01—Abstract
Summary
Summary of the 10-K filed March 1, 2017. Cited figures are marked; the original filing is the authoritative source.
Cognizant (CTSH) ended 2016 with revenues of $13.49 billiona, up 8.6% year over year, and GAAP net income of $1.55 billion, down 4.4%, with diluted EPS of $2.55 versus $2.65 in 2015.
The earnings decline was driven mainly by a $238 millionb incremental tax expense tied to the May 2016 India Cash Remittance, which repatriated about $1.0 billion of cash to the U.S. Excluding that charge and other items, non-GAAP diluted EPS rose to $3.39 from $3.07. GAAP operating margin slipped to 17.0% from 17.3%, and non-GAAP operating margin slipped to 19.5% from 19.7%, as compensation costs and professional service costs outpaced revenue growth. The filing is dominated by governance and legal risk.
The company disclosed an internal investigation into roughly $6 millionc of possibly improper payments tied to Company-owned facilities in India (2010–2015), a voluntary notification to the DOJ and SEC, multiple securities class actions and shareholder derivative suits, and a material weakness in internal control over financial reporting attributed to an ineffective tone at the top. PwC issued an adverse opinion on internal control, though it issued an unqualified opinion on the financial statements. The company also incurred $27 million of FCPA-related costs in 2016 and expects more in 2017 and beyond, and it cannot yet estimate potential losses.
The capital return plan is the key forward-looking item: $3.4 billiond returned over 2017–2018 through a $1.5 billion accelerated buyback, a $0.15 quarterly dividend starting in Q2 2017, and $1.2 billion of open-market repurchases, with a target of 22% non-GAAP operating margin by 2019. Funding will rely partly on new borrowing, and the credit agreement carries a debt-to-equity covenant of 0.40 to 1.00. Balance-sheet capacity is solid, with $5.2 billion of cash and short-term investments against $878 million of total debt, but roughly $4.0 billion of cash sits outside the U.S.
02—Key points
Key Highlights
- Revenue grew 8.6% to $13.49 billion in 2016, led by Manufacturing/Retail/Logistics and Other segments (+13.5% each), with North America at 78.2% of revenue.
- GAAP diluted EPS fell to $2.55 from $2.65 because of a $238 million India Cash Remittance tax charge; non-GAAP diluted EPS rose to $3.39 from $3.07.
- Operating margin compressed slightly: GAAP 17.0% (vs. 17.3%) and non-GAAP 19.5% (vs. 19.7%), with management targeting 22% non-GAAP margin by 2019.
- Material weakness in internal control over financial reporting; PwC issued an adverse opinion on ICFR while issuing an unqualified opinion on the financial statements.
- FCPA internal investigation (~$6 million in payments, 2010–2015) plus three securities class actions and four derivative suits create significant, currently unquantifiable legal exposure.
- Announced $3.4 billion capital return plan for 2017–2018 (including a $1.5 billion ASR and $0.15 quarterly dividend), with a new $3.5 billion repurchase authorization through 2019.
- Balance sheet: $5.2 billion cash and short-term investments versus $878 million total debt, but $4.0 billion of cash is held outside the U.S. and a 0.40:1 debt-to-equity covenant applies.
03—One dollar
04—Financials
Financial Highlights
Figures from 10-KFY2016filed March 1, 2017Financial Statements
FY2016 against FY2015
| Line item | FY2016FY2015 | Change |
|---|---|---|
| Revenue | $13.49B$12.42B | +8.6% |
| SG&A Expenses | $2.73B$2.51B | +8.8% |
| Operating Income | $2.29B$2.14B | +6.9% |
| Interest Expense | $19.00M$18.00M | +5.6% |
| Net Income | $1.55B$1.62B | −4.4% |
| EPS (Basic) | $2.56$2.67 | −4.1% |
| EPS (Diluted) | $2.55$2.65 | −3.8% |
| Shares Outstanding (Basic) | 607.00M609.00M | −0.3% |
| Shares Outstanding (Diluted) | 610.00M613.00M | −0.5% |
05—Questions
Frequently Asked Questions
Why did net income decline in 2016 even though revenue grew 8.6%?
Net income fell 4.4% to $1.55 billion mainly because of a $238 million incremental income tax expense from the India Cash Remittance, which lifted the effective tax rate to 34.2% from 25.0%. Operating income still rose 6.9% to $2.29 billion, so the decline reflects the one-time tax charge rather than weaker operations.
What is the potential financial impact of the FCPA investigation and related lawsuits?
The company has identified about $6 million in potentially improper payments and recorded $27 million of related costs in 2016, with more expected in 2017. The DOJ and SEC could impose fines, disgorgement, remediation, or a monitor, and the class actions and derivative suits seek damages. Management says it cannot yet estimate a loss range, so no accrual has been recorded, and the outcome could be material.
How will Cognizant fund the $3.4 billion capital return plan?
The plan combines a $1.5 billion accelerated buyback in Q1 2017, $1.2 billion of open-market repurchases in 2017–2018, and dividends of $0.15 per quarter from Q2 2017. Management expects to rely on U.S. cash, U.S. cash flow, and additional borrowing, possibly including a new syndicated facility and repatriation of foreign earnings. Future returns in 2019 and beyond target about 75% of U.S. free cash flow.
What does the material weakness mean for investors?
The material weakness relates to an ineffective control environment (tone at the top) involving senior management who may have overridden or failed to enforce controls over real estate and procurement in India. The auditor's opinion on internal control is adverse, though the financial statements themselves received an unqualified opinion. Management says no restatement is required, but remediation is ongoing and further weaknesses could be identified as the investigation continues.
How concentrated is the business by customer, industry, and geography?
Concentration is moderate. The top ten customers provided 16.7% of 2016 revenue, and no single customer exceeded 10%. Financial Services (39.8%) and Healthcare (28.7%) are the largest industry exposures. North America generated 78.2% of revenue, and Europe 15.9%. Most delivery staff, about 188,000 of 260,200 employees, are in India, which exposes the company to currency, wage, and regulatory risk.
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