How strong was Cognizant's revenue and profit growth in 2005?

Revenue grew 51.0% to $885.8 million, and net income rose to $166.3 million. About $12.4 million of that net income came from a one-time tax benefit, so underlying net income was $153.9 million, up roughly 54% from $100.2 million in 2004. Operating margin held at about 20%, so the growth came with stable profitability rather than margin expansion.

How much of the company's revenue depends on a small number of customers?

The top five customers made up 34% of 2005 revenue and the top ten made up 46%, down from 38% and 52% in 2004. No single customer exceeded 10% of revenue. Management expects the top-customer percentages to keep declining as it adds clients and expands existing relationships, but dependence on a handful of large clients remains a material risk.

What are the main risks from the company's reliance on India?

Most technical staff and development centers are in India, which exposes the company to rising Indian wages, currency swings (the rupee), and political or security risks. Its margins also depend on Indian tax holidays, which phase out completely by March 2009, and on the company's intent to keep Indian earnings offshore. Visa and immigration rules, including H-1B and L-1 limits and possible anti-outsourcing legislation in the U.S., could also constrain staffing.

What will change in 2006 reported earnings?

Starting January 1, 2006, the company will adopt SFAS 123R and expense employee stock options. Management expects the after-tax cost to be slightly above the approximately $18 million pro forma expense disclosed for 2005, which would reduce reported net income and EPS. The 2005 results also include a one-time $12.4 million tax benefit that will not recur, so the year-over-year comparison will look weaker than the underlying business trend.

How is the company funding its expansion?

Cognizant is funding growth mainly from operating cash flow and its existing cash, which totaled $424.0 million including short-term investments. Operating cash flow was $159.8 million in 2005. The company has no third-party debt, and it expects to fund its approximately $140 million India development center expansion primarily from current operations. Capital expenditures were $71.8 million in 2005.

CTSH 10-K FY2005 Annual Report — Revenue, Net Income, EPS

01—Abstract

Summary

Summary of the 10-K filed March 15, 2006. Cited figures are marked; the original filing is the authoritative source.

Cognizant Technology Solutions (CTSH) closed fiscal 2005 with revenue of $885.8 million^a, up 51.0% from $586.7 million in 2004, and net income of $166.3 million, or $1.13 per diluted share.

Excluding a one-time $12.4 million^b tax benefit tied to repatriating $60 million of Indian earnings under the American Jobs Creation Act, net income was $153.9 million, or $1.05 per diluted share. Operating margin held steady at about 20.1% (versus 20.0% in 2004), and gross margin was 45.8%. Growth was broad-based: Financial Services grew about 52% and Healthcare about 51%, and roughly 91% of 2005 revenue came from clients already using the company at the end of 2004.

The balance sheet is conservative. Cash and short-term investments totaled $424.0 million^c, the company carried no third-party debt, and working capital reached $507.7 million. Investors should weigh several items against that strength.

Revenue is concentrated, with the top five customers at 34% and the top ten at 46% of revenue, and about 87% of revenue comes from U.S. customers. Operations are concentrated in India, where wage inflation, tax-holiday phase-out by March 2009, and potential anti-outsourcing or H-1B/L-1 visa restrictions are key risks. The company also plans to spend roughly $140 million^d on new India development centers, and it will begin expensing stock options under SFAS 123R in 2006, which management expects to reduce 2006 net income by slightly more than the approximately $18 million pro forma expense recorded in 2005.

Overall, the filing shows a high-growth offshore IT services provider with strong margins, a clean balance sheet, and a steady expansion in headcount and capacity. The main investor debates center on how durable the growth is given customer concentration, the sustainability of Indian wage and tax advantages, and the earnings drag from expensing options beginning in 2006.

02—Key points

Key Highlights

Revenue rose 51.0% to $885.8 million in 2005, led by Financial Services (+51.8%) and Healthcare (+51.3%), with about 91% of revenue from repeat customers.
Net income grew to $166.3 million ($1.13 diluted EPS); excluding a one-time $12.4 million India repatriation tax benefit, net income was $153.9 million ($1.05 diluted EPS).
Operating margin was steady at 20.1% and gross margin at 45.8%, within management's historical 19–20% operating margin target range.
Cash and short-term investments of $424.0 million, no third-party debt, and working capital of $507.7 million at year-end 2005.
Customer concentration remains meaningful: top five customers were 34% of revenue and top ten were 46%, though no single customer exceeded 10%.
Headcount expanded to about 24,300 (roughly 18,900 in India), and a planned India development center expansion of 1.7 million sq. ft. is estimated at about $140 million.
SFAS 123R adoption on January 1, 2006 will expense stock options, with 2006 net income expected to fall by slightly more than the roughly $18 million pro forma expense seen in 2005.

03—Questions

Frequently Asked Questions

How strong was Cognizant's revenue and profit growth in 2005?
Revenue grew 51.0% to $885.8 million, and net income rose to $166.3 million. About $12.4 million of that net income came from a one-time tax benefit, so underlying net income was $153.9 million, up roughly 54% from $100.2 million in 2004. Operating margin held at about 20%, so the growth came with stable profitability rather than margin expansion.
How much of the company's revenue depends on a small number of customers?
The top five customers made up 34% of 2005 revenue and the top ten made up 46%, down from 38% and 52% in 2004. No single customer exceeded 10% of revenue. Management expects the top-customer percentages to keep declining as it adds clients and expands existing relationships, but dependence on a handful of large clients remains a material risk.
What are the main risks from the company's reliance on India?
Most technical staff and development centers are in India, which exposes the company to rising Indian wages, currency swings (the rupee), and political or security risks. Its margins also depend on Indian tax holidays, which phase out completely by March 2009, and on the company's intent to keep Indian earnings offshore. Visa and immigration rules, including H-1B and L-1 limits and possible anti-outsourcing legislation in the U.S., could also constrain staffing.
What will change in 2006 reported earnings?
Starting January 1, 2006, the company will adopt SFAS 123R and expense employee stock options. Management expects the after-tax cost to be slightly above the approximately $18 million pro forma expense disclosed for 2005, which would reduce reported net income and EPS. The 2005 results also include a one-time $12.4 million tax benefit that will not recur, so the year-over-year comparison will look weaker than the underlying business trend.
How is the company funding its expansion?
Cognizant is funding growth mainly from operating cash flow and its existing cash, which totaled $424.0 million including short-term investments. Operating cash flow was $159.8 million in 2005. The company has no third-party debt, and it expects to fund its approximately $140 million India development center expansion primarily from current operations. Capital expenditures were $71.8 million in 2005.

04—Continue

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