Cognizant Technology Solutions Corporation — Q2 2018 Form 10-Q
Reporting period: Three and six months ended June 30, 2018. Unaudited consolidated financial statements. Dollar amounts are in millions except per-share data.
Business context
Cognizant provides consulting, technology, outsourcing, and business-process services, with a stated focus on digital transformation. Its reportable segments are Financial Services, Healthcare, Products and Resources, and Communications, Media and Technology.
Key financial metrics
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Revenue | $4,006 | $3,670 | $7,918 | $7,216 |
| Income from operations | $670 | $606 | $1,363 | $1,176 |
| GAAP operating margin | 16.7% | 16.5% | 17.2% | 16.3% |
| Net income | $456 | $470 | $976 | $1,027 |
| Diluted EPS | $0.78 | $0.80 | $1.66 | $1.71 |
| Non-GAAP operating margin | 22.0% | 20.0% | 21.2% | 19.5% |
| Non-GAAP diluted EPS | $1.19 | $0.93 | $2.25 | $1.76 |
Q2 revenue grew 9.2%; first-half revenue grew 9.7%. All four segments grew in Q2, led by Communications, Media and Technology (+15.8%), Products and Resources (+12.4%), and Healthcare (+10.1%); Financial Services grew 4.5%. Non-GAAP measures exclude specified items and are not GAAP measures.
- Cash flow: First-half operating cash flow was $1,028, versus $798 a year earlier. Investing activities used $811, including $478 for acquisitions and $187 for property and equipment; financing activities used $1,222, including $949 in share repurchases and $236 in dividends. Cash and cash equivalents ended at $901, down from $1,925 at year-end 2017.
- Liquidity and debt: Cash, cash equivalents, and short-term investments totaled $4,247, including $419 of restricted India time deposits. The company reported $100 of short-term debt and $649 of long-term debt, and had $750 of undrawn revolving-credit capacity. Debt facilities mature in November 2019; the company disclosed a $625 final term-loan payment due at maturity.
- Other: The company declared dividends of $0.20 per share in each 2018 quarter. It completed two acquisitions for approximately $492 total consideration, including Bolder Healthcare Solutions and Hedera Consulting.
Material changes versus prior periods
- Net income and diluted EPS declined despite revenue and operating-income growth. Foreign-exchange results shifted from a $5 gain in Q2 2017 to an $80 loss in Q2 2018, and from a $57 gain in the first half of 2017 to a $111 loss in the first half of 2018. Management identified these losses as the primary reason for lower net income.
- First-half operating margin improved to 17.2% from 16.3%, while Q2 margin rose modestly to 16.7% from 16.5%. Cost of revenues declined as a share of revenue, but Q2 SG&A rose to 20.1% of revenue from 19.3%.
- Adoption of the new revenue standard on January 1, 2018 increased opening retained earnings by about $121. For Q2, it increased reported revenue by $31, operating income by $38, and diluted EPS by $0.05; first-half effects were $52, $67, and $0.09, respectively. Prior-year results were not restated, limiting direct comparability.
- The $100 initial funding of the Cognizant U.S. Foundation was recorded in Q2 SG&A and excluded from the company’s non-GAAP measures. Realignment charges were $1 in the first half of 2018, compared with $50 in the prior-year period.
Outlook, commentary, and risks
- Management’s stated goal was to gradually expand non-GAAP operating margin and reach 22% in 2019. It expected both GAAP and non-GAAP margins to trend below Q2 2018 levels during the remainder of 2018, citing salary revisions, promotions, and planned investments.
- The company expected $25–$35 of severance costs during the remainder of 2018 as it continued its realignment and cost-efficiency efforts. It reported 268,900 employees and annualized Q2 turnover of approximately 22.6%.
- Management highlighted digital-services demand and customer investment in transformation, but cited cost-containment priorities and potential variability from large, complex contracts. Banking-sector weakness, healthcare regulatory uncertainty, retail weakness, communications-industry M&A, currency movements, and competition for talent were also identified as factors affecting results.
- India tax dispute: The Indian Income Tax Department asserted an additional 33 billion rupees, or about $482, related to the 2016 India cash remittance; a separate dispute concerns a 2013 transaction. Cognizant said it believes applicable taxes were paid, recorded no reserve, and had no final decision. A court stay lifted an account attachment, but $72 was deposited in a segregated account and $419 of time deposits remained restricted. An adverse outcome could materially affect results, cash flows, and liquidity.
- Investigation and litigation: An internal investigation into potentially improper India payments continued, with Cognizant cooperating with the DOJ and SEC. Approximately $6 of potentially improper payments from 2009–2016 had been identified; no related adjustments were recorded in 2018 or 2017. Securities and derivative lawsuits were ongoing. The company could not estimate potential losses and warned that sanctions, remediation, litigation, or related costs could be material.
- The 2017 Tax Reform Act’s provisional tax accounting and the company’s interpretation of its provisions, including GILTI, could change. The company also cited foreign-exchange exposure, contract pricing and delivery risks, data security, and regulatory and geopolitical factors.
Important facts for investors to verify
- Assess earnings and margin trends after separating the revenue-standard adoption impact, non-GAAP adjustments, the $100 Foundation contribution, and foreign-exchange effects.
- Monitor the India tax disputes, court restrictions on funds, and any changes to reserves or liquidity exposure.
- Track developments in the FCPA investigation and related litigation, including any sanctions, remedial costs, or estimated loss range.
- Evaluate progress toward the 2019 non-GAAP margin goal against the near-term expectation of lower margins and planned severance and investment costs.
- Review cash conversion, receivables and days sales outstanding (76 days at June 30, 2018), capital returns, and the refinancing or repayment plan for the November 2019 debt maturity.