Q3 2020 Unisys Corp Earnings Call
[music].
Good day and welcome to the Unisys Corporation third quarter 2020 earnings Conference call.
All participants will be in listen only mode should you need assistance. Please signal I conference specialist by talking much Starkey followed by zero <unk>.
After todays presentation, there will be an opportunity to ask questions. Please note. This event is being recorded I would now like to turn the conference over to Courtney Holben Vice President of Investor Relations. Please go ahead.
Thank you operator, good morning, everyone. This is Courtney Holben, Vice president of Investor Relations.
Thank you for joining us.
Yesterday afternoon, Unisys released its third quarter 2020 financial result.
I'm joined this morning to discuss those results by Peter Alpha, though our chairman and CEO and Mike Thompson our CFO.
Before we begin I'd like to cover a few details first today's conference call and acuity session are being webcast via the Unisys Investor website <unk>.
Second you can find the earnings press release and the presentation slides that we will be using this morning to guide our discussion as well as other information relating to our third quarter performance on our Investor website, which we encourage you to visit.
Third today's presentation, which is complementary to the earnings press release includes some non-GAAP financial measures.
The non-GAAP measures have been reconciled to the related GAAP measures and we've provided reconciliations within the presentation.
Although appropriate under generally accepted accounting principle. The companys results reflect charges that the company believes are not indicative of its ongoing operation and that can make its profitability and liquidity results difficult to compare to prior periods anticipated future periods or to its competitors' results.
These items consist of pension that exchange and debt extinguishment.
Cost reduction and other expenses right.
Management believes each of these items can distort the visibility of trends associated with the company's ongoing performance.
Management also believes that the evaluation of the company's financial performance can be enhanced by use of supplemental presentation of its results that exclude the impact of these items in order to enhance consistency and comparative know with prior or future period results.
The following measures are often provided and utilized by the company's management analysts and investors to enhance comparability of year over year results as well as to comparable to other companies in our industry.
Non-GAAP operating profit non-GAAP diluted earnings per share free cash flow and adjusted free cash flow EBITDA and adjusted EBITDA in constant currency.
Addition, this quarter, we will be continuing to report non-GAAP adjusted revenue and related measures as a result of certain revenue relating to reimbursements from the company's check processing JV partners for restructuring expenses included as part of the company's restructuring program.
For more information regarding these adjustments please see our earnings release and our form 10-Q.
From time to time, Unisys may provide specific guidance or color regarding its expected future financial performance such information is effective only on the date given.
Unisys generally will not update reaffirm or otherwise comment on any such information, except as unisys deems necessary and then only in a manner that complies with regulation FD.
And finally I'd like to remind you that all forward looking statements made during this conference call are subject to various risks and uncertainties that could cause the actual results to differ materially from our expectations.
These factors are discussed more fully in the earnings release and in the company's SEC filings.
Copies of those FCC reports are available from the FCC and along with the other materials I mentioned earlier on the Unisys Investor website.
Now I'd like to turn the call over to Peter.
Thank you Kirk good morning, and thank you for joining us to discuss our third quarter financial results we.
We continue to hope that you your families and friends are safe and healthy.
Our financial results improved significantly versus the second quarter, and we took meaningful steps to improve our pension structure.
While keeping a sharp focus on near term goals. We have also been enhancing the productivity of our operations and focusing on higher margin higher growth segments of the market to drive the business going forward.
In addition to our overall operational productivity enhancements, we were pleased to see that the recovery from covered related impacts continued in the third quarter.
The combination of these factors helped drive significant sequential improvement in our key financial metrics.
The year over year, non-GAAP operating profit margin expansion, which Mike will go through in more detail.
One of the elements of the financial results that I will highlight.
Is that our services non-GAAP adjusted operating profit margin.
Creased 520 basis points sequentially and.
And there's increased 830 basis points since the end of the first quarter this year.
This has largely been driven by effectively removing negative synergies following the sale of our us federal business and there's also been helped by our ongoing efforts around workforce planning.
We are utilizing predictive analytics and near real time data to optimize the efficiency of our workforce, including through improved labor supply and demand management and skill gap resolution.
While these efforts are in early stages, we are pleased to see the improvement to date.
With the total services cost of labor as a percentage of services revenue down 320 basis points year over year in the third quarter and down 250 basis points sequentially.
Moving to revenue in the quarter factors contributing to our sequential revenue improvement include.
The increase in monthly tickets in our field services business from approximately 70% of their pre cobot levels in June to approximately 80% in September.
Volumes on the two large BP old contracts that we referenced last quarter increased from 38% and 80% of their pre cobrand, mostly levels in June to 57% and 91% respectively in September.
Within travel and transportation, our global average daily way build count increased from 51% of its pre Cobrand monthly volumes in June to 68% in September.
We also saw an increase in sales with services total contract value signings, increasing 4.3% sequentially in the quarter.
[noise], we've taken significant steps to improve our pensions structure and liquidity since the second quarter, including with the notes offering we just priced.
Mike will provide more detail on this but the progress enhances both our financial and operational flexibility.
We have been making improvements to the business to drive efficiencies overtime, including the workforce management efforts I noted.
As well as increasing the implementation of automation and artificial intelligence and enhancing collaboration tools to increased associate productivity.
We also saw sales momentum with our pipeline increasing over 20% sequentially. As a result of increased unsolicited bids to help clients solve their business challenges.
