Cognizant Technology Solutions Corporation — Q3 2011 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2011; comparisons are to the corresponding 2010 periods. Unaudited results. Dollar amounts below are in U.S. dollars.
Business context and performance
Cognizant provides IT consulting, technology services and outsourcing, with delivery operations concentrated in India. Management attributed growth to stronger demand across industries, higher customer spending on development projects, expansion of existing accounts, and broader service offerings and geographic reach.
- Active clients rose to approximately 777 from 697 a year earlier; strategic clients totaled 185. No customer exceeded 10% of revenue. Q3 top five and top ten customers represented 16.3% and 27.8% of revenue, respectively.
- Q3 revenue growth was broad-based: Healthcare +41.7%, Manufacturing/Retail/Logistics +34.7%, Financial Services +26.0%, and Other +25.8%.
- For the first nine months, segment revenue growth ranged from 28.4% in Other to 44.9% in Manufacturing/Retail/Logistics.
Financial results
| Metric | Q3 2011 | Q3 2010 | Nine months 2011 | Nine months 2010 |
|---|---|---|---|---|
| Revenue | $1,601m | $1,217m | $4,457m | $3,282m |
| Operating income | $293m | $228m | $828m | $617m |
| Operating margin | 18.3% | 18.8% | 18.6% | 18.8% |
| Net income | $227m | $204m | $643m | $527m |
| Diluted EPS | $0.73 | $0.66 | $2.07 | $1.71 |
| Effective tax rate | 21.1% | 16.3% | 23.9% | 16.3% |
- Q3 revenue increased 31.6%, while net income increased 11.5%; for nine months, revenue rose 35.8% and net income 22.0%. Net margin declined to 14.2% in Q3 from 16.7%, and to 14.4% for nine months from 16.1%, mainly because of higher taxes.
- Excluding stock-based compensation, operating margin was 19.8% in Q3 versus 19.9%, and 20.0% for nine months versus 20.1%. This is a non-GAAP measure; stock-based compensation is recurring.
- Operating costs rose with hiring, compensation and benefits, and investment in growth. Q3 headcount was approximately 130,400, up about 34,800 year over year.
Cash, liquidity and capital allocation
- Nine-month operating cash flow was $590m, up from $372m. Investing used $677m, including $164m for property and equipment, net investment purchases, and $75m for acquisitions. Financing used $277m, including $365m of share repurchases.
- Cash and cash equivalents were $1,181m and short-term investments $1,110m at September 30, 2011, together $2,291m. Working capital was $2,772m. Management said operating cash flow and available cash should meet requirements for the next 12 months and that it did not anticipate near-term liquidity issues.
- Total liabilities were $1,165m; the balance sheet presents no borrowings or debt item. The filing does not provide a separate debt balance.
- Trade and unbilled receivables totaled approximately $1,268m, versus $1,014m at year-end 2010. Days sales outstanding, including unbilled receivables, were 73 days, versus 71 days at year-end and 81 days a year earlier.
- The company repurchased $163m of stock in Q3. Its repurchase authorization had been increased to $600m, excluding fees and expenses, and extended through June 30, 2012.
Outlook, risks and unusual items
- No specific consolidated revenue or EPS forecast is stated in the provided filing text. Management maintained a target operating margin of 19%–20% excluding stock-based compensation and expected to continue investing above that level in talent, services and geographic expansion.
- Management cited a fragile global economy, customer IT-budget trends, foreign-exchange volatility and higher taxes as factors affecting the remainder of 2011. The company planned continued investment, cost discipline, international growth and selective acquisitions.
- Indian Software Technology Park tax holidays expired in Q1 2011; the filing identifies this as the main reason for the higher effective tax rate. Indian profits, including those from Special Economic Zones, became subject to minimum alternative tax of approximately 20%, creditable against future taxes subject to limitations.
- Foreign-exchange exposure is material: approximately 33.4% of global operating costs were denominated in Indian rupees. The company reported a $130m Q3 pre-tax loss recognized in OCI on designated cash-flow hedges and a $70m net unrealized loss on those contracts at quarter-end. Settled hedge gains benefited Q3 operating margin by about 44 basis points. A 10% exchange-rate movement was estimated to change hedge fair value by approximately $285m for designated contracts and $20m for undesignated contracts, all else equal.
- The company planned approximately $500m of India development-center investment through 2014; fixed capital commitments outstanding were $96m. It expected approximately $285m of global capital expenditures in 2011.
- Two acquisitions were completed in the first nine months for approximately $91m net of cash acquired, to strengthen business-process and analytics offerings and retail SAP capabilities; management said they were not material to operations, financial position or cash flow.
- Ordinary-course legal claims were not expected by management to have a material adverse effect. Potential material exposures include client-service failures, data breaches, indemnification claims, project delivery, wage inflation, talent retention, immigration restrictions, competition, and risks associated with India and international operations.
- Management reported effective disclosure controls as of September 30, 2011 and no material changes to internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether revenue growth can continue while absorbing hiring, compensation, infrastructure and currency costs without further margin pressure.
- How the expiration of Indian tax holidays and minimum alternative tax credits affect the effective tax rate and future cash taxes.
- Receivables and unbilled balances, collection performance, and the impact of the increase in days sales outstanding.
- Rupee movements, hedge effectiveness and the potential earnings and OCI volatility from the substantial hedge portfolio.
- Execution, spending and returns on the India facilities program, alongside acquisitions and the expanded share-repurchase authorization.