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(Exact Name of Registrant as Specified in Its Charter)
iDelaware
i13-3728359
(State
or Other Jurisdiction of
Incorporation or Organization)
(I.R.S. Employer Identification No.)
iGlenpointe Centre West
i500
Frank W. Burr Blvd.
iTeaneck,
iNew Jersey
i07666
(Address
of Principal Executive Offices)
(Zip Code)
Registrant’s telephone number, including area code: (i201) i801-0233
N/A
(Former Name, Former Address and
Former Fiscal Year,
if Changed Since Last Report)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Trading Symbol(s)
Name of each exchange on which registered
iClass
A Common Stock, $0.01 par value per share
iCTSH
iThe Nasdaq Stock Market LLC
Indicate by check mark whether the registrant:
(1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. iYes☒ No: ☐
Indicate by check mark whether the registrant
has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). iYes☒ No: ☐
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,”“accelerated filer”, “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act. (Check one):
iLarge Accelerated Filer
☒
Accelerated filer
☐
Non-accelerated
filer
☐
Smaller reporting company
i☐
Emerging growth company
i☐
If
an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes i☐No ý
Indicate the number of shares outstanding of each of the issuer’s class of common stock, as of July 24, 2020:
Preferred stock, $ii0.10/
par value, ii15.0/ shares authorized, iinone/
issued
i—
i—
Class A
common stock, $ii0.01/ par value, ii1,000/
shares authorized, ii542/ and ii548/
shares issued and outstanding as of June 30, 2020 and December 31, 2019, respectively
i5
i5
Additional
paid-in capital
i83
i33
Retained
earnings
i11,072
i11,022
Accumulated
other comprehensive income (loss)
(i188)
(i38)
Total
stockholders’ equity
i10,972
i11,022
Total
liabilities and stockholders’ equity
$
i18,216
$
i16,204
The
accompanying notes are an integral part of the unaudited consolidated financial statements.
(1)Reflects
the adoption of the Credit Loss Standard as described in Note 1.
(2)Reflects the adoption of ASC Topic 842 “Leases” on January 1, 2019. Refer to the notes in the consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2019.
The accompanying notes are an integral part of the unaudited consolidated financial statements.
The terms “Cognizant,”“we,”“our,”“us” and “the Company” refer to Cognizant Technology Solutions Corporation and its subsidiaries
unless the context indicates otherwise. We have prepared the accompanying unaudited consolidated financial statements included herein in accordance with GAAP and the Exchange Act. The accompanying unaudited consolidated financial statements should be read in conjunction with our audited consolidated financial statements (and notes thereto) included in our Annual Report on Form 10-K for the year ended December 31, 2019. In our opinion, all adjustments considered necessary for a fair statement of the accompanying unaudited consolidated financial statements have been included and all adjustments are of a normal and recurring nature. Operating results for the interim periods are not necessarily indicative of results that may be expected to occur for the entire year.
Our unaudited consolidated financial statements presented herein reflect the latest estimates and assumptions made
by management that affect the reported amounts of assets and liabilities and related disclosures as of the date of the unaudited consolidated financial statements and reported amounts of revenues and expenses during the reporting periods presented. During the first half of 2020, the global COVID-19 pandemic caused significant loss of life and interruption to the global economy, including the curtailment of activities by businesses and consumers in much of the world as governments and others seek to limit the spread of the disease.The COVID-19 pandemic negatively impacted our results of operations, cash flows and financial position. In addition, the pandemic may affect management's estimates and assumptions of variable consideration in contracts
with customers as well as other estimates and assumptions, in particular those that require a projection of our financial results, our cash flows or broader economic conditions, such as the annual effective tax rate, the allowance for doubtful accounts, the recoverability of capitalized deferred charges and the fair values of goodwill, long-lived assets and indefinite-lived intangible assets.
For the quarter ended March 31, 2020, we deemed the COVID-19-related deterioration in general economic conditions sufficient to trigger an interim impairment test of goodwill as of March 31, 2020. Our interim test results as of March 31 indicated that the fair values of all of our reporting units exceed their carrying values and thus, no impairment of goodwill existed as of March
31, 2020. No additional triggers for an interim impairment test have been identified since March 31, 2020.
Due to the size of past acquisitions in our healthcare reporting unit, this reporting unit carries the most significant portion of our goodwill balance and has the least amount of excess fair value over its carrying value.
The new standard requires the measurement and recognition of expected credit losses using the current expected credit loss model for financial assets held at amortized cost, which includes the Company’s trade accounts receivable, certain financial instruments and contract
assets. It replaces the existing incurred loss impairment model with an expected loss methodology. The recorded credit losses are adjusted each period for changes in expected lifetime credit losses. The standard requires a cumulative effect adjustment to the statement of financial position as of the beginning of the first reporting period in which the guidance is effective.
As a result of the adoption, we recorded an increase to our opening retained earnings and "Trade accounts receivable, net" of $ii1/
million each.
Prior year amounts are not adjusted and continue to be reported in accordance with our historical accounting policies.
The tables below present disaggregated revenues from contracts with clients by client location, service line and contract-type for each of our business segments. We believe this disaggregation best depicts how the nature, amount, timing and uncertainty of our revenues and cash flows are affected by industry, market and other economic factors. Revenues are attributed to regions based upon client location. Substantially all revenues in our North America region relate to operations in the United States.
We have defined our Financial Services, Healthcare, Products and Resources and Communications, Media and Technology
segments as ("FS"), ("HC"), ("P&R"), and ("CMT"), respectively, in our disaggregation of revenues tables.
We
expect the COVID-19 pandemic to continue to impact demand across all our segments throughout the remainder of 2020 and potentially beyond. We expect demand from our retail and consumer goods clients and our travel and hospitality clients in our Products and Resources segment as well as communications and media clients in our Communications, Media and Technology segment to be particularly negatively impacted by the COVID-19 pandemic.
Costs to fulfill, such as set-up or transition activities, are recorded in "Other noncurrent assets" in our unaudited consolidated statements of financial position and the amortization expense of costs to fulfill is included in "Cost of revenues" in our unaudited consolidated statements of operations. Costs to obtain contracts were immaterial for the period disclosed. The following table presents information related to the capitalized
costs to fulfill for the six months ended June 30:
A contract asset is a right to consideration that is conditional upon factors other than the passage of time. Contract assets are presented in "Other current assets" in our unaudited consolidated statements of financial position and primarily relate to unbilled amounts on fixed-price contracts utilizing the cost to cost method of revenue recognition. iThe
table below shows significant movements in contract assets for the six months ended June 30:
2020
2019
(in millions)
Beginning
balance
$
i334
$
i305
Revenues
recognized during the period but not billed
Our contract liabilities, or deferred revenue, consist of advance payments and billings in excess of revenues recognized. The tables below show significant movements in the deferred revenue balances (current and noncurrent) for the six months ended June 30:
2020
2019
(in
millions)
Beginning balance
$
i336
$
i348
Amounts
billed but not recognized as revenues
i297
i203
Revenues
recognized related to the opening balance of deferred revenue
(i268)
(i203)
Ending
balance
$
i365
$
i348
Revenues
recognized during the three and six months ended June 30, 2020 for performance obligations satisfied or partially satisfied in previous periods were immaterial.
Remaining Performance Obligations
As of June 30, 2020, the aggregate amount of transaction price allocated to remaining performance obligations was $i1,690 million
of which approximately i70% is expected to be recognized as revenue within i2
years. Disclosure is not required for performance obligations that meet any of the following criteria:
(1)contracts with a duration of one year or less as determined under ASC Topic 606: "Revenue from Contracts with Customers",
(2)contracts for which we recognize revenues based on the right to invoice for services performed,
(3)variable consideration allocated entirely to a wholly unsatisfied performance obligation or to a wholly unsatisfied promise to transfer a distinct good or service
that forms part of a single performance obligation in accordance with ASC 606-10-25-14(b), for which the criteria in ASC 606-10-32-40 have been met, or
(4)variable consideration in the form of a sales-based or usage-based royalty promised in exchange for a license of intellectual property.
Many of our performance obligations meet one or more of these exemptions and therefore are not included in the remaining performance obligation amount disclosed above.
Trade Accounts Receivable and Allowance for Doubtful Accounts
We calculate expected credit losses for our trade accounts receivable based on historical credit loss rates for each aging category as adjusted for the current market conditions and forecasts about future economic conditions. iThe
following table presents the activity in the allowance for doubtful accounts for trade accounts receivable:
During the six months ended June 30, 2020, we acquired i100%
ownership in the following:
•Code Zero, a provider of consulting and implementation services that strengthens our cloud solutions portfolio and Salesforce Configure-Price-Quote and billing capabilities (acquired on January 31, 2020).
•Lev, a Salesforce Platinum Partner specializing in digital marketing consultancy and implementation of custom cloud solutions that further expands our global Salesforce practice (acquired on March 27, 2020).
•EI-Technologies, a digital technology consulting firm and leading Salesforce specialist that expands our global Salesforce practice (acquired on May 29, 2020).
•Collaborative Solutions, a provider of Workday enterprise cloud applications for finance and human resources that strengthens our portfolio of cloud offerings (acquired on June 10, 2020).
i
The
allocations of preliminary purchase price to the fair value of the aggregate assets acquired and liabilities assumed in the aforementioned acquisitions were as follows:
Collaborative Solutions
Other
Total
Weighted
Average Useful Life
(in millions)
Cash
$
i5
$
i8
$
i13
Trade
accounts receivable
i41
i22
i63
Property
and equipment and other assets
i5
i19
i24
Operating
lease assets, net
i6
i12
i18
Non-deductible
goodwill
i327
i108
i435
Customer
relationship intangible assets
i42
i12
i54
i9.2
years
Other intangible assets
i8
i2
i10
i6.5
years
Current liabilities
(i30)
(i21)
(i51)
Noncurrent
liabilities
(i4)
(i18)
(i22)
Purchase
price, inclusive of contingent consideration(1)
$
i400
$
i144
$
i544
/
(1)The
purchase price for Collaborative Solutions includes a contingent consideration component with a maximum payout of $i54 million, valued at $i38 million
at the date of acquisition, which is contingent upon achieving certain performance thresholds during the first two calendar years following the date of acquisition.
The allocations are preliminary and will be finalized as soon as practicable within the measurement period, but in no event later than one year following the date of acquisition.
The acquisitions completed during the six months ended June 30, 2020 were not individually or in the aggregate material to our operations or cash flows. Accordingly, pro forma results have not been presented. We have allocated the purchase price related to these transactions to tangible and intangible assets acquired and liabilities assumed, including non-deductible goodwill, based on their
estimated fair values. Goodwill from these acquisitions is intended to benefit all of our reportable segments and has been allocated as such. The primary items that generated goodwill are the value of the acquired assembled workforces and synergies between the acquired companies and us, neither of which qualify as an identifiable intangible asset.
Note 4 — Restructuring Charges
i
In
2017, we began a realignment program with the objective of improving our client focus, our cost structure and the efficiency and effectiveness of our delivery while continuing to drive revenue growth. In 2019, we announced our 2020 Fit for Growth Plan which involves certain measures to simplify our organizational model and optimize our cost structure in order to partially fund the investments required to execute on our strategy and advance our growth agenda as well as our decision to exit certain content-related services that are not in line with our strategic vision for the Company.
The total costs related to our realignment program and our 2020 Fit for Growth Plan are reported in "Restructuring charges" in our unaudited consolidated statements of operations. We do not allocate these charges
to individual segments in internal management reports used by the chief operating decision maker. Accordingly, such expenses are included in our segment reporting as “unallocated costs”. See Note 13.
(1)Includes
$i1 million and $i4 million of accelerated depreciation for the three and six months ended June
30, 2020, respectively.
/
The 2020 Fit for Growth Plan charges include $i8 million and $i19
million for the three and six months ended June 30, 2020, respectively, of costs incurred related to our exit from certain content-related services.
i
Changes in our accrued employee separation costs included in "Accrued expenses and other current liabilities" in our consolidated statements of financial position are presented in the table below for the six months ended June 30.
(1)As
of June 30, 2020, $i391 million in restricted time deposits were classified as long-term. As of December 31, 2019, $i414
million in restricted time deposits were classified as short-term. See Note 8.
/
Equity Investment Securities
Our equity investment security is a U.S. dollar denominated investment in an open-ended mutual fund. Realized and unrealized gains and losses were immaterial for the three and six months ended June 30, 2020 and 2019.
Held-to-Maturity Investment
Securities
Our held-to-maturity investment securities consist of Indian rupee denominated investments primarily in commercial paper, international corporate bonds and government debt securities. Our investment guidelines are to purchase securities that are investment grade at the time of acquisition. The basis for the measurement of fair value of our held-to-maturity investments is Level 2 in the fair value hierarchy.
i
The amortized cost, gross unrealized gains and losses and
fair value of held-to-maturity investment securities at June 30, 2020 were as follows:
Amortized Cost
Unrealized Gains
Unrealized Losses
Fair Value
(in
millions)
Short-term investments, due within one year:
Corporate and other debt securities
$
i56
$
i—
$
i—
$
i56
Commercial
paper
i74
i1
i—
i75
Total
short-term held-to-maturity investments
$
i130
$
i1
$
i—
$
i131
The
amortized cost, gross unrealized gains and losses and fair value of held-to-maturity investment securities at December 31, 2019 were as follows:
Amortized Cost
Unrealized Gains
Unrealized Losses
Fair Value
(in
millions)
Short-term investments, due within one year:
Corporate and other debt securities
$
i101
$
i—
$
i—
$
i101
Commercial
paper
i186
i—
i—
i186
Total
short-term held-to-maturity investments
$
i287
$
i—
$
i—
$
i287
/
As
of June 30, 2020, there were ino held-to-maturity investment securities in an unrealized loss position. As of December 31, 2019, commercial paper in the amount of $i70 million
and corporate and other debt securities in the amount of $i42 million
were in an unrealized loss position. The total unrealized loss was less than $i1 million and inone
of the securities had been in an unrealized loss position for longer than 12 months.
We monitor the credit ratings of the securities in our portfolio on an ongoing basis and evaluate the need for an allowance for expected credit losses. The securities in our portfolio are highly rated and short-term in nature. Historically, we have not had any impairment losses on our portfolio. As of June 30, 2020, our corporate and other debt securities were rated AAA and our commercial paper were rated A-1+ by CRISIL, an Indian subsidiary of S&P Global.
During the six months ended June 30, 2020 and the year ended December 31, 2019, there were no transfers
of investments between our available-for-sale and held-to-maturity investment portfolios.
Equity and Cost Method Investments
During 2020, we acquired a $i26 million equity method investment in the technology sector. As of June 30, 2020 and December 31, 2019, we had equity method investments of $i34 million
and $i9 million, respectively and cost method investments of $i4 million and $i8 million,
respectively.
