Item 2. Management’s Discussion and Analysis
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 June 30, 2021, servicing customers from service centers in 23 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 second quarter of 2021, we have expanded the focus of our project portfolio 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 and six months ended June 30, 2021, our strategy is showing results, including the following:
• Revenue of $1,026 million and $2,054 million for the three and six months ended June 30, 2021, respectively, was an increase of 1.0% and a decrease of less than 1.0%, respectively, a significantly improved trend compared with the same periods last year.
• Positive net income of $12 million and $1 million for the three and six months ended June 30, 2021, respectively, as compared to net loss of $51 million and $100 million for the same periods in the prior year.
• Strong new business signings results:
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◦ New business total contract value (TCV) signings of $775 million for the three months ended June 30, 2021, representing an increase of 24% compared to that of the prior year period.
◦ Annual recurring revenue signings of $115 million for the three months ended June 30, 2021, an increase of 10% compared to that of the prior year period.
• The Company has shown year-over-year operational progress, including an improvement to technology platform uptime, improvements in associate satisfaction survey results and increases in performance incentives from customers.
• The Company redeemed the remainder of its previously outstanding $34 million Senior Notes.
COVID-19 Pandemic
Throughout the COVID-19 pandemic, we have continued to provide critical and best-in-class services to our customers and their end-users, while ensuring the health and safety of our greatest assets - our associates. To address the potential impact to our business over the near-term, our Business Continuity team established a proactive plan in the first quarter of 2020 that has continued into the second quarter of 2021, which includes:
• Supporting our associates with a number of specific initiatives, including making improvements to our policies to extend short-term disability, providing extra supplemental sick leave coverage and introducing a hardship leave policy.
• At the end of 2020, approximately 75% of our workforce had been shifted to work-from-home. In 2021, we have started a slow and measured approach to bringing associates back to Conduent offices, as appropriate. This is an ongoing phased process and is based on the specific COVID-19 conditions in certain geographies, as well as business requirements.
• Increased sanitation and social distancing for required on-site essential associates.
As the world increasingly becomes vaccinated, we will evolve our approach to various initiatives or take additional actions to meet the needs of our employees, customers and their end-users and the Company to continue to provide our mission-critical services and solutions.
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Financial Review of Operations
Three Months Ended
June 30, 2021 vs. 2020
($ in millions) 2021 2020 $ Change % Change
Revenue $ 1,026 $ 1,016 $ 10 1 %
Operating Costs and Expenses
Cost of services (excluding depreciation and amortization) 772 795 (23) (3) %
Selling, general and administrative (excluding depreciation and amortization) 125 111 14 13 %
Research and development (excluding depreciation and amortization) 1 — 1 n/m
Depreciation and amortization 86 115 (29) (25) %
Restructuring and related costs 8 29 (21) (72) %
Interest expense 13 15 (2) (13) %
(Gain) loss on divestitures and transaction costs (1) 2 (3) (150) %
Litigation costs 1 14 (13) (93) %
Loss on extinguishment of debt 2 — 2 n/m
Other (income) expenses, net — (1) 1 (100) %
Total Operating Costs and Expenses 1,007 1,080 (73)
Income (Loss) Before Income Taxes 19 (64) 83
Income tax expense (benefit) 7 (13) 20
Net Income (Loss) $ 12 $ (51) $ 63
Six Months Ended
June 30, 2021 vs. 2020
($ in millions) 2021 2020 $ Change % Change
Revenue $ 2,054 $ 2,067 $ (13) (1) %
Operating Costs and Expenses
Cost of services (excluding depreciation and amortization) 1,559 1,627 (68) (4) %
Selling, general and administrative (excluding depreciation and amortization) 251 227 24 11 %
Research and development (excluding depreciation and amortization) 1 1 — — %
Depreciation and amortization 181 232 (51) (22) %
Restructuring and related costs 21 36 (15) (42) %
Interest expense 26 32 (6) (19) %
(Gain) loss on divestitures and transaction costs 1 6 (5) (83) %
Litigation costs 2 20 (18) (90) %
Loss on extinguishment of debt 2 — 2 n/m
Other (income) expenses, net — 1 (1) (100) %
Total Operating Costs and Expenses 2,044 2,182 (138)
Income (Loss) Before Income Taxes 10 (115) 125
Income tax expense (benefit) 9 (15) 24
Net Income (Loss) $ 1 $ (100) $ 101
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Revenue
Revenue for the three months ended June 30, 2021 increased by 1%, compared to the prior year period, primarily due to lesser impacts of the COVID-19 pandemic across our Transportation and Commercial Industries segments, increased volumes in our Government Services Solutions offering within our Government Services segment, primarily increased payments activity because of Federal stimulus, and the ramp of new business. These increases were partially offset by lost business from prior years.
