reputation.

We're investing more in our marketing in 2018 for greater outreach across the industries we compete.

We will focus on creating greater awareness in select segments about who we are and the value we create.

Slide 6. I will now briefly review the performance of our 3 segments, with 2 of our segments, namely Commercial and Other segments, showing particularly impressive results as we close out the year.

In Commercial, revenue was down 7% as expected, again, driven heavily by strategic actions we took to improve our revenue quality.

That work in addition to improved efficiencies, contract remediation and cross-selling led to significantly improved profitability.

Margins improved 110 basis points year-on-year and we exited the year even stronger, improving 160 basis points in the fourth quarter.

Our Public Sector business revenue declined 6%, in line with our expectations.

Margins declined by 140 basis points year-on-year as a result of revenue pressure.

But our exit margin of 12.4% showed an improving trajectory.

Public Sector in many ways best exemplifies those characteristics we define as core: Technology platform solutions supported with a range of corresponding business services.

We are well positioned in this market segment and it contains many attractive opportunities.

Going forward, we will be targeting growing segments like transportation, payments and government health care for future growth.

In 2017, we called out the European market as a new focus of the organization.

Our European business is advantaged with several large global clients and we see an immediate opportunity to expand these relationships.

In addition to dedicated leadership, client coverage and improved delivery, we expect to develop industry-specific solutions for this region over time.

As I mentioned in my previous calls, we spent a considerable amount of time and effort in our Other segment to drive overall profit improvement.

Today, we are glad to report that it's a breakeven business.

Driven by improved pricing and other contract improvements, adjusted EBITDA in our Other segment improved by approximately $70 million.

Our decision last year to isolate these businesses as standalone unit paid off as it created the focus we needed to address what had been a systemic drag on our results.

Moving to Slide 7, I will share the progress we have made on signings, renewals and our sales pipeline in the most recent quarter.

We are advantaged with a stellar client portfolio, representing some of the world's top brands as well as every state in the country.

As we reimagine Conduent and strengthen our client relationships, we are seeing improved penetration and better cross-sell of our various server offerings in our client base.

We signed over $1.7 billion in total business last quarter, up overall on a year-over-year basis.

While fourth quarter renewals were a big factor, this growth illustrates growing momentum in our sales engine, stemming from our new client coverage model and greater cross and upselling.

Let me elaborate on this a bit more by looking at our new business, TCV.

We signed $683 million in new business last quarter, which is down from 2016.

However, we have raised the bar significantly for the new businesses we are targeting.

New opportunities must contain the right technology content and provide acceptable margins, and they must be contracted with terms and conditions more consistent with our aspirations and thus creating the right balance of risk and return.

Identifying and capturing these opportunities has required more than a shift to our verticalized structure.

It requires new skills, content and relationships within our accounts.

As an example, in our consumer and media vertical, the percentage of customer experience business we have in our pipeline has declined from 80% at the start of 2017 to around 40% today.

Providing customer support will always remain a component of our business services portfolio, but we are now bundling it as a component of a platform-based engagement versus providing it purely as a standalone service.

Renewals were exceptionally strong for the year, hitting 96% with large renewals within health care insurance, communications and media and industrial clients.

This reflects not only our deep client relationships, but stronger account management, new focus on higher value services and improved quality of delivery.

Our rolling 12-month pipeline indicates demand for our service line is healthy.

Total pipeline stands at approximately $13 billion.

This is flat both quarter-over-quarter and year-over-year, but it is important to view this in the context of the strategic shift we took in year 1. Some of these I mentioned at the beginning of the call when discussing our revenue performance.

We exited markets.

We ended unprofitable client relationships.

We shifted our pipeline composition from opportunities with high labor content to one with greater technology and software content at higher margins, and we refocused our sales and engagement management in a narrower set of high-value markets and clients.

Client feedback on our new, more focused go-to-market strategy has been positive and its benefits are showing up in some of the notable wins we had last quarter.

Here are some examples: We had 2 impressive new logo wins in our Public Sector business.

One was a full year contract with two 1-year options with a large Midwestern state to verify that providers are eligible to deliver services to Medicaid-eligible patients.

The other was a new 3-year contract, also with two 1-year options, with an independent nonprofit organization to provide program information and support as well as speedier third party eligibility determination.

This was a very successful quarter for wins in the Commercial Health Care space with notable wins with 2 top-5 U.S. health care carriers.

