Q4 2022 Conduent Inc Earnings Call
Greetings and welcome to the condo in fourth quarter 2022 earnings announcements.
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As a reminder, this conference is being recorded.
I would now like to turn the conference over to your host Charles Good Byrne, Vice President of Investor Relations.
Thank you operator, and thanks, everyone for joining us today to discuss <unk> fourth quarter and full year 2022 earnings. We hope you had a chance to review our press release issued earlier this afternoon.
Joining me today is cliff Skelton, our president and CEO and Steve Wood, our CFO .
Today's agenda is as follows Cliff will provide an overview of our results and a business update Steve will then walk you through the financials for the quarter and full year as well as providing a financial outlook Cliff will then provide his closing comments.
This call is being webcast and a copy of the slides used during the school as well as the press release filed with the FTC. This afternoon on form 8-K.
This information as well as the detailed financial metrics package are available on the Investor Relations section of the website.
During this call we may make statements that are forward looking these forward looking statements reflect management's current beliefs assumptions and expectations 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 <unk> annual report on Form 10-K filed with the SEC.
We do not intend to update these forward looking statements.
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.
For more information regarding definitions of our non-GAAP measures, how we use them as well as the limitations to the usefulness for comparative purposes. Please see our press release.
And now I'd like to turn the call over to Cliff.
Thanks, Charles and good afternoon, everyone and thanks for joining <unk> Q4, and full year 2022 earnings call.
I will make some high level comments about the quarter the year and 2023.
In addition, I'll call it some exciting future opportunities as we like others slog through the somewhat uncertain times.
First let me say that Q4 and full year revenue.
We ended within the range of previous guidance, albeit on the low end drill.
Driven primarily by lower volume in our commercial business.
Some revenue implementation timing in our transportation business.
EBITDA finished directly in line with our previous guidance and margins also met expectations.
Of particular interest as new business sales the year finished strong.
Especially in our government healthcare business, where we won two large state Medicaid contracts in Q4.
Commercial customer experience also progressed nicely through the year generally speaking sales continue to improve each year and we just need to keep that rolling.
Now as I step back and debrief the year I.
I would say, it's a tale of many cities with headwinds in tailwind, perhaps more headwinds than <unk>.
<unk> events tended to bring interest rate tailwind in the P&L.
However, some of those same inflation fighting trends create recession like slowness to volumes, which impacted our commercial business.
Meanwhile, foreign exchange rates, primarily in Europe created some headwind for our transportation and commercial businesses.
On the upside when we received a modest tailwind from the remnants of government stimulus through pandemic snap volumes.
The blending of all that in a company with strong businesses and a large and strong client base.
Brought us to the low end of our full year guidance.
Our operational performance continued to improve in 2022 as well.
Acknowledging uptime is now a hallmark of success for us.
However, having been a chief information officer for two Fortune 500 companies.
One never says we have arrived when it comes to technology or information security.
But we can say that we've had a strong and concentrated effort.
Round technology discipline and standards.
In addition, operational process improvements has helped with readiness.
Especially in our call center space and staffing.
We worked hard in 2022 to ensure we operated with a culture of inclusion.
In fairness.
Any company with 50, plus thousand production folks knows how important culture values and leadership.
For client retention.
This all helps our associates to act as strong ambassadors for our clients in the treatment of their end customers.
In that regard we received recognition from general Motors Toyota H&R block.
Several other top 50 companies for supplier excellence.
Regarding culture, we're proud to have been recognized by Newsweek as a top 100, most loved workplace.
As well as receiving several awards from others and recognition for diversity.
Disability inclusion gender and thriving in a remote culture.
Finally, we received industry leadership recognition, especially in customer service by Nelson Hall, Everest Group, Gartner and others.
That all said.
More should always be expected when it comes to financial progress.
2023 brings with it a year, we're past our legacy performance related losses finally run off.
We returned to more normalized loss rate as a percentage of revenue.
At some level, it's just math.
When onboarding sales ramp outpaces losses, all else being equal.
Do you have growth.
All else is equalizing for us in 2023.
