SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-K
FOR ANNUAL AND TRANSITION REPORTS
PURSUANT TO SECTIONS 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2002
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OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
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Commission File Number 0-24429
COGNIZANT TECHNOLOGY SOLUTIONS CORPORATION
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(Exact Name of Registrant as Specified in Its Charter)
Delaware 13-3728359
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(State or Other Jurisdiction of (I.R.S. Employer Identification No.)
Incorporation or Organization)
500 Glenpointe Centre West, Teaneck, New Jersey 07666
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(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code: (201) 801-0233
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Securities registered pursuant to Section 12(b) of the Act: None
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Securities registered pursuant to Section 12(g) of the Act:
Class A Common Stock, $0.01 par value per share
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(Title of Class)
Class B Common Stock, par value $0.01 per share
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(Title of Class)
Preferred Share Purchase Rights
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(Title of Class)
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes[X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
Indicate by check mark whether the registrant is an accelerated filer as defined
in Rule 12b-2 of the Act. Yes [X] No [ ]
The aggregate market value of the registrant's voting shares of common stock
held by non-affiliates of the registrant on June 28, 2002, based on $53.75 per
share, the last reported sale price on the NASDAQ National Market on that date,
was $447,186,563 million.
The number of shares of Class A common stock, $0.01 par value, of the registrant
outstanding as of March 3, 2003 was 20,470,238 shares. There were no shares of
Class B common stock, $0.01 par value, of the registrant outstanding as of March
3, 2003.
The following documents are incorporated by reference into the Annual Report on
Form 10-K: Portions of the registrant's definitive Proxy Statement for its 2003
Annual Meeting of Stockholders are incorporated by reference into Part III of
this Report.
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TABLE OF CONTENTS
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Item PAGE
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PART I 1. Business................................................. 4
2. Properties............................................... 17
3. Legal Proceedings........................................ 19
4. Submission of Matters to a Vote of Security Holders...... 19
PART II 5. Market for the Company's Common Equity and
Related Stockholder Matters.............................. 21
6. Selected Consolidated Financial Data..................... 27
7. Management's Discussion and Analysis of
Financial Condition and Results of Operations ........... 28
7A. Quantitative and Qualitative Disclosures
Amount Market Risk ...................................... 47
8. Financial Statements and Supplementary Data.............. 47
9. Changes in and Disagreements with Accountants
on Accounting and Financial Disclosure................... 47
PART III 10. Directors and Executive Officers of the Company.......... 48
11. Executive Compensation................................... 48
12. Security Ownership of Certain Beneficial Owners
and Management........................................... 48
13. Certain Relationships and Related Transactions........... 48
14. Controls and Procedures.................................. 48
PART IV 15. Exhibits, Financial Statement Schedule,
and Reports on Form 8-K.................................. 49
SIGNATURES.............................................................. 51
EXHIBIT INDEX........................................................... 57
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS.............................. F-1
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PART I
Item 1. Business
Overview
Cognizant Technology Solutions Corporation ("Cognizant", "CTS" or the
"Company") is a leading provider of custom IT design, development, integration
and maintenance services primarily for Fortune 1000 companies located in the
United States and Europe. Cognizant's core competencies include web-centric
applications, data warehousing, component-based development and legacy and
client-server systems. Cognizant provides the IT services it offers using an
integrated on-site/offshore business model. This seamless on-site/offshore
business model combines technical and account management teams located on-site
at the customer location and offshore at dedicated development centers located
in India and Ireland.
Cognizant began its IT development and maintenance services business in
early 1994, as an in-house technology development center for The Dun &
Bradstreet Corporation and its operating units. In 1996, Cognizant, along with
certain other entities, was spun-off from the Dun & Bradstreet Corporation to
form a new company, Cognizant Corporation. On June 24, 1998, Cognizant completed
an initial public offering of an Class A common stock (the "IPO"). On June 30,
1998, a majority interest in Cognizant, and certain other entities were spun-off
from Cognizant Corporation to form IMS Health Incorporated ("IMS Health").
Subsequently, Cognizant Corporation was renamed Nielsen Media Research,
Incorporated. At December 31, 2002, IMS Health owned 55.3% of the outstanding
stock of Cognizant (representing all of Cognizant's Class B common stock) and
held 92.5% of the combined voting power of Cognizant's common stock. Holders of
Cognizant's Class A common stock have one vote per share and holders of
Cognizant's Class B common stock had ten votes per share.
On February 11, 2000, the Board of Directors declared a 2-for-1 stock split
effected by a 100% dividend payable on March 16, 2000 to stockholders of record
on March 2, 2000. The stock split has been reflected in the accompanying
consolidated financial statements, and all applicable references as to the
number of common shares and per share information have been restated.
Appropriate adjustments have been made in the exercise and number of shares
subject to stock options. Stockholder equity accounts have been restated to
reflect the reclassification of an amount equal to the par value of the increase
in issued common shares from the additional paid-in-capital account to the
common stock accounts.
On May 23, 2000, the stockholders of the Company approved an increase in
the number of authorized Class B common stock from 15,000,000 shares to
25,000,000 shares.
On January 30, 2003, the Company filed a tender offer in which IMS Health
stockholders could exchange IMS Health shares held by them for Cognizant Class B
common stock held by IMS Health.
On February 13, 2003, IMS Health distributed all of the Cognizant Class B
common stock that IMS Health owned (a total of 11,290,900 shares) in an exchange
offer to its stockholders. IMS Health distributed 0.309 shares of Cognizant
Class B common stock to its
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stockholders for every one share of IMS Health's common stock tendered. There
was no impact on the number of Cognizant's total shares outstanding upon the
completion of the exchange offer.
As of February 21, 2003, pursuant to Cognizant's Restated Certificate of
Incorporation, all of the shares of Class B common stock automatically converted
into shares of Class A common stock. According to Cognizant's Restated
Certificate of Incorporation, if at any time the outstanding shares of Cognizant
Class B common stock ceased to represent at least 35% of the economic ownership
represented by the aggregate number of shares of Cognizant common stock then
outstanding, each share of Cognizant Class B common stock shall automatically
convert into one share of Class A common stock. This automatic conversion
occurred on February 21, 2003 based on share numbers received by Cognizant from
its transfer agent (American Stock Transfer and Trust Company) as of the close
of business February 20, 2003, which indicated that the Class B common stock
represented less than 35% ownership represented by the aggregate number of
shares of Cognizant common stock then outstanding. Accordingly, as of February
21, 2003, there are no shares of Class B common stock outstanding.
On March 5, 2003, the Board of Directors declared a 3-for-1 stock split
effected by a 200% stock dividend payable on April 1, 2003 to stockholders of
record on March 19, 2003. Pro forma unaudited earnings per share reflective of
the stock split have been presented in Cognizant's Consolidated Statement of
Operations. The historical share and per share amounts in the consolidated
financial statements have not been restated to reflect the 3-for-1 stock split.
Such amounts will be restated on the effective date of the stock dividend.
The Company provides the IT services it offers using an integrated
on-site/offshore business model. This seamless on-site/offshore business model
combines technical and account management teams located on-site at the customer
location and offshore at dedicated development centers located in India and
Ireland. The Company markets and sells its technology consulting services
directly through its professional staff, senior management and sales personnel.
The Company operates out of its Teaneck, New Jersey headquarters and its
regional and international offices. The number of customers for whom the Company
has provided services has grown from 90 customers in 2000 to 100 customers in
2001; and to 115 customers in 2002. The Company's customers include:
ACNielsen Corporation First Data Corporation
ADP, Incorporated IMS Health Incorporated ("IMS Health")
Brinker International, Incorporated Metropolitan Life Insurance Company
CCC Information Services Incorporated Nielsen Media Research, Incorporated
Computer Sciences Corporation PNC Bank
The Dun & Bradstreet Corporation Royal & SunAlliance USA
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ACQUISITIONS
On June 30, 2002, the Company acquired the assets of UnitedHealthcare
Ireland Limited ("UHCI"), a subsidiary of UnitedHealth Group. UHCI previously
provided, and will continue to provide through Cognizant Technology Solutions
Ireland Limited ("CTS Ireland"), application development and maintenance
services, using the existing staff of approximately 70 software professionals.
This acquisition is designed to enable the Company to provide a wide range of
services to the Company's clients in Europe and worldwide and represents the
initial implementation of the Company's previously announced international
expansion strategy.
Additionally, on October 29, 2002, the Company completed the transfer of
Silverline Technologies, Inc.'s practice, which serviced a major financial
services company to the Company. Under the terms of the transfer, the Company
will provide application design, development and maintenance services to such
major financial services company through an acquired workforce of approximately
three hundred IT and support professionals located primarily in the United
States and India.
INDUSTRY BACKGROUND
Many companies today face intense competitive pressure and rapidly changing
market dynamics. In addition, the evolution of technology and the
commercialization of the Internet have contributed to the rapid change in the
business environment. In response to these challenges, many companies are
focused on improving productivity, increasing service levels, lowering costs and
accelerating delivery times. In order to achieve these goals, companies are
implementing a broad range of technologies, such as,
o e-business and e-commerce applications;
o data warehousing;
o customer and supply chain management; and
o middleware/enterprise application integration.
These technologies facilitate faster, more responsive, lower-cost business
operations. However, their development, integration and on-going maintenance
present major challenges and require a large number of highly skilled
professionals trained in many diverse technologies. In addition, companies also
require additional technical resources to maintain, enhance and re-engineer
their core legacy IT systems and to address application maintenance projects.
Increasingly, companies are relying on custom IT solutions providers, such as
Cognizant, to provide these services.
In order to respond effectively to a changing and challenging business
environment, IT departments of many companies have focused increasingly on
improving returns on IT investments, lowering costs and accelerating the
delivery of new systems and solutions. To accomplish these objectives, many IT
departments have shifted all or a portion of their IT
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development, integration and maintenance requirements to outside service
providers. This outsourcing enables companies to eliminate or reduce the large
in-house IT staffs otherwise required to evaluate, implement and manage IT
initiatives, thereby reducing the present and future investments required to
maintain and continually train a technical staff. In order to achieve greater
cost savings and to increase delivery times, companies are increasingly turning
to IT services providers operating with on-site/offshore business models.
