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 seven sections: • Overview; • Financial Information and Analysis of Results of Operations; • Metrics; • Capital Resources and Liquidity; • Critical Accounting Estimates and Policies; • Recent Accounting Changes; and • Non-GAAP Financial Measures. 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 We deliver digital business solutions and services to streamline and manage enterprise processes on behalf of commercial, government and transportation organizations – creating valuable outcomes for our clients and the millions of people who count on them. Our solutions combine innovative technology platforms with automation, artificial intelligence, process expertise and services that improve quality, efficiency and productivity. With a dedicated global team of approximately 57,000 associates, our solutions span customer service, business administration and operations, healthcare administration and payment management. Across many industries and government agencies, we reduces costs, improves end-user experiences and enables digital transformation for our global clients. Headquartered in Florham Park, New Jersey, we have operations in 25 countries. Our reportable segments correspond to how we organize and manage the business and are aligned to the industries in which our clients operate. These three segments are: • Commercial – Our Commercial segment provides business process solutions and services 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 enhance performance for our clients and deliver better experiences for their consumers and employees. • Government – Our Government segment provides government-centric business process services to U.S. federal, state and local government agencies and foreign governments for public assistance, healthcare programs and administration, transaction processing and payment services. The solutions in this segment help governments provide constituents access and delivery of benefits, respond to changing rules for eligibility and keep pace with increasing citizen expectations. • Transportation – Our Transportation segment provides systems, support, and revenue-generating solutions, to government transportation agencies. We deliver mission-critical public safety, mobility and digital payment solutions that streamline operations, increase revenue and reduce congestion while creating safe, seamless travel experiences for consumers and reducing impact on the environment. CNDT Q1 2024 Form 10-Q 20 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. We remain focused on accelerating growth and enhancing value for our stakeholders and intend to achieve this by doubling down on key themes outlined in the March 2023 investor briefing. We also intend to continue our portfolio rationalization strategy, divesting certain solutions which have either scarcity value outside of Conduent or are capital intensive relative to their growth opportunity, and thereby allowing management the bandwidth and increased capital to focus on solutions where we believe we have competitive advantages or higher growth expectations. We believe this focus on our portfolio rationalization strategy 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. During 2024 we have achieved the following: • We continue to make progress with our portfolio rationalization strategy. During the first quarter we closed the first tranche of the BenefitWallet portfolio transfer, representing approximately 40% of the total assets, receiving $164 million as the pro-rata share of the Purchase Price. The second tranche closed in April representing approximately 20% of the total assets, receiving $85 million as the pro-rata share of the Purchase Price. We anticipate the remainder of the portfolio to transfer later in the second quarter. Proceeds from the first and second tranches, plus cash on hand, were used to voluntarily prepay $259 million of the Term Loan B. • The Curbside Parking and Public Safety Solutions divestiture announced on December 28, 2023 closed on April 30, 2024. We also continue to pursue other divestiture opportunities, each at different stages of the divestiture process. • Continued our share repurchase program, repurchasing 4.8 million shares of common stock during the quarter. CNDT Q1 2024 Form 10-Q 21 Table of Contents Financial Information and Analysis of Results of Operations Three Months Ended March 31, 2024 vs. 2023 (in millions) 2024 2023 $ Change % Change Revenue $ 921 $ 922 $ (1) — % Operating Costs and Expenses Cost of services (excluding depreciation and amortization) 735 720 15 2 % Selling, general and administrative (excluding depreciation and amortization) 116 111 5 5 % Research and development (excluding depreciation and amortization) 2 2 — — % Depreciation and amortization 62 61 1 2 % Restructuring and related costs 9 29 (20) (69) % Interest expense 27 27 — — % (Gain) loss on divestitures and transaction costs, net (161) 2 (163) n/m Litigation settlements (recoveries), net 4 (21) 25 (119) % Loss on extinguishment of debt 2 — 2 n/m Other (income) expenses, net (2) (1) (1) n/m Total Operating Costs and Expenses 794 930 (136) Income (Loss) Before Income Taxes 127 (8) 135 Income tax expense (benefit) 28 (2) 30 Net Income (Loss) $ 99 $ (6) $ 105 Revenue Revenue for the three months ended March 31, 2024 was substantially unchanged, compared to the prior year period, with new business ramp including the State of Victoria contract, stronger volumes and operational execution in our Transportation segment, offsetting lost business, lower volumes in our Commercial and Government