Cognizant Technology Solutions Corporation — Q3 2017 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2017. Financial statements are unaudited and prepared under U.S. GAAP. Amounts are in U.S. dollars; financial figures below are in millions except per-share data.
Business context
Cognizant provides consulting, technology, application, infrastructure and business-process services. Management is shifting investment toward digital services while seeking operating efficiencies. The company reported four segments: Financial Services; Healthcare; Products and Resources; and Communications, Media and Technology.
Financial performance
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Revenue | $3,766 | $3,453 | $10,982 | $10,025 |
| Operating income | $648 | $583 | $1,824 | $1,728 |
| GAAP operating margin | 17.2% | 16.9% | 16.6% | 17.2% |
| Net income | $495 | $444 | $1,522 | $1,137 |
| Diluted EPS | $0.84 | $0.73 | $2.55 | $1.87 |
| Non-GAAP operating margin | 20.0% | 19.3% | 19.7% | 19.8% |
| Non-GAAP diluted EPS | $0.98 | $0.86 | $2.75 | $2.53 |
Q3 revenue rose 9.1%; nine-month revenue rose 9.5%. Q3 growth was strongest in Communications, Media and Technology (18.2%), Products and Resources (14.0%) and Healthcare (9.3%); Financial Services grew 3.8%. For the nine months, revenue growth was broad-based, led by Communications, Media and Technology (17.2%) and Products and Resources (14.5%).
Q3 GAAP operating margin improved year over year, while the nine-month margin declined 0.6 percentage points. Management cited higher compensation and benefits, investment in digital capabilities and currency pressure; lower subcontractor and other operating costs supported Q3 margin. Non-GAAP figures exclude stock compensation, acquisition-related charges and 2017 realignment charges, among other EPS adjustments.
For the nine months, operating cash flow was $1,571, versus $1,041 in 2016. Investing cash outflow was $422, compared with $873; financing cash outflow was $1,652, compared with $748, principally reflecting the $1.5 billion accelerated share repurchase and $179 in dividends. Cash and cash equivalents ended the period at $1,577, down from $2,034 at year-end 2016.
At September 30, 2017, cash, cash equivalents and short-term investments totaled $4,713; total assets were $14,580 and total liabilities were $3,601. Debt was $823, comprising $100 current and $723 long-term; $825 of term-loan principal was outstanding before deferred financing costs and current maturities. The $750 revolving facility had no balance outstanding, and the company reported covenant compliance. Cash, cash equivalents and short-term investments held outside the U.S. totaled $4,336. Days sales outstanding was 74, versus 72 at December 31, 2016.
Material changes and unusual items
- Q3 2017 included $19 of pre-tax realignment charges; nine-month charges were $69, primarily employee separation costs, advisory fees and lease termination costs. No realignment charges were reported in 2016. Management estimated the voluntary separation program would reduce annualized compensation expense by about $60.
- Nine-month net income benefited from a lower effective tax rate: 21.7% versus 36.7%. The 2016 comparison included $214 of incremental tax expense related to the India cash remittance; 2017 included recognition of $72 in previously unrecognized tax benefits.
- Currency effects were mixed. For the nine months, foreign exchange gains were $41 net, including $57 of currency remeasurement gains and $16 of losses on non-designated forward contracts. Cash-flow hedge settlements provided a reported $89 gain during the period.
- The company completed three acquisitions for initial consideration of approximately $72, net of cash acquired, adding digital, healthcare consulting and government healthcare business-process capabilities.
Outlook, commentary and risks
- Management’s stated objective was a 22% non-GAAP operating margin in 2019 while continuing revenue growth. No specific near-term revenue or earnings guidance is provided in the supplied filing text.
- The company announced a plan to return $3.4 billion to stockholders by the end of 2018 through repurchases and dividends. It completed a $1.5 billion accelerated repurchase in 2017, paid $179 in dividends, and intended to repurchase an additional $1.2 billion of shares by the end of 2018. Future actions depend on board review and business, liquidity and market conditions.
- Management cited ongoing demand for digital services and transformational projects, but noted that larger managed-services contracts may have longer sales cycles and ramp-up periods, increasing period-to-period variability. Banking, U.K. financial services, retail and healthcare regulatory uncertainty were identified as demand risks.
- The company is investigating potentially improper payments associated with India facilities and is cooperating with the DOJ and SEC. The investigation identified approximately $6 of potentially improper payments from 2010–2015; prior-period corrections were recorded in 2016, and no related adjustments were recorded in the first nine months of 2017. The company could not estimate any possible loss and recorded no accrual. It expects further investigation and remediation costs; sanctions or penalties could materially affect results and financial condition.
- A material weakness in internal control over financial reporting remained at September 30, 2017, and management concluded disclosure controls and procedures were not effective. The filing states the weakness had not caused a material misstatement in current or prior-period financial statements. Remediation steps included management and personnel changes and enhanced compliance, procurement and accounts-payable controls; effectiveness remained under evaluation.
- Other key exposures include Indian rupee and other currency movements, wage inflation and talent retention, customer delivery and cybersecurity risks, and the related securities class action and shareholder derivative litigation. The company could not reliably estimate losses from the investigation or related cases.
Important facts for investors to verify
- Progress and outcomes of the FCPA investigation, DOJ/SEC inquiries and related litigation, including any sanctions, remediation costs or indemnification advances.
- Whether the material weakness is remediated and whether disclosure controls and internal financial reporting controls become effective.
- Execution and sustainability of the 2019 non-GAAP margin objective, including the effects of realignment, wage costs, digital investment and Indian rupee movements.
- Cash generation, receivables and collections, the location and availability of foreign cash, debt repayment, and the feasibility of the announced capital-return plan.
- The impact of adopting the new revenue-recognition standard in 2018; management said it was evaluating the effect and could not yet quantify it.