# COGNIZANT TECHNOLOGY SOLUTIONS CORP (CTSH) FY 2023 MD&A

Verbatim Item 7 Management's Discussion and Analysis from COGNIZANT TECHNOLOGY SOLUTIONS CORP's 10-K for fiscal year 2023.

SEC filing source: https://www.sec.gov/Archives/edgar/data/1058290/000105829024000017/ctsh-20231231.htm
Accession: 0001058290-24-000017
Filing date: 2024-02-14
Report date: 2023-12-31
Extracted structurally from real Item 7 body heading to real Item 7A/8 boundary.
Confidence: high

Company profile: /company/CTSH/
All MD&A years: /company/CTSH/mda/
Previous year: /company/CTSH/mda/fy2022/ (FY 2022)
Next year: /company/CTSH/mda/fy2024/ (FY 2024)

Item 7.     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, engineering modern businesses and delivering strategic outcomes for our clients. We help clients modernize technology, reimagine processes and transform experiences so they can stay ahead in a fast-changing world. We provide industry expertise and close client collaboration, combining critical perspective with a flexible engagement style. 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. Our collaborative services include digital services and solutions, consulting, application development, systems integration, quality engineering and assurance, application maintenance, infrastructure and security as well as business process services and automation. Digital services continue to be an important part of our portfolio, aligning with our clients' focus on becoming data-enabled, customer-centric and differentiated businesses.

In the second quarter of 2023, we initiated the NextGen program aimed at simplifying our operating model, optimizing corporate functions and consolidating and realigning office space to reflect the post-pandemic hybrid work environment. Our drive for simplification includes operating with fewer layers in an effort to enhance agility and enable faster decision making. We expect the savings generated by the program to help fund continued investments in our people, revenue growth opportunities and the modernization of our office space.

In connection with the NextGen program, in 2023 we incurred $115 million of employee separation costs and $114 million of facility exit and other costs totaling $229 million. See Note 4 to our audited consolidated financial statements. We currently expect to incur total costs of approximately $300 million with approximately $70 million of such costs anticipated in 2024. The estimates of the charges and expenditures that we expect to incur in connection with the NextGen program, and the timing thereof, are subject to a number of assumptions, including local law requirements in various jurisdictions, and actual amounts may differ materially from estimates. In addition, we may incur other charges or cash expenditures not currently contemplated due to unanticipated events that may occur in connection with the NextGen program.

2023 Financial Results1

Revenues

Income from Operations

Operating Margin

Diluted EPS

[[GREPCENT_TABLE]]
[["GAAP","","Adjusted1"]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["GAAP","","Adjusted1"]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["GAAP","","Adjusted1"]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["Revenue declined $75 million or 0.4% from 2022; a decline of 0.3% in constant currency1","","Income from Operations declined $279 million or 9.4% from 2022 Adjusted Income from Operations1 declined $50 million or 1.7% from 2022","","","","Operating margin down 140 bps compared to 2022 Adjusted Operating Margin1 down 20 basis points from 2022","","","","Diluted EPS declined $0.20 or 4.5% from 2022 Adjusted Diluted EPS1 increased $0.15 or 3.4% from 2022"]]
[[/GREPCENT_TABLE]]

1 Adjusted 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.

[[GREPCENT_TABLE]]
[["Cognizant","28","December 31, 2023 Form 10-K"]]
[[/GREPCENT_TABLE]]

Table of Contents                                                

During the year ended December 31, 2023, revenues decreased by $75 million as compared to the year ended December 31, 2022, representing a decrease of 0.4%, or a decrease of 0.3% on a constant currency basis2. Revenue decline was driven by our Financial Services segment, which was negatively impacted by weakness in the banking sector, partially offset by growth in our Communications, Media and Technology, Products and Resources and Health Sciences segments. Our recently completed acquisitions contributed 110 basis points to revenue growth, primarily benefiting our Products and Resources and Communications, Media and Technology segments.

Our operating margin and Adjusted Operating Margin2 was 13.9% and 15.1%, respectively, for the year ended December 31, 2023. This compares to operating margin and Adjusted Operating Margin of 15.3% for the year ended December 31, 2022. Our 2023 GAAP and Adjusted Operating Margins were negatively impacted by increased compensation costs, primarily as a result of two merit increase cycles for the majority of our employees since October 2022, partially offset by the benefit of the depreciation of the Indian rupee against the U.S. dollar, savings generated from our NextGen program and improvement in profitability of a large contract with a Health Sciences client in 2023. In addition, as discussed in Note 4 to our audited consolidated financial statements, our 2023 GAAP operating margin was negatively impacted by the NextGen charges, which were excluded from our Adjusted Operating Margin.

