Conduent Incorporated — 2016 Form 10-K
Business context and reporting period. This annual report covers the fiscal year ended December 31, 2016, not a standalone fourth-quarter filing. Conduent provides business process services across Commercial Industries, Healthcare and Public Sector, with approximately 96,000 employees and operations in 42 countries. It completed its spin-off from Xerox on December 31, 2016; its shares began regular-way trading on January 3, 2017. Historical results largely reflect the business as part of Xerox and may not represent standalone costs or future performance.
Financial results and position
| Metric | 2016 | 2015 |
|---|---|---|
| Revenue | $6.408 billion | $6.662 billion |
| Net loss | $983 million | $414 million |
| Loss per diluted share | $4.85 | $2.04 |
| Cash from operating activities | $108 million | $493 million |
| Cash and cash equivalents at year-end | $390 million | $140 million |
| Working capital | $515 million | $(867) million |
| Total assets | $7.709 billion | $9.058 billion |
- Revenue fell 4% year over year (3% on a constant-currency basis). The filing attributes the decline to lower volumes, delayed new-business ramps, contract exits, Student Loan runoff and pricing pressure; new Public Sector contracts partly offset these trends.
- Reported gross margin was 14.2%, versus 10.3%. Excluding specified items, gross margin was 16.5%, versus 15.8%. Adjusted operating margin was 5.5%, versus 4.8%; these are non-GAAP measures and should not be confused with reported results.
- Adjusted net income from continuing operations was $223 million, or $1.06 per diluted share, compared with $174 million, or $0.83, in 2015. Adjustments exclude goodwill impairment, project charges and other items; reported GAAP results were losses.
- Operating cash flow dropped $385 million, chiefly reflecting lower receivables factoring and collection timing, Health Enterprise settlement payments, separation and restructuring payments, and changes in working capital. Investing activities provided $16 million; financing activities provided $132 million.
- At year-end, principal debt was $1.997 billion, including $1.444 billion drawn under the credit facility, $510 million of 10.5% senior notes due 2024 and $43 million of capital leases. Balance-sheet debt was $1.941 billion after debt issuance costs and current maturities. The revolving facility totaled $750 million, with $17 million of capacity used for letters of credit. The company also had $142 million of Series A convertible preferred stock.
Material changes and unusual items
- A $935 million non-cash goodwill impairment was recorded in Commercial Industries after weaker results, including a weak fourth quarter. The reporting unit’s fair value was estimated 53% below carrying value; goodwill remaining in that unit was approximately $908 million.
- Following a February 2017 determination that the New York Medicaid Management Information System project was unlikely to be completed in its current form, Conduent recorded a $161 million pretax fourth-quarter 2016 charge ($98 million after tax). It included an $83 million revenue reduction and $78 million in costs, impairments and write-offs. Management said the estimate could change as discussions with New York continue.
- In 2015, the company recorded a $389 million charge related to Health Enterprise implementations in California and Montana. The company also sold its ITO business to Atos in June 2015.
- 2016 segment results: Commercial Industries revenue of $2.690 billion and profit of $59 million; Healthcare revenue of $1.686 billion and profit of $159 million; Public Sector revenue of $1.731 billion and profit of $223 million; Other revenue of $301 million and loss of $245 million, including the NY MMIS charge.
- Conduent recorded $101 million of restructuring and related costs in 2016 and reduced headcount by approximately 3,600. It expected approximately $75 million of additional pretax restructuring charges in 2017.
Outlook, management commentary and risks
- Management forecast 2017 revenue to decline at a rate similar to 2016, with stabilization in 2018 and stronger growth momentum later. The company targeted cumulative transformation savings of $700 million through 2018 and stated it was on track.
- The transformation program targets automation, labor productivity, delivery-network and infrastructure efficiencies, procurement savings and remediation of underperforming contracts. Management intends to invest in targeted growth markets, sales capacity, platforms and technology, and may consider acquisitions.
- Management reported an 86% contract renewal rate in 2016, within its 85%–90% target range; signings declined 14% to $6.9 billion in total contract value. Over 80% of revenue was recurring.
- Key risks include government contract termination, funding and audit exposure; competitive bidding and contract execution or cost-estimation failures; significant debt and restrictive covenants; client losses and pricing pressure; data privacy, cybersecurity and service interruptions; and reliance on third-party providers and skilled personnel.
- Spin-off risks include higher standalone costs, dependence on transitional services from Xerox, less favorable purchasing or financing terms, and uncertainty that expected separation benefits will be achieved. The company does not anticipate common dividends for the foreseeable future.
- Contingencies include ongoing litigation and regulatory matters. The filing describes a Texas Medicaid lawsuit and a CFPB investigation concerning student-loan servicing; the CFPB could pursue enforcement, but the likely outcome was not predictable. Conduent said it had accrued for known matters and did not consider a material excess loss reasonably possible at year-end.
Important facts for investors to verify
- Progress and final financial exposure on the NY MMIS project, including any settlement with New York and additional cash costs.
- Whether the $700 million transformation savings target is achieved, and how much is offset by restructuring charges or revenue attrition.
- Commercial Industries’ operating recovery and the assumptions underlying goodwill valuations and future impairment risk.
- Cash conversion, receivables collection and factoring levels, alongside debt service, leverage covenant compliance and refinancing needs.
- Standalone operating costs after Xerox transition services end, and the outcome of the Texas, CFPB and other legal or regulatory matters.
The filing’s financial statements received an unqualified audit opinion. Management’s internal-control-over-financial-reporting assessment and the auditor’s attestation were omitted under the SEC transition relief for newly public companies.