DXC Technology Company

Good day, and welcome to the DXC Technology Fiscal 2020 First Quarter Earnings Call. Today's call is being recorded. At this time, I would like to turn the conference over to Mr. Jonathan Ford, Head of Investor Relations. Please go ahead, sir.

Thank you, and good afternoon, everyone. I'm pleased you're joining us for DXC Technology's First Quarter Fiscal 2020 Earnings Call. Our speakers on today's call will be Mike Laurie, our Chairman, President, and Chief Executive Officer, and Paul Soleil, our Chief Financial Officer. Call is being webcast at dxc.com slash investor relations, and we've posted slides to our website, which will accompany the discussion today. Slide two informs our participants that DXC Technologies' presentation includes certain non-GAAP financial measures and certain further adjustments to these measures, which we believe provide useful information to our investors. In accordance with SEC rules, we have provided a reconciliation of these measures to their respective and most directly comparable GAAP measures. These reconciliations can be found in the tables included in today's earnings release, as well as in our supplemental slides. Both documents are available on the investor relations section of our website. On slide three, you'll see that certain comments we make on the call will be forward-looking. These statements are subject to known and unknown risks and uncertainties, which could cause actual results to differ materially from those expressed on the call. A discussion of risks and uncertainties is included in our annual report on Form 10-K and other SEC filings. I'd like to remind our listeners that DXC Technology assumes no obligation to update the information presented on the call, except as required by law. Now, I'd like to introduce DXC Technology's Chairman, President, and CEO, Mike Lor.