Note 6 — Accrued Expenses and Other Current Liabilities
ii
Accrued
expenses and other current liabilities were as follows:
Total
accrued expenses and other current liabilities
$
i2,290
$
i2,191
//
Note
7 — Debt
i
In 2018, we entered into a Credit Agreement providing for a $i750
million Term Loan and a $i1,750 million unsecured revolving credit facility. During the first quarter of 2020, we borrowed $i1,740
million against our revolving credit facility. Both our Term Loan and the borrowing under our revolving credit facility mature in November 2023.
The Credit Agreement requires interest to be paid, at our option, at either the ABR or the Eurocurrency Rate (each as defined in the Credit Agreement), plus, in each case, an Applicable Margin (as defined in the Credit Agreement). Initially, the Applicable Margin is i0.875% with respect
to Eurocurrency Rate loans and i0.00% with respect to ABR loans. Subsequently, the Applicable Margin with respect to Eurocurrency Rate loans may range from i0.75%
to i1.125%, depending on our public debt ratings (or, if we have not received public debt ratings, from i0.875% to i1.125%,
depending on our Leverage Ratio, which is the ratio of indebtedness for borrowed money to Consolidated EBITDA, as defined in the Credit Agreement). Our Credit Agreement also provides a mechanism for determining an alternative rate of interest to the Eurocurrency rate after LIBOR is no longer available. The outstanding balance under our revolving credit facility as of June 30, 2020 is a Eurocurrency Rate loan with an Interest Period (as defined in the Credit Agreement) of ione month.
We
are required under the Credit Agreement to make scheduled quarterly principal payments on the Term Loan. The Credit Agreement contains customary affirmative and negative covenants as well as a financial covenant. We were in compliance with all debt covenants and representations as of June 30, 2020.
In February 2020, our India subsidiary renewed its i13 billion
Indian rupee ($i172 million at the June 30, 2020 exchange rate) working capital facility, which requires us to repay any balances within 90 days from the date of disbursement. There is a 1.0% prepayment penalty applicable to payments made prior to 30 days after disbursement. This working capital facility contains affirmative and negative covenants and may be renewed annually in February.
Short-term
Debt
As of both June 30, 2020 and December 31, 2019, we had $ii38/ millionof short-term debt related to current maturities of our Term Loan.
Long-term Debt
i
The following summarizes our long-term debt balances as of:
The
effective tax rate for the three and six months ended June 30, 2020 increased primarily due to the depreciation of the Indian rupee against the U.S. dollar, which resulted in non-deductible foreign currency exchange losses on our unaudited consolidated statement of operations.
In March 2020, the Indian parliament enacted the Budget, which contains a number of provisions related to income tax, including a replacement of the DDT, previously due from the dividend payer, with a tax payable by the shareholder receiving the dividend. This provision reduces the tax rate applicable to us for cash repatriated from India. During the first quarter of 2020, we limited our indefinite reinvestment assertion to India earnings accumulated in prior years.
On
July 20, 2020, the U.S. Treasury Department and the Internal Revenue Service released final regulations related to the global intangible low-taxed income, or GILTI, high-tax exclusion. We are evaluating the potential impact of these regulations. While we do not anticipate a material impact on our overall income tax provision, the regulations may reduce our income taxes payable in 2020.
We are involved in an ongoing dispute with the ITD in connection with a previously disclosed 2016 share repurchase transaction undertaken by CTS India to repurchase shares from its shareholders (non-Indian Cognizant entities) valued at $i2.8
billion. As a result of that transaction, which was undertaken pursuant to a plan approved by the Court in Chennai, India, we previously paid $i135 million in Indian income taxes - an amount we believe includes all the applicable taxes owed for this transaction under Indian law. In March 2018, we received a communication from the ITD asserting that the ITD is owed an additional i33
billion Indian rupees ($i437 million at the June 30, 2020 exchange rate) on the 2016 transaction. Immediately thereafter, the ITD placed an attachment on certain of our India bank accounts. In addition to the dispute on the 2016 transaction, we are also involved in another ongoing dispute with the ITD relating to a 2013 transaction undertaken by CTS India to repurchase shares from its shareholders valued at $i523
million (the two disputes are collectively referred to as the "ITD Dispute").
In April 2018, the Court admitted our writ petition for a stay of the actions of the ITD and lifted the ITD’s attachment on our bank accounts. As part of the interim stay order, we deposited i5
billion Indian rupees ($i66 million at the June 30, 2020 exchange rate and $ii70/ million
at the December 31, 2019 exchange rate) representing i15% of the disputed tax amount related to the 2016 transaction, with the ITD. In addition, the Court also placed a lien on certain time deposits of CTS India in the amount of i28
billion Indian rupees ($i371 million at the June 30, 2020 exchange rate and $i393 million
at the December 31, 2019 exchange rate), which is the remainder of the disputed tax amount related to the 2016 transaction. In June 2019, the Court dismissed our previously admitted writ petitions on the ITD Dispute, holding that the Company must exhaust other remedies, such as pursuing the matter before other appellate bodies, for resolution of the ITD Dispute prior to intervention by the Court. The Court did not issue a ruling on the substantive issue of whether we owe additional tax as a result of either the 2016 or the 2013 transaction. In July 2019, we appealed the Court’s orders before the Division Bench. In September 2019, the Division Bench partly allowed the Company’s appeal with respect to the 2016 transaction, but did not issue a ruling
on the substantive issue of the tax implications of the transactions. In October 2019, we filed a Special Leave Petition before the SCI with respect to the 2016 transaction.
In March 2020, the SCI referred the case based on the 2016 transaction back to the ITD with directions to carry out the assessment following the due process of law. Further, until the conclusion of the assessment, the SCI maintained in place the lien on our i28 billion Indian rupees time
deposit and did not order the release of the i5 billion Indian rupees deposit held by the ITD. In April 2020, we received an assessment from the ITD, which is consistent with its previous assertions regarding our 2016 transaction. In June 2020 we filed an appeal against this assessment. The ruling of the SCI and the ITD's assessment created additional uncertainty as to the timing of the resolution of this case and, as a result, in the first quarter of 2020 we reclassified the deposits under lien, which are considered restricted assets, and the deposit with the ITD to noncurrent assets. As of June 30,
2020 and December 31, 2019, the balance of deposits under lien was $i391 million presented in "Long-term investments" and $i414
million presented in "Short-term investments", respectively, including a portion of the interest previously earned. As of June 30, 2020 and December 31, 2019, the deposit with the ITD was $i66 million presented in "Other noncurrent assets" and $i70
million presented in "Other current assets", respectively.
We believe we have paid all applicable taxes owed on both the 2016 and the 2013 transactions. Accordingly, we have not recorded any reserves for these matters as of June 30, 2020.
Note 9 — Derivative Financial Instruments
iIn
the normal course of business, we use foreign exchange forward and option contracts to manage foreign currency exchange rate risk. Derivatives may give rise to credit risk from the possible non-performance by counterparties. Credit risk is limited to the fair value of those contracts that are favorable to us. We have limited our credit risk by limiting the amount of credit exposure with any one financial institution and conducting ongoing evaluation of the creditworthiness of the financial institutions with which we do business. In addition, all the assets and liabilities related to our foreign exchange derivative contracts set forth in the below table
are subject to master netting arrangements, such as the International Swaps and Derivatives Association, with each individual counterparty. These master netting arrangements generally provide for net settlement of all outstanding contracts with the counterparty in the case of an event of default or a termination event. We have presented all the assets and liabilities related to our foreign exchange derivative contracts, as applicable, on a gross basis, with no offsets, in our unaudited consolidated statements of financial position. There is no financial collateral (including cash collateral) posted or received by us related to our foreign exchange derivative contracts.
The following table provides information on the location and fair values of derivative financial instruments included in our unaudited consolidated statements of financial position as of:
Foreign exchange forward and option contracts – Designated as cash flow hedging instruments
Other current assets
$
i8
$
—
$
i32
$
—
Other
noncurrent assets
i4
—
i8
—
Accrued
expenses and other current liabilities
—
i21
—
i7
Other
noncurrent liabilities
—
i17
—
i2
Total
i12
i38
i40
i9
Foreign
exchange forward contracts – Not designated as hedging instruments
Other current assets
i1
—
i3
—
Accrued
expenses and other current liabilities
—
i3
—
i1
Total
i1
i3
i3
i1
Total
$
i13
i41
$
i43
$
i10
/
Cash
Flow Hedges
We have entered into a series of foreign exchange derivative contracts that are designated as cash flow hedges of Indian rupee denominated payments in India. These contracts are intended to partially offset the impact of movement of the Indian rupee against the U.S. dollar on future operating costs and are scheduled to mature each month during the remainder of 2020, 2021 and the first half of 2022. The changes in fair value of these contracts are initially reported in "Accumulated other comprehensive income (loss)" in our unaudited consolidated statements of financial position and are subsequently reclassified to earnings within the
captions "Cost of revenues" and "Selling, general and administrative expenses" in our unaudited consolidated statements of operations in the same period that the forecasted Indian rupee denominated payments are recorded in earnings. As of June 30, 2020, we estimate that $i17 million, net of tax, of net losses related
to derivatives designated as cash flow hedges reported in "Accumulated other comprehensive income (loss)" in our unaudited consolidated statements of financial position is expected to be reclassified into earnings within the next 12 months.
i
The notional value of our outstanding contracts by year of maturity and the net unrealized gains and losses included in the caption "Accumulated other comprehensive
income (loss)" in our unaudited consolidated statements of financial position, for our cash flow hedges, were as follows:
The following table provides information on the location and amounts of pre-tax gains and losses on our cash flow hedges for the three months ended June 30:
Change
in Derivative Gains Recognized in Accumulated Other Comprehensive Income (Loss) (effective portion)
Location of Net (Losses) Gains Reclassified from Accumulated Other Comprehensive Income (Loss) into Income (effective portion)
Net (Losses) Gains Reclassified from Accumulated Other Comprehensive Income (Loss) into Income (effective portion)
2020
2019
2020
2019
(in
millions)
Foreign exchange forward and option contracts – Designated as cash flow hedging instruments
$
i35
$
i19
Cost
of revenues
$
(i9)
$
i3
SG&A
expenses
(i2)
i1
Total
$
(i11)
$
i4
/
The
following table provides information on the location and amounts of pre-tax gains and losses on our cash flow hedges for the six months ended June 30:
Change in Derivative (Losses) Gains Recognized in Accumulated Other Comprehensive Income (Loss) (effective
portion)
Location of Net (Losses) Reclassified from Accumulated Other Comprehensive Income (Loss) into Income (effective portion)
Net (Losses) Reclassified from Accumulated Other Comprehensive Income (Loss) into Income (effective portion)
2020
2019
2020
2019
(in
millions)
Foreign exchange forward and option contracts – Designated as cash flow hedging instruments
$
(i78)
$
i58
Cost
of revenues
$
(i12)
$
i—
SG&A
expenses
(i2)
i—
Total
$
(i14)
$
i—
The
activity related to the change in net unrealized gains and losses on our cash flow hedges included in "Accumulated other comprehensive income (loss)" in our unaudited consolidated statements of stockholders equity is presented in Note 11.
Other Derivatives
We use foreign exchange forward contracts to provide an economic hedge against balance sheet exposures to certain monetary assets and liabilities denominated in currencies other than the functional currency of our foreign subsidiaries, primarily the Indian rupee,
Euro and British pound. We entered into foreign exchange forward contracts that are scheduled to mature in 2020. Realized gains or losses and changes in the estimated fair value of these derivative financial instruments are recorded in the caption "Foreign currency exchange gains (losses), net" in our consolidated statements of operations.
i
Additional information related
to our outstanding foreign exchange forward contracts not designated as hedging instruments was as follows:
The following table provides information on the location and amounts of realized and unrealized pre-tax gains and losses on our other derivative financial instruments for the three and six months ended June 30:
Location of Net
(Losses) Gains on Derivative Instruments
Amount of Net (Losses) Gains on Derivative Instruments
Foreign exchange forward contracts – Not designated as hedging instruments
Foreign currency exchange (losses) gains, net
$
(i3)
$
(i4)
$
i3
$
(i5)
/
The
related cash flow impacts of all of our derivative activities are reflected as cash flows from operating activities.
Note 10 — Fair Value Measurements
i
We
measure our cash equivalents, certain investments, contingent consideration liabilities and foreign exchange forward and option contracts at fair value. The authoritative guidance defines fair value as the exit price, or the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants as of the measurement date. The authoritative guidance also establishes a fair value hierarchy that is intended to increase consistency and comparability in fair value measurements and related disclosures. The fair value hierarchy is based on inputs to valuation techniques that are used to measure fair value that are either observable or unobservable. Observable inputs reflect assumptions market participants would use in pricing an asset or liability based on market data obtained from independent sources while unobservable inputs
reflect a reporting entity’s pricing based upon their own market assumptions.
The fair value hierarchy consists of the following three levels:
•Level 1 – Inputs are quoted prices in active markets for identical assets or liabilities.
•Level 2 – Inputs are quoted prices for similar assets or liabilities in an active market, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable and market-corroborated inputs which are derived principally from or corroborated by observable market data.
•Level 3 – Inputs are derived from valuation techniques in which one or more significant inputs or value drivers are unobservable.
(1)Includes
$i414 million in restricted time deposits. See Note 8.
/
We measure the fair value of money market funds based on quoted prices in active markets for identical assets and measure
the fair value of our equity security based on the published daily net asset value at which investors can freely subscribe
to or redeem from the fund. The carrying value of our time deposits approximated fair value as of June 30, 2020 and December 31, 2019.
We estimate the fair value of each foreign exchange forward contract by using a present value of expected cash flows model. This
model calculates the difference between the current market forward price and the contracted forward price for each foreign exchange contract and applies the difference in the rates to each outstanding contract. The market forward rates include a discount and credit risk factor. We estimate the fair value of each foreign exchange option contract by using a variant of the Black-Scholes model. This model uses present value techniques and reflects the time value and intrinsic value based on observable market rates.
We estimate the fair value of contingent consideration liabilities associated with our acquisitions utilizing one
or more significant inputs that are unobservable. We calculate the fair value of such liabilities based on the probability-weighted expected performance of the acquired entity against the target performance metric, discounted to present value when appropriate.