As a global professional services company, we compete on the basis of the knowledge, experience, insights, skills and talent of our employees and the value they can provide to our clients. We closely monitor attrition trends focusing on the metric that we believe is most relevant to our business. This metric, which we refer to as Voluntary Attrition - Tech Services, includes all voluntary separations with the exception of employees in our Intuitive Operations and Automation practice. For the year ended December 31, 2023 our Voluntary Attrition - Tech Services was 13.8% as compared to 25.6% for the year ended December 31, 2022. We finished 2023 with approximately 347,700 employees as compared to 355,300 employees at the end of 2022.

Business Outlook

See "Overview" within Part I, Item 1. Business for information on our six strategic priorities.

We continue to expect the long-term focus of our clients to be on their digital transformation into software-driven, data-enabled, customer-centric and differentiated businesses. We believe clients will 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 and geopolitical factors, including the increasing uncertainty related to the global economy, which has affected and may continue to affect their demand for our services.

We are focused on expanding our partner ecosystem across a broad range of technology companies, including hyperscalers, cloud providers, enterprise software companies, best-in-class digital software enterprises and emerging start-ups. We believe this partner ecosystem will enable us to enhance our innovative, integrated offerings, by combining third-party products with our service solutions, to deliver enterprise-wide digital transformation.

We increasingly use AI-based technologies, including GenAI, in our client offerings and our own internal operations. AI technologies and services are part of a highly competitive and rapidly evolving market. We plan to make significant investments in our AI capabilities to meet the needs of our clients and harness its value in a flexible, secure, scalable and responsible way. As AI-based technologies evolve, we expect that some services that we currently perform for our clients will be replaced by AI or forms of automation. This may lead to reduced demand for certain services or harm our ability to obtain favorable pricing or other terms for our services.

In connection with the NextGen program, in 2023 we incurred $229 million in employee separation, facility exit and other costs. We currently expect to incur total costs of approximately $300 million in connection with the NextGen program, with approximately $70 million of such costs anticipated in 2024. In addition to the NextGen program, potential tax law and other regulatory changes, including possible U.S. corporate income tax reform and potentially increased costs for employment and post-employment benefits in India as a result of the Code on Social Security, 2020, among other items, may impact our future results. For additional information, see Part I, Item 1A. Risk Factors.

2 Adjusted Operating Margin 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.

[[GREPCENT_TABLE]]
[["Cognizant","29","December 31, 2023 Form 10-K"]]
[[/GREPCENT_TABLE]]

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Results of Operations

For a discussion of our results of operations for the year ended December 31, 2021, including a year-to-year comparison between 2022 and 2021, refer to Part II, Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations" in our Annual Report Form 10-K for the year ended December 31, 2022.

The Year Ended December 31, 2023 Compared to The Year Ended December 31, 2022

The following table sets forth certain financial data for the years ended December 31:

[[GREPCENT_TABLE]]
[["","","","","% of","","","","% of","","","Increase / Decrease"],["(Dollars in millions, except per share data)","","2023","","Revenues","","2022","","Revenues","","","$","","%"],["Revenues","","$","19,353","","","100.0","","$","19,428","","","100.0","","","$","(75)","","","(0.4)"],["Cost of revenues(a)","","12,664","","","65.4","","12,448","","","64.1","","","216","","","1.7"],["Selling, general and administrative expenses(a)","","3,252","","","16.8","","3,443","","","17.7","","","(191)","","","(5.5)"],["Restructuring charges","","229","","","1.2","","\u2014","","","\u2014","","","229","","","N/A"],["Depreciation and amortization expense","","519","","","2.7","","569","","","2.9","","","(50)","","","(8.8)"],["Income from operations and operating margin","","2,689","","","13.9","","2,968","","","15.3","","","(279)","","","(9.4)"],["Other income (expense), net","","98","","","","","48","","","","","","50","","","104.2"],["Income before provision for income taxes","","2,787","","","14.4","","3,016","","","15.5","","","(229)","","","(7.6)"],["Provision for income taxes","","(668)","","","","","(730)","","","","","","62","","","(8.5)"],["Income (loss) from equity method investments","","7","","","","","4","","","","","","3","","","75.0"],["Net income","","$","2,126","","","11.0","","$","2,290","","","11.8","","","$","(164)","","","(7.2)"],["Diluted EPS","","$","4.21","","","","","$","4.41","","","","","","$","(0.20)","","","(4.5)"],["Other Financial Information 3"],["Adjusted Income From Operations and Adjusted Operating Margin","","$","2,918","","","15.1","","$","2,968","","","15.3","","","$","(50)","","","(1.7)"],["Adjusted Diluted EPS","","$","4.55","","","","","$","4.40","","","","","","$","0.15","","","3.4"]]
[[/GREPCENT_TABLE]]

(a)    Exclusive of depreciation and amortization expense    

N/A    Not applicable3

Revenues

During the year ended December 31, 2023, revenues declined by $75 million as compared to the twelve months ended December 31, 2022, representing a decline of 0.4%, or a decline of 0.3% on a constant currency basis.3 Our recently completed acquisitions contributed 110 basis points of growth to the change in revenues.

