Cognizant Technology Solutions Corporation — FY 2016 Form 10-K
Reporting period: Fiscal year ended December 31, 2016. The filing was signed March 1, 2017. Cognizant provides consulting, technology and outsourcing services, with a strategic emphasis on digital services and a global delivery model.
Financial results and liquidity
| Metric | FY 2016 | FY 2015 | Change |
|---|---|---|---|
| Revenue | $13.487 billion | $12.416 billion | +8.6% |
| Operating income (GAAP) | $2.289 billion | $2.142 billion | +6.9% |
| Operating margin (GAAP) | 17.0% | 17.3% | Down 0.3 percentage points |
| Operating income (non-GAAP) | $2.636 billion | $2.450 billion | +7.6% |
| Operating margin (non-GAAP) | 19.5% | 19.7% | Down 0.2 percentage points |
| Net income | $1.553 billion | $1.624 billion | Down 4.4% |
| Diluted EPS (GAAP) | $2.55 | $2.65 | Down $0.10 |
| Diluted EPS (non-GAAP) | $3.39 | $3.07 | +10.4% |
| Cash from operating activities | $1.621 billion | $2.153 billion | Down $532 million |
Non-GAAP measures exclude specified items, including stock-based compensation and acquisition-related charges; non-GAAP diluted EPS also excludes non-operating foreign-exchange losses and the 2016 India-remittance tax expense. They are not GAAP measures.
At year-end, cash, cash equivalents and short-term investments totaled $5.169 billion, including $4.029 billion held outside the United States. Working capital was $6.182 billion. Reported total debt was $878 million; the term loan had $881 million outstanding before current-maturity and financing-cost presentation, and the $750 million revolving facility had no balance drawn. The term loan matures in November 2019. Cognizant reported compliance with debt covenants and approximately $750 million of available revolver capacity.
FY 2016 operating cash flow was lower mainly due to lower net income, taxes paid in connection with the India cash remittance and higher incentive-compensation payments. Capital expenditures were $300 million. Year-end trade receivables were $2.556 billion and days sales outstanding were 72, versus 70 a year earlier.
Business performance and changes
- Revenue growth was led by Manufacturing/Retail/Logistics and Other, each up 13.5%; Financial Services grew 7.3% and Healthcare 5.5%.
- North America generated 78.2% of revenue and grew 8.1%. Europe grew 6.8%, including a 1.0% decline in U.K. revenue after a 10.0% adverse currency impact. Rest of World revenue grew 22.7%.
- Consulting and technology services represented 57.5% of revenue and grew 8.6%; outsourcing services represented 42.5% and grew 8.7%.
- Operating-margin pressure reflected higher compensation and benefits excluding incentive compensation, professional-service costs, acquisition-related depreciation and continued investment. Currency depreciation and hedge settlements partly offset these costs. A $27 million loss on a fixed-price Healthcare contract also affected segment results.
- Net income fell despite higher revenue and operating income, principally because the effective tax rate rose to 34.2% from 25.0%, including a one-time $238 million tax expense associated with the India cash remittance.
- Quarterly results were uneven: Q4 revenue was $3.462 billion, operating income $561 million, net income $416 million and diluted EPS $0.68. A lower annual incentive-compensation accrual estimate benefited Q4 operating income by $75 million.
Outlook, capital plans and risks
- Management targeted gradual non-GAAP margin improvement, with a goal of 22% non-GAAP operating margin in 2019. This is a target, not a guarantee; FY 2016 non-GAAP margin was 19.5%.
- The company announced a plan to return $3.4 billion to stockholders over two years, including an expected $1.5 billion accelerated repurchase in Q1 2017, a proposed quarterly dividend of $0.15 per share beginning in Q2 2017, and $1.2 billion of open-market repurchases during 2017–2018. A February 2017 authorization permits up to $3.5 billion of repurchases through December 31, 2019. The board retains discretion over dividends and repurchases.
- Management expected operating cash flow, cash and investments, and available credit capacity to cover operating requirements for the next 12 months. The company intended to keep most foreign earnings indefinitely reinvested; future repatriation could trigger additional U.S. taxes.
- Key business risks include intense competition and pricing pressure, wage inflation and talent retention, fixed-price project execution, customer spending and concentration in financial services and healthcare, cybersecurity and privacy obligations, foreign-exchange exposure, and regulatory uncertainty including Brexit, immigration and tax changes.
- FCPA investigation and litigation: An Audit Committee-supervised investigation concerns potentially improper payments relating to company-owned facilities in India. Approximately $6 million of payments from 2010–2015 had been identified; the company recorded a $4 million out-of-period correction and said the identified amounts were not material to prior or 2016 financial statements. Cognizant notified and was cooperating with the DOJ and SEC. It recorded $27 million of 2016 costs related to the investigation and lawsuits, expected further costs, and could not estimate any potential loss; no accrual was recorded for these matters. Securities class actions and shareholder derivative actions were pending.
- Controls: Management and the auditor concluded that internal control over financial reporting was ineffective at December 31, 2016 because of a material weakness involving the control environment and real-estate procurement controls in India. Disclosure controls were also deemed ineffective. Management reported remediation steps, but the weakness remained unremediated at year-end. The auditor’s adverse ICFR opinion did not modify its opinion on the financial statements.
Important facts for investors to verify
- Progress and adequacy of remediation of the material weakness, and whether further control deficiencies or financial-statement revisions emerge.
- Developments, potential sanctions and eventual costs from the FCPA investigation and related litigation; the filing provides no reliable estimate of possible losses.
- Whether revenue growth and the stated 2019 non-GAAP margin target are achieved while GAAP margins remain under pressure.
- Execution and funding of the announced repurchases and dividend, including the effect of additional borrowing and the geographic availability of cash.
- Effects of the India-remittance tax, foreign-currency movements, customer-sector demand and the 72-day receivables collection period on earnings and cash generation.