This is also at higher quality pipeline.
As we have been more rigorous in pre qualifying opportunities and we have enhanced sales training efforts through the implementation of boot camps and investment in more sophisticated training platforms to aid our new digital selling approach.
And as a result.
Our year to date win rate was up significantly relative to win rates in the last two years.
Within digital workplace services as we discussed last quarter, we are shifting our focus to higher growth higher margin segments of the market such as end user experience.
Intelliserv, which is our artificial intelligence and advanced analytics powered platform.
Helped differentiate us within digital workplace services.
Intelliserv uses cloud based mobile centric solutions to improve end user experience and productivity, while supporting workforce optimization and reducing our cost.
As an example of how Intelliserv can help clients transform their digital workplace strategy. During the third quarter, we signed a contract with D.J.O. global Inc., a provider of intelligent medical devices and services Intelliserv will enable omni channel service to support to help provide a.
More affordable and effective experience for D.J. owes customers.
[noise] within cloud and infrastructure, we are prioritizing our cloud efforts enhanced by cloud Forte, which offers a comprehensive set of cloud services are cross applications and infrastructure with embedded governance and security to accelerate digital transformation.
And for our clients.
During the quarter, we signed a new scope contract with the state of North Dakota as part of this contract Unisys will be providing cloud fourg services related to the Microsoft as your Gulf cloud to support that state unemployment insurance agency.
With respect to clarify with respect to clear path forward, while we report license revenue in our technology segment and Clearpath forward services revenue and our services segment.
Think about this business as a franchise with the services inherently linked to the technology.
We continue to innovate this platform and enhance our offerings.
During the quarter, we announced the general availability of clear path forward from Microsoft assure.
This offering provides our clients with the ability to utilize secure high intensity computing in a public cloud environment.
The solution creates the opportunity for clients to increase volumes processed by Clearpath forward systems.
And to increase their usage of related Unisys services and solutions, such as Unisys cloud Forte hybrid and multi cloud services stealth and stealth services.
The new work with the state of North Dakota is an example of the power of leveraging Clearpath forward for sure with other units of services such as cloud for Tech.
Clearpath forward services represents an ongoing opportunity for growth, including application development.
Modernization and managed services.
We believe all these initiatives will help us maintain our very high clearpath forward client retention rate.
[noise] Ive spoken in recent quarters about our ongoing commitment to diversity equity and inclusion.
This quarter I want to highlight our focus on E. S G matters.
While environmental social and governance activities have been important to us for years.
During the third quarter, we published our first sustainability report, which is available on our website.
Among the targets and accomplishments highlighted in the report.
We note that in 2006, we announced a goal of a 75% reduction in our absolute greenhouse gas emissions from scope, one and scope to sources by 2026.
We are currently 96% of the way to achieving this goal and we'll do so years ahead of schedule.
We've achieved a 99% reduction of our hazardous waste generation over the last 20 years with zero hazardous waste generated across our U.S. operations in 2019.
We also recognize the need to expand the impact of our yes Ci efforts. So we have announced a target of having 75% of our key suppliers disclose their E.S.G. targets and committed actions.
Before turning the next section of the call over to Mike.
I would like to thank all of our associates for coming together to support each other and our clients this year.
As examples our field services technicians put themselves on the front line even.
Even during the height of the initial wave of COVID-19 to serve our clients.
Our sales executives have quickly adapted strategies to achieve success in a more virtual world.
We are truly grateful for our associates commitment to unisys, our clients and our investors.
I am proud of our progress since our last call and we look forward to continuing to execute in the fourth quarter.
Mike over to you.
Thank you Peter and good morning, everyone.
My discussions today I'll refer to both GAAP and non-GAAP results.
As a reminder, reconciliations of those metrics are available on our earnings material.
Likewise information related to discontinued operations is available on our website.
As Peter has already highlighted our financial results improved significantly on a sequential basis relative to the second quarter, including being free cash flow positive for the quarter.
We also took steps to significantly improve the pension structure and our full year expectations for revenue and profitability are unchanged.
We were able to accomplish this while also streamlining operations to enhance our margin profile and focusing on higher margin higher growth market segments.
I'll begin by noting that we were ahead of consensus on all major financial metrics for the quarter.
Our non-GAAP adjusted revenue increased 12.8% sequentially relative to the second quarter to 495.1 million.
This was driven by both improvements in services and technology revenue.
Services non-GAAP adjusted revenue increased 7.6% sequentially to 425.9 million.
This improvement was driven by increased volumes in the businesses that were most impacted by Copel <unk> as well as growth in our cloud business, which was particularly strong in the public sector.
Services backlog ended the quarter at 3.3 billion.
We expect a sequential improvement in services TCB that Peter mentioned to continue into the fourth quarter and expect backlog to be higher in the fourth quarter as a result.
Technology revenue was also significantly higher sequentially and ahead of internal expectations up 61.7% versus the second quarter to 69.2 million.
The two clear path forward contracts that were delayed from Q2 were signed in the third quarter, which contributed to the sequential improvement in revenue no technology revenue would have been up sequentially, even excluding these contracts.
Last quarter, we noted that we expected technology revenue to be split approximately 30% and 70% between the third and fourth quarter.
Given that technology revenue was slightly stronger than expected in Q3. This split is now more likely to be approximately 40% and 60%.