3 Adjusted Income from Operations, Adjusted Operating Margin, Adjusted Diluted EPS and constant currency revenue growth are not measures 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.

[[GREPCENT_TABLE]]
[["Cognizant","30","December 31, 2023 Form 10-K"]]
[[/GREPCENT_TABLE]]

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Revenues - Reportable Business Segments and Geographic Markets

Revenues of $19,353 million across our business segments and geographies were as follows for the year ended December 31, 2023:

[[GREPCENT_TABLE]]
[["2023 as compared to 2022","","","","","Increase / (Decrease)"],["(Dollars in millions)","","$","","%","","CC %4"],["Financial Services","","","","","$","(263)","","","(4.3)","","","(4.2)"],["Health Sciences","","","","","43","","","0.8","","","0.5"],["Products and Resources","","","","","62","","","1.4","","","1.5"],["CMT","","","","","83","","","2.6","","","3.1"],["Total revenues","","","","","$","(75)","","","(0.4)","","","(0.3)"]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["2023 as compared to 2022","","","","","Increase / (Decrease)"],["(Dollars in millions)","","$","","%","","CC %4"],["North America","","","","","$","(172)","","","(1.2)","","","(1.1)"],["United Kingdom","","","","","75","","","4.1","","","3.5"],["Continental Europe","","","","","114","","","6.4","","","4.3"],["Europe - Total","","","","","189","","","5.2","","","3.9"],["Rest of World","","","","","(92)","","","(6.6)","","","(2.6)"],["Total revenues","","","","","$","(75)","","","(0.4)","","","(0.3)"]]
[[/GREPCENT_TABLE]]

Change in revenues was driven by the following factors:

•Reduced demand for discretionary work negatively impacted revenues across all segments, and primarily in North America. Banking clients in our Financial Services segment, retail and consumer goods clients in our Products and Resources segment and clients in our Communications, Media and Technology segment were particularly affected;

•Recently completed acquisitions which contributed 110 basis points of growth to the overall change in revenues, including 230 basis points of growth to our Products and Resources segment (primarily in North America) and 290 basis points of growth to our Communications, Media and Technology segment (primarily in Continental Europe and the United Kingdom);

•North America revenues in the Communications, Media and Technology segment included growing demand among the largest clients in this segment, including for services related to digital content;

•The resale of third-party products in North America in connection with our integrated offerings strategy, primarily in the Financial Services and Products and Resources segments, contributed 70 basis points of growth to the overall change in revenue;

•North America revenues in the Communications, Media and Technology and Products and Resources segments were positively impacted by the ramp up of several recently won large deals;

•Revenue growth in the United Kingdom was driven by expansion of work public sector clients included in our Communications, Media and Technology and Financial Services segments;

•Revenues in the Continental Europe region were driven by increased demand from pharmaceutical clients within the Health Sciences segment and automotive clients within the Products and Resources segment; and

•Revenue decline in our Rest of World region was primarily driven by weakness in the Financial Services segment and the negative impact of foreign currency exchange rate movements.

4 Constant currency revenue growth is not a measure of financial performance prepared in accordance with GAAP. See “Non-GAAP Financial Measures” for more information.

[[GREPCENT_TABLE]]
[["Cognizant","31","December 31, 2023 Form 10-K"]]
[[/GREPCENT_TABLE]]

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Cost of Revenues (Exclusive of Depreciation and Amortization Expense)

[[GREPCENT_TABLE]]
[["\u00e9","$216M"],["\u00e9","1.3% as a % of revenues"],["\u00a1 % of Revenues"]]
[[/GREPCENT_TABLE]]

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 costs of third-party products and services relating to revenues. The increase, as a percentage of revenues, was due to higher compensation costs for delivery personnel, primarily as a result of two merit increase cycles for the majority of our employees since October 2022, partially offset by the benefit of the depreciation of the Indian rupee against the U.S. dollar and improvement in profitability of a large contract with a Health Sciences client in 2023.

SG&A Expenses (Exclusive of Depreciation and Amortization Expense)

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. The decrease, as a percentage of revenues, was primarily due to savings generated from our NextGen program and the beneficial impact of foreign currency exchange rate movements, partially offset by higher compensation costs, primarily as a result of two merit increase cycles for the majority of our employees since October 2022.

