Good day, and welcome to the Exela Technologies Incorporated Third Quarter 2019 Financial Results Conference Call. [Operator Instructions]. Please note that this event is being recorded. I would now like to turn the conference over to William Maina, Investor Relations. Please go ahead, sir..

Thank you, Chuck. Good afternoon. Welcome, everyone, to the Exela Technologies Third Quarter 2019 Conference Call. I'm joined here by Ron Cogburn, Exela's Chief Executive Officer; and Jim Reynolds, our Chief Financial Officer. Following prepared remarks made by Ron and Jim, we'll take your questions.

Today's conference call is being broadcast live via webcast, which is available on our Investor Relations page of Exela's website at exelatech.com. Replay of this call will be available until November 19, 2019.

Information to access the replay is listed in today's press release, which is now also available on the Investor Relations page of Exela's website. During today's call, Exela will make certain statements regarding future events and financial performance that may be characterized as forward-looking statements.

Under the Private Securities Litigation Reform Act of 1995, these forward-looking statements are subject to known and unknown risks and uncertainties and are based on current expectations and assumptions.

We undertake no obligation to update any statements to reflect the events that occur after this call, and actual results could differ materially from those -- from any forward-looking statements.

For more information, please refer to the risk factors discussed in Exela's most recently filed periodic report on Form 10-Q, along with the Associated Press release and the company's other filings with the SEC. Copies are available from the SEC or Investor Relations page of Exela's website.

During today's call, we will refer to certain non-GAAP financial measures. We believe these non-GAAP financial measures provide additional information on how management view the operating performance of our business. Reconciliations between GAAP and non-GAAP results we discuss on today's call can be found on the Investor Relations page of our website.

As a reminder, financial results discussed on today's call reflect pro forma combined company results for the business combination of SourceHOV Holdings and Novitex Holdings, which closed on July 12, 2017.

Please note the presentation that accompanies this conference call and investor fact sheet are also accessible on the Investor Relations page of our website. I'd now like to turn the call over to Ron Cogburn, our CEO.

Ron?.

Thanks, Will. Good afternoon, and thanks, everyone, for joining us today. As you have read in our earnings press release, Exela has shared an important update to the strategic process that we've been working on over the past few months.

With the approval of the Board, we recently adopted a new strategic debt reduction and liquidity improvement initiative. The goals of this initiative are simple, pay down debt, increase liquidity and divest of noncore assets.

In addition to improving our financial flexibility in the near term, we believe this initiative will further enable Exela to focus on our core business where we are best positioned for sustained, profitable, long-term growth, and I'll provide a little more detail in a couple of slides.

Now let's look at Slide 4 to begin and discuss the Q3 2019 financial summary. I'm just going to call out a couple of points here. Jim Reynolds, our CFO, will cover further details later in the presentation.

Our revenue, excluding postage and postage handling and our previously announced low-margin client exit, grew by 2.4% in the third quarter and is up 3.2% year-to-date, details of which can be found in our fact sheet and our earnings release.

Additionally, as part of the strategic initiative announced today, we have a goal of increasing our liquidity to approximately $125 million to $150 million from $50.4 million as of September 30. In addition, we're planning to repay debt with a target reduction of $150 million to $200 million through the sale of certain noncore assets.

Now let's turn to Slide 5, and I'll give you a little more color on the initiative that I just mentioned. As I said, the Board has adopted the debt reduction and liquidity improvement initiative. As part of the initiative, we're taking steps to increase our liquidity through a number of financing options.

This is a message that we've heard mentioned by the market a few times. And to that end, the company has retained an adviser and we'll provide further details as they emerge. To fund the debt reduction side of the initiative, the company is pursuing the sale of certain noncore assets which are not central to our long-term strategic vision.

We've attained -- we have retained additional financial advisers to assist us with the sale of those assets. As I noted earlier, we expect to use the net proceeds of the initiative to repay and balance our debt with a target reduction of $150 million to $200 million.

We expect to announce information about the specific transactions forming part of this overall initiative in Q4 or in Q1 of 2020. We've set a 2-year timetable for the completion of this initiative, and we look forward to providing you updates on our plan as soon as we have further details to announce. Now let's turn to Slide 6.