And it will be a transition to growth year.
Every year since 2019, we've made progress and decreased the year over year decline, while fixing the foundation.
That foundation phases over.
In 2023, two of our three businesses will grow.
In our government sector will be poised for growth in 2024 after the runoff of two or three large state contracts lost due to legacy performance.
Now Steve will discuss our net <unk> numbers in his remarks.
But as we've discussed in the past assuming the baseline business remained steady.
Now of course, the economy can sway that assumption and did so in 2022, but with a steady baseline.
Net net our number remains positive over time growth must manifest.
And that number was positive again at $114 million up quarter over quarter.
As Steve mentioned, all three of our sales metrics net IRR or annual recurring revenue.
Annual contract value and total contract value were up in Q4, which again is a positive sign once we finish outrunning stimulus and legacy losses.
Regarding that government business, we are still quite optimistic.
We won significant contracts in our state of the art Medicaid claims platform from what we can tell the only platform in the industry built from the ground up.
As cloud native.
The government health care pipeline has never been stronger.
Now we must implement with precision.
Steve will go into more detail regarding government's performance and why as we've now outrun the stimulus grow over we see Blue skies ahead in the back half of the year.
There are many reasons to be quite bullish on kind of doing.
It wasn't that long ago that we were worried about our commercial business.
Declined modestly in 2022, and we will grow in 2023.
Transportation declined in 2022 and will grow in 2023.
Government is the business requiring a little more explanation.
Revenue declined 12% in 2022, driven by continued stimulus fee snap grow over and prior losses manifesting as I previously mentioned however.
The strong upside from new sales ramp will reverse that trend by the end of 2023.
We also have geographies and entrees into new client opportunities generated by our business development effort new to conduit.
We rolled out a new one of a kind digital payments hub in partnership with <unk> Mellon.
That will enable real time, bill payments to governments and businesses.
Real time disbursements for disaster relief and reimbursements.
And climbed to vendor payments, providing cost reduction benefits to clients.
We're beginning to integrate these capabilities into our current offering sets and we are seeing traction and sales.
For payments, we definitely see real opportunity in our current client base as well.
Finally, we.
We're in the middle of planning, our Investor event for the last part of March we.
We intend to show the three year growth trajectory for the company.
We think they are acceleration opportunities as well.
On portfolio rationalization unique.
Unique investments in go to market opportunities that could enhance our posture, even further with investors.
Steve will now take you through more details around the quarter 2022 and 2023.
But the bottom line message is we did what we said we would do in 2022 will do the same in 2023.
Once our government business gets through the last bit of 2023 headwind and reaps the rewards of a strong market and sales efforts will.
We will experience the overall growth rates, we've been waiting for.
As always we appreciate the patience from our investors the confidence from our clients and the perseverance and hard work from our team.
I'll now hand, it over to our CFO Steve.
Thanks Cliff.
As we have done in the past, we are reporting both GAAP and non-GAAP numbers reconciliations or in our filings and in the appendix of the presentation let's.
Let's turn to slide five and discuss our key sales metrics.
Our primary sales metric ACP grew 22% in the quarter versus the prior year to $194 million.
It is also being up sequentially for the past five quarters.
For the full year 2020 to ACP also grew approximately 17% ignoring the impact of the prior year government stimulus revenues, which as we have said before are nonrecurring and we saw the tail end of 2022.
New business <unk> was very strong in the quarter growing 132% as compared to Q4 2021.
More importantly, again, ignoring the impact of government stimulus it was up approximately 18% on a full year basis.
Double clicking on some of the detail here the main driver of these year over year increases.
As Cliff mentioned was a very strong finish to the year in our government segment.
Including two significant wins for our modular cloud native condiment Medicaid suite.
And another for a state to disbursement programs, which benefit low income families.
The combination of these three deals contributed in excess of $400 million in TCP.
We will drive strong implementation revenues in 2023 and 2024 with.
With follow on operations and maintenance revenues at the conclusion of the implementations.
We said in prior quarters that we have a strong pipeline of late stage government healthcare deals.