Note 11 — Accumulated Other Comprehensive Income (Loss)
ii
Changes
in accumulated other comprehensive income (loss) by component were as follows for the three and six months ended June 30, 2020:
Three
Months
Six Months
Before Tax Amount
Tax Effect
Net of Tax Amount
Before Tax Amount
Tax Effect
Net of Tax Amount
(in
millions)
Foreign currency translation adjustments:
Beginning balance
$
(i202)
$
i3
$
(i199)
$
(i63)
$
(i1)
$
(i64)
Change
in foreign currency translation adjustments
i37
i1
i38
(i102)
i5
(i97)
Ending
balance
$
(i165)
$
i4
$
(i161)
$
(i165)
$
i4
$
(i161)
Unrealized
(losses) gains on cash flow hedges:
Beginning balance
$
(i79)
$
i14
$
(i65)
$
i31
$
(i5)
$
i26
Unrealized
gains (losses) arising during the period
Changes in accumulated other comprehensive income (loss) by component were as follows for the three and six months ended June 30, 2019:
Three
Months
Six Months
Before Tax Amount
Tax Effect
Net of Tax Amount
Before Tax Amount
Tax Effect
Net of Tax Amount
(in
millions)
Foreign currency translation adjustments:
Beginning balance
$
(i111)
$
i6
$
(i105)
$
(i108)
$
i5
$
(i103)
Change
in foreign currency translation adjustments
(i6)
(i3)
(i9)
(i9)
(i2)
(i11)
Ending
balance
$
(i117)
$
i3
$
(i114)
$
(i117)
$
i3
$
(i114)
Unrealized
(losses) on available-for-sale investment securities:
Beginning balance
$
(i3)
$
i1
$
(i2)
$
(i12)
$
i4
$
(i8)
Net
unrealized gains arising during the period
i4
(i1)
i3
i13
(i4)
i9
Reclassification
of net gains to Other, net
(i1)
i—
(i1)
(i1)
i—
(i1)
Net
change
i3
(i1)
i2
i12
(i4)
i8
Ending
balance
$
i—
$
i—
$
i—
$
i—
$
i—
$
i—
Unrealized
gains (losses) on cash flow hedges:
Beginning balance
$
i39
$
(i6)
$
i33
$
(i4)
$
i1
$
(i3)
Unrealized
gains arising during the period
i19
(i4)
i15
i58
(i11)
i47
Reclassifications
of net losses to:
Cost of revenues
(i3)
i—
(i3)
i—
i—
i—
SG&A
expenses
(i1)
i—
(i1)
i—
i—
i—
Net
change
i15
(i4)
i11
i58
(i11)
i47
Ending
balance
$
i54
$
(i10)
$
i44
$
i54
$
(i10)
$
i44
Accumulated
other comprehensive income (loss):
Beginning balance
$
(i75)
$
i1
$
(i74)
$
(i124)
$
i10
$
(i114)
Other
comprehensive income (loss)
i12
(i8)
i4
i61
(i17)
i44
Ending
balance
$
(i63)
$
(i7)
$
(i70)
$
(i63)
$
(i7)
$
(i70)
Note
12— Commitments and Contingencies
i
We are involved in various claims and legal proceedings arising in the ordinary course of business. We accrue a liability when a loss is considered probable and the amount can be reasonably estimated. When a material loss contingency is reasonably possible but not probable, we do not record a liability,
but instead disclose the nature and the amount of the claim, and an estimate of the loss or range of loss, if such an estimate can be made. Legal fees are expensed as incurred. While we do not expect that the ultimate resolution of any existing claims and proceedings (other than the specific matters described below, if decided adversely), individually or in the aggregate, will have a material adverse effect on our financial position, an unfavorable outcome in some or all of these proceedings could have a material adverse impact on results of operations or cash flows for a particular period. This assessment is based on our current understanding of relevant facts and circumstances. As such, our view of these matters is subject to inherent uncertainties and may change in the future.
On April 20, 2020, we announced a security incident involving
a Maze ransomware attack. Based on numerous remediation steps that have been undertaken and our continued monitoring of our environment, we believe we have contained the attack and eradicated remnants of the attacker activity from our environment. Based on our investigation, we believe the attack principally impacted certain of our systems and data. The attack resulted in unauthorized access to certain data and caused significant disruption to our business. This included the disabling of some of our systems and disruption caused by our taking certain other internal systems and networks offline as a precautionary measure. The attack compounded the challenges we faced in enabling work-from-home arrangements during the COVID-19 pandemic and resulted in setbacks and delays to
such efforts. The impact to clients and their responses to the security incident varied. Some clients experienced no disruption. As to other clients, we experienced service disruptions due to our reliance on certain of the impacted systems and networks to perform work for clients and the impact to our systems and networks supporting work-from-home capabilities. The systems that comprise the technology platforms that support our business process-as-a-service solutions were not impacted. Most clients maintained connectivity with our network, allowing us to continue to provide service, but some clients opted to suspend our access to their networks as a security precaution. In this circumstance, we are unable to continue providing services via client networks until access is restored. We engaged leading outside forensics and cybersecurity experts, launched a comprehensive containment and remediation effort
and forensic investigation, restored the security of our internal systems and networks and are adopting various enhancements to the security of our systems and networks. We also notified and are coordinating with law enforcement.
The lost revenue and containment, investigation, remediation, legal and other costs may exceed our insurance policy limits or may not be covered by insurance at all. Further, we may be subject to regulatory enforcement actions and litigation that could result in financial judgments or the payment of settlement amounts, and disputes with insurance carriers concerning coverage.
On February 28, 2019, a ruling of the Supreme Court of India interpreting the India Defined Contribution Obligation altered historical understandings of the obligation, extending it to cover additional portions
of the employee’s income. As a result, the ongoing contributions of our affected employees and the Company were required to be increased. In the first quarter of 2019, we accrued $i117 million with respect to prior periods, assuming retroactive application of the Supreme Court’s ruling, in "Selling, general and administrative expenses" in our unaudited consolidated statement of operations. There is significant uncertainty as to how the liability should be calculated
as it is impacted by multiple variables, including the period of assessment, the application with respect to certain current and former employees and whether interest and penalties may be assessed. Since the ruling, a variety of trade associations and industry groups have advocated to the Indian government, highlighting the harm to the information technology sector, other industries and job growth in India that would result from a retroactive application of the ruling. It is possible the Indian government will review the matter and there is a substantial question as to whether the Indian government will apply the Supreme Court’s ruling on a retroactive basis. As such, the ultimate amount of our obligation may be materially different from the amount accrued.
On October 5, 2016, October 27,
2016 and November 18, 2016, three putative securities class action complaints were filed in the United States District Court for the District of New Jersey, naming us and certain of our current and former officers as defendants. These complaints were consolidated into a single action and on April 7, 2017, the lead plaintiffs filed a consolidated amended complaint on behalf of a putative class of persons and entities who purchased our common stock during the period between February 27, 2015 and September 29, 2016, naming us and certain of our current and former officers as defendants and alleging violations of the Exchange Act, based on allegedly false or misleading statements related to potential violations of the Foreign Corrupt Practices Act, our business, prospects
and operations, and the effectiveness of our internal controls over financial reporting and our disclosure controls and procedures. The lead plaintiffs seek an award of compensatory damages, among other relief, and their reasonable costs and expenses, including attorneys’ fees. Defendants filed a motion to dismiss the consolidated amended complaint on June 6, 2017. On August 8, 2018, the United States District Court for the District of New Jersey issued an order which granted the motion to dismiss in part, including dismissal of all claims against current officers of the Company, and denied them in part. On September 7, 2018, we filed a motion in the United States District Court for the
District of New Jersey to certify the August 8, 2018 order for immediate appeal to the United States Court of Appeals for the Third Circuit pursuant to 28 U.S.C. § 1292(b). On October 18, 2018, the District Court issued an order granting our motion, and staying the action pending the outcome of our appeal petition to the Third Circuit. On October 29, 2018, we filed a petition for permission to appeal with the United States Court of Appeals for the Third Circuit. On March 6, 2019, the Third Circuit denied our petition without prejudice. In an order dated March 19, 2019, the District Court directed the lead plaintiffs to provide the defendants with a proposed amended complaint. On April
26, 2019, lead plaintiffs filed their second amended complaint. We filed a motion to dismiss the second amended complaint on June 10, 2019. On June 7, 2020, the District Court issued an order denying our motion to dismiss the second amended complaint. On July 24, 2020, we filed a motion to certify the dismissal order for immediate appeal pursuant to 28 U.S.C. 1292(b).
On October 31, 2016, November 15, 2016 and November 18, 2016, three putative shareholder derivative complaints were filed in New Jersey Superior Court, Bergen County, naming us, all of our then current directors and certain of our current
and former officers as defendants. These actions were consolidated in an order dated January 24, 2017. The complaints assert claims for breach of fiduciary duty, corporate waste, unjust enrichment, abuse of control, mismanagement, and/or insider selling by defendants. On March 16, 2017, the parties filed a stipulation deferring all further proceedings pending a final, non-appealable ruling on the then anticipated motion to dismiss the consolidated putative securities class action. On April 26, 2017, in lieu of ordering the stipulation filed by the parties, the New Jersey Superior Court deferred further proceedings by dismissing
the consolidated putative shareholder derivative litigation without prejudice but permitting the parties to file a motion to vacate the dismissal in the future.
On February 22, 2017, April 7, 2017 and May 10, 2017, three additional putative shareholder derivative complaints alleging similar claims were filed in the United States District Court for the District of New Jersey, naming us and certain of our current and former directors and officers as defendants. These complaints asserted claims similar to those in the previously-filed putative shareholder derivative actions. In an order dated June 20, 2017, the United States
District Court for the District of New Jersey consolidated these actions into a single action, appointed lead plaintiff and lead counsel, and stayed all further proceedings pending a final, non-appealable ruling on the motions to dismiss the consolidated putative securities class action. On October 30, 2018, lead plaintiff filed a consolidated verified derivative complaint.
On March 11, 2019, a seventh putative shareholder derivative complaint was filed in the United States District Court for the District of New Jersey, naming us, certain of our current and former directors, and certain of our current and former officers as defendants. The complaint in that action asserts claims similar to those in the previously-filed putative shareholder derivative actions. On May
14, 2019, the United States District Court for the District of New Jersey approved a stipulation that (i) consolidated this action with the putative shareholder derivative suits that were previously filed in the United States District Court for the District of New Jersey; and (ii) stayed all of these suits pending a final, non-appealable order on the motion to dismiss the second amended complaint in the securities class action.
We are presently unable to predict the duration, scope or result of the consolidated putative securities class action, the putative shareholder derivative actions or any other lawsuits. As such, we are presently unable to develop a reasonable estimate of a possible loss or range of losses, if any, and thus have not recorded any accruals related to these matters. While the
Company intends to defend the lawsuits vigorously, these lawsuits and any other related lawsuits are subject to inherent uncertainties, the actual cost of such litigation will depend upon many unknown factors and the outcome of the litigation is necessarily uncertain.
We have indemnification and expense advancement obligations pursuant to our bylaws and indemnification agreements with respect to certain current and former members of senior management and the Company’s directors. In connection with the matters that were the subject of our previously disclosed internal investigation, the United States Department of Justice and SEC investigations and the related litigation, we have received and expect to continue
to receive requests under such indemnification agreements and our bylaws to provide funds for legal fees and other expenses. We have expensed such costs incurred through June 30, 2020.
We have maintained directors and officers insurance and have recorded an insurance receivable of $i15 million as
of June 30, 2020, reported in "Other current assets," in our unaudited consolidated statement of financial position related to the recovery of a portion of the indemnification expenses and costs related to the putative securities class action complaints. We are unable to make a reliable estimate of the eventual cash flows by period related to the indemnification and expense advancement obligations described here.
See Note 8 for information relating to the ITD Dispute.
Many of our engagements involve projects that are critical to the operations of our clients’ business and provide benefits that are difficult to quantify. Any failure in a client’s
systems or our failure to meet our contractual obligations to our clients, including any breach involving a client’s confidential information or sensitive data, or our obligations under applicable laws or regulations could result in a claim for substantial damages against us, regardless of our responsibility for such failure. Although we attempt to contractually limit our liability for damages arising from negligent acts, errors, mistakes, or omissions in rendering our services, there can be no assurance that the limitations of liability set forth in our contracts will be enforceable in all instances or will otherwise protect us from liability for damages. Although we have general liability insurance coverage, including coverage for errors or omissions, there can be no assurance that such coverage will cover all types of claims, continue to be available on reasonable terms or
will be available in sufficient amounts to cover one or more large claims, or that the insurer will not disclaim coverage as to any future claim. The successful assertion of one or more large claims against us that exceed or are not covered by our insurance coverage or changes in our insurance policies, including premium increases or the imposition of large deductible or co-insurance requirements, could have a material adverse effect on our business, results of operations, financial position and cash flows for a particular period.
In the normal course of business and in conjunction with certain client engagements, we have entered into contractual arrangements through which we may be obligated to indemnify clients or other parties with whom we conduct business with respect to certain matters. These arrangements can include provisions whereby we agree to hold the indemnified party and
certain of their affiliated entities harmless with respect to third-party claims related to such matters as our breach of certain
representations or covenants, our intellectual property infringement, our gross negligence or willful misconduct or certain other claims made against certain parties. Payments by us under any of these arrangements are generally conditioned on the client making a claim and providing us with full control over the defense and settlement of such claim. It is not possible to determine the maximum potential liability under these indemnification agreements due to the unique facts and circumstances involved in each particular agreement.
Historically, we have not made material payments under these indemnification agreements and therefore they have not had a material impact on our operating results, financial position, or cash flows. However, if events arise requiring us to make payment for indemnification claims under our indemnification obligations in contracts we have entered, such payments could have a material adverse effect on our business, results of operations, financial position and cash flows for a particular period.
Note
13 — Segment Information
i
Our reportable segments are:
•Financial Services, which consists of our banking and insurance operating segments;
•Healthcare, which consists of our healthcare and life sciences operating segments;
•Products
and Resources, which consists of our retail and consumer goods; manufacturing, logistics, energy, and utilities; and travel and hospitality operating segments;
•Communications, Media and Technology, which includes our communications and media operating segment and our technology operating segment.
Our sales managers, account executives, account managers and project teams are aligned in accordance with the specific industries they serve. Our chief operating decision maker evaluates the Company's performance and allocates resources based on segment revenues and operating profit. Segment operating profit is defined as income from operations before unallocated costs. Generally, operating expenses for each operating segment have similar characteristics and are subject to the
same factors, pressures and challenges. However, the economic environment and its effects on industries served by our operating segments may affect revenues and operating expenses to differing degrees.
Expenses included in segment operating profit consist principally of direct selling and delivery costs (including stock-based compensation expense) as well as a per employee charge for use of our global delivery centers and infrastructure. Certain SG&A expenses, the excess or shortfall of incentive-based compensation for commercial and delivery personnel as compared to target, restructuring costs, COVID-19 Charges, costs related to the ransomware attack, a portion of depreciation and amortization and the impact of the settlements of our cash flow hedges are not allocated to individual segments in internal management reports used by the chief operating decision maker. Accordingly,
such expenses are excluded from segment operating profit and are included below as “unallocated costs” and adjusted against our total income from operations. The incremental accrual related to the India Defined Contribution Obligation recorded in the first quarter of 2019 has been excluded from segment operating profits for the six months ended June 30, 2019 and is included in "unallocated costs" in the table below. Additionally, management has determined that it is not practical to allocate identifiable assets by segment, since such assets are used interchangeably among the segments.
For revenues by reportable segment and geographic area, please see Note 2.
Segiment
operating profits by reportable segment were as follows:
(1)Long-lived
assets include property and equipment, net of accumulated depreciation and amortization.
(2)Substantially all relates to the United States.
(3)Substantially all relates to India.
/
Note
14 — Subsequent Events
i
Acquisitions
In July 2020, we entered into an agreement to acquire New Signature, an independent Microsoft public cloud transformation specialist, for a preliminary purchase price of approximately $i305 million.
