Cognizant Technology Solutions Corporation — Q1 2012 Form 10-Q
Reporting period: Three months ended March 31, 2012; unaudited. Unless noted, dollar amounts are in millions. Comparisons are with Q1 2011.
Business context and results
Cognizant provides IT consulting, technology services and outsourcing across Financial Services, Healthcare, Manufacturing/Retail/Logistics and Other. Revenue grew across all segments, supported by existing-client expansion, new customers, discretionary development work and demand for global delivery. Active clients rose to approximately 805 from 714 a year earlier; strategic clients totaled 196 after adding five during the quarter.
| Metric | Q1 2012 | Q1 2011 | Change |
|---|---|---|---|
| Revenue | $1,711.3 | $1,371.3 | +24.8% |
| Operating income | $317.9 | $265.4 | +19.8% |
| Operating margin | 18.6% | 19.4% | Down 0.8 percentage points |
| Operating margin excluding stock compensation (non-GAAP) | 20.4% | 20.5% | Down 0.1 percentage points |
| Net income | $243.7 | $208.3 | +17.0% |
| Diluted EPS | $0.79 | $0.67 | +17.9% |
| Operating cash flow | $101.8 | $45.6 | Increased |
GAAP net margin was 14.2%, versus 15.2% in Q1 2011. Stock-based compensation was $31.4 million, or $0.07 per diluted share after tax, compared with $16.1 million, or $0.04 per diluted share, a year earlier. The effective tax rate declined to 24.4% from 25.7%, primarily reflecting Indian tax-holiday earnings and lower foreign statutory rates.
Segment and geographic performance
- Financial Services: Revenue $694.7 million, up 21.9%; segment operating profit $237.9 million, up 22.3%.
- Healthcare: Revenue $467.4 million, up 33.9%; segment operating profit $182.4 million, up 43.0%.
- Manufacturing/Retail/Logistics: Revenue $334.8 million, up 22.0%; segment operating profit $122.9 million, up 21.2%.
- Other: Revenue $214.4 million, up 20.5%; segment operating profit $70.0 million, up 24.7%.
- North America generated $1,360.7 million of revenue, Europe $283.9 million and Other regions $66.7 million. Europe revenue grew 11.0%; management expected the region to grow more slowly than the company for the rest of 2012.
Cash flow, liquidity and capital
At March 31, 2012, cash and cash equivalents were $1,328.5 million and short-term investments were $1,162.7 million, totaling $2,491.2 million. Working capital was approximately $3,175.5 million; the company reported no third-party debt and no anticipated near-term liquidity issues. Total assets were $5,668.1 million and total liabilities $1,300.9 million.
Q1 operating cash flow of $101.8 million improved from $45.6 million, mainly due to higher net income and more efficient working-capital deployment. Investing activities used $95.5 million, including $60.5 million of property and equipment purchases; financing activities provided $7.1 million. Cash increased $17.6 million during the quarter. Days sales outstanding, including unbilled receivables, increased to 76 days from 73 at year-end 2011.
Capital expenditures were expected to be approximately $370 million globally in 2012. The India development-center program plans 10.5 million square feet of construction through 2015 and more than $700 million of investment; outstanding fixed capital commitments were approximately $219.7 million.
Changes, outlook and key risks
- Revenue growth outpaced operating-income growth, and GAAP operating and net margins contracted. Management attributed margin pressure chiefly to higher compensation and benefits, including stock compensation; rupee depreciation partially offset costs. Excluding stock compensation, the operating margin remained within management’s historic 19%–20% target range.
- Management expected continued investment above that target margin in hiring, training, service offerings, analytics and geographic expansion. It also cited fragile global conditions, particularly European uncertainty, customer focus on cost containment, currency volatility and wage pressures.
- No specific consolidated revenue or EPS guidance is stated in the supplied filing text. Management described expected business drivers and spending plans rather than providing a clear numeric full-year earnings forecast.
- Q1 repurchases totaled $42.7 million. In May 2012, the board increased the authorization from $600 million to $1.0 billion and extended the program through December 31, 2013.
- Foreign-exchange risk is material: designated rupee hedge contracts had $3.73 billion notional value and a net unrealized loss of $203.1 million after tax in accumulated other comprehensive income. A 10% exchange-rate movement was estimated to change their fair value by approximately $323.4 million, all else equal. Undesignated hedges generated $13.2 million of Q1 losses.
- Principal risks include reliance on India-based delivery and skilled labor, wage inflation and employee retention, currency movements and hedge performance, economic weakness and customer spending, client concentration, fixed-price project execution, receivable collection, immigration restrictions, data security and service failures, tax-policy changes, and legal or indemnification claims. Top five and top ten clients represented 14.5% and 25.1% of revenue, respectively; no single customer exceeded 10%.
- Management said ordinary-course legal claims were not expected to have a material adverse effect. It also warned that large client claims, data breaches, contract failures or indemnification obligations could nonetheless have material consequences; maximum indemnification exposure was not determinable.
Most important facts for investors to verify
- Whether revenue growth can continue while compensation, hiring and infrastructure costs are controlled and GAAP margins stabilize.
- Whether receivable days and unbilled receivables improve, and whether operating cash flow keeps pace with earnings.
- How European demand, financial-services spending and other macroeconomic conditions affect growth relative to management’s expectations.
- The sensitivity of costs, reported earnings and hedge-related amounts to rupee movements, and the timing of hedge losses reclassified into earnings.
- Progress and returns from the India expansion program, including the $219.7 million of outstanding capital commitments and planned 2012 capital spending.
- How much of reported performance depends on stock compensation exclusions; the company identifies that non-GAAP expense as recurring.
- Whether Indian tax holidays and minimum-alternative-tax credits remain usable, and the implications of foreign cash being intended for permanent reinvestment.