Okay, thank you. Good afternoon, everyone. I'm going to follow my standard format, then turn this over to Paul, and then we'll be available for any questions. First, our non-GAAP EPS in the first quarter was $1.74. The adjusted EBIT was $652 million, and the adjusted EBIT margin was 13.3 percent. And we generated $72 million of adjusted free cash flow in the first quarter. Revenue in the first quarter was $4.89 billion on a GAAP basis. In constant currency, revenue was down 4.2 percent year over year, pretty much in line with what we expected. And the book to bill was .9X for the quarter, reflecting a couple of delays in some deals that we had expected to close in Q1. In the first quarter, the digital revenue grew 35% year over year, primarily driven by enterprise and cloud apps, cloud infrastructure, and our digital workplace. Our industry IP and BPS revenue grew 3.5% year-over-year, and the digital book-to-bill was 1.3x, and the industry IP and BPS book-to-bill was 1.2x. On my fourth point in June, we completed the acquisition of Luxoft, which strengthens DXC's value proposition as an end-to-end mainstream IT and digital services market leader. We also announced a joint DXC in Microsoft Azure digital transformation practice, building on our longstanding relationship with Microsoft. In the next few days, we also plan to announce a strategic partnership with Google Cloud, which will enable enterprise clients to modernize IT and integrate digital solutions, capitalizing on the Google Cloud platform. And I'll talk a little bit more about that in a moment. And finally, we now expect additional currency headwinds for the full year. Combined with some of the delays in these deals, as well as additional pressure on our traditional business, we're revising our revenue guidance for the full year to a range of 20.2 to 20.7 billion. And given this lower revenue and some delays in cost savings, which I'll talk about in a moment, our non-GAAP EPS target is now $7 to $7.75, and we continue to target adjusted free cash flow of 90% or more of adjusted net income. Now, let me just go into a little more detail. As I said, the first quarter non-GAAP EPS was $1.74. The effective tax rate was 20.1%. The first quarter adjusted EBIT was $652 million, and the adjusted EBIT margin was 13.3%, including the impact of the investments I discussed last quarter, an accelerated mixed shift to digital, and some delays executing resources in high-cost, complex countries. And I'll provide a little more color on these points. As we discussed, we continue to make significant investments in digital talent, including both hiring new employees and upskilling our existing workforce. We also are expanding our digital transformation centers and investing in joint practices with partners such as AWS, Microsoft, and Google. These investments are necessary to continue building on the strong momentum we have in the digital business. and we continue to plan on roughly 100 million of incremental investments this year. The first quarter also has the most impact from the accelerated client savings we discussed last quarter. We're seeing these trade-offs translate into greater opportunities and a qualified digital pipeline, which was up roughly 80% year over year in Q1. During the quarter, we saw an acceleration in the shift from traditional infrastructure to digital solutions. For example, our cloud infrastructure business was up 36% year over year, which was faster growth than what we had expected. And as we migrate client workloads out of the legacy environments, there are stranded costs that we have to address. including assets as well as people. Given the accelerated pace and expanded scope of cloud migrations, we weren't able to get these costs out during the first quarter, but we're taking action and expect to remove the stranded costs by the end of the third quarter. Our delivery team was also behind on its fiscal 20 cost improvement plan, particularly on workforce actions in high-cost countries. As we continue to expand deployment of our Bionics Automation Program into additional geographies and client environments, it is taking longer to eliminate the headcount as we automate activities. And in some cases, we're required to implement the full automation solution prior to removing any of the resources. Now, we're implementing actions to improve execution and second-half profit, including accelerated labor pyramid improvements, reductions in non-billable and underutilized resources, and further optimization of non-labor spend, such as hardware maintenance and software rates. And as I said, adjusted free cash flow for the quarter was $72 million, or 15% of adjusted net income, reflecting lumpiness of cash flow, including the timing of our sales commission payments, our fiscal 2019 bonus payments, and prepaid software enterprise license agreements. However, we continue to expect adjusted free cash flow to be 90% or more of adjusted net income for the year. Now, let me turn to revenue. As I said in the first quarter, revenue was $4.89 billion on a GAAP basis. All revenue comparisons I'll discuss will be in constant currency. In the first quarter, revenue was down 4.2 percent year-over-year, in line with what we expected, and the book to bill in the quarter was 0.9, reflecting some delays on some large deals. In the first quarter, GBS revenue was 2.2 billion, which was up 0.5 percent year-over-year. The year-over-year improvement reflects continued momentum in our enterprise and cloud applications business, as well as the addition of Molina and two weeks of the Luxoft business. As I discussed last quarter, accelerated cloud adoption is eliminating some of the services associated with rationalizing and refactoring traditional applications, and this dynamic is an ongoing headwind for legacy application services. GBS booked a bill in the quarter was 1.1, and bookings were up 22% year-over-year, reflecting strong bookings in enterprise cloud apps, analytics, and industry IP and BPS. GIS revenue was 2.7 billion in the first quarter, down 7.6% year-over-year. This reflects the accelerated client savings we discussed last quarter. as well as increased momentum in digital migrations. Cloud and digital workplace both grew more than 35% year over year. And similar to the dynamic I discussed in traditional applications, these accelerated shifts pressure the traditional GIS business as clients lift and shift existing workloads to recognize immediate savings. Over time, we typically grow revenue by migrating additional workloads, into our multi-cloud environment, but the initial shift often results in less near-term revenue. And we're also seeing some slowdown in additional add-on project work in the legacy environment as more investment is made in the digital solutions. Now, to offset these traditional headwinds, we're taking a much more aggressive approach on the GIS pipeline development. We've expanded our sales efforts targeting large infrastructure