Cognizant Technology Solutions Corporation — Q2 2012 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2012; filed August 6, 2012. Amounts below are in U.S. dollars. The interim financial statements are unaudited.
Business context
Cognizant provides IT consulting, technology services and outsourcing, including business process outsourcing. Its reportable segments are Financial Services, Healthcare, Manufacturing/Retail/Logistics, and Other. Management attributed growth to greater customer use of global delivery, broader services, increased discretionary development spending and deeper relationships with existing clients.
Financial performance
| Metric | Q2 2012 | Q2 2011 | Six months 2012 | Six months 2011 |
|---|---|---|---|---|
| Revenue | $1,795.2 million | $1,485.2 million | $3,506.6 million | $2,856.5 million |
| Revenue growth | 20.9% | — | 22.8% | — |
| Operating income | $332.0 million | $270.0 million | $649.9 million | $535.3 million |
| GAAP operating margin | 18.5% | 18.2% | 18.5% | 18.7% |
| Net income | $251.9 million | $208.0 million | $495.6 million | $416.4 million |
| Diluted EPS | $0.82 | $0.67 | $1.61 | $1.34 |
| Effective tax rate | 24.8% | 25.1% | 24.6% | 25.4% |
Q2 net income rose 21.1%; first-half net income rose 19.0%. Net margin was 14.0% in Q2 in both years and 14.1% for the first half of 2012 versus 14.6% a year earlier. Operating margin excluding stock-based compensation, a non-GAAP measure, was 20.0% in Q2 versus 19.8%, and 20.2% for the first half versus 20.1%. Stock-based compensation is recurring, and the company cautions that this non-GAAP measure is not a substitute for GAAP results.
All segments grew in Q2: Healthcare revenue +25.3%, Manufacturing/Retail/Logistics +21.8%, Financial Services +20.3%, and Other +12.4%. Healthcare was the fastest-growing segment; Other grew below the company average.
Cash flow, balance sheet and capital allocation
- First-half operating cash flow was $425.9 million, versus $260.7 million in 2011. Investing activities used $342.8 million and financing activities used $341.4 million. Cash and cash equivalents decreased $260.7 million to $1,050.2 million.
- At June 30, cash, cash equivalents and short-term investments totaled $2,346.1 million; working capital was $3,001.3 million. The company reported no third-party debt and said it expected operating cash flow and cash to cover requirements for the next 12 months.
- Trade receivables were $1,296.2 million and unbilled receivables $207.7 million. Days sales outstanding, including unbilled receivables, increased to 76 days from 73 at December 31, 2011.
- Capital expenditures were $138.8 million in the first half. Management expected approximately $370 million of global capital expenditures in 2012. India development-center expansion carried approximately $234.5 million of outstanding fixed commitments; the broader 2011–2015 program planned more than $700 million of spending.
- The repurchase authorization was increased to $1.0 billion and extended through December 31, 2013. The company repurchased 6.6 million shares for approximately $401.0 million in the first half; $218.6 million remained authorized at June 30. Repurchases were funded from working capital.
- $1,367.8 million of cash, cash equivalents and short-term investments was held by foreign subsidiaries. The company stated its intent to permanently reinvest foreign funds outside the U.S., other than specified previously taxed Indian earnings.
Material changes, outlook and risks
- Revenue growth reflected both existing and new clients: clients active at June 30 increased to approximately 815 from 721 a year earlier. No single customer exceeded 10% of revenue. The top five customers contributed 14.8% of Q2 revenue, down from 16.9% a year earlier.
- Management described the global economic environment as fragile and expected Europe to grow more slowly than the company for the rest of 2012. It cited possible restraint on banking-sector discretionary spending and softness in discretionary spending by certain life sciences clients. The filing gives no clear full-year revenue or EPS guidance.
- Management expected continued investment in talent, services, geographic expansion and infrastructure, while maintaining a target operating margin of 19%–20% excluding stock-based compensation. Q2 GAAP margin benefited from rupee depreciation, partly offset by hedge settlement losses and growth investments. Management said hedge settlements reduced Q2 and first-half operating margin by approximately 169 and 109 basis points, respectively.
- Foreign-exchange exposure is material: Indian rupee-denominated costs were approximately 31.0% of global operating costs for the first half. Cash-flow hedges had $3.80 billion notional value and a $474.2 million net liability fair value at June 30; $137.7 million of net hedge losses in accumulated other comprehensive income was expected to be reclassified into earnings within 12 months. A 10% exchange-rate change was estimated to change the fair value of these hedges by approximately $310.1 million, holding other factors constant.
- Principal risks include economic weakness and customer spending reductions, currency movements, Indian wage inflation and talent retention, competition and pricing pressure, concentration in North America and financial services, collections and rising receivables, fixed-price contract execution, immigration restrictions, data security and service failures, and changes to Indian tax incentives. The company also disclosed ordinary-course claims and contingent client indemnification obligations; management did not expect existing claims to have a material adverse effect, but the maximum potential indemnification amount could not be determined.
- Management reported disclosure controls were effective at June 30, 2012 and no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether revenue growth and segment performance continued, particularly in Healthcare, Europe, banking and life sciences.
- Whether receivables, unbilled work and DSO stabilized, and whether operating cash flow continued to track earnings.
- The effect of rupee movements and hedge settlements on GAAP margins, earnings and accumulated other comprehensive loss.
- Execution and funding of planned capital spending and share repurchases, including the use and location of foreign-held cash.
- Whether wage costs, hiring needs and customer spending pressure affected the stated margin target; distinguish GAAP results from measures excluding recurring stock-based compensation.