[[GREPCENT_TABLE]]
[["\u00ea","$191M"],["\u00ea","0.9% as a % of revenues"],["\u00a1 % of Revenues"]]
[[/GREPCENT_TABLE]]

Restructuring Charges

Restructuring charges consist of costs related to the NextGen program. Restructuring charges were $229 million or 1.2%, as a percentage of revenues for the year ended December 31, 2023. For further detail on our restructuring charges see Note 4 to our audited consolidated financial statements.

Depreciation and Amortization Expense

Depreciation and amortization expense decreased by 8.8%, and by 0.2% as a percentage of revenues, in 2023 as compared to 2022, primarily driven by a reduction in amortization expense due to certain intangible assets reaching the end of their useful lives and savings generated from our NextGen program.

Operating Margin and Adjusted Operating Margin5 - Overall

Our 2023 operating margin and Adjusted Operating Margin5 were negatively impacted by increased compensation costs, primarily as a result of two merit increase cycles for the majority of our employees since October 2022, partially offset by the benefit of the depreciation of the Indian rupee against the U.S. dollar, savings generated from our NextGen program and improvement in profitability of a large contract with a Health Sciences client in 2023. In addition, as discussed in Note 4 to our audited consolidated financial statements, our 2023 GAAP operating margin was negatively impacted by the NextGen charges, which were excluded from our Adjusted Operating Margin5.

5 Adjusted Income From Operations 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.

[[GREPCENT_TABLE]]
[["Cognizant","32","December 31, 2023 Form 10-K"]]
[[/GREPCENT_TABLE]]

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A predominant portion of our costs in India are denominated in the Indian rupee, representing approximately 24% of our global operating costs during the year ended December 31, 2023. These costs are subject to foreign currency exchange rate fluctuations, which have an impact on our results of operations. We enter into foreign exchange derivative contracts to hedge certain Indian rupee denominated payments in India. These hedges are intended to mitigate the volatility of the changes in the exchange rate between the U.S. dollar and the Indian rupee. Net of the impact of the hedges, the depreciation of the Indian rupee contributed 90 basis points to the improvement in our operating margin for the year ended December 31, 2023 as compared to December 31, 2022.

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 96 basis points in 2023. 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 19 basis points (excluding the impact of our cash flow hedges). In 2023, the settlement of our cash flow hedges negatively impacted our operating margin by approximately 13 basis points, compared to a negative impact of 7 basis points in 2022.

We finished the year ended December 31, 2023 with approximately 347,700 employees as compared to 355,300 employees for the year ended December 31, 2022. For the year ended December 31, 2023 our Voluntary Attrition - Tech Services was 13.8% as compared to 25.6% for the year ended December 31, 2022.

Segment Operating Profit

In 2023, we made certain changes to the internal measurement of segment operating profit for the purpose of evaluating segment performance and resource allocation. The primary reason for the change was to reflect a more complete cost of delivery. Specifically, segment operating profit now includes an allocation of both SG&A costs related to our integrated practices and the excess or shortfall of incentive-based compensation for commercial and delivery employees as compared to target, which were previously included in "unallocated costs." We have reported 2023 segment operating profits using the new allocation methodology and have recast the 2022 and 2021 results to conform to the new methodology. See Note 18 to our audited consolidated financial statements for the recast 2021 segment operating profits.

Segment operating profit and operating margin percentage were as follows:

[[GREPCENT_TABLE]]
[["","","Segment operating profit","","%","Segment operating margin"]]
[[/GREPCENT_TABLE]]

In 2023, segment operating margins across all our segments were negatively impacted by increased compensation costs, primarily as a result of two merit increase cycles for the majority of our employees since October 2022, partially offset by the benefit of the depreciation of the Indian rupee against the U.S. dollar and savings generated from our NextGen program. In addition, 2023 segment operating margin in Health Sciences benefited from the improvement in profitability of a large contract with a payer client, while segment operating profit in Communications, Media and Technology was negatively affected by higher costs typical to the initial phases of several recently won large deals in this segment.

[[GREPCENT_TABLE]]
[["Cognizant","33","December 31, 2023 Form 10-K"]]
[[/GREPCENT_TABLE]]

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Total segment operating profit was as follows for the year ended December 31:

[[GREPCENT_TABLE]]
[["(Dollars in millions)","2023","","% of Revenues","","2022","","% of Revenues","","Increase / (Decrease)"],["Total segment operating profit","$","4,117","","","21.3","","","$","4,353","","","22.4","","","$","(236)"],["Less: unallocated costs","1,428","","","7.4","","","1,385","","","7.1","","","43"],["Income from operations","$","2,689","","","13.9","","","$","2,968","","","15.3","","","$","(279)"]]
[[/GREPCENT_TABLE]]

The increase in unallocated costs for 2023 as compared to 2022 was primarily driven by the NextGen charges in 2023, see Note 4 to our audited consolidated financial statements, partially offset by lower corporate expenses.