This acquisition will expand our hyperscale cloud advisory services and provide the foundation for our new, dedicated practice centered on Microsoft cloud solutions. It is expected to close during the third quarter of 2020.
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Executive Summary
Cognizant
is one of the world’s leading professional services companies, transforming clients’ business, operating and technology models for the digital era. Our services include digital services and solutions, consulting, application development, systems integration, application testing, application maintenance, infrastructure services and business process services. Digital services have become an increasingly important part of our portfolio, aligning with our clients' focus on becoming data-enabled, customer-centric and differentiated businesses. We tailor our services and solutions to specific industries with an integrated global delivery model that employs client service and delivery teams based at client locations and dedicated global and regional delivery centers.
In the first quarter of 2020, the global COVID-19 pandemic began causing significant loss of life and interruption to the global economy, including the curtailment of
activities by businesses and consumers in much of the world as governments and others seek to limit the spread of the disease. In response to COVID-19, we have prioritized the safety and well-being of our employees, business continuity for our clients and supporting the efforts of governments around the world to contain the spread of the virus. In light of our commitment to help our clients as they navigate unprecedented business challenges while protecting the safety of our employees, we have taken numerous steps, and will continue to take further actions, to address the COVID-19 pandemic. We have been working closely with our clients to support them as they implemented their contingency plans, helping them access our services and solutions remotely. We also undertook a significant effort to enable our employees to work from home by providing them with computer and Internet accessibility equipment while seeking to maintain appropriate security
protocols. Despite these efforts, we experienced some delays in project fulfillment as delivery, particularly in India and the Philippines, shifted to work-from-home. While these delays continued early in the second quarter, we are now near full project fulfillment capacity with the exception of certain client projects where a work-from-home scenario is not possible due to regulatory or other requirements.
As a result of the ongoing pandemic, we are experiencing reduced client demand. We expect project deferrals, furloughs, temporary rate concessions and deferred payment term requests to continue to adversely affect revenues across all our business segments in 2020 and potentially beyond.
We continue to actively monitor the impacts of and responses to COVID-19 and the related risks, and plan to respond accordingly. The pandemic continues to rapidly evolve, and its ultimate impacts will depend on future developments that are uncertain and cannot be predicted with confidence, and may materially adversely affect our business irrespective of our efforts to mitigate the impact. See Part II, Item 1A. Risk Factors.
In the second quarter of 2020, we incurred approximately $25 million of costs in response to the COVID-19 pandemic, including a one-time bonus to our employees at the designation of associate and below in both India and the Philippines and costs incurred to enable our employees to work remotely.
During the third quarter of 2020 we may incur incremental costs related to the COVID-19 pandemic, primarily related to operating in a work-from-home environment.
We remain committed to implementing our 2020 Fit for Growth Plan, investing in the key digital areas of IoT, AI and analytics, digital engineering and cloud, while working to maintain and optimize our core portfolio of services through efficiency, tooling and automation, delivery optimization, protection of renewals, industry alignment and geographic expansion. Our 2020 Fit for Growth Plan involves certain measures to simplify our organizational model and optimize our cost structure in order to partially fund the investments required to execute on our strategy and advance our growth agenda as well as our decision to exit certain content-related services that are not in line with our strategic vision for the
Company. During the three months ended June 30, 2020, we incurred $59 million of employee separation, retention and facility exit costs under this plan, including $8 million of costs related to our exit from certain content-related services. See Note 4 for additional information on these costs which are reported in the caption "Restructuring charges" in our unaudited consolidated statements of operations. The optimization measures that are part of the 2020 Fit for Growth Plan are expected to result in total charges in the range of $170 million to $200 million, primarily related to severance and facility exit costs, and are expected to be substantially completed by the end of 2020. The optimization measures are expected to
generate an annualized savings run rate, before anticipated investments, in the range of approximately $500 million to $550 million in 2021. The potential negative impact of the COVID-19 pandemic on our revenues may require us to take additional cost optimization measures. At the same time, the pandemic may adversely impact our ability to execute and realize the benefits of our strategy and various transformation initiatives, including the 2020 Fit for Growth Plan. See Part II, Item 1A. Risk Factors.
Our
2019 decision to exit certain content-related services negatively impacted our second quarter 2020 revenues by approximately $48 million within our Communications, Media and Technology segment in North America and we anticipate the impact on 2020 revenuesto beapproximately $180 million.
On April 20, 2020, we announced a security incident involving a Maze ransomware attack. Based on numerous remediation steps that have been undertaken and our continued
monitoring of our environment, we believe we have contained the attack and eradicated remnants of the attacker activity from our environment. Based on our investigation, we believe the attack principally impacted certain of our systems and data. The attack resulted in unauthorized access to certain data and caused significant disruption to our business. This included the disabling of some of our systems and disruption caused by our taking certain other internal systems and networks offline as a precautionary measure. The attack compounded the challenges we faced in enabling work-from-home arrangements during the COVID-19 pandemic and resulted in setbacks and delays to such efforts. The impact to clients and their responses to the security incident varied. Some clients experienced no disruption. As to other clients, we experienced service disruptions due to our reliance on certain of the impacted systems and networks to perform work for clients
and the impact to our systems and networks supporting work-from-home capabilities. The systems that comprise the technology platforms that support our business process-as-a-service solutions were not impacted. Most clients maintained connectivity with our network, allowing us to continue to provide service, but some clients opted to suspend our access to their networks as a security precaution. In this circumstance, we are unable to continue providing services via client networks until access is restored. We engaged leading outside forensics and cybersecurity experts, launched a comprehensive containment and remediation effort and forensic investigation, restored the security of our internal systems and networks and are adopting various enhancements to the security of our systems and networks. We also notified and are coordinating with law enforcement.
As a result of fulfillment challenges caused by the ransomware attack,
our year over year revenue growth for the second quarter was negatively impacted by approximately 90 basis points. We do not expect the attack to significantly impact our revenues for the remainder of 2020. Additionally, in the second quarter of 2020, we incurred $24 million in costs related to the ransomware attack and we will continue to incur significant incremental costs for the remediation of the security incident and investments to enhance our overall security environment. The lost revenue and containment, investigation, remediation, legal and other costs may exceed our insurance policy limits or may not be covered by insurance at all. Other actual and potential consequences include, but are not limited to, negative publicity, reputational damage, lost trust with customers, regulatory enforcement action, litigation that could result in financial judgments or the payment of settlement amounts and disputes with insurance carriers concerning
coverage. See Part II, Item 1A. Risk Factors.
Q2 2020 Financial Results
The following table sets forth a summary of our financial results for the three months ended June 30, 2020 and 2019:
Increase
/ (Decrease)
2020
2019
$
%
(Dollars in millions, except per share data)
Revenues
$
4,000
$
4,141
$
(141)
(3.4)
Income
from operations
467
619
(152)
(24.6)
Net income
361
509
(148)
(29.1)
Diluted
EPS
0.67
0.90
(0.23)
(25.6)
Other Financial Information1
Adjusted
Income from Operations
$
563
$
668
$
(105)
(15.7)
Adjusted Diluted EPS
0.82
0.94
(0.12)
(12.8)
1 Adjusted
Income From Operations and Adjusted Diluted EPS are not measurements of financial performance prepared in accordance with GAAP. See “Non-GAAP Financial Measures” for more information and reconciliations to the most directly comparable GAAP financial measures.
The following charts set forth revenues and change in revenues by business segment and geography for the three months ended June 30, 2020 as compared to the three months ended June 30, 2019:
Financial
Services
Healthcare
Increase / (Decrease)
Increase
/ (Decrease)
Dollars in millions
Revenues
$
%
CC %2
Revenues
$
%
CC
%2
North America
$
978
(57)
(5.5)
(5.4)
$
999
(7)
(0.7)
(0.7)
United
Kingdom
110
(9)
(7.6)
(5.2)
36
7
24.1
27.2
Continental
Europe
182
(12)
(6.2)
(4.8)
102
22
27.5
27.8
Europe
- Total
292
(21)
(6.7)
(4.9)
138
29
26.6
27.6
Rest
of World
126
1
0.8
6.5
20
1
5.3
9.5
Total
$
1,396
(77)
(5.2)
(4.3)
$
1,157
23
2.0
2.2
Products
and Resources
Communications, Media and Technology
Increase / (Decrease)
Increase
/ (Decrease)
Dollars in millions
Revenues
$
%
CC %2
Revenues
$
%
CC
%2
North America
$
620
(38)
(5.8)
(5.6)
$
409
(31)
(7.0)
(7.0)
United
Kingdom
89
(8)
(8.2)
(5.1)
79
2
2.6
5.3
Continental
Europe
94
(16)
(14.5)
(10.2)
41
(2)
(4.7)
(2.5)
Europe
- Total
183
(24)
(11.6)
(7.8)
120
—
—
2.5
Rest
of World
64
2
3.2
9.9
51
4
8.5
17.9
Total
$
867
(60)
(6.5)
(5.0)
$
580
(27)
(4.4)
(3.2)
Our
second quarter revenue decline reflected the negative impact of fulfillment challenges, project deferrals, furloughs and temporary rate concessions brought on by the COVID-19 pandemic. While revenues across all our segments were negatively impacted by the COVID-19 pandemic, retail, consumer goods, travel and hospitality clients within our Products and Resources segment as well as communications and media clients in our Communications, Media and Technology segment were particularly adversely affected by the pandemic. Clients in those industries represented 11% of our total revenues in the second quarter of 2020. At the same time, our manufacturing, logistics, energy and utilities clients within our Products and Resources segment generated revenue growth due to our clients' continued adoption and integration of digital technologies. Our second quarter revenues were also impacted
by the ransomware attack, primarily among clients in our Financial Services segment and healthcare clients within our Healthcare segment. Additionally, our Financial Services and Healthcare segments continued to see certain clients transition the support of some of their legacy systems and operations in-house or to captives. Revenues among our life sciences clients within the Healthcare segment experienced growth, primarily due to our acquisition of Zenith in the third quarter of 2019. Revenues among our technology clients in our Communications, Media and Technology segment in the North America region were negatively impacted by approximately $48 million due to our 2019 strategic decision to exit certain content-related services. We continue to see growing demand from our technology clients for our digital content services.
Our operating margin and Adjusted Operating Margin2
decreased to 11.7% and 14.1%, respectively, for the quarter ended June 30, 2020 from 14.9%and 16.1%, respectively, for the quarter ended June 30, 2019. Our GAAP and Adjusted Operating Margin2 were adversely impacted by the decline in revenues brought on by the COVID-19 pandemic, the effect of the ransomware attack on both revenues and costs, and higher incentive-based compensation accrual rates. These impacts were partially offset by the depreciation of the Indian rupee against the U.S. dollar, a significant decrease in travel and entertainment expenses due to the COVID-19 pandemic, lower immigration costs and
cost savings generated by our cost optimization initiatives. In addition, our 2020 GAAP operating margin was negatively impacted by higher restructuring charges as discussed in Note 4 to our unaudited consolidated financial statements as well as COVID-19 Charges.
We finished the second quarter of 2020 with approximately 281,200 employees, which is a decrease of approximately 7,000 as compared to June 30, 2019 and 10,500 as compared to March 31, 2020. Annualized turnover, including both voluntary and involuntary, was approximately 24.0% for the three months ended June 30, 2020. A significant
portion of our attrition is related to involuntary exits and is weighted towards the more junior members of our staff.
2Constant currency revenue growth and Adjusted Operating Margin are not measurements of financial performance prepared in accordance with GAAP. See “Non-GAAP Financial Measures” for more information and reconciliations to the most directly comparable GAAP financial measures, as applicable.
The significant and continuing impact and rapidly evolving nature of the COVID-19 pandemic makes it difficult to estimate its future impact on our ongoing business, results of operations and overall financial performance. As clients work through significant financial challenges related to the COVID-19 pandemic, we have faced and may continue to face reduced client demand for services, client pricing pressure, payment term extensions and insolvency risk, additional delivery challenges, increased costs, a diversion of and strain on management and other corporate resources, and reduced employee morale and productivity. See Part II, Item 1A. Risk Factors.
While the immediate focus of many clients is on the COVID-19 pandemic
impacts to their businesses, we continue to expect the long-term focus of our clients to be on their digital transformation into data-enabled, customer-centric and differentiated businesses. As our clients seek to optimize the cost of supporting their legacy systems and operations, our core portfolio of services may be subject to pricing pressure and lower demand due to clients transitioning certain work in-house or to new or existing captives.
Our clients will likely continue to contend with industry-specific changes driven by evolving digital technologies, uncertainty in the regulatory environment, industry consolidation and convergence as well as international trade policies and other macroeconomic factors, which could affect their demand for our services. Additionally, revenue from our technology clients will be affected by our 2019 strategic decision to exit certain content-related work under our 2020 Fit for Growth
Plan.
We expect our 2020 financial results to be impacted by the initial cost optimization measures executed as part of our 2020 Fit for Growth Plan, and the expected execution of additional measures under this plan during the remainder of 2020. In addition, our 2020 results may be impacted by the uncertainty regarding regulatory changes, including potential regulatory changes with respect to immigration and taxes as well as costs related to the potential resolution of legal and regulatory matters discussed in Note 12 to our unaudited consolidated financial statements.
As discussed earlier in the Executive Summary, we expect the business disruption caused by and incremental costs resulting from the ransomware attack to adversely impact our
financial results for the remainder of 2020. See Part II, Item 1A. Risk Factors.
During the remainder of 2020, we intend to continue to invest in our digital capabilities, our talent base and new service offerings across industries and geographies, while increasing our investment in sales and marketing professionals to help us expand existing accounts and acquire new ones. We will continue to pursue strategic acquisitions that we believe add new technologies or platforms that complement our existing services, improve our overall service delivery capabilities or expand our geographic presence. Additionally, we will continue to focus on maintaining and optimizing our core portfolio of services through efficiency, tooling and automation, delivery optimization,
protection of renewals, industry alignment and geographic expansion. Finally, through the execution of our 2020 Fit for Growth Plan and other initiatives, we will focus on operating discipline in order to appropriately manage our cost structure, giving consideration to the impact of the COVID-19 pandemic on our revenues.
The following table sets forth, for the periods indicated, certain financial data for the three months ended June 30:
%
of
% of
Increase / Decrease
2020
Revenues
2019
Revenues
$
%
(Dollars
in millions, except per share data)
Revenues
$
4,000
100.0
$
4,141
100.0
$
(141)
(3.4)
Cost
of revenues(1)
2,615
65.4
2,629
63.5
(14)
(0.5)
Selling,
general and administrative expenses(1)
711
17.8
719
17.3
(8)
(1.1)
Restructuring
charges
71
1.8
49
1.2
22
44.9
Depreciation and amortization expense
136
3.4
125
3.0
11
8.8
Income
from operations
467
11.7
619
14.9
(152)
(24.6)
Other income (expense), net
28
57
(29)
(50.9)
Income
before provision for income taxes
495
12.4
676
16.3
(181)
(26.8)
Provision
for income taxes
(134)
(167)
33
(19.8)
Net
income
$
361
9.0
$
509
12.3
$
(148)
(29.1)
Diluted
earnings per share
$
0.67
$
0.90
$
(0.23)
(25.6)
Other
Financial Information3
Adjusted Income from Operations and Adjusted Operating Margin
$
563
14.1
$
668
16.1
$
(105)
(15.7)
Adjusted
Diluted EPS
$
0.82
$
0.94
$
(0.12)
(12.8)
(1)Exclusive
of depreciation and amortization expense.
