CONDUENT Inc 10-Q

ITEM 2 — MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following Management’s Discussion and Analysis (MD&A) is intended to help the reader understand the results of operations and financial condition of Conduent Incorporated and its consolidated subsidiaries. MD&A is provided as a supplement to, and should be read in conjunction with, our Condensed Consolidated Financial Statements and the accompanying Notes. Overview We are a leading provider of business process services with expertise in transaction-intensive processing, analytics and automation. We serve as a trusted business partner in both the front office and back office, enabling personalized, seamless interactions on a massive scale that improve end-user experience. Headquartered in Florham Park, New Jersey, we have a team of approximately 59,000 associates as of March 31, 2021, servicing customers from service centers in 24 countries. Our reportable segments correspond to how we organize and manage the business and are aligned to the industries in which our clients operate. We organize and manage our businesses through three reportable segments. • Commercial Industries – Our Commercial Industries segment provides business process services and customized solutions to clients in a variety of industries. Across the Commercial Industries segment, we operate on our clients’ behalf to deliver mission-critical solutions and services to reduce costs, improve efficiencies and enable revenue growth for our clients and their consumers and employees. • Government Services – Our Government Services segment provides government-centric business process services to U.S. federal, state and local and foreign governments for public assistance, health services, program administration, transaction processing and payment services. Our solutions in this segment help governments respond to changing rules for eligibility and increasing citizen expectations. • Transportation – Our Transportation segment provides systems and support, as well as revenue-generating services, to government clients. On behalf of government agencies and authorities in the transportation industry, we deliver mission-critical mobility and payment solutions that improve automation, interoperability and decision-making to streamline operations, increase revenue and reduce congestion while creating safer communities and seamless travel experiences for consumers. Executive Summary We continue to transform our business through an intense focus on growth, quality, and efficiency – utilizing a programmatic and project management approach. Beginning in the first quarter of 2020 and through the first quarter of 2021, we have expanded the focus of our transformation initiative to include both efficiency and growth initiatives, aimed to position the company to pivot to revenue growth and margin expansion over time. We intend to drive portfolio focus, operating discipline, sales and delivery excellence and innovation, complemented by tightly aligned investments to achieve this mission and purpose. Our strategy is designed to deliver value by delivering profitable growth, expanding operating margins and deploying a disciplined capital allocation strategy. During the three months ended March 31, 2021, our strategy is showing results, including the following: • Revenue of $1,028 million for the three months ended March 31, 2021 was a decline of 2.2%, a significantly improved trend compared with the same quarter last year. • Significantly lower net loss of $11 million for the three months ended March 31, 2021 as compared to a net loss of $49 million for the same period in the prior year. • Strong new business signings results: CNDT Q1 2021 Form 10-Q 23 Table of Contents ◦ New business total contract value (TCV) signings of $356 million for the three months ended March 31, 2021, representing an increase of 10% compared to that of the prior year period. ◦ Annual recurring revenue signings of $95 million for the three months ended March 31, 2021, an increase of 67% compared to that of the prior year period. • The Company has shown year-over-year operational progress, including a reduction of the number of technology related incidents and outages, improvements in associate satisfaction survey results and increases in performance incentives from customers. COVID-19 Pandemic Throughout the COVID-19 pandemic, we have continued to provide critical and best-in-class services to our customers and their end-users, while ensuring the health and safety of our greatest assets - our associates. To address the potential impact to our business over the near-term, our Business Continuity team established a proactive plan in the first quarter of 2020 that has continued into the first quarter of 2021, which includes: • Supporting our associates with a number of specific initiatives, including making improvements to our policies to extend short-term disability, providing extra supplemental sick leave coverage and introducing a hardship leave policy. • At the end of 2020, approximately 75% of our workforce had been shifted to work-from-home. In 2021, we have started a slow and measured approach to bringing associates back to Conduent offices, as appropriate. This is an ongoing phased process and is based on the specific COVID-19 conditions in certain geographies, as well as business requirements. • Increased sanitation and social distancing for required on-site essential associates. As the world increasingly becomes vaccinated, we will evolve our approach to various initiatives or take additional actions to meet the needs of our employees, customers and their end-users and the Company