Other Income (Expense), Net

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 years ended December 31:

[[GREPCENT_TABLE]]
[["(in millions)","2023","","2022","","","","Increase / Decrease"],["Foreign currency exchange gains (losses)","$","42","","","$","(16)","","","","","$","58"],["(Losses) gains on foreign exchange forward contracts not designated as hedging instruments","(40)","","","23","","","","","(63)"],["Foreign currency exchange gains (losses), net","2","","","7","","","","","(5)"],["Interest income","126","","","59","","","","","67"],["Interest expense","(41)","","","(19)","","","","","(22)"],["Other, net","11","","","1","","","","","10"],["Total other income (expense), net","$","98","","","$","48","","","","","$","50"]]
[[/GREPCENT_TABLE]]

The foreign currency exchange losses were attributed to the remeasurement of net monetary assets and liabilities denominated in currencies other than the functional currencies of our subsidiaries. The gains on foreign exchange forward contracts not designated as hedging instruments related to the realized and unrealized gains and losses on contracts entered into to offset our foreign currency exposures. As of December 31, 2023, the notional value of our undesignated hedges was $1,317 million. The increase in interest income and interest expense was each primarily attributable to higher interest rates in the current period.

Provision for Income Taxes

[[GREPCENT_TABLE]]
[["\u00ea","$62M"],["\u00a1 Effective Income Tax Rate \u00ea 0.2%"]]
[[/GREPCENT_TABLE]]

The effective income tax rate decreased primarily driven by the geographical mix of earnings in 2023 as compared to 2022. See Note 11 to our consolidated financial statements for additional information.

In December 2021, the OECD adopted model rules for a global framework to impose a 15% global minimum tax referred to as Pillar Two with a targeted effective date of January 1, 2024. The OECD has continued and is continuing to issue additional guidance on the operation of the model rules. While the United States has not enacted Pillar Two, certain countries in which we operate have adopted their own version of the Pillar Two model rules. Although Management continues to monitor additional guidance from the OECD and countries’ implementation of Pillar Two, based on current guidance, we believe that our net income, cash flows, or financial condition will not be materially impacted by Pillar Two.

Net Income

The decrease in net income was primarily driven by lower income from operations, partially offset by higher interest income and lower provision for income taxes in 2023.

[[GREPCENT_TABLE]]
[["\u00ea","$164M"],["\u00ea","0.8% as a % of revenues"],["\u00a1 % of Revenues"]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["Cognizant","34","December 31, 2023 Form 10-K"]]
[[/GREPCENT_TABLE]]

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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 non-GAAP financial measures to the corresponding GAAP measures set forth below should be carefully evaluated.

Our non-GAAP financial measures Adjusted Operating Margin and Adjusted Income from Operations exclude unusual items, such as NextGen charges. Our non-GAAP financial measure Adjusted Diluted EPS excludes unusual items, such as NextGen charges and the effect of recognition in the third quarter of 2022 of an income tax benefit related to a specific uncertain tax position that was previously unrecognized in our prior-year consolidated financial statements, and net non-operating foreign currency exchange gains or losses and the tax impact of all the applicable adjustments. For further detail on the NextGen charges, see Note 4 to our audited consolidated financial statements. The income tax impact of each item excluded from Adjusted Diluted EPS 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. Free cash flow is defined as cash flows from operating activities net of purchases of property and equipment.

We believe providing investors with an operating view consistent with how we manage the Company provides enhanced transparency into our operating results. For 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 executive officers and for making comparisons of our operating results to those of our competitors. We believe that the presentation of non-GAAP financial measures, which exclude certain costs, read in conjunction with our reported GAAP results and 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 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 non-GAAP financial measures to allow investors to evaluate such non-GAAP financial measures.

