UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K
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(Mark One)
| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |||||
For the fiscal year ended: December 31, 2019
| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |||||
For the transition period from: _______ to: _______
Commission File Number 001-37817
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(Exact Name of Registrant as specified in its charter)
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| (State or other jurisdiction of incorporation or organization) | (IRS Employer Identification No.) | ||||||||||||||||
| (Address of principal executive offices) | (Zip Code) | ||||||||||||||||
(844 ) 663-2638
(Registrant’s telephone number, including area code)
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Securities registered pursuant to Section 12(b) of the Act:
| Title of each class | Trading Symbol(s) | Name of each exchange on which registered | ||||||
Securities registered pursuant to Section 12(g) of the Act: None
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Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes x No o
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No x
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes x No o
Indicate by a check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and "emerging growth company" in Rule 12b-2 of the Exchange Act.
| ☒ | Accelerated filer | ☐ | Non-accelerated filer | ☐ | Small reporting company | Emerging growth company | |||||||||||||||||||||||
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If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o
Indicate by a check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ý
The aggregate market value of the voting and non-voting common stock of the registrant held by non-affiliates as of June 30, 2019 was $2,012,432,097 .
Indicate the number of shares outstanding of each of the Registrant's classes of common stock, as of the latest practicable date:
| Class | Outstanding at January 31, 2020 | ||||||||||||||||
| Common Stock, | $ | ||||||||||||||||
DOCUMENTS INCORPORATED BY REFERENCE
Part III of this Form 10-K incorporates by reference certain portions of the Registrant's Notice of 2020 Annual Meeting of Shareholders and Proxy Statement (to be filed with the Securities and Exchange Commission pursuant to Regulation 14A no later than 120 days after the close of the fiscal year covered by this report on Form 10-K).
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FORWARD-LOOKING STATEMENTS
From time to time, we and our representatives may provide information, whether orally or in writing, including certain statements in this Annual Report on Form 10-K (Form 10-K), which are deemed to be "forward-looking" within the meaning of the Private Securities Litigation Reform Act of 1995 (the "Litigation Reform Act"). These forward-looking statements and other information are based on our beliefs as well as assumptions made by us using information currently available.
The words “anticipate,” “believe,” “estimate,” “expect,” “intend,” “will,” "aim," “should,” "continue to," and similar expressions, as they relate to us, are intended to identify forward-looking statements. These statements reflect our current views with respect to future events and are subject to certain risks, uncertainties and assumptions. Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may vary materially from those expressed or implied herein as anticipated, believed, estimated, expected or intended or using other similar expressions.
In accordance with the provisions of the Litigation Reform Act, we are making investors aware that such forward-looking statements, because they relate to future events, are by their very nature subject to many important factors and uncertainties that could cause actual results to differ materially from those contemplated by the forward-looking statements contained in this Form 10-K, any exhibits to this Form 10-K and other public statements we make.
Important factors and uncertainties that could cause actual results to differ materially from those in our forward-looking statements include, but are not limited to: government appropriations and termination rights contained in our government contracts; risk and impact of potential goodwill and other asset impairments; our ability to renew commercial and government contracts, including contracts awarded through competitive bidding processes; our ability to recover capital and other investments in connection with our contracts; our ability to attract and retain necessary technical personnel and qualified subcontractors; our ability to deliver on our contractual obligations properly and on time; competitive pressures; our significant indebtedness; changes in interest in outsourced business process services; our ability to obtain adequate pricing for our services and to improve our cost structure; risk and impact of geopolitical events, natural disasters and other factors (such as pandemics, including coronavirus) in a particular country or region on our workforce, customers and vendors; claims of infringement of third-party intellectual property rights; the failure to comply with laws relating to individually identifiable information, and personal health information and laws relating to processing certain financial transactions, including payment card transactions and debit or credit card transactions; breaches of our information systems or security systems or any service interruptions; our ability to estimate the scope of work or the costs of performance in our contracts; our continuing emphasis on and shift toward technology-led digital transactions; customer decision-making cycles and lead time for customer commitments; our ability to collect our receivables, including those for unbilled services; a decline in revenues from, or a loss of, or a reduction in business from or failure of significant clients; fluctuations in our non-recurring revenue; our failure to maintain a satisfactory credit rating; our ability to attract and retain key employees; increases in the cost of telephone and data services or significant interruptions in such services; our failure to develop new service offerings; our ability to modernize our information technology infrastructure and consolidate data centers; our ability to comply with data security standards; our ability to receive dividends or other payments from our subsidiaries; changes in tax and other laws and regulations; changes in government regulation and economic, strategic, political and social conditions; and other factors that are set forth in the “Risk Factors” section, the “Legal Proceedings” section, the “Management's Discussion and Analysis of Financial Condition and Results of Operations” section and other sections of this Form 10-K, as well as in our Quarterly Reports on Form 10-Q and Current Reports on Form 8-K. We do not intend to update these forward-looking statements, except as required by law.
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CONDUENT INCORPORATED
FORM 10-K
December 31, 2019
TABLE OF CONTENTS
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| Part I | ||||||||
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PART I
ITEM 1. BUSINESS
In this Form 10-K, unless the content otherwise dictates, "Conduent", the "Company", "we" or "our" mean Conduent Inc. and its consolidated subsidiaries.
Our Business
As one of the largest business process services companies in the world, Conduent delivers mission-critical services and solutions on behalf of businesses and governments – creating exceptional outcomes for our clients and the millions of people who count on them. Through people, process, expertise in transaction-intensive processing and technology such as analytics and automation, Conduent's services and solutions create value by improving efficiencies, reducing costs and enabling revenue growth. A majority of Fortune 100 companies and over 500 government entities depend on Conduent every day to manage their business processes and essential interactions with their end-users.
Conduent's commercial portfolio includes leading solutions in attractive markets such as end-user customer experience management, transaction processing services, commercial healthcare and human resource and learning services. For example, Conduent is a leading provider of medical bill review. In 2019, Conduent processed over 28 million medical bills and saved customers over $17 billion.
Conduent serves a vast range of the public sector including market leading transportation and government solutions. For example, Conduent’s systems support 11 million traveler transactions per day via electronic tolling and process over 40% of Supplemental Nutrition Assistance Program (SNAP) payments on behalf of government entities.
We create value for our clients through efficient global service delivery combined with a personalized and seamless experience for the end-user. We apply our expertise, technology and innovation to continually modernize our offerings for improved customer and constituent satisfaction and loyalty, increased process efficiency and rapid response to changing market dynamics.
Conduent Incorporated is a New York corporation, organized in 2016. Our common stock began trading on January 3, 2017, on the New York Stock Exchange, under the ticker "CNDT". In December 2019, Conduent changed the listing of its publicly traded common stock from the New York Stock Exchange to the NASDAQ Global Select Market (NASDAQ), where it remains listed under the ticker "CNDT".
With approximately 67,000 employees globally as of December 31, 2019, we provide differentiated services to clients spanning medium and large businesses and governments around the world.
In the third quarter of 2019, management and the Board of Directors jointly commenced a strategic and operational review of the Company and each line of business. Each of the lines of business were evaluated across multiple factors including competitive positioning, financial performance, investment needs, market scarcity and execution risk, among others. The Company’s transformation plan and perspective on allocating capital amongst its business units changed as a result of this review.
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Our Transformation
We continue to focus on transformation and optimization throughout the business. We have seen tremendous optimization from our real estate consolidation efforts. Going forward, we intend to transform the business through an intense focus on Growth, Quality, and Efficiency – utilizing a programmatic, project management approach. We are intent on hiring and organizing top-talent, instituting and instilling processes and investing in and upgrading our technology. We are using a deliberate process that identifies the biggest gaps and then prioritizes actions to ensure success.
•Growth: In 2019, we hired a Chief Revenue Officer and re-organized our sales team. We centralized the sales executives from the business delivery operations. Previously, the sales and delivery organizations were co-mingled. We believe isolating sales executives to a single organization with a sole purpose of selling will enable the team to benefit from increased focus and shared sales knowledge transfer. Additionally, we simplified our go-to-market strategy to align our focus on solution-based selling. We are taking a very client-centric approach to strengthen our relationships, better understand our clients' businesses and proactively respond to or pre-empt our clients' needs. We are examining the entire “sales to service continuum” to improve our performance and have launched a client retention program. We are measuring success in “Growth” through revenue retention and new business signings, among other metrics.
•Quality: In 2019, we continued to improve processes and procedures to address our technology infrastructure and our client delivery. We hired new executive leadership in the technology organization and continued the consolidation process of our data centers. We are also establishing a new and a more centralized command center to boost proactive management and monitoring of infrastructure incidents. We believe these changes will provide stability and a streamlined delivery of services to our clients and their end-users. In addition to optimizing the quality and stability of our service delivery, we continue to invest to upgrade our solutions to enable exceptional outcomes for our clients and their end-users as we work to standardize the service delivery processes. We are measuring success in “Quality” by service level agreement performance, severity 1 outages, and client satisfaction.
•Efficiency: We continue to find ways to reduce costs via increased efficiencies. We are implementing standardized processes and a singular operating model across the business, which we believe will eliminate silos and improve our leadership across the company. We believe greater efficiencies will be driven through simplified, standardized processes and a motivated workforce. We continue to find efficiencies from the ongoing consolidation of our data centers and real estate footprint. We are making steady progress in reshaping our culture and are investing in associate engagement programs as well as improvements to our work environments across our global locations. We are measuring success in “Efficiency” by associate retention and adjusted earnings before interest, depreciation and amortization (EBITDA) margin, among other metrics.
Our Market Opportunity
We estimate our addressable market size in the global business process service industry at over $200 billion in 2019, according to third party industry reports, and we are a leader across several segments of this large, diverse and growing market. Providing business process services is complex and multi-faceted with services that span many industries.
Ongoing competitive pressures and increasing demand for further productivity gains have motivated businesses to outsource elements of their day-to-day operations to accelerate performance and innovation. As a result, our clients have become more focused on their core businesses and the range of outsourced activities has expanded greatly. Increasing globalization has also required many companies to optimize cost structures to retain competitiveness and business process services have become a key component of this strategy.
The ongoing shift to next-generation software and automation technologies is driving greater demand for, and expectation of, efficiency and personalization by the constituents and customers of the businesses and governments we serve. Addressing these business and operational challenges is necessary for business process services companies to capitalize on these trends. In addition, business process services have the potential to meaningfully enhance productivity for businesses and governments and satisfaction for their customers and constituents.
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Segments
We organize, manage and report our businesses through three reportable segments (Commercial Industries, Government Services and Transportation), Other operations and Shared IT / Infrastructure & Corporate Costs.
Our Commercial Industries is our largest segment, with $2.4 billion in revenues in 2019, representing 53.4% of our total revenues. 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.
Our Government Services segment revenue for 2019 was $1.3 billion, representing 28.3% of our total revenues. This segment provides government-centric business process services to U.S. federal, state and local governments for public assistance program administration, transaction processing and payment services. Our solutions in this segment help governments respond to changing rules for eligibility and increasing citizen expectations.
Our Transportation segment revenue for 2019 was $0.8 billion, representing 17.5% of our total revenues. This segment provides systems and support, as well as revenue-generating services, to government clients in 25 countries. 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.
Other represents our divestitures, our Student Loan business, which the Company exited in the third quarter of 2018. In 2019, Other accounted for $38 million or 0.8% of total revenues, which was mainly from the portfolio of select standalone customer care contracts sold in February 2019. Refer to Note 4 – Divestiture to the Consolidated Financial Statements for additional information regarding this sale.
Shared IT / Infrastructure & Corporate Costs includes both normal ongoing IT infrastructure costs and costs related to modernization of a significant portion of our infrastructure with new systems and processes and consolidation of our data centers as part of our transformation initiatives. It also includes costs related to corporate overhead functions and shared real estate costs. These costs are not allocated to the reportable segments. We expect that our transformation initiatives will provide greater strategic and operational flexibility and efficiency and better control of our systems and processes. There is a risk, however, that our modernization efforts and data center consolidations could materially and adversely disrupt our operations. Refer to Part I, Item 1A – Risk Factors of this Form 10-K for additional information.
We present segment financial information in Note 3 – Segment Reporting to our Consolidated Financial Statements included in Part II, Item 8 of this Form 10-K, which is incorporated herein by reference.
Our Service Offerings
Our portfolio of business process services includes a combination of industry-specific and cross-industry services. We have subject matter experts who are responsible for implementing each of these services, delivering service excellence to clients, ensuring best practices to improve cost competitiveness, innovating our next generation offerings and supporting worldwide sales.
Commercial Industries
Our solutions and services include end-user customer experience, transaction processing, commercial healthcare and human resource and learning services.
•End-User Customer Experience (EUCE)
◦We offer a range of services that help our clients support their end-users. This includes in-bound and out-bound call support for both simple and complex transactions, technical support and patient assistance. We also provide multi-channel communication support (both print and digital) across a range of industries.
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•Transaction Processing Solutions (TP)
◦We help our clients improve communications with their customers and constituents, whether it is on paper, on-line or through other communication channels. By supporting our clients’ customer communication processes, we help our clients deliver a better experience to their customers and operate with improved efficiency and greater effectiveness.
◦We offer a broad array of flexible transaction processing services that include data entry, scanning, image processing, enrollment processing, claims processing, high volume offsite print and mail services and file indexing. Our multi-channel communication capabilities (including secure print, email, text and web) enable the delivery of personalized and targeted communications that are designed to elicit the desired response from customers or other end-users (e.g., on-time bill payment and increased marketing response rates). Our service offerings utilize both proprietary and commercially available third-party technologies, combined with our expertise, to ensure continued quality and innovation for our clients.
◦We also serve clients by managing their critical finance, accounting and procurement processes. Our services include general accounting and reporting, billing and accounts receivable and purchasing, accounts payable and expense management services. We also offer wholesale and retail lockbox services and process auto and mortgage loans in the United States. With a global, dedicated team, we manage the core, end-to-end process areas of finance, accounting and procurement for some of the world’s most recognized brands.