Global demand for high quality, lower cost IT services from outside
providers has created a significant opportunity for IT service providers which
can successfully leverage the benefits of, and address the challenges in using,
an offshore talent pool. The effective use of offshore personnel can offer a
variety of benefits, including lower costs, faster delivery of new IT solutions
and more flexible scheduling. Certain developing countries, particularly India,
have a large talent pool of highly qualified technical professionals that can
provide high quality IT services at a lower cost. India is a leader in IT
services and is regarded as having one of the largest pools of IT talent in the
world. Historically, IT service providers have used offshore labor pools
primarily to supplement the internal staffing needs of customers. However,
evolving customer demands have led to the increasing acceptance and use of
offshore resources for higher value-added services. These services include
application design, development, integration and maintenance. India's services
and software exports have grown from $5.2 billion for the fiscal year ended
March 31, 2001 to $6.0 billion for the fiscal year ended March 31, 2002, as
estimated by the National Association of Software and Services Companies
(NASSCOM) in India (converted from rupees to U.S. dollars at the respective
year-end noon-buying rates announced by the New York Federal Reserve Bank). This
represents a 15% growth over the prior period. NASSCOM has projected India's
services and software exports to grow at a rate of approximately 22% for fiscal
year 2002-03.
Using an offshore workforce to provide value-added services presents a
number of challenges to IT service providers. The offshore implementation of
value-added IT services requires that IT service providers continually and
effectively attract, train and retain highly skilled software development
professionals with the advanced technical skills necessary to keep pace with
continuing changes in information technology, evolving industry standards and
changing customer preferences. These skills are necessary to design, develop and
deploy high-quality technology solutions in a cost-effective and timely manner.
In addition, IT service providers must have the methodologies, processes and
communications capabilities to enable offshore workforces to be successfully
integrated with on-site personnel. Service providers must also have strong
research and development capabilities, technology competency centers and
relationship management skills in order to compete effectively.
THE COGNIZANT SOLUTION
Cognizant believes that it has developed an effective integrated
on-site/offshore business model, and that this business model will be a critical
element of Cognizant's continued growth. To support this business model, at
December 31, 2002, Cognizant employed over 3,900 programmers in India and over
5,400 globally. Cognizant has also established facilities, technology and
communications infrastructure in order to support its business model. By basing
certain technical operations in India, Cognizant has access to a large pool of
skilled, English-speaking IT professionals. These IT professionals provide high
quality services to Cognizant's
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customers at costs significantly lower than services sourced exclusively in
developed countries. Cognizant's strengths, which Cognizant believes
differentiate it from other IT service providers, include the following:
ESTABLISHED AND SCALABLE PROPRIETARY PROCESSES. Cognizant has developed
proprietary methodologies for integrating on-site and offshore teams to
facilitate cost-effective, on-time delivery of high-quality projects. These
methodologies comprise Cognizant's proprietary Q*VIEW software engineering
process, which is available to all on-site and offshore programmers. Cognizant
uses this ISO 9000 certified process to define and implement projects from the
design, development and deployment stages through to on-going application
maintenance. For most projects, Q*VIEW is used as part of an initial assessment
that allows Cognizant to define the scope and risks of the project and subdivide
the project into smaller phases with frequent deliverables and feedback from
customers. Cognizant also uses its Q*VIEW process to detect, mitigate and
correct possible quality defects and to establish appropriate contingencies for
each project. In order to ensure implementation of the quality process,
Cognizant assigns a quality facilitator to each project who reports to a
centralized quality assurance and software engineering group. This group
performs, on a sample basis, quality audits, deliverables verifications, metrics
collection and analysis, which are used to improve processes and methodologies.
These processes and methodologies have proven to be scalable, as Cognizant has
significantly increased the number of offshore development centers, customers
and projects. In addition, all of Cognizant's principal development centers have
been assessed by KPMG at Level 5 (the highest possible rating) of the Capability
Maturity Model of the Software Engineering Institute at Carnegie Mellon
University, which is a widely recognized means of measuring the quality and
maturity of an organization's software development and maintenance processes.
HIGHLY SKILLED WORKFORCE. Cognizant's managers and senior technical
personnel provide in-depth project management expertise to customers. To
maintain this level of expertise, Cognizant has placed significant emphasis on
recruiting and training its workforce of highly skilled professionals. Cognizant
has over 350 project managers and senior technical personnel around the world,
many of whom have significant work experience in the United States and Europe.
Cognizant also maintains programs and personnel to hire and train the best
available technical professionals in both legacy systems and emerging
technologies. Cognizant provides five months of combined classroom and
on-the-job training to newly hired programmers, as well as additional annual
training programs designed to enhance the business practices, tools, technology
and consulting skills of Cognizant's professional staff. Cognizant was recently
assessed at Level 5 (the highest possible rating) of the People Capability
Maturity Model (P-CMM) version 2.0.
RESEARCH AND DEVELOPMENT AND COMPETENCY CENTERS. Cognizant has project
experience and expertise across multiple architectures and technologies, and
makes significant investments in its competency centers and in research and
development to keep abreast of the latest technology developments. Most of
Cognizant's programmers are trained in multiple technologies and architectures.
As a result, Cognizant is able to react to customers' needs quickly and
efficiently redeploy programmers to different technologies. In order to develop
and maintain this flexibility, Cognizant has made a substantial investment in
its competency centers where the
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experience gained from particular projects and research and development efforts
is leveraged across the entire company. In addition, through its investment in
research and development activities and the continuing education of its
technical personnel, Cognizant enlarges its knowledge base and develops the
necessary skills to keep pace with emerging technologies. Cognizant believes
that its ability to work in new technologies allows it to foster long-term
relationships by having the capacity to continually address the needs of both
existing and new customers.
WELL-DEVELOPED INFRASTRUCTURE. Cognizant's extensive facilities, technology
and communications infrastructure facilitate the seamless integration of its
on-site and offshore workforces. This is accomplished by permitting team members
in different locations to access common project information and to work directly
on customer projects. This infrastructure allows for:
o rapid completion of projects;
o highest level of quality;
o off-peak use of customers' technological resources; and
o real-time access to project information by the on-site account
manager or the customer.
International time differences enable Cognizant's offshore teams located in
India to access a customer's computing facilities located in the United States
and Europe during off-peak hours. This ability to perform services during
off-peak hours enables Cognizant to complete projects more rapidly and does not
require Cognizant's customers to invest in duplicative hardware and software. In
addition, for large projects with short time frames, Cognizant's offshore
facilities allow for parallel processing of various development phases to
accelerate delivery time. In addition, Cognizant can deliver services more
rapidly than some competitors without an offshore labor pool because Cognizant's
lower labor costs enable it to cost-effectively assign more professionals to a
project.
BUSINESS STRATEGIES
Cognizant's objectives are to maximize stockholder value and enhance
Cognizant's position as a leading provider of custom IT design, development,
integration and maintenance services. Cognizant implements the following core
strategies to achieve these objectives:
FURTHER DEVELOP LONG-TERM CUSTOMER RELATIONSHIPS. Cognizant has strong
long-term strategic relationships with its customers and business partners.
Cognizant seeks to establish long-term relationships that present recurring
revenue opportunities, frequently trying to establish relationships with its
customers' chief information officers, or other IT decision makers, by offering
a wide array of cost-effective high quality services. Over 80% of Cognizant's
revenues in the year ended December 31, 2002 were derived from customers who had
been using Cognizant's services for one year or more. Cognizant also seeks to
leverage its experience with a customer's IT systems into new business
opportunities. Knowledge of a customer's IT systems
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gained during the performance of application maintenance services, for example,
may provide Cognizant with a competitive advantage in securing additional
development and maintenance projects from that customer.
EXPAND SERVICE OFFERINGS AND SOLUTIONS. Cognizant has several teams
dedicated to developing new, high value services. These teams collaborate with
customers to develop these services. For example, Cognizant is currently
developing new solutions for IT systems portfolio analysis, program management,
technology architecture and strategy, systems testing, legacy restoration and
digital security and forensics. In addition, Cognizant invests in internal
research and development and promotes knowledge building and sharing across the
organization in order to promote the development of new services and solutions
that it can offer to customers. Furthermore, Cognizant continues to enhance its
capabilities and service offerings in the areas of Customer Relationship
Management, or CRM, and Enterprise Resource Planning, or ERP. Cognizant believes
that the continued expansion of its service offerings will reduce its reliance
on any one technology initiative and will help foster long-term relationships
with customers by allowing Cognizant to serve the needs of its customers better.
ENHANCE PROCESSES, METHODOLOGIES AND PRODUCTIVITY TOOLSETS. Cognizant is
committed to improving and enhancing its proprietary Q*VIEW software engineering
process and other methodologies and toolsets. In light of the rapid evolution of
technology, Cognizant believes that continued investment in research and
development is critical to its continued success. Cognizant is constantly
designing and developing additional productivity software tools to automate
testing processes and improve project estimation and risk assessment techniques.
In addition, Cognizant uses groupware technology to share project experience and
best practice methodologies across the organization with the objective of
improving productivity.
EXPAND DOMESTIC AND INTERNATIONAL GEOGRAPHIC PRESENCE. As Cognizant expands
its customer base, it plans to open additional sales and marketing offices in
the United States and internationally. It is expected that this expansion will
facilitate sales and service to existing and new customers. Cognizant has
established sales and marketing offices in Atlanta, Chicago, Dallas,
Minneapolis, Los Angeles, San Francisco and in Teaneck, New Jersey. In addition,
Cognizant has been pursuing market opportunities in Europe through its London
office, which was established in the beginning of 1998, and its recently
acquired development center in Limerick, Ireland.
PURSUE SELECTIVE STRATEGIC ACQUISITIONS, JOINT VENTURES AND STRATEGIC
ALLIANCES. Cognizant believes that opportunities exist in the fragmented IT
services market to expand its business through selective strategic acquisitions,
joint ventures and strategic alliances. Cognizant believes that acquisition and
joint venture candidates may enable it to expand its geographic presence and its
capabilities more rapidly, especially in the European market, as well as
accelerate its entry into areas of new technology. In addition, through its
working relationships with independent software vendors Cognizant obtains
projects using the detailed knowledge it gains in connection with a joint
development process. Finally, Cognizant will strategically partner with select
IT service firms that offer complementary services in order to best meet the
requirements of its customers.
