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CTSH > SEC Filings for CTSH > Form 10-K on 25-Feb-2014All Recent SEC Filings

Show all filings for COGNIZANT TECHNOLOGY SOLUTIONS CORP

Form 10-K for COGNIZANT TECHNOLOGY SOLUTIONS CORP


25-Feb-2014

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.

Executive Summary

We are a leading provider of IT, consulting and business process services, dedicated to helping the world's leading companies build stronger businesses. Our clients engage us to help them build more efficient operations, provide solutions to critical business and technology problems, and to help them drive technology-based innovation and growth. Our core competencies include: Business, Process, Operations and IT Consulting, Application Development and Systems Integration, EIM, Application Testing, Application Maintenance, IT IS, and BPS. We tailor our services to specific industries and utilize an integrated global delivery model. This seamless global sourcing model combines client service teams based on-site at the client locations with delivery teams located at dedicated near-shore and offshore global delivery centers.

In 2013, our revenue increased to $8,843.2 million compared to $7,346.5 million in 2012. Net income increased to $1,228.6 million or $4.03 per diluted share, compared to net income of $1,051.3 million or $3.44 per diluted share. On a non-GAAP basis our 2013 diluted earnings per share increased to $4.381 compared to $3.741 during 2012.

The key drivers of our revenue growth in 2013 were as follows:

Strong performance across all of our business segments, particularly our Manufacturing/Retail/Logistics and Financial Services business segments, which reported revenue growth of 24.7% and 22.5%, respectively, as compared to 2012;

Continued penetration of the European and Rest of World (primarily the Asia Pacific) markets where we experienced revenue growth of 32.1% and 28.3%, respectively, as compared to 2012;

Sustained strength in the North American market where revenues grew 17.5%, as compared to 2012;

Increased customer spending on discretionary projects;

Expansion of our service offerings, including Consulting, IT IS, and BPS services, which enabled us to cross-sell new services to our customers and meet the rapidly growing demand for complex large-scale outsourcing solutions;

Increased penetration at existing customers, including strategic clients; and

Continued expansion of the market for global delivery of IT services and BPS.

We saw a continued demand from our customers for a broad range of services, including IT strategy and business consulting, application development and systems integration, EIM, application testing, application maintenance, IT IS, and BPS. In addition, we are seeing an increased customer interest in our social, mobile, analytics and cloud-based services. We finished the year with approximately 1,197 active clients, compared to approximately 821 active clients as of December 31, 2012, and increased the number of strategic clients by 29 during the year, bringing the total number of our strategic clients to 243. We define a strategic client as one offering the potential to generate at least $5 million to $50 million or more in annual revenues at maturity.

Our revenue growth is also attributed to increasing market acceptance of, and strong demand for, offshore IT software and services and BPS. NASSCOM (India's National Association of Software and Service Companies) reports indicate that export revenues from India's IT software and services and BPS sectors are expected to grow approximately 12% to 14% for NASSCOM's fiscal year ending March 31, 2014. For the fiscal year ended March 31, 2013, the industry recorded export revenue growth of 10.2%, which was at the lower end of NASSCOM's growth projection.

1 Non-GAAP diluted earnings per share and non-GAAP operating margin are not measurements of financial performance prepared in accordance with GAAP. See "Non-GAAP Financial Measures" for more information and a reconciliation to the most directly comparable GAAP financial measures.


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In 2013, our operating margin increased to approximately 19.0% compared to 18.5% in 2012. Our non-GAAP operating margin in 2013 was approximately 20.6%1 compared to 20.2%1 in 2012. The increase in our GAAP and non-GAAP operating margins was due to revenue growth outpacing headcount growth and the impact of the depreciation of the Indian rupee against the U.S. dollar, net of losses on our cash flow hedges, partially offset by increases in compensation and benefit costs, including incentive-based compensation. Historically, we have invested our profitability above the 19% to 20% non-GAAP operating margin level back into our business, which we believe is a significant contributing factor to our strong revenue growth. This investment is primarily focused in the areas of hiring client partners and relationship personnel with specific industry experience or domain expertise, training our technical staff in a broader range of service offerings, strengthening our business analytics capabilities, strengthening and expanding our portfolio of services, continuing to expand our geographic presence for both sales and delivery as well as recognizing and rewarding exceptional performance by our employees. In addition, this investment includes maintaining a level of resources, trained in a broad range of service offerings, to be well positioned to respond to our customer requests to take on additional projects. We expect to continue to invest amounts in excess of our targeted operating margin levels back into the business.