Revenue for the six months ended June 30, 2021 decreased by less than 1%, 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, which had only a minimal impact on the first quarter of 2020. These unfavorable impacts were partially offset by 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 June 30, 2021 decreased, compared to the prior year period, driven by lost business from prior years as well as increased operational efficiency, which led to reductions in information technology, labor and real estate costs.
Cost of services for the six months ended June 30, 2021 decreased, compared to the prior year period, driven by lost business from prior years 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 and six months ended June 30, 2021 increased, compared to the prior year periods, driven by an increase in certain employee-related costs and growth in the sales organization and higher recruiting expenses.
Depreciation and Amortization
Depreciation and amortization for the three and six months ended June 30, 2021 decreased, compared to the prior year periods, primarily due to a portion of certain customer relationship intangible assets being fully amortized in the first quarter of 2021.
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
June 30, Six Months Ended
June 30,
(in millions) 2021 2020 2021 2020
Severance and related costs $ 2 $ 10 $ 2 $ 10
Data center consolidation 8 6 15 8
Termination, asset impairment and other costs (3) 11 2 14
Total net current period charges 7 27 19 32
Consulting and other costs (1)
1 2 2 4
Restructuring and related costs $ 8 $ 29 $ 21 $ 36
___________
(1) Represents professional support costs associated with certain strategic transformation programs.
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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 decreases in Interest expense for the three and six months ended June 30, 2021, compared to the prior year periods, was driven primarily by lower interest rates, a lower Term Loan A principal balance and the May 1, 2021 repayment of the previously outstanding $34 million Senior Notes. Additionally, the three and six months ended June 30, 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.
(Gain) Loss on Divestitures and Transaction Costs
These costs consist of professional fees and other costs related to certain consummated and non-consummated transactions considered by the Company.
Litigation Costs
Net litigation costs for the three and six months ended June 30, 2021 primarily consist of reserves for various matters that are subject to litigation; the three and six months ended June 30, 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 June 30, 2021 was 38.2%, compared to 20.3% for the three months ended June 30, 2020. The June 30, 2021 rate was higher than the U.S. statutory rate of 21%, primarily due to geographic mix of income, other non-deductible permanent differences, valuation allowances and tax audit reserves, partially offset by tax credits. The June 30, 2020 rate was slightly lower than the U.S. statutory rate of 21%, primarily due to the geographic mix of income.
Excluding the impact of discrete tax adjustments, amortization of intangible assets and restructuring costs, the normalized effective tax rate for the three months ended June 30, 2021 was 25.7%. The normalized effective tax rate for the three months ended June 30, 2020 was 32.5%, predominately due to excluding the impact of amortization and restructuring costs. The normalized effective tax rate for the three months ended June 30, 2021 was lower than the three months ended June 30, 2020 rate predominantly due to earnings mix.
The effective tax rate for the six months ended June 30, 2021 was 94.3% compared with 13.0% for the six months ended June 30, 2020. The June 30, 2021 rate was higher than the U.S. statutory rate of 21% primarily due to geographic mix of income, other non-deductible permanent differences, valuation allowances, and tax audit reserve partially offset by tax credits. The June 30, 2020 rate 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 the vesting of employee equity awards partially offset by tax credits.
Excluding the impact of discrete tax adjustments, amortization of intangible assets and restructuring, the normalized effective tax rate for the six months ended June 30, 2021 was 24.7%. The normalized effective tax rate for the six months ended June 30, 2020 was 32.8%, predominantly due to excluding the impact of valuation allowances, vesting of equity awards, charges for amortization of intangible assets and restructuring. The normalized effective tax rate for the six months ended June 30, 2021 was lower than the six months ended June 30, 2020 rate predominantly due to earnings mix.