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SERVICES
Cognizant provides a broad range of IT services, including:
Service Summary Description of Service Offerings
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Application Design, Development, Define customer requirements, write
Integration and Re-engineering specifications and design, develop, test and
integrate software across multiple platforms
including Internet technologies. Modify and
test applications to enable systems to
function in new operating environments.
Application Maintenance Support some or all of a customer's
applications ensuring that systems remain
operational and responsive to changing user
requirements, and to provide on-going
enhancement as required by the customer.
Cognizant uses its Q*VIEW software engineering process, its on-site and
offshore business model and well-developed technology and communications
infrastructure to deliver these services.
APPLICATION DEVELOPMENT, INTEGRATION AND RE-ENGINEERING SERVICES. Cognizant
follows either of two alternative approaches to application development and
integration:
o full life-cycle application development, in which Cognizant
assumes start-to-finish responsibility for analysis, design,
implementation, testing and integration of systems; or
o cooperative development, in which Cognizant employees work with a
customer's in- house IT personnel to jointly analyze, design,
implement, test and integrate new systems.
In both cases, Cognizant's on-site team members work closely with the
end-users of the application to define requirements and develop specifications.
Detailed design, implementation and testing are generally performed offshore at
Cognizant's ten IT development centers located in India, as well its development
center in Limerick, Ireland. In addition, Cognizant maintains an on-site
presence at each customer location in order to address evolving customer needs
and resulting changes to the project.
A key part of Cognizant's application development and integration offering
is a suite of services to help organizations build and integrate business
applications with the rest of their operations. In this suite of services,
Cognizant leverages its skills in business application development and
enterprise application integration to build sophisticated business applications
and to integrate these new applications and websites with client server and
legacy systems. Cognizant builds and deploys robust, scalable and extensible
architectures for use in a wide range of industries. Cognizant maintains
competency centers specializing in Microsoft, IBM and
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Sun, among others, in order to be able to provide application development and
integration services to a broad spectrum of customers.
Cognizant's re-engineering service offerings assist customers migrating
from systems based on legacy computing environments to newer, open systems-based
platforms and client/server architectures, often in response to the more
stringent demands of business. Cognizant's re-engineering tools automate many of
the processes required to implement advanced client/server technologies.
Cognizant believes that this automation substantially reduces the time and cost
to perform re-engineering services, savings that benefit both Cognizant and its
customers. These tools also enable Cognizant to perform source code analysis and
to re-design target databases and convert certain programming languages. If
necessary, Cognizant's programmers also help customers re-design and convert
user interfaces.
APPLICATION MAINTENANCE SERVICES. Cognizant provides services to help
ensure that a customer's core operational systems are free of defects and
responsive to the customer's changing needs. As part of this process, Cognizant
is often able to introduce product and process enhancements and improve service
levels to customers requesting modifications and on-going support.
Cognizant's on-site/offshore business model enables Cognizant to provide a
range of rapid response and cost-effective support services to its customers.
Cognizant's on-site team members often provide help-desk services at the
customer's facility. These team members typically carry pagers in the event of
an emergency service request and are available to quickly resolve customer
problems from remote locations. In the case of more complex maintenance
services, including modifications, enhancements and documentation, which
typically have longer turnaround times, Cognizant takes full advantage of its
offshore resources to develop solutions more cost-effectively than would be
possible relying on higher cost local professionals. The services provided by
Cognizant's offshore team members are delivered to customers using satellite and
fiber-optic telecommunications.
As part of Cognizant's application maintenance services, it assists
customers in renovating their core systems to meet the requirements imposed by
new regulations, new standards or other external events. These services include,
or have previously included, Year 2000 compliance, Eurocurrency compliance,
decimalization within the securities industry and compliance with the Health
Insurance Portability and Accountability Act for the healthcare industry.
Application maintenance service contracts are usually long term in nature
and, at times, can include an element of application development (See Note 2 to
the Consolidated Financial Statements).
Cognizant seeks to anticipate the operational environment of customer's IT
systems as it designs and develops such systems. Cognizant also offers
diagnostic services to customers to assist them in identifying shortcomings in
their IT systems and optimizing the performance of their systems.
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SALES AND MARKETING
Cognizant markets and sells its services directly through its professional
staff, senior management and direct sales personnel operating out of its
Teaneck, New Jersey headquarters and its business development offices in
Atlanta, Chicago, Dallas, Minneapolis, Los Angeles, San Francisco and London.
Cognizant manages its business and results of operations on a geographic basis.
At December 31, 2002, Cognizant had approximately 21 direct sales persons and 68
account managers. The sales and marketing group works with Cognizant's technical
team as the sales process moves closer to the customer's selection of an IT
service provider. The duration of the sales process varies depending on the type
of service, ranging from approximately two months to over one year. The account
manager or sales executive works with the technical team to:
o define the scope, deliverables, assumptions and execution
strategies for a proposed project;
o develop project estimates;
o prepare pricing and margin analyses; and
o finalize sales proposals.
Management reviews and approves proposals, which are then presented to the
prospective customer. Cognizant sales and account management personnel remain
actively involved in the project through the execution phase. Cognizant focuses
its marketing efforts on businesses with intensive information processing needs.
Cognizant maintains a prospect/customer database that is continuously updated
and used throughout the sales cycle from prospect qualification to close. As a
result of this marketing system, Cognizant pre-qualifies sales opportunities,
and direct sales representatives are able to minimize the time spent on prospect
qualification. In addition, substantial emphasis is placed on customer retention
and expansion of services provided to existing customers. In this regard,
Cognizant's account managers play an important marketing role by leveraging
their ongoing relationship with the customer to identify opportunities to expand
and diversify the type of services provided to that customer.
CUSTOMERS
The number of customers served by Cognizant has increased significantly in
recent years. Cognizant provided services to 90 customers in 2000; 100 customers
in 2001; and 115 customers in 2002.
For the year ended December 31, 2002, Cognizant derived its revenues from
the following industries: 34% from financial related services, 24% from
healthcare services, 17% from retail, manufacturing and logistics and 14% from
information services. The remaining portions of Cognizant's revenues were
derived from strategic alliances and other sources.
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Cognizant dedicates a number of its employees to each of the major industries it
services to better serve its customers.
Cognizant provides services either on a time-and-material basis or on the
basis of an agreed fixed bid. The volume of work performed for specific
customers is likely to vary from year to year, and a significant customer in one
year may not use Cognizant's services in a subsequent year.
Presented in the table below is additional information about
Cognizant's customers.
Year ended December 31,
2000 2001 2002
---- ---- ----
Percent of revenues from top five customers, including IMS 40% 35% 38%
Percent of revenues from top ten customers, including IMS 59% 53% 54%
Percent of revenues from IMS Health and current subsidiaries 10% 11% 9%
Application development services as a percent of revenues 46% 43% 43%
Application maintenance services as a percent of revenues 47% 52% 57%
Revenues under fixed-bid contracts as a percent of revenues 15% 24% 25%
For the year ended December 31, 2002, Cognizant derived 9% of its revenues
from IMS Health, 13% of its revenues from other companies formerly affiliated
with The Dun & Bradstreet Corporation, and 78% of its revenues from companies
never affiliated with The Dun & Bradstreet Corporation.
COMPETITION
The intensely competitive IT services market includes a large number of
participants and is subject to rapid change. This market includes participants
from a variety of market segments, including:
o systems integration firms;
o contract programming companies;
o application software companies;
o Internet solutions providers;
o the professional services groups of computer equipment companies;
and
o facilities management and outsourcing companies.
Cognizant's most direct competitors include, among others, WIPRO Ltd. and
Infosys Technologies Limited, which utilize an integrated on-site/offshore
business model comparable to that used by Cognizant. Cognizant also competes
with large IT service providers with greater resources, such as Accenture Ltd.,
Electronic Data Systems Corporation and IBM Global Services, who have announced
their intentions to develop more offshore capabilities to lower
14
their cost structure. In addition, Cognizant competes with numerous smaller
local companies in the various geographic markets in which Cognizant operates.
Many of Cognizant's competitors have significantly greater financial,
technical and marketing resources and greater name recognition than does
Cognizant. The principal competitive factors affecting the markets for
Cognizant's services include:
o performance and reliability;
o quality of technical support, training and services;
o responsiveness to customer needs;
o reputation, experience and financial stability; and
o competitive pricing of services.
Cognizant relies on the following to compete effectively:
o a well developed recruiting, training and retention model;
o a successful service delivery model;
o a broad referral base;
o continual investment in process improvement and knowledge
capture;
o investment in research and development;
o continued focus on responsiveness to customer needs, quality of
services, competitive; and
o prices, project management capabilities and technical expertise.
INTELLECTUAL PROPERTY
Cognizant's intellectual property rights are important to its business.
Cognizant presently holds no patents or registered copyrights. Instead,
Cognizant relies on a combination of intellectual property laws, trade secrets,
confidentiality procedures and contractual provisions to protect its
intellectual property. Cognizant requires its employees, independent
contractors, vendors and customers to enter into written confidentiality
agreements upon the commencement of their relationships with Cognizant. These
agreements generally provide that any confidential or proprietary information
developed by Cognizant or on its behalf be kept confidential. In addition, when
Cognizant discloses any confidential or proprietary information to third
parties, it routinely requires those third parties to agree in writing to keep
that information confidential.
15
A portion of Cognizant's business involves the development for customers of
highly complex information technology software applications and other technology
deliverables. This intellectual property includes written specifications and
documentation in connection with specific customer engagements. Cognizant's
customers usually own the intellectual property in the software Cognizant
develops for them.
Pursuant to a license agreement with IMS Health, all rights to the
"Cognizant" name and certain related trade and service marks were transferred to
Cognizant in July 1998. As of December 31, 2002, Cognizant held three registered
trademarks in the United States and four pending trademark applications in
India.
EMPLOYEES
At December 31, 2002, Cognizant employed approximately 1,425 persons on a
full-time basis in its North American headquarters and satellite offices and
on-site North American customer locations. Cognizant also employed approximately
240 persons on a full-time basis in its European satellite offices and on-site
European customer locations, principally in the United Kingdom and Ireland, and
approximately 4,500 persons on a full-time basis in its offshore IT development
centers in India. None of Cognizant's employees are subject to a collective
bargaining arrangement. Cognizant considers its relations with its employees to
be good.
