Cognizant Technology Solutions Corporation — Q1 2020 Form 10-Q
Reporting period: Three months ended March 31, 2020. Unaudited results are compared with Q1 2019 unless otherwise noted. Cognizant provides IT and professional services, including digital, consulting, application, infrastructure and business-process services.
Financial performance
| Metric | Q1 2020 | Q1 2019 / change |
|---|---|---|
| Revenue | $4.225 billion | $4.110 billion; up 2.8% reported and 3.5% constant currency |
| Operating income and margin | $579 million; 13.7% | $539 million; 13.1% |
| Adjusted operating income and margin (non-GAAP) | $640 million; 15.1% | $658 million; 16.0% |
| Net income and net margin | $367 million; 8.7% | $441 million; 10.7% |
| Diluted EPS | $0.67 | $0.77 |
| Adjusted diluted EPS (non-GAAP) | $0.96 | $0.91 |
| Operating cash flow | $497 million | $269 million |
| Cash, cash equivalents and short-term investments | $4.282 billion | $3.424 billion at December 31, 2019 |
| Total debt | $2.468 billion | $738 million at December 31, 2019 |
Cost of revenue rose 6.7% to $2.747 billion, increasing to 65.0% of revenue from 62.7%. Selling, general and administrative expense fell 18.4% to $711 million, largely because Q1 2019 included a $117 million accrual for India employee contributions. The effective tax rate rose to 27.8% from 24.4%. A $102 million net foreign-exchange loss, primarily related to Indian rupee remeasurement, was a major factor in lower net income.
Operating cash flow improved partly because of lower incentive-compensation payments and improved days sales outstanding (74 days, versus 76 a year earlier). Investing activities used $272 million, including $112 million of property and equipment purchases and $86 million for acquisitions. Financing activities provided $1.135 billion, including $1.740 billion drawn on the revolving credit facility. Cognizant returned $632 million to shareholders through $511 million of repurchases and $121 million of dividends.
Business trends and changes
- Revenue increased in each segment: Financial Services 1.0%, Healthcare 2.5%, Products and Resources 4.4%, and Communications, Media and Technology 5.2%. Growth reflected digital-services demand and acquisitions, partly offset by COVID-19-related delivery challenges, pricing pressure and clients moving some work in-house.
- Q1 revenue growth slowed meaningfully in March. Management reported some project-fulfillment delays as delivery shifted to work-from-home arrangements, particularly in India and the Philippines.
- GAAP operating margin improved year over year, but adjusted operating margin declined. Delivery-personnel costs grew faster than revenue; reduced travel costs and cost savings partly offset the pressure.
- Q1 restructuring charges were $55 million, versus $2 million a year earlier. These included $35 million under the 2020 Fit for Growth Plan and $20 million of other realignment costs.
Outlook, risks and unusual items
- COVID-19: Management expected reduced demand across all segments in Q2 and potentially longer, including project deferrals, furlough requests, rate concessions and extended payment terms. Retail, consumer goods, travel and hospitality, communications, and media clients were identified as particularly exposed. The company stated that the pandemic’s future financial impact could not then be reasonably estimated. It expected near-full project-fulfillment capacity before the end of Q2, subject to client, regulatory and compliance constraints.
- Cost program and content-services exit: Fit for Growth optimization charges were expected to total $150 million–$200 million, with an annualized savings run rate of approximately $500 million–$550 million in 2021, before anticipated investments. Exiting certain content services was expected to reduce annualized revenue by $225 million–$255 million, with a $180 million–$200 million impact on 2020 revenue; Q1 impact was approximately $23 million.
- Ransomware incident: Cognizant disclosed an April 20, 2020 Maze ransomware attack that caused unauthorized access to certain data and business disruption. Management expected lost revenue and response costs to significantly affect Q2 results; costs could exceed insurance limits or be uninsured. The investigation and remediation were ongoing.
- Liquidity and debt: The $1.740 billion revolver draw increased U.S. cash availability; the company said cash, short-term investments and operating cash flows should cover operating needs and debt service for the next 12 months. Debt facilities mature in November 2023, and Cognizant reported compliance with covenants at March 31, 2020. Share repurchases were suspended after March 31, except under its 10b5-1 plan.
- India tax dispute: The Indian tax department asserted an additional 33 billion rupees, about $438 million, relating to a 2016 share repurchase; a separate dispute concerns a 2013 transaction. The company reported $393 million of deposits under lien and a $66 million deposit with the tax department as restricted, noncurrent assets. It recorded no reserve, stating that it believed applicable taxes had been paid. In April 2020, the tax department issued an assessment consistent with its prior assertion; Cognizant planned to appeal.
- Other contingencies: Securities class-action and shareholder derivative litigation remained unresolved; the company could not estimate potential losses and recorded no accrual. A 2019 Indian Supreme Court ruling on employee defined-contribution obligations creates uncertainty over the ultimate amount owed; the filing describes a $117 million accrual made in Q1 2019.
- Acquisitions and dividend: Q1 acquisitions of Code Zero and Lev had a preliminary combined purchase price of $95 million. In May, Cognizant agreed to acquire Collaborative Solutions for approximately $385 million, excluding contingent consideration. The board approved a $0.22-per-share dividend payable May 29, 2020.
- Goodwill: An interim COVID-19-triggered impairment test found no impairment as of March 31, 2020; Healthcare had the least excess fair value over carrying value among reporting units.
Important facts for investors to verify
- Subsequent filings and results for the pandemic’s effects on demand, delivery capacity, margins, collections and liquidity.
- The ransomware incident’s final scope, client impact, revenue loss, remediation costs, insurance recovery and any regulatory or litigation outcomes.
- Progress and actual charges, savings and revenue attrition under Fit for Growth and the content-services exit.
- Developments in the India tax disputes, restricted deposits and employee-contribution obligation, including any resulting liability or cash payment.
- Debt balances, covenant headroom, cash availability by country and any changes to dividends or share repurchases.