•Commercial Healthcare Services (CH)
◦On behalf of the healthcare industry, we deliver administration, clinical support and medical management solutions across the health ecosystem to reduce costs, increase compliance and enhance utilization, while improving health outcomes and experience for members and patients. Our solutions span: trials, sales, access, adherence and long-term differentiation solutions to pharmaceutical clients; case management, performance management and patient safety for hospital clients; medical bill review, care integration, subrogation and payment integrity solutions to managed care companies; and workers compensation medical bill review, mailroom/data capture and medical management services to claims payers and third-party administrators.
•Human Resource and Learning Services (HRL)
◦We help our clients support their employees at all stages of employment from initial on-boarding through retirement, as well as HSA administration. We offer clients a range of customized advisory, technology and administrative services that improve the ability of employees to manage their benefits, professional development and retirement planning.
◦We also provide clients with a simplified approach to help their employees manage their healthcare costs and accumulate wealth with tax-advantaged accounts. We consolidate administration of all health spending accounts onto one common platform, including HSA, Health Reimbursement Arrangements, Flexible Spending Accounts and Commuter and Dependent Care Accounts. By consolidating and integrating the management of health spending accounts, we help our clients improve benefit enrollment and account opening, consolidate customer service, simplify communications and streamline account funding and management. As of December 31, 2019, we had approximately 1 million active HSA accounts and $2.7 billion of assets under management within our HSA offering.
◦We are a provider of end-to-end learning services, designed to accelerate the productivity and development of our clients’ employees and extended work forces. Our global presence, superior innovation and expertise allow us to deliver performance-based learning services tailored to our clients’ unique strategic business goals. Our offerings include learning strategy and assessment, instructor management and learning administration.
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Government Services
Our solutions and services include government health services, payment solutions, child support services, and labor workforce and general government solutions.
•Government Healthcare
◦We provide medical management and fiscal agent care management services to Medicaid programs and federally-funded U.S. government healthcare programs in 23 states, Puerto Rico and the District of Columbia. Our services include a range of innovative solutions such as Medicaid management, provider services, Medicaid business intelligence, pharmacy benefits management, eligibility verification and case management solutions. Our case management solutions make it easy to process and access large volumes of digital data. This can be used to track public health metrics (such as diseases, vitals, and birth defects), perform electronic visit verification, and more. These services help states optimize their costs by streamlining access to care and improve patient health outcomes through population health management, while helping families in need, by improving beneficiary support.
•Payment Solutions
◦With more than $80 billion disbursed annually, we are a leader in government payment disbursements for federally sponsored programs like SNAP, commonly known as food stamps and Women, Infant and Children (WIC) as well as government-initiated cash disbursements such as child support and unemployment. Conduent delivers electronic payments for government services in 33 states, including 106 prepaid debit card programs, 26 Electronic Benefit Transfer (EBT) programs, 13 EBT for WIC programs and 7 Electronic Child Care programs. As part of our payment solutions, we are also a preferred partner to child support enforcement agencies nationwide, we deliver innovative services and solutions to help agencies reduce costs and improve processes.
•State and Local
◦Child Support Services: As a preferred partner to child support enforcement agencies nationwide, we deliver innovative services and solutions to help agencies reduce costs and improve processes. We offer a broad set of child support services, including processing and distributing State Disbursement Units (SDUs), Child support payment cards, child care credentialing and case management, among others, to help states comply with federal standards.
◦Labor, Workforce and Government Solutions: We help agencies streamline onerous, paper-based tasks by turning them into efficient, digital processes. We offer unemployment insurance, workers compensation, parks and recreation, utilities and information technology solutions (such as cloud, hosting, maintenance and operations) to all the 50 U.S. states.
•Federal
◦As a preferred partner to government IT clients, we leverage technology as a key mechanism for improving citizen service and cost savings. Our solutions include: technology infrastructure, application portfolio management, IT consulting, and other IT managed services.
Transportation
On behalf of government agencies and authorities in the transportation industry, we deliver fare collection, violation management, notification, 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. Our solutions span tolling, transit, photo and parking and commercial vehicle.
•Tolling
◦Our electronic tolling, urban congestion management and mileage-based user solutions help clients keep up with an ever-changing environment and get more travelers where they need to go while generating revenue for much-needed infrastructure improvements. Our solutions include vehicle passenger detection systems, electronic toll collection, automated license plate recognition and congestion management solutions.
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•Transit
◦For today’s travelers, we aim to make journeys more personalized and convenient while increasing capacity and profitability for authorities and agencies. We combine the latest in fare collection, intelligent mobility so that clients can get the added efficiency of having a single point of contact for all their transit solutions.
•Photo and Parking
◦Curbside Management: We deliver intelligent curbside management systems that simplify parking programs and deliver convenient and hassle-free experience for drivers. Our curbside solutions include citation and permit administration, parking enforcement, and curbside demand management. We collect over $850 million annually for citations and delinquent revenue collections.
◦Public Safety: Public safety is a priority in every community, especially as budgets shrink and populations grow. We provide data analytics, automated photo enforcement and other public safety solutions to make streets and communities safer. One in every four US public safety enforcement systems are implemented by Conduent Transportation.
•Commercial vehicle
◦We provide computer-aided dispatch/automatic vehicle location technology to help customers manage their fleet operations.
Our Strategies
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. Our differentiated services and solutions improve experiences for millions of people every day.
Specific elements of our strategy include the following:
Portfolio Focus – The industries in which we operate have attractive revenue growth rates, generally in the mid-single digits. We intend to sharpen our focus and expand our business in industries with strong growth and profitability characteristics. We will aim to employ a disciplined approach to portfolio management to complement our competitive strengths and build depth and breadth in our core businesses. Within the Healthcare industry, we leverage our data analytics, differentiated service offerings and industry know-how to continue to service payer, provider and core government healthcare clients. Within the Transportation industry, we leverage our global, end-to-end platforms to continue to deliver seamless travel experiences while providing back-end transaction processing and call center services for government clients globally. Within the Government industry, we leverage our relationships with 41 different states and various government agencies to streamline operations and improve the citizen experience.
Operating Discipline – We continue to invest in our people, processes, and technology to optimize and strengthen our services capabilities. We plan to optimize our services capabilities and strengthen several core areas, including TP and finance and accounting services by building out our services offerings and continuing to improve our competitive strengths. We have divested non-core assets, refocused our business towards higher margin growing segments and consolidated delivery operations to enable greater productivity. Within TP, we continue to build industry-specific service offerings and advance inbound and outbound processing capabilities. Within EUCE, we capitalize on our global scale, cost efficiencies and our ability to provide seamless communications between our clients and their end-users through traditional (e.g., voice) and digital (e.g., web, mobile and Internet of Things) channels. Conduent’s solutions deliver exceptional outcomes for its clients, including:
•$17 billion in medical bill savings,
•$11 billion in child support payments processed more efficiently,
•up to 40% efficiency increase in HR operations, and
•up to 40% improvement in processing costs, while driving higher end-user satisfaction.
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Sales and Delivery Excellence – We look for the opportunity to exceed expectations and strive to be the best at what we do. Our clients are at the forefront of everything we do. We do our best to make things simple both in the solutions we design and the way we do business. We engage, develop and support our people. We intend to increasingly develop our employees by investing in training, processes and systems to equip them with modern tools that enable them to perform their jobs more efficiently. Furthermore, we plan to strengthen our sales teams through improved and optimized coverage and effective talent management. In 2019, we centralized our sales organization to report under a single Chief Revenue Officer and are investing in providing leadership and coaching to our sales team. The dedication and expertise of our employees have resulted in Conduent serving a majority of Fortune 100 companies, including:
•9 of top 10 health insurers,
•8 of 10 pharma companies,
•6 of top 10 automakers, and
•8 of top 10 U.S. banks.
Innovation complemented by tightly aligned investments – We are thinking about how we invest into the business differently than before. We intend to be disciplined in how we allocate capital and what our investments will fund. We have designated our businesses into three categories, each with a different approach to growing the business.
•Category 1- “Optimize”: The businesses where we will drive optimization are generally areas of significant scale and where we believe that with process optimization, automation, and an investment into the current offerings, we can improve the end-user experience, reduce our cost of delivery, expand our margins, and thus capture additional “share”. We have identified EUCE, TP, Government Services (State, Local and Federal and Payment solutions) as businesses that fit into this category.
•Category 2- “Enhance”: These are businesses where we see the potential to enhance our solutions and market share with modest investment. These tend to have strong client relationships and a long history of servicing the markets we operate in, but legacy technology that needs to be refreshed or modernized. We have identified Government Healthcare services and HRL services as businesses that fit into this category.
•Category 3- “Expand”: These are businesses where we believe opportunities to expand our capabilities may require more meaningful investment, but we see the payback as more significant than the other businesses. These businesses, augmented with new capabilities, perhaps supplemented by modest acquisitions, will address market dynamics and provide additional growth opportunities. We have identified Commercial Healthcare and Transportation as businesses that fit into this category.
Our Competitive Strengths
We possess certain competitive strengths that distinguish us from our competitors, including:
Leadership in attractive growth markets – We are a large player in business process services delivering exceptional outcomes for our clients at an unparalleled scale. Our clients continue to outsource key business processes to improve efficiencies and to accelerate performance and digital transformation. Additionally, clients are moving beyond services for back-office functions in order to drive customer satisfaction and loyalty. The increase in globalization and cost competition continues to accelerate, forcing companies to seek ways to stay ahead of the competition. These factors, along with clients and their customers demanding more personalized, seamless and secure solutions, are collectively driving the ongoing shift to next-generation solutions and services. Through our portfolio of services and solutions, we have reached significant scale in our interactions including:
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•Healthcare – U.S. healthcare spending is expected to rise from the 17.9% of GDP in 2017 to 19.4% of GDP by 2027and is projected to grow at an average rate of 5.5% per year for 2018-2027. As one of the most regulated industries, healthcare providers must balance increased utilization with heightened complexity and new financial pressures such as government budget challenges to significantly reduce reimbursements, reimbursement penalties for hospital readmissions and a shift from fee-for-service to “value-based” population health management. We are widely recognized by industry analysts as a leader in healthcare payer operations, serving 9 of the top 10 U.S. managed healthcare plans and providing administrative and care management solutions to Medicaid programs and federally funded U.S. government healthcare programs in 23 states, Puerto Rico and the District of Columbia. Two out of every three U.S. insured patients are touched by Conduent. Conduent’s healthcare capabilities have been recognized by NelsonHall, HfS Research and Everest Group.
•Transportation – Traffic congestion continues to increase as urbanization and changing demographics take hold globally. As a result, optimized transportation systems are becoming critical to increase efficiency while maintaining strict safety requirements. Electronic toll collection, public transit and parking all represent key growth drivers as governments at all levels increasingly focus on transportation infrastructure. We are an award-winning innovator in parking management. 46% of U.S. toll services are managed by Conduent and 11 million traveler transactions go through Conduent transportation toll systems daily.
•Transaction Processing – We provide high volume print and mail services, enrollment processing and personalized and targeted marketing and communications to large corporations and are a leading provider in this market with more than 3.6 billion documents captured, indexed and classified annually. We process 89 million invoices annually for our Finance, Accounting and Procurement clients.
Global delivery expertise – Our scale and global delivery network enables us to deliver our proprietary technology, differentiated service offerings and service capabilities expertly to clients around the world. We have operations in 23 countries including India, Philippines, Jamaica, Guatemala, Mexico, Romania, Dominican Republic and several locations within the United States, giving our customers the option for "onshore", "nearshore" or "offshore" outsourced business process services. This global delivery model enables us to leverage lower-cost production locations, consistent methodologies and processes, time zone advantages and business continuity plans. As of December 31, 2019, 51% of our employees were located in high cost countries and 49% were located in low cost countries.
Differentiated suite of multi-industry service offerings at scale – We manage transaction-intensive processes and work directly with end-users to meet their needs often in real-time. We are unique in our ability to offer our clients these business process services on a large scale and with high quality. Additionally, we are able to leverage our cross-industry services to bring the same scale and quality to our portfolio of industry-specific service offerings, such as healthcare claims management, employee benefits management and public transit fare collection.
Recurring revenue model supported by a loyal, diverse client base – We have a broad and diverse base of clients in countries across geographies and industries, including a majority of the Fortune 100 as well as Fortune 1,000 companies and midsize businesses and governmental entities. Our close client relationships and successful client execution support our stable recurring revenue model and high renewal rates. Excluding our strategic decision not to renew certain contracts and the impact of divestitures, renewal rates for 2019 and 2018 were 81% and 95%, respectively.
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Competition
Although we encounter competition in all areas of our portfolio, we lead across certain areas of our principal businesses. We compete on the basis of technology, performance, price, quality, reliability, reputation and customer service and support. In the current political environment in the U.S. and other territories, we also consider our "onshore" delivery capacity to be a competitive advantage. We participate in a highly competitive and rapidly evolving market, driven by changes in industry standards and demands of customers to become more efficient. Our competitors range from large international companies to relatively small firms. Our competitors include:
•Large multinational service providers such as CGI Group, Accenture, Aon Hewitt, Cognizant, Hewlett-Packard Enterprise, Fidelity Information Systems, Bank of America, IBM, Teletech and Teleperformance;
•Traditional Business Process Outsourcing companies such as Genpact, ELX Services, Exela Technologies and WNS Global Services;
•Payroll processing and human capital management providers such as ADP and Paychex;
•Healthcare-focused IT and service solutions providers such as Cerner and Maximus;
•Human resource services providers such as Alight and Willis Towers Watson;
•Health Savings Account administrators such as Health Equity, HSA Bank, and WexHealth;
•U.S. Federal focused government services such as CACI International and DXC Technology;
•Transportation multi-nationals such as Roper/TransCore, Cubic, Kapsch and Verra Mobility; and
•Smaller niche business processing service providers and in-house departments that perform functions that could be outsourced to us.
