01—Abstract
Summary
Summary of the 10-K filed February 28, 2008. Cited figures are marked; the original filing is the authoritative source.
Cognizant Technology Solutions (CTSH) closed 2007 with strong top-line and earnings growth.
Revenue rose 49.9% to $2,135.6 milliona from $1,424.3 million, and net income increased 50.4% to $350.1 million, or $1.15 per diluted share (after a 2-for-1 stock split in October 2007). Growth was broad-based: European revenue grew 86.5% to $342.9 million, Healthcare and Manufacturing/Retail/Logistics each grew roughly 52%, and about 96% of 2007 revenue came from clients that were already customers at the end of 2006. Client count rose to roughly 500 from 400, and headcount reached about 55,400, up 16,600 year over year.
Margins were the main pressure point. Operating margin fell to 17.9%b from 18.2% in 2006 and 20.1% in 2005. Management attributes the decline mainly to Indian rupee appreciation (about 210 basis points of headwind in 2007), wage inflation in India, stock-based compensation under SFAS 123R, and the new Indian fringe benefit tax on equity awards.
Excluding stock compensation and the fringe benefit tax, operating margin was 19.8%, within the company's stated 19%–20% target range. Management expects to keep reinvesting profits above that range into the business in 2008, so investors should expect margins to stay near this level rather than expand. The balance sheet is conservative: no third-party debt, $670.4 millionc in cash and short-term investments, and $901.5 million of working capital.
Two watch items stand out. First, $282.8 milliond of short-term investments are auction-rate municipal securities, and $71.1 million of auctions failed in mid-February 2008, so that cash is temporarily illiquid.
Second, the company faces significant India-linked risk, including the phase-out of India tax holidays by March 2009, a U.S. Department of Labor H-1B investigation, and roughly $330 million planned for India facility expansion through 2009. Capital spending is expected to reach about $250 million in 2008.
02—Key points
Key Highlights
- Revenue grew 49.9% to $2,135.6 million in 2007 (from $1,424.3 million), with European revenue up 86.5% to $342.9 million.
- Net income rose 50.4% to $350.1 million; diluted EPS was $1.15 (post 2-for-1 split), compared with $0.77 in 2006.
- Operating margin declined to 17.9% (from 18.2%); excluding stock-based compensation and Indian fringe benefit tax, it was 19.8%, within the 19%–20% target range.
- Rupee appreciation reduced operating margin by about 210 basis points in 2007; each further 1% move in the rupee/USD rate shifts margin by about 25 basis points.
- No third-party debt; cash and short-term investments totaled $670.4 million; working capital was $901.5 million.
- About $282.8 million of auction-rate securities are held, and $71.1 million of auctions failed in February 2008, leaving those funds temporarily illiquid.
- India tax holidays phase out by March 2009, which management expects to raise the effective tax rate significantly beginning in 2009.
03—One dollar
04—Financials
Financial Highlights
Figures from 10-KFY2007filed February 28, 2008Financial Statements
| Revenue | $2.14B |
| SG&A Expenses | $494.10M |
| Operating Income | $381.52M |
| Net Income | $350.13M |
| EPS (Basic) | $0.61 |
| EPS (Diluted) | $0.57 |
| Shares Outstanding (Basic) | 576.31M |
| Shares Outstanding (Diluted) | 607.19M |
05—Questions
Frequently Asked Questions
How much of Cognizant's 2007 growth came from existing customers versus new ones?
Roughly 96% of 2007 revenue came from clients that were already using Cognizant's services at the end of 2006, and revenue from customers added during 2007 was about $80.9 million, or 3.8% of total revenue. Active clients grew to about 500 from 400, and strategic clients rose to 107. Top five and top ten clients accounted for 24% and 34% of revenue, respectively, down from 29% and 39% in 2006.
Why did operating margin decline even as revenue grew strongly?
Management cites three main drivers: appreciation of the Indian rupee against the dollar, wage inflation in India, and higher stock-based compensation after SFAS 123R, including the Indian fringe benefit tax introduced in April 2007. Excluding stock compensation and that fringe benefit tax, margin was 19.8%. Cognizant also said it intends to reinvest profits above its 19%–20% target range back into the business in 2008.
Is Cognizant's cash position at risk because of the auction-rate securities?
Management says the exposure is manageable but not fully liquid. Of the $282.8 million in auction-rate municipal securities at year-end 2007, $176.3 million was still held as of February 26, 2008, with $71.1 million in auctions failing in mid-February. The securities are AAA-rated, about 95% of the underlying student loans are backed by the FFELP, and they are callable at par. Management believes the holdings can be recovered and that liquidity is sufficient for at least the next 12 months, though full recovery could take until final maturity, up to 33 years.
What are the biggest medium-term risks to earnings from India?
The main risks are the expiration of India's software export tax holidays by March 2009, which could significantly raise the effective tax rate from 2009 onward; continued rupee appreciation and wage inflation that pressure margins; a U.S. Department of Labor investigation into H-1B wage compliance, which could bring back-pay liability, fines, or a ban on H-1B use; and possible U.S. anti-outsourcing legislation. About 83% of revenue comes from U.S. customers, and most delivery capacity is in India.
06—Continue