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 provide a reader of our financial statements with a narrative from the perspective of management on our financial condition, results of operations, liquidity, and certain other factors that may affect our future results. Unless otherwise noted, transactions and other factors significantly impacting our financial condition, results of operations and liquidity are discussed in order of magnitude. Our MD&A is presented in six sections: • Overview; • Financial Information and Analysis of Results of Operations; • Metrics; • Capital Resources and Liquidity; • Critical Accounting Estimates and Policies; and • Recent Accounting Changes. The 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 As a global technology-led business process solutions company, we deliver digital business solutions and services spanning the commercial, government and transportation spectrum – creating exceptional outcomes for our clients and the millions of people who count on them. Through a dedicated global team of associates, process expertise, and advanced technologies, our solutions and services digitally transform our clients’ operations to enhance customer experiences, improve performance, increase efficiencies and reduce costs. We add momentum to our clients’ missions in many ways including delivering 43 percent of nutrition assistance payments in the U.S., enabling 1.3 billion customer service interactions annually, empowering millions of employees through HR services every year and processing nearly 12 million tolling transactions every day. Headquartered in Florham Park, New Jersey, we have a team of approximately 59,000 associates as of March 31, 2023, servicing customers from service centers in 25 countries. Our reportable segments correspond to how we organize and manage the business and are aligned to the solutions we offer our clients. We organize and manage our businesses through three reportable segments. • Commercial – Our Commercial segment provides business process services and customized solutions to clients in a variety of industries. Across the Commercial 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 – Our Government 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. CNDT Q1 2023 Form 10-Q 21 Table of Contents Executive Summary During the first quarter of 2023, we held an investor briefing to communicate the next chapter in the Conduent journey. Our intense emphasis on growth, quality, and efficiency, beginning in the first quarter of 2020 resulted in a strengthened foundation and we remain focused on accelerating growth and enhancing value for our stakeholders. We intend to achieve this by doubling down on key themes outlined in the briefing, as well as through a process of portfolio rationalization, divesting certain solutions which have either scarcity value outside of Conduent or are capital intensive relative to their growth opportunity, enabling management bandwidth and capital investments to be focused on solutions where we believe we have competitive advantages or higher growth expectations. This renewed portfolio focus will result in a more nimble and faster growing Conduent with modest levels of net leverage, enhanced valuation, and significant excess capital to be deployed over time. Macroeconomic and Geopolitical Uncertainty Given the nature of our business and our global operations, the effects of global macroeconomic and geopolitical uncertainty could have a materially adverse effect on our business, results of operations and financial condition. Financial Information and Analysis of Results of Operations Three Months Ended March 31, 2023 vs. 2022 ($ in millions) 2023 2022 $ Change % Change Revenue $ 922 $ 967 $ (45) (5) % Operating Costs and Expenses Cost of services (excluding depreciation and amortization) 720 755 (35) (5) % Selling, general and administrative (excluding depreciation and amortization) 111 102 9 9 % Research and development (excluding depreciation and amortization) 2 1 1 100 % Depreciation and amortization 61 61 — — % Restructuring and related costs 29 9 20 222 % Interest expense 27 19 8 42 % (Gain) loss on divestitures and transaction costs, net 2 (163) 165 n/m Litigation settlements (recoveries), net (21) (28) 7 (25) % Other (income) expenses, net (1) 1 (2) n/m Total Operating Costs and Expenses 930 757 173 Income (Loss) Before Income Taxes (8) 210 (218) Income tax expense (benefit) (2) 74 (76) Net Income (Loss) $ (6) $ 136 $ (142) Revenue Revenue for the three months ended March 31, 2023 decreased, compared to the prior year period, primarily due to non-repeating federal stimulus revenue, lost business in our Government and Commercial segments, extended completion timelines to meet client requirements in the Transit solutions division of our Transportation segment and the impact of an out of period adjustment in our Government segment further described below, partially offset by higher interest rates positively impacting our Benefit Wallet business and new business ramp. In the first quarter of 2023, the Company identified an error and recorded an out-of-period adjustment to correct the recognition of revenue on