Moving to profitability non-GAAP operating profit margin expanded 50 basis points year over year, and 830 basis points sequentially to 8.5% again, driven by improvements in both services and technology margins.
Services non-GAAP adjusted gross margin increased 200 basis points year over year, and 350 basis points sequentially to 19% and the services non-GAAP adjusted operating profit margin increased 250 basis points year over year, and 520 basis points sequentially to four point.
8%.
These improvements were driven by the flow through of higher revenue as well as additional savings from effectively removing negative synergies earlier in the year following the U.S. federal sale and the workforce management efforts that Peter outlined.
Technology margins were up significantly on a sequential basis with technology gross margin up 17.7 points sequentially and technology operating profit margins up 30.9 points sequentially.
Adjusted EBITDA margin expanded 350 basis points sequentially to 14.9% driven by many of the factors I've already noted with respect to revenue and operating profit.
We continue to be pleased with our associate productivity in our remote work environment and as Peter noted we're proud of the work our associates did during the quarter to drive progress.
Despite the significant sequential improvement in non-GAAP adjusted revenue it was still down year over year, but consistent with our previously discussed expectations.
The year over year decline was driven largely by lower volumes in both field services and our check processing JV within VPO.
As a reminder, we noted coming into the year that our Clearpath forward renewal schedule was expected to be lighter in 2020, and then also contributed to the year over year decline in non-GAAP adjusted revenue.
Technology margins were down year over year because of the flow through impact of the lighter renewal schedule on revenue against a relatively fixed cost base.
Our full year expectations for revenue and non-GAAP operating profit margin remained unchanged relative to the end of the second quarter.
Our models continue to indicate a 10% year over year revenue decline and 5.2% to 6.7% range for non-GAAP operating profit margin for the full year 2020.
All of these forward looking indicators are based on our current visibility and should spikes in the virus result in material negative economic consequences. Our actual results may different from our expectations.
We had previously discussed a onetime noncash charge of $20 million related to our media optimization plan, which we now expect to incur in the fourth quarter instead of in the third quarter.
Our previously mentioned facility rationalization is also on track and we anticipate a fourth quarter charge of $5 million to $10 million.
The resulting in run rate savings from the charges taken in third quarter and the fourth quarter is expected to be between 20 and $30 million exiting 2021.
Moving now to pension and liquidity, we're very pleased with the progress we were able to make on both of these fronts since our last call.
Our recent notes offering will allow us to significantly reduce the pension deficit and our remaining required pension cash contributions.
Pro forma for contributing the net proceeds from the notes as well as up to $285 million from cash on the balance sheet, we will have effectively prefunded substantially all the expected future contributions to the U.S. pension plan.
Given that we upsized the recent notes offerings and based on the current calculations for future payment, we may not need to contribute to full remaining 285 million I'm just highlight as we do not want to be in a position, where we have funded more than our required contributions.
Pro forma for the contribution of the notes proceeds we will have contributed just under 800 million to the U.S. pension plan in 2020, thereby dramatically reducing the deficit.
The notes offerings was a roughly leverage neutral transactions given that the net proceeds were used to reduce the pension deficit.
As a result pro forma net leverage is three times LTM adjusted EBITDA as of September Thirtyth.
Also with respect to pension I'd like to update you on our pension liability reduction strategy.
As a reminder, I mentioned on the second quarter earnings call that we were planning to remove approximately 1 billion in gross pension liabilities by the end of the first quarter 2021.
This program is on track and during the third quarter, we notified a group of plan participants of our offer to make bulk lump sum payments.
We expect this bulk lump sum offer to remove between 200 and 350 million of gross pension liabilities from our U.S. pension obligation and we anticipate this process to be completed by the end of the fourth quarter.
U.S. GAAP requires that proportional settlement charge accompany the removal of significant pension liabilities.
Charge represents unrecognized actuarial gains and losses currently sitting in accumulated other comprehensive income or AOCI.
In the equity section of our balance sheet.
To that end, we anticipate 150 million onetime noncash settlement charge to be associated with this portion of our liability reduction to be recognized in the fourth quarter.
In the first quarter of 2021, we expect to remove an additional $750 million of gross pension liabilities with approximately 250 million coming from the U.S. pension and approximately 500 million coming from foreign pensions.
This corresponding onetime noncash settlement charge associated with the liability removal of these plans is expected to be approximately $250 million and would be recognized in the first quarter of 2021.
Both of these charges are equity neutral and will reduce future pension expense.
With respect to liquidity, our cash flow this quarter with strong cash.
Cash from operations increased 48.6 million year over year, and 80.5 million sequentially to a total of $66.3 million.
We were also free cash flow positive for the third quarter with 34.3 million of free cash flow, an increase of 48.6 million year over year and 83.9 million sequentially.
Adjusted free cash flow increased 38.5 million year over year, and 89.5 million sequentially to 52.4 million.
As a result, we ended the third quarter with a strong liquidity position.
We paid down the 59 million previously outstanding on the ROV revolver with cash from operations.
And after doing so we had an ending cash balance for the quarter of $774 million down less than 10 million versus the end of the second quarter.
Given the issuance of the notes and contributions towards the pension we have limited near term cash requirements outside of normal operational funding.
In conjunction with the recent notes offering we've also obtain commitments to renew and extend our asset backed lending facility or a deal at the size of $145 million with a new maturity date of 2025.
As in the second quarter, we had no negative impact on cash collections due to COVID-19 and continued to be in line with historic norms.
