Conduent Inc. — 2017 Form 10-K Summary
Business context and reporting period
For the fiscal year ended December 31, 2017, Conduent was in its first full year as an independent, publicly traded company after its December 2016 spin-off from Xerox. It provides business process services, including transaction processing, customer care, healthcare, transportation, government administration and payment services. The company reported approximately 90,000 employees and operations serving clients in 31 countries.
Financial performance and position
| Metric | 2017 | 2016 |
|---|---|---|
| Total revenue | $6.022 billion | $6.408 billion |
| Gross margin | $1.045 billion; 17.4% of revenue | $910 million; 14.2% |
| Income (loss) from continuing operations | $177 million | $(983) million |
| Net income (loss) | $181 million | $(983) million |
| Operating cash flow | $302 million | $108 million |
| Cash and cash equivalents at year-end | $658 million | $390 million |
| Total debt, including capital leases | $2.061 billion carrying value; $2.117 billion principal balance | $1.941 billion carrying value |
Revenue declined 6%, reflecting strategic contract exits, runoff of the Student Loan business, contract losses and lower volumes, partly offset by new business. Gross margin improved as cost and productivity initiatives, contract remediation and lower Student Loan costs more than offset revenue pressure. SG&A fell 10% to $615 million. The company reported a $193 million income tax benefit; the resulting 1,206.3% effective tax rate was unusually high because of a pretax loss and tax-law-related items, including a provisional $210 million benefit from remeasuring deferred taxes and a $12 million transition-tax expense.
Adjusted net income was $186 million and adjusted diluted EPS was $0.85; adjusted EBITDA was $672 million, or 11.2% of revenue. These are non-GAAP measures and should be considered alongside GAAP results. Commercial Industries revenue was $3.548 billion with adjusted EBITDA margin of 9.7%; Public Sector revenue was $2.163 billion with adjusted EBITDA margin of 15.3%. Other reported a $10 million segment loss.
Working capital was $1.342 billion, versus $515 million in 2016. Current assets were $2.710 billion and current liabilities $1.368 billion. Operating cash flow increased to $302 million, primarily due to working-capital improvements and lower project wind-down payments, partly offset by higher interest payments. The company had $1.574 billion outstanding under its credit agreement and $12 million of revolving capacity used for letters of credit. Interest expense rose to $137 million from $14 million. Term Loan B pricing was reduced twice during 2017, to LIBOR plus 3.0%.
Material changes and unusual items
- Conduent divested five businesses for $56 million in cash and recorded a $16 million pretax gain. It also sold its former ACS headquarters property, recording a $24 million pretax gain.
- In the fourth quarter, the company classified selected businesses as held for sale, reclassifying $757 million of assets and $169 million of liabilities. The assets included $537 million of goodwill.
- The New York Health Enterprise contract terminated effective December 15, 2017 under a settlement requiring approximately $20 million in payments or costs. The amount had already been reserved, so no additional settlement charge was recorded.
- Restructuring and related costs were $101 million in 2017, including lease cancellation, severance, transformation support and impairment costs. Workforce reductions affected approximately 3,200 employees.
- The prior-year comparison includes a $935 million goodwill impairment in 2016. The 2016 result also included a $161 million charge related to the New York Medicaid platform project.
- Fourth-quarter 2017 revenue was $1.493 billion and net income was $208 million, including a $204 million income tax benefit. Quarterly earnings therefore reflected a material tax benefit; fourth-quarter pretax income was $4 million.
Outlook, risks and contingencies
The filing provides no specific 2018 revenue, earnings or cash-flow guidance. Management’s stated priorities are portfolio focus, operational discipline, sales and delivery improvement, automation and cost transformation, with the aim of profitable growth and margin expansion. Management reported a 94% renewal rate excluding contracts it strategically chose not to renew; including those contracts, the rate was approximately 87%. It expects approximately $8 million of pension contributions in 2018 and approximately $100 million of payments to participants in terminated deferred-compensation plans in the fourth quarter of 2018.
Key risks include declining revenue and contract losses, competitive pricing, successful delivery and cost estimation on complex contracts, government contract funding and termination rights, substantial indebtedness and restrictive covenants, dependence on key clients and third-party providers, cybersecurity and privacy compliance, and execution of the transformation and post-spin-off transition. The company disclosed a Texas Medicaid lawsuit in which the State asserted claims exceeding $2 billion; Conduent said it could not estimate a reasonably possible loss beyond its existing $38 million accrual and intends to contest the claim. Other disclosed matters include a Cognizant dispute, with Conduent seeking more than $150 million and Cognizant counterclaiming for more than $22 million, and regulatory investigations concerning student-loan servicing for which the outcome and potential loss were not estimable.
The company adopted new revenue-recognition guidance on January 1, 2018, anticipating an approximately $20 million cumulative adjustment and approximately $15 million impact to 2018 revenue, excluding postage presentation changes. It expected the lease-accounting standard, effective for it in 2019, to materially affect the balance sheet. Management and the independent auditor concluded that internal control over financial reporting was effective as of year-end. No common-stock dividends were paid in 2017, and none were anticipated for the foreseeable future.
Important facts for investors to verify
- Whether revenue declines and weaker signings continue: total signings fell 28% to $4.952 billion, and annual recurring revenue signings fell 10% to $533 million.
- Whether transformation and contract-remediation savings translate into sustainable operating improvement, particularly given lower Public Sector profit and continuing contract losses.
- The expected timing, proceeds and realized gains or losses from the businesses held for sale, including the disposal of $537 million in goodwill.
- Debt-service capacity, covenant headroom, variable-rate exposure and the scheduled $560 million of principal payments in 2021.
- Developments in the Texas litigation, the Cognizant dispute and student-loan servicing investigations, including any changes to accruals or potential exposure.
- Final tax accounting under the 2017 Tax Act and the actual effects of revenue-recognition and lease-accounting changes.