Revenues - Overall
During the quarter ended June 30, 2020, revenues decreased by $141 million as compared to the quarter ended June 30, 2019, representing a decline of 3.4%, or 2.5% on a constant currency basis3. The revenue decline reflected fulfillment challenges, project deferrals, furloughs and temporary rate concessions brought on by the COVID-19 pandemic. Additionally, as a result of fulfillment challenges caused by the ransomware attack, our year over year revenue growth was negatively impacted by approximately 90 basis points. We continue to experience pricing pressure within our core portfolio of services as our clients optimize the cost
of supporting their legacy systems and operations. At the same time, clients continue to adopt and integrate digital technologies and their demand for our digital operations services and solutions continues to grow. In addition, our revenues benefited from our recently completed acquisitions, including Zenith, Contino and Collaborative Solutions. Revenues from clients added since June 30, 2019 were $110 million.
Revenues from our top clients as a percentage of total revenues were as follows:
3Adjusted
Income From Operations, Adjusted Operating Margin, Adjusted Diluted EPS and constant currency revenue growth are not measurements of financial performance prepared in accordance with GAAP. See “Non-GAAP Financial Measures” for more information and reconciliations to the most directly comparable GAAP financial measures, as applicable.
Revenues by reportable business segment were as follows for the three months ended June 30:
2020
2019
Increase/
(Decrease)
$
%
CC %4
(Dollars in millions)
Financial
Services
$
1,396
$
1,473
$
(77)
(5.2)
(4.3)
Healthcare
1,157
1,134
23
2.0
2.2
Products
and Resources
867
927
(60)
(6.5)
(5.0)
Communications, Media and Technology
580
607
(27)
(4.4)
(3.2)
Total
revenues
$
4,000
$
4,141
$
(141)
(3.4)
(2.5)
Financial Services
Revenues from our Financial Services segment decreased
5.2%, or 4.3% on a constant currency basis4, for the three months ended June 30, 2020, as compared to the three months ended June 30, 2019. Revenues in this segment decreased by $41 million from our banking clients and $36 million from our insurance clients and were negatively impacted by the COVID-19 pandemic and the ransomware attack. Revenues from clients added since June 30, 2019 were $26 million. Demand from certain banking clients has been and may continue to be negatively affected as they transition the support of some of their legacy systems and operations in-house or to captives.
Healthcare
Revenues from our Healthcare segment grew 2.0%, or 2.2% on a constant currency basis4,
for the three months ended June 30, 2020, as compared to the three months ended June 30, 2019. Revenues in this segment increased by $49 million from our life sciences clients, driven by revenues from our acquisition of Zenith, while revenues from our healthcare clients decreased by $26 million. Revenues in this segment were negatively impacted by the COVID-19 pandemic and the ransomware attack. Revenues from clients added since June 30, 2019 were $19 million. Demand from our healthcare clients may continue to be affected by uncertainty in the regulatory and political environment while demand among our life sciences clients may be affected by industry consolidation.
Products
and Resources
Revenues from our Products and Resources segment decreased 6.5%, or 5.0% on a constant currency basis4, for the three months ended June 30, 2020, as compared to the three months ended June 30, 2019.Retail, consumer goods, travel and hospitality clients were particularly adversely affected by the pandemic and are expected to continue to be negatively impacted for the remainder of 2020 and possibly beyond. In the second quarter of 2020, revenues decreased by $51 million among our retail and consumer goods clients and $41 million among our travel and hospitality clients. Revenues from our manufacturing, logistics, energy and utilities
clients increased $32 million due to our clients' adoption and integration of digital technologies. Revenues from clients added since June 30, 2019 were $35 million.
Communications, Media and Technology
Revenues from our Communications, Media and Technology segment decreased 4.4%, or 3.2% on a constant currency basis4, for the three months ended June 30, 2020, as compared to the three months ended June 30, 2019. Revenues from our technology clients and our communications and media clients decreased by $23 million and $4 million, respectively. Revenues
among our technology clients in this segment were negatively impacted by approximately $48 million due to our 2019 strategic decision to exit certain content-related services and we anticipate the impact on 2020 revenues to be approximately $180 million. Additionally, revenues were negatively impacted by the COVID-19 pandemic, particularly among our communications and media clients, partially offset by the demand from our technology clients for digital content services. Revenues from clients added, including those related to acquisitions, since June 30, 2019 were $30 million.
4 Constant
currency revenue growth is not a measurement of financial performance prepared in accordance with GAAP. See “Non-GAAP Financial Measures” for more information.
Revenues by geographic market were as follows for the three months ended June 30:
2020
2019
Increase
/ (Decrease)
$
%
CC %5
(Dollars in millions)
North
America
$
3,006
$
3,139
$
(133)
(4.2)
(4.1)
United Kingdom
314
322
(8)
(2.5)
0.2
Continental
Europe
419
427
(8)
(1.9)
0.2
Europe - Total
733
749
(16)
(2.1)
0.2
Rest
of World
261
253
8
3.2
9.7
Total revenues
$
4,000
$
4,141
$
(141)
(3.4)
(2.5)
North
America continues to be our largest market, representing 75.2% of total revenues for the second quarter of 2020. Across all regions, revenueswere negatively impacted by the COVID-19 pandemic and the ransomware attack, partially offset by the revenue from our recently completed acquisitions, including Zenith, Contino and Collaborative Solutions. Our North America region was also negatively impacted by our strategic decision to exit certain content-related services in our Communications, Media and Technology segment and the transition of the support of legacy systems for certain financial services and healthcare clients in-house or to captives. Revenue growth in our Rest of World region was driven by our communications and media clients. We believe that there are opportunities for long-term growth across all of our geographic markets.
Cost
of Revenues (Exclusive of Depreciation and Amortization Expense)
Our cost of revenues consists primarily of salaries, incentive-based compensation, stock-based compensation expense, employee benefits, project-related immigration and travel for technical personnel, subcontracting and equipment costs relating to revenues. Our cost of revenues decreased by 0.5% during the second quarter of 2020 as compared to the second quarter of 2019, increasing as a percentage of revenues to 65.4% in the second quarter of 2020 compared to 63.5% in the second quarter of 2019. The increase in cost of revenues, as a percentage of revenues, was primarily due to the impact on revenues of the COVID-19 pandemic and the ransomware attack, as well as higher incentive compensation accrual rates. These impacts were partially offset by the depreciation of the Indian rupee against the U.S. dollar, a significant decrease in travel and entertainment costs
as a result of a reduction in travel due to the COVID-19 pandemic and the cost savings generated as a result of our cost optimization strategy.
SG&A Expenses
SG&A expenses consist primarily of salaries, incentive-based compensation, stock-based compensation expense, employee benefits, immigration, travel, marketing, communications, management, finance, administrative and occupancy costs. SG&A expenses decreased by 1.1% during the second quarter of 2020 as compared to the second quarter of 2019. However, they increased as a percentage of revenues to 17.8% in 2020 as compared to 17.3% in 2019. The increase, as a percentage of revenues, was primarily due to the decline in revenues brought on by the COVID-19 pandemic, the effect of the ransomware attack on both revenues and costs, as well as higher incentive compensation accrual
rates, partially offset by a significant decrease in travel and entertainment costs as a result of the reduction in travel due to the pandemic and lower immigration costs.
Depreciation and Amortization Expense
Depreciation and amortization expense increased by 8.8% during the second quarter of 2020 as compared to the second quarter of 2019. The increase is due to procurement of additional computer equipment primarily to provision work-from-home arrangements and amortization of intangibles from recently completed acquisitions.
Restructuring Charges
Restructuring charges consist of our 2020 Fit for Growth Plan and our realignment program. Restructuring charges were $71 million or 1.8%, as a percentage of revenues for the
three months ended June 30, 2020, as compared to $49 million or 1.2%, as a percentage of revenues for the three months ended June 30, 2019. For further detail on our restructuring charges see Note 4 to our unaudited consolidated financial statements.
5 Constant currency revenue growth is not a measurement of financial performance prepared in accordance with GAAP. See “Non-GAAP Financial Measures” for more information.
Our operating margin and Adjusted Operating Margin6 decreased to 11.7% and 14.1%, respectively, for the quarter ended June 30, 2020 from 14.9%and 16.1%, respectively, for the quarter ended June 30, 2019. Our GAAP and Adjusted Operating Margin6 were adversely impacted by the decline in revenues brought on by the COVID-19 pandemic, the effect of the ransomware attack on both revenues and costs, and higher incentive-based compensation
accrual rates. These impacts were partially offset by the depreciation of the Indian rupee against the U.S. dollar, a significant decrease in travel and entertainment expenses due to the COVID-19 pandemic, lower immigration costs and cost savings generated by our cost optimization initiatives. In addition, our 2020 GAAP operating margin was negatively impacted by higher restructuring charges as discussed in Note 4 to our unaudited consolidated financial statements as well as COVID-19 Charges.
Excluding the impact of applicable designated cash flow hedges, the depreciation of the Indian rupee against the U.S. dollar positively impacted our operating margin by approximately 164 basis points,
or 1.64 percentage points, during the three months ended June 30, 2020. Each additional 1.0% change in exchange rate between the Indian rupee and the U.S. dollar will have the effect of moving our operating margin by approximately 18 basis points or 0.18 percentage points.
We enter into hedges of certain Indian rupee denominated payments in India, which are intended to mitigate the volatility of the changes in the exchange rate between the U.S. dollar and the Indian rupee. During the three months ended June 30, 2020, the settlement of our cash flow hedges negatively impacted our operating margin by approximately 28 basis points or 0.28 percentage points as compared to a positive impact of approximately 10 basis points or 0.10 percentage points during the
three months ended June 30, 2019.
Segment Operating Profit
Segment operating profits were as follows for the three months ended June 30:
2020
Operating
Margin %
2019
Operating Margin %
Increase / (Decrease)
(Dollars in millions)
Financial Services
$
365
26.1
$
407
27.6
$
(42)
Healthcare
305
26.4
314
27.7
(9)
Products
and Resources
237
27.3
255
27.5
(18)
Communications, Media and Technology
174
30.0
184
30.3
(10)
Total
segment operating profit
1,081
27.0
1,160
28.0
(79)
Less: unallocated costs
614
541
73
Income
from operations
$
467
11.7
$
619
14.9
$
(152)
Operating
margins in our Financial Services and Healthcare segments decreased as revenues were negatively impacted by the COVID-19 pandemic and the ransomware attack, partially offset by cost savings generated by our cost optimization initiatives and a significant decrease in travel and entertainment costs due to COVID-19 related reductions in travel. Our operating margins in our Products and Resources and Communications, Media and Technology segments remained relatively flat as revenues were negatively impacted by the COVID-19 pandemic, offset by cost savings generated by our cost optimization initiatives and a significant decrease in travel and entertainment costs due to COVID-19 related reductions in travel.
Certain SG&A expenses, the excess or shortfall of incentive-based compensation for commercial and delivery personnel as compared to target, restructuring costs, COVID-19 Charges, costs related to
the ransomware attack, a portion of depreciation and amortization and the impact of the settlements of our cash flow hedges are not allocated to individual segments in internal management reports used by the chief operating decision maker. Accordingly, such expenses are excluded from segment operating profit and are included above as “unallocated costs” and adjusted against our total income from operations. The increase in unallocated costs in 2020 compared to 2019 is primarily due to a smaller shortfall in 2020 than in 2019 of incentive-based compensation as compared to target, higher restructuring costs, COVID-19 Charges and costs related to the ransomware attack.
6 Adjusted
Operating Margin is not a measurement of financial performance prepared in accordance with GAAP. See “Non-GAAP Financial Measures” for more information and a reconciliation to the most directly comparable GAAP financial measure.
Total other income (expense), net consists primarily of foreign currency exchange gains and losses, interest income and interest expense. The following table sets forth total other income (expense), net for the three months ended June 30:
2020
2019
Increase/ Decrease
(in
millions)
Foreign currency exchange gains
$
1
$
20
$
(19)
(Losses) on foreign exchange forward contracts
not designated as hedging instruments
(3)
(4)
1
Foreign currency exchange gains (losses), net
(2)
16
(18)
Interest
income
37
45
(8)
Interest expense
(9)
(6)
(3)
Other,
net
2
2
—
Total other income (expense), net
$
28
$
57
$
(29)
The
foreign currency exchange gains and losses were attributable to the remeasurement of net monetary assets and liabilities denominated in currencies other than the functional currencies of our subsidiaries. The gains and losses on foreign exchange forward contracts not designated as hedging instruments relate to the realized and unrealized gains and losses on foreign exchange forward contracts entered into to partially offset foreign currency exposure to non-U.S. dollar denominated net monetary assets and liabilities. As of June 30, 2020, the notional value of our undesignated hedges was $1,156 million.
The decrease in interest income of $8 million was primarily attributable to a decrease in average invested balances and lower yields in 2020.
Provision for Income Taxes
The provision for income taxes decreased to $134 million during the three months ended June 30, 2020 from $167 million for the three months ended June 30, 2019 as a result of the decrease in the income before provision for income taxes, partially offset by a higher effective income tax rate. The effective income tax rate increased to 27.1% for the three months ended June 30, 2020 compared to 24.7% for the three months ended June 30, 2019, primarily driven by the depreciation
of the Indian rupee against the U.S. dollar, which resulted in non-deductible foreign currency exchange losses on our unaudited consolidated statement of operations.
Net Income
Net income decreased to $361 million for the three months ended June 30, 2020 from $509 million for the three months ended June 30, 2019, representing 9.0% and 12.3% of revenues, respectively. The decrease in net income was driven by lower income from operations.
Non-GAAP Financial Measures
Portions of our disclosure include non-GAAP financial measures. These non-GAAP financial measures
are not based on any comprehensive set of accounting rules or principles and should not be considered a substitute for, or superior to, financial measures calculated in accordance with GAAP, and may be different from non-GAAP financial measures used by other companies. In addition, these non-GAAP financial measures should be read in conjunction with our financial statements prepared in accordance with GAAP. The reconciliations of our non-GAAP financial measures to the corresponding GAAP measures, set forth below, should be carefully evaluated.
Our non-GAAP financial measures, Adjusted Operating Margin, Adjusted Income From Operations and Adjusted Diluted EPS exclude unusual items. Additionally, Adjusted Diluted EPS excludes net non-operating foreign currency exchange gains or losses and the tax impact of all the applicable adjustments. The income tax impact of each item is calculated by applying
the statutory rate and local tax regulations in the jurisdiction in which the item was incurred. Constant currency revenue growth is defined as revenues for a given period restated at the comparative period’s foreign currency exchange rates measured against the comparative period's reported revenues.