Capex was roughly flat year over year at 32 million and we're reducing our overall capex target for 2000 $20 million to $140 million down from 150 million.
Overall, we're very pleased with the progress we've made during the third quarter and we remain focused on continuing our strong execution in the fourth quarter to achieve our full year goals.
With that I will turn the call back over to Peter.
Thank you Mike operator, we're now ready to take a comments and questions.
Thank you.
We'll now begin the question and answer session to ask a question you May Press Star then one on your Touchtone phone. If you are using a speakerphone. Please pick up your handset, that's where pricing is key.
Let's try your question. Please press Star then Q.
The first question today comes from John Tim Kaine.
Ah CJ Securities. Please go ahead.
Hi, good morning, and thank you for taking my questions very nice quarter guys. It's clearly you've done a lot of good work here.
Wanted to ask about the sequential margin uptick specifically in technology, you got some pretty good operating margin there on only 70 million in revenue.
As we look into Q4, where you have more renewals coming can we see much of that drop to the bottom line with them. We did in Q3 or how should we think of the incremental as those renewals come in.
I have a follow up after that thank you.
No John you might want to do you want to see us you're typically to that John. Thanks for the question I would say that in general the technology revenue that comes in is all hub customized due to specific client specific contracts and.
And so there are allocation issues that apply throughout but there's a lot of very specific facts about each of these contracts. So it makes generalization about profitability of specific contracts, a little more difficult, but over to you Mike.
Yeah, Hey, John how are you.
Yeah, John as you know the bulk of that is is clearpath forward technology revenue, it's a relatively fixed base and so we.
We would expect the the margin pull through to be consistent with.
With the third quarter again, with the cost basis being relatively.
Fixed and flat the expectation on margin the one variable that comes into play and probably not indigenous to what's coming through in the fourth quarter is the amount of third party hardware that might end up being included in any given scenario.
But in this case I think the expectation is it's consistent with what happened in Q3.
Got it that's helpful and again as we look to the fourth quarter and then I know you have your full year guidance out there, but you know with Covidien.
Ramping and hitting new highs in many regions of the world. How are you preparing for that especially as it comes to the ability to visit sites and do your processing and call Center work are you doing you know are you going to be impacted similar to the way you're impacting Q2 are you going to able to mitigate that in some way.
Well I'd say, we're smarter than we were in Q2 I think the thing we did as many of the companies in that sector did really effectively in Q2 was to be able to move people out of contact centers out of main facilities, where they were all working together to end development work and have them work remotely that dramatically.
Decreased the spread of the virus within our team.
It was harder to do in Q2 or was really to stand up to from a workforce planning standpoint, exactly how you would support all of your clients exactly how you would do remote field service effectively.
And so that did take a while to get a handle on I would tell you. We now have that much more in hand, so I would expect more efficiencies.
If we get a strong second wave if that's what you want to call. It from what we experienced in the second quarter. The other thing to keep in mind about us as a company is the real strength of our diversity. So the U.S. accounts for about 40, what we U.S. and Canada is about 41% of revenue.
He is about 30 to Asia Pacific and Latin America, together about 37, or so from a standpoint of client demand.
You know different countries are going to be affected in different ways and I think we have a strength of diversity in the same way we have a strength of delivery because our people are you know spread so for around the world. So that's not going to make it perfect, but I do believe we're in a better position than we were in the second quarter.
Understood. Thank you and I'm, sorry to squeeze one more in just as it relates to pension reform and simulate if that passes as their provision to pay the.
The senior secured notes back.
The senior secured notes John or a no call three in.
And the seven year term so.
Certainly not immediately that would not happen.
Got it thank you very much.
Hey, good job.
Our next question today comes from Joseph Fathi, Brett Canaccord. Please go ahead.
Hey, guys. Good morning, nice to see the rebound in the business. So I know Peter you you mentioned some work force official.
Efficiency metrics year upfront some of your comments on.
It sounds like there may be more progress there in terms of no efficient staffing and and optimization.
Do you have a feel for kind of best practices or or or benchmarks out there.
Relative to perhaps where you are and you know.
How much how much more opportunity may be.
Front of you here.
Yeah, Joe that's a it's a it's a great question and be thank you for waking up so early this morning [laughter].
With Oh, we stood up what was effectively a brand new re imagined workforce management system in.
In January a new team, leaving it new processes. So you know that team has had to get up and running and on the go.
During most of the cobot situation, so as I say, when we look at the savings that.
That we were able to pull through this calendar year in some of our operations is really two buckets.
One is getting rid of the negative synergies if you will from downsizing with this with the sale of the U.S. Federal group that that is effectively done on a run rate basis, there's a there's a.
About less than 20% more to go in the fourth quarter and it's all been identified.
So the second part of that productivity is through workforce planning that has been the smaller part in 2020, we actually expect that to accelerate in 2021.
So oh, we think the bigger savings with respect to that are ahead of us and not behind us and workforce planning is actually only one of three what I would call big internal housekeeping jobs, we have done during COVID-19 [noise]. So obviously, we've we've we've put in place that workforce planning.
System.
That involves not only a advanced training, but matching of skills and labor and cost it means not going through a turned style of.
How do you hire people for specific jobs and then what happens if you don't need them anymore, but really taking that workforce and retraining that workforce. So you get out of this endless cycle of of people moving in and out of the company, we think thats very productive for them and very productive for us but in addition to two workforce planning we have two other ones.