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.
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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.
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Results of financial performance by segment were:
Three Months Ended
June 30,
(in millions) Commercial Industries Government Services Transportation Other Unallocated Costs Total
2021
Revenue $ 503 $ 338 $ 185 $ — $ — $ 1,026
Segment profit (loss) $ 29 $ 110 $ 17 $ — $ (82) $ 74
Segment depreciation and amortization $ 25 $ 8 $ 8 $ — $ 13 $ 54
Adjusted EBITDA $ 54 $ 118 $ 25 $ — $ (69) $ 128
% of Total Revenue 49.0 % 33.0 % 18.0 % — % — % 100.0 %
Adjusted EBITDA Margin 10.7 % 34.9 % 13.5 % — % — % 12.5 %
2020
Revenue $ 520 $ 331 $ 165 $ — $ — $ 1,016
Segment profit (loss) $ 25 $ 90 $ 20 $ (1) $ (79) $ 55
Segment depreciation and amortization $ 27 $ 6 $ 9 $ — $ 13 $ 55
Adjusted EBITDA $ 52 $ 96 $ 29 $ (1) $ (66) $ 110
% of Total Revenue 51.2 % 32.6 % 16.2 % — % — % 100.0 %
Adjusted EBITDA Margin 10.0 % 29.0 % 17.6 % — % — % 10.8 %
Six Months Ended
June 30,
(in millions) Commercial Industries Government Services Transportation Other Unallocated Costs Total
2021
Revenue $ 1,029 $ 656 $ 369 $ — $ — $ 2,054
Segment profit (loss) $ 64 $ 197 $ 38 $ — $ (165) $ 134
Segment depreciation and amortization $ 52 $ 13 $ 17 $ — $ 27 $ 109
Adjusted EBITDA $ 116 $ 210 $ 55 $ — $ (138) $ 243
% of Total Revenue 50.1 % 31.9 % 18.0 % — % — % 100.0 %
Adjusted EBITDA Margin 11.3 % 32.0 % 14.9 % — % — % 11.8 %
2020
Revenue $ 1,092 $ 621 $ 354 $ — $ — $ 2,067
Segment profit (loss) $ 67 $ 160 $ 30 $ 3 $ (160) $ 100
Segment depreciation and amortization $ 55 $ 13 $ 18 $ — $ 27 $ 113
Adjusted EBITDA $ 122 $ 173 $ 48 $ (4) $ (133) $ 206
% of Total Revenue 52.8 % 30.1 % 17.1 % — % — % 100.0 %
Adjusted EBITDA Margin 11.2 % 27.9 % 13.6 % — % — % 10.0 %
Commercial Industries Segment
Revenue
Commercial Industries revenue for the three months ended June 30, 2021 decreased, compared to the prior year period, due to lost business from prior years, partially offset by higher volumes as the impacts from COVID-19 were lesser in the second quarter of 2021 as many regions began to loosen restrictions.
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Commercial Industries revenue for the six months ended June 30, 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 a result of Federal Reserve initiated interest rate reductions, as well as lost business from prior years.
Segment Profit and Adjusted EBITDA
Increases in the Commercial Industries segment profit and adjusted EBITDA margin for the three months ended June 30, 2021, compared to the prior year period, were mainly driven by the result of progress in our efficiency initiatives and one-time contract exit costs in the second quarter of 2020.
Commercial Industries segment profit decreased and adjusted EBITDA margin increased for the six months ended June 30, 2021, compared to the prior year period, mainly driven by overall revenue declines, partially offset by the result of progress in our efficiency initiatives and one-time contract exit costs in the second quarter of 2020.
Government Services Segment
Revenue
Government Services revenue for the three months ended June 30, 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 were largely driven by the increases in the Supplemental Nutrition Assistance Program (SNAP) volumes and Pandemic SNAP volumes.
Government Services revenue for the six months ended June 30, 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.
Segment Profit and Adjusted EBITDA
Increases in the Government Services segment profit and adjusted EBITDA margin for the three and six months ended June 30, 2021, compared to the prior year period, were mainly driven by increased COVID-19 related volume increases at strong margins and expense reductions resulting from progress in our efficiency initiatives.
