Cognizant Technology Solutions Corporation — Q2 2019 Form 10-Q
Reporting period: Three and six months ended June 30, 2019; filed August 1, 2019. Unless stated otherwise, financial amounts are in millions of dollars. The company provides consulting, technology and outsourcing services, with four reportable segments: Financial Services, Healthcare, Products and Resources, and Communications, Media and Technology.
Financial performance and liquidity
| Metric | Q2 2019 | Q2 2018 | First half 2019 | First half 2018 |
|---|---|---|---|---|
| Revenue | $4,141 | $4,006 | $8,251 | $7,918 |
| Operating income / margin | $619 / 14.9% | $670 / 16.7% | $1,158 / 14.0% | $1,363 / 17.2% |
| Net income | $509 | $456 | $950 | $976 |
| Diluted EPS | $0.90 | $0.78 | $1.67 | $1.66 |
| Adjusted operating margin | 16.1% | 19.2% | 16.1% | 18.5% |
| Adjusted diluted EPS | $0.94 | $1.05 | $1.85 | $1.99 |
| Operating cash flow | — | — | $844 | $1,028 |
Q2 revenue grew 3.4% year over year, or 4.7% at constant currency. First-half revenue grew 4.2%, or 5.7% at constant currency. Q2 net income rose despite lower operating income, primarily because foreign currency results improved substantially from the prior-year quarter. The adjusted measures are non-GAAP and exclude specified items; they should be considered alongside GAAP results.
Margins weakened as delivery employee and subcontractor costs grew faster than revenue, with additional pressure from healthcare customer contract renegotiations. First-half results also reflected a $117 million accrual for India’s defined-contribution obligation, $51 million in realignment charges, and customer bankruptcy-related costs. The company reported $266 million of depreciation and amortization for the first half.
Liquidity and debt: At June 30, cash and cash equivalents were $1,660 and short-term investments were $1,343; $429 of the short-term investments were restricted in India. The company reported $844 of first-half operating cash flow and $3,003 of cash, cash equivalents and short-term investments in total. Term-loan debt was $750 before financing costs and current maturities; reported short- and long-term debt totaled approximately $746. No revolving-credit borrowings were outstanding, and approximately $1,750 of revolving capacity remained available. The company said it expected available liquidity and operating cash flow to meet requirements for the next 12 months and was in compliance with debt covenants.
First-half investing cash flow was positive $1,623, primarily because of net sales and maturities of investments; financing cash outflow was $1,976, including substantial share repurchases and dividends. The company returned $2,019 to shareholders in the first half through repurchases and dividends. DSO was 79 days, compared with 75 days at December 31, 2018.
Material changes and operating trends
- Q2 growth was led by Communications, Media and Technology (+12.2%) and Products and Resources (+10.4%). Financial Services was broadly flat (+0.3%); Healthcare declined 1.9%.
- North America generated 75.8% of Q2 revenue. Europe grew 8.6% reported, with particularly strong growth in Continental Europe.
- Q2 cost of revenues increased 8.8%, faster than revenue growth, and rose to 63.5% of revenue from 60.3%. SG&A declined 4.6%, partly because Q2 2018 included a $100 million Cognizant U.S. Foundation contribution.
- Reported Q2 operating income included $49 million of realignment charges. The comparable 2018 quarter included the Foundation contribution; adjusted operating margin nevertheless fell to 16.1% from 19.2%.
- First-half operating cash flow declined $184 million year over year. The company attributed the decrease primarily to lower operating income.
- The company repurchased $1,037 million of stock under its repurchase program in Q2 and declared a $0.20-per-share dividend for payment in August. Shares outstanding declined to 552 million from 577 million at year-end 2018.
Outlook, management commentary, risks and unusual items
The filing provides no specific quantified full-year revenue or earnings guidance. Management cited continued investment in digital capabilities, talent, new services and delivery models, pursuit of strategic acquisitions, and cost discipline. It identified customer demand for digital services and transformation, as well as opportunities in Europe, the Middle East, Asia Pacific and Latin America, as business priorities.
- Management expected additional realignment charges in 2019. Retention awards offered in July were expected to generate about $48 million of charges in the remainder of 2019 and $17 million in the first half of 2020. Completed Q2 employee separations were expected to reduce annualized compensation expense by about $65 million.
- The company accrued $117 million in Q1 for the India Defined Contribution Obligation following a Supreme Court of India ruling. Calculation and retroactive application remain uncertain, and the ultimate obligation may differ materially from the accrual.
- The Indian Income Tax Department disputes taxes associated with 2013 and 2016 share repurchases and asserted an additional 33 billion rupees, approximately $479 million at the June 30 exchange rate, relating to the 2016 transaction. The company recorded no reserve, believing applicable taxes had been paid. A court dismissed its writ petitions on procedural grounds without deciding the tax merits; an appeal was pending, with the tax department directed to maintain the status quo until the next hearing. $429 million of time deposits remained restricted, in addition to a $72 million deposit.
- The company paid approximately $28 million to resolve DOJ and SEC investigations concerning the FCPA; the DOJ issued a declination letter. Securities class-action and shareholder derivative litigation remained unresolved, and the company could not estimate a possible loss. It also disclosed customer indemnity, service-performance, data-security and insurance-related exposures.
- Management cited risks from macroeconomic conditions, trade policies, Brexit uncertainty, customer insourcing and cost optimization, healthcare consolidation and regulatory uncertainty, technology-sector regulation and consolidation, immigration changes, foreign-exchange volatility, and possible disruption from leadership transition and realignment.
- In the third quarter, Cognizant acquired Zenith Technologies for $160 million in cash, excluding contingent consideration. First-half acquisitions included three businesses for approximately $293 million in total consideration.
Most important facts for investors to verify
- Whether revenue growth can improve margins, given that delivery costs outpaced revenue and adjusted operating margin declined materially.
- The eventual amount and timing of the India Defined Contribution Obligation and the outcome of the Indian tax disputes, including when restricted funds may become available.
- Whether healthcare and banking customer transitions, industry consolidation, customer bankruptcies and insourcing continue to weigh on revenue and profitability.
- The full cost and expected benefits of realignment, including the announced retention awards and any further charges.
- Cash conversion and capital allocation: first-half operating cash flow fell, while share repurchases and dividends were substantial.
- Acquisition integration, customer concentration in parts of the faster-growing technology segment, and unresolved litigation or other contingencies.