I would call inside baseball initiatives going on of substance.
One of them is a brand new ERP system, which doesn't sound exciting but.
But is exciting ours is about 20 years old I can talk about it we actually have two systems running concurrently and everybody on this call those the benefit of a real effect of ERP system. In particular, we expect that to increase our net cash flow and Mike can get into more detail on that and finally over the course of.
This year, we have been standing up a very significant a brand new digital sales platform, which I alluded to in my comments and that is dramatically accelerating our ability for the sales team.
To work with clients and prospects and as you've seen from my remarks.
That is just beginning but it's already having an effect with a really any dramatic increase in our win rate. So more to come on all three of those initiatives next year, we expect that to be more powerful next year than this year, but we like what we're seeing in all three might you want to speak to the ERP systems and the effects of that for a minute.
Sure Hey, Joe how are you really I'd like to tie to first Peter into your comment about workforce management, Joe when we look at our total cost of labor, we're seeing that come down dramatically across the board right. So it's not only managing our internal workforce and the flow rate.
Sources, but its managing any any outsourced component of that that we have so our total cost of labor.
Is really being helped by that and as you know with the geographical footprint that we have in being diverse we want to be nimble, but and we want to be.
Ensure that we've got the right people in the right place and that that's been really helpful to us and to Peters point, we expect a 21 to continue that momentum and continue to drive that internal cost of labor down.
Maybe specifically to the ERP and as you can imagine it's a it's a vast project that encompasses many aspects of our business, but one thing in particular and specifically as we talk about working capital improvements within.
Within the RP would be the new billing system component of that and.
The allowance for on demand and real time billing in a web based environment.
He's going to help significantly and we'd be looking for a significant deal so reductions out of that which buying turn would obviously reduce our working capital.
Profile a bit because we're we're now aligning on the power side of the coin consisting with the ATP side of the coin and our goal here is to get to a point.
That we're we're using a minimum working capital in the context of our free cash flow. So a lot of good things in the pipeline from an operational perspective, and we feel pretty good about the direction and where we're going right now.
That's great. Thanks for the extra color both of you.
Maybe we're just trying to focus again on that last point, Peter mentioned as well on the.
The digital initiatives I mean, if you kind of look across the enterprise and and software sales and the macro and.
The digital transformation efforts underway or just you know really kind of amazing the pace that they are going right now it does sound like you're tapping into that with this kind of non solicited.
Bid opportunity.
Can you kind of expand on that relative to the offerings that that you're seeing in these in these situations and you know do you think the products that needs to expand to kind of exploit what you are seeing across enterprise customers.
So Joe that's a that's a great question, it's not a simple question, but it's a great question. So I'll I'll try to start three it with three kinda subsets and then let bike continue on top of it let me start with the last of your statements about the products that [noise].
So I have referred to in the last two calls both this call on the prior call about you know us it.
Evolving into a higher margin and higher growth areas. So specifically when you think about some of our lines of business. They are more stable with growth opportunities and other lines of business or.
Have even higher growth opportunities, so what I would categorize as the more stable lines would be our clearpath forward family of Ah of solutions, there's opportunities to grow that vis-a-vis a particular services on top of Clearpath forward are related to things like cloud for Jay the new Mike.
This off to assure general applicability for the M.C.P. version of cloud for China is a big deal.
So there are opportunities and we're spending a great deal of time and focus making sure that core franchise remains viable and has opportunities to grow.
The BPL business of ours as you know has been kind of a a very specific set of clients and capabilities and remains a specific set of clients who capabilities.
That leaves really our two other large areas of revenue.
One is what we call digital workplace services. The other is a cloud infrastructure so within digital workplace services or we have set down.
Really since April with Mckenzie, and and really kind of plan down what is the future of digital workplace services. Horace same thing, we sat down and worked through with Mackenzie what does the future for us in cloud and infrastructure and in both cases I.
I think we pretty much knew the direction of the answer and some of the specifics, but it is a much more fulsome fleshed out kind of approach than we have in April so with respect to digital workplace services, you know that evolution of going for really an end user.
Services to end user experience is going to increase the size of the market. We can approach is going to increase the value of our services to our clients and that should result in increased margin to us we are very committed.
To the digital workplace services environment, It's a major area of focus for us and I would just point out it's a major area of focus for us while it is less of a focus for some of our competitors.
And it's interesting because that is an area that is growing that is getting more profitable and you know you might say why are a bunch of people, leaving that market well, they're leaving because they find another market, even more attractive but for us we find that a very attractive market, especially given our position in that market as.
One of the leaders of that park.
Second market, where we are really expanding our capabilities is in the world of cloud and infrastructure. There is a focus on cloud.
And that is the market that everybody is going to you've seen that with announcements from a number of other companies in.
In our space really over the last year and over the last month.
And so it is a big market. It is growing quickly. It is a profitable market. So everybody is there and so our approach is not like everybody's.
Again, working with Mackenzie, we've taken a very specific approach to the cloud market and said you know we have very specific very capable assets at our cloud Forte approach that have been well received and wouldn't be but when we look at that big market. The question is where are you differentiated and.
Why will you succeed and so we have really looked at specific parts of that market I'll talk about one of them, which is the public sector state and local in the U.S. and then governments around the world as Mike alluded to in his remarks, we have been very successful.
