Cognizant Technology Solutions Corporation — Q3 2013 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2013; unaudited. Financial amounts below are in U.S. dollars and generally shown in millions.
Business context and results
Cognizant provides IT consulting, technology and outsourcing services. Growth reflected broad-based demand, expansion at existing clients, new clients, discretionary project spending and increased global delivery. The company reported approximately 1,133 active clients, up from 821 a year earlier, and 236 strategic clients.
| Metric | Q3 2013 | Q3 2012 | First 9 months 2013 | First 9 months 2012 |
|---|---|---|---|---|
| Revenue | $2,305.7 | $1,891.7 | $6,487.7 | $5,398.3 |
| Revenue growth | 21.9% | — | 20.2% | — |
| Operating income | $437.4 | $355.4 | $1,230.1 | $1,005.2 |
| Operating margin | 19.0% | 18.8% | 19.0% | 18.6% |
| Net income | $319.6 | $276.9 | $904.2 | $772.5 |
| Diluted EPS | $1.05 | $0.91 | $2.97 | $2.52 |
| Non-GAAP operating margin | 20.4% | 20.1% | 20.6% | 20.3% |
| Non-GAAP diluted EPS | $1.13 | $0.98 | $3.22 | $2.74 |
Q3 net margin was 13.9%, compared with 14.6% a year earlier; nine-month net margin was 13.9%, versus 14.3%. Non-GAAP measures exclude stock-based compensation and acquisition-related charges and are not GAAP substitutes.
Growth, margins and material changes
- All segments grew in Q3: Financial Services revenue rose 21.0%, Healthcare 24.2%, Manufacturing/Retail/Logistics 23.7%, and Other 16.6%. For the first nine months, growth ranged from 12.9% in Other to 26.4% in Manufacturing/Retail/Logistics.
- Q3 revenue by geography grew 18.5% in North America, 37.0% in Europe and 28.0% in the rest of the world. Europe revenue included contributions from acquisitions completed earlier in 2013.
- Management attributed improved operating margin to revenue growth outpacing headcount growth and rupee depreciation, partly offset by higher compensation and incentive costs. Higher Indian rupee wages and employee growth drove much of the increase in operating expenses.
- The effective tax rate increased to 27.2% in Q3 from 24.0%, and to 26.9% for nine months from 24.4%. The filing cites geographic earnings mix, an Indian tax-rate increase and reduced Indian tax-holiday benefits.
Cash flow, liquidity and capital
- Nine-month operating cash flow was $917.9, versus $810.7 a year earlier. Investing used $378.4; financing used $61.0. Cash and cash equivalents increased $461.0 to $2,031.1.
- At September 30, cash, cash equivalents and short-term investments totaled $3,360.6; working capital was $4,137.2. Cognizant reported no third-party debt and said it expected operating cash flow and cash to meet requirements for the next 12 months.
- Trade receivables were $1,637.1 and unbilled receivables $254.1. Days sales outstanding, including unbilled receivables, was 75 days, compared with 72 at year-end 2012 and 77 a year earlier.
- Approximately $1,924.3 of cash, cash equivalents and short-term investments was held by foreign subsidiaries. The company intends to indefinitely reinvest foreign earnings not already subject to accrued U.S. taxes.
- Management expected approximately $300 million of global capital expenditures in 2013. India development-center expansion carried $93.1 of outstanding fixed capital commitments. The company completed two acquisitions for approximately $146.6 net of cash acquired.
- The repurchase authorization was expanded to $1.5 billion and extended through December 31, 2014. No shares were repurchased under the program in Q3; $502.1 remained authorized at quarter-end.
Outlook, risks and unusual items
No specific revenue or EPS forecast for the remainder of 2013 is provided in the supplied filing text. Management anticipated continued customer focus on cost containment and innovation, and planned further investment in talent, service offerings, international growth and selective acquisitions. It also cited economic uncertainty, technology and regulatory changes, and currency volatility.
- Foreign exchange is a significant exposure: nine-month rupee-denominated operating costs were approximately 27.9% of global operating costs. Cash-flow hedges had $2,655.0 notional value and a $463.7 net unrealized loss at September 30; $191.1 net of tax was expected to be reclassified to earnings within 12 months. Settled hedge losses were $111.2 for the nine-month period.
- Management said rupee depreciation, before the impact of designated hedges, benefited Q3 operating margin by approximately 263 basis points; hedge settlements reduced margin by approximately 255 basis points. Foreign-exchange losses excluding hedging were $54.1 for the first nine months.
- Other principal risks include wage inflation and talent retention, client spending and concentration, receivables collection, competition and pricing, fixed-price contract execution, data security and service failures, immigration restrictions, Indian tax incentives, and geopolitical or regulatory disruption. The top five and ten clients accounted for 13.5% and 23.1% of nine-month revenue, respectively; no single client exceeded 10%.
- Management considered ordinary-course legal claims not expected to have a material adverse effect, but noted potential exposure from client-service failures, confidentiality or data breaches, and contractual indemnities. The maximum potential indemnification exposure was not determinable.
- Q3 comprehensive income was $269.1, down from $483.6 a year earlier, largely reflecting a $77.1 after-tax change in unrealized cash-flow hedge losses versus a $198.5 gain in the prior-year quarter.
Important facts for investors to verify
- Whether revenue growth and operating-margin performance persist after considering wage growth, headcount, utilization and currency movements.
- Receivables growth, the increase in days sales outstanding, and cash conversion as revenue expands.
- The accounting and earnings effects, maturity profile and sensitivity of the substantial Indian rupee hedge portfolio.
- Future effective tax rates and continued availability and utilization of Indian tax benefits and MAT credits.
- Execution and returns on planned capital spending, acquisitions and the expanded share repurchase authorization, including foreign-cash availability and repatriation implications.
- Client concentration, fixed-price contract profitability, data-security exposure and the potential financial impact of claims or indemnities.