Cognizant Technology Solutions Corporation — Q1 2011 Form 10-Q
Business context and period: Unaudited results for the three months ended March 31, 2011, compared with Q1 2010. Cognizant provides IT consulting, technology services and outsourcing, with four reported segments: Financial Services, Healthcare, Manufacturing/Retail/Logistics, and Other. Amounts below are in U.S. dollars; financial statement figures are converted from thousands to millions where appropriate.
Financial results and position
| Metric | Q1 2011 | Q1 2010 / comparison |
|---|---|---|
| Revenue | $1,371.3 million | $959.7 million; up 42.9% |
| Operating income and margin | $265.4 million; 19.4% | $183.0 million; 19.1% |
| Operating income excluding stock compensation (non-GAAP) | $281.4 million; 20.5% margin | $197.0 million; 20.5% margin |
| Net income and net margin | $208.3 million; 15.2% | $151.5 million; 15.8%; net income up 37.5% |
| Diluted EPS | $0.67 | $0.49 |
| Effective tax rate | 25.7% | 15.2% |
| Cash from operating activities | $45.6 million | $2.3 million |
Cost of revenues rose 40.7%, slower than revenue growth, while SG&A rose 52.0%. Management attributed margin improvement to pricing and operating efficiencies, substantially offset by higher compensation costs. Stock-based compensation was $16.1 million in Q1 2011; the company notes its exclusion from the non-GAAP measure is a limitation because it is recurring.
At March 31, 2011, cash and cash equivalents were $1,293.5 million and short-term investments were $874.6 million, totaling $2,168.1 million. Working capital was $2,734.1 million. Total assets were $4,637.9 million and total liabilities were $873.7 million; the presented balance sheet has no separate interest-bearing debt line. Cash declined $247.5 million during the quarter. Investing activities used $252.7 million, including $55.8 million for property and equipment and $7.9 million for acquisitions; financing activities used $49.0 million.
Trade and unbilled receivables increased to $995.0 million and $128.2 million, respectively. Days sales outstanding, including unbilled receivables, increased to 74 days from 71 at year-end 2010. Operating cash flow remained well below net income, with working-capital movements including a $149.8 million outflow from other current and noncurrent liabilities.
Performance changes and operating trends
- Revenue increased across every segment: Financial Services $570.0 million, up 43.0%; Healthcare $349.0 million, up 38.2%; Manufacturing/Retail/Logistics $274.3 million, up 58.5%; and Other $178.0 million, up 31.4%.
- North American revenue was $1,070.0 million, up from $755.7 million; European revenue was $255.9 million, up 47.4% from $173.6 million. Management cited existing-customer expansion, new customers, discretionary development spending, broader services and increased European penetration.
- Active clients rose to approximately 714 from 597 a year earlier; strategic clients totaled 173 after seven additions during the quarter. The top five customers represented 17.0% of revenue, versus 17.6% a year earlier; no individual customer exceeded 10%.
- Headcount reached approximately 111,200, about 25,700 higher year over year. Annualized turnover was approximately 15.1%.
- Revenue from IT consulting and technology services grew 58.6%; IT outsourcing revenue grew 29.9%. Fixed-price contracts accounted for approximately 31.8% of Q1 revenue.
Outlook, commentary and risks
- The filing gives no specific full-year revenue or EPS guidance. Management expected to reinvest 2011 operating margin above its 19%–20% target, excluding stock-based compensation, into talent, training, service offerings and geographic expansion.
- Management expected approximately $285 million of global capital expenditures in 2011. Its India development-center program plans approximately $500 million of investment through the end of 2014 and about 8.0 million square feet of new space; fixed commitments for the program were $125.9 million at quarter-end. Management said it expected operating cash flow and cash to cover requirements for the next 12 months and anticipated no near-term liquidity issues.
- The expiration of Indian Software Technology Park tax holidays during Q1 raised the effective tax rate. From April 1, 2011, Indian profits, including profits from Special Economic Zones, are subject to Minimum Alternative Tax at a stated 20% rate; MAT paid may be credited against future taxable income for up to 10 years.
- Currency exposure is significant: approximately 31.6% of global operating costs were denominated in Indian rupees. Management said rupee appreciation reduced operating margin by about 38 basis points before designated hedge effects; settlements of certain cash-flow hedges benefited margin by about 85 basis points in Q1. Salary-hedge notional value was $2.685 billion. The company cautioned that hedging may not fully offset currency exposure.
- Key risks include wage and benefit inflation, competition for skilled staff, client spending and contract cancellations, pricing and fixed-price project execution, customer concentration, receivable collection, foreign exchange volatility, Indian tax changes, immigration limits, geopolitical or operational disruptions, data security and privacy, and potential liability or indemnification claims. Management said ordinary-course litigation was not expected to have a material adverse effect; indemnification exposure cannot be quantified from the filing.
- Available-for-sale investments had $1.5 million of gross unrealized losses at quarter-end, primarily attributed to interest-rate changes; management reported no other-than-temporary impairment. Disclosure controls were assessed as effective, with no material change in internal control over financial reporting reported for the quarter.
Important facts for investors to verify
- How the higher Indian tax burden, including the new MAT, affects subsequent effective tax rates and realization of related tax credits and deferred tax assets.
- Whether strong revenue growth converts into sustained operating cash flow, particularly as receivables and DSO rise.
- Whether compensation inflation and rupee movements can be offset through pricing, productivity and hedges without weakening margins.
- Progress, spending and returns from the India facilities program, including the $125.9 million committed amount and planned 2011 capital expenditures.
- The reconciliation of $77.1 million of repurchases described under the repurchase program with $88.3 million of total common-stock repurchases shown in the cash-flow statement.
- Whether the filing’s growth and margin expectations are supported by subsequent reported results; this 10-Q provides no quantified full-year revenue or EPS forecast.