Alight, Inc. (NYSE:ALIT) Q2 2023 Earnings Call Transcript

Alight, Inc. (NYSE:ALIT) Q2 2023 Earnings Call Transcript August 1, 2023

Alight, Inc. beats earnings expectations. Reported EPS is $0.14, expectations were $0.12.

Operator: Good afternoon and thank you for holding. My name is Stacy, and I will be your conference operator today. Welcome to Alight’s Second Quarter 2023 Earnings Conference Call. At this time, all participants are in a listen-only mode. As a reminder, today’s call is being recorded, and a replay of the call will be available on the Investor Relations section of the company’s website. And now, I would like to turn the call over to Jeremy Cohen, Vice President of Investor Relations at Alight. Please go ahead.

Jeremy Cohen: Good afternoon and thank you for joining us. Earlier today, the company issued a press release with second quarter 2023 results. A copy of the release can be found on the Investor Relations section of the company’s website at investor.alight.com. Before we get started, please note that some of the company’s discussion today will include forward-looking statements. Such forward-looking statements are not guarantees of future performance. Actual results may differ materially from those expressed or implied in the forward-looking statements due to a variety of factors. These factors are discussed in more detail in the company’s filings with the SEC; including the company’s most recent Form 10-K as such factors may be updated from time to time in the company’s periodic filings.

The company does not undertake any obligation to update forward-looking statements. Also, throughout this conference call, the company will be presenting non-GAAP financial measures. Reconciliations of the company’s historical non-GAAP financial measures to their most directly comparable GAAP financial measures appear in today’s earnings press release. On the call from management today are Stephan Scholl, CEO; and Katie Rooney, CFO. After their prepared remarks, we will open the call up for questions. I will now hand the call over to Stephan.

Stephan Scholl: Good afternoon and thank you all for joining us. Earlier today, we released our second quarter results and are pleased to close out the first half of 2023 with double-digit growth across revenue, adjusted EBITDA, and operating cash flow. We believe these results coupled with a consistent track record and increasing levels of visibility, leave us well-positioned to achieve our 2023 and mid-term growth outlook. During the quarter, we delivered revenue and BPaaS growth of nearly 13% and 40%, respectively. As a result, recurring revenue represented nearly 85% of total revenue for the quarter. The mix towards tech-enabled revenue, coupled with investments to improve our operating model, are enhancing returns with adjusted EBITDA up almost 11% for the quarter.

As we drive our profitable growth agenda forward, we’re also generating stronger operating cash flow, which was up 37% for the first half. Our strong performance is led by the collective components of BPaaS and non-BPaaS solutions, which have created a resilient book of business and taken together allows us to sit here today with over 90% of our 2023 revenue under contract and already an unprecedented amount of backlog of $2.5 billion for 2024. Let me briefly explain our recipe and how each component contributes to the totality of our business. First, our non-BPaaS revenue led by professional services and standalone core administration represents nearly 80% of total revenue and is seeing higher than normal growth rates of 8% in the first half.

Our recent growth was driven by one-time project work supporting the go-lives of large BPaaS deals. It is these mission critical standalone solutions that are the foundation for our moat characterized as highly recurring and with long-term contracts. And they are the feeder enabling us to upgrade our customers into larger platform deals that are driving better outcomes. And the platform Alight Worklife is the backbone of BPaaS, which as a reminder, our tech-enabled solutions wrapped with our service capabilities that drive improved engagement and outcomes for our customers. Since 2020, bookings for these solutions have grown over 80% per year resulting in revenue up 45% during the first half of 2023. BPaaS bookings were $149 million for the second quarter, and as we have noted previously, there will be lumpiness in our sales cycle.

To effectively evaluate our bookings, you need to take a longer-term view that isn’t captured in a quarter-to-quarter movement. Cumulatively, we have sold $1.7 billion of BPaaS TCV bookings since 2021 well ahead of initial expectations and a key driver of higher sustainable growth. And speaking to the lumpiness, the total bookings exclude a large deal with a Fortune 10 company that we’ve already closed here in July. Once again, deal timing may fluctuate, but it’s the totality of these great deals that drive the long-term performance of the business. The investments we have made and are continuing to make in our platform and products have resulted in a tremendous opportunity in our pipeline with a number of transformational deals. We also continue to monetize our offerings through a modernized pricing model that is being rapidly accepted by customers and provides upside going forward.