Sales and Marketing
We market our business process services to both potential and existing clients through our worldwide sales force and our business development team. Additionally, we have dedicated “solution architects” who work with clients to better understand their business requirements and to develop custom-tailored solutions to meet their unique needs.
Our sales and marketing strategy is to go to market by solutions to deliver key industry-specific and cross-industry
services and solutions to our clients. We focus on developing new prospects through market research and analysis, demand generation, renewing expiring contracts and leveraging existing client relationships to offer additional services. We leverage our broad, cross-industry service offerings to package solutions through enterprise selling, while maintaining a disciplined approach to pricing and contracting. Our sales efforts typically involve extended selling cycles and our deep domain and industry expertise is critical to winning new business.
Intellectual Property
Our general policy is to seek patent protection for those inventions likely to be incorporated into our products and services or where obtaining such proprietary rights will improve our competitive position. We own approximately 1,030 patents and pending applications. Our patent portfolio evolves as new patents are awarded to us and as older patents expire. These patents expire at various dates, generally 20 years from their original filing dates. While we believe that our portfolio of patents and applications has value, in general, no single patent is essential to our business or any individual segment. In addition, any of our proprietary rights could be challenged, invalidated or circumvented, or may not provide significant competitive advantages.
Our business relies on software provided to an approximately equal extent, by both internal development and external sourcing to deliver our services. With respect to internally developed software, we claim copyright on all such software, registering works which may be accessible to third parties. In addition, we rely on maintaining source code confidentiality to assure our market competitiveness. With respect to externally sourced software, we rely on contracts assuring our continued access for our business usage.
In the United States, we own 76 trademarks, which are either registered or applied for, reflecting the many businesses we participate in. These trademarks may have a perpetual life, subject to renewal every 10 years and may be subject to cancellation or invalidation based on certain use requirements and third party challenges, or on other grounds. We vigorously enforce and protect our trademarks.
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People and Culture
We draw on the skills, expertise, and experience of our talented and diverse global workforce to deliver mission-critical services and solutions that drive exceptional client outcomes. We have 67,000 associates in 23 countries working towards a common vision and purpose, with 44% located in North America and the remainder located primarily in our delivery centers in India, Philippines, Jamaica, Guatemala and Mexico.
We believe an engaged and motivated workforce is our most important asset, which is why we are focused on building a workplace where our people can do their best work, feel empowered to innovate and put forth new ideas and solutions and have the tools and resources they need to be successful. We take pride in our ‘One Conduent’ culture, which is underpinned by our core values and leadership and teamwork principles. We place a strong emphasis on teamwork and shared success – and we amplify this unity across our associate base through several programs, including employee volunteerism, diversity and inclusion programs and continuous, open and transparent two-way communication.
Corporate Ethics
We operate according to our ethics and compliance program, which is designed to meet general governance and specific industry and regulatory requirements with a focus on values, culture and performance with integrity. Conduent has a business ethics program, which is overseen by the business ethics office, and a code of business conduct (Code), which serves as the foundation of our business ethics program. The Code sets forth our expectations for ethical leadership, performance of job responsibilities and compliance with company policies and the law. In addition, the Code embodies and reinforces Conduent’s commitment to integrity and helps employees resolve ethics and compliance concerns consistent with operating principles and legal and policy controls. In addition, our employees are required to complete business ethics training annually and we periodically solicit their input to gauge the state of Conduent’s ethical culture and help identify areas for improvement.
Our directors must act in accordance with our Code of Business Conduct and Ethics for Members of the Board; our principal executive officer, principal financial officer and principal accounting officer, among others, must act in accordance with our Finance Code of Conduct; and all of our executives and employees must act in accordance with our Code of Business Conduct. Each of these codes of conduct can be accessed through our website at www.conduent.com/corporate-governance. They are also available to any shareholder who requests them in writing addressed to Conduent Incorporated, 100 Campus Drive Suite 200, Florham Park, NJ 07932, Attention: Corporate Secretary. We will disclose any future amendments to, or waivers from, provisions of our Code of Business Conduct and Ethics for members of the Board and, our Code of Business Conduct and our Finance Code of Conduct for our officers on our website as promptly as practicable, and consistent with the requirements of applicable U.S. Securities and Exchange Commission (SEC) and NASDAQ rules.
Seasonality
Our revenues can be affected by various factors such as our clients’ demand pattern for our services, which includes peak windows for benefit enrollment and new product launch by clients.
Availability of Company Information
Our internet address is www.conduent.com. In the Investor Information section of our Internet website, you will find our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, our Proxy Statements and any amendments to these reports and statements. We make these documents available as soon as we can after we have filed them with, or furnished them to, the SEC free of charge.
The SEC maintains an internet address (www.sec.gov) that contains reports, proxy and information statements and other information regarding issuers that file electronically with the SEC. The content on any website referred to in this Form 10-K is nor incorporated by reference in this Form 10-K unless expressly noted.
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Information about our Executive Officers
The following is a list of the executive officers of Conduent as of February 26, 2020, their current ages, their present positions and the year appointed to their present positions.
Each officer is elected to hold office until the meeting of the Board of Directors held on the day of the next annual meeting of shareholders, subject to the provisions of the by-laws.
| Name | Age | Present Position | Year Appointed to Present Position | Conduent Officer Since | ||||||||||||||||||||||
| Clifford Skelton* | 64 | Chief Executive Officer | 2019 | 2019 | ||||||||||||||||||||||
| Brian J. Webb-Walsh | 44 | Executive Vice President & Chief Financial Officer | 2017 | 2017 | ||||||||||||||||||||||
| Mario A. Pompeo | 50 | Vice President & Chief Accounting Officer | 2019 | 2019 | ||||||||||||||||||||||
| Michael Krawitz | 50 | Executive Vice President, General Counsel & Secretary | 2019 | 2019 | ||||||||||||||||||||||
| Mark Brewer | 55 | Executive Vice President & President–Public Sector | 2019 | 2019 | ||||||||||||||||||||||
_____________________________
*Member of Conduent Board of Directors
Each of the officers named above has been an officer or an executive of Conduent or its subsidiaries for less than five years.
Mr. Skelton was appointed Chief Operating Officer of Conduent in June 2019 and Chief Executive Officer of Conduent in August 2019. He served as President of Fiserv Output Solutions from March 2017 to June 2019. Prior to that, Mr. Skelton was the Group President and Chief Information Officer at Fiserv from April 2012 until March 2017. Mr. Skelton also held a variety of leadership roles at companies such as Ally Financial (formerly General Motors Acceptance Corporation) and Bank of America. Mr. Skelton is a former Navy fighter pilot and served in the Navy for over 20 years.
Mr. Webb-Walsh served as the Chief Financial Officer of Xerox Services since January 2016. Prior to this, Mr. Webb-Walsh was Senior Vice President of Finance for the Government Healthcare Group and the Platform Development and Systems Integration Group of Xerox Services. Mr. Webb-Walsh joined Xerox Corporation in 1997 and has held a variety of leadership positions.
Mr. Pompeo previously served as Chief Audit Executive of Conduent since 2017 and was appointed Chief Accounting Officer of Conduent in June 2019. Prior to joining Conduent, Mr. Pompeo was a partner and the National Chief Financial Officer (CFO) Advisory Services Leader at CohnReznick, LLP from 2015 – 2017 and served as Senior Vice President – Finance & CFO of Stuart Weitzman, Inc. from 2013 – 2015. He began his accounting career in the Assurance and Business Advisory Practice of PricewaterhouseCoopers, LLP.
Mr. Michael Krawitz served as Executive Vice President, General Counsel and Secretary since November 2019. Prior to joining Conduent, from June 2015 to November, 2019, Mr. Krawitz was Executive Vice President, General Counsel and Corporate Secretary of insurance services firm York Risk Services Group, a portfolio company of Onex Corp. From 2014 to 2015, he was Chief Legal Officer of Veriteq Corp., a biotech company. From 1999 to 2014, Mr. Krawitz held leadership roles in public and private companies in technology and finance sectors. Mr. Krawitz began his career at Fried Frank and was educated at Cornell University and Harvard Law School.
Mr. Brewer joined Conduent as Executive Vice President & President – Public Sector in June 2019. Prior to joining Conduent, he served as Senior Vice President and Managing Director of Diebold Nixdorf from 2018 to 2019. Prior to that Mr. Brewer was Global Vice President for DXC’s Technology, Enterprise Application and Cloud Businesses from 2016 to 2018. He also held a variety of Senior Executive leadership roles at IBM Corporation for over 20 years, in Europe, Asia and the Americas. Mr. Brewer has served as a member of several boards of global companies, including IBM Australia and Softlayer, and has advised clients and boards around the world on changes that will fundamentally transform their businesses.
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ITEM 1A. RISK FACTORS
Our government contracts are subject to appropriation of funds, termination rights, audits and investigations, which, if exercised, could negatively impact our reputation and reduce our ability to compete for new contracts.
A significant portion of our revenues is derived from contracts with U.S. federal, state and local governments and their agencies, and some of our revenues are derived from contracts with foreign governments and their agencies. Government entities typically finance projects through appropriated funds. While these projects are often planned and executed as multi-year projects, government entities usually reserve the right to change the scope of or terminate these projects for lack of approved funding and/or at their convenience. Changes in government or political developments, including budget deficits, shortfalls or uncertainties, failures to enact appropriation legislation (e.g., a government "shut-down"), government spending reductions (e.g., Congressional sequestration of funds under the Budget Control Act of 2011) or other debt or funding constraints, have result in and in the future could result in lower governmental sales and in our projects being reduced in price or scope or terminated altogether, which also could limit our recovery of incurred costs, reimbursable expenses and profits on work completed prior to the termination. Additionally, if the government discovers what it considers to be improper or illegal activities or contractual non-compliance (including improper billing or non-compliant performance of contract requirements), we may be subject to various civil and criminal penalties and administrative sanctions, which has occurred in the past and may in the future include termination of contracts, forfeiture of profits, suspension of payments, contractual service penalties, fines and suspensions or debarment from doing business with the government. Any resulting penalties or sanctions could materially adversely affect our results of operations and financial condition. Moreover, government contracts are generally subject to audits and investigations by government agencies. If the government finds that we inappropriately charged any costs to a contract, the costs are not reimbursable or, if already reimbursed, the cost must be refunded to the government. Further, the negative publicity that could arise from any such penalties, sanctions or findings in such audits or investigations could have an adverse effect on our reputation in the industry and reduce our ability to compete for new contracts and could materially adversely affect our results of operations and financial condition.
We derive significant revenue and profit from commercial and government contracts awarded through competitive bidding processes, including renewals, which can impose substantial costs on us, and we will not achieve revenue and profit objectives if we fail to accurately and effectively bid on such projects.
Many of these contracts are extremely complex and require the investment of significant resources in order to prepare accurate bids and proposals. Competitive bidding imposes substantial costs and presents a number of risks, including: (i) the substantial cost and managerial time and effort that we spend to prepare bids and proposals for contracts that may or may not be awarded to us; (ii) the need to estimate accurately the resources and costs that will be required to implement and service any contracts we are awarded, sometimes in advance of the final determination of their full scope and design; (iii) the expense and delay that may arise if our competitors protest or challenge awards made to us pursuant to competitive bidding and the risk that such protests or challenges could result in the requirement to resubmit bids and in the termination, reduction or modification of the awarded contracts; and (iv) the opportunity cost of not bidding on and winning other contracts we might otherwise pursue. If our competitors protest or challenge an award made to us on a government contract, the costs to defend such an award may be significant and could involve subsequent litigation that could take years to resolve.
Our ability to recover capital and other investments in connection with our contracts is subject to risk.
In order to attract and retain large outsourcing contracts, we sometimes make significant capital and other investments to enable us to perform our services under those contracts, such as purchases of information technology equipment, facility costs, labor resources and costs incurred to develop and implement software. The net book value of certain assets recorded, including a portion of our intangible assets, could be impaired, and our results of operations and financial condition could be materially adversely affected in the event of the early termination of all or a part of such a contract or a reduction in volumes and services thereunder for reasons such as a customer’s or client’s merger or acquisition, divestiture of assets or businesses, business failure or deterioration or a customer’s or client’s exercise of contract termination rights.
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We rely to a significant extent on third-party providers, such as subcontractors, a relatively small number of primary software vendors, utility providers and network providers; if they cannot deliver or perform as expected or if our relationships with them are terminated or otherwise change, our results of operations and financial condition could be materially adversely affected.
Our ability to service our customers and clients and deliver and implement solutions depends to a large extent on third-party providers such as subcontractors, a relatively small number of primary software vendors, software application developers, utility providers and network providers meeting their obligations to us and our expectations in a timely, quality manner. We have experienced suboptimal performance from an inherited legacy technology vendor, which has caused certain operational challenges and customer delivery performance issues that we have been aggressively addressing. Our results of operations and financial condition have been and in the future may be materially adversely affected and we might incur significant additional liabilities (a) if we are unable to adequately renegotiate these legacy contracts, or (b) if any of our third-party providers (1) do not meet their service level obligations, (2) do not meet our or our clients’ expectations, (3) terminate or refuse to renew their relationships with us, or (4) offer their products to us with less advantageous prices and other terms than previously offered.
Failure to deliver on our contractual obligations properly and on time could materially adversely affect our
results of operations and financial condition.