segments, and the impact of the completion of the first tranche of the BenefitWallet Transfer. Cost of Services (excluding depreciation and amortization) Cost of services for the three months ended March 31, 2024 increased, compared to the prior year period, primarily driven by the absence of a $17 million reversal of liabilities due to the settlement of the Cognizant matter in the prior year described in Note 16 – Contingencies and Litigation to the Consolidated Financial Statements included in our 2023 Annual Report on Form 10-K. Selling, General and Administrative ("SG&A") (excluding depreciation and amortization) SG&A for the three months ended March 31, 2024 increased, compared to the prior year period, driven by costs to transition away from a technology vendor. Depreciation and Amortization Depreciation and amortization for the three months ended March 31, 2024 was substantially unchanged compared to the prior year period. CNDT Q1 2024 Form 10-Q 22 Table of Contents 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) 2024 2023 Severance and related costs $ 4 $ 20 Data center consolidation costs 1 2 Termination, insourcing and asset impairment costs 4 7 Total net current period charges 9 29 Consulting and other costs (1) — — Restructuring and related costs $ 9 $ 29 ___________ (1) Represents professional support costs associated with certain strategic transformation programs. Restructuring and related costs for the three months ended March 31, 2024 decreased compared to the prior year period. The decrease is primarily driven by severance and related costs related to the closure of one of our Commercial segment operations in Europe in the prior year period. 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. Interest expense for the three months ended March 31, 2024, compared to the prior year period, was substantially unchanged. (Gain) Loss on Divestitures and Transaction Costs The completion of the first tranche of the BenefitWallet Transfer in the first quarter of 2024 resulted in a gain of $164 million. 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. Litigation Settlements (Recoveries), Net Litigation settlements (recoveries), net for the three months ended March 31, 2023 primarily consisted of a $26 million reversal of reserves due to the settlement of the Cognizant matter. Income Taxes The effective tax rate for the three months ended March 31, 2024 was 21.9%, compared to 20.8% for the three months ended March 31, 2023. The March 31, 2024 rate approximates the U.S. statutory rate of 21% as incremental tax from geographic mix of income and state taxes was offset by tax benefit from valuation and audit settlement reserve releases. The effective tax rate for the three months ended March 31, 2023 also approximated the U.S. statutory rate. Excluding the impact of the Benefit Wallet Transfer, restructuring costs, amortization of intangible assets, litigation reserve, audit settlement reserve release, valuation allowance and other discrete tax items, the normalized effective tax rate for the three months ended March 31, 2024 was 22.2%. The normalized effective tax rate for the three months ended March 31, 2023 was 35.0%, primarily due to 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, 2024 was lower than the three months ended March 31, 2023 rate due to the geographic mix of income. CNDT Q1 2024 Form 10-Q 23 Table of Contents In 2021, the Organization for Economic Cooperation and Development ("OECD") released model rules for a 15% global minimum tax, known as Pillar Two. Pillar Two has now been enacted by approximately 30 countries. This alternative minimum tax is treated as a period cost beginning in 2024 and does not have a material impact on the Company's financial results of operations for the current period. The Company is monitoring legislative developments, as well as additional guidance from countries that have enacted legislation. We anticipate further legislative activity and administrative guidance in 2024. Operations Review of Segment Revenue and Profit Our financial performance is based on Segment Profit/(Loss) and Segment Adjusted Earnings before Interest, Taxes, Depreciation and Amortization ("Adjusted EBITDA") for the following three segments: • Commercial; • Government; and • Transportation. The BenefitWallet and the Curbside Management and Public Safety Solutions businesses are expected to be reclassified to Divestitures from our Commercial and Transportation segments, respectively, beginning in the second quarter of 2024. 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. Results of financial performance by segment were: Three Months Ended March 31, (in millions) Commercial Government Transportation Unallocated Costs Total 2024 Revenue $ 483 $ 258 $ 180 $ — $ 921 Segment profit (loss) $ 40 $ 42 $ (3) $ (72) $ 7 Segment depreciation and amortization $ 30 $ 13 $ 11 $ 8 $ 62 Adjusted EBITDA $ 70 $ 55 $ 8 $ (64) $ 69 % of Total Revenue 52.5 % 28.0 % 19.5 % — % 100.0 % Adjusted EBITDA Margin 14.5 % 21.3 % 4.4 % — % 7.5 % 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 % CNDT Q1 2024 Form 10-Q 24 Table of Contents (in millions) Three Months Ended March 31, Segment Profit (Loss) Reconciliation to Pre-tax Income (Loss) 2024 2023 Income (Loss) Before Income Taxes $ 127 $ (8) Reconciling items: Amortization of acquired intangible assets 1 2 Restructuring and related costs 9 29 Interest expense 27 27 (Gain) loss on divestitures and transaction costs (161) 2 Litigation settlements (recoveries) 4 (21) Loss on extinguishment of debt 2 — Other (income) expenses, net (2) (1) Segment Profit (Loss) $ 