And the business had a very strong sales finish to 2022.
Our pipeline remains strong in this area.
This year end performance in government drove the ACB up 36% as compared to 2021.
In addition to this our commercial segment ACD was up 14% as compared to 2021, but how does slow finish to the year.
Transportation ACD was up 5% year over year as compared to 2021.
New business <unk>.
Our recurring component of our sales was essentially flat quarter over quarter and year over year.
The net IRR activity metric, our combined measure of wins losses pricing effects and other contractual changes has continued to remain positive.
As a reminder, this trailing 12 month measure does not predict the timing of revenue and is based on the timing of notification.
Definition of this metric as covenant in the appendix of our presentation.
Turning to slide six to review some of our key sales metric trends.
Previously commented on our improving sequential trend in HCV.
And you can see in Q4 2022, the impact of the government segment deals mentioned earlier driving upticks in <unk>, new business in Iraq and average contract length.
To differentiate project implementations from the recurring run component of a contract we define the project implementation phases as NRI because they are onetime in nature.
Three of these government deals mentioned earlier, how strong components of Anoro, but we'll also have recurring revenue components from operations and maintenance.
Now, let's turn to slide seven and discuss our full year 2022 P&L metrics.
We finished the year with results coming in at the low end of our full year guided range, but consistent with how I messaged. It in the fourth quarter during our last earnings update.
Revenue for 2022 was 385 billion as compared to $4 7 billion in 2021 down five 4% or four 4% in constant currency.
As we have said previously 2022 was the year, we were growing over the long time government stimulus volumes from 2021.
This represented a net headwind of $185 million in 2022.
There were a lot of other puts and takes which I'll cover as I talk about the individual segment results.
Tailwind from benefit wallet interest rates headwinds from foreign exchange volume reductions from a couple of our larger commercial clients ramp from new business and offsets from loss clients all of which we'll discuss later.
Adjusted EBITDA was $394 million for the full year 2022, as compared to $448 million in 2021.
And our adjusted EBITDA margin at 10, 2% was 80 basis points down year over year as compared to 2021.
This was within our full year guided range, but.
Slightly below highlight laid out Q4 in our last earnings update <unk>.
To a couple of discrete items that affected the fourth quarter that I'll cover when we go through the segment results individually.
The puts and takes on the adjusted EBITDA for the full year with headwinds from the run off of the one time government stimulus volumes headwinds from mix and foreign exchange offset with the positive impact of increased fall through from benefit wallet revenue and our ongoing cost efficiency programs.
Our GAAP net income in 2022 was impacted by two significant events.
In the first half of 2022, we recorded a pre tax gain on sale of $166 million on the divestiture of our Midas suite of solutions.
In the fourth quarter, we recorded a pre tax impairment charge of $358 million on the carrying value of goodwill for our commercial reporting unit.
After completing the annual goodwill impairment test the commercial reporting unit experienced lower than expected new customer contract signings in the fourth quarter.
And an unexpected softening of the near term business pipeline for certain solutions.
Which we believe are being driven by macroeconomic conditions present in the fourth quarter.
The combination of these factors led us to review the commercial reporting unit and further evaluate the portfolio.
This triggered a goodwill impairment assessment for this reporting unit as of December 31, 2022, which resulted in this pre tax impairment charge.
The effectiveness can be found in our filings and in the appendix of the presentation.
Let's now turn to slide eight and go on to the segment results.
For the full year commercial segment revenues declined one 2% year over year, which was a significant improvement to 2021 when it declined four 1% from 2020.
The net effect in the year of incremental benefit wallet revenue offset with foreign exchange headwinds was an approximate $18 million benefit for.
For the first time ramped revenue from new clients exceeded runoff from lost revenue a function of both increased sales and better retention.
The offset to this was the previously messaged decline in volumes from a couple of our largest clients, where I think we're normalizing that post pandemic volumes.
The full year effect of that was approximately $50 million in yet and we expect that to continue into 2023.
Net net the commercial segment declined slightly but performed well.
Underlying revenues have stabilized and we are projecting modest growth in 2023.
More to come on that later.