outsourcing opportunities for new clients with a focus on deals that involve modernization of the traditional environment while at the same time investing in digital projects. We're still early in this process. However, we're seeing good traction. Total infrastructure pipeline in the first quarter was up 32% year over year and 22% percent sequentially, and we expect to drive additional revenue during the second half of the year. The GIS book to bill in the quarter was .7x, reflecting the lumpiness in large deal signings and some of the delays that I had mentioned previously. Now, let me move on to our digital industry IP and BPS results. Digital revenue was up 35% year-over-year, including two weeks of revenue from Luxoff. Excluding Luxoff, digital revenue grew 31%, and the book to bill in the quarter was 1.3x. Now, as I discussed, we're seeing good enterprise spend environment in digital, particularly with respect to enterprise cloud migrations. As we partner with our clients on these transformations, we continue to see strong momentum in our cloud infrastructure solutions. This business grew 36% year over year, reflecting accelerated migrations and continued demand for multi-cloud solutions. And we're seeing good traction in this business across geographies and across industries. For example, during the first quarter, we want to deal with a major European aerospace and defense company to provide cloud migration, security, and analytic services. We're leveraging our knowledge of the legacy estate to modernize the client's IT architecture and help them thrive in a highly competitive market. We built an agile platform that enables development and deployment of solutions such as next-generation smart factories, asset use optimization, and application of artificial intelligence to everyday business challenges. Enterprise cloud apps and consulting continues to perform well with a 17.1% year-over-year growth, including strong growth in our Americas region, particularly in our Microsoft ServiceNow and SAP practices. We're also partnered with Salesforce to win a major multi-year deal with four global luxury retail brands. We are providing development and support services on Salesforce, Commerce Cloud, supporting roughly 35 B2C websites globally. Security revenue performance improved in the quarter and grew 5.7% year over year with particular strength in Asia and Europe. And during the quarter, we want a multi-year deal to provide managed security services for major European car manufacturer leveraging standard DXC offerings as well as partnered offerings with Micro Focus, Fortify, and Carbon Black. The solution includes threat intelligence, security event monitoring, vulnerability management, forensic investigations, and regulatory and policy compliance controls. We also saw improved performance in industry IP and BPS. Revenue was up 3.5% year-over-year in constant currency, driven by a 7% growth in our industry IP offerings. And with the addition of Molina, we're seeing strong demand in our U.S. state Medicaid business. During the first quarter, we signed add-on deals with Tennessee, California, and Ohio worth over $100 million each. and Industry IP and BPS booked the bill in the quarter was 1.2x. Now, my fourth point, during the first quarter, we completed the acquisition of LuxOff, which strengthens DXC's unique value proposition as a leading end-to-end IT services provider. As we previously announced, LuxOff will continue to be led by Dimitri Lushinin, who will report directly to me. LuxOff brings a 13,000-person workforce that provides digital strategy consulting and engineering services for companies across North America, Europe, and Asia. LuxOff will retain its brand and operate as a DXC technology company, but we've already launched joint go-to-market efforts to cross-sell solutions to both companies' current clients and to target new clients across industry verticals. Processes and incentives have been put in place to promote and reward cross-selling, and we're encouraged by the early progress we're seeing in the joint pipeline of opportunities. The acquisition also expands DXC's access to digital talent by leveraging Luxoff presence in key markets especially Eastern Europe, and by broadly deploying Luxoff's unique talent acquisition and management platform. We're undertaking several changes to quickly apply Luxoff's strengths and capabilities to DXC's business. Within Luxoff, we're creating industry-leading verticals in automotive and financial services. These two verticals will serve more than 20 major automotive OEMs and more than half of the top financial institutions in the Americas and Europe. And two key digital offerings, the Internet of Things and blockchain, will also be combined within Luxoff. Now, we continue to expect Luxoff to provide roughly 700 million in revenue during the last three quarters of the fiscal year, in addition to the two weeks of revenue we were able to recognize by closing the deal in the middle of June. Returning to our partnerships, we recently announced a joint practice with Microsoft Azure. The DXC and Microsoft Azure digital transformation practice enhances our deep and long-standing relationship with Microsoft. This joint practice will provide clients with a highly integrated approach to modernizing their IT systems on Azure. And the result will be a reduced time to digital and a more rapid movement of client workloads from legacy IT to a modern cloud architecture on Azure. In addition, we recently signed a strategic partnership with Google Cloud. This partnership will allow us to modernize mission-critical IT for enterprise clients and integrate digital solutions capitalizing on the Google Cloud platform. Now, under our partnership agreement, DXC will also be launching Centers of Excellence for Google Cloud Platform, and Google Cloud artificial intelligence to provide clients with secure, agile, and scalable cloud-based digital platforms that leverage our advanced analytics capability. And we'll be providing more information on this as the partnership evolves. The Microsoft Azure and Google Cloud practice complement our ongoing cloud work with AWS, Oracle, and VMware to give our clients access to the largest cloud providers in the world. And my fifth point before I turn this over to Paul is we now expect an additional $150 to $200 million of currency headwind for the full year. And as I discussed, we're also seeing more impact on our traditional business as accelerated client migrations pressure near-term revenue. And combined with some of the delays I've talked about, we're revising our revenue guidance for the full year to a range of $20.2 to $20.7 billion. In addition to this lower revenue outlook, delays in some of our cost savings actions will lower our margins, and our non-GAAP EPS target is now $7 to $7.75. And as I said, we continue to expect adjusted free cash flow to be 90% or more of adjusted net income. And with that, I will turn it over to Paul.

