Conduent Inc. — Q2 2017 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2017. Conduent spun off from Xerox on December 31, 2016, and now operates as an independent public company. The 2016 comparative results largely reflect the business as previously reported within Xerox.
Financial performance
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|---|---|---|---|
| Total revenue | $1.496 billion | $1.613 billion | $3.049 billion | $3.298 billion |
| Net loss | $4 million | $10 million | $10 million | $33 million |
| Continuing-operations diluted loss per share | $0.03 | $0.05 | $0.09 | $0.17 |
| Operating cash flow | $67 million | $(61) million | $(39) million | $(178) million |
Q2 revenue declined 7% year over year; the six-month decline was 8% (including a 1% adverse currency impact). Management attributed the declines to lost business, the New York Medicaid Management Information System (NY MMIS) wind-down, student-loan run-off, strategic contract actions, lower volumes and price declines; new contract ramps partly offset these pressures.
Q2 GAAP gross margin was 16.2%, up 0.4 percentage points; GAAP pre-tax loss margin improved to 0.7% from 2.1%. Adjusted operating margin, a non-GAAP measure, was 5.9% versus 4.8%. Adjusted continuing-operations net income was $36 million, or $0.16 per diluted share, versus $63 million, or $0.30. For the first half, adjusted net income was $71 million versus $110 million. These adjusted measures exclude specified items and should be considered alongside GAAP results.
Q2 segment revenue and profit: Commercial Industries $876 million and $32 million (3.7% margin); Public Sector $540 million and $59 million (10.9%); Other $80 million and a $4 million loss. Revenue declined across all three segments. Public Sector margin fell 2.6 percentage points year over year; Commercial Industries margin was flat. Other’s loss improved substantially from $36 million in Q2 2016.
Cash, debt and liquidity
Cash and cash equivalents were $309 million at June 30, 2017, down from $390 million at year-end. Six-month investing cash outflow was $19 million and financing cash outflow was $25 million. Current assets were $1.986 billion and current liabilities $1.212 billion.
Debt principal totaled $2.191 billion, including $70 million drawn on the revolving credit facility; reported long-term debt was $2.071 billion, with $59 million classified as current debt. Interest expense was $34 million in Q2 versus $1 million a year earlier, primarily reflecting debt issued in connection with the spin-off and subsequent borrowing. In April, Conduent repriced its Term Loan B spread from 5.5% to 4.0% over LIBOR, after an approximately $8 million prepayment fee.
Changes, outlook and material items
- Transformation initiatives supported margin improvement and lower SG&A, but were accompanied by restructuring costs and dis-synergies. First-half restructuring and related costs were $54 million; approximately 2,500 employees were included in headcount reductions, and $38 million of the $42 million restructuring reserve was expected to be spent within 12 months.
- Q2 included a $24 million pre-tax gain on a real-estate sale. Litigation-related income and lower separation costs also helped reported results; higher interest expense and restructuring costs offset some gains.
- Total contract signings were $1.244 billion in Q2, down 42% year over year, mainly due to fewer renewals, strategic contract remediation and a large renewal in Q2 2016. Reported renewal rate was 89% for Q2 and 90% for the first half; excluding contracts not renewed as part of strategic actions, the rates were approximately 76% and 78%, respectively.
- No specific financial guidance or quantitative forward outlook is provided in the supplied filing text. Management said it expected to quantify the potential effects of adopting the new revenue-recognition standard during the second half of 2017; adoption was planned for January 1, 2018.
- For NY MMIS, Conduent said it believed full implementation would not be completed and that a negotiated resolution with New York might not succeed; a contractual dispute or claim could follow, with outcome undetermined. The filing also describes a Texas Medicaid litigation matter alleging damages exceeding hundreds of millions of dollars and a CFPB review concerning student-loan servicing; outcomes were not predictable. Management said it did not believe a material loss beyond recorded amounts was reasonably possible for the matters discussed, while warning adverse outcomes could materially affect results, cash flows or financial position.
- Other exposures include $645 million of outstanding surety bonds and $128 million of letters of credit and bank guarantees, generally payable upon specified performance defaults. The company reported no material changes to previously disclosed risk factors. Management concluded disclosure controls were effective and reported no material quarterly change in internal control over financial reporting.
Most important facts for investors to verify
- Whether declining revenue and signings stabilize, and how contract losses, renewals and strategic exits affect future revenue.
- Whether cost and transformation initiatives deliver durable margins and cash generation, rather than relying on sale gains or other adjustments.
- Debt-service capacity and liquidity, particularly given negative first-half operating cash flow and higher interest expense.
- Developments and potential financial exposure related to NY MMIS, the Texas Medicaid case and the CFPB student-loan review.
- The eventual financial and reporting effects of revenue-recognition adoption, and the difference between GAAP results and management’s non-GAAP measures.