These deals included a multiyear extension to support member services, benefit eligibility, claim status inquiries and fulfillment as well as a new 5-year engagement and contract renewal in our multi-channel services offering.

This positions Conduent as a preeminent provider of these services in the health care insurance industry.

3 of the top 4 health care payers now rely on Conduent for their insurance member outbound communications.

Lastly, we expanded our relationship with one of the largest brands in the pharmaceutical industry by winning a deal to manage their philanthropy programs, providing access to life-saving medicines to patients who struggle to afford them.

Before I hand it over to Brian, let me share a few closing thoughts on our first year as an independent standalone company.

I'm extremely proud of what we delivered in 2017.

Financially, our performance was within guidance or exceeded the targets that we had set.

Margins improved, cash flow was healthy and our balance sheet is in much better shape.

At the same time, we made impressive progress towards transforming our company in almost every dimension with every function and unit contributing in some way.

Let me recap some of these, some of which I've mentioned on previous earnings calls.

We have made significant progress turning around our commercial business, aggressively remediated difficult client contracts, repriced our Term Loan B twice, reducing our interest expense and improving our profitability and cash flow.

We consolidated over 50 standalone company brands under a single umbrella.

Reset our go-to-market model in support of broader service line penetration.

Consolidated our infrastructure for greater commonality and asset leverage.

And finally, stood up a One Conduent way of running our company across management processes and decision-making.

We are well on our path to building a single, unified company that delivers market-leading performance and a company with a single, clear, strategic thread that runs all the way through our core portfolio.

I will talk more about that at the end of my presentation.

With that, I will turn it over to Brian to take us through the financials in more detail.

Following Brian's remarks, I will take (sic) [make] some additional comments about the way we are positioning Conduent in the marketplace.

Then we'll take some Q&A.

Thank you, Ashok.

Let's start on Slide 9 with an overview of the fourth quarter financial results and a walk through the P&L.

Revenue of just under $1.5 billion was down 1% as reported and 2% on a constant currency basis compared with Q4 2016.

The year-over-year revenue decline was driven by strategic decisions, lost business, lower volumes from existing clients and the impact from the Q3 divestitures.

These factors were partially offset by the Q4 2016 revenue adjustment taken as a result of our decision to exit the New York MMIS contract as well as the ramp of new business.

Gross margin of 18.9% was an increase of over 10 percentage points versus the prior year, reflecting the impact from the New York MMIS charge taken in Q4 2016.

Adjusted gross margin, which removes the impact from New York MMIS, was up about 100 basis points compared with the prior year period driven by our transformation program.

SG&A was $21 million lower year-over-year, driven by strategic transformation, partially offset by corporate dissynergies and investments.

Dissynergies were approximately $18 million in the quarter.

Q4 adjusted operating margin of 8.7% improved 190 basis points compared with the prior year, driven by the operational improvements in adjusted gross margin and SG&A.

Adjusted EBITDA in the quarter was $188 million, an increase of 9% year-over-year while adjusted EBITDA margin improved 180 basis points to 12.6%, driven primarily by the improvement in our Commercial segment as a result of our transformation program as well as modest improvement in our Other segment.

Moving below the operating margin line, restructuring charges were $25 million as we continue to close facilities and reduce headcount.

Our pretax income in the fourth quarter was $4 million.

When looking at the year-over-year improvement, remember that we had the impact of the goodwill impairment and the New York MMIS charge in 2016.

GAAP net income in the quarter was $208 million or $0.98 per share on a fully diluted basis, driven by the revaluation of our deferred tax liabilities as a result of recent tax reform.

I'll note, this is a noncash item, so only impacts the GAAP profitability.

Our adjusted tax rate in the quarter was 31.6% compared to 40.2% in the prior-year period, primarily as a result of favorable tax adjustments that were realized in Q4.

Adjusted net income was $67 million, up $6 million compared with the prior year period as operating margin expansion and lower tax rate was partially offset by higher interest expense.

Adjusted EPS was $0.31 in Q4, an increase of $0.02 compared with Q4 2016.

Ashok went through some of the full year results so I won't go through every line item, but we'll touch on some highlights.

I'm now on Slide 10.

Revenue of approximately $6 billion was down 6% on both a reported and constant-currency basis compared with 2016.

Dissynergies were $73 million in the year in line with our expectations of the last call.