Our business model depends in large part on our ability to retain existing and attract new work from our base of existing clients, as well as on relationships we develop with our clients so that we can understand our clients’ needs and deliver solutions and services that are tailored to meet those needs. In order for our business to grow, we must successfully manage the provision of services under our contracts. If a client is not satisfied with the quality of work performed by us or a subcontractor, or with the type of services or solutions delivered, or if we or our subcontractors fail to perform in accordance with contract requirements, then we could incur additional costs to address the situation, the profitability of that work might be impaired and the client’s dissatisfaction with our services could damage our ability to obtain additional work from that client or obtain new work from other potential clients. In particular, many of our contracts with non-government clients may be terminated by the client, without cause, upon specified advance notice. Accordingly, clients who are not satisfied might seek to terminate existing contracts prior to their scheduled expiration date, which may result in our inability to fully recover our up-front investments. In addition, clients could direct future business to our competitors. We could also trigger contractual credits to clients or a contractual default. Failure to properly transition new clients to our systems, properly budget transition costs or accurately estimate contract operational costs could result in delays in our contract performance, trigger service level penalties, impair fixed or intangible assets or result in contract profit margins that do not meet our expectations or our historical profit margins.
In addition, we incur significant expenditures for the development and construction of system software platforms needed to support our clients’ needs. Our failure to fully understand client requirements or implement the appropriate operating systems or databases or solutions which enable the use of other supporting software may delay the project and result in cost overruns or potential impairment of the related software platforms, which could materially adversely affect our results of operations and financial condition.
We face significant competition and our failure to compete successfully could materially adversely affect our results of operations and financial condition.
To remain competitive, we must develop services and applications, periodically enhance our existing offerings, remain cost efficient and attract and retain key personnel and management. If we are unable to compete successfully, we could lose market share and important customers to our competitors and that could materially adversely affect our results of operations and financial condition.
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We have recorded significant goodwill impairment charges and may be required to record additional charges to future earnings if our goodwill or intangible assets become impaired.
We are required under generally accepted accounting principles to review our intangible assets for impairment when events or changes in circumstances indicate the carrying value may not be recoverable. Goodwill is required to be tested for impairment at least annually. Factors that may be considered a change in circumstances indicating that the carrying value of our intangible assets and/or goodwill may not be recoverable include a decline in stock price and market capitalization, slower growth rates in our industry or our own operations, and/or other materially adverse events that have implications on the profitability of our business or business segments. We may be required to record additional charges to earnings during the period in which any impairment of our goodwill or other intangible assets is determined which could adversely impact our results of operations. As of December 31, 2019, our goodwill balance was $1.5 billion, which represented 33.3% of total consolidated assets. Refer to Note 8 – Goodwill and Intangible Assets, Net to our Consolidated Financial Statements for additional information about our goodwill impairment.
Our significant indebtedness could materially adversely affect our results of operations and financial condition.
We have and will continue to have a significant amount of debt and other obligations. Our substantial debt and other obligations could have important consequences. For example, it could (i) increase our vulnerability to general adverse economic and industry conditions; (ii) limit our ability to obtain additional financing for future working capital, capital expenditures, acquisitions and other general corporate requirements; (iii) require us to dedicate a substantial portion of our cash flows from operations to service debt and other obligations thereby reducing the availability of our cash flows from operations for other purposes; (iv) limit our flexibility in planning for, or reacting to, changes in our businesses and the industries in which we operate; (v) place us at a competitive disadvantage compared to our competitors that have less debt; and (vi) become due and payable upon a change in control. If new debt is added to our current debt levels, these related risks could increase.
Our ability to make payments on and to refinance our indebtedness, as well as any future debt that we may incur, will depend on our ability to generate cash in the future from operations, financings or asset sales. Our ability to generate cash is subject to general economic, financial, competitive, legislative, regulatory and other factors that are beyond our control.
The terms of our indebtedness may restrict our current and future operations, particularly our ability to incur debt that we may need to fund initiatives in response to changes in our business, the industries in which we operate, the economy and governmental regulations.
The terms of our indebtedness include a number of restrictive covenants that impose significant operating and financial restrictions on us and our subsidiaries and limit our ability to engage in actions that may be in our long-term best interests. These may restrict our and our subsidiaries’ ability to take some or all of the following actions:
•incur or guarantee additional indebtedness or sell disqualified or preferred stock;
•pay dividends on, make distributions in respect of, repurchase or redeem, capital stock;
•make investments or acquisitions;
•sell, transfer or otherwise dispose of certain assets, including accounts receivable;
•create liens;
•enter into sale/leaseback transactions;
•enter into agreements restricting the ability to pay dividends or make other intercompany transfers;
•consolidate, merge, sell or otherwise dispose of all or substantially all of our or our subsidiaries’ assets;
•enter into transactions with affiliates;
•prepay, repurchase or redeem certain kinds of indebtedness;
•issue or sell stock of our subsidiaries; and/or
•significantly change the nature of our business.
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As a result of all of these restrictions, we may be:
•limited in how we conduct our business and pursue our strategy;
•unable to raise additional debt financing to operate during general economic or business downturns; or
•unable to compete effectively or to take advantage of new business opportunities.
A breach of any of the restrictive covenants, if applicable, could result in an event of default under the terms of this indebtedness. If an event of default occurs, the lenders would have the right to accelerate the repayment of such debt and the event of default or acceleration may result in the acceleration of the repayment of any other of our debt to which a cross-default or cross-acceleration provision applies. Furthermore, under this indebtedness we have pledged our assets as collateral as security for our repayment obligations. If we were unable to repay any amount of this indebtedness when due and payable, the lenders could proceed against the collateral that secures this indebtedness. In the event our creditors accelerate the repayment of our borrowings, we may not have sufficient assets to repay such indebtedness, which could materially adversely affect our results of operations and financial condition.
In addition, our credit facility bears interest at a rate that varies depending on the LIBOR. On July 27, 2017, the UK's Financial Conduct Authority, which regulates LIBOR, announced that it intends to phase out LIBOR by the end of 2021. It is unclear if at that time LIBOR will cease to exist or if new methods of calculating LIBOR will be established such that it continues to exist after 2021. The U.S. Federal Reserve, in conjunction with the Alternative Reference Rates Committee, a steering committee comprised of large U.S. financial institutions, announced replacement of U.S. dollar LIBOR with a new index calculated by short-term repurchase agreements, backed by U.S. Treasury securities called the Secured Overnight Financing Rate ("SOFR"). The first publication of SOFR was released in April 2018. Whether or not SOFR attains market traction as a LIBOR replacement tool remains in question and the future of LIBOR at this time is uncertain. If LIBOR rates are no longer available, our costs of borrowings under our credit facilities may be negatively impacted, which could have an adverse effect on our results of operations.
Our business is dependent on continued interest in outsourcing.
Our business and growth depend in large part on continued interest in outsourced business process services. Outsourcing means that an entity contracts with a third-party, such as us, to provide business process services rather than perform such services in-house. There can be no assurance that this interest will continue, as organizations may elect to perform such services themselves and/or the business process outsourcing industry could move to an as-a-Service model, thereby eliminating traditional business process outsourcing tasks. A significant change in this interest in outsourcing could materially adversely affect our results of operations and financial condition. Additionally, there can be no assurance that our cross-selling efforts will cause clients to purchase additional services from us or adopt a single-source outsourcing approach.
Our profitability is dependent upon our ability to obtain adequate pricing for our services and to improve our cost structure.
Our success depends on our ability to obtain adequate pricing for our services that will provide a reasonable return to our shareholders. Depending on competitive market factors, future prices we obtain for our services may decline from previous levels. If we are unable to obtain adequate pricing for our services, it could materially adversely affect our results of operations and financial condition. In addition, our contracts are increasingly requiring tighter timelines for implementation as well as more stringent service level metrics. This makes the bidding process for new contracts much more difficult and requires us to adequately consider these requirements in the pricing of our services.
In order to meet the service requirements of our customers, which often includes 24/7 service, and to optimize our employee cost base, including our back-office support, we often locate our delivery service and back-office support centers in lower-cost locations, including several developing countries. Concentrating our centers in these locations presents a number of operational risks, many of which are beyond our control, including the risks of political instability, natural disasters, safety and security risks, labor disruptions, excessive employee turnover and rising labor rates. Additionally, a change in the political environment in the United States or the adoption and enforcement of legislation and regulations curbing the use of such centers outside of the United States could materially adversely affect our results of operations and financial condition. These risks could impair our ability to effectively provide services to our customers and keep our costs aligned to our associated revenues and market requirements.
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Our ability to sustain and improve profit margins is dependent on a number of factors, including our ability to continue to improve the cost efficiency of our operations through such programs as robotic process automation, to absorb the level of pricing pressures on our services through cost improvements and to successfully complete information technology initiatives. If any of these factors adversely materialize or if we are unable to achieve and maintain productivity improvements through restructuring actions or information technology initiatives, our ability to offset labor cost inflation and competitive price pressures would be impaired, each of which could materially adversely affect our results of operations and financial condition.
Our business may be adversely affected by geopolitical events, natural disasters and other factors that could directly impact certain of our employees, customers and vendors in countries or regions effected by such events and factors.
We have a global workforce and global customers. Our employees and customers in a particular country or region in the world may be impacted as a result of a variety of diversions, including: geopolitical events, such as war, the threat of war, or terrorist activity; natural disasters or the effects of climate change (such as drought, flooding, wildfires, increased storm severity, and sea level rise); power shortages or outages, major public health issues, including pandemics (such as the coronavirus); and significant local, national or global events capturing the attention of a large part of the population. If any of these, or any other factors, disrupt a country or region where we have a significant workforce (such as the U.S., India or the Philippines) or customers (such as the U.S. or Europe), or vendors, our business could be materially adversely affected.
We may be subject to claims of infringement of third-party intellectual property rights which could adversely affect our results of operation and financial condition.
We rely heavily on the use of intellectual property. We do not own all of the software that we use to run our business; instead we license this software from a small number of primary vendors. If these vendors assert claims that we or our clients are infringing on their software or related intellectual property, we could incur substantial costs to defend these claims, which could materially adversely affect our results of operations and financial condition. In addition, if any of our vendors’ infringement claims are ultimately successful, our vendors could require us to (i) cease selling or using products or services that incorporate the challenged software or technology, (ii) obtain a license or additional licenses from our vendors or (iii) redesign our services which rely on the challenged software or technology. In addition, we may be exposed to claims for monetary damages. If we are unsuccessful in defending an infringement claim and our vendors require us to initiate any of the above actions, or we are required to pay monetary damages, then such actions could materially adversely affect our results of operations and financial condition.
We are subject to laws of the United States and foreign jurisdictions relating to individually identifiable information and personal health information, and failure to comply with those laws, whether or not inadvertent, could subject us to legal actions and negatively impact our operations.
We receive, process, transmit and store information relating to identifiable individuals, both in our role as a service provider and as an employer. As a result, we are subject to numerous laws and regulations in the United States (both federal and state) and foreign laws and regulations designed to protect both individually identifiable information and personal health information, including the Health Insurance Portability and Accountability Act of 1996, as amended (“HIPAA”), and the regulations promulgated under HIPPA governing, among other things, the privacy, security and electronic transmission of individually identifiable health information, and the European Union General Data Protection Regulation (GDPR) (effective May 25, 2018), which imposes stringent data protection requirements and significant penalties for noncompliance and has had a significant impact on how we process and handle certain data.
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Additional laws of the United States and foreign jurisdictions apply to our processing of individually identifiable information. These laws have been subject to frequent changes, and new legislation in this area may be enacted at any time. For example, the GDPR and the invalidation of the U.S.-EU Safe Harbor regime have required us to implement alternative mechanisms in order for some of our data flows from Europe to the United States to comply with applicable law. Changes to existing laws, the introduction of new laws in this area or our failure to comply with existing laws that are applicable to us may subject us to, among other things, additional costs or changes to our business practices, liability for monetary damages, fines and/or criminal prosecution, unfavorable publicity, restrictions on our ability to obtain and process information and allegations by our customers and clients that we have not performed our contractual obligations, any of which could materially adversely affect our results of operations and financial condition.
We are subject to laws of the United States and foreign jurisdictions relating to processing certain financial
transactions, including payment card transactions and debit or credit card transactions, and failure to comply with those laws, whether or not inadvertent, could subject us to legal actions and materially adversely affect our results of operations and financial condition.
We process, support and execute financial transactions, and disburse funds, on behalf of both government and commercial customers, often in partnership with financial institutions. This activity includes receiving debit and credit card information, processing payments for and due to our customers and disbursing funds on payment or debit cards to payees of our customers. As a result, we are subject to numerous laws and regulations in the United States (both federal and state) and in foreign jurisdictions, including the Electronic Fund Transfer Act, as amended, the Currency and Foreign Transactions Reporting Act of 1970 (commonly known as the Bank Secrecy Act), as amended, the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (including the so-called Durbin Amendment), as amended, the Gramm-Leach-Bliley Act (also known as the Financial Modernization Act of 1999), as amended, and the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism (USA PATRIOT ACT) Act of 2001, as amended. Other United States (both federal and state) and foreign jurisdiction laws apply to our processing of certain financial transactions and related support services. These laws are subject to frequent changes, and new statutes and regulations in this area may be enacted at any time. Changes to existing laws, the introduction of new laws in this area or our failure to comply with existing laws that are applicable to us may subject us to, among other things, additional costs or changes to our business practices, liability for monetary damages, fines and civil and/or criminal prosecution, unfavorable publicity, restrictions on our ability to process and support financial transactions and allegations by our customers, partners and clients that we have not performed our contractual obligations. Any of these could materially adversely affect our results of operations and financial condition.
Our data systems, information systems and network infrastructure may be subject to hacking or other cybersecurity threats and other service interruptions, which could expose us to liability, impair our reputation or temporarily render us unable to fulfill our service obligations under our contracts.