This gives us confidence in our medium-term guidance of BPaaS growth of 15-plus-percent, coupled with the non-BPaaS growth of 2% to 4% with an improving margin profile. So with that important context, let me now turn to the strategic investments that are driving the success of our transformation and overall trajectory. At the center is an ongoing focus of executing on our platform strategy and engaging people in a truly personal way that eliminates complexity, drives better participant outcomes and yields better ROI for customers. To accomplish this, the Alight Worklife platform has been constructed as a recommendation engine of one by unlocking the value of data within our core administrative services and leveraging AI in a meaningful way.

So let me talk more about how we’re doing this. Starting with product, early in the quarter, we announced a major upgrade to our SmartSelect MD search engine and launched New Behavioral Health Services, both enhancing our navigation capabilities. In addition, yesterday, we announced our second major annual release of Alight Worklife. The latest release leverages Alight’s robust proprietary data to deliver AI driven personalization and automation capabilities across the Alight Worklife platform and provides customers with advanced tools to increase the ROI of their benefit programs. I’m particularly excited to share our improved virtual chatbot experience, which will offer users greater access to AI-based personalization and the ability to answer specific inquiries efficiently and in a digital environment.

Improving the chatbot experience will allow us to continue reducing the need for participants to use the call center channel, an improvement that drives greater client satisfaction and underscores our long-term margin expansion by driving down our service costs. Though the advancement in our chatbot is exciting, Alight has been investing in and utilizing AI for years. AI has been core to powering individual benefit decisions and delivery automation. Our experienced models, highly leveraged data sets and established connections with data sources are driving better engagement and improving ROI for our customers. And this is the foundation for our BPaaS growth. Still, we’re just scratching the surface of what is possible. We’re unlocking concrete generative AI use cases by building internal applications.

For example, given the many millions of interactions and hard to digitize PDF documents that we handle annually, generative AI provides the ability to at scale, ingest, comprehend, and answer questions about these documents in a faster self-service format. While we were busy this quarter improving our platform, we also were hard at work on the commercial side as our ongoing investments are translating to customer wins and new partnerships. In the case of Weis Markets, a Mid-Atlantic food retailer with nearly 23,000 employees, our new relationship has grown from an original remit of taking over a complex workday deployment led by a competitor to a OneAlight engagement that includes benefits administration and services work. And with Siemens Healthineers a multinational with nearly 70,000 employees, they were seeking a solution that prioritized employee health and wellbeing while also driving sustainable engagement.

Through our OneAlight solution, Siemens will have the tools to address its objectives and positively impact wellbeing, retention and cost. These wins underscore the continued strength in our commercial pipeline and the need for employers to drive better outcomes for their people and together serve as a powerful foundation for our new Chief Commercial Officer, Greg George. Greg joined us midway through the quarter and I’m excited for our organization as his background in driving growth for cloud-based systems and in the HCM space fits with our transformational initiatives and will serve as a catalyst to accelerate our momentum. Another lever for commercial growth is through our numerous partnerships across the globe. This quarter we announced an expanded partnership with Workday to help companies in various European countries source, manage, and pay their global workforce with a simple unified offering.

This software partnership is in the early stages of its rollout with the joint teams focusing on sales enablement, account planning, and our collective go-to-market strategy. And finally, although much of our transformation is growth-oriented, we’re also well along the path of improving the efficiency of our backend infrastructure, migration of our data centers to the cloud is progressing to plan with high priority applications being moved in advance of annual enrollment and final applications migrating in the first half of 2024. The end result of this program will be significant cost savings, better delivery for our customers, and an accelerated pace of innovation. I also want to take a moment to share more on the leadership changes announced this afternoon.

Katie Rooney will be expanding her responsibilities to take on the role of Chief Operating Officer focused on running Alight’s Professional Services segment and our Global Payroll capabilities. Many of you have gotten to know Katie well and can attest to her strong leadership abilities built from her over 14 years with Alight and its predecessors. In addition to her new role, Katie will continue to serve as Global CFO and Jeremy Heaton will move into the Operating CFO role accountable for many of the day-to-day responsibilities across the finance function. Jeremy was Executive Vice President of FP&A and has been part of Katie’s team for over three years. Before Alight, he was a Divisional CFO for GE and spent over 20 years there. Many of you have had the opportunity to spend time with him and you’ll be seeing much more of him in the future.