Transportation Segment
Revenue
Transportation revenue for the three and six months ended June 30, 2021 increased, compared to the prior year period, primarily driven by the impact of loosening of numerous COVID-19 related restrictions, particularly in the United States, and the ramp of new business, partially offset by lost business from prior years.
Segment Profit and Adjusted EBITDA
Transportation segment profit and adjusted EBITDA margin decreased for the three months ended June 30, 2021, compared to the prior year period, mainly driven by unfavorable revenue mix in the quarter and short term cost savings in the prior year. Transportation segment profit and adjusted EBITDA margin increased for the six months ended June 30, 2021, compared to the prior year period, mainly driven by progress in our efficiency initiatives and beneficial revenue mix.
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Other
Segment Profit (Loss) and Adjusted EBITDA
The segment profit in the 2020 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 expiring in March 2020. This benefit was excluded from adjusted EBITDA for segment reporting purposes due to its non-recurring nature.
Unallocated Costs
Unallocated Costs for the three and six months ended June 30, 2021 increased, compared to the prior year period. This was primarily driven by increases in certain employee costs, partially offset by progress in our efficiency initiatives.
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. TCV signings is defined as estimated future revenues from contracts signed during the period, including renewals of existing contracts.
For the three months ended June 30, 2021, the Company signed $775 million of new business, representing a 24% increase compared to the prior year period. This increase was driven by the signing of large contracts in the Transportation and Governments segments. Renewal TCV for the three months ended June 30, 2021 was $825 million, a decrease of 10% compared to the prior year period, primarily as a result of fewer renewal opportunities in the quarter. The Company continues to scale the centralized Sales and Account Management functions to deliver on our growth objectives.
For the six months ended June 30, 2021, the Company signed $1,131 million of new business, representing a 19% increase compared to the prior year period. Renewal TCV for the six months ended June 30, 2021 was $1,098 million, a decrease of 23% compared to the prior year period, primarily as a result of fewer renewal opportunities in the quarter.
Three Months Ended
June 30, 2021 vs. 2020
($ in millions) 2021 2020 $ Change % Change
New business TCV $ 775 $ 623 $ 152 24 %
Renewals TCV 825 912 (87) (10) %
Total Signings $ 1,600 $ 1,535 $ 65 4 %
Annual recurring revenue signings (1)
$ 115 $ 105 $ 10 10 %
Non-recurring revenue signings (2)
$ 152 $ 76 $ 76 100 %
Six Months Ended
June 30, 2021 vs. 2020
($ in millions) 2021 2020 $ Change % Change
New business TCV $ 1,131 $ 947 $ 184 19 %
Renewals TCV 1,098 1,427 (329) (23) %
Total Signings $ 2,229 $ 2,374 $ (145) (6) %
Annual recurring revenue signings (1)
$ 210 $ 162 $ 48 30 %
Non-recurring revenue signings (2)
$ 279 $ 120 $ 159 133 %
___________
(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.
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The total new business pipeline at the end of June 30, 2021 and 2020 was $21.0 billion and $22.0 billion, respectively. 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 June 30, 2021 and December 31, 2020, total cash and cash equivalents were $397 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 June 30, 2021, was $743 million.
As of June 30, 2021, our total debt outstanding was $1.4 billion of which $89 million was due within one year. Refer to Note 6 – Debt 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:
Six Months Ended June 30,
(in millions) 2021 2020 Better (Worse)
Net cash provided by (used in) operating activities $ 103 $ (118) $ 221
Net cash provided by (used in) investing activities $ (69) $ (58) (11)
Net cash provided by (used in) financing activities $ (87) $ 114 (201)
Operating activities
The net improvement in cash used in operating activities of $221 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 and other working capital timing of $126 million, partly offset by higher cash used on product software and deferred contract costs for new business activities of $9 million and higher income tax net payments of $14 million.
Investing activities
The increase in cash used in investing activities of $11 million was primarily due to increased spending related to modernizing our infrastructure and productivity tools.
Financing activities
The increase in cash used in financing activities was primarily related to the absence of the March 2020 $150 million draw down from our $750 million revolving credit facility, which was subsequently repaid in December 2020. Additionally, we repaid the previously outstanding $34 million of Senior Notes on May 1, 2021 and made higher scheduled payments on Term loans of $18 million in 2021.
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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.