Successful in the public sector, we expect to be more successful in the public sector. So that is an area, where we really expect to double down and make a lot of gross and much progress in a larger market, where there's a lot of other things going on but we really like that public sector.
And we think we like it for very good reasons, we are very well known in that sector.
And we have very good capabilities that speak to that sector in particular.
Every one of our cloud initiatives focuses on saving money, yes, it increases capability, yes, it increases.
No security, yes, it increases the ability to be flexible and moving workload, but every one of them saves money that way.
When you look at governments around the world. That's just that's just an absolute requirement and we fit that requirement. So Mike from a solution standpoint that those are kind of the the areas, where we're probably change air solutions. The most.
Then when you're talking about the non solicited bids that's something we have been talking about we think it's really important I will say that when we look when we work with TPH.
Pipeline, we are getting from TPH has actually increased very dramatically the win rate related to TPL work.
Is the win rate I mean, you're going to win a certain percentage of those you're not going to win all of them. The win rate related to non solicited bids is much higher you know the clients better and you know what the client needs and you specifically addressing that so as we look at our overall win rate.
I think we're getting a little better on the T.P.A. bids or just because you know we we simply got our act together more for those unsolicited bids have a much higher win rate and that is coming through in our numbers.
Mike anything to add to that yeah. So Joe maybe just add Peter you know, obviously very fulsome answer so I think Joe probably got most of what do you get out of that but I would say that the new business from our perspective is up year on year, Peter talked about the pipeline.
Crees, we're seeing that the typically from a deal count perspective, and were attributing a lot of that to the non solicit bids to Peters point, when you're when you're walking the hallways and able to pick up that incremental work without going through the RFP process and typically that's a little higher margin work as well so far.
From that perspective, I think Joe all of those things are are things again that that we feel pretty good about we're seeing a pipeline continued to pick up I mentioned in my comment that our expectation is that backlog will will increase.
In Q4, and close higher than we close Q3, and a lot of that is new business new logo, new scope type work.
Hi, Joe just to give you a number are you know new business services TCV.
Which is new scope, where new client was up 71% year on year now that we need our signings to continue to increase but that's a very good number for us.
Your next question comes from Rod bourgeois keep.
Deep dive equity research. Please go ahead.
Hey, guys, Hey, so I want to.
Ask a little more about the improved win rate clearly your new digital sales platform as part of the improved win rates story.
Can you talk specifically or is to give us. Some some examples of how the digital sales platform is helping the win rate and are there factors. Besides the new digital sales platform that are also helping on the win rate front.
Yeah, Rob. Thanks for the question you know I think one of the one of the requirements.
Clients are going to expect in the future and we are just trying to stand in front of that and get a little ahead of that with our digital sales platform is transparency I mean, you know most clients at this point are doing most of their research ER, but on the web you know well before they talk to any of our salespeople.
Or marketing people you know they know more about us that we do have a good day and they want that same ability when it comes to pricing.
So what are the things that our digital sales platform does is it gives them access to pricing information.
That we have never even thought to provide before and frankly, we havent been able to provide it before because it moves from being you know everything is being kind of a custom in a in a large model to something that is much more available from a pea in Q standpoint, So that's what we've done a and then b.
Beyond what is even available you know from a web site from a digital sales standpoint, the modeling itself has become so much cleaner.
That we can be very very responsive EPS to pricing it doesn't have to be that big black box. That's all that complicated and as you move more to Hsas services as you move more to service on demand you have to have that approach. So as we have evolved into that approach we find the clients like it they they not only like.
The fact that the pricing is perhaps more competitive but they like the speed with which we can respond to them.
As well as the transparency of it so it's a big deal for US and you know I would say if we look at the at the win rates so far in 2020.
That digital sales platform is contributing to the win rate, but in addition to that it is this higher mix of unsolicited opportunities, which is also contributing to the win rates and I talked about that in response to Joe's question. You know, we simply know more about those opportunities.
One of the advantages of our company is good.
The depth of our relationships with our clients our top 10 clients, we've been with for an average of more than 22 years and that includes clients that we have had only for the last three to five years. So for some of those clients. You know we go back even further so we have a very very in depth understanding of their needs.
And we can use that in depth understanding to create unsolicited bids that we think are compelling and more and more they are compelling and that's why the win rate is going up.
Hey, Brian It's Mike I'll, maybe just add two points to that you know weve talked about in the last couple of quarters. He continued work we're doing to qualify the pipeline and I think you know the more qualified that pipeline that better your conversion of that pipeline tends to be and then the other thing just to touch on.
On a point that the Peter made in his opening remarks, we spend a lot of time just retooling our sales go to motion our go to market motion training internally. So during the pandemic, we've really taken an opportunity to deepen and I think the understanding.
Of the sales force about our platforms and what we've got to offer so on so the non unsolicited bid the enhanced training and depth of the team and the selling motion the qualified pipeline and to Peters point are are significantly higher NPS scores.
Happy clients, we think are all contributing factors to that increased win rate.
Great and then the follow up is I'm very glad to hear about efforts to shift your mix into these higher margin segments.
It also it also seems that that's another effort that can help the win rate as you are very deliberate about the segments that are being targeted.
As you as you pursue those efforts to shift the mix to what extent might you see low margin revenues as you make that shift.
Help me out a little bit Rod see low margin revenue Oh sure yeah, Yeah, I I've meant to use the word seed in other words like we would you would you move away from certain contracts that are at a very low margin in order to focus.