Adding operational experience to Katie’s skillset and elevating Jeremy’s role will deepen the expertise of our executive leadership team and give our Board, colleagues, shareholders and customers confidence in our long-term success. Additionally, Cesar Jelvez will be leaving Alight. I want to thank him for his contributions in moving the business forward and I wish him well. Before I hand it over to Katie, I also want to express my gratitude for our colleagues around the world who in just two years as a public company have made tremendous progress, transforming Alight, building upon our strong foundation and setting us up for sustainable long-term success. Katie, over to you.

Katie Rooney: Thank you, Stephan, and good afternoon, everyone. Our second quarter performance was highlighted by double-digit growth in total revenue, BPaaS revenue, adjusted EBITDA, and operating cash flow. In addition, the strength of our foundational non-BPaaS business is also driving increasing levels of long-term visibility. With Stephan noting earlier that we now have over 90% of 2023 revenue under contract and $2.5 billion of 2024 revenue under contract as well. The line of sight we have from our backlog is what enables us to confidently invest to sustain profitable growth. Let me now turn to our performance. Starting with our consolidated results, during the second quarter, we achieved revenue growth of 12.7% highlighted by BPaaS revenue growth of nearly 40% as prior bookings continue to translate into higher contracted revenue.

This is resulting in an ongoing shift towards higher quality recurring revenues, which were up 13.6%. Recurring revenue comprised 84.7% of total revenue, a 70 basis point increase from the prior year. Adjusted EBITDA increased 10.6% to $157 million with an adjusted EBITDA margin of 19.5%. With strong growth across the Board, we are generating increasing levels of cash flow, which strengthens our balance sheet and funds our transformation. For the first half, we generated operating cash flow of $162 million with a conversion rate of 52% up significantly versus prior year as we continue to make improvements in working capital. As a reminder, our second half cash flow tends to be seasonally stronger and we would expect the same this year. And as planned, both investments and restructuring activity are projected to slow compared to the first half, which will impact both profitability and cash flow.

Let me now expand on our bookings performance, both for the quarter and more holistically. To start with the results, BPaaS bookings for the quarter were $149 million and cumulatively, we’re pleased to report we have now achieved over $1.7 billion in total bookings since we began our transformation in 2021. As BPaaS revenue is long-term and recurring in nature, this foundational backlog will continue improving our overall quality of revenue as we leverage the Alight Worklife platform. For 2023, we now expect BPaaS bookings to be in the range of $700 million to $900 million, which implies a strong second half and well over $2 billion of cumulative bookings more than $500 million ahead of our original three-year plan. As you may recall, we will see lumpiness in our bookings from large deals, for example, the two we closed in the fourth quarter of 2022.

The GE deal is a great example of this dynamic. Our engagement is designed to drive long-term BPaaS revenue starting in 2024 through our Alight Worklife platform and comprehensive payroll and benefit solutions. However, this year our team is hard at work implementing the core platform and systems across GE’s three companies, and this work is driving higher non-BPaaS revenue in 2023. The closing of one Alight deals such as this are lucrative, but the size and complexity of finalizing these offerings typically means they take longer to close. Another case was for a deal closed in July as Stephan discussed, and as you evaluate Alight, it remains an important reason to take a longer-term view of bookings. We also continue to have a very strong pipeline across our business with over $2 billion in opportunity just within our install base.

We’re making progress with new logos and we’ve introduced our new pricing model, which is not yet contemplated in our total backlog. Our pricing model is being implemented in new deals and will enable us to monetize new products more effectively. Overall, the implications of building our platform and driving value-based pricing will be multi-fold. We’d expect increased revenue growth, improved margin potential, and faster cash collection as we prove out a better model for our customers. Overall, these levers taken collectively are driving growth for our business and position us well to achieve our mid-term outlook. With that, let me now turn to our segments. Starting with Employer Solutions, second quarter revenue was up 13.5% with recurring revenue up 14.3% and project revenue up 5.5%.

Contributing to our growth was two months of Federal Thrift as well as increased net commercial activity volumes and the impact from the ReedGroup acquisition. Our strong growth, coupled with productivity savings, are driving better profitability with second quarter adjusted gross profit up 21.3% to $268 million. Adjusted gross margin increased by 250 basis points to 38.5%. Turning to our Professional Services segment. Second quarter revenue growth accelerated sequentially and was up almost 10% from the prior year to $100 million. This was driven by a 10% increase in project revenue and a 9% increase in recurring revenue building from a strong backlog. On a profitability basis, adjusted gross profit was slightly off from the prior year down $1 million.

