Cognizant Technology Solutions Corporation — Q2 2013 Form 10-Q
Reporting period: Three and six months ended June 30, 2013; financial statements are unaudited. Amounts below are in U.S. dollars. Cognizant provides IT consulting and technology services, outsourcing, infrastructure services, and business process outsourcing.
Financial performance
| Metric | Q2 2013 | Q2 2012 | H1 2013 | H1 2012 |
|---|---|---|---|---|
| Revenue | $2,161.2 million | $1,795.2 million | $4,182.0 million | $3,506.6 million |
| Revenue growth | 20.4% | — | 19.3% | — |
| Operating income | $426.8 million | $332.0 million | $792.7 million | $649.9 million |
| GAAP operating margin | 19.7% | 18.5% | 19.0% | 18.5% |
| Net income | $300.4 million | $251.9 million | $584.6 million | $495.6 million |
| Diluted EPS | $0.99 | $0.82 | $1.92 | $1.61 |
| Effective tax rate | 28.5% | 24.8% | 26.7% | 24.6% |
- Q2 net income increased 19.2% and diluted EPS increased 20.7%; H1 net income increased 18.0% and diluted EPS increased 19.3%.
- Q2 non-GAAP operating margin was 21.4% versus 20.0%; H1 was 20.7% versus 20.4%. Non-GAAP measures exclude stock-based compensation and acquisition-related charges and are not GAAP measures.
- Cost of revenues rose faster than revenue: 23.4% in Q2 and 22.7% in H1. Management attributed much of the increase to compensation and benefits from workforce growth. SG&A including depreciation and amortization declined as a share of revenue.
Cash flow, liquidity and capital
- H1 operating cash flow was $439.0 million, compared with $425.9 million a year earlier. Trade and unbilled receivables increased with growth and higher days sales outstanding; DSO including unbilled receivables was 75 days, versus 72 days at year-end 2012.
- H1 investing cash use was $225.8 million, including $122.5 million for property and equipment and $151.1 million for acquisitions, net of cash acquired. Financing cash use was $89.4 million, including $147.4 million of share repurchases.
- At June 30, cash, cash equivalents and short-term investments totaled $2,900.6 million; working capital was $3,776.7 million. The company reported no third-party debt and said it expected operating cash flow and cash to cover operating needs for the next 12 months.
- $1,614.7 million of cash, cash equivalents and short-term investments was held by foreign subsidiaries. Cognizant intends to indefinitely reinvest foreign earnings not already subject to accrued U.S. tax.
Business and changes versus prior periods
- Growth was broad-based. Q2 segment revenue growth: Financial Services 23.6%, Healthcare 11.8%, Manufacturing/Retail/Logistics 28.7%, and Other 14.8%. Financial Services and Manufacturing/Retail/Logistics were the fastest-growing segments.
- Q2 North American revenue grew 16.9%; European revenue grew 37.0%, with part of growth outside the U.K. attributable to the C1 Group acquisitions. Revenue from the U.K. increased about $50.8 million year over year.
- The company reported approximately 1,100 active clients, up from 815 a year earlier, and 229 strategic clients. Its top five and top ten clients generated 13.4% and 23.1% of Q2 revenue, respectively, down from 14.8% and 25.9%.
- Two acquisitions were completed in H1 for approximately $146.6 million net of cash acquired, adding capabilities and presence in Germany and Switzerland and expanding enterprise applications, testing, and finance and accounting BPO. Acquisitions were described as not material to operations or financial position.
- In May, the board increased the share repurchase authorization from $1.0 billion to $1.5 billion and extended the program through December 31, 2014. Q2 repurchases were $115.2 million; $502.1 million remained authorized at quarter-end.
Outlook, commentary and risks
- No specific revenue or EPS guidance for the rest of 2013 is stated in the provided filing text. Management expects the remainder-of-year non-GAAP operating margin to be more in line with its targeted 19%–20% range, after Q2’s 21.4%, as it continues investing in the business.
- Management expected approximately $400 million of global capital expenditures in 2013, within a longer-term India facilities program planned to spend over $700 million during 2011–2015. Fixed capital commitments for that India expansion were approximately $102.8 million at June 30.
- Management cited customer focus on cost containment alongside innovation, evolving technology and regulation, currency volatility, and uncertainty in Europe. Its stated priorities include investment in talent and services, international growth, strategic-client expansion, selective acquisitions, and cost discipline.
- The effective tax rate increased, primarily due to geographic earnings mix, an increase in India’s statutory rate effective April 1, 2013, and scheduled reductions in certain Indian tax-holiday benefits.
- Foreign exchange is a material sensitivity. The company reported $37.8 million of H1 currency losses before hedging and $52.5 million of H1 losses on settled cash-flow hedges. Cash-flow hedge contracts had $2.97 billion notional value and a $314.9 million net-of-tax unrealized loss in accumulated other comprehensive income; management estimated $149.6 million would be reclassified into earnings within 12 months.
- Other key risks include wage inflation and talent retention, pricing and utilization pressure, fixed-price contract cost overruns, client concentration and termination rights, receivable collection, data security and service liability, immigration restrictions, Indian tax incentives, and geopolitical or operational disruption. Management said ordinary-course claims were not expected to have a material adverse effect, but indemnification exposure cannot be quantified.
Important facts for investors to verify
- Whether revenue growth converts to cash as receivables rise and DSO increases.
- How Indian rupee movements, hedge settlements and the large accumulated hedge loss affect future operating margins and earnings.
- Whether the higher tax rate and reductions in Indian tax benefits persist or increase.
- Whether margin performance returns to the stated 19%–20% non-GAAP target as hiring, wage costs, and investment continue.
- How acquisitions, capital spending, and the expanded share repurchase program affect returns and cash deployment.
- The assumptions and exclusions behind non-GAAP measures, and the potential impact of client, contract, cybersecurity, legal, and India-related risks.