We believe providing investors with an operating view consistent with how we manage the Company provides enhanced transparency into our operating results. For our internal management reporting and budgeting purposes, we use various GAAP and non-GAAP financial measures for financial and operational decision-making, to evaluate period-to-period comparisons, to determine portions of the compensation for our executive officers and for making comparisons of our operating results to those of our competitors.
Therefore, it is our belief that the use of non-GAAP financial measures excluding certain costs provides a
meaningful supplemental measure for investors to evaluate our financial performance. We believe that the presentation of our non-GAAP financial measures along with reconciliations to the most comparable GAAP measure, as applicable, can provide useful supplemental information to our management and investors regarding financial and business trends relating to our financial condition and results of operations.
A limitation of using non-GAAP financial measures versus financial measures calculated in accordance
with GAAP is that non-GAAP financial measures do not reflect all of the amounts associated with our operating results as determined in accordance with GAAP and may exclude costs that are recurring such as our net non-operating foreign currency exchange gains or losses. In addition, other companies may calculate non-GAAP financial measures differently than us, thereby limiting the usefulness of these non-GAAP financial measures as a comparative tool. We compensate for these limitations by providing specific information regarding the GAAP amounts excluded from our non-GAAP financial measures to allow investors to evaluate such non-GAAP financial measures.
The following table presents a reconciliation of each non-GAAP financial measure to the most comparable GAAP measure for the three months ended June 30:
2020
%
of Revenues
2019
% of Revenues
(Dollars in millions, except per share amounts)
GAAP income from operations and operating margin
$
467
11.7
$
619
14.9
Realignment
charges (1)
12
0.3
49
1.2
2020 Fit for Growth plan restructuring charges (2)
59
1.5
—
—
COVID-19
Charges (3)
25
0.6
—
—
Adjusted Income from Operations and Adjusted Operating Margin
(1)As
part of the realignment program, during the three months ended June 30, 2020, we incurred employee retention costs and professional fees. See Note 4 to our unaudited consolidated financial statements for additional information.
(2)As part of our 2020 Fit for Growth plan, during the three months ended June 30, 2020, we incurred certain employee separation, employee retention and facility exit costs. See Note 4 to our unaudited consolidated financial statements for additional information.
(3)During
the three months ended June 30, 2020, we incurred costs in response to the COVID-19 pandemic including a one-time bonus to our employees at the designation of associate and below in both India and the Philippines and costs to enable our employees to work remotely, partially offset by benefits provided to us by certain jurisdictions in which we operate. Most of the costs related to the pandemic are reported in "Cost of revenues" in our unaudited consolidated statements of operations.
(4)Non-operating foreign currency exchange gains and losses, inclusive of gains and losses on related foreign exchange forward contracts not designated as hedging instruments for accounting purposes, are reported in "Foreign currency exchange gains (losses), net" in our
unaudited consolidated statements of operations.
(5)Presented below are the tax impacts of each of our non-GAAP adjustments to pre-tax income:
The effective tax rate related to each of our non-GAAP adjustments varies depending on the jurisdictions in which such income and expenses are generated and the statutory rates applicable in those jurisdictions.
The following table sets forth, for the periods indicated, certain financial data for the six months ended June 30:
%
of
% of
Increase / Decrease
2020
Revenues
2019
Revenues
$
%
(Dollars
in millions, except per share data)
Revenues
$
8,225
100.0
$
8,251
100.0
$
(26)
(0.3)
Cost
of revenues(1)
5,362
65.2
5,204
63.1
158
3.0
Selling, general and administrative expenses(1)
1,422
17.3
1,590
19.3
(168)
(10.6)
Restructuring
charges
126
1.5
51
0.6
75
147.1
Depreciation and amortization expense
269
3.3
248
3.0
21
8.5
Income
from operations
1,046
12.7
1,158
14.0
(112)
(9.7)
Other income (expense), net
(41)
101
(142)
(140.6)
Income
before provision for income taxes
1,005
12.2
1,259
15.3
(254)
(20.2)
Provision for income taxes
(276)
(309)
33
(10.7)
Income
from equity method investments
(1)
—
(1)
*
Net income
$
728
8.9
$
950
11.5
$
(222)
(23.4)
Diluted
EPS
$
1.34
$
1.67
$
(0.33)
(19.8)
Other Financial Information (7)
Adjusted
Income From Operations and Adjusted Operating Margin
$
1,203
14.6
$
1,326
16.1
$
(123)
(9.3)
Adjusted
Diluted EPS
$
1.78
$
1.85
$
(0.07)
(3.8)
(1)Exclusive
of depreciation and amortization expense.
*Not meaningful
Revenues - Overall
During the six months ended June 30, 2020, revenues decreased by $26 million as compared to the six months ended June 30, 2019, representing a decline of 0.3%, or growth of 0.5% on a constant currency basis7. The revenue decline reflected fulfillment challenges, project deferrals, furloughs and temporary rate concessions brought on by the COVID-19 pandemic. Additionally, as a result of fulfillment challenges caused by the ransomware attack, our year over year revenue growth was negatively impacted by approximately 45 basis
points. We continue to experience pricing pressure within our core portfolio of services as our clients optimize the cost of supporting their legacy systems and operations. At the same time, clients continue to adopt and integrate digital technologies and their demand for our digital operations services and solutions continues to grow. In addition, our revenues benefited from our recently completed acquisitions, including Zenith and Contino. Revenues from clients added since June 30, 2019 were $166 million.
Revenues from our top clients as a percentage of total revenues were as follows:
7Adjusted
Income From Operations, Adjusted Operating Margin, Adjusted Diluted EPS and constant currency revenue growth are not measurements of financial performance prepared in accordance with GAAP. See “Non-GAAP Financial Measures” for more information and reconciliations to the most directly comparable GAAP financial measures.
Revenues by reportable business segment were as follows for the six months ended June 30:
2020
2019
Increase
/ (Decrease)
$
%
CC %8
(Dollars in millions)
Financial
Services
$
2,847
$
2,909
$
(62)
(2.1)
(1.3)
Healthcare
2,351
2,299
52
2.3
2.4
Products
and Resources
1,821
1,841
(20)
(1.1)
0.1
Communications, Media and Technology
1,206
1,202
4
0.3
1.5
Total
revenues
$
8,225
$
8,251
$
(26)
(0.3)
0.5
Financial Services
Revenues from our Financial Services segment declined 2.1%, or 1.3% on a constant currency
basis8, for the six months ended June 30, 2020, as compared to the six months ended June 30, 2019. Revenues in this segment decreased $41 million from our insurance clients and $21 million from our banking clients and were negatively impacted by the COVID-19 pandemic and the ransomware attack. Demand from certain banking clients has been and may continue to be negatively affected as they transition the support of some of their legacy systems and operations in-house or to captives.Revenues from clients added, including those related to acquisitions, since June 30, 2019 were $40 million.
Healthcare
Revenues
from our Healthcare segment grew 2.3%, or 2.4% on a constant currency basis8, for the six months ended June 30, 2020, as compared to the six months ended June 30, 2019. Revenues in this segment increased by $95 million from our life sciences clients, driven by revenues from our acquisition of Zenith, while revenues from our healthcare clients decreased by $43 million. Revenues from our healthcare clients were negatively impacted by the establishment of an offshore captive by a large client, the COVID-19 pandemic and the ransomware attack. Revenues from clients added since June 30, 2019 were $31 million.
Products and Resources
Revenues
from our Products and Resources segment declined 1.1%, remaining relatively flat on a constant currency basis8, for the six months ended June 30, 2020, as compared to the six months ended June 30, 2019. Retail, consumer goods, travel and hospitality clients were particularly adversely affected by the pandemic. Thus, revenues decreased by $42 million from our travel and hospitality clients and $29 million from our retail and consumer goods clients. Revenues from our manufacturing, logistics, energy and utilities clients increased $51 million due to our clients' adoption and integration of digital technologies. Revenues from clients added since June 30, 2019 were $50 million.
Communications,
Media and Technology
Revenues from our Communications, Media and Technology segment grew 0.3%, or 1.5% on a constant currency basis8, for the six months ended June 30, 2020, as compared to the six months ended June 30, 2019. Revenues from our communications and media clients increased $14 million while revenues from our technology clients decreased $10 million. Revenues among our technology clients in this segment were negatively impacted by approximately $71 million due to our 2019 strategic decision to exit certain content-related services. Additionally, revenues were negatively impacted by the COVID-19 pandemic, particularly among our communications and media clients, partially offset by the demand from our technology clients for digital content services. Revenues from clients
added, including those related to acquisitions, since June 30, 2019 were $45 million.
8 Constant currency revenue growth is not a measurement of financial performance prepared in accordance with GAAP. See “Non-GAAP Financial Measures” for more information.
Revenues by geographic market were as follows for the six months ended June 30:
2020
2019
Increase
/ (Decrease)
$
%
CC %9
(Dollars in millions)
North
America
$
6,196
$
6,262
$
(66)
(1.1)
(1.0)
United Kingdom
651
651
—
—
2.2
Continental
Europe
856
832
24
2.9
5.2
Europe - Total
1,507
1,483
24
1.6
3.9
Rest
of World
522
506
16
3.2
8.6
Total revenues
$
8,225
$
8,251
$
(26)
(0.3)
0.5
North
America continues to be our largest market, representing 75.3% of total revenues for the six months ended June 30, 2020. Across all regions, revenues were negatively impacted by the COVID-19 pandemic and the ransomware attack, partially offset by the revenue from our recently completed acquisitions, including Zenith and Contino. Our North America region was also negatively impacted by our strategic decision to exit certain content-related services in our Communications, Media and Technology segment and the transition of the support of legacy systems for certain financial services and healthcare clients in-house or to captives. Revenue growth in our Continental Europe and Rest of World regions was driven by our life sciences clients and our Communications, Media and Technology clients, respectively.
Cost of Revenues (Exclusive of Depreciation and Amortization Expense)
Our
cost of revenues consists primarily of salaries, incentive-based compensation, stock-based compensation expense, employee benefits, project-related immigration and travel for technical personnel, subcontracting and equipment costs relating to revenues. Our cost of revenues increased by 3.0% during the six months ended June 30, 2020 as compared to the six months ended June 30, 2019, increasing as a percentage of revenues to 65.2% during the 2020 period compared to 63.1% in the 2019 period. The increase in cost of revenues, as a percentage of revenues, was due primarily to an increase in costs related to our delivery personnel (including employees and subcontractors), the impact on revenues of the COVID-19 pandemic and the ransomware attack. These impacts were partially offset by the depreciation of the Indian rupee against the U.S. dollar, a significant decrease in travel
and entertainment costs as a result of a reduction in travel due to the COVID-19 pandemic and the cost savings generated as a result of our cost optimization strategy.
SG&A Expenses
SG&A expenses consist primarily of salaries, incentive-based compensation, stock-based compensation expense, employee benefits, immigration, travel, marketing, communications, management, finance, administrative and occupancy costs. SG&A expenses decreased by 10.6% during the six months ended June 30, 2020 as compared to the six months ended June 30, 2019, decreasing as a percentage of revenues to 17.3% during the 2020 period as compared to 19.3% in the 2019 period. The decrease, as a percentage of revenues, was due primarily to the $117 million
incremental accrual in 2019 related to the India Defined Contribution Obligation, as discussed in Note 12 to our unaudited consolidated financial statements, a significant decrease in travel and entertainment costs as a result of a reduction in travel due to the COVID-19 pandemic and lower immigration costs, partially offset by the decline in revenues brought on by the COVID-19 pandemic and the impact of the ransomware attack on both revenues and costs.
Depreciation and Amortization Expense
Depreciation and amortization expense increased by 8.5% during the six months ended June 30, 2020 as compared to the six months ended
June 30, 2019. The increase is due to procurement of additional computer equipment primarily to provision work-from-home arrangements and amortization of intangibles from recently completed acquisitions.
Restructuring Charges
Restructuring charges consist of our 2020 Fit for Growth Plan and our realignment program. Restructuring charges were $126 million or 1.5%, as a percentage of revenues for the six months ended June 30, 2020, as compared to $51 million or 0.6%, as a percentage of revenues for the six months ended June 30, 2019. For further detail on our restructuring charges see Note 4
to our unaudited consolidated financial statements.
9 Constant currency revenue growth is not a measurement of financial performance prepared in accordance with GAAP. See “Non-GAAP Financial Measures” for more information.
Income from Operations and Operating Margin - Overall
Our operating margin and Adjusted Operating Margin10 decreased to
12.7% and 14.6%, respectively, for the six months ended June 30, 2020 from 14.0% and 16.1% for the six months ended June 30, 2019. Our GAAP and Adjusted Operating Margin10 were adversely impacted by an increase in costs related to our delivery personnel (including employees and subcontractors), the decline in revenues brought on by the COVID-19 pandemic and the impact of the ransomware attack on both revenues and costs. These impacts were partially offset by the depreciation of the Indian rupee against the U.S. dollar, a significant decrease in travel and entertainment expenses due to the COVID-19 pandemic, lower immigration costs and the cost savings generated as a result of our cost optimization strategy. In addition, our 2019 GAAP operating margin included
a 2.9% negative impact of the incremental accrual in 2019 related to the India Defined Contribution Obligation as discussed in Note 12 to our unaudited consolidated financial statements, while our 2020 GAAP operating margin was negatively impacted by higher restructuring charges as discussed in Note 4 to our unaudited consolidated financial statements as well as COVID-19 Charges.
Excluding the impact of applicable designated cash flow hedges, the depreciation of the Indian rupee against the U.S. dollar positively impacted our operating margin by approximately 105 basis points, or 1.05 percentage points, during the six
months ended June 30, 2020. Each additional 1.0% change in exchange rate between the Indian rupee and the U.S. dollar will have the effect of moving our operating margin by approximately 18 basis points or 0.18 percentage points.
We enter into hedges of certain Indian rupee denominated payments in India, which are intended to mitigate the volatility of the changes in the exchange rate between the U.S. dollar and the Indian rupee. During the six months ended June 30, 2020 the settlement of our cash flow hedges negatively impacted our operating margin by approximately 17 basis points or 0.17 percentage points while the settlement of cash flow hedges during the six months ended June 30, 2019 had an immaterial impact on our operating margin.
Segment
Operating Profit
Segment operating profits were as follows for the six months ended June 30:
2020
Operating Margin %
2019
Operating
Margin %
Increase / (Decrease)
(Dollars in millions)
Financial Services
$
746
26.2
$
807
27.7
$
(61)
Healthcare
626
26.6
651
28.3
(25)
Products
and Resources
498
27.3
489
26.6
9
Communications, Media and Technology
364
30.2
358
29.8
6
Total
segment operating profit
2,234
27.2
2,305
27.9
(71)
Less: unallocated costs
1,188
1,147
41
Income
from operations
$
1,046
12.7
$
1,158
14.0
$
(112)
In
our Financial Services and Healthcare segments, operating margins were negatively impacted by an increase in costs related to our delivery personnel (including employees and subcontractors) and the impact on revenues of the COVID-19 pandemic and the ransomware attack, partially offset by cost savings generated by our cost optimization initiatives and a significant decrease in travel and entertainment costs due to COVID-19 related reductions in travel.In our Products and Resources and Communications, Media and Technology segments, operating margins increased as a result of cost savings generated by our cost optimization initiatives and a significant decrease in travel and entertainment costs due to COVID-19 related reductions in travel, partially offset by an increase in costs related to our delivery personnel (including employees and subcontractors) and the negative impact of the COVID-19 pandemic on revenues. Additionally,
2019 operating margin in our Products and Resources segment was negatively affected by bankruptcy filings by several clients in that segment. The increase in unallocated costs in 2020 compared to 2019 is primarily due to a smaller shortfall in 2020 than in 2019 of incentive-based compensation as compared to target, higher restructuring costs, COVID-19 Charges and costs related to the ransomware attack, partially offset by the India Defined Contribution Obligation presented in unallocated costs in 2019.
