Cognizant Technology Solutions Corporation — Q3 2014 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2014. Unaudited consolidated results; financial amounts below are in U.S. dollars. Comparisons are with the corresponding 2013 periods unless noted.
Business context and performance
Cognizant provides IT consulting, technology and business-process services through a global delivery model. It reported approximately 1,255 active clients and 199,700 employees at quarter-end. No individual customer accounted for more than 10% of revenue.
| Metric | Q3 2014 | Q3 2013 | Nine months 2014 | Nine months 2013 |
|---|---|---|---|---|
| Revenue | $2,581.0 million | $2,305.7 million | $7,520.5 million | $6,487.7 million |
| Revenue growth | 11.9% | — | 15.9% | — |
| Income from operations | $457.5 million | $437.4 million | $1,405.5 million | $1,230.1 million |
| Operating margin | 17.7% | 19.0% | 18.7% | 19.0% |
| Net income | $355.6 million | $319.6 million | $1,076.4 million | $904.2 million |
| Diluted EPS | $0.58 | $0.53 | $1.76 | $1.48 |
Q3 non-GAAP operating margin was 19.5%, down from 20.4%; nine-month non-GAAP margin was 20.4%, down from 20.6%. These company-defined non-GAAP measures exclude stock-based compensation and acquisition-related charges; non-GAAP diluted EPS also excludes net non-operating foreign-exchange gains and losses.
Revenue mix and material changes
- All reportable segments grew revenue in Q3: Financial Services 13.4%, Healthcare 9.2%, Manufacturing/Retail/Logistics 8.6%, and Other 19.0%. Other was the fastest-growing segment.
- For the first nine months, segment revenue growth ranged from 13.2% in Manufacturing/Retail/Logistics to 19.3% in Other. North America generated 76.4% of nine-month revenue; Europe grew 22.5%.
- Consulting and technology services grew 18.0% in Q3 and represented 53.5% of quarterly revenue. Outsourcing services grew 5.7% and represented 46.5%.
- Management attributed growth to broad customer demand, discretionary projects, cross-selling and geographic expansion. Q3 revenue from new customers was $64.0 million, or 23.3% of the year-over-year increase.
- Q3 operating income rose 4.6%, slower than revenue growth, and operating margin fell 1.3 percentage points. Management cited compensation and benefit costs, business investment and currency effects; lower realized cash-flow-hedge losses partly offset these pressures. Segment operating profit declined 4.2% in Q3, while lower unallocated costs helped lift consolidated operating income.
Cash, liquidity and financing
- Nine-month operating cash flow was $1,148.8 million, compared with $917.9 million. Investing activities used $626.6 million; financing activities used $108.4 million.
- At September 30, cash and cash equivalents were $2,617.6 million and short-term investments were $2,000.9 million, totaling $4,618.5 million. Working capital was $5,518.6 million.
- Total liabilities were $1,845.3 million. The balance sheet lists no debt balance at quarter-end; the company had obtained a committed, unsecured bridge facility of up to $1,000 million for the proposed TriZetto acquisition.
- Trade and unbilled receivables increased from year-end; days sales outstanding, including unbilled receivables, rose to 77 days from 73 at December 31, 2013.
- The board expanded the stock-repurchase authorization to $2.0 billion and extended it through December 31, 2015. The remaining authorization was $871.9 million at quarter-end.
Outlook, transaction and risks
- No specific revenue or earnings guidance is provided in the supplied filing text. Management expected continued investment in talent and services, client expansion, international growth and operating discipline. It cited customer cost-containment priorities, technology and regulatory changes, currency volatility and economic uncertainty as factors affecting the remainder of 2014.
- Cognizant agreed to acquire healthcare IT company TriZetto for $2.7 billion in cash, subject to customary adjustments, with closing expected in Q4 2014. Funding was expected from cash on hand and debt. The company was pursuing permanent financing, including a proposed five-year $1.0 billion term loan and $750 million revolving facility; these were anticipated, not shown as funded at quarter-end.
- Key risks include wage inflation and competition for skilled staff, rupee and other currency movements, customer spending and contract cancellations, fixed-price project execution, cybersecurity and service-liability exposure, immigration and regulatory changes, and acquisition closing and integration risks.
- Management said existing legal and regulatory proceedings were not expected to have a material adverse effect. It also disclosed client indemnification obligations whose maximum potential amount could not be determined; no historical payments had been made under those arrangements.
Important facts for investors to verify
- Whether TriZetto closed as expected, its final purchase price, financing mix, and subsequent effects on debt, interest expense and results.
- Whether margin pressure from compensation, hiring and investment persists, and how currency movements and hedge settlements affect reported margins.
- Whether receivable growth and the increase in days sales outstanding reverse or continue.
- Whether growth remains broad across segments and geographies, and whether customer concentration or discretionary spending changes materially.
- How much of the expanded repurchase authorization is used and how capital allocation changes after the acquisition.