2017 adjusted operating margin was 6.9%, a 140 basis point increase compared with the prior year, driven by significant cost takeout and improvements in our Other segment.

Adjusted EBITDA was $672 million, an increase of 6% compared with last year, while adjusted EBITDA margin improved 140 basis points to 11.2%.

I'll take a minute to highlight that we also achieved an 18% improvement in adjusted operating income.

This is higher than the improvement in adjusted EBITDA.

While we believe that both metrics are important to focus on, the overt performance in operating income was driven by lower depreciation and amortization in 2017.

CapEx came in lower in 2017, compared with our historical run rates.

Moving forward, as we ramp investments, we would expect to see CapEx closer to 2.5% to 3% of revenue.

Moving below the operating margin line, restructuring costs were $101 million in 2017, as a result of closing facilities and rightsizing our workforce.

This was slightly higher than the $95 million we expected on the Q3 call, driven by continued progress on the transformation effort.

As Ashok mentioned, we overachieved on our target for the year and are doing well in terms of real estate, which tends to account for a large portion of restructuring expenses.

Full year adjusted net income was $186 million while adjusted EPS was $0.85, both down year-over-year, reflecting higher operating margin expansion more than offset by higher interest expense.

Turning to Slide 11, I'll provide an overview of the Commercial segment results.

Q4 revenue declined 5% compared with Q4 last year, impacted by strategic actions and lost business, partially offset by new business ramp.

Normalizing for the impact of the Q3 divestitures, revenue would have declined by about 4% year-over-year.

Sequentially, revenue grew more than 2% due to both seasonality and new business ramp.

Normalizing for the divestitures, this would have been closer to a 4% increase.

Segment profit increased 42% year-over-year, driven by cost improvements from strategic transformation, including the impact from our customer experience contract remediation efforts.

Segment margin improved 260 basis points compared with Q4 2016, primarily driven by these same factors.

Adjusted EBITDA in the segment increased 31% versus the prior year period and adjusted EBITDA margin increased by 330 basis points.

Q4 tends to be a seasonally strong quarter for our Commercial business, given both open enrollment season and higher volumes from our travel, retail and health care clients.

The progress on profitability year-over-year is very encouraging, and we're ending the year on a strong note.

I'm pleased with the improvement that we have achieved in this segment in 2017.

Now, onto Public Sector segment results on Slide 12.

Revenue was down 7% compared with Q4 2016 and 1% sequentially as we continue to realize the impact of the contract losses for decisions made prior to 2017 that we discussed earlier this year within our government health care, state and local and payments offerings.

Transportation revenues declined compared with Q4 2016 and were flat compared with last quarter as new business ramp offset lost business.

Segment profit and adjusted EBITDA were down $10 million and $18 million, respectively, compared with Q4 2016 driven by the revenue decline, dissynergies and investments in our core offerings.

However, both metrics improved sequentially driven by the continued impact from the strategic transformation initiative, the sequential improvement is better than our expectations as of the last earnings call and points to the progress the team has made.

Moving on to Slide 13, I'll provide an overview of the Other segment.

Revenue within our Other segment was $74 million in the quarter.

This was an increase of $70 million on a GAAP basis as we had the impact of the revenue adjustment related to our New York MMIS contract in Q4 2016.

On an adjusted basis, revenue declined $13 million year-over-year.

The Education business, which includes the student loan portfolio, lost approximately $1 million in the quarter and the Health Enterprise business made just under $4 million in the quarter.

We have focused on improving profitability in this segment in 2017 and we achieved a $78 million segment profit improvement year-over-year.

Given the progress that we've made in improving our Health Enterprise contracts, we now see these contracts as part of our core government health care business.

As a result, beginning in Q1 2018, we will move the Health Enterprise contracts into our Public Sector segment.

Other will continue to have our Education business in it, which is in runoff.

While this will obviously change the reported profitability for both the Public Sector and Other segments, it will reflect how we plan to run the business moving forward.

Slide 14 provides an overview of our cash flow in Q4 and for the full year.

Cash flow from operations was $237 million in Q4 and $302 million for the full year.

Adjusted free cash flow was $205 million in the quarter and $204 million for the full year.

This compares with a use of cash of $81 million in 2016.

We ended the year just above the top end of our guidance range for free cash flow.

This was partially driven by the sale of the former ACS headquarters in Dallas as well as lower CapEx for the year, which came in at $132 million or just over 2% of revenue.