[[GREPCENT_TABLE]]
[["Cognizant","35","December 31, 2023 Form 10-K"]]
[[/GREPCENT_TABLE]]

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The following table presents a reconciliation of each non-GAAP financial measure to the most comparable GAAP measure, as applicable, for the years ended December 31:

[[GREPCENT_TABLE]]
[["(Dollars in millions, except per share data)","2023","","% of Revenues","","2022","","% of Revenues"],["GAAP income from operations and operating margin","$","2,689","","","13.9","%","","$","2,968","","","15.3","%"],["NextGen charges (1)","229","","","1.2","","","\u2014","","","\u2014"],["Adjusted Income From Operations and Adjusted Operating Margin","$","2,918","","","15.1","%","","$","2,968","","","15.3","%"],["GAAP diluted EPS","$","4.21","","","","","$","4.41"],["Effect of NextGen charges, pre-tax","0.45","","","","","\u2014"],["Effect of non-operating foreign currency exchange losses (gains), pre-tax (2)","\u2014","","","","","(0.01)"],["Tax effect of above adjustments (3)","(0.11)","","","","","0.07"],["Effect of recognition of income tax benefit related to an uncertain tax position (4)","\u2014","","","","","(0.07)"],["Adjusted Diluted EPS","$","4.55","","","","","$","4.40"],["Net cash provided by operating activities","$","2,330","","","","","$","2,568"],["Purchases of property and equipment","(317)","","","","","(332)"],["Free cash flow","$","2,013","","","","","$","2,236"]]
[[/GREPCENT_TABLE]]

(1)    As part of the NextGen program, during the year ended December 31, 2023, we incurred employee separation, facility exit and other costs. See Note 4 to our audited consolidated financial statements for additional information.

(2)    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 consolidated statements of operations.

(3)    Presented below are the tax impacts of each of our non-GAAP adjustments to pre-tax income for the years ended December 31:

[[GREPCENT_TABLE]]
[["(in millions)","2023","","2022"],["Non-GAAP income tax benefit (expense) related to:"],["NextGen charges","$","59","","","$","\u2014"],["Foreign currency exchange gains and losses","(6)","","","(39)"]]
[[/GREPCENT_TABLE]]

The effective tax rate related to non-operating foreign currency exchange gains and losses varies depending on the jurisdictions in which such income and expenses are generated and the statutory rates applicable in those jurisdictions. As such, the income tax effect of non-operating foreign currency exchange gains and losses shown in the above table may not appear proportionate to the net pre-tax foreign currency exchange gains and losses reported in our consolidated statements of operations.

(4)    As previously reported in our 2022 Annual Report on Form 10-K, during the three months ended September 30, 2022, we recognized an income tax benefit of $36 million related to a specific uncertain tax position that was previously unrecognized in our prior-year consolidated financial statements. The recognition of the benefit in the third quarter of 2022 was based on management’s reassessment regarding whether this unrecognized tax benefit met the more-likely-than-not threshold in light of the lapse in the statute of limitations as to a portion of such benefit.

[[GREPCENT_TABLE]]
[["Cognizant","36","December 31, 2023 Form 10-K"]]
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Liquidity and Capital Resources

Cash generated from operations has historically been our primary source of liquidity to fund operations and investments to grow our business. As of December 31, 2023, we had cash, cash equivalents and short-term investments of $2,635 million. Additionally, as of December 31, 2023, we had available capacity under our credit facilities of approximately $2.0 billion.

The following table provides a summary of our cash flows for the years ended December 31:

[[GREPCENT_TABLE]]
[["(in millions)","","2023","","2022","","","","Increase / Decrease"],["Net cash provided by (used in):"],["Operating activities","","$","2,330","","","$","2,568","","","","","$","(238)"],["Investing activities","","(331)","","","(106)","","","","","(225)"],["Financing activities","","(1,609)","","","(1,939)","","","","","330"],["Other Cash Flow Information6"],["Free cash flow","","2,013","","","2,236","","","","","(223)"]]
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Operating activities6

The decrease in cash provided by operating activities in 2023 compared to 2022 was primarily driven by an increase in income tax payments. In 2023, we made tax payments related to the mandatory capitalization of research and experimental expenditures for the 2022 tax year of approximately $300 million as well as the estimated tax payments for 2023 of approximately $230 million. Cash provided by operating activities for 2023 benefited from improved collections of our trade accounts receivable as compared to 2022.

We monitor turnover, aging and the collection of trade accounts receivable by client. Our DSO calculation includes trade accounts receivable, net of allowance for credit losses, and contract assets, reduced by the uncollected portion of our deferred revenue. DSO was 77 days as of December 31, 2023, 74 days as of December 31, 2022 and 69 days as of December 31, 2021.

Investing activities

The increase in cash used in investing activities in 2023 compared to 2022 was primarily driven by lower net maturities of investments in 2023 as compared to 2022 and higher payments for business combinations in 2023.

Financing activities

The decrease in cash used in financing activities in 2023 compared to 2022 was primarily driven by lower repurchases of common stock.