a Government segment contract that originated in 2020 and impacted all quarterly periods through December 31, 2022. This adjustment resulted in a reduction to revenue and income (loss) before income taxes of $7 million. CNDT Q1 2023 Form 10-Q 22 Table of Contents Cost of Services (excluding depreciation and amortization) Cost of services for the three months ended March 31, 2023 decreased, compared to the prior year periods, primarily driven by the impact of reduced revenue and a $17 million reversal of liabilities due to the settlement of the Cognizant matter described in Note 12 – Contingencies and Litigation to the Condensed Consolidated Financial Statements. Selling, General and Administrative (SG&A) (excluding depreciation and amortization) SG&A for the three months ended March 31, 2023 increased, compared to the prior year period, driven by the absence of the recovery of $14 million of defense costs as part of the settlement with insurance carriers relating to the previously disclosed State of Texas matter that occurred in 2022. Depreciation and Amortization Depreciation and amortization for the three months ended March 31, 2023 was unchanged from the prior year. This reflects new depreciation from recent capital expenditures being offset by run-off of depreciation on older assets. 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. In addition, during the three months ended March 31, 2023, the Company also incurred $4 million of professional support costs associated with bringing certain technology functions in-house. The following are the components of our Restructuring and related costs: Three Months Ended March 31, (in millions) 2023 2022 Severance and related costs $ 20 $ — Data center consolidation costs 2 4 Termination, insourcing and asset impairment costs 7 4 Total net current period charges 29 8 Consulting and other costs (1) — 1 Restructuring and related costs $ 29 $ 9 ___________ (1) Represents professional support costs associated with certain strategic transformation programs. The severance and related costs included costs related to the closure of one of our Commercial segment operations in Europe. Refer to Note 6 – 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 increase in Interest expense for the three months ended March 31, 2023, compared to the prior year periods, was driven by higher interest rates on our credit facilities, partially offset by a lower total outstanding debt balance. (Gain) Loss on Divestitures and Transaction Costs The divestiture of the Midas business in the first quarter of 2022 resulted in a gain of $166 million ($165 million in the first quarter of 2022 and $1 million in the second quarter of 2022). Additionally, professional fees and other costs related to certain consummated and non-consummated transactions considered by the Company are included in this financial statement line item for both years. CNDT Q1 2023 Form 10-Q 23 Table of Contents Litigation Settlements (Recoveries), Net Litigation settlements (recoveries), net for the three months ended March 31, 2023 primarily consist of a $26 million reversal of reserves due to the settlement of the Cognizant matter. Litigation settlements (recoveries), net for the three months ended March 31, 2022 primarily consist of $24 million of insurance recoveries recorded in the first quarter of 2022 related to the previously disclosed State of Texas matter. Refer to Note 12 – 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, 2023 was 20.8%, compared to 35.2% for the three months ended March 31, 2022. The March 31, 2023 rate approximates the U.S. statutory rate of 21%. The effective tax rate for the three months ended March 31, 2022 was higher than the U.S. statutory rate of 21%, primarily due to the geographic mix of income, state and local taxes and permanently non-deductible amounts related to the divestiture transaction, partially offset by the tax benefit of valuation allowances released due to the gain from divestiture and tax credits. Excluding the impact of restructuring costs, litigation reserve releases, valuation allowance and certain discrete tax items, the normalized effective tax rate for the three months ended March 31, 2023 was 35.0%. The normalized effective tax rate for the three months ended March 31, 2022 was 29.6%, predominantly due to excluding the impact of the Midas divestiture, the litigation insurance recoveries, amortization of intangible assets, restructuring costs and certain discrete tax items. The normalized effective tax rate for the three months ended March 31, 2023 was higher than the three months ended March 31, 2022 due to the geographic mix of income. 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; • Government; and • Transportation. Divestitures includes our Midas business which was sold in the first quarter of 2022. 