We are a leading provider of business processing services concentrated in transaction-intensive processing, analytics and automation. We act as a trusted business partner in both front office and back office platforms, providing interactions on a substantial scale with our customers and other third-parties. Our customers include global commercial clients and government clients who depend upon our operational efficiency, non-interruption of service, and accuracy and security of information. We also use third-party providers such as subcontractors, software vendors, utility providers and network providers, upon whom we rely for our business processing services, to deliver uninterrupted, secure service. As part of our business processing services we also develop system software platforms necessary to support our customers’ needs, with significant ongoing investment in developing and operating customer-appropriate operating systems, data bases and system software solutions. We also receive, process, transmit and store substantial volumes of information relating to identifiable individuals, both in our role as a service provider and as an employer, and we are subject to numerous laws, rules and regulations in the United States (both federal and state) and foreign jurisdictions designed to protect both individually identifiable information as well as personal health information. We also receive, process and implement financial transactions, and disburse funds, on behalf of both commercial and government customers, which activity includes receiving debit and credit card information to process payments due to our customers as well as disbursing funds to payees of our customers. As a result of these and other business processing services, the integrity, security, accuracy and non-interruption of our systems and information technology and that of our third-party providers and our interfaces with our customers are extremely important to our business, operating results, growth, prospects and reputation.
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We have implemented security systems and controls, both directly and with third-party subcontractors and service providers, with the intent of maintaining both the physical security of our facilities and the data security of our customers’, clients’ and suppliers’ confidential information and information related to identifiable individuals (including payment card and debit and credit card information and health information) against unauthorized access through our information systems or by other electronic transmission or through the misdirection, theft or loss of physical media. These include, for example, the appropriate encryption of information. Despite such efforts, we are susceptible to breach of security systems which may result in unauthorized access to our facilities and those of our customers and/or the information we and our customers are trying to protect. Cybersecurity failure might be caused by computer hacking, malware, computer viruses, worms and other destructive software, “cyber-attacks” and other malicious activity, as well as natural disasters, power outages, terrorist attacks and similar events. Operational or business delays may also result from the disruption of network or information systems and subsequent remediation activities.
Because the techniques used to obtain unauthorized access are constantly changing and becoming increasingly more sophisticated and often are not recognized until launched against a target, we or our third-party service providers may be unable to anticipate these techniques or implement sufficient preventative measures. Hacking, malware, phishing, viruses and other “cyber-attacks” have become more prevalent, have occurred in our systems in the past, and may occur in our systems in the future. Although we have implemented and intend to continue to implement what we believe to be appropriate cyber practices and cybersecurity systems, these systems may prove to be inadequate and result in the disruption, failure, misappropriation or corruption of our network and information systems. Notwithstanding the preventative and protective measures we have in place, it may not be possible for us to fully or timely know if or when such incidents arise, or the full business impact of any cybersecurity breach.
Additionally, with advances in computer capabilities and data protection requirements to address ongoing threats, we may be required to expend significant capital and other resources to protect against potential security breaches or to alleviate problems caused by security breaches. Moreover, employee error or malfeasance, faulty password management or other irregularities may result in a defeat of our or our third-party service providers’ security measures and a breach of our or our third-party service providers’ information systems (whether digital, cloud-based or otherwise).
If unauthorized parties gain physical access to one of our or one of our third-party service providers’ facilities or gain electronic access to our or one of our third-party service providers’ information systems, such access could result in, among other things, unfavorable publicity and significant damage to our brand, governmental inquiry, oversight and possible regulatory action, difficulty in marketing our services, loss of existing and potential customers, allegations by our customers that we have not performed our contractual obligations, litigation by affected parties and possible financial obligations for substantial damages related to the theft or misuse of such information, any of which could materially adversely affect our results of operations and financial condition. Similar consequences may arise if sensitive or confidential information is misdirected, lost or stolen during transmission or transport, or is stolen or misused. Moreover, a security breach could require us to devote significant management resources to address the problems created by the security breach and to expend significant additional resources to upgrade further the security measures that we employ to guard such personal information against "cyber-attacks" and to maintain various systems and data centers for our customers. Often these systems and data centers must be maintained worldwide and on a 24/7 basis. Although we endeavor to ensure that there is adequate backup and maintenance of these systems and centers, we have in the past experienced and in the future could experience service interruptions that could result in curtailed operations and loss of existing and potential customers, which could significantly reduce our revenues and profits in addition to significantly impairing our reputation. If our information systems and our back-up systems are damaged, breached or cease to function properly, we may have to make a significant investment to repair or replace them, and we may suffer interruptions in our operations in the interim, each of which could materially adversely affect our results of operations and financial condition and diminish the value of our shares.
In addition, our and our customers’ systems and networks are subject to continued threats of terrorism, which could disrupt our operations as well as disrupt the utilities and telecommunications infrastructure on which our business depends. To the extent any such disruptions were to occur, our business, operating results and financial condition could be materially adversely affected.
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If we underestimate the scope of work or the costs entailed in performing our contracts, or if we do not fully perform our contracts, our results of operations and financial condition could be materially adversely affected.
In order to stay competitive in our industry, we must keep pace with changing technologies and customer preferences. Many of our contracts require us to design, develop and implement new technological and operating systems for our customers. Many of these systems involve detailed and complex computer source code which must be created and integrated into a working system that meets contract specifications. The accounting for these contracts requires judgment relative to assessing risks, estimating contract revenues and costs and making assumptions for schedule and technical issues. To varying degrees, each contract type involves some risk that we could underestimate the costs and resources necessary to fulfill the contract. In each case, our failure to accurately estimate costs or the resources and technology needed to perform our contracts or to effectively manage and control our costs during the performance of our work could result, and in some instances has resulted, in reduced profits or in losses. In addition, many of our contracts contain complicated performance obligations, including, without limitation, designing and building new integrated computer systems. These contracts carry potential financial penalties or could result in financial damages or exposures if we fail to properly perform those obligations and have in the past resulted in and in the future could result in our results of operations and financial condition being materially adversely affected.
Our continuing emphasis and shift toward technology-led digital transactions, rather than more labor intensive commoditized services, could impact our type and timing of the customer contracts that we enter into, particularly in the short-term.
We have made the strategic decision to increase our focus on technology-led digital transactions and focus less on historic labor-intensive commoditized services and customer contracts. We believe technology-led digital transactions are becoming, and will become, the type of services required by many of our customers and those in the industry. We believe that our continuing focus on digital transactions will better create long-term value and increased profitability. However, this increased emphasis on technology-led digital transactions has resulted in and will continue to result in our exiting certain services and contracts, and could adversely impact our revenues and our results of operations, particularly in the short-term.
Our customers’ decision-making cycles are changing and the lead time for customers to commit to contracts with us has been lengthening.
As our services industry and our service offerings change and evolve, particularly with our customers increasing their focus on digital offerings, our customers are spending increased time and resources evaluating technology and other investments needed to obtain optimal results and performance, including from their outsourcing providers including the Company. This has led to longer sales lead time cycles for contract commitments from our customers, which can adversely affect the timing of customer commitments and our revenues and results of operations.
If we are unable to collect our receivables for billed or unbilled services, our results of operations and financial condition could be materially adversely affected.
The profitability of certain of our large contracts depends on our ability to successfully obtain payment from our clients of the amounts they owe us for work performed. Actual losses on client balances could differ from current estimates and, as a result, may require adjustment of our receivables for unbilled services. Our receivables include long-term contracts. Over the course of a long-term contract, our customers’ financial condition may change such that their ability to pay their obligations, and our ability to collect our fees for services rendered, is adversely affected. Additionally, we may perform work for the federal, state and local governments, with respect to which we must file requests for equitable adjustment or claims with the proper agency to seek recovery in whole or in part, for out-of-scope work directed or caused by the government customer in support of its project, and the amounts of such recoveries may not meet our expectations or cover our costs. Timely collection of client balances also depends on our ability to complete our contractual commitments (such as our ability to achieve specified milestones in percentage-of-completion contracts) and bill and collect our contracted revenues. If we are unable to meet our contractual requirements, we might experience delays in collection of and/or be unable to collect our client balances, and if this occurs, our results of operations and cash flows could be adversely affected. In addition, if we experience an increase in the time to bill and collect for our services, our results of operations and financial condition could be materially adversely affected.
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A decline in revenues from or a loss or failure of significant clients could materially adversely affect our
results of operations and financial condition.
Our results of operations and financial condition could be materially adversely affected by the loss or failure of significant clients or any significant reduction in revenue volumes from our significant customers, which has occurred in the past and could occur in the future. Some of our clients are in business sectors which have experienced significant financial difficulties or consolidation, and/or the reduction of volumes or their inability to make payments to us, as a result of, among other things, their merger or acquisition, divestiture of assets or businesses, contract expiration, nonrenewal or early termination (including termination for convenience) or business or financial failure or deterioration. Economic and political conditions could affect our clients’ businesses and the markets they serve. Competition from other service providers and bringing these services in-house could also be expected to adversely impact out services revenues.
We have non-recurring revenue, which subjects us to a risk that our revenues and cash flows from operations may fluctuate from period to period.
Revenue generated from our non-recurring services may fluctuate due to factors both within and outside of our control. Our mix of non-recurring and recurring revenues is impacted by acquisitions as well as growth in our non-recurring lines of business, as well as our strategic decisions to exit or reduce our services in particular service areas. There is less predictability and certainty in the timing and amount of revenues generated by our non-recurring services and, accordingly, our results of operations and financial condition could be materially adversely affected by the timing and amount of revenues generated from our non-recurring services.
The failure to obtain or maintain a satisfactory credit rating could adversely affect our liquidity, capital position, borrowing costs, access to capital markets and ability to post surety or performance bonds to support clients’ contracts.
Any future downgrades to our credit rating could negatively impact our ability to renew contracts with our existing clients, limit our ability to compete for new clients, result in increased premiums for surety or performance bonds to support our clients’ contracts and/or result in a requirement that we provide collateral to secure our surety or performance bonds. Further, certain of our commercial outsourcing contracts provide that, in the event our credit ratings are downgraded to specified levels, the client may elect to terminate its contract with us and either pay a reduced termination fee or, in some limited instances, no termination fee. Such a credit rating downgrade could adversely affect these client relationships.
There can be no assurance that we will be able to maintain our credit ratings. Any additional actual or anticipated downgrades of our credit ratings, including any announcement that our ratings are under review for a downgrade, may have a negative impact on our liquidity, capital position and access to capital markets.
The loss of key senior management or the failure to attract and retain necessary technical personnel and qualified subcontractors could materially adversely affect our results of operations and financial condition.
Our success depends, in part, upon key managerial and technical personnel, including our ability to attract and retain additional qualified personnel, as well as qualified subcontractors. The loss of certain key personnel, such as our Chief Executive Officer (CEO), could materially adversely affect our results of operations and financial condition. On May 8, 2019, we announced Ashok Vemuri’s plan to step down as CEO. On August 6, 2019, our Board of Directors transitioned Mr. Vemuri out as CEO and he resigned as a Director. Also, on August 6, 2019, the Board of Directors appointed Clifford Skelton to serve as CEO and as a Director on the Board to fill the vacancy created by Mr. Vemuri’s departure. There is no assurance that we can retain our key managerial personnel, or that we can attract similar employees, in the future.
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In addition, because we operate in intensely competitive markets, our success depends to a significant extent upon our ability to attract, retain and motivate highly skilled and qualified technical personnel and to subcontract with qualified, competent subcontractors. If we fail to attract, train and retain sufficient numbers of qualified engineers, technical staff and sales and marketing representatives, or if we are unable to contract with qualified, competent subcontractors, our results of operations and financial condition could be materially adversely affected. Experienced and capable personnel in the services industry remain in high demand, and there is continual competition for their talents. Our ability to renegotiate certain of our legacy third-party contracts which we view as unfavorable, or to improve the service levels we expect from these contracts and third-party providers, is key to our ability to timely, efficiently and profitably deliver our services to our customers. Additionally, we have increased and expect to continue to increase our hiring in geographic areas outside of the United States, which could subject us to increased geopolitical and exchange rate risk. The loss of any key technical employee, the loss of a key subcontractor relationship or our inability to renegotiate or obtain required service levels from legacy and other third-party providers, could materially adversely affect our results of operations and financial condition.
Increases in the cost of telephone and data services or significant interruptions in such services could
materially adversely affect our results of operations and financial condition.
Our business is significantly dependent on telephone and data service provided by various local and long distance telephone and data service providers around the world. Accordingly, any disruption of these services could materially adversely affect our results of operations and financial condition. We have taken steps to mitigate our exposure to service disruptions by investing in redundant circuits, although there is no assurance that the redundant circuits would not also suffer disruption. Any inability to obtain telephone or data services at favorable rates could materially adversely affect our results of operations and financial condition. Where possible, we have entered into long-term contracts with various providers to mitigate short-term rate increases and fluctuations. There is no obligation, however, for the vendors to renew their contracts with us, or to offer the same or lower rates in the future, and such contracts are subject to termination or modification for various reasons outside of our control. A significant increase in the cost of telephone or data services that is not recoverable through an increase in the price of our services could materially adversely affect our results of operations and financial condition. In addition, a number of our facilities are located in jurisdictions outside of the United States where the provision of utility services, including electricity and water, may not be consistently reliable, and while there are backup systems in many of our operating facilities, an extended outage of utility or network services could materially adversely affect our results of operations and financial condition.
If we fail to successfully develop new service offerings, including new technology components, and protect our intellectual property rights, we may be unable to retain current customers and gain new customers and our revenues would decline.
The process of developing new service offerings, including new technology components, is inherently complex and uncertain. It requires accurate anticipation of customers’ changing needs and emerging technological trends. We must make long-term investments and commit significant resources before knowing whether these investments will eventually result in service offerings that achieve customer acceptance and generate the revenues required to provide desired returns. For example, establishing internal automation processes to help us develop new service offerings will require significant up-front costs and resources, which, if not monetized effectively, could materially adversely affect our revenues. In addition, some of our service offerings rely on technologies developed by and licensed from third-parties. We may not be able to obtain or continue to obtain licenses and technologies from these third-parties at all or on reasonable terms, or such third-parties may demand cross-licenses to our intellectual property. It is also possible that our intellectual property rights could be challenged, invalidated or circumvented, allowing others to use our intellectual property to our competitive detriment. We also must ensure that all of our service offerings comply with both existing and newly enacted regulatory requirements in the countries in which they are sold. If we fail to accurately anticipate and meet our customers’ needs through the development of new service offerings (including technology components) or if we fail to adequately protect our intellectual property rights or if our new service offerings are not widely accepted or if our current or future service offerings fail to meet applicable worldwide regulatory requirements, we could lose market share and customers to our competitors and that could materially adversely affect our results of operations and financial condition.