So the government segment full year 2022 revenue declined 12% as compared to 2021.
The runoff from the onetime government stimulus volumes in 2022 was a net $185 million.
This decline was less than we had messaged at the beginning of the year and the underlying business also performed well with higher volumes in our snap summer programs and other solutions within both our government services and government health care businesses.
Transportation segment revenues declined 5% year over year in 2022 as compared to 2021.
With approximately half of this decline being driven by foreign exchange headwinds affecting the international transit business the.
The remainder of the decline with some one time revenues that benefited our Q4 2021 results.
And the effects of slower than expected implementation and certain projects, where we expect the revenue to catch up in 2023.
In terms of adjusted EBITDA and margin the commercial segment improved 17% year over year on.
The adjusted EBITDA margin of 11, 3% was up 170 basis points year over year.
Increased benefit wallet revenue contributed to this margin improvement along with operational efficiencies and increased work from home, allowing continued real estate rationalization.
This was offset by some headwinds from mix.
In the government segment adjusted EBITDA declined 24%.
And the adjusted EBITDA margin of 28, 8% was down 460 basis points year over year.
The rollout of the one time government stimulus volumes was the significant driver of this change in 2022.
For the transportation segment, adjusted EBITDA declined 21% year over year as compared to 2021.
And the adjusted EBITDA margin of 11, 8% was down 240 basis points year over year.
In addition to the one time revenue item that benefited the fourth quarter of 2021 quarter and the year were impacted by some higher than expected expenses related to certain projects.
Overall this was an approximate three and a half point decline in the adjusted EBITDA margin for the quarter as compared to Q4 2021 on approximately 120 basis points on a full year.
Some of these headwinds will persist in Q1 2023.
Before we see a more normalized margin rate returning.
Let's turn to slide nine and discuss the balance sheet and cash flow.
Our total liquidity position is strong.
With a combined $1 5 billion in cash and available revolving credit facility.
We ended the quarter with approximately $600 million of total cash on the balance sheet.
And a $550 million revolving credit facility is almost completely unused at this point.
Our net leverage ratio is one eight tons, which we believe is below our normalized range of two to two five times.
Our debt maturities are long dated and we have no significant debt repayments until 2026.
Our capital expenditure in the fourth quarter included a cash purchase of client equipment, which later in the quarter we financed.
This gross staff our U S GAAP cash flow statement by recognizing both investing capex and proceeds from the issuance of debt.
$13 million, but had no impact to adjusted free cash flow.
Without the effect of this item our capital expenditure as a percentage of revenue in the fourth quarter would have been three 2% and three 7% for the full year.
Which was more in line with how we laid it out for you earlier in the year.
During the fourth quarter, a combination of factors drove a lower than anticipated adjusted free cash flow outcome.
Firstly unexpected federal tax refund was pushed to 2023.
As discussed earlier some of the slower implementations in the transportation segment and other timing impacts in the government segment caused certain billing milestones to shift which will now collect in 2023.
Just the nature of our businesses that serve the transportation and government segments, but the cash flows can be lumpy.
Finally, we repaid the second and final installment of our deferred payroll taxes under the cares act in the fourth quarter.
Let's turn to slide 10.
And walk through our 2023 guidance.
Overall, we expect adjusted revenues in 2023 to be in the range of $3 seven to $3 8 billion.
The midpoint of this range would represent a year over year decline of $100 million or two 6%.
Within this number as the previously communicated year over year impact of two of our largest clients, reducing that post pandemic volume assumptions, representing 130 basis points of decline.
On the run off of the one time government stimulus volumes, representing a 110 basis points of decline.
Additionally, we're anticipating some incremental volume headwinds that we believe are most of the recession right.
Contribute an additional 75 basis points of decline.
And the unanticipated loss of our government segment call center clients, representing 70 basis points of decline.
This is offset with an approximate 100 basis points of improvement from previously communicated interest rate decisions to positively impact our benefit wallet business.
These discrete items represent approximately a net negative 285 basis points of our year over year revenue decline.
As you can see from this our underlying base business has stabilized.