to continue to provide our mission-critical services and solutions. Financial Review of Operations Three Months Ended March 31, 2021 vs. 2020 ($ in millions) 2021 2020 $ Change % Change Revenue $ 1,028 $ 1,051 $ (23) (2) % Operating Costs and Expenses Cost of services (excluding depreciation and amortization) 787 832 (45) (5) % Selling, general and administrative (excluding depreciation and amortization) 126 116 10 9 % Research and development (excluding depreciation and amortization) — 1 (1) (100) % Depreciation and amortization 95 117 (22) (19) % Restructuring and related costs 13 7 6 86 % Interest expense 13 17 (4) (24) % Loss on divestitures and transaction costs 2 4 (2) (50) % Litigation costs 1 6 (5) (83) % Other (income) expenses, net — 2 (2) (100) % Total Operating Costs and Expenses 1,037 1,102 (65) Loss Before Income Taxes (9) (51) 42 Income tax expense (benefit) 2 (2) 4 Net Loss $ (11) $ (49) $ 38 CNDT Q1 2021 Form 10-Q 24 Table of Contents Revenue Revenue for the three months ended March 31, 2021 decreased, compared to the prior year period, primarily due to lost business from prior years and the effect of the COVID-19 pandemic across our Commercial Industries and our Transportation segments. These were partially offset by higher revenue due to increased volumes in our Government Services Solutions service offering within our Government Services segment, primarily increased payments activity because of Federal stimulus, and the ramp of new business. Cost of Services (excluding depreciation and amortization) Cost of services for the three months ended March 31, 2021 decreased, compared to the prior year period, driven by loss of business and lower volumes as well as increased operational efficiency, which led to reductions in information technology, labor and real estate costs. Also contributing to the decline were lower costs to support volume loss resulting from the effect of the COVID-19 pandemic. Selling, General and Administrative (SG&A) (excluding depreciation and amortization) SG&A for the three months ended March 31, 2021 increased, compared to the prior year period, driven by an increase in certain employee-related costs, partially offset by reductions in real estate, corporate overhead and labor costs, as well as savings from lower travel and marketing expenses. Restructuring and Related Costs We engage in a series of restructuring programs related to optimizing our employee base, reducing our real estate footprint, exiting certain activities, outsourcing certain internal functions, consolidating our data centers and engaging in other actions designed to reduce our cost structure and improve productivity. The following are the components of our Restructuring and related costs: Three Months Ended March 31, (in millions) 2021 2020 Severance and related costs $ — $ — Data center consolidation 7 2 Termination, asset impairment and other costs 5 3 Total net current period charges 12 5 Consulting and other costs (1) 1 2 Restructuring and related costs $ 13 $ 7 ___________ (1) Represents professional support costs associated with certain strategic transformation programs. Refer to Note 5 – Restructuring Programs and Related Costs to the Condensed Consolidated Financial Statements for additional information regarding our restructuring programs. Interest Expense Interest expense represents interest on long-term debt and the amortization of debt issuance costs. The decrease in Interest expense for the three months ended March 31, 2021, compared to the prior year period, was driven primarily by lower interest rates and a lower Term Loan A principal balance. Additionally, the three months ended March 31, 2020 included interest expense attributable to the drawdown on our Senior Revolving Credit Facility (Revolver) in March 2020, which was repaid in December 2020. Refer to Note 6 – Debt in the Condensed Consolidated Financial Statements for additional information. Loss on Divestitures and Transaction Costs The costs included in the three months ended March 31, 2021 consist of professional fees and other costs related to certain consummated and non-consummated transactions considered by the Company. CNDT Q1 2021 Form 10-Q 25 Table of Contents Litigation Costs Net litigation costs for the three months ended March 31, 2021 primarily consist of reserves for various matters that are subject to litigation; the three months ended March 31, 2020 amount also included costs related to certain reimbursement matters with our former parent company, Xerox Corporation. Refer to Note 11 – Contingencies and Litigation to the Condensed Consolidated Financial Statements for additional information. Income Taxes The effective tax rate for the three months ended March 31, 2021 was negative 23.4%, compared to 3.9% for the three months ended March 31, 2020. The March 31, 2021 rate was negative as compared to the U.S. statutory rate of 21%, primarily due to pre-tax loss and tax expense resulting from geographic mix of income, valuation allowances and tax charges recognized on employee equity award vesting partially offset by tax credits. The effective tax rate for the three months ended March 31, 2020 was lower than the U.S. statutory rate of 21%, primarily due to the geographic mix of income, valuation allowances, and tax charges recognized on employee equity award vesting partially offset by tax credits. Excluding the impact of valuation allowances, equity award vesting, amortization of intangible assets and restructuring costs, the normalized effective tax rate for the three months ended March 31, 2021 was 23.4%. The normalized effective tax rate for the three months ended March 31, 2020 was 