10 Adjusted Operating Margin is not a measurement of financial performance prepared in accordance with GAAP.
See “Non-GAAP Financial Measures” for more information and a reconciliation to the most directly comparable GAAP financial measure.
Total other income (expense), net consists primarily of foreign currency exchange gains and losses, interest income and interest expense. The following table sets forth total other income (expense), net for the six months ended June 30:
2020
2019
Increase/ Decrease
(in
millions)
Foreign currency exchange (losses) gains
$
(107)
$
23
$
(130)
Gains (losses) on foreign exchange forward contracts
not designated as hedging instruments
3
(5)
8
Foreign currency exchange gains (losses), net
(104)
18
(122)
Interest
income
78
93
(15)
Interest expense
(15)
(13)
(2)
Other,
net
—
3
(3)
Total other income (expense), net
$
(41)
$
101
$
(142)
The
foreign currency exchange gains and losses were primarily attributed to the remeasurement of the Indian rupee denominated net monetary assets and liabilities in our U.S. dollar functional currency India subsidiaries and, to a lesser extent, the remeasurement of other net monetary assets and liabilities denominated in currencies other than the functional currencies of our subsidiaries. The gains and losses on our foreign exchange forward contracts not designated as hedging instruments related to the realized and unrealized gains and losses on foreign exchange forward contracts entered into primarily to offset
foreign currency exposure to non-U.S. dollar denominated net monetary assets and liabilities. The decrease in interest income of $15 million was primarily attributable to a decrease in average invested balances and lower yields in 2020.
Provision for Income Taxes
The provision for income taxes decreased to $276 million during the six months ended June 30, 2020 from $309 million during the six months ended June 30, 2019 as a result of the decrease in the income before provision for income taxes, partially offset by a higher effective income tax rate. The effective income tax rate increased to 27.5% for the six months ended June 30, 2020 from 24.5% for the six months ended June 30,
2019 primarily driven by the depreciation of the Indian rupee against the U.S. dollar, which resulted in non-deductible foreign currency exchange losses on our unaudited consolidated statement of operations.
Net Income
Net income decreased to $728 million for the six months ended June 30, 2020 from $950 million for the six months ended June 30, 2019, representing 8.9% and 11.5% of revenues, respectively. The decrease in net income was driven by foreign exchange losses as well as lower income from operations.
(1)As
part of the realignment program, during the six months ended June 30, 2020, we incurred employee retention costs and professional fees. See Note 4 to our unaudited consolidated financial statements for additional information.
(2)As part of our 2020 Fit for Growth plan, during the six months ended June 30, 2020, we incurred certain employee separation, employee retention and facility exit costs. See Note 4 to our unaudited consolidated financial statements for additional information.
(3)During
the six months ended June 30, 2020, we incurred costs in response to the COVID-19 pandemic including a one-time bonus to our employees at the designation of associate and below in both India and the Philippines, costs to enable our employees to work remotely and provide medical staff and extra cleaning services for our facilities, partially offset by benefits provided to us by certain jurisdictions in which we operate. Most of the costs related to the pandemic are reported in "Cost of revenues" in our unaudited consolidated statements of operations.
(4)In the first quarter of 2019, we recorded an accrual of $117 million related to the India Defined Contribution Obligation as further described in Note 12
to our unaudited consolidated financial statements.
(5)Non-operating foreign currency exchange gains and losses, inclusive of gains and losses on related foreign exchange forward contracts not designated as hedging instruments for accounting purposes, are reported in "Foreign currency exchange gains (losses), net" in our unaudited consolidated statements of operations.
(6)Presented below are the tax impacts of each of our non-GAAP adjustments to pre-tax income:
Incremental accrual related to the India Defined Contribution Obligation
—
31
Foreign
currency exchange gains and losses
(18)
1
The effective tax rate related to each of our non-GAAP adjustments varies depending on the jurisdictions in which such income and expenses are generated and the statutory rates applicable in those jurisdictions.
Our cash generated from operations has historically been our primary source of liquidity to fund operations and investments to grow our business. In addition, as of June 30, 2020, we had cash, cash equivalents and short-term investments of $4,582 million. During the first quarter of 2020, we borrowed $1.74 billion against our revolving credit facility in order to increase our cash on hand in the United States, as a large portion of our cash is held in India. This will allow us the flexibility to continue to help and support our clients during
the COVID-19 pandemic and also to continue to invest in the business, both organically and inorganically.
The following table provides a summary of our cash flows for the six months ended June 30:
2020
2019
Increase
/ Decrease
(in millions)
Net cash provided by (used in):
Operating activities
$
1,476
$
844
$
632
Investing
activities
(531)
1,623
(2,154)
Financing activities
964
(1,976)
2,940
Operating
activities
The increase in cash provided by operating activities for the six months ended June 30, 2020 compared to the same period in 2019 was primarily driven by deferrals of certain tax payments due to COVID-19 pandemic regulatory relief provided by several jurisdictions in which we operate and lower incentive-based compensation payouts.
We monitor turnover, aging and the collection of accounts receivable by client. Our DSO calculation includes receivables, net of allowance for doubtful accounts, and contract assets, reduced by the uncollected portion of our deferred revenue. Our DSO was 77 days as of both June 30, 2019 and 2020
and 73 days as of December 31, 2019. During the fourth quarter of 2019, we changed our policy with regard to the presentation of certain amounts due to customers, such as discounts and rebates, and retrospectively applied this policy to the calculation of DSO as of June 30, 2019. This change in policy had the effect of reducing our June 30, 2019DSO by 2 days.
Investing activities
Net cash used in investing activities for the six months ended June 30, 2020 was driven by payments for acquisitions and outflows for capital expenditures, partially offset by net sales of investments.
Net cash provided by investing activities for the six months ended June 30, 2019 was driven by net sales of investments partially offset by payments for acquisitions and outflows for capital expenditures.
Financing activities
The cash provided by financing activities for the six months ended June 30, 2020 compared to cash used in financing activities in the six months ended June, 2019 is primarily a result of our borrowing against the revolving credit facility and lower repurchases of common stock in the six months ended June 30, 2020 as compared to the six months ended June 30, 2019.
We
have a Credit Agreement providing for a $750 million Term Loan and a $1,750 million unsecured revolving credit facility, which are due to mature in November 2023. We are required under the Credit Agreement to make scheduled quarterly principal payments on the Term Loan.
The Credit Agreement requires interest to be paid, at our option, at either the ABR or the Eurocurrency Rate (each as defined in the Credit Agreement), plus, in each case, an Applicable Margin (as defined in the Credit Agreement). Initially, the Applicable Margin is 0.875% with respect to Eurocurrency Rate loans and 0.00% with respect to ABR loans. Subsequently, the Applicable Margin with respect to Eurocurrency Rate loans may range from 0.75% to 1.125%, depending on our public debt ratings (or, if we have not received public debt ratings, from 0.875% to 1.125%, depending on our Leverage Ratio, which is the ratio
of indebtedness for borrowed money to Consolidated EBITDA, as defined in the Credit Agreement). Our Credit Agreement also provides a mechanism for determining an alternative rate of interest to the Eurocurrency rate after LIBOR is no longer available. The outstanding balance under our revolving credit facility as of June 30, 2020 is a Eurocurrency Rate loan with a maturity of November 2023 and an Interest Period (as defined in the Credit Agreement) of one month.
The Credit Agreement contains customary affirmative and negative covenants as well as a financial covenant. The financial covenant is tested at the
end of each fiscal quarter and requires us to maintain a Leverage Ratio not in excess of 3.50 to 1.00, or for a period of up to four quarters following certain material acquisitions, 3.75 to 1.00. We were in compliance with all debt covenants and representations of the Credit Agreement as of June 30, 2020.
In February 2020, our India subsidiary renewed its one-year 13 billion Indian rupee ($172 million at the June 30, 2020 exchange rate) working capital facility, which requires us to repay any balances drawn down within 90 days from the date of disbursement. There is a 1.0% prepayment penalty applicable to payments made prior to 30 days after disbursement. This working capital facility contains affirmative and negative covenants and may be renewed annually in February.
During
the six months ended June 30, 2020, we returned $793 million to our stockholders through $551 million in share repurchases under our stock repurchase program and $242 million in dividend payments. We have not repurchased any shares since April 30, 2020. We review our capital return plan on an on-going basis, considering the potential impacts of COVID-19 pandemic, our financial performance and liquidity position, investments required to execute our strategic plans and initiatives, acquisition opportunities, the economic outlook, regulatory changes and other relevant factors. As these factors may change over time, the actual amounts expended on stock repurchase activity, dividends, and acquisitions, if any, during any particular period cannot be predicted and may fluctuate from time to time.
Other
Liquidity and Capital Resources Information
We seek to ensure that our worldwide cash is available in the locations in which it is needed. As part of our ongoing liquidity assessments, we regularly monitor the mix of our domestic and international cash flows and cash balances. As of June 30, 2020, the amount of our cash, cash equivalents and short-term investments held outside the United States was $3,603 million, of which $2,098 million was in India. We evaluate on an ongoing basis what portion of the non-U.S. cash, cash equivalents and short-term investments held outside India is needed locally to execute our strategic plans and what amount is available for repatriation back to the United States.
In March 2020, the Indian parliament enacted the Budget, which contains a number of provisions related to income
tax, including a replacement of the DDT, previously due from the dividend payer, with a tax payable by the shareholder receiving the dividend. This provision reduces the tax rate applicable to us for cash repatriated from India. As of the first quarter of 2020, we limited our indefinite reinvestment assertion to India earnings accumulated in prior years. Future events may occur, such as material changes in cash estimates, discretionary transactions, including corporate restructurings, and changes in applicable laws or interpretations of such laws, that may lead us to change our assertion.
On July 20, 2020, the U.S. Treasury Department and the Internal Revenue Service released final regulations related to the global intangible low-taxed income, or GILTI, high-tax exclusion. We are evaluating the potential impact of these regulations.
While we do not anticipate a material impact on our overall income tax provision, the regulations may reduce our income taxes payable in 2020.
Given the dynamic nature of the COVID-19 pandemic, its future impact on our ongoing business, results of operations, liquidity needs and overall financial performance are difficult to estimate at this time. However, we expect our operating cash flows, cash and short-term investment balances to be sufficient to meet our operating requirements and service our debt for the next twelve months. Our ability to expand and grow our business in accordance with current plans, make acquisitions and form joint ventures, meet our long-term capital requirements beyond a twelve-month period and execute our capital return plan will depend on many factors, including the rate, if any, at which our cash flow increases, our ability and willingness to pay for acquisitions and joint ventures with capital
stock and the availability of public and private debt and equity financing. We cannot be certain that additional financing, if required, will be available on terms and conditions acceptable to us, if at all.
Commitments and Contingencies
See
Note 12 to our unaudited consolidated financial statements.
Off-Balance Sheet Arrangements
Other
than our foreign exchange forward and option contracts, there were no off-balance sheet transactions, arrangements or other relationships with unconsolidated entities or other persons in the six months ended June 30, 2020 that have, or are reasonably likely to have, a current or future effect on our financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.
Management’s discussion and analysis of our financial condition and results of operations is based on our unaudited consolidated financial statements that have been prepared in accordance with GAAP. The preparation of these financial statements requires management to make estimates and assumptions that affect the amounts reported for assets and liabilities, including the recoverability of tangible and intangible assets, disclosure of contingent assets and liabilities as of the date of the financial statements, and the reported amounts of revenues and expenses during the reported period. On an on-going basis, we evaluate our estimates. The most significant estimates relate to the recognition of revenue and profits, including the application of
the cost to cost method of measuring progress to completion for certain fixed-price contracts, income taxes, business combinations, valuation of goodwill and other long-lived assets and contingencies. We base our estimates on historical experience, current trends and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. The actual amounts may differ from the estimates used in the preparation of the accompanying unaudited consolidated financial statements. For a discussion of our critical accounting estimates, see “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the year ended December
31, 2019. Our significant accounting policies are described in Note 1 to the audited consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2019.
Goodwill is tested for impairment at the reporting unit level on an annual basis and between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying value. During the first quarter of 2020, COVID-19 negatively affected all major economic and financial markets and, although there is an extremely wide range of possible outcomes and the associated impact is highly dependent on variables that are difficult to forecast, we deemed the deterioration in general economic conditions sufficient to trigger an interim impairment testing of goodwill as of March
31, 2020. Our interim test results as of March 31, 2020 indicated that the fair values of all of our reporting units exceed their carrying values and thus, no impairment of goodwill existed as of March 31, 2020. No additional triggers for an interim impairment test have been identified since March 31, 2020. Due to the size of past acquisitions in our healthcare reporting unit, this reporting unit carries the most significant portion of our goodwill balance and has the least amount of excess fair value over its carrying value.
Recently
Adopted and New Accounting Pronouncements
See Note 1 to our unaudited consolidated financial statements.
Forward
Looking Statements
The statements contained in this Quarterly Report on Form 10-Q that are not historical facts are forward-looking statements (within the meaning of Section 21E of the Exchange Act) that involve risks and uncertainties. Such forward-looking statements may be identified by, among other things, the use of forward-looking terminology such as “believe,”“expect,”“may,”“could,”“would,”“plan,”“intend,”“estimate,”“predict,”“potential,”“continue,”“should” or “anticipate” or the negative thereof or other variations thereon or comparable terminology, or by discussions of strategy that involve risks and uncertainties. From time to time, we or our representatives have made or may make forward-looking
statements, orally or in writing.
