Cognizant Technology Solutions Corporation — Q1 2010 Form 10-Q
Business context and period. Unaudited results cover the three months ended March 31, 2010, compared with Q1 2009. Cognizant provides IT consulting, technology and outsourcing services. Its reportable segments are Financial Services, Healthcare, Manufacturing/Retail/Logistics, and Other.
Financial performance and position
Amounts are in millions of U.S. dollars, except per-share data and percentages.
| Metric | Q1 2010 | Q1 2009 / prior date | Change |
|---|---|---|---|
| Revenue | $959.7 | $745.9 | +28.7% |
| Operating income / margin | $183.0 / 19.1% | $138.1 / 18.5% | Income +32.5% |
| Operating margin excluding stock-based compensation and related Indian fringe benefit tax | 20.5% | 20.2% | Non-GAAP measure |
| Net income / net margin | $151.5 / 15.8% | $113.1 / 15.2% | Net income +33.9% |
| Diluted EPS | $0.49 | $0.38 | +28.9% |
| Operating cash flow | $2.3 | $75.1 | Down $72.8 |
| Cash and cash equivalents | $1,080.9 | $1,100.9 at Dec. 31, 2009 | Down $20.0 |
| Cash, cash equivalents and short-term investments | $1,433.9 | — | — |
| Working capital | $1,891.1 | — | — |
| Total liabilities | $623.4 | $685.1 at Dec. 31, 2009 | Down $61.7 |
- Revenue growth was broad-based: Financial Services +20.3%, Healthcare +33.3%, Manufacturing/Retail/Logistics +40.7%, and Other +32.7% year over year.
- Cost of revenues rose 32.5%, faster than sales, reflecting higher staffing, compensation and benefits costs, including the effect of rupee appreciation. SG&A, including depreciation and amortization, fell as a share of revenue to 23.0% from 25.2%.
- Effective tax rate declined to 15.2% from 16.5%. Management cited geographic earnings mix, tax effects of foreign-exchange contracts and favorable discrete items.
- Cash flow from operations was markedly below net income, mainly because of working-capital needs, incentive compensation payments and growth in receivables. Days sales outstanding, including unbilled receivables, rose to 76.2 from 72.3 at year-end.
- Investing activities used $57.1 million, including $24.2 million of property and equipment purchases; financing activities provided $43.5 million. The balance sheet reports no borrowings; the filing does not separately state a debt balance.
Changes, outlook and management commentary
- Management attributed growth to demand for global delivery and outsourcing, expansion at existing customers, new clients, broader service offerings, and European market growth. Active clients increased to approximately 597 from 560; strategic clients reached 149.
- North America generated 78.7% of Q1 revenue and Europe 18.1%. UK revenue grew 32.6% year over year. The top five customers contributed 17.6% of revenue; no individual customer exceeded 10%.
- Management’s historical target operating-margin range is 19%–20% excluding stock-based compensation and applicable related tax. It expects to continue investing amounts above that range back into the business in 2010. This is not specific revenue or EPS guidance.
- Management expected approximately $180 million of 2010 capital expenditures and stated that cash, investments and expected operating cash flow should meet operating needs for at least the next 12 months, with no near-term liquidity issue anticipated.
- Management cited a fragile economic environment, customer budget normalization, demand for cost-containment services, industry consolidation, technology and regulatory changes, and currency volatility as factors affecting 2010. Planned priorities include investing in talent and services, expanding in Europe and Asia Pacific, growing BPO and infrastructure management, and pursuing selective acquisitions.
Risks, contingencies and unusual items
- Currency exposure: Rupee appreciation reduced operating margin by approximately 177 basis points, excluding designated hedge effects. Cash-flow hedges favorably affected Q1 operating margin by about 98 basis points; undesignated forward contracts generated a $16.1 million loss. Total reported net foreign-currency losses were $10.5 million.
- Indian tax holidays: Most Indian Software Technology Parks had a 100% income-tax exemption scheduled to expire March 31, 2011. Management warned that the effective tax rate could rise significantly from 2011 if benefits are not extended or replaced. SEZ facilities have separate incentives for periods up to 15 years.
- Illiquid auction-rate securities: Auctions had failed since February 2008. At March 31, 2010, auction-rate securities had $137.6 million par value and $119.1 million carrying value; the related UBS Right was valued at $18.4 million and could be exercised between June 30, 2010 and July 2, 2012. Recovery could be delayed if UBS cannot perform or no liquidity event occurs.
- Commitments and legal matters: Fixed capital commitments for India development centers were approximately $21.3 million. A 2008 acquisition has contingent consideration of up to $14 million payable in 2010, subject to performance; no liability was recorded. Ordinary-course claims and litigation were not expected by management to have a material adverse effect, though service failures, data breaches and limits or availability of insurance present potential exposure.
- Other material risks include wage inflation and hiring/retention, reliance on North American and European customers and financial services, competition and pricing pressure, fixed-price project overruns, immigration restrictions, offshore-sourcing regulation, and operational, political, cybersecurity and compliance risks. The company reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether receivables, unbilled revenue and collection days normalize, given the sharp year-over-year decline in operating cash flow.
- Whether reported margin improvement can be sustained after wage inflation, rupee movements, growth investment and recurring stock-based compensation.
- The timing and impact of the March 2011 Indian tax-holiday expirations on the effective tax rate.
- The valuation, liquidity and ultimate recovery of auction-rate securities and the ability of UBS to honor the UBS Right.
- Whether the stated $180 million capital expenditure plan and continued investment above the target margin produce expected growth and utilization.