Your efforts on higher margin segments or do you plan to kind of keep the core low margin work and then just add kind of higher margin work on top of it is there is there a bit of a effort to sort of give up on low margin contracts to.
To make this shift to the higher margin segments.
Yeah. So that's a great question right. You know we have we have actually been moving away from lower margin contracts for really a few years.
And I see that movement it.
Accelerating over the next couple of years. So you know basically what you are seeing from US I would say really over the past almost two years is as as we approach renewals, we very rarely I can't think of a of an example of where we walk away from a client that's just not.
What we do.
But in the context of renewals.
We are absolutely looking at the business that we have and saying how does this fit into the current portfolio and Oh, we really fairly pricing this business with our clients and we have and will continue to go to those clients, where we say we have not fairly priced the work and where the work.
Is not advantageous to us from a target margin standpoint, and go to the client at the renewal opportunity or even before renewal opportunity in the in the context EPS extension.
I'd say look you know here's the deal were very open book about this here's the value we're providing.
But this is why this is problematic for us and you know some clients have approached that with a view of I got it you know I've got a really good deal that I understand that this pricing you know isn't going to be acceptable going forward. So clients are going to say I've gotten used to this pricing and I'm not going to take anything but this pricing.
And you know either is illegitimate response.
But we are not going to be inclined to accept that level of pricing going forward. So I think there will be an element of our revenue as we make this shift to higher margin there just isn't compatible.
And and and therefore, we'll leave it it's not because of the nature of the work.
It's really because of the those specific contract terms as we look at the kind of work we're doing for clients today, we can make it all work inside our profit targets. So we don't have to a band that things because we're doing the wrong kind of work, but we still have some contracts that are simply not a structured.
That makes sense for us and it doesn't make sense for us we don't think it makes sense for our client.
Like anything further to add on that.
No Peter I think that's right Rod as you know we've been Ah we've been looking.
Looking at pruning bad portfolio for many years, we do have contracts in that space that are three to seven years in duration and you know so there are a couple of those still lingering around but Peter's point as they come up for a natural renewal is when we're having those discussions and you know at least four.
A good chunk of what we've seen to date clients have been willing to work with us and actually increase that margin profile a bit to make it.
Advantageous for both parties, so, but we'll continue that approach.
Thank you Ross.
Thank you. The next question comes from Frank Jarman Goldman Sachs. Please go ahead.
All right great. Thanks for taking my questions I guess, one for Mike Yeah. If you look at your full year guidance for 2020 revenue and operating margins and an update on on Capex.
And then just you know given the nice improvement that we saw on free cash flow in the third quarter could you just talk to sort of what that implies for free cash flow in the fourth quarter. You know just in in the broader context, given the guidance you provided for revenues and operating margins. Thank you.
Sure. Thanks Frank.
Yeah actually I said at the end of the second quarter earnings call that I expected the back half to be free cash flow positive. So.
The fact that Q3 was was free cash flow positive and to your point. The expectation is capex should be about $10 million lower that also supports that and just the weight of the technology right.
Revenue and profit that is coming in in the fourth quarter I mentioned to a shift there and we're at 40 60 now for third quarter fourth quarter. So all of those elements tend to support continuing pre cash flow positivity and and I would.
Expect Frank that Q.
Q4 to be stronger than Q3 from you know a cash free cash flow positivity for those reasons now obviously, we don't we don't guide to that particular value, but I think if you take the increase technology revenue in the commentary about the profitability coming through and the $10 million of savings.
As it pertains to capex coming through to free cash flow gives you a good sense of where we expect the.
Fourth quarter to come in as well as the full year.
Oh, so again feel pretty good about that story and I'm hopeful.
Hopeful that will continue along that path.
Great and maybe just as a follow up as we roll it into it to 2021.
You've obviously made a lot of progress on the liability side and you know as I think about that.
Progress you've made with the pension I'm as I think about the interest cost associated with the new that and you know think about Capex working capital. Some of those factors you know how should we be thinking about you.
You know some of those factors that build into free cash flow for for 2021.
If if you have any early thoughts.
Yeah, well look out as part of the road show when we did the offering we had some color on that and and I'll point you to some some slides in that materials as well.
But but I think in general one of the comments that I've made during that is our expectation was if not for the voluntary pension contributions that we'd be making and 21.
We we were calling free cash flow positive EBITDA for the year right and as you know for following the story here.
That free cash flow positive not adjusted free cash flow positive, so really very a significant milestone from our perspective.
And it really is going to largely depend on you know we're talking about adjusted free cash flow what those pension contributions might look like but but as you know we've continually been driving down our capex number I think maybe a couple of years back we were maybe two fifteenish million you can.
He now closing the year at 140, we think Thats, probably a good metric for for for modeling purposes.
For 21, but you know continued work efforts on.
Minimizing some of the Capex dollar spend for software capitalization as we continue to.
Advance our.
Our public sector business and using more capital light strategy. There, we think thats driving down the outsourcing asset component as well. So so still think there's some goodness out of capex.
Typically what we tell folks is 3% to 5% is a good barometer for international revenues of 3% to 5% all of international revenues is a good bogey hurt for tax purposes.
Use from a modeling perspective, I guess the other component Youve got the interest expense component that you that you just mentioned on.
The new the new debt. So the only other real component there is working capital and from a working capital perspective.