Well, thank you, Mike. As usual, I'll start by covering some items that are excluded from our non-GAAP results. In the first quarter, we had restructuring costs of $142 million pre-tax, or 42 cents per diluted share. and this is primarily related to workforce optimization. Also in the quarter, we had $105 million pre-tax, or $0.31 per diluted share, of integration, separation, and transaction-related costs, including costs associated with the Luxoff transaction. In the first quarter, amortization of acquired intangibles was $138 million pre-tax, or $0.40 per diluted share. Excluding the impact of these special items, non-GAAP income before taxes from continuing operations was $591 million and non-GAAP EPS was $1.74. Turning now to our first quarter results in more detail, GAAP revenue in Q1 was $4.89 billion, down 4.2% year-over-year in constant currency. Adjusted EBIT in the quarter was $652 million. Adjusted EBIT margin was 13.3%, reflecting the investment we're making to help clients accelerate their digital transformations with us, as well as incremental investments we're making to support the continued momentum in our digital business. Our EBIT margin in the quarter was lower than we had anticipated. We experienced delays in executing on our cost take-out plans. And while we reduced our headcount by 3,900 people in a quarter, we fell short of our expectations as we experienced delays in exiting resources in high-cost, complex countries. Also, in our Bionics program, we've expanded beyond DXC's delivery centers into clients' environments. Now this involves reengineering of client processes before savings can be realized, and it is taking more time to execute on these joint efforts. Now we still intend to execute on our original workforce optimization plans, but the benefit will now be pushed out to the second half of the year. In the quarter, our non-GAAP tax rate was 20.1%, reflecting our global mix of income and the benefit of a return to provision true-up in certain foreign jurisdictions. Turning now to our segment results. GBS revenue was $2.16 billion in the first quarter, up 0.5% year-over-year in constant currency. In the first quarter, GBS segment profit was $366 million, and profit margin was 17%, compared with 18.2% in the prior year. GBS margins reflect the investments we are making in hiring and training digital talent, as well as the expansion of our digital transformation centers. GIS revenue was two point seven three billion dollars in the first quarter GIS segment profit in the first quarter was three hundred and forty million dollars and profit margin was to twelve point four percent GIS margin reflects the investment we're making to help accelerate our clients digital transformations and the timing on some of some of our cost takeout actions and Turning to other financial results, adjusted free cash flow in the quarter was $72 million, or 15% of adjusted net income. And this reflects the timing of annual payments for software licenses and maintenance, investment made to consolidate real estate facilities, and the timing of refresh programs on a few large accounts. As a result, our CapEx was $357 million in the quarter, or 7.3% of revenue, but we expect our CapEx to moderate over the course of the year. During the quarter, we paid $51 million in dividends. We also repurchased $400 million of shares through a combination of open market purchases and an accelerated share repurchase program. In total, we returned $451 million in capital to shareholders. And we continue to be opportunistic in returning more capital to our shareholders. Cash at the end of the quarter was $1.9 billion. During the quarter, we funded the Luxoft acquisition with $2 billion of additional debt. We also paid down $430 million of current maturities of long-term debts. At the end of the quarter, our total debt was $9.4 billion, including capitalized leases for a net debt to total capitalization ratio of 36.5%. Now let me close by covering our revised fiscal 20 targets. We're targeting revenue of $20.2 to $20.7 billion, including Luxsoft. This revised outlook includes the impact of $150 to $200 million of additional currency headwind from a strengthening dollar since the beginning of May. Our revised outlook also reflects the near-term impact from delayed deal closings, as well as slippage on a few large transformation milestones. However, we expect a second-half improvement in revenue as those deals close and we convert on our strong pipeline, including cross-sell opportunities with Luxoft. We're now targeting non-GAAP EPS of $7 to $7.75 for the full year, reflecting the impact of lower revenue as well as the first half delays in executing on our delivery cost takeout programs. We now expect to achieve $250 to $300 million of cost savings this year versus our original target of $400 million. We expect a lower revenue and delays in cost takeout to impact second quarter margins by about a point sequentially. but we expect margins to improve in the second half of the year through labor actions, supply chain improvements, and real estate consolidation. Our workforce optimization actions include labor pyramid and location mix improvements. Now, while we've driven significant productivity improvements in our delivery organization the last several quarters, we have additional opportunities to extract greater efficiencies from our middle management layers, including the number of managers as well as their location mix. In supply chain, we're in the process of renegotiating several large software contracts as well as driving additional vendor consolidation to achieve incremental savings. In real estate, we plan to eliminate an additional 600,000 square feet of office space and close three additional data centers throughout the year. Our EPS target assumes a tax rate of 26% to 28% for the full year, reflecting our tax attributes in four jurisdictions, as well as the increased BEAT liability due to the Luxoft acquisition. Given our lower tax rate in Q1, we expect a higher tax rate over the next three quarters of about 30%. We continue to expect adjusted free cash flow to be 90% or more of adjusted net income. I'll now hand the call back to the operator for the Q&A session.