As I mentioned, we would expect CapEx as a percent of revenue to be closer to 2.5% to 3% in 2018 as we ramp investments to drive revenue growth.

As I noted last quarter, most of the proceeds generated from the termination of our deferred compensation plan are yet to be dispersed and will be done so throughout 2018.

This will ultimately flow through our operating cash flow and will be adjusted out of our reported free cash flow accordingly as we did this quarter with the $17 million of payments that we have already made.

Turning to Slide 15, I'll provide an overview of our capital structure.

During Q4, cash increased to $559 million, excluding the $99 million that we'd expect to pay out related to the deferred compensation plan.

This compares with $352 million at the end of last quarter.

We have approximately $300 million of cash that we see available for reinvestment in the business for acquisitions.

I'll also note that our revolver, which has over $730 million of availability under our credit agreement, remains undrawn.

We expect to raise additional cash in 2018 from future divestitures and would expect to use this either to repay debt or for future acquisitions.

Given our adjusted EBITDA and growth in our cash balance, our adjusted net leverage ratio is at 2.2 turns, down from 2.6 turns last quarter.

We are now below our target leverage ratio.

Before I close, I want to discuss our 2018 guidance.

Please turn to Slide 16.

We have included a table highlighting some adjustments to items impacting the year-over-year results.

In order to have a clean year-over-year comparison, we're removing the revenue, adjusted EBITDA and free cash flow impact from the divestitures that we closed in Q3 2017.

Until we have a signed deal, we will wait to incorporate the impact from any additional divestitures or any acquisitions into our guidance.

In addition, like all companies in 2018, we'll be adopting the most recent accounting standards for revenue recognition and on this table, we have highlighted the impact the new standard would have had on our 2017 actual results had this been in place.

This provides you with an apples-to-apples comparison when looking at our year-over-year guidance.

The major impacts from the change for us are no longer recognizing certain pass-through revenues, primarily postage, and changes in deferring certain revenue items.

As you can see, the accounting change will be an approximate $165 million negative driver on the revenue line and a $15 million impact to adjusted EBITDA.

It will have no impact to free cash flow.

Given these adjustments, our 2018 guidance ranges are as follows: Compared with the $5.8 billion of revenue, we expect 2018 revenue to be flat to down 3% on a constant currency basis.

For adjusted EBITDA, compared with the $652 million, we expect growth of between 8% and 12% in 2018.

Let me spend a few minutes on the hydraulics driving the adjusted EBITDA from 2017 to 2018.

In 2017, the 2 largest positive drivers in adjusted EBITDA growth were our transformation program and the improvement in our Other segment.

One of the negative drivers was the $73 million in dissynergies.

Looking at 2018, our year-over-year growth will be driven by our transformation initiative, including improvements in our customer care offering where we see contract remediation benefits flowing through.

Our Other segment, as currently constructed, should be largely breakeven and will not have additional dissynergies.

Both of these items should be relatively neutral to adjusted EBITDA in 2018.

We'll continue to make meaningful investments into the business in 2018, which will position us for growth over the longer term, but will also be an offset to other adjusted EBITDA positive growth drivers.

Moving to free cash flow, we expect free cash flow to be between 25% and 35% of our 2018 adjusted EBITDA.

Before I hand the call back to Ashok, I want to spend a minute on the recent tax reform and how it could impact our tax rate moving forward.

The lower corporate tax will be a benefit for us; however, given our global footprint and delivery model, there will be other tax provisions that will offset some of the benefit of the lower corporate rate such as the BEAT and guilty tax provisions.

Overall, we expect our 2018 adjusted tax rate to be between 30% and 35%.

I will now turn the call back to Ashok for some additional remarks.

Thank you, Brian.

Before we wrap up, I'd like to pick up on a discussion that began last quarter around the way we're describing our company.

Many of you have asked for additional clarification for how to think about Conduent.

Looking at Slide 18, you might remember this chart from last quarter.

It is a depiction of our value chain.

At the highest level, we manage essential aspects of our client operations while engaging directly with the people they serve.

We manage millions of interactions every day, 24 by 7 with patients, physicians, employees, customers and citizens.

Across the full spectrum of the work we do, whether it's procurement, finance and accounting, customer experience, Worker's Compensation, compliance or HR outsourcing, we work on behalf of our clients to manage data intensive, repeatable, individualized trends, interactions happening at massive scale.

