01—Abstract
Summary
Summary of the 10-K filed March 14, 2003. Cited figures are marked; the original filing is the authoritative source.
Cognizant Technology Solutions (CTSH) closed 2002 with strong top- and bottom-line growth.
Total revenues rose 28.9% to $229.1 milliona from $177.8 million, and net income climbed 56% to $34.6 million, or $1.63 per diluted share. Income from operations grew 26.9% to $45.2 million, though operating margin slipped slightly to 19.7% from 20.0% because of higher incentive compensation. The headline improvement in net margin to 15.1% (from 12.5%) was driven mainly by a lower effective tax rate of 23.4%, versus 37.4% in 2001, following a change in intent to reinvest Indian earnings rather than repatriate them.
Investors should note that a portion of the earnings benefit reflects this tax change, which is tied to the company's ongoing international expansion and carries repatriation risk if management's intent changes. The balance sheet strengthened considerably, with cash and equivalents of $126.2 millionb, no significant third-party debt, and stockholders' equity up to $165.5 million. Operating cash flow was $56.7 million.
Growth was supported by the June 2002 UnitedHealthcare Ireland asset purchase and the October 2002 Silverline practice transfer, and the company expanded its India development capacity, with a remaining $28.8 millionc capital commitment. Revenue concentration remains a consideration: IMS Health accounted for about 9% of revenue, and the top ten customers for 54%. The filing also documents a major governance shift.
IMS Health distributed its entire 55.3%d stake (all Class B shares, 92.5% of voting power) in a February 13, 2003 exchange offer, and the Class B shares then converted to Class A. Cognizant is now widely held and no longer controlled by a single parent.
New anti-takeover provisions were adopted, including a classified board, an 80% supermajority requirement for certain charter amendments, and a stockholder rights plan. The company also announced a 3-for-1 stock split payable April 1, 2003.
02—Key points
Key Highlights
- Revenue grew 28.9% to $229.1 million in 2002, driven by application management and development services; application maintenance rose to 57% of revenue.
- Net income rose to $34.6 million ($1.63 diluted EPS), up 56%, aided by a tax rate that fell from 37.4% to 23.4% due to a change in the intent to repatriate Indian earnings.
- Income from operations increased 26.9% to $45.2 million, though operating margin dipped to 19.7% as incentive compensation rose.
- Strong balance sheet: $126.2 million in cash, no significant third-party debt, and stockholders' equity of $165.5 million; operating cash flow was $56.7 million.
- IMS Health fully exited its controlling stake via the February 2003 exchange offer, ending its 92.5% voting control; the shares are now widely held Class A common stock.
- New takeover defenses were adopted, including a classified board, supermajority voting for charter amendments, a ban on stockholder written consent and special meetings, and a stockholder rights plan.
- A 3-for-1 stock split (April 1, 2003 payable) was declared, and the company expanded offshore capacity in India, with a $28.8 million remaining capital commitment for development centers.
03—Questions
Frequently Asked Questions
How much of the 2002 earnings improvement came from operations versus the lower tax rate?
Operating income rose $9.6 million (26.9%), while pre-tax income rose about $9.7 million. Net income rose $12.4 million, so the reduced tax provision (down $2.7 million in absolute terms despite higher pre-tax income) contributed meaningfully to the increase. The lower effective rate of 23.4% stems from the company's decision to reinvest Indian earnings outside the U.S. rather than repatriate them, which is a structural benefit that could reverse if that policy changes.
What does the end of IMS Health's control mean for investors?
IMS Health no longer holds any Class B shares, so the company has no controlling shareholder. Any investor or group that acquires a majority of the Class A common stock could gain control of the board. The company has offset some of this through a classified board, supermajority requirements, and a rights plan triggered at 15% ownership, which could deter takeover attempts and reduce shareholder flexibility.
What risks are tied to the company's offshore model and India operations?
Most development centers and the majority of employees are in India, exposing Cognizant to currency fluctuations (it does not hedge), geopolitical and terrorism risk, and changes in Indian tax law. Recent Indian tax changes reduced the export exemption from 100% to 90% and added a surtax. The company also faces competition for skilled engineers, a risk that could raise wage costs, particularly on fixed-price contracts.
How concentrated is Cognizant's customer base?
Concentration is moderate but notable. The top five customers accounted for 38% of 2002 revenue and the top ten for 54%, including IMS Health at 9%. No third-party customer exceeded 10% of revenue. Customer relationships are long-term, with over 80% of revenue from clients using the company's services for at least a year, but the company notes that a significant customer in one year may not continue in the next.
What should investors watch in 2003 given the disclosed items?
Key items include the 3-for-1 stock split effective April 1, 2003; the completion of the Chennai development center (about 370,000 sq ft, expected 2003); the one-time exchange-offer costs (about $3.5 million total, with $1.7 million booked in Q4 2002); the indemnification exposure to IMS Health if the spin-off is found taxable under Section 355 (potentially material); and the tax-holiday expiration beginning in 2004, which could raise the company's effective tax rate.
04—Continue