7 $ 30 Segment depreciation and amortization (including contract inducements) $ 62 $ 60 Adjusted EBITDA $ 69 $ 90 Commercial Segment Revenue Commercial revenue for the three months ended March 31, 2024 declined compared to the prior year period, driven by lost business across the segment, the impact of the completion of the first tranche of the BenefitWallet portfolio transfer and lower volumes in certain industries of our client base, partially offset by new business ramp. Segment Profit and Adjusted EBITDA Commercial segment profit, adjusted EBITDA and adjusted EBITDA margin for the three months ended March 31, 2024 increased compared to the prior year period primarily driven by cost efficiencies, partially offset by the completion of the first tranche of the BenefitWallet Transfer. Government Segment Revenue Government revenue for the three months ended March 31, 2024 decreased, compared to the prior year period, primarily driven by lost business and lower volumes, partially offset by the ramping of new business and a non-repeating item in the prior year. Segment Profit and Adjusted EBITDA Government segment profit, adjusted EBITDA and adjusted EBITDA margin for the three months ended March 31, 2024 decreased compared to the prior year period primarily due to the absence of a $17 million reversal of liabilities due to the settlement of the Cognizant matter in the prior year and revenue mix. Transportation Segment Revenue Transportation revenue for the three months ended March 31, 2024 increased compared to the prior year period, primarily driven by the ramping of new business, including the State of Victoria contract, higher volumes and less impact from extended implementation timelines compared to the prior year. Segment Profit and Adjusted EBITDA Transportation segment profit, adjusted EBITDA and adjusted EBITDA margin for the three months ended March 31, 2024 increased primarily due to the impact of increased revenue and less impact from extended implementation timelines compared to the prior year, partially offset with costs to transition the non-retained portion of a Transit contract. CNDT Q1 2024 Form 10-Q 25 Table of Contents Unallocated Costs Unallocated Costs for the three months ended March 31, 2024 increased slightly compared to the prior year period primarily due to costs to transition away from a technology vendor. Metrics Metrics We use metrics to evaluate our business, determine the allocation of our resources, make decisions regarding corporate strategies and evaluate forward-looking projections and trends affecting our business. We disclose these metrics to provide transparency in our performance trends. We present certain key metrics, including Signings and Net ARR Activity below. Signings Signings are defined as estimated future revenues from contracts signed during the period, including renewals of existing contracts. Total Contract Value ("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 Annual Contract Value ("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, 2024, the Company signed $99 million of new business ACV. Signing information for the three months ended March 31, 2024 and 2023 is as follows: Three Months Ended March 31, 2024 vs. 2023 ($ in millions) 2024 (3) 2023 (3) $ Change % Change New business ACV $ 99 $ 125 $ (26) (21) % New business TCV $ 153 $ 244 $ (91) (37) % Renewals TCV 417 390 27 7 % Total Signings $ 570 $ 634 $ (64) (10) % Annual recurring revenue signings (1) $ 33 $ 61 $ (28) (46) % Non-recurring revenue signings (2) $ 71 $ 67 $ 4 6 % ___________ (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. CNDT Q1 2024 Form 10-Q 26 Table of Contents The total new business pipeline at the end of March 31, 2024 and 2023 was $24.0 billion and $23.2 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 Net ARR Activity is a 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 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, 2024 $ 17 December 31, 2023 62 September 30, 2023 103 June 30, 2023 137 March 31, 2023 108 Capital Resources and Liquidity As of March 31, 2024 and December 31, 2023, total cash and cash equivalents were $415 million and $498 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, 2024, was $548 million. As of March 31, 2024, our total principal debt outstanding was $1,131 million, of which $33 million was due within one year. Refer to Note 7 – Debt in the Condensed Consolidated Financial Statements for additional debt information. 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. 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) 2024 2023 Better (Worse) Net cash provided by (used in) operating activities $ (37) $ (12) $ (25) Net cash provided by (used in) investing activities $ 143 $ (22) 165 Net cash provided by (used in) financing activities $ (199) $ (19) (180) Operating activities The net increase in cash used in operating activities of $25 million, compared to the prior year period, was primarily related to lower adjusted EBITDA, slightly higher accounts receivable days sales outstanding and lower days payable outstanding. These were partially offset by lower cash income tax payments. In the first quarter of 2024, we had net cash tax refunds of $22 million, primarily due to the receipt of the U.S. federal income tax refund related to tax year 2018. CNDT Q1 2024 Form 10-Q 27 Table of Contents Investing activities Investing cash flow increased by $165 million mainly due to $164 million of proceeds received for the first tranche of the BenefitWallet Transfer. Financing activities The increase in cash used in financing activities was mainly driven by the voluntary prepayment of $164 million of debt using the proceeds received for the first tranche of the BenefitWallet Transfer along, with the repurchase of $17 million of treasury stock. 