We support these digital interactions with a range of industry-specific, technology-based, workflow and business process solutions from our core offerings.

In each case, we are managing large amounts of data and personal information, and with each interaction, those we serve expect these interactions to be seamless, personalized, intuitive and secure.

While our portfolio spans many segments, we are not simply in the tolling business or HR outsourcing business or the payments business.

We're not simply a business services company.

We're in the business of helping our clients manage digital interactions with the people they serve, seamlessly, securely, personally and at massive scale.

We are a digital interactions company.

And as part of our next stage of work, we will undertake the important work of showcasing our assets, expertise and capabilities to demonstrate this distinctive position.

In closing, we are off to a solid start for our new company.

We're improving our performance.

Our balance sheet is healthier.

We are executing against our transformation.

We're making the right investments in our technology platforms and elevating our position as an essential participant in our clients' value chain.

And as the next step, we're holding a unique and differentiated positioning that captures our value simply and provocatively, digital interactions.

These are the essential components for supporting our ambition to become a leader in our industry and ultimately, over time, a great company.

I'll open the call now for Q&A.

(Operator Instructions) And our first question today comes from Frank Atkins of SunTrust.

First one would be on signings.

Can you talk about how much of the new signings is industry-specific or has some sort of technology component?

And then was there any onetime-ish impact in that signings number?

Yes.

So let me take that question.

Last -- in Q3, we had mentioned that we had about $200 million of signings that skipped or missed the time line by which we could have qualified them to be in Q3 so that's $200 million that slipped into Q4.

In terms of most of the signings and business are a combination of technology and domain-based capabilities that we have built for our industry solutions or for our verticals.

So all of the new business that we are signing has to necessarily be technology platform-based either -- or has to be a software-based and is a vertical solution, so whether it's compliance in the financial services, whether it is a better outreach in the PBM market, whether it is a more sophisticated way of doing claims management in the payer space, et cetera.

So these are all -- the direction that we're moving in is into a more verticalized solution, which is of course, technology and domain based.

Okay, great.

And could you give us a quick update on headcount mix by geography and how that's diversifying?

And also, what do you see out there in terms of the labor environment and talent acquisition?

So maybe I'll start with the headcount mix.

Headcount, we ended the year at 90,000 employees versus 96,000 in 2016 and we do have a shift to lower cost geographies.

Inside of that, we also have some insourcing that we've done on the technology side that's increasing our headcount as we insourced some of the things we had previously outsourced.

On the talent part, I would say, it is -- we will operate out of locations and geographies where the availability of talent is there and it makes economic sense for us to do business.

Clearly, as we are moving into a more sophisticated technology zone, we will be looking for talent, both in the U.S. as well as outside the U.S.

I think we're continuing to be challenged by being able to find that at scale, but this war for talent has been going on for a while and we have to attract people based on the kind of value proposition that we want to create.

The next question comes from Brian Essex of Morgan Stanley.

Maybe for you, Ashok.

As you shift your strategy towards technology and analytics-driven platform business, what percentage of your business right now would you consider platform?

And maybe what do you anticipate that reaching in the future?

And then what is a margin profile of this business relative to the rest of the business that you have?

Yes.

So Brian, the percentage of work that we deliver on platforms at this point in time is about 60% to 65%.

So it's a fairly healthy -- and that's one part of our business that's actually, we've been maniacally focused on and that's the one that we are driving.

And that also, interestingly, is the one that's finding the most reception in our client base.

With regards to obviously, as we do more of work on platforms and you know from a -- the more software we deploy, the margin profile dramatically improves.

We've not seen the benefit of that dramatic improvement as yet, but our focus is on to continue to drive that because we're talking about bundled services, low labor concentration or low labor utilization, allowing us to reuse the platforms because these are multiuse platforms.

So the idea here is that even though we're beginning only now to see some of the impact of the better margin performance as we deploy our software and platforms, the expectation based on the deals that we have already signed and the deals that we're working on that, that margin profile will definitely improve.

But from a delivery perspective at this point in time, between 60% to 65% of what we deliver is on platforms, but the efficiency of that, the multi-use of that, the fact that we need to bundle that better to provide seamless transactions at scale needs to get better, therefore, the investments that we're talking about in our technology platforms and infrastructure.

Okay, that's helpful.

