Cognizant Technology Solutions Corporation — 2012 Form 10-K
Reporting period: Fiscal year ended December 31, 2012; filed February 26, 2013. This is an annual filing, not a standalone quarterly report. The filing also reports fourth-quarter results.
Business context
Cognizant provides IT consulting, technology and outsourcing services through a global delivery model, with most delivery operations and employees in India. Its four reported segments are Financial Services, Healthcare, Manufacturing/Retail/Logistics, and Other. North American customers generated 79.4% of 2012 revenue; no individual customer exceeded 10%.
Key financial metrics
| Metric | FY 2012 | FY 2011 |
|---|---|---|
| Revenue | $7.346 billion | $6.121 billion |
| Income from operations; operating margin | $1.361 billion; 18.5% | $1.136 billion; 18.6% |
| Operating income excluding stock-based compensation; margin | $1.469 billion; 20.0% | $1.227 billion; 20.0% |
| Net income; net margin | $1.051 billion; 14.3% | $884 million; 14.4% |
| Diluted EPS | $3.44 | $2.85 |
| Cash from operating activities | $1.173 billion | $875 million |
| Cash, cash equivalents and short-term investments at year-end | $2.864 billion | $2.432 billion |
| Working capital at year-end | $3.437 billion | $2.876 billion |
| Third-party debt | None | None reported |
Revenue grew 20.0%; net income rose about 19.0%, and diluted EPS increased about 20.7%. Reported operating margin eased 0.1 percentage point, while net margin declined 0.1 point. Cost of revenues rose to 58.2% of revenue from 57.8%. FY 2012 capital expenditures were $334 million. Days sales outstanding, including unbilled receivables, were 72 days versus 73 days in 2011.
Fourth quarter: Revenue was $1.948 billion, operating income $356 million, net income $279 million and diluted EPS $0.92. In Q4 2011, the corresponding figures were $1.664 billion, $308 million, $240 million and $0.78.
Segments and material changes
- Financial Services: revenue $3.035 billion, up 20.5%; 41.3% of consolidated revenue.
- Healthcare: revenue $1.935 billion, up 19.3%; 26.3% of consolidated revenue.
- Manufacturing/Retail/Logistics: revenue $1.499 billion, up 25.2%; 20.4% of consolidated revenue.
- Other: revenue $877 million, up 12.0%; 12.0% of consolidated revenue. This was the slowest-growing segment.
Management attributed growth to demand across segments, increased discretionary project spending, deeper work with existing clients, expanded services and continued adoption of global delivery. North American revenue grew 21.5%; European revenue grew 8.9%. The client base increased to approximately 821 from 785, and strategic clients reached 214. About 98% of 2012 revenue came from clients already using Cognizant’s services at the end of 2011.
Cash, investment and capital allocation
- Operating cash flow increased to $1.173 billion. Investing activities used $570 million, including $334 million of property and equipment purchases and $60 million net cash for business combinations. Financing activities used $343 million, primarily reflecting share repurchases.
- Management reported no third-party debt and said cash and expected operating cash flow should cover operating requirements for the next 12 months. Approximately $2.055 billion of cash, cash equivalents and short-term investments was held by foreign subsidiaries; foreign earnings were generally intended to remain invested abroad.
- Cognizant repurchased approximately $486 million of stock under its repurchase program during 2012. The program authorization was $1.0 billion and expired December 31, 2013. The cash-flow statement reports $521 million of total share repurchases.
- The company did not pay dividends and did not anticipate cash dividends in the foreseeable future.
Outlook, commentary and risks
- No specific 2013 revenue, earnings or EPS guidance is provided in the supplied filing text. Management expected to reinvest above its targeted 19%–20% operating margin excluding stock-based compensation, and expected approximately $400 million of 2013 capital expenditures.
- Management cited continued customer focus on cost containment and innovation, regulatory and technology change, foreign-exchange volatility, and uncertainty in the global economy, particularly Europe. Plans included investing in talent and services, expanding in Europe, the Middle East and Asia Pacific, pursuing selective acquisitions, and maintaining cost discipline.
- Foreign exchange is a notable exposure. The Indian rupee’s depreciation benefited 2012 operating margin by about 355 basis points before the effect of designated hedge settlements; those settlements reduced margin by about 131 basis points. Cash-flow hedges had $3.353 billion notional value and a $296.6 million net unrealized loss at year-end; management expected $106 million of related net losses to be reclassified into earnings within 12 months.
- India tax incentives materially reduced tax expense: the filing estimates 2012 tax-holiday benefits increased net income by about $152 million, or $0.50 per diluted share. Risks include changes to Indian tax benefits, MAT credit utilization, and potential U.S. tax if foreign earnings are repatriated. Unrecognized tax benefits were $92.7 million.
- Other principal risks include wage inflation and competition for skilled staff, pricing and utilization pressure, fixed-price project cost overruns, client concentration and contract termination, cybersecurity and data privacy incidents, immigration restrictions, outsourcing-related legislation, and geopolitical or operational disruption. Fixed-price contracts represented 33.1% of revenue.
- Management said ordinary-course legal claims were not expected to have a material adverse effect. Contractual indemnities and potential claims involving client systems, data or service performance could nevertheless be significant; maximum indemnification exposure was not quantifiable from the filing.
- Three business combinations were completed in 2012 for approximately $28 million net cash consideration; the company also paid approximately $31 million in contingent consideration related to prior acquisitions. The 2012 acquisition activity included expanding healthcare and insurance outsourcing capabilities.
- Management and the auditor reported effective disclosure controls and internal control over financial reporting as of December 31, 2012. The auditor issued an unqualified opinion on the financial statements and internal controls.
Important facts for investors to verify
- Whether revenue growth continues across segments and geographies, especially given slower growth in Other and economic uncertainty in Europe.
- Whether the 20.0% operating margin excluding stock-based compensation can be sustained, and how recurring stock-based compensation affects GAAP profitability.
- How rupee movements, hedge settlements and the $3.353 billion hedge portfolio affect future margins, cash flows and earnings.
- Whether planned 2013 capital spending and India expansion generate returns commensurate with the investment, and whether foreign-held cash is practically available for U.S. needs.
- Whether Indian tax incentives and MAT credits remain usable, and the potential tax cost if foreign earnings cease to be indefinitely reinvested.
- Whether receivables, fixed-price project estimates, client retention and contractual or data-security exposures develop differently from management’s expectations.