Cognizant Technology Solutions Corporation — Q3 2016 Form 10-Q
Business context and period. Unaudited results for the quarter and nine months ended September 30, 2016, compared with the corresponding 2015 periods. Cognizant provides IT, consulting and business-process services. Amounts below are in U.S. dollars; financial statement amounts are in millions except per-share data.
Key financial results
| Metric | Q3 2016 | Q3 2015 | 9M 2016 | 9M 2015 |
|---|---|---|---|---|
| Revenue | $3,453.2 | $3,187.0 | $10,025.1 | $9,183.5 |
| Income from operations | $583.4 | $542.8 | $1,728.3 | $1,588.6 |
| Operating margin | 16.9% | 17.0% | 17.2% | 17.3% |
| Net income | $444.4 | $397.2 | $1,138.0 | $1,200.2 |
| Diluted EPS | $0.73 | $0.65 | $1.87 | $1.96 |
| Operating cash flow | Not presented separately | Not presented separately | $1,022.4 | $1,463.3 |
- Q3 revenue grew 8.4%; operating income rose 7.5% and net income rose 11.9%. Nine-month revenue grew 9.2%, but net income fell 5.2%, principally due to higher tax expense.
- Q3 non-GAAP operating margin was 19.3% versus 19.4%; nine-month non-GAAP margin was 19.8% in both years. These company-defined measures exclude stock-based compensation and acquisition-related charges; non-GAAP diluted EPS also excludes specified foreign-exchange and India-remittance tax effects.
- For the nine months, operating cash flow declined $440.9 million year over year. Investing cash use was $872.7 million and financing cash use was $729.6 million. Cash and cash equivalents decreased $574.9 million from year-end to $1,550.3 million.
- At September 30, cash, cash equivalents and short-term investments totaled $4,858.6 million; working capital was $5,899.1 million. Debt was $896.6 million, including $75.0 million current and $821.6 million long-term debt. The company reported no revolver borrowings and $750 million of available capacity.
- Current ratio was approximately 3.6x, based on current assets of $8,199.8 million and current liabilities of $2,300.7 million.
Material changes and operating performance
- Q3 segment revenue growth: Financial Services 7.1%, Healthcare 5.7%, Manufacturing/Retail/Logistics 12.0%, and Other 13.6%. Nine-month growth was 8.6%, 5.5%, 13.7%, and 13.1%, respectively.
- North America remained the largest market, generating 78.5% of Q3 revenue. Q3 U.K. revenue declined 2.3%; management cited a 13.9% adverse currency impact associated with sterling weakness after the Brexit referendum. Rest of Europe grew 17.0% and Rest of World 23.2%.
- Q3 margin eased slightly amid higher operating and professional-service costs and continued investment. For the nine months, results also included a $27.4 million pretax loss on a revised estimate for a fixed-price healthcare implementation contract.
- The nine-month effective tax rate rose to 36.7% from 25.1%. A 2016 Indian-subsidiary share repurchase/remittance generated $213.7 million of incremental tax expense through September; the company expected a further $23.8 million in Q4, for a stated full-year incremental tax expense of $237.5 million.
- Operating cash flow was pressured by lower net income, higher incentive-compensation payments and working-capital movements. Days sales outstanding was 75 days, compared with 70 days at December 31, 2015.
Outlook, risks and unusual items
- Management expected cash from operations, cash and investments, and revolver availability to meet operating requirements for the next 12 months. It planned to continue investing in talent, digital services and delivery capacity, pursuing acquisitions selectively, and managing costs. No specific revenue or EPS guidance is provided in the supplied filing text.
- Management cited uncertain customer spending, low interest rates affecting banking clients, healthcare-sector consolidation, retail weakness, Brexit-related uncertainty, currency volatility, wage inflation and longer sales cycles for large transformation and managed-services projects.
- Internal investigation and controls: Cognizant disclosed an investigation into approximately $5.0 million of potentially improper payments relating to company-owned facilities in India and possible FCPA or other-law violations. It notified and is cooperating with the DOJ and SEC. The company expensed $3.1 million previously capitalized; $1.9 million remained under investigation. It said these amounts were not material to prior statements and no material restatement was required.
- The investigation identified possible senior-management override or failure to enforce real-estate and procurement controls. Cognizant concluded that a material weakness existed at December 31, 2015 and persisted through September 30, 2016; disclosure controls and internal control over financial reporting were ineffective. Remediation was underway, including personnel actions and enhanced procurement and accounts-payable oversight.
- Two securities class actions and a state-court lawsuit were filed after quarter-end. The company could not estimate potential losses or predict outcomes; possible sanctions, fines, remedial costs and litigation could materially affect results, cash flows or financial condition. A November 5 credit-agreement amendment and limited waiver addressed potential defaults tied to the disclosed investigation matters.
- Other notable items: the board expanded the share-repurchase authorization from $2.0 billion to $3.0 billion and extended it through December 31, 2018; $180.1 million of fixed capital commitments related to India development centers remained outstanding. Four acquisitions were completed during the nine months, with initial consideration of approximately $124.7 million, net of cash acquired.
Important facts for investors to verify
- Progress, scope and financial consequences of the India payments investigation, including any DOJ or SEC action, related litigation and remediation costs.
- Remediation and independent effectiveness of controls following the disclosed material weakness and ineffective disclosure controls.
- Cash conversion, receivables and DSO trends, and the effect of incentive payments and working capital on operating cash flow.
- Whether revenue growth and margins can be sustained amid currency movements, wage inflation, customer-industry pressures and investment needs.
- Final tax effects of the India cash remittance, future repatriation plans, and the impact of share repurchases and debt obligations on liquidity.