Conduent Incorporated — Q2 2018 Form 10-Q
Reporting period: Three and six months ended June 30, 2018. Unaudited results; amounts in U.S. dollars. Conduent provides business process services to commercial and government clients.
Financial performance
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Revenue | $1.387bn | $1.496bn | $2.807bn | $3.049bn |
| Gross margin | $262m; 18.9% | $243m; 16.2% | $514m; 18.3% | $502m; 16.5% |
| Income (loss) from continuing operations | $11m | $(4)m | $(39)m | $(14)m |
| Net income (loss) | $11m | $(4)m | $(39)m | $(10)m |
| Diluted EPS | $0.04 | $(0.03) | $(0.21) | $(0.07) |
| Adjusted EBITDA | $166m | $157m | $327m | $310m |
| Operating cash flow | $98m | $67m | $60m | $(40)m |
Q2 revenue declined 7% year over year and first-half revenue declined 8%. Management cited adoption of the new revenue standard, divestitures, portfolio actions including exiting unprofitable contracts, contract losses and lower volumes; new-business ramp partially offset the declines. The new standard reduced reported revenue by $32m in Q2 and $76m in the first half, primarily because postage revenue is presented net rather than gross. Prior periods were not restated.
Gross margin improved as cost reductions and productivity initiatives—including lower real estate, IT and labor costs—and remediation or exit of underperforming contracts outweighed some revenue pressure. Q2 adjusted EBITDA margin was 12.0%, versus 10.5% a year earlier; first-half margin was 11.6%, versus 10.2%. These are non-GAAP measures.
Liquidity, debt and significant items
- At June 30, cash and cash equivalents were $993m, compared with $658m at December 31, 2017. Current assets were $2.661bn and current liabilities $1.313bn.
- Principal debt was $2.092bn ($2.001bn long-term debt reported net of issuance costs and current maturities); total debt less cash was approximately $1.099bn on a principal basis. Q2 interest expense was $37m; first-half expense was $70m.
- First-half investing cash flow was $322m, including $400m proceeds from the sale of Commercial Vehicle Operations (CVO). The CVO sale generated a reported pre-tax gain of $74m. First-half capital additions to property and equipment were $76m.
- In June, Conduent amended its credit agreement, extending revolving and Term A maturities by one year and reducing stated borrowing spreads. In July, it redeemed $476m of $510m 10.5% senior notes, paying a $95m premium; the company reported total principal, premium and interest paid of $575m.
- Assets held for sale were $316m, down from $757m at year-end. In July, the company sold its off-street and airport parking businesses for $24m; in August, it announced an agreement, subject to regulatory approval, to sell its local and municipal government software business.
Outlook, risks and contingencies
- The filing provides no specific full-year revenue or earnings guidance. Management said it expected to exit the run-off Student Loan business in Q3 2018; remaining costs thereafter would be reported in other income/expenses.
- Signings rose 57% in Q2 and 55% in the first half, driven by renewals. New-business total contract value fell 43% in Q2 and 34% in the first half; annual recurring revenue signings also declined. Renewal rates, excluding certain strategic non-renewals, were 99% for Q2 and 97% for the first half.
- Conduent accrued $38m for the Texas Medicaid litigation. The state asserted claims exceeding $2bn; the company said it could not estimate any reasonably possible loss above its accrual. The trial was rescheduled for May 2019.
- Other notable exposures include Cognizant counterclaims exceeding $22m in a contract dispute, regulatory investigations related to student-loan servicing, and $635m of surety bonds and $339m of letters of credit outstanding. Management said litigation outcomes could exceed reserves and be material.
- The effective tax rate was unusually high in Q2 (79.6%) and anomalous for the first half, which reported zero pre-tax income but $39m tax expense. Management attributed this chiefly to the CVO divestiture, nondeductible allocated goodwill and geographic income mix. The filing expects a material balance-sheet impact from adopting lease accounting in 2019.
- Management cited significant indebtedness, contract renewal and performance risks, client concentration or loss, pricing and cost pressures, cybersecurity and privacy risks, and litigation/regulatory matters. It reported no material change to previously disclosed risk factors.
Important facts for investors to verify
- Underlying revenue trends excluding the revenue-standard presentation change, divestitures and deliberate contract exits—and whether new-business ramps can offset those headwinds.
- Renewal quality and pipeline conversion, given higher total signings but lower new-business and recurring-revenue signings.
- Cash generation and liquidity after the senior-note redemption, including the premium paid and remaining debt maturities.
- Potential outcomes and reserve adequacy for the Texas Medicaid case, student-loan regulatory matters and other litigation.
- Completion and proceeds of announced or planned divestitures, and the effect of portfolio changes on ongoing margins and cash flow.