Conduent Incorporated — Q3 2017 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2017; unaudited. Conduent spun off from Xerox on December 31, 2016 and now operates independently. Comparisons with 2016 reflect periods when the business was part of Xerox, so standalone costs and financing differ.
Financial performance
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Revenue | $1.480bn | $1.596bn | $4.529bn | $4.894bn |
| Gross margin | $261m | $268m | $763m | $787m |
| Pre-tax income (loss) | $13m | $2m | $(20)m | $(86)m |
| Net income (loss) | $(17)m | $1m | $(27)m | $(32)m |
| Diluted EPS | $(0.09) | $0.01 | $(0.17) | $(0.16) |
| Operating cash flow | $104m | $140m | $65m | $(38)m |
- Q3 revenue fell about 7% year over year; nine-month revenue fell about 7%. Management cited lost business, contract wind-downs, strategic contract actions, lower volumes and price declines. New contract ramps partly offset the declines.
- Q3 gross margin dollars declined $7m; gross margin was approximately 17.6% of revenue, versus 16.8% a year earlier. Management attributed pressure to lost business, customer-experience service offerings, price declines and, to a lesser extent, hurricanes.
- Q3 adjusted operating income was $111m, or 7.5% of revenue, versus $97m, or 6.1%, in Q3 2016. Nine-month adjusted operating income was $288m, or 6.4%, versus $245m, or 5.0%. These are non-GAAP measures; reported GAAP pre-tax income was $13m for Q3 and a $20m loss year to date.
- Q3 results included $30m income-tax expense on $13m pre-tax income, an effective rate of 230.8%. The filing attributes the unusually high rate primarily to taxable gains on termination of the company-owned life insurance plan and U.S. divestitures. The plan termination generated a $19m tax expense.
- At September 30, cash and cash equivalents were $468m, including about $141m from liquidation of deferred-compensation plan investments. The company expected to pay plan participants about $15m in Q4 2017 and $101m in 2018. Cash was $390m at year-end 2016.
- Debt: $71m short-term/current and $1.991bn long-term, or approximately $2.062bn on the balance sheet. No revolving-credit-facility borrowings were outstanding. Term Loan B was repriced in April, and an October 10 subsequent amendment reduced its spread from 4.0% to 3.0% over LIBOR.
- Nine-month investing cash flow was $122m, including proceeds from investments and divestitures; financing cash flow was a use of $111m. Operating cash flow improved from a $38m use in the 2016 period, primarily due to working-capital improvement and lower wind-down payments, partly offset by tax payments.
Material changes and operating trends
- Commercial Industries Q3 revenue was $864m, down 6%; segment profit increased to $53m from $42m. Public Sector revenue was $540m, down 8%; segment profit fell to $59m from $78m. Other revenue was $76m, down 15%, while segment profit improved to $1m from a $23m loss.
- Strategic transformation and restructuring continued. Nine-month restructuring and asset-impairment charges were $68m, including severance associated with approximately 3,200 employee reductions and lease-cancellation costs. The restructuring reserve was $40m, of which about $28m was expected to be spent within 12 months. Worldwide employment was about 90,000, down approximately 6,000 since December 2016.
- Q3 total contract signings were $1.047bn, down 32%; nine-month signings were $3.222bn, down 38%. Management linked the decline to lower renewals, including strategic contract remediation and a large prior-year renewal. Renewal rate was 98% for Q3 and 93% year to date, excluding specified strategic actions; reported rates would have been about 95% and 83%, respectively, absent those actions.
- Divestitures generated $56m cash proceeds and a $16m pre-tax gain; a property sale generated an additional $24m pre-tax gain. The divested businesses represented $60m of revenue for the first nine months of 2017.
Outlook, risks and contingencies
- The filing provides no quantified full-year revenue or earnings guidance. Management describes ongoing revenue pressure, transformation benefits, contract wins and investments, but does not provide a specific forecast.
- For the New York Medicaid Management Information System project, Conduent recorded a $161m pre-tax charge in Q4 2016 and recorded further estimated wind-down cost increases of $10m in the first nine months of 2017. It had an agreement in principle with New York involving about $20m of payments or costs, reserved, but no definitive settlement had been signed.
- Notable matters include the Texas Medicaid fraud lawsuit seeking damages described as exceeding hundreds of millions of dollars, and CFPB and other regulatory reviews concerning student-loan servicing. Conduent said it did not believe a material loss in excess of recorded amounts was reasonably possible for its contingencies overall, while noting outcomes could materially affect results if adverse developments occur.
- Performance guarantees included $570m of surety bonds and $238m of letters of credit and bank guarantees. Management considered default under these guarantees remote. Other stated risks include contract renewals and termination rights, client concentration, delivery and cost-estimation risks, data security and privacy, indebtedness, and ability to collect receivables.
Important facts for investors to verify
- Whether declining revenue and contract signings stabilize, and whether new business offsets losses, price pressure and strategic contract exits.
- Whether reported cash generation is sustainable after accounting for the $141m plan-related cash and anticipated participant payments.
- Progress and final cost of the New York settlement, other Health Enterprise wind-downs, and the Texas and student-loan regulatory matters.
- Execution and cash costs of restructuring, including the $40m reserve and expected near-term spending.
- Debt service and interest expense after the Term Loan B repricing; distinguish reported GAAP results from management’s non-GAAP adjusted measures.