Cognizant's future success depends to a significant extent on its ability
to attract, train and retain highly skilled IT development professionals. In
particular, Cognizant needs to attract, train and retain project managers,
programmers and other senior technical personnel. Cognizant believes there is a
shortage of, and significant competition for, IT development professionals in
the United States and in India with the advanced technological skills necessary
to perform the services Cognizant offers. Cognizant has an active recruitment
program in India, and has developed a recruiting system and database that
facilitates the rapid identification of skilled candidates. During the course of
the year, Cognizant conducts extensive recruiting efforts at premier colleges
and technical schools in India. Cognizant evaluates candidates based on academic
performance, the results of a written aptitude test measuring problem-solving
skills and a technical interview. In addition, Cognizant has an active lateral
recruiting program. A substantial majority of the personnel on most on-site
teams and virtually all the personnel staffed on offshore teams is comprised of
Indian nationals.
Cognizant's senior project managers are hired from leading consulting firms
in the United States and India. Cognizant's senior management and most of its
project managers have experience working in the United States and Europe. This
enhances Cognizant's ability to attract and retain other professionals with
experience in the United States. Cognizant has also adopted a career and
education management program to define its employees' objectives and career
plans. Cognizant has implemented an intensive orientation and training program
to introduce new employees to the Q*VIEW software engineering process and
Cognizant's services.
16
AVAILABLE INFORMATION
Cognizant makes available the following public filings with the Securities
and Exchange Commission (the "SEC") free of charge through its website at
www.cognizant.com as soon as reasonably practicable after they are filed with
the SEC:
o its Annual Reports on Form 10-K and any amendments thereto;
o its Quarterly Reports on Form 10-Q and any amendments thereto;
and
o its Current Reports on Form 8-K and any amendments thereto.
No information on Cognizant's Internet website is incorporated by reference into
this Form 10-K or any other public filing made by Cognizant with the SEC.
ITEM 2. PROPERTIES
Cognizant has recently completed construction of two fully-owned
state-of-the-art development centers containing approximately 250,000 square
feet of space in the Indian cities of Calcutta and Pune, and expects
construction of a third state-of-the-art development center in Chennai, India
containing approximately 370,000 square feet to be completed in 2003. Each of
these development centers will contain up-to-date technology infrastructure and
communications capabilities. These three facilities will be able to accommodate
approximately 6,000 employees in total. Cognizant believes that these new
facilities will provide Cognizant with an advantage in recruiting new employees
and in retaining customers.
Cognizant operates out of its Teaneck, New Jersey headquarters and its
regional and international offices. Cognizant believes that its current
facilities are adequate to support its existing operations. Cognizant also
believes that it will be able to obtain suitable additional facilities on
commercially reasonable terms on an "as needed" basis.
The Company occupies the following properties:
Approximate Area
Location (in sq. feet) Use Nature of Occupancy
- -------------------------------------------------------------------------------------------------------
Bangalore, India 25,849 Software Development Multiple leases expiring 04/30/05
Facility - 06/30/06 with renewal options
Bangalore, India 35,475 Software Development Lease expires 10/31/11 with
Facility renewal options
Chennai, India 96,002 Software Development Multiple leases expiring 06/30/03
Facility - 11/30/04 with renewal options
Chennai, India 15,536 Software Development Multiple leases expiring 1/31/06 -
Facility 4/30/06 with renewal options
17
Approximate Area
Location (in sq. feet) Use Nature of Occupancy
- -------------------------------------------------------------------------------------------------------
Chennai, India 43,350 Software Development Multiple leases expiring 8/31/04
Facility -03/14/06 with renewal options
Chennai, India 35,126 Software Development Multiple leases expiring 4/30/06
Facility with renewal options
Chennai, India 33,688 Software Development Lease expires 12/15/06 with
Facility renewal options
Chennai, India 397,440 Software Development Owned
Facility
Pune, India 172,800 Software Development Owned
Facility
Calcutta, India 129,600 Software Development Owned
Facility
Calcutta, India 13,928 Software Development Lease expires 04/30/03 with a
Facility renewal option
Calcutta, India 9,296 Software Development Lease expiring 01/31/03 with a
Facility renewal option
Calcutta, India 4,000 Software Development Multiple leases expiring 01/15/04
Facility -04/30/05 with renewal options
Hyderabad, India 40,640 Software Development Multiple leases expiring 01/31/03
Facility - 12/31/08
Teaneck, New Jersey 24,745 Executive and Business Multiple leases expiring 09/30/05
Development Office - 12/30/10
Atlanta, Georgia 957 Business Development Lease expires 9/14/03
Office
Chicago, Illinois 5,113 Business Development Lease expires 7/31/05
Office
Dallas, Texas 836 Business Development Lease expires 3/31/03
Office
Los Angeles, California 1,018 Business Development Lease expires 5/31/03
Office
Minneapolis, Minnesota 766 Business Development Lease expires 6/30/03
Office
San Ramon, California 5,670 Business Development Multiple leases expiring 10/15/06
Office
18
Approximate Area
Location (in sq. feet) Use Nature of Occupancy
- -------------------------------------------------------------------------------------------------------
Phoenix, Arizona 15,953 Software Development Lease on Month to Month basis
Facility
Toronto, Canada 200 Business Development Lease on Month to Month basis
Office
Frankfurt, Germany 66 Business Development Lease expires 03/31/07
Office
Limerick, Ireland 10,495 Software Development Multiple leases expiring 03/27/23 -
Facility 05/31/32
London, England 2,080 Business Development Multiple leases expiring 9/28/04
Office and month-to-month
Zurich, Switzerland 102 Business Development Lease expires 11/30/03
Office
Singapore 200 Business Development Lease expires 09/30/03
Office
ITEM 3. LEGAL PROCEEDINGS
The Company is involved in various claims and legal actions arising in the
ordinary course of business. In the opinion of management, the outcome of such
claims and legal actions, if decided adversely, is not expected to have a
material adverse effect on its quarterly or annual operating results, cash flows
or consolidated financial position.
ITEM 4. SUBMISSION OF MATTER TO A VOTE OF SECURITY HOLDERS
Subsequent to the end of the fiscal year, on January 7, 2003, the Board of
Directors, and IMS Health, the holder on such date of approximately 55% of the
Company's outstanding common stock and approximately 93% of the combined voting
power of the Company's outstanding common stock, by written consent in lieu of a
special stockholders meeting, approved the amendment and restatement of
Cognizant's Amended and Restated Certificate of Incorporation. As of January 7,
2003, 9,129,438 shares of Cognizant's Class A common stock and 11,290,900 shares
of Cognizant's Class B common stock were issued and outstanding. Each share of
Cognizant's Class A common stock entitles its holder to one vote on each matter
submitted to the stockholders and each share of Cognizant's Class B common stock
entitled its holder to ten votes on each matter submitted to the stockholders.
Because IMS Health, which held in excess of a majority of the voting power of
Cognizant's outstanding common stock as of the date of such stockholder action,
approved the foregoing amendment and restatement of the certificate of
incorporation by written consent, no other stockholder consents were solicited
in connection with the stockholder action. In compliance with Delaware law,
notice of such stockholder action was sent to all non-consenting stockholders on
January 17, 2003. The material terms of the amendments to the Amended and
Restated Certificate of Incorporation are summarized in Item 5 below. For
complete information, you should read the full text of the
19
Restated Certificate of Incorporation, which has been filed with the SEC as an
exhibit to the Company's Current Report of Form 8-K dated February 13, 2003. The
Restated Certificate of Incorporation is incorporated by reference into this
Annual Report on Form 10-K. The approved amendments were effected on February 7,
2003 upon the filing of the Restated Certificate of Incorporation with the
Secretary of State of the State of Delaware.
PART II
ITEM 5. MARKET FOR THE COMPANY'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Prior to June 1998, there was no established market for the Company's Class
B common stock. Since June 19, 1998, the Class A common stock has traded on the
Nasdaq National Market ("NNM") under the symbol "CTSH". Cognizant Class B common
stock is not listed on a stock exchange and does not trade.
Prior to February 13, 2003, all of the issued and outstanding shares of
Class B common stock were held by IMS Health. On February 13, 2003, IMS Health
distributed all of the Cognizant Class B common stock that IMS Health owned (a
total of 11,290,900 shares) in an exchange offer to its stockholders. IMS Health
distributed 0.309 shares of Cognizant Class B common stock to its stockholders
for every one share of IMS Health's common stock tendered. As of February 21,
2003, pursuant to Cognizant's Restated Certificate of Incorporation, all of the
shares of Class B common stock automatically converted into shares of Class A
common stock. According to Cognizant's Restated Certificate of Incorporation, if
at any time the outstanding shares of Cognizant Class B common stock ceased to
represent at least 35% of the economic ownership represented by the aggregate
number of shares of Cognizant common stock then outstanding, each share of
Cognizant Class B common stock shall automatically convert into one share of
Class A common stock. This automatic conversion occurred on February 21, 2003
based on share numbers received by Cognizant from its transfer agent (American
Stock Transfer and Trust Company) as of the close of business February 20, 2003,
which indicated that the Class B common stock represented less than 35%
ownership represented by the aggregate number of shares of Cognizant common
stock then outstanding. Accordingly, as of February 21, 2003, there are no
shares of Class B common stock outstanding.
The following table describes the per share range of high and low sale
prices for shares of Cognizant Class A common stock, as listed for quotation on
the NNM, and the quarterly cash dividends per share for the periods indicated.
Cash Dividend
Quarter Ended High Low Per Share
----------------------------------- ------ ------ -----------------
March 31, 2001..................... $50.25 $28.38 $0.00
June 30, 2001...................... $46.25 $31.48 $0.00
September 30, 2001................. $45.55 $20.94 $0.00
December 31, 2001.................. $45.10 $20.00 $0.00
March 31, 2002..................... $42.10 $33.01 $0.00
June 30, 2002...................... $54.22 $37.71 $0.00
September 30, 2002................. $63.68 $48.47 $0.00
December 31, 2002.................. $75.66 $48.00 $0.00
As of March 3, 2003, the approximate number of holders of record of the
Class A common stock was 28 and the approximate number of beneficial holders of
the Class A common stock was 29,950.
21
The Company has never declared or paid cash dividends on its Class A or
Class B common stock. The Company currently intends to retain any future
earnings to finance the growth of the business and, therefore, does not
currently anticipate paying any cash dividends in the foreseeable future.