We finished the year with approximately 171,400 employees, which is an increase of approximately 14,700 over the prior year. The increase in the number of our technical personnel and the related infrastructure costs to meet the demand for our services is the primary driver of the increase in our operating expenses in 2013. Annualized turnover, including both voluntary and involuntary, was approximately 14.5% for the three months ended December 31, 2013. The majority of our turnover occurs in India. As a result, annualized attrition rates on-site at clients are below our global attrition rate. In addition, attrition is weighted towards the more junior members of our staff. We have experienced increases in compensation and benefit costs, including incentive-based compensation costs, in India which may continue in the future; however, historically, this has not had a material impact on our results of operations as we have been able to absorb such cost increases through price increases or cost management strategies such as managing discretionary costs, the mix of our professional staff as well as utilization levels, and achieving other operating efficiencies.

At December 31, 2013, we had cash, cash equivalents and short-term investments of $3,747.5 million and working capital of $4,373.4 million. Accordingly, we do not anticipate any near-term liquidity issues.

During 2014, barring any unforeseen events, we expect the following factors to affect our business and our operating results:

Continued focus by customers on directing IT spending towards cost containment projects, such as application maintenance, IT IS and BPS;

Demand from our customers to help them achieve their dual mandate of simultaneously achieving cost savings while investing in innovation;

Secular changes driven by evolving technologies and regulatory changes;

Volatility in foreign currency rates; and

Continued uncertainty in the world economy.

In response to this macroeconomic environment, we plan to:

Continue to invest in our talent base and new service offerings;

Partner with our existing customers to garner an increased portion of our customers' overall IT spend by providing innovative solutions;

Continue our focus on growing our business in Europe, the Middle East, the Asia Pacific and Latin America regions, where we believe there are opportunities to gain market share;

Continue to increase our strategic customer base across all of our business segments;


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Opportunistically look for acquisitions that may improve our overall service delivery capabilities, expand our geographic presence and/or enable us to enter new areas of technology;

Continue to focus on operating discipline in order to appropriately manage our cost structure; and

Continue to locate most of our new development center facilities in tax incentivized areas.

Business Segments

Our four reportable business segments are:

Financial Services, which includes customers providing banking/transaction processing, capital markets and insurance services;

Healthcare, which includes healthcare providers and payers as well as life sciences customers;

Manufacturing/Retail/Logistics, which includes consumer goods manufacturers, retailers, travel and other hospitality customers, as well as customers providing logistics services; and

Other, which is an aggregation of industry operating segments each of which, individually, represents less than 10.0% of consolidated revenues and segment operating profit. The Other segment includes information, media and entertainment services, communications, and high technology operating customers.

Our chief operating decision maker evaluates Cognizant's performance and allocates resources based on segment revenues and operating profit. Segment operating profit is defined as income from operations before unallocated costs. Generally, operating expenses for each operating segment have similar characteristics and are subject to the same factors, pressures and challenges. However, the economic environment and its effects on industries served by our operating groups may affect revenue and operating expenses to differing degrees. Expenses included in segment operating profit consist principally of direct selling and delivery costs as well as a per seat charge for use of the development and delivery centers. Certain selling, general and administrative expenses, excess or shortfall of incentive compensation for delivery personnel as compared to target, stock-based compensation expense, a portion of depreciation and amortization and the impact of the settlements of our cash flow hedges are not allocated to individual segments in internal management reports used by the chief operating decision maker. Accordingly, such expenses are excluded from segment operating profit.

We had approximately 1,197 active clients as of December 31, 2013. Accordingly, we provide a significant volume of services to many customers in each of our business segments. Therefore, a loss of a significant customer or a few significant customers in a particular segment could materially reduce revenues for that segment. However, no individual customer accounted for sales in excess of 10% of our consolidated revenues during 2013, 2012 or 2011. In addition, the services we provide to our larger customers are often critical to the operations of such customers and we believe that a termination of our services would require an extended transition period with gradually declining revenues.