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. CNDT Q1 2023 Form 10-Q 24 Table of Contents Results of financial performance by segment were: Three Months Ended March 31, (in millions) Commercial Government Transportation Divestitures Unallocated Costs Total 2023 Revenue $ 508 $ 264 $ 150 $ — $ — $ 922 Segment profit (loss) $ 35 $ 73 $ (8) $ — $ (70) $ 30 Segment depreciation and amortization $ 30 $ 10 $ 11 $ — $ 9 $ 60 Adjusted EBITDA $ 65 $ 83 $ 3 $ — $ (61) $ 90 % of Total Revenue 55.1 % 28.6 % 16.3 % — % — % 100.0 % Adjusted EBITDA Margin 12.8 % 31.4 % 2.0 % — % — % 9.8 % 2022 Revenue $ 512 $ 286 $ 162 $ 7 $ — $ 967 Segment profit (loss) $ 28 $ 75 $ 8 $ 2 $ (59) $ 54 Segment depreciation and amortization $ 26 $ 8 $ 9 $ — $ 12 $ 55 Adjusted EBITDA $ 54 $ 83 $ 17 $ 2 $ (47) $ 109 % of Total Revenue 52.9 % 29.6 % 16.8 % 0.7 % — % 100.0 % Adjusted EBITDA Margin 10.5 % 29.0 % 10.5 % — % — % 11.3 % (in millions) Three Months Ended March 31, Segment Profit (Loss) Reconciliation to Pre-tax Income (Loss) 2023 2022 Income (Loss) Before Income Taxes $ (8) $ 210 Reconciling items: Amortization of acquired intangible assets 2 6 Restructuring and related costs 29 9 Interest expense 27 19 (Gain) loss on divestitures and transaction costs 2 (163) Litigation settlements (recoveries) (21) (28) Other (income) expenses, net (1) 1 Segment Profit (Loss) $ 30 $ 54 Segment depreciation and amortization (including contract inducements) 60 55 Adjusted EBITDA $ 90 $ 109 Commercial Segment Revenue Commercial revenue for the three months ended March 31, 2023 was lower compared to the prior year period primarily due to the final impact of the merger of two of our clients disclosed in the second quarter of 2022 resulting in lower volumes, partially offset by higher interest rates positively impacting our Benefit Wallet business. Segment Profit and Adjusted EBITDA Increases in the Commercial segment profit, adjusted EBITDA and adjusted EBITDA margin for the three months ended March 31, 2023, compared to the prior year period, were mainly driven by higher interest rates positively impacting our Benefit Wallet business. CNDT Q1 2023 Form 10-Q 25 Table of Contents Government Segment Revenue Government revenue for the three months ended March 31, 2023 decreased, compared to the prior year period. This decrease was primarily driven by non-repeating federal stimulus revenue, lost business from prior years and the out of period adjustment mentioned above, partially offset by the ramping of new business in Government Healthcare solutions and higher volumes in Government services solutions. Segment Profit and Adjusted EBITDA Government segment profit and adjusted EBITDA for the three months ended March 31, 2023 were substantially unchanged compared to the prior year period with the $17 million reversal of reserves due to the settlement of the Cognizant matter being offset by the out of period adjustment and lower revenue. Adjusted EBITDA margin improved due to the Cognizant matter partially offset by the out of period adjustment and the non-repeating federal stimulus revenue. Transportation Segment Revenue Transportation revenue for the three months ended March 31, 2023 decreased compared to the prior year period, primarily driven by extended completion timelines to meet client requirements in our Transit solutions service offering, which affected the recognition timeframe for revenue. Segment Profit and Adjusted EBITDA Transportation segment profit, adjusted EBITDA and adjusted EBITDA margin for the three months ended March 31, 2023 decreased primarily due to extended completion timelines to meet client requirements in our Transit solutions service offering. Divestitures Revenue, Segment Profit (Loss) and Adjusted EBITDA The decline in revenue, segment profit and Adjusted EBITDA for the three months ended March 31, 2023 was due to the sale of the Midas Suite of products. The prior year included activity through the date of disposition whereas there was no activity in the current year. Unallocated Costs Unallocated Costs for the three months ended March 31, 2023 increased compared to the prior year period primarily due to the prior year reflecting the recovery of defense costs as part of the settlement with insurance carriers relating to the previously disclosed State of Texas matter, partially offset by progress with 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. Due to the inconsistency of when existing contracts end, quarterly and yearly comparisons are not a good measure of renewal performance. New business ACV is calculated as TCV divided by the contract term, in months, multiplied by 12 for an annual measure. For the three months ended March 31, 2023, the Company signed $125 million of new business ACV. CNDT Q1 2023 Form 10-Q 26 Table of Contents Signing information for the three months ended March 31, 2023 and 2022 is as follows: Three Months Ended March 31, 2023 vs. 2022 ($ in millions) 2023 (3) 2022 (3) $ Change % Change New business ACV $ 125 $ 167 $ (42) (25) % New business TCV $ 244 $ 464 $ (220) (47) % Renewals TCV 390 936 (546) (58) % Total Signings $ 634 $ 1,400 $ (766) (55) % Annual recurring revenue signings (1) $ 61 $ 108 $ (47) (44) % Non-recurring revenue signings (2) $ 67 $ 62 $ 5 8 % ___________ (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. (3) Adjusted to remove Midas new business signings. The total new business pipeline at the end of March 31, 2023 and 2022 was $23.2 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. Net ARR Activity