Thank you. If you would like to ask a question, please signal by pressing star 1 on your telephone keypad. If you are using a speakerphone, please make sure that your mute function is turned off to allow your signal to reach our equipment. Again, press star 1 to ask a question. We will pause for just a moment to allow parties an opportunity to signal for questions. Our first question comes from Lisa Ellis from Moffitt Nathanson.

Hi. Good afternoon, guys. Thanks for taking my question. Given the reduction in your outlook for the year just three months in, you appear to be seeing the business deteriorate a little bit faster, I guess to state the obvious, than you expected three months ago. So beyond the Luxoft integration and the organic investments you're making in digital, are there other strategic options you're considering, meaning at this point is there a plan B on the table and sort of what are the options for plan B, you know, particularly, I guess, with a focus on industry IP and BPS, which you called out, is doing fairly well at this point and I think is pretty independent of the rest of DXE.

Yeah, I think, Lisa, Liz, Mike, as always, all options are always on the table. The way I look at this is you know, our digital performance is quite good. And, you know, if I look out over the full year, we see probably upside to that performance. You're right. Our industry IP in particular and BPS business has strengthened since we exited last fiscal year. I think the new news for me here as I look through the quarter were a couple things. One, we saw a greater acceleration, particularly on the move to cloud. And that does impact our business. It impacts, we've seen this impact certainly on the application business, but it also is impacting what I refer to as sort of the volume metrics. Many of our contracts, we get paid on the amount of volume. So we are seeing some greater acceleration there. Now, we're seeing the other side of it, too, because our our cloud infrastructure business is growing faster than what we had expected. Now that's requiring us to take more actions from a cost standpoint and how we do that. We didn't execute that as quickly as we wanted to in the first quarter, and we think we can catch up on that as we go through the second, third, fourth quarter of this year. But that's primarily the new news, is an acceleration of this cloud migration, and that does impact our infrastructure business in particular.

Okay, and then I guess my follow-up is, at this point, do you feel like you have enough, like, what's your confidence level in feeling like this reset is it, if you know what I mean? Meaning, you know, do you now feel like you have a good sense of sort of the dynamics or the shift level, the rate? And so at this point, you feel like you're pretty confident in the outlook for the remainder of the year?

Yeah, we've got some very strong plans in place to recover. I felt it was important to reflect what we saw in the first quarter that was different than what we saw exiting in the year. And that's what I am signaling. Now, it doesn't mean we don't have plans in place to try to recapture the bulk of that. We do. But when you see a slightly different trend than what you saw, it's important to the investors to call that out. So, yes, are we... Confident about that? Yes, we are.

Okay, great, great. Thank you. Thanks a lot.

Thank you. Our next question comes from Raina Kumar with Evercore ISI.

Hi, thanks for taking my question. So you cut your EPS guide by 75 cents at the midpoint. Do you just break out how much of that is from incremental FX, headwinds, deal closing delays, larger declines in your legacies? IT services business, and then the slower cost takeout versus what you initially planned?

Paul, you want to take that?

Yeah, I would say if you look at it from an EPS perspective, right, the revenue probably is somewhere around 25 plus cents of the impact of that, and the rest of it is a combination, again, of the a mixed change that we're seeing with the traditional being a little softer than we had anticipated by digital picking up, but the differential has an impact. And also the cost that got pushed out, in a sense, things that we did not execute as fast as we had anticipated, particularly in the complex market. And that will just really be with us through the second quarter. but we expect to catch up in third and fourth quarter. So that the combination is that it was happening too fast in a certain market. We couldn't take the cost fast enough. So net I think it's about 75 cents and it's broken down, as I mentioned, 25 plus from revenue, the rest from the cost.

Great. That's really helpful. And then can you just talk about maybe like on a quarterly basis your expectations for this revenue growth on a constant currency basis?

We will right now, I think we reflected the currency from where it is now. I think we said it was about $150 to $200 million impact for the full year, right? There was some impact on the revenue side, right? And right now we would expect relatively, you know, slight flat, I would say, for Q2. And for the full year we gave you the, you know, the expectations of, you know, a pickup in the second half of the year. We expect to have about a couple hundred million dollars of pickup in Q3 and a similar amount in Q4, right? And then we would, as I mentioned, the margins would be impacted in Q2 by about a point, but then we'll expect to see quite a rapid acceleration of our margin improvement in the second half of the year as our cost takeout actions starts to materialize in the third quarter and carry through into the fourth quarter.

That's very helpful. And this is one housekeeping question for me. What was the acquisition, the revenue contribution from Luxoft in the quarter?

$45 million.

Thank you.

Thank you. Our next question comes from Jim Schneider with Goldman Sachs.

Good afternoon. Thanks for taking my question. I was wondering if you could maybe help us, Mike, understand the dynamics. Clearly the faster transition to cloud is one thing. Can you maybe give us an update on what you're hearing from clients who you gave on the outsourcing business and the rate at which they're booking digital revenues and talk about your level of confidence that those revenues are actually going to materialize throughout the year as you expected. Thanks.

Yeah, that is pretty much working just as we had discussed before. Again, when I step back and I look at this, you know, the digital revenue is clearly accelerating above, you know, the level that I thought. So just exclude Luxor for a second. It was up 31%. That's about... the fastest growth rate we've had in digital revenue, and some of that is attributable to some of the deals we did. As I said, some of those deals that we did, we saw that impact in the first quarter, okay? So my confidence level on that part of the strategy is very high, because we're seeing that absolutely flow through. And if I look at the pipeline, as I look out for the balance of the year in digital, very strong. And that's before we even throw... you know, lucks off into the equation. So from a strategy standpoint and a plan standpoint, that is working. Where we had some new news was the acceleration of the movement to cloud and the impact that is having on our traditional ITO business. And then our ability to respond to that in the first quarter from a cost standpoint, we were not able to respond quickly enough. The other factor I mentioned is bionics. I'm really pleased with the progress we're making in bionics, but that now is becoming much more client by client, and many clients or want to see that improvement from Bionics before we actually exit the people. And that's fine. That makes good sense. But that does delay some of the cost takeout in the first quarter, and that then has an impact on the full year. So that's fundamentally what's going on here. The digital strategy is working. Matter of fact, it's accelerating. But at the same time, we're seeing an acceleration of that impact, particularly on the infrastructure business.