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Results of Operations for the Three Years Ended December 31, 2013

The following table sets forth certain financial data for the three years ended December 31, 2013:

(Dollars in thousands)

                                                    % of                             % of                             % of              Increase (Decrease)
                                   2013           Revenues          2012           Revenues          2011           Revenues          2013              2012
Revenues                        $ 8,843,189           100.0      $ 7,346,472           100.0      $ 6,121,156           100.0      $ 1,496,717       $ 1,225,316
Cost of revenues(1)               5,265,469            59.5        4,278,241            58.2        3,538,622            57.8          987,228           739,619
Selling, general and
administrative(1)                 1,727,609            19.5        1,557,646            21.2        1,328,665            21.7          169,963           228,981
Depreciation and
amortization                        172,201             1.9          149,089             2.0          117,401             1.9           23,112            31,688

Income from operations            1,677,910            19.0        1,361,496            18.5        1,136,468            18.6          316,414           225,028
Other income (expense), net          10,007                           26,100                           32,681                          (16,093 )          (6,581 )
Provision for income taxes          459,339                          336,333                          285,531                          123,006            50,802

Net income                      $ 1,228,578            13.9      $ 1,051,263            14.3      $   883,618            14.4      $   177,315       $   167,645

Diluted earnings per share      $      4.03                      $      3.44                      $      2.85                      $      0.59       $      0.59

Other Financial
Information(2)
Non-GAAP income from
operations and non-GAAP
operating margin                $ 1,820,712            20.6      $ 1,484,722            20.2      $ 1,240,121            20.3      $   335,990       $   244,601

Non-GAAP diluted earnings
per share                       $      4.38                      $      3.74                      $      3.10                      $      0.64       $      0.64

(1) Exclusive of depreciation and amortization expense.

(2) Non-GAAP income from operations, non-GAAP operating margin and non-GAAP diluted earnings per share are not measurements of financial performance prepared in accordance with GAAP. See "Non-GAAP Financial Measures" for more information and a reconciliation to the most directly comparable GAAP financial measure.

Revenue-Overall. Revenue increased by 20.4% to $8,843.2 million during 2013 as compared to an increase of 20.0% to $7,346.5 million in 2012. In both years, the increase was primarily attributed to greater acceptance of our global delivery model among an increasing number of industries, continued interest in using our global delivery model as a means to reduce overall IT and operations costs, increased customer spending on discretionary projects, and continued penetration in all our geographic markets. Revenues from new customers contributed $243.4 million and $136.5 million, representing 16.3% and 11.1% of the year-over-year revenue growth for 2013 and 2012, respectively. Our acquisitions of the C1 Group companies and Equinox Consulting contributed to new customer revenue growth in 2013. In 2013, our consulting and technology services revenues increased by approximately 18.3% and represented approximately 50.2% of total 2013 revenues, while our outsourcing services revenue increased by approximately 22.6% and constituted approximately 49.8% of total revenues. In 2012, consulting and technology services revenue increased by 20.4% and represented


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approximately 51.1% of total 2012 revenues, while our outsourcing services increased by approximately 19.6% and constituted approximately 48.9% of total 2012 revenues.

We had approximately 1,197 active clients as of December 31, 2013 as compared to approximately 821 and 785 active clients as of December 31, 2012 and 2011, respectively. Revenues from our top five customers as a percentage of total revenues were 13.2%, 14.0% and 16.3% in 2013, 2012 and 2011, respectively. Revenues from our top ten customers as a percentage of total revenues were 22.6%, 25.0% and 27.7% in 2013, 2012 and 2011, respectively. As we continue to add new customers and increase our penetration at existing customers, we expect the percentage of revenues from our top five and top ten customers to decline over time.

Revenue-Reportable Segments. Revenues by reportable business segment were as follows:

(Dollars in thousands)

                                                                                                     Increase
                                                                                          2013                       2012
                                    2013            2012            2011              $            %             $            %
Financial services               $ 3,717,573     $ 3,035,447     $ 2,518,422     $   682,126       22.5     $   517,025       20.5
Healthcare                         2,264,826       1,934,898       1,622,157         329,928       17.1         312,741       19.3
Manufacturing/Retail/Logistics     1,868,305       1,498,668       1,197,472         369,637       24.7         301,196       25.2
Other                                992,485         877,459         783,105         115,026       13.1          94,354       12.0

Total revenue                    $ 8,843,189     $ 7,346,472     $ 6,121,156     $ 1,496,717       20.4     $ 1,225,316       20.0

