Cognizant Technology Solutions Corporation — Q1 2017 Form 10-Q
Business context and period. Cognizant provides consulting, technology, application, infrastructure and business-process services. This unaudited filing covers the three months ended March 31, 2017, compared with the same period in 2016; balance-sheet figures are compared with December 31, 2016. Amounts are in U.S. dollars.
Key financial results
| Metric | Q1 2017 | Q1 2016 / comparison |
|---|---|---|
| Revenue | $3.546 billion | $3.202 billion; up 10.7% |
| Income from operations / operating margin | $570 million / 16.1% | $554 million / 17.3% |
| Net income / net margin | $557 million / 15.7% | $441 million / 13.8% |
| Diluted EPS | $0.92 | $0.72 |
| Non-GAAP operating income / margin | $669 million / 18.9% | $637 million / 19.9% |
| Non-GAAP diluted EPS | $0.84 | $0.80 |
| Operating cash flow | $277 million | $72 million |
| Cash and cash equivalents | $1.308 billion | $2.034 billion at Dec. 31, 2016 |
| Short- and long-term investments | $3.076 billion | $3.197 billion at Dec. 31, 2016 |
| Debt | $1.209 billion | $878 million at Dec. 31, 2016 |
Cash, cash equivalents and short-term investments totaled $4.274 billion at quarter-end. The company also reported approximately $400 million of available capacity under its revolving credit facility. Total current assets were $7.842 billion and current liabilities were $2.585 billion. The company said it was compliant with debt covenants.
Operating cash flow improved by $205 million year over year, primarily because incentive-compensation payments were lower. Investing activities provided $91 million, versus $228 million used in Q1 2016, largely reflecting net investment sales. Financing activities used $1.124 billion, including $1.514 billion of common-stock repurchases, partly offset by $350 million of revolving-credit borrowings.
Performance and changes versus prior year
- Revenue growth was led by Communications, Media and Technology, up 16.5%, and Products and Resources, up 16.4%; Healthcare grew 9.7% and Financial Services 7.0%.
- North America revenue rose 10.6%; Rest of Europe rose 26.1% and Rest of World 25.6%. United Kingdom revenue fell 8.4%, including adverse currency effects.
- Cost of revenue rose 14.6%, faster than revenue, primarily reflecting higher compensation and benefits and professional-service costs. Management attributed lower GAAP and non-GAAP operating margins mainly to compensation and other operating costs; segment operating profit declined in each segment.
- Net income growth also reflected $52 million of net foreign-currency gains, compared with $9 million in Q1 2016, and a lower tax provision. The effective tax rate was 14.2%, versus 25.1%, primarily due to recognition of $72 million of previously unrecognized tax benefits following reassessment of uncertain tax positions and statute-of-limitations developments.
- Non-GAAP figures exclude specified items and are not GAAP measures. Q1 2017 GAAP results included $11 million of realignment charges; the company also reported $34 million of acquisition-related charges and $54 million of stock-based compensation expense.
Outlook, capital allocation and risks
- Management’s stated objective is to reach a 22% non-GAAP operating margin in 2019 while continuing revenue growth. The filing does not provide a specific numerical revenue or EPS forecast for 2017.
- Management cited demand for digital services and transformational projects, but noted that larger managed-services contracts may have longer sales cycles and ramp-ups, increasing period-to-period variability. Its 2017 watch factors include customer spending, healthcare regulatory uncertainty, retail weakness, immigration and tax regulation, currency volatility and economic uncertainty.
- A realignment program is underway. A voluntary separation program announced in May 2017 is expected to result primarily in Q2 2017 severance costs; total costs could not yet be estimated. Realignment costs are excluded from the company’s stated non-GAAP measures.
- The company announced a stock-repurchase authorization of up to $3.5 billion through 2019 and a broader plan to return $3.4 billion to stockholders over two years. A $1.5 billion accelerated share repurchase began in March; 21.5 million shares were initially delivered, with the final amount dependent on the purchase-period average share price. A $0.15-per-share dividend was declared for payment May 31, 2017. Future repurchases and dividends are not assured.
- FCPA investigation and litigation: An internal investigation concerns approximately $6 million of potentially improper India facility-related payments from 2010–2015. The company voluntarily notified and is cooperating with the DOJ and SEC. It recorded a $4 million correction in 2016; no additional adjustment was recorded in Q1 2017. The company could not estimate any potential loss and recorded no accrual for the investigation or related lawsuits; it warned sanctions, fines and remedial measures could materially affect results, cash flows or financial condition.
- Controls: Management reported a continuing material weakness in internal control over financial reporting as of March 31, 2017, and concluded disclosure controls were not effective. The filing states that no material misstatement or restatement was required based on the investigation to date; remediation efforts include enhanced oversight of India real-estate procurement and accounts payable.
- Other exposures include foreign-exchange movements, wage inflation, customer claims and contractual indemnities. The company had $184 million of fixed capital commitments for India delivery-center construction. Most foreign cash was intended to remain invested abroad; repatriation could generate U.S. tax.
Important facts for investors to verify
- Progress, conclusions and potential financial consequences of the FCPA investigation, DOJ/SEC inquiries and related securities and derivative litigation.
- Whether remediation resolves the material weakness and restores effective disclosure controls.
- How much of the earnings improvement is sustainable excluding the $72 million tax benefit and elevated foreign-currency gains.
- Whether revenue growth can be maintained while recovering operating margins amid faster cost growth and weaker segment operating profit.
- Completion economics of the accelerated repurchase, subsequent buybacks and dividends, and the resulting debt and liquidity position.
- Impact of customer spending, U.K. currency and Brexit-related uncertainty, Indian-rupee exposure, wage inflation and the planned 2017 realignment.