Cognizant Technology Solutions Corporation — Q1 2018 Form 10-Q
Reporting period: Three months ended March 31, 2018. Financial statements are unaudited. Cognizant provides technology, consulting, and business-process services. Unless noted, amounts are in millions of U.S. dollars.
Financial results
| Metric | Q1 2018 | Q1 2017 | Change |
|---|---|---|---|
| Revenue | $3,912 | $3,546 | +10.3% |
| Operating income | $693 | $570 | +21.6% |
| Operating margin | 17.7% | 16.1% | +1.6 percentage points |
| Net income | $520 | $557 | -6.6% |
| Diluted EPS | $0.88 | $0.92 | -$0.04 |
| Non-GAAP operating margin | 20.3% | 18.9% | +1.4 percentage points |
| Non-GAAP diluted EPS | $1.06 | $0.84 | +$0.22 |
Non-GAAP measures exclude specified items and are not GAAP measures. Revenue-standard adoption increased reported Q1 2018 revenue by $21, operating income by $29, and diluted EPS by $0.04; 2017 comparatives were not recast. Accordingly, reported year-over-year comparisons are not fully on the same accounting basis.
- Cash flow: Operating cash flow was $388, versus $277 a year earlier. Investing activities used $227, compared with $91 provided in Q1 2017; financing activities used $488, compared with $1,124 used. Cash, cash equivalents, and restricted cash at quarter-end were $1,599.
- Liquidity: Cash, cash equivalents, and short-term investments totaled $4,989, including $507 restricted in connection with the Indian tax dispute. Revolving-credit availability was approximately $750.
- Debt: Short-term debt was $100 and long-term debt, net of current maturities, was $673. The company had no revolving-credit borrowings at March 31 and reported compliance with debt covenants.
- Margins and earnings: Operating margin improved primarily as compensation and benefits, immigration, subcontractor, and other operating costs declined as a share of revenue. Net income fell despite higher operating income, mainly because of foreign-exchange losses rather than gains and a higher income-tax provision. The effective tax rate was 25.4%, compared with 14.2%.
Business performance and changes versus prior year
- Revenue grew in all segments: Financial Services 6.2% to $1,461; Healthcare 11.8% to $1,121; Products and Resources 11.4% to $821; and Communications, Media and Technology 18.4% to $509.
- North America revenue rose 7.8% to $2,975; Europe rose 22.4% to $684, including a positive currency impact of 11.7%; and Rest of World rose 11.9% to $253.
- Management cited demand for digital services, discretionary projects, and broader service offerings. Financial Services growth was below the company average as some banking clients focused on optimizing operating costs. UK growth was also affected by weakness in banking.
- Segment operating profit increased to $1,200 from $1,053; unallocated costs rose to $507 from $483. Segment-profit measurement changed in 2018, with prior-period results restated to conform.
- Operating cash flow rose by $111 year over year, while financing cash use was lower largely because share repurchases declined, partly offset by dividends and revolving-credit repayments.
Outlook, risks, and unusual items
- Management’s stated goal was to gradually expand non-GAAP operating margin, targeting 22% in 2019; it cautioned that achieving this goal is not assured. The filing provides no specific Q1-issued revenue or EPS guidance.
- Management identified digital demand, customer cost-containment and transformation spending, banking and healthcare sector conditions, retail weakness, foreign-exchange volatility, talent competition, and regulatory changes as factors that could affect 2018 results.
- Indian tax dispute: India’s tax department asserted an additional $507 tax claim related to the 2016 India cash remittance; a separate dispute concerns a 2013 transaction, with no claim amount specified in the filing text. Cognizant said it believes applicable taxes were paid and recorded no reserve. After a court stay in April, $76 was deposited in a segregated account and $431 of time deposits were subject to a lien. The outcome remains unresolved and could materially affect results, cash flows, or liquidity.
- FCPA investigation and related litigation: The company is cooperating with DOJ and SEC investigations into potentially improper payments in India. The investigation had identified approximately $6 in payments; no related adjustments were recorded in 2018 or 2017. Securities and derivative lawsuits are also pending. The company could not estimate a possible loss and warned of potential fines, remediation costs, and business consequences.
- Tax reform: Cognizant recorded a provisional $617 one-time tax expense in Q4 2017, including a $635 transition tax, and made no adjustment in Q1 2018. The accounting remained subject to clarification and could change.
- Capital returns: The company had announced a plan to return $3.4 billion to shareholders by the end of 2018. It reported $2.1 billion of share repurchases and $383 in dividends paid to date under the plan. The remaining repurchase authorization was $1.4 billion; future returns were not assured.
- Subsequent events: Cognizant completed its acquisition of Bolder Healthcare Solutions in April 2018 for initial consideration of approximately $477. In May, the board approved a $0.20-per-share dividend payable May 31, 2018.
Most important facts for investors to verify
- How much of reported growth and earnings improvement reflects ASC 606 adoption, and how comparable are reported results with 2017?
- Developments, potential exposure, and duration of the Indian tax disputes; confirm how much cash and deposits remain restricted.
- Progress and potential costs or sanctions relating to the FCPA investigation and associated litigation.
- Whether operating-margin gains and digital-services growth continue, and whether the 22% 2019 non-GAAP margin target remains achievable.
- Cash generation, capital returns, and liquidity after the acquisition and any changes to the repurchase or dividend plans.