Mentioned in some of my opening comments here and then on one of the questions was related to the DSO favorability that we expect to start to achieve Q1 of next year as we roll out the ERP through the year. So we think that working capital positivity will flow through as well into free cash flow.
So all of those components, you know again or are favorable to our current position.
We as we get a little closer to year end and we talk about.
Next years guidance and in the fourth quarter call, we'll be able to give some more specificity on onto those numbers, but hopefully that gives you a pretty good sense of how you're modeling ought to look.
And Frank if I were just a follow up on Mikes comments, which I think are very responsive to you I hope are responsive to your question about 2021.
But then go you know a little bit beyond the 2021 timeframe.
When we look or when I look at the perspective of this calendar year and what we have done about our capital structure.
Obviously, the sale of the federal unit, a required us to sell or pre pre.
Close out or four fortys in terms of their long term debt.
But dramatically reduced our need to contribute to the pension and the U.S. over the course of time because of the contributions we have made with the <unk> the offerings that we have now priced.
Which is expected to close subject to terms and conditions. This Thursday, we will effectively have replaced the four fortys.
With a second level of debt.
That is a lower in cost and allows us to again you.
You know kind of put the the nail in the coffin of our expected U.S. pension contributions overtime Theres Theres still some limited amount out there, but it becomes de minimis at some point.
And so you know as somebody who has been at the company for the last five years and Mike has been here for the five years [noise].
The thought that we would now get to a place where from a contribution standpoint.
We had no a really minimal amount of U.S. pension contributions expected over the entirety of the time to come.
Is quite a statement.
And and we are no longer a as subject to the whims of interest rates, we're no longer as subject to the whims of other variables that came with that expected contribution and the fluctuations of those expected contributions. So this is a this is a big deal for us and.
And I do want to congratulate our financial team and our legal team for making this happen from an operational standpoint, we.
We don't have to go you know to bed at night thinking about how do we fund the U.S. pension contribution.
Our operators have grown a bedroom and saying how do we use our assets to build the business. So that's a pretty big difference.
The next question comes from Doug Thomas Jet equity partners. Please go ahead.
Good morning, Peter.
Good morning, Thanks for the call.
I.
Actually was just gone to offer you a hardy and your team a hearty congratulations.
You know for the tremendous work that you've done and point out yes that you're right I mean, it's a it was a distraction for sort of five years and that ought to.
Allow you guys now to focus on growing the company. So all those things you Senator correct I'm just.
I'm curious to you know the Companys performance has improved steadily as the pension issue has become less of a factor and I'm wondering if.
You know companies customers potential customers.
We are also feeling better about your current situation and whether or not that ought to help you continue.
Continue to grow the top line or in near future.
You know I think what we have done over the past couple of years first of all Doug. Thanks for the question.
I think what we have done over the past several years.
Has really taken the issue about our capital structure off the table it was an issue.
And I go back a three to four years ago. It wasn't an issue before the things we have done in the last three to four years, it's simply not an issue anymore and so to your point from a client standpoint from a prospect standpoint, you know weve gone from a company with a relatively high debt or equity ratio to.
The company you know is one of the lowest ratios in the business.
And that financial strengthening is something that people pay attention to and it has been a really important part of this process as well. So yes, I'd say, we have turned that from a liability to a strength and it also strengthens our ability to invest in the business in terms of new solutions.
And to drive that business forward, Mike other thoughts.
No I think that's exactly right here and you know I guess certainly it will be a lot harder for our competitors in an RFP process to kind of point to our liquidity and say Hey look are you are you sure about this right I mean, we've taken that aspect of it completely off the table.
No.
You know net leverage ratio below industry averages a cash contributions behind us I'm really puts us in a much stronger balance sheet position and that can only help dog in the context of Dialogs externally and I will say to you you know part of the reason for our.
Minimum capital requirements around the world is really about strengthening the equity in certain jurisdictions, where we do public sector work you need to have a certain ratio in certain countries.
To to really data on that work. So so we think from that perspective and from our ability to have cash to support outsourcing arrangements and go after some some bigger public sector work that you know frankly, we we may have shied away from just because of the the amount of cash that would.
Being required to put out on the upfront side of that work effort.
Both of those constraints are lifted from us. So so again I think we feel pretty strongly that we're all all in on on driving top line and continuing to drive profitability.
Thank you. This concludes our question and answer session I would like to turn the conference back over to Peter after that for any closing remarks.
Thank you Melissa and I do want to thank everyone for participating.
In the call. This morning, as Mike mentioned, we are in the process of a really standing up a an almost continual dialogue with both our buy and sell side analysts and we think an important part of that a will be a virtual analyst event, which we are.
Calendaring for January 12 of next year, where we expect to take everyone through in more detail or some of the things we have in store as well as trying to medium and long term projections. So I do hope that everyone joins us on January 12.
Our IR team led by Courtenay will reach out to all of the people on this call well make sure you have information about it as it becomes available. We'll also have continuing updates about that event.
From an information standpoint on our IR website.
So with that this maybe the last one I. This is expected to be the last one of these calls in this calendar year. So I look forward to a rejoining with each of you on January 12, and in the meantime, coordinating that our IR function, Mike myself and the rest of our leadership team are always.
As available to have conversations with he and we look forward to those as well.
Behalf of Mike Courtnee and the team. Thank you very much.
The conference is now concluded. Thank you for attending today's presentation you may now disconnect.
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