Cognizant Technology Solutions Corporation — Q2 2016 Form 10-Q
Reporting period: Three and six months ended June 30, 2016. Financial statements are unaudited. Cognizant provides IT, consulting and business-process services.
Financial performance
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Revenue | $3,369.9 million | $3,085.1 million | $6,571.9 million | $5,996.5 million |
| Operating income | $590.9 million | $545.5 million | $1,144.9 million | $1,045.8 million |
| Operating margin | 17.5% | 17.7% | 17.4% | 17.4% |
| Net income | $252.4 million | $420.1 million | $693.6 million | $803.0 million |
| Diluted EPS | $0.41 | $0.68 | $1.14 | $1.31 |
| Operating cash flow | Not stated for quarter alone | $428.4 million | $645.4 million |
- Q2 revenue increased 9.2%; first-half revenue increased 9.6%. Q2 growth was strongest in Manufacturing/Retail/Logistics (14.2%) and Other (11.2%); Healthcare grew 6.9%.
- Q2 GAAP net income fell 39.9%, primarily because of the India Cash Remittance tax charge. Q2 effective tax rate was 57.6%, versus 23.5%; first-half rates were 41.4% and 24.2%.
- Management-reported non-GAAP operating margin was 20.3% in Q2 and 20.1% for the first half, versus 20.2% and 20.0%. Non-GAAP diluted EPS was $0.87 for Q2 and $1.67 for the first half. These measures exclude specified expenses and, for EPS, the remittance tax and non-operating foreign-exchange effects; they are not GAAP measures.
Financial position and liquidity
- At June 30, cash and cash equivalents were $1,684.5 million and short-term investments were $2,796.7 million, totaling $4,481.2 million. Working capital was $5,638.9 million.
- Debt carrying value was $908.8 million: $68.8 million current and $840.0 million long-term. Term-loan principal was $912.5 million; there were no revolver borrowings and $750 million of revolving capacity was available. The debt facilities mature in November 2019. The company reported compliance with its debt covenants.
- First-half operating cash flow was $428.4 million, down $217.0 million year over year, attributed mainly to lower net income and higher incentive-compensation payments. Cash and cash equivalents decreased $440.7 million during the half.
- Trade and unbilled receivables rose to $2,427.4 million and $451.1 million, respectively. Days sales outstanding was 74 days, compared with 70 at December 31, 2015.
Material changes and unusual items
- In May, an Indian subsidiary repurchased $2.8 billion of shares from non-Indian Cognizant entities; net of taxes, $1.0 billion was remitted to the United States. The transaction generated $190.0 million of incremental tax expense in Q2. The company expects total incremental 2016 tax expense of $237.5 million, including approximately $23.7 million in each of Q3 and Q4.
- A revised estimate on a fixed-price healthcare implementation contract resulted in a $27.4 million pretax loss in Q2, recorded in the Healthcare segment. Healthcare segment operating profit fell 15.0% year over year in Q2.
- First-half investing cash use was $260.3 million, including $151.3 million of payments for business combinations and an equity-method investment. The company completed three acquisitions and purchased a 49% interest in a strategic consulting firm for $59.1 million; options and performance conditions could require additional payments of up to $100 million if the remaining interest is acquired.
- First-half share repurchases totaled $335.1 million in cash-flow reporting. In August 2016, the board expanded the repurchase authorization from $2.0 billion to $3.0 billion and extended the program through December 31, 2018.
- The company recorded a $3.0 million impairment loss on a mutual fund investment after determining it intended to sell the investment.
Outlook, management commentary and risks
- No specific revenue or EPS forecast is provided in the filing. Management targets a 19%–20% non-GAAP operating margin and says it expects to reinvest amounts above that range in talent, service offerings, digital capabilities, geographic expansion and other growth initiatives.
- Management expects cash, investments, operating cash flow and available revolver capacity to be sufficient for operating requirements over the next 12 months. It also plans continued investment and opportunistic acquisitions.
- Demand drivers include digital and cloud services, discretionary projects, cost optimization and global delivery. Management cited potential headwinds from banking-sector conditions, healthcare consolidation, Brexit-related uncertainty, currency volatility and continued global economic uncertainty.
- Foreign-exchange exposure is significant: the Indian rupee affects costs, while Brexit-related pound volatility may affect UK revenue. The company uses currency forwards; it reported a $10.8 million first-half foreign-exchange loss before hedging effects.
- Other disclosed risks include wage and benefit inflation, competition for skilled personnel, fixed-price contract estimation and delivery risk, cybersecurity and data-protection claims, customer concentration, and acquisition integration. Management said ordinary-course legal matters were not expected to have a material adverse effect; fixed capital commitments for India delivery-center expansion were approximately $184 million.
Most important facts for investors to verify
- Whether the remaining $47.5 million of expected 2016 remittance-related tax expense is recognized as anticipated, and its effect on GAAP earnings.
- Whether revenue growth and operating margins persist after the one-time tax charge and the $27.4 million fixed-price contract loss.
- Receivables, DSO and operating cash flow trends, given the first-half cash-flow decline and higher DSO.
- Exposure to Brexit, currency movements, banking and healthcare-sector conditions, and wage inflation.
- Use of the enlarged repurchase authorization, acquisition-related contingent payments, and delivery-center capital commitments.