01—Abstract
Summary
Summary of the 10-K filed March 19, 1999. Cited figures are marked; the original filing is the authoritative source.
Cognizant Technology Solutions (CTSH) reported strong results for fiscal 1998 in its first annual report following its June 1998 IPO.
Revenue grew 136.8% to $58.6 milliona (from $24.7 million), driven by Year 2000 compliance work ($44.1% of revenue) and a rapidly growing base of unaffiliated customers, which rose to 76.8% of revenue from 56.2% in 1997. Gross margin expanded to 45.5% from 42.0%, operating income rose 319% to $8.9 million, and net income reached $6.0 million, or $0.73 diluted EPS. The balance sheet was transformed by the IPO, which raised roughly $22.4 million in net proceeds, leaving cash of $28.4 million, stockholders' equity of $32.6 million, and no significant third-party debt.
Investors should weigh several risks. IMS Health controls about 94.2%b of the combined voting power through its high-vote Class B stock, which limits minority shareholders' influence. Revenue is concentrated: the top five non-IMS customers generated 43.7% of 1998 revenue, and a single related-party customer accounted for 23.2%.
Management explicitly warns that Year 2000 demand may fade after 2000 and that it must generate new business from Y2K clients. The company also faces a trademark challenge from Cognizant Design Group over the name "Cognizant" and has most of its development staff in India, creating currency, regulatory, and talent-retention exposure. The stock traded between $7c and $33.50 during the fourth quarter following the IPO, indicating high volatility.
02—Key points
Key Highlights
- Revenue up 136.8% to $58.6M in 1998, with Y2K compliance services contributing about 44% of revenue
- Gross margin improved to 45.5% from 42.0%, and operating income rose 319% to $8.9M (15.2% operating margin)
- Net income of $6.0M ($0.73 diluted EPS) versus $1.0M in 1997; effective tax rate rose to 37.4%
- IPO completed June 1998 at $10.00/share, raising about $22.4M net; year-end cash of $28.4M and no significant third-party debt
- IMS Health holds 61.7% of economic ownership and 94.2% of voting power, giving it effective control
- Revenue diversification improving: unaffiliated customers reached 76.8% of 1998 revenue versus 56.2% in 1997
- Workforce of roughly 1,660 employees (about 1,170 in India) and seven offshore development centers support the on-site/offshore delivery model
03—Questions
Frequently Asked Questions
How concentrated is Cognizant's customer base?
Concentration is significant. The top ten customers accounted for 81.0% of 1998 revenue, and one related-party customer (IMS Health) represented 23.2%. Two third-party customers each accounted for more than 10%, at 12.5% and 11.3%. Management acknowledges that large customers may not repeat in future years.
What happens to Cognizant's business after Year 2000 demand fades?
This is the central long-term question. Y2K work made up 44.1% of 1998 revenue, and management believes demand will diminish after 2000. The company's strategy is to convert Y2K clients to application development and maintenance work, which the 1998 revenue growth partially demonstrates, but it cannot guarantee success in that transition.
Who controls Cognizant, and what does that mean for public shareholders?
IMS Health owns about 61.7% of the stock and 94.2% of the voting power through Class B shares carrying ten votes each. Public Class A holders therefore have little influence over corporate decisions. Class B shares convert automatically if IMS's economic ownership falls below 35%, and a future tax-free spin-off could alter the ownership structure.
Are there material legal or intellectual property risks?
Cognizant Design Group has alleged infringement of its prior rights to the name 'Cognizant' and demanded the company stop using it. The company is investigating and may seek a settlement, but litigation could follow. The company holds no patents or registered copyrights and relies on copyright, trade secret, and contractual protections, with some risk that Indian law changes could restrict software transfers to the US.
Is the stock attractively valued based on this filing?
The filing does not provide valuation metrics, but it offers context. Class A shares traded between $7.00 and $33.50 in the fourth quarter of 1998, and 1998 diluted EPS was $0.73. Investors should weigh the strong growth and margin expansion against the concentration, Y2K dependence, and the limited governance rights of public shareholders.
04—Continue