I'd like to talk about the Q3 results in more detail, beginning with our optimization and restructuring charges, or what we call the O&R. In the third quarter, O&R charges totaled $16.8 million. Our M&A-related O&R charges, which include all the initiatives that are attributable to the recently completed acquisitions, were $1.2 million.

We continue to expect these costs to become negligible once these initiatives are completed. Moving to our process transformation O&R charges. As we've discussed, process transformation is primarily related to our cost optimization initiatives through the deployment of our in-house proprietary technology.

This creates better efficiency, reduces head count and enables us to take advantage of planned facility consolidations and related vendor spend reductions. For the quarter, $15.7 million worth of process transformation costs in Q3 are expected to be shed through these initiatives and should be realized once the initiatives are completed.

Looking at the third O&R category, which is customer transformation. This expense was zero in the third quarter. As we've discussed in the past quarters, cost in this bucket will be more intermittent in nature and will appear in particular quarters where there is a specific customer transformation initiative.

This cost occurs when specific customers need a transition period for the work to be ramped or onboarded or even moved from one location to another. Similar to Q2, we've also shown the split of the O&R, but between COGS and SG&A.

$12.7 million of O&R is attributable to COGS and $4.2 million is related to SG&A to help illustrate the pro forma impact of our gross profit dollars and operating income once all the initiatives are realized. Now let's turn to Slide 7, which covers our business transformation.

Similar to the last quarter, we wanted to provide you with a view into how much of our transformation has been accomplished so far and to the -- and to quantify the expected pro forma impact of the savings on the gross profit dollars.

Now the rightmost bar, which represents for the business stands as of Q3 2019, is at 26% gross margin net of postage, postage handling revenue and low-margin client exit. Once the $12.7 million of O&R charges have been realized, the gross margin is expected to reach approximately 31%.

Next, let's jump back to the left side of the slide, starting with the first column. Approximately 45% to 50% of our business is operating around 35% gross margin, which is about 9 points higher than the consolidated gross margin.

The margin performance is reflective of the process transformation and operational improvements that we have made and been executing over the last decade. The second column represents 35% to 40% of the revenue, currently operates at approximately 18% gross margin after 2 years under our transformation plan.

And the third bar from the left represents the remaining 15% to 20% of our revenue and generates approximately 21% gross margin after 5 years in transformation.

By continuing to execute our technology and process transformation initiatives, we believe the businesses in the second and third column from the left have the potential to generate margins approaching 35% as represented in the first column.

This implies significant opportunity to expand our gross profit margin and does not include any expected impact from noncore asset sales as part of our debt reduction initiative. Now as a reminder, while we remain confident that the ongoing improvements we are making will fundamentally transform our COGS, they require both investment and time.

Let's turn to Slide 8. Head count is our largest cost component of our business. The technology we use to provide automation to the business processes enables Exela to work toward a lower total variable cost.

We saw total employee head count decline 3.2% sequentially in Q3, with reductions across each of our major geographies driven primarily by our ongoing O&R initiatives. Now let's turn to Slide 9, and let's talk about our top 200 customers and our customer segmentation.

Let's take a moment and look at the positive effect our strategy is having on our customer segmentation. Now you'll recall back in 2018, our focus on the top 200 customers yielded an impressive growth rate of 12% on an organic basis year-over-year. The remaining customers in that category, called All Others, declined by 13%.

Now 3 quarters of the way through 2019, Exela continues to transform the statistic of the All Others basket into one of positive growth on a year-over-year basis. We accomplished this turnaround through deploying the same strategies that we utilized on the top 200 to grow these customers.

We're very encouraged by the investments and the focus of the top 200 customers and expanding to the rest of the business. The strategy primarily is responsible for the growth year-over-year and year-to-date of our businesses when excluding the pass-through revenue and the lower-margin client exit.

The relative contributions of revenue from the top 200 and All Other customers has stayed flat to Q2 levels at 72% and 28%, respectively, demonstrating that we are holding the All Others basket steady. Now let's move to Slide 10, and let's talk about our customer scorecard and our revenue.