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The Company’s business, operating results and reputation may be negatively impacted by failures or delays in our efforts to modernize our information technology infrastructure and to consolidate to fewer data centers.
We have experienced certain disruptions in our operations and service delivery performance issues as a result of some of our information technology infrastructure that is outdated and needs to be enhanced and updated, which disruptions have adversely impacted client and delivery performance. As a result, we are investing in modernizing a significant portion of our information technology infrastructure with new systems and processes and consolidating our data centers as part of our transformation initiatives. This also includes investments in our data center and networks, enhancement, modernization and consolidation of our IT infrastructure and customer-facing technologies, enhanced cybersecurity and movement to cloud-based technology. We expect that these changes will provide greater strategic and operational flexibility and efficiency and better control of our systems and processes. There is a risk, however, that our modernization efforts and data center consolidations could materially and adversely disrupt our operations and our service delivery to customers, could result in contractual penalties or damage claims from customers, could occur over a period longer than planned, and could require greater than expected investment and other internal and external resources. It may also take longer to realize the intended favorable benefits from an enhanced technology infrastructure than we expected, or that disruptions may continue to occur while we enhance this infrastructure.
The process of consolidating our data center involves inherent risks and may cause disruptions to our operations. In October 2018, we suffered a significant outage as a result of a data center migration, which resulted in unplanned system unavailability and disruption for our customers. We plan to undertake several data center migrations in the future and, in the course of these data migrations, could potentially experience significant service outages. Future service disruptions could hinder our ability to attract new customers, cause us to incur legal liability, contractual penalties or issue service credits to our customers and cause us to lose current customers, each of which could have a material adverse effect on our business, financial condition and results of operations.
If we fail to meet industry data security standards, our ability to meet contractual obligations may be impaired and result in contractual damage or contract breach claims.
In some of our services lines, we are contractually subject to industry data security standards. These industry data security standards include Card Brand (Visa, Mastercard, American Express, Discover and JCB) operating rules, certification requirements and rules governing electronic funds transfers, including the Payment Card Industry Data Security Standard (PCI DSS), a data security standard applicable to companies that collect, store or transmit payment card data. Another industry standard is the Health Information Trust Alliance (HITRUST) which applies to aspects of the healthcare industry and in addition to other industries. While we are taking steps to achieve future compliance and/or certification for our systems, we may not be compliant now, and in the future we may not be able to maintain compliance with PCI DSS, HITRUST and other applicable industry standards. We are taking steps to achieve compliance and/or certification for our systems, but we cannot assure that these efforts will be successful in the time period required or at all. Any failure to comply fully or materially with PCI DSS, HITRUST and other applicable industry standards now or at any point in the future may provide customers the right to terminate contracts with us or to enforce provisions obligating us to reimburse them for any penalties or costs incurred by them as a result of our non-compliance, or subject us to other fines, penalties, damages or civil liability, each of which could have a material adverse effect on our business, financial condition and results of operations. In addition, failure to meet PCI DSS standards could result in the loss of our ability to accept credit card payments and the failure to meet HITRUST standards could impact our ability to service customers in the healthcare and other industries, both of which could have a material adverse impact on our business, financial condition and results of operations.
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We are a holding company and, therefore, may not be able to receive dividends or other payments in
needed amounts from our subsidiaries.
Our principal assets are the shares of capital stock and indebtedness of our subsidiaries. We rely on dividends, interest and other payments from these subsidiaries to meet our obligations for paying principal and interest on outstanding debt obligations, paying corporate expenses and, if determined by our Board, paying dividends to shareholders and repurchasing common shares. Certain of our subsidiaries are subject to regulatory requirements of the jurisdictions in which they operate or other restrictions that may limit the amounts that these subsidiaries can pay in dividends or other payments to us. No assurance can be given that there will not be further changes in law, regulatory actions or other circumstances that could restrict the ability of our subsidiaries to pay dividends to us. In addition, due to differences in tax rates, repatriation of funds from certain countries into the United States could have unfavorable tax ramifications for us.
Our results of operations and financial condition could be materially adversely affected by legal and
regulatory matters.
We are potentially subject to various contingent liabilities that are not reflected on our balance sheet, including those arising as a result of being involved in a variety of claims, lawsuits, investigations and proceedings concerning: securities laws; governmental and non-governmental entity contracting, servicing and governmental entity procurement laws; intellectual property laws; environmental laws; employment laws; the Employee Retirement Income Security Act of 1974 (ERISA); and other laws, regulations and contractual undertakings, as discussed under Note 16 – Contingencies and Litigation to our Consolidated Financial Statements. If developments in any of these matters cause a change in our determination as to an unfavorable outcome and result in the need to recognize a material accrual or materially increase an existing accrual, or if any of these matters result in an adverse judgment or are settled for significant amounts above any existing accruals, it could materially adversely affect our results of operations and financial condition in the period or periods in which such change in determination, judgment or settlement occurs. There can be no assurances as to the favorable outcome of any claim, lawsuit, investigation or proceeding. It is possible that a resolution of one or more such proceedings, through judgment, settlement or otherwise, could require us to make substantial payments to satisfy judgments, fines or penalties or settlement amounts, any of which could materially adversely affect our results of operations and financial condition. Additionally, the terms of dismissal, settlement, release or other resolution may permit certain claims to be reopened under certain conditions. Claims, lawsuits investigations and proceedings involving the Company could also result in reputational harm, criminal sanctions, consent decrees or orders preventing us from offering certain services, requiring a change in our business practices in costly ways or requiring development of non-infringing or otherwise altered products or technologies. In addition, it can be very costly to defend litigation and these costs could materially adversely affect our results of operations and financial condition. Refer to Note 16 – Contingencies and Litigation to our Consolidated Financial Statements.
Our results of operations and financial condition may be materially adversely affected by conditions abroad, including local economics, political environments, fluctuating foreign currencies and shifting regulatory schemes.
A portion of our revenues is generated from operations outside the United States. In addition, we maintain significant operations outside the United States. Our results of operations and financial condition could be materially adversely affected by changes in foreign currency exchange rates, as well as by a number of other factors, including, without limitation, changes in economic conditions from country to country, changes in a country’s political conditions, trade controls and protection measures, financial sanctions, licensing requirements, local tax issues, capitalization and other related legal matters. The withdrawal of the United Kingdom from the European Union, and the resulting impact on cross-border transactions and operations between the United Kingdom and the European Union member states, could materially and adversely affect our operations and financial condition. We generally hedge foreign currency denominated assets, liabilities and anticipated transactions primarily through the use of currency derivative contracts. The use of derivative contracts is intended to mitigate or reduce transactional level volatility in the results of foreign operations but does not completely eliminate volatility. We do not hedge the translation effect of international revenues and expenses, which are denominated in currencies other than our U.S. parent functional currency, within our Consolidated Financial Statements. If we are unable to effectively hedge these risks, our results of operations and financial condition could be materially adversely affected.
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ITEM 1B. UNRESOLVED STAFF COMMENTS
None
ITEM 2. PROPERTIES
We lease and own numerous facilities worldwide with larger concentrations of space in Kentucky, New Jersey, California, Mexico, Guatemala, the Philippines, Jamaica, Romania and India. Our owned and leased facilities house general offices, sales offices, service locations, call centers and distribution centers. The size of our property portfolio as of December 31, 2019 was approximately 6.6 million square feet at an annual operating cost (lease costs and expenses) of approximately $157 million and comprised 206 leased properties and 4 owned properties. We believe that our current facilities are suitable and adequate for our current businesses. Because of the interrelation of our business segments, each of the segments uses substantially all of these properties at least in part.
We had 1.8 million square feet of our leased and owned properties that became surplus in 2019 due to the implementation of our strategic transformation program as well as various productivity initiatives to consolidate our real estate footprint. We aggressively managed our surplus properties through early terminations and subleasing of leased properties and the sale of owned properties. As a result, approximately 1.6 million square feet of the surplus property portfolio were resolved as of December 31, 2019. Additional leased and owned properties may become surplus in the future as we continue the strategic transformation program. We are obligated to maintain our leased surplus properties through required contractual lease periods and plan to dispose of or sublease these properties.
ITEM 3. LEGAL PROCEEDINGS
The information set forth under Note 16 – Contingencies and Litigation to the Consolidated Financial Statements in Part II, Item 8 is incorporated herein by reference.
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.
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Part II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Stock Exchange Information
The common stock of Conduent Incorporated began trading on January 3, 2017, on the New York Stock Exchange, under the ticker "CNDT". In December 2019, Conduent changed the listing of its publicly traded common stock from the New York Stock Exchange to the NASDAQ, where it remains listed under the ticker "CNDT".
Common Shareholders of Record
Refer to Item 6. Selected Financial Data – Five Years in Review for common shareholders of record at year-end, which is incorporated here by reference.
Conduent Common Stock Dividends
We did not pay any dividends on our common stock in 2019. We intend to retain future earnings for use in the operation of our business and to fund future growth. We do not anticipate paying any dividends on our common stock for the foreseeable future.
Performance Graph
Sales of Unregistered Securities During the Quarter Ended December 31, 2019
None
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ITEM 6. SELECTED FINANCIAL DATA
FIVE YEARS IN REVIEW
(in millions, except per-share and common shareholders of record data)
| 2019 | 2018 | 2017 | 2016 | 2015 | ||||||||||||||||||||||||||||
| Operations | ||||||||||||||||||||||||||||||||
| Revenues | $ | 4,467 | $ | 5,393 | $ | 6,022 | $ | 6,408 | $ | 6,662 | ||||||||||||||||||||||
Income (loss) income from continuing operations(1) | (1,934) | (416) | 177 | (983) | (336) | |||||||||||||||||||||||||||
Net income (loss)(1) | (1,934) | (416) | 181 | (983) | (414) | |||||||||||||||||||||||||||
| Per-Share Data | ||||||||||||||||||||||||||||||||
| Income (loss) from continuing operations | ||||||||||||||||||||||||||||||||
| Basic | $ | (9.29) | $ | (2.06) | $ | 0.82 | $ | (4.85) | $ | (1.65) | ||||||||||||||||||||||
| Diluted | (9.29) | (2.06) | 0.81 | (4.85) | (1.65) | |||||||||||||||||||||||||||
| Net income (loss) attributable to Conduent | ||||||||||||||||||||||||||||||||
| Basic | (9.29) | (2.06) | 0.84 | (4.85) | (2.04) | |||||||||||||||||||||||||||
| Diluted | (9.29) | (2.06) | 0.83 | (4.85) | (2.04) | |||||||||||||||||||||||||||
| Financial Position | ||||||||||||||||||||||||||||||||
| Working capital | $ | 409 | $ | 767 | $ | 1,342 | $ | 515 | $ | (867) | ||||||||||||||||||||||
| Total Assets | 4,514 | 6,680 | 7,548 | 7,709 | 9,058 | |||||||||||||||||||||||||||
| Consolidated Capitalization | ||||||||||||||||||||||||||||||||
| Current portion of long-term debt | $ | 50 | $ | 55 | $ | 82 | $ | 28 | $ | 24 | ||||||||||||||||||||||
| Long-term debt | 1,464 | 1,512 | 1,979 | 1,913 | 37 | |||||||||||||||||||||||||||
Total Debt(2) | 1,514 | 1,567 | 2,061 | 1,941 | 61 | |||||||||||||||||||||||||||
| Series A preferred stock | 142 | 142 | 142 | 142 | n/a | |||||||||||||||||||||||||||
Conduent shareholders' equity/former parent investment(3) | 1,300 | 3,222 | 3,529 | 3,288 | 5,162 | |||||||||||||||||||||||||||
| Total Consolidated Capitalization | $ | 2,956 | $ | 4,931 | $ | 5,732 | $ | 5,371 | $ | 5,223 | ||||||||||||||||||||||
Selected Data and Ratios(4) | ||||||||||||||||||||||||||||||||
Common shareholders of record at year-end(4) | 25,660 | 26,226 | 26,936 | n/a | n/a | |||||||||||||||||||||||||||
Book value per common share(4) | $ | 6.60 | $ | 15.68 | $ | 16.77 | n/a | n/a | ||||||||||||||||||||||||
Year-end common stock market price(4) | $ | 6.20 | $ | 10.63 | $ | 16.16 | n/a | n/a | ||||||||||||||||||||||||
| Cash dividends paid - preferred stock, $80/per share | $ | 10 | $ | 10 | $ | 10 | $ | — | $ | — | ||||||||||||||||||||||
__________
(1)The 2019 amounts include goodwill impairment charge of approximately $2.0 billion. Refer to Note 8 – Goodwill and Intangible Assets, Net to the Consolidated Financial Statements included in Item 8 of this Form 10-K for further discussion.
(2)Includes finance lease obligations. Refer to Note 1 – Basis of Presentation and Summary of Significant Accounting Policies and Note 11 – Debt to the Consolidated Financial Statements included in Item 8 of this Form 10-K for a discussion concerning finance lease obligations.
(3)The amount for 2015 represents former parent company's investments.
(4)Common stock of Conduent Incorporated began trading on the NYSE on January 3, 2017; therefore, selected data and ratios are not available for years prior to 2017. In December 2019, Conduent changed the listing of its publicly traded common stock from the New York Stock Exchange to NASDAQ, where it remains listed under the ticker "CNDT".