The Net ARR Activity metric is defined as Projected Annual Recurring Revenue for contracts signed in the prior 12 months, less the annualized impact of any client losses, contractual volume and price changes, and other known impacts for which the Company was notified in that same time period, which could positively or negatively impact results. The metric annualizes the net impact to revenue. Timing of revenue impact varies and may not be realized within the forward 12-month timeframe. The metric is for indicative purposes only. This metric excludes COVID-related volume impacts and non-recurring revenue signings. This metric is not indicative of any specific 12-month timeframe. The Net ARR activity metric for the trailing twelve months for each of the prior five quarters was as follows: (in millions) Net ARR Activity metric March 31, 2023 $ 108 December 31, 2022 114 September 30, 2022 70 June 30, 2022 104 March 31, 2022 102 Capital Resources and Liquidity As of March 31, 2023 and December 31, 2022, total cash and cash equivalents were $526 million and $582 million, respectively. We also have a $550 million revolving line of credit for our various cash needs, of which $2 million was used for letters of credit. The net amount available to be drawn upon under our revolving line of credit as of March 31, 2023, was $548 million. As of March 31, 2023, our total debt outstanding was $1,277 million of which $38 million was due within one year. Refer to Note 7 – 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 our revolving line of credit will continue to provide sufficient financial resources to meet our expected business obligations for at least the next twelve months. CNDT Q1 2023 Form 10-Q 27 Table of Contents 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) 2023 2022 Better (Worse) Net cash provided by (used in) operating activities $ (12) $ 11 $ (23) Net cash provided by (used in) investing activities $ (22) $ 273 (295) Net cash provided by (used in) financing activities $ (19) $ (110) 91 Operating activities The net decrease in cash generated from operating activities of $23 million, compared to the prior year period, was primarily related to the absence of the $38 million of insurance recoveries related to the previously disclosed State of Texas matter. Investing activities Investing cash flow decreased by $295 million primarily due to the proceeds from the divestiture of the Midas business in the prior year, partially offset by decreased capital spending in the current year. Financing activities The decrease in cash used in financing activities was primarily related to the repayment of the $100 million borrowed under the revolver in the prior year partially offset by higher taxes paid for settlement of stock-based compensation. Sales of Accounts Receivable We have entered into a factoring agreement in the normal course of business as part of our cash and liquidity management, to sell certain accounts receivable without recourse to a third-party financial institution. The transactions under this agreement are treated as a sale and are accounted for as a reduction in accounts receivable because the agreement transfers effective control over, and risk related to, the receivables to the buyer. Cash proceeds from this arrangement are included in cash flow from operating activities in the Consolidated Statements of Cash Flows. The net impact from the sales of accounts receivable on net cash provided by (used in) operating activities for the three months ended March 31, 2023 and 2022 was $(27) million and $(8) million, respectively. Material Cash Requirements from Contractual Obligations The Company believes its balances of cash and cash equivalents, which totaled $526 million as of March 31, 2023, along with cash generated by operations and amounts available for borrowing under its 2021 Revolving Credit Facility, will be sufficient to satisfy its cash requirements over the next 12 months and beyond. At March 31, 2023, the Company’s material cash requirements include debt, leases and estimated purchase commitments. See Part II, Item 7 – Management's Discussion and Analysis of Financial Condition and Results of Operation of our Annual Report on Form 10-K for the year ended December 31, 2022 for additional information on our material cash requirements. Critical Accounting Estimates and Policies The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America (U.S. GAAP) requires us to make estimates and assumptions in certain circumstances that affect amounts reported in the accompanying Condensed Consolidated Financial Statements and notes thereto. There have been no significant changes during the three months ended March 31, 2023 to our critical accounting estimates and policies from those disclosed in our Annual Report on Form 10-K for the year ended December 31, 2022. CNDT Q1 2023 Form 10-Q 28 Table of Contents Recent Accounting Changes See Note 2 – Recent Accounting Pronouncements for information on accounting standards adopted during the current year, as well as recently issued accounting standards not yet required to be adopted and the expected impact of the adoption of these accounting standards.