Double clicking on each of the three segments at the midpoint of our range. We expect the commercial segment to grow approximately one 3% in 2023.
And we expect the transportation segment to grow approximately one 8% in 2023.
This is offset by a decline of approximately 12, 5% in the government segment, driven by client losses, and $42 million of government stimulus volumes in 2022.
Most of which was anticipated and communicated on our previous outlook that we gave in our Q4 2021 earnings update.
We said we expected the government segment to decline in 2023 mid to high single digits.
Revised outlook, Kevin here reflects the loss of the additional call center client I referenced stone yet that was notified in Q4 and is included in our net IRR metric in the fourth quarter.
In addition to the stronger than expected contribution in 2022 from the tail of the government stimulus volumes.
In terms of the pacing of revenue in 2023, we see it being very similar to 2022 in terms of waiting between the front half and back half of the year.
As a reminder, Q1 is usually slightly higher than Q2 because of the impact of open enrollment period within our healthcare client base.
In 2023, we expect adjusted EBITDA margin to be in the range of 10 to 10, 8%.
The larger puts and takes in this outlook of the impact of previously announced interest rate increases that benefit our revenues and EBITDA and the benefit wallet business and our continued work on cost efficiency across our business segments and corporate functions.
Offsetting fees or the margin impacts on the nonrecurring government stimulus volumes and the previously noted volume reductions some of which are recessionary in.
In the commercial segment.
Like last year, we expect adjusted EBITDA margins to start the year slightly below the guided range and finished the year slightly above the guided range.
Driven by factors that include a sales ramp that is more weighted towards the second half of the year as well as continued work on cost efficiency.
We expect to convert adjusted EBITDA to adjusted free cash flow in the range of 15% to 20%.
As I mentioned previously our cash flow in the short term is sensitive to some of these larger government and transportation segment projects as we work towards milestones that can move due to client requirements or other factors.
We expect capex to be approximately a $130 million and restructuring charges to be approximately $40 million.
The increase in our outlook on restructuring charges at least for 2023.
It's largely driven by opportunities to further rationalize certain infrastructure expense as well as our real estate footprint as we continue to evolve our hybrid work from work from home model.
That concludes our financial review of the 2022 Q4 and full year results.
And I'll hand, it back to cliff for closing comments cliff.
Thanks, Steve look in closing I think it's important to restate that 2022 brought with it a lot of exogenous components.
From interest rates being positive to EBITDA two based volume changes that were unexpected from some of our largest clients to foreign exchange rates that were certainly not planned for.
All of which when coupled with the normal puts and takes are a very diverse portfolio made for a year when finishing within our guidance range on topline and EBITDA was somewhat impressive.
The one time events on cash are somewhat anomalous and normalize out in 2023, we believe.
Regarding 2023, we were hopeful that our pivot to growth would have an earlier in the year.
But government buying timing patterns can sometimes be unpredictable.
The good news is that selling and retaining revenue remains paramount.
In two of our three businesses are growing.
And the third is very strong legs to it as we see real growth opportunity in that government health care business.
Our very diverse portfolio can and has been a.
Our strength in the past.
Particularly during the pandemic.
But today, we need to keep looking closely at where within that portfolio.
We can generate the most future accretion in value.
By way of where there is first scarcity value externally and.
And second where we can focus the combination of our bandwidth.
New products and payments.
New geographies, especially in transportation and disciplined investment protocols into something that not only grows.
But generates the kind of market appreciation, we think we should enjoy.
Now more to come on all of that in our Investor event.
But please be on the look out for the next week or two for a firm date. The last part of March for that event.
In closing, we're proud of what we accomplished in our foundational work over the past three years.
We're proud of our ability to hit the numbers, we predicted in 2022 year that brought with it some of its own unpredictability.
And we look forward to again doing what we say we will do in 2023.
The bottom line here is it we're quite sanguine about the future of conduits.
Thank you again to our listeners.
And as always thanks to our clients into our associates.
Good day, everyone back to you operator.
This concludes today's conference you may disconnect your lines at this time. Thank you for your participation.