Such forward-looking statements may be included in various filings made by us with the SEC, in press releases or in oral statements made by or with the approval of one of our authorized executive officers. These forward-looking statements, such as statements regarding our anticipated future revenues or operating margin, earnings, capital expenditures, impacts to our business, financial results and financial condition as a result of the COVID-19 pandemic, anticipated effective income tax rate and income tax expense, liquidity, access to capital, capital return plan, investment strategies, cost management, realignment program, 2020 Fit for Growth Plan, plans and objectives, including those related to our digital practice areas, investment in our business, potential acquisitions, industry trends, client
behaviors and trends, the outcome of regulatory and litigation matters, the incremental accrual related to the India Defined Contribution Obligation and other statements regarding matters that are not historical facts, are based on our current expectations, estimates and projections, management’s beliefs and certain assumptions made by management, many of which, by their nature, are inherently uncertain and beyond our control. Actual results, performance, achievements and outcomes could differ materially from the results expressed in, or anticipated or implied by, these forward-looking statements. There are a number of important factors that could cause our results to differ materially from those indicated by such forward-looking statements, including:
•economic and political conditions globally and in particular in the markets in which our clients and operations are concentrated;
•the significant and continuing adverse impact of the COVID-19 pandemic on our business, results of operations, liquidity and financial condition, and the potential for such impact being materially adverse to us as the pandemic continues to rapidly evolve and cause significant loss of life and interruption to the global economy;
•our ability to attract, train and retain skilled professionals, including highly skilled technical personnel to satisfy client demand and senior management to lead our business globally;
•challenges related to growing our business organically as well as inorganically through acquisitions, and our ability to achieve our targeted growth rates;
•our ability
to achieve our profitability and capital return goals;
•our ability to successfully implement our 2020 Fit for Growth Plan and achieve the anticipated benefits from the plan;
•our ability to meet specified service levels or milestones required by certain of our contracts;
•intense and evolving competition and significant technological advances that our service offerings must keep pace with in the rapidly changing markets we compete in;
•legal, reputation and financial risks related to our recent ransomware attack and if we otherwise fail to protect client and/or Cognizant data from security breaches or cyberattacks;
•the
effectiveness of our business continuity and disaster recovery plans and the potential that our global delivery capacity could be impacted;
•restrictions on visas, in particular in the United States, United Kingdom and EU, or immigration more generally, which may affect our ability to compete for and provide services to our clients;
•risks related to anti-outsourcing legislation, if adopted, and negative perceptions associated with offshore outsourcing, both of which could impair our ability to serve our clients;
•risks related to complying with the numerous and evolving legal and regulatory requirements to which we are subject in the many jurisdictions in which we operate;
•potential changes in
tax laws, or in their interpretation or enforcement, failure by us to adapt our corporate structure and intercompany arrangements to achieve global tax efficiencies or adverse outcomes of tax audits, investigations or proceedings;
•potential exposure to litigation and legal claims in the conduct of our business;
•potential significant expense that would occur if we change our intent not to repatriate prior year Indian accumulated undistributed earnings; and
•the factors set forth in "Part I, Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2019, as updated by “Part
II, Item 1A. Risk Factors” in this Quarterly Report on Form 10-Q for the quarter ended June 30, 2020.
You are advised to consult any further disclosures we make on related subjects in the reports we file with the SEC, including this report in the section titled “Part I, Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Part I, Item 1. Business” in our Annual Report on Form 10-K for the year ended December 31, 2019. We undertake no obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, except as may be required under applicable securities laws.
Item 3.
Quantitative and Qualitative Disclosures about Market Risk.
There have been no material changes in our quantitative and qualitative disclosures about market risk from those disclosed in Part II, Item 7A, Quantitative and Qualitative Disclosures about Market Risk, in our Annual Report on Form 10-K for the fiscal year ended December 31, 2019, filed with the SEC on February 14, 2020.
Our management, under the supervision and with the participation of our chief executive officer and our chief financial officer, evaluated the design and operating effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of June 30,
2020. Based on this evaluation, our chief executive officer and our chief financial officer concluded that, as of June 30, 2020, our disclosure controls and procedures were effective.
Changes in Internal Control over Financial Reporting
No changes in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) occurred during the fiscal quarter ended June 30, 2020 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
See Note
12 to our unaudited consolidated financial statements.
Item 1A. Risk Factors
The risk factors disclosed in Part I, Item 1A, Risk Factors, in our Annual Report on Form 10-K for the fiscal year ended December
31, 2019 filed with the SEC on February 14, 2020 continue to apply to our business. The information presented below should be read in conjunction with the other risk factors disclosed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2019.
The COVID-19 pandemic has had a significant and continuing adverse impact upon, and may have a material adverse impact upon, our business, liquidity, results of operations and financial condition.
The ongoing global COVID-19 pandemic has caused and continues to cause significant loss of life and interruption to the global economy, including the curtailment of activities by businesses and consumers in much of the world as governments and others seek to limit
the spread of the disease, including through business and transportation shutdowns and restrictions on people’s movement and congregation. Among other things, “stay at home”, “shelter in place” and various states of “lockdown” in many countries around the world has meant that many of our and our clients’ offices have been closed and employees have been working from home and many consumer-facing businesses have closed or are operating at a significantly reduced level to observe various social distancing requirements and government-mandated closures. The result has been a dramatic reduction in activity in the global economy, a reduction in demand for many products and services and significant adverse impacts to the financial markets, including the trading price of our common stock.
The COVID-19 pandemic has had a significant and continuing adverse impact upon, and may have a material adverse impact upon,
our business, liquidity, results of operations and financial condition, including as a result of the following:
•Reduced client demand for services – The vast majority of our business is with clients in the United States, the United Kingdom and other countries in Europe, all regions that have been hard hit by the pandemic. Since March 2020, many of these countries have imposed restrictions on businesses and people, thus limiting economic activity. The timeframe for fully reopening their economies is uncertain and could be lengthy. This has reduced demand for our services, particularly from clients in the retail, consumer goods, travel and hospitality industries, and is likely to continue to result in reduced demand for our services as clients across many industries face reduced demand for their products and services as consumers and other businesses reduce spending, reduce business
activity including through facility closures, production slowdowns, work from home arrangements and employee furloughs, financial pressure on their businesses and/or a need to reduce costs. Among other things, many of our clients have postponed, cancelled or scaled-back existing projects and not entered into or reduced the scope of potential projects, and may continue to do so. The inability to meet with current and prospective clients in person has limited and may continue to limit our ability to win work with current and prospective clients.
•Client pricing pressure, payment term extensions and insolvency risk – As clients face reduced demand for their products and services, reduce their business activity and face increased financial pressure on their businesses, we have faced and expect to continue to face downward pressure on our pricing and gross margins due to pricing concessions
to clients and requests from clients to extend payment terms. In addition, some of our clients have requested and may continue to request extended payment terms, which may have an adverse on our cash flows from operations. We may also face a significantly elevated risk of client insolvency, bankruptcy or liquidity challenges where we may perform services and incur expenses for which we are not paid.
•Delivery challenges – Due to the closures of many of our and our clients’ facilities, including as a result of various orders from national, state or local governments, sickness of employees or their families or the desire of employees to avoid contact with large groups of people, we have faced and may continue to face challenges delivering services to our clients and satisfying contractually agreed upon service levels. Two-thirds of our employees and the core of our delivery capabilities
are in India, where the Indian government has imposed significant restrictions on movement since March and whose population density presents a very significant risk of the spread of the pandemic. We also have significant delivery operations in the Philippines, which has also had significant restrictions on movement since March. The impact of pandemic, particularly in India, but also in the Philippines and other countries where we have near-shore or onshore delivery operations for clients, as well as our in-country offices and offices of clients where our associates may normally work, has impacted and may continue to impact our ability to deliver services to clients,
particularly for those clients for whom work-from-home arrangements may not be possible. Our work-from-home arrangements for many of our employees may be unsuccessful in mitigating the impact of such closures and increase our exposure to security breaches or cyberattacks. The ransomware attack we were subject to in April 2020 compounded the challenges we faced in enabling work-from-home arrangements and resulted in setbacks and delays to such efforts. A significant worsening of the pandemic, particularly in India, or another security incident during the pandemic, could materially impair our ability to deliver services to clients to an extent that may have a material adverse impact to our business, liquidity, results of operations and financial condition.
•Increased costs – We face increased costs from the pandemic,
including as a result of mitigation efforts such as enabling increased work-from-home capabilities and additional health and safety measures.
•Diversion of and strain on management and other corporate resources – Addressing the significant personal and business challenges presented by the pandemic, including various business continuity measures and the need to enable work-from-home arrangements for many of our associates, has demanded significant management time and attention and strained other corporate resources, and is expected to continue to do so. Among other things, this may adversely impact our client and associate development and our ability to execute our strategy and various transformation initiatives, and may increase our exposure to security breaches or cyberattacks.
•Reduced employee morale and
productivity – The significant personal and business challenges presented by the pandemic, including the potentially life-threatening health risks to employees and their families and friends, the closures of schools and the unavailability of various services our employees may rely upon, such as childcare, are a cause of employee morale concerns and may adversely impact employee productivity.
The COVID-19 pandemic continues to rapidly evolve. The ultimate extent to which the outbreak impacts our business, liquidity, results of operations and financial condition will depend on future developments, which are highly uncertain and cannot be predicted with confidence, such as the transmission rate and geographic spread of the disease, the duration and extent of the pandemic, travel restrictions and social distancing in the United States, the United Kingdom, other countries in Europe, India, the Philippines
and other countries, the duration and extent of business closures and business disruptions and the effectiveness of actions taken to contain, treat and prevent the disease. If we or our clients experience prolonged shutdowns or other business disruptions, our business, liquidity, results of operations, financial condition and the trading price of our common stock are likely to be materially adversely affected, and our ability to access the capital markets may be limited.
We face legal, reputational and financial risks resulting from the security incident we announced on April 20, 2020 and if we otherwise fall victim to security breaches or cyberattacks that may impact client and/or Cognizant data.
In order to provide our services and solutions, we depend on global information technology networks and systems, including those of third
parties, to process, transmit, host and securely store electronic information (including our confidential information and the confidential information of our clients) and to communicate among our locations around the world and with our clients, suppliers and partners. Security breaches, employee malfeasance, or human or technological error create risks of shutdowns or disruptions of our operations and potential unauthorized access and/or disclosure of our or our clients’ sensitive data, which in turn could jeopardize projects that are critical to our operations or the operations of our clients’ businesses and have other adverse impacts on our business. For example, on April 20, 2020, we announced a security incident involving a Maze ransomware attack (see Part I, Item 2. Management's Discussion and Analysis
of Financial Condition and Results of Operations for additional information regarding the security incident). The attack resulted in unauthorized access to certain data and caused significant disruption to our business. This included the disabling of some of our systems and disruption caused by our taking certain other internal systems and networks offline as a precautionary measure. The attack compounded the challenges we faced in enabling work-from-home arrangements during the COVID-19 pandemic and resulted in setbacks and delays to such efforts. Some of our clients experienced service disruptions due to our reliance on certain of the impacted systems and networks to perform work for clients and the impact to our systems and networks supporting work-from-home capabilities. In addition, some clients opted to suspend our access to their networks as a security precaution. In this circumstance, we are unable to continue providing services via
client networks until access is restored. As a result of the fulfillment challenges caused by the ransomware attack, our year over year revenue growth for the second quarter was negatively impacted by approximately 90 basis points. We do not expect the attack to significantly impact our revenues for the remainder of 2020. Additionally, in the second quarter of 2020, we incurred $24 million in costs related to the ransomware attack, and we will continue to incur significant incremental costs for the remediation of the security incident and investments to enhance our overall security environment. The lost revenue and containment, investigation, remediation, legal and other costs may exceed our insurance policy limits or may not be covered by insurance at all. Other actual and potential consequences include, but are not limited to, negative publicity, reputational damage, lost trust with customers, regulatory enforcement action, litigation that could result in financial
judgments or the payment of settlement amounts and disputes with insurance carriers concerning coverage. In addition to the ransomware attack, we and the businesses we interact with face other threats to data and systems, including by perpetrators of random or targeted malicious cyberattacks, computer viruses, malware, worms, bot
attacks or other destructive or disruptive software and attempts to misappropriate client information and cause system failures and disruptions.
A security compromise of our information systems, such as the security incident announced in April 2020, or of those of businesses with whom
we interact, that results in confidential information being accessed by unauthorized or improper persons, could harm our reputation and expose us to regulatory actions, client attrition due to reputational concerns or otherwise, containment and remediation expenses, and claims brought by our clients or others for breaching contractual confidentiality and security provisions or data protection laws. Monetary damages imposed on us could be significant and may impose costs in excess of insurance policy limits or not covered by our insurance at all. Techniques used by bad actors to obtain unauthorized access, disable or degrade service, or sabotage systems evolve frequently and may not immediately produce signs of intrusion, and we may be unable to anticipate these techniques or to implement adequate preventative measures. In addition, a security breach could require that we expend substantial additional resources related to the security of our information systems, diverting
resources from other projects and disrupting our businesses. Any remediation measures that we have taken or that we may undertake in the future in response to the security incident announced in April 2020 or other security breaches may be insufficient to prevent future attacks.
We are required to comply with increasingly complex and changing data security and privacy regulations in the United States, the United Kingdom, the European Union and in other jurisdictions in which we operate that regulate the collection, use and transfer of personal data, including the transfer of personal data between or among countries. For example, the European Union’s General Data Protection Regulation has imposed stringent compliance obligations regarding the handling of personal data and has resulted in the issuance of significant financial penalties for noncompliance. In the United States, there have been proposals for federal privacy legislation
and many new state privacy laws are on the horizon. Recently enacted legislation, such as the California Consumer Privacy Act, impose extensive privacy requirements on organizations governing personal information. Existing US sectoral laws such as the Health Insurance Portability and Accountability Act also impose extensive privacy and security requirements on organizations operating in the healthcare industry, which Cognizant serves. Additionally, in India, the Personal Data Protection Bill, 2018 was recently cleared for introduction in the current session of the Indian Parliament. If enacted in its current form it would impose stringent obligations on the handling of personal data, including certain localization requirements for sensitive data. Other countries have enacted or are considering enacting data localization laws that require certain data to stay within their borders. We may also face audits or investigations by one or more domestic or foreign government
agencies or our clients pursuant to our contractual obligations relating to our compliance with these regulations. Complying with changing regulatory requirements requires us to incur substantial costs, exposes us to potential regulatory action or litigation, and may require changes to our business practices in certain jurisdictions, any of which could materially adversely affect our business operations and operating results.
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
Issuer Purchases of Equity Securities
Our stock repurchase program, as amended by our Board of Directors in February 2020, allows for the repurchase of up to $7.5 billion, excluding fees and expenses, of our Class A common stock through open market purchases, including under a 10b5-1 Plan or in private transactions, including through ASR agreements entered into with financial institutions, in accordance with applicable federal securities laws. The timing of repurchases and the exact number of shares to be purchased are determined by management, in its discretion, or pursuant to a 10b5-1 Plan, and will depend upon market conditions and other factors.
During the three months ended June 30, 2020, we repurchased $40 million of our Class A common stock under our stock repurchase program pursuant to a 10b5-1 Plan that was in place prior to the COVID-19 pandemic. The stock repurchase activity under our stock repurchase program during the three months ended June 30, 2020 was as follows:
Month
Total
Number of Shares Purchased
Average Price Paid per Share
Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs
Approximate Dollar Value of Shares that May Yet Be Purchased under the Plans or Programs (in millions)
During
the three months ended June 30, 2020, we also purchased shares in connection with our stock-based compensation plans, whereby shares of our common stock were tendered by employees for payment of applicable statutory tax withholdings. For the three months ended June 30, 2020, such repurchases totaled 0.3 million shares at an aggregate cost of $19 million.
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Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