I would add to what Mike has said. The pipeline, as he mentioned, on the digital is growing 80% on a year-over-year basis, about 18% sequentially. So that's a strong one. But also the pipeline on the traditional business is also holding up right now. And so we see actually opportunities as customers are coming to us that had insourced their environment and asking for modernization opportunities. opportunities and discussions with us.

I'd say the composition of the pipeline is much more geared towards not just standard outsourcing, but much more modernization of the current IT estate and then the move to digital.

That's helpful. And then maybe just a little bit more color on the deterioration in the traditional business. Can you maybe talk about over how broad a client base or how many clients that deterioration is that you're seeing? Is it kind of relegated to a few clients? Is it broader than that? And I guess to the earlier question, you know, what's your level of confidence you won't see that from additional clients in the next couple of quarters? Thanks.

Yeah. Well, you know, we look at, you know, our top 200 or 300 clients, which is what I look at. And across that, I'm not going to name any specific clients, but we are seeing an acceleration of this move to a cloud infrastructure. It is somewhat industry-specific. So some of the industries that we are more exposed to, like consumer packaged goods, for example, is migrating more rapidly to the cloud than, let's say, financial services or insurance. So it's not so much that there's new clients that we're seeing this in. We're just seeing a slightly more rapid adoption of the cloud infrastructure in the top two, 300 clients that we have. Now, that's being offset. It's being offset by some of this additional revenue that we talked about. And then now that we have what I'll call shored up most of our large contracts and renewed most of those large contracts. We don't have a lot of those on the horizon this year. We're being more aggressive in targeting now more new clients from an IT modernization standpoint. That's what we're now seeing in the pipeline. As a matter of fact, we've got probably a stronger pipeline on traditional IT modernization than we've had in years as we begin to make that shift to driving much more of sort of aggressive offensive play around IT modernization.

Thank you. Thank you. Our next question comes from Edward Queso with Wells Fargo.

Hi, good evening. I was wondering if you could talk a little bit about the competitive aspect dynamics in the market? Are you seeing any shifting in, say, the last six, nine months? And I guess I'm particularly thinking about IBM here, if they're emerging more as a competitor. Thanks.

No. Particularly in the digital world, we are competing more frequently with an Accenture, for an example. Particularly in some of the areas like our enterprise cloud apps business. Think about that as SAP and the upgrade to S4 HANA. So we are running into some of those players more often, and we're having quite a bit of success with that. On traditional, more traditional outsourcing things, we see the same competitors we've seen. We haven't really seen any difference in that. I would say there's quite a bit of There's certainly pricing pressure around some of those traditional outsourcing and IT modernization programs. But many of our competitors are seeing the same, exactly the same dynamics in their infrastructure business that we are seeing. There's not significant differences there. So, I wouldn't say there's been any significant change from a competitive posture over the last three or four months.

Historically, you've given us a multi-year view, a three-year view. Can you update any of that now that you've got Luxoft in-house?

No, we're not going to update that today. I think at some point in time it will be important to sit down, do another analyst meeting, and go through what those longer-term models look like. But right now we're sort of focused on recovering some of the shortfalls that we had in the first quarter and building a plan to get where we need to get to here on a full-year basis. But long-term, there's no changes to that model. Great. Thank you.

Thank you. Our next question comes from Ashwin Shirkevar with Citi.

Hi, Mike. Hi, Paul. Hey, my first question is, it seems that based on the information you provided in these questions, you should be able to exit the year approaching breakeven overall. So I first wanted to confirm that possibility. But then as we break out GIS, GVS, are we in a situation where it's primarily you can get a little bit of growth from GVS, but GIS is in a much longer multi-year situation because of these accelerated cloud migrations, pricing, productivity, things like that? Could you break that down a bit for us?

Yeah, I would say your comment is well taken in the sense that as we exit the year, we would have recovered quite a bit of that revenue shortfall that would have happened particularly in Q2 from our original expectations were maybe off. maybe by about $100 to $150 million from our original exit rate. That being said, also, you're absolutely right. I think the GDS business will be a little bit closer to its original targets, because that's where we have a whole lot of our digital assets, but the GIS will have a little bit longer road ahead just because the trends that Mike was indicated will take longer to moderate. And as we get to new deals in the sense that we have in the pipeline, this will also hopefully will do better than over time.