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 sales and are accounted for as reductions 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 Condensed 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, 2024 and 2023 was $(8) million and $(13) million, respectively. Material Cash Requirements from Contractual Obligations The Company believes its balances of cash and cash equivalents, which totaled $415 million as of March 31, 2024, 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, 2024, 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, 2023 for additional information on our material cash requirements. Critical Accounting Estimates and Policies Our management’s discussion and analysis of our financial condition and results of operations is based on our condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America ("U.S. GAAP"). The preparation of financial statements in conformity with 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, 2024 to our critical accounting estimates and policies from those disclosed in our Annual Report on Form 10-K for the year ended December 31, 2023. 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. Non-GAAP Financial Measures We reported our financial results in accordance with accounting principles generally accepted in the U.S. (U.S. GAAP). In addition, within this Form 10-Q Part I Item 2 we have discussed our financial results using non-GAAP measures. CNDT Q1 2024 Form 10-Q 28 Table of Contents We believe these non-GAAP measures allow investors to better understand the trends in our business and to better understand and compare our results. Accordingly, we believe it is necessary to adjust several reported amounts, determined in accordance with U.S. GAAP, to exclude the effects of certain items as well as their related tax effects. Management believes that these non-GAAP financial measures provide an additional means of analyzing the results of the current period against the corresponding prior period. However, these non-GAAP financial measures should be viewed in addition to, and not as a substitute for, the Company’s reported results prepared in accordance with U.S. GAAP. Our non-GAAP financial measures are not meant to be considered in isolation or as a substitute for comparable U.S. GAAP measures and should be read only in conjunction with our Consolidated Financial Statements prepared in accordance with U.S. GAAP. Our management regularly uses our non-GAAP financial measures internally to understand, manage and evaluate our business and make operating decisions, and providing such non-GAAP financial measures to investors allows for a further level of transparency as to how management reviews and evaluates our business results and trends. These non-GAAP measures are among the primary factors management uses in planning for and forecasting future periods. Compensation of our executives is based in part on the performance of our business based on certain of these non-GAAP measures. A reconciliation of the non-GAAP financial measures Adjusted EBITDA and EBITDA Margin to the most directly comparable financial measures calculated and presented in accordance with U.S. GAAP are provided in the Segment Performance Review above. Adjusted EBITDA and Adjusted EBITDA Margin We use adjusted EBITDA and adjusted EBITDA Margin as an additional way of assessing certain aspects of our operations that, when viewed with the U.S. GAAP results and the accompanying reconciliations to corresponding U.S. GAAP financial measures, provide a more complete understanding of our on-going business. Adjusted EBITDA Margin is adjusted EBITDA divided by revenue. Adjusted EBITDA represents income (loss) before interest, income taxes, depreciation and amortization and contract inducement amortization adjusted for the following items: • Amortization of acquired intangible assets. The amortization of acquired intangible assets is driven by acquisition activity, which can vary in size, nature and timing as compared to other companies within our industry and from period to period. • Restructuring and related costs. Restructuring and related costs include restructuring and asset impairment charges as well as costs associated with our strategic transformation program. • Goodwill impairment. This represents goodwill impairment charges related to entering the agreement to transfer the BenefitWallet portfolio. • (Gain) loss on divestitures and transaction costs. Represents (gain) loss on divested businesses and transaction costs. • Litigation settlements (recoveries), net represents settlements or recoveries for various matters subject to litigation. • Loss on extinguishment of debt. This represents write-off of debt issuance costs related to prepayments of debt. • Other charges (credits). This includes Other (income) expenses, net on the Consolidated Statements of Income (loss) and other insignificant (income) expenses and other adjustments. Adjusted EBITDA is not intended to represent cash flows from operations, operating income (loss) or net income (loss) as defined by U.S. GAAP as indicators of operating performance. Management cautions that amounts presented in accordance with Conduent's definition of adjusted EBITDA and adjusted EBITDA Margin may not be comparable to similar measures disclosed by other companies because not all companies calculate adjusted EBITDA and adjusted EBITDA Margin in the same manner.