01—Abstract
Summary
Summary of the 10-K filed February 27, 2012. Cited figures are marked; the original filing is the authoritative source.
Cognizant Technology Solutions (CTSH) closed 2011 with a strong year of growth and profitability.
Revenue rose 33.3% to $6.12 billiona (from $4.59 billion), and net income climbed 20.5% to $883.6 million, or $2.85 per diluted share. Income from operations grew 31.9% to $1.14 billion, with the operating margin slipping modestly to 18.6% from 18.8%. Excluding stock-based compensation of about $90.2 million, the operating margin was 20.0%, in line with management's targeted 19% to 20% range.
Growth was broad-based across all four segments, led by Manufacturing/Retail/Logistics (+40.9%b) and Healthcare (+37.8%), with Europe up 28.3%. Roughly 97% of 2011 revenue came from customers who were already clients at the end of 2010. The main headwind to earnings was taxes.
The effective tax rate rose from 16.5% to 24.4% because the Indian Software Technology Park tax holiday expired on March 31, 2011, and the Minimum Alternative Tax now applies to Indian profits. Management expects this to keep pressuring margins, and the company also flagged rising Indian wage costs and rupee volatility. Foreign exchange hedges are a large item on the balance sheet: the net unrealized loss on cash flow hedges reached about $385.6 millionc at year-end, driven by rupee depreciation in late 2011, which pushed accumulated other comprehensive loss to $(325.4) million.
Those hedges are a risk to watch, though they are mark-to-market and do not reflect operating cash losses. The balance sheet remains very strong, with $2.43 billiond in cash and short-term investments, no third-party debt, and working capital of $2.88 billion. Operating cash flow was $875 million and capital expenditures were $288 million, with about $370 million planned for 2012.
Share repurchases were $374 million in 2011, and the authorization was raised to $600 million. Management did not declare cash dividends and said it intends to retain earnings to fund growth.
02—Key points
Key Highlights
- Revenue grew 33.3% to $6.12B in 2011, with all four business segments growing 26% to 41%.
- Diluted EPS rose to $2.85 from $2.37 (+20%), and net income reached $883.6M.
- Operating margin was 18.6% GAAP and 20.0% excluding stock-based compensation, within the company's 19%–20% target range.
- The effective tax rate jumped to 24.4% from 16.5% after the India STP tax holiday expired in 2011, a key earnings headwind.
- Strong liquidity: $2.43B in cash and short-term investments, no debt, and $2.88B working capital.
- Large FX hedge exposure: net unrealized loss of about $386M on rupee forward contracts, reducing equity via OCI.
- Concentration is moderate: top five customers were 16.3% of revenue, and 78.5% of revenue came from North America.
03—One dollar
04—Financials
Financial Highlights
Figures from 10-KFY2011filed February 27, 2012Financial Statements
FY2011 against FY2010
| Line item | FY2011FY2010 | Change |
|---|---|---|
| Revenue | $6.12B$4.59B | +33.3% |
| SG&A Expenses | $1.33B$972.09M | +36.7% |
| Operating Income | $1.14B$861.85M | +31.9% |
| Net Income | $883.62M$733.54M | +20.5% |
| EPS (Basic) | $1.46$1.22 | +19.3% |
| EPS (Diluted) | $1.43$1.19 | +20.3% |
| Shares Outstanding (Basic) | 606.55M601.56M | +0.8% |
| Shares Outstanding (Diluted) | 620.70M618.27M | +0.4% |
05—Questions
Frequently Asked Questions
Why did the effective tax rate increase so sharply in 2011, and will it stay elevated?
The main driver was the expiration of India's Software Technology Park (STP) income tax holiday on March 31, 2011. STP income is now taxed at the 32.4% corporate rate, and the Minimum Alternative Tax (about 20%) applies to all Indian profits, including those from Special Economic Zones. Newer development centers in SEZs still receive tax incentives for up to 15 years, so the company expects to keep locating most new facilities there. Investors should expect the tax rate to stay structurally higher than in 2010 unless Indian tax policy changes.
How significant is the foreign exchange hedging exposure?
It is material on the balance sheet. The company had about $3.5 billion in notional value of cash flow hedges on Indian rupee payments, with a net unrealized loss of roughly $385.6 million at year-end 2011, mostly from rupee depreciation in late 2011. This reduced accumulated other comprehensive income by about $323 million net of tax. These hedges are designed to offset operating cost increases, so the economic impact is partly offset over time. A 10% move in the rupee would change the fair value of these contracts by about $291 million. Operationally, each 1% rupee move affects operating margin by about 27 basis points.
How concentrated is the customer base and what are the revenue quality risks?
The client base is diversified. In 2011 the company served about 785 active customers, and no single customer exceeded 10% of revenue. The top five and top ten customers represented 16.3% and 27.7% of revenue, respectively, both down from 2010. Roughly 97% of 2011 revenue came from customers who were active in 2010. Still, most contracts are short-term or terminable on short notice, and about 31.7% of revenue came from fixed-price contracts that carry cost-overrun risk. The Financial Services segment, at 41.1% of revenue, is the largest industry concentration.
What is the outlook and capital allocation plan?
Management expects to keep investing above its 19%–20% target operating margin in 2012, focusing on talent, new service offerings, and geographic expansion in Europe, the Middle East, and Asia Pacific. Planned 2012 capital expenditures are about $370 million, including the India real estate program (roughly 10.5 million square feet through 2015, over $700 million of spending). Management noted the European economy is expected to grow more slowly than the rest of the company in 2012. Capital allocation has leaned toward buybacks, with $374 million repurchased in 2011 under an expanded $600 million authorization that runs through June 2012. No dividends are planned.
06—Continue