AMENDMENTS TO COGNIZANT'S CERTIFICATE OF INCORPORATION
In connection with the exchange offer, IMS Health executed a written
consent in lieu of a special stockholders meeting to approve amendments to
Cognizant's certificate of incorporation that included the provisions described
below and became effective following consummation of the exchange offer. The
material terms of these amendments are summarized below. For complete
information, you should read the full text of the Restated Certificate of
Incorporation, which has been filed with the SEC as an exhibit to the Company's
Current Report of Form 8-K dated February 13, 2003. The Restated Certificate of
Incorporation is incorporated by reference into this Annual Report on Form 10-K.
EFFECTS OF THE AMENDMENTS
The exchange offer may make it easier for a single person or group of
related persons to gain control over Cognizant. Because IMS Health held
approximately 55% of Cognizant's outstanding common stock, constituting
approximately 93% of the combined voting power of Cognizant's common stock, it
was impossible for a person other than IMS Health to gain control of Cognizant
without IMS Health's consent. Following the exchange offer, however, the new
holders of Cognizant's common stock have the ability to elect Cognizant's entire
Board of Directors. Accordingly, a person or group of related persons could gain
control of Cognizant by acquiring a majority of the outstanding common stock, or
the votes represented by those shares. In addition, the control position that
IMS Health had in matters voted on by Cognizant stockholders were eliminated as
a result of the exchange offer. Eliminating IMS Health as holder of
approximately 55% of Cognizant's outstanding common stock, constituting
approximately 93% of the combined voting power of Cognizant's common stock, as a
result of the exchange offer could increase Cognizant's vulnerability to an
unsolicited takeover proposal. The charter amendments, together with the by-law
amendments and Cognizant's stockholders' rights plan will make it more difficult
for a potential acquirer of Cognizant to take advantage of Cognizant's new
capital structure in acquiring Cognizant by means of a transaction that is not
negotiated with Cognizant's Board of Directors.
CLASSIFIED BOARD
Cognizant's certificate of incorporation was amended to provide for a
classified Board of Directors, also known as a staggered board. The Board of
Directors, other than those directors who may be elected by the holders of
Cognizant's preferred stock, will be divided into three classes of directors
effective as of the first annual meeting of stockholders following the
completion of the exchange offer.
22
Cognizant's directors will be elected to three separate classes at
Cognizant's next annual meeting, as follows:
o two "Class I Directors" will be elected at Cognizant's next annual
meeting to serve for a term expiring at the first annual meeting of
stockholders to be held following that meeting;
o two "Class II Directors" will be elected at Cognizant's next annual
meeting to serve for a term expiring at the second annual meeting of
stockholders to be held following that meeting; and
o two "Class III Directors" will be elected at Cognizant's next annual
meeting to serve for a term expiring at the third annual meeting of
stockholders to be held following that meeting.
At each annual meeting following Cognizant's next annual meeting, only
directors of the class whose term is expiring that year will be required to
stand for election, and upon election each director will serve a three-year
term. Any newly created directorship that results from an increase in the number
of directors and any vacancy occurring in the Board of Directors can be filled
only by a majority of the directors then in office. No change may have the
effect of removing any director from office. Upon any change in the authorized
number of directors, the total number of directors will be allocated as evenly
as possible among the three classes, provided that the term of office may not be
shortened for any incumbent director. Any director elected to fill a vacancy not
resulting from an increase in the number of directors will have the same
remaining term as that of his or her predecessor. Any director elected to fill a
newly created directorship resulting from an increase in the size of any class
will have the same remaining term as the other directors of that class.
Cognizant's certificate of incorporation provides that directors can be
removed only by the affirmative vote of at least 80% in voting power of all
outstanding shares of Cognizant common stock entitled to vote generally in the
election of directors. In addition, following Cognizant's next annual meeting
and the implementation of the classified Board of Directors, directors may be
removed only for cause.
BOARD SIZE
Cognizant's certificate of incorporation was amended to provide that the
number of Cognizant's directors will be not less than three and that the exact
number of directors will be fixed from time to time by a majority of Cognizant's
Board of Directors. The Board of Directors set the number of directors at six,
which was effective immediately following consummation of the exchange offer.
STOCKHOLDERS MAY NOT ACT BY WRITTEN CONSENT
Unless otherwise provided in a company's certificate of incorporation,
Delaware law permits any action required or permitted to be taken by
stockholders of a company at a meeting to be taken without notice, without a
meeting and without a stockholder vote if a written consent setting forth the
action to be taken is signed by the holders of shares of outstanding stock
having the requisite number of votes that would be necessary to authorize the
action at a meeting of stockholders at which all shares entitled to vote were
present and voted. Cognizant's Restated
23
Certificate of Incorporation and Amended and Restated By-laws require that
stockholder action be taken only at an annual or special meeting of
stockholders, and prohibits stockholder action by written consent.
STOCKHOLDERS MAY NOT CALL A SPECIAL MEETING
Upon the consummation of the exchange offer, Cognizant's certificate of
incorporation was amended, and conforming changes were made to Cognizant's
by-laws, to prohibit stockholders from calling a special meeting, to provide
that a special meeting of the stockholders may be called only by the chief
executive officer of Cognizant or Cognizant's Board of Directors, and to require
that business transacted at any special meeting be limited to the purpose stated
in the notice of the meeting.
SUPERMAJORITY APPROVAL REQUIREMENTS
Prior to the exchange offer, in addition to approval by Cognizant's Board
of Directors, the approval of the holders of a majority in voting power of
Cognizant's outstanding shares of stock entitled to vote was required to amend
any provision of Cognizant's certificate of incorporation. Delaware law permits
a company to include provisions in its certificate of incorporation that require
a greater vote than the vote otherwise required by law for any corporate action.
Upon completion of the exchange offer, Cognizant's certificate of incorporation
was amended to require the affirmative vote of the holders of at least 80% in
voting power of the outstanding shares of Cognizant entitled to vote generally
in the election of directors, voting together as a single class, to amend,
alter, change, add to or repeal specified provisions of Cognizant's certificate
of incorporation and any provision of the by-laws. The provisions in Cognizant's
certificate of incorporation affected by this amendment are:
o the provisions concerning the classified board, the size of the board
and the filling of board vacancies and newly created directorships;
o the provision concerning the inability of Cognizant's stockholders to
call special meetings;
o the provision concerning the inability of Cognizant's stockholders to
act by written consent; and
o the provisions concerning the ability of Cognizant's stockholders to
amend, alter, change, add to or repeal the foregoing provisions of the
certificate of incorporation or the by-laws.
This supermajority voting requirement may discourage or deter a person from
attempting to obtain control of Cognizant by making it more difficult to amend
Cognizant's by-laws, whether to eliminate provisions that have an anti-takeover
effect or those that protect the interests of minority stockholders. This
supermajority voting amendment permits a minority of Cognizant's stockholders to
block an attempt by its stockholders to amend or repeal its by-laws.
24
AMENDMENTS TO COGNIZANT'S BY-LAWS
In connection with the exchange offer, Cognizant's Board of Directors also
approved amendments to Cognizant's by-laws, which became effective following
completion of the exchange offer. The material terms of these amendments are
summarized below. For complete information, you should read the full text of the
Amended and Restated By-laws, which has been filed with the SEC as an exhibit to
the Company's Current Report of Form 8-K dated February 13, 2003. The Amended
and Restated By-laws are incorporated by reference into this Annual Report on
Form 10-K.
Cognizant's Amended and Restated By-laws require that, at any annual or
special meeting of stockholders, the only nominations of persons for election to
the Board of Directors and proposals of business to be considered will be the
nominations made or proposals of business brought before the meeting:
o pursuant to Cognizant's notice of meeting;
o by or at the direction of the Board of Directors; and
o by a stockholder of Cognizant who was a stockholder of record of
Cognizant at the time of the delivery of the notice provided for in
the Amended and Restated By-laws, who is entitled to vote at the
meeting and who complies with the notice procedures set forth in the
by-laws.
These amendments may preclude nominations or the conduct of business by
stockholders at a particular stockholders meeting if the proper procedures are
not followed, and may discourage or deter a third party from attempting to
obtain control of Cognizant, even if this attempt might be viewed as beneficial
to Cognizant by its stockholders.
STOCKHOLDERS' RIGHTS PLAN
In connection with the completion of the exchange offer, on March 5, 2003
Cognizant's Board of Directors adopted a stockholders' rights plan. The
stockholders' rights plan did not require stockholder approval.
The stockholders' rights plan provides that holders of Cognizant's
outstanding Class A or Class B common stock will receive, in the form of a
dividend, a right to purchase 1/1000 of a share of a newly created series of
preferred stock, which will be the economic equivalent of one share of
Cognizant's common stock. The rights will become exercisable on the earlier of
(1) the tenth day following the public announcement that a person or group has
acquired beneficial ownership of 15% or more of Cognizant's total voting power
represented by the Class A common stock and Class B common stock and (2) the
tenth business day (or such later date as may be determined by Cognizant's Board
of Directors) following the commencement or announcement of an intention to make
a tender offer or exchange offer pursuant to which a person would acquire more
than 15% of Cognizant's voting power. The rights are redeemable at a price of
$.01 per right, by the vote of Cognizant's Board of Directors, at any time prior
to the
25
time a person acquires more than 15% of the voting power. If any person were to
do so, each holder of a right (other than rights held by the acquiring person,
which would become void) will receive, upon exercise of the right at the
then-current exercise price, shares of Cognizant's common stock having a market
value on that date of twice the exercise price of the right, commonly referred
to as a "flip-in right." If the flip-in right were exercised, the acquiring
person's voting and economic interest in Cognizant would be dramatically diluted
by the issuance by Cognizant of large numbers of its shares of common stock to
its current stockholders other than the acquiring person at a reduced price. If,
after any person acquired shares of Cognizant's outstanding common stock
representing more than 15% of the voting power, Cognizant were acquired in a
business consolidation or 50% or more of its assets or earning power were sold,
each holder of a right (other than rights held by the acquiring person, which
would become void) will receive, upon exercise of the right at the then-current
exercise price, shares of the acquirer having a market value on that date of
twice the exercise price of the right, commonly referred to as a "flip-over
right." This would cause significant dilution to the acquirer's existing
stockholders.