But I just think that the trend here is quite straightforward. You know, we're seeing an accelerated shift to the cloud that is clearly impacting our ITO business that's being offset by some of the things we're doing by participating with them in many of their digital projects, integrating those digital projects into the existing IT infrastructure. So there's nothing different here from a strategy standpoint other than it has accelerated a little bit, and now we've got to make some adjustments, both from a cost standpoint and going out and attracting newer, new clients beyond our current install base in this IT modernization space. That's the fundamental message here.

Got it. Understood. And I see that you haven't changed the free cash flow conversion, but there will be correspondingly lower FCF based on the guide down. The question is, does that affect the magnitude or timing of your capital return plans? And how does that, I mean, can you kind of go through capital allocation a bit?

No, I think we have still. It will not make a significant, have a significant impact on our capital return. We look at it much more opportunistically against all the other opportunities that we see for tucking acquisitions, for example, or investment that we're making in the business. And, you know, we're still, as I said, 90% or more of free cash flow for the remainder of For the full year, even though we started the year at a lower point, but we just, again, there were more timing issues than something more fundamental.

Got it. Thank you. Thank you. Our next question comes from Jason Kupferberg with Bank of America Merrill Lynch.

Hey, good afternoon, guys. So obviously the pace of change in the business just seems to be accelerating on a couple different fronts, as you outlined, Mike. Does that speak to the need to evolve some of the internal forecasting processes you guys use? I mean, it just seems like there was some pretty significant change in just, you know, two, two and a half months relative to when you reported your Q4. So I'm just wondering if you guys are contemplating any changes in terms of how you formulate your forward guidance as you think ahead?

I think the runoff and things like that, we've got a really pretty good handle on. I think for me, what we need to do a little better job, and I'm going to qualify this because it's really not that easy to do, is some of the volumetrics. So, again, the way our contracts are set up, you get paid based on volumes. It's a little difficult to forecast too far out what's going to happen with those volumes. And they do fluctuate month to month, and they certainly fluctuate quarter to quarter. Now, we're going to try to do a better job of understanding that and forecasting it, but I've got to tell you, there are some – you know, some limits as to how you can forecast those volumes. This has not been a huge issue in the past because the volumes were quite stable. But what we're seeing with this accelerated shift to the cloud, some of those volumes are shifting around, and that is now something we're going to have to get a better handle on and forecast. We get enough data points you'll be able to calculate with a little more precision. But that's the fundamental new news for me and what was different from what I saw coming out of last year.

Okay. Okay. Paul, just one for you. As we're tinkering with the model here, it looks like the adjusted EBIT margin outlook for the full year fiscal 20 is coming down by maybe, a point or so, so I just wanted to see if you can validate that. I know you talked directionally about a better second half, obviously, but just so that we have the models calibrated properly on that line.

Yes, I think from where we gave you some directions before by a point to a point and a half.

Okay, and then just very quickly that you talked about... That's for the full year.

Excuse me, that's for the full year.

Yeah, for the full year. Yep, yep, understood. And then you talked about some deals that slipped out of Q1. Did those already close in Q2?

No, a couple of them, I'll be very honest, because a couple of them I decided not to do. Typically, at the end of the quarter, you get into an equation of, there was one, for example, I think it was roughly $400 million, roughly. I won't name the name. But at the end of the quarter, it's okay. If you give us a bigger discount, we'll sign it. I decided not to do it. I'm just not going to take, I'm not going to give up that profit for the sake of a book-to-bill number over a week or two-week transition period. So we'll get that closed, and we'll get it closed in the second quarter. But that was an example of just something we were unwilling to do to get that done before the June 30th deadline. So there's probably at least $400 million or $500 million that fell into that general category, and there were just some deals that we just couldn't get across. I don't want to get into the pricing. giving away profit, it's just we couldn't get them done. Yes, and we do expect to get them closed in the second or some may go as far as the third quarter.

Okay. Understood. Thank you.

Thank you. Our next question comes from Arvind Ranani from KeyBank.

Hey, guys. Thanks. Thanks for taking my question. So just a couple of questions. When you think of all the strategic options you have, are you able to outline what may fall sort of within your control, sort of given your current financials, versus what you may need to really kind of get help externally?

Well, yeah, I mean, there's all kinds of strategic options. As I've said before, you know, all options are on the table. We've got a strategy. We're executing that strategy. Yes, there was some new news here, particularly around the acceleration on the infrastructure business. Does that change the strategy? No. Does it change some of the options that are available? No. Could that change some of the timing to think about some of those? Yes, it could. So I just... I don't think any, from a strategic options standpoint, I don't really fundamentally see any change. All those options have always been on the table.

Great, great. And, you know, from an investor perspective, you know, I think, you know, it's pretty vocal, you know, sentiment, you know, has been weak for some time now. But, you know, can you maybe help outline, you know, the mood at DXC? And it may be you know, different types of businesses, but what's the mood internally? And secondly, what's the message either to existing employees or recruits?