Our diversified revenue base for the first 9 months has remained fairly constant, with 35% of the revenue within our top 20 customers that has an average tenure now of more than 16 years. That's very impressive. The top 100 and 200 customers represent 60% and 72%, respectively.

Americas now is represented by 82% of revenue, and as we mentioned, Europe has grown and it now represents 18% of the revenue in the first 9 months of 2019. Here's an important statistic. Now we have 10 customers that were $25 million or more who have annual revenue in 2018.

But year-to-date, we have 8 customers now through 9 months that is $25 million or more. Through the first 9 months of 2019, our customer count generating over $1 million in annual revenue has now grown to $267 million as compared to all of 2018, which was $259 million.

Now let's take a moment, and I'd like to talk about what's making a difference on our global sales, and that is our strategic deal teams. These folks are focused on identifying the opportunities to expand within our top customers, while partnering with them on their digital journeys.

Our conversation with those customers centers on our platforms and solutions, and it addresses their mission-critical challenges with everything from revenue cycle management to digital mailroom, workflow automation, information management, just to mention a few.

Now one example that we're very proud of is that recent win that you probably read about with the VA, with our new $2 billion Veterans Intake, Conversion, and Communication Services, or what they call the VICCS program. We're very proud of this win. You probably are curious about what we're going to actually do for the program with our partner, GDIT.

Some of the services we are already providing in previous contracts with the VA as well. Our services with this new engagement include digital claims intake, enterprise-wide facts consolidation and intake processing, centralized mail handling and processing and digitization and NARA-compliant records management services and storage.

Future services could also include automated print and mail, outbound communications, further automation of incoming and outgoing processes and data analysis and intelligent processing and service delivery.

This award promises to expand Exela's current role in assisting the veterans benefit claims nationwide and is a consequence of many years of investment by Exela digital health care technologies and services.

In closing, with our continued focus on our core business and our new initiative for debt reduction and increased liquidity, we believe Exela is well positioned for sustained growth and improve shareholder value. You'll begin to see the early results of some of our efforts in Q4, whilst the overall journey will take up to 2 years to complete.

This is a pivotal moment for us. While we have a lot of work to do over this time period, we believe we are building the foundation for a stronger Exela for the long term. Now I'd like to hand the call over to Jim Reynolds, our CFO, who will discuss our financial results in greater detail.

Jim?.

Thanks, Ron. Moving to Slide 12 and looking at our P&L. Third quarter revenue totaled $372.9 million. On a constant currency basis, revenue was $375.9 million. Looking at our segments. Revenue for our ITPS segment was $292 million, a decrease of 5% year-over-year from $307.3 million.

This decrease was driven primarily by the impact of the low-margin contract exit we had discussed in the third quarter of 2018, along with a few customer contracts that got pushed to start later in this year. Our Healthcare Solutions segment grew 9% on a year-over-year basis, totaling $62.1 million, up from $56.8 million in the third quarter of 2018.

The results in health care were consistent with our expectations and driven by the health care acquisition and increased volume with existing clients. Our Legal and Loss Prevention Segment, or legal, totaled $18.8 million in the third quarter, flat with the prior year period.

Gross margins for the third quarter declined on a year-over-year basis by 83 bps to approximately 22%. The margin decline was due primarily to a revenue decline in wage increases, offset by continued transformation and cost-savings initiatives.

As Ron mentioned, gross margins in our business net of pass-through and the low-margin contract exit was 26% in Q3 of 2019. SG&A for the quarter totaled $50.4 million and was 13.5% of revenue compared to 11.7% in the third quarter of 2018.

The increase in SG&A was driven primarily by higher expenses related to onetime legal costs and increased professional fees. This was offset partially by savings realization. Our depreciation and amortization expense was $27.1 million, down from $35 million in the prior period. During 2018, we had accelerated amortization of certain trade names.

During the third quarter, the company recorded a noncash impairment charge to goodwill and trade names of $99.7 million. This review was completed during the current quarter versus the fourth quarter, as the company concluded that a triggering event had occurred for an interim impairment analysis.

The operating loss for the third quarter of 2019 was $96.9 million compared with operating income of $6.4 million in the third quarter of 2018. This decline was primarily driven by the noncash impairment charge we just discussed, along with lower revenue and higher SG&A expenses. Looking at EBITDA to adjusted EBITDA.