Any person owning in excess of 15% of Cognizant's voting power on the date
of the adoption of the plan or as a result of the exchange offer will not
trigger these rights so long as that person does not acquire additional shares.
EQUITY COMPENSATION PLAN INFORMATION
The following table provides information as of December 31, 2002 with
respect to the shares of the Company's common stock that may be issued under the
Company's existing equity compensation plans.
Number of
Securities to be Weighted Number of
Issued Upon Average Securities Available
Exercise of Exercise Price for Future Issuance
Outstanding of Outstanding Under Equity
Plan Category Options Options Compensation Plans
- --------------------------------------------------------------------------------
Equity compensation
plans that have been
approved by security
holders 3,809,551 $29.01 1,727,431
- --------------------------------------------------------------------------------
In addition, there are 708,605 shares available for issuance under the
Company's Employee Stock Purchase Plan, which is an equity compensation plan
approved by security holders. There are no equity compensation plans that have
not been approved by security holders.
26
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The following table sets forth selected consolidated historical financial
data of the Company as of the dates and for the periods indicated. The selected
consolidated financial data set forth below for the Company as of December 31,
2001 and 2002 and for each of the three years in the period ended December 31,
2002 has been derived from the audited financial statements included elsewhere
herein. The selected consolidated financial data set forth below for the Company
as of December 31, 1998, 1999 and 2000 and for each of the years ended December
31, 1998 and 1999 are derived from the audited financial statements not included
elsewhere herein. The selected consolidated financial information for 2000, 2001
and 2002 should be read in conjunction with the Consolidated Financial
Statements and the Notes and "Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations" which are included elsewhere in
this Annual Report on Form 10-K.
YEAR ENDED DECEMBER 31,
1998 1999 2000 2001 2002
---- ---- ---- ---- ----
(IN THOUSANDS, EXCEPT PER SHARE DATA)
CONSOLIDATED STATEMENT OF OPERATIONS DATA:
Revenues................................... $ 45,031 $ 74,084 $ 122,758 $ 158,969 $ 208,657
Revenues - related party................... 13,575 14,820 14,273 18,809 20,429
--------- --------- --------- ------ ------
Total revenues.......................... 58,606 88,904 137,031 177,778 229,086
Cost of revenues........................... 31,919 46,161 70,437 90,848 122,701
--------- --------- --------- --------- --------
Gross profit............................... 26,687 42,743 66,594 86,930 106,385
Selling, general and administrative
expenses................................ 15,547 23,061 35,959 44,942 53,345
Depreciation and amortization expense...... 2,222 3,037 4,507 6,368 7,842
--------- --------- --------- --------- --------
Income from operations..................... 8,918 16,645 26,128 35,620 45,198
Other income (expense):
Interest income.......................... 638 1,263 2,649 2,501 1,808
Split-off costs.......................... -- -- -- -- (1,680)
Impairment loss on investment............ -- -- -- (1,955) --
Other income (expense) - net............ 83 37 (530) (767) (235)
--------- --------- --------- ---------- --------
Total other income (expense)............ 721 1,300 2,119 (221) (107)
--------- --------- --------- ---------- --------
Income before provision for income taxes... 9,639 17,945 28,247 35,399 45,091
Provision for income taxes................. (3,606) (6,711) (10,564) (13,239) (10,529)
Net income................................. $ 6,033 $ 11,234 $ 17,683 $ 22,160 $ 34,562
======== ========= ========= ========= ========
Net income per share, basic................ $ 0.38 $ 0.61 $ 0.95 $ 1.17 $ 1.75
========= ========= ========= ======== ========
Net income per share, diluted.............. $ 0.37 $ 0.58 $ 0.87 $ 1.09 $ 1.63
========= ========= ========= ======== ========
Weighted average number of common
shares outstanding...................... 15,886 18,342 18,565 19,017 19,747
============ ========= ========= ========= =========
Weighted average number of common
shares and stock options outstanding.... 16,538 19,416 20,256 20,371 21,231
========= ========= ========= ========= =========
CONSOLIDATED STATEMENT OF FINANCIAL POSITION
DATA:
Cash and cash equivalents.................. $ 28,418 $ 42,641 $ 61,976 $ 84,977 $ 126,211
Working capital............................ 29,416 43,507 61,501 95,637 134,347
Total assets............................... 51,679 69,026 109,540 144,983 231,473
Due to related party....................... 9 -- 8 -- --
Stockholders' equity....................... 32,616 45,461 66,116 98,792 165,481
27
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
GENERAL
Cognizant is a leading provider of custom IT design, development,
integration and maintenance services primarily for Fortune 1000 companies
located in the United States and Europe. Cognizant's core competencies include
web-centric applications, data warehousing, component-based development and
legacy and client-server systems. Cognizant provides the IT services it offers
using an integrated on-site/offshore business model. This seamless
onsite/offshore business model combines technical and account management teams
located on-site at the customer location and offshore at dedicated development
centers located in India and Ireland. Cognizant began its IT development and
maintenance services business in early 1994, as an in-house technology
development center for The Dun & Bradstreet Corporation and its operating units.
In 1996, Cognizant, along with certain other entities, was spun-off from the Dun
& Bradstreet Corporation to form a new company, Cognizant Corporation. On June
24, 1998, Cognizant completed its initial public offering. On June 30, 1998, a
majority interest in Cognizant, and certain other entities were spun-off from
Cognizant Corporation to form IMS Health Incorporated ("IMS Health").
Subsequently, Cognizant Corporation was renamed Nielsen Media Research,
Incorporated. At December 31, 2002, IMS Health owned 55.3% of the outstanding
stock of Cognizant (representing all of Cognizant's Class B common stock) and
held 92.5% of the combined voting power of Cognizant's common stock. Holders of
Cognizant's Class A common stock have one vote per share and holders of
Cognizant's Class B common stock have ten votes per share.
On June 30, 2002, the Company acquired the assets of UHCI, a subsidiary of
UnitedHealth Group. UHCI previously provided, and will continue to provide
through CTS Ireland, application development and maintenance services, using the
existing staff of approximately 70 software professionals. This acquisition is
designed to enable the Company to provide a wide range of services to the
Company's clients in Europe and worldwide and represents the initial
implementation of the Company's previously announced international expansion
strategy.
Additionally, on October 29, 2002, the Company completed the transfer of
Silverline Technologies, Inc.'s practice, which serviced a major financial
services company to the Company. Under the terms of the transfer, the Company
will provide application design, development and maintenance services to such
major financial services company through an acquired workforce of approximately
three hundred IT and support professionals located primarily in the United
States and India.
On February 13, 2003, IMS Health distributed all of the Cognizant Class B
common stock that IMS Health owned (a total of 11,290,900 shares) in an exchange
offer to its stockholders. IMS Health distributed 0.309 shares of Cognizant
Class B common stock to its stockholders for every one share of IMS Health's
common stock tendered. There was no impact on the number of Cognizant's total
shares of common stock outstanding as a result of the completion of the exchange
offer. As a direct result of the IMS Health exchange offer Cognizant has
incurred charges in the fourth quarter of 2002 of $1.7 million and expects total
charges
28
aggregating approximately $3.5 million. Such charges primarily relate to direct
and incremental legal, accounting, printing and other costs. In addition, total
estimated charges include approximately $0.5 million of costs related to the
retention and acceleration of Cognizant stock options by two former Directors of
Cognizant who resigned on February 13, 2003 as a result of the split-off. As of
February 21, 2003, pursuant to the Company's Restated Certificate of
Incorporation, all of the shares of Class B common stock converted into shares
of Class A common stock. Accordingly, as of such date, there are no shares of
Class B common stock outstanding.
CRITICAL ACCOUNTING POLICIES, ESTIMATES AND RISKS
Financial Reporting Release No. 60 requires all companies to include a
discussion of critical accounting policies or methods used in the preparation of
financial statements. Note 2 to the Consolidated Financial Statements include a
summary of the significant accounting policies and methods used in the
preparation of the Company's Consolidated Financial Statements. The following is
a brief discussion of the more significant accounting policies and methods used
by the Company.
In addition, Financial Reporting Release No. 61 requires all companies to
include a discussion to address, among other things, liquidity, off-balance
sheet arrangements, contractual obligations and commercial commitments.
The Company's discussion and analysis of its financial condition and
results of operations are based upon its consolidated financial statements,
which have been prepared in accordance with accounting principles generally
accepted in the United States. The preparation of financial statements in
accordance with generally accepted accounting principles in the United States
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities, including the recoverability of tangible and
intangible assets, disclosure of contingent assets and liabilities as of the
date of the financial statements, and the reported amounts of revenues and
expenses during the reported period.
On an on-going basis, the Company evaluates its estimates. The most
significant estimates relate to the allowance for doubtful accounts, reserve for
warranties, reserves for employee benefits, income taxes, depreciation of fixed
assets and long-lived assets, contingencies and litigation and the recognition
of revenue and profits based on the percentage of completion method of
accounting for certain fixed-bid contracts. The Company bases its estimates on
historical experience and on various other assumptions that are believed to be
reasonable under the circumstances, the results of which form the basis for
making judgments about the carrying values of assets and liabilities that are
not readily apparent from other sources. The actual amounts will differ from the
estimates used in the preparation of the accompanying financial statements.
Most of the Company's IT development centers, including a substantial
majority of its employees are located in India. As a result, the Company may be
subject to certain risks associated with international operations, including
risks associated with foreign currency exchange rate fluctuations and risks
associated with the application and imposition of protective legislation and
regulations relating to import and export or otherwise resulting from foreign
29
policy or the variability of foreign economic conditions. To date, the Company
has not engaged in any hedging transactions to mitigate its risks relating to
exchange rate fluctuations. Additional risks associated with international
operations include difficulties in enforcing intellectual property rights, the
burdens of complying with a wide variety of foreign laws, potentially adverse
tax consequences, tariffs, quotas and other barriers.
The Company believes the following critical accounting policies affect its
more significant judgments and estimates used in the preparation of its
consolidated financial statements:
REVENUE RECOGNITION. The Company's services are entered into on either a
time-and-materials or fixed-price basis. Revenues related to time-and-material
contracts are recognized as the service is performed. Revenues related to
fixed-price contracts that provide for application development services or that
provide for a combination of application development and application management
services are recognized as the service is performed using the
percentage-of-completion method of accounting, under which the sales value of
performance is recognized on the basis of the percentage that each contract's
cost to date bears to the total estimated cost. Revenues related to fixed-priced
contracts that provided solely for application management services are
recognized on a straight-line basis or as services are rendered or transactions
processed in accordance with contract terms. Expenses are recorded as incurred
over the contract period.