33.3%, predominantly due to excluding the impact of valuation allowances, vesting of equity awards, amortization of intangible assets and restructuring costs. The normalized effective tax rate for the three months ended March 31, 2021 was lower than the comparable 2020 rate due to foreign earnings mix, increased income in the U.S. and favorable change in U.S. taxation of foreign income. The Company believes it is reasonably possible that unrecognized tax benefits of approximately $14 million will reverse within 12 months due to an anticipated audit settlement. Operations Review of Segment Revenue and Profit Our financial performance is based on Segment Profit/(Loss) and Segment Adjusted EBITDA for the following three segments: • Commercial Industries, • Government Services, and • Transportation. Other includes our Student Loan business, which the Company exited in the third quarter of 2018. Unallocated Costs includes IT infrastructure costs that are shared by multiple reportable segments, enterprise application costs and certain corporate overhead expenses not directly attributable or allocated to our reportable segments. We continue to modernize a significant portion of our infrastructure with new systems and processes and consolidate our data centers as part of our transformation initiatives. There is a risk, however, that our modernization efforts and data center consolidations could materially and adversely disrupt our operations. In addition, the Company’s COVID-19 response has also resulted in diversion of management's time and delayed investments from strategic, transformational and technology initiatives which had been planned. See Part I, Item 1A – Risk Factors of our Annual Report on Form 10-K for the year ended December 31, 2020 for additional information. CNDT Q1 2021 Form 10-Q 26 Table of Contents Results of financial performance by segment were: Three Months Ended March 31, (in millions) Commercial Industries Government Services Transportation Other Unallocated Costs Total 2021 Revenue $ 526 $ 318 $ 184 $ — $ — $ 1,028 Segment profit (loss) $ 35 $ 87 $ 21 $ — $ (83) $ 60 Segment depreciation and amortization $ 27 $ 5 $ 9 $ — $ 14 $ 55 Adjusted EBITDA $ 62 $ 92 $ 30 $ — $ (69) $ 115 % of Total Revenue 51.2 % 30.9 % 17.9 % — % — % 100.0 % Adjusted EBITDA Margin 11.8 % 28.9 % 16.3 % — % — % 11.2 % 2020 Revenue $ 572 $ 290 $ 189 $ — $ — $ 1,051 Segment profit (loss) $ 42 $ 70 $ 10 $ 4 $ (81) $ 45 Segment depreciation and amortization $ 28 $ 7 $ 9 $ — $ 14 $ 58 Adjusted EBITDA $ 70 $ 77 $ 19 $ (3) $ (67) $ 96 % of Total Revenue 54.4 % 27.6 % 18.0 % — % — % 100.0 % Adjusted EBITDA Margin 12.2 % 26.6 % 10.1 % — % — % 9.1 % Commercial Industries Segment Revenue Commercial Industries revenue for the three months ended March 31, 2021 decreased, compared to the prior year period, due to COVID-19 related volume declines in our Business Operations Solutions service offering and reduced revenue from our HSA offering "Benefit Wallet" (within our HRLS business), as well as lost business from prior years. Segment Profit and Adjusted EBITDA Decreases in the Commercial Industries segment profit and adjusted EBITDA margin for the three months ended March 31, 2021, compared to the prior year period, were mainly driven by overall revenue declines. Adjusted EBITDA margin remained relatively flat compared with the prior year period as a result of efficiency program progress. Government Services Segment Revenue Government Services revenue for the three months ended March 31, 2021 increased, compared to the prior year period, primarily driven by COVID-19 related volume increases. These increases were partially offset by lost business from prior years. The increased volumes from the COVID-19 pandemic was largely driven by the increases in the Supplemental Nutrition Assistance Program (SNAP) volumes and Pandemic SNAP volumes, an increase in the number of citizens to which we distribute unemployment insurance benefits, and additional unemployment insurance benefit distributions as a result of Federal stimulus. Within the unemployment benefit business, we generate revenue based on the amount of spending by card holders. CNDT Q1 2021 Form 10-Q 27 Table of Contents Segment Profit and Adjusted EBITDA Increases in the Government Services segment profit and adjusted EBITDA margin for the three months ended March 31, 2021, compared to the prior year period, were mainly driven by increased revenue and expense reductions from efficiency program progress. Transportation Segment Revenue Transportation revenue for the three months ended March 31, 2021 decreased, compared to the prior year period, primarily driven by COVID-19 related impacts and lost business from prior years, partially offset by the ramp of new business. The COVID-19 related impacts were primarily driven by volume pressure in Curbside Management Solutions service offering and Public Safety service offerings. Segment Profit and Adjusted EBITDA Transportation segment profit and adjusted EBITDA margin increased for the three months ended March 31, 2021, compared to the prior year period, mainly driven by efficiency program progress and temporarily beneficial revenue mix, partially offset by slightly lower revenue. Other Segment Profit (Loss) and Adjusted EBITDA Our Other segment did not have any segment profit for the three months ended March 31, 2021. The segment profit in the prior year period was primarily due to an adjustment to the then remaining California Medicaid Management Information System settlement liability of $7 million as a result of the contract expiration in March 2020. This benefit was removed from adjusted EBITDA for segment reporting