And maybe to follow up.

On the contracts that you remediated, it seems as though that's at least kind of helped the bleeding a little bit.

But how profitable can those contracts be going forward?

And maybe remind us, are these commodity contracts?

Are these higher value contracts?

And how do we think about how this plays in your customer relationships, if they are commodity contracts, in terms of why you need to invest in those businesses?

So I'll start.

The 6 contracts that we're remediating are standalone customer care contracts.

And they've been losing money -- even in the fourth quarter, they lost money, but they improved year-over-year.

Now that we've remediated through today, 5 of the 6, we're going to start to see every quarter -- we're expecting to see year-on-year improvements in 2018 and we expect by the middle of the year to get to breakeven or better on these group of contracts.

And we're still working aggressively to remediate the 6th contract, which we expect to have done over the next couple quarters.

This is not part of what we're looking to divest in the $250 million to $500 million.

We do have a lot of important big relationships here where we do other offerings -- other offerings, but we'll continue to look at the portfolio and we'll make the best decisions for the company so we continue to look at it.

I guess, what I was getting at though, is there a good rationale?

I mean, I understand that they're important relationships, but it seemed as though in previous quarters, some of the comments around those contracts were that they were relatively commodity in nature.

So is it -- I guess the question would be, is it really that critical to hold onto them?

So some of them are commodity.

So we have to take a look at every option that's available to us.

I think the first way to look at this is to find -- see if we can remediate them, make them much more efficient, drive a lot more automation and technology into it, and see how they perform.

We have to remember that a lot of the experience business is bundled with other services.

The end of the value chain in the digital interaction space is still the experience part of it.

Now do we need to be picking up phone calls for all of these things?

Maybe not.

Are we shifting to chat?

Are we shifting to web-based?

Yes.

Are we moving the whole experience part from a low-end commodity base to a higher end?

Yes.

So we'll see how they perform.

And as I said, none of the options are off the table and we are very clear that we are not signing or interested in signing any deal which is a standalone experience business.

And next, we have a question from Shannon Cross of Cross Research.

I was wondering, can you talk a bit about what leads you to see the improvement in revenue through the year?

I understand that first half had some tough comps because you divested revenue.

But specifically, what are you hearing from your customers, what are you seeing in terms of signings that lead you to believe that you should be at an organic revenue growth rate by the end of the year?

And then I have a follow-up.

So if we look at the strategic decisions we took in 2017 as we go through the first half of 2018, we start to lap those decisions.

So the first couple of quarters will be harder compares and then the compares get easier in the second half and we'll also have new business that starts to ramp in the second half.

So if you look at both Commercial and Public Sector, we'll have tougher compares Q1, Q2 and then they get easier and we'll see more new business come in, in the second half of the year.

I agree.

I'm just wondering what leads you to have comfort about the new business that's coming in?

How much of that is sort of signed and in the pipeline at this point?

Or how much of that is just based upon conversations you're having with potential customers?

So a lot of what we're ramping and talking about is already signed, and there's a transportation deal for example in Public Sector that's going to go live in Q2.

We expect transportation inside of Public Sector to grow in 2018.

We have the government health care and payments contracts that have been running off.

We'll lap those as we get through Q2 so you take a look at Public Sector and we can see, based on the new business that we've already signed plus the lapping of those other contracts, the revenue trend improving.

Commercial.

The same thing, we've signed a lot of new business in Commercial the last 2 quarters that will ramp.

And again, a lot of the strategic decision will be behind us.

We continue to have a strong pipeline at $13 billion.

We're very focused on the sales investments and driving in-year signings that deliver revenue, but we have a lot -- a line-of-sight to a large portion of it.

Okay, great.

Then my second question is just on use of cash.

You talked about, especially with the divestitures that you would -- you liked cash for debt paydown or for acquisitions.

How do you sort of balance the 2?

And how are you thinking about acquisitions?

You haven't done any, obviously, you're trying to divest right now, but how are you sort of thinking about that in timing?

Yes, so we've specifically called out acquisitions because we do realize that there are gaps in our capabilities.

There are adjacencies that we could expand into.

We're not talking about Big Bang acquisitions, more tuck-in, in the nature.

And as we -- and we have said that the acquisitions will actually be funded by conversion of EBITDA to free cash flow.