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QUARTERLY RESULTS OF OPERATIONS (Unaudited)
| (in millions, except per-share data) | First Quarter | Second Quarter | Third Quarter | Fourth Quarter | Full Year | |||||||||||||||||||||||||||
| 2019 | ||||||||||||||||||||||||||||||||
| Revenues | $ | 1,158 | $ | 1,112 | $ | 1,098 | $ | 1,099 | $ | 4,467 | ||||||||||||||||||||||
Costs and Expenses(1) | 1,496 | 2,231 | 1,112 | 1,734 | 6,573 | |||||||||||||||||||||||||||
| (Loss) Income before Income Taxes | (338) | (1,119) | (14) | (635) | (2,106) | |||||||||||||||||||||||||||
| Income tax (benefit) expense | (30) | (90) | 2 | (54) | (172) | |||||||||||||||||||||||||||
| Net (Loss) Income | $ | (308) | $ | (1,029) | $ | (16) | $ | (581) | $ | (1,934) | ||||||||||||||||||||||
Earnings (Loss) per Share(2): | ||||||||||||||||||||||||||||||||
| Basic | $ | (1.49) | $ | (4.94) | $ | (0.09) | $ | (2.76) | $ | (9.29) | ||||||||||||||||||||||
| Diluted | $ | (1.49) | $ | (4.94) | $ | (0.09) | $ | (2.76) | $ | (9.29) | ||||||||||||||||||||||
| 2018 | ||||||||||||||||||||||||||||||||
| Revenues | $ | 1,420 | $ | 1,387 | $ | 1,304 | $ | 1,282 | $ | 5,393 | ||||||||||||||||||||||
| Costs and Expenses | 1,474 | 1,333 | 1,556 | 1,425 | 5,788 | |||||||||||||||||||||||||||
| (Loss) Income before Income Taxes | (54) | 54 | (252) | (143) | (395) | |||||||||||||||||||||||||||
| Income tax (benefit) expense | (4) | 43 | (15) | (3) | 21 | |||||||||||||||||||||||||||
| Net (Loss) Income | $ | (50) | $ | 11 | $ | (237) | $ | (140) | $ | (416) | ||||||||||||||||||||||
Earnings (Loss) per Share(2): | ||||||||||||||||||||||||||||||||
| Basic | $ | (0.26) | $ | 0.05 | $ | (1.16) | $ | (0.69) | $ | (2.06) | ||||||||||||||||||||||
| Diluted | $ | (0.26) | $ | 0.04 | $ | (1.16) | $ | (0.69) | $ | (2.06) | ||||||||||||||||||||||
_________________
(1)First quarter, second quarter, fourth quarter and full year include goodwill impairment charge of $284 million, $1.1 billion, $601 million and approximately $2.0 billion, respectively. Refer to Note 8 – Goodwill and Intangible Assets, Net to the Consolidated Financial Statements included in Item 8 of this Form 10-K for further discussion.
(2)The sum of quarterly earnings per share may differ from the full-year amounts due to rounding, or in the case of diluted earnings per share, because securities that are anti-dilutive in certain quarters may not be anti-dilutive on a full-year basis.
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ITEM 7. 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. This MD&A is provided as a supplement to, and should be read in conjunction with, our Consolidated Financial Statements and the accompanying notes in this Form 10-K for the year ended December 31, 2019. This MD&A provides additional information about our operations, current developments, financial condition, cash flows and results of operations.
Throughout the MD&A, we refer to various notes to our Consolidated Financial Statements which appear in Item 8 of this Form 10-K, and the information contained in such notes is incorporated by reference into the MD&A in the places where such references are made.
Overview
With revenues of $4.5 billion, 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 67,000 people as of December 31, 2019, servicing customers from service centers in 23 countries. In 2019, 10% of our revenue was generated outside the U.S.
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, Other operations and Shared IT / Infrastructure & Corporate Costs.
•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, 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.
Other operations include our divestitures, our Student Loan business, which the Company exited in the third quarter of 2018.
Shared IT / Infrastructure & Corporate Costs includes both normal ongoing IT infrastructure costs and costs related to modernization of a significant portion of our infrastructure with new systems and processes and consolidation of our data centers as part of our transformation initiatives. It also includes costs related to corporate overhead functions and shared real estate costs. These costs are not allocated to the reportable segments. We expect that our transformation initiatives will provide greater strategic and operational flexibility and efficiency and better control of our systems and processes. There is a risk, however, that our efforts, plans and transactions related to our strategic and operational review, as well as our modernization efforts and data center consolidations could materially and adversely disrupt our operations. Refer to Part I, Item 1A – Risk Factors of this Form 10-K for additional information.
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Significant 2019 Actions
•Business Acquisition – In January 2019, we acquired Health Solution Plus, a software provider of healthcare payer administration solutions for a total base consideration of $90 million. This acquisition is part of the Commercial Industries segment. Refer to Note 5 – Business Acquisition to the Consolidated Financial Statements for additional information regarding this acquisition.
•Disposition – In February 2019, we completed the sale of a portfolio of select standalone customer care contracts for $25 million. The business sold represented $36 million and $439 million of revenues in 2019 and 2018, respectively. Refer to Note 4 – Divestiture to the Consolidated Financial Statements for additional information regarding this sale.
•Litigation Settlement – In February 2019, we reached a settlement agreement and release with the State of Texas ("State") and the Texas Department of Health and Human Services, which was amended in May 2019 ("Texas Agreement"). Pursuant to the terms of the Texas Agreement, the Company was required to pay the State $236 million, of which $118 million was paid in 2019 and the remaining $118 million paid in January 2020. Refer to Note 16 – Contingencies and Litigation to the Consolidated Financial Statements for additional information regarding this litigation settlement.
•Goodwill Impairment – During the first quarter of 2019, we recorded a pre-tax impairment charge of $284 million related to our Transportation reporting unit. Also, during the second quarter of 2019, we performed an interim goodwill impairment assessment for all reporting units and recognized a total pre-tax impairment charge of $1.1 billion. No impairment was identified during our annual impairment test performed as of October 1, 2019. Subsequent to completing the annual impairment test, the Company experienced further unanticipated contract losses within the Government Services reporting unit, and as result, management performed a goodwill impairment assessment for this reporting unit as of December 31, 2019 which resulted in a pre-tax impairment charge of $512 million. In addition, in the fourth quarter we recorded an immaterial correction to the impairment charges recorded in the first and second quarters to properly reflect the impact of tax deductible goodwill on the previous impairments as well as the related income tax benefit. The impairment adjustment and related income tax benefit to the first quarter charge for the Transportation reporting unit totaled $20 million and $1 million, respectively. The impairment adjustment and related income tax benefit to the second quarter charge totaled $69 million and $6 million, respectively. The second quarter impairment and income tax benefit adjustments corrected the combined Commercial Industries reporting units by $53 million and $5 million, respectively, and the Government Services reporting unit by $16 million and $1 million, respectively. We believe these adjustments are not material to the current period or any prior period. The cumulative impairment charge for the year ended December 31, 2019 was approximately $2.0 billion. Refer to Note 8 – Goodwill and Intangible Assets, Net to the Consolidated Financial Statements and MD&A – Critical Accounting Policies – Goodwill for additional information regarding the goodwill impairment assessment and resulting charges.
Significant 2018 Actions
•Loan Redemption – In July 2018, we redeemed $476 million of our $510 million Senior Notes due 2024 at a premium of $95 million. Refer to Note 11 – Debt to the Consolidated Financial Statements for additional information regarding this redemption.
•Dispositions – In 2018, we completed divestitures of: (1) our Commercial Vehicle Operations business; (2) our off-street parking business; (3) our U.S. human resource consulting and actuarial business and the human resource consulting and outsourcing business located in Canada and the United Kingdom; and (4) our local and municipal constituent government software solutions business. The aggregate proceeds for these divestitures was $703 million in cash. The businesses sold represented $304 million and $500 million of 2018 and 2017 revenue, respectively. We recorded a pre-tax gain of $78 million on these divestitures for the year ended December 31, 2018.
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Critical Accounting 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 Consolidated Financial Statements and notes thereto. In preparing our Consolidated Financial Statements, we have made our best estimates and judgments of certain amounts included in the Consolidated Financial Statements giving due consideration to materiality. However, application of these accounting policies involves the exercise of judgment and use of assumptions as to future uncertainties and, as a result, actual results could differ from these estimates. Senior management has discussed the development and selection of the critical accounting policies, estimates and related disclosures included herein with the Audit Committee of the Board of Directors. We consider these as critical to understanding our Consolidated Financial Statements, as their application places the most significant demands on management's judgment, since financial reporting results rely on estimates of the effects of matters that are inherently uncertain. In instances where different estimates could have reasonably been used, we disclose the impact of these different estimates on our operations. In certain instances, the accounting rules are prescriptive; therefore, it would not have been possible to reasonably use different estimates. Changes in assumptions and estimates are reflected in the period in which they occur. The impact of such changes could be material to our results of operations and financial condition in any quarterly or annual period.
Specific risks associated with these critical accounting policies are discussed throughout the MD&A, where such policies affect our reported and expected financial results. For a detailed discussion of the application of these and other accounting policies, refer to Note 1 – Basis of Presentation and Summary of Significant Accounting Policies to the Consolidated Financial Statements.
Leases
The Company determines if an arrangement is a lease at the inception of the contract and whether that lease meets the classification criteria of a finance or operating lease. The Company accounts for lease and non-lease components separately for its equipment leases, based on the estimated standalone price of each component, and combines lease and non-lease components for its real estate leases. The Company's leases generally do not provide an implicit rate, therefore the Company uses its incremental borrowing rate as the discount rate when measuring operating lease liabilities. The incremental borrowing rate represents an estimate of the interest rate the Company would incur at lease commencement to borrow an amount equal to the lease payments on a collateralized basis over the term of a lease within a particular currency environment. Refer to Note 1 – Basis of Presentation and Summary of Significant Accounting Policies for additional information regarding our lease accounting policies.
Revenue Recognition
Application of the accounting principles in U.S. GAAP related to the measurement and recognition of revenue requires us to make judgments and estimates. Complex arrangements with nonstandard terms and conditions may require significant contract interpretation to determine the appropriate accounting. Refer to Note 1 – Basis of Presentation and Summary of Significant Accounting Policies and Note 2 – Revenue to the Consolidated Financial Statements for additional information regarding our revenue recognition policies.
Held for Sale
We classify assets as held for sale in the period when the following conditions are met: (i) management, having the authority to approve the action, commits to a plan to sell the asset (disposal group); (ii) the asset (disposal group) is available for immediate sale in its present condition subject only to terms that are usual and customary for sales of such assets (disposal group); (iii) an active program to locate a buyer and other actions required to complete the plan to sell the asset (disposal group) have been initiated; (iv) the sale of the asset (disposal group) is probable, and transfer of the asset (disposal group) is expected to qualify for recognition as a completed sale within one year, except if events or circumstances beyond our control extend the period of time required to sell the asset (disposal group) beyond one year; (v) the asset (disposal group) is being actively marketed for sale at a price that is reasonable in relation to its current fair value; and (vi) actions required to complete the plan indicate that it is unlikely that significant changes to the plan will be made or that the plan will be withdrawn.
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A long-lived asset (disposal group) that is classified as held for sale is initially measured at the lower of its carrying value or fair value less any costs to sell. Any loss resulting from this measurement is recognized in the period in which the held for sale criteria are met. Conversely, gains are not recognized on the sale of a long-lived asset (disposal group) until the date of sale.
The fair value of a long-lived asset (disposal group) less any costs to sell is assessed each reporting period it remains classified as held for sale and any subsequent changes are reported as an adjustment to the carrying value of the asset (disposal group), as long as the new carrying value does not exceed the carrying value of the asset at the time it was initially classified as held for sale. Upon determining that a long-lived asset (disposal group) meets the criteria to be classified as held for sale, the Company reports the assets and liabilities of the disposal group in the line items Assets held for sale and Liabilities held for sale, respectively, in the Consolidated Balance Sheets.
In 2018, management approved the disposal through sale of certain assets and businesses, which were a mix of Commercial Industries, Government Services and Transportation businesses. This action was taken as a result of our evaluation of these businesses as they represent businesses in markets or with services that we did not see as strategic or core. As of December 31, 2019, all of these businesses have been sold. Refer to Note 4 – Divestiture to the Consolidated Financial Statements for additional information.
Intangible Assets
The fair values of identifiable intangible assets are primarily estimated using an income approach. These estimates include market participant assumptions and require projected financial information, including assumptions about future revenue growth and costs necessary to facilitate the projected growth. Other key inputs include assumptions about technological obsolescence, customer attrition rates, brand recognition, the allocation of projected cash flows to identifiable intangible assets and discount rates. We regularly review intangible assets with finite lives for impairment whenever events or changes in circumstances indicate the carrying amount of an asset may not be recoverable. Factors we consider important which could trigger an impairment review include the following:
•significant underperformance relative to historical or projected future operating results;
•significant changes in the manner of our use of the acquired assets or the strategy for our overall business; and
•significant negative industry or economic trends.
When we determine that the carrying value of intangibles and long-lived assets may not be recoverable based upon the existence of one or more of the above indicators of potential impairment, we assess whether an impairment has occurred based on whether net book value of the assets exceeds the related projected undiscounted cash flows from these assets groups. We consider a number of factors, including past operating results, budgets, economic projections, market trends and product development cycles in estimating future cash flows. Differing estimates and assumptions as to any of the factors described above could result in a materially different impairment charge, if any, and thus materially different results of operations.
Goodwill
In January 2017, the FASB issued updated accounting guidance for simplifying the goodwill impairment test. We early adopted this guidance for our goodwill impairment tests performed after January 1, 2017.
Goodwill is not amortized but rather tested for impairment annually, or more frequently if an event or circumstance indicates that impairment may have been incurred. Events or circumstances that might indicate an interim evaluation is warranted include, among other things, unexpected adverse business conditions, macro and reporting unit specific economic factors, supply costs, unanticipated adverse events or conditions impacting revenues, cash flows or profitability, unanticipated competitive activities and acts by governments and courts.