Revenue from our Financial Services segment grew 22.5% or $682.1 million in 2013, as compared to 2012. This strength was driven by revenue growth of $494.1 million from our banking customers who benefited from the improving economy. In this segment, revenue from customers added during 2013 was approximately $75.3 million and represented 11.0% of the year-over-year revenue increase in this segment. During the year, key areas of focus for our Financial Services customers included cost optimization, regulatory and compliance driven initiatives, risk management, and the adoption and integration of SMAC solutions to align with shifts in consumer preferences. Revenue from our Financial Services segment grew 20.5% or $517.0 million in 2012, as compared to 2011. During 2012, our banking and insurance customers each almost equally contributed to the year-over-year revenue increase. In 2012, revenue from customers added during that year was approximately $35.5 million and represented 6.9% of the year-over-year revenue increase in this segment.

Revenue from our Healthcare segment grew 17.1% or $329.9 million in 2013, as compared to 2012. Our healthcare and life sciences customers contributed approximately $241.5 million and $88.4 million, respectively, to the year-over-year revenue increase. Revenue from customers added during 2013 was approximately $30.4 million and represented 9.2% of the year-over-year revenue increase in this segment. Growth within the segment was driven by work related to Affordable Care Act initiatives, including extended support for member enrollment and the implementation of direct to consumer programs through mobile platforms. Revenue from our Healthcare segment grew 19.3% or $312.7 million in 2012, as compared to 2011. In 2012, growth was driven primarily by our healthcare customers, which contributed $222.4 million to year-over-year revenue growth. Revenue from customers added during 2012 was approximately $19.8 million and represented 6.3% of the year-over-year revenue increase in this segment. IT spending by some of our life sciences customers has been and may continue to be adversely impacted by the patent cliff affecting some of our pharmaceutical customers.

Revenue from our Manufacturing/Retail/Logistics segment grew 24.7% or $369.6 million in 2013, as compared to 2012. During 2013, growth was stronger among our manufacturing and logistics customers, where revenue increased by approximately $200.0 million as compared to approximately $169.6 million for our retail and hospitality customers. Revenue from customers added during 2013 was approximately $79.9 million and represented 21.6% of the year-over-year revenue increase in this segment. Demand within this segment was


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driven by multichannel commerce implementation and integration efforts, supply chain consulting and implementation initiatives, and increased adoption of SMAC solutions. Revenue from our Manufacturing/Retail/Logistics segment grew 25.2% or $301.2 million in 2012, as compared to 2011. In 2012, growth within this segment was stronger among our retail and hospitality customers, where revenue increased by approximately $219.0 million, while revenue for our manufacturing and logistics customers increased by approximately $82.2 million. In 2012, revenue from customers added during that year was approximately $57.8 million and represented 19.2% of the year-over-year revenue increase in this segment.

Revenue from our Other segment grew 13.1% or $115.0 million in 2013, as compared to 2012. In 2013, growth within Other was particularly strong among our high technology customers, where revenue increased by approximately $54.0 million due to an increase in discretionary spending. Revenue from customers added during 2013 was approximately $57.9 million and represented 50.3% of the year-over-year revenue increase in this segment. Revenue from our Other segment grew 12.0% or $94.4 million in 2012, as compared to 2011. In 2012, each of our operating segments within Other, including information, media and entertainment services, communications and high technology, grew slower than the company average. In 2012, revenue from customers added during that year was approximately $23.4 million and represented 24.8% of the year-over-year revenue increase in this segment.

Revenue-Geographic Locations. Revenues by geographic location were as follows:

(Dollars in thousands)

                                                                                                  Increase
                                                                                       2013                       2012
                                 2013            2012            2011              $            %             $            %
North America                 $ 6,860,067     $ 5,836,258     $ 4,802,958     $ 1,023,809       17.5     $ 1,033,300       21.5

United Kingdom                    942,579         764,936         698,853         177,643       23.2          66,083        9.5
Rest of Europe                    636,626         430,554         398,622         206,072       47.9          31,932        8.0

Europe-Total                    1,579,205       1,195,490       1,097,475         383,715       32.1          98,015        8.9

Rest of World                     403,917         314,724         220,723          89,193       28.3          94,001       42.6

Total Revenue                 $ 8,843,189     $ 7,346,472     $ 6,121,156     $ 1,496,717       20.4     $ 1,225,316       20.0