Obviously, as we generate more cash with regard to divestitures, we will balance the opportunity for reducing debt vis-à-vis acquisitions and we'll do this in a way that is both fair to our shareholders as value creating for our shareholders as well as that for the company.

And our next question comes from Puneet Jain of JPMorgan.

Good quarter, guys.

So you are in the final year of your cost takeout program.

The Other segment is also going to be breakeven this year.

So how should we think about drivers of margin expansion and level of investments beyond this year?

And then as you move past restructuring payments, should we expect any change in your use of cash priorities from next year?

Yes.

So on the first one, when we take a look at -- what was the first question?

Margin expansion and level of investments beyond this.

Margin expansion, as we look at this year, we have $225 million of incremental cost savings coming from the transformation program.

And at the midpoint, we're calling $65 million of adjusted EBITDA expansion and the rest will be used for investments and other offsets as we need them.

We have investments that are going to ramp in our technology platform investment.

Ashok mentioned the $200 million 3-year program, part of that is CapEx, part of that is OpEx so that will take a lot of our investment.

And then we have to continue to make the go-to-market investments we talked about.

When we think about the long-term margin profile of the company, if you look at the midpoint of our guidance for '18, we get to 12.6% margin roughly, from a 9.8% margin that we started with in 2016.

So we're half-way towards our long-term model of 15%.

We'll continue in the out years to get margin improvement by pulling back on some of the investments eventually, by revenue growth and by takeout.

There will always be cost takeout even though the formal program will be over at the end of this year.

We will always have cost takeout programs in place to drive margin expansion.

I was just going to say, everything we see today, we are confident in our long-term model that we've been talking about.

And should we expect changing use of cash?

Maybe capital returns could be on the table as you move past restructuring payments?

Yes.

So right now, we're focused on acquisitions and paying down debt, restructuring the business, obviously, we're calling for $50 million to $75 million in restructuring in '18, which is down from $100 million in '17.

So restructuring will be less of a cash use and it'll help us generate more free cash flow.

When we get -- we're really focused on the divestitures and paying down debt and acquisitions in '18.

As we get out to '19 we'll have to see what makes the most sense for the company.

And next, we have a question from Bryan Bergin of Cowen.

On the accumulative gross savings, you're currently ahead by $75 million, what's the potential for you outperforming that total savings target?

And if you can, what are the areas that are most likely to drive that?

So we're ahead by $475 million.

So we're ahead by $45 million and we're focused on overachieving the whole program, but right now, we're confident we're on track for the $700 million.

We believe the $225 million of incremental savings gives us what we need to drive the investments and the profitability improvement this year.

In the areas that would overachieve, if we overachieve would most likely be real estate, which Ashok talked about and G&A.

Those are areas that we've been very focused on.

They've been overachieving up to this point and we stay focused on them.

Okay.

And then on signings, can you comment on the new business bookings trajectory, particularly within the Public Sector?

And then just overall mix within the pipeline, can you just comment how that has changed?

Yes, so in terms of our signings, we are fairly comfortable with the way that's progressed.

Renewals have been high, new business signings.

I would actually say it's been sort of middling, but you have to remember that we have introduced a lot more stringent conditions in order for people to sign new business.

That level of discipline and rigor has allowed us to improve the quality of the pipeline for sure, but then, of course, it's been -- it's much tougher to get a deal past -- deal approved past us.

I would say that Commercial has obviously done extremely well because of how lag -- how much of a laggard it was and we paid specific attention to it.

In the case of Public Sector, you have to remember that decisions that have taken a few years past, a few decisions that were taken prior to 2016 as -- or losses that we had prior to 2016, the impact is being felt.

Now that's the way the Public Sector business is, longer term deals, sales cycle is longer.

Feel very confident about how we're progressing in the transportation and the payment space especially in the Public Sector space where we will continue to concentrate.

In the Commercial space, clearly, we're seeing a huge amount of traction in the high-tech, in the retail and industry space.

We're seeing transaction in the banking and insurance space and I think the one call-out for us would be the entire payer space in Commercial, which is doing extremely well.

We're beginning to see traction in Europe, but I think it'll take some amount of time before we actually see that ramp up as aggressively as the Commercial business in the U.S. is.

The next question comes from Jim Suva of Citigroup.

I have a clarification question that might be more appropriate for Brian and then a more strategy question probably for Ashok.

So Brian, a clarification question is on the revenue guidance, I think it was minus 3% to flat.

