Conduent Inc. — Form 10-Q Summary
Reporting period: Three and nine months ended September 30, 2016. The statements present Xerox’s Business Processing Services (BPS) business on a combined, historical basis, not a standalone public-company basis. Xerox planned to distribute Conduent shares on December 31, 2016, subject to conditions; at filing, Xerox remained the sole equity holder and there was no publicly traded market for Conduent stock.
Financial performance
Amounts are in millions unless stated otherwise.
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Revenue | $1,596 | $1,571 | $4,894 | $4,932 |
| Income (loss) from continuing operations | $1 | $(236) | $(32) | $(345) |
| Net income (loss) | $1 | $(239) | $(32) | $(409) |
| Adjusted operating income / margin (non-GAAP) | $97 / 6.1% | $96 / 5.7% | $245 / 5.0% | $229 / 4.5% |
| Operating cash flow | $140 | $128 | $(38) | $5 |
- Reported revenue rose 2% in Q3 and fell 1% year to date. Excluding the 2015 Health Enterprise (HE) charge, revenue declined 5% in Q3 and 3% year to date; constant-currency declines were 5% and 2%, respectively.
- Reported Q3 pre-tax income was $2 million versus a $390 million loss in 2015; nine-month pre-tax loss was $86 million versus $582 million. Comparisons are heavily affected by the 2015 HE charge ($389 million) and, for the nine-month comparison, a 2015 software impairment charge ($146 million).
- Adjusted continuing-operations net income was $53 million in Q3 and $159 million for nine months, versus $45 million and $105 million in the comparable 2015 periods. These are non-GAAP measures and exclude specified charges, including amortization, restructuring and separation costs.
- Reported gross margin was 16.8% in Q3 and 16.1% year to date. On an adjusted basis, gross margin improved 0.3 and 0.5 percentage points, respectively. Management cited productivity, transformation initiatives, lower HE implementation costs and mix, partly offset by price declines, customer-care margin pressure and weaker Student Loan profitability.
Segments and operating trends
- Commercial Industries: Q3 revenue $664 million, down 8%; segment margin 3.2%, up from 1.9%. Year-to-date revenue of $2,030 million declined 6%, and margin of 2.2% declined 0.2 percentage points.
- Healthcare: Q3 revenue $397 million, down 6%; margin 9.6%, up from 7.6%. Year-to-date revenue of $1,277 million declined 1%; margin was 8.8%, up 0.1 percentage points.
- Public Sector: Q3 revenue $443 million, up 3%; margin 13.3%, up from 11.9%. Year-to-date revenue of $1,290 million rose 1%; margin was 12.6%, up 1.3 percentage points.
- Management attributed declines mainly to lost business, lower volumes, pricing and Student Loan run-off; Public Sector growth was supported by new transportation contracts. Q3 signings were $1.5 billion, up 15%; nine-month signings were $5.3 billion, down 4%. Renewal rate was 86%, within the stated 85%–90% target range.
Financial position, liquidity and planned capitalization
- At September 30, 2016, cash was $148 million, current assets $2,020 million and current liabilities $2,306 million. Total assets were $8,923 million and total liabilities $3,433 million.
- Third-party short- and long-term debt totaled $48 million. Related-party notes payable were $1,106 million, expected to be settled as part of the separation; related-party notes receivable were $205 million. The combined statements exclude Xerox debt for which the BPS business was not the legal obligor.
- Nine-month operating cash flow was negative $38 million; investing cash flow was negative $129 million and financing cash flow was positive $177 million, including $216 million of net transfers from the parent. Cash increased $8 million from year-end.
- For the separation, management expected approximately $2.25 billion of total principal debt, including about $2.2 billion of new borrowings, at a projected weighted-average interest cost of 5.75% and six-year term; a new undrawn secured revolver was also planned. Expected starting cash was about $400 million. Xerox and Conduent also agreed to transfer preferred stock with a $140 million carrying value and an 8% dividend rate.
Outlook, risks and unusual items
- The filing gives no conventional revenue or earnings guidance. Management expected additional standalone-company expenses after separation, alongside potential incremental productivity; historical allocations may not represent future costs. Xerox allocated corporate support costs of $41 million in Q3 and $125 million year to date.
- New York’s HE platform implementation was behind its contractual schedule, with added delivery costs. Further regulatory, policy and security requirements could extend the schedule and materially increase completion costs; Conduent was seeking a contract amendment for schedule and reimbursement changes.
- Commercial Services goodwill fair value exceeded carrying value by approximately 17% in the prior assessment. Given year-to-date declines in revenue and operating profit, management warned assumptions in the planned Q4 2016 impairment test could be adversely affected.
- Material contingencies include the Texas Medicaid lawsuit, which alleges damages exceeding hundreds of millions of dollars, and a CFPB investigation concerning student-loan servicing. Management stated it had accrued appropriate provisions and did not consider a material excess loss reasonably possible at September 30, but outcomes remain uncertain. The business also reported $655 million of surety bonds and $102 million of letters of credit; management considered default risk remote.
- Restructuring and asset-impairment charges were $45 million year to date, including severance associated with approximately 3,300 employee reductions. Separation costs were $15 million in Q3 and $34 million year to date. The filing also notes a $6 million first-quarter tax-benefit adjustment, deemed immaterial to that quarter, to be reflected in a future filing.
Important facts for investors to verify
- Whether the planned December 31, 2016 spin-off and stated debt, preferred-stock and cash capitalization were completed on the expected terms.
- Standalone operating costs and cash generation after separation, given parent allocations and negative year-to-date operating cash flow.
- Progress, cost exposure and contract amendments for the New York HE implementation, and the result of the Q4 2016 goodwill impairment test.
- Developments and potential financial exposure in the Texas Medicaid litigation and CFPB/student-loan servicing reviews.
- Underlying revenue, margin and renewal trends by segment, distinguishing reported GAAP results from management’s adjusted non-GAAP measures and the effects of the 2015 HE charge.