Cognizant Technology Solutions Corporation — Q2 2014 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2014. Results are unaudited. Cognizant provides IT, consulting and business-process services through industry-focused segments and a global delivery model.
Financial performance
| Metric | Q2 2014 | Q2 2013 | Six months 2014 | Six months 2013 |
|---|---|---|---|---|
| Revenue | $2.517B | $2.161B | $4.939B | $4.182B |
| Income from operations | $487.9M | $426.8M | $948.0M | $792.7M |
| Operating margin | 19.4% | 19.7% | 19.2% | 19.0% |
| Net income | $371.9M | $300.4M | $720.8M | $584.6M |
| Diluted GAAP EPS | $0.61 | $0.49 | $1.18 | $0.96 |
| Non-GAAP diluted EPS | $0.66 | $0.58 | $1.28 | $1.09 |
Q2 revenue rose 16.5% year over year and net income rose 23.8%; first-half revenue rose 18.1% and net income 23.3%. First-half operating margin improved, while Q2 margin declined. Management attributed margin pressure principally to compensation and benefit costs, including incentive compensation; currency movements partly offset those costs. Non-GAAP measures exclude stock compensation and acquisition-related charges; non-GAAP diluted EPS also excludes non-operating foreign-exchange gains or losses under the 2014 definition.
All four segments grew in Q2: Financial Services 16.2%, Healthcare 19.2%, Manufacturing/Retail/Logistics 11.4%, and Other 20.8%. North America remained the largest market, with Q2 growth of 15.0%; Europe grew 20.4% and Rest of World 26.6%. Consulting and technology services grew faster than outsourcing services in Q2 (20.9% versus 11.9%).
Cash flow, balance sheet and capital allocation
- First-half operating cash flow was $565.6M, up from $439.0M. Investing cash outflow was $691.2M, chiefly reflecting purchases of investments; financing cash outflow was $100.0M.
- Cash and cash equivalents were $1.992B and short-term investments $2.137B at June 30, for combined liquidity of $4.129B. Working capital was $5.173B. The company reported no third-party debt.
- Cash and cash equivalents declined $220.6M from year-end 2013. Trade and unbilled receivables increased; days sales outstanding including unbilled receivables was 77 days, versus 73 at December 31, 2013.
- During the first half, Cognizant repurchased 2.7 million shares for $130.2M under its repurchase program and separately repurchased shares tendered for employee tax withholding. In August 2014, after quarter-end, the board increased program authorization from $1.5B to $2.0B and extended it through December 31, 2015.
Outlook, commentary and risks
The filing provides no specific numerical full-year revenue or earnings guidance. Management expected continued customer demand for cost-containment work and innovation, and planned to invest in talent, services and international expansion while managing costs. It said operating cash flow and cash were expected to meet day-to-day requirements for the next 12 months and reported no anticipated near-term liquidity issue. Management also noted that larger, more complex projects can involve longer sales cycles and ramp-ups, increasing results variability.
Key exposures include compensation inflation and competition for skilled personnel, foreign-exchange volatility (particularly the Indian rupee), customer spending and contract termination risk, fixed-price project execution, and economic or regulatory changes. Indian operations and tax incentives are significant: management cited possible effects from changes to India’s tax benefits and tax laws. The company had $2.040B notional value of Indian-rupee cash-flow hedges; it estimated that a 10% exchange-rate change would change their fair value by approximately $176M, all else equal. Management reported $92.8M, net of tax, of hedge losses in accumulated other comprehensive income expected to be reclassified into earnings within 12 months.
Outstanding India development-center capital commitments were approximately $45.4M. The company reported ordinary-course legal claims and contractual indemnities; management did not expect existing legal proceedings, if decided adversely, to have a material adverse effect, but noted that certain client, data-security, service-delivery or indemnification claims could be substantial. No other off-balance-sheet arrangements were reported apart from foreign-exchange forwards. Disclosure controls were considered effective, with no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether receivables growth and the increase in DSO affect collections and operating cash conversion.
- How wage and incentive-cost growth, hiring, utilization and pricing affect margins as the workforce expands.
- The cash-flow and earnings sensitivity to rupee movements, hedge settlements and the $2.040B hedge portfolio.
- Progress on the expanded share-repurchase authorization and competing uses of cash, including investment and acquisitions.
- Exposure to India tax-holiday changes, fixed-price project performance, customer concentration and potential claims.