North America continues to be our largest market representing approximately 77.6% of total revenue in 2013 and accounted for $1,023.8 million of the $1,496.7 million revenue increase in 2013. Revenue from Europe grew 32.1% in 2013. Excluding approximately $93.5 million of revenue from our 2013 acquisitions of the C1 Group companies and Equinox Consulting, revenue from Europe grew 24.3%. The strong revenue growth in Europe was driven by Europe's economic recovery and the increasing acceptance of our global delivery model. Conversely, in 2012, revenue in Europe grew 8.9% year-over-year and was negatively impacted by the economic downturn in Europe during 2012. We believe the European market is under-penetrated and represents a significant future growth opportunity for us. The acquisitions of the C1 Group companies and Equinox Consulting significantly strengthen our local presence in Germany and France. Revenue growth from Rest of World customers in 2013 was primarily driven by the Middle East, Singapore and India markets and, in 2012, the revenue growth for Rest of World was driven primarily by the Singapore market. We believe that Europe, the Middle East, the Asia Pacific and Latin America regions will continue to be areas of significant investment for us as we see these regions as growth opportunities for the long term.

Cost of Revenues (Exclusive of Depreciation and Amortization Expense). Our cost of revenues consists primarily of salaries, incentive-based compensation, stock-based compensation expense, payroll taxes, employee benefits, immigration and project-related travel for technical personnel, subcontracting and sales commissions related to revenues. Our cost of revenues increased by 23.1% or $987.2 million during 2013 as compared to an increase of approximately 20.9% or $739.6 million during 2012. In both 2013 and 2012, the increase was due


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primarily to an increase in compensation and benefits costs, including incentive-based compensation. In 2013, compensation and benefit costs, including incentive-based compensation, increased by approximately $870.2 million as a result of the increase in the number of our technical personnel and higher accrual of individual bonus payouts. In 2012, the increase in compensation and benefit costs, including incentive based compensation, was approximately $660.3 million and was due primarily to the increase in the number of our technical personnel, partially offset by the favorable impact of the depreciation of the Indian rupee versus the U.S. dollar, net of the impact of our cash flow hedge losses.

Selling, General and Administrative Expenses. Selling, general and administrative expenses consist primarily of salaries, incentive-based compensation, stock-based compensation expense, payroll taxes, employee benefits, immigration, travel, promotion, communications, management, finance, administrative and occupancy costs. Selling, general and administrative expenses, including depreciation and amortization, increased by 11.3%, or $193.1 million during 2013 as compared to an increase of approximately 18.0% or $260.7 million during 2012. Selling, general and administrative expenses, including depreciation and amortization, decreased as a percentage of revenue to 21.5% in 2013 as compared to 23.2% in 2012 and 23.6% in 2011. In both 2013 and 2012, the decrease as a percentage of revenue was due primarily to economies of scale that allowed us to leverage our cost structure over a larger organization and the favorable impact of the depreciation of the Indian rupee versus the U.S. dollar, net of losses on our cash flow hedges.

Income from Operations and Operating Margin-Overall. Income from operations increased 23.2%, or approximately $316.4 million in 2013 as compared to an increase of 19.8% or approximately $225.0 million during 2012. Our operating margin increased to 19.0% of revenues in 2013 from 18.5% of revenues in 2012, due to revenue growth outpacing headcount growth and the impact of the depreciation of the Indian rupee against the U.S. dollar, net of losses on our cash flow hedges, partially offset by increases in compensation and benefit costs, including incentive-based compensation costs. In 2012, operating margin decreased slightly to 18.5% of revenues in 2012 from 18.6% of revenues in 2011, due to continued investments to grow our business partially offset by the favorable impact of the depreciation of the Indian rupee against the U.S. dollar, net of losses on our cash flow hedges, and economies of scale that allowed us to leverage our cost structure over a larger organization. Excluding the impact of applicable designated cash flow hedges, the depreciation of the Indian rupee against the U.S. dollar positively impacted our operating margin by approximately 209 basis points or 2.09 percentage points in 2013 and 355 basis points or 3.55 percentage points in 2012. Each additional 1.0% change in exchange rate between the Indian rupee and the U.S. dollar will have the effect of moving our operating margin by approximately 22 basis points or 0.22 percentage points.

For the years ended December 31, 2013, 2012, and 2011, our non-GAAP operating . . .

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