In November 2002, the Emerging Issues Task Force (EITF) reached a consensus
in EITF 00-21 "Revenue Arrangements with Multiple Deliverables". The consensus,
which is effective for contracts entered into in fiscal periods beginning after
June 15, 2003, requires that a Company evaluate all deliverables in an
arrangement to determine whether they represent separate units of accounting.
That evaluation must be performed at the inception of the arrangement and as
each item in the arrangement is delivered. Arrangement consideration should be
then allocated among the separate units of accounting based on their relative
fair values. EITF 00-21 indicates that the best evidence of fair value is the
price of a deliverable when it is regularly sold on a stand-alone basis. Fair
value evidence often consists of entity-specific or vendor-specific objective
evidence of fair value.
The Company enters into contracts that could be considered arrangements
with multiple deliverables. These contracts are primarily long-term fixed-bid
contracts that provide both application maintenance and application development
services. As indicated above and in Note 2 to the Consolidated Financial
Statements, the Company accounts for such contracts using percentage of
completion accounting. The Company is currently evaluating the prospective
impact of EITF 00-21 on the Company's results of operations related to contracts
entered into after June 15, 2003.
Fixed-price contracts are cancelable subject to a specified notice period.
All services provided by the Company through the date of cancellation are due
and payable under the contract terms. The Company issues invoices related to
fixed price contracts based upon achievement of milestones during a project or
other contractual terms. Differences between the timing of billings, based upon
contract milestones or other contractual terms, and the recognition of revenue,
based upon the percentage-of-completion method of accounting, are recognized as
30
either unbilled or deferred revenue. Estimates are subject to adjustment as a
project progresses to reflect changes in expected completion costs. The
cumulative impact of any revision in estimates is reflected in the financial
reporting period in which the change in estimate becomes known and any
anticipated losses on contracts are recognized immediately. A reserve for
warranty provisions under such contracts, which generally exist for ninety days
past contract completion, is estimated and accrued during the contract period.
Revenues related to services performed without a signed agreement or work
order are not recognized until there is evidence of an arrangement, such as when
agreements or work orders are signed or payment is received; however the cost
related to the performance of such work is recognized in the period the services
are rendered. Such revenue is recognized when, and if, evidence of an
arrangement is obtained.
FOREIGN CURRENCY TRANSLATION. The assets and liabilities of the Company's
Canadian and European subsidiaries are translated into U.S. dollars from local
currencies at current exchange rates and revenues and expenses are translated
from local currencies at average monthly exchange rates. The resulting
translation adjustments are recorded in a separate component of stockholders'
equity. For the Company's Indian subsidiary ("CTS India"), the functional
currency is the U.S. dollar, since its sales are made primarily in the United
States, the sales price is predominantly in U.S. dollars and there is a high
volume of intercompany transactions denominated in U.S. dollars between CTS
India and its U.S. affiliates. Non-monetary assets and liabilities are
translated at historical exchange rates, while monetary assets and liabilities
are translated at current exchange rates. The resulting gain (loss) is included
in other income.
ALLOWANCE FOR DOUBTFUL ACCOUNTS. The Company maintains allowances for
doubtful accounts for estimated losses resulting from the inability of its
customers to make required payments. The allowance for doubtful accounts is
determined by evaluating the relative credit-worthiness of each customer based
upon market capitalization and other information, including the aging of the
receivables. If the financial condition of the Company's customers were to
deteriorate, resulting in an impairment of their ability to make payments,
additional allowances may be required.
INCOME TAXES. The Company records a valuation allowance to reduce its
deferred tax assets to the amount that is more likely than not to be realized.
While the Company has considered future taxable income and on-going prudent and
feasible tax planning strategies in assessing the need for the valuation
allowance, in the event the Company were to determine that it would be able to
realize its deferred tax assets in the future in excess of its net recorded
amount, an adjustment to the deferred tax asset would increase income in the
period such determination was made. Likewise, should the Company determine that
it would not be able to realize all or part of its net deferred tax asset in the
future, an adjustment to the deferred tax asset would be charged to income or
equity (if the deferred tax asset is related to tax benefits from stock option
benefits that have not been realized) in the period such determination was made.
Cognizant's Indian subsidiary, CTS India, is an export-oriented company,
which, under the Indian Income Tax Act of 1961 is entitled to claim tax holidays
for a period of ten years with respect to its export profits. Substantially all
of the earnings of CTS India are attributable to export profits and are
therefore currently entitled to a 90% exemption from Indian income tax.
31
These tax holidays will begin to expire in 2004 and under current law will be
completely phased out by March of 2009. Prior to 2002, it was management's
intent to repatriate all accumulated earnings from India to the United States;
accordingly, Cognizant has provided deferred income taxes in the amount of
approximately $24.9 million on all such undistributed earnings through December
31, 2001. During the first quarter of 2002, Cognizant made a strategic decision
to pursue an international strategy that includes expanded infrastructure
investments in India and geographic expansion in Europe and Asia. As a component
of this strategy, Cognizant intends to use 2002 and future Indian earnings to
expand operations outside of the United States instead of repatriating these
earnings to the United States. Accordingly, effective January 1, 2002, pursuant
to Accounting Principles Bulletin 23, Cognizant will no longer accrue taxes on
the repatriation of earnings recognized in 2002 and subsequent periods as these
earnings are considered to be indefinitely reinvested outside of the United
States. As of December 31, 2002, the amount of unrepatriated earnings upon which
no provision for taxation has been recorded is approximately $30.1 million. If
such earnings are repatriated in the future, or are no longer deemed to be
indefinitely reinvested, Cognizant will accrue the applicable amount of taxes
associated with such earnings. Due to the various methods by which such earnings
could be repatriated in the future, it is not currently practicable to determine
the amount of applicable taxes that would result from such repatriation.
This change in intent, as well as a change in the manner in which
repatriated earnings are taxed in India, resulted in an estimated effective tax
rate for the year ended December 31, 2002 of 23.4%. This rate compares to an
effective tax rate for the year ended December 31, 2001 of 37.4%.
Effective April 1, 2002, the government of India passed various tax law
changes which affected the way in which the Company's earnings are taxed in
India. The tax exemption for export earnings was reduced from 100% to 90%, a
surtax was imposed increasing the effective rate from 35.7% to 36.75% for income
that is subject to tax, and the corporate level tax on the payment of dividends
was replaced with a withholding tax on dividends.
Cognizant's cash requirements could change over time, which could
effectively force it to change its intent on repatriating Indian earnings. If
Cognizant's earnings are intended to be repatriated in the future, or are no
longer reinvested outside the United States, Cognizant will have to accrue the
applicable amount of taxes associated with such earnings and pay taxes at a
substantially higher rate than the effective rate in 2002. These increased taxes
could have a material adverse effect on Cognizant's business, results of
operations and financial condition, as well as cash flows to fund such taxes. In
addition, Cognizant may need to accelerate the payment of significant deferred
taxes, which would have a significant impact on its cash position.
GOODWILL AND OTHER INTANGIBLES. Prior to 2002, goodwill, which related to
the acquisition of the former minority interest in the Company's Indian
subsidiary, was amortized using the straight-line basis over a period of seven
years. Effective January 1, 2002, in accordance with Statement of Financial
Accounting Standards ("SFAS") No. 142 "Goodwill and Other Intangible Assets"
("FAS 142"), the Company is no longer amortizing its remaining goodwill balance;
however, at each balance date, the Company does evaluate goodwill and other
intangible assets for impairment at least annually, or as circumstances warrant.
If such assets were determined to
32
be impaired, it could have a material adverse effect on Cognizant's business,
results of operations and financial condition.
LONG-LIVED ASSETS. In accordance with Statement of Financial Accounting
Standards ("SFAS") No. 144, "Accounting for the Impairment or Disposal of
Long-Lived Assets", which was adopted in 2002, the Company reviews for
impairment long-lived assets and certain identifiable intangibles whenever
events or changes in circumstances indicate that the carrying amount of an asset
may not be recoverable. In general, the Company will recognize an impairment
loss when the sum of undiscounted expected future cash flows is less than the
carrying amount of such assets. The measurement for such an impairment loss is
then based on the fair value of the asset.
RESULTS OF OPERATIONS
The following table sets forth for the periods indicated certain financial
data expressed as a percentage of total revenue:
2000 2001 2002
-------- ------- --------
Total revenues............................... 100.0% 100.0% 100.0%
Cost of revenues............................. 51.4 51.1 53.6
---- ---- ----
Gross profit............................. 48.6 48.9 46.4
Selling, general and administrative expenses. 26.2 25.3 23.3
Depreciation and amortization expense........ 3.3 3.6 3.4
--- --- ---
Income from operations................... 19.1 20.0 19.7
Other income (expense):
Interest income.......................... 1.9 1.4 0.8
Split-off costs.......................... -- -- (0.7)
Impairment loss on Investment............ -- (1.1) --
Other income / (expense)................. (0.4) (0.4) (0.1)
---- ---- ----
Total other income / (expense) .............. 1.5 (0.1) --
--- ---- ----
Income before provision for income taxes..... 20.6 19.9 19.7
Provision for income taxes................... (7.7) (7.4) (4.6)
---- ---- ----
Net income.................................. 12.9% 12.5% 15.1%
======= ======= =======
33
YEAR ENDED DECEMBER 31, 2002 COMPARED TO YEAR ENDED DECEMBER 31, 2001
REVENUE. Revenue increased by 28.9%, or approximately $51.3 million, from
approximately $177.8 million during 2001 to approximately $229.1 million in
2002. This increase resulted primarily from an increase in application
management and application development and integration services. The Company
provides services through time and materials ("T&M") and fixed-bid contracts.
Over the course of the last three years revenues recognized under fixed-bid
contracts have increased as a percent of total revenues from 15.1% in 2000 to
23.9% in 2001 and 24.6% in 2002. This increase is attributable primarily to
increased demand for such services due to the customer's ability to specifically
quantify project costs prior to entering into contracts.