Does that include the divestitures that you've identified?

You mentioned during this call that you identified several more, or would those be incremental we need to take out?

And I think on the last earnings call, you mentioned you identified about $250 million to $500 million.

Where do we sit in the realm of -- is that still the target?

Have they kind of been whittled away?

The strategy question for Ashok is, Ashok, you'd mentioned you're a lot more disciplined, a lot more stringent to get deals approved with multi-faceted profitability and you're just not doing deals to win deals.

That's very commemorable (sic) [commendable] and I think why your profitability is improving.

But I wanted to ask, is your criteria now at the industry average or above the industry average?

Or was this just a catch-up or how can we think about the move to be more stringent and disciplined versus the rest of the industry?

Okay, so I'll start.

All additional divestitures, future divestitures are not in our guidance and when we close a deal, we'll update guidance and provide the information.

We are still working $250 million to $500 million of revenue to divest and that is in process, and we're working it as quickly as we can, but we're balancing, making sure we get the right buyers with the right price points.

The same goes for future acquisitions.

We've included nothing in our guidance for acquisitions and, as we said in our commentary, we have $300 million available to do acquisitions with and as we do those deals, we'll include them in our guidance.

Yes.

So in terms of the criteria, the way we are looking at it is we have a set of aspirational goals.

We look at the industry leaders in this particular space and in the various segments that we compete in and we see what their margin profile or the kind of transactions that they're doing.

Of course, this is a function of -- we have to be pragmatic in terms of how much the market can bear and where we are at this point in time.

So it's a journey for us, but we definitely have aspirational targets.

And as we set those targets and be pragmatic about being able to be a little flexible about it, we will cross our catch-up so it's not just a catch-up, it's more than a catch-up.

We're just not doing this from a 1-year perspective; some of these transactions are 3 and 5 years.

So we intend to catch up and we intend to overtake, and we're using our competitors and we're using what we have done traditionally, how we can do that better.

We're also seeing what the market can bear.

There are transactions out there, quite honestly, which we have done at lower margins than our aspirations and expectations are because of the belief that as we bundle more transactions into it, the profitability paradigm will improve.

Again, as I tell everybody, you cannot make revenue out of profit.

You can make profit only when you get revenue so we have to balance the 2, but we have to be very disciplined about the kind of transactions, the terms and conditions, the contractual agreements, the tenure and where we are delivering these services from and how we're delivering these services.

And our next question comes from Mayank Tandon of Needham & Company.

This is actually Kyle Peterson on for Mayank today.

Just wanted to touch a little bit on organic revenue growth.

Realize that there's a lot of moving pieces with some of the divestitures and kind of reramping the sales force and rightsizing contracts.

But I guess, once some of that dust has settled, kind of what are you guys looking at in terms of organic revenue growth opportunity for the business?

Yes.

So in 2018, at the midpoint of our guidance, organic is declining 1.5 points, which is in line with the commentary we previously gave where we said flat with the help of M&A.

As we look into the future years, we'd expect 2%, 3% growth organically and then to get to industry level growth rates with the help of acquisitions, that's been our model and we're still working towards that model.

And again, we'll see revenue improve in 2018 quarter-by-quarter as we lap our strategic decisions.

A lot of the revenue decline we'll see in 2018 will be driven by the strategic decisions, and then we'll have the new business and other normal losses starting to get positive as we go throughout the year.

Okay, great.

And then I guess just a little bit, if you guys could touch on, I know you guys mentioned central divestiture proceeds could be easier for additional acquisitions or kind of debt paydown.

On the debt side, have you guys kind of thought about which pieces of the debt stack you guys would maybe kind of prioritize?

Whether it be kind of one of the term loans or any possibility for any action on the senior notes?

So we are looking and spending a lot of time on this and we will do what makes the most shareholder value, makes the most sense from a shareholder value perspective.

So we'll talk about it more as we get there.

And this concludes our question-and-answer session.

I would like to turn the conference back over to Ashok Vemuri, Conduent's CEO, for any closing remarks.

Okay.

Thank you.

Thank you, everybody.

Quite pleased with the performance.

I have to again thank everybody in Conduent, our clients and our partners for helping us through this fairly interesting first year.

We continue to hope to expand the performance in 2018 and to turn ourselves into a profitable growth company, not just meeting competitor standards, but exceeding them as well.

Look forward to talking to you again.

Thank you very much.

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