We have a Credit Agreement providing for a $650 million Term Loan and a $1,850 million unsecured revolving credit facility, which are each due to mature in October 2027. We are required under the Credit Agreement to make scheduled quarterly principal payments on the Term Loan beginning in December 2023. See Note 10 to our consolidated financial statements. We believe that we currently meet all conditions set forth in the Credit Agreement to borrow thereunder, and we are not aware of any conditions that would prevent us from borrowing part or all of the remaining available capacity under the revolving credit facility as of December 31, 2023 and through the date of this filing. As of December 31, 2023, we had no outstanding balance on our revolving credit facility.

In March 2023, our India subsidiary renewed its working capital facility at 15 billion Indian rupee ($180 million at the December 31, 2023 exchange rate). This facility 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 within 30 days after disbursement. This working capital facility contains affirmative and negative covenants and may be renewed annually. As of December 31, 2023, we have not borrowed funds under this facility or any of its predecessor facilities.

6 Free cash flow is not a measurement of financial performance prepared in accordance with GAAP. See “Non-GAAP Financial Measures” for more information.

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[["Cognizant","37","December 31, 2023 Form 10-K"]]
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Capital Allocation Framework

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[["","Acquisitions"],["","Share repurchases"],["","Dividend payments"]]
[[/GREPCENT_TABLE]]

Our capital allocation framework anticipates the deployment of approximately 50% of our free cash flow7 for acquisitions, 25% for share repurchases and 25% for dividend payments. We review our capital allocation on an ongoing basis, considering 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. We evaluate on an ongoing basis what portion of the non-U.S. cash, cash equivalents and short-term investments is needed locally to execute our strategic plans and what amount is available for repatriation back to the United States.

We expect operating cash flows, cash and short-term investment balances, together with the available capacity under our revolving credit facilities, to be sufficient to meet our operating requirements, including purchase commitments, tax payments, including Tax Reform Act transition tax payments, and servicing our debt for the next twelve months. Our remaining Tax Reform Act transition tax payments are $123 million and $157 million in the years 2024 and 2025, respectively. In 2023, our Tax Reform Act transition tax payment was $94 million. In addition, we also have purchase commitments of approximately $615 million that will be paid over the next four years, of which approximately $180 million will be paid during the next twelve months. In addition, see Note 7 to our consolidated financial statements for a description of our operating lease obligations.

In connection with our ongoing dispute with the ITD, on January 8, 2024, the SCI ruled that, in order to proceed with our appeal, we must deposit 30 billion Indian rupees ($355 million at the December 31, 2023 exchange rate), representing the time deposits of CTS India under lien, on the condition that, if CTS India prevails at the High Court, the amount deposited will be returned to CTS India, along with interest accrued, within 4 weeks of the judgment. The SCI also requested the High Court to consider and dispose of the appeal as expeditiously as possible, preferably within 6 weeks of the January 8, 2024 ruling. We made the required deposit in January 2024. See Note 11 to our consolidated financial statements.

The ability to expand and grow our business in accordance with current plans, make acquisitions, meet 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 cash flow increases, our ability and willingness to pay for acquisitions with capital stock and the availability of public and private debt, including the ability to extend the maturity of or refinance our existing 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.

Critical Accounting Estimates

Management’s discussion and analysis of our financial condition and results of operations is based on our accompanying consolidated financial statements that have been prepared in accordance with GAAP. We base our estimates on historical experience, current trends and on various other assumptions that are believed to be relevant at the time our consolidated financial statements are prepared. We evaluate our estimates on a continuous basis. However, the actual amounts may differ from the estimates used in the preparation of our consolidated financial statements.

We believe the following accounting estimates are the most critical to aid in fully understanding and evaluating our consolidated financial statements as they require the most difficult, subjective or complex judgments, resulting from the need to make estimates about the effect of matters that are inherently uncertain. Changes to these estimates could have a material effect on our results of operations and financial condition. Our significant accounting policies are described in Note 1 to our consolidated financial statements.

7 Free cash flow is not a measurement of financial performance prepared in accordance with GAAP. See “Non-GAAP Financial Measures” for more information.

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[["Cognizant","38","December 31, 2023 Form 10-K"]]
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Revenue Recognition. Revenues related to fixed-price contracts for application development and systems integration services, consulting or other technology services are recognized as the service is performed using the cost-to-cost method, under which the total value of revenues is recognized on the basis of the percentage that each contract’s total labor cost to-date bears to the total expected labor costs. Revenues related to fixed-price application maintenance, quality engineering and assurance and business process services are recognized using the cost-to-cost method, if the right to invoice is not representative of the value being delivered. The cost-to-cost method requires estimation of future costs, which is updated as the project progresses to reflect the latest available information. Such estimates and changes in estimates involve the use of judgment. The cumulative impact of any revision in estimates is reflected in the financial reporting period in which the change in estimate becomes known. Net changes in estimates of such future costs were immaterial to the consolidated results of operations for the periods presented.

