Conduent Incorporated — Q1 2018 Form 10-Q
Reporting period: Three months ended March 31, 2018. Unaudited results; comparisons are with Q1 2017 unless stated otherwise.
Business context
Conduent provides digital business process services to commercial and government clients, including transaction processing, customer experience, human resources, public-sector administration, payments and transportation services. It reported approximately 85,000 employees serving customers in 28 countries. Its reportable segments are Commercial Industries and Public Sector; Other includes the student-loan business in run-off.
Financial performance
| Metric | Q1 2018 | Q1 2017 |
|---|---|---|
| Revenue | $1.420 billion | $1.553 billion |
| Gross margin | $252 million; 17.7% of revenue | $259 million; 16.7% of revenue |
| Operating costs and expenses | $306 million | $281 million |
| Loss from continuing operations | $50 million; $0.26 per diluted share | $10 million; $0.06 per diluted share |
| Net cash used in operating activities | $38 million | $107 million |
| Capital expenditures for property and equipment | $33 million | $17 million |
| Adjusted EBITDA (non-GAAP) | $161 million; 11.3% margin | $153 million; 9.9% margin |
Revenue declined 9%. The company attributed the decline to adoption of the new revenue standard, 2017 divestitures, portfolio rationalization, exited unprofitable contracts and contract losses; new-business ramps and price increases partly offset these factors. The new revenue standard reduced reported Q1 2018 revenue by $44 million, primarily because postage receipts were reported net rather than gross; its effects on pretax income, the balance sheet and cash flows were not material. Comparatives were not restated.
Cost of services fell 10%, but gross profit dollars decreased 3%; gross margin as a percentage of revenue increased. Management cited cost and productivity initiatives as support for margins, partly offset by contract losses and lower client volumes. SG&A decreased to $145 million from $169 million. Results included $20 million of restructuring and related costs, $15 million of divestiture and transaction costs, and $31 million of net litigation costs, versus an $11 million litigation recovery in Q1 2017. Adjusted EBITDA is a company-defined non-GAAP measure and excludes specified items.
Liquidity, debt and balance sheet
Cash and cash equivalents were $553 million at March 31, 2018, down from $658 million at year-end 2017. Current assets were $2.620 billion and current liabilities $1.374 billion. Total liabilities were $3.859 billion. Debt principal was $2.106 billion, comprising Term Loan A, Term Loan B, senior notes and capital leases; reported short-term debt/current maturities plus long-term debt totaled $2.053 billion after debt discounts and issuance costs. The company reported $1.6 billion of borrowings under its Credit Agreement.
Operating cash use improved by $69 million year over year, which management attributed primarily to working-capital improvements and lower Health Enterprise wind-down payments, partly offset by prepaid software-license payments. Investing cash use was $39 million and financing cash use was $27 million; financing outflows included $21 million of debt repayments. Cash, cash equivalents and restricted cash totaled $563 million at quarter-end, including approximately $10 million of restricted cash.
Segments and commercial indicators
Commercial Industries revenue was $854 million and adjusted EBITDA was $78 million, with a 9.1% margin; Public Sector revenue was $558 million and adjusted EBITDA was $87 million, with a 15.6% margin. Segment revenues declined year over year, while both segments’ adjusted EBITDA margins improved, which management attributed mainly to cost transformation and contract remediation. Total contract signings were $1.428 billion, up 53%, driven by renewals; new-business total contract value fell 23% to $406 million. Annual recurring revenue signings declined 35% to $93 million. Renewal rate was 94%, excluding contracts the company strategically chose not to renew.
Outlook, risks and unusual items
- The filing provides no specific forward earnings or revenue guidance. Management described a strategy focused on portfolio discipline, operational improvement, sales and delivery excellence, and innovation.
- Restructuring charges included $14 million of severance associated with reductions of approximately 740 employees and $5 million of lease-cancellation costs. Management said further restructuring provisions or estimate changes could occur.
- Texas Medicaid litigation: the State asserted a claim in excess of $2 billion; Conduent had accrued $38 million and said it could not estimate any reasonably possible loss above that amount. A trial was scheduled for November 2018.
- In its dispute with Cognizant, Conduent sought damages exceeding $150 million and had terminated the contract for cause; Cognizant asserted counterclaims exceeding $22 million. The ultimate outcome was not estimable.
- Regulatory investigations concerning the student-loan servicing business could result in fines, penalties or other liabilities; the company could not predict their outcome. It serviced a Federal Family Education Loan portfolio with approximately $4 billion outstanding principal.
- At quarter-end, Conduent had $590 million of surety bonds and $340 million of letters of credit outstanding. These are performance and other guarantees, not reported borrowings.
- Businesses classified as held for sale included $659 million of assets and $173 million of liabilities at March 31, 2018. In April, the company announced agreements, subject to regulatory approval, to sell parking and certain human-resource consulting businesses that generated $321 million of 2017 revenue.
- The company adopted the new revenue standard on January 1, 2018, recording a $17 million increase to opening retained earnings. It expects the new lease standard, effective for it in 2019, to have a material balance-sheet impact.
- Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter. It reported no material changes to the risk factors in its 2017 Form 10-K.
Most important facts for investors to verify
- Whether revenue declines, contract losses and lower volumes stabilize, and whether new business offsets portfolio exits and divestitures.
- Whether improved segment margins and operating cash flow persist after restructuring and other excluded costs are considered.
- Cash generation, working-capital movements, capital spending and capacity to service approximately $2.1 billion of debt principal.
- Developments in the Texas Medicaid case, the Cognizant dispute and student-loan regulatory reviews, including any changes to accruals or estimated exposure.
- Completion, timing and financial effects of announced asset sales, and the balance-sheet impact of adopting the lease standard.
- How much of reported revenue movement reflects the $44 million accounting presentation change rather than underlying business activity; assess non-GAAP adjusted EBITDA alongside GAAP results.