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Application of the interim and annual goodwill impairment test requires judgment, including the identification of reporting units, assignment of assets and liabilities to reporting units, assignment of goodwill to reporting units and the assessment of the fair value of each reporting unit. We determined during the first three quarters of 2019 that we had five reporting units (Financial Services & Healthcare (FS&H), Consumer & Industrial (C&I), Europe (together comprising Commercial Industries), Government Services and Transportation). During the fourth quarter of 2019, we changed our reporting units within the Commercial Industries reportable segment to reflect how we currently manage our business. We currently have six reporting units (End-User Customer Experience (EUCE), Transaction Processing (TP), Commercial Healthcare (CH) and Human Resources and Learning Services (HRL) (together comprising Commercial Industries), Government Services and Transportation), which support our three reportable segments.
Interim Goodwill Impairment Evaluation
During the first quarter of 2019, the Transportation reporting unit experienced unanticipated losses of certain customer contracts, lower than expected new customer contracts and higher costs of delivery (all subsequent to February 2019), and as a result, the expected growth of this reporting unit decreased resulting in its fair value being below its carrying value by an estimated $284 million. Accordingly, the Company recorded a pre-tax impairment charge of $284 million for the three months ended March 31, 2019.
In the second quarter of 2019, there were further unanticipated losses of certain customer contracts, lower potential future volumes and lower than expected new customer contracts (all subsequent to May 9, 2019). This led to actual results being below budget and a further downward revision of the long-term forecast across all of the Company’s former reporting units (FS&H, C&I, Europe, Government Services, and Transportation). As a consequence of the business performance and the strategy pivot due to changes in management that occurred in the second quarter of 2019, we lowered our sales outlook, average margin expectation for the future years, and increased our weighted average cost of capital.
The table below summarizes key factors (by reporting unit) impacting our revised forecast within the second quarter of 2019 goodwill assessment.
| Key Factors | FS&H | C&I | Europe | Government Services | Transportation | |||||||||||||||||||||||||||
| Lower anticipated new business | X | X | X | X | X | |||||||||||||||||||||||||||
| Potential higher than anticipated contract losses | X | X | X | X | ||||||||||||||||||||||||||||
| Potential volume pressures | X | X | X | |||||||||||||||||||||||||||||
| Strategic pivot | X | X | X | X | X | |||||||||||||||||||||||||||
Based upon the information identified in the second quarter of 2019, we performed an interim goodwill impairment assessment for all our reporting units which resulted in a pre-tax impairment charge of $1.1 billion for the three months ended June 30, 2019.
Annual Goodwill Impairment Evaluation
Our annual quantitative impairment test of goodwill was performed as of October 1, 2019.
In our quantitative test, we estimate the fair value of each reporting unit by weighting the results from the income approach (discounted cash flow methodology) and market approach. These valuation approaches require significant judgment and consider several factors that include, but are not limited to, expected future cash flows, growth rates and discount rates and comparable multiples from publicly traded companies in our industry. In addition, we are required to make certain assumptions and estimates regarding the current economic environment, industry factors and the future profitability of our businesses.
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When performing our discounted cash flow analysis for each reporting unit, we incorporate the use of projected financial information and discount rates that are developed using market participant-based assumptions. The cash-flow projections are based on three-year financial forecasts developed by management that include revenue and expense projections, restructuring and strategic transformation activities, capital spending trends and investment in working capital to support anticipated revenue growth or other changes in the business. The selected discount rates consider the risk and nature of the respective reporting units' cash flows, appropriate capital structure and rates of return that market participants would require to invest their capital in our reporting units.
We believe these assumptions are appropriate and reflect our forecasted long-term business model and consider our historical results as well as the current economic environment and markets that we serve.
Based on our quantitative assessments, we concluded that the fair value of our reporting units exceeded their respective carrying values by approximately $100 million (for all Commercial Industries), $21 million for Government Services and $24 million for Transportation, respectively.
The most significant assumption used in the goodwill analysis relates to the discount rates (ranging from 8.75% to 12.75%) and long-term organic growth rates (ranging from 2.5% to 3.0%) for the reporting units comprising the Commercial Industries, Government Services and Transportation reporting units.
Subsequent to completing the annual impairment test, the Company experienced further unanticipated contract losses within the Government Services reporting unit, and as result, management performed a goodwill impairment assessment for this reporting unit as of December 31, 2019, which resulted in a pre-tax impairment charge of $512 million. In addition, in the fourth quarter we recorded an immaterial correction to the impairment charges recorded in the first and second quarters to properly reflect the impact of tax deductible goodwill on the previous impairments as well as the related income tax benefit. The impairment adjustment and related income tax benefit to the first quarter charge for the Transportation reporting unit totaled $20 million and $1 million, respectively. The impairment adjustment and related income tax benefit to the second quarter charge totaled $69 million and $6 million, respectively. The second quarter impairment and income tax benefit adjustments corrected the combined Commercial Industries reporting units by $53 million and $5 million, respectively, and the Government Services reporting unit by $16 million and $1 million, respectively. We believe these adjustments are not material to the current period or any prior period. The cumulative impairment charge for the year ended December 31, 2019 was approximately $2.0 billion.
Refer to Note 8 – Goodwill and Intangible Assets, Net to the Consolidated Financial Statements for additional information regarding goodwill by reportable segment.
Income Taxes
We are subject to income taxes in the United States and numerous foreign jurisdictions. The determination of our provision for income taxes requires significant judgment, the use of estimates and the interpretation and application of complex tax laws. Our provision is based on nonrecurring events as well as recurring factors, including the taxation of foreign income. In addition, our provision will change based on discrete or other nonrecurring events such as audit settlements, tax law changes, changes in valuation allowances and other factors, that may not be predictable. In the event that there is a significant unusual or one-time item recognized in our operating results, the taxes attributable to that item would be separately calculated and recorded at the same time as an unusual or one-time item.
We record the estimated future tax effects of temporary differences between the tax bases of assets and liabilities and amounts reported in our Consolidated Balance Sheets, as well as operating loss and tax credit carryforwards. We follow very specific and detailed guidelines in each tax jurisdiction regarding the recoverability of any tax assets recorded in our Consolidated Balance Sheets and provide valuation allowances as required. We regularly review our deferred tax assets for recoverability considering historical profitability, projected future taxable income, the expected timing of the reversals of existing temporary differences and tax planning strategies. Gross deferred tax assets of $309 million and $210 million had valuation allowances of $72 million and $44 million at December 31, 2019 and 2018, respectively.
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On December 22, 2017, the U.S. enacted the Tax Cuts and Jobs Act (Tax Reform). The Tax Reform includes a tax on global intangible low-taxed income (“GILTI”), which imposes a U.S. tax on certain income earned by the Company’s foreign subsidiaries. The Company elected to treat the tax on GILTI as a period cost when incurred and therefore, no deferred taxes for GILTI have been recognized for the year ended December 31, 2019.
We are subject to ongoing tax examinations and assessments in various jurisdictions. Accordingly, we may incur additional tax expense based upon our assessment of the more-likely-than-not outcomes of such matters. In addition, when applicable, we adjust previously recorded tax expense to reflect examination results. Our ongoing assessments of the more-likely-than-not outcomes of examinations and related tax positions require judgment and can materially increase or decrease our effective tax rate, as well as impact our operating results. Unrecognized tax benefits were $24 million, $20 million and $15 million at December 31, 2019, 2018 and 2017, respectively.
Refer to Note 15 – Income Taxes to the Consolidated Financial Statements for additional information regarding deferred income taxes and unrecognized tax benefits.
Loss Contingencies
We are currently involved in various claims and legal proceedings. At least quarterly, we review the status of each significant matter and assess its potential financial exposure considering all available information including, but not limited to, the impact of negotiations, settlements, rulings, advice of legal counsel and other updated information and events pertaining to a particular matter. If the potential loss from any claim or legal proceeding is considered probable and the amount can be reasonably estimated, we accrue a liability for the estimated loss. Significant judgment is required in both the determination of probability and the determination as to whether an exposure is reasonably estimable. Because of uncertainties related to these matters, accruals are based only on the best information available at the time. As additional information becomes available, we reassess the potential liability related to pending claims and litigation and may revise estimates. These revisions in the estimates of the potential liabilities could have a material impact on the results of operations and financial position.
Refer to Note 16 – Contingencies and Litigation to the Consolidated Financial Statements for additional information regarding loss contingencies.
Recent Accounting Changes
See Note 1 – Basis of Presentation and Summary of Significant Accounting Policies 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. To the extent we believe the adoption of new accounting standards has had or will have a material impact on our consolidated results of operations, financial condition or liquidity, we also discuss the impact in the applicable section(s) of this MD&A.
Other Developments
SEC Rule—FAST Act Modernization and Simplification of Regulation S-K
In March 2019, the SEC adopted amendments to modernize and simplify certain disclosure requirements in Regulation S-K as part of modernization and simplification of Regulation S-K and related rules and forms. The amendments, which, among other things, change the requirements for the content of MD&A and change the process for redacting confidential information in certain exhibits, are intended to improve the readability and navigability of disclosure documents and discourage repetition and disclosure of immaterial information. The final rule became effective May 2, 2019.
The provisions of the rule that have the most significant impact on our disclosures under Regulation S-K and the content of this Form 10-K include: (i) the elimination, where appropriate, of the requirement to include in MD&A a discussion of the earliest year for registrants that provide financial statements covering three years in their filings, as such discussion is already included in prior filings; and (ii) a requirement that registrants identify the location in the prior filing where the omitted discussion can be found.
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Financial Information
The section below provides a comparative discussion of our consolidated results of operations for the year ended December 31, 2019 and 2018. See Item 7. MD&A–Financial Information in our Annual Report on Form 10-K for the year ended December 31, 2018, for a comparative discussion of our consolidated results of operations between 2018 and 2017.
| Year Ended December 31, | 2019 vs. 2018 | |||||||||||||||||||||||||
| (in millions) | 2019 | 2018 | $ Change | % Change | ||||||||||||||||||||||
| Revenue | $ | 4,467 | $ | 5,393 | $ | (926) | (17) | % | ||||||||||||||||||
| Operating Costs and Expenses | ||||||||||||||||||||||||||
| Cost of services (excluding depreciation and amortization) | 3,494 | 4,182 | $ | (688) | (16) | % | ||||||||||||||||||||
| Selling, general and administrative (excluding depreciation and amortization) | 479 | 560 | $ | (81) | (14) | % | ||||||||||||||||||||
| Research and development (excluding depreciation and amortization) | 8 | 11 | (3) | (27) | % | |||||||||||||||||||||
| Depreciation and amortization | 459 | 460 | (1) | — | % | |||||||||||||||||||||
| Restructuring and related costs | 71 | 81 | (10) | (12) | % | |||||||||||||||||||||
| Interest expense | 78 | 112 | (34) | (30) | % | |||||||||||||||||||||
| (Gain) loss on extinguishment of debt | — | 108 | (108) | (100) | % | |||||||||||||||||||||
| Goodwill impairment | 1,952 | — | 1,952 | |||||||||||||||||||||||
| (Gain) loss on divestitures and transaction costs | 25 | 42 | (17) | (40) | % | |||||||||||||||||||||
| Litigation costs (recoveries), net | 17 | 227 | (210) | (93) | % | |||||||||||||||||||||
| Other (income) expenses, net | (10) | 5 | (15) | (300) | % | |||||||||||||||||||||
| Total Operating Costs and Expenses | 6,573 | 5,788 | 785 | |||||||||||||||||||||||
| Income (Loss) Before Income Taxes | (2,106) | (395) | (1,711) | |||||||||||||||||||||||
| Income tax expense (benefit) | (172) | 21 | (193) | |||||||||||||||||||||||
| Net Income (Loss) | $ | (1,934) | $ | (416) | $ | (1,518) | ||||||||||||||||||||
Revenue
Revenue for 2019 decreased, compared to the prior year period, mainly due to the impact from divestitures completed in 2019 and 2018, lost business in the Commercial Industries and Government Services segments, price and volume pressure and currency fluctuations. Partially offsetting these declines were increases from the ramp of new business.
Cost of Services (excluding depreciation and amortization)
Cost of services for 2019 decreased, compared to the prior year period, mainly driven by the divestitures completed in 2019 and 2018, reductions in real estate, IT and labor costs from our transformation initiatives, lost business and lower volumes.
Selling, General and Administrative (SG&A) (excluding depreciation and amortization)
Lower SG&A for 2019, compared to the prior year period, was reflective of divested SG&A expenses, reductions in real estate costs, lower corporate overhead costs and reductions labor costs, including reductions in 401(k) costs.
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Depreciation and Amortization
Depreciation and amortization for 2019 decreased, compared to the prior year period, primarily due to the divestitures in 2019 and 2018, partially offset by the HSP acquisition and increased capitalized software amortization for new projects placed in service. Refer to Note 5 – Business Acquisition and Note 8 – Goodwill and Intangible Assets, Net to the Consolidated Financial Statements for additional information regarding the HSP acquisition and our intangible assets, respectively.
Restructuring and Related Costs
We engage in a series of restructuring programs related to downsizing 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:
| Year Ended December 31, | ||||||||||||||
| (in millions, except headcount in whole numbers) | 2019 | 2018 | ||||||||||||
| Severance and related costs | $ | 28 | $ | 34 | ||||||||||
| Data center consolidation | 21 | 4 | ||||||||||||
| Other contractual termination costs | 3 | 37 | ||||||||||||
| Asset impairment | 15 | 3 | ||||||||||||
| Total Net Current Period Charges | 67 | 78 | ||||||||||||
Consulting and other costs(1) | 4 | 3 | ||||||||||||
| Restructuring and Related Costs | $ | 71 | $ | 81 | ||||||||||
Reduction in headcount(2) | 1,300 | 3,300 | ||||||||||||
__________
(1)Represents professional support costs associated with our strategic transformation program.
(2)Relates to headcount reductions worldwide associated with Severance and related costs
Refer to Note 9 – Restructuring Programs and Related Costs to the Consolidated Financial Statements for additional information regarding our restructuring programs.