Item 7.     Management’s Discussion and Analysis of Financial Condition and Results of Operations

Cognizant is one of the world’s leading professional services companies, transforming clients’ business, operating and technology models for the digital era. Our industry-based, consultative approach helps customers envision, build and run more innovative and efficient businesses. Our services include digital services and solutions, consulting, application development, systems integration, application testing, application maintenance, infrastructure services and business process services. Digital services are becoming an increasingly important part of our portfolio of services and solutions and are often integrated or delivered along with our other services. We tailor our services and solutions to specific industries and use an integrated global delivery model that employs customer service teams based at customer locations and delivery teams located at customer locations and dedicated global and regional delivery centers.

In 2018, we executed on our strategy to grow revenues and expand operating margins while completing our previously announced capital return plan. Revenues for the year ended December 31, 2018 increased to $16,125 million from $14,810 million for the year ended December 31, 2017, representing growth of 8.9%, or 8.5% on a constant currency basis ¹ . Going forward, we expect to continue to invest in our digital capabilities, including the extensive training and re-skilling of our technical teams and the expansion of our local workforces in the United States and other markets around the world. We expect these investments to contribute significantly to our organic revenue growth. Additionally, we plan to supplement our organic growth through select strategic acquisitions, joint ventures, investments and alliances that can expand our digital capabilities, geographic footprint or industry capabilities. In 2018, we completed five acquisitions: Bolder Healthcare Solutions ("Bolder"), a provider of revenue cycle management solutions to the healthcare industry in the United States; Hedera Consulting, a business advisory and data analytics service provider in Belgium and the Netherlands; Softvision, a digital engineering and consulting company with significant operations in Romania and India that focuses on agile development of custom cloud-based software and platforms for customers primarily in the United States; ATG, a United States based consulting company that helps companies plan, implement, and optimize automated cloud-based quote-to-cash business processes and technologies; and SaaSfocus, a Salesforce services provider in Australia.

We are focused on driving margin enhancement while continuing to invest in our business. In 2018, our operating margin increased to 17.4% as compared to 16.8% in 2017, as we continued to target higher margin digital services customer contracts and improve our cost structure through our realignment program and other margin enhancement initiatives, primarily by optimizing our resource pyramid, improving utilization and containing our corporate spend.

As part of our capital return plan, we returned $3.7 billion to our stockholders through share repurchases and dividend payments over the two years ended December 31, 2018, exceeding our previously announced target of $3.4 billion as shown below.

Beginning in 2019, our new capital return plan anticipates the deployment of approximately 50% of our global free cash flow ¹ for dividends and share repurchases and approximately 25% of our global free cash flow ¹ for acquisitions, as needed. For the year ended December 31, 2018, our cash flows from operating activities were $2,592 million while our global free cash flow ¹ was $2,215 million. We review our capital return plan on an on-going 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.

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In 2018, we announced a plan to modify our non-GAAP financial measures. Our historical non-GAAP financial measures, non-GAAP operating margin ² , non-GAAP income from operations ² and non-GAAP diluted earnings per share ² ("non-GAAP diluted EPS") ² , excluded stock-based compensation expense, acquisition-related charges and unusual items, and our non-GAAP diluted EPS ² additionally excluded net non-operating foreign currency exchange gains or losses and the tax impacts of all applicable adjustments. Our new non-GAAP financial measures, Adjusted Operating Margin ² , Adjusted Income From Operations ² and Adjusted Diluted Earnings Per Share ² ("Adjusted Diluted EPS") ² , exclude only unusual items and Adjusted Diluted EPS ² additionally excludes net non-operating foreign currency exchange gains or losses and the tax impact of all applicable adjustments. We are also introducing two new non-GAAP financial measures, free cash flow ² and constant currency revenue growth ² . Free cash flow ² is defined as cash flow from operating activities net of purchases of property and equipment. Constant currency revenue growth ² 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. See “Non-GAAP Financial Measures” for more information.

2018 Financial Results

The following table sets forth a summary of our financial results for the years ended December 31, 2018 and 2017 :

The following charts set forth revenues and revenue growth by business segment and geography for the years ended December 31, 2017 and 2018:

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The following factors impacted our revenue growth during the year ended December 31, 2018 as compared to the year ended December 31, 2017:

The following chart sets forth our GAAP operating margin, Adjusted Operating Margin ³ and non-GAAP operating margin ³ for the years ended December 31, 2017 and 2018:

The increases in our GAAP operating margin, Adjusted Operating Margin ³ and non-GAAP operating margin ³ were attributable to our margin enhancement initiatives, which targeted the optimization of our resource pyramid, improvement of utilization and the containment of our corporate spend, as well as the depreciation of the Indian Rupee against the U.S. dollar, net of lower gains on settlement of our cash flow hedges in 2018 compared to 2017. Our GAAP operating margin was negatively impacted by the initial funding of the Cognizant U.S. Foundation. Our GAAP operating margin and our Adjusted Operating Margin were both negatively impacted by the increase in amortization expense due to recent acquisitions.