purposes due to its non-recurring nature. Unallocated Costs Unallocated Costs for the three months ended March 31, 2021 increased, compared to the prior year period. This was primarily driven by increases in certain employee costs, partially offset by efficiency program progress. Metrics Signings Signings are defined as estimated future revenues from contracts signed during the period, including renewals of existing contracts. TCV is the estimated total contractual revenue related to signed contracts, excluding the impact of divested business as required. TCV signings are defined as estimated future revenues from contracts signed during the period, including renewals of existing contracts. For the three months ended March 31, 2021, the Company signed $356 million of new business, representing a 10% increase compared to the prior year period. Renewal TCV for the three months ended March 31, 2021 was $273 million, a decrease of 47% compared to the prior year period, primarily as a result of fewer renewal opportunities in the quarter. The Company continues to build the size and strength of the newly centralized sales team. CNDT Q1 2021 Form 10-Q 28 Table of Contents The amounts in the following table exclude divestitures. Three Months Ended March 31, 2021 vs. 2020 ($ in millions) 2021 2020 $ Change % Change New business TCV $ 356 $ 324 $ 32 10 % Renewals TCV 273 515 (242) (47) % Total Signings $ 629 $ 839 $ (210) (25) % Annual recurring revenue signings (1) $ 95 $ 57 $ 38 67 % Non-recurring revenue signings (2) $ 127 $ 44 $ 83 189 % ___________ (1) Recurring revenue signings are for new business contracts longer than one year. (2) Non-recurring revenue signings are for contracts shorter than one year. The total new business pipeline at the end of both March 31, 2021 and 2020 was $21.0 billion. Total new business pipeline is defined as total new business TCV pipeline of deals in all sell stages. This extends past the next twelve-month period to include total pipeline, excluding the impact of divested business as required. Capital Resources and Liquidity As of March 31, 2021, and December 31, 2020, total cash and cash equivalents were $389 million and $450 million, respectively. The Company also has a $750 million Revolver for its various cash needs, of which $7 million was used for letters of credit. The net amount available to be drawn upon under our Revolver as of March 31, 2021, was $743 million. As of March 31, 2021, our total debt outstanding was $1.5 billion of which $89 million was due within one year. Refer to Note 6 – Debt and Note 17 - Subsequent Event in the Condensed Consolidated Financial Statements for additional debt information. In order to provide financial flexibility and finance certain investments and projects, we may continue to utilize external financing arrangements. However, we believe that our cash on hand, projected cash flow from operations, sound balance sheet and revolving line of credit will continue to provide sufficient financial resources to meet our expected business obligations for at least the next twelve months. Cash Flow Analysis The following table summarizes our cash flows, as reported in our Condensed Consolidated Statement of Cash Flows in the accompanying Condensed Consolidated Financial Statements: Three Months Ended March 31, (in millions) 2021 2020 Better (Worse) Net cash provided by (used in) operating activities $ (2) $ (192) $ 190 Net cash provided by (used in) investing activities $ (29) $ (23) (6) Net cash provided by (used in) financing activities $ (25) $ 130 (155) Historically the Company generates the majority of its cash from operating activities in the latter part of the year. Operating activities The net improvement in cash used in operating activities of $190 million, compared to the prior year period, was primarily related to the absence of the 2020 Texas Litigation payment of $118 million, improved collections of Accounts receivable of $44 million, other working capital timing of $36 million primarily related to Accounts payable and other current liabilities and annual management incentive payments, partially offset by lower income tax net refunds of $9 million. CNDT Q1 2021 Form 10-Q 29 Table of Contents Investing activities The increase in cash used in investing activities of $6 million was primarily due to increased spending for capital expenditures. Financing activities The decrease in cash from financing activities was primarily related to the $150 million draw down from our $750 million revolving credit facility in March 2020, which was repaid in December 2020. Market Risk Management We are exposed to market risk from changes in foreign currency exchange rates which could affect operating results, financial position and cash flows. We manage our exposure to these market risks through our regular operating and financing activities and, when appropriate, through the use of derivative financial instruments. We may utilize derivative financial instruments to hedge economic exposures, as well as to reduce earnings and cash flow volatility resulting from shifts in market rates. We also may hedge the cost to fund material non-dollar entities by buying currencies periodically in advance of the funding date. This is accounted for using derivative accounting. Recent market and economic events, including the effects of the COVID-19 pandemic, have not caused us to materially modify nor change our financial risk management strategies with respect to our exposures to foreign currency risk. Refer to Note 7 – Financial Instruments in the Condensed Consolidated Financial Statements for additional discussion on our financial risk management.