The largest adjustment was the noncash impairments charge, which is included in 2 as an adjustment for noncash and other charges. This bucket also includes onetime debt extinguishment costs, onetime legal costs, cash severance for employees and customer exit costs.

The adjustment for optimization and restructuring expense in the quarter totaled $16.8 million. Approximately $15.7 million is related to the costs associated with process transformation. Adjusted EBITDA for the quarter totaled $58.5 million, a decrease of 15.1% on a year-over-year basis.

Adjusted EBITDA margin for the third quarter was 15.7% compared with 18% in the third quarter of 2018. Turning to our next slide, 13. Liquidity at the end of the third quarter was $50.4 million. Our total net debt was $1.485 billion. As discussed earlier, the company is pursuing a debt reduction and liquidity improvement plan.

As a reminder, the company's debt maturities come due in July 2023, over 3.5 years from now. Also, during the third quarter of 2019, the company did not purchase any shares of common stock. Cumulative shares repurchased under the company's share buyback program totaled 2,787,147 shares since the program inception. Moving to Slide 14.

Taking into account our consolidated third quarter results, the continued unpredictable nature of our revenue from postage, a slower ramp of certain new projects and longer-than-expected sales cycles, we are updating our 2019 full year guidance.

We now expect 2019 revenue of $1.55 billion to $1.56 billion and adjusted EBITDA of $255 million to $265 million. We remain highly focused on our initiatives to grow our core lines of business and to generate incremental cash flow.

Our CapEx is expected to be approximately 2.5% of revenue, and our capital allocation policy remains unchanged, and it is to pay down debt and reduce our leverage. We expect our near-term net leverage ratio to be approximately 4x. This concludes our formal comments. Operator, with that, please open up the line for questions..

[Operator Instructions]. And our first question will come from Joseph Foresi of Cantor Fitzgerald..

This is Dan Reagan on for Joe Foresi.

So I just wanted to ask if you could provide a little more color on free cash flow expectations? And in addition, I'm interested in knowing a little more about the liquidity initiative? And how you actually plan to execute the debt paydown?.

Sure. This is Jim Reynolds. Thanks for the question. If you take a look at free cash flow, this is something we have discussed historically, which is the impact on our overall cash flows in Q1 and Q3 with respect to the large bond payment of over $55 million. If you take a look at Q1, our liquidity at that point in time was about $57.9 million.

And if you look at Q3, we're at $50.4 million, so down slightly. What I would also say is, we're pursuing the liquidity plan because we think it's prudent to add incremental cushion.

In talking with all of our investors and looking at the business, we feel comfortable with where our liquidity is heading for the rest of the year, but it's the right thing to do because there's not a ton of cushion.

So we think it's well better received and discussed with the Board on the appropriate plan to move forward, and those are the actions we've discussed at length..

Got it. Got it. And then I just wanted to follow up with one more.

Just was hoping to get some updates on synergies that you might be seeing from SourceHoV and Novitex?.

So once again, Ron discussed the OR -- O&R expenses we incurred during the quarter. Those are a direct result of us focusing our attention on the synergies overall. If you look at the slide that presents our gross margin, it shows the trend based on the amount of time we've held on to the asset.

You see the expansion in gross margins, which is what's driven through synergies and the cost-savings initiatives. During the quarter, we did see a slight improvement in the assets we've held less than a few years.

That's where we're focusing to embed and put in our technology to drive those margins in excess of where we are across the Board from a company perspective..

And you're talking about Slide 7, Jim, right?.

That's correct. Yes..

Our next question will come from Trent Porter of Nuveen..

All right. I have a couple of easy ones, I think. The first one, you may have -- forgive me if you've answered this on last quarter's call, but the -- I find myself scratching my head again. The postage, I think, is zero margin, and then the exit of the -- from the low-margin customer was expected an unknown quantity.

So can you expand a little bit on kind of the major buckets of what's driving the margin miss versus your expectations? And then sort of tie into that, the margin decline year-over-year because I would think that the sort of the mix impact of exiting a low-margin account, all other things being equal, would have a positive impact on margin? And then just sort of a follow-up to that same question, can you talk about just what's behind the slower ramp of projects in the longer sales cycle?.