Turning to our balance sheet. Our quarter end cash and cash equivalents balance was $271 million and our total debt was $2.8 billion. We continue to actively manage our debt and our hedge portfolio is 84% fixed through 2024 and 60% through 2025. Our net leverage ratio at the end of the second quarter was 3.7x down from 3.8x at the end of the first quarter. And as a reminder, we are targeting mid-term net leverage of approximately 3x. Turning to our outlook. Our strong first half keeps us on track for another successful year with more than 90% of our revenue under contract; we are reaffirming our 2023 guidance with the exception of BPaaS bookings mentioned earlier. Our outlook includes revenue of $3.47 billion to $3.51 billion, or growth of 11% to 12%; adjusted EBITDA of $735 million to $750 million, or growth of 12% to 14%; adjusted EPS of $0.62 to $0.67, or growth of 9% to 18%; and an operating cash flow conversion rate of 45% to 55% up from 43% in 2022.

From a phasing perspective, we expect second half adjusted EBITDA to follow historic trends with higher upfront costs in the third quarter, supporting growth in the fourth quarter. In closing, I’m so proud of what we’ve accomplished and continue to achieve with double-digit revenue adjusted EBITDA and operating cash flow growth. These results demonstrate the attractiveness of our long-term strategy as we pivot toward the higher growth and higher margin operating model positioning us to enhance long-term shareholder value. This concludes our prepared remarks and we will now move into the question-and-answer session. Operator, would you please instruct participants on how to ask questions?

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Q&A Session

Operator: Thank you. We will now be conducting a question-and-answer session. [Operator Instructions]. Your first question comes from Kyle Peterson with Needham & Company. Please go ahead.

Kyle Peterson: Great. Thanks. Good afternoon, guys. Katie and Jeremy congratulations on the new roles. Just wanted to start off, on the guidance revisions, particularly on the BPaaS bookings, understand and can appreciate there’s some lumpiness there, but just wanted to see, is this just a few large deals shifting around here or there, or is there any hesitation or signs of slowdown from clients maybe one push off, some of these projects a little bit just given some of the macro uncertainty. Any color would be very helpful.

Stephan Scholl: Sure. Thanks, Kyle. Appreciate it. And listen, you got to go back to what we said almost three years ago, right, when our original guidance was $1.5 billion and we all felt that was a big goal to achieve. And look where we sit, we’re going to be call it, $0.5 billion ahead of that plan. So we’ve had some good success early days in the last couple of years on driving that book of business. You’ve all seen how that bookings performance has translated into starting 2023 with $2.9 billion of revenue under contract, which was the entire revenue book of business we did in 2022. And if you translate the success of our BPaaS bookings from the beginning of when we started in 2021, we started the year in 2023 with almost $800 million of revenue under contract more than we did in 2021.

So over two years, almost $800 million of high quality valuable backlog. And then you heard Katie say $2.5 billion of revenue under contract for next year, which we’ve never at this point in time had that much as well. So that should give confidence looking into 2024 and mid-term. And then Katie also said 90% of 2023 revenue under contract. In terms of pipeline, we’re looking at right now over 20 deals that are over $20 million in value each one of them, and some of them of course, significantly more than that as well. So pipeline is strong. We’re seeing the same enthusiasm from clients, especially now heading into second half where CFOs and CEOs are continuing to try and look at how to take costs out of their business. As you all know, during COVID, there was a lot of spend that happened on what I would call point solutions.

We’ve come in with our platform capability and really stitched together an end-to-end front door kind of capability with our Alight Worklife platform. And that has resonated. So we are doing a lot of work around value engineering and process re-engineering for a lot of our largest clients, which could again as I said with our pipeline yield some pretty significant transactions for us moving into the outer quarters as well. But we feel really good about where we are. Again, as I said during my segment, it’s very hard to look at this business in a 30, 60, 90 or even 6 to 12-month view you have to take a multi-year long-term view. And again, as shareholders, I know the shareholders that I’ve talked to appreciate the long-term view of making sure that we drive a better quality book of business at higher margins and better contribution to the company.

So we feel really good about where we are.

Kyle Peterson: Yes. That makes sense. And it’s good color. Maybe just a follow-up on capital allocation, specifically thinking about the back half of the year is cash flow seasonally typically tends to be better for you guys in the second half versus the first half. How are you guys thinking about whether it’s kind of camping up the buyback in the second half of the year or are there interesting M&A opportunities you guys would look to pursue any additional color on how you’re looking to deploy capital in the back half of the year would be great.