Well, I think the messaging is very similar to the messaging we have for you. It doesn't change, okay, because it's the facts. It's the truth. Now, if you go into different parts of the world, it is slightly different. I've said this before. You go to Asia, you go to Australia, where we've largely gotten through this transformation of where the digital revenue streams are more than offsetting some of the traditional. Well, that's a much more upbeat mood. If you go to our digital transformation centers where people are totally focused on these digital projects, it's a different world. you go into an account where you've got a significant amount of runoff and you're taking costs out, well, it's not nearly as positive. So it differs based on where you are. and it differs on where the business is in that transition. But we're seeing good opportunities to attract people. We've hired, I think last year we hired 25,000 people. We're continuing to hire, particularly in the digital business. And most people see the opportunity that we're communicating here around helping our clients not only modernize their existing IT infrastructure, but being able to help them on these digital projects and then integrating that into the existing ID infrastructure.

Great. That's super helpful. Certainly wishing you the best of luck for the remainder of the year.

I'm sorry, what?

I said super helpful. Thank you for answering the question and wish you luck for the rest of the year.

Thank you. Thank you. Thank you. Thank you. Our next question comes from Rod Bourgeois. with Deep Dive Equity Research.

Hey, guys. You've sort of answered the same questions over and over, so let me ask a question from a different angle here.

I thought you were going to answer for me, Rob. That's good.

All right. No, I mean, you're clearly seeing volumes at your clients shift more rapidly to the cloud. My question is, is that spend as it shifts going completely away from DXC Or is this more of a case where over time that spend is still available to you, you can recover that spend, but at a lag effect? I mean, you mentioned last quarter that you're pursuing these deals where you give clients upfront savings, but then you get a commitment to make up the spend gap over time by shifting into digital scope. So I'd like your take on whether this accelerated cloud shift is an outright negative, or is it more of a situation where you're taking a hit now but with the benefit later of a shift into more of a digital business mix, which is kind of the long-term goal that you're trying to accomplish. So how much of it is a negative versus an opportunity? Can you give us the balance on that right now?

Yeah, I think on balance it's much more positive. I do think there's a delay, but we're seeing that because, you know, the increase that we're seeing in our cloud infrastructure business is increasing. It was up, again, I think 36% in the first quarter. So it's much more of a lag effect. We're also doing other things where some of the revenue associated with the actual cloud is beginning to be captured as part of the contract. That is a lag effect as well. So I view it much more as a lag effect than just a negative. And a matter of fact, I go through this all the time, our top two or three, you know, roughly our top 250 accounts that we've got about $14 billion of revenue. I go through every one of those accounts. Where are we? What's the runoff? What's the digital pipeline look like? But there is a timing issue, as you point out. You are 100% correct.

Okay. And a couple of quick ones related to that. Can you quantify on these deals where you're giving clients proactively, you're giving them upfront savings, that's clearly affecting your revenues this year because of that lag effect. Can you quantify how much revenue impact that's having this year? Is there a number you can give us on that?

I can't. I can't give you an accurate number on that right now. What I can... I'll be able to do that a little bit more retrospectively. For example, in X account, I know what we've given. I also know what that current forecast is. I know what the digital pipeline is. I know what the revenue associated with that is, but I want to see that materialized. And then we'll be able to look back and make some judgments as to whether that's something we ought to continue, something we shouldn't continue. But right now I don't see any major change in what we have communicated up to this point in time.

Okay. And then one other quick one is as the, in your, particularly in your GIS business, as the volumes move to the cloud and you shift your scope to more digital services, is that a positive margin event? Or is it neutral or negative? What's the margin mix that's happening, mix shift that's happening as you shift into more digital in your GIS business?

I think, Rod, near term it's a little bit more negative just because you have to think of transformation project early on don't have the same margins as you could imagine from a environment that we were managing in the traditional side. So there's a differential in margin early on. We also have to take cost action also to deal with some of the stranded assets in the old environment. So in that net, it puts more pressure on the cost side near term, and therefore the margins are more pressured near term. But over time, then you get the efficiency.

Because as those costs come out, the margins actually, there's an opportunity to expand those margins. It's really tough when these volumes go away. I mean, you don't need as many servers. You don't need as much storage. You don't need as much this, that. That stuff doesn't move out in 60 days. It just doesn't work that way. It takes time to do that. But, yes, as those costs come out, then that gives you a great opportunity for a margin expansion on the new digital business.

Got it. Thanks, guys.

Thank you. And, Operator, we'll close the call now.

Thank you. Ladies and gentlemen, this concludes today's conference. We thank you for your participation. You may now disconnect your phone lines, and we hope you have a great day.