Income Taxes. Determining the consolidated provision for income taxes, deferred income tax assets (and related valuation allowance, if any) and liabilities requires significant judgment. We are required to calculate and provide for income taxes in each of the jurisdictions where we operate. Changes in the geographic mix of income before taxes or estimated level of annual pre-tax income can affect our overall effective income tax rate. In addition, transactions between our affiliated entities are arranged in accordance with applicable transfer pricing laws, regulations and relevant guidelines. As a result, and due to the interpretive nature of certain aspects of these laws and guidelines, we have pending applications for APAs before the taxing authorities in some of our most significant jurisdictions. It could take years for the relevant taxing authorities to negotiate and conclude these applications. The consolidated provision for income taxes may change period to period based on changes in facts and circumstances, such as settlements of income tax audits, the expiration of the applicable statute of limitations or finalization of our applications for APAs.

Our provision for income taxes also includes the impact of reserves established for uncertain income tax positions, as well as the related interest, which may require us to apply judgment to complex issues and may require an extended period of time to resolve. Although we believe we have adequately reserved for our uncertain tax positions, no assurance can be given that the final outcome of these matters will not differ from our recorded amounts. We adjust these reserves in light of changing facts and circumstances, such as the closing of a tax audit or the expiration of the applicable statute of limitations. To the extent that the final outcome of these matters differs from the amounts recorded, such differences will impact the provision for income taxes in the period in which such determination is made.

Business Combinations, Goodwill and Intangible Assets. Goodwill and intangible assets, including indefinite-lived intangible assets, arise from the accounting for business combinations. We account for business combinations using the acquisition method which requires us to estimate the fair value of identifiable assets acquired, liabilities assumed, including any contingent consideration, and any noncontrolling interest in the acquiree to properly allocate purchase price to the individual assets acquired and liabilities assumed. The allocation of the purchase price utilizes estimates and assumptions in determining the fair values of identifiable assets acquired and liabilities assumed, especially with respect to intangible assets, including the timing and amount of forecasted revenues and cash flows, anticipated growth rates, client attrition rates and the discount rate reflecting the risk inherent in future cash flows.

At each acquisition date, we allocate goodwill and intangible assets to our reporting units based on how we expect each reporting unit to benefit from the respective business combination. Our seven industry-based operating segments are our reporting units. We exercise judgment to allocate goodwill to the reporting units expected to benefit from each business combination. 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. These events or circumstances could include a significant change in the business climate, regulatory environment, established business plans, operating performance indicators or competition. Evaluation of goodwill for impairment requires judgment, including the identification of reporting units, assignment of assets, liabilities and goodwill to reporting units and determination of the fair value of each reporting unit.

We estimate the fair value of our reporting units using a combination of an income approach, utilizing a discounted cash flow analysis, and a market approach, using market multiples. Under the income approach, we estimate projected future cash flows, the timing of such cash flows and long-term growth rates, and determine the appropriate discount rate that reflects the risk inherent in the projected future cash flows. The discount rate used is based on a market participant weighted-average cost of capital and may be adjusted for the relevant risk associated with business-specific characteristics and the uncertainty related to the reporting unit’s ability to execute on the projected future cash flows. Under the market approach, we estimate fair value based on market multiples of revenues and earnings derived from comparable publicly-traded companies with characteristics similar to the reporting unit. The estimates used to calculate the fair value of a reporting unit change from year to year based on operating results, market conditions and other factors. Changes in these estimates and assumptions could materially affect the determination of fair value for each reporting unit.

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[["Cognizant","39","December 31, 2023 Form 10-K"]]
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Based on our most recent evaluation of goodwill performed during the fourth quarter of 2023, we concluded that the goodwill in each of our reporting units was not at risk of impairment. As of December 31, 2023, our goodwill balance was $6,085 million.

We review our finite-lived assets, including our finite-lived intangible assets, for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset group may not be recoverable. The carrying amount may not be recoverable when the sum of undiscounted expected future cash flows is less than the carrying amount of such asset groups. The impairment loss is determined as the amount by which the carrying amount of the asset group exceeds its fair value. Assessing the fair value of asset groups involves significant estimates and assumptions including estimation of future cash flows, the timing of such cash flows and discount rates reflecting the risk inherent in future cash flows.

Recently Adopted and New Accounting Pronouncements

See Note 1 to our consolidated financial statements for additional information.

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[["Cognizant","40","December 31, 2023 Form 10-K"]]
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