In 2017, the United States enacted the Tax Cuts and Jobs Act ("Tax Reform Act") which significantly revised the U.S. corporate income tax law for tax years beginning after December 31, 2017. As a result of this enactment, in 2017, we recorded a one-time provisional net income tax expense of $617 million. During 2018, we recognized a $5 million reduction to the provision for income taxes as we finalized our calculation of this one-time net income tax expense, bringing the one-time cost to $612 million. Our effective income tax rate for 2018 was 25.0% as compared to 43.4% in 2017. The decrease in our effective tax rate in 2018 was primarily driven by the one-time net income tax expense of $617 million that was recorded in 2017 as a result of the enactment of the Tax Reform Act and the reduction of the U.S. federal statutory corporate income tax rate in 2018 from 35% to 21%.

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Other Matters

We are involved in an ongoing dispute with the Indian Income Tax Department ("ITD") in connection with which we received a notice in March 2018 asserting that the ITD is owed additional taxes on our previously disclosed 2016 India Cash Remittance, which was the transaction undertaken by our principal operating subsidiary in India ("CTS India") to repurchase shares from its shareholders, which are non-Indian Cognizant entities, valued at $2.8 billion. As a result of that transaction, undertaken pursuant to a plan approved by the Madras High Court in Chennai, India, we previously paid $135 million in Indian income taxes, which we believe are all the applicable taxes owed for this transaction under Indian law. The ITD is asserting that we owe an additional 33 billion Indian rupees ($475 million at the December 31, 2018 exchange rate) related to the 2016 India Cash Remittance. In addition to the dispute on the 2016 India Cash Remittance, we are 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 $523 million (the two disputes collectively referred to as the "ITD Dispute"), for which we also believe we have paid all applicable taxes owed. Accordingly, we have not recorded any reserves for these matters as of December 31, 2018. The ITD Dispute is currently pending before the Madras High Court, and no final decision has been reached. While we believe that we have paid all applicable taxes related to the transactions underlying the ITD Dispute, if it is ultimately determined that we are liable for the full amount of additional taxes the ITD alleges we owe, there could be a material adverse effect on our results of operations, cash flows and financial condition.

    

In March 2018, the ITD placed an attachment on certain of our India bank accounts, relating to the 2016 India Cash Remittance. In April 2018, the Madras High Court granted our application for a stay of the actions of the ITD and lifted the ITD’s attachment of our bank accounts. As part of the interim stay order, we have deposited 5 billion Indian rupees ($71 million at the December 31, 2018 exchange rate), representing 15% of the disputed tax amount related to the 2016 India Cash Remittance, with the ITD. This amount is presented in "Other current assets" on our consolidated statement of financial position. In addition, the court has placed a lien on certain time deposits of CTS India in the amount of 28 billion Indian rupees ($404 million at the December 31, 2018 exchange rate), which is the remainder of the disputed tax amount related to the 2016 India Cash Remittance. The affected time deposits are considered restricted assets and we have reported them in “Short-term investments” on our consolidated statement of financial position. As of December 31, 2018, the restricted time deposits balance was $423 million , including accumulated interest.

In February 2019, we completed our internal investigation focused on whether certain payments relating to Company-owned facilities in India were made improperly and in violation of the U.S. Foreign Corrupt Practices Act ("FCPA") and other applicable laws. The investigation was conducted under the oversight of the Audit Committee, with the assistance of outside counsel. During the year ended December 31, 2016, we recorded out-of-period corrections related to $4 million of potentially improper payments between 2009 and 2016 that had been previously capitalized when they should have been expensed. These out-of-period corrections were not material to any previously issued financial statements. There were no adjustments recorded during 2018 or 2017 related to the amounts then under investigation.

On February 15, 2019, we announced a resolution of the previously disclosed investigations by the U.S. Department of Justice ("DOJ") and the U.S. Securities and Exchange Commission ("SEC") into the matters that were the subject of our internal investigation. The resolution required the Company to pay approximately $28 million to the DOJ and SEC, an amount consistent with the Company’s accrual ("FCPA Accrual") recorded during the quarter ended September 30, 2018.

During the years ended December 31, 2018, 2017 and 2016, we incurred $16 million (not including the FCPA Accrual), $36 million and $27 million, respectively, in costs related to the above investigations and the legal matters described in Note 15 to our consolidated financial statements. We expect to continue to incur legal fees and other expenses, including indemnification and expense advancement obligations, related to stockholder litigation and other legal proceedings pertaining to the matters that were the focus of the now completed FCPA investigations described above.

2019 Business Considerations

During 2019 , barring any unforeseen events, we expect the following factors to affect our business and our operating results:

In response to this environment, we plan to:

Our reportable segments are:

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.

We provide a significant volume of services to many customers in each of our business segments. Therefore, a loss of a significant customer or a few significant customers in a particular segment could materially reduce revenues for that segment. However, the services we provide to our larger customers are often critical to the operations of such customers and we believe that a termination of our services would require an extended transition period with gradually declining revenues.

See Note 19 to our consolidated financial statements for additional information on our business segments.