How much did Cognizant's revenue and earnings grow in 2006?

Revenue grew 60.8% to $1,424.3 million, and net income rose 40% to $232.8 million. Diluted EPS was $1.55, compared with $1.13 in 2005. The 2005 figure included a one-time tax benefit of about $0.08 per diluted share, so underlying growth was somewhat stronger than the headline comparison suggests, though 2006 EPS was also reduced by stock-option expense.

Why did operating margin decline in 2006?

Operating margin fell to 18.2% from 20.1%, mainly because of $29.9 million of stock-based compensation under SFAS 123R, which began in 2006. Excluding that expense, operating margin was 20.3%. Management also said it intends to keep reinvesting profit above its 19%–20% target range (excluding stock compensation) into growth, which may limit margin expansion going forward.

Which business segments drove growth, and how concentrated is the customer base?

Financial Services is the largest segment at about 48% of revenue, growing 54.2% to $679.9 million, led by insurance clients. Healthcare grew 87.9% to $330.9 million, and Other grew 75.3%. No single customer exceeded 10% of revenue in 2006 or 2005, but the top five customers still accounted for 29% of revenue, and about 86% of revenue came from U.S. customers.

What are the main risks investors should monitor?

Key risks include rising wages in India, which could compress margins; rupee appreciation, which raises offshore delivery costs; restrictions on H-1B and L-1 visas that affect staffing for U.S. and U.K. projects; and proposed anti-outsourcing legislation. Most contracts can be terminated on short notice, and roughly 25% of revenue comes from fixed-price contracts that carry cost-overrun risk. The company also has potential tax liabilities tied to the 2003 IMS Health distribution agreement and legacy Dun & Bradstreet obligations.

Is Cognizant's balance sheet strong enough to fund its expansion?

Yes. As of December 31, 2006, the company held $648.2 million in cash and short-term investments, had no third-party debt, and reported working capital of $790.9 million. Operating cash flow was $252.9 million. Management expects existing resources and operating cash flow to cover current plans for at least 12 months, including the roughly $200 million India development program through 2008.

CTSH 10-K FY2006 Annual Report — Revenue, Net Income, EPS

01—Abstract

Summary

Summary of the 10-K filed February 16, 2007. Cited figures are marked; the original filing is the authoritative source.

Cognizant Technology Solutions (CTSH) closed fiscal 2006 with revenue of $1,424.3 million^a, up 60.8% from $885.8 million in 2005, and net income of $232.8 million, or $1.55 per diluted share.

Growth was broad-based: the Financial Services segment contributed about 48% of revenue and grew 54.2%, Healthcare grew 87.9%, Manufacturing/Retail/Logistics grew 37.5%, and the Other segment grew 75.3%. Clients rose to roughly 400 from 250, and 96% of 2006 revenue came from customers that were already clients at the end of 2005. European revenue grew about 77% to $183.9 million^b, though it remains a small share of the total at roughly 13%.

Profitability was mixed. Operating margin fell to 18.2% from 20.1%, mainly because of $29.9 million^c of stock-based compensation expense following the adoption of SFAS 123R. Excluding that charge, operating margin was 20.3%, slightly above management's historic 19%–20% target range.

Management said it will keep reinvesting margin above that range into sales, delivery capacity, and training, so investors should expect margins to stay closer to the target band than to the adjusted 2006 level. The 2005 net income figure also included a one-time $12.4 million^d tax benefit from repatriating $60 million of Indian earnings, which flatters the year-over-year comparison. The balance sheet is strong: cash and short-term investments total $648.2 million, there is no third-party debt, and working capital is $790.9 million.

The company is also spending heavily on capacity, with a planned investment of about $200 million through 2008 in fully owned India development centers, against $57.7 million of existing capital commitments. Key risks include wage inflation in India, rupee appreciation, H-1B and L-1 visa restrictions, short-term client contracts, concentration in India, and the IMS Health distribution-agreement tax indemnities. The top five customers still represent 29% of revenue.

02—Key points

Key Highlights

Revenue rose 60.8% to $1,424.3 million in 2006, from $885.8 million in 2005, with growth across all four vertical segments.
Net income reached $232.8 million, or $1.55 per diluted share, versus $166.3 million ($1.13) in 2005, which included a one-time $12.4 million tax benefit.
Operating margin declined to 18.2% from 20.1% due to $29.9 million of SFAS 123R stock compensation; excluding this, margin was 20.3%.
Client count grew to about 400 from 250, and 96% of 2006 revenue came from existing clients, indicating strong account expansion.
European revenue grew about 77% to $183.9 million, supporting the company's geographic diversification strategy.
The company holds $648.2 million in cash and short-term investments with no third-party debt, and it plans roughly $200 million of India development center investment through 2008.
Concentration and talent risks persist: top five customers were 29% of revenue, about 86% of revenue came from the U.S., and H-1B/L-1 visa constraints and Indian wage inflation are ongoing pressures.

03—Questions

Frequently Asked Questions

How much did Cognizant's revenue and earnings grow in 2006?
Revenue grew 60.8% to $1,424.3 million, and net income rose 40% to $232.8 million. Diluted EPS was $1.55, compared with $1.13 in 2005. The 2005 figure included a one-time tax benefit of about $0.08 per diluted share, so underlying growth was somewhat stronger than the headline comparison suggests, though 2006 EPS was also reduced by stock-option expense.
Why did operating margin decline in 2006?
Operating margin fell to 18.2% from 20.1%, mainly because of $29.9 million of stock-based compensation under SFAS 123R, which began in 2006. Excluding that expense, operating margin was 20.3%. Management also said it intends to keep reinvesting profit above its 19%–20% target range (excluding stock compensation) into growth, which may limit margin expansion going forward.
Which business segments drove growth, and how concentrated is the customer base?
Financial Services is the largest segment at about 48% of revenue, growing 54.2% to $679.9 million, led by insurance clients. Healthcare grew 87.9% to $330.9 million, and Other grew 75.3%. No single customer exceeded 10% of revenue in 2006 or 2005, but the top five customers still accounted for 29% of revenue, and about 86% of revenue came from U.S. customers.
What are the main risks investors should monitor?
Key risks include rising wages in India, which could compress margins; rupee appreciation, which raises offshore delivery costs; restrictions on H-1B and L-1 visas that affect staffing for U.S. and U.K. projects; and proposed anti-outsourcing legislation. Most contracts can be terminated on short notice, and roughly 25% of revenue comes from fixed-price contracts that carry cost-overrun risk. The company also has potential tax liabilities tied to the 2003 IMS Health distribution agreement and legacy Dun & Bradstreet obligations.
Is Cognizant's balance sheet strong enough to fund its expansion?
Yes. As of December 31, 2006, the company held $648.2 million in cash and short-term investments, had no third-party debt, and reported working capital of $790.9 million. Operating cash flow was $252.9 million. Management expects existing resources and operating cash flow to cover current plans for at least 12 months, including the roughly $200 million India development program through 2008.

04—Continue

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