Cognizant Technology Solutions Corporation — Q2 2011 Form 10-Q
Reporting period: Three and six months ended June 30, 2011; unaudited. Comparisons are with the corresponding 2010 periods unless noted. Amounts below are in millions of U.S. dollars except per-share data.
Business context and reporting period
Cognizant provides IT consulting and technology services, IT outsourcing, and business process outsourcing. It reported four industry segments: Financial Services, Healthcare, Manufacturing/Retail/Logistics, and Other. Growth was supported by expansion at existing customers, discretionary development work, broader service offerings, and demand for global delivery and outsourcing.
Financial and operating metrics
| Metric | Q2 2011 | Q2 2010 | Six months 2011 | Six months 2010 |
|---|---|---|---|---|
| Revenue | $1,485.2 | $1,105.2 | $2,856.5 | $2,064.9 |
| Revenue growth | 34.4% | — | 38.3% | — |
| Income from operations | $270.0 | $205.9 | $535.3 | $388.9 |
| Operating margin, GAAP | 18.2% | 18.6% | 18.7% | 18.8% |
| Net income | $208.0 | $172.2 | $416.4 | $323.7 |
| Diluted EPS | $0.67 | $0.56 | $1.34 | $1.05 |
| Effective tax rate | 25.1% | 17.2% | 25.4% | 16.3% |
| Cash from operating activities | Not separately stated | Not separately stated | $260.7 | $137.6 |
| Cash used in investing activities | Not separately stated | Not separately stated | $(496.4) | $(258.0) |
| Cash used in financing activities | Not separately stated | Not separately stated | $(129.8) | Cash provided: $73.4 |
- Excluding stock-based compensation, operating margin was 19.8% in Q2 and 20.1% for the first half, versus 19.9% and 20.2%, respectively, in 2010. This is a non-GAAP measure; stock-based compensation is recurring.
- At June 30, cash and cash equivalents were $1,193.0; short-term investments were $1,076.4; working capital was approximately $2,870.5. Total current assets were $3,757.9 and current liabilities $887.4.
- Total liabilities were $964.9 and total assets $4,916.7. The balance sheet presented does not show a debt line item; the filing text does not provide a clear separate borrowings figure.
- Trade receivables were $1,075.2 and unbilled receivables $152.4. Days sales outstanding, including unbilled receivables, rose to 75 from 71 at December 31, 2010.
Material changes versus the prior comparable period
- Revenue and operating income grew substantially, while GAAP operating margin declined 0.4 percentage points in Q2 and 0.1 points for the first half. Net income grew more slowly than revenue, principally reflecting higher taxes.
- The effective tax rate increased following the expiration of Indian Software Technology Park tax holidays in Q1 2011. From April 1, Indian profits, including SEZ profits, became subject to India’s approximately 20% Minimum Alternative Tax, creditable against future tax subject to limitations.
- All reported segments grew. Q2 revenue growth ranged from 28.6% in Other to 44.9% in Manufacturing/Retail/Logistics; first-half growth ranged from 29.9% to 51.2% across those same segments.
- Headcount reached approximately 118,300, up approximately 29,600 year over year. Management cited staffing, compensation and benefit costs, stock-based compensation, and investment in growth as pressures on margins.
- Operating cash flow increased year over year, while investing outflows rose with investment purchases and capital spending. Financing cash use reflected increased share repurchases: $192.1 for the first half versus $4.9 in 2010.
Outlook, management commentary, risks and unusual items
- Management reported a target operating margin of 19%–20% excluding stock-based compensation and said it expects to continue reinvesting amounts above that target in talent, services, sales capabilities, and geographic expansion. No specific revenue or EPS guidance is stated in the filing text.
- Management expected approximately $285 million of global capital expenditures in 2011. Its India development-center program planned approximately 8 million square feet and about $500 million of spending through 2014; outstanding fixed commitments were approximately $110.7 million at June 30.
- The company repurchased $96.1 million of shares in Q2. The repurchase authorization was increased to $300 million and extended through June 30, 2012.
- Indian rupee appreciation pressured margins; management estimated that each additional 1% exchange-rate change would move operating margin by approximately 27–29 basis points, depending on the period. Cash-flow hedge settlements favorably affected operating margin by approximately 0.98 percentage points in Q2 and 0.91 points for the first half.
- Key risks include a fragile global economy and customer spending changes; wage inflation and competition for skilled workers; foreign-exchange volatility; higher Indian taxes; customer concentration and short-notice contract termination; fixed-price project cost overruns; collection and billing delays; immigration limits; data security, service failures, and potentially significant indemnity or liability claims.
- Management said ordinary-course legal claims were not expected to have a material adverse effect. It noted that maximum exposure under certain client indemnification agreements cannot be determined and that a material claim could affect results or cash flows.
- Management stated that disclosure controls were effective as of June 30, 2011 and that no material change in internal control over financial reporting occurred during the quarter.
Important facts for investors to verify
- Whether growth and demand across segments and geographies continued after Q2, and how much came from existing versus new customers.
- Whether the higher Indian tax burden, MAT credits, compensation inflation, and rupee movements affect reported margins and earnings as expected.
- Receivables aging, unbilled balances, and DSO trends, given the increase to 75 days.
- Actual capital expenditures and fixed commitments for the India expansion, alongside cash and investment levels and share repurchases.
- How much of the non-GAAP margin comparison depends on recurring stock-based compensation and favorable hedge settlements.