Sure. Thanks. This is Jim. You had multiple questions, obviously, in there. I'll try and make sure I address them all. So let me get started. The first question is really about the postage and pass-through costs. It is low-margin business. It's just really not predictable for us.

And when that postage comes through, it will fluctuate significantly between quarters. That's something we haven't been very good at predicting historically, so we're working on improving that.

But in one day, you can find out a month later that you're going to have a large job that requires to be delivered, which will show a lot of incremental revenue and no corresponding profit. So that's one aspect of the question.

With respect to the low-margin contract we exited, we made -- we discussed it at length on our Q3 call, I think, again, in our Q4 call, that contract was a profitable contract for us.

And as a result of us rebidding the contract, they were looking for -- we presented a digital solution which would have reduced our overall revenue but increased our margins from where they were. The customer was looking for more of an analog solution with a digital price. So when we talk about the exit of the low-margin contract, it was profitable.

But if we were to continue with that, we would have lost money under the contract. And since we are for profit, we did not go forward with losing money on that contract, so we walked away from that contract. It had been with us for a period of time.

And as we have contracts that have been with us longer, we put a lot of our technology, we've increased our productivity so it comes through at a higher margin. With respect to the comment about the customers maybe not ramping fully, we're -- these are complex solutions.

We have decent visibility into when they're going to hit based on our discussions with our ops people. But you're relying on multiple constituents from the customer that requires sign-offs, and those sign-offs take time. You're using your IT resources and others.

So while the contracts are there, it's not always easy to predict the exact time the contract will fully ramp. We've been ramping new contracts throughout the year, but as a result of certain delays, some of them have not fully ramped..

I understand. I think I'm having a hard time articulating my question. So my question is more -- I get it on the postage, it's almost -- it's very difficult to anticipate. It's going to be lumpy. But as I understand it, if you thought you're going to have $1 million and you've got $500 million, it's zero margin, it's passthrough.

So it's zero margin business, so it shouldn't impact your EBITDA margin -- the EBITDA margin. It will impact the revenue, but not the margin that you had anticipated as a management team. And then the -- in addition, the loss of the customer or the exit from the customer business -- I understand, I'm with you on that.

It's just that, that was a known quantity to you. So the -- that said, the miss on the earnings side is what I'm -- on the EBITDA margin side relative to your expectations is what I'm having a hard time completely understanding. And maybe we can take it offline, but that's -- it's hard to articulate, I get it, but....

No, no, I hear you. I think that, also, we talked about onetime cost that impacted our SG&A. During the quarter, we had some unfavorable costs associated with legal and professional fees..

Weren't those an add back?.

So those things are onetime in nature that we didn't necessarily predict..

Okay.

I mean, were those not added back to EBITDA?.

They were in the add backs, yes. I'm saying from a GAAP perspective..

Right. Right. And so I guess, I mean, that there is -- for example, your EBITDA guidance for the year, it went down last quarter. And I'm not -- I hate to be a pain, it's just -- I want to make sure that I understand. The EBITDA guidance has gone down. And so -- and the EBITDA margin is down year-over-year.

So I just want to better understand what's driving -- what was unfavorable? What is the unfavorable variance versus your budget, specifically on the EBITDA margin side?.

So I think that's another thing we discussed on the call, and maybe it was missed, is that in Q3, we have Europe, which we have incremental cost where we're adding staff. Now 18% of our business overall in Europe -- is in Europe.

And in the month of August, a lot of that business slows down, but we don't terminate people, obviously, we keep them on the payroll, and we have to hire incremental staff and temp help to get work done. So there was some of that, that we were not able to predict. But I appreciate the question and be more than happy to follow up offline..

This concludes our question-and-answer session. I would like to turn the conference back over to Ron Cogburn for any closing remarks. Please go ahead, sir..

Yes, I want to thanks everybody for attending the call today. We look forward to seeing you on our next quarterly call. And if you do have questions, you can reach out to myself or to Jim Reynolds or to Will Maina with ICR who handles our Investor Relations. Thanks, everyone, for attending..

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect..