Conduent Inc. — Q3 2018 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2018. Unaudited results. Conduent provides business process services to commercial and government clients; it reported approximately 84,000 employees in 26 countries.
Financial results and liquidity
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Revenue | $1.304bn | $1.480bn | $4.111bn | $4.529bn |
| Gross margin | $250m | $261m | $764m | $763m |
| Net loss | $237m | $17m | $276m | $27m |
| Diluted loss per share | $1.16 | $0.09 | $1.38 | $0.19 |
| Adjusted EBITDA (non-GAAP) | $157m | $174m | $484m | $484m |
| Operating cash flow | $(30)m | $104m | $30m | $64m |
- Q3 revenue fell 12%; nine-month revenue declined 9%. Management cited the new revenue accounting standard, divestitures, strategic exits from contracts and contract losses, partly offset by new-business ramps. Adoption of the standard reduced reported revenue by $34m in Q3 and $110m year to date, primarily because postage is reported net rather than gross; management said the impact on pretax income was not material.
- Gross margin was approximately 19.2% of revenue in Q3 versus 17.6% a year earlier; nine-month margin was approximately 18.6% versus 16.8%. Management attributed margin improvement, excluding divestitures, to cost and productivity measures and remediation or exit of underperforming contracts.
- Q3 GAAP results included $78m of net litigation costs, $54m of divestiture losses and transaction costs, and a $108m loss on extinguishment of debt. The latter reflected the premium and related write-offs from redeeming most of the 10.5% senior notes. Q3 adjusted net income was $61m, or $0.28 per diluted share, versus $48m, or $0.22, in Q3 2017; these are non-GAAP measures.
- Cash and cash equivalents were $586m at September 30, 2018, down from $658m at year-end 2017. Total debt principal was $1.610bn; balance-sheet debt was $1.577bn net of discounts and issuance costs, including $49m current. A $750m revolving facility was available, with $12m used for letters of credit. Nine-month investing cash flow included $672m of proceeds from divestitures and asset sales; financing cash outflow was $627m, primarily reflecting debt repayment.
- Q3 segment revenue and adjusted EBITDA: Commercial Industries $727m and $67m; Public Sector $520m and $85m. Their adjusted EBITDA margins were 9.2% and 16.3%, respectively. Total adjusted EBITDA margin was 12.0%, versus 11.8% a year earlier.
Material changes, outlook and unusual items
- Conduent redeemed $476m of its $510m 10.5% senior notes in July, paying a $95m premium. June loan amendments reduced applicable spreads by 0.5 percentage points and extended revolving and Term A maturities to 2022.
- Divestitures included the local and municipal government software business, HR consulting and actuarial operations, off-street and airport parking, and Commercial Vehicle Operations. A portfolio of customer care contracts was classified as held for sale; a $47m impairment was recorded, and the sale agreement was subject to regulatory approval.
- Management continued restructuring and transformation efforts, including approximately 1,400 employee reductions in Q3 and real-estate consolidation. It noted potential additional restructuring charges. The company exited its Student Loan Services business in Q3.
- Signings were $771m in Q3, down 26%, as new-business and renewal total contract value declined. Nine-month signings rose 29% to $4.146bn, mainly due to increased renewals; new-business TCV fell 33%. Renewal rates, excluding contracts not renewed as part of strategic actions, were 91% for Q3 and 96% year to date.
- Remaining performance obligations were approximately $2bn, with about 66% expected to be recognized over the next two years. This is a revenue-recognition estimate, not formal earnings guidance; the filing provides no specific full-year earnings or revenue guidance.
- In October, Conduent announced an agreement to acquire Health Solutions Plus for approximately $98m. Also in October, a data-center migration caused a significant service outage; management said its financial impact was not material but warned future migrations could disrupt service. The filing identifies IT modernization and possible payment-card-industry security compliance issues as risks.
Risks and contingencies
- For the Texas Medicaid litigation, Conduent added $72m to its reserve in Q3, bringing the total to $110m. The state asserted claims exceeding $2bn; the company said it could not estimate potential losses above its reserve. A trial was rescheduled for May 2019.
- Other disclosed matters include Cognizant contract litigation, actuarial-negligence litigation retained after the Buck sale, and potential regulatory or other claims related to former student-loan servicing. Outcomes and possible losses were not clearly estimable in the filing.
- Conduent had $631m of outstanding surety bonds and $345m of letters of credit supporting contractual and other obligations. Management said it believed existing reserves were adequate for disclosed litigation, while warning adverse outcomes could materially affect results, cash flows or liquidity.
- The company said its annual goodwill impairment test would take place in Q4 and that assumptions could materially affect reporting-unit carrying values.
Important facts for investors to verify
- Progress and final outcome of the Texas litigation, and whether exposure could exceed the $110m reserve.
- Underlying revenue trends, contract renewals and new-business wins, separating organic performance from divestitures and the accounting-standard effect.
- Cash conversion, working-capital needs, available revolver capacity and debt service following the note redemption.
- Execution and customer impact of IT modernization and data-center migrations, including payment-card security compliance.
- Completion and proceeds of the customer-care contract sale, Q4 goodwill impairment results, and potential costs from other legal or regulatory matters.