Sales to related parties on a year-over-year basis were 10.6% in 2001
compared to 8.9% in 2002. For statement of operations purposes, revenues from
related parties only include revenues recognized during the period in which the
related party was affiliated with the Company. During 2001 and 2002, no third
party accounted for greater than 10% of revenues.
GROSS PROFIT. The Company's cost of revenues consists primarily of the cost
of salaries, payroll taxes, benefits, immigration and travel for technical
personnel, and the cost of sales commissions related to revenues. The Company's
cost of revenues increased by 35.1%, or approximately $31.9 million, from
approximately $90.8 million during 2001 to approximately $122.7 million in 2002.
The increase was due primarily to the increased cost resulting from the increase
in the number of the Company's technical professionals from approximately 3,470
employees at December 31, 2001 to over 6,100 employees at December 31, 2002. The
increased number of technical professionals is a direct result of greater demand
for the Company's services and on employees acquired through acquisitions. (See
Note 2 to the Consolidated Financial Statements.) The Company's gross profit
increased by 22.4%, or approximately $19.5 million, from approximately $86.9
million during 2001 to approximately $106.4 million during 2002. Gross profit
margin decreased from 48.9% of revenues during 2001 to 46.4% of revenues in
2002. The decrease in such gross profit margin was primarily attributable to
higher incentive compensation costs in 2002 as compared to 2001, due to the
significantly increased performance of the Company.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses consist primarily of salaries, employee benefits,
travel, promotion, communications, management, finance, administrative and
occupancy costs. Selling, general and administrative expenses, including
depreciation and amortization, increased by 19.2%, or approximately $9.9
million, from approximately $51.3 million during 2001 to approximately $61.2
million during 2002, and decreased as a percentage of revenue from approximately
28.9% to 26.7%, respectively. The increase in such expenses in absolute dollars
was due primarily to expenses incurred to expand the Company's sales and
marketing activities and increased infrastructure expenses to support the
Company's growth. The decrease in such expenses as a percentage of revenue was
due primarily to the increased revenues that have resulted from the Company's
expanded sales and marketing activities in the current and prior years.
34
INCOME FROM OPERATIONS. Income from operations increased 26.9%, or
approximately $9.6 million, from approximately $35.6 million during 2001 to
approximately $45.2 million during 2002, representing approximately 20.0% and
19.7% of revenues, respectively. The decrease in operating margin was due
primarily to higher incentive compensation costs in 2002 as compared to 2001.
OTHER INCOME/EXPENSE. Other income/expense consists primarily of interest
income offset, by foreign currency exchange losses and, in 2001, an impairment
loss on an investment, and in 2002, split-off costs related to the exchange
offer in which IMS Health has offered to its stockholders to exchange its
holdings of the Company's Class B common stock for shares of IMS Health.
Interest income decreased by approximately 27.7%, from approximately $2.5
million during 2001 to approximately $1.8 million during 2002. The decrease in
such interest income was attributable primarily to lower interest rates, offset,
in part, by higher operating cash balances. The Company recognized a net foreign
currency exchange loss of approximately $767,000 during 2001 compared to an
exchange loss of approximately $235,000 during 2002, as a result of the effect
of changing exchange rates on the Company's transactions. The Company recognized
an impairment loss on its investment in Questra Corporation ("Questra") of
approximately $2.0 million during the fourth quarter of 2001 in recognition of
an other than temporary decline in value. The impairment loss was based upon an
implied valuation of Questra as a result of a recent new round of venture
capital funding in which the Company's equity interest in Questra was
substantially diluted and investors, other than the Company, received
preferential liquidation rights. The impairment loss, net of tax benefit, was
approximately $1.2 million, or $0.06 per diluted share. (See Note 4 to the
Consolidated Financial Statements). The Company recognized split-off costs of
approximately $1.7 million, or $0.08 per diluted share, in the fourth quarter of
2002 related to the exchange offer and expects total charges aggregating
approximately $3.5 million in relation to one-time costs associated with the
exchange offer. Such charges primarily relate to direct and incremental legal,
accounting, printing and other costs. In addition, total estimated charges
include approximately $0.5 million of costs related to the retention and
acceleration of Cognizant stock options by two former Directors of Cognizant who
resigned on February 13, 2003 as a result of the split-off.
PROVISION FOR INCOME TAXES. The provision for income taxes decreased from
approximately $13.2 million in 2001 to approximately $10.5 million in 2002, with
an effective tax rate of 37.4% in 2001 and 23.4% in 2002. The lower effective
tax rate reflects Cognizant's change in its intention regarding the repatriation
of 2002 and future earnings from its subsidiary in India, as well as a change in
the manner in which repatriated earnings are taxed in India. (See Note 6 to the
Consolidated Financial Statements.)
NET INCOME. Net income increased from approximately $22.2 million in 2001
to approximately $34.6 million in 2002, representing approximately 12.5% and
15.1% as a percentage of revenues, respectively. The higher percentage in 2002
primarily reflects the decrease in the effective tax rate discussed above.
35
RESULTS BY BUSINESS SEGMENT
The Company, operating globally, provides software services for medium and
large businesses. North American operations consist primarily of software
services in the United States and Canada. European operations consist of
software services principally in the United Kingdom. Asian operations consist of
software services principally in India. The Company is managed on a geographic
basis. Accordingly, regional sales managers, sales managers, account managers,
project teams and facilities are segmented geographically and decisions by the
Company's chief operating decision maker regarding the allocation of assets and
assessment of performance are based on such geographic segmentation. In this
regard, revenues are allocated to each geographic area based on the location of
the customer.
North American Segment
REVENUE. Revenue increased by 31.4%, or approximately $47.7 million, from
approximately $151.9 million during 2001 to approximately $199.6 million in
2002. The increase in revenue was attributable primarily to increased market
awareness and acceptance of the on-site/offshore software delivery model, as
well as sales and marketing activities directed at the U.S. market for the
Company's services.
INCOME FROM OPERATIONS. Income from operations increased 29.4%, or
approximately $8.9 million, from approximately $30.4 million during 2001 to
approximately $39.4 million during 2002. The increase in operating income was
attributable primarily to increased revenues and achieving leverage on prior
sales and marketing investments.
European Segment
REVENUE. Revenue increased by 15.1%, or approximately $3.7 million, from
approximately $24.2 million during 2001 to approximately $27.9 million in 2002.
The increase in revenue was attributable to the Company's sales and marketing
activities in the United Kingdom, partially offset by weak demand for the
Company's services elsewhere in Europe.
INCOME FROM OPERATIONS. Income from operations increased 13.2%, or
approximately $0.6 million, from approximately $4.9 million during 2001 to
approximately $5.5 million during 2002. The increase in operating income was
attributable primarily to increased revenues and achieving leverage on prior
sales and marketing investments.
Asian Segment
REVENUE. Revenue was essentially constant from 2001 to 2002 at
approximately $1.6 million in each year.
INCOME FROM OPERATIONS. Income from operations was essentially constant
from 2001 to 2002 at approximately $0.3 million in each year.
36
YEAR ENDED DECEMBER 31, 2001 COMPARED TO YEAR ENDED DECEMBER 31, 2000
REVENUE. Revenue increased by 29.7%, or approximately $40.7 million, from
approximately $137.0 million during 2000 to approximately $177.8 million in
2001. This increase resulted primarily from approximately a $27.7 million
(42.9%) increase in application management and approximately a $13.5 million
(18.8%) increase in application development and integration, partially offset by
an approximately $0.5 million (100.0%) decrease in Year 2000 compliance
services. The Company provides services through T&M and fixed-bid contracts.
Over the course of the last three years fixed-bid contracts have increased as a
percent of revenues from 15.0% in 1999 to 15.1% in 2000 to 23.9% in 2001.
Sales to related parties on a year-over-year basis were relatively stable
at 10.6% in 2001 compared to 10.4% in 2000. For statement of operations
purposes, revenues from related parties only include revenues recognized during
the period in which the related party was affiliated with the Company. During
2001 and 2000, no third party accounted for greater than 10% of revenues.
GROSS PROFIT. The Company's cost of revenues consists primarily of the cost
of salaries, payroll taxes, benefits, immigration and travel for technical
personnel, and the cost of sales commissions related to revenues. The Company's
cost of revenues increased by 29.0%, or approximately $20.4 million, from
approximately $70.4 million during 2000 to approximately $90.8 million in 2001.
The increase was due primarily to the increased cost resulting from the increase
in the number of the Company's technical professionals from approximately 2,800
employees at December 31, 2000 to approximately 3,470 employees at December 31,
2001. The increased number of technical professionals is a direct result of
greater demand for the Company's services. The Company's gross profit increased
by 30.5%, or approximately $20.3 million, from approximately $66.6 million
during 2000 to approximately $86.9 during 2001. Gross profit margin increased
from 48.6% of revenues during 2000 to 48.9% of revenues in 2001. The increase in
such gross profit margin was primarily attributable to a continued shift toward
higher margin fixed-bid contracts and a lower incentive compensation accrual in
2001 as compared to 2000.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses consist primarily of salaries, employee benefits,
travel, promotion, communications, management, finance, administrative and
occupancy costs. Selling, general and administrative expenses, including
depreciation and amortization, increased by 26.8%, or approximately $10.8
million, from approximately $40.5 million during 2000 to approximately $51.3
million during 2001, and decreased as a percentage of revenue from approximately
29.5% to 28.9%, respectively. The increase in such expenses in absolute dollars
was due primarily to expenses incurred to expand the Company's sales and
marketing activities and increased infrastructure expenses to support the
Company's growth. The decrease in such expenses as a percentage of revenue was
primarily due to the increased revenues that have resulted from the Company's
expanded sales and marketing activities in the current and prior years.
INCOME FROM OPERATIONS. Income from operations increased 36.3%, or
approximately $9.5 million, from approximately $26.1 million during 2000 to
approximately $35.6 million during 2001, representing approximately 19.1% and
20.0% of revenues, respectively. The
37
increase in operating margin was primarily due to a continued shift toward
higher margin fixed bid contracts and a lower incentive compensation accrual in
2001 as compared to 2000.
OTHER INCOME/EXPENSE. Other income/expense consists primarily of interest
income offset, by foreign currency exchange losses and, in 2001, an impairment
loss on an investment. Interest income decreased by approximately 5.6%, from
approximately $2.6 million during 2000 to appr