Cognizant Technology Solutions Corporation — Q3 2009 Form 10-Q
Business context and period: Unaudited results for the quarter and nine months ended September 30, 2009, compared with the corresponding 2008 periods. Cognizant provides IT consulting, technology services, outsourcing and business-process services. Most employees and development centers are in India.
Financial performance
| Metric | Q3 2009 | Q3 2008 | Nine months 2009 | Nine months 2008 |
|---|---|---|---|---|
| Revenue | $853.5 million | $734.7 million | $2,375.9 million | $2,063.3 million |
| Operating income | $161.8 million | $142.6 million | $451.6 million | $374.0 million |
| Operating margin | 19.0% | 19.4% | 19.0% | 18.1% |
| Net income | $136.6 million | $112.8 million | $391.0 million | $318.6 million |
| Diluted EPS | $0.45 | $0.38 | $1.30 | $1.06 |
- Revenue grew 16.2% in Q3 and 15.2% year to date; net income rose 21.0% and 22.7%, respectively. Q3 operating income grew more slowly than revenue, and GAAP operating margin declined 0.4 percentage points year over year.
- Excluding stock-based compensation and applicable Indian fringe benefit tax, operating margin was 20.2% in Q3 versus 20.8% a year earlier, and 20.4% for nine months versus 20.1%. These are non-GAAP measures; stock-based compensation remains a recurring expense.
- Healthcare and Manufacturing/Retail/Logistics were the fastest-growing Q3 segments, up 30.0% and 27.1%. Financial Services grew 7.4%; Other grew 9.5%. North America revenue grew 15.7% in Q3. IT outsourcing revenue grew 21.9% in Q3, versus 9.7% for IT consulting and technology services.
- Nine-month cash from operations was $434.8 million, compared with $236.8 million. Investing used $219.7 million, including investment purchases; capital expenditures were $62.0 million versus $146.3 million. Cash and cash equivalents ended at $992.9 million.
- At September 30, cash, cash equivalents and short-term investments totaled $1,182.7 million; working capital was $1,508.5 million. Total assets were $2,976.5 million and total liabilities $540.3 million. The balance sheet reports no debt.
Material developments, outlook and risks
- Management cited customer demand for cost-containment services, outsourcing and complex IT work, growth in existing accounts, and expansion of service offerings. Active clients numbered approximately 570, versus 551 a year earlier; headcount was approximately 68,100.
- Management expected to reinvest amounts above its historical 19%–20% targeted operating-margin range for the remainder of 2009. It forecast 2009 global capital expenditures of approximately $100–$120 million and expected negligible Indian wage inflation. The filing provides no specific full-year revenue or EPS guidance.
- Management highlighted continued pressure on customer IT budgets, possible delays in discretionary projects, global economic conditions and foreign-currency volatility. A stronger Indian rupee could raise delivery costs; rupee depreciation had favorably affected year-to-date operating margin by about 271 basis points, excluding designated hedges.
- Indian tax holidays for Software Technology Parks were extended by one year and were scheduled to expire March 31, 2011. The company warned that, absent further incentives, its effective tax rate could rise significantly beginning in 2011.
- Auction-rate securities remained illiquid after failed auctions beginning in February 2008. Their reported fair value was $136.6 million, with a related UBS liquidity right valued at $20.9 million; the securities’ par value was $157.8 million. The company expected to use the UBS right during its June 2010–July 2012 exercise period, but ultimate liquidity depends in part on UBS performance and valuation assumptions.
- During Q3, Cognizant acquired an Invensys multi-year service agreement, workforce and other assets, with no initial cash consideration. On October 15, 2009, it agreed to acquire UBS Service Centre (India) for approximately $75 million, subject to closing conditions; this was a subsequent event.
- Commitments included $44.2 million of fixed capital obligations for India development centers and possible acquisition earn-out payments of up to $14 million in 2010. Management said ordinary-course claims were not expected to have a material adverse effect, while noting potential exposure from client system failures or data disclosures.
Important facts for investors to verify
- Whether revenue growth and strong operating cash flow persist, particularly as receivables and unbilled receivables rose and days sales outstanding reached 73.8 from 70.8 at year-end 2008.
- The sustainability of margins given compensation and incentive costs, reinvestment plans, exchange-rate sensitivity and the recurring impact of stock-based compensation.
- The fair-value assumptions, liquidity timeline and UBS counterparty exposure associated with auction-rate securities and the UBS right.
- The outlook for Indian tax incentives after March 2011 and the potential effect on the effective tax rate.
- Completion and integration of the UBS Service Centre acquisition, associated commitments, and execution of the India facilities expansion.